<PAGE>
LOGO
PROXY STATEMENT
FOR THE 1998 ANNUAL MEETING
AND FORM 10-K
1997
<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[ X ]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-06590
LOGO
COX COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 58-2112281
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1400 LAKE HEARN DRIVE, ATLANTA, 30319
GEORGIA
(Address of principal executive (Zip Code)
offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (404) 843-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Class A Common Stock, $1.00 par value
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO
SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [_]
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENTS TO
THIS FORM 10-K. [X]
AS OF MARCH 10, 1998, THE AGGREGATE MARKET VALUE OF THE CLASS A COMMON STOCK
HELD BY NON-AFFILIATES OF THE REGISTRANT WAS $2,651,419,494 BASED ON THE
CLOSING PRICE ON THE NEW YORK STOCK EXCHANGE ON SUCH DATE.
THERE WERE 257,452,514 SHARES OF CLASS A COMMON STOCK OUTSTANDING AS OF MARCH
10, 1998.
THERE WERE 13,798,896 SHARES OF CLASS C COMMON STOCK OUTSTANDING AS OF MARCH
10, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 1997 Annual Report to Stockholders are incorporated by
reference into Part II. Portions of the Proxy Statement for the 1998 Annual
Meeting of Stockholders are incorporated by reference into Part III.
<PAGE>
COX COMMUNICATIONS, INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 31
Item 3. Legal Proceedings.............................................. 32
Item 4. Submission of Matters to a Vote of Security Holders............ 32
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 32
Item 6. Selected Financial Data........................................ 33
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 34
Item 7a. Quantitative and Qualitative Disclosure about Market Risk...... 42
Item 8. Financial Statements and Supplementary Data.................... 43
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 71
PART III
Item 10. Directors and Executive Officers of the Registrant............. 71
Item 11. Executive Compensation......................................... 71
Item 12. Security Ownership of Certain Beneficial Owners and Management. 71
Item 13. Certain Relationships and Related Transactions................. 71
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-
K.............................................................. 71
SIGNATURES............................................................... 75
</TABLE>
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PART I
ITEM 1. BUSINESS
Cox Communications, Inc. ("Cox") is among the nation's largest broadband
communications companies with (i) U.S broadband network operations and (ii)
investments in cable television programming, telecommunications and technology
and broadband networks.
Cox is an indirect 75.0% owned subsidiary of Cox Enterprises, Inc. ("CEI").
CEI, a privately-held corporation headquartered in Atlanta, Georgia, is one of
the largest media companies in the United States with consolidated revenues in
1997 of approximately $4.9 billion. CEI, which has an 100-year history in the
media and communications industry, publishes 16 daily newspapers and owns or
operates 11 television stations in addition to its interest in Cox. Through
its indirect majority-owned subsidiary, Cox Radio, Inc., CEI owns or operates
54 radio broadcast stations pending closing of previously announced
transactions. Through Manheim Auctions, CEI is also the world's largest
operator of auto auctions.
Cox's business strategy includes the development of new and advanced
communications services for its customers by capitalizing on its highly
clustered cable television systems, its industry leading position in upgrading
the technological capabilities of its broadband networks, and its commitment
to customer service. Cox believes that an integrated package of existing
multichannel video, new services such as digital video, high-speed Internet
access and local and long-distance telephone, and commercial competitive local
exchange carrier operations, will enhance its ability to acquire and retain
customers while increasing revenues per customer.
In addition, Cox has sought to utilize its expertise and position as one of
the nation's premier cable television companies to invest in programming,
telecommunications and technology companies which are complementary to Cox's
business strategy. Cox believes that these investments have contributed
substantially to the growth of its core broadband communications business and
that its leadership position in broadband communications has facilitated the
growth of these investments. Cox seeks to utilize insights gained from the
integrated operations of its cable television systems and related programming,
telecommunications and technology investments to continue its leadership in
the broadband communications industry by anticipating and capitalizing upon
long-term industry trends.
U.S. BROADBAND NETWORKS
BUSINESS STRATEGY
Cox's strategy for its U.S. broadband network is to capitalize on the
capabilities of its advanced broadband platform and the strength of its
current cable television business to provide its residential and commercial
customers with an integrated package of existing multichannel video and new
services, including digital video, high-speed Internet access and local and
long distance telephone services. Cox believes that the long-term competitive
advantages of clustering, its aggressive investment in the technological
capabilities of its broadband network and its commitment to customer service
will enhance Cox's ability to continue to grow its core cable television
operations and offer this package of new services to existing and new
customers.
CLUSTERING. As an integral part of its broadband communications strategy,
Cox has continually sought the advantages and efficiencies of operating large
cable television clusters. As of December 31, 1997, approximately 85% of Cox's
customers were served by Cox's nine largest clusters which averaged over
300,000 customers each. See "--Cable Television Business--Operating Data."
Large cable television clusters enable Cox to reduce expenses through the
consolidation of marketing and support functions and to place more experienced
management teams at the system level who are better equipped to meet the new
regulatory and competitive challenges of today's telecommunications industry.
Large operating clusters will also increase the speed and effectiveness of
Cox's new product and services deployment, enhancing its ability to increase
both customers and revenues.
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Cox has and will continue to make strategic acquisitions of contiguous cable
television systems to create and expand large clusters, while disposing of
cable operations in non-strategic regions. In the past year, Cox has made the
following acquisitions and exchanges of cable television systems:
In January 1997, Cox and Tele-Communications, Inc. ("TCI") exchanged certain
cable television systems with the result that Cox increased the size of its
existing clusters in Hampton Roads, Phoenix, New Orleans, Rhode Island, and
Omaha and disposed of several non-strategic cable television systems. Cox and
TCI each exchanged more than 300,000 customers.
In January 1997, Cox exchanged its western Massachusetts and Weymouth,
Massachusetts cable television systems serving approximately 48,000 customers
for the MediaOne of Delaware, Inc., formally Continental Cablevision, Inc.,
("MediaOne") James City and York County, Virginia and Pawtucket, Rhode Island
systems serving approximately 49,000 customers. This exchange resulted in an
increase to the size of Cox's existing clusters in Hampton Roads and New
England.
In March 1997, Cox exchanged its Myrtle Beach, South Carolina cable
television system serving approximately 42,200 customers for Time Warner
Entertainment Company L.P.'s ("Time Warner") Hampton and Williamsburg,
Virginia systems serving approximately 45,300 customers. This transaction also
included a Texas cable television system serving approximately 7,000 customers
which was purchased by Cox and immediately traded to Time Warner. This
exchange increased the size of Cox's existing cluster in Hampton Roads.
In December 1997, Cox exchanged its Lafayette, Indiana cable television
system serving approximately 38,000 customers for a suburban Phoenix cable
system serving approximately 36,000 customers. This exchange increased the
size of Cox's existing cluster in Phoenix.
TECHNOLOGY AND CAPITAL IMPROVEMENTS. Cox emphasizes high technical standards
for its cable television clusters. Cox continues to deploy fiber optic cable
and to upgrade the technical quality of its hybrid fiber-coaxial ("HFC")
broadband network. The result is a significant increase in network capacity,
quality and reliability, facilitating the delivery of additional programming
and services such as digital video, high-speed Internet access and local and
long-distance telephone services. Cox's aggressive investment in its broadband
network upgrade will allow it to offer these services more quickly.
Cox strives to maintain the highest technological standards in the industry.
Cox's U.S. cable television systems have bandwidth capacities ranging from
400 MHz to 750 MHz, which permits carriage of 54 to 112 analog channels. At the
end of 1997, approximately 68% of Cox's network had bandwidth capacity of
550 MHz or 750 MHz. Cox anticipates that approximately 82% of its network will
have bandwidth capacity of 550 MHz or 750 MHz by the end of 1998. In Cox's
nine largest systems, by the end of 1998, Cox anticipates that approximately
67% of its customers will have access to 750 MHz capacity and approximately
2.5 million customers will be able to receive two-way services.
In addition to increasing channel capacity, Cox's aggressive investment in
technology has improved the reliability of its service. Cox's HFC broadband
networks had a 99.991% reliability rate in 1997, as measured by average
customer minutes of outage per year, which exceeds the BellCore standard of
99.989% utilized by the RBOCs. Cox's fiber optic network design of ring-in-
ring architecture provides significant improvements over existing non-ring
network architecture in capability, flexibility, and reliability, without
creating additional cost.
CUSTOMER AND COMMUNITY SERVICE. Strong customer service is a key element of
Cox's business strategy to deliver new advanced communications services for
its customers. Cox has always been committed to customer service and has been
recognized by several industry groups as a leader in providing quality
customer service. In 1996, Cox was distinguished by J.D. Power & Associates
for achieving highest overall customer satisfaction among cable television
users in the first study on the cable industry. Cox systems have won the
"Customer is Key Award" nine times, more than all other cable companies
combined. The award is presented by CTAM, the
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marketing society of the cable and telecommunications industries, to recognize
outstanding customer service. Cox anticipates that its high level of customer
satisfaction will help it compete more effectively as it has begun delivering
new services such as digital video, high-speed Internet access and local and
long-distance telephone. Cox places special emphasis on training its customer
contact employees and has developed customer service standards and programs
that exceed national customer service standards developed by the National
Cable Television Association ("NCTA") and the Federal Communications
Commission ("FCC").
A key element of Cox's community service is enhancing education through the
use of cable technology and programming. Cox currently participates in four
education initiatives. First, Cox participates in a national initiative, "Cox
Cable in the Classroom", which provides schools with free basic cable service
and more than 540 hours of commercial-free educational television programming
each month. Second, Cox is participating in the NCTA nationwide initiative
called "Cable's High Speed Connection," branded "Cox Line to Learning"
program, in which major cable companies are providing high-speed Internet
access, free of charge, to each accredited public and private school in their
respective communities where digital services are available. Third, Cox has
established Cox Model Technology Schools in Chula Vista, California, Omaha,
Nebraska, Norfolk, Virginia, and Warwick, Rhode Island where it is testing
future broadband services, such as interactive fiber optic links to local
colleges, to determine their value in the classroom. Additionally, Cox has
established The Multimedia Academy to train educators, students, parents, and
community leaders about the use of multimedia technology as an educational
tool.
ALTERNATIVE REVENUE SOURCES. Implementation of Cox's business strategy will
allow Cox to develop revenue sources ancillary to its core cable television,
telephony and high-speed Internet access businesses. In recent years, Cox has
increasingly generated revenues from additional sources such as advertising,
pay-per-view and home shopping.
Cox derives revenues from the sale of advertising time on satellite-
delivered networks such as ESPN, MTV and CNN. Currently, Cox inserts
advertising on approximately 15 channels in each of its cable television
systems. Local cable television advertising is often more effective and less
expensive than alternative local advertising sources. As such, Cox expects
continued growth in this revenue source. In addition, Cox participates in the
national and regional cable television advertising market through its
investment in National Cable Communications, L.P. ("NCC"), a partnership which
represents cable television companies to advertisers. NCC is the largest
representation firm in spot cable advertising sales.
CABLE TELEVISION BUSINESS
Cox's domestic cable television operations represent the core element of its
integrated broadband communications strategy. Cox owns and operates cable
television systems organized into 16 locally managed clusters in 14 states.
These clusters pass approximately 5.0 million homes and provide service to
approximately 3.2 million customers. Cox's U.S. cable television systems are
diversified geographically and are not dependent on the economic viability of
any one particular region.
Cox's U.S. cable television systems offer customers packages of basic and
cable programming services consisting of television signals available off-air,
a limited number of television signals from so-called "superstations,"
numerous satellite-delivered non-broadcast channels (such as Cable News
Network, MTV: Music Television, USA Network, ESPN, Arts and Entertainment
Channel, The Discovery Channel, The Learning Channel, Turner Network
Television and Nickelodeon), displays of information featuring news, weather,
stock and financial market reports and public, governmental and educational
access channels. In some systems, some of these satellite-delivered non-
broadcast services are offered at a per channel charge or are packaged
together to form a tier of services offered at a discount from the combined
per channel rate. Cox's cable television systems also provide premium
television services to their customers for an extra monthly charge. Such
services (including Home Box Office, Showtime and Cinemax) are satellite-
delivered channels that consist principally of feature motion pictures
presented without commercial interruption, sports events, concerts and other
entertainment programming. Customers generally pay initial connection charges
and fixed monthly fees for cable programming and premium television services,
which constitute the principal sources of revenues to Cox.
5
<PAGE>
OPERATING DATA. The following table indicates the growth of Cox's cable
television systems by summarizing the number of homes passed by cable, basic
customers, premium service units and penetration levels as of December 31 for
each of the five years set forth below:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Homes passed (a)........ 5,023,870 5,016,749 5,005,858 2,878,857 2,838,197
Basic customers (b)..... 3,235,338 3,259,384 3,248,759 1,851,726 1,784,337
Basic penetration (c)... 64.4% 65.0% 64.9% 64.3% 62.9%
Premium service units
(d).................... 1,865,184 2,000,673 1,827,068 1,203,606 1,205,587
Premium penetration (e). 57.7% 61.4% 56.2% 65.0% 67.6%
</TABLE>
- --------
(a) A home is deemed to be "passed" if it can be connected to the distribution
system without any further extension of the distribution plant.
(b) A home with one or more television sets connected to a cable television
system is counted as one basic service customer.
(c) Basic customers as a percentage of homes passed by cable.
(d) Premium service units include single or multi-channel services offered for
a monthly fee per service.
(e) Premium service units as a percentage of basic customers. A basic service
customer may purchase more than one premium service, each of which is
counted as a separate premium service unit.
The following table is a summary of certain operating data as of December
31, 1997 for Cox's U.S. cable television clusters:
<TABLE>
<CAPTION>
HOMES BASIC
PASSED CUSTOMERS
--------- ---------
<S> <C> <C>
TOP NINE CLUSTERS:
Phoenix, AZ................................................ 1,061,531 577,862
San Diego, CA.............................................. 701,346 482,086
New England................................................ 610,194 420,396
Hampton Roads, VA.......................................... 593,739 392,008
New Orleans, LA............................................ 455,073 272,931
Orange County, CA.......................................... 324,354 247,267
Omaha, NE.................................................. 246,830 151,345
Pensacola/Ft. Walton Beach, FL (a)......................... 200,368 148,704
Oklahoma City, OK.......................................... 204,449 120,320
--------- ---------
Subtotal Top Nine......................................... 4,397,884 2,812,919
OTHER SYSTEMS:
Central Coast California................................... 131,037 91,375
Gainesville/Ocala, FL...................................... 118,784 87,305
West Texas................................................. 134,177 78,516
Middle Georgia............................................. 105,353 72,368
Cleveland, OH.............................................. 98,664 71,917
Roanoke, VA................................................ 78,629 57,576
Humboldt, CA............................................... 43,495 31,948
--------- ---------
Subtotal Other Systems.................................... 710,139 491,005
--------- ---------
TOTAL (INCLUDING FT. WALTON BEACH) (A)...................... 5,108,023 3,303,924
========= =========
TOTAL....................................................... 5,023,870 3,235,338
========= =========
</TABLE>
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(a) Includes the Ft. Walton Beach, FL system which is managed as part of Cox's
Pensacola cluster. The system is 50% owned by Cox through a partnership
with Time Warner. This partnership also owns a system in Staten Island, NY
which is managed by Time Warner.
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FRANCHISES. Cable television systems are constructed and operated under non-
exclusive franchises granted by local governmental authorities. These
franchises typically contain many conditions, such as time limitations on
commencement and completion of system construction, service standards
including number of channels, types of programming and the provision of free
service to schools and certain other public institutions, and the maintenance
of insurance and indemnity bonds. The provisions of local franchises are
subject to federal regulation under the Cable Communications Policy Act of
1984 (the "1984 Cable Act"), as amended by the Cable Television Consumer
Protection and Competition Act of 1992 (the "1992 Cable Act") and the
Telecommunications Act of 1996 (the "1996 Act").
As of March 1998, Cox held 171 franchises. These franchises provide for the
payment of fees to the issuing authority. The 1984 Cable Act prohibits
franchising authorities from imposing annual franchise fees in excess of 5% of
gross revenues and also permits the cable television system operator to seek
renegotiation and modification of franchise requirements if warranted by
changed circumstances. For each of 1997 and 1996, franchise fee payments made
by Cox averaged approximately 4% of gross revenues.
Cox has never had a franchise revoked. The 1984 Cable Act provides for an
orderly franchise renewal process, and it establishes comprehensive renewal
procedures which require that an incumbent franchisee's renewal application be
assessed on its own merit and not as part of a comparative process with
competing applications. A franchising authority may not unreasonably withhold
the renewal of a franchise. If a franchise renewal is denied and the system is
acquired by the franchise authority or a third party, then the franchise
authority must pay the operator the "fair market value" for the system covered
by the franchise, but with no value allocated to the franchise itself. Cox
believes that it has satisfactory relationships with its franchising
authorities.
PROGRAMMING SUPPLIERS. Cox has various contracts to obtain basic and premium
programming from program suppliers whose compensation is typically based on a
fixed fee per customer or a percentage of Cox's gross receipts for the
particular service. Some program suppliers provide volume discount pricing
structures or offer marketing support to Cox. Cox's programming contracts are
generally for a fixed period of time and are subject to negotiated renewal.
Cox's programming costs have increased in recent years and are expected to
continue to increase due to additional programming being provided to Cox's
customers, increased costs to produce or purchase programming, inflationary
increases and other factors. Increases in the cost of programming services
have been offset in part by additional volume discounts as a result of the
growth of Cox and its success in selling such services to its customers. Cox
believes that it will continue to have access to programming services at
reasonable cost levels.
DIGITAL TELEVISION
Digital compression technology currently allows up to 12 digital channels to
be inserted into the space of only one traditional analog channel. Digital
compression will enable Cox to increase the channel capacity of its cable
television systems by approximately 200 channels. Cox believes that the cable
television system upgrades, along with the distribution of digital compression
technology, will provide its customers with greater programming diversity,
better picture quality, improved reliability, and enhanced customer service.
In October 1997, Cox introduced "Cox Digital TV" in Orange County, California
and Cox anticipates that it will be launched in several of the other top nine
clusters during 1998. A Cox Digital TV customer can currently receive up to
200 channels including enhanced pay-per-view service, digital music channels,
new networks grouped by genre and an interactive program guide.
HIGH-SPEED INTERNET ACCESS
The use of computers, online services and the Internet has increased
significantly over the last few years. Cox believes in the revenue
opportunities of Internet related services and is taking advantage of these
opportunities by developing and providing high-speed Internet access and work-
at-home services to residential and commercial customers. In December 1996,
Cox launched high-speed Internet access, offered as
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"Cox@Home," in Orange County, California and introduced the service in five
additional markets in 1997. Cox@Home delivers access to the Internet at speeds
up to 100 times faster than traditional phone modems and provides unique
online content that capitalizes on the immense capacity of Cox's broadband
network. In 1997, Cox launched "Cox@Work" to provide high-speed Internet
access and work-at-home services to businesses. To enhance Cox's entry into
the cable based high-speed Internet access market, in August 1996 Cox acquired
an interest in At Home Corporation. See "--Investments--Telecommunications and
Technology Investments--@Home." Below is a summary of Cox@Home operating
statistics as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1997 1996
------- ------
<S> <C> <C>
Markets Launched........................................... 6 1
"Data Ready" Homes Passed.................................. 954,271 70,909
Customers.................................................. 15,296 134
Penetration................................................ 1.6% 0.2%
</TABLE>
LOCAL AND LONG DISTANCE TELEPHONY
Cox utilizes the capacity and reliability of its advanced broadband network,
which will pass virtually all homes and most businesses in its markets, by
providing local telephone services and reselling long distance services. Cox
can thereby access a portion of a revenue market as large as $180 billion for
telephony services. In 1996, Cox began offering phone service, along with
cable television and high-speed Internet access services, to residents of a
large apartment complex. In 1997, "Cox Digital Telephone" was introduced to
residential customers in Orange County, California and Omaha, Nebraska. During
1998, Cox will launch Cox Digital Telephone in additional markets.
COMMERCIAL CLEC OPERATION
Cox delivers telecommunications services to businesses through its
competitive local exchange carrier ("CLEC") operation. Through its dedicated
fiber optic networks, Cox's CLEC operation provides business customers video,
telephony and high-speed Internet access services. Below is a summary of Cox's
CLEC operation as of December 1997 and 1996:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- -------
<S> <C> <C>
Cities in Operation....................................... 4 3
Buildings Connected On-Net................................ 433 313
Fiber Route Miles......................................... 2,889 2,652
Circuit Switches Installed................................ 7 --
Network ATM Switches Installed............................ 35 8
Voice Grade Equivalent Circuits........................... 251,086 176,512
</TABLE>
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INVESTMENTS
CABLE TELEVISION PROGRAMMING INVESTMENTS
Cox has made substantial investments in cable television networks as a means
of generating additional interest among consumers in cable television. A
summary of Cox's significant programming investments as of December 31, 1997
is set forth below:
<TABLE>
<CAPTION>
COX
PERCENTAGE
OWNERSHIP
INVESTMENT DESCRIPTION INTEREST
---------- ----------- ----------
<C> <S> <C>
Speedvision Network................. Automotive, marine and 51.4%
aviation-related programming
GEMS Television..................... Spanish-language service 50.0
targeted at women
Outdoor Life Network................ Outdoor recreation-related 49.3
programming
Product Information Network......... Infomercial distribution 45.0
Discovery Communications, Inc....... Owns Discovery Channel, 24.6
Learning Channel, Animal
Planet Network, retail and
other ancillary businesses
PPVN, Inc........................... Pay-per-view programming, 20.0
including Viewer's Choice
Digital Cable Radio Associates...... Digital audio services, 13.6
including Music Choice
Flextech plc........................ Cable and satellite 12.6
programming based in the
U.K.
European Channel Management Limited. News and entertainment 10.0
programming in Europe,
including BBC Europe and BBC
Prime
The Sunshine Network Inc............ Sports, public affairs and 5.3
general entertainment
</TABLE>
SPEEDVISION NETWORK AND OUTDOOR LIFE NETWORK. In October 1995, Cox acquired
a 39% interest in the Speedvision Network ("Speedvision") and a 41% interest
in the Outdoor Life Network ("Outdoor Life"), two new U.S. programming
services. Speedvision's programming consists of a broad variety of material
for automobile, boat and airplane enthusiasts; Outdoor Life's programming
consists primarily of outdoor recreation, adventure and wildlife themes. Cox's
interest in Speedvision and Outdoor Life was increased to 51.4% and 49.3% as
of December 31, 1997, respectively. Cox's interest is expected to be reduced
below 50% as a result of a third party investment.
GEMS TELEVISION. In June 1994, Cox entered into an equal partnership with
International Television, Inc. ("ITI"), a subsidiary of Empresas 1-BC,
Venezuela's largest media company. Prior to the formation of the partnership,
ITI had licensed and broadcast Spanish-language television programming under
the name of GEMS Television. The Cox-ITI partnership will continue the
existing business of GEMS Television and expand into additional markets in the
United States, South America and other Spanish or Portuguese-speaking regions.
The programming of GEMS Television is produced in Venezuela, consists largely
of telenovelas (soap operas) and is targeted primarily to women in Latin
America and to Spanish-speaking women in the United States.
PRODUCT INFORMATION NETWORK. Cox and Jones International Ltd. formed a joint
venture known as the Product Information Network ("PIN"). PIN was organized to
develop a network for the distribution of multiple direct response television
commercials, or "infomercials," through cable television systems and other
television programming outlets. In January 1996, Adelphia Communications
purchased an interest in PIN, reducing Cox's interest to 45%.
DISCOVERY COMMUNICATIONS, INC. The principal businesses of Discovery
Communications, Inc. ("Discovery") are the advertiser-supported basic cable
networks The Discovery Channel, The Learning Channel, Animal Planet Network
and Discovery Europe and its retail division consisting primarily of 113
stores of The Nature Company. The Discovery Channel provides nature, science
and technology, history, exploration and adventure programming and is
distributed to customers in virtually all U.S. cable homes. The Learning
Channel broadcasts a variety of educational and non-fiction programming. In
addition, through internally generated funding, significant investments are
being made by Discovery in building a documentary programming library. The
Learning Channel has increased distribution from fewer than 14 million cable
homes prior to its acquisition
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by Discovery in 1991 to over 61 million homes as of December 31, 1997. Cox
holds a 24.6% interest in Discovery, with TCI, NewChannels Corp.
("NewChannels") and Discovery's management holding interests of 49.3%, 24.6%
and 1.4%, respectively.
The following table sets forth certain financial and subscriber data
relating to Discovery, The Discovery Channel and The Learning Channel:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
DISCOVERY
Revenues (millions of dollars)......................... $859.8 $661.8 $447.2
Growth................................................. 29.9% 47.8% 35.7%
THE DISCOVERY CHANNEL
Subscribers (millions)................................. 72.6 70.6 66.5
Growth................................................. 2.8% 6.2% 8.1%
Nielsen Rating--Avg.................................... 0.64 0.61 0.63
THE LEARNING CHANNEL
Subscribers (millions)................................. 61.7 53.9 43.2
Growth................................................. 14.5% 24.8% 37.1%
Nielsen Rating--Avg.................................... 0.46 0.38 0.35
</TABLE>
PPVN, INC. PPVN, Inc. ("PPVN"), which operates under the brand-name Viewer's
Choice, is a cable operator-controlled buying cooperative for pay-per-view
programming. Cox holds a 20% interest in PPVN, with the remaining equity
interests held in varying proportions by Time Warner, TCI, Comcast Corporation
("Comcast"), MediaOne, Viacom International Inc. and Walt Disney Pictures and
Television.
DIGITAL CABLE RADIO ASSOCIATES. Digital Cable Radio Associates distributes
audio programming, under the brand name Music Choice, in a digital format via
coaxial cable to more than one million customers in the United States. This
service allows cable television customers to receive compact disc quality
sound in diverse music formats. Cox currently holds a 13.6% interest, with the
remaining interests held in varying proportions by Jerrold Communications,
Sony Music Entertainment, Inc., MediaOne, Comcast, Time Warner, Adelphia
Communications and EMI Music.
FLEXTECH PLC. In April 1997, Cox exchanged its 37.9% interest in UK Gold and
49.6% interest in UK Living for 20,701,084 shares, or a 12.6% interest, in
Flextech plc, a United Kingdom publicly held programming company.
EUROPEAN CHANNEL MANAGEMENT LIMITED. In January 1995, Cox invested in an
international programming joint venture in Europe. Cox is a 10% partner in
European Channel Management Limited which delivers BBC World, a 24-hour news
channel, and BBC Prime, an entertainment channel, to European subscribers
outside the United Kingdom. The ventures' other partners are the BBC and
Pearson plc.
E! ENTERTAINMENT TELEVISION. E! Entertainment Television, Inc. is an
entertainment-related news service which seeks to build value based on
international interest in Hollywood and entertainment industry news,
information and features. In December 1997, Cox sold its 10.4% interest in E!
Entertainment to Comcast/The Walt Disney Company for $57 million, resulting in
a pre-tax gain of $44.9 million.
10
<PAGE>
TELECOMMUNICATIONS AND TECHNOLOGY INVESTMENTS
Cox has made substantial investments in telecommunications and technology. A
summary of Cox's significant telecommunications and technology investments as
of December 31, 1997 is set forth below:
<TABLE>
<CAPTION>
COX
PERCENTAGE
OWNERSHIP
INVESTMENT DESCRIPTION INTEREST
---------- ----------- ----------
<C> <S> <C>
Cox Communications PCS, L.P......... Operation of the PCS system 40.0%
in the Los Angeles-San Diego
MTA
Teleport Communications Group Inc... Competitive local exchange 22.4
carrier
PhillieCo, L.P...................... Operation of the PCS system 17.6
in the Philadelphia MTA
Sprint Spectrum, L.P................ Wireless communications 15.0
business, primarily PCS
National Cable Communications, L.P.. Cable television advertising 12.5
sales
@Home............................... National Internet services 12.3
PrimeStar Partners, L.P............. DBS services 10.4
</TABLE>
COX COMMUNICATIONS PCS, L.P. In 1995, Cox was awarded a broadband personal
communications service ("PCS") license for the Los Angeles-San Diego Major
Trading Area ("MTA") under the FCC's pioneer preference program. The Los
Angeles-San Diego market has a total population of over 22 million and
includes most of southern California, southern Nevada and a small portion of
Arizona.
Cox and CEI, through subsidiaries, have formed a partnership, Cox Pioneer
Partnership ("CPP"), to own the two companies' joint interest in a PCS system
in the Los Angeles-San Diego MTA. CPP is owned approximately 78% by Cox and
approximately 22% by CEI. Cox and CEI have made and will make capital
contributions to CPP in proportion to their percentage interests. In December
1996, pursuant to previous agreements, CPP and Sprint Spectrum Holding
Company, L.P. (a partnership of Cox, TCI, Comcast and Sprint Corporation
("Sprint")) formed Cox Communications PCS, L.P. ("Cox PCS") to operate the PCS
system in the Los Angeles-San Diego MTA. Cox PCS is currently owned 49% by
Sprint Spectrum Holding Company, L.P. as limited partner and 51% by CPP as
general partner. In March 1997, upon approval from the FCC, Cox transferred
the PCS license for the Los Angeles-San Diego MTA to Cox PCS and Cox PCS
assumed the related license payment obligation to the FCC of $251.9 million.
The December 1996 formation of Cox PCS and the March 1997 transfer of the
license and obligation resulted in Cox recording $36.5 million as a capital
contribution from CEI.
In February 1998, CPP exercised its right under the Cox PCS partnership
agreement to sell a portion of its interest in Cox PCS to Sprint Spectrum
Holding Company, L.P. Upon the consummation of this sale, which will occur
following the receipt of required regulatory approvals, Cox PCS will be owned
59.2% by Sprint Spectrum Holding Company, L.P. as general partner and limited
partner and 40.8% by CPP as general partner. The net proceeds of the sale will
be allocated between Cox and CEI in accordance with the partnership agreement
of CPP.
In addition, Cox PCS agreed to affiliate its PCS system with the Sprint PCS
nationwide network and use the "Sprint PCS" trademark. As of December 31,
1997, Cox PCS had launched service in San Diego, Orange County and Los
Angeles, California under the "Sprint PCS" trademark.
TELEPORT COMMUNICATIONS GROUP INC. Prior to June 1996, Cox held a 30.06%
interest in each of Teleport Communications Group Inc. ("TCGI") and TCG
Partners ("TCGP"), which both owned and operated fiber optic networks serving
several U.S. markets and provide point-to-point digital communications links
to telecommunications businesses and long-distance carriers. In June 1996,
TCGI entered into a reorganization under which, among other things, TCGI's
four stockholders, Cox, Comcast, MediaOne and TCI (collectively, the "Cable
Stockholders") contributed to TCGI all of their partnership interests in TCGP,
additional interests in local joint ventures and debt and accrued interest
owed by TCGI to the Cable Stockholders (the "Reorganization"). Following the
Reorganization, TCGI conducted an initial public offering in which it
11
<PAGE>
sold 27,025,000 shares of its Class A Common Stock (the "TCGI IPO"). MediaOne
sold its equity interest in TCGI through several transactions culminating in a
secondary offering in November 1997. Cox owns 39,087,594 shares of TCGI's
Class B Common Stock which, as of December 31, 1997, represented 34.4% of
TCGI's Class B Common Stock, 22.4% of total shares outstanding and 32.7% of
the voting power of TCGI. Each share of Class B Common Stock is convertible
into one share of TCGI's Class A Common Stock.
In January 1998, TCGI agreed to a merger with AT&T Corp. ("AT&T") under
which TCGI shareholders will exchange each share of TCGI common stock for
0.943 of a share of AT&T common stock. Pending regulatory approval, the
transaction is expected to close in late 1998. Cox has been named along with
TCGI and TCGI officers and directors (including some who are officers of Cox),
as defendants in three putative class action suits filed in the Chancery Court
of New Castle County, Delaware. The suits challenge the proposed AT&T/TCGI
merger and seek injunctive relief and damages based on various theories
alleging that the proposed AT&T/TCGI merger's terms do not offer appropriate
compensation or protection to TCGI's public shareholders. The actions are
being defended vigorously. As a result of this transaction, if consummated,
Cox will own 36,859,601 shares of AT&T common stock, representing
approximately 2% of total AT&T common shares outstanding. Cox expects to
recognize a gain on this transaction.
PHILLIECO, L.P. Cox also owns, as of December 31, 1997, a 17.6% interest in
PhillieCo L.P. ("PhillieCo"), a partnership formed by subsidiaries of Cox, TCI
and Sprint. PhillieCo was the successful bidder for a broadband PCS license
for the Philadelphia MTA. The approximately $85 million purchase price for
this license has already been paid to the FCC. PhillieCo is also affiliated
with the Sprint PCS nationwide network and uses the "Sprint PCS" trademark.
SPRINT SPECTRUM L.P. Cox, TCI, Comcast and Sprint engage in the wireless
communications business, primarily PCS, through a limited partnership, Sprint
Spectrum L.P. with its subsidiaries ("Sprint PCS"), of which Cox owns a 15%
interest. Sprint PCS was the successful bidder for 29 broadband PCS licenses
in the auction conducted by the FCC that was completed in March 1995. The $2.1
billion total purchase price for the 29 licenses has been paid to the FCC.
Additionally, Sprint PCS has invested in other entities that hold and operate
PCS licenses. Sprint PCS and its affiliates have obtained licenses to offer a
full range of wireless telecommunications services using the "Sprint PCS"
trademark to areas with an aggregate population of approximately 200 million
and Sprint PCS is in the process of building and completing its seamless
integrated nationwide network. As of March 1, 1998, Sprint PCS had launched
service in most major U.S. markets and had approximately 1 million customers.
As of January 1, 1998, a "Deadlock Event" occurred due to the failure of the
partnership board of Sprint Spectrum Holding Company, L.P. (the parent of
Sprint PCS) to approve the proposed 1998 budget. If the 1998 budget is not
approved through the resolution procedures set forth in the Sprint Spectrum
Holding Company, L.P. partnership agreement, certain specified buy/sell
procedures may be triggered which might result in a restructuring of the
partners' interests in Sprint Spectrum Holding Company, L.P., Cox's sale of
its interest in Sprint Spectrum Holding Company, L.P., Cox's acquisition of
interests in Sprint Spectrum Holding Company, L.P. held by other partners, or
liquidation of Sprint Spectrum Holding Company, L.P. Discussions among the
partners about restructuring their interests in Sprint PCS are ongoing.
However, there is no certainty the discussions will result in a change to the
partnership structure.
NATIONAL CABLE COMMUNICATIONS, L.P. Cox has a 12.5% limited partnership
interest in NCC, a partnership which represents cable television companies to
advertisers. NCC is the largest representation firm in spot cable advertising
sales. It enables advertisers to place advertising in selected multiple
systems on a regional or national single-source basis, and enhances the
ability of affiliated cable television systems to attract advertisers other
than purely local advertisers. The other limited partners in NCC are MediaOne,
Time Warner and Comcast. Katz Cable Corporation is the sole general partner.
@HOME. In August 1996, Cox acquired a 14.2% interest in At Home Corporation
("@Home"). @Home is a national Internet "backbone" service that allows
customers access to the Internet at speeds up to a hundred times faster than
traditional phone modems by using a cable modem and the cable television
broadband network. In July 1997, @Home conducted an initial public offering.
As a result, the value of the @Home share price became readily determinable,
and accordingly Cox began to account for its investment in @Home as an
12
<PAGE>
available-for-sale investment under Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The initial public offering reduced Cox's ownership
percentage to approximately 12.3% as of December 31, 1997. Also in the fourth
quarter 1997, Cablevision Systems Corporation was admitted as a partner
through the issuance of warrants. On a fully diluted basis giving effect to
the exercise of these warrants, Cox's ownership is approximately 11.3%.
PRIMESTAR PARTNERS, L.P. PrimeStar Partners, L.P. ("PrimeStar Partners") is
a provider of DBS services. As of December 31, 1997, Cox owned a 10.4%
interest in PrimeStar Partners. PrimeStar Partners' direct-to-home television
delivery business served, as of December 31, 1997, approximately 1,949,000
customers (representing an estimated 40% of the U.S. DBS market) using a
single satellite owned and operated by GE Americom. PrimeStar Partners
programming includes 94 channels of popular cable and network television,
professional sports and movies, as well as 14 channels of quality audio
services. PrimeStar Partners has secured a long-term agreement with GE
Americom for the use of a new satellite which was launched in January 1997.
The new satellite will increase PrimeStar Partners' offering to approximately
160 channels. PrimeStar Partners was formed in 1990 by GE Americom and nine of
the nation's largest cable television companies, including Cox, TCI, Comcast,
MediaOne and Time Warner.
The following table sets forth certain financial and subscriber data with
respect to PrimeStar Partners:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Revenues (millions)............................. $ 626.1 $ 413.0 $180.6
Growth.......................................... 52% 129% 550%
Subscribers (thousands)......................... 1,949.1 1,565.7 961.2
Growth.......................................... 24% 63% 316%
</TABLE>
Pursuant to the Letter Agreement and Summary of Business Terms dated June
11, 1997, as superseded by certain definitive documentation, each of the
partners of PrimeStar agreed to merge with, or contribute their partnership
interests in PrimeStar and related assets and liabilities to, a new subsidiary
of TCI Satellite Entertainment, Inc., PrimeStar, Inc., in exchange for shares
of common stock of PrimeStar, Inc. and cash or the assumption of indebtedness.
Upon consummation of this transaction, Cox will own approximately 9.35% of
PrimeStar, Inc. The balance of PrimeStar, Inc. will be owned by the other
PrimeStar partners and the shareholders of TSAT. It is anticipated that Cox
will recognize a gain on this transaction, which is expected to close during
the second quarter of 1998.
GEMSTAR INTERNATIONAL GROUP LIMITED. In May 1997, Gemstar International
Group Limited ("Gemstar"), a public company that develops and markets
proprietary technologies aimed at making technology more user-friendly to
consumers, merged with Starsight Telecast, Inc. ("Starsight"). Cox, as a
holder of 2,166,647 Starsight shares, received 1,313,421 shares of Gemstar as
a result of the merger, representing a 2.8% interest in Gemstar as of December
31, 1997, and recognized a gain of approximately $11.0 million related to this
transaction. In December 1997, Cox sold its entire interest in Gemstar for
$29.3 million, resulting in an additional gain of approximately $9.9 million.
SYNTELLECT, INC. Cox holds 1,150,000 shares of Syntellect, Inc.
("Syntellect") common stock, representing approximately 8.6% of the equity of
Syntellect as of December 31, 1997. Syntellect designs and markets ARUs. In
March 1996, Syntellect merged with Telecorp Systems, Inc. ("Telecorp"), which
also designs, manufactures and markets ARUs and a full line of cable-specific
voice and data products and services. Applications include inbound and
outbound call processing, pay-per-view ordering, information management and
voice production services.
BROADBAND NETWORK INVESTMENTS
TELEWEST COMMUNICATIONS PLC. At December 31, 1997, Cox had a 14.6% ownership
interest in TeleWest Communications plc ("TeleWest"), a company that is
currently operating and constructing cable television and telephony systems in
the United Kingdom. Other significant shareholders of TeleWest are U S West
Inc., TCI and SBC Communications, Inc.
13
<PAGE>
TeleWest is the largest cable television and telephony operator in the U.K.
based on the number of homes passed and subscribers. The following table sets
out certain data concerning TeleWest's owned and operated and affiliated
franchises:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
--------- ---------
<S> <C> <C>
CABLE TELEVISION
Homes passed and marketed............................ 3,096,582 2,626,835
Basic subscribers.................................... 687,352 599,599
RESIDENTIAL TELEPHONY
Homes passed and marketed............................ 3,062,327 2,543,041
Residential subscribers.............................. 894,682 686,101
Residential lines connected.......................... 922,540 693,521
BUSINESS TELEPHONY
Business subscribers................................. 28,331 23,297
Business lines connected............................. 116,673 78,569
</TABLE>
In December 1997, the decline in the fair market value of TeleWest was
considered to be other than temporary and accordingly Cox recognized an $183.9
million loss on write down of affiliated company in its Consolidated Statement
of Operations.
TWC CABLE PARTNERS. Cox and Time Warner each have a 50% ownership interest
in a joint venture which owns two additional cable television systems in Fort
Walton Beach, Florida and Staten Island, New York, which, as of December 31,
1997, passed approximately 244,000 homes and provided service to approximately
172,000 customers. The Ft. Walton Beach system is managed as part of Cox's
Pensacola cluster and the Staten Island system is managed by Time Warner.
COMPETITION
Each of Cox's major business segments faces competition in varying forms.
Cable television faces competition from other providers of video and other
entertainment. Telephone services face competition from incumbent and new
entrant providers of landline and wireless communications services. Wireless
services face competition from incumbent and recently-authorized cellular, PCS
and SMR providers.
CABLE TELEVISION COMPETITION
The cable television systems owned by Cox compete with other communications
and entertainment media, including conventional off-air television
broadcasting service, newspapers, movie theaters, live sporting events and
home video products. Cable television service was first offered as a means of
improving television reception in markets where terrain factors or remoteness
from major cities limited the availability of off-air television. In some of
the areas served by Cox's systems, a substantial variety of television
programming can be received off-air. The extent to which cable television
service is competitive depends upon the cable television system's ability to
provide a greater variety of programming than is available off-air.
Since Cox's U.S. cable television systems operate under non-exclusive
franchises, other companies may obtain permission to build cable television
systems in areas where Cox operates. To date, the extent of actual
overbuilding in these areas has been relatively slight, and fewer than 2% of
Cox's total homes passed are overbuilt at this time. While Cox believes that
the current level of overbuilding has not had a material impact on its
operations, it is unable to predict the extent to which adverse effects may
occur in the future as a result of overbuilds.
Additional competition may come from private satellite master antenna
television ("SMATV") systems which transmit signals by satellite to receiving
facilities located on customers' premises such as condominiums, apartment
complexes and other private residential developments. The 1996 Act broadens
the definition of SMATV systems not subject to regulation as a franchised
cable communications service. The operators of these private systems often
enter into exclusive agreements with apartment building owners or homeowners'
associations that may preclude operators of franchised cable television
systems from serving residents of such private complexes. A private cable
television system normally is free of the regulatory burdens imposed on
franchised cable television systems. Cox is unable to predict the extent to
which additional competition from these services will materialize in the
future or the impact such competition would have on Cox's operations.
14
<PAGE>
In recent years, the FCC has initiated new policies and authorized new
technologies to provide a more favorable operating environment for new and
existing technologies that provide, or have the potential to provide,
substantial additional competition to cable television systems. These
technologies include, among others, DBS and MMDS (as defined below) services.
High-powered direct-to-home satellites have made possible the wide-scale
delivery of programming to individuals throughout the United States using
roof-top or wall-mounted antennas. Companies offering DBS services are using
video compression technology to increase satellite channel capacity and to
provide a package of movies, network programming and other program services
competitive to those of cable television systems.
The availability of reasonably-priced home satellite dish earth stations
("HSDs") enables individual households to receive many of the satellite-
delivered program services formerly available only to cable subscribers.
Furthermore, the 1992 Cable Act contains provisions, which the FCC has
implemented with regulations, to enhance the ability of cable competitors to
purchase and make available to HSD owners certain satellite-delivered cable
programming at competitive costs. The 1996 Act and FCC regulations
implementing that law preempt certain local restrictions on the use of HSDs
and roof-top antennae to receive satellite programming and over-the-air
broadcasting services.
Programming is currently available to the owners of HSDs through
conventional, medium and high-powered satellites. PrimeStar, a consortium
comprised of cable operators including Cox and a satellite company, commenced
operation in 1990 of a medium-power DBS satellite system using the Ku portion
of the frequency spectrum and currently provides service consisting of
approximately 95 channels of programming, including broadcast signals and pay-
per-view services. See "--Investments--Telecommunications and Technology
Investments--PrimeStar Partners L.P." In January 1997, PrimeStar launched a
replacement medium-power DBS satellite which will enable it to increase its
capacity to approximately 160 channels. NewsCorp., MCI and ASkyB recently
announced several agreements in which the three would sell to PrimeStar two
high-powered DBS satellites under construction. This sale, which is subject to
various governmental consents, has been challenged by several parties and is
currently under review by the Justice Department and the FCC. The previously
announced plan of News Corp. to purchase an interest in EchoStar
Communications Corporation ("EchoStar") is currently the subject of litigation
between News Corp. and EchoStar. On February 19, 1998, the FCC initiated a DBS
rulemaking proceeding, which, among other issues, requests comments on whether
the FCC should implement cross-ownership restrictions between DBS and cable
television operators and whether the FCC's alien ownership restrictions should
apply to DBS subscription services.
Several other major companies are offering or are currently developing
nation-wide high-power DBS services, including DirecTV and EchoStar. DirecTV
began offering nationwide high-power DBS service in 1994 accompanied by
extensive marketing efforts, along with United States Satellite Broadcasting
Company which uses capacity on DirecTV's satellite. Together, both companies
offer over 200 channels of service using video compression technology.
Currently, satellite program providers are only authorized to provide the
signals of television network stations to subscribers who live in areas where
over-the-air reception of such signals cannot be received. EchoStar, which
currently offers a similar package of programming, recently announced plans to
offer some local television signals in a limited number of markets. Efforts
are underway at the United States Copyright Office and in Congress to ensure
that such offerings are permissible under the Copyright law. Legislation has
been introduced which would permit DBS operators to rebroadcast local
television upon compliance with certain requirements, including market-
specific must-carry requirements and compliance with programming black-out
obligations. Cox cannot predict whether such legislation will be passed, or
the effect that it will have on Cox's business. The offering of local
broadcast signals in DBS program packages would provide substantial
competition to the cable industry.
The degree to which DBS service providers will be able to compete with the
cable television industry will depend on, among other factors, the
availability of reception equipment at reasonable prices and whether DBS
providers will be permitted to offer local broadcast signals in their program
packages. Although it is not possible at this time to predict the likelihood
of success of any DBS services venture, DBS may offer substantial competition
to cable television operators.
15
<PAGE>
Cable television systems also compete with wireless program distribution
services such as multichannel, multipoint distribution service ("MMDS"),
commonly called wireless cable, which are licensed to serve specific areas
using low-power microwave frequencies to transmit video programming over-the-
air to subscribers. There are MMDS operators who are authorized to provide or
are providing broadcast and satellite programming to subscribers in areas
served by Cox's cable systems. Several Regional Bell Operating Companies
("BOCs") have acquired significant interests in major MMDS companies operating
in certain of Cox's cable service areas. BellSouth Entertainment, a Bell
South-affiliated company, recently commenced wireless cable service in the New
Orleans market using MMDS technology and offering a basic package of over 160
local, cable, satellite and CD music channels. Cox has initiated the
introduction of new programming services in response to the increasing
competitive environment in which the New Orleans system operates. Under the
1996 Act, the provision of video service by a telephone affiliated company
constitutes effective competition and permits deregulation of both basic and
CPS tier rates. (See Federal Regulation-Rate Regulation.) On January 28, 1998,
Cox filed a petition with the FCC which requested deregulation of its rates in
the New Orleans and Jefferson Parish markets. Pacific Telesis Enterprises, a
BOC operating in California, also is providing or is authorized to provide
wireless cable services in several California communities which Cox serves.
However, recent reports indicate that it is reconsidering its business plans
to provide video services, will not expand its operations, and is seeking a
purchaser for its wireless cable system. Additionally, the FCC recently
adopted new regulations allocating frequencies in the 28 GHz band for a new
multichannel wireless video service similar to MMDS called Local Multipoint
Distribution Service ("LMDS"), which is capable for transmitting voice as well
as video transmissions. Spectrum auctions for LMDS licenses commenced in
February 1998. The FCC has imposed cross-ownership restrictions of these
frequencies by cable operators and telephone companies which were recently
upheld by the United States Court of Appeals for the District of Columbia
Circuit. For a three-year period, cable operators and telephone companies will
be precluded from operating on these frequencies in the same authorized or
franchised service areas in which they provide service. Cox is unable to
predict whether wireless video services will have a material impact on its
operations.
The 1996 Act repeals the cable/television cross-ownership ban adopted in the
1984 Cable Act, and contains restrictions on telephone companies buying out
incumbent cable operators in a telephone company's service area, especially in
suburban and rural markets. The 1996 Act will enable common carriers to
provide video programming services as either cable operators or open video
system ("OVS") operators.
Other new technologies may become competitive with respect to certain non-
entertainment services that cable television systems can also offer. The FCC
has authorized television broadcast stations to transmit textual and graphic
information useful both to consumers and to businesses. The FCC also permits
commercial and non-commercial FM stations to use their subcarrier frequencies
to provide non-broadcast services, including data transmissions. The FCC
established an over-the-air Interactive Video and Data Service that will
permit two-way interaction with commercial and educational programming along
with informational and data services. Telephone companies and other common
carriers also provide facilities for the transmission and distribution of data
and other non-video services.
TELEPHONY COMPETITION
LANDLINE TELECOMMUNICATIONS SERVICES. While the current switched voice and
data telecommunications market is dominated by local telephone companies, also
known as incumbent LECs, the 1996 Act presents new opportunities for new
entrants into these markets. Incumbent LECs provide a wide range of local
telecommunications services and equipment to customers, as well as providing
originating and terminating access to their local networks to interexchange
carriers and mobile radio service providers. Because LECs historically have
had exclusive state franchises by law to provide telephone service, they have
established long-term, exclusive relationships with their customers. Under the
new law, and subject to certain limitations for rural LECs, the FCC is
directed to preempt any state law or regulation that acts to prevent new
competitive entry into incumbent LEC markets.
The 1996 Act represents the most comprehensive reform of the nation's
telecommunications laws since the Communications Act of 1934. The 1996 Act is
intended to open local exchange markets to competition, which
16
<PAGE>
should result in a substantial increase in Cox's business opportunities to
deliver telephony over its broadband networks. Among its more significant
provisions, the 1996 Act: (i) removes legal barriers to entry in local
telephone markets; (ii) requires incumbent LECs to "interconnect" with
competitors, including the provision of necessary elements for local
competition such as telephone number portability; (iii) establishes procedures
for incumbent LEC entry into new markets such as long distance and cable
television; (iv) relaxes regulation of telecommunications services provided by
incumbent LECs and all other telecommunications service providers; and (v)
directs the FCC to establish an explicit subsidy mechanism for the
preservation of universally affordable telephone service.
Under the 1996 Act, new landline entrants will become subject to additional
federal regulatory requirements when they provide local exchange service in
any market. The 1996 Act imposes a number of access and interconnection
requirements on all LECs, with additional requirements imposed on incumbent
LECs. Specifically, the 1996 Act required the FCC to implement rules under
which all LECs must provide telephone number portability, dialing parity,
reciprocal compensation for transport and termination of local traffic, resale
and access to rights of way. The 1996 Act also requires state commissions to
review and approve voluntarily negotiated interconnection agreements and to
arbitrate compulsory interconnection negotiations between new entrants and
incumbent LECs. These requirements also place burdens on new entrants that may
benefit other competitors. In particular, the resale requirement means that a
company could seek to resell the facilities of a new entrant without making a
similar investment in facilities.
The 1996 Act eliminates the requirement that incumbent LECs obtain FCC
authorization prior to constructing facilities for interstate services. The
1996 Act also limits the FCC's ability to review incumbent LEC tariff filings.
These changes will increase the speed with which the LECs are able to
introduce new service offerings and new pricing of existing services, thereby
increasing their flexibility to respond to new entrants.
In addition to incumbent LECs and existing competitive access providers, new
entrants potentially capable of offering switched and non-switched services
include individual cable television companies, electric utilities, long-
distance carriers, microwave carriers, wireless service providers, resellers
and private networks built by large end-users.
The FCC has adopted most, but not all, of the rules required to implement
the 1996 Act. On August 1, 1996 the FCC adopted a report and order
promulgating rules and regulations to implement the 1996 Act's provision that
obligates CLECs and incumbent LECs to interconnect their networks and to
develop a methodology to translate the 1996 Act's pricing guidelines into
incumbent LEC pricing of interconnection for reciprocal transport and
termination, unbundled elements and resale (the "Local Competition Order").
The Local Competition Order adopts a national pro-competitive framework for
interconnection but leaves to the individual state commissions the task of
implementing the FCC's rules in their process of reviewing interconnection
agreements. The states are to base rates for interconnection, the reciprocal
termination of local telephone traffic and the purchase of ILEC unbundled
network elements on an incremental cost methodology established by the FCC,
called Total Element Long-Run Incremental Cost ("TELRIC"). Incumbent LECs may
present the states with TELRIC cost studies, while the FCC adopted interim
"default" rates the states could apply pending state review of TELRIC studies.
Additionally, the FCC interpreted the non-discrimination provisions of the
1996 Act to allow carriers to request that the incumbent LEC make available to
them any interconnection, service or network element contained in an approved
agreement to which the LEC was a party under the same terms and conditions
(known as the "pick and choose" rule).
Many petitions for reconsideration of the FCC's Local Competition Order
remain pending at the FCC. Despite the adoption of generally pro-competitive
rules that Cox views as consistent with the requirements of the 1996 Act, the
interconnection rules, particularly those containing the TELRIC pricing
methodology and "default" rates, have not taken effect due to successful
appeals filed by incumbent LECs and jurisdictional challenges filed by several
state utility commissions. The Eighth Circuit Court of Appeals has overturned
many of the interconnection rules affecting LECs, including most aspects of
the FCC's pricing rules, intrastate dialing parity rules, certain rules
governing unbundled elements and the "pick and choose" rule. The Eighth
Circuit permitted the FCC's rules governing interconnection by wireless
providers to remain in effect. While the Eighth
17
<PAGE>
Circuit's decision remains in effect, on January 26, 1998, the United States
Supreme Court agreed to hear several appeals from that decision. The Supreme
Court will hear oral argument in its October 1998 term, and its not expected
to issue its decision until late 1998 or early 1999. The Eighth Circuit's
determination regarding wireless providers was not appealed to the Supreme
Court. Many states have applied the FCC's interpretations of the 1996 Act as
guidelines, even though many FCC interconnection rules are not in effect.
The Local Competition Order was the first part in a "trilogy" of orders that
will reform access pricing and universal service consistent with the 1996
Act's goal of encouraging competition. As described below, the FCC also issued
orders in 1997 that were intended to substantially reduce the prices incumbent
LECs charge for interstate access services in separate proceedings on reform
of the current access charge regime and of current universal service
procedures.
In July 1996 the FCC released an Order promulgating rules implementing the
1996 Act's directive for local telephone number portability (the "Number
Portability Order"). Under the Number Portability Order and several subsequent
orders in that proceeding, the FCC ordered all LECs to begin phased
development of a long-term service provider portability method in the 100
largest Metropolitan Statistical Areas ("MSAs") no later than October 1, 1997,
and to complete deployment in those MSAs by March 31, 1998 in areas where
other carriers have requested the availability of portability. After March 31,
1998, each LEC must make number portability available within specified
periods, but no longer than six months, after receiving a specific request by
another telecommunications carrier in areas outside the 100 largest area MSAs.
Several LECs have petitioned the FCC for additional time to implement
portability in certain markets due to difficulties in performing required
equipment upgrades and the failure of a vendor to provide necessary database
services. Until long-term service provider number portability is available,
all LECs must provide currently available number portability measures as soon
as reasonably possible after a specific request from another carrier. Because
new carriers are at a competitive disadvantage without telephone number
portability, the Number Portability Order should enhance Cox's ability to
offer service in competition with the incumbent LECs. It is uncertain how
effective these regulations will be in promoting cost effective and efficient
number portability. The Number Portability Order does not address how the
costs of implementing long-term service provider number portability will be
recovered. This issue was subject to an additional comment period and has not
yet been decided. The Number Portability Order is subject to appeals pending
before the Eighth Circuit Court of Appeals.
The 1996 Act mandated creation of a Federal-State Joint Board regarding
universal service and subsequent action by the FCC. In the fall of 1996, the
Joint Board proposed a new regime for funding universal telephone service and
for distributing universal service subsidies. The FCC received public comment
on that proposal and adopted an order in the universal service proceeding (the
"Universal Service Order") on May 7, 1997. The recommended decision proposed,
and the Universal Service Order adopted, specific subsidy programs to replace
the previous subsidies for high cost carriers and for low income consumers,
new subsidies for telecommunications services, Internet access services and
internal connections for schools and libraries and new subsidies for
telecommunications services for rural health care facilities. Under the
Universal Service Order, any telecommunications carrier that provided all of
the services that fall within the definition of "universal service" would be
eligible to receive subsidies, as would any entity that provided
telecommunications services, internal connections or Internet services used by
schools and libraries. The FCC has not adopted final rules governing subsidies
for high cost areas generally or final rules for subsidies to rural carriers.
These topics are the subject of ongoing proceedings that are expected to
continue through 1998. As part of this process, the FCC is developing a "cost
proxy" model intended to identify those markets and carriers in need of
subsidies to maintain universal service.
Funding for the federal universal service subsidies will come from mandatory
payments imposed on all telecommunications carriers (with limited exceptions).
For the first quarter of 1998, the amount of payment is 0.72 percent of all
revenues and 3.19 percent of interstate and international revenues for all
carriers with interstate revenues. For the second quarter of 1998, the amount
of the payment is 0.76 percent of all revenues and 3.14 percent of interstate
and international revenues. In addition to the federal universal service plan,
it is likely that most or all states will adopt their own universal service
support mechanisms.
Although the FCC has acted on many petitions for reconsideration of the
Universal Service Order, many other petitions for reconsideration remain
pending. The Universal Service Order also is the subject of pending
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appeals by incumbent LECs, wireless service providers and state regulators in
the United States Court of Appeals for the Fifth Circuit. The FCC has been
directed to submit a report to Congress by April 10, 1998 concerning certain
universal service issues, including its decision to exempt certain non-
telecommunications offerings of Internet service providers from federal
universal service assessments; what services may be subsidized; the extent to
which the support should be subsidized through federal or state universal
service programs and the FCC's ability to use intrastate revenues to calculate
payment obligations.
While not directly required under the 1996 Act, the FCC also adopted an
order intended to reform interstate access charges that are generally
acknowledged to contain subsidy elements (the "Access Reform Order"). The
Access Reform Order modified the previous access charge system by shifting
some costs from per-minute charges to flat charges and through other changes.
The FCC also simultaneously adopted an order that reduced access charges under
the existing regime of rate regulation for those charges. The Access Reform
Order also affirmed the FCC's previous determination that interstate access
charges should not be imposed on enhanced services traffic such as Internet
access traffic.
In a separate proceeding, the FCC was asked in 1997 to declare that traffic
to Internet service providers should be treated as local traffic for purposes
of determining whether a carrier is entitled to compensation for terminating
such traffic. Incumbent LECs opposed this petition, which remains pending. As
of February 23, 1998, every state commission that had considered this issue
had concluded that traffic to Internet service providers should be treated as
local traffic.
On February 19, 1998, the FCC adopted new rules concerning the privacy of
customer information held by telecommunications providers. These rules will
apply to all telecommunications providers and will permit carriers to use such
information for marketing services within specified categories, such as local
service or long distance service, without specific customer permission. Use of
such information to market services in a different category of service will
require affirmative oral or written customer permission.
OTHER PCS PROVIDERS. Sprint PCS and Cox PCS will face direct competition for
PCS subscribers from other licensed PCS systems within its markets. There are
potentially six PCS providers (not counting resellers and marketing agents for
licensees) in each PCS service area. Three licensees will each hold 30 MHz of
PCS spectrum, one of which is licensed for a basic trading area, and the
remaining three licensees will hold 10 MHz of PCS spectrum. It is likely that
some of the 10 MHz licenses will be used to provide niche services or will be
purchased by existing cellular providers for added spectrum, while the 30 MHz
licenses will be used to offer a broad range of voice, data and related
communications services, and may ultimately develop into services that include
a wireless local loop functionality.
Sprint PCS may also face competition from other current or developing
technologies. Specialized Mobile Radio ("SMR") systems, such as those used by
taxicabs, as well as other forms of mobile communications service, may provide
competition in certain markets. SMR systems are permitted by the FCC to be
interconnected to the public switched telephone network and are significantly
less expensive to build and operate than cellular telephone systems. SMR
systems, however, are licensed to operate on substantially fewer channels than
PCS systems and generally lack PCS's ability to expand capacity through
frequency reuse by using many low-power transmitters and micro-cells to hand
off calls.
Nextel, which holds a considerable number of SMR licenses across the nation,
is implementing its digital system to use available SMR spectrum to provide a
range of mobile radio communications services. The implementation of this
service, known as Enhanced Specialized Mobile Radio ("ESMR") service, has
resulted in legislation and FCC rules that regulate ESMR services in a manner
that reflects its potential interchangeability ith cellular and PCS services.
In 1994, the FCC decided to license SMR systems in the 800 Mhz bands for wide-
area use, thus increasing potential competition with cellular and PCS. In
1997, the FCC completed the first of two auctions of contiguous spectrum
blocks for ESMR. This auction resulted in the company described above winning
rights to a significant number of additional SMR licenses. The second auction
is scheduled to take place in 1998. These results of these auctions may
further the potential of digital SMR services to compete with cellular and
PCS.
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LEGISLATION AND REGULATION
The cable television industry is regulated by the FCC, some state
governments and substantially all local governments. In addition, various
legislative and regulatory proposals under consideration from time to time by
the Congress and various federal agencies may materially affect the cable
television industry. The following is a summary of federal laws and
regulations affecting the growth and operation of the cable television
industry and a description of certain state and local laws.
CABLE COMMUNICATIONS POLICY ACT OF 1984. The 1984 Cable Act generally became
effective in December 1984. This federal statute, which amended the
Communications Act of 1934, 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, in turn, was charged with responsibility for adopting rules to implement
the 1984 Cable Act. Among other things, the 1984 Cable Act affirmed the right
of franchising authorities (state or local, depending on the practice in
individual states) to award one or more franchises within their jurisdictions.
It also prohibited non-grandfathered cable television systems from operating
without a franchise in such jurisdictions. In connection with new franchises,
the 1984 Cable Act provides that in granting or renewing franchises,
franchising authorities may establish requirements for cable-related
facilities and equipment, but may not establish or enforce requirements for
video programming or information services other than in broad categories.
CABLE TELEVISION CONSUMER PROTECTION AND COMPETITION ACT OF 1992. In October
1992, Congress enacted the 1992 Cable Act. This legislation, which amended the
1984 Cable Act, made significant changes to the legislative and regulatory
environment for the cable industry. The 1992 Cable Act became effective in
December 1992, although certain provisions, most notably those dealing with
rate regulation and retransmission consent, took effect at later dates. The
1992 Cable Act permitted a greater degree of regulation of the cable industry
with respect to, among other things: (i) cable system rates for both basic and
certain cable programming services; (ii) programming access and exclusivity
arrangements; (iii) access to cable channels by unaffiliated programming
services; (iv) leased access terms and conditions; (v) horizontal and vertical
ownership of cable systems; (vi) customer service requirements; (vii)
franchise renewals; (viii) television broadcast signal carriage and
retransmission consent; (ix) technical standards; (x) customer privacy; (xi)
consumer protection issues; (xii) cable equipment compatibility; (xiii)
obscene or indecent programming; and (xiv) subscription to tiers of service
other than basic service as a condition of purchasing premium services.
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 MMDS or
SMATV systems. The 1992 Cable Act 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 legislation required the FCC to initiate a number of
rulemaking proceedings to implement various provisions of the statute, the
majority of which, including certain proceedings related to rate regulation,
have been completed.
THE TELECOMMUNICATIONS ACT OF 1996. On February 1, 1996, Congress passed the
1996 Act, which was signed into law by the President on February 8, 1996. The
1996 Act substantially revises the Communications Act of 1934, as amended (the
"Communications Act"), including the 1984 Cable Act and the 1992 Cable Act
under which the cable industry is regulated. The FCC has been conducting
various rulemaking proceedings to implement the provisions of the 1996 Act
over the last two years.
The 1996 Act has been described as one of the most significant changes in
communications regulation since the passage of the Communications Act. The
1996 Act modifies various rate regulation provisions of the Cable Act of 1992.
Generally, under the 1996 Act, cable programming service ("CPS") tier rates
are deregulated on March 31, 1999. Upon enactment, the CPS rates charged by
small cable operators are deregulated in systems serving 50,000 or fewer
subscribers. The 1996 Act also revises the CPS complaint filing procedures and
adds a new effective competition test under which cable rates may be
deregulated. The 1996 Act allows cable operators
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to aggregate equipment costs into broad categories, such as converter boxes,
regardless of the varying levels of functionality of the equipment within each
such broad category, on a franchise, system, regional, or company level. The
statutory changes also facilitate the rationalizing of equipment rates across
jurisdictional boundaries. These favorable cost-aggregation rules do not apply
to the limited equipment used by basic service-only subscribers.
The 1996 Act is intended, in part, to promote substantial competition in the
marketplace for telephone local exchange service and in the delivery of video
and other services and permits cable television operators to enter the local
telephone exchange market. Cox's ability to competitively offer telephone
services may be adversely affected by the degree and form of regulatory
flexibility afforded to LECs, and in part, will depend upon the final outcome
of the appeals of various FCC orders, including the Local Competition Order,
the Universal Service Order and the Number Portability Order. The 1996 Act
also repeals the cable television/telephone cross-ownership ban adopted in the
1984 Cable Act and permits local telephone companies (also known as LECs) and
other service providers to provide video programming.
The most far-reaching changes in communications businesses will result from
the telephony provisions of the 1996 Act. These provisions promote local
exchange competition as a national policy by eliminating legal barriers to
competition in the local telephone business and setting standards to govern
the relationships among telecommunications providers, establishing uniform
requirements and standards for entry, competitive carrier interconnection and
unbundling of LEC monopoly services. The statute expressly preempts any legal
barriers to competition under state and local laws. Many of these barriers had
been lifted by state actions during the early 1990s, but the 1996 Act
completes the task. The 1996 Act also establishes new requirements to maintain
and enhance universal telephone service and new obligations for
telecommunications providers to maintain the privacy of customer information.
Under the 1996 Act, LECs may provide video service as cable operators or
through "open video systems" ("OVSs"), a regulatory regime that gives them
more flexibility than traditional cable systems. The 1996 Act eliminates the
requirement that telephone companies file Section 214 applications with the
FCC before providing video service. This will limit the ability of cable
operators to challenge the economic viability of telephone company entry into
the video market. With certain exceptions, the 1996 Act also restricts
telephone companies from buying out incumbent cable operators in the LECs
service area.
Other parts of the 1996 Act also will affect cable operators. The 1996 Act
directs the FCC to revise the current pole attachment rate formula. This will
result in an increase in the rates paid by entities, including cable
operators, that provide telecommunication services. (Cable operators that
provide only cable services are unaffected.) The 1996 Act also contains
provisions regulating the content of video programming and computer services.
Specifically, the new law prohibits the use of computer services to transmit
"indecent" and "obscene" material to minors. The U.S. Supreme Court has held
that these computer-related provisions are unconstitutional to the extent they
regulate the transmission of indecent material. The 1992 Cable Act requires
cable operators to block fully both the video and audio portion of sexually
explicit or indecent programming on channels that are primarily dedicated to
sexually oriented programming, or alternatively, to carry such programming
only at "safe harbor" time, periods currently defined by the FCC as the hours
between 10 p.m. to 6 a.m. Several adult-oriented cable programmers have
challenged the constitutionality of this statutory provision, but the U.S.
Supreme Court recently refused to overturn a lower court's denial of a
preliminary injunction motion seeking to enjoin the enforcement of this law.
The FCC's regulations implementing this statutory provision became effective
in May 1997. In accordance with the 1996 Act, the television industry recently
adopted a voluntary ratings system for violent and indecent video programming.
The 1996 Act also requires all new television sets to contain a so-called "V-
chip" capable of blocking all programs with a given rating.
Under the 1996 Act, a franchising authority may not require a cable operator
to provide telecommunications services or facilities, other than an
institutional network, as a condition to a grant, renewal, or transfer of a
cable franchise, and franchising authorities are preempted from regulating
telecommunications services provided by
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cable operators and from requiring cable operators to obtain a franchise to
provide such services. The 1996 Act also repeals the 1992 Cable Act's anti-
trafficking provision which generally required the holding of cable television
systems for three years.
It is premature to predict the effect of the 1996 Act on the cable industry
in general or Cox in particular. The FCC must undertake numerous rulemaking
proceedings to interpret and implement the 1996 Act. Most of these rulemakings
have been completed, but are subject to pending petitions for reconsideration,
appeals, or both. It is not possible at this time to predict the outcome of
those proceedings or their effect on Cox.
FEDERAL REGULATION
The FCC, the principal federal regulatory agency with jurisdiction over
cable television, has promulgated regulations covering such areas as the
registration of cable television systems, cross-ownership between cable
television systems and other communications businesses, carriage of television
broadcast programming, consumer education and lockbox enforcement, origination
cablecasting and sponsorship identification, children's programming, the
regulation of non-premium cable service rates in areas where cable television
systems are not subject to effective competition, signal leakage and frequency
use, technical performance, maintenance of various records, equal employment
opportunity, and antenna structure notification, marking and lighting. The FCC
may enforce these regulations through the imposition of substantial fines, the
issuance of cease and desist orders and/or the imposition of other
administrative sanctions, such as the revocation of FCC licenses needed to
operate certain transmission facilities often used in connection with cable
operations. The 1992 Cable Act required the FCC to adopt additional
regulations covering, among other things, cable rates, broadcast signal
carriage, consumer protection and customer service, leased access, indecent
programming, programmer access to cable television systems, programming
agreements, technical standards, consumer electronics equipment compatibility,
ownership of home wiring, program exclusivity, equal employment opportunity,
and various aspects of DBS system ownership and operation. A brief summary of
certain of these federal regulations as adopted to date follows.
RATE REGULATION. The 1992 Cable Act substantially changed the regulatory
environment. Although the regulation of premium channels is still prohibited,
the 1992 Cable Act replaced the FCC's effective competition test, under which
most cable systems were not subject to local rate regulation, with a statutory
provision that results in nearly all cable television systems becoming subject
to rate regulation. Additionally, the legislation eliminated the permissible
automatic 5% annual rate increase for regulated basic services previously
allowed by the 1984 Cable Act; required the FCC to adopt a formula for
franchising authorities to enforce to assure that basic cable rates are
reasonable; allowed the FCC to review rates for cable programming service
tiers (other than per-channel or per-event services) in response to complaints
filed by franchising authorities and/or cable customers; prohibited cable
television systems from requiring subscribers to purchase service tiers above
basic service in order to purchase premium services if the system is
technically capable of doing so; required the adoption of regulations by the
FCC to establish, on the basis of actual costs, the price for installation of
cable service, remote controls, converter boxes and additional outlets; and
permitted the imposition by the FCC of restrictions on the retiering and
rearrangement of cable services, under certain limited circumstances. The
FCC's rules governing rates for the regulation of basic and cable programming
service tiers generally became effective in September 1993.
In February 1994, the FCC revised its benchmark regulations adopted in April
1993. Effective May 1994, cable television systems not seeking to justify
rates with a cost-of-service showing were to reduce rates by up to 17% of the
rates in effect on September 30, 1992, adjusted for inflation, channel
modifications, equipment costs and certain increases in programming costs.
Under certain conditions systems were permitted to defer these rate
adjustments until July 14, 1994. Further rate reductions for cable systems
whose rates are below the revised benchmark levels, as well as reductions that
would require operators to reduce rates below benchmark levels in order to
achieve a 17% rate reduction were held in abeyance pending completion of cable
system cost studies. The FCC adopted an order which made permanent its
deferral of the full 17 percent rate reduction, and consequently these systems
will not be required to reduce their rates by the full competitive
differential previously implemented by the FCC.
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The FCC also revised its regulations governing the manner in which cable
operators may charge subscribers for new channels added to cable programming
services tiers. The FCC instituted a three-year flat fee mark-up plan.
Commencing on January 1, 1995, operators may charge subscribers up to $.20 per
channel for any channels added after May 14, 1994, but may not make
adjustments to monthly rates totaling more than $1.20 plus an additional $.30
to cover programming license fees for those channels over the first two years
of the three-year period. In year three, an additional channel may be added
with another $.20 increase in rates. Rates also may increase in the third year
to cover any additional costs for the programming for any of the channels
added during the entire three-year period. Cable operators electing to use the
$.20 per channel adjustment may not also take a 7.5% mark-up on programming
cost increases, which is otherwise permitted under the FCC's regulations. The
FCC has requested further comment on whether cable operators should continue
to receive the 7.5% mark-up on increases in license fees on existing
programming services.
The FCC will permit cable operators to exercise their discretion in setting
rates for New Product Tiers ("NPT") so long as, among other conditions, the
channels that are subject to rate regulation are priced in conformity with
applicable regulations and cable operators do not remove programming services
from existing rate-regulated service tiers and offer them on an NPT.
In September 1995, the FCC authorized a new, alternative method of
implementing rate adjustments which will allow cable operators to increase
rates for programming annually on the basis of projected increases in external
costs (programming costs, local regulatory fees and state and local taxes
applicable to the provision of cable television services), inflation and
changes in the number of regulated channels rather than on the basis of cost
increases incurred in the preceding quarter. Operators that elect not to
recover all of their accrued external costs and inflation pass-throughs each
year may recover them (with interest) in subsequent years. In March, 1997, the
FCC implemented regulations that provide cable operators with the option of
establishing uniform rates throughout multiple franchise areas served by the
same system. The FCC will review proposals to implement uniform rates on a
case by case basis.
In December 1995, the FCC adopted final cost-of-service rate regulations
requiring, among other things, cable operators to exclude 34% of system
acquisition costs related to intangible and tangible assets used to provide
regulated services. The FCC also reaffirmed the industry-wide 11.25% after tax
rate of return on an operator's allowable rate base, but initiated a further
rulemaking in which it proposed to use an operator's actual debt cost and
capital structure to determine an operator's cost of capital or rate of
return. After a rate has been set pursuant to a cost-of-service showing, rate
increases for regulated services are indexed for inflation, and operators are
permitted to increase rates in response to increases in costs beyond their
control, such as taxes and increased programming costs.
The 1996 Act amends the rate regulation provisions of the 1992 Cable Act.
Regulation of basic cable service continues in effect until a cable system
becomes subject to effective competition. Regulation of CPS rates will be
deregulated in franchise areas with more than 50,000 residents on March 31,
1999. The 1996 Act deregulates rates of small operators upon enactment where a
small cable operator serves 50,000 or fewer subscribers. A small cable
operator is defined as an operator that serves fewer than 1% of all
subscribers and is not affiliated with any entity whose gross annual revenues
in the aggregate exceed $250 million. Subscribers are no longer permitted to
file programming service complaints with the FCC, and complaints may only be
brought by a franchising authority if, within 90 days after a rate increase
becomes effective, it receives subscriber complaints. The FCC is required to
act on such complaints within 90 days. In addition to the existing definition
of effective competition, a new effective competition test permits
deregulation of both basic and CPS tier rates where a telephone company offers
cable service by any means (other than direct-to-home satellite services)
provided that such service is comparable to the services provided in the
franchise area by the unaffiliated cable operator. The uniform rate provision
of the 1992 Cable Act is amended to exempt bulk discounts to multiple dwelling
units so long as a cable operator that is not subject to effective competition
does not charge predatory prices to a multiple dwelling unit.
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Franchising authorities in a number of communities in which Cox operates
cable television systems initiated basic service rate regulation pursuant to
Section 623 of the Communications Act and corresponding regulations of the FCC
and required Cox to justify its existing basic service rates. In addition,
certain subscribers and franchising authorities filed complaints with the FCC
pursuant to Section 623 of the Communications Act and corresponding FCC
regulations challenging the reasonableness of Cox's rates for cable
programming services. Cox submitted rate justifications to these franchising
authorities and filed responses to the rate complaints with the FCC.
Franchising authorities and the FCC issued a number of rate decisions
regarding basic and CPS rates, and the FCC is currently processing several
additional rate complaints.
On December 1, 1995, the FCC issued an order adopting the terms of a rate
settlement in the form of a proposed resolution between Cox and the FCC's
Cable Services Bureau (the "Resolution"). The order resolves the outstanding
programming service rate complaints covering all of Cox's systems as of June
30, 1995. The order provides for $7 million in refunds plus interest and
covers one million subscribers. The fees paid by the former TMCT subscribers
for additional were eliminated as of January 6, 1996 and accounted for
virtually all of the refund amount. The order also permits Cox to move as many
as four regulated services to a new tier in each franchise area where an a la
carte package previously was not provided, which provides Cox additional
pricing flexibility for this new tier. In addition, the order confirms that
Cox's cable programming service tier rates, as of June 30, 1995, are not
unreasonable and that the acceptance of the Resolution by the FCC does not
constitute an admission by Cox of any violation or failure to conform to any
law, rule or policy. On January 29, 1996, the City of Irvine and six other
cities located in California filed an appeal to set aside the order in the
United States Court of Appeals for the Ninth Circuit. Cox and the cities
reached a settlement of the suit and the appeal was dismissed by the Ninth
Circuit with prejudice on November 6, 1997.
The FCC and Congress continue to be concerned that rates for regulated
programming services are rising at a rate exceeding inflation. The FCC has
begun to explore ways of addressing this issue. Congress is also looking into
this matter. It is therefore possible that the FCC will further restrict the
ability of cable operators to implement rate increases and/or Congress will
enact legislation which would, for example, delay or suspend the scheduled
March 1999 termination of CPST rate regulation. Congress and the FCC are also
examining means to spur competition in the delivery of video services as an
alternative to new rate regulations. In December 1997 the FCC initiated a
rulemaking to address a number of possible changes to its program access
rules. The FCC is seeking comment, among other issues, on whether it has
jurisdiction to extend its program access rules to terrestrially-delivered
programming, and if it has such jurisdiction, whether it should expand the
rules in this fashion.
CARRIAGE OF BROADCAST TELEVISION SIGNALS. In March 1997 the U.S. Supreme
Court affirmed a three-judge court decision upholding the constitutional
validity of the 1992 Cable Act's mandatory "must carry" signal carriage
requirements. The FCC adopted rules implementing the must-carry provisions for
non-commercial and commercial stations and the retransmission consent
provision for commercial stations in March 1993. These rules allow commercial
television broadcast stations which are "local" to a cable system, i.e., the
system is located in the station's Area of Dominant Influence ("ADI"), to
elect every three years whether to require the cable system to carry the
station, subject to certain exceptions, or whether to require the cable system
to negotiate for "retransmission consent" to carry the station. The first such
election was made in June 1993 and the second in October 1996. With the 1999
election, FCC rules require broadcasters to use their DMA as the relevant
television market for must-carry purposes. A recent amendment to the Copyright
Act of 1976 will in some cases increase the number of stations that may elect
must-carry status on cable systems located within such stations' ADI. Cable
systems must obtain retransmission consent for the carriage of all "distant"
commercial broadcast stations, except for certain "superstations" (i.e.,
commercial satellite-delivered independent stations such as WGN). All
commercial stations entitled to carriage were to have been carried by June
1993, and any non-must-carry stations (other than superstations) for which
retransmission consent had not been obtained could no longer be carried after
October 5, 1993. A number of stations previously carried by Cox's cable
television systems elected retransmission consent. Cox generally reached
agreements with broadcasters who elected retransmission consent or negotiated
extensions to the retransmission deadline. Cox has agreed to carry some
services (e.g., fX and
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ESPN2) in specified markets pursuant to retransmission consent agreements
which it believes are comparable to those entered into by most other large
cable television operators. Local non-commercial television stations are also
given mandatory carriage rights, subject to certain exceptions, within the
larger of: (i) a 50 mile radius from the station's city of license; or (ii)
the station's Grade B contour (a measure of signal strength). Unlike
commercial stations, non-commercial stations are not given the option to
negotiate retransmission consent for the carriage of their signals. The must-
carry provisions for non-commercial stations became effective in December
1992. The FCC will soon initiate a rulemaking proceeding on the carriage of
television signals in high definition and digital formats. Cox cannot predict
the ultimate outcome of this proceeding which could have a material effect on
the number of services that a cable operator will be required to carry.
NONDUPLICATION OF NETWORK PROGRAMMING. Cable television systems that have
1,000 or more customers must, upon the appropriate request of a local
television station, delete the simultaneous or nonsimultaneous network
programming of a distant station when such programming has also been
contracted for by the local station on an exclusive basis.
DELETION OF SYNDICATED PROGRAMMING. FCC regulations enable television
broadcast stations that have obtained exclusive distribution rights for
syndicated programming in their market to require a cable system to delete or
"black out" such programming from other distant television stations which are
carried by the cable system. The extent of such deletions will vary from
market to market and cannot be predicted with certainty. However, it is
possible that such deletions could be substantial and could lead the cable
operator to drop a distant signal in its entirety. The FCC also has commenced
a proceeding to determine whether to relax or abolish the geographic
limitations on program exclusivity contained in its rules, which would allow
parties to set the geographic scope of exclusive distribution rights entirely
by contract, and to determine whether such exclusivity rights should be
extended to noncommercial educational stations. It is possible that the
outcome of these proceedings will increase the amount of programming that
cable operators are required to black out. Finally, the FCC has declined to
impose equivalent syndicated exclusivity rules on satellite carriers who
provide services to the owners of home satellite dishes similar to those
provided by cable systems.
REGISTRATION PROCEDURE 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.
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 revised its standards and made them applicable to all classes of
channels which carry downstream National Television System Committee ("NTSC")
video programming. Local franchising authorities are permitted to enforce the
FCC's new technical standards. The FCC also has adopted additional standards
applicable to cable television systems using frequencies in the 108-137 MHz
and 225-400 MHz bands in order to prevent harmful interference with
aeronautical navigation and safety radio services and has also established
limits on cable system signal leakage. The 1992 Cable Act requires the FCC to
periodically update its technical standards to take into account changes in
technology and to entertain waiver requests from franchising authorities who
seek to impose more stringent technical standards upon their franchised cable
television systems.
POLE ATTACHMENTS. The FCC currently regulates the rates, terms and
conditions imposed by certain public utilities for use of their poles, unless
under the Federal Pole Attachment Act state public utilities commissions are
able to demonstrate that they regulate rates, terms and conditions of the
cable television pole attachments. A number of states and the District of
Columbia have so certified to the FCC. In the absence of state regulation, the
FCC administers such pole attachment rates through use of a formula which it
has devised and from time to time revises. Recently the FCC initiated a
proceeding to determine whether it should make other adjustments to the
current pole attachment formula which, if implemented, generally would result
in increased rates for pole
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attachments and conduit space. The 1996 Act extends the regulation of rates,
terms and conditions of pole attachments to telecommunications service
providers, and requires the FCC to prescribe regulations to govern the charges
for pole attachments used by telecommunications carriers to provide
telecommunications services when the parties fail to resolve the dispute over
such charges. The 1996 Act, among other provisions, increases significantly
future pole attachment rates for cable systems which use pole attachments in
connection with the provision of telecommunications services as a result of a
new rate formula charged to telecommunication carriers for the non-useable
space of each pole. These rates are to be phased in after a five-year period
beginning in 2001.
REGULATORY FEES AND OTHER MATTERS. Pursuant to the Communications Act, the
FCC has adopted requirements for payment of annual "regulatory fees" by the
various industries it regulates, including the cable television industry.
Currently, cable television systems are required to pay regulatory fees of
$0.54 per subscriber per year, which may be passed on to subscribers as
"external cost" adjustments to rates for basic cable service. Fees are also
assessed for other licenses, including licenses for business radio and cable
television relay systems (CARS). Those fees, however, may not be collected
directly from subscribers.
In addition, the FCC has adopted regulations pursuant to the 1992 Cable Act
which require cable systems not subject to effective competition to permit
customers to purchase video programming on a per-channel or a per-event basis
without the necessity of subscribing to any tier of service, other than the
basic service tier, unless the cable system is technically incapable of doing
so. Generally cable systems must become technically capable of complying with
the statutory obligation by December 2002. On October 9, 1997, three
individual subscribers filed a putative class action suit in Superior Court of
the State of California, County of San Diego against Cox and its cable system
subsidiaries in California (the "Cox California Systems") arising out of the
manner in which the Cox California Systems sell premium channel cable
services. The suit alleges that the Cox California Systems unlawfully require
limited basic cable customers to purchase the expanded basic services tier in
order to purchase premium channels, i.e., channels sold on an a la carte basis
such as Home Box Office and Showtime. The suit asserts causes of action under
California antitrust and consumer protection laws. The suit seeks injunctive
relief as well as an order awarding the class members compensatory damages,
plus statutory damages, punitive damages, interest and attorney's fees. On
February 13, 1998, the Court granted Cox's motion to stay the suit and
referred it on grounds of Primary Jurisdiction to the Federal Communications
Commission for consideration of issues best addressed by the FCC's expertise.
The outcome of this matter cannot be predicted at this time. Consistent with
its statutory obligations, the FCC also has adopted a number of measures for
improving compatibility between existing cable systems and consumer
electronics equipment, including a prohibition from scrambling program signals
carried on the basic tier, absent a waiver. The FCC also is considering
whether to extend this prohibition to cover all regulated tiers of
programming.
In December 1994, the FCC announced that its long-standing Emergency
Broadcast System rules were to be replaced. The new rules establish cable
television and broadcast technical standards to support a new Emergency Alert
System. Cable operators that serve 10,000 or more subscribers from a headend
must install and activate equipment necessary for the new system by December
31, 1998.
FCC regulations also address the carriage of local sports programming;
restrictions on origination and cablecasting by cable system operators; closed
captioning of video programming; application of the rules governing political
broadcasts; customer service standards; home wiring and limitations on
advertising contained in nonbroadcast children's programming. The FCC recently
adopted new procedural guidelines governing the disposition of home run wiring
(a line running to an individual subscriber's unit from a common feeder or
riser cable) in multi-dwelling units ("MDUs"). MDU owners can use these new
rules to attempt to force cable operators without contracts to either sell,
abandon or remove home run wiring which may carry voice as well as video
communications and terminate service to MDU subscribers unless operators
retain rights under common or state law to maintain ownership rights in the
home run wiring.
CONSUMER EQUIPMENT. The 1996 Act requires the FCC, in consultation with
industry standard-setting organizations, to adopt regulations which would
encourage commercial availability to consumers of all services offered by
multichannel video programming distributors, such as converter boxes,
interactive communications
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equipment and other equipment used by consumers to access multichannel video
programming. The FCC has initiated a proceeding seeking comment as to how to
implement its obligations under the 1996 Act. Pursuant to the 1996 Act, the
regulations adopted may not prohibit programming distributors from offering
consumer equipment, so long as the cable operator's rates for such equipment
are not subsidized by charges for the services offered. The rules also may not
compromise the security of the services offered, or the efforts of service
providers from preventing theft of service. The FCC may waive these rules so
as not to hinder the development of advanced services and equipment.
FRANCHISE FEES AND OBLIGATIONS. Although franchising authorities may impose
franchise fees under the 1984 Cable Act, such payments cannot exceed 5% of a
cable system's annual gross revenues. Recently, a federal appellate court
overturned an FCC order which had held that a cable operator's gross revenue
does not include money collected from subscribers that is allocated to pay
local franchise fees. Franchising authorities are also empowered in awarding
new franchises or renewing existing franchises to require cable operators to
provide cable-related facilities and equipment and to enforce compliance with
voluntary commitments. In the case of franchises in effect prior to the
effective date of the 1984 Cable Act, franchising authorities may enforce
requirements contained in the franchise relating to facilities, equipment and
services, whether or not cable-related. The 1984 Cable Act, under certain
limited circumstances, permits a cable operator to obtain modifications of
franchise obligations.
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. While the 1984 Cable Act allowed cable operators
substantial latitude in setting leased access rates, the 1992 Cable Act
requires leased access rates to be set according to an FCC-prescribed formula.
The FCC has adopted rules regulating: (i) the maximum reasonable rate a cable
operator may charge for commercial use of the designated channel capacity;
(ii) the terms and conditions for commercial use of such channels; and (iii)
the procedures for the expedited resolution of disputes concerning rates or
commercial use of the designated channel capacity. The FCC recently
reconsidered and revised the formula governing the rates that may be charged
for the use of leased access channels. The new formula, which resulted in a
downward adjustment in such rates, has been appealed by a party seeking even
lower rates for access.
OWNERSHIP. The FCC rules generally prohibit the direct or indirect common
ownership, operation, control or interest in a cable television system, on the
one hand, and a local television broadcast station whose television signal
(predicted grade B contour as defined under FCC regulations) reaches any
portion of the community served by the cable television system, on the other
hand. For purposes of the cross-ownership rules, "control" of licensee
companies is attributed to all 5% or greater stockholders, except for mutual
funds, banks and insurance companies which may own less than 10% without
attribution of control. This rule prohibits Cox from owning or operating a
cable television system in the same area in which CEI or one of CEI's
subsidiaries owns or operates a television broadcast station. The FCC has
requested comment as to whether to raise the attribution criteria from 5% to
10% and for passive investors from 10% to 20%, and whether it should exempt
from attribution certain widely held limited partnership interests where each
individual interest represents an insignificant percentage of total
partnership equity. The 1996 Act eliminated the statutory ban on the cross-
ownership of a cable system and a television station and permits the FCC to
amend or revise its own regulations regarding the cross-ownership ban. The FCC
has repealed its broadcast network/cable system cross-ownership ban, and
recently initiated a rulemaking proceeding in connection with a review of its
cross-ownership rules to determine whether the cable television/broadcast
cross-ownership ban is necessary and in the public interest or whether it
should be eliminated.
Finally, in order to encourage competition in the provision of video
programming, the FCC adopted a rule in 1993 prohibiting the common ownership,
affiliation, control or interest of cable television systems and MMDS
facilities having overlapping service areas, except in very limited
circumstances. However, the 1996 Act permits co-ownership of MMDS and cable
systems in areas where the cable operator is subject to effective competition.
The 1992 Cable Act also codified this restriction and extended it to co-
located SMATV systems, except that a
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cable system may acquire a co-located SMATV system if it provides cable
service to the SMATV system in accordance with the terms of its cable
television franchise. Under the 1992 Cable Act, permitted arrangements in
effect as of October 5, 1992 were grandfathered. The 1992 Cable Act permits
states or local franchising authorities to adopt certain additional
restrictions on the transfer of ownership of cable television systems.
The cross-ownership prohibitions would preclude investors from holding
ownership interests in Cox if they simultaneously served as officers or
directors of, or held an attributable ownership interest in, these other
businesses, and would also preclude Cox from acquiring a cable television
system when Cox's officers or directors served as officers or directors of, or
held an attributable ownership in, these other businesses which were located
within the same area as the cable system which was to be acquired.
The 1996 Act generally restricts common carriers from holding greater than a
10% financial interest or any management interest in cable operators which
provide cable service within the carrier's telephone exchange service area or
from entering joint ventures or partnerships with cable operators in the same
market subject to four general exceptions which include population density and
competitive market tests. The FCC may waive the buyout restrictions if it
determines that, because of the nature of the market served by the cable
system or the telephone exchange facilities, the cable operator or LEC would
be subject to undue economic distress by enforcement of the restrictions, the
system or LEC facilities would not be economically viable if the provisions
were enforced, the anticompetitive effects of the proposed transaction clearly
would be outweighed by the public interest in serving the community, and the
local franchising authority approves the waiver.
Pursuant to the 1992 Cable Act, the FCC has imposed regulatory ownership
restrictions on the number of cable systems which a single cable operator may
own. In general, no cable operator may hold an attributable interest in cable
systems which pass more than 30% of all homes nationwide. Attributable
interests for these purposes include voting interests of 5% or more (unless
there is another single holder of more than 50% of the voting stock),
officerships, directorships and general partnership interests. The FCC has
stayed the effectiveness of these rules pending the outcome of the appeal of
the United States District Court decision holding the multiple ownership limit
provision of the 1992 Cable Act unconstitutional. The appeal of that decision
has been consolidated with an appeal of the FCC's regulatory ownership
restrictions. The FCC also has adopted rules which limit the number of
channels on a cable system that can be occupied by programming in which the
entity that owns the cable system has an attributable interest. The limit is
40% of all activated channels.
Federal cross-ownership restrictions have previously limited entry into the
cable television business by potentially strong competitors such as telephone
companies. The 1996 Act repeals the cross-ownership ban and provides that
telephone companies may operate cable television systems within their own
service areas.
The 1996 Act permits telephone companies to provide video programming
services as common carriers, cable operators or open video system ("OVS")
operators. If OVS systems become widespread in the future, cable television
systems could be placed at a competitive disadvantage because, unlike OVS
operators, cable television systems are required to obtain local franchises to
provide cable television service and must comply with a variety of obligations
under such franchises. Under the 1996 Act, common carriers leasing capacity
for the provision of video programming services over cable systems or OVS
operators are not bound by the interconnection obligations of Title II, which
otherwise would require the carrier to make capacity available on a
nondiscriminatory basis to any other person for the provision of cable service
directly to subscribers. Additionally, under the 1996 Act, common carriers
providing video programming are not required to obtain a Section 214
certification to establish or operate a video programming delivery system.
Common carriers that qualify as OVS operators are exempt from many of the
regulatory obligations that currently apply to cable operators. However,
certain restrictions and requirements that apply to cable operators will still
be applicable to OVS operations. Common carriers that elect to provide video
services over an OVS may do so upon obtaining certification by the FCC. Among
other requirements, the 1996 Act prohibits OVS operators from discriminating
in the provision of video programming services and requires OVS operators to
limit carriage of video services selected by the OVS operator to one-third of
the OVS's capacity. OVS operators must also comply with the FCC's sports
exclusivity, network nonduplication and syndicated
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exclusivity restrictions, public, educational, and government channel use
requirements, the "must-carry" requirements of the 1992 Cable Act, and
regulations that prohibit anticompetitive behavior or discrimination in the
prices, terms and conditions of providing vertically integrated satellite-
delivered programming. The manner in which OVS operators will be treated as
cable operators for purposes of copyright liability has not yet been
determined by the Copyright Office. Upon compliance with such requirements and
FCC rules that mirror statutory requirements, an OVS operator will be exempt
from various statutory restrictions which apply to cable operators, such as
broadcast-cable ownership restrictions, commercial leased access requirements,
franchising, rate regulation, and consumer electronics compatibility
requirements. Although OVS operators are not subject to franchise fees, as
defined by the 1996 Act, they may be subject to fees charged by local
franchising authorities or other governmental entities in lieu of franchise
fees. Such fees may not exceed the rate at which franchise fees are imposed on
cable operators and may be itemized separately on subscriber bills.
The FCC has ruled that cable operators may opt to operate OVS systems, but
only if they are subject to effective competition. Under the FCC's rules, a
cable operator may not terminate an existing franchise agreement to become an
OVS operator. An appeal of these rules is currently pending in the United
States Court of Appeals for the Fifth Circuit.
TELECOMMUNICATIONS REGULATION. The telecommunications services currently
offered by Cox affiliates and Sprint PCS are subject to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications service providers
to the extent that those facilities are used to provide, originate and
terminate interstate or international communications.
LANDLINE TELECOMMUNICATIONS SERVICES. While the current switched voice and
data market is dominated by local exchange companies, also known as incumbent
LECs, the 1996 Act presents new opportunities for new entrants into these
markets. The LECs provide a full range of local telecommunications services
and equipment to customers, as well as originating and terminating access to
their local networks to interexchange carriers and commercial mobile radio
service providers. Because LECs historically have had exclusive state
franchises by law to provide telephone services, they have established
monopoly relationships with their customers. Under the new law and subject to
certain exemptions for rural telephone companies, the FCC is directed to
preempt any state law or regulation that acts to prevent new competitive entry
into incumbent LEC markets.
The 1996 Act also eliminates the interexchange (interLATA) restrictions
contained in the Modified Final Judgment, the 1981 consent decree, and
establishes procedures under which a Bell Operating Company (BOC) can enter
the market for interLATA services within its telephone service area. Before a
BOC can enter the landline interLATA market, it must enter into a state-
approved interconnection agreement with a company that provides local exchange
service to business and residential customers predominantly over its own
facilities. Alternatively, if no such competitor requests interconnection, the
BOC can request authority to provide interLATA services if it offers
interconnection pursuant to state-approved terms and conditions. The
interconnection provided by the BOC must comply with a "competitive
checklist." Several BOCs have filed applications for authority to provide
interLATA services, including Southwestern Bell for Oklahoma and BellSouth for
Louisiana. The FCC has denied each of the applications it has considered to
date, although some of these denials are subject to pending appeals in the
United States Court of Appeals for the District of Columbia Circuit. The
United States District Court for the Northern District of Texas has declared
these provisions of the 1996 Act unconstitutional on the ground that they
constitute an impermissible bill of attainder against the BOCs, but the
effectiveness of that order has been stayed and both the FCC and several long
distance carriers have announced their intention to appeal the decision.
REGULATORY REQUIREMENTS FOR ALL LECS INCLUDING NEW ENTRANTS. Under the 1996
Act, new landline entrants will become subject to additional federal
regulatory requirements when they provide local exchange service in any
market. The 1996 Act imposes a number of access and interconnection
requirements on all LECs, with additional requirements imposed on incumbent
LECs. Specifically, the 1996 Act required the FCC to implement rules under
which all LECs must provide telephone number portability, dialing parity,
reciprocal compensation for transport and termination of local traffic, resale
and access to rights of way. In addition, the 1996 Act specifies procedures
for state commissions to review and approve both voluntary and compulsory
interconnection
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agreements entered into between new entrants and incumbent LECs. These
requirements also place burdens on new entrants that may benefit other
competitors. In particular, the resale requirement means that a company can
seek to resell the facilities of a new entrant without making a similar
investment in facilities.
One of the primary goals of the original Communications Act of 1934 was to
extend telephone service to all citizens of the United States. This goal has
been achieved primarily by maintaining the rates for basic local exchange
service at a reasonable level. It was widely accepted that incumbent LECs were
able to maintain relatively low local rates by subsidizing them with revenues
from business and toll services, and by subsidizing rural service at the
expense of urban customers. The extent of these subsidies has been widely
disputed and incumbent LECs that have this information generally have not made
it available for review and verification.
The 1996 Act continues the goal of preserving and advancing universal
service by requiring the FCC to establish an explicit mechanism for
subsidizing service to those who might otherwise drop off the public switched
telephone network. The rules adopted by the FCC in the Universal Service Order
require telecommunications carriers generally (subject to limited exemptions)
to contribute to funding existing universal service programs for high cost
carriers and low income customers and to new universal service programs for
schools, libraries and rural health care providers. The FCC has not yet
addressed universal service funding for high cost areas generally or
modifications to its universal service programs for rural carriers.
Depending upon how the FCC completes the implementation of its statutory
mandate and how states adjust their existing programs or create new programs,
this subsidy mechanism may provide an additional source of revenue to those
LECs willing and able to provide service to those markets that are less
financially desirable, either because of the high cost of providing service or
the limited revenues that might be available from serving a particular subset
of customers in an area, i.e., residential customers.
Another goal of the 1996 Act is to increase competition for
telecommunications services, thereby reducing the need for continuing
regulation of these services. To this end the 1996 Act requires the FCC to
streamline its regulation of incumbent LECs and permits the FCC to forbear
from regulating particular classes of telecommunications services or
providers, including through relaxation or potentially eventual termination of
FCC service tariffing requirements.
The 1996 Act eliminates the requirement that incumbent LECs obtain FCC
authorization prior to constructing facilities for interstate services. The
1996 Act also limits the FCC's ability to review incumbent LEC tariff filings.
These changes will increase the speed with which incumbent LECs are able to
introduce new service offerings and new pricing of existing services, thereby
increasing their flexibility to respond to new entrants.
In addition to incumbent LECs and existing competitive access providers, new
entrants potentially capable of offering switched and non-switched services
include individual cable television companies, electric utilities, long
distance carriers, microwave carriers, wireless service providers, resellers
and private networks built by large end-users.
BROADBAND PCS AUCTION. In the 1993 Budget Act, Congress gave the FCC the
authority to preempt states from regulating the entry of or the rates charged
by any Commercial Mobile Radio Service ("CMRS") provider, including PCS
providers. On February 3, 1994, the FCC adopted rules implementing the 1993
Budget Act and
created the CMRS regulatory classification. The CMRS classification applies to
all mobile services (including PCS) that are for profit and that provide
interconnected service to the public or a substantial portion of the public.
At that time, the FCC preempted state regulation and established a procedure
for states to petition the FCC for authority to regulate CMRS rates. Eight
states submitted requests to continue regulation of cellular providers within
their jurisdictions. On May 19, 1995, the FCC released orders denying the
requests.
States are permitted under the 1993 Budget Act to regulate "other terms and
conditions" of CMRS, including the siting and zoning of CMRS equipment. A
petition for rulemaking is pending before the FCC requesting that the FCC
preempt state and local siting and zoning regulation to the extent such
regulation acts to
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inhibit or prevent entry into the CMRS marketplace. The petition generally has
been opposed by state and local governments and supported by CMRS providers
and potential PCS providers. The 1996 Act contains a provision prohibiting
state and local governments from discriminating in their zoning decisions that
apply to personal wireless service facilities and enforcing rules or
regulations that prevent the provision of wireless services.
Additionally, the 1996 Act specifically determined that CMRS providers are
not required to provide equal access to interexchange carriers for the
provision of interexchange services. While the FCC has prescribed rules for
the unblocking of access to a preferred interexchange carrier, the legislation
does away with the equal access requirement imposed on the wireless affiliates
of the BOCs. In addition, the 1996 Act permits the BOCs, on enactment, to
provide interexchange service to their cellular customers.
The FCC has allocated 120 MHz of spectrum in the 2 GHz band to be licensed
to competing broadband PCS providers, which it is anticipated will offer
advanced digital wireless services in competition with current cellular and
specialized mobile radio services as well as with landline telephone service.
Broadband PCS spectrum was first auctioned by MTA licenses by the FCC in an
auction which ended in mid-March 1995. Six broadband PCS licenses have been
auctioned in each service area (except that only five licenses were auctioned
in the three markets in which pioneer preference licenses were issued), and
FCC rules permit some aggregation and disaggregation of PCS spectrum by PCS
operators. The first broadband PCS auction included two 30 MHz frequency
blocks of spectrum (Blocks "A" and "B") licensed by MTA. The second auction
was for 30 MHz blocks of broadband spectrum, licensed using Basic Trading
Areas (Block "C" auction). Block C licenses were available only to parties
that met specific FCC eligibility criteria. A Basic Trading Area spectrum
block, Block "F," was also auctioned only to parties meeting specific
eligibility criteria following the Block "C" auction. The FCC also has
licensed two Basic Trading Area 10 MHz blocks of spectrum, Blocks "D" and "E,"
which are not be subject to the additional eligibility requirements imposed on
Blocks "C" and "F."
STATE AND LOCAL REGULATION
CABLE TELEVISION REGULATION. Because a cable television system uses local
streets and rights-of-way, cable television systems are subject to state and
local regulation, typically imposed through the franchising process.
Consistent with the Communications Act, state and/or local officials are
usually involved in franchise selection, system design and construction,
safety, service rates, consumer relations, billing practices and community
related programming and services.
Cable television systems generally are operated pursuant to non-exclusive
franchises, permits or licenses granted by a municipality or other state or
local government entity. Franchises generally are granted for fixed terms and
in many cases are terminable if the franchise operator fails to comply with
material provisions. Although the 1984 Cable Act provides for certain
procedural protections, there can be no assurance that renewals will be
granted or that renewals will be made on similar terms and conditions.
Franchises usually call for the payment of fees, often based on a percentage
of the system's gross customer revenues, to the granting authority. Upon
receipt of a franchise, the cable system owner usually is subject to a broad
range of obligations to the issuing authority directly affecting the business
of the system. The terms and conditions of franchises vary materially from
jurisdiction to jurisdiction, and even from city to city within the same
state, historically ranging from reasonable to highly restrictive or
burdensome. The 1984 Cable Act places certain limitations on a franchising
authority's ability to control the operation of a cable system, and courts
have from time to time reviewed the constitutionality of several general
franchise requirements, including franchise fees and access channel
requirements, often with inconsistent results. On the other hand, the 1992
Cable Act prohibits exclusive franchises and allows franchising authorities to
exercise greater control over the operation of franchised cable television
systems, especially in the area of customer service and rate regulation. The
1992 Cable Act also allows franchising authorities to operate their own
multichannel video distribution system without having to obtain a franchise
and permits states or local franchising authorities to adopt certain
restrictions on the ownership of cable television systems. Moreover,
franchising authorities have immunity from monetary damage awards arising from
regulation of cable television systems or decisions made on franchise grants,
renewals, transfers and amendments.
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The specific terms and conditions of a franchise and the laws and
regulations under which it was granted directly affect the profitability of
the cable television system. Cable franchises generally contain provisions
governing fees to be paid to the franchising authority, length of the
franchise term, renewal, sale or transfer of the franchise, territory of the
franchise, design and technical performance of the system, use and occupancy
of public streets and number and types of cable services provided.
Various proposals have been introduced at the state and local levels with
regard to the regulation of cable television systems, and a number of states
have adopted legislation subjecting cable television systems to the
jurisdiction of centralized state governmental agencies, some of which impose
regulation of a character similar to that of a public utility.
STATE TELECOMMUNICATIONS REGULATION. In addition to federal rules and
regulations that apply to Cox's telephony operations, state commissions
regulate, to varying degrees, the intrastate services of landline
telecommunications providers, including those of Cox's landline affiliates.
While state commission regulation of new telecommunications providers is
generally less onerous than the regulation imposed on incumbent LECs, new
entrants providing local exchange services typically must apply for and
receive state certification and operate in accordance with state commission
pricing, terms and quality of service regulations. Under the 1996 Act, state
commissions also must review interconnection agreements entered into between
incumbent LECs and new entrants, as well as enforce the terms of disputed
agreements. States may also choose to assess universal service funding
contributions from new carriers provided that a state's program is consistent
with the FCC's universal service rules.
Most wireless services, including cellular and PCS, are exempted from state
certification requirements and from state rate regulation by Section 332 of
the Communications Act. States are permitted to regulate "other terms and
conditions" of wireless service, although the extent of that authority has not
been determined. The FCC has held that states are permitted to require
wireless providers to make payments into state universal service funds. That
determination is subject of pending appeals in the U.S. Courts of Appeals for
the Fifth Circuit and before the District of Columbia Circuit.
The foregoing does not purport to describe all present and proposed federal,
state and local regulations and legislation relating to the cable television
or telephony industries. Other existing federal regulations, copyright
licensing and, in many jurisdictions, state and local franchise requirements
currently are the subject of a variety of judicial proceedings, legislative
hearings and administrative and legislative proposals which could change, in
varying degrees, the manner in which cable television or telephony systems
operate. Neither the outcome of these proceedings nor their impact upon the
cable television or telephony industries can be predicted at this time.
The government of Mexico has authorized the allocation of a new broadcast
station on channel 3 in Tijuana, Mexico, which if constructed, will cause
interference with the operations of the Cox's cable system serving the San
Diego area. Cox provides its subscribers with converters which are tuned to
channel 3, and ingress from the station's signal wall cause co-channel
interference on the system in those areas of the San Diego market where the
station's signal is received. The United States Government has requested the
Mexican government to modify its proposed allocation. If the Mexican
government declines, Cox would be required to incur expenses to retune
subscribers' converters to a different channel. Cable reception in those
franchise areas where the station could be received would be disrupted until
the converters were retuned.
EMPLOYEES
At December 31, 1997, Cox had approximately 7,700 full-time-equivalent
employees. Cox considers its relations with its employees to be satisfactory.
ITEM 2. PROPERTIES
Cox's principal physical assets consist of cable television operating plant
and equipment, including signal receiving, encoding and decoding devices,
headends and distribution systems and customer house drop equipment for each
of its cable television systems. The signal receiving apparatus typically
includes a tower,
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antenna, ancillary electronic equipment and earth stations for reception of
satellite signals. Headends, consisting of associated electronic equipment
necessary for the reception, amplification and modulation of signals, are
located near the receiving devices. Cox's distribution system consists
primarily of coaxial and fiber optic cables and related electronic equipment.
Customer devices consist of decoding converters, cable modems and telephone
network interface units. The physical components of cable television systems
require maintenance and periodic upgrading to keep pace with technological
advances.
Cox's cable distribution plant and related equipment are generally attached
to utility poles under pole rental agreements with local public utilities,
although in some areas the distribution cable is buried in underground ducts
or trenches. Cox owns or leases parcels of real property for signal reception
sites (antenna towers and headends), microwave facilities and business offices
in each of its market areas and leases most of its service vehicles. Cox
believes that its properties, both owned and leased, taken as a whole, are in
good operating condition and are suitable and adequate for Cox's business
operations.
ITEM 3. LEGAL PROCEEDINGS
On October 9, 1997, three individual subscribers filed a putative class
action suit in Superior Court of the State of California, County of San Diego
against Cox and its cable system subsidiaries in California (the "Cox
California Systems") arising out of the manner in which the Cox California
Systems sell premium channel cable services. The suit alleges that the Cox
California Systems unlawfully require limited basic cable customers to
purchase the expanded basic services tier in order to purchase premium
channels, i.e., channels sold on an a la carte basis such as Home Box Office
and Showtime. The suit asserts causes of action under California antitrust and
consumer protection laws. The suit seeks injunctive relief as well as an order
awarding the class members compensatory damages, plus statutory damages,
punitive damages, interest and attorney's fees. On February 13, 1998, the
Court granted Cox's motion to stay the suit and referred it on grounds of
Primary Jurisdiction to the Federal Communications Commission for
consideration of issues best addressed by the FCC's expertise should the
plaintiffs elect to file a complaint with the FCC. The outcome of this matter
cannot be predicted at this time.
Cox and its subsidiaries in Arizona, Oklahoma, Louisiana and Florida are
defendants in seven putative subscriber class action suits in the respective
state courts initiated between October 17, 1997 and January 26, 1998. The
suits all challenge the propriety of late fees charged by the subsidiaries to
customers who fail to pay for services in a timely manner. The suits seek
injunctive relief and various formulations of damages under various claimed
causes of action under various bodies of state law. The actions are being
defended vigorously. The outcome of these matters cannot be predicted at this
time.
Cox is a party to various legal proceedings that are ordinary and incidental
to its business. Management does not expect that any legal proceedings
currently pending, individually or in the aggregate, will have a material
adverse effect on Cox or its business or operations. See Note 16 to the
Consolidated Financial Statements included herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference to the
section entitled "Shareholder Information" of Cox's 1997 Annual Report to
Stockholders (see Exhibit 13).
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected historical financial information for each of the five
years in the period ended December 31, 1997 has been derived from and should
be read in conjunction with the Consolidated Financial Statements and notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following selected pro forma data give effect to the Merger (as defined
herein) and related transactions as if they occurred on January 1, 1994. The
pro forma data do not purport to represent what Cox's results of operations or
financial condition would actually have been had the Merger occurred on such
date and are not necessarily indicative of future operating results or
financial condition.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------------------------------
PRO FORMA
------------------
1997 1996 1995 1994 1993 1995 1994
-------- -------- -------- -------- -------- -------- --------
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues............... $1,610.4 $1,460.3 $1,286.2 $ 736.3 $ 708.0 $1,328.1 $1,235.2
Operating income....... 205.3 221.7 226.0 139.8 179.7 231.3 219.8
Interest expense....... 202.1 146.1 132.3 46.1 12.9 140.1 148.9
Equity in net losses of
affiliated companies.. 404.4 170.4 79.7 43.9 28.2 79.7 54.2
Gain on sale and
exchange of cable
television systems.... 51.8 -- -- -- -- -- --
Gain on issuance of
stock by affiliated
companies............. 90.8 50.1 -- -- -- -- --
Gain on sale of
affiliated companies.. 248.7 4.6 188.8 -- -- 188.8 --
Loss on write down of
affiliated company.... 183.9 -- -- -- -- -- --
Income (loss) before
cumulative effect of
accounting changes.... (136.5) (51.6) 103.8 26.6 77.1 101.2 (12.8)
Net income (loss)...... (136.5) (51.6) 103.8 26.6 97.8 101.2 (12.8)
Basic and diluted net
income (loss) per
share................. $ (0.50) $ (0.19) $ 0.41 -- -- $ 0.39 $ (0.05)
OTHER OPERATING AND
FINANCIAL DATA (A):
Operating cash flow.... $ 609.8 $ 556.9 $ 493.3 $ 268.5 $ 295.7 $ 510.4 $ 473.6
Operating cash flow
margin................ 37.9% 38.1% 38.4% 36.5% 41.8% 38.4% 38.3%
Debt to operating cash
flow ratio............ 5.2x(b) 5.2x(b) 5.2x 2.9x 2.0x 5.0x 4.5x
BALANCE SHEET DATA:
December 31
Total assets........... $6,556.6 $5,784.6 $5,555.3 $1,874.7 $1,527.4 $5,555.3 $4,460.7
Total debt (including
amounts due to CEI)... 3,148.8 2,881.0 2,575.3 787.8 595.6 2,575.3 2,150.9
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------------------------------------------------
HISTORICAL PRO FORMA (A)
----------------------------------------------------- --------------------
1997 1996 1995 1994 1993 1995 1994
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
CUSTOMER DATA:
December 31
Homes passed........... 5,023,870 5,016,749 5,005,858 2,878,857 2,838,197 5,005,858 4,956,055
Basic customers........ 3,235,338 3,259,384 3,248,759 1,851,726 1,784,337 3,248,759 3,126,634
Premium service units.. 1,865,184 2,000,673 1,827,068 1,203,606 1,205,587 1,827,068 1,984,561
Basic penetration...... 64.4% 65.0% 64.9% 64.3% 62.9% 64.9% 63.1%
PrimeStar customers.... 171,531 130,606 56,822 17,894 -- 56,822 17,894
</TABLE>
- --------
(a) Operating cash flow (operating income before depreciation and
amortization) is a commonly used financial analysis tool for measuring and
comparing cable television companies in several areas, such as liquidity,
operating performance and leverage. Operating cash flow should not be
considered by the reader as an alternative to net income as an indicator
of Cox's performance or as an alternative to cash flows from operating
activities as a measure of liquidity.
(b) Using the fourth quarter annualized operating cash flow, the ratio was
4.6x and 4.9x at December 31, 1997 and 1996, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT ACQUISITIONS, DISPOSITIONS AND INVESTMENTS
U.S. BROADBAND NETWORKS
On February 1, 1995, Cox Communications, Inc. ("Cox"), Cox Enterprises, Inc.
("CEI"), The Times Mirror Company ("Times Mirror") and New TMC Inc. ("New
Times Mirror") consummated a merger (the "Merger"), pursuant to which Times
Mirror (which, at the time of the Merger, was engaged only in the cable
television business) merged with and into Cox. In connection with the Merger,
Cox Class A Common Stock became publicly traded on the New York Stock
Exchange. Following the Merger, New Times Mirror changed its name to "The
Times Mirror Company." As a result of the Merger, the former Times Mirror
stockholders received a total of approximately 54,904,252 shares of Cox Class
A Common Stock. Subsidiaries of CEI received 181,296,833 shares of Cox Class A
Common Stock and 13,798,896 shares of Cox Class C Common Stock.
In September 1995, Cox sold its cable television system serving
approximately 13,000 customers in Bullhead City, Arizona for $20 million. No
gain or loss resulted from this transaction.
In January 1996, Cox acquired a cable television system serving
approximately 51,000 customers in Newport News, Virginia, for approximately
$122.3 million. Cox operates this system as part of its cluster of systems in
the Hampton Roads, Virginia area.
In January 1996, Cox sold its cable television system in Texarkana, Texas.
The system, which was acquired as part of the Merger, served approximately
23,400 customers. No gain or loss resulted from this transaction.
In April 1996, Cox exchanged its Williamsport, Pennsylvania cable television
system for $13 million and a cable television system in East Providence, Rhode
Island. The Williamsport system, which was acquired as part of the Merger,
served approximately 24,500 customers in Williamsport. The East Providence
system serves approximately 15,500 customers. No gain or loss resulted from
this transaction.
In April 1996, Cox sold certain cable television systems in the Ashland,
Kentucky and Defiance, Ohio area for $136 million. These systems, which were
acquired as a result of the Merger, together served approximately 78,600
customers. No gain or loss resulted from this transaction.
In January 1997, Cox and Tele-Communications, Inc. ("TCI") exchanged certain
cable television systems owned by Cox serving approximately 319,000 customers
for certain cable television systems owned by TCI serving approximately
296,000 customers. As a result of the transaction, Cox received TCI's systems
in
35
<PAGE>
Bellevue/LaVista, Nebraska and Council Bluffs, Iowa; Chesapeake, Virginia;
Scottsdale, Arizona; North Attleboro/Taunton, Massachusetts; Lincoln, Rhode
Island; and St. Bernard, Louisiana. In exchange, TCI received Cox's systems in
the greater Pittsburgh area; Spokane, Washington; Springfield, Illinois; Cedar
Rapids, Iowa and the Quad Cities area of Illinois and Iowa; and Saginaw,
Michigan. No significant gain or loss resulted from this transaction.
In January 1997, Cox exchanged cable television systems in western
Massachusetts and Weymouth, Massachusetts for cable television systems in
James City and York County, Virginia and Pawtucket, Rhode Island. Each of the
systems served approximately 48,000 customers. No gain or loss resulted from
this transaction.
In March 1997, Cox exchanged its Myrtle Beach, South Carolina cable
television system serving approximately 42,200 customers for Hampton and
Williamsburg, Virginia cable television systems serving approximately 45,300
customers. The transaction included a Texas cable television system serving
approximately 7,000 customers which was purchased and them immediately traded
by Cox. Cox recognized a book gain of $27.8 million in conjunction with the
exchange.
In September 1997, Cox sold its Sun City, California cable television
system, serving approximately 10,000 customers. An insignificant loss was
recognized in conjunction with the sale. The net proceeds from the sale of Sun
City were used in the Lafayette exchange described below.
In December 1997, Cox exchanged its Lafayette, Indiana cable television
system serving approximately 38,000 customers and the net proceeds from the
sale of Sun City for a suburban Phoenix cable system serving approximately
36,000 customers. No gain or loss resulted from this transaction.
In December 1997, Cox sold its Central Ohio cable television system, serving
approximately 85,000 customers for $204.2 million. Cox recognized a book gain
of $26.4 million in conjunction with the sale. For tax purposes, Cox accounted
for the disposition as a like-kind exchange. Tax rules allow Cox to defer a
substantial portion of the related tax gain on this transaction upon the
reinvestment of the net proceeds in qualifying future acquisitions. Cox is
presently pursuing additional qualifying reinvestment assets. At December 31,
1997, restricted cash of $204.2 million was held in escrow pending
reinvestment.
Telephony
Cox, TCI, Comcast and Sprint Corporation ("Sprint") engage in the wireless
communications business, primarily personal communication services ("PCS")
through a limited partnership, Sprint Spectrum L.P. with its subsidiaries
("Sprint PCS"), of which Cox owns a 15% interest. Sprint PCS was the
successful bidder for 29 broadband PCS licenses in the auction conducted by
the FCC that was completed in March 1995. The $2.1 billion total purchase
price for the 29 licenses has been paid to the FCC. Additionally, Sprint PCS
has invested in other entities that hold and operate PCS licenses. The
partnership agreement of Sprint PCS contemplates that the partners in the
aggregate may be required to make cash capital of up to $4.2 billion. Cox
recorded $225.2 million, $56.5 million and $7.9 million of equity in net
losses in affiliated companies for the years ended December 31, 1997, 1996 and
1995, respectively, for its ownership interest in Sprint PCS. As of January 1,
1998, a "Deadlock Event" occurred due to the failure of the partnership board
of Sprint Spectrum Holding Company, L.P. (the parent of Sprint PCS) to approve
the proposed 1998 budget. If the 1998 budget is not approved through the
resolution procedures set forth in the Sprint Spectrum Holding Company, L.P.
partnership agreement, certain specified buy/sell procedures may be triggered
which might result in a restructuring of the partners' interests in Sprint
Spectrum Holding Company, L.P., Cox's sale of its interest in Sprint Spectrum
Holding Company, L.P., Cox's acquisition of interests in Sprint Spectrum
Holding Company, L.P. held by other partners, or liquidation of Sprint
Spectrum Holding Company, L.P. Discussions among the partners about
restructuring their interest in Sprint PCS are ongoing. However, there is no
certainty the discussion will result in a change to the partnership structure.
Cox also owns, as of December 31, 1997, a 17.6% interest in PhillieCo L.P.
("PhillieCo"), a partnership formed by subsidiaries of Cox, TCI and Sprint.
PhillieCo was the successful bidder for a broadband PCS license for the
Philadelphia MTA. The approximately $85 million purchase price for this
license has already been paid to the FCC. PhillieCo is also affiliated with
the Sprint PCS nationwide network and uses the "Sprint PCS" trademark.
36
<PAGE>
In 1995, Cox was awarded a broadband personal communications service ("PCS")
license for the Los Angeles-San Diego Major Trading Area ("MTA") under the
Federal Communications Commission's ("FCC") pioneer preference program. Cox
and CEI, through subsidiaries, have formed a partnership, Cox Pioneer
Partnership ("CPP"), to own the two companies' joint interest in a PCS system
in the Los Angeles-San Diego MTA. CPP is owned approximately 78% by Cox and
approximately 22% by CEI. Cox and CEI have made and will make capital
contributions to CPP in proportion to their percentage interests. In December
1996, pursuant to previous agreements, CPP and Sprint Spectrum Holding
Company, L.P. (a partnership of Cox, TCI, Comcast and Sprint) formed Cox
Communications PCS, L.P. ("Cox PCS") to operate the PCS system in the Los
Angeles-Sand Diego MTA. Cox PCS is currently owned 49% by Sprint Spectrum
Holding Company, L.P. as limited partner and 51% by CPP as general partner. In
March 1997, upon approval from the FCC, Cox transferred the PCS license for
the Los Angeles-San Diego MTA to Cox PCS and Cox PCS assumed the related
license payment obligation to the FCC of $251.9 million. The December 1996
formation of Cox PCS and the March 1997 transfer of the license and obligation
resulted in Cox recording $36.5 million as a capital contribution from CEI.
In February 1998, CPP exercised its right under the Cox PCS partnership
agreement to sell a portion of its interest in Cox PCS to Sprint Spectrum
Holding Company, L.P. Upon the consummation of this sale, which will occur
following the receipt of required regulatory approvals, Cox PCS will be owned
59.2% by Sprint Spectrum Holding Company, L.P. as general partner and limited
partner and 40.8% by CPP as general partner. The net proceeds of the sale will
be allocated between Cox and CEI in accordance with the partnership agreement
of CPP. Cox recorded $85 million of equity in net losses in affiliated
companies for the year ended December 31, 1997 related to the operations of
Cox PCS. Additionally, Cox recorded $60.7 million and $6 million of equity in
net losses of affiliated companies for the years ended December 31, 1996 and
1995 respectively, related to the operations of the PCS system prior to the
formation of Cox PCS.
Prior to June 1996, Cox held a 30.06% interest in each of Teleport
Communications Group Inc. ("TCGI") and TCG Partners ("TCGP"), which both owned
and operated fiber optic networks serving several U.S. markets and provide
point-to-point digital communications links to telecommunications businesses
and long-distance carriers. In June 1996, TCGI entered into a reorganization
under which, among other things, TCGI's four stockholders, Cox, Comcast,
MediaOne of Delaware, Inc., formerly Continental Cablevision, Inc.
("MediaOne") and TCI (collectively, the "Cable Stockholders") contributed to
TCGI all of their partnership interests in TCGP, additional interests in local
joint ventures and debt and accrued interest owned by TCGI to the Cable
Stockholders (the "Reorganization"). Following the Reorganization, TCGI
conducted an initial public offering in which it sold 27,025,000 shares of its
Class A Common Stock (the "TCGI IPO"). MediaOne sold its equity interest in
TCGI through several transactions culminating in a secondary offering in
November 1997. Cox owns 39,087,594 shares of TCGI's Class B Common Stock
which, as of December 31, 1997, represented 34.4% of TCGI's Class B Common
Stock, 22.4% of total shares outstanding and 32.7% of the voting power of
TCGI. Each share of Class B Common Stock is convertible into one share of
TCGI's Class A Common Stock. As a result of the TCGI IPO, Cox recorded a pre-
tax gain of $50.1 million to recognize Cox's proportionate increase in its
share of the underlying net assets of TCGI. Cox recorded $48.6 million, $28.5
million, and $19.3 million of equity in net losses of affiliated companies for
the years ended December 31, 1997, 1996 and 1995, respectively, for its
ownership interests in TCGI, TCGP and related joint ventures. In November
1997, Cox recognized a gain of approximately $90.8 million primarily resulting
from a secondary offering by TCGI. This offering reduced Cox's ownership
percentage to 22.4%.
In January 1998, TCGI agreed to a merger with AT&T Corp. ("AT&T") under
which TCGI shareholders will exchange each share of TCGI common stock for
0.943 of a share of AT&T common stock. Pending regulatory approval, the
transaction is expected to close in late 1998. Cox has been named along with
TCGI and TCGI officers and directors (including some who are officers of Cox),
as defendants in three putative class action suits filed in the Chancery Court
of New Castle County, Delaware. The suits challenge the proposed AT&T/TCGI
merger and seek injunctive relief and damages based on various theories
alleging that the proposed AT&T/TCGI merger's terms do not offer appropriate
compensation or protection to TCGI's public shareholders. The actions are
being defended vigorously. As a result of this transaction, if consummated,
Cox will own 36,859,601 shares of AT&T common stock, representing
approximately 2% of total AT&T common shares outstanding. Cox expects to
recognize a gain on this transaction.
37
<PAGE>
International Broadband Networks
In May 1995, Cox sold its 50% interest in STOFA A/S, a private operator of
cable television systems in Denmark, for $13.3 million resulting in a pre-tax
gain of approximately $10.2 million.
At December 31, 1997, Cox had a 14.6% ownership interest in TeleWest
Communications plc ("TeleWest"), a company that is currently operating and
constructing cable television and telephony systems in the U.K. Cox acquired
this interest in October 1995 through the merger of SBC CableComms (UK), which
was 50% owned by Cox, with TeleWest (the "TeleWest Merger"). As a result of
the TeleWest Merger, Cox recognized a pre-tax net gain of $174.8 million. In
December 1997, the decline in the fair market value of TeleWest was considered
to be other than temporary and accordingly Cox recognized an $183.9 million
loss on write down of affiliated company in its Consolidated Statement of
Operations. At December 31, 1997 and 1996, the carrying value of Cox's
investment in TeleWest was $240.4 million and $440.4 million, respectively.
Cable Television Programming and Other Investments
In October 1995, Cox acquired a 39% interest in the Speedvision Network
("Speedvision") and a 41% interest in the Outdoor Life Network ("Outdoor
Life"), two new U.S. programming services. Speedvision's programming consists
of a broad variety of material for automobile, boat and airplane enthusiasts;
Outdoor Life's programming consists primarily of outdoor recreation, adventure
and wildlife themes. Cox's interest in Speedvision and Outdoor Life was
increased to 51.4% and 49.3% as of December 31, 1997, respectively. Cox's
interest is expected to be reduced below 50% as a result of a third-party
investment. Cox recorded $22.6 million and $18.7 million of equity in net
losses of affiliated companies for the years ended December 31, 1997 and 1996,
respectively, for its ownership interests in both Speedvision and Outdoor
Life. The other partners include Comcast and MediaOne.
In March 1996, Syntellect, Inc. ("Syntellect") merged with the operations of
Telecorp Systems, Inc. ("Telecorp"). As a result of this merger, Cox received
an 8.6% interest in Syntellect in exchange for its 24.5% interest in Telecorp.
Cox recognized a pre-tax gain of $4.6 million related to this transaction.
In August 1996, Cox acquired a 14.2% interest in At Home Corporation
("@Home"). @Home is a national Internet "backbone" service that allows
customers access to the Internet at speeds up to a hundred times faster than
traditional phone modems by using a cable modem and the cable television
broadband network. In July 1997, @Home conducted an initial public offering.
As a result, the value of the @Home share price became readily determinable,
and accordingly Cox began to account for its investment in @Home as an
available-for-sale investment under Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The initial public offering reduced Cox's ownership
percentage to approximately 12.3% as of December 31, 1997. Also in the fourth
quarter 1997, Cablevision Systems Corporation was admitted as a partner
through the issuance of warrants. On a fully diluted basis giving effect to
the exercise of these warrants, Cox's ownership is approximately 11.3%.
In April 1997, Cox exchanged its 37.9% interest in UK Gold and 49.6%
interest in UK Living for 20,701,084 shares, or a 12.6% interest as of
December 31, 1997, in Flextech plc, a United Kingdom publicly held programming
company. Cox recognized a gain related to this transaction of $179.8 million.
In May 1997, Starsight Telecast, Inc. ("Starsight") merged with Gemstar
International Group Limited ("Gemstar"), a public company that develops and
markets proprietary technologies aimed at making technology more user-friendly
to consumers. Cox, as a holder of 2,166,647 Starsight shares, received
1,313,421 shares of Gemstar as a result of the merger, representing a 2.8%
interest in Gemstar as of December 31, 1997, and recognized a gain of
approximately $11 million related to this transaction. In December 1997, Cox
sold its entire interest in Gemstar for $29.3 million resulting in an
additional gain of approximately $9.9 million.
Pursuant to the Letter Agreement and Summary of Business Terms dated June
11, 1997, as superseded by certain definitive documentation, each of the
partners of PrimeStar agreed to merge with, or contribute their partnership
interests in PrimeStar and related assets and liabilities to, a new subsidiary
of TCI Satellite
38
<PAGE>
Entertainment, Inc., PrimeStar, Inc., in exchange for shares of common stock
of PrimeStar, Inc. and cash or the assumption of indebtedness. Upon
consummation of this transaction, Cox will own approximately 9.35% of
PrimeStar, Inc. The balance of PrimeStar, Inc. will be owned by the other
PrimeStar partners and the shareholders of TSAT. It is anticipated that Cox
will recognize a gain on this transaction, which is expected to close during
the second quarter of 1998.
In December 1997, Cox sold its 10.4% interest in E! Entertainment to
Comcast/The Walt Disney Company for $57 million, resulting in a pre-tax gain
of $44.9 million.
RESULTS OF OPERATIONS
1997 COMPARED WITH 1996
Revenues for the year ended December 31, 1997 were $1,610.4 million, a 10%
increase over revenues of $1,460.3 million for the year ended December 31,
1996. Basic customers were 3,235,338, a 2.7% increase over customers at
December 31, 1996 after adjusting for the trades and sales of cable systems
during 1997.
Complete basic revenues increased 8% to $1,074.5 million in 1997 due to
customer growth and average rate increases ranging between 6-7% each
implemented during the fourth quarters of 1996 and 1997. These increases are
the result of new channel additions, increased programming costs and pass-
through of inflation adjustments. New product tier revenues grew 28% to $18.2
million as a result of launching channel offerings in additional systems
during 1997.
Premium service revenues in 1997 were $186.6 million, down $2.2 million
compared to the comparable period in 1996, as premium units decreased to
1,865,184 due to the completion of the spring 1996 three-for-one promotion.
Pay-per-view revenues in 1997 were $47.3 million, a 4% increase from the same
period in 1996; however, excluding revenues from a March 1996 Tyson/Bruno
boxing event and a November 1996 Tyson/Holyfield boxing event, pay-per-view
revenues increased 21%. Advertising revenues increased 8% to $103.3 million
due to growth in local and national advertising sales during 1997; however,
excluding revenues from non-recurring 1996 Sprint campaigns, advertising
revenues increased 12%.
Revenues from satellite operations were $120.6 million for the current year,
a 45% increase over revenues of $83.2 million for the same period in 1996 as
PrimeStar customers increased to 171,531 at December 31, 1997 from 130,606 at
December 31, 1996. Other revenues increased to $59.9 million due to strong
growth in competitive local exchange carrier operations and residential high-
speed data services.
Programming costs were $357.9 million in 1997, an increase of 9% over 1996
due primarily to Cox's customer growth, January 1997 programming rate
increases and new channel additions. Plant operations expenses decreased 5% to
$133.3 million and included the effect of a revised cost component factor used
to capitalize indirect costs relating to network construction activity.
Marketing costs increased to $76.6 million in 1997 due in part to costs
associated with the rollout of high-speed data and telephony services. General
and administrative expenses for the year ended December 31, 1997 increased 9%
to $323.5 million due primarily to the increase in direct costs associated
with high-speed data and telephony services.
Depreciation was $330 million for the year ended December 31, 1997, a 25%
increase compared to the same period in 1996 due to the continued upgrade and
rebuild of the broadband network. Amortization increased 5% to $74.6 million
due to additional goodwill resulting from the trades of cable systems during
1997. Operating income for 1997 was $205.3 million, a decrease of 7% compared
to the same period in 1996.
Interest expense increased $56.1 million to $202.1 million due to the
discontinuance of capitalizing interest resulting from the launch of services
by Cox's PCS investments. Equity in net losses of affiliated companies was
$404.4 million primarily due to losses of $225.2 million, $85 million and
$48.8 million associated with Sprint PCS, Cox PCS and Teleport, respectively.
Gain on sale and exchange of cable television systems of $51.8 million
includes $24.6 million primarily related to the exchange of the Myrtle Beach
cable system during the first quarter of 1997 and $27.2 million
39
<PAGE>
primarily related to the sale of the Central Ohio cable television operation
in December 1997. Gain on issuance of stock by affiliated companies of $90.8
million, recognized during the fourth quarter 1997, primarily resulted from a
secondary public offering of Teleport. Gain on sale of affiliated companies of
$248.7 million includes $190.8 million recognized in the second quarter of
1997 primarily as a result of the exchange of Cox's interest in UK Gold and UK
Living to Flextech plc and $54.9 million recognized in the fourth quarter of
1997 primarily related to the sale of E! Entertainment Television. Loss on
write down of affiliated company of $183.9 million is due to the decline in
fair value of TeleWest considered to be other than temporary.
Net loss for the year ended December 31, 1997 was $136.5 million as compared
to net loss of $51.6 million for the year ended December 31, 1996.
Operating cash flow (operating income before depreciation and amortization)
is a commonly used financial analysis tool for measuring and comparing cable
television companies in several areas, such as liquidity, operating
performance and leverage. Consolidated operating cash flow increased 10% to
$609.8 million for the year ended December 31, 1997. Operating cash flow for
the core video business, which excludes satellite and competitive local
exchange carrier operations and $23.5 million of direct costs associated with
residential and commercial high-speed data and telephony services, grew 11% to
$612.3 million compared to 1996.
The consolidated operating cash flow margin (operating cash flow as a
percentage of revenues) for the year ended December 31, 1997 was 37.9%, a
slight decrease from 38.1% for the year ended December 31, 1996 due to the
increased launch costs associated with residential and commercial data and
telephony. The core video business operating cash flow margin was 41.6% for
the year, an increase from 40.4% for the comparable period of 1996. Operating
cash flow should not be considered as an alternative to net income as an
indicator of Cox's performance or as an alternative to cash flows from
operations as a measure of liquidity.
1996 COMPARED WITH 1995
The historical results discussed below for 1995 include the results of
operations for the former Times Mirror cable television systems from the
merger date of February 1, 1995.
Revenues for the year ended December 31, 1996 increased 14% over 1995 to
$1,460.3 million. Basic customers at December 31, 1996 were 3,259,384.
Adjusting for the acquisitions and sales of cable systems during 1996, basic
customers grew 2.3% in 1996.
Complete basic revenues grew 11% to $996.0 million in 1996 due to the larger
customer base and rate increases resulting from the 1996 channel additions and
pass-through of inflation adjustments. Premium service revenues for 1996 were
$188.8 million, a 2% increase over 1995. Although premium units increased 10%
to 2,000,673 at December 31, 1996, the average rate per unit was lower in the
current year due to a three-for-one premium channel promotion launched in
spring 1996. Pay-per-view revenues grew 8% to $45.6 million in 1996 primarily
due to the Tyson/Bruno and Tyson/Holyfield boxing events in 1996. Advertising
revenues increased 17% to $95.8 million in 1996 reflecting continued gains in
national account revenue and new customers such as Sprint.
Revenues from satellite operations (Cox Satellite Programming and PrimeStar)
for 1996 were $83.2 million compared to $41.1 million in 1995. This increase
is due to strong growth as PrimeStar customers more than doubled during the
current year to 130,606 at December 31, 1996 from 56,822 at December 31, 1995.
Programming costs were $326.9 million in 1996, a 11% increase over 1995 due
to Cox's larger customer base and the offering of additional channels in 1996.
Plant operations expenses increased 9% in 1996 as a result of Cox's increased
focus on customer retention programs and repairs of storm damage in certain
systems. Marketing costs were up 12% in 1996 due to the sales programs
associated with the premium channel promotion and an increase in overall Cox
advertising. General and administrative expenses were $297.3 million in 1996,
a 11% increase over 1995 due in part to direct costs associated with the
development of new high-speed data and
40
<PAGE>
telephony services and higher property taxes resulting from the continued
upgrade and rebuild of the broadband network in preparation for the delivery
of these new services.
Depreciation increased 33% in 1996 to $264.2 million reflecting accelerated
depreciation expensed in the current year as a result of the upgrade and
rebuild of the broadband network. Operating income for 1996 was $221.7
million, a 2% decrease compared to 1995.
Interest expense increased $13.8 million due primarily to the increase in
total debt outstanding. Equity in net losses of affiliated companies increased
$90.7 million due to increased losses from Sprint PCS, Cox PCS, Outdoor Life
and Speedvision. During 1996, Sprint PCS and Cox PCS's losses increased as a
result of developing and constructing their PCS networks in preparation for
their commercial launch of PCS services in December 1996. Outdoor Life and
Speedvision, which were launched as new cable programming networks during 1995
and 1996, respectively, incurred higher losses in the current year due to the
development of their customer base and program content.
A gain on issuance of stock by affiliated companies of $50.1 million was
recognized as a result of the initial public offering of TCGI. A gain on sale
of affiliated companies of $4.6 million was recognized as a result of the
merger of Telecorp and Syntellect. Net loss for the year was $51.6 million as
compared to net income of $103.8 million in 1995.
Operating cash flow for 1996 was $556.9 million, a 13% increase over
operating cash flow of $493.3 million in 1995. The consolidated operating cash
flow margin was 38.1% for 1996 as compared to 38.4% for 1995. The core video
business operating cash flow margin was 40.4% for 1996, an increase from 39.8%
for 1995.
LIQUIDITY AND CAPITAL RESOURCES
USES OF CASH
As part of Cox's ongoing strategic plan, Cox has invested, and will continue
to invest, significant amounts of capital to enhance the reliability and
capacity of its broadband network in preparation for the offering of new
services and to make investments in affiliated companies primarily focused on
telephony, programming and communications-related activities.
During 1997, Cox made capital expenditures of $708.1 million. These
expenditures were primarily directed at upgrading and rebuilding its broadband
network in preparation for the delivery of high-speed data and telephony.
Capital expenditures for 1998 and 1999 are expected to range between $725
million and $775 million. Capital expenditures for 2000 are expected to range
between $575 million and $625 million and for 2001 and 2002 are expected to
range between $475 million and $525 million.
In addition to expenditures in existing systems, Cox made strategic
investments in businesses focused on telephony, programming and communications
related activities. Investments in affiliated companies of $388.1 million
included additional equity funding of $366.7 million to Sprint PCS, Cox PCS
and other telephony investments and $21.4 million to PrimeStar Partners,
Outdoor Life, Speedvision and other interests. Future funding requirements for
investments in affiliated companies are expected to be approximately $70
million, primarily for Sprint PCS. These capital requirements for investments
in affiliated companies may vary significantly from the amounts stated above
and will depend on numerous factors as many of these affiliates are growing
businesses and specific financing requirements will change depending on the
evolution of these businesses.
Payments for exchange and acquisition of cable television systems of $66.8
million were made for exchanges of cable television systems that closed during
the first and fourth quarters of 1997.
Cox's current credit facilities contain covenants which, among other
provisions, restrict the payment of cash dividends or the repurchase of
capital stock if certain requirements are not met as to the ratio of debt to
operating
41
<PAGE>
cash flow. Historically, Cox has not paid dividends nor does Cox intend to pay
dividends in the foreseeable future but to reinvest future earnings,
consistent with Cox's business strategy. At December 31, 1997, the amount
available for the payment of dividends was $34.1 million; however, Cox does
not intend to pay dividends in the foreseeable future.
SOURCES OF CASH
During 1997, Cox generated $554.5 million from operations. Additionally, net
cash provided by financing activities was $539.3 million and included the
proceeds from revolving credit borrowings and the issuance of medium term
notes.
At December 31, 1997, Cox had $1,200 million revolving credit facility which
matures on October 9, 2002. In addition, Cox had an $800 million revolving
credit facility which matures on October 8, 1998, at which time any
outstanding borrowings convert to a long-term loan due October 8, 2001. These
facilities are committed to back outstanding commercial paper.
In June 1996, Cox entered into a commercial paper program under which Cox
may borrow $750 million. The commercial paper program is backed by amounts
available under the revolving credit facilities. The outstanding notes have
maturities up to 270 days and interest rates based on market. The interest
rates for outstanding commercial paper at December 31, 1997 and 1996 ranged
from 5.84% to 6.19% and 5.52% to 5.80%, respectively. In January, 1998 the
program was amended to increase the facility to $1,500 million. The proceeds
from the increase in the program will be used to refinance existing bank debt.
Thereafter, the proceeds will be used for general corporate purposes.
In April 1996, Cox filed a Form S-3 Registration Statement (the "Shelf
Registration") with the Securities and Exchange Commission under which Cox may
from time to time offer and issue debentures, notes, bonds or other evidence
of indebtedness for a maximum aggregate amount of $750 million. During 1996,
Cox sold $125 million of medium term notes under the Shelf Registration. The
notes are due in varying amounts through November 2006 with interest at fixed
rates ranging from 6.94% to 7.19%. The net proceeds to Cox were approximately
$124.3 million. During 1997, Cox sold an $100 million medium term note due
September 20, 2004 with interest at a fixed rate of 6.69%. The net proceeds to
Cox were approximately $99.4 million.
In June 1997, Cox issued $150 million principal amount of Floating Rate
Reset Notes due June 15, 2009 (the "Notes"). The Notes bear interest at a
floating rate equal to 0.8975% per annum below LIBOR until June 15, 1999, at
which time the interest rate will be reset at a fixed annual rate equal to
5.34% plus Cox's spread to the ten year Treasury. The Notes are redeemable at
the election of the holder, in whole but not in part, at 100% of the principal
amount on June 15, 1999. In addition, in exchange for a premium paid to Cox of
$2.9 million, the Notes may be purchased by a third party at the election of
the third party, in whole but not in part, at 100% of the principal amount on
June 15, 1999. Amortization of the premium will be reflected as adjustments to
interest expense. The interest rate for the Notes at December 31, 1997 was
4.91%.
In March 1997, upon approval from the FCC, Cox transferred the PCS license
for the Los Angeles-San Diego MTA and the related obligation to the FCC of
$251.9 million to Cox PCS. Prior to this transfer, the obligation to the FCC
was included in Cox's outstanding debt.
Proceeds from sale of affiliated companies of $93.3 million consist
primarily of proceeds received for the sale of E! Entertainment Television.
Proceeds from sale of cable television systems of $217.6 million included
$204.2 million resulting from the sale of the Central Ohio cable television
operation in December 1997 and $13.4 million resulting primarily from the sale
of the Sun City cable system in September 1997. Cash restricted for investment
of $204.2 million resulting from the sale of the Central Ohio cable television
operation will be held in escrow pending reinvestment in a future cable system
acquisition.
CEI continues to perform day-to-day cash management services for Cox with
settlements of balances between Cox and CEI occurring periodically at market
interest rates.
42
<PAGE>
At December 31, 1997, Cox had approximately $3,148.8 million of outstanding
indebtedness and had approximately $2,504 million available under its
revolving credit facilities, Shelf Registration and commercial paper program.
Cox's Notes and Debentures issued during 1997 are rated Baa2 by Moody's and A-
by Standard & Poor's.
Cox expects that the cost of its cable upgrades and investment activity will
exceed Cox's funds from operations and, therefore, additional capital will be
necessary. Cox believes it will be able to meet its capital needs for the next
twelve months with unused amounts available under existing revolving
agreements, the Shelf Registration and the commercial paper program. In
addition, Cox is pursuing alternatives to monetize certain unconsolidated
investments.
OTHER MATTERS
Cox is currently working to resolve the potential impact of the year 2000 on
the processing of data-sensitive information by Cox's computerized information
systems. The year 2000 problem is the result of computer programs being
written using two digits rather than four to define the applicable year. Any
of Cox's programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. Based on preliminary information, costs of
addressing potential problems are not currently expected to have a material
adverse impact on Cox's financial position, results of operations or cash
flows in future periods. However, if Cox, its customers or vendors are unable
to resolve such processing issues in a timely manner, it could result in a
material financial risk. Accordingly, Cox plans to devote the necessary
resources to resolve all significant year 2000 issues in a timely manner.
RATE REGULATION
Many franchising authorities have become certified by the FCC to regulate
rates charged by Cox for basic cable service and associated basic cable
service equipment. Some local franchising authority decisions have been
rendered that were adverse to Cox. In addition, a number of such franchising
authorities and customers of Cox filed complaints with the FCC regarding the
rates charged for cable programming services. In December 1995, the FCC
approved a Resolution of all outstanding rate complaints covering the Cox and
former Times Mirror cable television systems. The Resolution, among other
things, provided for the payment of refunds of $7.1 million plus interest to
one million customers in January 1996, and the removal of additional outlet
charges for regulated services from all of the former Times Mirror cable
television systems. The Resolution also stated that Cox's CPS tier rates as of
June 30, 1995 were not unreasonable. Refunds under the Resolution were fully
provided for in Cox's financial statements at December 31, 1995. In January
1996, the City of Irvine and six other cities located in California filed an
appeal to set aside the Resolution in the United States Court of Appeals for
the Ninth Circuit. Cox and the cities reached a settlement of the suit and the
appeal was dismissed with prejudice on November 6, 1997.
The Telecommunications Act of 1996 ("the 1996 Act") became effective in
February 1996. The 1996 Act is intended to promote substantial competition in
the delivery of video and other services by local telephone companies (also
known as local exchange carriers or "LECs") and other service providers, and
permits cable television operators to provide telephone services. Among other
provisions, the 1996 Act deregulates the CPS tier of large cable operators on
March 31, 1999 and upon enactment the CPS rates of small cable operators
serving 50,000 or fewer subscribers, revises the procedures for filing a CPS
complaint, and adds a new effective competition test.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Cox is exposed to interest rate risk due to its various debt instruments. In
accordance with the requirements of SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments," Cox estimated the fair value of its debt
instruments based on discounted cash flow analyses using Cox's incremental
borrowing rate for similar types of borrowing arrangements and dealer
quotations. The revolving credit agreements, commercial paper and floating
rate reset notes, at December 31, 1997 and 1996, bear interest at current
market rates and, thus, approximate fair value. The effect of a hypothetical
one percentage point increase in interest rates would decrease the estimated
fair value of remaining debt with a carrying amount of $1,518.4 million to
$1,477.7.
43
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
COX COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
ASSETS
Cash................................................... $ 28,259 $ 42,349
Restricted cash........................................ 204,210 --
Accounts and notes receivable, less allowance for
doubtful accounts of
$6,955 and $7,778..................................... 144,073 122,574
Net plant and equipment................................ 1,979,063 1,531,811
Investments............................................ 1,598,273 1,219,082
Intangible assets...................................... 2,458,717 2,728,955
Amounts due from Cox Enterprises, Inc. ("CEI")......... 50,856 --
Other assets........................................... 93,150 139,819
----------- -----------
Total assets......................................... $ 6,556,601 $ 5,784,590
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses.................. $ 217,984 $ 220,859
Deferred income........................................ 26,698 29,440
Deferred income taxes.................................. 721,594 294,453
Other liabilities...................................... 84,179 97,526
Debt................................................... 3,148,834 2,823,853
Amounts due to CEI..................................... -- 57,147
----------- -----------
Total liabilities.................................... 4,199,289 3,523,278
----------- -----------
Commitments and contingencies (Note 16)
Shareholders' equity
Preferred Stock, $1 par value; 5,000,000 shares
authorized; none issued............................. -- --
Class A Common Stock, $1 par value; 316,000,000
shares authorized; shares issued and outstanding:
257,276,414 and 256,463,651......................... 257,276 256,464
Class C Common Stock, $1 par value; 14,000,000 shares
authorized; shares issued and outstanding:
13,798,896.......................................... 13,799 13,799
Additional paid-in capital........................... 1,790,833 1,742,121
Retained earnings.................................... 79,605 216,097
Foreign currency translation adjustment.............. 13,510 23,424
Net unrealized gain on securities.................... 202,289 9,407
----------- -----------
Total shareholders' equity......................... 2,357,312 2,261,312
----------- -----------
Total liabilities and shareholders' equity......... $6,556,601 $5,784,590
=========== ===========
</TABLE>
See notes to consolidated financial statements.
44
<PAGE>
COX COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(THOUSANDS OF DOLLARS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C>
REVENUES
Complete basic..................... $ 1,074,495 $ 995,952 $ 900,869
New product tier................... 18,151 14,222 8,227
Premium service.................... 186,625 188,809 184,586
Pay-per-view....................... 47,314 45,610 42,343
Advertising........................ 103,271 95,840 81,858
Satellite.......................... 120,574 83,164 41,084
Other.............................. 59,934 36,688 27,279
------------ ------------ ------------
Total revenues................... 1,610,364 1,460,285 1,286,246
COSTS AND EXPENSES
Programming costs.................. 357,880 326,857 293,943
Plant operations................... 133,348 140,927 128,810
Marketing.......................... 76,570 62,589 55,954
General and administrative......... 323,536 297,335 267,418
Satellite operating and
administrative.................... 109,195 75,680 41,682
Restructuring charge............... -- -- 5,139
Depreciation....................... 329,951 264,188 198,788
Amortization....................... 74,587 70,973 68,524
------------ ------------ ------------
OPERATING INCOME..................... 205,297 221,736 225,988
Interest expense..................... (202,136) (146,077) (132,308)
Equity in net losses of affiliated
companies........................... (404,440) (170,435) (79,734)
Gain on sale and exchange of cable
television systems.................. 51,835 -- --
Gain on issuance of stock by
affiliated companies................ 90,796 50,100 --
Gain on sale of affiliated companies. 248,656 4,640 188,806
Loss on write down of affiliated
company............................. (183,914) -- --
Other, net........................... 3,918 11,531 951
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES.... (189,988) (28,505) (203,703)
Income taxes......................... (53,496) 23,046 99,894
------------ ------------ ------------
NET INCOME (LOSS).................... $ (136,492) $ (51,551) $ 103,809
============ ============ ============
PER SHARE DATA
Basic and diluted net loss per
share............................. $ (0.50) $ (0.19) $ 0.41
Basic weighted-average shares
outstanding....................... 270,500,791 270,240,757 255,886,525
Diluted weighted-average shares
outstanding....................... 270,500,791 270,240,757 255,457,955
</TABLE>
See notes to consolidated financial statements.
45
<PAGE>
COX COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
NET
FOREIGN UNREALIZED
ADDITIONAL CURRENCY GAIN
COMMON STOCK
PREFERRED ---------------- PAID-IN RETAINED TRANSLATION (LOSS) ON
STOCK CLASS A CLASS C CAPITAL EARNINGS ADJUSTMENT SECURITIES TOTAL
--------- -------- ------- ---------- --------- ----------- ---------- ----------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1994................... -- -- -- $ 670,495 $ 163,839 $(1,221) $ 1,712 $ 834,825
Net income............. 103,809 103,809
Issuance of stock
related to Merger..... $236,201 $13,799 682,001 932,001
Issuance of stock
related to public
offering and private
placement............. 19,799 337,231 357,030
Issuance of stock
related to stock
compensation plans.... 365 5,851 6,216
Capital contribution by
CEI................... 43,844 43,844
Foreign currency
translation
adjustment............ (2,192) (2,192)
Change in net
unrealized gain (loss)
on securities......... 56,480 56,480
--- -------- ------- ---------- --------- ------- -------- ----------
BALANCE AT DECEMBER 31,
1995................... -- 256,365 13,799 1,739,422 267,648 (3,413) 58,192 2,332,013
Net loss............... (51,551) (51,551)
Issuance of stock
related to stock
compensation Plans.... 99 1,591 1,690
Capital contribution by
CEI................... 1,108 1108
Foreign currency
translation
adjustment............ 26,837 26,837
Change in net
unrealized gain (loss)
on securities......... (48,785) (48,785)
--- -------- ------- ---------- --------- ------- -------- ----------
BALANCE AT DECEMBER 31,
1996................... -- 256,464 13,799 1,742,121 216,097 23,424 9,407 2,261,312
Net loss............... (136,492) (136,492)
Issuance of stock
related to stock
compensation plans.... 812 12,188 13,000
Capital contribution by
CEI................... 36,524 36,524
Foreign currency
translation
adjustment............ (9,914) (9,914)
Change in net
unrealized gain (loss)
on securities......... 192,882 192,882
--- -------- ------- ---------- --------- ------- -------- ----------
BALANCE AT DECEMBER 31,
1997................... -- $257,276 $13,799 $1,790,833 $ 79,605 $13,510 $202,289 $2,357,312
=== ======== ======= ========== ========= ======= ======== ==========
</TABLE>
See notes to consolidated financial statements.
46
<PAGE>
COX COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------
1997 1996 1995
----------- --------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................ $ (136,492) $ (51,551) $ 103,809
Adjustments to reconcile net income
(loss) to net cash provided by operating
activities, net of effects of
acquisitions:
Depreciation........................... 329,951 264,188 198,788
Amortization........................... 74,587 70,973 68,524
Equity in net losses of affiliated
companies............................. 404,440 170,435 79,734
Deferred income taxes.................. 101,821 (52,519) 22,730
Gain on issuance of stock by affiliated
companies............................. (90,796) (50,100) --
Gain on sale and exchange of cable
television systems.................... (51,835) -- --
Gain on sale of affiliated companies... (248,656) (4,640) (188,806)
Loss on write down of affiliated
company............................... 183,914 -- 20,662
Increase in accounts receivable.......... (29,312) (4,222) (25,372)
Increase (decrease) in accounts payable
and accrued expenses.................... (4,350) 31,161 15,666
Increase (decrease) in taxes payable..... 7,730 (32,762) 25,389
Other, net............................... 13,535 (31,826) 3,786
----------- --------- -----------
Net cash provided by operating
activities.......................... 554,537 309,137 324,910
=========== ========= ===========
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures..................... (708,089) (578,926) (369,557)
Investments in affiliated companies...... (388,075) (338,402) (527,922)
Proceeds from affiliated companies....... -- 162,287 113,222
Proceeds from sale of affiliated
companies............................... 93,342 -- --
Proceeds from sale of cable television
systems................................. 217,578 201,791 20,000
Cash restricted for investments.......... (204,210) -- --
Payments for exchange and acquisition of
cable television systems................ (66,762) -- (102,909)
Increase in amounts due from CEI......... (50,856) -- --
Other, net............................... (889) 1,085 1,632
----------- --------- -----------
Net cash used in investing activities.. (1,107,961) (552,165) (865,534)
----------- --------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Revolving credit borrowings (repayments),
net..................................... 350,000 (418,364) (1,191,902)
Commercial paper borrowings (repayments),
net..................................... (34,748) 718,704 --
Proceeds from issuance of debt........... 246,457 124,279 1,203,662
Repayment of debt........................ (15,993) (8,104) (19,990)
Proceeds from exercise of stock options.. 13,000 1,275 --
Payment to reacquire nonvoting redeemable
preferred stock outstanding............. (10,000) -- --
Increase (decrease) in amounts due to
CEI..................................... (19,359) (126,764) 175,770
Proceeds from issuance of common stock... -- -- 357,030
Increase (decrease) in book overdrafts... 9,977 (44,815) 51,874
----------- --------- -----------
Net cash provided by financing
activities............................ 539,334 246,211 576,444
----------- --------- -----------
Net increase (decrease) in cash.......... (14,090) 3,183 35,820
Cash at beginning of period.............. 42,349 39,166 3,346
----------- --------- -----------
Cash at end of period.................... $ 28,259 $ 42,349 $ 39,166
=========== ========= ===========
</TABLE>
See notes to consolidated financial statements.
47
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
Cox Communications, Inc. ("Cox"), an indirect 75.0% owned subsidiary of CEI,
is among the nation's largest multiple system operators, serving more than 3.2
million customers. Cox is a fully integrated, diversified broadband
communications company with interests in domestic cable distribution systems,
programming networks, telecommunications and technology and broadband
networks.
All significant intercompany accounts have been eliminated in the
consolidated financial statements of Cox. Certain amounts in the 1996 and 1995
financial statements have been reclassified for comparative purposes with
1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Restricted Cash
In December 1997, Cox sold its Central Ohio cable television operation,
serving approximately 85,000 customers, for $204,210,000. For tax purposes,
Cox accounted for the disposition as a like-kind exchange. Tax rules allow Cox
to defer a substantial portion of the related tax gain on this transaction
upon the reinvestment of the net proceeds in qualifying future acquisitions.
Cox is presently pursuing qualifying reinvestment properties. At December 31,
1997, restricted cash of $204,210,000 was held in escrow pending reinvestment.
Plant and Equipment
Depreciation is computed using principally the straight-line method at rates
based upon estimated useful lives of five to 20 years for buildings and
building improvements, five to 12 years for cable television systems and three
to 10 years for other plant and equipment.
The costs of initial cable television connections are capitalized as cable
plant at standard rates for Cox's labor and at actual costs for materials and
outside labor. Expenditures for maintenance and repairs are charged to
operating expense as incurred. At the time of retirements, sales or other
dispositions of property, the original cost and related accumulated
depreciation are written off.
Effective July 1, 1997, Cox revised the cost component factor used to
capitalize indirect costs relating to network construction activity resulting
in additional indirect costs being capitalized during the third and fourth
quarters.
Investments
Investments in affiliates are accounted for under the equity method or cost
basis depending upon the level of ownership in the investment and/or Cox's
ability to exercise significant influence over the operating and financial
policies of the investee. Equity method investments are recorded at cost and
adjusted periodically to recognize Cox's proportionate share of the investees'
undistributed income or losses.
Cost method investments in publicly traded companies are classified as
available-for-sale and are stated at publicly quoted market values with the
unrealized gains and losses recorded, net of taxes, as a separate component of
shareholders' equity. Losses are recorded as expense for any decline in market
value considered to be other than temporary. Cost method investments in
privately held companies are stated at cost adjusted for any known diminution
in value determined to be other than temporary in nature.
48
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Intangible Assets
Intangible assets consist primarily of goodwill and franchise costs.
Intangibles resulting from business combinations generally are amortized on a
straight-line basis over 40 years. Cox assesses on an on-going basis the
recoverability of intangible assets based on estimates of future undiscounted
cash flows for the applicable business acquired compared to net book value. If
the future undiscounted cash flow estimate is less than net book value, net
book value is then reduced to the undiscounted cash flow estimate. Cox also
evaluates the amortization periods of intangible assets to determine whether
events or circumstances warrant revised estimates of useful lives.
Impairment of Long-Lived Assets
Effective January 1, 1996, Cox adopted Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." This Statement requires
that long-lived assets and certain intangibles be reviewed for impairment when
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable, with any impairment losses being reported in the
period in which the recognition criteria are first applied based on the fair
value of the asset. Long-lived assets and certain intangibles to be disposed
of are required to be reported at the lower of carrying amount or fair value
less cost to sell. There was no impact on the financial statements upon
adoption of SFAS No. 121.
Pension, Postretirement and Postemployment Benefits
Cox generally provides defined pension benefits to all employees based on
years of service and compensation during those years. Cox provides certain
health care and life insurance benefits to substantially all employees and
retirees through certain CEI plans. Expense related to the CEI plans is
allocated to Cox through the intercompany account. The amount of the
allocations is generally based on actuarial determinations of the effects of
Cox employees' participation in the plans.
Stock Compensation Plans
As described in Note 11, Cox accounts for stock compensation plans using the
intrinsic value method prescribed in APB Opinion 25, "Accounting for Stock
Issued to Employees," and discloses the pro forma effect on net income and
earnings per share of using the fair value method as required by SFAS No. 123,
"Accounting for Stock-Based Compensation."
Foreign Currency Translation
The financial statements of Cox's non-U.S. investments are translated into
U.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation."
Net assets of non-U.S. investments whose functional currencies are other than
the U.S. dollar are translated at the current rate of exchange. Income and
expense items are translated at the average exchange rate for the year. The
resulting translation adjustments are recorded, net of taxes, directly into a
separate component of shareholders' equity.
Revenue Recognition
Cox bills its customers in advance; however, revenue is recognized as cable
television services are provided. Receivables are generally collected within
30 days. Credit risk is managed by disconnecting services to customers who are
delinquent. Other revenues are recognized as services are provided. Revenues
obtained from
49
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the connection of customers to the cable television systems are less than
related direct selling costs; therefore, such revenues are recognized as
received.
Restructuring Charge
During December 1995, Cox recorded a $5,139,000 pre-tax restructuring
charge. This charge principally represents severance, benefits and other
related costs associated with the elimination of 202 accounting and MIS staff
positions during 1996. At December 31, 1997 and 1996, the balance of the
restructuring liability was $0 and $1,698,000, respectively.
Capitalized Interest
Interest is capitalized as part of the historical cost of acquiring
qualifying assets, including advances to equity method investees used to
acquire qualifying assets while the investee has activities in progress
necessary to commence its planned principal operations. Interest capitalized
for the years ended December 31, 1996 and 1995 was $43,183,000 and
$14,188,000, respectively.
Income Taxes
The accounts of Cox historically have been included in the consolidated
federal income tax return and certain state income tax returns of CEI. Current
federal and state income tax expenses and benefits have been allocated on a
separate return basis to Cox based on the current year tax effects of the
inclusion of its income, expenses and credits in the consolidated income tax
returns of CEI or based on separate state income tax returns.
Deferred income tax assets and liabilities arise from differences in
recording certain income and expenses for financial reporting and income tax
purposes and are principally related to depreciation and amortization and
equity in net losses of affiliated companies.
Net Income (Loss) Per Common Share
Effective December 1997, Cox adopted SFAS No. 128, "Earnings per Share."
This statement establishes standards for computing and presenting earnings per
share ("EPS"). It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS on
the face of the consolidated statement of operations for all entities with
complex capital structures. Basic EPS is computed by dividing income available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS is computed similarly to fully diluted
EPS pursuant to APB Opinion No. 15, "Earnings per Share," which is superseded
by this Statement. This Statement requires restatement of all prior-period EPS
data presented. As Cox is in a net loss position for the years ended December
31, 1997 and 1996, basic and diluted EPS are based on the actual weighted-
average number of common shares outstanding. All potentially dilutive
securities are currently anti-dilutive and are not included in the diluted EPS
caluclation.
Cox Class A Common Stock became publicly traded on the New York Stock
Exchange effective February 1, 1995. The basic and diluted EPS calculations
for the year ended December 31, 1995 are presented in Note 12.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
50
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Recently Issued Accounting Pronouncements
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued.
This Statement requires that Cox (a) classify, by nature, items of
comprehensive income in a financial statement and (b) display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the balance sheet. This
statement will also require Cox to report comprehensive income, a measure of
performance that includes all non-owner sources of changes in equity, in
addition to net income (loss) reported in the financial statements.
Reclassification of financial statements for earlier periods provided for
comparative purposes will be required. There will be no effect on Cox's
financial position upon adoption in the first quarter of 1998.
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued. This Statement establishes standards for the
way public companies report information about their operating segments.
Operating segments are components of the enterprise about which separate
financial information is available and is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. This Statement requires that a public company report
segment profit or loss, certain specific revenue and expense items, and
segment assets. Companies must report information about the revenues derived
from the products or services (or groups of similar products and services),
about the countries in which the companies earn revenues and hold assets, and
about major customers regardless of whether that information is used in making
operating decisions. This Statement also requires that a public company
enterprise report descriptive information about the way that the operating
segments were determined, the products and services provided by the operating
segments, differences between the measurements used in reporting segment
information and those used in the enterprise's general-purpose financial
statements, and changes in the measurement of segment amounts from period to
period. SFAS 131 is effective for Cox's annual 1998 financial statements and
interim 1999 financial statements. The applicability of this statement to Cox
is still being assessed.
3. CASH MANAGEMENT SYSTEM
Cox participates in CEI's cash management system, whereby the bank sends
daily notification of checks presented for payment. CEI transfers funds from
other sources to cover the checks presented for payment. Book overdrafts of
$33,602,000 and $23,663,000 existed at December 31, 1997 and 1996,
respectively, as a result of checks outstanding. These book overdrafts are
reclassified as accounts payable and are considered financing activities in
the Consolidated Statement of Cash Flows.
4. ACQUISITIONS, DISPOSITIONS AND EXCHANGES OF BUSINESSES
Effective February 1, 1995, Cox, CEI, The Times Mirror Company ("Times
Mirror") and New TMC Inc. ("New Times Mirror") consummated a merger (the
"Merger"), pursuant to which Times Mirror (which, at the time of the Merger,
was engaged only in the cable television business) merged with and into Cox.
In connection with the Merger, Cox Class A Common Stock became publicly traded
on the New York Stock Exchange. Following the Merger, New Times Mirror changed
its name to "The Times Mirror Company." As a result of the Merger, the former
Times Mirror stockholders received a total of approximately 54,904,252 shares
of Cox Class A Common Stock. Subsidiaries of CEI received 181,296,833 shares
of Cox Class A Common Stock and 13,798,896 shares of Cox Class C Common Stock.
The Merger was accounted for by the purchase method of accounting, whereby the
purchase price was allocated to the assets and liabilities assumed based on
their estimated fair values at the date of acquisition. The excess of the
purchase price over the fair value of net assets acquired has been recorded as
goodwill and is being amortized on a straight-line basis over 40 years.
Results of operations have been included in the consolidated financial
statements from the date of acquisition.
51
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In September 1995, Cox sold its cable television system serving
approximately 13,000 customers in Bullhead City, Arizona for $20,000,000. No
gain or loss resulted from this transaction.
In January 1996, Cox acquired a cable television system serving
approximately 51,000 customers in Newport News, Virginia, for approximately
$122,250,000. Cox operates this system as part of its cluster of systems in
the Hampton Roads, Virginia area.
In January 1996, Cox sold its cable television system in Texarkana, Texas.
The system, which was acquired as part of the Merger, served approximately
23,400 customers. No gain or loss resulted from this transaction.
In April 1996, Cox exchanged its Williamsport, Pennsylvania cable television
system for $13,000,000 and a cable television system in East Providence, Rhode
Island. The Williamsport system, which was acquired as part of the Merger,
served approximately 24,500 customers in Williamsport. The East Providence
system serves approximately 15,500 customers. No gain or loss resulted from
this transaction.
In April 1996, Cox sold certain cable television systems in the Ashland,
Kentucky and Defiance, Ohio area for $136,000,000. These systems, which were
acquired as a result of the Merger, together served approximately 78,600
customers. No gain or loss resulted from this transaction.
In January 1997, Cox and Tele-Communications, Inc. ("TCI") exchanged certain
cable television systems owned by Cox serving approximately 319,000 customers
for certain cable television systems owned by TCI serving approximately
296,000 customers. As a result of the transaction, Cox received TCI's systems
in Bellevue/LaVista, Nebraska and Council Bluffs, Iowa; Chesapeake, Virginia;
Scottsdale, Arizona; North Attleboro/Taunton, Massachusetts; Lincoln, Rhode
Island; and St. Bernard, Louisiana. In exchange, TCI received Cox's systems in
the greater Pittsburgh area; Spokane, Washington; Springfield, Illinois; Cedar
Rapids, Iowa and the Quad Cities area of Illinois and Iowa; and Saginaw,
Michigan. No significant gain or loss resulted from this transaction.
In January 1997, Cox exchanged cable television systems in western
Massachusetts and Weymouth, Massachusetts for cable television systems in
James City and York County, Virginia and Pawtucket, Rhode Island. Each of the
systems served approximately 48,000 customers. No gain or loss resulted from
this transaction.
In March 1997, Cox exchanged its Myrtle Beach, South Carolina cable
television system serving approximately 42,230 customers for Hampton and
Williamsburg, Virginia cable television systems serving approximately 45,300
customers. The transaction included a Texas cable television system serving
approximately 7,000 customers which was purchased and them immediately traded
by Cox. Cox recognized a book gain of $27,800,000 in conjunction with the
exchange.
In September 1997, Cox sold its Sun City California cable television system,
serving approximately 10,000 customers. An insignificant loss was recognized
in conjunction with the sale. The net proceeds from the sale of Sun City were
used in the Lafayette exchange described below.
In December 1997, Cox exchanged its Lafayette, Indiana cable television
system serving approximately 38,000 customers for a suburban Phoenix cable
system serving approximately 36,000 customers. No gain or loss resulted from
this transaction.
In December 1997, Cox sold its Central Ohio cable television system, serving
approximately 85,000 customers for $204,200,000. Cox recognized a book gain of
$26,400,000 in conjunction with the sale. For tax purposes, Cox accounted for
the disposition as a like-kind exchange. Tax rules allow Cox to defer a
substantial
52
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
portion of the related tax gain on this transaction upon the reinvestment of
the net proceeds in qualifying future acquisitions. Cox is presently pursuing
qualifying reinvestment assets. At December 31, 1997, restricted cash of
$204,200,000 was held in escrow pending reinvestment.
5. PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Land.................................................. $ 29,384 $ 26,649
Buildings and building improvements................... 128,772 90,522
Transmission and distribution plant................... 2,398,746 1,923,729
Miscellaneous equipment............................... 239,068 187,496
Construction in progress.............................. 44,948 114,627
----------- -----------
Plant and equipment, at cost........................ 2,840,918 2,343,023
Less accumulated depreciation......................... (861,855) (811,212)
----------- -----------
Net plant and equipment............................. $ 1,979,063 $ 1,531,811
=========== ===========
</TABLE>
6. INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Equity method investments.............................. $ 795,179 $ 713,500
Cost method investments:
Publicly traded companies............................ 799,518 474,396
Privately held companies............................. 3,576 31,186
----------- -----------
Total investments.................................. $ 1,598,273 $ 1,219,082
=========== ===========
</TABLE>
Summarized combined unaudited financial information for all equity method
investments and Cox's proportionate share (determined based on Cox's ownership
interest in each investment) for 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
COX'S
COMBINED PROPORTIONATE SHARE
YEAR ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
----------------------- --------------------
1997 1996 1997 1996
----------- ---------- --------- ---------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
Revenues......................... $ 2,589,222 $1,569,634 $ 541,655 $ 359,926
Operating loss................... (1,740,697) (283,539) (324,465) (82,637)
Net loss......................... (2,243,610) (566,626) (421,830) (159,415)
</TABLE>
<TABLE>
<CAPTION>
COMBINED
DECEMBER 31
-----------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Current assets.......................................... $ 1,854,575 $ 1,925,686
Noncurrent assets....................................... 10,685,314 6,144,486
Current liabilities..................................... 2,462,963 925,633
Noncurrent liabilities.................................. 6,633,148 3,497,226
Equity.................................................. 3,443,778 3,647,313
</TABLE>
53
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The summarized unaudited financial information presented below for certain
significant equity method investments served as the basis for which Cox
recorded its share of equity in net losses:
<TABLE>
<CAPTION>
SPRINT OUTDOOR GEMS
PCS COX PCS TCGI LIFE SPEEDVISION TELEVISION
---------- -------- --------- ------- ----------- ----------
YEAR ENDED DECEMBER 31, 1997
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues................ 248,607 37,366 494,300 13,287 10,882 11,529
Operating loss.......... (1,310,734) (223,656) (132,500) (22,029) (32,279) (5,406)
Net loss................ (1,563,387) (226,667) (222,700) (23,944) (34,314) (9,665)
Current assets.......... 456,823 71,612 600,161 17,034 11,143 9,338
Noncurrent assets....... 6,440,186 633,709 1,856,140 1,680 1,186 11,472
Current liabilities..... 750,546 164,457 375,272 11,002 11,329 7,245
Noncurrent liabilities.. 4,301,931 196,720 1,049,413 -- -- 22,815
Equity.................. 1,844,532 344,144 1,031,616 7,712 1,000 (9,250)
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues................ 4,175 692 283,400 3,278 2,254 8,776
Operating loss.......... (355,873) (60,871) (83,600) (23,173) (32,530) (11,444)
Net loss................ (443,094) (60,757) (126,600) (22,990) (32,418) (14,793)
Current assets.......... 399,543 26,381 787,561 3,584 2,239 4,997
Noncurrent assets....... 3,923,858 197,797 1,262,536 14,862 7,372 15,367
Current liabilities..... 450,869 123,070 242,236 4,327 7,085 19,973
Noncurrent liabilities.. 1,425,879 2,450 1,010,991 -- -- --
Equity.................. 2,446,653 98,658 796,870 14,119 2,526 391
</TABLE>
Cox's share of the net losses as stated above is not equal to the net losses
from equity investments reported in the Consolidated Statements of Operations
due to amortization and other expenses. At December 31, 1997, the aggregate
unamortized excess of Cox's investments over its equity in the underlying net
assets of the affiliates was approximately $31,184,000 and is being amortized
over periods ranging from five to 40 years. Amortization included in equity in
net losses of affiliates for the years ended December 31, 1997, 1996 and 1995
was $2,527,000, $4,272,000 and $5,622,000, respectively.
The investment balances above include investments in and advances to
affiliated companies. The advances are generally interest-bearing, long-term
notes receivable totaling $5,740,000 and $72,175,000 at December 31, 1997 and
1996, respectively. Interest income recognized on notes receivable was
$1,700,000, $11,951,000 and $9,496,000 in 1997, 1996 and 1995, respectively.
Cox has classified its cost method investments in publicly traded companies
as available-for-sale which have an aggregate cost of $439,378,000. At
December 31, 1997 and 1996, the carrying values of publicly traded companies
included unrealized gains of $339,356,000 ($202,289,000 net-of-tax) and
$15,787,000 ($9,407,000 net-of-tax), respectively. These unrealized gains are
based on quoted market values of publicly traded investments. The carrying
value of publicly traded companies at December 31, 1997 and 1996 also includes
a $20,784,000 and $33,277,000 foreign currency translation adjustment,
respectively, related primarily to Cox's interest in TeleWest Communications
plc ("TeleWest").
At December 31, 1997 and 1996, cost method investments in privately held
companies were carried at an aggregate cost of $3,576,000 and $31,186,000,
respectively. It was not practicable to estimate the fair values of privately
held investments due to lack of quoted market prices and the excessive cost
involved in determining such fair values.
54
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Telephony
In 1995, Cox was awarded a broadband PCS license for the Los Angeles-San
Diego Major Trading Area ("MTA") under the Federal Communications Commission's
("FCC") pioneer preference program. Cox and CEI, through subsidiaries, have
formed a partnership, Cox Pioneer Partnership ("CPP"), to own the two
companies' joint interest in a PCS system in the Los Angeles-San Diego MTA.
CPP is owned approximately 78% by Cox and approximately 22% by CEI. Cox and
CEI have made and will make capital contributions to CPP in proportion to
their percentage interests. In December 1996, pursuant to previous agreements,
CPP and Sprint Spectrum Holding Company, L.P. (a partnership of Cox, TCI,
Comcast Corporation ("Comcast") and Sprint Corporation ("Sprint")) formed Cox
Communications PCS, L.P. ("Cox PCS") to operate the PCS system in the Los
Angeles-San Diego MTA. Cox PCS is currently owned 49% by Sprint Spectrum
Holding Company, L.P. as limited partner and 51% by CPP as general partner. In
March 1997, upon approval from the FCC, Cox transferred the PCS license for
the Los Angeles-San Diego MTA to Cox PCS and Cox PCS assumed the related
license payment obligation to the FCC of $251.9 million. The December 1996
formation of Cox PCS and the March 1997 transfer of the license and obligation
resulted in Cox recording $36.5 million as a capital contribution from CEI.
In February 1998, CPP exercised its right under the Cox PCS partnership
agreement to sell a portion of its interest in Cox PCS to Sprint Spectrum
Holding Company, L.P. Upon the consummation of this sale, which will occur
following the receipt of required regulatory approvals, Cox PCS will be owned
59.2% by Sprint Spectrum Holding Company, L.P. as general partner and limited
partner and 40.8% by CPP as general partner. The net proceeds of the sale will
be allocated between Cox and CEI in accordance with the partnership agreement
of CPP. Cox recorded $84,980,000 of equity in net losses in affiliated
companies for the year ended December 31, 1997 related to the operations of
Cox PCS. Additionally, Cox recorded $60,700,000 and $6,000,000 of equity in
net losses of affiliated companies for the years ended December 31, 1996 and
1995 respectively, related to the operations of the PCS system prior to the
formation of Cox PCS.
In addition, Cox is a 15% partner in Sprint Spectrum L.P. ("Sprint PCS"),
which owns and operates a national, integrated wireless communications network
providing PCS services. Cox recorded $225,160,000, $56,500,000 and $7,900,000
of equity in net losses in affiliated companies for the years ended December
31, 1997, 1996 and 1995, respectively, for its ownership interest in Sprint
PCS. As of January 1, 1998, a "Deadlock Event" occurred due to the failure of
the partnership board of Sprint Spectrum Holding Company, L.P. (the parent of
Sprint PCS) to approve the proposed 1998 budget. If the 1998 budget is not
approved through the resolution procedures set forth in the Sprint Spectrum
Holding Company, L.P. partnership agreement, certain specified buy/sell
procedures may be triggered which might result in a restructuring of the
partners' interests in Sprint Spectrum Holding Company, L.P., Cox's sale of
its interest in Sprint Spectrum Holding Company, L.P., Cox's acquisition of
interests in Spring Spectrum Holding Company, L.P. held by other partners, or
liquidation of Sprint Spectrum Holding Company, L.P. Discussions among the
partners about restructuring their interests in Sprint PCS are ongoing.
However, there is no certainty the discussions will result in a change to the
partnership structure.
Prior to June 1996, Cox held a 30.06% interest in each of Teleport
Communications Group Inc. ("TCGI") and TCG Partners ("TCGP"), which both owned
and operated fiber optic networks serving several U.S. markets and provide
point-to-point digital communications links to telecommunications businesses
and long-distance carriers. In June 1996, TCGI entered into a reorganization
under which, among other things, TCGI's four stockholders, Cox, Comcast,
MediaOne of Delaware, Inc., formerly Continental Cablevision, Inc.
("MediaOne") and TCI (collectively, the "Cable Stockholders") contributed to
TCGI all of their partnership interests in TCGP, additional interests in local
joint ventures and debt and accrued interest owed by TCGI to the Cable
Stockholders (the "Reorganization"). Following the Reorganization, TCGI
conducted an initial public offering in which it sold 27,025,000 shares of its
Class A Common Stock (the "TCGI IPO"). MediaOne sold its equity interest in
TCGI through several transactions culminating in a secondary offering in
November 1997. Cox owns 39,087,594 shares of TCGI's Class B Common Stock
which, as of December 31, 1997, represented 34.4% of
55
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TCGI's Class B Common Stock, 22.4% of total shares outstanding and 32.7% of
the voting power of TCGI. Each share of Class B Common Stock is convertible
into one share of TCGI's Class A Common Stock. As a result of the TCGI IPO,
Cox recorded a pre-tax gain of $50,100,000 to recognize Cox's proportionate
increase in its share of the underlying net assets of TCGI. Cox recorded
$48,631,000, $28,500,000, and $19,300,000 of equity in net losses of
affiliated companies for the years ended December 31, 1997, 1996 and 1995,
respectively, for its ownership interests in TCGI, TCGP and related joint
ventures. In November 1997, Cox recognized a gain of approximately $90,800,000
primarily resulting from a secondary offering by TCGI. This offering reduced
Cox's ownership percentage to 22.4%.
In January 1998, TCGI agreed to a merger with AT&T Corp. ("AT&T") under
which TCGI shareholders will exchange each share of TCGI common stock for
0.943 of a share of AT&T common stock. Pending regulatory approval, the
transaction is expected to close in late 1998. Cox has been named along with
TCGI and TCGI officers and directors (including some who are officers of Cox),
as defendants in three putative class action suits filed in the Chancery Court
of New Castle County, Delaware. The suits challenge the proposed AT&T/TCGI
merger and seek injunctive relief and damages based on various theories
alleging that the proposed AT&T/TCGI merger's terms do not offer appropriate
compensation or protection to TCGI's public shareholders. The actions are
being defended vigorously. As a result of this transaction, if consummated,
Cox will own 36,859,601 shares of AT&T common stock, representing
approximately 2% of total AT&T common shares outstanding. Cox expects to
recognize a gain on this transaction.
International Broadband Networks
In May 1995, Cox sold its 50% interest in STOFA A/S, a private operator of
cable television systems in Denmark for $13,300,000 resulting in a pre-tax
gain of approximately $10,200,000.
At December 31, 1997, Cox had a 14.6% ownership interest in TeleWest, a
company that is currently operating and constructing cable television and
telephony systems in the U.K. Cox acquired this interest in October 1995
through the merger of SBC CableComms (UK), which was 50% owned by Cox, with
TeleWest (the "TeleWest Merger"). As a result of the TeleWest Merger, Cox
recognized a pre-tax net gain of $174,833,000. In December 1997, the decline
in the fair market value of TeleWest was considered to be other than temporary
and accordingly Cox recognized an $183,914,000 loss on write down of
affiliated company in its Consolidated Statement of Operations. At December
31, 1997 and 1996, the carrying value of Cox's investment in TeleWest was
$240,409,000 and $440,398,000, respectively.
Cable Television Programming and Other Investments
In October 1995, Cox acquired a 39% interest in the Speedvision Network
("Speedvision") and a 41% interest in the Outdoor Life Network ("Outdoor
Life"), two new U.S. programming services. Speedvision's programming consists
of a broad variety of material for automobile, boat and airplane enthusiasts;
Outdoor Life's programming consists primarily of outdoor recreation, adventure
and wildlife themes. Cox's interest in Speedvision and Outdoor Life was
increased to 51.4% and 49.3% as of December 31, 1997, respectively. Cox's
interest is expected to be reduced below 50% as a result of a third party
investment. Cox recorded $18,700,000 and $22,600,000 of equity in net losses
of affiliated companies for the years ended December 31, 1997 and 1996,
respectively, for its ownership interests in both Speedvision and Outdoor
Life. The other partners include Comcast and MediaOne.
In March 1996, Syntellect, Inc. ("Syntellect") merged with the operations of
Telecorp Systems, Inc. ("Telecorp"). As a result of this merger, Cox received
an 8.6% interest in Syntellect in exchange for its 24.5% interest in Telecorp.
Cox recognized a pre-tax gain of $4,640,000 related to this transaction.
In August 1996, Cox acquired a 14.2% interest in At Home Corporation
("@Home"). @Home is a national Internet "backbone" service that allows
customers access to the Internet at speeds up to a hundred times faster than
traditional phone modems by using a cable modem and the cable television
broadband network. In July
56
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1997, @Home conducted an initial public offering. As a result, the value of
the @Home share price became readily determinable, and accordingly Cox began
to account for its investment in @Home as an available-for-sale investment
under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The initial public offering reduced Cox's ownership percentage to
approximately 12.3%. Also in the fourth quarter 1997, Cablevision Systems
Corporation was admitted as a partner through the issuance of warrants. On a
fully diluted basis giving effect to the exercise of these warrants, Cox's
ownership is approximately 11.3%.
In April 1997, Cox exchanged its 37.9% interest in UK Gold and 49.6%
interest in UK Living for 20,701,084 shares, or a 12.6% interest, in Flextech
plc, a United Kingdom publicly held programming company. Cox recognized a gain
related to this transaction of $179,800,000.
In May 1997, Starsight Telecast, Inc. ("Starsight") merged with Gemstar
International Group Limited ("Gemstar"), a public company that develops and
markets proprietary technologies aimed at making technology more user friendly
to consumers. Cox, as a holder of 2,166,647 Starsight shares, received
1,313,421 shares of Gemstar as a result of the merger, representing a 2.8%
interest in Gemstar and recognized a gain of approximately $11,000,000 related
to this transaction. In December 1997, Cox sold its 2.8% interest in Gemstar
for $29,300,000 resulting in an additional gain of approximately $9,900,000.
Pursuant to the Letter Agreement and Summary of Business Terms dated June
11, 1997, as superseded by certain definitive documentation, each of the
partners of PrimeStar agreed to merge with, or contribute their partnership
interests in PrimeStar and related assets and liabilities to, a new subsidiary
of TCI Satellite Entertainment, Inc., PrimeStar, Inc., in exchange for shares
of common stock of PrimeStar, Inc. and cash or the assumption of indebtedness.
Upon consummation of this transaction, Cox will own approximately 9.35% of
PrimeStar, Inc. The balance of PrimeStar, Inc. will be owned by the other
PrimeStar partners and the shareholders of TSAT. It is anticipated that Cox
will recognize a gain on this transaction, which is expected to close during
the second quarter of 1998.
In December 1997, Cox sold its 10.4% interest in E! Entertainment to
Comcast/The Walt Disney Company for $57,000,000 resulting in a pre-tax gain of
$44,900,000.
Cox also owns: a 50% interest in TWC Cable Partners, which owns cable
television systems in Staten Island, New York, and Fort Walton Beach, Florida;
a 24.6% interest in Discovery Communications, Inc., a documentary programming
network that operates The Discovery Channel and The Learning Channel; a 50%
interest in GEMS Television, a Spanish-language network in North and South
America; and various other programming networks and cable television
businesses.
7. INTANGIBLE ASSETS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Goodwill.............................................. $ 2,727,321 $ 2,659,258
Franchise costs....................................... 66,232 79,195
PCS licenses including capitalized interest........... -- 277,176
Other................................................. 15,033 17,671
----------- -----------
Total............................................... 2,808,586 3,033,300
Less accumulated amortization......................... (349,869) (304,345)
----------- -----------
Net intangible assets............................... $ 2,458,717 $ 2,728,955
=========== ===========
</TABLE>
57
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. INCOME TAXES
Current and deferred income tax expenses (benefits) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------
1997 1996 1995
--------- -------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Current:
Federal......................................... $(152,623) $ 41,694 $59,029
State........................................... (2,694) 33,871 18,135
--------- -------- -------
Total current................................. (155,317) 75,565 77,164
--------- -------- -------
Deferred:
Federal......................................... 95,932 (38,340) 22,806
State........................................... 5,889 (14,179) (76)
--------- -------- -------
Total deferred................................ 101,821 (52,519) 22,730
--------- -------- -------
Net income tax expense........................ $ (53,496) $ 23,046 $99,894
========= ======== =======
</TABLE>
Income tax expense differs from the amount computed by applying the U.S.
statutory federal income tax rate (35%) to income (loss) before income taxes
as a result of the following items:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1997 1996 1995
-------- ------- -------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Computed tax expense (benefit) at federal statutory
rates on income (loss) before income taxes........ $(66,499) $(9,977) $71,296
State income taxes, net of federal tax benefit..... (7,404) 12,793 11,738
Amortization of acquisition adjustments............ 18,491 19,075 19,257
Benefit arising from low income housing credits.... -- (3,494) (4,532)
Non-deductible preferred stock dividends of a
subsidiary........................................ 1,169 2,339 2,339
Other, net......................................... 747 2,310 (204)
-------- ------- -------
Net income tax expense........................... $(53,496) $23,046 $99,894
======== ======= =======
</TABLE>
Significant components of the net deferred tax liability consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Depreciation and amortization........................ $ (463,527) $ (266,219)
Equity in net losses of affiliated companies......... (124,478) (27,921)
Unrealized gain on securities........................ (143,788) (6,341)
Other................................................ 10,199 6,028
----------- -----------
Net deferred tax liability......................... $ (721,594) $ (294,453)
=========== ===========
</TABLE>
Management believes that any additional liabilities arising from current
tax-related audits are sufficiently provided for at December 31, 1997.
58
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. DEBT
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Revolving credit facilities........................... $ 799,999 $ 449,999
Commercial Paper, net of unamortized discount of
$2,191 and $3,296.................................... 683,300 718,704
Medium-term notes..................................... 263,352 166,082
Floating Rate Reset Notes, due June 15, 2009, net of
unamortized discount
of $2,820............................................ 147,180 --
6.375% Notes due June 15, 2000, net of unamortized
discount of $587 and $821............................ 424,414 424,179
6.5% Notes, due November 15, 2002, net of unamortized
discount of $430
and $517............................................. 199,570 199,483
6.875% Notes, due June 15, 2005, net of unamortized
discount and hedging of $12,462 and $13,661.......... 362,538 361,339
7.25% Debentures, due November 15, 2015, net of
unamortized discount of $840 and $880................ 99,160 99,120
7.625% Debentures, due June 15, 2025, net of
unamortized discount and hedging of $17,953 and
$18,128.............................................. 132,047 131,872
Obligation to the FCC................................. -- 251,918
Capitalized lease obligations......................... 37,274 21,157
----------- -----------
Total debt............................................ $ 3,148,834 $ 2,823,853
=========== ===========
</TABLE>
Revolving Credit Facilities
At December 31, 1997, Cox had an $1,200 million revolving credit facility
which matures on October 9, 2002. In addition, Cox had an $800 million
revolving credit facility which matures on October 8, 1998, at which time any
outstanding borrowings convert to a long-term loan due October 8, 2001. These
facilities are committed to back outstanding commercial paper as discussed
below.
At Cox's option, the interest rates on borrowings under the revolving credit
agreements are based on the London Interbank Offered Rate or the certificate
of deposit rate plus varying percentages or an alternate base rate. In
addition, the $1,200 million facility permits up to $500 million in borrowings
in any G-7 currency, with interest thereon based on the interbank domestic
eurocurrency rate for such currency. Interest rates under the revolving credit
facilities ranged from 5.81% to 6.37% and 5.69% to 6.94% during the years
ended December 31, 1997 and 1996, respectively. The credit facilities impose a
commitment fee on the unused portion of the total amount available of.085%
to.375% based on the ratio of debt to operating cash flow and a utilization
fee of.0625% to.1250% based on the level of borrowings.
These facilities contain covenants which, among other provisions, limit
Cox's ability to pay dividends and sell assets and require Cox to meet certain
requirements as to the ratio of debt to operating cash flow and the ratio of
operating cash flow to debt service. Historically, Cox has not paid dividends
nor does Cox intend to pay dividends in the foreseeable future but intends to
reinvest future earnings, consistent with Cox's business strategy. At December
31, 1997, the amount available for the payment of dividends was $34.1 million;
however, Cox does not intend to pay dividends in the foreseeable future.
Commercial Paper
In June 1996, Cox entered into a commercial paper program under which Cox
may borrow $750 million. The commercial paper program is backed by amounts
available under the revolving credit facilities. The
59
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
outstanding notes have maturities up to 270 days and interest rates based on
market. The interest rates for outstanding commercial paper at December 31,
1997 and 1996 ranged from 5.84% to 6.19% and 5.52% to 5.80%, respectively.
In January 1998 the program was amended to increase the facility to $1,500
million. The proceeds from the increase in the program will be used to
refinance existing bank debt. Thereafter, the proceeds will be used for
general corporate purposes.
Medium Term Notes
In April 1996, Cox filed a Form S-3 Registration Statement (the "Shelf
Registration") with the Securities and Exchange Commission under which Cox may
from time to time offer and issue debentures, notes, bonds or other evidence
of indebtedness for a maximum aggregate amount of $750 million. During 1996,
Cox sold $125 million of medium term notes under the Shelf Registration. The
notes are due in varying amounts through November 2006 with interest at fixed
rates ranging from 6.94% to 7.19%. The net proceeds to Cox were approximately
$124.3 million. During 1997, Cox sold $100 million medium term notes due
September 20, 2004 with interest at a fixed rate of 6.69%. The net proceeds to
Cox were approximately $99.4 million.
In addition, at December 31, 1997 and 1996, Cox had outstanding borrowings
under several fixed rate medium term notes totaling $41.8 million. The notes
are due in varying amounts through 2023 and interest is fixed at rates ranging
from 7.125% to 8.875%.
Floating Rate Reset Notes, due June 15, 2009
In June 1997, Cox issued $150 million principal amount of Floating Rate
Reset Notes due June 15, 2009 (the "Notes"). The Notes bear interest at a
floating rate equal to 0.8975% per annum below LIBOR until June 15, 1999, at
which time the interest rate will be reset at a fixed annual rate equal to
5.34% plus Cox's spread to the ten year Treasury. The Notes are redeemable at
the election of the holder, in whole but not in part, at 100% of the principal
amount on June 15, 1999. In addition, in exchange for a premium paid to Cox of
$2.9 million, the Notes may be purchased by a third party at the election of
the third party, in whole but not in part, at 100% of the principal amount on
June 15, 1999. Amortization of the premium will be reflected as adjustments to
interest expense. The interest rate for the Notes at December 31, 1997 was
4.91%.
6.375% Notes Due 2000
6.875% Notes Due 2005
7.625% Debentures Due 2025
In June 1995, Cox issued $425 million of unsecured 6.375% Notes Due 2000,
$375 million of unsecured 6.875% Notes Due 2005 and $150 million of unsecured
7.625% Debentures Due 2025. In anticipation of the issuance of these debt
securities, Cox had entered into a series of transactions under a forward
treasury lock agreement in order to hedge its interest rate exposure. Such
hedging transactions totaled a notional amount of $100 million for the Notes
Due 2005 and $100 million for the Debentures Due 2025. The hedging
transactions were settled at a total cost of approximately $32.3 million,
which will be reflected as adjustments to interest expense over the life of
the Notes Due 2005 and Debentures Due 2025. Amortization of the market
discounts, underwriting discounts and commissions and hedging and other
issuance costs will increase the effective interest rates on the Notes Due
2005 and Debentures Due 2025 to 7.452% and 8.784%, respectively.
The debt securities may not be redeemed by Cox prior to maturity, nor is Cox
required to make mandatory redemption or sinking fund payments prior to
maturity. In addition, the debt securities contain certain restrictive
60
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
covenants relating to, among other things, liens on assets, indebtedness of
restricted subsidiaries, designation of restricted subsidiaries and mergers
and sales of assets.
6.5% Notes Due 2002
7.25% Debentures Due 2015
In November 1995, Cox issued $200 million of unsecured 6.5% Notes Due 2002
and $100 million of unsecured 7.25% Debentures Due 2015. Amortization of the
market discounts, underwriting discounts and commissions and other issuance
costs increased the effective interest rates to 6.724% and 7.431%,
respectively. Net proceeds to Cox from the issuance of the debt securities
were approximately $296 million after market discounts, underwriting discounts
and commissions and other issuance costs.
The debt securities are redeemable in whole or in part, at Cox's option, at
fixed redemption prices. Cox is not required to make mandatory redemption or
sinking fund payments prior to maturity. In addition, the debt securities
contain certain restrictive covenants relating to, among other things, liens
on assets, indebtedness of restricted subsidiaries, designation of restricted
subsidiaries and mergers and sales of assets.
Obligation to the FCC
In March 1995, Cox was awarded a broadband PCS license for the Los Angeles-
San Diego MTA under the FCC's pioneer preference program at a cost to Cox of
$251.9 million. In March 1997, upon approval from the FCC, Cox transferred the
license and the related obligation to the FCC of $251.9 million to Cox PCS.
See additional discussion at Note 6.
Other
Maturities of long-term debt, including debt discount, for each of the five
years following December 31, 1997, are: $7.6 million, $28.4 million, $435.5
million, $44.3 million, $1,001.3 million, respectively. Commercial paper
outstanding at December 31, 1997 is classified as long-term as Cox intends to
refinance these borrowings on a long-term basis either through continued
commercial paper borrowings or utilization of other available credit
facilities. Included in the maturities of long-term debt are obligations under
capital leases of $7.6 million, $6.5 million, $4.9 million, $3.1 million and
$1.7 million for each of the five years following December 31, 1997,
respectively.
Fair Value of Financial Instruments
In accordance with the requirements of SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments," Cox estimated the fair value of its debt
instruments. The estimates are based on discounted cash flow analyses using
Cox's incremental borrowing rate for similar types of borrowing arrangements
and dealer quotations. The revolving credit agreements, commercial paper and
floating rate reset notes, at December 31, 1997 and 1996, bear interest at
current market rates and, thus, approximate fair value. Remaining debt with a
carrying amount of $1,518.4 million and $1,645.3 million is estimated to have
a fair value of $1,595.0 million and $1,671.6 million at December 31, 1997 and
1996, respectively.
10. RETIREMENT PLANS
Qualified Pension Plan
Effective January 1, 1996, Cox established the Cox Communications, Inc.
Pension Plan (the "CCI Plan"), a qualified noncontributory defined benefit
pension plan. The employees of the former Times Mirror cable
61
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
television systems became participants in the CCI Plan retroactive to the
Merger date of February 1, 1995. The remaining Cox employees, excluding
certain key employees, participated in the qualified noncontributory defined
benefit pension plan of CEI (the "CEI Plan") until August 1, 1996, when they
entered the CCI Plan and plan assets were transferred to the CCI Plan from
CEI. Times Mirror also transferred plan assets to the CCI Plan during 1996.
Plan assets consist primarily of common stock, investment-grade corporate
bonds, cash and cash equivalents and U.S. government obligations. The CCI Plan
calls for benefits to be paid to eligible employees at retirement based
primarily upon years of service with Cox and compensation rates near
retirement. Current policy is to fund the CCI Plan in an amount that falls
between the minimum contribution required by ERISA and maximum tax deductible
contribution.
Total pension expense attributable to Cox employees' participation in the
CCI Plan and the CEI Plan was $4,027,000, $5,180,000 and $3,972,000 for the
years ended December 31, 1997, 1996 and 1995, respectively. The 1997 pension
expense includes a credit to adjust for prior years estimates of pension
expense recognized for former employees of Times Mirror.
The reconciliation of the funded status of the CCI Plan at December 31, 1997
and 1996 is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------
1997 1996
----------- -----------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Actuarial present value
of:
Vested benefit
obligation............. $ 41,633 $ 22,212
Nonvested benefit
obligation............. 6,723 1,259
----------- ----------
Accumulated benefit
obligation............... $ 48,356 $ 23,471
=========== ==========
Plan assets at fair value. $ 95,083 $ 78,425
Projected benefit
obligation............... 75,676 68,486
----------- ----------
Plan assets in excess of
projected benefit
obligation............... 19,407 9,939
Unrecognized:
Net gain on plan assets. (15,304) (8,285)
Prior service costs..... 735 535
Net transition asset.... (1,107) (1,346)
----------- ----------
Prepaid pension cost...... $ 3,731 $ 843
=========== ==========
</TABLE>
The assumptions used in the actuarial computations at December 31, 1997 and
1996 were:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
------------
1997 1996
----- -----
<S> <C> <C>
Discount rate..................................................... 7.25% 7.75%
Rate of increase in compensation levels........................... 5.00 5.50
Expected long-term rate of return on plan assets.................. 9.00 9.00
</TABLE>
Nonqualified Pension Plan
Certain key employees of Cox participate in an unfunded, nonqualified
supplemental pension plan of CEI (the "Nonqualified CEI Plan") which has
generally the same benefit payout formula as the CCI Plan. Total pension
expense recorded by Cox for the Nonqualified CEI Plan was $1,474,000,
$1,386,000, and $895,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
62
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Other Retirement Plans
CEI provides certain health care and life insurance benefits to
substantially all retirees of Cox. Postretirement expense allocated to Cox by
CEI was $1,185,000, $1,060,000 and $888,000 for the years ended December 31,
1997, 1996 and 1995, respectively. The accumulated postretirement benefit
obligation ("APBO") attributable to Cox employees and retirees was $11,598,000
and $8,804,000 at December 31, 1997 and 1996, respectively. The funded status
of the postretirement plan covering the employees of Cox is not determinable.
The APBO for the postretirement plan of CEI substantially exceeded the fair
value of assets held in the plan at December 31, 1997 and 1996.
Actuarial assumptions used to determine the APBO include a discount rate of
7.25% and 7.75% for the years ended December 31, 1997 and 1996, respectively,
and an expected long-term rate of return on plan assets of 9% for both years.
For the years ended December 31, 1997 and 1996, the assumed health care cost
trend rate for retirees is 10.5% and 11.5%, respectively. For participants
prior to age 65, the trend rate gradually decreases to 5.5% by year 2007 and
remains level thereafter. For retirees at age 65 or older, this rate decreases
to 5.0% by year 2008. Increasing the assumed health care cost trend rate by
one percentage point would have resulted in an increase in the CEI plan's APBO
of approximately 9.6% and 6.5% and an increase in the aggregate of the service
cost and interest cost components of the net periodic postretirement benefit
cost of approximately 4.5% and 5.1% for the years ended December 31, 1997 and
1996, respectively.
In addition, substantially all of Cox's employees are eligible to
participate in the savings and investment plan of CEI. Under the terms of the
plan, Cox matches 50% of employee contributions up to a maximum of 6% of the
employee's base salary. Cox's expense under the plan was $4,606,000,
$4,504,000 and $3,881,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
11. STOCK COMPENSATION PLANS
At December 31, 1997, Cox had two stock-based compensation plans: a Long-
Term Incentive Plan ("LTIP") and an Employee Stock Purchase Plan ("ESPP"). Cox
applies APB Opinion 25 in accounting for its plans and accordingly, since the
grant price of stock compensation awards equals or exceeds the current market
price at the grant date, no compensation cost was recognized in 1997, 1996 and
1995 for these plans. Had compensation cost for the LTIP and ESPP been
determined based on the fair value at the grant dates for awards in 1997, 1996
and 1995 consistent with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," Cox's net income (loss) and net income (loss) per
share would have been reduced (increased) to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
(THOUSANDS OF DOLLARS)
-----------------------------
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
Net income (loss)--As reported................... $(136,492) $(51,551) $103,809
Net income (loss)--Pro Forma..................... (146,465) (55,807) 99,192
Basic and diluted net income (loss) per share--As
reported........................................ $ (0.50) $ (0.19) $ 0.41
Basic and diluted net income (loss) per share--
Pro Forma....................................... (0.54) (0.21) 0.39
</TABLE>
Effective upon consummation of the Merger, Cox adopted a LTIP under which
executive officers and selected key employees are eligible to receive awards
of various forms of equity-based incentive compensation, including stock
options, stock appreciation rights, stock bonuses, restricted stock awards,
performance units and phantom stock. Cox has reserved 6,000,000 shares of
Class A Common Stock for issuance under the LTIP. The LTIP is to be
administered by the Compensation Committee of the Cox Board of Directors or
its designee.
63
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Options granted may be "Incentive Stock Options" or "Nonqualified Stock
Options." The exercise prices of the options are determined by the
Compensation Committee when the options are granted, subject to a minimum
price of the fair market value of the Class A Common Stock on the date of
grant. These options become exercisable over a period of three to five years
from the date of grant and expire 10 years from the date of grant. An
accelerated vesting schedule has been provided such that the options become
fully vested if the market value of the shares exceeds the exercise price by
140% for ten consecutive trading days. During 1997, the acceleration
provisions were met based on the market value of the shares, effectively
resulting in all outstanding options becoming fully vested.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants in 1997 and 1996: expected volatility of 28%, no payment of dividends,
expected life of 4 years after vesting and risk-free interest rates of 6.3%
and 5.6%, respectively.
A summary of the status of Cox's stock options granted under the LTIP as of
December 31, 1997 1996 and 1995 and changes during the years ending on those
dates is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------- -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year................ 2,007,695 $18.34 1,506,253 $17.03 -- --
Granted................. 665,129 22.63 706,930 20.94 1,530,202 $17.03
Exercised............... (239,865) 17.87 (59,210) 16.98 -- --
Canceled................ (120,549) 19.25 (146,278) 17.98 (23,949) 16.98
--------- --------- ---------
Outstanding at end of
year................... 2,312,410 $19.57 2,007,695 $18.34 1,506,253 $17.03
========= ========= =========
Options exercisable at
year-end............... 2,312,410 18,851 59,277
Weighted-average grant
date fair value of
options granted during
the year............... $ 10.22 $ 9.17 $ 6.28
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------- --------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED- NUMBER WEIGHTED-
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$16.98 1,062,265 7.28 $16.98 1,062,265 $16.98
$20.44-
$21.13 619,707 7.81 20.93 619,707 20.93
$22.63 630,438 8.78 22.63 630,438 22.63
--------- ---------
2,312,410 7.83 $19.57 2,312,410 $19.57
========= =========
</TABLE>
In June 1995, Cox adopted an ESPP (the "1995 ESPP"), under which Cox was
authorized and did issue purchase rights totaling 750,000 shares of Class A
Common Stock to substantially all employees who had completed six months of
service. Under the terms of the 1995 ESPP, the purchase price was 90% of the
market value on June 1, 1995 and employees were allowed to purchase the shares
via payroll deductions through August 31, 1997, at which time the shares were
issued to the employees. As of August 31, 1997 the 1995 ESPP was completed and
557,209 shares were issued to employees. During 1996, 20,203 shares were
issued to employees due to cancellation of employees' participation in the
1995 ESPP or termination of employment. The fair value of the employees'
purchase rights granted in 1995 was estimated using the Black-Scholes model
with the
64
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
following assumptions: expected volatility of 28%, no payment of dividends,
expected life of 2.25 years and risk-free interest rate of 5.8%. The weighted-
average fair value of each purchase right granted in 1995 was $4.38.
In January 1998, Cox began administering a second ESPP which had been
adopted by Cox in April 1997 (the "1997 ESPP"), under which Cox was authorized
to issue purchase rights totaling 1,250,000 shares of Class A Common Stock to
substantially all employees who had completed six months of service. Purchase
rights totaling 558,001 shares were issued under the 1997 ESPP. Under the
terms of the ESPP, the purchase price was 85% of the market value on October
31, 1997 and employees were allowed to purchase the shares via payroll
deductions through January 31, 2000, at which time the shares will be issued
to the employees.
Units awarded under the UAP that would have matured in 1995, 1996 and 1997
were converted to 365,954 shares of restricted stock issued under the LTIP in
1995. These restricted shares vested on January 1, 1997 following the end of
the original five-year UAP appreciation period except that 34,684 shares
vested and 5,533 shares were canceled during 1995 and 1996 due to the
retirement or termination of certain participants.
12. SHAREHOLDERS' EQUITY
Cox is authorized to issue 316,000,000 shares of Class A Common Stock and
14,000,000 shares of Class C Common Stock. Except with respect to voting,
transfer and convertibility, shares of Class A Common Stock and Class C Common
Stock are identical in all respects. Holders of Class A Common Stock are
entitled to one vote per share and holders of Class C Common Stock are
entitled to ten votes per share. The Class C Common Stock is subject to
significant transfer restrictions and is convertible on a share for share
basis into Class A Common Stock at the option of the holder. In addition, Cox
is authorized to issue 5,000,000 shares of Preferred Stock. There are no
issued or outstanding shares of Preferred Stock at December 31, 1997.
In June 1995, Cox completed a public offering of 11,500,000 shares of Class
A Common Stock at a price of $18.875 per share. Cox also sold 8,298,755 shares
of Class A Common Stock for $150,000,000 in a private placement to CEI. Total
proceeds to Cox were approximately $357,031,000, net of underwriting discounts
and commissions and other issuance costs of approximately $10,032,000.
The following table reconciles the numerator and the denominator of the
basic and diluted per-share computations for income from operations for the
year ended December 31, 1995:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ ------------- ---------
<S> <C> <C> <C>
Net income................................. $103,809,000
------------
BASIC EPS.................................. 103,809,000 255,886,525 $0.41
=====
EFFECT OF DILUTIVE SECURITIES
Options.................................. -- (111,392)
ESPP..................................... -- (317,178)
------------ -----------
DILUTED EPS................................ $103,809,000 255,457,955 $0.41
============ =========== =====
</TABLE>
Options to purchase 542,717 shares of common stock at $39.22 per share were
granted on January 1, 1998. In addition, purchase rights totaling 558,001
shares of common stock were issued under the 1998 ESPP effective January 1998.
As of December 31, 1997 and 1996, CEI owned approximately 75.0% and 75.3%,
respectively, of the outstanding shares of Cox Common Stock and 82.9% and
83.1%, respectively, of the voting power of Cox.
65
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. TRANSACTIONS WITH AFFILIATED COMPANIES
Cox borrows funds for working capital and other needs from CEI. In addition,
certain management services are provided to Cox by CEI. Such services include
legal, corporate secretarial, tax, cash management, internal audit, risk
management, benefits administration and other support services. Cox was
allocated expenses for the years ended December 31, 1997, 1996 and 1995 of
approximately $2,838,000, $2,493,000 and $2,000,000, respectively, related to
these services. Cox pays rent and certain other occupancy costs to CEI for its
home office facilities, which amounts approximated $3,844,000, $3,000,000 and
$2,600,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Allocated expenses are based on CEI's estimate of expenses related to the
services provided to Cox in relation to those provided to other divisions of
CEI. Rent and occupancy expense is allocated based on occupied space.
Management believes that these allocations were made on a reasonable basis.
However, the allocations are not necessarily indicative of the level of
expenses that might have been incurred had Cox contracted directly with third
parties. Management has not made a study or any attempt to obtain quotes from
third parties to determine what the cost of obtaining such services from third
parties would have been. The fees and expenses to be paid by Cox to CEI are
subject to change.
In connection with the Merger, during 1995 CEI made additional capital
contributions to Cox of $43,844,000 by forgiving indebtedness in such amount
which Cox owed CEI.
In June 1995, CEI purchased 8,298,755 shares of Cox Class A Common Stock for
$150,000,000 in a private placement at a price per share equal to the public
offering price of the June 27, 1995 public offering less the underwriting
discounts thereon.
In August 1996, CEI transferred to the CCI Plan a prepaid pension cost of
$1,816,000 which represents the excess of the plan assets over the projected
benefit obligation attributable to the Cox employees that had previously
participated in the CEI Plan. This transfer resulted in a contribution to
capital of $1,108,000, net of federal and state deferred tax liabilities of
$708,000.
In March 1997, the formation of Cox PCS and the subsequent transfer to Cox
PCS of the PCS license for the Los Angeles-San Diego MTA and the related
obligation to the FCC (see Note 9) resulted in a capital contribution to Cox
of $36,524,000 from CEI.
The amounts due to CEI are generally due on demand and represent the net of
various transactions, including those described above. Outstanding amounts
to/from CEI bear interest at fifty basis points above CEI's current commercial
paper borrowings. This rate as of December 31, 1997 and 1996 was 6.5% and
6.2%, respectively.
Included in amounts due to (from) CEI are the following transactions:
<TABLE>
<CAPTION>
(THOUSANDS OF DOLLARS)
----------------------
<S> <C>
Intercompany due to CEI, December 31, 1995............... $ 182,605
Cash transferred to CEI................................ (282,829)
Net operating expense allocations and reimbursements... 158,479
Contribution to capital................................ (1,108)
---------
Intercompany due to CEI, December 31, 1996............... 57,147
Cash transferred from CEI.............................. 83,900
Net operating expense allocations and reimbursements... (155,379)
Contribution to capital................................ (36,524)
---------
Intercompany due from CEI, December 31, 1997............. $ (50,856)
=========
</TABLE>
66
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In accordance with the requirements of SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments," Cox has estimated the fair value of its
intercompany advances and notes payable. Given the short-term nature of these
advances, the carrying amounts reported in the balance sheets approximate fair
value.
Cox pays fees to certain entities in which it has an ownership interest in
exchange for cable television programming. Programming fees paid to such
affiliates for the years ended December 31, 1997, 1996 and 1995 were
approximately $30,225,000, $24,535,000 and $28,178,000, respectively.
14. SUBSIDIARY PREFERRED STOCK
At December 31, 1996, a subsidiary of Cox had $177,000,000 of nonvoting
redeemable preferred stock outstanding. In exchange for the stock, the
subsidiary of Cox received $10,000,000 in cash upon issuance of the stock in
1990 and a note receivable due in January 2001 of $167,000,000.
The long-term notes receivable from the outside investor have been netted
against the preferred stock due to a right of offset. The net amount,
$10,000,000 at December 31, 1996, has been included in other liabilities in
the Consolidated Balance Sheets.
The subsidiaries pay annual dividends of approximately $6,700,000 in the
aggregate on the outstanding preferred stock, which have been recorded as a
reduction of interest income on the notes.
On July 1, 1997, the Cox subsidiary exercised its right to call the
nonvoting redeemable preferred stock and paid the outside investor the
$10,000,000 originally received in 1990. The preferred stock was outstanding
for six months of 1997; thus, total dividends paid in 1997 were $3,300,000 and
were recorded as a reduction of interest income on the notes.
15. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- ----------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
SIGNIFICANT NON-CASH TRANSACTIONS:
Capital contributions by CEI.................. $ 36,524 $ 1,108 $ 43,844
Cox Common Stock issued in connection with the
Merger....................................... -- -- 932,000
Debt assumed in connection with Merger........ -- -- 1,364,000
Purchase (transfer) of PCS license............ (251,918) -- 251,918
TeleWest Merger stock exchange................ -- -- 407,800
Capitalized lease obligations................. 31,201 11,408 17,177
ADDITIONAL CASH FLOW INFORMATION:
Cash paid for interest........................ $ 206,861 $143,094 $ 141,692
Cash paid (refunded) for income taxes......... (151,047) 108,964 52,135
</TABLE>
67
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. COMMITMENTS AND CONTINGENCIES
Cox leases land, office facilities, and various items of equipment under
noncancellable operating leases. Rental expense under operating leases
amounted to $19,767,000 in 1997, $19,009,000 in 1996 and $15,660,000 in 1995.
Future minimum lease payments as of December 31, 1997 for all noncancellable
operating leases are as follows:
<TABLE>
<CAPTION>
(THOUSANDS OF DOLLARS)
----------------------
<S> <C>
1998..................................................... $ 7,206
1999..................................................... 5,583
2000..................................................... 4,794
2001..................................................... 4,191
2002..................................................... 3,175
Thereafter............................................... 18,506
-------
Total.................................................. $43,455
=======
</TABLE>
At December 31, 1997, Cox had outstanding purchase commitments totaling
approximately $54,285,000 for additions to plant and equipment and $95,377,000
to rebuild certain existing cable systems. Other commitments include
approximately $45,000,000 to fund the operations of Sprint PCS.
Cox has guaranteed borrowings of certain affiliates totaling approximately
$2,519,000 at December 31, 1997. Cox has unused letters of credit outstanding
totaling $1,839,000 at December 31, 1997, as required under agreements with
its franchise authorities.
Many franchising authorities have become certified by the FCC to regulate
rates charged by Cox for basic cable service and associated basic cable
service equipment. Some local franchising authority decisions have been
rendered that were adverse to Cox. In addition, a number of such franchising
authorities and customers of Cox filed complaints with the FCC regarding the
rates charged for cable programming services. In December 1995, the FCC
approved a Resolution of all outstanding rate complaints covering the Cox and
former Times Mirror cable television systems. The Resolution, among other
things, provided for the payment of refunds of $7,120,000 plus interest to one
million customers in January 1996, and the removal of additional outlet
charges for regulated services from all of the former Times Mirror cable
television systems. The Resolution also stated that Cox's cable programming
services tier rates as of June 30, 1995 were not unreasonable. Refunds under
the Resolution were fully provided for in Cox's financial statements at
December 31, 1995. In January 1996, the City of Irvine and six other cities
located in California filed an appeal to set aside the Resolution in the
United States Court of Appeals for the ninth Circuit. Cox and the cities
reached a settlement of the suit and the appeal was dismissed with prejudice
on November 6, 1997.
On October 9, 1997, three individual subscribers filed a putative class
action suit in Superior Court of the State of California, County of San Diego
against Cox and its cable system subsidiaries in California (the "Cox
California Systems") arising out of the manner in which the Cox California
Systems sell premium channel cable services. The suit alleges that the Cox
California Systems unlawfully require limited basic cable customers to
purchase the expanded basic services tier in order to purchase premium
channels, i.e., channels sold on an a la carte basis such as Home Box Office
and Showtime. The suit asserts causes of action under California antitrust and
consumer protection laws. The suit seeks injunctive relief as well as an order
awarding the class members compensatory damages, plus statutory damages,
punitive damages, interest and attorney's fees. On February 13, 1998, the
Court granted Cox's motion to stay the suit and referred it on grounds of
Primary Jurisdiction to the
68
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Federal Communications Commission for consideration of issues best addressed
by the FCC's expertise. The outcome of this matter cannot be predicted at this
time.
Cox and its subsidiaries in Arizona, Oklahoma, Louisiana and Florida are
defendants in seven putative subscriber class action suits in the respective
state courts initiated between October 17, 1997 and January 26, 1998. The
suits all challenge the propriety of late fees charged by the subsidiaries to
customers who fail to pay for services in a timely manner. The suits seek
injunctive relief and various formulations of damages under various claimed
causes of action under various bodies of state law. The actions are being
defended vigorously. The outcome of these matters cannot be predicted at this
time.
Cox is a party to various other legal proceedings that are ordinary and
incidental to its business. Management does not expect that any legal
proceedings currently pending, including the putative class actions, will have
a material adverse impact on Cox's consolidated financial position,
consolidated results of operations or consolidated cash flows.
17. UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following table sets forth selected historical quarterly financial
information for Cox. This information is derived from unaudited financial
statements of Cox and includes, in the opinion of management, all normal and
recurring adjustments that management considers necessary for a fair
presentation of the results for such periods.
<TABLE>
<CAPTION>
1997
----------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Complete basic.............. $ 263.3 $ 265.9 $ 267.6 $ 277.7
New product tier............ 4.7 4.8 4.6 4.1
Premium service............. 45.7 47.3 46.7 46.9
Pay-per-view................ 11.0 15.7 9.5 11.1
Advertising................. 21.3 25.8 25.5 30.7
Satellite................... 25.9 29.9 32.3 32.5
Other....................... 11.2 11.7 22.0 15.0
----------- ----------- ----------- -----------
Total revenues............ 383.1 401.1 408.2 418.0
Programming costs........... 88.5 92.2 89.2 88.0
Plant operations............ 38.1 38.2 33.2 23.8
Marketing................... 17.8 18.0 23.7 17.1
General and administrative.. 74.8 77.1 82.7 88.9
Satellite operating and
administrative............. 24.3 28.3 27.1 29.5
Depreciation................ 72.9 85.3 81.4 90.4
Amortization................ 17.0 19.0 21.6 17.0
----------- ----------- ----------- -----------
Operating income............ $ 49.7 $ 43.0 $ 49.3 $ 63.3
=========== =========== =========== ===========
Net income (loss)........... $ (37.8) $ 61.2 $ (82.0) $ (77.9)
=========== =========== =========== ===========
Basic and diluted net income
(loss) per share........... $ (0.14) $ 0.23 $ (0.30) $ (0.29)
=========== =========== =========== ===========
</TABLE>
69
<PAGE>
COX COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
1996
---------------------------------------------------
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
(MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Complete basic............. $ 247.9 $ 246.7 $ 246.1 $ 255.3
New product tier........... 3.2 3.4 3.5 4.1
Premium service............ 47.5 47.7 47.3 46.3
Pay-per-view............... 12.9 9.9 10.2 12.6
Advertising................ 20.5 22.0 25.3 28.0
Satellite.................. 17.7 19.3 22.0 24.2
Other...................... 7.8 8.4 9.4 11.1
----------- ----------- ----------- -----------
Total revenues........... 357.5 357.4 363.8 381.6
Programming costs.......... 82.7 79.5 81.8 82.9
Plant operations........... 34.8 34.5 35.8 35.8
Marketing.................. 15.3 17.0 16.0 14.3
General and administrative. 72.6 73.2 72.9 78.6
Satellite operating and
administrative............ 15.7 17.6 19.3 23.1
Depreciation............... 55.9 63.2 61.0 84.1(a)
Amortization............... 18.5 17.6 17.4 17.5
----------- ----------- ----------- -----------
Operating income........... $ 62.0 $ 54.8 $ 59.6 $ 45.3
=========== =========== =========== ===========
Net income (loss).......... $ 7.3 $ 27.0 $ (28.1) $ (57.8)
=========== =========== =========== ===========
Basic and diluted net
income (loss) per share... $ 0.03 $ 0.10 $ (0.10) $ (0.21)
=========== =========== =========== ===========
</TABLE>
- --------
(a) Depreciation for the fourth quarter of 1996 includes accelerated
depreciation of $18.5 million as a result of the upgrade and rebuild of the
broadband network.
70
<PAGE>
COX COMMUNICATIONS, INC.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Cox Communications, Inc.
We have audited the accompanying consolidated balance sheets of Cox
Communications, Inc. (Cox) as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of Cox'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 Cox
Communications, Inc. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
February 6, 1998
71
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated by reference to Cox's
Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to Cox's
Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to Cox's
Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to Cox's
Proxy Statement for the 1998 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents incorporated by reference or filed with this Report
(1) The financial statements required by Item 8 with respect to Cox
Communications PCS, L.P. and Cox California PCS, Inc. are incorporated by
reference herein (see Exhibit 99.1). The financial statements required by
Item 8 with respect to Sprint Spectrum Holding Company, L.P. are
incorporated by reference herein (see Exhibit 99.2). The financial
statements required by Item 8 with respect to Teleport Communications Group
Inc. are incorporated by reference herein (see Exhibit 99.3).
(2) No financial statement schedules are required to be filed by Items 8
and 14(d) because they are not required or are not applicable, or the
required information is set forth in the applicable financial statements or
notes thereto.
(3) Exhibits required to be filed by Item 601 of Regulation S-K:
72
<PAGE>
Listed below are the exhibits which are filed as part of this Report
(according to the number assigned to them in Item 601 of Regulation S-K):
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 -- Agreement and Plan of Merger, dated as of June 5, 1994, by and
among The Times Mirror Company, New TMC Inc., Cox Communications,
Inc. and Cox Enterprises, Inc. (Incorporated by reference to Exhibit
2.1 to Cox's Registration Statement on Form S-4, File No. 33-80152,
filed with the Commission on December 16, 1994.)
2.2 -- Amendment No. 1, dated as of December 16, 1994, to Agreement and
Plan of Merger by and among The Times Mirror Company, New TMC Inc.,
Cox Communications, Inc. and Cox Enterprises, Inc. (Incorporated by
reference to Exhibit 2.2 to Cox's Registration Statement on Form S-
4, File No. 33-80152, filed with the Commission on December 16,
1994.)
2.3 -- Amendment No. 2, dated as of January 30, 1995, to Agreement and
Plan of Merger by and among The Times Mirror Company, New TMC Inc.,
Cox Communications, Inc., and Cox Enterprises, Inc. (Incorporated by
reference to Exhibit 2.3 to Cox's Current Report on Form 8-K filed
with the Commission on February 15, 1995.)
3.1 -- Amended Certificate of Incorporation of Cox Communications, Inc.
(Incorporated by reference to Exhibit 3.1 to Cox's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.)
3.2 -- Certificate of Amendment to Certificate of Incorporation of Cox
Communications, Inc. (Incorporated by reference to Exhibit 3.3 to
Cox's Form 10-Q filed with the Commission on May 14, 1997.)
3.3 -- Bylaws of Cox Communications, Inc. (Incorporated by reference to
Exhibit 3.2 to Cox's Registration Statement on Form S-4, File No.
33-80152, filed with the Commission on December 16, 1994.)
4.1 -- Indenture dated as of June 27, 1995 between Cox Communications,
Inc. and The Bank of New York, as Trustee, relating to the 6 3/8%
Notes due 2000, 6 1/2% Notes due 2002, 6 7/8 Notes due 2005, 7 1/4%
Debentures due 2015 and the 7 5/8% Debentures due 2025 of Cox
Communications, Inc. (Incorporated by reference to Exhibit 4.1 to
Cox's Registration Statement on Form S-1, File No. 33-99116, filed
with the Commission on November 8, 1995.)
10.1 -- Amended and Restated Agreement of Limited Partnership of MajorCo,
L.P., dated as of January 31, 1996, among Sprint Spectrum, L.P., TCI
Network Services, Comcast Telephony Services and Cox Telephony
Partnership. * (Incorporated by reference to Exhibit 10.1 to Cox's
Current Report on Form 8-K filed with the Commission on February 9,
1996.)
10.2 -- Second Amended and Restated Joint Venture Formation Agreement,
dated as of January 31, 1996, by and between Sprint Corporation,
Tele-Communications, Inc., Comcast Corporation and Cox
Communications, Inc. * (Incorporated by reference to Exhibit 10.2 to
Cox's Current Report on Form 8-K filed with the Commission on
February 9, 1996.)
10.3 -- Parents Agreement, dated as of January 31, 1996 between Cox
Communications, Inc and Sprint Corporation. * (Incorporated by
reference to Exhibit 10.3 to Cox's Current Report on Form 8-K filed
with the Commission on February 9, 1996.)
10.4 -- Amended and Restated Agreement of Limited Partnership of PhillieCo,
L.P., dated as of February 17, 1995, by and among Sprint Spectrum,
Inc., TCI Network, Inc. and Cox Communications Wireless, Inc. *
(Incorporated by reference to Exhibit 10.4 to the Annual Report on
Form 10-K of Cox Communications, Inc., filed with the Commission on
March 31, 1995.)
10.5 -- Contribution Agreement, dated as of March 28, 1995, by and among
TCI Network Services, Comcast Telephony Services, Cox Telephony
Partnership, MajorCo, L.P. and Newtelco, L.P. * (Incorporated by
reference to Exhibit 10.5 to the Annual Report on Form 10-K of Cox
Communications, Inc., filed with the Commission on March 31, 1995.)
</TABLE>
73
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.6 -- Registration Rights Agreement, dated as of January 31, 1995, by and
between Cox Communications, Inc., and Bank of America National Trust
and Savings Association, Thomas Unterman, James F. Guthrie, James R.
Simpson, Robert F. Erburu and David Laventhol, each as trustees for
certain employee benefit plans of The Times Mirror Company.
(Incorporated by reference to Exhibit 10.6 to the Annual Report on
Form 10-K of Cox Communications, Inc., filed with the Commission on
March 31, 1995.)
10.7 -- Tax Allocation Agreement, dated as of February 1, 1995, by and
between Cox Enterprises, Inc. and Cox Communications, Inc.
(Incorporated by reference to Exhibit 10.7 to the Annual Report on
Form 10-K of Cox Communications, Inc., filed with the Commission on
March 31, 1995.)
10.8 -- Asset Purchase Agreement, dated as of November 8, 1994, by and
between Newport News Cablevision, Ltd. and Cox Cable Hampton Roads,
Inc. (Incorporated by reference to Exhibit 10.8 to the Annual Report
on Form 10-K of Cox Communications, Inc., filed with the Commission
on March 31, 1995.)
10.9 -- Cox Executive Supplemental Plan of Cox Enterprises, Inc.
(Incorporated by reference to Exhibit 10.5 to Cox's Registration
Statement on Form S-4, File No. 33-80152, filed with the Commission
on December 16, 1994.)
10.10 -- Cox Communications, Inc. Long-Term Incentive Plan. (Incorporated by
reference to Exhibit 10.8 to Cox's Registration Statement on Form S-
4, File No. 33-80152, filed with the Commission on December 16,
1994.)
10.11 -- Cox Communications, Inc. Restricted Stock Plan for Non-Employee
Directors. (Incorporated by reference to Exhibit 10.9 to Cox's
Registration Statement on Form S-4, File No. 33-80152, filed with
the Commission on December 16, 1994.)
10.12 -- 5-Year Credit Agreement, dated as of January 24, 1995, by and among
Cox Communications, Inc., Texas Commerce Bank National Association
and Chemical Bank, individually and as agents, and the other banks
signatory thereto. * (Incorporated by reference to Exhibit 10.13 to
the Annual Report on Form 10-K of Cox Communications, Inc., filed
with the Commission on March 31, 1995.)
10.13 -- 364-Day Credit Agreement, dated January 24, 1995, by and among Cox
Communications, Inc., Texas Commerce Bank National Association and
Chemical Bank, individually and as agents, and the other banks
signatory. * (Incorporated by reference to Exhibit 10.14 to the
Annual Report on Form 10-K of Cox Communications, Inc., filed with
the Commission on March 31, 1995.)
10.14 -- Assumption and Amendment Agreement, dated as of February 1, 1995,
among Cox Communications, Inc., Texas Commerce Bank National
Association, individually and as agent, and the other bank
signatory. (Incorporated by reference to Exhibit 10.15 to the Annual
Report on Form 10-K of Cox Communications, Inc., filed with the
Commission on March 31, 1995.)
10.15 -- Form of Letter Agreement between Cox Enterprises, Inc. and Cox
Communications, Inc. relating to the CEI Purchase. (Incorporated by
reference to Exhibit 10.16 to Cox's Amendment No. 2 to Registration
Statement on Form S-1, File No. 33-92000, filed with the Commission
on June 21, 1995.)
10.16 -- Share Exchange Agreement, dated August 11, 1995, among Southwestern
Bell International Holdings (UK-1) Corporation, Southwestern Bell
International Holdings (UK-2) Corporation, Cox UK Communications,
LP, TeleWest plc, TeleWest Communications plc, SBC International,
Inc., Cox Communications, Inc. and SBC Cable Comms (UK) relating to
the TeleWest Merger. (Incorporated by reference to Exhibit 10.1 on
Form 10-Q of Cox Communications, Inc., filed with the Commission on
November 8, 1995.)
</TABLE>
74
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.17 -- Form of Co-Operation Agreement among Cox U.K. Communications, LP,
Cox Communications, Inc., Southwestern Bell International Holdings
(UK-1) Corporation and Southwestern Bell International Holdings (UK-
2) Corporation, SBC International, Inc. and TeleWest plc relating to
the TeleWest Merger. (Incorporated by reference to Exhibit 10.2 on
Form 10-Q of Cox Communications, Inc., filed with the Commission on
November 8, 1995.)
10.18 -- Form of Share Dealing Agreement among Cox Communications, Inc., Cox
U.K. Communications, LP, SBC International, Inc., Southwestern Bell
International Holdings (UK-1) Corporation and Southwestern Bell
International Holdings (UK-2) Corporation, Telecommunications
International Holdings, Inc., US West International Holdings, Inc.
and TeleWest plc relating to the TeleWest Merger. (Incorporated by
reference to Exhibit 10.3 on Form 10-Q of Cox Communications, Inc.,
filed with the Commission on November 8, 1995.)
10.19 -- Asset Exchange Agreement, dated December 31, 1996, by and among
Heritage Cablevision of Southeast Massachusetts, Inc., Heritage
Cablevue, Inc., TCI Cablevision of St. Bernard, Inc., TCI of Council
Bluffs, Inc., TCI of Virginia, Inc., UA-Columbia Cablevision of
Massachusetts, Inc., United Cable Television of Sarpy County, Inc.,
United Cable Television of Scottsdale, Inc., and TCI American Cable
Holdings, L.P., and CoxCom, Inc.* (Incorporated by reference to
Exhibit 10.17 on Form 10-K of Cox Communications, Inc., filed with
the Commission on March 28, 1997.)
10.20 -- Subscription Agreement, dated March 21, 1997, between Cox
Communications, Inc. and Flextech plc.* (Incorporated by reference
to Exhibit 10.17 on Form 10-K of Cox Communications, Inc., filed
with the Commission on March 28, 1997.)
10.21 -- Letter Agreement, dated February 24, 1993, between Ajit M. Dalvi
and Cox Communications, Inc.
10.22 -- Amendment, dated December 16, 1997, to Letter Agreement between
Ajit M. Dalvi and Cox Communications, Inc.
10.23 -- Letter Agreement, dated December 16, 1997, between Ajit M. Dalvi
and Cox Communications, Inc.
10.24 -- Merger and Contribution Agreement, dated as of February 6, 1998,
among TCI Satellite Entertainment, Inc., PrimeStar, Inc., Time
Warner Entertainment Company L.P., Advance/Newhouse Partnership,
Comcast Corporation, Cox Communications, Inc., MediaOne of Delaware,
Inc., GE American Communications, Inc. *
10.25 -- Agreement and Plan of Merger, dated as of February 6, 1998, between
PrimeStar, Inc. and Cox Satellite, Inc. *
13 -- Portions of the 1997 Annual Report to Stockholders (expressly
incorporated by reference in Part II, Item 5 of this Report).
21 -- Subsidiaries of Cox Communications, Inc.
23.1 -- Consent of Deloitte & Touche LLP, Atlanta, Georgia
23.2 -- Consent of Deloitte & Touche LLP, Kansas City, Missouri
23.3 -- Consent of Deloitte & Touche LLP, New York, New York
23.4 -- Consent of Deloitte & Touche LLP, Costa Mesa, California
24 -- Power of Attorney (included on page 76)
27 -- Financial data schedule
99.1 -- Combined financial statements of Cox Communications PCS, L.P. and
Cox California PCS, Inc.
99.2 -- Financial statements of Sprint Spectrum Holding Company, L.P.
99.3 -- Financial statements of Teleport Communications Group Inc.
* Schedules and exhibits intentionally omitted.
</TABLE>
- --------
(b) Current reports on Form 8-K
None.
75
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Cox Communications, Inc. has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
COX COMMUNICATIONS, INC.
By: /s/ James O. Robbins
----------------------------------
James O. Robbins
President and Chief Executive
Officer
Date: March 18, 1998
POWER OF ATTORNEY
Cox Communications, Inc., a Delaware corporation, and each person whose
signature appears below, constitutes and appoints James O. Robbins and Jimmy
W. Hayes, and either of them, with full power to act without the other, such
person's true and lawful attorneys-in-fact, with full power of substitution
and resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign this Annual Report on Form 10-K and any and all amendments
to such Annual Report on Form 10-K and other documents in connection
therewith, and to file the same, and all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact, and each of them, full power and authority to do
and perform each and every act and thing necessary or desirable to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, thereby ratifying and confirming all that said attorneys-
in-fact, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF COX
COMMUNICATIONS, INC. AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
/s/ James C. Kennedy Chairman of the Board of March 18,
- ------------------------------------- Directors 1998
JAMES C. KENNEDY
/s/ James O. Robbins President and Chief March 18,
- ------------------------------------- Executive Officer; Director 1998
JAMES O. ROBBINS
/s/ Jimmy W. Hayes Senior Vice President, March 18,
- ------------------------------------- Finance and Chief 1998
JIMMY W. HAYES Financial Officer
(principal financial
officer)
/s/ John M. Dyer Vice President of March 18,
- ------------------------------------- Accounting and Financial 1998
JOHN M. DYER Planning (principal
accounting officer)
/s/ Janet Morrison Clarke Director March 18,
- ------------------------------------- 1998
JANET MORRISON CLARKE
/s/ John R. Dillon Director March 18,
- ------------------------------------- 1998
JOHN R. DILLON
/s/ David E. Easterly Director March 18,
- ------------------------------------- 1998
DAVID E. EASTERLY
/s/ Robert F. Erburu Director March 18,
- ------------------------------------- 1998
ROBERT F. ERBURU
/s/ Andrew J. Young Director March 18,
- ------------------------------------- 1998
ANDREW J. YOUNG
76
<PAGE>
[COX CABLE COMMUNICATIONS LETTERHEAD]
February 24, 1993
Mr. Ajit Dalvi
Senior Vice President
of Marketing & Programming
Cox Cable Communications
1400 Lake Hearn Drive, NE
Atlanta, Georgia 30319
RE: Cox Cable Communications
Reward and Incentive Program for Ajit Dalvi
Dear Ajit:
Cox Cable Communications desires to recognize the special efforts made by
you in creating significant shareholder value through your finding and nurturing
the Company's investment in Discovery Communications, Inc. (DCI). As such, a
tailored reward and incentive program has been approved that contains many of
the features of the long-term incentive plan which is anticipated to be offered
to key executives at DCI.
In its essence, Cox Cable will fund for you a phantom equity investment of
$100,000 in DCI as a reward for efforts to date. To encourage further expansion
of the Discovery vision and creation of additional value for shareholders,
appreciation rights on $200,000 of phantom equity is granted. Yearly values
represented by these investments will be determined by appraisers selected by
Cox Enterprises, Inc. In total, the sum of the future value of the phantom
equity investment and the appreciation rights can be worth up to $1 million.
The intent of this special program is to produce significant net worth for you
based on your continued service and contributions.
Specific features of the program are:
. At a subsequent date, the phantom equity investment and the appreciation
rights will be determined as a specific number of units or rights whose
grant value is based on the dollar amounts shown above. The value of DCI,
which will be converted to a per-share value for plan purposes, will be
back dated to the value as of December 31, 1991. In this manner, you have
the opportunity to be rewarded for the growth in value during 1992.
<PAGE>
. The phantom equity investment and the appreciation rights are for a period
of six years, at which time all value generated under the plan will be paid
to you, subject to your continuous employment by Cox Cable or another unit
of Cox Enterprises, Inc. during the program's full term. Thus, the full
term of the program will run from January 1, 1992 to December 31, 1997.
. Appreciation rights will vest on the same schedule used by Cox
Enterprises, Inc. Unit Appreciation Plan; -- 60 percent will vest after
three years after start date of January 1, 1993, and an additional 20
percent each year thereafter.
. In order to avoid constructive receipt, only in the event of significant
financial hardship approved by the Chairman and Chief Executive Officer of
Cox Enterprises, Inc. will the value represented by the phantom equity
investment be made available before the end of the six year period.
Further, all opportunities for current or future value from the phantom
equity investment are forfeited should your employment be terminated for
reasons other than retirement, disability, or death.
. Should your employment terminate for reasons of death, disability, or
retirement, the value of the phantom equity investment, together with the
value of the appreciation rights, will be paid out to your estate, based on
the most recent appraisal of DCI. Vesting in these cases will follow that
prescribed by the Cox Enterprises, Inc. Unit Appreciation Plan.
. Values generated under the program may be paid either cash, CEI common
stock, or a combination of both. If the payment is made in cash, it can be
paid either as a lump sum or in five equal installments. All
determinations as to the type of payout and the time period are to be
determined by the Chairman and Chief Executive Officer of Cox Enterprises,
Inc.
<PAGE>
To provide some perspective on the potential future value of the program,
the following scenarios are offered:
<TABLE>
<CAPTION>
$100,000 Phantom Equity Investment
$200,000 Phantom Appreciation Rights
6 year term (initial value of December 31, 1991)
Maximum total value $1 million.
- -----------------------------------------------------------------------------------
COMPOUND ANNUAL GROWTH IN VALUE SCENARIOS
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
10% 15% 20% 25% 30%
- -----------------------------------------------------------------------------------
Phantom Equity Investment $171,200 $231,300 $298,600 $381,500 $ 482,700
- -----------------------------------------------------------------------------------
Appreciation Rights 154,300 $262,600 $397,200 $562,900 $ 765,400
- -----------------------------------------------------------------------------------
Total $325,500 $493,900 $695,800 $944,400 $1,000.000*
- -----------------------------------------------------------------------------------
*Maximum
- -----------------------------------------------------------------------------------
</TABLE>
With thanks for your many contributions to the success of DCI, I remain,
Very truly yours,
/s/ James O.Robbins
---------------------
James O. Robbins
<PAGE>
AMENDMENT TO EXECUTIVE INCENTIVE AGREEMENT
This Amendment, effective as of the 16th day of December, 1997, by and
between Cox Communications, Inc. a Delaware corporation ("Cox"), and Ajit M.
Dalvi, Senior Vice President of Programming & Strategy of Cox (the "Employee").
W I T N E S S E T H:
WHEREAS, Employee has participated in an appreciation program, pursuant to
which Employee is entitled to the payment of compensation based on the
appreciation in the value of Discovery Communications, Inc. ("DCI");
WHEREAS, the terms of the appreciation program were set forth in a letter
agreement Employee received from Cox Cable Communications, the corporate
predecessor to the businesses of Cox, which was dated February 24, 1993 (the
"Agreement"); and
WHEREAS, pursuant to the Agreement, Dalvi is entitled to receive a payment
in the amount of $1,000,000, payable under the terms of the Agreement;
WHEREAS, Cox and Employee intend to negotiate modifications to the terms of
the Agreement in accordance with the terms of this Amendment, and have concluded
the execution of this Amendment is in the best interest of the Corporation.
NOW, THEREFORE, the parties hereto agree to amend the Agreement as follows:
1.
Employee and Cox agree that $500, 000 of the payment otherwise payable to
Employee under the Agreement shall be reinvested in a phantom equity interest in
DCI, and will adjust in value in the same fashion as set forth in the Agreement
throughout the period ending on December 31, 1999. The maximum value that may
be payable to Employee under this Section 1 of the Amendment shall be
$1,500,000. This phantom equity interest will be payable to Employee as soon as
practicable after the later of January 1, 2000 or the date of Employee's
termination of employment with Cox, subject to earlier payment to the extent
provided for in the Agreement.
-1-
<PAGE>
2.
Employee and Cox agree that the remaining $500,000 of the payment otherwise
payable to Employee under the Agreement shall be paid to him in the form of
13,675 shares of Class A common stock of Cox. The shares of Class A common
stock issued to Employee hereunder shall be subject to forfeiture by Employee in
the event he does not remain in the continuous employment of Cox or one of its
affiliates from the date hereof until January 1, 2000. As of such date, the
risk of forfeiture shall lapse.
3.
All capitalized terms used in this Amendment shall have the same meanings
ascribed thereto in the Agreement.
IN WITNESS WHEREOF, the parties hereto have executed or caused this
Amendment to be executed, on the date first above written.
COX COMMUNICATIONS, INC.
By: /s/ James O. Robbins
--------------------
Title: President/CEO
--------------------
-2-
<PAGE>
[COX COMMUNICATIONS LETTERHEAD]
December 16, 1997
Mr. Ajit Dalvi
Senior Vice President, Marketing & Programming
Cox Communications, Inc.
1400 Lake Hearn Drive, N.E.
Atlanta, Georgia 30319
RE: Reward and Incentive Program for Ajit Dalvi
Dear Ajit:
Cox Communications, Inc. ("Cox") desires to recognize the continuing
efforts made by you in creating significant shareholder value for Cox through
your nurturing of Cox's investment in Discovery Communications, Inc. ("DCI").
In that regard, the Compensation Committee of the Board of Directors of Cox has
approved a reward and incentive program for you that will be dependent upon the
future appreciation in the value of DCI under the terms and conditions set forth
in this letter.
Under this program, Cox will "fund" for you two appreciation rights awards
based on a phantom equity investment in DCI, each in the amount of $200,000 (the
"Base Amount"). For the purpose of this program, the 1996 Award Base Amount
("1996 Award") will be assumed to have been invested in DCI as of January 1,
1996 and the 1998 Award Base Amount ("1998 Award") will be assumed to have been
invested as of January 1, 1998. You hereby are granted the right to later
payment to you of the excess of the value of the phantom equity investment in
DCI over the Base Amount (the "Awards"), under the terms and conditions set
forth herein. The effective date of your 1996 Award shall be January 1, 1996
and the effective date of the 1998 Award shall be January 1, 1998. The value of
DCI, and thus your Award, will be determined on a yearly basis by appraisers
selected by Cox, and the determination of such value by the appraisers, once
accepted by Cox, shall be final and binding for all program purposes. The
maximum amount of each Award that shall be payable to you under the program
shall be $500,000.
The specific features of the program are as follows:
. Each year Cox will determine the Annual Growth Rate of the value of DCI
and shall compute a Cumulative Growth Rate. This Cumulative Growth Rate
<PAGE>
for each year will be applied to the Base Amount of each award to determine
the current value of each Award. The value of each Award shall be the
excess of the current value over the Base Amount.
. The appreciation in the value of each Award will be measured over a five
(5) year period commencing on January 1, 1996 and ending on December 31,
2000 for the 1996 Award and commencing on January 1, 1998 and ending on
December 31, 2002 for the 1998 Award (the "Appreciation Periods"). As of
the last day of each applicable Appreciation Period, the value of your
Award under the program shall be payable to you in accordance with this
letter, but only to the extent you remain in the continuous employment of
Cox or of another subsidiary thereof throughout the Appreciation Period.
. Your Award will vest according to the following schedule: 20 percent will
be vested as of the date one year after the effective date of the Award, 75
percent will be vested as of the date three years after the effective date,
90 percent will be vested as of the date four years after the effective
date. You will not be 100 percent vested in the 1996 Award until January
1, 2001 and 100 percent vested in the 1998 Award until January 1, 2003.
. In the event your employment terminates before the end of the applicable
Appreciation Period by reason of death or disability, the Award will become
fully vested, and the value of your Award will be paid to you or to your
estate based on the most recent appraisal of DCI that occurred before the
date of your death or the date your disability commenced. In the event of
your termination of employment for other reasons before the end of the
applicable Appreciation Period, the vested amount of your Award will be
paid to you based on the most recent appraisal of DCI that occurred before
the date your employment so terminated.
. Upon a showing of a financial hardship prior to the end of the applicable
Appreciation Period, on terms considered satisfactory by Cox in its sole
discretion, you shall be entitled to a lump sum cash payment equal to the
value of the vested portion of your Award based on the most recent
appraisal of DCI that occurred before the date you requested the hardship
exception.
. Except as noted above, payment of your Awards will be made to you after
the end of the applicable Appreciation Period as soon as practicable after
the later of your termination of employment or January 1, 2001 for the 1996
Award and January 1, 2003 for the 1998 Award.
. Your Award will be paid to you in the form of cash, Cox Class A common
stock or any combination thereof as Cox determines in its sole discretion.
If the Award is paid in cash, it may be made either in the form of a lump
sum or in five or less equal annual installments, as Cox determines in its
sole discretion.
With thanks for your many contributions to the success of Cox and of DCI, I
remain,
Very truly yours,
/s/ James O. Robbins
------------------------
James O. Robbins
<PAGE>
EXHIBIT 10.24
================================================================================
MERGER AND CONTRIBUTION AGREEMENT
Dated as of February 6, 1998,
Among
TCI SATELLITE ENTERTAINMENT, INC.
PRIMESTAR, INC.
TIME WARNER ENTERTAINMENT COMPANY L.P.
ADVANCE/NEWHOUSE PARTNERSHIP
COMCAST CORPORATION
COX COMMUNICATIONS, INC.
MEDIAONE OF DELAWARE, INC.
GE AMERICAN COMMUNICATIONS, INC.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Parties and Recitals...................................... 1
ARTICLE I
Definitions
-----------
SECTION 1.01. Definitions............................... 2
SECTION 1.02. Terms and Usage Generally................. 21
ARTICLE II
Subsidiary Transactions
-----------------------
SECTION 2.01. Subsidiary Transactions................... 22
ARTICLE III
Asset Transfers and Mergers
---------------------------
SECTION 3.01. Drop Down; Charter and By-Laws............ 22
SECTION 3.02. Post-Drop Down Transactions............... 23
SECTION 3.03. Primestar Customer Statement.............. 23
SECTION 3.04. Primestar Inventory Statement............. 23
SECTION 3.05. Consideration............................. 24
ARTICLE IV
Closing
-------
SECTION 4.01. Closing Date.............................. 24
SECTION 4.02. Closing Adjustments on
Primestar Inventory....................... 25
SECTION 4.03. Adjustment for Primestar Customers........ 27
SECTION 4.04. Adjustment for Capital Contributions...... 30
SECTION 4.05. Netting................................... 30
</TABLE>
ARTICLE V
(i)
<PAGE>
<TABLE>
<S> <C>
Representations and Warranties
------------------------------
SECTION 5.01. Representations and Warranties of
TSAT................................... 31
SECTION 5.02 Representations and Warranties of
Certain Parties........................ 42
SECTION 5.03. Special Representation................. 47
ARTICLE VI
Covenants Relating to Business
------------------------------
SECTION 6.01. Alternative Transactions............... 47
SECTION 6.02 Interim Operations of TSAT............. 48
SECTION 6.03. Interim Operations of each Class C
Holder................................. 51
SECTION 6.04 Other Actions.......................... 52
ARTICLE VII
Additional Covenants
--------------------
SECTION 7.01. Preparation of Form S-4 and the Proxy
Statement/Prospectus; TSAT Stockholders
Meeting................................ 52
SECTION 7.02. Listing Application.................... 54
SECTION 7.03. Access to Information;
Confidentiality........................ 54
SECTION 7.04. Commercially Reasonable Efforts;
Notification........................... 55
SECTION 7.05 Primestar Customers.................... 57
SECTION 7.06 GE Agreements.......................... 57
SECTION 7.07 Equipment.............................. 57
SECTION 7.08 Financing; Letters of Credit........... 57
SECTION 7.09 Agreements............................. 58
SECTION 7.10 Compliance............................. 58
SECTION 7.11 ASkyB Transaction...................... 58
SECTION 7.12 Indemnification........................ 59
SECTION 7.13 Tax Indemnification.................... 61
SECTION 7.14 Post-Closing Cooperation;
Confidentiality........................ 63
SECTION 7.15 TCI Agreements......................... 64
</TABLE>
(ii)
<PAGE>
<TABLE>
<S> <C>
SECTION 7.16 Employee Matters....................... 64
SECTION 7.17 Other Stockholder Approvals............ 64
ARTICLE VIII
Conditions Precedent
--------------------
SECTION 8.01. Conditions Precedent................... 65
SECTION 8.02 Conditions to Obligations of each
of Comcast, Cox, MediaOne, TWE,
Newhouse and GE........................ 66
SECTION 8.03. Conditions to Obligations of TSAT...... 68
ARTICLE IX
Termination, Amendment and Waiver
---------------------------------
SECTION 9.01. Termination............................ 70
SECTION 9.02. Effect of Termination.................. 70
SECTION 9.03. Amendment.............................. 70
SECTION 9.04. Extension; Waiver...................... 71
ARTICLE X
General Provisions
------------------
SECTION 10.01. Nonsurvival of Representations and
Warranties............................. 71
SECTION 10.02. Notices................................ 72
SECTION 10.03. Assignment............................. 74
SECTION 10.04. Severability........................... 75
SECTION 10.05. Entire Agreement; No Third-Party
Beneficiaries.......................... 75
SECTION 10.06. Governing Law.......................... 76
SECTION 10.07. Enforcement; Exclusive Jurisdiction.... 76
SECTION 10.08. Counterparts........................... 77
SECTION 10.09. Headings............................... 77
</TABLE>
(iii)
<PAGE>
[DRAFT--2/9/98]
MERGER AND CONTRIBUTION AGREEMENT (the "Agreement"), dated
---------
as of February 6, 1998, among TCI SATELLITE ENTERTAINMENT, INC.,
a Delaware corporation, PRIMESTAR, INC., a Delaware corporation,
TIME WARNER ENTERTAINMENT COMPANY, L.P., a Delaware limited
partnership, ADVANCE/NEWHOUSE PARTNERSHIP, a New York general
partnership, COMCAST CORPORATION, a Pennsylvania corporation, COX
COMMUNICATIONS, INC., a Delaware corporation, MEDIAONE OF
DELAWARE, INC., a Delaware corporation, and GE AMERICAN
COMMUNICATIONS, INC., a Delaware corporation.
RECITALS
1. The parties hereto are either general and limited partners of
PRIMESTAR Partners L.P. or affiliates of such partners, and desire to consummate
the transactions contemplated herein, pursuant to which (a) TSAT will contribute
to a newly formed wholly owned subsidiary of TSAT, PRIMESTAR, Inc., all of
TSAT's assets and liabilities other than its stock in Tempo Satellite, Inc., and
PRIMESTAR, Inc. will acquire the partnership interests and certain related
Primestar assets from each of TWE, Newhouse, Comcast, Cox, MediaOne and GE, (b)
TSAT will agree to merge with and into PRIMESTAR, Inc., and (c) TSAT will enter
into certain other agreements with PRIMESTAR, Inc.;
2. For federal income tax purposes, the parties hereto intend that
the Restructuring Transaction (as defined below) qualify as an exchange under
Section 351 of the United States Internal Revenue Code of 1986, as amended (the
"Code"), and that the mergers under the Merger Agreements (as defined below)
----
each qualify as reorganizations under Section 368(a) of the Code;
3. The parties desire to make certain representations, warranties,
covenants and agreements in connection with the transactions contemplated
hereby.
NOW, THEREFORE, in consideration of the mutual promises set forth
herein and for other good and valuable consideration, the receipt and
sufficiency of which are
<PAGE>
2
hereby acknowledged, the parties to this Agreement hereby agree as follows:
ARTICLE I
DEFINITIONS
SECTION 1.01. Definitions. As used in this Agreement, the following
-----------
terms shall have the following meanings:
"Accounting Firm" is defined in Section 4.02(a).
---------------
"Agency Agreement" means an Agency Agreement with the Company on the
----------------
terms set forth under the caption "Founders' Distribution Rights--Medium Power
Subscribers" in the Term Sheet and in form and substance reasonably satisfactory
to each of the Parties.
"Agreement" is defined in the preamble hereto.
---------
"ASkyB Agreement" means the Asset Acquisition Agreement dated as of
---------------
June 11, 1997, among The News Corporation Limited, MCI Telecommunications
Corporation, American Sky Broadcasting LLC, the Partnership, and, with respect
to specified provisions only, the partners in the Partnership.
"Asset Transfer Agreements" means the MediaOne Asset Transfer
-------------------------
Agreement, the Newhouse Asset Transfer Agreement and the TWE Asset Transfer
Agreement.
"Assumed Employment Liabilities" of any Person means (i) all
------------------------------
obligations and liabilities of such Person or any of its subsidiaries in respect
of the Stay Bonuses, (ii) all obligations and liabilities of such Person or any
of its subsidiaries relating to the employment by the Company of any Selected
Employee of such Person after the Closing Date and (iii) all obligations and
liabilities of such Person or any of its subsidiaries relating to the
termination of employment of any Selected Employee of such Person after the
Closing Date.
"Benefit Plans" is defined in Section 5.01(j).
-------------
<PAGE>
3
"BSS Authorizations" means the FCC construction permit and related
------------------
authorizations, including earth station permits, held by Tempo on the date of
this Agreement, as the same may be modified, renewed or expanded from time to
time after the date of this Agreement by the FCC or any other Governmental
Entity. For avoidance of doubt, the BSS Authorizations include the permits,
authorizations and earth station permits relating to the 119 degrees West
Longitude orbital position and the permits, authorizations and earth station
permits relating to the 166 degrees West Longitude orbital position.
"By-laws" means the Amended and Restated By-laws of the Company in the
-------
form of Exhibit C hereto.
"Call Center Debt" means indebtedness, in an amount not in excess of
----------------
$23.75 million, incurred by TSAT to fund the acquisition by TSAT of TCI's call
center located in Boise, Idaho.
"Charter" means the Restated Certificate of Incorporation of the
-------
Company in the form of Exhibit B hereto.
"Class A Stock" means Class A Common Stock, par value $.01 per share,
-------------
of the Company.
"Class B Stock" means Class B Common Stock, par value $.01 per share,
-------------
of the Company.
"Class C Holder" means any of Comcast, Cox, MediaOne (collectively
--------------
with the MediaOne Transferors), TWE and Newhouse.
"Class C Stock" means Class C Common Stock, par value $.01 per share,
-------------
of the Company.
"Class D Stock" means Class D Common Stock, par value $.01 per share,
-------------
of the Company.
"Closing" is defined in Section 4.01.
-------
"Closing Date" is defined in Section 4.01.
------------
"Code" is defined in the preamble hereto.
----
<PAGE>
4
"Comcast" means Comcast Corporation, a Pennsylvania corporation.
-------
"Comcast I Merger Agreement" means the agreement between the Company
--------------------------
and Comcast Sub I in substantially the form of the Form Merger Agreement.
"Comcast II Merger Agreement" means the agreement between the Company
---------------------------
and Comcast Sub II in substantially the form of the Form Merger Agreement.
"Comcast Sub I" means Comcast DBS, Inc. a Delaware corporation.
-------------
"Comcast Sub II" means Comcast Satellite Communications, Inc., a
--------------
Delaware corporation.
"Communications Act" is defined in Section 5.01(e).
------------------
"Company" means PRIMESTAR, Inc., a Delaware corporation and, prior to
-------
the Effective Time, a wholly owned subsidiary of TSAT.
"Contributed Corporation" is defined in Section 7.13(b).
-----------------------
"ContributionIndemnitor" is defined in Section 7.13(b).
----------------------
"Covered Taxes" means all Taxes, other than transfer Taxes applicable
-------------
to the conveyance and transfer of Primestar Assets and Primestar Liabilities
pursuant to any Asset Transfer Agreement. For avoidance of doubt, "transfer
Taxes" do not include any income Tax, capital gains Tax or similar Tax
attributable to the Pre-Closing Tax Period, even if such Tax is triggered by the
transfer of Primestar Assets and Primestar Liabilities or any related assumption
of indebtedness.
"Cox" means Cox Communications, Inc., a Delaware corporation.
---
"Cox Merger Agreement" means the agreement between the Company and Cox
--------------------
Sub in substantially the form of the Form Merger Agreement.
<PAGE>
5
"Cox Sub" means Cox Satellite, Inc., a Delaware corporation.
-------
"Customer Payment" of any Class C Holder means an amount (which may be
----------------
a positive or negative number) equal to:
(A) $1,100
multiplied by
(B) an amount equal to
(I) (x) the TSAT Customer Ratio multiplied by (y) the
Initial Primestar Customers of such Class C Holder
minus
(II) the Final Primestar Customers of such Class C Holder.
"Customer Premises Equipment" of any Person means equipment and drop-
---------------------------
materials (other than IRDs, LNBs, Dishes and Primefinder Remotes), used in the
reception of the PRIMESTAR programming service and either located at a Selected
Office of such Person or installed in the home of any PRIMESTAR subscriber or
disconnected PRIMESTAR subscriber of such Person.
"DGCL" means the Delaware General Corporation Law.
----
"Digital Satellite Assets" is defined in Section 7.12(a).
------------------------
"Digital Satellite Business" means the business of distributing
--------------------------
multichannel programming services directly to consumers in the United States via
digital broadcast satellite, including the rental and sale of customer premises
equipment relating thereto.
"Dish" means a satellite dish, including mount and assembly, for
----
reception of the PRIMESTAR programming service.
<PAGE>
6
"Distributor Agreement" means a Distributor Agreement with the Company
---------------------
on the terms set forth in the first paragraph under the caption "Founders'
Distribution Rights--High Power Subscribers" in the Term Sheet and in form and
substance reasonably satisfactory to each of the Parties.
"Drop Down" means the contribution of assets and liabilities by TSAT
---------
to the Company pursuant to the Drop Down Agreement.
"Drop Down Agreement" means the TSAT Asset Transfer Agreement dated as
-------------------
of February 6, 1998, between the Company and TSAT.
"Effective Time" means the time on the Closing Date at which the
--------------
filing of the certificates of merger under the Merger Agreements with the
Secretary of State of the State of Delaware in accordance with the DGCL shall
occur.
"Employee Stock Option" means any stock option to purchase shares of
---------------------
TSAT A Stock or TSAT B Stock granted under the TSAT Stock Plans.
"ERISA" is defined in Section 5.01(k).
-----
"Exchange Act" is defined in Section 5.01(e).
------------
"Excluded Accounts Receivable" of any Person means all accounts
----------------------------
receivable of such Person and its subsidiaries relating to the distribution of
the PRIMESTAR programming service, including rental and sales fees, to the
extent that such accounts receivable relate to service periods ending on or
prior to the Closing Date, plus a pro rata portion of any such accounts
--- ----
receivable that relate to any service period commencing on or prior to, and
ending after, the Closing Date (based on the numbers of days in such service
period on or prior to the Closing Date, and after the Closing Date, respectively
(i.e. the "earned" portion of such accounts receivable)).
"Excluded Liabilities" of any Person (other than TSAT) means (i)
--------------------
indebtedness for borrowed money of such Person and its subsidiaries incurred on
or prior to the Closing Date, other than Primestar Debt, (ii) accounts payable
incurred on or prior to the Closing Date in respect
<PAGE>
7
of such Person's Primestar Business, (iii) Covered Taxes attributable to the
operation or ownership of such Person's Primestar Assets and Partnership
Interest during the Pre-Closing Tax Period and (iv) Retained Employment
Liabilities of such Person. For purposes hereof, "accounts payable" of a Person
include all obligations of such Person to pay for goods and services received by
such Person on or prior to the Closing Date in respect of such Person's
Primestar Business, whether or not an invoice for such goods and services shall
have been received by such Person on or prior to the Closing Date, including all
obligations of such Person to the Partnership in respect of programming and/or
satellite services for periods ending on or prior to the Closing Date. To the
extent any such obligation relates to any period that includes the Closing Date,
such obligation shall be allocated between "pre-closing" accounts payable and
"post-closing" accounts payable based on the numbers of days in such period on
or prior to the Closing Date, and after the Closing Date, respectively.
"FCC" is defined in Section 5.01(e).
---
"Field Assets" of any Person means the office equipment, furniture,
------------
tools and vehicles located at a Selected Office of such Person and exclusively
used to support such Person's Primestar Business (but in the case of office
equipment, tools and vehicles, only to the extent used by such Person's Selected
Employees).
"Filed SEC Documents" is defined in Section 5.01(h).
-------------------
"Final Primestar Customer Statement" is defined in Section 4.03(b).
----------------------------------
"Final Primestar Customers" of any Person means the number of
-------------------------
Primestar Customers set forth on such Person's Final Primestar Customer
Statement.
"Final Primestar Inventory" of any Person for any category of
-------------------------
Primestar Inventory set forth on Schedule 3.04 means the amount of such category
of Primestar Inventory set forth on such Person's Final Primestar Inventory
Statement.
"Final Primestar Inventory Statement" is defined in Section 4.02(a).
-----------------------------------
<PAGE>
8
"Five Year Plan" is defined in Section 8.01(a).
--------------
"Form Asset Transfer Agreement" means the Asset Transfer Agreement in
-----------------------------
the form of Exhibit H hereto.
"Form Merger Agreement" means the Agreement and Plan of Merger in the
---------------------
form of Exhibit G hereto.
"Form S-4" is defined in Section 5.01(e).
--------
"Founder" means each of Comcast, Cox, MediaOne, TWE, and TCI, in each
-------
case, together with any or all of its affiliates that are controlled by it.
"GAAP" means U.S. generally accepted accounting principles as in
----
effect from time to time.
"GE" means GE American Communications, Inc., a Delaware corporation.
--
"GE Merger Agreement" means the agreement between the Company and GE
-------------------
Sub in substantially the form of the Form Merger Agreement.
"GE Sub" means GE Americom Services, Inc., a Delaware corporation.
------
"Glue Letters" means the two letters, each dated July 30, 1993, from
------------
the Partnership to Tempo, relating to the Option Agreement.
"Governmental Entity" is defined in Section 5.01(e).
-------------------
"HP Agency Agreement" means an HP Agency Agreement with the Company on
-------------------
the terms set forth in the second paragraph under the caption "Founders'
Distribution Rights--High Power Subscribers" in the Term Sheet and in form and
substance reasonably satisfactory to each of the Parties.
"HSR Act" is defined in Section 5.01(e).
-------
"Included Options" means the options, SARs and restricted stock listed
----------------
on Schedule 1.01-A.
"Indemnitor" is defined in Section 7.13(c).
----------
<PAGE>
9
"Initial Primestar Customers" of any Person means the number of
---------------------------
Primestar Customers set forth on such Person's Primestar Customer Statement
(prior to any adjustment pursuant to Section 4.03(a)).
"Interim Financing Debt" means (i) any indebtedness of TSAT or the
----------------------
Company under any credit facility or other financing arrangement which
indebtedness is incurred to fund the payment of cash consideration to (or the
assumption of indebtedness of) Comcast, Cox, MediaOne, Newhouse, TWE or GE (or
their respective affiliates) pursuant to this Agreement and (ii) any
indebtedness of TSAT incurred to fund the payment of arrangement fees,
commitment fees and any other fees or expenses charged by the lenders and/or
arrangers of the indebtedness referred to in clause (i) above.
"Inventory Payment" of any Class C Holder means an amount (which may
-----------------
be a positive or negative number) equal to (A) the product of (x) the Final
Primestar Customers of such Class C Holder and (y) the TSAT Inventory Ratio
minus (B) the Primestar Inventory Valuation of such Class C Holder.
"IRD" means an Integrated Receiver Decoder.
---
"Letters of Credit" means letters of credit provided by Comcast, Cox,
-----------------
MediaOne, TWE, Newhouse, TCI or their respective affiliates, to Loral and GE on
behalf of the Partnership.
"Liens" is defined in Section 5.01(b).
-----
"LNB" means a Low Noise Block Converter.
---
"Loral" means Space Systems/Loral, Inc., a Delaware corporation.
-----
"Loral Contract" means Contract Amendment No. 4, dated July 19, 1993,
--------------
to Contract No. TPO-1-290 between Tempo and Loral for Tempo Direct Broadcast
Satellite System (DBSS).
"Losses" is defined in Section 7.12.
------
"Malone" means John C. Malone.
------
<PAGE>
10
"Malone Letter" means the letter dated the date hereof from Malone to
-------------
each Party.
"Material Adverse Change" or "Material Adverse Effect" with respect
----------------------- -----------------------
to:
(A) TSAT or the Company means any change or effect (or any development
that, insofar as can reasonably be foreseen, is likely to result in any
change or effect) that (i) is materially adverse to the business,
properties, assets, condition (financial or otherwise) or results of
operations or prospects of TSAT or the Company, as applicable, and its
subsidiaries taken as a whole or (ii) would impair the ability of TSAT or
the TSAT Sub to perform its obligations under any of its Relevant
Agreements or (iii) would prevent the consummation of all or any part of
the Restructuring Transaction, the TSAT Merger or the Tempo Sale; or
(B) any Class C Holder or GE means any change or effect (or any
development that, insofar as can reasonably be foreseen, is likely to
result in any change or effect) that (i) is materially adverse to the
business, properties, assets, condition (financial or otherwise) or results
of operations or prospects of, in the case of a Class C Holder, such Class
C Holder's Primestar Business or (ii) would impair the ability of such
Class C Holder or any of its Subsidiaries, if any, or GE or its Subsidiary,
as applicable, to perform its obligations under any of its Relevant
Agreements or (iii) would prevent the consummation of all or any part of
the Restructuring Transaction, the TSAT Merger or the Tempo Sale.
Notwithstanding anything to the contrary contained herein, a change or effect
(or any development that, insofar as can reasonably be foreseen, is likely to
result in a change or effect) that affects the business of distributing the
PRIMESTAR programming service in general shall not constitute a "Material
Adverse Change" or a "Material Adverse Effect".
"MediaOne" means MediaOne of Delaware, Inc., a Delaware corporation.
--------
<PAGE>
11
"MediaOne Asset Transfer Agreement" means the agreement among the
---------------------------------
Company, MediaOne and the MediaOne Transferors in substantially the form of the
Form Asset Transfer Agreement.
"MediaOne Sub" means MediaOne Satellite I, Inc., a Delaware
------------
corporation.
"MediaOne Transferors" means each of (i) Continental Satellite
--------------------
Company, Inc., a Massachusetts corporation, (ii) Continental Satellite Company
of Chicago, Inc., an Illinois corporation, (iii) Continental Satellite Company
of Minnesota, Inc., a Minnesota corporation, (iv) Continental Satellite Company
of New England, Inc., a New Hampshire corporation, (v) Continental Satellite
Company of Michigan, Inc., a Michigan corporation, (vi) Continental Satellite
Company of Ohio, Inc., an Ohio corporation, (vii) Continental Satellite Company
of Virginia, Inc., a Virginia corporation, and (viii) MediaOne Satellite II,
Inc., a Delaware corporation.
"Merger Agreements" means the Comcast I Merger Agreement, the Comcast
-----------------
II Merger Agreement, the Cox Merger Agreement and the GE Merger Agreement.
"MergerIndemnitor" is defined in Section 7.13(a).
----------------
"Monthly Fee" is defined in Section 7.08(c).
-----------
"Multiemployer Pension Plans" is defined in Section 5.01(k).
---------------------------
"NASDAQ" means the Nasdaq NMS Stock Market.
------
"Newhouse" means Advance/Newhouse Partnership, a New York general
--------
partnership.
"Newhouse Asset Transfer Agreement" means the agreement between the
---------------------------------
Company and Newhouse in substantially the form of the Form Asset Transfer
Agreement.
"Newhouse Voting Agreement" means the Voting Agreement between TWE and
-------------------------
Newhouse in substantially the form of Exhibit E hereto.
<PAGE>
12
"Notice of Disagreement" is defined in Section 4.02(a).
----------------------
"Option Agreement" means the Option Agreement dated as of February 8,
----------------
1990, between Tempo and the Partnership.
"Partnership" means PRIMESTAR Partners L.P., a Delaware limited
-----------
partnership.
"Partnership Agreement" means the Partnership Agreement of the
---------------------
Partnership, as amended from time to time.
"Partnership Interest" means a partnership interest in the
--------------------
Partnership.
"Party" means any of Comcast, Cox, GE, MediaOne, TSAT, TWE and
-----
Newhouse.
"Pension Plans" is defined in Section 5.01(k).
-------------
"Person" means any individual, corporation, partnership, limited
------
liability company, joint venture, trust, business association or other entity.
"Post-Closing Accounts Receivable" means all accounts receivable of
--------------------------------
the Company and its subsidiaries relating to the distribution of the PRIMESTAR
programming service, including rental and sales fees in respect of Dishes, to
the extent that such accounts receivable relate to service periods commencing
after the Closing Date, plus a pro rata portion of any such accounts receivable
--- ----
that relate to any service period commencing on or prior to, and ending after,
the Closing Date (based on the numbers of days in such service period on or
prior to the Closing Date, and after the Closing Date, respectively (i.e. the
"unearned" portion of such accounts receivable)).
"Post-Closing Tax Period" means a taxable period that begins after the
-----------------------
Closing Date or the portion that begins after the Closing Date of any taxable
period that begins before and ends after the Closing Date.
"Pre-Closing Tax Period" means a taxable period ending on or before
----------------------
the Closing Date or the portion that
<PAGE>
13
ends on the Closing Date of any taxable period that begins before and ends after
the Closing Date.
"Primary Executives" is defined in Section 5.01(m).
------------------
"Primefinder Remote" means a "Primefinder Remote" remote control
------------------
device for selection of channels of the PRIMESTAR programming service by program
category.
"Primestar Assets" of any Person means:
----------------
(i) each PRIMESTAR subscriber of such Person's Primestar Business as
of the Closing Date (whether or not such PRIMESTAR subscriber is counted as
a Primestar Customer hereunder), together with any subscription contract,
equipment rental contract or other agreement with such subscriber relating
to such Person's Primestar Assets and all rights, claims and causes of
action thereunder (other than Excluded Accounts Receivable);
(ii) all leases, contracts and other agreements relating exclusively
to such Person's Primestar Business and all rights, claims and causes of
action thereunder (other than Excluded Accounts Receivable);
(iii) such Person's Primestar Inventory;
(iv) all IRDs, LNBs and Dishes installed in the home of any PRIMESTAR
subscriber of such Person;
(v) such Person's Unrecovered Inventory;
(vi) all Customer Premises Equipment held for use (wherever located,
whether in warehouses or in transit) in such Person's Primestar Business or
installed in the home of any current or disconnected PRIMESTAR subscriber
of such Person;
(vii) all rights, claims and causes of action, including under
warranties, of such Person in respect of (A) such Person's Primestar
Inventory, (B) such Person's Unrecovered Inventory, (C) outstanding
purchase orders of such Person in respect of IRDs, LNBs, Dishes and
Primefinder Remotes, (D) supply
<PAGE>
14
agreements to which such Person is a party (or beneficiary) for IRDs, LNBs,
Dishes and Primefinder Remotes and (E) such Person's Customer Premises
Equipment;
(viii) all Primestar Records of such Person; and
(ix) all Field Assets of such Person.
"Primestar Business" of any Person means such Person's business of
------------------
distributing the PRIMESTAR programming service.
"Primestar Customer" of any Person as of any date of determination
------------------
means each PRIMESTAR subscriber of such Person's Primestar Business having an
"active" account (as defined below) on such date, determined in accordance with
the subscriber's receivable status on such date as follows: (i) a subscriber who
has a receivable balance of not more than 60 days from the first day of the
service period to which such receivable balance relates (without giving effect
to older balances that do not exceed $10 in the aggregate) shall count as one
full Primestar Customer; (ii) a subscriber who has a receivable balance of at
least 61 but not more than 90 days from the first day of the service period to
which such receivable balance relates (without giving effect to older balances
that do not exceed $10 in the aggregate) shall count as one half of a Primestar
Customer; and (iii) a subscriber who has a receivable balance of 91 days or more
from the first day of the service period to which such receivable balance
relates shall not be counted as a Primestar Customer. For purposes hereof, a
PRIMESTAR subscriber shall have an "active" account as of any date of
determination if (x) it is then authorized to receive service or (y) it has been
de-authorized, but has not yet been "hard" disconnected (as indicated by such
Person's billing system), and such subscriber has not voluntarily requested de-
authorization or disconnection. "Active" accounts shall not include
complimentary ("comp"), demonstration ("demo"), or other free accounts (other
than accounts which are provided one or two free months of service in connection
with any marketing, customer service or similar promotion).
"Primestar Customer Statement" is defined in Section 3.03.
----------------------------
<PAGE>
15
"Primestar Debt" of any Person means the amount of indebtedness of
--------------
such Person to be assumed by the Company as set forth in Section 3.05, if any.
"Primestar Inventory" of any Person means all IRDs, LNBs, Dishes and
-------------------
Primefinder Remotes held for use (wherever located, whether in warehouses or in
transit) in such Person's Primestar Business, or, in the case of Primefinder
Remotes, installed in the home of any PRIMESTAR subscriber of such Person;
provided, however, that "Primestar Inventory" of any Person shall not include
- -------- -------
(i) IRDs, LNBs or Dishes installed in the home of any PRIMESTAR subscriber of
such Person or (ii) Unrecovered Inventory of such Person.
"Primestar Inventory Statement" is defined in Section 3.04.
-----------------------------
"Primestar Inventory Valuation" of any Person means the sum of the
-----------------------------
amounts determined by taking the product, for each category of Primestar
Inventory set forth on Schedule 3.04, of (x) such Person's Final Primestar
Inventory of such category and (y) the dollar value set forth on Schedule 3.04
for such category of Primestar Inventory.
"Primestar Liabilities" of any Person means all obligations and
---------------------
liabilities of such Person of any nature, whether known or unknown, absolute,
accrued, contingent or otherwise, and whether due or to become due, arising out
of, relating to, or otherwise in respect of, (i) such Person's Primestar
Business, Primestar Assets or Partnership Interest, (ii) the operation by such
Person or any of its subsidiaries or affiliates of the Digital Satellite
Business, (iii) in the case of Comcast, Newhouse, TWE and GE, such Person's
Primestar Debt, together with all arrangement fees, commitment fees and any
other fees or expenses charged by the lenders and/or arrangers of any such
indebtedness that becomes Interim Financing Debt and (iv) such Person's Assumed
Employment Liabilities, other than, in any such case, Excluded Liabilities, all
of which are expressly excluded.
"Primestar Records" of any Person means all PRIMESTAR subscriber
-----------------
lists, billing records, subscriber and supplier correspondence (in any form or
medium) used or held
<PAGE>
16
for use in such Person's Primestar Business, other than any of the foregoing
directly relating to such Person's Excluded Accounts Receivable or Excluded
Liabilities.
"Proceeding" is defined in Section 10.07(b).
----------
"Providing Person" means any of Comcast, Cox, MediaOne, TWE and
----------------
Newhouse, as the case may be.
"Proxy Statement/Prospectus" is defined in Section 5.01(e).
--------------------------
"Recent Customer Reduction" is defined in Section 4.03(b).
-------------------------
"Recent Primestar Subscriber" of any Person means any Primestar
---------------------------
Customer of such Person included on such Person's Primestar Customer Statement
who became a subscriber of such Person's Primestar Business 90 days or less
prior to the Closing Date, or in the case of subscribers receiving one (or two)
initial "free" month(s) for promotional purposes, 120 days or less (or 150 days
or less, as applicable) prior to the Closing Date.
"Registration Rights Agreement" means the Registration Rights
-----------------------------
Agreement among the Specified Class B Holders, the Class C Holders, GE and the
Company in substantially the form of Exhibit F hereto.
"Reimbursement Agreement" means a Reimbursement Agreement with the
-----------------------
Company in substantially the form of Exhibit I hereto.
"Relevant Agreements" means, (a) with respect to TSAT, this Agreement,
-------------------
the Drop Down Agreement, the TSAT Stockholders Agreement, the TSAT Merger
Agreement, the TSAT Tempo Agreement, and any agreement or instrument to be
delivered by TSAT under any of the foregoing agreements; (b) with respect to the
Company, this Agreement, the Drop Down Agreement, the TSAT Stockholders
Agreement, the TSAT Merger Agreement, the TSAT Tempo Agreement, each of the
Asset Transfer Agreements, each of the Merger Agreements, and any agreement or
instrument to be
<PAGE>
17
delivered by the Company under any of the foregoing agreements; and (c) with
respect to any other Person, this Agreement, any Asset Transfer Agreement, any
Merger Agreement, and any agreement or instrument to be delivered by such Person
under any of the foregoing agreements, in each case to the extent such Person is
named as a party thereto.
"Representor" is defined in Section 5.02.
-----------
"ResNet Debt" means up to $12 million in indebtedness incurred by TSAT
-----------
to fund the acquisition by TSAT of a 4.99% interest in each of ResNet
Communications, LLC and ResNet Communications, Inc.
"Restricted Stock Award" means any award of shares of TSAT A Stock or
----------------------
TSAT B Stock granted under the TSAT Stock Plans.
"Restructuring Transaction" means the transactions contemplated by
-------------------------
this Agreement, the Drop Down Agreement, the Merger Agreements and the Asset
Transfer Agreements.
"Retained Employment Liabilities" of any Person means (i) all
-------------------------------
obligations and liabilities relating to the employment or termination of
employment of any Selected Employee of such Person's Primestar Business by such
Person or any of its subsidiaries on or prior to the Closing Date and (ii) all
obligations and liabilities relating to the employment or termination of
employment of any Terminated Employee of such Person's Primestar Business by
such Person or any of its subsidiaries at any time.
"Revised Primestar Customer Statement" is defined in Section 4.03(b).
------------------------------------
"Roll-up Plan" is defined in the Proxy Statement/Prospectus.
------------
"SAR" means a stock appreciation right granted under a TSAT Stock
---
Plan.
"Satellite Debt" means indebtedness of Tempo Satellite, Inc. to the
--------------
Partnership reflecting amounts advanced by the Partnership to fund certain
payments under the Satellite Construction Agreement dated as of February 22,
1990 between Tempo Satellite, Inc. and Space Systems/Loral, Inc.
<PAGE>
18
"Satellite Financing" means any financing of the Partnership in
-------------------
respect of satellites that is supported by Letters of Credit.
"Satellite LOC Debt" means all reimbursement obligations of TSAT and
------------------
its subsidiaries to TCI (or, in the case of letters of credit for the account of
TSAT, to the issuer thereof) in respect of letters of credit supporting
Satellite Financing, but only to the extent such letters of credit are not drawn
upon on or prior to the Closing Date.
"SEC Documents" is defined in Section 5.01(f).
-------------
"Securities Act" is defined in Section 5.01(f).
--------------
"Selected Employee" means any full-time employee of any Class C
-----------------
Holder's Primestar Business engaged full-time in Primestar Business operations
who is informed in writing by the Company (or such Class C Holder at the
direction of the Company) on or prior to March 20, 1998 that he or she will be
employed by the Company.
"Selected Office" of any Person means an office of such Person listed
---------------
on Schedule 1.01-B.
"Senior Subordinated Discount Notes" means the 12-1/4% Senior
----------------------------------
Subordinated Discount Notes due 2007 of TSAT.
"Senior Subordinated Notes" means the 10-7/8% Senior Subordinated
-------------------------
Notes due 2007 of TSAT.
"Specified Class B Holder" has the meaning set forth in the
------------------------
Stockholders Agreement.
"Stay Bonus" means a bonus, in an amount equal to 50% of an employee's
----------
monthly base salary and accruing on a monthly basis from December 1, 1997 until
the date such employee's employment is terminated, payable to any full-time
employee of any Class C Holder's Primestar Business engaged full-time in
Primestar Business operations who is (i) informed in writing by such Class C
Holder (at the direction of the Company) that he or she will not be employed by
the Company after the Closing Date or (ii) offered employment by the Company but
chooses not to accept such offer but only if the position offered is not
"comparable" to such employee's position with such Class C
<PAGE>
19
Holder's Primestar Business or would require a relocation to an office that is
more than 55 miles from such employee's current office.
"Stockholders Agreement" means the Stockholders Agreement among the
----------------------
Specified Class B Holders, the Class C Holders, GE and the Company in
substantially the form of Exhibit D hereto.
"Subsidiary" means, (i) with respect to Comcast, Comcast Sub I and
----------
Comcast Sub II, (ii) with respect to Cox, Cox Sub, (iii) with respect to GE, GE
Sub and (iv) with respect to MediaOne, MediaOne Sub and each MediaOne
Transferor.
"Super-majority Vote" shall have the meaning assigned thereto in the
-------------------
Partnership Agreement.
"Supplemental Indentures" means supplemental indentures providing for
-----------------------
assumption by the Company on the Closing Date of the Senior Subordinated
Discount Notes and the Senior Subordinated Notes, which supplemental indentures
shall be in form reasonably satisfactory to the Parties and which shall not
otherwise effect any amendment or modification of the indentures under which
such notes were issued without the prior approval of the Partnership by a Super-
majority Vote.
"Taxes" is defined in Section 5.01(l).
-----
"Tax Sharing Agreement" means the Tax Sharing Agreement dated as of
---------------------
June 11, 1997, between TCI and TSAT.
"TCI" means Tele-Communications, Inc., a Delaware corporation.
---
"TCIC Credit Facility" means the Amended and Restated Credit Agreement
--------------------
dated as of February 19, 1997, between TCIC and TSAT.
"Tempo" means Tempo Satellite, Inc., an Oklahoma corporation.
-----
"Tempo Assets" means the BSS Authorizations, the Tempo Satellites, the
------------
Loral Contract, and all rights, claims and causes of action under the Loral
Contract, all insurance
<PAGE>
20
claims in respect of the Tempo Satellites, and Tempo's rights under the Tempo
Option.
"Tempo Option" means the Option Agreement and the Glue Letters,
------------
together with the option granted to the Partnership thereunder.
"Tempo Sale" is defined in the TSAT Tempo Agreement.
----------
"Tempo Satellites" means the satellites constructed under the Loral
----------------
Contract.
"Terminated Employee" means (i) any full-time employee of any Class C
-------------------
Holder's Primestar Business engaged full-time in Primestar Business operations
who is informed in writing by the Company (or such Class C Holder at the
direction of the Company) on or prior to March 20, 1998 that he or she will not
be employed by the Company, (ii) any full-time employee of any Class C Holder
not engaged full-time in Primestar Business operations and (iii) any part-time
employee of any Class C Holder's Primestar Business.
"Term Sheet" means the Summary of Business Terms attached to the
----------
letter dated June 11, 1997, from the Partnership to the Parties (or their
affiliates).
"Transition Services Agreement" means the Transition Services
-----------------------------
Agreement dated as of December 4, 1996, between TCI and TSAT.
"Transition Services Term Sheet" means a term sheet governing
------------------------------
transition arrangements between the Company and Comcast, Cox, MediaOne and TWE
in form and substance reasonably satisfactory to each of such Parties.
"TSAT" means TCI Satellite Entertainment, Inc., a Delaware
----
corporation.
"TSAT A Stock" means Series A Common Stock, par value $1.00 per share,
------------
of TSAT.
"TSAT B Stock" means Series B Common Stock, par value $1.00 per share,
------------
of TSAT.
<PAGE>
21
"TSAT Closing Date" is defined in the TSAT Merger Agreement.
-----------------
"TSAT Credit Agreement Amendment" means an amendment to the Credit
-------------------------------
Agreement dated as of February 19, 1997, between TSAT and the lenders under the
Credit Agreement, to permit the Restructuring Transaction, which amendment shall
have been approved by a Super-majority Vote.
"TSAT Customer Ratio" means the ratio of (x) the Final Primestar
-------------------
Customers of TSAT to (y) the Initial Primestar Customers of TSAT.
"TSAT Debt" means, as of any date of determination, (i) the principal
---------
of and premium (if any) in respect of (A) indebtedness of TSAT and its
subsidiaries for borrowed money and (B) indebtedness of TSAT and its
subsidiaries evidenced by notes, debentures, bonds or other similar instruments;
(ii) the capitalized amount of all obligations of TSAT and its subsidiaries
required to be classified and accounted for as capital leases for financial
reporting purposes in accordance with GAAP; (iii) all obligations of TSAT and
its subsidiaries for the deferred purchase price of property or under title
retention agreements (excluding trade accounts payable arising in the ordinary
course of business); (iv) all reimbursement obligations of TSAT and its
subsidiaries in respect of letters of credit, banker's acceptances and similar
instruments; and (v) all guarantees (and similar instruments) issued by TSAT and
its subsidiaries in respect of obligations of the type listed in clauses (i)
through (iv) above of any other Person; provided, that the term "TSAT Debt"
--------
shall not include Call Center Debt, Interim Financing Debt, ResNet Debt,
Satellite Debt or Satellite LOC Debt.
"TSAT Inventory Ratio" means the ratio of (x) the Primestar Inventory
--------------------
Valuation of TSAT to (y) the Final Primestar Customers of TSAT.
"TSAT Merger Agreement" means the Agreement and Plan of Merger dated
---------------------
as of February 6, 1998, between the Company and TSAT.
<PAGE>
22
"TSAT Merger" means the merger of TSAT with and into the Company, with
-----------
the Company as the surviving corporation, pursuant to the TSAT Merger Agreement.
"TSAT Stockholders Agreement" means the Stockholders Agreement among
---------------------------
the Company, Malone and TSAT in substantially the form of Exhibit N hereto.
"TSAT Stockholder Approval" is defined in Section 5.01(e).
-------------------------
"TSAT Stockholders Meeting" is defined in Section 5.01(g).
-------------------------
"TSAT Stock Plans" means (i) the TSAT 1996 Stock Incentive Plan and
----------------
(ii) the TSAT 1997 Nonemployee Director Stock Option Plan.
"TSAT Sub" means the Company until consummation of the Closing.
--------
"TSAT Tempo Agreement" means the TSAT Tempo Agreement dated as of
--------------------
February 6, 1998, between the Company and TSAT.
"TWE" means Time Warner Entertainment Company, L.P., a Delaware
---
limited partnership.
"TWE Asset Transfer Agreement" means the agreement between the Company
----------------------------
and TWE in substantially the form of the Form Asset Transfer Agreement.
"Unrecovered Inventory" of any Person means all IRDs, LNBs, Dishes and
---------------------
Primefinder Remotes installed in the home of any disconnected PRIMESTAR
subscriber of such Person.
"Up-Front Fee" is defined in Section 7.08(c).
------------
"US West" means U S WEST Media Group, Inc., a Delaware corporation.
-------
"US West Guarantee" means the Guarantee Agreement dated as of the date
-----------------
hereof among US West, Comcast, Cox, TSAT, TWE and Newhouse.
<PAGE>
23
"Voting Agreements" means (i) the Voting Agreement dated as of June
-----------------
12, 1997, among Donne F. Fisher, a division of TWE, Comcast, TSAT, Cox,
MediaOne, Newhouse and GE; (ii) the Voting Agreement dated as of June 12, 1997,
among Malone, a division of TWE, Comcast, TSAT, Cox, MediaOne, Newhouse and GE;
and (iii) the Voting Agreement dated as of June 12, 1997, among TCI, a division
of TWE, Comcast, TSAT, Cox, MediaOne, Newhouse and GE.
SECTION 1.02. Terms and Usage Generally. The definitions in Article
--------------------------
I shall apply equally to both the singular and plural forms of the terms defined
therein. Whenever the context may require, any pronoun shall include the
corresponding masculine, feminine and neuter forms. All references herein to
Articles or Sections shall be deemed to be references to Articles or Sections of
this Agreement, unless the context shall otherwise require. The words
"include", "includes" and "including" shall be deemed to be followed by the
phrase "without limitation". All accounting terms not defined in this Agreement
shall have the meanings determined by GAAP. The words "hereof", "herein" and
"hereunder" and words of similar import when used in this Agreement shall refer
to this Agreement as a whole and not to any particular provision of this
Agreement. Unless otherwise expressly provided herein, any agreement,
instrument or statute defined or referred to herein or in any agreement or
instrument that is referred to herein means such agreement, instrument or
statute as from time to time amended, modified or supplemented, including (in
the case of agreements or instruments) by waiver or consent and (in the case of
statutes) by succession of comparable successor statutes and references to all
attachments thereto and instruments incorporated therein.
ARTICLE II
SUBSIDIARY TRANSACTIONS
SECTION 2.01. Subsidiary Transactions. Concurrently with the
-----------------------
execution and delivery of this Agreement:
(a) TSAT and the Company are executing and delivering the Drop Down
Agreement, the TSAT Merger Agreement and the TSAT Tempo Agreement;
<PAGE>
24
(b) TSAT, Malone and the Company are executing and delivering the TSAT
Stockholders Agreement;
(c) Comcast Sub I and the Company are executing and delivering the
Comcast I Merger Agreement;
(d) Comcast Sub II and the Company are executing and delivering the
Comcast II Merger Agreement;
(e) Cox Sub and the Company are executing and delivering the Cox
Merger Agreement;
(f) GE Sub and the Company are executing and delivering the GE Merger
Agreement;
(g) MediaOne, the MediaOne Transferors and the Company are executing
and delivering the MediaOne Asset Transfer Agreement;
(h) Newhouse and the Company are executing and delivering the Newhouse
Asset Transfer Agreement; and
(i) TWE and the Company are executing and delivering the TWE Asset
Transfer Agreement.
ARTICLE III
ASSET TRANSFERS AND MERGERS
SECTION 3.01. Drop Down; Charter and By-laws. Upon the terms and
------------------------------
subject to the conditions set forth in this Agreement, immediately prior to the
Effective Time, TSAT shall consummate the Drop Down in accordance with the terms
of the Drop Down Agreement, and concurrently therewith, the Charter shall be
filed with the Delaware Secretary of State in accordance with the DGCL, and the
Charter and the By-laws shall become effective.
SECTION 3.02. Post-Drop Down Transactions. Upon the terms and
---------------------------
subject to the conditions set forth in this Agreement, at the Effective Time:
(a) each of Comcast Sub I, Comcast Sub II, Cox Sub and GE Sub,
respectively, shall merge with and into the Company, in each case in
accordance with the respective terms of the Comcast I Merger Agreement, the
Comcast II
<PAGE>
25
Merger Agreement, the Cox Merger Agreement and the GE Merger Agreement; and
(b) each of MediaOne and the MediaOne Transferors (other than MediaOne
Satellite II, Inc.), Newhouse and TWE, respectively, shall assign and
transfer all of such Party's right, title and interest in, to and under
such Party's Primestar Assets and Partnership Interest to the Company, and
the Company shall assume all of such Party's Primestar Liabilities, and
MediaOne Satellite II, Inc., will contribute all the issued and outstanding
capital stock of MediaOne Sub to the Company, in each case in accordance
with the respective terms of the MediaOne Asset Transfer Agreement, the
Newhouse Asset Transfer Agreement and the TWE Asset Transfer Agreement.
SECTION 3.03. Primestar Customer Statement. On the day immediately
-----------------------------
preceding the Closing Date, TSAT and each Class C Holder shall deliver to each
other Party a statement, certified by an officer of such Person (a "Primestar
---------
Customer Statement"), setting forth the number of Primestar Customers of such
- ------------------
Person as of 4 p.m. New York time on such day, as determined in good faith by
such Person, and such number shall be deemed to be the number of Primestar
Customers of such Person as of the Closing Date for purposes of the transactions
contemplated by Section 3.05.
SECTION 3.04. Primestar Inventory Statement. On the Closing Date,
------------------------------
TSAT and each Class C Holder shall deliver to each other Party a statement,
certified by an officer of such Person (a "Primestar Inventory Statement"),
-----------------------------
setting forth the Primestar Inventory transferred (whether by asset transfer or
merger) to the Company or a subsidiary thereof by or on behalf of such Person on
the Closing Date as set forth in Sections 3.01 or 3.02. Such Primestar
Inventory shall be stated by category in accordance with the categories and
subclassifications set forth in the definition of Primestar Inventory and on
Schedule 3.04.
SECTION 3.05. Consideration. At the Closing, TSAT will receive
--------------
(pursuant to the Drop Down Agreement) from the Company, in connection with the
transactions described above, shares of Class A Stock of the Company and shares
of Class B Stock of the Company, in such amounts as are
<PAGE>
26
determined in accordance with the methodology set forth in Exhibit A hereto as
of the Closing Date. At the Closing, each of Comcast, Cox, MediaOne, Newhouse
and TWE will receive (directly, or through one or more of its Subsidiaries, in
each case pursuant to the Merger Agreements and/or Asset Transfer Agreements to
which it or any of its Subsidiaries is a party) from the Company, in connection
with the transactions described above, (i) shares of Class A Stock of the
Company and shares of Class C Stock of the Company and (ii) in the case of Cox
and MediaOne, an amount of cash, and in the case of Comcast, Newhouse and TWE,
an assumption of indebtedness by the Company, in each case in such amounts as
are determined in accordance with the methodology set forth in Exhibit A hereto
as of the Closing Date. At the Closing, GE will receive (indirectly, through its
Subsidiary, pursuant to the GE Merger Agreement to which its Subsidiary is a
party) from the Company, in connection with the transactions described above,
(i) shares of Class A Stock of the Company and (ii) an assumption of
indebtedness by the Company, in each case in such amounts as are determined in
accordance with the methodology set forth in Exhibit A hereto as of the Closing
Date. The numbers set forth in Exhibit A are for illustrative purposes only and
are not binding on the parties hereto.
ARTICLE IV
CLOSING
SECTION 4.01. Closing Date. (a) Subject to the terms and conditions
-------------
of this Agreement, the closing of the Restructuring Transaction (the "Closing")
-------
shall take place (i) at the offices of Cravath, Swaine & Moore, Worldwide Plaza,
825 Eighth Avenue, New York, New York, 10019, on the later of (x) March 31, 1998
and (y) the first business day following the date on which the last to be
fulfilled or waived of the conditions set forth in Article VIII shall be
fulfilled or waived in accordance herewith or (ii) at such other time, date or
place as the Parties may agree (the "Closing Date").
------------
(b) At the Closing:
(i) the transactions described in Article III shall be consummated as
provided therein, in the Drop Down Agreement and in the applicable Merger
Agreements
<PAGE>
27
and Asset Transfer Agreements, and appropriately executed documents to be
delivered pursuant to the Drop Down Agreement, the Merger Agreements and
Asset Transfer Agreements shall be delivered by the applicable parties;
(ii) the Company shall deliver to TSAT, Comcast, Cox, MediaOne, TWE,
Newhouse and GE (in connection with the Drop Down Agreement and the
applicable Merger Agreements and Asset Transfer Agreements) (x)
certificates representing the shares of Class A Stock, Class B Stock and
Class C Stock as provided in Section 3.05, which shares (when delivered to
such Parties pursuant to such agreements) shall have been duly authorized,
validly issued, fully paid and nonassessable, (y) in the case of Comcast,
TWE, Newhouse and GE, an instrument assuming the amount of debt determined
pursuant to Section 3.05 and (z) in the case of Cox and MediaOne, the
amount of cash determined pursuant to Section 3.05;
(iii) the Company shall deliver to Comcast, Cox, MediaOne and TWE, by
wire transfer of immediately available funds, each such Party's respective
Up-Front Fee;
(iv) TSAT, Comcast, Cox, MediaOne, TWE and Newhouse shall deliver to
the Company a list of its Primestar subscribers as of the day immediately
preceding the Closing Date, in paper and magnetic form;
(v) the Company and the appropriate Parties shall deliver to one
another duly executed counterparts of the Stockholders Agreement, the
Registration Rights Agreement and the Reimbursement Agreements;
(vi) TWE and Newhouse shall deliver to one another duly executed
counterparts of the Newhouse Voting Agreement; and
(vii) the Company and each of the Founders shall deliver to one
another duly executed counterparts of an Agency Agreement, an HP Agency
Agreement and a Distributor Agreement.
<PAGE>
28
SECTION 4.02. Closing Adjustments on Primestar Inventory. (a)
-------------------------------------------
During the 45 day period following the Closing Date, the Company and its
independent auditors shall be permitted to review the working papers relating to
each Person's Primestar Inventory Statement delivered pursuant to Section 3.04,
and each Providing Person shall cooperate in good faith with the Company to
respond to any questions the Company may have in respect of such Providing
Person's Primestar Inventory Statement. At or prior to the conclusion of such
45 day period, the Company shall give written notice to each Party of its
agreement with a Primestar Inventory Statement (in which case such Primestar
Inventory Statement shall be deemed final and binding upon each Party), or of
its disagreement with the statement (a "Notice of Disagreement"). Any such
----------------------
Notice of Disagreement shall specify in detail the nature of such disagreement.
If a Notice of Disagreement is received in a timely manner, then the applicable
Primestar Inventory Statement, as revised in accordance with clause (x) or (y)
below, shall become final and binding upon each Party on the earlier of (x) the
date the Company and the applicable Providing Person resolve in writing the
differences they have with respect to the matter specified in a Notice of
Disagreement or (y) the date any disputed matters are finally resolved in
writing by the Accounting Firm, as described below; provided, that if any matter
--------
in respect of any Providing Person's Primestar Inventory Statement is submitted
to the Accounting Firm, then the Company shall submit TSAT's Primestar Inventory
Statement to the Accounting Firm so that the Accounting Firm may review and
revise (if necessary) TSAT's Primestar Inventory Statement, and TSAT's Primestar
Inventory Statement as so reviewed and/or revised shall become final and binding
upon each Party. Upon becoming final and binding as set forth above, a
Primestar Inventory Statement shall become a "Final Primestar Inventory
-------------------------
Statement".
- ---------
During the 30 day period following the delivery of a Notice of
Disagreement, the Company and the applicable Providing Person shall seek in good
faith to resolve in writing any differences they have with respect to the
matters specified in the Notice of Disagreement. During such period such
Providing Person and its auditors shall have access to the working papers of the
Company and its auditors prepared in connection with the Notice of Disagreement.
At the end of such 30 day period, the Company
<PAGE>
29
and such Providing Person shall submit to an independent accounting firm (the
"Accounting Firm") for review and resolution any and all matters which remain
---------------
in dispute and which were properly included in the Notice of Disagreement. The
Accounting Firm shall be such nationally recognized independent public
accounting firm as shall be agreed upon by the Company and all the Providing
Persons in writing. The Company and each applicable Providing Person shall
jointly request, and shall use their respective commercially reasonable efforts
to cause, the Accounting Firm to render a decision resolving the matters
submitted to it within 75 days following submission. The Company and each other
Party hereby agree that judgment may be entered upon the determination of the
Accounting Firm in any court having jurisdiction over the Party against which
such determination is to be enforced. The fees and expenses of an Accounting
Firm shall in each case be borne equally by the Company and the applicable
Providing Person.
(b) Within 5 business days after the Final Primestar Inventory and
Final Primestar Customers of TSAT and each Class C Holder shall have been
determined in accordance with Sections 4.02 and 4.03, the Company shall
calculate each Class C Holder's Inventory Payment. If a Class C Holder's
Inventory Payment is a positive number, such Class C Holder shall pay that
amount to the Company. If a Class C Holder's Inventory Payment is a negative
number, the Company shall pay the absolute value of that amount to such Class C
Holder. Any such payment shall be made by wire transfer of immediately
available funds within 5 business days after written notice from the Company to
the applicable Class C Holder of the amount thereof.
SECTION 4.03. Adjustment for Primestar Customers. (a) During the 45
-----------------------------------
day period following the Closing Date, the Company and its independent auditors
shall be permitted to review the working papers relating to each Person's
Primestar Customer Statement delivered pursuant to Section 3.03 to determine
whether the number of Primestar Customers set forth therein has been overstated
(including overstatements described in Section 7.05, and excluding
overstatements in respect of delinquencies of Recent Primestar Subscribers which
is addressed in Section 4.03(b)), and each Providing Person shall cooperate in
good faith with the Company to respond to any questions the Company may have in
respect of such Providing Person's
<PAGE>
30
Primestar Customer Statement. At or prior to the conclusion of such 45 day
period, the Company shall give written notice to each Party of its agreement
with a Primestar Customer Statement (in which case such Primestar Customer
Statement shall be deemed final and binding upon each Party), or shall deliver a
Notice of Disagreement. Any such Notice of Disagreement shall specify in detail
the nature of such disagreement and the amount by which the Company believes
Primestar Customers have been overstated. If a Notice of Disagreement is
received in a timely manner, then the applicable Primestar Customer Statement,
as adjusted in accordance with clause (x) or (y) below, shall become final and
binding upon each Party on the earlier of (x) the date the Company and the
applicable Providing Person resolve in writing the differences they have with
respect to the matter specified in a Notice of Disagreement or (y) the date any
disputed matters are finally resolved in writing by the Accounting Firm, as
described below; provided, that if any matter in respect of any Providing
--------
Person's Primestar Customer Statement is submitted to the Accounting Firm, then
the Company shall submit TSAT's Primestar Customer Statement to the Accounting
Firm so that the Accounting Firm may review and revise (if necessary) TSAT's
Primestar Customer Statement, and TSAT's Primestar Customer Statement as so
reviewed and/or revised shall become final and binding upon each Party.
During the 30 day period following the delivery of a Notice of
Disagreement, the Company and the applicable Providing Person shall seek in good
faith to resolve in writing any differences they have with respect to the
matters specified in such Notice of Disagreement. During such period such
Providing Person shall have access to the working papers of the Company and its
auditors prepared in connection with the Notice of Disagreement. At the end of
such 30 day period, the Company and such Providing Person shall submit to the
Accounting Firm for review and resolution any and all matters which remain in
dispute and which were properly included in the Notice of Disagreement. The
Company and each applicable Providing Person shall jointly request, and shall
use their respective commercially reasonable efforts to cause, the Accounting
Firm to render a decision resolving the matters submitted to it within 75 days
following submission. The Company and each other Party hereby agree that
judgment may be entered upon the determination of the Accounting Firm in any
court having
<PAGE>
31
jurisdiction over the Party against which such determination is to be enforced.
The fees and expenses of the Accounting Firm shall be borne equally by the
Company and the applicable Providing Person.
(b) On the 151st day following the Closing Date, the Company shall
determine, for each Person's Primestar Customer Statement (as adjusted pursuant
to Section 4.03(a)), the number of Recent Primestar Subscribers on such
statement which, if subjected to the delinquency tests set forth in the
definition of Primestar Customer as of such 151st day, would count as less than
one full Primestar Customer (for each such Person, the aggregate amount of such
reductions is referred to as such Person's "Recent Customer Reduction"). The
-------------------------
Company shall prepare and deliver to each Providing Person a revised Primestar
Customer Statement (a "Revised Primestar Customer Statement") for TSAT and each
------------------------------------
Providing Person, which shall set forth a number of Primestar Customers equal to
(x) the number of Primestar Customers set forth on such Person's Primestar
Customer Statement (as adjusted pursuant to Section 4.03(a)) minus (y) such
Person's Recent Customer Reduction (as determined by the Company), and the
Company shall cooperate in good faith with each Providing Person to respond to
any questions such Providing Person may have in respect of such Providing
Person's Revised Primestar Customer Statement. During the 30 day period
following receipt by the applicable Providing Person of such Providing Person's
Revised Primestar Customer Statement, such Providing Person and its independent
auditors shall be permitted to review the working papers relating to such
Revised Primestar Customer Statement. At the conclusion of such 30 day period,
such Providing Person shall give written notice to the Company of its agreement
with such Revised Primestar Customer Statement (in which case such Revised
Primestar Customer Statement shall be deemed final and binding upon each Party),
or shall deliver a Notice of Disagreement. Any such Notice of Disagreement
shall specify in detail the nature of such disagreement. If a Notice of
Disagreement is received in a timely manner, then the applicable Revised
Primestar Customer Statement, as further revised in accordance with clause (x)
or (y) below, shall become final and binding upon each Party on the earlier of
(x) the date the Company and the applicable Providing Person resolve in writing
the differences they have with respect to the matter specified in a Notice of
Disagreement or (y) the date any disputed matters are
<PAGE>
32
finally resolved in writing by the Accounting Firm, as described below;
provided, that if any matter in respect of any Providing Person's Revised
- --------
Primestar Customer Statement is submitted to the Accounting Firm, then the
Company shall submit TSAT's Revised Primestar Customer Statement to the
Accounting Firm so that the Accounting Firm may review and further revise (if
necessary) TSAT's Revised Primestar Customer Statement, and TSAT's Revised
Primestar Customer Statement as so further reviewed and/or revised shall become
final and binding upon each Party. Upon becoming final and binding as set forth
above, a Revised Primestar Customer Statement shall become a "Final Primestar
---------------
Customer Statement".
- ------------------
During the 30 day period following the delivery of a Notice of
Disagreement, the Company and the applicable Providing Person shall seek in good
faith to resolve in writing any differences they have with respect to the
matters specified in the Notice of Disagreement. During such period the Company
and its auditors shall have access to the working papers of such Providing
Person and its auditors prepared in connection with the Notice of Disagreement.
At the end of such 30 day period, the Company and such Providing Person shall
submit to the Accounting Firm for review and resolution any and all matters
which remain in dispute and which were properly included in the Notice of
Disagreement. The Company and each applicable Providing Person shall jointly
request, and shall use their respective commercially reasonable efforts to
cause, the Accounting Firm to render a decision resolving the matters submitted
to it within 75 days following submission. The Company and each other Party
hereby agree that judgment may be entered upon the determination of the
Accounting Firm in any court having jurisdiction over the Party against which
such determination is to be enforced. The fees and expenses of an Accounting
Firm shall in each case be borne equally by the Company and the applicable
Providing Person.
(c) Within 5 business days after the Final Primestar Customer
Statement of TSAT and each Class C Holder shall have been determined, the
Company shall calculate each Class C Holder's Customer Payment. If a Class C
Holder's Customer Payment is a positive number, such Class C Holder shall pay
that amount to the Company. If a Class C Holder's Customer Payment is a
negative number, the Company shall pay the absolute value of that amount to such
Class C Holder.
<PAGE>
33
Any such payment shall be made by wire transfer of immediately available funds
within 5 business days after written notice from the Company to the applicable
Class C Holder of the amount thereof.
SECTION 4.04. Adjustment for Capital Contributions. Within 10 days
-------------------------------------
after the Closing Date, the Company shall reimburse each Class C Holder and GE
(by wire transfer of immediately available funds) for 100% of any capital
contributions made to the Partnership after March 31, 1997 by such Party, as
evidenced by the Partnership's records of such contributions; provided, that for
--------
avoidance of doubt, such reimbursement shall not include any payment in respect
of interest on any such amount.
SECTION 4.05. Netting. Any payments pursuant to this Article IV by
--------
the Company to any Person on any payment date may be netted against payments due
to the Company on such date from such Person pursuant to this Article IV, and in
such event the Company shall deliver written notice to such Person setting forth
the calculation of such netting.
<PAGE>
34
ARTICLE V
REPRESENTATIONS AND WARRANTIES
SECTION 5.01. Representations and Warranties of TSAT. TSAT
---------------------------------------
represents and warrants to each other Party as follows:
(a) Organization, Standing and Corporate Power. Each of TSAT and each
-------------------------------------------
of its subsidiaries is a corporation duly organized, validly existing and
in good standing under the laws of the jurisdiction in which it is
incorporated and has the requisite corporate power and authority to carry
on its business as now being conducted. Each of TSAT and each of its
subsidiaries is duly qualified or licensed to do business and is in good
standing in each jurisdiction in which the nature of its business or the
ownership or leasing of its properties makes such qualification or
licensing necessary, other than in such jurisdictions where the failure to
be so qualified or licensed (individually or in the aggregate) would not
have a Material Adverse Effect on TSAT. TSAT has delivered to each other
Party complete and correct copies of its certificate of incorporation and
by-laws and the certificates of incorporation and by-laws of its
subsidiaries, in each case as amended to the date of this Agreement.
(b) Subsidiaries. (A) Schedule 5.01(b) lists each subsidiary of
-------------
TSAT. All the outstanding shares of capital stock of the TSAT Sub and each
such other subsidiary have been validly issued and are fully paid and
nonassessable and, except as set forth in Schedule 5.01(b), are directly
owned by TSAT, free and clear of all pledges, claims, liens, charges,
encumbrances and security interests of any kind or nature whatsoever
(collectively, "Liens"). Except for the capital stock of its subsidiaries
-----
and except for the ownership interests set forth in Schedule 5.01(b), TSAT
does not own, directly or indirectly, any capital stock or other ownership
interest in any corporation, partnership, limited liability company, joint
venture or other entity.
(B) The TSAT Sub was formed by TSAT solely for the purpose of engaging
in the transactions contemplated by
<PAGE>
35
this Agreement. The TSAT Sub does not have any liabilities or obligations
of any nature (whether accrued, absolute, contingent or otherwise) other
than those under this Agreement, the Drop Down Agreement, the Merger
Agreements, the Asset Transfer Agreements, the TSAT Merger Agreement, the
TSAT Tempo Agreement and the TSAT Stockholders Agreement.
(c) Tempo. Tempo's sole assets and liabilities consist of the Tempo
------
Assets and the liabilities associated therewith (including Tempo's
obligations to the Partnership in respect of advances by the Partnership to
Tempo). All agreements to which Tempo is a party or bound are listed on
Schedule 5.01(c). Except as set forth on Schedule 5.01(c), Tempo has no
indebtedness for borrowed money and has no other obligations of the type
set forth in the definition of "TSAT Debt".
(d) Capital Structure. The authorized capital stock of TSAT consists
------------------
of 185,000,000 shares of TSAT A Stock, 10,000,000 shares of TSAT B Stock
and 5,000,000 shares of preferred stock, par value $.01 per share. The
authorized capital stock of the TSAT Sub is as set forth in Schedule
5.01(b). At the close of business on February 6, 1998, (i) 58,237,114
shares of TSAT A Stock, 8,465,324 shares of TSAT B Stock and no shares of
preferred stock were issued and outstanding, (ii) no shares of TSAT A Stock
and no shares of TSAT B Stock were held by TSAT in its treasury, and (iii)
3,700,000 shares of TSAT A Stock and no shares of TSAT B Stock were
reserved for issuance pursuant to the TSAT Stock Plans. Except as set
forth above, at the close of business on February 6, 1998, no shares of
capital stock or other voting securities of TSAT were issued, reserved for
issuance or outstanding. Except as set forth in Schedule 5.01(d), there
are no outstanding SARs which were not granted in tandem with a related
Employee Stock Option. Ten shares of common stock of the TSAT Sub are
issued and outstanding and held by TSAT. All outstanding shares of capital
stock of TSAT and the TSAT Sub are, and all shares which may be issued
pursuant to the TSAT Stock Plans will be, when issued, duly authorized,
validly issued, fully paid and nonassessable and not subject to preemptive
rights. Except as set forth in
<PAGE>
36
Schedule 5.01(d), there are not any bonds, debentures, notes or other
indebtedness of TSAT having the right to vote (or convertible into, or
exchangeable for, securities having the right to vote) on any matters on
which stockholders of TSAT may vote. Schedule 5.01(d) sets forth a complete
list of all outstanding options (together with applicable exercise prices)
to purchase capital stock of TSAT. Except as set forth in Schedule 5.01(d),
there are not any securities, options, warrants, calls, rights,
commitments, agreements, arrangements or undertakings of any kind to which
TSAT or any of its subsidiaries is a party or by which any of them is bound
obligating TSAT or any of its subsidiaries to issue, deliver or sell, or
cause to be issued, delivered or sold, additional shares of capital stock
or other voting securities of TSAT or of any of its subsidiaries or
obligating TSAT or any of its subsidiaries to issue, grant, extend or enter
into any such security, option, warrant, call, right, commitment,
agreement, arrangement or undertaking. There are not any outstanding
contractual obligations of TSAT or any of its subsidiaries to repurchase,
redeem or otherwise acquire any shares of capital stock of TSAT or any of
its subsidiaries.
(e) Authority; Noncontravention. TSAT and the TSAT Sub each have the
----------------------------
requisite corporate power and authority to enter into their respective
Relevant Agreements and, subject to approval and adoption of the Roll-up
Plan by the holders of 66-2/3% of the total voting power of the outstanding
shares of TSAT A Stock and TSAT B Stock, voting together as a class (the
"TSAT Stockholder Approval"), to consummate the transactions contemplated
--------------------------
by each of its Relevant Agreements. The execution and delivery by TSAT and
the TSAT Sub of their respective Relevant Agreements and the consummation
by TSAT and the TSAT Sub of the Restructuring Transaction, the TSAT Merger
and the Tempo Sale have been duly authorized by all necessary corporate
action on the part of TSAT and the TSAT Sub, subject to the TSAT
Stockholder Approval. Each Relevant Agreement of TSAT and the TSAT Sub has
been (or upon execution will be) duly executed and delivered by TSAT and/or
the TSAT Sub and constitutes (or upon execution will constitute) a valid
and binding obligation of TSAT and/or the TSAT Sub, enforceable
<PAGE>
37
against TSAT and/or the TSAT Sub in accordance with their respective terms.
The execution and delivery of each Relevant Agreement of TSAT and the TSAT
Sub does not, and the consummation of the Restructuring Transaction, the
TSAT Merger and the Tempo Sale, and compliance with the provisions of such
Relevant Agreements will not, conflict with, or result in any violation of,
or default (with or without notice or lapse of time, or both) under, or
give rise to a right of termination, cancelation or acceleration of any
obligation or to loss of a material benefit under, or result in the
creation of any Lien upon any of the properties or assets of TSAT or any of
its subsidiaries under, (i) the certificate of incorporation or by-laws of
TSAT or the comparable charter or organizational documents of any of its
subsidiaries, (ii) except as disclosed on Schedule 5.01(e), any loan or
credit agreement, note, bond, mortgage, indenture, lease or other
agreement, instrument, permit, concession, franchise or license applicable
to TSAT or any of its subsidiaries or their respective properties or assets
or (iii) subject to the governmental filings and other matters referred to
in the following sentence, any judgment, order, decree, statute, law,
ordinance, rule or regulation applicable to TSAT or any of its subsidiaries
or their respective properties or assets, other than, in the case of clause
(ii), any such conflicts, violations, defaults, rights or Liens that
individually or in the aggregate would not have a Material Adverse Effect
on TSAT. No consent, approval, order or authorization of, or registration,
declaration or filing with, any Federal, state or local government or any
court, administrative agency or commission or other governmental authority
or agency, domestic or foreign, including, without limitation, the European
Community (a "Governmental Entity"), is required by or with respect to TSAT
-------------------
or any of its subsidiaries in connection with (I) the execution and
delivery of any Relevant Agreement of TSAT or the TSAT Sub or (II) the
consummation by TSAT or the TSAT Sub of the Restructuring Transaction,
except for (i) the filing of a premerger notification and report form by
TSAT under the Hart-Scott-Rodino Antitrust Improvements Act of 1976
(together with the rules and regulations promulgated thereunder, the "HSR
---
Act"), (ii) applicable approvals of the Federal Communications Commission
---
(the
<PAGE>
38
"FCC") pursuant to the Communications Act of 1934, as amended, and any
---
regulations promulgated thereunder (the "Communications Act"), (iii) the
------------------
filing with the SEC of (x) a proxy statement relating to the TSAT
Stockholder Approval (as amended or supplemented from time to time, the
"Proxy Statement/Prospectus"), (y) a registration statement of the Company
---------------------------
on Form S-4 in connection with the issuance of capital stock of the Company
in the TSAT Merger (the "Form S-4") and (z) such reports under Section
--------
13(a) of the Securities Exchange Act of 1934, as amended (together with the
rules and regulations promulgated thereunder, the "Exchange Act"), as may
------------
be required in connection with this Agreement and the Restructuring
Transaction, (iv) the filing of a certificate of merger under the TSAT
Merger Agreement and each other Merger Agreement with the Delaware
Secretary of State and appropriate documents with the relevant authorities
of other states in which TSAT is qualified to do business and (v) such
other consents, approvals, orders, authorizations, registrations,
declarations and filings as are set forth on Schedule 5.01(e).
(f) SEC Documents; Undisclosed Liabilities. TSAT has filed all
---------------------------------------
required reports, schedules, forms, statements and other documents with the
SEC since January 1, 1996 (the "SEC Documents"). As of their respective
-------------
dates, the SEC Documents complied in all material respects with the
requirements of the Securities Act of 1933 (together with the rules and
regulations promulgated thereunder, the "Securities Act"), or the Exchange
--------------
Act, as the case may be, and the rules and regulations of the SEC
promulgated thereunder applicable to such SEC Documents, and none of the
SEC Documents contained any untrue statement of a material fact or omitted
to state a material fact required to be stated therein or necessary in
order to make the statements therein, in light of the circumstances under
which they were made, not misleading. Except to the extent that
information contained in any SEC Document has been revised or superseded by
a later filed SEC Document, none of the SEC Documents contains any untrue
statement of a material fact or omits to state any material fact required
to be stated therein or necessary in order to make the statements therein,
in light of the circumstances under which they were made,
<PAGE>
39
not misleading. The financial statements of TSAT included in the SEC
Documents comply as to form in all material respects with applicable
accounting requirements and the published rules and regulations of the SEC
with respect thereto, have been prepared in accordance with generally
accepted accounting principles (except, in the case of unaudited
statements, as permitted by Form 1O-Q of the SEC) applied on a consistent
basis during the periods involved (except as may be indicated in the notes
thereto) and fairly present the consolidated financial position of TSAT and
its consolidated subsidiaries as of the dates thereof and the consolidated
results of their operations and cash flows for the periods then ended
(subject, in the case of unaudited statements, to normal year-end audit
adjustments). Except as set forth in the Filed SEC Documents or in Schedule
5.01(f), neither TSAT nor any of its subsidiaries has any liabilities or
obligations of any nature (whether accrued, absolute, contingent or
otherwise) required by generally accepted accounting principles to be set
forth on a consolidated balance sheet of TSAT and its consolidated
subsidiaries or in the notes thereto.
(g) Information Supplied. None of the information supplied or to be
---------------------
supplied by TSAT or any of its subsidiaries for inclusion or incorporation
by reference in (i) the Form S-4 will, at the time the Form S-4 is filed
with the SEC, at any time it is amended or supplemented or at the time it
becomes effective under the Securities Act, contain any untrue statement of
a material fact or omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of
the circumstances under which they are made, not misleading, or (ii) the
Proxy Statement/Prospectus will, at the date it is first mailed to TSAT's
stockholders or at the time of the meeting of TSAT's stockholders held to
vote on approval and adoption of the Roll-up Plan, including, for avoidance
of doubt, this Agreement, the Drop Down Agreement, the TSAT Merger
Agreement and the TSAT Tempo Agreement (the "TSAT Stockholders Meeting"),
-------------------------
contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or
<PAGE>
40
necessary in order to make the statements therein, in light of the
circumstances under which they are made, not misleading. The financial
statements of TSAT included in the Form S-4 and the Proxy Statement/
Prospectus will comply as to form in all material respects with applicable
accounting requirements and the published rules and regulations of the SEC
with respect thereto, and will be prepared in accordance with generally
accepted accounting principles (except, in the case of unaudited
statements, as permitted by Form 10-Q of the SEC) applied on a consistent
basis during the periods involved (except as may be indicated in the notes
thereto) and will fairly present the consolidated financial position of
TSAT and its consolidated subsidiaries as of the dates thereof and the
consolidated results of their operations and cash flows for the periods
then ended (subject, in the case of unaudited statements, to normal year-
end audit adjustments). The Proxy Statement/Prospectus will comply as to
form in all material respects with the requirements of the Exchange Act and
the rules and regulations thereunder, except that no representation is made
by TSAT with respect to statements made or incorporated by reference
therein based on information supplied by any other Party for inclusion or
incorporation by reference in the Proxy Statement/Prospectus.
(h) Absence of Certain Changes or Events. Except as disclosed in the
-------------------------------------
SEC Documents filed and publicly available prior to the date of this
Agreement (the "Filed SEC Documents") or in Schedule 5.01(h), since the
-------------------
date of the most recent audited financial statements included in the Filed
SEC Documents, TSAT has conducted its business only in the ordinary course,
and there has not been (i) any Material Adverse Change in TSAT, (ii) any
declaration, setting aside or payment of any dividend or other distribution
(whether in cash, stock or property) with respect to any of TSAT's capital
stock, (iii) any split, combination or reclassification of any of its
capital stock or any issuance or the authorization of any issuance of any
other securities in respect of, in lieu of or in substitution for shares of
its capital stock, (iv) (x) any granting by TSAT or any of its
<PAGE>
41
subsidiaries to any executive officer or director of TSAT or any of its
subsidiaries of any increase in compensation, except in the ordinary course
of business consistent with prior practice or as was required under
employment agreements in effect as of the date of the most recent audited
financial statements included in the Filed SEC Documents, (y) any granting
by TSAT or any of its subsidiaries to any such executive officer or
director of any increase in severance or termination pay, except as was
required under any employment, severance or termination agreements in
effect as of the date of the most recent audited financial statements
included in the Filed SEC Documents or (z) any entry by TSAT or any of its
subsidiaries into any employment, severance or termination agreement with
any such executive officer or director, (v) any damage, destruction or
loss, whether or not covered by insurance, that has or is likely to have a
Material Adverse Effect on TSAT, or (vi) any change in accounting methods,
principles or practices by TSAT materially affecting its assets,
liabilities or business, except insofar as may have been required by a
change in generally accepted accounting principles.
(i) Litigation. Except as disclosed in the Filed SEC Documents or in
-----------
Schedule 5.01(i), there is no suit, action or proceeding pending or, to the
knowledge of TSAT, threatened against or affecting TSAT or any of its
subsidiaries (and TSAT is not aware of any basis for any such suit, action
or proceeding) that, individually or in the aggregate, could reasonably be
expected to have a Material Adverse Effect on TSAT, nor is there any
judgment, decree, injunction, rule or order of any Governmental Entity or
arbitrator outstanding against TSAT or any of its subsidiaries having, or
which, insofar as reasonably can be foreseen, in the future would have, any
such effect.
(j) Absence of Changes in Benefit Plans. Except as disclosed in the
------------------------------------
Filed SEC Documents or in Schedule 5.01(j), since the date of the most
recent audited financial statements included in the Filed SEC Documents,
there has not been any adoption or amendment in any material respect by
TSAT or any of its subsidiaries of any collective bargaining agreement or
any bonus, pension, profit sharing, deferred
<PAGE>
42
compensation, incentive compensation, stock ownership, stock purchase,
stock option, phantom stock, retirement, vacation, severance, disability,
death benefit, hospitalization, medical or other plan, arrangement or
understanding (whether or not legally binding) providing benefits to any
current or former employee, officer or director of TSAT or any of its
subsidiaries (collectively, "Benefit Plans"). Except as disclosed in the
-------------
Filed SEC Documents, there exist no employment, consulting, severance,
termination or indemnification agreements, arrangements or understandings
between TSAT or any of its subsidiaries and any current or former employee,
officer or director of TSAT or any of its subsidiaries.
(k) ERISA Compliance. (i) Schedule 5.01(k) contains a list and
-----------------
brief description of all "employee pension benefit plans" (as defined in
Section 3(2) of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA")) (sometimes referred to herein as "Pension Plans"),
-------------
"employee welfare benefit plans" (as defined in Section 3(1) of ERISA) and
all other Benefit Plans maintained, or contributed to, by TSAT or any of
its subsidiaries for the benefit of any current or former employees,
officers or directors of TSAT or any of its subsidiaries. TSAT has
delivered to each other Party true, complete and correct copies of (v) each
Benefit Plan (or, in the case of any unwritten Benefit Plans, descriptions
thereof), (w) the most recent annual report on Form 5500 filed with the
Internal Revenue Service with respect to each Benefit Plan (if any such
report was required), (x) the most recent summary plan description for each
Benefit Plan for which such summary plan description is required, (y) each
trust agreement and group annuity contract relating to any Benefit Plan and
(z) the most recent actuarial and financial valuations prepared with
respect to each Benefit Plan.
(ii) Except as disclosed in Schedule 5.01(k), all Pension Plans
intended to be qualified under Section 401(a) of the Code have been the
subject of determination letters from the Internal Revenue Service to the
effect that such Pension Plans are so qualified and exempt from Federal
income Taxes under Section 501(a) of the Code, and no such determination
<PAGE>
43
letter has been revoked nor, to the knowledge of TSAT, has revocation been
threatened, nor has any such Pension Plan been amended since the date of
its most recent determination letter or application therefor in any respect
that would adversely affect its qualification or materially increase its
costs.
(iii) Each Benefit Plan has been administered in material compliance
with its terms and the applicable provisions of ERISA, the Code and all
other applicable laws. No event has occurred that could reasonably be
expected to result in material liability with respect to the Benefit Plans.
There are no pending or, to the knowledge of TSAT, threatened
investigations, claims or lawsuits (other than routine benefit claims) with
respect to the Benefit Plans that could reasonably be expected to result in
material liability to the Benefit Plans, TSAT or its subsidiaries.
(iv) No Pension Plan that TSAT or any of its subsidiaries maintains,
or to which TSAT or any of its subsidiaries is obligated to contribute,
other than any Pension Plan that is a "multiemployer plan" (as such term is
defined in Section 4001(a)(3) of ERISA; collectively, the "Multiemployer
-------------
Pension Plans"), had, as of the respective last annual valuation date for
-------------
each such Pension Plan, an "unfunded benefit liability" (as such term is
defined in Section 4001(a)(18) of ERISA), based on actuarial assumptions
which have been furnished to each other Party. None of the Pension Plans
has an "accumulated funding deficiency" (as such term is defined in Section
302 of ERISA or Section 412 of the Code), whether or not waived. None of
the Pension Plans has an "accumulated funding deficiency" (as such term is
defined in Section 302 of ERISA or Section 412 of the Code), whether or not
waived. None of TSAT, any of its subsidiaries, any officer of TSAT or any
of its subsidiaries or any of the Benefit Plans which are subject to ERISA,
including the Pension Plans, any trusts created thereunder or any trustee
or administrator thereof, has engaged in a "prohibited transaction" (as
such term is defined in Section 406 of ERISA or Section 4975 of the Code)
or any other breach of fiduciary responsibility that could subject TSAT,
any of its subsidiaries or any officer of TSAT or any of its subsidiaries
to the Tax or penalty on prohibited
<PAGE>
44
transactions imposed by such Section 4975 or to any liability under Section
502(i) or (1) of ERISA. Neither any of such Benefit Plans nor any of such
trusts has been terminated, nor has there been any "reportable event" (as
that term is defined in Section 4043 of ERISA) with respect to any of the
Benefit Plans during the last five years. Neither TSAT nor any of its
subsidiaries has incurred a "complete withdrawal" or a "partial withdrawal"
(as such terms are defined in Section 4203 and Section 4205, respectively,
of ERISA) since the effective date of such Sections 4203 and 4205 with
respect to any of the Multiemployer Pension Plans.
(v) With respect to any Benefit Plan that is an employee welfare
benefit plan, except as disclosed in Schedule 5.01(k), (x) each such
Benefit Plan that is a "group health plan", as such term is defined in
Section 5000(b)(1) of the Code, complies with the applicable requirements
of Section 4980B(f) of the Code and (y) each such Benefit Plan (including
any such Plan covering retirees or other former employees) may be amended
or terminated without material liability to TSAT or any of its subsidiaries
on or at any time after the Effective Time.
(vi) Except as disclosed in Schedule 5.01(k), consummation of the
transactions contemplated by this Agreement will not result in any
increased compensation or benefits, or the acceleration of the payment of
any increased compensation or benefits for any current or former employee
or director of TSAT or its subsidiaries.
(l) Taxes. Except as disclosed in Schedule 5.01(l), each of TSAT and
------
each of its subsidiaries has filed all material Tax returns and reports
required to be filed by it and has paid (or TSAT has paid on its behalf)
all material Taxes required to be paid by it, and the most recent financial
statements contained in the Filed SEC Documents reflect an adequate reserve
for all material Taxes payable by TSAT and its subsidiaries for all taxable
periods and portions thereof through the date of such financial statements.
No deficiencies for any material Taxes have been proposed, asserted or
assessed
<PAGE>
45
against TSAT or any of its subsidiaries, and no requests for waivers of the
time to assess any such Taxes are pending. As used in this Agreement,
"Taxes" shall include all Federal, state, local and foreign income,
-----
property, sales, excise and other taxes, tariffs or governmental charges of
any nature whatsoever.
(m) No Excess Parachute Payments. Other than payments that may be
-----------------------------
made to the persons listed on Schedule 5.01(m) (the "Primary Executives"),
------------------
any amount that could be received (whether in cash or property or the
vesting of property) as a result of the Restructuring Transaction by any
employee, officer or director of TSAT or any of its affiliates who is a
"disqualified individual" (as such term is defined in proposed Treasury
Regulation Section 1.280G-1) under any employment, severance or termination
agreement, other compensation arrangement or Benefit Plan currently in
effect would not be characterized as an "excess parachute payment" (as such
term is defined in Section 280G(b)(1) of the Code). Set forth in Sched-
ule 5.01(m) is (i) the maximum amount that could be paid to each Primary
Executive as a result of the transactions contemplated by this Agreement
and the TSAT Merger Agreement under all employment, severance and
termination agreements, other compensation arrangements and Benefit Plans
currently in effect and (ii) the "base amount" (as such term is defined in
Section 280G(b)(3) of the Code) for each Primary Executive calculated as of
the date of this Agreement.
(n) Voting Requirements. The TSAT Stockholder Approval is the only
--------------------
vote of the holders of any class or series of TSAT's capital stock
necessary to approve the Roll-up Plan, including, for avoidance of doubt,
this Agreement, the Drop Down Agreement, the TSAT Merger Agreement, the
TSAT Tempo Agreement, the Restructuring Transaction, the TSAT Merger and
the Tempo Sale, and the respective transactions contemplated by such
agreements.
(o) State Takeover Statutes. The Board of Directors of TSAT has
------------------------
unanimously approved the Roll-up Plan, including, for avoidance of doubt,
the Restructuring Transaction, the TSAT Merger, the Tempo
<PAGE>
46
Sale, the Voting Agreements, this Agreement, the TSAT Merger Agreement, the
TSAT Tempo Agreement and the TSAT Stockholders Agreement, and such approval
is sufficient to render inapplicable to the Roll-up Plan, the Restructuring
Transaction, the TSAT Merger, the Tempo Sale, the Voting Agreements, this
Agreement, the TSAT Merger Agreement, the TSAT Tempo Agreement and the TSAT
Stockholders Agreement, the provisions of Section 203 of the DGCL.
(p) Brokers; Schedule of Fees and Expenses. Except for Merrill Lynch
---------------------------------------
& Co. Incorporated, no broker, investment banker, financial advisor or
other person is entitled to any broker's, finder's, financial advisor's or
other similar fee or commission in connection with the Restructuring
Transaction, the TSAT Merger and the Tempo Sale, based upon arrangements
made by or on behalf of TSAT. The estimated fees and expenses incurred and
to be incurred by TSAT in connection with this Agreement, the TSAT Merger
Agreement, the TSAT Tempo Agreement, the Restructuring Transaction, the
TSAT Merger and the Tempo Sale (including the fees of TSAT's legal counsel)
are set forth in Schedule 5.01(p).
(q) Opinion of Financial Advisor. TSAT has received the opinion of
-----------------------------
Merrill Lynch & Co. Incorporated, dated as of a date on or about the date
of this Agreement, a complete and correct copy of which has been provided
to each Party.
SECTION 5.02. Representations and Warranties of Certain Parties.
--------------------------------------------------
Each of Comcast, Cox, GE, MediaOne, TWE and Newhouse, severally and not jointly,
represents and warrants (each in such capacity, a "Representor") to each other
-----------
Party as follows:
(a) Organization, Standing and Corporate Power. Such Representor and
-------------------------------------------
each of its Subsidiaries, if any, is a corporation or partnership duly
organized or formed, validly existing and, in the case of a corporation, in
good standing, under the laws of the jurisdiction in which it is
incorporated or formed and has the requisite corporate or partnership power
and authority to carry on its business as now being conducted. Such
Representor and each of its
<PAGE>
47
Subsidiaries, if any, is duly qualified or licensed to do business and is
in good standing in each jurisdiction in which the nature of its business
or the ownership or leasing of its properties makes such qualification or
licensing necessary, other than in such jurisdictions where the failure to
be so qualified or licensed (individually or in the aggregate) would not
have a Material Adverse Effect on such Representor.
(b) Subsidiaries; All Assets. (A) The authorized capital stock of
-------------------------
such Representor's Subsidiaries, if any, and the number of shares of such
capital stock that are issued and outstanding, are as set forth on such
Representor's Schedule 5.02(b)(A). Except as set forth on such
Representor's Schedule 5.02(b)(A), no shares of capital stock or other
voting securities of any of such Representor's Subsidiaries, if any, are
issued, reserved for issuance or outstanding. All the outstanding shares
of capital stock of each of such Representor's Subsidiaries, if any, have
been validly issued, fully paid and nonassessable and are owned, directly
or indirectly, by such Representor free and clear of all Liens.
(B) Except as disclosed on such Representor's Schedule 5.02(b)(B), on
and as of the Closing Date: (i) the sole assets of each Subsidiary of such
Representor, if any, will be Primestar Assets and Partnership Interests and
such Subsidiary's rights under its Merger Agreement or Asset Transfer
Agreement; (ii) no Subsidiary of such Representor will own, directly or
indirectly, any capital stock or other ownership interest in any
corporation, partnership, limited liability company, joint venture or other
entity, other than Partnership Interests; (iii) no Subsidiary of such
Representor will have any obligations or liabilities of any nature, whether
known or unknown, absolute, accrued, contingent or otherwise, and whether
due or to become due, other than Primestar Liabilities (which shall not
include any Primestar Debt unless such Representor is Comcast, Newhouse,
TWE or GE), and such Subsidiary's obligations under its Merger Agreement or
Asset Transfer Agreement; and (iv) no Subsidiary of such Representor will
have any employees other than Selected Employees.
<PAGE>
48
(c) Authority; Noncontravention. Such Representor and each of its
----------------------------
Subsidiaries, if any, has the requisite corporate power and authority to
enter into its Relevant Agreements and to consummate the transactions
contemplated by each of its Relevant Agreements. The execution and
delivery by such Representor and each of its Subsidiaries, if any, of its
Relevant Agreements and the consummation by such Representor and such
Subsidiaries of the Restructuring Transaction have been duly authorized by
all necessary corporate or partnership action on the part of such
Representor and such Subsidiaries. Each Relevant Agreement of such
Representor and each of its Subsidiaries, if any, has been (or upon
execution will be), duly executed and delivered by such Representor or
Subsidiary, as applicable, and constitutes (or upon execution will
constitute) a valid and binding obligation of such Representor or
Subsidiary, as applicable, enforceable against such Representor or
Subsidiary, as applicable, in accordance with their respective terms. The
execution and delivery of each Relevant Agreement of such Representor or
any of its Subsidiaries, if any, does not, and the consummation of the
Restructuring Transaction and compliance with the provisions of such
Relevant Agreements will not, conflict with, or result in any violation of,
or default (with or without notice or lapse of time, or both) under, or
give rise to a right of termination, cancelation or acceleration of any
obligation or to loss of a material benefit under, or result in the
creation of any Lien upon any of the properties or assets of such
Representor or Subsidiary under, (i) its certificate of incorporation or
by-laws or partnership agreement, as applicable, (ii) any loan or credit
agreement, note, bond, mortgage, indenture, lease or other agreement,
instrument, permit, concession, franchise or license applicable to such
Representor or Subsidiary or their properties or assets or (iii) subject to
the governmental filings and other matters referred to in the following
sentence, any judgment, order, decree, statute, law, ordinance, rule or
regulation applicable to such Representor or Subsidiary or their respective
properties or assets, other than, in the case of clause (ii), any such
conflicts, violations, defaults, rights or Liens that individually or in
the aggregate would not have a
<PAGE>
49
Material Adverse Effect on such Representor. No consent, approval, order or
authorization of, or registration, declaration or filing with, any
Governmental Entity is required by or with respect to such Representor or
any of its subsidiaries in connection with (I) the execution and delivery
of any Relevant Agreement of such Representor or any of its Subsidiaries,
if any, or (II) the consummation by such Representor or any of its
Subsidiaries, if any of the Restructuring Transaction, except for (i) the
filing of a premerger notification and report form by such Representor
under the HSR Act, (ii) applicable approvals of the FCC pursuant to the
Communications Act, (iii) the filing with the SEC of (x) the Proxy
Statement/Prospectus, (y) the Form S-4 and (z) such reports under Section
13(a) of the Exchange Act, as may be required in connection with this
Agreement and the Restructuring Transaction, (iv) the filing of a
certificate of merger and appropriate documents with the relevant
authorities of other states in which such Representor is qualified to do
business and (v) such other consents, approvals, orders, authorizations,
registrations, declarations and filings as are set forth on such
Representor's Schedule 5.02(c).
(d) Information Supplied. None of the informa tion supplied or to be
---------------------
supplied by such Representor or any of its subsidiaries for inclusion or
incorporation by reference in (i) the Form S-4 will, at the time the Form
S-4 is filed with the SEC, at any time it is amended or supplemented or at
the time it becomes effective under the Securities Act, contain any untrue
statement of a material fact or omit to state any material fact required to
be stated therein or necessary in order to make the statements therein, in
light of the circumstances under which they are made, not misleading, or
(ii) the Proxy Statement/Prospectus will, at the date it is first mailed to
TSAT's stockholders or at the time of the TSAT Stockholders Meeting,
contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make
the statements therein, in light of the circumstances under which they are
made, not misleading. The financial statements of such Representor's
Primestar Business included in the Form S-4 and the Proxy
<PAGE>
50
Statement/Prospectus will comply as to form in all material respects with
applicable accounting requirements and the published rules and regulations
of the SEC with respect thereto, and will be prepared in accordance with
generally accepted accounting principles (except, in the case of unaudited
statements, as permitted by Form 10-Q of the SEC) applied on a consistent
basis during the periods involved (except as may be indicated in the notes
thereto) and will fairly present the consolidated financial position of
such Representor's Primestar Business as of the dates thereof and the
consolidated results of operations and cash flows of such Representor's
Primestar Business for the periods then ended (subject, in the case of
unaudited statements, to normal year-end audit adjustments).
(e) Absence of Certain Changes or Events. Except as disclosed in
------------------------------------
such Representor's Schedule 5.02(e), since June 11, 1997, such Representor
has conducted its Primestar Business (directly or through its Subsidiaries,
if any) only in the ordinary course, and there has not been (i) any
Material Adverse Change in such Representor's Primestar Business or (ii)
any damage, destruction or loss, whether or not covered by insurance, that
has or is likely to have a Material Adverse Effect on such Representor.
(f) Litigation. Except as disclosed on such Representor's Schedule
-----------
5.02(f), there is no suit, action or proceeding pending or, to the
knowledge of the Representor, threatened against or affecting such
Representor or such Representor's Primestar Assets or Partnership Interest
or any Subsidiary of such Representor (and the Representor is not aware of
any basis for any such suit, action or proceeding) that, individually or in
the aggregate, could reasonably be expected to have a Material Adverse
Effect on such Representor, nor is there any judgment, decree, injunction,
rule or order of any Governmental Entity or arbitrator outstanding against
such Representor or any of its Primestar Assets or Partnership Interest or
any Subsidiary of such Representor having, or which, insofar as reasonably
can be foreseen, in the future would have, any such effect.
<PAGE>
51
(g) Taxes. Such Representor and each of its Subsidiaries, if any,
------
have filed all material Tax returns and reports required to be filed by
them and have paid all material Taxes required to be paid by them, with
respect to their Primestar Assets and Partnership Interest. Except as
disclosed on such Representor's Schedule 5.02(g), no deficiencies for any
material Taxes have been proposed, asserted or assessed against such
Representor or any of its Subsidiaries, and no requests for waivers of the
time to assess any such Taxes are pending.
(h) Employee Matters. Neither the Representors, their Subsidiaries
-----------------
nor any entity required to be treated with the Representors as a single
employer under Section 414 of the Code has any unsatisfied liability under
Title IV of ERISA (other than insurance premiums not yet due). Each of the
employee benefit plans (as defined in Section 3(3) of ERISA) covering any
current or former employee of the Subsidiaries or the Primestar Business
(the "Representors' Benefit Plans") is in material compliance with ERISA,
the Code and all other applicable laws. No event or condition has occurred
with respect to the Representors' Benefit Plans that could give rise to any
liability of the Subsidiaries or the Primestar Business.
SECTION 5.03. Special Representation. (a) Comcast represents and
-----------------------
warrants to each other Party that Comcast Sub I and Comcast Sub II, together,
hold all of the Primestar Assets and Partnership Interests of Comcast's
Primestar Business.
(b) Cox represents and warrants to each other Party that Cox Sub
holds all of the Primestar Assets and Partnership Interests of Cox's Primestar
Business;
(c) MediaOne represents and warrants to each other Party that
MediaOne, the MediaOne Transferors, and MediaOne Sub, together, hold all of the
Primestar Assets and Partnership Interests of US West's Primestar Business.
(d) TWE and Newhouse, jointly and severally, represent and warrant to
each other Party that except as disclosed on TWE's Schedule 5.03(d), TWE and
Newhouse
<PAGE>
52
together hold all of the Primestar Assets and Partnership Interests of TWE's and
Newhouse's Primestar Business.
(e) GE represents and warrants to each other Party that GE Sub holds
all of the Partnership Interests of GE.
ARTICLE VI
COVENANTS RELATING TO BUSINESS
SECTION 6.01. Alternative Transactions. (a) Prior to the Closing
-------------------------
Date, TSAT agrees that neither it nor any of its subsidiaries shall, nor shall
it or any of its subsidiaries permit their respective officers, directors,
employees, agents and representatives to, initiate, solicit or encourage,
directly or indirectly, any inquiries or the making or implementation of any
proposal or offer (including any proposal or offer to its stockholders) with
respect to a merger, acquisition, consolidation or similar transaction that
would impede, interfere with, delay, postpone, discourage or adversely affect
the transactions contemplated in this Agreement, or could reasonably be expected
to have such effect. Prior to the Closing Date, neither the Board of Directors
of TSAT nor any committee thereof shall (i) withdraw or modify, or propose to
withdraw or modify, in a manner adverse to any other Party, the approval or
recommendation by such Board of Directors or any such committee of the Roll-up
Plan, including, for avoidance of doubt, the Restructuring Transaction, the TSAT
Merger, the Tempo Sale, the Voting Agreements, this Agreement, the TSAT Merger
Agreement, the TSAT Tempo Agreement or the TSAT Stockholders Agreement or (ii)
approve or recommend, or propose to approve or recommend, any alternative
transaction of the type described in the first sentence of this Section 6.01.
(b) Each of TSAT, Comcast, Cox, GE, MediaOne, TWE and Newhouse,
severally and not jointly, agrees that prior to the Closing Date, it will not,
and it will not permit any of its subsidiaries to, sell, or agree to sell, all
or any part of its Primestar Assets or Partnership Interests to any other
Person, except for sales of Primestar Inventory in the ordinary course of
business consistent with past practice; provided, that the foregoing shall not
--------
apply to any transfers between TWE and Newhouse and their affiliates; and
<PAGE>
53
provided, further, that the foregoing shall not apply to any indirect transfer
- -------- -------
resulting from a merger of, a sale of substantially all the assets of, a spin-
off by, or a similar transaction involving all or any significant part of, any
of Comcast, Cox, GE, US West, TWE, Time Warner Inc. or Newhouse (so long as the
successor entity that succeeds to its predecessor(s) obligations under this
Agreement, after giving effect to such transaction, continues to (x) be bound by
the provisions of this Agreement to the same extent as such predecessor(s) and
(y) hold, directly or indirectly, substantially all the cable systems that such
predecessor(s) held prior to consummation of such transaction).
SECTION 6.02. Interim Operations of TSAT. For the period from June
---------------------------
11, 1997 until the Closing Date, TSAT:
(a) shall not (and shall cause each of its subsidiaries not to), take
any action that would result in any representation or warranty of TSAT
being untrue in any material respect;
(b) shall (and shall cause each of its subsidiaries to), conduct its
business and operations according to its ordinary course of business
consistent with past practice;
(c) shall use its commercially reasonable efforts to preserve intact
its and its subsidiaries' business organization;
(d) shall use its commercially reasonable efforts to keep available
the services of its and its subsidiaries' officers and employees;
(e) except for the amendments to the Company's certificate of
incorporation and by-laws as contemplated by Section 3.01, shall not (and
shall cause each of its subsidiaries not to) amend its certificate of
incorporation or by-laws;
(f) shall not (and shall cause each of its subsidiaries not to)
authorize for issuance, issue, sell, deliver, pledge or otherwise encumber
any shares of its capital stock, any other voting securities or any
securities convertible into, or any rights, warrants or options to acquire,
any such shares, voting
<PAGE>
54
securities or convertible securities (other than (i) shares issued upon
exercise of any rights, warrants or options outstanding as of June 11, 1997
or, in the case of Benefit Plans existing as of June 11, 1997, any rights,
warrants or options authorized under such existing plans and shares issued
upon exercise thereof and (ii) Employee Stock Options issued to directors,
officers or other employees of TSAT in the ordinary course of business and
consistent with past practice);
(g) shall not (and shall cause each of its subsidiaries not to) (i)
split, combine or reclassify any shares of its capital stock, (ii) declare,
set aside or pay any dividend or make any other distribution or payment
with respect to any shares of its capital stock or any other ownership
interests (whether in stock or property or a combination thereof) or (iii)
directly or indirectly purchase, redeem or otherwise acquire any shares of
or options or warrants or rights relating to its capital stock or that of
any of its subsidiaries, or make any commitment for any such action;
(h) shall not (and shall cause each of its subsidiaries not to) (i)
create, incur, assume, maintain or permit to exist any long term debt or
short term debt for borrowed money (other than (x) under lines of credit
and other credit facilities of TSAT existing on the date of this Agreement
and described in Schedule 6.02(h) and debt securities outstanding on the
date of this Agreement and in respect of capitalized lease obligations, not
to exceed $525,000,000 in the aggregate, and (y) the Interim Financing
Debt, (ii) issue or sell any debt securities, (other than borrowings under
existing lines of credit in the ordinary course of business), (iii) assume,
guarantee, endorse or otherwise become liable or responsible (whether
directly, contingently or otherwise) for the obligations of any other
Person except the Partnership and/or TSAT's wholly owned subsidiaries, or
(iv) make any loans, advances or capital contributions to or investments in
any other Person other than in the ordinary course of business and
consistent with past practice;
<PAGE>
55
(i) shall not make any change to its (or any of its subsidiaries')
accounting (including Tax accounting) methods, principles, practices, or
policies, other than those required by GAAP and except, in the case of Tax
accounting methods, principles or practices, in the ordinary course of
business of TSAT or any of its subsidiaries;
(j) shall not make any payment in respect of indebtedness for borrowed
money (other than payments in accordance with the terms of such
indebtedness (as they existed as of June 11, 1997 if incurred prior to such
date));
(k) shall not (and shall cause each of its subsidiaries not to), sell,
lease, transfer, mortgage, subject to any Lien or otherwise dispose of, any
of its properties or assets except in the ordinary course of business;
(l) shall not (and shall cause each of its subsidiaries not to),
acquire or agree to acquire (x) by merging or consolidating with, or by
purchasing a substantial portion of the assets of, or by any other manner,
any business or any corporation, partnership, joint venture, association or
other business organization or division thereof or (y) any assets that are
material, individually or in the aggregate, to TSAT and its subsidiaries
taken as a whole, except purchases of inventory in the ordinary course of
business consistent with past practice;
(m) shall not (and shall cause each of its subsidiaries not to),
purchase or acquire any property or assets from or otherwise engage in any
transactions with, any Person that is affiliated with (i) TSAT, (ii) Malone
or (iii) TCI, other than in the ordinary course of business and consistent
with past practice and on terms and conditions not less favorable to TSAT
than could be obtained on an arm's length basis from unrelated third
parties;
(n) shall not (and shall cause the Company not to) amend, modify,
deliver any consent under or terminate, or agree to amend, modify, deliver
any consent under or terminate, any provision of the TSAT Stockholders
<PAGE>
56
Agreement, the TSAT Merger Agreement or the TSAT Tempo Agreement, unless
each other Party shall have consented thereto;
(o) shall (and shall cause the Company to), comply with its respective
obligations under the TSAT Stockholders Agreement, the TSAT Merger
Agreement and the TSAT Tempo Agreement;
(p) shall cause the Company not to waive any defaults under the TSAT
Stockholders Agreement, the TSAT Merger Agreement or the TSAT Tempo
Agreement, unless each other Party shall have consented thereto; and
(q) shall not, and shall cause the Company not to, agree to do any of
the foregoing.
SECTION 6.03. Interim Operations of each Class C Holder. For the
------------------------------------------
period from June 11, 1997 until the Closing Date, GE, with respect to clause (a)
below only, and each Class C Holder, with respect to its Primestar Business,
Primestar Assets and its Subsidiaries, if any:
(a) except as otherwise provided in the Transition Term Sheet, shall
not, and shall cause its Subsidiaries not to, take any action that would
result in any representation or warranty of such Class C Holder or GE being
untrue in any material respect;
(b) except for transactions required in connection with consummation
of the Restructuring Transaction and except as otherwise provided in the
Transition Term Sheet, shall conduct its Primestar Business according to
its ordinary course of business consistent with past practice;
(c) except as otherwise provided in the Transition Term Sheet, shall
use its commercially reasonable efforts to preserve intact the organization
of its Primestar Business; and
(d) except as otherwise provided in the Transition Term Sheet, and
except for the orderly transitioning of Terminated Employees, shall use its
commercially reasonable efforts to keep available the services of
<PAGE>
57
the officers and employees of its Primestar Business, to the extent failure
to do so would have a Material Adverse Effect on such Class C Holder.
SECTION 6.04. Other Actions. Subject to Section 7.04(b), each of
--------------
TSAT and each Class C Holder and (for purposes of clauses (a) through (c) below)
GE, hereby agrees to take no action that would reasonably be expected to cause:
(a) the failure of any such Party to perform and comply in all
material respects with all agreements, obligations and conditions required by
this Agreement to be performed or complied with by such Party on or prior to the
Closing Date;
(b) the failure of any such Party to obtain all necessary approvals or
appropriate consents of any United States Federal or state governmental entity
or any other third party in connection with the consummation of the transactions
contemplated herein, including approvals and consents under the HSR Act and
applicable FCC rules and regulations;
(c) the institution of any suit, action or proceeding challenging,
seeking to restrain, prohibiting or adversely affecting in any material respect
the consummation of the transactions contemplated herein; or
(d) any Material Adverse Effect, in the case of TSAT, on TSAT, and in
the case of each Class C Holder, on such Class C Holder.
ARTICLE VII
ADDITIONAL COVENANTS
SECTION 7.01. Preparation of Form S-4 and the Proxy
-------------------------------------
Statement/Prospectus; TSAT Stockholders Meeting. (a) Each Party shall cooperate
- ------------------------------------------------
in the preparation of the Proxy Statement/Prospectus and the Form S-4 and all
pre- and post-effective amendments thereto and the filing thereof with the SEC.
Such cooperation shall include, without limitation, (i) preparation of
historical and pro forma financial statements relating to such Party required to
be included in such filings, (ii) provision of financial and
<PAGE>
58
other information relating to such Party required to be included in such
filings, (iii) engagement of accountants to report on and provide comfort
letters in customary form in respect of financial information provided by such
Party for inclusion in such filings (which comfort letters will be received by
TSAT in accordance with customary practice) and (iv) responding to comments
relating to such Party received from the staff of the SEC in respect of such
filings promptly after receipt thereof.
(b) Each Party shall be entitled to review any materials related to
the Proxy Statement/Prospectus at any time and from time to time prior to their
mailing to the TSAT stockholders, and to comment thereon, and TSAT and the
Company shall incorporate into such materials each Party's reasonable comments
thereon so that such materials are reasonably acceptable to each Party. TSAT
shall cause the Company to prepare and file with the SEC the Form S-4 in which
the Proxy Statement/Prospectus will be included as a prospectus, as promptly as
practicable after the date of this Agreement. Each of TSAT and the Company
shall use its best efforts to have the Form S-4 declared effective under the
Securities Act as promptly as practicable after such filing. TSAT will use its
best efforts to cause the Proxy Statement/Prospectus to be mailed to TSAT's
stockholders as promptly as practicable after the date the Form S-4 is declared
effective under the Securities Act. TSAT and the Company shall also take any
commercially reasonable action (other than qualifying to do business in any
jurisdiction in which TSAT is not now so qualified) required to be taken under
any applicable state securities laws in connection with the issuance of capital
stock of the Company in the Restructuring Transaction.
(c) TSAT will, as soon as practicable following the date of this
Agreement, duly call, give notice of, convene and hold the TSAT Stockholders
Meeting, and will use its best efforts to cause the TSAT Stockholders Meeting to
be held as promptly as practicable after the date the Proxy Statement/Prospectus
is mailed to the TSAT Stockholders, and to cause the TSAT Stockholder Approval
to be obtained at such meeting. TSAT will, through its Board of Directors,
recommend to its stockholders approval of the Roll-up Plan, including, for
avoidance of doubt, this Agreement, the TSAT Merger Agreement and the
Restructuring Transaction. Without limiting the generality of the foregoing,
TSAT agrees that
<PAGE>
59
its obligations pursuant to the first sentence of this Section 7.01(c) shall not
be affected by the commencement, public proposal, public disclosure or
communication to TSAT of any alternative transaction of the type referred to in
Section 6.01.
(d) The Parties acknowledge and agree that, subject to Section
7.04(b), they shall each use their commercially reasonable efforts to cause the
Closing to occur by March 31, 1998 (or as soon as reasonably practicable
thereafter), and to cause the TSAT Stockholders Meeting to occur sufficiently
prior to such date to permit the Closing to occur by such date.
SECTION 7.02. Listing Application. The Company and TSAT shall
--------------------
prepare and submit to NASDAQ listing applications covering the shares of Class A
Stock and Class B Stock issuable by the Company pursuant to the TSAT Merger, and
shall use their respective best efforts to obtain, prior to the Effective Time,
approval for the listing of such stock, subject to official notice of issuance.
SECTION 7.03. Access to Information; Confidenti ality. The Company
----------------------------------------
and TSAT shall afford to each Class C Holder and GE, and each Class C Holder and
GE shall afford to TSAT, and, in each case, to the officers, employees,
accountants, counsel, financial advisors and other representatives of such
Parties, reasonable access during normal business hours during the period prior
to the Effective Time to (i) in the case of TSAT and each TSAT Sub, all their
respective properties, books, contracts, commitments, personnel and records and
(ii) in the case of each Class C Holder and GE, all their respective properties,
books, contracts, commitments, personnel and records in respect of their
Primestar Assets and Subsidiaries, if any. Each of the foregoing parties agrees
to use its best efforts in good faith to obtain all waivers and consents
necessary under any confidentiality or non-disclosure agreement (other than any
such agreement with a Party seeking disclosure hereunder, as to which the Party
seeking disclosure shall be deemed to have waived such confidentiality or non-
disclosure with respect to itself) to afford reasonable access to the applicable
Party. During such period, each of the Company and TSAT shall, and shall cause
each of its respective subsidiaries to, furnish promptly to each other Party (a)
a copy of each report, schedule, registration statement and
<PAGE>
60
other document filed by it during such period pursuant to the requirements of
Federal or state securities laws and (b) all other information concerning its
business, properties and personnel as such other Party may reasonably request.
Except as required by law, each Party will hold, and will cause its respective
officers, employees, accountants, counsel, financial advisors and other
representatives and affiliates to hold, any nonpublic information in confidence
until such time as such information becomes publicly available (otherwise than
through the wrongful act of any such Person) and shall use its best efforts to
ensure that such Persons do not disclose such information to others without the
prior written consent of the applicable Party from whom such information was
received. In the event of the termination of this Agreement for any reason, each
Party shall promptly return or destroy all documents containing nonpublic
information so obtained from any other Party or any of its subsidiaries and any
copies made of such documents.
SECTION 7.04. Commercially Reasonable Efforts; Notification. (a)
----------------------------------------------
Upon the terms and subject to the conditions set forth in this Agreement, each
Party agrees to use its commercially reasonable efforts to take, or cause to be
taken, all actions, and to do, or cause to be done, and to assist and cooperate
with the other parties in doing, all things necessary, proper or advisable to
consummate and make effective, in the most expeditious manner practicable, the
Restructuring Transaction, the TSAT Merger and (if the TSAT Merger shall not
first have been consummated) the Tempo Sale, including using its commercially
reasonable efforts to (i) obtain all necessary actions or nonactions, waivers,
consents and approvals from Governmental Entities and the making of all
necessary registrations and filings (including filings with Governmental
Entities, if any) and the taking of all commercially reasonable steps as may be
necessary to obtain an approval or waiver from, or to avoid an action or
proceeding by, any Governmental Entity, (ii) obtain all necessary consents,
approvals or waivers from third parties, (iii) respond to requests for
information from the Department of Justice, the Federal Trade Commission, the
FCC and any other Governmental Entity relating to the Restructuring Transaction,
the TSAT Merger or the Tempo Sale, (iv) defend any lawsuits or other legal
proceedings, whether judicial or administrative, challenging this Agreement or
all or any part of the Restructuring
<PAGE>
61
Transaction, the TSAT Merger or the Tempo Sale, including seeking to have any
stay or temporary restraining order entered by any court or other Governmental
Entity vacated or reversed and (v) execute and deliver any additional
instruments necessary to consummate the transactions contemplated by, and to
fully carry out the purposes of, this Agreement. In connection with and without
limiting the foregoing, TSAT and its Board of Directors shall (i) take all
action necessary to ensure that no state takeover statute or similar statute or
regulation is or becomes applicable to the Roll-up Plan, including, for
avoidance of doubt, the Restructuring Transaction, the TSAT Merger, the Tempo
Sale, the Voting Agreements, this Agreement, the TSAT Merger Agreement, the TSAT
Tempo Agreement or the TSAT Stockholders Agreement and (ii) if any state
takeover statute or similar statute or regulation becomes applicable to the
Restructuring Transaction, the TSAT Merger, the Tempo Sale, the Voting
Agreements, this Agreement, the TSAT Merger Agreement, the TSAT Tempo Agreement
or the TSAT Stockholders Agreement, take all action necessary to ensure that the
Restructuring Transaction may be consummated as promptly as practicable on the
terms contemplated by this Agreement and otherwise to minimize the effect of
such statute or regulation on the Restructuring Transaction, the TSAT Merger and
the Tempo Sale.
(b) Notwithstanding anything to the contrary in this Agreement, no
Party shall be required to agree to any prohibition, limitation or other
requirements that would (i) prohibit or limit the ownership or operation by such
Party or any of its subsidiaries or affiliates of any portion of the business or
assets of such Party or any of its subsidiaries or affiliates, or compel such
Party or any of its subsidiaries or affiliates to dispose of or hold separate
any portion of the business or assets of such Party or any of its subsidiaries
or affiliates, (ii) impose limitations on the ability of such Party to acquire
or hold, or exercise full rights of ownership of, any shares of capital stock of
the Company, including the right to vote the capital stock of the Company
acquired by it on all matters properly presented to the stockholders of the
Company, (iii) prohibit such Party or any of its subsidiaries or affiliates from
effectively controlling in any material respect the business or operations of
such Party or any of its subsidiaries or affiliates or (iv) change in any
respect the governance of the Company from
<PAGE>
62
that set forth in the Charter and By-laws, or change such Party's rights under
the Stockholders Agreement or the Newhouse Voting Agreement, or impose
limitations on the ability of such Party to exercise any such rights.
(c) Each Party shall give prompt written notice to the other Parties
of (i) any representation or warranty contained in this Agreement that is
qualified as to materiality becoming untrue or inaccurate in any respect or any
such representation or warranty that is not so qualified becoming untrue or
inaccurate in any material respect or (ii) the failure by it to comply with or
satisfy in any material respect any covenant, condition or agreement to be
complied with or satisfied by it under this Agreement; provided, however, that
-------- -------
no such notification shall affect the representations, warranties, covenants or
agreements of the parties or the conditions to the obligations of the parties
under this Agreement.
SECTION 7.05. Primestar Customers. None of TSAT, TWE, Newhouse, Cox,
--------------------
Comcast or MediaOne shall engage in any unusual selling or subscriber retention
practices (including rebates, give-backs, discounts and debt forgiveness outside
the ordinary course of business consistent with past practice) prior to the
Closing that are designed to inflate their Primestar Customer additions or
retentions beyond normal levels, and thereby increase the percentage of high
risk customers. The Company shall be entitled to review individual PRIMESTAR
subscriber records of each such Party to ensure that the foregoing has been
complied with, and instances of noncompliance shall be deemed to be
overstatements for purposes of the adjustment pursuant to Section 4.03(a) (and
shall be subject to the dispute resolution procedure set forth in Section
4.03(a)).
SECTION 7.06. GE Agreements. The Company shall succeed to and assume
--------------
the rights and obligations of the Partnership to GE under the existing
agreements between the Partnership and GE or its affiliates, including, without
limitation, the Ku-1 User Agreement between Primestar and GE, dated as of
February 8, 1990 and the Amended and Restated Memorandum of Agreement, dated as
of October 18, 1996, with GE.
SECTION 7.07. Equipment. Each party to this Agreement hereto
----------
acknowledges that the ground equipment and
<PAGE>
63
"System" technology to be used by the Company in its high power business will be
General Instrument's DigiCipher II technology.
SECTION 7.08. Financing; Letters of Credit. (a) TSAT shall use its
-----------------------------
commercially reasonable efforts to arrange for financing sufficient to enable
the Company to pay the cash and assume the indebtedness contemplated to be paid
and assumed pursuant to Section 3.05, and shall consult with each of Comcast,
Cox, MediaOne, TWE, Newhouse and GE in respect of the terms of such financing.
(b) TSAT shall negotiate in good faith with the banks in respect of
the TSAT Credit Agreement Amendment and the Supplemental Indentures and shall
use its best efforts to ensure that the TSAT Credit Agreement Amendment and the
Supplemental Indentures are entered into as soon as is reasonably practicable
after the date hereof.
(c) Each of Comcast, Cox, MediaOne and TWE, severally and not
jointly, agrees to maintain each of its Letters of Credit as in existence on the
date of this Agreement on the respective terms of such Letters of Credit, and in
consideration thereof, the Company shall pay to each such Party by wire transfer
of immediately available funds (i) on the Closing Date, a fee (the "Up-Front
--------
Fee") equal to 0.125% of the aggregate face amount of such Party's Letters of
- ---
Credit and (ii) on the first business day of each month during which such
Party's Letters of Credit are in effect, a fee (the "Monthly Fee") equal to
-----------
0.10% of the aggregate face amount of such Party's Letters of Credit
(retroactive to January 1, 1998). Each of Comcast, Cox, MediaOne and TWE,
severally and not jointly, agrees that prior to the expiration of its respective
Letters of Credit referred to above, such Party shall extend the maturity of
such Letters of Credit to June 30, 1999, and the Monthly Fee shall be payable in
respect of each such extended Letter of Credit in the same manner set forth
above. In addition, the Company shall reimburse each of Comcast, Cox, MediaOne
and TWE for all commitment fees and other costs incurred by such Parties in
respect of their Letters of Credit, as incurred, but only to the extent the
Company (directly or through TSAT) shall have agreed to reimburse such amounts
to TCI in respect of its Letters of Credit.
<PAGE>
64
SECTION 7.09. Agreements. On the Closing Date, each Party and the
-----------
Company shall enter into the agreements referenced in Section 4.01.
SECTION 7.10. Compliance. (a) During the period from the date
-----------
hereof through the Closing Date, each Representor shall cause each of its
Subsidiaries, if any, to comply with and perform its obligations under each
Relevant Agreement of any such Subsidiary.
(b) During the period from the date hereof through the Closing Date,
TSAT shall cause the TSAT Sub to comply with and perform its obligations under
each Relevant Agreement of the TSAT Sub.
SECTION 7.11. ASkyB Transaction. (a) The Parties acknowledge and
-----------------
agree that the intent and desire of the Parties is to close both the
Restructuring Transaction and the transactions contemplated by the ASkyB
Agreement as promptly as possible and simultaneously if feasible. The Parties
hereto agree that the closing of the Restructuring Transaction is not contingent
on the closing of the transactions contemplated by the ASkyB Agreement. The
Parties hereto agree that if all conditions to the closing of the Restructuring
Transaction set forth in Article VIII are satisfied (or otherwise waived) prior
to the satisfaction (or waiver) of all conditions to the closing of the
transactions contemplated by the ASkyB Agreement, the Parties hereto agree
promptly to close the Restructuring Transaction.
(b) Subject to Section 7.04(b), the Parties shall cooperate with each
other in good faith to consummate the transactions contemplated by the ASkyB
Agreement. Subject to the preceding paragraph, the Parties shall also use
commercially reasonable efforts to respond to requests for information from the
Department of Justice, the Federal Trade Commission, the FCC and any other
Governmental Entity relating to the transactions contemplated by the ASkyB
Agreement, and to prepare and make such other filings as may be reasonably
required to apply for any approvals, authorizations and consents of any
Governmental Entity regarding the transactions contemplated by the ASkyB
Agreement as may be required by applicable law or regulation, and to prepare and
provide each other Party with the financial information regarding such Party and
its
<PAGE>
65
Primestar Business (subject to appropriate confidentiality safeguards) as may be
reasonably required to comply with the requirements of such laws and
regulations, including the requirements of the Securities Act or the Exchange
Act relating to any filings to be made by TSAT or the Company in connection with
the transactions contemplated by the ASkyB Agreement, in each case on as prompt
a basis as is reasonably practicable.
SECTION 7.12. Indemnification. (a) Indemnification by the Company.
---------------- -------------------------------
If the Closing shall occur, the Company and its subsidiaries, jointly and
severally, shall indemnify each of TSAT, Comcast, Cox, MediaOne, TWE, Newhouse,
GE, each affiliate of TSAT, Comcast, Cox, MediaOne, TWE, Newhouse or GE, and
each of their respective officers, directors, employees and agents against and
hold them harmless from (i) any and all losses, liabilities, claims, damages,
costs and expenses (including attorneys' fees and disbursements and other
reasonable professional fees and disbursements, whether or not litigation is
instituted) (collectively, "Losses") suffered or incurred by any such
------
indemnified party arising out of or resulting from any Primestar Liabilities of
any of TSAT, Comcast, Cox, MediaOne, TWE, Newhouse or GE (or any of their
respective affiliates), (ii) any and all Losses arising out of or resulting from
the operation by the Company, its subsidiaries, or any of their respective
predecessors of the Primestar Business or the Digital Satellite Business or the
ownership by the Company, its subsidiaries, or any of their respective
predecessors of the Primestar Assets or any assets used primarily in the Digital
Satellite Business (the "Digital Satellite Assets"), whether before, on or after
------------------------
the Closing Date and (iii) any and all Losses arising out of or resulting from
the business, affairs, assets or liabilities of the Company and its
subsidiaries, whether arising before, on or after the Closing Date.
(b) Indemnification by Comcast, Cox, MediaOne, TWE, Newhouse and GE.
----------------------------------------------------------------
If the Closing shall occur, each of Comcast, Cox, MediaOne, TWE, Newhouse and
GE, severally and not jointly, shall indemnify the Company its subsidiaries and
each of their respective officers, directors, employees and agents against and
hold them harmless from, any and all Losses arising out of or resulting from (A)
such indemnitor's Excluded Liabilities, (B)(i) the operation by such indemnitor,
its subsidiaries or any of their respective
<PAGE>
66
predecessors of any business other than the Primestar Business or the Digital
Satellite Business or (ii) the ownership by such indemnitor, its subsidiaries or
any of their respective predecessors of any assets other than Primestar Assets
or Digital Satellite Assets, in any such case whether before, on or after the
Closing Date or (C) any and all Losses arising out of or resulting from the
business, affairs, assets or liabilities, other than Primestar Liabilities, of
such indemnitor after the Closing Date.
(c) Indemnification by Comcast, Cox, MediaOne and GE. If the Closing
-------------------------------------------------
shall occur, each of Comcast, Cox, MediaOne and GE, severally and not jointly,
shall indemnify the Company its subsidiaries and each of their respective
officers, directors, employees and agents against and hold them harmless from,
any and all Losses arising out of or resulting from the breach of any of such
indemnitor's representations and warranties set forth in Section 5.02(b)(B).
(d) Procedures. Any party seeking indemnification hereunder shall
-----------
give prompt notice to the other party of any claim as to which indemnification
is sought, and the indemnifying party shall have the right to control, at its
own expense, the conduct of any such claim, and any litigation arising out of
such claim. An indemnifying party shall not be liable for any settlement of any
action or claim effected without its consent, which consent shall not be
unreasonably withheld. Notwithstanding the foregoing, the party seeking
indemnification hereunder shall have the right, at its own expense, to
participate in (but not control) the defense of any third-party claim giving
rise to a claim of indemnification hereunder, and shall have the right to
control (with counsel of its own choice and at the expense of the indemnifying
party) the defense of any such third party claim if such third party claim shall
seek any material non-monetary damages or criminal penalties, or if the
indemnifying party shall also be a party or potential party to such claim (or
another claim based on substantially similar facts) and the party seeking
indemnification shall have received an opinion of counsel stating that the party
seeking indemnification has substantive defenses to such claim that are
different from and potentially inconsistent with those available to the
indemnifying party.
<PAGE>
67
SECTION 7.13. Tax Indemnification. (a) Each of Comcast, Cox, and GE
--------------------
(each, in such capacity, a "MergerIndemnitor") shall indemnify the Company, its
----------------
affiliates and each of their respective officers, directors, employees,
stockholders, agents and representatives against and hold them harmless from (i)
all liability for Covered Taxes of the MergerIndemnitor's Subsidiary for the
Pre-Closing Tax Period, (ii) all liability (as a result of Treasury Regulation
(S) 1.1502-6(a) or otherwise) for Covered Taxes of any corporation which, prior
to the Closing, was affiliated with the MergerIndemnitor's Subsidiary or with
which the MergerIndemnitor's Subsidiary, prior to the Closing, otherwise filed a
consolidated, combined, unitary or aggregate Tax return, (iii) all liability for
Covered Taxes resulting from the merger of the MergerIndemnitor's Subsidiary
with and into the Company failing to qualify under either (I) Section 351(a) of
the Code coupled with a deemed liquidation of the MergerIndemnitor's Subsidiary
under Section 332 of the Code or (II) Section 368(a) of the Code, (except, in
either such case, if and to the extent any failure to so qualify attributable to
any action taken after the Closing by the Company or any of its subsidiaries,
other than any such action expressly required or contemplated by this
Agreement), and (iv) all liability for any reasonable legal, accounting,
appraisal, consulting or similar fees and expenses relating to the foregoing.
(b) Each of MediaOne, Newhouse, and TWE (each, in such capacity, a
"ContributionIndemnitor") shall indemnify the Company, its affiliates and each
- -----------------------
of their respective officers, directors, employees, stockholders, agents and
representatives against and hold them harmless from (i) in the case of a
transfer of assets (other than stock of a corporation) to the Company by such
ContributionIndemnitor, all liability for Covered Taxes attributable to the
operation or ownership of such assets during the Pre-Closing Tax Period, (ii) in
the case of a transfer of stock of a corporation (a "Contributed Corporation")
-----------------------
to the Company by such ContributionIndemnitor, all liability for Covered Taxes
of the Contributed Corporation for the Pre-Closing Tax Period, (iii) in the case
of a Contributed Corporation, all liability (as a result of Treasury Regulation
(S)1.1502-6(a) or otherwise) for Covered Taxes of any corporation which, prior
to the Closing, was affiliated with the Contributed Corporation or with which
the Contributed Corporation, prior to the Closing, otherwise filed a
consolidated, combined,
<PAGE>
68
unitary or aggregate Tax return, and (iv) all liability for any reasonable
legal, accounting, appraisal, consulting or similar fees and expenses relating
to the foregoing.
(c) Notwithstanding the foregoing, each MergerIndemnitor and
ContributionIndemnitor (together, each an "Indemnitor") shall not be required to
----------
indemnify and hold harmless the Company and its affiliates and each of their
respective officers, directors, employees, stockholders, agents and
representatives, and the Company shall indemnify each Indemnitor, its affiliates
and each of their respective officers, directors, employees, stockholders,
agents, and representatives against and hold them harmless from, (i) all
liability for Covered Taxes of the Company for the Post-Closing Tax Period, (ii)
all liability for Covered Taxes resulting from the merger of the
MergerIndemnitor's Subsidiary with and into the Company failing to qualify under
Section 368(a) of the Code if and to the extent such failure is attributable to
any action taken after the Closing by the Company or any of its subsidiaries
(other than any such action expressly required or contemplated by this
Agreement), and (iii) all liability for any reasonable legal, accounting,
appraisal, consulting or similar fees and expenses relating to the foregoing.
(d) If a MergerIndemnitor is required to make an indemnity payment
pursuant to clause (iii) of Section 7.13(a) by virtue of a merger failing to
qualify under Section 368(a) of the Code and, as a result of such failure, the
Company or any of its subsidiaries actually realizes a tax benefit in a Post-
Closing Tax Period (including by virtue of an increase in the tax basis of the
assets acquired in the merger to fair market value), then the Company shall pay
to such MergerIndemnitor the amount of such tax benefit within ten days of
having actually realized such benefit (including at the time estimated Tax
payments are due). For this purpose, the Company or any of its subsidiaries
shall be deemed to actually realize a tax benefit to the extent, and at such
time as, the amount of the Tax payable by the Company or such subsidiary for the
relevant taxable period is reduced below the amount of Tax that the Company or
such subsidiary would otherwise have been required to pay for such taxable
period at such time if the merger had qualified under Section 368(a) of the
Code.
<PAGE>
69
SECTION 7.14. Post-Closing Cooperation; Confidentiality. (a) For a
------------------------------------------
period of 180 days after the Closing, each Party shall cooperate with the
Company to ensure the orderly transition of such Person's Primestar Business to
the Company. Each Party and the Company shall cooperate with one another in
connection with the furnishing of information that is reasonably necessary for
financial reporting and accounting matters and in respect of compliance with
disclosure and reporting requirements under the Securities Act and the Exchange
Act.
(b) After the Closing, upon reasonable written notice, the Company
and each other Party shall furnish or cause to be furnished to one another, as
promptly as practicable, such information and assistance (to the extent within
the control of such Party) relating to such Party's Primestar Assets or
Partnership Interests (including access to books and records) as is reasonably
necessary for the filing of all Tax returns, and making of any election related
to Taxes, the preparation for any audit by any taxing authority, and the
prosecution or defense of any claim, suit or proceeding related to any Tax
return. The Company and each other Party shall cooperate with each other in the
conduct of any audit or other proceeding relating to Taxes involving such
Party's Primestar Assets or Partnership Interest. The Company and each other
Party shall retain the books and records relating to such Party's Primestar
Assets and Partnership Interest for a period of seven years after the Closing.
With respect to ad valorem Taxes attributable to the conduct of a Party's
Primestar Business prior to the Closing Date, the Company shall prepare the
first draft of each such Tax return and shall provide such draft to the
applicable Party for review and comment, and such Party shall file such Tax
return and shall be liable for, and shall pay, the amount of such Taxes as due
and shall reimburse the Company for its reasonable out-of-pocket costs and
expenses incurred in the preparation of such Tax returns.
(c) Each of Comcast and Cox, severally and not jointly, agrees that
from and after the Closing, the Company shall have the right and authority (x)
to collect for its own account all Post-Closing Accounts Receivable, (y) to
collect for the account of Comcast or Cox, as applicable, all Excluded Accounts
Receivable and (z) to collect for the respective accounts of the Company and
Comcast or Cox, as
<PAGE>
70
applicable, (as provided herein) all accounts receivable that comprise both
Post-Closing Accounts Receivable and Excluded Accounts Receivable. Each of
Comcast and Cox, severally and not jointly, agrees to promptly deliver (or cause
its subsidiaries to deliver) to the Company any cash or other property received
directly or indirectly by it with respect to the Post-Closing Accounts
Receivable, including any amounts payable as interest. The Company agrees to
promptly deliver to Comcast or Cox, as applicable, any cash or other property
received directly or indirectly by it with respect to Excluded Accounts
Receivable of Comcast or Cox, as applicable. In the event that any amounts
received by the Company, Comcast or Cox, as applicable, relate to both Post-
Closing Accounts Receivable and Excluded Accounts Receivable, such amounts shall
be duly allocated by the recipient to the appropriate categories and the amounts
so allocated shall be delivered to the appropriate party as provided above.
(d) For a period of three years after the Closing, except as required
by law, each Party will hold, and will cause its respective officers and
employees to hold, any nonpublic information included in such Party's Primestar
Records in confidence until such time as such information becomes publicly
available (otherwise than through the wrongful act of any such Person).
SECTION 7.15. TCI Agreements. TSAT shall cause the Transition
---------------
Services Agreement to terminate effective on or prior to the Closing Date.
SECTION 7.16. Employee Matters. If the Closing shall occur, the
-----------------
Company shall make an offer of employment to each Selected Employee of TWE,
Newhouse, MediaOne, Comcast and Cox, or any of their respective subsidiaries,
and shall take such other steps as shall be reasonably required to effectuate
the provisions of this Agreement in respect of such Selected Employees.
SECTION 7.17. Other Stockholder Approvals. (a) As soon as
----------------------------
practicable after the date of this Agreement and in any event prior to the TSAT
Stockholders Meeting, TSAT, as the sole stockholder of the Company, shall
execute and deliver a written consent of sole stockholder, approving and
adopting this Agreement, the Merger Agreements, the Asset
<PAGE>
71
Transfer Agreements, the TSAT Merger Agreement and the TSAT Tempo Agreement.
(b) As soon as practicable after the date of this Agreement and in any
event prior to the TSAT Stockholders Meeting, Cox, as the sole stockholder of
Cox Sub, Comcast, as the sole stockholder of Comcast Sub I and Comcast Sub II,
and GE, as the sole stockholder of GE Sub, shall execute and deliver a written
consent of sole stockholder, approving and adopting the respective Merger
Agreements to which such respective Subsidiaries are parties.
ARTICLE VIII
CONDITIONS PRECEDENT
SECTION 8.01. Conditions Precedent. The rights and obligations of
---------------------
each Party shall be subject to the satisfaction or waiver on or prior to the
Closing Date of each of the following conditions precedent:
(a) Strategic Plan. The five year strategic plan of the Company
--------------
shall have been approved by a Super-majority Vote (in the form approved,
the "Five Year Plan").
--------------
(b) Stockholder Approval. The TSAT Stockholder Approval shall have
---------------------
been obtained.
(c) HSR Act. The waiting period (and any extension thereof)
--------
applicable to the Restructuring Transaction under the HSR Act shall have
been terminated or shall have expired.
(d) Communications Act. All orders and approvals of the FCC required
-------------------
in connection with the consummation of the Restructuring Transaction, if
any, shall have been obtained or made.
(e) No Injunctions or Restraints. No temporary restraining order,
-----------------------------
preliminary or permanent injunction or other order issued by any court of
competent jurisdiction or other legal restraint or prohibition preventing
the consummation of the Restructuring Transaction shall be in effect.
<PAGE>
72
(f) NASDAQ Listing. The shares of Class A Stock and Class B Stock
---------------
issuable to the stockholders of TSAT pursuant to the TSAT Merger Agreement
and under the TSAT Stock Plans shall have been approved for listing on
NASDAQ, subject to official notice of issuance.
(g) Form S-4. The Form S-4 shall have become effective under the
---------
Securities Act and shall not be the subject of any stop order or
proceedings seeking a stop order.
(h) Secretary's Certificates. Each Party shall have received
-------------------------
certificates from a Secretary or Assistant Secretary of each other Party
(and any Subsidiary of any such Party that is a party to the Drop Down
Agreement or an Asset Transfer Agreement or Merger Agreement) (i)
certifying organizational documents of such Party and relevant board (or
partnership) resolutions authorizing the transactions contemplated by this
Agreement, the Drop Down Agreement (if applicable) and any applicable Asset
Transfer Agreement or Merger Agreement and (ii) as to the incumbency of
each person signing any Relevant Agreement on behalf of such Party or
Subsidiary.
SECTION 8.02. Conditions to Obligations of each of Comcast, Cox,
--------------------------------------------------
MediaOne, TWE, Newhouse and GE. The obligations of each of Comcast, Cox,
- -------------------------------
MediaOne, TWE, Newhouse and GE are further subject to the following conditions:
(a) Representations and Warranties. The representation and
-------------------------------
warranties of each other Party set forth in this Agreement (and of Malone
set forth in the Malone Letter) that are qualified as to materiality shall
be true and correct, and the representations and warranties of each other
Party set forth in this Agreement (and of Malone set forth in the Malone
Letter) that are not so qualified shall be true and correct in all material
respects, in each case as of the date of this Agreement and as of the
Closing Date, except as otherwise contemplated by this Agreement, and such
Party shall have received certificates signed on behalf of each such other
Party by the chief executive officer and the chief financial officer of
such other Party (and from Malone) to such effect.
<PAGE>
73
(b) Performance of Obligations. Each other Party (including any
---------------------------
Subsidiary of such other Party) and each TSAT Sub (and Malone) shall have
performed in all material respects all obligations required to be performed
by it under each of its Relevant Agreements (and under the Malone Letter)
at or prior to the Closing Date, and such Party shall have received a
certificate signed on behalf of each such other Party (and Subsidiary) and
the TSAT Sub, by the chief executive officer and the chief financial
officer of such other Party (or Subsidiary) and the TSAT Sub (and from
Malone) to such effect.
(c) Financing. All financing arrangements of the Company (including
---------
those of TSAT to be assumed by the Company or to remain in effect after the
Effective Time) shall be in accordance with the Five Year Plan.
(d) Capacity. The Company shall have sufficient credit lines and
--------
borrowing capacity to pay the cash and assume the indebtedness contemplated
to be paid and assumed pursuant to Section 3.05.
(e) Letters of Credit. The Letters of Credit of TCI and each other
-----------------
Party (or their respective affiliates, as applicable) shall be in effect,
and TCI shall have agreed in writing with TSAT to extend the maturity of
its Letters of Credit to June 30, 1999, and the consideration payable to
TCI in respect of its Letters of Credit shall be the same as that for the
other Parties as set forth in Section 7.08(c).
(f) No Litigation. There shall not be pending or threatened any
-------------
suit, action or proceeding by any Governmental Entity that has a reasonable
likelihood of success, (i) challenging the acquisition by such Party of any
shares of capital stock of the Company, seeking to restrain or prohibit the
consummation of the Restructuring Transaction or seeking to obtain from
such Party or the Company any damages that are material in relation to the
Company and its subsidiaries taken as a whole, (ii) seeking to prohibit or
limit the ownership or operation by the Company or such Party or any of
their respective subsidiaries or affiliates of any portion of the business
or assets of the Company, such Party or any of their respective
subsidiaries or
<PAGE>
74
affiliates, or to compel the Company, such Party or any of their respective
subsidiaries or affiliates to dispose of or hold separate any portion of
the business or assets of the Company, such Party or any of their
respective subsidiaries or affiliates, as a result of the Restructuring
Transaction, (iii) seeking to impose limitations on the ability of such
Party to acquire or hold, or exercise full rights of ownership of, any
shares of capital stock of the Company, including the right to vote the
capital stock of the Company acquired by it on all matters properly
presented to the stockholders of the Company, (iv) seeking to prohibit the
Company, such Party or any of their respective subsidiaries or affiliates
from effectively controlling in any material respect the business or
operations of the Company, such Party or any of their respective
subsidiaries or affiliates, (v) seeking to change in any respect the
governance of the Company from that set forth in the Charter and By-laws,
or to change such Party's rights under the Stockholders Agreement or the
Newhouse Voting Agreement, or seeking to impose limitations on the ability
of such Party to exercise any such rights or (vi) which otherwise is
reasonably likely to have a Material Adverse Effect on the Company.
(g) State Takeover Statutes. TSAT and the Board of Directors of TSAT
------------------------
shall have taken all actions required to render inapplicable to the Roll-up
Plan, including, for avoidance of doubt, the Restructuring Transaction, the
TSAT Merger, the Tempo Sale, the Voting Agreements, this Agreement, the
TSAT Merger Agreement, the TSAT Tempo Agreement and the TSAT Stockholders
Agreement, any state takeover statute or similar statute or regulation that
would otherwise apply or purport to apply to such transactions and
agreements.
(h) Tax Representation Letter. Each other Party shall have delivered
--------------------------
a tax representation letter, dated the Closing Date, in the same form as
the letter delivered by each such Party on the date of this Agreement.
<PAGE>
75
SECTION 8.03. Conditions to Obligations of TSAT. The obligations of
----------------------------------
TSAT are further subject to the following conditions:
(a) Representations and Warranties. The representations and
-------------------------------
warranties of each other Party set forth in this Agreement that are
qualified as to materiality shall be true and correct, and the
representations and warranties of each other Party set forth in this
Agreement that are not so qualified shall be true and correct in all
material respects, in each case as of the date of this Agreement and as of
the Closing Date, except as otherwise contemplated by this Agreement, and
TSAT shall have received certificates signed on behalf of each such other
Party by the chief executive officer and the chief financial officer of
such other Party to such effect.
(b) Performance of Obligations. Each other Party (including any
---------------------------
Subsidiary of such other Party) shall have performed in all material
respects all obligations required to be performed by it under each of its
Relevant Agreements at or prior to the Closing Date, and TSAT shall have
received a certificate signed on behalf of each such other Party (and
Subsidiary) by the chief executive officer and the chief financial officer
of such other Party (or Subsidiary) to such effect.
(c) Letters of Credit. The Letters of Credit of each other Party (or
-----------------
their respective affiliates, as applicable) shall be in effect.
(d) No Litigation. There shall not be pending or threatened any
-------------
suit, action or proceeding by any Governmental Entity that has a reasonable
likelihood of success, (i) seeking to restrain or prohibit the consummation
of the Restructuring Transaction or seeking to obtain from TSAT or the
Company any damages that are material in relation to the Company and its
subsidiaries taken as a whole, (ii) seeking to prohibit or limit the
ownership or operation by the Company or TSAT or any of their respective
subsidiaries or affiliates of any portion of the business or assets of the
Company, TSAT or any of their respective affiliates, or to compel the
Company, TSAT or any of their respective affiliates to dispose of or hold
<PAGE>
76
separate any portion of the business or assets of the Company, TSAT or any
of their respective affiliates, as a result of the Restructuring
Transaction, (iii) seeking to prohibit the Company or any of its
subsidiaries from effectively controlling in any material respect the
business or operations of the Company or its subsidiaries, (iv) seeking to
impose limitations on the ability of TSAT or any Person that (as of the
date of this Agreement) holds 5% or more of the TSAT A Stock or TSAT B
Stock to acquire or hold, or exercise full rights of ownership of, any
shares of capital stock of the Company, including the right to vote all
capital stock of the Company acquired by such Person pursuant to the
Restructuring Transaction on all matters properly presented to the
stockholders of the Company, (v) seeking to change in any respect the
governance of the Company from that set forth in the Charter and By-laws,
or to change TSAT's rights under the Stockholders Agreement, or seeking to
impose limitations on the ability of TSAT to exercise any such rights or
(vi) which otherwise is reasonably likely to have a Material Adverse Effect
on the Company.
(e) Tax Representation Letter. Each other Party shall have delivered
--------------------------
a tax representation letter, dated the Closing Date, in the same form as
the letter delivered by each such Party on the date of this Agreement.
ARTICLE IX
TERMINATION, AMENDMENT AND WAIVER
SECTION 9.01. Termination. This Agreement may be terminated at any
------------
time prior to the Effective Time, whether before or after the vote of the
stockholders of TSAT at the TSAT Stockholders Meeting:
(a) by mutual written consent of the parties hereto; or
(b) by any Party:
(i) if, upon a vote at a duly held TSAT Stockholders Meeting or
any adjournment thereof,
<PAGE>
77
the TSAT Stockholder Approval shall not have been obtained; or
(ii) if any judgment, decree, injunction, rule or order of any
Governmental Entity which prohibits, restricts or delays consummation
of the Restructuring Transaction shall have become final and
nonappealable;
provided, however, that the Party seeking termination is not in breach in any
- -------- -------
material respect of any of its representations, warranties, covenants or
agreements contained in this Agreement.
SECTION 9.02. Effect of Termination. In the event of termination of
----------------------
this Agreement by any Party as provided in Section 9.01, this Agreement shall
forthwith become void and have no effect, without any liability or obligation
hereunder on the part of any Party, other than this Section 9.02 and Article X
and except to the extent that such termination results from the wilful and
material breach by a Party of any of its representations, warranties, covenants
or agreements set forth in this Agreement.
SECTION 9.03. Amendment. This Agreement may be amended by the
----------
Parties at any time before or after the TSAT Stockholder Approval; provided,
--------
however, that after any such approval, there shall be made no amendment that by
- -------
law requires further approval by such stockholders without the further approval
of such stockholders. This Agreement may not be amended except by an instrument
in writing signed on behalf of each of the Parties.
SECTION 9.04. Extension; Waiver. At any time prior to the Effective
------------------
Time, the Parties may (a) extend the time for the performance of any of the
obligations or other acts of the other Parties, (b) waive any inaccuracies in
the representations and warranties contained in this Agreement or in any
document delivered pursuant to this Agreement or (c) subject to the proviso of
Section 9.03, waive compliance with any of the agreements or conditions
contained in this Agreement. Any agreement on the part of a party to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party. The failure of any party to this Agreement to
assert any of its
<PAGE>
78
rights under this Agreement or otherwise shall not constitute a waiver of such
rights.
ARTICLE X
GENERAL PROVISIONS
SECTION 10.01. Nonsurvival of Representations and Warranties. Except
----------------------------------------------
as set forth in either of the next two sentences, none of the representations
and warranties in this Agreement or in any instrument delivered pursuant to this
Agreement shall survive the Closing. The representations and warranties of TSAT
in this Agreement shall survive the Closing solely for purposes of Section
5.02(a) of the TSAT Merger Agreement, and shall terminate on the earlier of (i)
the TSAT Closing Date and (ii) termination of the TSAT Merger Agreement. The
representation and warranty of MediaOne, Comcast, Cox and GE set forth in
Section 5.02(b)(B) shall survive the Closing solely for purposes of Section
7.12(c) and shall terminate at the close of business 18 months following the
Closing Date. This Section 10.01 shall not limit any covenant or agreement of
the parties which by its terms contemplates performance after the Effective
Time.
SECTION 10.02. Notices. Any notice or other communication that is
--------
required or that may be given in connection with this Agreement shall be in
writing and shall be delivered personally, telecopied or sent by certified,
registered or express mail or by Federal Express or similar courier service,
postage prepaid, and shall be deemed given when so received if delivered
personally or by telecopy or, if mailed, seven (7) calendar days after the date
of mailing (three (3) calendar days in the case of express mail, Federal Express
or similar courier service), as follows:
If to the Company:
8085 South Chester Street, Suite 300
Englewood, CO 80112
Attention of President
Facsimile: (303) 712-4977
<PAGE>
79
With a separate copy delivered to:
Baker & Botts, LLP
599 Lexington Avenue
New York, NY 10022
Attention of Marc A. Leaf, Esq.
Facsimile: (212) 705-5125
If to TWE:
290 Harbor Drive
Stamford, CT 06902
Attention of General Counsel,
Time Warner Cable
Facsimile: (203) 328-4840
With a separate copy delivered to:
Cravath, Swaine & Moore
825 Eighth Avenue
New York, NY 10019
Attention of John T. Gaffney, Esq.
Facsimile: (212) 474-3700
If to Newhouse:
5015 Campuswood Drive
East Syracuse, NY 13057
Attention of Robert J. Miron
Facsimile: (315) 463-4127
With a separate copy delivered to:
Sabin, Bermant & Gould LLP
350 Madison Avenue
New York, NY 10017
Attention of Arthur J. Steinhauer, Esq.
Facsimile: (212) 692-4406
If to Comcast:
1500 Market Street
Philadelphia, PA 19102
Attention of General Counsel
Facsimile: (215) 981-7794
<PAGE>
80
With a separate copy delivered to:
Comcast Corporation
1500 Market Street
Philadelphia, PA 19102
Attention of Kathleen M. Hyneman, Esq.
Facsimile: (215) 981-7794
If to Cox:
1400 Lake Hearn Drive
Atlanta, GA 30319
Attention of Ajit Dalvi
Facsimile: (404) 847-6542
With a separate copy delivered to:
Dow, Lohnes & Albertson
1200 New Hampshire Avenue, N.W.
Suite 800
Washington, DC 20036
Attention of Stuart Sheldon, Esq.
Facsimile: (202) 776-222
If to MediaOne:
US WEST Media Group, Inc.
9785 Maroon Circle, Suite 420
Englewood, CO 80111
Attention of President
Facsimile: (303) 754-5452
With a separate copy delivered to:
US WEST Media Group, Inc.
188 Inverness Drive
Englewood, CO 80112
Attention of General Counsel
Facsimile: (303) 793-6707
<PAGE>
81
If to GE:
Four Research Way
Princeton, NJ 08540
Attention of General Counsel
Facsimile: (609) 987-4233
With a separate copy delivered to:
Hogan & Hartson
555 13th Street NW
Washington, DC 20004
Attention of Timothy A. Lloyd, Esq.
Facsimile: (202) 637-5910
If to TSAT:
8085 South Chester, Suite 300
Englewood, CO 80112
Attention of Kenneth G. Carroll
Facsimile: (303) 712-4973
With a separate copy delivered to:
Baker & Botts, LLP
599 Lexington Avenue
New York, NY 10022
Attention of Marc A. Leaf, Esq.
Facsimile: (212) 705-5125
SECTION 10.03. Assignment. Neither this Agreement nor any of the
-----------
rights, interests or obligations hereunder shall be assigned by any of the
parties hereto (whether by operation of law or otherwise) without the prior
written consent of the other parties. Notwithstanding the foregoing, this
Agreement may be assigned, in whole but not in part, to any Person who acquires
all or substantially all the assets of a party (whether by asset transfer, stock
transfer, merger, spin-off or other business combination or transaction or
series of transactions) so long as such assignee assumes in writing all of the
assignor's obligations under this Agreement; provided, that the assignor shall
--------
remain liable for such obligations unless such assignee (or any guarantor of
such assignee's obligations under such assumption) is, at the time of such
assignment and after giving effect to the transactions to be
<PAGE>
82
consummated in connection with such assignment, at least as creditworthy as the
assignor was immediately prior to the assignment (and, in the case of MediaOne,
as creditworthy as US West was immediately prior to the assignment), and such
assignee agrees in writing that the other parties hereto shall be third party
beneficiaries of such assumption, in which case the assignor shall be released
in writing by the other parties hereto from such assumed obligations. Subject to
the preceding sentence, this Agreement shall be binding upon and shall inure to
the benefit of the parties hereto and their respective successors and permitted
assigns. Notwithstanding anything contained in this Agreement to the contrary,
nothing in this agreement, expressed or implied, is intended to confer on any
Person other than the parties hereto or their respective successors and
permitted assigns any rights, remedies, obligations or liabilities under or by
reason of this Agreement.
SECTION 10.04. Severability. If any term or other provision of this
-------------
Agreement is invalid, illegal or incapable of being enforced by any rule or law,
or public policy, all other conditions and provisions of this Agreement shall
nevertheless remain in full force and effect so long as the economic or legal
substance of the transactions contemplated hereby is not affected in any manner
materially adverse to any party. Upon such determination that any term or other
provision is invalid, illegal or incapable of being enforced, the parties hereto
shall negotiate in good faith to modify this Agreement so as to effect the
original intent of the parties as closely as possible in an acceptable manner to
the end that transactions contemplated hereby are fulfilled to the extent
possible.
SECTION 10.05. Entire Agreement; No Third-Party Beneficiaries. This
-----------------------------------------------
Agreement, the Merger Agreements, the Asset Transfer Agreements, the TSAT Merger
Agreement, the Stockholders Agreement, the US West Guarantee, the Malone Letter,
the Registration Rights Agreement, the Newhouse Voting Agreement, the Voting
Agreements, the Reimbursement Agreements, the Tax Sharing Agreement, the TSAT
Stockholders Agreement, the TSAT Tempo Agreement and the Drop Down Agreement
(a) constitute the entire agreement, and supersede all prior agreements and
understandings, both written and oral, among the parties with respect to the
Restructuring Transaction and (b) except for the provisions
<PAGE>
83
of Sections 7.12, 7.13 and 10.03, are not intended to confer upon any person
other than the parties any rights or remedies.
<PAGE>
84
SECTION 10.06. Governing Law. This Agreement shall be governed by
--------------
and construed in accordance with the internal laws of the State of New York,
regardless of the laws that might otherwise govern under applicable principles
of conflicts of laws thereof, except to the extent the laws of the State of
Delaware are mandatorily applicable to the TSAT Merger or any other merger under
any of the Merger Agreements.
SECTION 10.07. Enforcement; Exclusive Jurisdiction. (a) The Parties
------------------------------------
agree that irreparable damage would occur in the event that any of the
provisions of this Agreement were not performed in accordance with their
specific terms or were otherwise breached. It is accordingly agreed that the
Parties shall be entitled to an injunction or injunctions to prevent breaches of
this Agreement and to enforce specifically the terms and provisions of this
Agreement in any court of the State of New York or the State of Delaware and any
court of the United States located in the Borough of Manhattan in New York City
or the State of Delaware.
(b) With respect to any suit, action or proceeding relating to this
Agreement (collectively, a "Proceeding"), each party to this Agreement
----------
irrevocably:
(i) consents and submits to the exclusive jurisdiction of the courts
of the States of New York and Delaware and any court of the United States
located in the Borough of Manhattan in New York City or the State of
Delaware;
(ii) waives any objection which such party may have at any time to the
laying of venue of any Proceeding brought in any such court, waives any
claim that such Proceeding has been brought in an inconvenient forum and
further waives the right to object, with respect to such Proceeding, that
such court does not have jurisdiction over such party; and
(iii) consents to the service of process at the address set forth for
notices in Section 10.02 herein; provided that such manner of service of
--------
process shall not preclude the service of process in any other manner
permitted under applicable law.
<PAGE>
85
SECTION 10.08. Counterparts. This Agreement may be executed by the
-------------
parties hereto in separate counterparts, each of which when so executed and
delivered shall be an original, but all such counterparts shall together
constitute one and the same instrument. Each counterpart may consist of a
number of copies hereof each signed by less than all, but together signed by all
of the parties hereto.
SECTION 10.09. Headings. Headings of the Articles and Sections of
---------
this Agreement are for the convenience of the parties only, and shall be given
no substantive or interpretive effect whatsoever.
IN WITNESS WHEREOF, each Party has caused this Agreement to be duly
executed as of the day first written above.
TCI SATELLITE ENTERTAINMENT, INC.,
by /s/ Kenneth G. Carroll
-----------------------
Name: Kenneth G. Carroll
Title: Sr. Vice President/CFO
PRIMESTAR, INC.,
by /s/ Kenneth G. Carroll
-----------------------
Name: Kenneth G. Carroll
Title: President
TIME WARNER ENTERTAINMENT COMPANY, L.P.,
by AMERICAN TELEVISION AND
COMMUNICATIONS CORPORATION,
a general partner,
by /s/ David E. O'Hayre
-----------------------
Name: David E. O'Hayre
Title: Vice President
<PAGE>
86
ADVANCE/NEWHOUSE PARTNERSHIP,
by ADVANCE COMMUNICATION CORP., as
general partner
by /s/ Robert Miron
-----------------------------
Name: Robert Miron
Title: President
COMCAST CORPORATION,
by /s/ Jack. A. Markell
--------------------------------
Name: Jack A. Markell
Title: Vice President
COX COMMUNICATIONS, INC.,
by /s/ Ajit Dalvi
--------------------------------
Name: Ajit Dalvi
Title: Senior Vice President
MEDIAONE OF DELAWARE, INC.,
by /s/ Douglas D. Holmes
--------------------------------
Name: Douglas D. Holmes
Title: EVP - Finance & Strategy
GE AMERICAN COMMUNICATIONS, INC.,
by /s/ John F. Connelly
--------------------------------
Name: John F. Connelly
Title: Chairman and CEO
<PAGE>
EXHIBIT 10.25
================================================================================
AGREEMENT AND PLAN OF MERGER
Dated as of February 6, 1998,
Between
PRIMESTAR, INC.
And
COX SATELLITE, INC.
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Parties and Recitals .............................. 1
ARTICLE I
The Merger
----------
SECTION 1.01. The Merger...................... 1
SECTION 1.02. Closing......................... 2
SECTION 1.03. Effective Time.................. 2
SECTION 1.04. Effects......................... 2
SECTION 1.05. Certificate of Incorporation
and By-Laws..................... 2
SECTION 1.06. Directors....................... 2
SECTION 1.07. Officers........................ 2
ARTICLE II
Effect on the Capital Stock of the
--------------------------------
Constituent Corporations; Exchange of Certificates
- --------------------------------------------------
SECTION 2.01. Effect on Capital Stock ........... 3
SECTION 2.02. Exchange of Certificates .......... 3
ARTICLE III
Conditions Precedent .............................. 4
ARTICLE IV
Termination, Amendment and Waiver
---------------------------------
SECTION 4.01. Termination..................... 4
SECTION 4.02. Effect of Termination........... 4
SECTION 4.03. Amendment....................... 4
</TABLE>
<PAGE>
<TABLE>
<S> <C>
ARTICLE V
General Provisions
------------------
SECTION 5.01. Notices......................... 5
SECTION 5.02 Interpretation.................. 5
SECTION 5.03. Assignment...................... 5
SECTION 5.04. Severability.................... 5
SECTION 5.05. Entire Agreement; No
Third-Party Beneficiaries....... 5
SECTION 5.06. Governing Law................... 6
SECTION 5.07. Enforcement; Exclusive
Jurisdiction.................... 6
SECTION 5.08. Counterparts.................... 7
</TABLE>
(ii)
<PAGE>
AGREEMENT AND PLAN OF MERGER dated as of February 6,
1998, between PRIMESTAR, INC. a Delaware corporation ("Parent"),
------
and COX SATELLITE, INC., a Delaware corporation (the "Company").
-------
WHEREAS Parent and an affiliate of the Company and certain other
parties are parties to a Merger and Contribution Agreement dated as of February
6, 1998 (the "Restructuring Agreement"), pursuant to which the Restructuring
-----------------------
Transaction (as defined therein) will be consummated by the parties thereto or
their respective affiliates (capitalized terms used herein but not defined
herein shall have the meanings assigned thereto in the Restructuring Agreement);
WHEREAS the respective Boards of Directors of Parent and the Company
have approved the acquisition of the Company by Parent on the terms and subject
to the conditions set forth in this Agreement;
WHEREAS the respective Boards of Directors of Parent and the Company
have approved the merger of the Company into Parent on the terms and subject to
the conditions set forth in this Agreement, whereby the issued capital stock of
the Company ("Company Capital Stock") (excluding any shares owned by the
---------------------
Company), shall be converted into the right to receive, in the aggregate, the
consideration determined as set forth herein; and
WHEREAS for Federal income tax purposes it is intended that the Merger
qualify as a reorganization within the meaning of Section 368(a) of the Internal
Revenue Code of 1986, as amended (the "Code").
----
NOW, THEREFORE, the parties hereto agree as follows:
ARTICLE I
The Merger
----------
<PAGE>
2
SECTION 1.01. The Merger. On the terms and subject to the conditions
-----------
set forth in this Agreement, and in accordance with the DGCL, the Company shall
be merged with and into Parent at the Effective Time (as defined below). At the
Effective Time, the separate corporate existence of the Company shall cease and
Parent shall continue as the surviving corporation (the "Surviving
---------
Corporation").
- -----------
SECTION 1.02. Closing. The Closing shall take place as set forth in
--------
Section 4.01 of the Restructuring Agreement.
SECTION 1.03. Effective Time. Prior to the Closing Parent shall
---------------
prepare, and on the Closing Date or as soon as practicable thereafter Parent
shall file with the Secretary of State of the State of Delaware, a certificate
of merger or other appropriate documents (in any such case, the "Certificate of
--------------
Merger") executed in accordance with the relevant provisions of the DGCL and
- ------
shall make all other filings or recordings required under the DGCL. The Merger
shall become effective at such time as the Certificate of Merger is duly filed
with the Delaware Secretary of State or at such subsequent time as shall be
stated in the Certificate of Merger (the "Effective Time").
--------------
SECTION 1.04. Effects. The Merger shall have the effects set forth
--------
in Section 259 of the DGCL.
SECTION 1.05. Certificate of Incorporation and By-laws. (a) The
-----------------------------------------
Restated Certificate of Incorporation of Parent as in effect immediately prior
to the Effective Time shall be the certificate of incorporation of the Surviving
Corporation until thereafter changed or amended as provided therein or by
applicable law.
(b) The By-laws of Parent as in effect immediately prior to the
Effective Time shall be the By-laws of the Surviving Corporation until
thereafter changed or amended as provided therein or by applicable law.
SECTION 1.06. Directors. The directors of Parent immediately prior
----------
to the Effective Time shall be the directors of the Surviving Corporation, until
the earlier of their resignation or removal or until their respective
<PAGE>
3
successors are duly elected and qualified, as the case may be.
SECTION 1.07. Officers. The officers of Parent immediately prior to
---------
the Effective Time shall be the officers of the Surviving Corporation, until the
earlier of their resignation or removal or until their respective successors are
duly elected and qualified, as the case may be.
ARTICLE II
Effect on the Capital Stock of the
----------------------------------
Constituent Corporations; Exchange of Certificates
--------------------------------------------------
SECTION 2.01. Effect on Capital Stock. At the Effective Time, by
------------------------
virtue of the Merger and without any action on the part of the holder of any
shares of Company Capital Stock or any shares of capital stock of Parent:
(a) Capital Stock of Parent. Each issued and outstanding share of
------------------------
capital stock of Parent shall remain outstanding and unaffected by the Merger.
(b) Cancelation of Treasury Stock. Each share of Company Capital
------------------------------
Stock that is owned by the Company shall automatically be canceled and shall
cease to exist, and no Parent Common Stock or other consideration shall be
delivered in exchange therefor.
(c) Conversion of Company Capital Stock. Subject to Section 2.01(b),
------------------------------------
all outstanding shares of Company Capital Stock, in the aggregate, shall be
converted into the right to receive, in the aggregate, the consideration
determined as set forth in Section 3.05 of the Restructuring Agreement (the
"Merger Consideration"). As of the Effective Time, all such shares of Company
- ---------------------
Capital Stock shall no longer be outstanding and shall automatically be canceled
and shall cease to exist, and the holders of certificates ("Certificates") which
------------
immediately prior to the Effective Time represented any such shares of Company
Capital Stock shall cease to have any rights with respect thereto, except the
collective right to receive the Merger Consideration upon surrender of all such
Certificates in accordance with Section 2.02, without interest.
<PAGE>
4
SECTION 2.02. Exchange of Certificates. (a) Promptly following the
-------------------------
Effective Time, upon surrender of all Certificates for cancelation to Parent,
together with such other documents as may reasonably be required by Parent to
evidence such surrender, Parent shall deliver to the holders of Certificates,
for exchange in accordance with this Article II, their pro rata share (based on
--- ----
relative numbers of shares represented by the Certificates) of the Merger
Consideration payable pursuant to Section 2.01 in exchange for 100% of the
Certificates. Delivery shall be effected, and risk of loss and title to the
Certificates shall pass only upon delivery of such Certificates to Parent.
(b) No Further Ownership Rights in Company Capital Stock. The Merger
-----------------------------------------------------
Consideration issued (and paid) in accordance with the terms of this Article II
upon conversion of any shares of Company Capital Stock shall be deemed to have
been issued (and paid) in full satisfaction of all rights pertaining to such
shares and there shall be no further registration of transfers on the stock
transfer books of the Surviving Corporation of shares of Company Capital Stock
that were outstanding immediately prior to the Effective Time. If, after the
Effective Time, any Certificates are presented to the Surviving Corporation or
the Exchange Agent for any reason, they shall be canceled and exchanged as
provided in this Article II.
ARTICLE III
Conditions Precedent
--------------------
The sole condition precedent to the respective obligation of each
party to effect the Merger shall be satisfaction (or waiver by the applicable
beneficiary of the applicable condition) of the conditions set forth in Article
VIII of the Restructuring Agreement.
<PAGE>
5
ARTICLE IV
Termination, Amendment and Waiver
---------------------------------
SECTION 4.01. Termination. This Agreement may be terminated, whether
------------
before or after the TSAT Stockholder Approval and whether before or after
approval of the stockholders of the constituent corporations to the Merger, but
only upon termination of the Restructuring Agreement in accordance with the
terms thereof.
SECTION 4.02. Effect of Termination. In the event of termination of
----------------------
this Agreement by either the Company or Parent as provided in Section 4.01, this
Agreement shall forthwith become void and have no effect, without any liability
or obligation on the part of Parent or the Company, other than this Section 4.02
and Article V.
SECTION 4.03. Amendment. This Agreement may be amended, whether
----------
before or after the TSAT Stockholder Approval and whether before or after
approval of the stockholders of the constituent corporations to the Merger, but
only on the same terms set forth in Section 9.03 of the Restructuring Agreement.
ARTICLE V
General Provisions
------------------
SECTION 5.01. Notices. Any notice or other communication that is
--------
required or that may be given in connection with this Agreement shall be in
writing and shall be delivered in accordance with Section 10.02 of the
Restructuring Agreement.
SECTION 5.02. Interpretation. When a reference is made in this
---------------
Agreement to a Section, such reference shall be to a Section of this Agreement
unless otherwise indicated. The table of contents and headings contained in
this Agreement are for reference purposes only and shall not affect in any way
the meaning or interpretation of this Agreement. Whenever the words "include",
"includes" or "including" are used in this Agreement, they shall be deemed to be
followed by the words "without limitation".
SECTION 5.03. Assignment. Neither this Agreement nor any of the
-----------
rights, interests or obligations under this
<PAGE>
6
Agreement shall be assigned, in whole or in part, by operation of law or
otherwise by any of the parties without the prior written consent of the other
parties. Any purported assignment without such consent shall be void. Subject to
the preceding sentences, this Agreement will be binding upon, inure to the
benefit of, and be enforceable by, the parties and their respective successors
and assigns.
SECTION 5.04. Severability. If any term or other provision of this
-------------
Agreement is invalid, illegal or incapable of being enforced by any rule or law,
or public policy, all other conditions and provisions of this Agreement shall
nevertheless remain in full force and effect so long as the economic or legal
substance of the transactions contemplated hereby is not affected in any manner
materially adverse to any party. Upon such determination that any term or other
provision is invalid, illegal or incapable of being enforced, the parties hereto
shall negotiate in good faith to modify this Agreement so as to effect the
original intent of the parties as closely as possible in an acceptable manner to
the end that transactions contemplated hereby are fulfilled to the extent
possible.
SECTION 5.05. Entire Agreement; No Third-Party Beneficiaries. This
-----------------------------------------------
Agreement, the other Merger Agreements, the Asset Transfer Agreements, the
Restructuring Agreement, the US West Guarantee, the Malone Letter, the
Reimbursement Agreements, the Stockholders Agreement, the Newhouse Voting
Agreement, the Registration Rights Agreement, the Voting Agreements, the Tax
Sharing Agreement, the TSAT Merger Agreement, the TSAT Stockholders Agreement,
the Drop Down Agreement and the TSAT Tempo Agreement (a) constitute the entire
agreement, and supersede all prior agreements and understandings, both written
and oral, among the parties with respect to the Restructuring Transaction and
(b) except for the provisions of Article II are not intended to confer upon any
person other than the parties any rights or remedies.
SECTION 5.06. Governing Law. This Agreement shall be governed by and
--------------
construed in accordance with the laws of the State of New York, regardless of
the laws that might otherwise govern under applicable principles of conflicts of
laws thereof, except to the extent the laws of the State of Delaware are
mandatorily applicable to the Merger.
<PAGE>
7
SECTION 5.07. Enforcement; Exclusive Jurisdiction. (a) The parties
------------------------------------
hereto agree that irreparable damage would occur in the event that any of the
provisions of this Agreement were not performed in accordance with their
specific terms or were otherwise breached. It is accordingly agreed that the
parties shall be entitled to an injunction or injunctions to prevent breaches of
this Agreement and to enforce specifically the terms and provisions of this
Agreement in any court of the State of New York or the State of Delaware and any
court of the United States located in the Borough of Manhattan in New York City
or the State of Delaware.
(b) With respect to any suit, action or proceeding relating to this
Agreement (collectively, a "Proceeding"), each party to this Agreement
----------
irrevocably:
(i) consents and submits to the exclusive jurisdiction of the courts
of the States of New York and Delaware and any court of the United States
located in the Borough of Manhattan in New York City or the State of
Delaware;
(ii) waives any objection which such party may have at any time to the
laying of venue of any Proceeding brought in any such court, waives any
claim that such Proceeding has been brought in an inconvenient forum and
further waives the right to object, with respect to such Proceeding, that
such court does not have jurisdiction over such party; and
(iii) consents to the service of process at the address set forth for
notices in Section 10.02 of the Restructuring Agreement; provided that such
--------
manner of service of process shall not preclude the service of process in
any other manner permitted under applicable law.
SECTION 5.08. Counterparts. This Agreement may be executed in one or
-------------
more counterparts, all of which shall be considered one and the same agreement
and shall become effective when one or more counterparts have been signed by
each of the parties and delivered to the other parties.
<PAGE>
8
IN WITNESS WHEREOF, Parent and the Company have duly executed this
Agreement, all as of the date first written above.
PRIMESTAR, INC.,
by /s/ Kenneth G. Carroll
__________________________
Name: Kenneth G. Carroll
Title: President
COX SATELLITE, INC.,
by /s/ Ajit Dalvi
__________________________
Name: Ajit Dalvi
Title: Vice President
<PAGE>
EXHIBIT 13
SHAREHOLDER INFORMATION
[LOGO OF COX COMMUNICATIONS APPEARS HERE]
CORPORATE HEADQUARTERS:
Cox Communications, Inc.
1400 Lake Hearn Dr., NE
Atlanta, GA 30319
404-843-5000
www.cox.com
STOCK DATA:
Cox's Class A Common Stock is traded on the New York Exchange.
Ticker symbol: COX.
Daily newspaper stock table listing: CoxComm A.
As of February, 17, 1998, there were 5,585 shareholders of record of Cox's Class
A Common Stock and two shareholders of record of the Class C Common Stock. There
is no established trading market for Cox's Class C Common Stock. There have been
no stock dividends paid on any of Cox's equity securities. Cox does not intend
to pay cash dividends in the foreseeable future. See "Management's Discussion
and Analysis - Liquidity and Capital Resources - Uses of Cash," in the company's
Form 10-K.
QUARTERLY MARKET INFORMATION:
<TABLE>
<CAPTION>
CLASS A COMMON STOCK HIGH LOW
1997
<S> <C> <C>
First Quarter $ 23 1/4 $ 19 5/8
Second Quarter 27 7/8 18 1/8
Third Quarter 28 3/16 24 15/16
Fourth Quarter 40 1/16 27 11/16
1996
First Quarter $ 24 1/8 $ 18 7/8
Second Quarter 23 1/4 19 3/4
Third Quarter 22 3/8 17 5/8
Fourth Quarter 23 1/8 16 5/8
</TABLE>
TRANSFER AGENT AND REGISTRAR:
First Chicago Trust Company of New York
P.O. Box 2500
Jersey City, NJ 07303-2500
201-324-1225
www.fctc.com
[email protected]
ANNUAL MEETING OF SHAREHOLDERS:
April 24, 1998, 9 a.m.
Cox Corporate Headquarters
1400 Lake Hearn Dr., NE
Atlanta, GA 30319
FORM 10-K:
<PAGE>
Cox Communications' Annual Report on Form 10-K as filed with the Securities and
Exchange Commission is available free upon written request to: Finance
Department, Cox Communications, Inc., 1400 Lake Hearn Dr., NE, Atlanta, GA
30319, 404-843-5000, Ext. 6454.
COMPANY INFORMATION:
Communications regarding stock transfers, lost certificates or account changes
should be directed to the transfer agent. First Chicago Trust Company of New
York. For other information, contact one of the following:
Analysts and Institutional Investors: Mark Major, Director of Finance, 404-843-
5447, fax: 404-843-5939
Individual Shareholders and News Media: Anthony Surratt, Director of Corporate
Communications, 404-843-5124, fax: 404-843-5777
INDEPENDENT AUDITORS:
Deloitte & Touche LLP
100 Peachtree St.
Suite 1700
Atlanta, GA 30303-1943
404-220-1500
(c) 1998 Cox Communications, Inc. All rights reserved. Cox, Cox Communications,
the Cox Communications logo, Cox Digital TV, and Cox Digital Telephone are
registered trademarks, trademarks, or service marks of Cox Communications, Inc.
@Home Network and the @ ball are registered trademarks of @Home Network.
Designed by Corporate Reports Inc./Atlanta
Dinosaur Website can be found at www.dinosauria.com
Printed on Recycled Paper.
<PAGE>
EXHIBIT 21
Subsidiaries of Cox Communications Inc. as of March 10, 1998
<TABLE>
<S> <C>
CableRep, Inc.........................................................Delaware
Cox@Home, Inc.........................................................Delaware
CoxCom, Inc...........................................................Delaware
Cox Arizona Telcom, Inc...............................................Delaware
Cox Cable New York City, Inc..........................................New York
Cox California PCS, Inc...............................................Delaware
Cox California Telecom, Inc...........................................Delaware
Cox Communications Bakersfield, Inc...................................Delaware
Cox Communications E.T.E., Inc........................................Delaware
Cox Communications Hampton Roads, Inc.................................Delaware
Cox Communications Holdings, Inc......................................Delaware
Cox Communications International, Inc.................................Delaware
Cox Communications NCC, Inc...........................................Delaware
Cox Communications of Australia, Inc..................................Delaware
Cox Communications Palos Verdes, Inc..................................California
Cox Communications Payroll, Inc.......................................California
Cox Communications Pioneer, Inc.......................................Delaware
Cox Communications San Diego, Inc.....................................Delaware
Cox Communications Santa Barbara, Inc.................................Delaware
Cox Communications Services, Inc......................................Delaware
Cox Communications Shopping Services, Inc.............................Delaware
Cox Communications Virginia Beach, Inc................................Delaware
Cox Communications Wireless, Inc......................................Delaware
Cox Consumer Information Network, Inc.................................Delaware
Cox DC Radio, Inc.....................................................Delaware
Cox Fibernet Access Services, Inc.....................................Virginia
Cox Fibernet Commercial Services, Inc.................................Virginia
Cox Fibernet Louisiana, Inc...........................................Delaware
Cox Fibernet Oklahoma, Inc............................................Delaware
Cox Fibernet Virginia, Inc............................................Delaware
Cox Home Video North, Inc.............................................Delaware
Cox Louisiana Telecom, Inc............................................Delaware
Cox Nebraska Telcom, Inc..............................................Delaware
Cox Oklahoma Telcom, Inc..............................................Delaware
Cox Programming International, Inc....................................Delaware
Cox Programming Limited..........................................United Kingdom
Cox Rhode Island Telcom, Inc..........................................Delaware
Cox Satellite, Inc....................................................Delaware
Cox Satellite Services, Inc...........................................Delaware
Cox Telcom Partners, Inc..............................................Delaware
Cox Teleport Partners, Inc............................................Delaware
Cox Teleport Partners II, Inc.........................................Delaware
Cox Telephony Partners, Inc...........................................Delaware
PCS Leasing Co., Inc..................................................Delaware
TMJV, Inc.............................................................Delaware
Video Service Company.................................................Ohio
Cox Connecticut Telcom, LLC...........................................Delaware
Cox Oklahoma II, L.L.C................................................Delaware
Cox Communications Omaha, L.L.C.......................................Delaware
TWC Cable Partners............................................................
TWC/TVRO Service Partnership..................................................
</TABLE>
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference of our report dated February 6,
1998 appearing in this Annual Report on Form 10-K of Cox Communications, Inc.
for the year ended December 31, 1997, in the following Registration Statements
of Cox Communications, Inc. and to the reference to us under the heading
"Experts" in the Registration Statements on Form S-3:
<TABLE>
<CAPTION>
FORM FILE NO.
------------------ -------------------
<S> <C>
S-8 33-80993
S-8 33-80995
S-8 33-91506
S-8 33-93148
S-8 333-44399
S-3 333-03351
S-3 333-03766
</TABLE>
/s/ Deloitte & Touche LLP
Atlanta, Georgia
March 17, 1998
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements
(Nos. 333-44399, 33-80993, 33-80995, 33-91506 and 33-93148) on Form S-8 and the
Registration Statements (Nos. 333-03351 and 333-03766) on Form S-3 of Cox
Communications, Inc. of our report dated February 3, 1998 on the consolidated
financial statements of Sprint Spectrum Holding Company, L.P. and subsidiaries
(which expresses an unqualified opinion and includes an explanatory paragraph
referring to the emergence from the developmental stage of Sprint Spectrum
Holding Company, L.P. and subsidiaries) for each of the three years ended
December 31, 1997 appearing in the Annual Report on Form 10-K of Cox
Communications, Inc. for the year ended December 31, 1997.
/s/ Deloitte & Touche LLP
Kansas City, Missouri
March 17, 1998
<PAGE>
EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements
(Nos. 333-44399, 33-80993, 33-80995, 33-91506 and 33-93148) on Form S-8 and the
Registration Statements (Nos. 333-03351 and 333-03766) on Form S-3 of Cox
Communications, Inc. of our report dated March 3, 1998 on the consolidated
financial statements of Teleport Communications Group Inc. appearing in the
Annual Report on Form 10-K of Cox Communications, Inc. for the year ended
December 31, 1997.
/s/ Deloitte & Touche LLP
New York, New York
March 17, 1998
<PAGE>
EXHIBIT 23.4
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements
(Nos. 333-44399, 33-80993, 33-80995, 33-91506 and 33-93148) on Form S-8 and the
Registration Statements (Nos. 333-03351 and 333-03766) on Form S-3 of Cox
Communications, Inc. of our report dated January 30, 1998, except for Note 8, as
to which the date is February 25, 1998 (relating to the combined consolidated
financial statements of Cox Communications PCS, L.P. and subsidiaries and Cox
Communications PCS, Inc. and subsidiary), appearing in the Annual Report on Form
10-K of Cox Communications, Inc. for the fiscal year ended December 31, 1997.
/s/ Deloitte & Touche LLP
Costa Mesa, California
March 17, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-K
year ended 12/31/97 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> OCT-01-1997 JAN-01-1997
<PERIOD-END> DEC-31-1997 DEC-31-1997
<CASH> 28,259 28,259
<SECURITIES> 0 0
<RECEIVABLES> 151,028 151,028
<ALLOWANCES> (6,955) (6,955)
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 1,979,063 1,979,063
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 6,556,601 6,556,601
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
271,075 271,075
0 0
<COMMON> 0 0
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 6,556,601 6,556,601
<SALES> 0 0
<TOTAL-REVENUES> 417,973 1,610,364
<CGS> 0 0
<TOTAL-COSTS> 111,839 491,228
<OTHER-EXPENSES> 107,361 404,538
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 52,666 202,136
<INCOME-PRETAX> (133,698) (189,988)
<INCOME-TAX> (55,823) (53,496)
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (77,875) (136,492)
<EPS-PRIMARY> (0.29) (0.50)
<EPS-DILUTED> (0.29) (0.50)
</TABLE>
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
AND INDEPENDENT AUDITORS' REPORT
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Partners
Cox Communications PCS, L.P.
Irvine, California
We have audited the accompanying combined consolidated balance sheets of Cox
Communications PCS, L.P. and subsidiaries (the Partnership) and Cox California
PCS, Inc. and subsidiary (the Company) as of December 31, 1997 and 1996 and the
related combined consolidated statements of operations, partners' capital and
cash flows for the years then ended. These combined consolidated financial
statements are the responsibility of the Partnership's and 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 combined consolidated financial statements present fairly,
in all material respects, the combined financial position of Cox Communications
PCS, L.P. and subsidiaries and Cox California PCS, Inc. and subsidiary as of
December 31, 1997 and 1996 and the results of their operations and their cash
flows for the years then ended in conformity with generally accepted accounting
principles.
January 30, 1998, except for Note 8,
as to which the date is February 25, 1998
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
(dollars in thousands)
1997 1996
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 2) $ 41,516 $ 1,792
Accounts receivable, net of allowance for doubtful
accounts of $663 in 1997 (Note 2) 18,835 766
Receivable from partner 2,450
Receivable from parent 18,450
Inventories, net of valuation allowance of $1,000
in 1997 (Note 2) 9,672 1,919
Prepaid expenses and other current assets 1,589 1,004
-------- --------
Total current assets 71,612 26,381
INVESTMENT IN PCS LICENSE, net (Note 2) 282,605
PROPERTY AND EQUIPMENT, net (Notes 2 and 3) 326,850 181,684
MICROWAVE RELOCATION COSTS, net (Note 2) 24,254 15,832
OTHER ASSETS 281
-------- --------
$705,321 $224,178
======== ========
See notes to combined consolidated financial statements. 2
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
(dollars in thousands)
1997 1996
LIABILITIES AND PARTNERS' CAPITAL
AND STOCKHOLDER'S DEFICIT
CURRENT LIABILITIES:
Accounts payable $ 18,971 $ 34,908
Due to affiliates (Note 4) 16,809 9,062
Accrued expenses 40,244 7,855
Current maturities of long-term debt (Note 6) 57,650
Construction obligations (Note 5) 30,784 71,245
-------- --------
Total current liabilities 164,458 123,070
LONG-TERM DEBT (Note 6) 194,269
COMMITMENTS AND CONTINGENCIES (Note 5)
LIMITED PARTNER INTEREST IN CONSOLIDATED
SUBSIDIARY (Note 1) 2,450 2,450
PARTNERS' CAPITAL AND STOCKHOLDER'S DEFICIT:
Partners' capital:
General partner 86,842
Exclusive limited partner 257,302 165,369
Other capital 33,239 22,436
Due from exclusive limited partner (33,239) (22,436)
Stockholder's deficit:
Common stock, $1.00 par value; 1,000 shares
authorized; 100 shares issued and outstanding
Additional paid-in capital 66,711
Deficit (66,711) (66,711)
-------- --------
Total partners' capital and stockholder's deficit 344,144 98,658
-------- --------
$705,321 $224,178
======== ========
See notes to combined consolidated financial statements. 3
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
(dollars in thousands)
1997 1996
OPERATING REVENUES (Note 2):
Services $ 14,644 $ -
Equipment 22,722 692
--------- --------
Total operating revenues 37,366 692
OPERATING EXPENSES (Note 2):
Cost of services 24,991 3,705
Cost of equipment 22,722 692
Selling, general and administrative (Notes 4 and 5) 183,718 55,169
Depreciation and amortization 29,591 1,997
--------- --------
Total operating expenses 261,022 61,563
--------- --------
LOSS FROM OPERATIONS (223,656) (60,871)
OTHER (EXPENSE) INCOME:
Interest, net (3,090) 114
Other income 79
--------- --------
Total other (expense) income (3,011) 114
--------- --------
NET LOSS $(226,667) $(60,757)
========= ========
See notes to combined consolidated financial statements. 4
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
AND STOCKHOLDER'S DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
(dollars in thousands)
<TABLE>
<CAPTION>
COX CALIFORNIA PCS, INC. COX COMMUNICATIONS PCS, L.P.
AND SUBSIDIARY AND SUBSIDIARIES
------------------------ ACCUMULATED ---------------------------------
DEFICIT DUE FROM
ADDITIONAL DURING EXCLUSIVE EXCLUSIVE
COMMON PAID-IN DEVELOPMENT GENERAL LIMITED OTHER LIMITED
STOCK CAPITAL STAGE PARTNER PARTNER CAPITAL PARTNER
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES,
January 1, 1996 $ - $ - $ (5,954) $ - $ - $ -
Additional contribution
(Note 1) 22,436 (22,436)
Contributions (Note 1) 165,369
Net loss (60,757)
---------- ---------- ----------- -------------- --------- -------- ---------
BALANCES,
December 31, 1996 (66,711) 165,369 22,436 (22,436)
Contribution of amounts
due to shareholder,
converted to additional
paid-in capital (Note 1) 66,711
Retirement of receivable
from General Partner
against General
Partner's
capital account (Note 1) (66,625)
Additional contribution
(Note 1) 10,803 (10,803)
Contributions (Note 1) 269,067 203,000
Net loss (Note 7) (115,600) (111,067)
---------- ---------- ----------- -------------- --------- -------- ---------
BALANCES,
December 31, 1997 $ - $66,711 $(66,711) $ 86,842 $ 257,302 $33,239 $(33,239)
========== ========== =========== ============== ========= ======== =========
</TABLE>
See notes to combined consolidated financial statements. 5
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
(dollars in thousands)
1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(226,667) $ (60,757)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 29,591 1,997
Provision for doubtful trade accounts receivable 663
Loss on disposal of fixed assets 297
Changes in operating assets and liabilities:
Accounts receivable (18,732) (766)
Due to/from partners and affiliate 15,934 12,131
Inventories (7,753) (1,919)
Prepaid expenses and other assets (304) (928)
Accounts payable and accrued expenses 30,681 23,884
Other assets (150)
--------- ---------
Net cash used in operating activities (176,290) (26,508)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (213,564) (91,341)
Capitalized interest investment in PCS license (8,232)
Microwave relocation costs (8,422) (15,832)
--------- ---------
Net cash used in investing activities (230,218) (107,173)
CASH FLOWS FROM FINANCING ACTIVITIES:
Exclusive limited partner capital contributions 203,000 165,369
General partner capital contributions 96,232
Minority partner capital contribution 2,450
Proceeds from interim fund loans 147,000
Advances from parent 129,184
Repayment of advances from parent (159,866)
Receivable from partner (2,450)
--------- ---------
Net cash provided by financing activities 446,232 134,687
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 39,724 1,006
CASH AND CASH EQUIVALENTS, beginning of period 1,792 786
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 41,516 $ 1,792
========= =========
See notes to combined consolidated financial statements. 6
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
COMBINED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
(dollars in thousands)
1997 1996
CASH PAID DURING THE YEAR FOR:
Interest, net of amount capitalized $ 2,538 $ -
========= ========
Income taxes $ - $ -
========= ========
NONCASH TRANSACTIONS:
A $66,625 receivable from the General Partner was retired against the General
Partner's capital account (Note 1).
A $66,711 payable to the shareholder was converted to additional paid-in capital
of Cox California PCS, Inc. during 1997 (Note 1).
On March 31, 1997, the General Partner contributed $251,919 in the form of the
License and the Partnership assumed the related License Debt of $251,919
(Notes 1 and 6).
On March 31, 1997, previous interest-only payments of $24,405 made by the
General Partner in connection with the License Debt, were credited to the
General Partner's capital account (Notes 1 and 6).
On March 31, 1997, the General Partner contributed interim funding loans made to
the Partnership and related interest of $147,000 and $1,430, respectively, to
the Partnership (Notes 1 and 6).
On December 31, 1997 and 1996, the Partnership had made construction obligation
accruals of $30,784 and $71,245, respectively, and had increased the related
property accounts by the same balances.
See notes to combined consolidated financial statements. 7
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
1. DESCRIPTION OF ENTITIES AND BASIS OF PRESENTATION
Description of Entities - Cox Communications PCS, L.P. and subsidiaries (the
Partnership) is a limited partnership formed on December 31, 1996 by Cox
Pioneer Partnership (the General Partner) and Sprint Spectrum Holding
Company, L.P. (the Exclusive Limited Partner) pursuant to the provisions of
the Delaware Revised Uniform Limited Partnership Act as described in the
Agreement of Limited Partnership of Cox Communications PCS, L.P., a Delaware
limited partnership (the Agreement). The partners have the following
ownership interest as of December 31, 1997:
Cox Pioneer Partnership 51%
Sprint Spectrum Holding Company, L.P. 49%
Cox Communications PCS, L.P. is consolidated with its wholly-owned
subsidiaries Cox PCS License, L.L.C. and Cox PCS Assets, L.L.C. (the Special
Purpose Subsidiaries), both of which are limited liability companies
organized pursuant to the Delaware Limited Liability Company Act, and its
majority-owned subsidiary PCS Leasing Co., L.P., a Delaware limited
partnership. The Partnership and certain other affiliated partnerships
offer services as Sprint PCS.
Cox California PCS, Inc. (the Company) is a Delaware corporation which began
building a personal communications services (PCS) system in southern
California.
The purpose and business of the Partnership is to hold the Los Angeles/San
Diego Major Trading Area (MTA) Block "A" 30 MHz Personal Communication
Services (PCS) license (the License), and to build-out, own, operate and
maintain a PCS system in the Los Angeles/San Diego MTA and any other
wireless business license that may be affiliated or acquired by the
Partnership.
The Partnership will continue until the occurrence of a Liquidating Event,
as defined in the Agreement. The Agreement specifies that the General
Partner will be the Managing Partner of the Partnership, until the
occurrence of certain specified events. The Managing Partner has the
authority and responsibility to adopt a business plan and budget for the
Partnership, appoint senior management of the Partnership and invest funds
for the Partnership.
Concurrent with the formation of the Partnership on December 31, 1996, the
Partnership entered into a Systems Assets Sales and Expenditure
Reimbursement Agreement (the Sales Agreement) whereby the Partnership
purchased substantially all the assets (as defined) and assumed the
liabilities of the Company. Prior to December 31, 1996, the Company had
begun building a PCS system in southern California and was considered to be
in the development stage as defined under Statement of Financial Accounting
Standards (SFAS) No. 7, Accounting and Reporting by Development Stage
Enterprises.
8
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
The acquisition was accounted for as a purchase. The System Assets were
purchased and the related liabilities assumed at their recorded net book
values, which approximated their fair values, as of December 31, 1996. As
such, pursuant to the terms of the Sales Agreement, the Partnership's
purchase price was accounted for as follows (in thousands):
Fair value of assets acquired $ 224,178
Liabilities assumed (224,178)
---------
$ -
=========
Included in the liabilities assumed was an amount due to the General Partner
of $101,193,605. Concurrent with the purchase transaction, the Exclusive
Limited Partner advanced $167,818,633 to the General Partner of which
$165,368,633 was deemed to be a capital contribution to Cox Communications
PCS, L.P. and $2,450,000 was deemed to be a preferred capital contribution
to PCS Leasing Co., L.P. (Note 7). The Partnership recorded this
contribution transaction by establishing a receivable from the General
Partner for $66,625,028, which represents the difference between the
$167,818,633 contribution received by the General Partner on behalf of the
Partnership and the $101,193,605 due to the General Partner, which was
assumed in the purchase transaction. During 1997, the $66,625,028
receivable from the General Partner was retired and offset against the
General Partner's capital account.
Partner Contributions - Each partner is required to make contributions to
the Partnership, as called for in the Agreement. The Exclusive Limited
Partner is required to make a series of cash contributions at the Managing
Partner's request and upon the fulfillment of certain conditions and events
specified in the Agreement. These required cash contributions aggregate
$371,358,405. As of December 31, 1997, the Exclusive Limited Partner had
made aggregate required cash capital contributions of $370,818,633, of which
$167,818,633 was made to the General Partner in conjunction with the Sales
Agreement and Exclusive Limited Partner contribution discussed above.
Concurrent with each capital contribution, the Exclusive Limited Partner is
required to pay to the Partnership an additional capital contribution equal
to the interest at 7.25% per year on the amount, if any, by which the
Exclusive Limited Partner's required capital contribution exceeds the
aggregate cash capital contribution previously made. For this purpose, the
additional capital contribution began to accrue on March 1, 1996. This
unpaid additional capital contribution of $33,239,131 as of December 31,
1997 has been reflected in the accompanying combined consolidated financial
statements as a separate component of partners' capital. The due from
Exclusive Limited Partner has been shown as a reduction of partners' capital
until such payment is received (Note 8).
9
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
Cox California PCS, Inc. and Subsidiary - The condensed consolidated balance
sheets of the Company as of December 31, 1997 and 1996 are as follows (in
thousands):
1997 1996
LIABILITIES -
Advances from shareholder $ - $ 66,711
======== ========
STOCKHOLDER'S DEFICIT:
Common stock $ - $ -
Additional paid-in capital 66,711 (66,711)
Accumulated deficit during development stage (66,711) -
-------- --------
Total stockholder's deficit $ - $(66,711)
======== ========
During 1997, the Company and its shareholder elected to contribute the
advances from shareholder due to the Company as additional paid-in capital.
Other than the transaction described above, the Company has been inactive
during the year ended December 31, 1997.
On March 31, 1997, the Federal Communications Commission (FCC) approved the
assignment of the License and related debt (the License Debt) from the
General Partner to the Partnership. In conjunction with the assignment of
the License and the related License Debt, the General Partner became
obligated to contribute to the Partnership cash in an aggregate amount equal
to the License Debt, plus adjustments as described by the Agreement.
Concurrent with each capital contribution the General Partner was required
to pay to the Partnership an additional capital contribution equal to the
interest at 5.875% per year (compounded quarterly) on the amount, if any, by
which the License Debt exceeded the aggregate cash capital contribution
previously made. For this purpose, the additional capital contribution
began to accrue on March 1, 1996 and aggregated $17,149,350 as of December
31, 1997.
In accordance with the Agreement, the General Partner's capital account was
also credited for all interest payments made by the General Partner in
conjunction with the License Debt and the retirement of certain interim
funding loans, plus interest, made by the General Partner to the Partnership
from January 1, 1997 through March 31, 1997.
10
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
Total contributions credited to the General Partner's capital account as of
December 31, 1997 are as follows (in thousands):
Cash contributions $ 96,232
License debt interest paid 24,405
Retirement of interim funding loans, plus interest 148,430
--------
$269,067
========
Basis of Presentation - The accompanying combined consolidated financial
statements represent a combination of the accounts of the Partnership and
its subsidiaries and the accounts of the Company and its wholly-owned
subsidiary, PCS Leasing Co., Inc. Minority interest in the equity of PCS
Leasing Co., L.P. is shown separately in the accompanying combined
consolidated financial statements. All significant intercompany accounts
and transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Emergence from Development Stage - For the year ended December 31, 1996, the
Company had reported its operations as a development stage enterprise. The
Partnership, and previously the Company, has commenced service in certain
counties (San Diego, Orange, and Los Angeles) and is slated to launch its
services in the remaining counties included in the Los Angeles MTA. Service
commencement dates for those counties in which services were launched are as
follows:
San Diego December 27, 1996
Orange May 5, 1997
Los Angeles November 28, 1997
As a result, the balance sheet and statements of operations and of cash
flows are no longer presented in development stage format.
Revenue Recognition - Operating revenues for PCS services are recognized as
service is rendered. Operating revenues for equipment sales are recognized
at the time the equipment is shipped to a customer or an unaffiliated agent.
Cost of Equipment - The Partnership uses multiple methods of distribution of
its inventory including third-party regional retailers, Partnership owned
retail stores, its direct sales force and telemarketing. Cost of equipment
is limited to the net sales price of the equipment, although such varies by
distribution channel and includes the cost of multiple models of handsets,
related accessory equipment and warehousing and shipping expenses.
11
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
Cash and Cash Equivalents - The Partnership considers all highly-liquid debt
instruments purchased with an original maturity of three months or less to
be cash equivalents.
Inventories - Accessory inventories are stated at the lower of average cost
or market. Consistent with industry standards, handset inventories are
stated at replacement value. To the extent that the net purchase price
realized upon the sale of a handset to a customer or unaffiliated agent
results in less revenue than the replacement value of the handset to the
Partnership, such a loss is charged to selling, general and administrative
expenses.
Accounts Receivable and Major Customer - Accounts receivable are net of an
allowance for doubtful accounts of approximately $663,000. The
Partnership's revenues are generated from credit sales to retailers and
individual customers located throughout the Los Angeles MTA. The
Partnership performs ongoing credit evaluations of its customers and
generally does not require collateral in conjunction with a sale. Revenue
from one third-party retailer was approximately 34% of equipment revenue in
the combined consolidated statement of operations for the year ended
December 31, 1997.
Investment in PCS License and Microwave Relocation Costs - During 1994 and
1995, the FCC auctioned PCS licenses in specific geographic service areas.
The FCC grants licenses for terms of up to 10 years, and generally grants
renewals if the licensee has complied with its license obligations. The
Partnership believes it has, and will continue to meet, all requirements
necessary to secure renewal of its PCS license. The Partnership has also
incurred costs associated with microwave relocation in the construction of
the PCS network. Amortization of the PCS license and microwave relocation
costs commences as service is launched in a county within the Los Angeles
MTA, over estimated useful lives of 40 years. As of December 31, 1997,
accumulated amortization of the PCS license and microwave relocation costs
totaled $1,543,001 and $553,314, respectively .
The ongoing value and remaining useful life of intangible assets are subject
to periodic evaluation. The Partnership currently expects the carrying
amounts to be fully recoverable. Impairments of intangibles and long lived
assets, if any, are assessed based on an undiscounted cash flow methodology.
Depreciation - Depreciation of property and equipment commences the month
following the month when assets are placed into service and is provided over
the respective assets' estimated lives of 3 to 10 years using the straight-
line method. Leasehold improvements are amortized over the life of the
lease.
Capitalized Interest - Interest costs incurred during the construction of
the PCS license network are capitalized. As of December 31, 1997, the
Partnership had capitalized $32,637,000 of interest. Capitalized interest
is amortized over the same period as the related license.
12
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
Income Taxes - The Partnership has not provided for federal or state income
taxes because such taxes are the responsibility of the individual partners.
Fair Value of Financial Instruments - Management believes that the carrying
value of accounts receivable and accounts payable approximate fair value due
to the short maturity of these financial instruments. Management also
believes that the carrying value of the long-term debt approximates its fair
value as the yield is consistent with the yields obtained from financial
instruments with similar risk attributes.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Recent Accounting Pronouncements - In June 1997, the Financial Accounting
Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income,
and SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information. SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 131 establishes standards of reporting by
publicly-held business enterprises and disclosure of information about
operating segments in annual financial statements and, to a lesser extent,
in interim financial reports issued to shareholders. SFAS Nos. 130 and 131
are effective for the Partnership beginning in fiscal 1998 and 1999,
respectively. In February 1998, the FASB issued SFAS No. 132, Employers'
Disclosures About Pensions and Other Post-retirement Benefits, which
requires additional information to facilitate financial analysis and
eliminates certain disclosures which are no longer useful. SFAS No. 132 is
effective for the Partnership beginning in fiscal 1998. The Partnership
will adopt these new standards and provide the necessary financial
statements and disclosures when required.
13
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
3. PROPERTY AND EQUIPMENT
A summary of property and equipment, at cost, is as follows (in thousands):
1997 1996
Equipment $204,998 $ 57,983
Leasehold improvements 49,527 15,947
Furniture and fixtures 7,466 3,923
Capitalized software 17,900 15,621
Construction in progress 73,956 88,210
-------- --------
353,847 181,684
Less accumulated depreciation and amortization (26,997)
-------- --------
$326,850 $181,684
======== ========
4. RELATED-PARTY TRANSACTIONS
In addition to such transactions described elsewhere in the notes to the
combined consolidated financial statements, the Partnership entered into the
following related-party transactions for the years ended December 31, 1997
and 1996:
. The Partnership paid the General Partner or an affiliate of the General
Partner approximately $6,081,000 in 1997 and had accrued an additional
$1,562,000 as of December 31, 1997 in conjunction with services rendered,
lease expenses incurred, or commissions earned.
. The Partnership incurred expenses from the Exclusive Limited Partner or
an affiliate of the Exclusive Limited Partner of $22,984,000 in 1997 and
$8,000,000 in 1996 in conjunction with corporate allocations, affiliation
fees and inventory handling costs. Of these amounts, $2,449,000 and
$8,977,000 were payable as of December 31, 1997 and 1996, respectively.
. The Partnership also purchased handset and accessory inventory
approximating $84,000,000 from an affiliate of the Exclusive Limited
Partner during 1997, of which approximately $12,798,000 remained unpaid
as of December 31, 1997.
. As of December 31, 1996, due to affiliate includes the net amount of a
$66,625,000 receivable from the General Partner and a $66,711,000 payable
to the Company's shareholder (Note 1).
14
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
As described above and elsewhere in the footnotes to the combined
consolidated financial statements, the Partnership has various transactions
with the General Partner and the Exclusive Limited Partner and their
respective affiliates. Such transactions include the leasing of equipment
and facilities, the purchase of services and inventory, the payment of
affiliation fees, the reimbursement of corporate expenses and certain
allocations, and borrowings and repayments of funds at specified interest
rates, all of which are material in amount. Accordingly, the accompanying
combined consolidated financial statements may not necessarily be indicative
of the conditions that would have existed or the result of operations if the
Partnership had been operated as an unaffiliated entity.
Substantially all of the Partnership's employees were eligible to
participate in the savings and investment plan of Cox Enterprises, Inc. (the
CEI Plan). Under the terms of the CEI Plan, the partnership matches 50% of
employee contributions up to a maximum of 6% of the employees' base salary.
During 1996 and through June 30, 1997, the Partnership and the Company
contributed $276,000 and $366,000, respectively, to the CEI Plan.
The Partnership established the Cox Communications PCS, L.P. Savings and
Investment Plan (the Plan) effective July 1, 1997. Substantially all
employees of the Partnership, other than collective bargaining unit members,
are eligible to participate in the Plan after completing one year of
eligible service (as defined) and attaining age 21. Employees may make
contributions to the Plan on a pretax basis pursuant to Section 401(k) of
the Internal Revenue Code. The Partnership makes matching contributions
equal to 75% of the employee's contribution up to a maximum amount equal to
4.5% of the employee's annual compensation. Employee contributions vest
immediately, and the Partnership's matching contributions vest over three
years of service. However, employees who participated in the CEI Plan prior
to July 1, 1997 and commenced participation in this Plan on July 1, 1997 are
immediately vested in their matching contributions. The Partnership's
contributions to the Plan totaled $596,000 during the year ended December
31, 1997.
15
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
5. COMMITMENTS AND CONTINGENCIES
Leases - Future minimum lease payments under noncancelable operating
facility, auto leases, network and other equipment leases as of December 31,
1997 are as follows (in thousands):
Year ending December 31:
1998 $19,769
1999 19,404
2000 17,056
2001 14,554
2002 8,900
Thereafter 16,807
-------
$96,490
=======
Certain leases are subject to annual consumer price index increases and
contain various renewal clauses. Lease expense included in the accompanying
combined consolidated financial statements totaled $21,331,000 and
$4,545,000 in the years ended December 31, 1997 and 1996, respectively.
Affiliation Agreement - The Partnership has entered into an affiliation
agreement ( the Affiliation Agreement) with a subsidiary of the Exclusive
Limited Partner effective December 31, 1996. The Affiliation Agreement
requires the Partnership to pay an affiliation fee to the Exclusive Limited
Partner on a monthly basis in an amount equal to 2.75% of the first
$25,000,000 of gross revenues, plus 2% of the second $25,000,000 of gross
revenues, plus 1.5% of gross revenues in excess of $50,000,000. The
Affiliation Agreement also provides for the reimbursement to the Exclusive
Limited Partner of an allocated amount of certain advertising and
marketing, information technology, product development, accounting and
financing, general and administrative, and customer service expenses,
incurred by the Exclusive Limited Partner. The initial term of the
Affiliation Agreement is ten years, but will be automatically renewed for
successive five-year renewal periods (for a maximum of 50 years, including
the initial term), unless one year prior to the commencement of a renewal
period either party notifies the other that its does not wish to renew this
Affiliation Agreement.
Included in selling, general and administrative expense are $22,156,000 and
$8,000,000 of amounts representing affiliation fees and allocations to the
Partnership and Company for the years ended December 31, 1997 and 1996,
respectively.
Trademark Agreement - Sprint PCS(R) and other related trademarks are
registered trademarks of a partner of the Exclusive Limited Partner and are
licensed to the Partnership on a royalty-free basis pursuant to a trademark
license agreement. The trademark agreement requires the Partnership to
adhere to certain quality and other standards specified in the trademark
agreement.
16
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
Third-party Marketing Agreements - The Partnership has entered into a series
of third-party marketing agreements in conjunction with the distribution of
handsets and accessories. Generally, the terms of such third-party
marketing agreements allow for the third parties to be reimbursed, at
certain defined levels, for cooperative advertising benefiting the Company's
products and services. In addition, one of the third-party marketing
agreements requires the Partnership to pay, for a limited period of time, a
percentage of the service revenue generated in conjunction with the
subscribers identified by the third-party retailer.
Construction Obligations - In developing the PCS Network, the Partnership
has entered into various arrangements whereby it is obligated to purchase
equipment and services from vendors. The Partnership accrues for both the
obligation and related assets based on predetermined completion points
related to each network site construction project.
Contingencies - The Partnership is involved in various claims and other
matters incidental to its business. In the opinion of management, the
resolution of these matters will not have a material adverse effect on the
combined consolidated financial position or results of operations of the
Partnership or the Company.
6. LONG-TERM DEBT
In conjunction with the assignment of the License, the Partnership assumed
the License Debt, as described in Note 1 to the combined consolidated
financial statements. The License Debt requires eight quarterly interest-
only payments beginning April 30, 1996 through January 31, 1998. Commencing
April 30, 1998, the License Debt requires repayment in equal quarterly
installments of $23,729,973 representing both principal and interest. The
License Debt is collateralized by the License, bears interest at 7.75% per
annum, and matures on January 31, 2001.
The principal portion of future payments made in conjunction with the
License Debt are as follows (in thousands):
Year ending December 31:
1998 $ 57,650
1999 82,215
2000 88,775
2001 23,279
--------
$251,919
========
17
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
As discussed in Note 1 to the combined consolidated financial statements,
the General Partner made interim funding loans to the Partnership from
January 1, 1997 through March 31, 1997. The interim funding loans which
aggregated to $147,000,000, were unsecured and bore interest at 7.25%. On
March 31, 1997, in conjunction with the assumption of the License by the
Partnership, the interim funding loans were retired and the amounts advanced
plus the related accrued interest of $1,430,000, were credited to the
General Partner's capital account.
7. PARTNER CAPITAL ALLOCATIONS
Profits and losses from the operations of the Partnership will be allocated
between the partners as described in the Agreement, generally in proportion
to their percentage interests (51% for the General Partner and 49% for the
Exclusive Limited Partner).
The Exclusive Limited Partner's investment in PCS Leasing Co., L.P. of
$2,450,000, presented as a minority interest in the accompanying combined
consolidated financial statements, is deemed to represent a preferred
contribution in accordance with Agreement of Limited Partnership of PCS
Leasing Co., L.P. (the Leasing Co. Agreement). The Leasing Co. Agreement
provides for a cumulative preferred return to the Exclusive Limited Partner
in an amount equal to 9% per annum. Cox Communications PCS, L.P.'s
$2,550,000 investment in PCS Leasing Co., L.P. also constitutes a preferred
contribution in accordance with the Leasing Co. Agreement. In accordance
with the Leasing Co. Agreement, the Partnership has not declared or recorded
a preferred capital distribution representing the preferred return of
$450,000 for the year ended December 31, 1997.
Losses from the operations of PCS Leasing Co., L.P. for the years ended
December 31, 1997 and 1996 were allocated 100% to Cox Communications PCS,
L.P., in accordance with the Leasing Co. Agreement.
8. SUBSEQUENT EVENTS
Credit Facility - On February 25, 1998 the Partnership entered into a
$800,000,000, nine-year revolving and term loan agreements (the Credit
Agreement) with a bank syndicate. The Credit Agreement consists of a
revolving line of credit in an aggregate principal amount of $400,000,000
and two term loan facilities with aggregate principal amounts of
$200,000,000 each. The Credit Agreement grants the Partnership an option to
expand the revolving line of credit facility up to $750,000,000 from time to
time, upon the Partnership meeting certain requirements. The proceeds from
the loan are intended to repay the License Debt, finance working capital
needs, subscriber
18
<PAGE>
COX COMMUNICATIONS PCS, L.P. AND SUBSIDIARIES
AND COX CALIFORNIA PCS, INC. AND SUBSIDIARY
NOTES TO COMBINED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 (CONTINUED)
- --------------------------------------------------------------------------------
acquisition costs, capital expenditures and other general purposes of the
Partnership. Provisions of the Credit Agreement require the transfer of
certain of the Partnerships assets into the Special Purpose Subsidiaries of
the Partnership to facilitate the collateralization of substantially all of
the Partnerships assets.
Furthermore, the amounts advanced under the Credit Agreement are guaranteed
by each of the Special Purpose Subsidiaries. The Credit Agreement also
requires that the Partnership meet certain operational and financial
covenants, with which management believes the Partnership is in compliance
as of February 25, 1998 (the funding date). Amounts borrowed under the
facility are to be repaid based on scheduled repayment dates defined in the
Credit Agreement plus interest at a variable rate (as defined).
Put and Call Options - The Agreement grants the General Partner the right to
require the Exclusive Limited Partner to buy a defined percentage interest
of the General Partner's interest in the Partnership. Similarly, the
Agreement grants the Exclusive Limited Partner the right to buy from the
General Partner a defined percentage interest of the General Partner's
interest in the Partnership.
On November 28, 1997, the General Partner notified the Exclusive Limited
Partner as to its intent to begin the process of determining the gross
appraised value of the Partnership's net assets and performing other
procedures required in conjunction with its put option rights in accordance
with the terms of the Agreement. On February 3, 1998, the General Partner
notified the Exclusive Limited Partner of its intent to exercise the put
option and receive approximately $80,558,000 in consideration of a 10.2%
transfer of interest in the Partnership. The transaction requires the
approval of the FCC, upon which the ownership interests in the Partnership
will be as follows:
Cox Pioneer Partnership 40.8%
Sprint Spectrum Holding Company, L.P. 59.2%
Upon the consummation of the above transaction, the Agreement requires the
Exclusive Limited Partner's aggregate 59.2% interest to be recharacterized
as having 99% general partner interest and 1% limited partner interest
components.
Subsequent Exclusive Limited Partner Contribution - On January 12, 1998 the
Exclusive Limited Partner made a final capital contribution payment of
$33,780,082, which represents $539,772 of required capital contributions;
$33,239,131 of additional capital contributions through December 31, 1997;
and $1,179 of additional contributions representing the interest accrued
from December 31, 1997 through January 12, 1998 on $539,772 of outstanding
required capital contributions.
19
<PAGE>
INDEPENDENT AUDITORS' REPORT
Partners of Sprint Spectrum Holding Company, L.P.
Kansas City, Missouri
We have audited the accompanying consolidated balance sheets of Sprint Spectrum
Holding Company, L.P. and subsidiaries ("the Partnership") as of December 31,
1997 and 1996, and the related consolidated statements of operations, changes in
partners' capital and cash flows for the three years in the period ended
December 31, 1997. Our audits also included the financial statement schedule
(Schedule II) listed on page F-68. These financial statements and financial
statement schedule are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Sprint Spectrum
Holding Company, L.P. and subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for the three years then ended,
in conformity with generally accepted accounting principles. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
The Partnership was in the development stage at December 31, 1996; during the
year ended December 31, 1997, the Partnership completed its development
activities and commenced its planned principal operations.
Deloitte & Touche LLP
February 3, 1998
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY, L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
--------------- ---------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents...................................................... $ 117,164 $ 69,988
Accounts receivable, net....................................................... 113,507 3,310
Receivable from affiliates..................................................... 96,291 12,901
Inventory...................................................................... 101,366 72,414
Prepaid expenses and other assets, net......................................... 28,495 14,260
Note receivable--unconsolidated partnership.................................... - 226,670
--------------- ---------------
Total current assets............................................................ 456,823 399,543
INVESTMENT IN PCS LICENSES, net................................................. 2,303,398 2,122,908
INVESTMENTS IN UNCONSOLIDATED PARTNERSHIP(S).................................... 273,541 179,085
PROPERTY, PLANT AND EQUIPMENT, net.............................................. 3,429,238 1,408,680
MICROWAVE RELOCATION COSTS, net................................................. 264,215 135,802
MINORITY INTEREST............................................................... 56,667 -
OTHER ASSETS, net............................................................... 113,127 77,383
--------------- ---------------
TOTAL ASSETS.................................................................... $ 6,897,009 $ 4,323,401
=============== ===============
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Advances from partners........................................................ $ - $ 167,818
Accounts payable.............................................................. 415,944 196,146
Payable to affiliate.......................................................... 11,933 5,626
Accrued interest.............................................................. 56,678 34,057
Accrued expenses.............................................................. 231,429 47,173
Current maturities of long-term debt.......................................... 34,562 49
--------------- ---------------
Total current liabilities....................................................... 750,546 450,869
CONSTRUCTION OBLIGATIONS........................................................ 705,280 714,934
LONG-TERM DEBT.................................................................. 3,533,954 686,192
OTHER NONCURRENT LIABILITIES.................................................... 48,975 11,356
COMMITMENTS AND CONTINGENCIES
LIMITED PARTNER INTEREST IN CONSOLIDATED
SUBSIDIARY............................................................. 13,722 13,397
PARTNERS' CAPITAL AND ACCUMULATED DEFICIT:
Partners' capital............................................................. 3,964,750 3,003,484
Accumulated deficit........................................................... (2,120,218) (556,831)
--------------- ---------------
Total partners' capital......................................................... 1,844,532 2,446,653
--------------- ---------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL......................................... $ 6,897,009 $ 4,323,401
=============== ===============
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------
1997 1996 1995
------------- ----------- -----------
<S> <C> <C> <C>
OPERATING REVENUES............................... $ 248,607 $ 4,175 $ -
OPERATING EXPENSES:
Cost of revenues.............................. 555,030 36,076 -
Selling, general and administrative........... 696,911 312,697 66,340
Depreciation and amortization................. 307,400 11,275 211
------------- ----------- -----------
Total operating expenses..................... 1,559,341 360,048 66,551
------------- ----------- -----------
LOSS FROM OPERATIONS............................. (1,310,734) (355,873) (66,551)
OTHER INCOME (EXPENSE):
Interest income................................ 26,456 8,593 460
Interest expense............................... (121,844) (323) -
Other income................................... 5,474 1,586 38
Equity in loss of unconsolidated
partnerships................................. (168,935) (96,850) (46,206)
------------- ----------- -----------
Total other income (expense)................. (258,849) (86,994) (45,708)
------------- ----------- -----------
NET LOSS BEFORE MINORITY INTEREST................ (1,569,583) (442,867) (112,259)
MINORITY INTEREST................................ 6,196 (227) 1,830
------------- ----------- -----------
NET LOSS......................................... $ (1,563,387) $ (443,094) $ (110,429)
============= =========== ===========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(IN THOUSANDS)
<TABLE>
<CAPTION>
PARTNERS' ACCUMULATED
CAPITAL DEFICIT TOTAL
------------ ------------- -------------
<S> <C> <C> <C>
BALANCE, January 1, 1995....................................... $ 123,438 $ (3,308) $ 120,130
Contributions of capital....................................... 2,168,368 - 2,168,368
Net loss....................................................... - (110,429) (110,429)
------------ ------------- -------------
BALANCE, December 31, 1995..................................... 2,291,806 (113,737) 2,178,069
Contributions of capital....................................... 711,678 - 711,678
Net loss....................................................... - (443,094) (443,094)
------------ ------------- -------------
BALANCE, December 31, 1996..................................... 3,003,484 (556,831) 2,446,653
Contributions of capital....................................... 973,001 - 973,001
Net loss....................................................... - (1,563,387) (1,563,387)
Return of capital.............................................. (11,735) - (11,735)
------------ ------------- -------------
BALANCE, December 31, 1997..................................... $ 3,964,750 $ (2,120,218) $ 1,844,532
============ ============= =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................. $ (1,563,387) $ (443,094) $ (110,429)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Equity in loss of unconsolidated partnership............................. 168,935 96,850 46,206
Minority interest........................................................ (6,196) 227 (1,830)
Depreciation and amortization............................................ 307,930 11,275 242
Amortization of debt discount and issuance costs........................ 49,061 14,008 -
Changes in assets and liabilities, net of effects of acquisition of APC:
Receivables........................................................... (182,882) (15,871) (340)
Inventory............................................................. (24,870) (72,414) -
Prepaid expenses and other assets..................................... (12,497) (21,608) (178)
Accounts payable and accrued expenses................................. 371,168 231,754 47,503
Other noncurrent liabilities.......................................... 37,619 9,500 1,856
------------- ------------- -------------
Net cash used in operating activities.............................. (855,119) (189,373) (16,970)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................................. (2,041,313) (1,386,346) (31,763)
Proceeds on sale of equipment......................................... - - 37
Microwave relocation costs, net....................................... (116,278) (135,828) -
Purchase of PCS licenses.............................................. - - (2,006,156)
Purchase of APC, net of cash acquired................................. (6,764) - -
Investment in unconsolidated partnerships............................. (191,171) (190,390) (131,752)
Loan to unconsolidated partnership.................................... (111,468) (231,964) (655)
Payment received on loan to unconsolidated partnership................ 246,670 5,950 -
------------- ------------- -------------
Net cash used in investing activities............................. (2,220,324) (1,938,578) (2,170,289)
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances from partners................................................ - 167,818 -
Net borrowing under revolving credit agreement........................ 605,000 - -
Proceeds from issuance of long-term debt.............................. 1,763,045 674,201 -
Change in construction obligations.................................... (9,654) 714,934
Payments on long-term debt............................................ (170,809) (24) -
Debt issuance costs................................................... (20,000) (71,791) -
Partner capital contributions......................................... 966,772 711,678 2,183,368
Return of capital..................................................... (11,735) - -
------------- ------------- -------------
Net cash provided by financing activities......................... 3,122,619 2,196,816 2,183,368
------------- ------------- -------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................................................ 47,176 68,865 (3,891)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............................ 69,988 1,123 5,014
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................................. $ 117,164 $ 69,988 $ 1,123
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
. ..........Interest paid, net of amount capitalized..................... $ 35,629 $ 323 $ -
NON-CASH INVESTING AND FINANCING ACTIVITIES:
. Accrued interest of $51,673 related to vendor financing was converted
to long-term debt during the year ended December 31, 1997.
. A PCS license covering the Omaha MTA and valued at $6,229 was
contributed to the Company by Cox Communications during the
year ended December 31, 1997.
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Sprint Spectrum Holding Company, L.P. ("Holdings" or the "Company") is a limited
partnership formed in Delaware on March 28, 1995, by Sprint Enterprises, L.P.,
TCI Spectrum Holdings, Inc., Cox Telephony Partnership and Comcast Telephony
Services (together the "Partners"). Holdings was formed pursuant to a
reorganization of the operations of an existing partnership, WirelessCo, L.P.
("WirelessCo") which transferred certain operating functions to Holdings. The
Partners are subsidiaries of Sprint Corporation ("Sprint"), Tele-Communications,
Inc. ("TCI"), Cox Communications, Inc. ("Cox"), and Comcast Corporation
("Comcast", and together with Sprint, TCI and Cox, the "Parents"), respectively.
The Company and certain other affiliated partnerships offer services as Sprint
PCS.
The Partners of the Company have the following ownership interests as of
December 31, 1997, and 1996:
<TABLE>
<S> <C>
Sprint Enterprises, L.P. 40%
TCI Spectrum Holdings, Inc. 30%
Cox Telephony Partnership 15%
Comcast Telephony Services 15%
</TABLE>
Each Partner's ownership interest consists of a 99% general partner interest and
a 1% limited partnership interest.
The Company is consolidated with its subsidiaries, including NewTelco, L.P.
("NewTelco") and Sprint Spectrum L.P., which, in turn, has several subsidiaries.
Sprint Spectrum L.P.'s subsidiaries are Sprint Spectrum Equipment Company, L.P.
("EquipmentCo"), Sprint Spectrum Realty Company, L.P. ("RealtyCo"), Sprint
Spectrum Finance Corporation ("FinCo"), and WirelessCo. RealtyCo and EquipmentCo
were organized on May 15, 1996 for the purpose of holding personal
communications service ("PCS") network-related real estate interests and assets.
FinCo was formed on May 20, 1996 to be a co-obligor of the debt obligations
discussed in Note 5. Additionally, the results of American PCS, L.P. ("APC")
are consolidated from November 1997, the date the Federal Communications
Commission ("FCC") approved Holdings as the new managing partner (Note 4). APC,
through subsidiaries, owns a PCS license for and operates a broadband GSM
(global system for mobile communications) in the Washington D.C./Baltimore Major
Trading Area ("MTA"), and is in the process of building a code division multiple
access ("CDMA") overlay for its existing GSM PCS system. APC includes American
PCS Communications, LLC, APC PCS, LLC, APC Realty and Equipment Company, LLC and
American Personal Communications Holdings, Inc. MinorCo, L.P. ("MinorCo") holds
the minority ownership interests in NewTelco, Sprint Spectrum L.P., EquipmentCo,
RealtyCo and WirelessCo at December 31, 1997 and 1996, and APC at December 31,
1997.
VENTURE FORMATION AND AFFILIATED PARTNERSHIPS - A Joint Venture Formation
Agreement (the "Formation Agreement"), dated as of October 24, 1994, and
subsequently amended as of March 28, 1995, and January 31, 1996, was entered
into by the Parents, pursuant to which the Parents agreed to form certain
entities to (i) provide national wireless telecommunications services, including
acquisition and development of PCS licenses, (ii) develop a PCS wireless system
in the Los Angeles-San Diego MTA, and (iii) take certain other actions.
6
<PAGE>
On October 24, 1994, WirelessCo was formed and on March 28, 1995, additional
partnerships were formed consisting of Holdings, MinorCo, NewTelco, and Sprint
Spectrum L.P. The Partners' ownership interests in WirelessCo were initially
held directly by the Partners as of October 24, 1994, the formation date of
WirelessCo, but were subsequently contributed to Holdings and then to Sprint
Spectrum L.P. on March 28, 1995.
SPRINT SPECTRUM HOLDING COMPANY, L.P. PARTNERSHIP AGREEMENT - The Amended and
Restated Agreement of Limited Partnership of MajorCo, L.P. (the "Holdings
Agreement"), dated as of January 31, 1996, among Sprint Enterprises, L.P., TCI
Spectrum Holdings, Inc., Comcast Telephony Services and Cox Telephony
Partnership provides that the purpose of the Company is to engage in wireless
communications services.
The Holdings Agreement generally provides for the allocation of profits and
losses according to each Partner's proportionate percentage interest, after
giving effect to special allocations. After special allocations, profits are
allocated to partners to the extent of and in proportion to cumulative net
losses previously allocated. Losses are allocated, after considering special
allocations, according to each Partner's allocation of net profits previously
allocated.
The Holdings Agreement provides for planned capital contributions by thePartners
("Total Mandatory Contributions") of $4.2 billion, which includes agreed upon
values attributable to the contributions of certain additional PCS licenses by a
Partner. The Total Mandatory Contributions amount is required to be contributed
in accordance with capital contribution schedules to be set forth in approved
annual budgets. The partnership board of Holdings may request capital
contributions to be made in the absence of an approved budget or more quickly
than provided for in an approved budget, but always subject to the Total
Mandatory Contributions limit. The proposed budget for fiscal 1998 has not yet
been approved by the partnership board, which has resulted in the occurrence of
a Deadlock Event (as defined) under the Holdings Agreement as of January 1,
1998. If the 1998 proposed budget is not approved through resolution procedures
set forth in the Holdings Agreement, certain specified buy/sell procedures may
be triggered which may result in a restructuring of the partners' interest in
the Company or, in limited circumstances, liquidation of the Company. As of
December 31, 1997, approximately $4.0 billion of the Total Mandatory
Contributions had been contributed by the Partners to Holdings and its
affiliated partnerships, of which approximately $3.3 billion had been
contributed to Sprint Spectrum L.P.
EMERGENCE FROM DEVELOPMENT STAGE COMPANY - Prior to the third quarter of 1997,
the Company reported its operations as a development stage enterprise. The
Company has commenced service in all of the MTAs in which it owns a license. As
a result, the Company is no longer considered a development stage enterprise,
and the balance sheets and statements of operations and of cash flows are no
longer presented in development stage format.
Management believes that the Company will incur additional losses in 1998 and
require additional financial resources to support the current level of
operations and the remaining network buildout for the year ended December 31,
1998. Management believes the Company has the ability to obtain the required
levels of financing through additional financing arrangements or additional
equity funding from the Partners.
7
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The assets, liabilities, results of operations and cash
flows of entities in which the Company has a controlling interest have been
consolidated. All significant intercompany accounts and transactions have been
eliminated.
MINORITY INTERESTS - MinorCo, the limited partner in NewTelco, has been
allocated approximately $0.3 million and $0.2 million in income for the years
ended December 31, 1997, and 1996, respectively. Losses of $1.8 million for the
year ended December 31, 1995 incurred by NewTelco as losses in excess of the
general partner's capital accounts (which consisted of $1,000) are to be
allocated to the limited partner to the extent of its capital account.
In November 1997, concurrent with the acquisition discussed in Note 4, American
Personal Communications II, L.P. ("APC II") became the minority owner in APC.
APC II has been allocated approximately $6.5 million in losses in APC since the
date of acquisition. Prior to November 1997, APC II, as majority owner, had
been allocated approximately $50 million in losses in excess of its investment.
At December 31, 1997, after consolidation of APC, the total of such losses,
approximately $56.7 million, was recorded as minority interest in the Company's
consolidated balance sheet. This treatment reflects that APC II continued to be
responsible for funding its share of losses until January 1, 1998 when the
Company acquired the remaining interest in APC.
TRADEMARK AGREEMENT - Sprint(R) is a registered trademark of Sprint
Communications Company L.P. and Sprint(R) and Sprint PCS(R) are licensed to the
Company on a royalty-free basis pursuant to a trademark license agreement
between the Company and Sprint Communications Company L.P.
REVENUE RECOGNITION - Operating revenues for PCS services are recognized as
service is rendered. Operating revenues for equipment sales are recognized at
the time the equipment is delivered to a customer or an unaffiliated agent.
COST OF EQUIPMENT - The Company uses multiple distribution channels for its
inventory, including third-party retailers, Company-owned retail stores, its
direct sales force and telemarketing. Cost of equipment varies by distribution
channel and includes the cost of multiple models of handsets, related accessory
equipment, and warehousing and shipping expenses.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid instruments
with original maturities of three months or less to be cash equivalents. The
Company maintains cash and cash equivalents in financial institutions with the
highest credit ratings.
ACCOUNTS RECEIVABLE - Accounts receivable are net of an allowance for doubtful
accounts of approximately $9.0 million and $0.2 million at December 31, 1997 and
1996, respectively.
INVENTORY - Inventory consists of wireless communication equipment (primarily
handsets). Inventory is stated at lower of cost (on a first-in, first-out
basis) or replacement value. Any losses on the sales of handsets are recognized
at the time of sale.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at cost
or fair value at the date of acquisition. Construction work in progress
represents costs incurred to design and construct the PCS network. Repair and
maintenance costs are charged to expense as incurred. When network equipment is
retired, or otherwise disposed of, its book value, net of salvage, is charged to
accumulated depreciation.
8
<PAGE>
When non-network equipment is sold, retired or abandoned, the cost and
accumulated depreciation are relieved and any gain or loss is recognized.
Property, plant and equipment are depreciated using the straight-line method
based on estimated useful lives of the assets. Depreciable lives range from 3 to
20 years.
EQUIPMENT UNDER CAPITAL LEASES - APC leases certain of its office and other
equipment under capital lease agreements. The assets and liabilities under
capital leases are recorded at the lesser of the present value of aggregate
future minimum lease payments, including estimated bargain purchase options, or
the fair value of the assets under lease. Assets under these capital leases are
depreciated over their estimated useful lives of 5 to 7 years. Depreciation
related to capital leases is included within depreciation expense.
INVESTMENT IN PCS LICENSES - During 1994 and 1995, the Federal Communications
Commission ("FCC") auctioned PCS licenses in specific geographic service areas.
The FCC grants licenses for terms of up to ten years, and generally grants
renewals if the licensee has complied with its license obligations. The Company
believes it will be able to secure renewal of the PCS licenses held by its
subsidiaries. PCS licenses are amortized over estimated useful lives of 40
years once placed in service. Accumulated amortization for PCS licenses totaled
approximately $45.2 million and $1.7 million as of December 31, 1997, and 1996,
respectively. There was no amortization in 1995.
MICROWAVE RELOCATION COSTS - The Company has also incurred costs associated with
microwave relocation in the construction of the PCS network. Microwave
relocation costs are amortized over estimated useful lives of 40 years once
placed in service. Accumulated amortization for microwave relocation costs
totaled approximately $5.2 million as of December 31, 1997. There was no
amortization in 1996 or 1995.
INTANGIBLE ASSETS - The ongoing value and remaining useful life of intangible
assets are subject to periodic evaluation. The Company currently expects the
carrying amounts to be fully recoverable. Impairments of intangibles and long-
lived assets are assessed based on an undiscounted cash flow methodology.
CAPITALIZED INTEREST - Interest costs associated with the construction of
capital assets (including the PCS licenses) incurred during the period of
construction are capitalized. The total interest costs capitalized in 1997 and
1996 were approximately $98.6 million and $30.5 million, respectively. There
were no amounts capitalized in 1995.
DEBT ISSUANCE COSTS - Included in other assets are costs associated with
obtaining financing. Such costs are capitalized and amortized to interest
expense over the term of the related debt instruments using the effective
interest method. Accumulated amortization for the years ended December 31, 1997
and 1996 were approximately $13.4 million and $1.9 million, respectively. There
was no amortization in 1995.
OPERATING LEASES - Rent expense is recognized on the straight-line basis over
the life of the lease agreement, including renewal periods. Lease expense
recognized in excess of cash expended is included in non-current liabilities in
the consolidated balance sheet.
MAJOR CUSTOMER - The Company markets its products through multiple distribution
channels, including Company-owned retail stores and third-party retail outlets.
The Company's subscribers are disbursed throughout the United States. Sales to
one third-party retail customer represented approximately 21% and 88% of
operating revenue in the consolidated statements of operations for the years
ended December
9
<PAGE>
31, 1997 and 1996, respectively. The Company reviews the credit history of
retailers prior to extending credit and maintains allowances for potential
credit losses. The Company believes that its risk from concentration of credit
is limited.
INCOME TAXES - The Company has not provided for federal or state income taxes
since such taxes are the responsibility of the individual Partners.
FINANCIAL INSTRUMENTS - The carrying value of the Company's short-term financial
instruments, including cash and cash equivalents, receivables from customers and
affiliates and accounts payable approximates fair value. The fair value of the
Company's long-term debt is based on quoted market prices for the same issues or
current rates offered to the Company for similar debt. A summary of the fair
value of the Company's long-term debt at December 31, 1997 and 1996 is included
in Note 5.
The fair value of the interest rate contracts is the estimated net amount that
APC would pay to terminate the contracts at the balance sheet date. The fair
value of the fixed rate loans is estimated using discounted cash flow analysis
based on APC's current incremental borrowing rate at which similar borrowing
agreements would be made under current conditions.
DERIVATIVE FINANCIAL INSTRUMENTS - Derivative financial instruments (interest
rate contracts) are utilized by APC to reduce interest rate risk. APC has
established a control environment which includes risk assessment and management
approval, reporting and monitoring of derivative financial instrument
activities. APC does not hold or issue derivative financial instruments for
trading purposes.
The differentials to be received or paid under interest rate contracts that are
matched against underlying debt instruments and qualify for settlement
accounting are recognized in income over the life of the contracts as
adjustments to interest expense. Gains and losses on terminations of interest
rate contracts are recognized as other income or expense when terminated in
conjunction with the retirement of associated debt. Gains and losses on
terminations of interest rate contracts not associated with the retirement of
debt are deferred and amortized to interest expense over the remaining life of
the associated debt to the extent that such debt remains outstanding.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
RECLASSIFICATIONS - Certain reclassifications have been made to the 1996 and
1995 consolidated financial statements to conform to the 1997 consolidated
financial statement presentation.
10
<PAGE>
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at December 31, 1997 and
1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Land $ 1,444 $ 905
Buildings and leasehold improvements 618,281 86,467
Fixtures and office furniture 165,998 68,210
Network equipment 2,265,213 255,691
Telecommunications plant - construction work in progress 632,922 1,006,990
-------------------- --------------------
3,683,858 1,418,263
Less accumulated depreciation (254,620) (9,583)
-------------------- --------------------
$ 3,429,238 $ 1,408,680
==================== ====================
</TABLE>
Depreciation expense on property, plant and equipment was approximately $244.9
million, $ 9.6 million, and $0.2 million for the years ended December 31, 1997,
1996 and 1995, respectively.
4. INVESTMENTS IN PARTNERSHIPS
APC - On January 9, 1995, WirelessCo acquired a 49% limited partnership interest
in APC. In September 1997, Holdings increased its ownership in APC to a 58.3%
through additional capital contributions of $30 million, and became the managing
partner upon FCC approval in November, 1997. As of January 1, 1998, Holdings
and MinorCo increased their ownership percentages to 99.75% and 0.25%,
respectively, of the partnership interests for approximately $30 million.
The acquisition increasing ownership to 58.3% was accounted for as a purchase
and, accordingly, the operating results of APC has been included in the
Company's consolidated financial statements since the date of the FCC's approval
of the acquisition. The purchase price was allocated to the assets acquired and
the liabilities assumed based on a preliminary estimate of fair value. The
following table reflects the total of APC's assets and liabilities at the date
of acquisition:
<TABLE>
<S> <C>
Assets acquired $ 503
Cash paid (30)
Minority interest 50
-------
Liabilities assumed $ 523
========
</TABLE>
The ultimate allocation of the purchase price may differ from the initial
estimate.
11
<PAGE>
The following unaudited pro forma financial information assumes the acquisition
had occurred on January 1 of each year and that the Company had owned 100% of
APC and consolidated its results in the financial statements:
<TABLE>
<CAPTION>
Proforma - Sprint Spectrum Holding Company, L.P.
1997 1996
------------ -------------
<S> <C> <C>
Net sales......................................... $ 355,038 $ 76,013
Net loss (before minority interest)............... (1,646,551) (553,274)
</TABLE>
Pro forma data does not purport to be indicative of the results that would have
been obtained had these events actually occurred at the beginning of the periods
presented and is not intended to be a projection of future results.
Prior to acquisition of controlling interest, the Company's investment in APC
was accounted for under the equity method. The partnership agreement between
the Company and APC II specified that losses were allocated based on percentage
ownership interests and certain other factors. In January 1997, the Company and
APC II amended the APC partnership agreement with respect to the allocation of
profits and losses. For financial reporting purposes, profits and losses were
allocated in proportion to Holdings' and APC II's respective partnership
interests, except for costs related to stock appreciation rights and interest
expense attributable to the FCC interest payments which were allocated entirely
to APC II. Losses of approximately $60 million, $97 million and $46 million for
the years ended December 31, 1997, 1996 and 1995, respectively, are included in
equity in losses of unconsolidated subsidiaries during the period prior to the
acquisition of controlling interest.
COX COMMUNICATIONS PCS, L.P. - On December 31, 1996, the Company acquired a 49%
limited partner interest in Cox Communications PCS, L.P. ("Cox PCS"). Cox
Pioneer Partnership ("CPP") holds a 50.5% general and a 0.5% limited partner
interest and is the general and managing partner. The investment in Cox PCS is
accounted for under the equity method. Under the terms of the partnership
agreement, CPP and the Company are obligated to, among other things: (a) upon
FCC consent to the assumption and recognition of the license payment obligations
by Cox PCS, CPP is obligated to make capital contributions in an amount equal to
such liability and related interest (the PCS license covering the Los Angeles-
San Diego MTA was contributed to Cox PCS in March 1997) (b) the Company is
obligated to make capital contributions of approximately $368.9 million to Cox
PCS; (c) the Company is not obligated to make any cash capital contributions
upon the assumption by Cox PCS of the FCC payment obligations until CPP has
contributed cash in an amount equal to the aggregate principal and interest of
such obligations; and, (d) CPP and the Company are obligated to make additional
capital contributions in an amount equal to such partner's percentage interest
times the amount of additional capital contributions being requested.
As of December 31, 1997, approximately $348.2 million in equity, including $2.45
million to PCS Leasing Co, L.P. ("LeasingCo"), a subsidiary of Cox PCS, had been
contributed to Cox PCS by the Company. Through December 31, 1996, $168 million
had been contributed to Cox PCS. Losses are allocated to the partners based on
their ownership percentages. Subsequent to December 31, 1997, the Company
completed its funding obligation to Cox PCS under the partnership agreement.
Concurrent with this funding, the Company paid approximately $33.2 million in
interest that had accrued on the unfunded capital obligation.
12
<PAGE>
Additionally, the Company acquired a 49% limited partner interest in LeasingCo.
LeasingCo was formed to acquire, construct or otherwise develop equipment and
other personal property to be leased to Cox PCS. The Company is not obligated
to make additional capital contributions to LeasingCo beyond the initial funding
of approximately $2.45 million.
Under the partnership agreement, CPP has the right to require that Holdings
acquire all or part of CPP's interest in Cox PCS based on fair market value at
the time of the transaction. Subsequent to December 31, 1997, CPP elected to
exercise this right. As a result, the Company intends to acquire 10.2% of Cox
PCS, subject to FCC approval, which will give the Company controlling interest.
The purchase price, currently estimated at $80 million, will be based on the
fair market value of Cox PCS as determined by independent appraisals. Through
December 2008, CPP may put any remaining interest in Cox PCS to the Company.
5. LONG-TERM DEBT AND BORROWING ARRANGEMENTS
Long-term debt consists of the following as of December 31, 1997 and 1996 (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
<S> <C> <C>
11% Senior Notes due in 2006 $ 250,000 $ 250,000
12 1/2% Senior Discount Notes due in 2006, net of
unamortized discount of $177,720 and $214,501 at
December 31, 1997 and 1996, respectively 322,280 285,499
Credit Facility - term loans 300,000 150,000
Credit Facility - revolving credit 605,000 -
Vendor Financing 1,612,914 -
APC Senior Secured Term Loan Facility 220,000 -
APC Senior Secured Reducing Revolving Credit Facility 141,429 -
Due To FCC, net of unamortized discount of $11,989 90,355 -
Other 26,538 742
------------------ ------------------
Total debt 3,568,516 686,241
Less current maturities 34,562 49
------------------ ------------------
Long-term debt $ 3,533,954 $ 686,192
================== ==================
</TABLE>
SENIOR NOTES AND SENIOR DISCOUNT NOTES - In August 1996, Sprint Spectrum L.P.
and Sprint Spectrum Finance Corporation (together, the "Issuers") issued $250
million aggregate principal amount of 11% Senior Notes due 2006 ("the Senior
Notes"), and $500 million aggregate principal amount at maturity of 12 1/2%
Senior Discount Notes due 2006 (the "Senior Discount Notes" and, together with
the Senior Notes, the "Notes"). The Senior Discount Notes were issued at a
discount to their aggregate principal amount at maturity and generated proceeds
of approximately $273 million. Cash interest on the Senior Notes will accrue at
a rate of 11% per annum and is payable semi-annually in arrears on each February
15 and August 15, commencing February 15, 1997. Cash interest will not accrue
or be payable on the Senior Discount Notes prior to August 15, 2001.
Thereafter, cash interest on the Senior Discount Notes
13
<PAGE>
will accrue at a rate of 12 1/2% per annum and will be payable semi-annually in
arrears on each February 15 and August 15, commencing February 15, 2002.
On August 15, 2001, the Issuers will be required to redeem an amount equal to
$384.772 per $1,000 principal amount at maturity of each Senior Discount Note
then outstanding ($192 million in aggregate principal amount at maturity,
assuming all of the Senior Discount Notes remain outstanding at such date).
The Notes are redeemable at the option of the Issuers, in whole or in part, at
any time on or after August 15, 2001 at the redemption prices set forth below,
respectively, plus accrued and unpaid interest, if any, to the redemption date,
if redeemed during the 12 month period beginning on August 15 of the years
indicated below:
<TABLE>
<CAPTION>
SENIOR DISCOUNT
SENIOR NOTES NOTES
YEAR REDEMPTION PRICE REDEMPTION PRICE
- ------------------ -----------------------------------------
<S> <C> <C>
2001 105.500% 110.000%
2002 103.667% 106.500%
2003 101.833% 103.250%
2004 and thereafter 100.000% 100.000%
</TABLE>
In addition, prior to August 15, 1999, the Issuers may redeem up to 35% of the
originally issued principal amount of the Notes with the net proceeds of one or
more public equity offerings, provided that at least 65% of the originally
issued principal amount at maturity of the Senior Notes and Senior Discount
Notes would remain outstanding immediately after giving effect to such
redemption. The redemption price of the Senior Notes is equal to 111.0% of the
principal amount of the Senior Notes so redeemed, plus accrued and unpaid
interest, if any, to the redemption date. The redemption price of the Senior
Discount Notes is equal to 112.5% of the accreted value at the redemption date
of the Senior Discount Notes so redeemed.
The Notes contain certain restrictive covenants, including (among other
requirements) limitations on additional indebtedness, limitations on restricted
payments, limitations on liens, and limitations on dividends and other payment
restrictions affecting certain restricted subsidiaries.
BANK CREDIT FACILITY - Sprint Spectrum L.P. (the "Borrower") entered into an
agreement with The Chase Manhattan Bank ("Chase") as agent for a group of
lenders for a $2 billion bank credit facility dated October 2, 1996. The
proceeds of this facility are to be used to finance working capital needs,
subscriber acquisition costs, capital expenditures and other general Borrower
purposes.
The facility consists of a revolving credit commitment of $1.7 billion and a
$300 million term loan commitment. In November 1997, certain terms relating to
the financial and operating conditions were amended. As of December 31, 1997,
$605 million had been drawn at a weighted average interest rate of 8.42%, with
$1.1 billion remaining available. There were no borrowings under the revolving
credit commitment as of December 31, 1996. Commitment fees for the revolving
portion of the agreement are payable quarterly based on average unused revolving
commitments. As of February 15, 1998, the Company had borrowed an additional
$225 million under the revolving credit facility.
14
<PAGE>
The revolving credit commitment expires July 13, 2005. Availability will be
reduced in quarterly installments ranging from $75 million to $175 million
commencing January 2002. Further reductions may be required after January 1,
2002 to the extent that the Borrower meets certain financial conditions.
The term loans are due in sixteen consecutive quarterly installments beginning
January 2002 in aggregate principal amounts of $125,000 for each of the first
fifteen payments with the remaining aggregate outstanding principal amount of
the term loans due as the last installment.
Interest on the term loans and/or the revolving credit loans is at the
applicable LIBOR rate plus 2.5% ("Eurodollar Loans"), or the greater of the
prime rate or 0.5% plus the Federal Funds effective rate, plus 1.5% ("ABR
Loans"), at the Borrower's option. The interest rate may be adjusted downward
for improvements in the bond rating and/or leverage ratios. Interest on ABR
Loans and Eurodollar Loans with interest period terms in excess of 3 months is
payable quarterly. Interest on Eurodollar Loans with interest period terms of
less than 3 months is payable on the last day of the interest period. As of
December 31, 1997 and 1996, the weighted average interest rate on the term loans
was 8.39% and 8.19%, respectively.
Borrowings under the Bank Credit Facility are secured by the Borrower's
interests in WirelessCo, RealtyCo and EquipmentCo and certain other personal and
real property (the "Shared Lien"). The Shared Lien equally and ratably secures
the Bank Credit Facility, the Vendor Financing agreements (discussed below) and
certain other indebtedness of the Borrower. The credit facility is jointly and
severally guaranteed by WirelessCo, RealtyCo and EquipmentCo and is non-recourse
to the Parents and the Partners.
The Bank Credit Facility agreement and Vendor Financing agreements contain
certain restrictive financial and operating covenants, including (among other
requirements) maximum debt ratios (including debt to total capitalization),
limitations on capital expenditures, limitations on additional indebtedness and
limitations on dividends and other payment restrictions affecting certain
restricted subsidiaries. The loss of the right to use the Sprint(R) trademark,
the termination or non-renewal of any FCC license that reduces population
coverage below specified limits, or certain changes in controlling interest in
the Borrower, as defined, among other provisions, constitute events of default.
VENDOR FINANCING - As of October 2, 1996, the Company entered into financing
agreements with Northern Telecom, Inc. ("Nortel") and Lucent Technologies, Inc.
("Lucent" and together with Nortel, the "Vendors") for multiple drawdown term
loan facilities totaling $1.3 billion and $1.8 billion, respectively. The
proceeds of such facilities are to be used to finance the purchase of goods and
services provided by the Vendors. Additionally, the commitments allow for the
conversion of accrued interest into additional principal. Such conversions do
not reduce the availability under the commitments. Interest accruing on the
debt outstanding at December 31, 1997, can be converted into additional
principal through February 8, 1999 and March 30, 1999, for Lucent and Nortel,
respectively.
On April 30, 1997 and November 20, 1997, the Company amended the terms of its
financing agreement with Nortel. The amendments provide for a syndication of
the financing commitment between Nortel, several banks and other vendors (the
"Nortel Lenders"), and the modification of certain operating and financial
covenants. The commitment provides financing in two phases. During the first
phase, the Nortel Lenders will finance up to $800 million. Under the second
phase, the Nortel Lenders will finance up to an additional $500 million upon the
achievement of certain operating and financial conditions, as amended. As of
December 31, 1997, $630 million, including converted accrued interest of
15
<PAGE>
$18.6 million, had been borrowed at a weighted average interest rate of 8.98%
with $189 million remaining available under the first phase. In addition, the
Company paid $20 million in origination fees upon the initial drawdown under the
first phase and will be obligated to pay additional origination fees on the date
of the initial drawdown loan under the second phase. As of February 15, 1998,
the Company had borrowed an additional $47.0 million under the Nortel facility.
There were no borrowings under the Nortel facility at December 31, 1996.
On May 29, 1997 and November 20, 1997, the Company amended the terms of its
financing agreement with Lucent. The amendments provide for a syndication of
the financing commitment between Lucent, Sprint and other banks and vendors (the
"Lucent Lenders"), and the modification of certain operating and financial
covenants. The Lucent Lenders have committed to financing up to $1.5 billion
through December 31, 1997, and up to an aggregate of $1.8 billion thereafter.
The Company pays a facility fee on the daily amount of certain loans outstanding
under the agreement, payable quarterly. The Lucent agreement terminates June
30, 2001. As of December 31, 1997, the Company had borrowed approximately $983
million, including converted accrued interest of $33.1 million, under the Lucent
facility at a weighted average interest rate of 8.94%, with $850 million
remaining available. As of February 15, 1998, the Company had borrowed an
additional $104.1 million under the Lucent facility. There were no borrowings
under the Lucent facility at December 31, 1996.
The principal amounts of the loans drawn under both the Nortel and Lucent
agreements are due in twenty consecutive quarterly installments, commencing on
the date which is thirty-nine months after the last day of such "Borrowing Year"
(defined in the agreements as any one of the five consecutive 12-month periods
following the date of the initial drawdown of the loan). The aggregate amount
due each year is equal to percentages ranging from 10% to 30% multiplied by the
total principal amount of loans during each Borrowing Year.
The agreements provide two borrowing rate options. During the first phase of
the Nortel agreement and throughout the term of the Lucent agreement "ABR Loans"
bear interest at the greater of the prime rate or 0.5% plus the Federal Funds
effective rate, plus 2%. "Eurodollar Loans" bear interest at the London
interbank (LIBOR) rate (any one of the 30-, 60- or 90-day rates, at the
discretion of the Company), plus 3%. During the second phase of the Nortel
agreement, ABR Loans bear interest at the greater of the prime rate or 0.5% plus
the Federal Funds effective rate, plus 1.5%; and Eurodollar loans bear interest
at the LIBOR rate plus 2.5%. Interest from the date of each loan through one
year after the last day of the Borrowing Year is added to the principal amount
of each loan. Thereafter, interest is payable quarterly.
Borrowings under the Vendor Financing are secured by the Shared Lien. The
Vendor Financing is jointly and severally guaranteed by WirelessCo, RealtyCo,
and EquipmentCo and is non-recourse to the Parents and the Partners.
Certain amounts included under construction obligations on the consolidated
balance sheets may be financed under the Vendor Financing agreements.
DUE TO FCC - APC became obligated to the FCC for $102 million upon receipt of
the commercial PCS license covering the Washington D.C./Baltimore MTA. In March
1996, the FCC determined that interest on the amount due would begin to accrue
on March 8, 1996, at an interest rate of 7.75%. Beginning with the first
payment due in April 1996, the FCC granted two years of interest-only payments
followed by three years of principal and interest payments. Based on the
interest and payment provisions determined by the FCC and APC's incremental
borrowing rate for similar debt at the time the debt was issued, APC has accrued
interest beginning upon receipt of the license at an effective rate of 13%.
16
<PAGE>
In connection with the acquisition discussed in Note 4, Holdings became
responsible for making principal and interest payments under the APC's
obligation to the FCC.
APC SENIOR SECURED CREDIT FACILITIES - As of February 7, 1997, American PCS
Communications, LLC entered into credit facilities of $420 million, consisting
of a term loan facility of $220 million and a reducing revolving credit facility
of $200 million (together, the "Credit Agreement"). The Credit Agreement is
secured by first priority liens on all the equity interests held by American PCS
Communications LLC in its direct subsidiaries, including the equity interests of
the subsidiaries which will hold APC's PCS license and certain real property
interest and equipment and a first priority security interest in, and mortgages
on, substantially all other intangible and tangible assets of APC and
subsidiaries. The Credit Agreement matures February 7, 2005, with an interest
rate of LIBOR plus 2.25%. The interest rate may be stepped down over the term
of the credit agreement based on the ratio of outstanding debt to earnings
before interest, tax, depreciation and amortization. Proceeds from the Credit
Agreement were used to repay the outstanding financing from Holdings as of the
closing date of the credit agreement, capital expenditures for the
communications systems, general working capital requirements, and net operating
losses.
The Credit Agreement contains covenants which require APC to maintain certain
levels of wireless subscribers, as well as other financial and non-financial
requirements.
In January 1998 APC completed negotiations with its lenders to amend the Credit
Agreement. As amended, the Credit Agreement contains certain covenants which,
among other things, contain certain restrictive financial and operating
covenants including, maximum debt ratios (including debt to total
capitalization) and limitations on capital expenditures. The covenants require
American PCS Communications, LLC to enter into interest rate contracts on a
quarterly basis to protect and limit the interest rate on 40% of its aggregate
debt outstanding.
OTHER DEBT - At December 31, 1997, other debt included a note payable to Lucent
for the financing of debt issuance costs, a note payable for certain leasehold
improvements, and capital leases acquired in the purchase of APC. Maturities on
the debt range from 3 to 10 years, at interest rates from 8.32% to 21%.
INTEREST RATE CONTRACTS - As of December 31, 1997, APC had entered into nine
interest rate contracts (swaps and a collar), with an aggregate notional amount
of $122 million. Under the agreements APC pays a fixed rate and receives a
variable rate such that it will protect APC against interest rate fluctuations
on a portion of its variable rate debt. The fixed rates paid by APC on the
interest rate swap contracts range from approximately 5.97% to 6.8%. Option
features contained in certain of the swaps operate in a manner such that the
interest rate protection in some cases is effective only when rates are outside
a certain range. Under the collar arrangement, APC will receive 6.19% when
LIBOR falls below 6.19% and pay 8% when LIBOR exceeds 8%. The contracts expire
in 2001. The fair value of the interest rate contracts at December 31, 1997 was
an unrealized loss of approximately $1.3 million. The notional amounts
represent reference balances upon which payments and receipts are based and
consequently are not indicative of the level of risk or cash requirements under
the contracts. APC has exposure to credit risk to the counterparty to the
extent it would have to replace the interest rate swap contract in the market
when and if a counterparty were to fail to meet its obligations. The
counterparties to all contracts are primary dealers that meet APC's criteria for
managing credit exposures.
17
<PAGE>
FAIR VALUE - The estimated fair value of the Company's long-term debt at
December 31, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
--------------------------------------- ---------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
11% Senior Notes $ 250,000 $ 280,650 $ 250,000 $ 270,625
12 1/2% Senior Discount Notes 322,280 389,300 285,499 337,950
Credit facility - term loans 300,000 300,000 150,000 151,343
Credit facility - revolver 605,000 605,000 - -
Vendor facility - Lucent 983,299 983,299 - -
Vendor facility - Nortel 629,615 629,615 - -
APC Senior Secured Term Loan
Facility 220,000 220,000 - -
APC Senior Secured Reducing
Revolving Credit Facility 141,429 141,429 - -
FCC debt 90,355 98,470 - -
</TABLE>
At December 31, 1997, scheduled maturities of long-term debt and capital leases
during each of the next five years are as follows (in thousands):
<TABLE>
<CAPTION>
Long-term Capital
Debt Leases
--------------- ---------------
<S> <C> <C>
1998 $ 29,800 $ 5,411
1999 40,425 3,667
2000 53,624 591
2001 395,291 42
2002 583,113 -
----------
9,711
Less interest (898)
----------
Present value of minimum
lease payments
8,813
==========
</TABLE>
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - Minimum rental commitments as of December 31, 1997, for all
noncancelable operating leases, consisting principally of leases for cell and
switch sites and office space, for the next five years, are as follows (in
thousands):
<TABLE>
<S> <C>
1998 $ 135,124
1999 131,279
2000 104,658
2001 63,379
2002 21,254
</TABLE>
18
<PAGE>
Gross rental expense for cell and switch sites aggregated approximately $92.1
million and $13.1 million for the years ended December 31, 1997 and 1996,
respectively. Gross rental expense for office space approximated $33.2 million,
$11.4 million, and $0.7 million for the years ended December 31, 1997, 1996, and
1995, respectively. Certain cell and switch site leases contain renewal options
(generally for terms of 5 years) that may be exercised from time to time and are
excluded from the above amounts.
PROCUREMENT CONTRACTS - On January 31, 1996, the Company entered into
procurement and services contracts with AT&T Corp. (subsequently assigned to
Lucent ) and Nortel for the engineering and construction of a PCS network. Each
contract provides for an initial term of ten years with renewals for additional
one-year periods. The Vendors must achieve substantial completion of the PCS
network within an established time frame and in accordance with criteria
specified in the procurement contracts. Pricing for the initial equipment,
software and engineering services has been established in the procurement
contracts. The procurement contracts provide for payment terms based on
delivery dates, substantial completion dates, and final acceptance dates. In
the event of delay in the completion of the PCS network, the procurement
contracts provide for certain amounts to be paid to the Company by the Vendors.
The minimum commitments for the initial term are $0.8 billion and $1.0 billion
from Lucent and Nortel, respectively, which include, but are not limited to, all
equipment required for the establishment and installation of the PCS network.
HANDSET PURCHASE AGREEMENTS - In June, 1996, the Company entered into a three-
year purchase and supply agreement with a vendor for the purchase of handsets
and other equipment totaling approximately $500 million. During 1997 and 1996,
the Company purchased $332.7 million and $85 million under the agreement,
respectively. The total purchase commitment must be satisfied by April 30,
1998.
In September, 1996, the Company entered into another three-year purchase and
supply agreement with a second vendor for the purchase of handsets and other
equipment totaling more than $600 million, with purchases that commenced in
April, 1997. During 1997, the Company purchased $147.6 million under the
agreement. The total purchase commitment must be satisfied by April 2000.
SERVICE AGREEMENTS - The Company has entered into an agreement with a vendor to
provide PCS call record and retention services. Monthly rates per subscriber
are variable based on overall subscriber volume. If subscriber fees are less
than specified annual minimum charges, the Company will be obligated to pay the
difference between the amounts paid for processing fees and the annual minimum.
Annual minimums range from $20 million to $60 million through 2001. The
agreement extends through December 31, 2001, with two automatic, two-year
renewal periods, unless terminated by the Company. The Company may terminate
the agreement prior to the expiration date, but would be subject to specified
termination penalties.
The Company has also entered into an agreement with a vendor to provide prepaid
calling services. Monthly rates per minute of use are based on overall call
volume. If the average minutes of use are less than monthly specified minimums,
the Company is obligated to pay the difference between the average minutes used
at the applicable rates and the monthly minimum. Monthly minimums range from
$40,000 to $50,000 during the initial term. Certain installation and setup fees
for processing and database centers are also included in the agreement and are
dependent upon a need for such centers. The agreement extends through July
1999, with successive one-year term renewals, unless terminated by the Company.
The Company may terminate the agreement prior to the expiration date, but would
be subject to specified termination penalties.
19
<PAGE>
In January 1997, the Company entered into a four and one-half year contract for
consulting services. Under the terms of the agreement, consulting services will
be provided at specified hourly rates for a minimum number of hours. The total
commitment is approximately $125 million over the term of the agreement.
LITIGATION - The Company is involved in various legal proceedings incidental to
the conduct of its business. While it is not possible to determine the ultimate
disposition of each of these proceedings, the Company believes that the outcome
of such proceedings, individually and in the aggregate, will not have a material
adverse effect on the Company's financial condition or results of operations.
7. EMPLOYEE BENEFITS
Employees performing services for the Company were employed by Sprint through
December 31, 1995. Amounts paid to Sprint relating to pension expense and
employer contributions to the Sprint Corporation 401(k) plan for these employees
approximated $0.3 million in 1995.
The Company maintains short-term and long-term incentive plans. All salaried
employees of Sprint Spectrum L.P. are eligible for the short-term incentive plan
commencing at date of hire. Employees of APC are covered by the APC plans.
Short-term incentive compensation is based on incentive targets established for
each position based on the Company's overall compensation strategy. Targets
contain both an objective Company component and a personal objective component.
Charges to operations for the short-term plan approximated $20.0 million, $12.3
million, and $3.5 million for the years ended December 31, 1997, 1996, and 1995,
respectively.
LONG-TERM COMPENSATION OBLIGATION - The Company has two long-term incentive
plans, the 1996 Plan and the 1997 Plan. Employees meeting certain eligibility
requirements are considered to be participants in each plan. Participants in
the 1996 Plan will receive 100% of the pre-established targets for the period
from July 1, 1995 to June 30, 1996 (the "Introductory Term"). Participants in
the 1996 Plan elected either a payout of the amount due or converted 50% or 100%
of the award to appreciation units. Unless converted to appreciation units,
payment for the Introductory Term of the 1996 Plan will be made in the third
quarter of 1998. Under the 1996 plan, appreciation units vest 25% per year
commencing on the second anniversary of the date of grant and expire after a
term of ten years. The 1997 Plan appreciation units vest 25% per year
commencing on the first anniversary of the date of the grant and also expire
after ten years. For the years ended December 31, 1997, 1996, and 1995, $18.1
million, $9.5 million, and $1.9 million, respectively, has been expensed under
both plans. At December 31, 1997 a total of approximately 103 million units have
been authorized for grant for both plans. The Company has applied APB Opinion
No. 25, "Accounting for Stock Issued to Employees" for 1997 and 1996. No
significant difference would have resulted if SFAS No. 123, "Accounting for
Stock-Based Compensation" had been applied.
SAVINGS PLAN - Effective January, 1996, the Company established a savings and
retirement program (the "Savings Plan") for certain employees, which qualifies
under Section 401(k) of the Internal Revenue Code. Most permanent full-time,
and certain part-time, employees are eligible to become participants in the plan
after one year of service or upon reaching age 35, whichever occurs first.
Participants make contributions to a basic before tax account and supplemental
before tax account. The maximum contribution for any participant for any year
is 16% of such participant's compensation. For each eligible employee who
elects to participate in the Savings Plan and makes a contribution to the basic
before tax account, the Company makes a matching contribution. The matching
contributions equal 50%
20
<PAGE>
of the amount of the basic before tax contribution of each participant up to the
first 6% that the employee elects to contribute. Contributions to the Savings
Plan are invested, at the participant's discretion, in several designated
investment funds. Distributions from the Savings Plan generally will be made
only upon retirement or other termination of employment, unless deferred by the
participant. Expense under the Savings Plan approximated $4.9 million and $1.1
million in 1997 and 1996, respectively.
APC also has an employee savings plan that qualifies under Section 401(k) of the
Internal Revenue code. All APC employees completing one year of service are
eligible and may contribute up to 15% of their pretax earnings. APC matches
100% of the first 3% of the employee's contribution. Employees are immediately
fully vested in APC's contributions. In addition, APC makes discretionary
contributions on behalf of eligible participants in the amount of 2% of
employee's compensation. Expenses relating to the employee savings plan have
not been significant since the date of acquisition.
PROFIT SHARING (RETIREMENT) PLAN - Effective January, 1996, the Company
established a profit sharing plan for its employees. Employees are eligible to
participate in the plan after completing one year of service. Profit sharing
contributions are based on the compensation, age, and years of service of the
employee. Profit sharing contributions are deposited into individual accounts
of the Company's retirement plan. Vesting occurs once a participant completes
five years of service. For the years ended December 31, 1997 and 1996, expense
under the profit sharing plan approximated $2.5 million and $0.7 million,
respectively.
DEFERRED COMPENSATION PLAN FOR EXECUTIVES - Effective January, 1997, the Company
established a non-qualified deferred compensation plan which permits certain
eligible executives to defer a portion of their compensation. The plan allows
the participants to defer up to 80% of their base salary and up to 100% of their
annual short-term incentive compensation. The deferred amounts earn interest at
the prime rate. Payments will be made to participants upon retirement,
disability, death or the expiration of the deferral election under the payment
method selected by the participant.
8. RELATED PARTY TRANSACTIONS
BUSINESS SERVICES - The Company reimburses Sprint for certain accounting and
data processing services, for participation in certain advertising contracts,
for certain cash payments made by Sprint on behalf of the Company and other
management services. The Company is allocated the costs of such services based
on direct usage. Allocated expenses of approximately $10.5 million, $11.9
million, and $2.6 million are included in selling, general and administrative
expense in the consolidated statements of operations for 1997, 1996, and 1995,
respectively. In addition to the miscellaneous services agreement described
above, the Company has entered into agreements with Sprint for invoicing
services, operator services, and switching equipment. The Company is also using
Sprint as its interexchange carrier, with the agreement for such services
covered under the Holdings partnership agreement. Charges are based on the
volume of services provided, and are similar to those that would be incurred
with an unrelated third-party vendor.
APC - The Company entered into an affiliation agreement with APC in January 1995
which provides for the reimbursement of certain allocable costs and payment of
affiliation fees. For the year ended December 31, 1997, the reimbursement of
allocable costs of approximately $14.0 million is included in selling, general
and administrative expenses. There were no reimbursements recognized in 1996 or
1995. Additionally, affiliation fees are recognized based on a percentage of
APC's net revenues. During the year ended December 31, 1997, affiliation fees
of $4.2 million are included in other income.
21
<PAGE>
COX PCS - Concurrent with the execution of the partnership agreement, the
Company entered into an affiliation agreement with Cox PCS which provides for
the reimbursement of certain allocable costs and payment of affiliate fees. For
the years ended December 31, 1997 and 1996, allocable costs of approximately
$20.0 million and $7.3 million, respectively, are netted against selling,
general and administrative expenses in the accompanying consolidated statements
of operations. Of these total allocated costs, approximately $1.6 million and
$7.3 million were included in receivables from affiliates in the consolidated
balance sheets. In addition, the Company purchases certain equipment, such as
handsets, on behalf of Cox PCS. Receivables from affiliates for handsets and
related equipment were approximately $31.2 million and $6 million at December
31, 1997 and 1996, respectively.
PHILLIECO, L.P. - The Company provides various services to PhillieCo, L.P.
("PhillieCo"), a limited partnership organized by and among subsidiaries of
Sprint, TCI and Cox. PhillieCo owns a PCS license for the Philadelphia MTA.
During the year ended December 31, 1997, costs for services incurred during 1996
and 1997 of $36.3 million were allocated to PhillieCo. and are included as a
reduction of selling, general and administrative expenses in the accompanying
consolidated statements of operations. Additionally, affiliation fees are
recognized based on a percentage of PhillieCo's net revenues. During the year
ended December 31, 1997, affiliation fees of $0.3 million are included in other
income in the accompanying consolidated statements of operations. The allocated
costs and affiliate fees of $36.6 million are included in receivable from
affiliates at December 31, 1997 and were paid during January 1998. There were no
such costs at December 31, 1996.
SPRINTCOM, INC. - The Company provides services to SprintCom, Inc.
("SprintCom"), an affiliate of Sprint. The Company is currently building out
the network infrastructure in certain BTA markets where SprintCom was awarded
licenses. Such services include engineering, management, purchasing, accounting
and other related services. For the year ended December 31, 1997, costs for
services provided of $29.1 million were allocated to SprintCom, and are included
as a reduction of selling, general and administrative expenses in the
accompanying consolidated statements of operations. Of the total allocated
costs, approximately $14.0 million are included in receivables from affiliates
at December 31, 1997. No such costs were incurred in 1996.
PAGING SERVICES - In 1996, the Company commenced paging services pursuant to
agreements with Paging Network Equipment Company and Sprint Communications
Company L.P. ("Sprint Communications"). For the years ended December 31, 1997
and 1996, Sprint Communications received agency fees of approximately $10.6
million and $4.9 million, respectively.
ADVANCES FROM PARTNERS - In December 1996, the Partners advanced approximately
$168 million to the Company, which was contributed to Cox PCS (Note 4). The
advances were repaid in February 1997.
22
<PAGE>
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 1997 and 1996 is as follows (in
thousands):
<TABLE>
<CAPTION>
1997 First Second Third Fourth
---- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Operating revenues...................... $ 9,467 $ 25,386 $ 72,534 $141,220
Operating expenses...................... 200,281 303,098 455,236 600,726
Net loss................................ 188,884 287,664 420,914 665,925
<CAPTION>
1996
----
<S> <C> <C> <C> <C>
Operating revenues...................... $ - $ - $ - $ 4,175
Operating expenses...................... 30,978 46,897 87,135 195,038
Net loss................................ 67,425 90,770 101,497 183,402
</TABLE>
SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Company reorganized operations under which
certain field offices will be consolidated. Costs associated with this
reorganization are expected to be recorded in the first quarter of 1998 and will
consist primarily of severance pay, write-off of certain leasehold improvements
and termination payments under lease agreements.
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Teleport Communications Group Inc.:
We have audited the accompanying consolidated balance sheets of Teleport
Communications Group Inc. and its subsidiaries ("TCG") as of December 31, 1997
and 1996 and the related consolidated statements of operations, changes in
stockholders' equity and partners' capital (deficit), and cash flows for the
two years then ended and the related combined statements of operations,
changes in stockholders' equity and partners' capital (deficit), and cash
flows of Teleport Communications Group Inc. and its subsidiaries and TCG
Partners ("TCGP"), which were under common ownership and management, for the
year ended December 31, 1995. These financial statements are the
responsibility of 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 consolidated financial position of TCG and subsidiaries at
December 31, 1997 and 1996 and the results of their operations and their cash
flows for the years ended December 31, 1997 and 1996 and the results of the
combined operations and cash flows of TCG and TCGP for the year ended December
31, 1995 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
New York, New York
March 3, 1998
1
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 173,331 $ 277,540
---------- ----------
Marketable securities................................ 306,828 440,806
---------- ----------
Accounts receivable:
Trade--net of allowance for doubtful accounts
($11,684 in 1997 and $5,989 in 1996).............. 85,081 46,325
Related parties.................................... 6,351 4,191
Miscellaneous--net of allowance for doubtful
accounts ($297 in 1997 and $1,406 in 1996)........ 6,639 6,795
---------- ----------
Accounts receivable--net......................... 98,071 57,311
---------- ----------
Prepaid expenses................................... 13,988 9,531
---------- ----------
Other current assets............................... 7,943 2,373
---------- ----------
Total current assets............................. 600,161 787,561
---------- ----------
Fixed assets--at cost:
Communications network............................... 1,722,093 1,211,922
Other................................................ 150,990 92,307
---------- ----------
1,873,083 1,304,229
Less accumulated depreciation and amortization....... (379,987) (236,967)
---------- ----------
Fixed assets--net.................................... 1,493,096 1,067,262
---------- ----------
Investments in and advances to unconsolidated
affiliates............................................ 8,822 126,561
---------- ----------
Goodwill and other intangible assets, net of
accumulated amortization ($13,836 in 1997 and $3,789
in 1996).............................................. 237,806 57,764
---------- ----------
Licenses--net of accumulated amortization ($183 in
1997)................................................. 39,503 --
---------- ----------
Other assets........................................... 76,913 10,949
---------- ----------
Total assets..................................... $2,456,301 $2,050,097
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--(CONTINUED)
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities ($4,019 in
1997 and $1,079 in 1996 with related parties)....... $ 282,231 $ 215,808
Current portion of capital lease obligations ($28,172
in 1997 and $21,139 in 1996 with related parties)... 33,724 24,063
Short-term bank debt................................. 52,575 --
Other current liabilities............................ 6,742 2,365
---------- ----------
Total current liabilities.......................... 375,272 242,236
Capital lease obligations ($13,388 in 1997 and $28,716
in 1996 with related parties)......................... 19,095 34,489
Senior Notes........................................... 300,000 300,000
Senior Discount Notes.................................. 734,984 659,567
Unamortized notes costs................................ (23,059) (25,761)
TCI Subordinated Note (including accrued interest of $0
in 1997 and $1,007 in 1996)........................... -- 27,007
Other liabilities...................................... 18,393 15,689
---------- ----------
Total liabilities.................................. 1,424,685 1,253,227
---------- ----------
Commitments and contingencies
Stockholders' equity:
Common Stock, Class A $.01 par value: 450,000,000
shares authorized, 61,273,746 and 28,668,400 shares
issued and outstanding at December 31, 1997 and
1996................................................ 613 287
Common Stock, Class B $.01 par value: 300,000,000
shares authorized, 121,464,778 and 139,250,370
shares issued and outstanding at December 31, 1997
and 1996............................................ 1,215 1,393
Additional paid-in capital........................... 1,654,328 1,197,252
Unrealized gain (loss) on marketable securities...... 164 (25)
Accumulated deficit.................................. (503,679) (281,012)
---------- ----------
1,152,641 917,895
Less cost of Class B Common Stock held in treasury,
7,975,738 shares at December 31, 1997 and 1996...... (121,025) (121,025)
---------- ----------
Total stockholders' equity......................... 1,031,616 796,870
---------- ----------
Total liabilities and stockholders' equity............. $2,456,301 $2,050,097
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
CONSOLIDATED CONSOLIDATED COMBINED
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Revenues:
Telecommunications services ($9,968,
$2,330 and $154 with related
parties in 1997, 1996 and 1995,
respectively)...................... $ 494,304 $ 244,864 $ 134,652
Management and royalty fees from
affiliates......................... -- 22,805 31,517
------------ ------------ -----------
Total revenues.................... 494,304 267,669 166,169
------------ ------------ -----------
Expenses:
Operating........................... 283,440 157,591 93,118
Selling, general and
administrative..................... 165,977 85,025 50,475
In-process research and development
costs.............................. 22,000 -- --
Depreciation and amortization....... 155,402 78,416 37,837
------------ ------------ -----------
Total expenses.................... 626,819 321,032 181,430
------------ ------------ -----------
Operating loss........................ (132,515) (53,363) (15,261)
------------ ------------ -----------
Interest:
Interest income..................... 31,111 30,219 4,067
Interest expense ($2,022, $14,997
and $18,763 with related parties)
in 1997, 1996 and 1995,
respectively....................... (116,172) (73,633) (23,331)
------------ ------------ -----------
Total interest.................... (85,061) (43,414) (19,264)
------------ ------------ -----------
Loss before minority interest, equity
in losses of unconsolidated
affiliates and income tax provision.. (217,576) (96,777) (34,525)
Minority interest..................... -- 3,520 663
Equity in losses of unconsolidated
affiliates........................... (3,427) (19,400) (19,541)
------------ ------------ -----------
Loss before income tax provision...... (221,003) (112,657) (53,403)
Income tax provision.................. (1,664) (2,193) (401)
------------ ------------ -----------
Net loss.............................. $ (222,667) $ (114,850) $ (53,804)
============ ============ ===========
Loss per share........................ $ (1.34) $ (1.00) $ (0.77)
============ ============ ===========
Weighted average number of shares
outstanding.......................... 165,728,059 114,443,695 70,000,140
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND
PARTNERS' CAPITAL (DEFICIT)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
TOTAL
UNREALIZED STOCKHOLDERS'
GAIN (LOSS) EQUITY AND
CLASS B ADDITIONAL ON PARTNERS' PARTNERS'
COMMON COMMON PAID-IN MARKETABLE ACCUMULATED CAPITAL TREASURY CAPITAL
STOCK STOCK CAPITAL SECURITIES DEFICIT (DEFICIT) STOCK (DEFICIT)
------ ------- ---------- ----------- ----------- --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Combined balance at
January 1, 1995........ $ 2 $ -- $ 195,388 $-- $ (33,261) $17,023 $ -- $179,152
Net loss................ -- -- -- -- (32,387) (21,417) -- (53,804)
---- ------ ---------- ---- --------- ------- --------- --------
Combined balance at
December 31, 1995...... 2 -- 195,388 -- (65,648) (4,394) -- 125,348
Issuance of 27,025,000
shares of Class A
Common Stock, net of
issuance costs of
$24.8 million.......... 270 -- 407,374 -- -- -- -- 407,644
Conversion of and 42,000
to 1 stock split of
$1.00 par value Common
Stock to 139,250,370
shares of Class B
Common Stock as part of
the TCG
Reorganization......... (2) 1,393 307,828 -- (100,514) 4,394 -- 213,099
Purchase of 7,975,738
shares of Class B
Common Stock from
Continental
Cablevision, Inc....... -- -- -- -- -- -- (121,025) (121,025)
Conversion of
subordinated debt to
parents plus accrued
interest of $20.6
million to equity...... -- -- 263,602 -- -- -- -- 263,602
Issuance of 1,587,791
shares of Class A
Common Stock to
purchase the minority
interests in two Local
Market Partnerships.... 16 -- 22,673 -- -- -- -- 22,689
Issuance of 55,609
shares of Class A
Common Stock upon
exercise of options.... 1 -- 387 -- -- -- -- 388
Unrealized loss on
marketable securities.. -- -- -- (25) -- -- -- (25)
Net loss................ -- -- -- -- (114,850) -- -- (114,850)
---- ------ ---------- ---- --------- ------- --------- --------
Consolidated balance at
December 31, 1996...... $287 $1,393 $1,197,252 $(25) $(281,012) $ -- $(121,025) $796,870
---- ------ ---------- ---- --------- ------- --------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND
PARTNERS' CAPITAL (DEFICIT)--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
TOTAL
UNREALIZED STOCKHOLDERS'
GAIN (LOSS) EQUITY AND
CLASS B ADDITIONAL ON PARTNERS' PARTNERS'
COMMON COMMON PAID-IN MARKETABLE ACCUMULATED CAPITAL TREASURY CAPITAL
STOCK STOCK CAPITAL SECURITIES DEFICIT (DEFICIT) STOCK (DEFICIT)
------ ------- ---------- ----------- ----------- --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of 7,304,408
shares of Class A
Common Stock, net of
issuance costs of $11.3
million................ 73 -- 317,324 -- -- -- -- 317,397
Issuance of 990,639
shares of Class A
Common Stock upon
exercise of options and
employee stock grants.. 9 -- 16,484 -- -- -- -- 16,493
Issuance of 2,100,000
shares of Class A
Common Stock to
purchase CERFnet
Services, Inc.......... 21 -- 47,386 -- -- -- -- 47,407
Issuance of 2,757,083
shares of Class A
Common Stock to
purchase remaining
interest in Eastern
TeleLogic Corporation.. 28 -- 46,050 -- -- -- -- 46,078
Issuance of 1,667,624
shares of Class A
Common Stock to
purchase the remaining
interest in BizTel
Communications, Inc. .. 17 -- 29,832 -- -- -- -- 29,849
Conversion of 17,785,592
shares of Class B
Common Stock to Class A
Common Stock........... 178 (178) -- -- -- -- -- --
Unrealized gain on
marketable securities.. -- -- -- 189 -- -- -- 189
Net loss................ -- -- -- -- (222,667) -- -- (222,667)
---- ------ ---------- ---- --------- ---- --------- ----------
Consolidated balance at
December 31, 1997...... $613 $1,215 $1,654,328 $164 $(503,679) $-- $(121,025) $1,031,616
==== ====== ========== ==== ========= ==== ========= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONSOLIDATED CONSOLIDATED COMBINED
1997 1996 1995
------------ ------------ ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................ $(222,667) $ (114,850) $ (53,804)
Adjustments to reconcile net loss to net
cash (used in) provided by operating
activities, net of effects of the TCG
Reorganization and acquisitions:
Depreciation and amortization......... 155,402 78,416 37,837
Amortization of notes costs........... 2,702 1,350 --
Equity in losses of unconsolidated
affiliates........................... 3,427 19,400 19,541
In-process research and development
costs................................ 22,000 -- --
Amortization of deferred credits...... (18,178) (2,965) (2,228)
Provision for losses on accounts
receivable........................... 11,526 3,442 877
Accretion of discount on Senior
Discount Notes....................... 75,417 34,567 --
Minority interest..................... -- (3,520) (663)
Other................................. (1,914) -- --
(Increase) decrease in operating assets
and (decrease) increase in operating
liabilities:
Accounts receivable................... (48,608) (18,386) (12,771)
Other assets.......................... (21,786) (3,596) (3,108)
Accounts payable and accrued
liabilities.......................... (3,709) 97,230 45,832
Deferred credits...................... 25,177 2,530 4,628
--------- ---------- ---------
Net cash (used in) provided by
operating activities............... (21,211) 93,618 36,141
--------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................... (462,791) (294,078) (139,656)
Due from related parties................ -- (23,042) (6,707)
Purchases of marketable securities, net
of sales and maturities................ 134,166 (440,831) --
Purchase of a Local Market Partnership
interest............................... -- (11,618) --
Capital contributions to Local Market
Partnerships prior to TCG
Reorganization......................... -- (16,435) --
Investments in and advances to
unconsolidated affiliates.............. (6,290) (127,509) (65,004)
Repayment of advances to unconsolidated
affiliate.............................. -- -- 3,400
Cash paid for acquisitions, net of cash
acquired............................... (6,709) -- --
--------- ---------- ---------
Net cash used for investing
activities......................... (341,624) (913,513) (207,967)
--------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term
debt................................... -- 162,500 159,000
Payments on bank revolving credit
facility............................... -- (250,000) --
Proceeds from Senior Notes.............. -- 300,000 --
Proceeds from Senior Discount Notes..... -- 625,000 --
Costs associated with the Offerings..... (11,302) (51,867) --
Proceeds from the issuance of Class A
Common Stock........................... 328,699 432,400 --
Proceeds from the exercise of employee
stock options.......................... 11,721 388 --
Purchase of treasury stock.............. -- (121,025) --
Capital contributions from minority
partners............................... -- -- 2,168
Principal payments on capital leases.... (45,399) (11,823) (3,480)
Repayment of TCI Subordinated Note, net
of discount............................ (25,093) -- --
--------- ---------- ---------
Net cash provided by financing
activities......................... 258,626 1,085,573 157,688
--------- ---------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS.............................. (104,209) 265,678 (14,138)
CASH AND CASH EQUIVALENTS, JANUARY 1...... 277,540 11,862 26,000
--------- ---------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31.... $ 173,331 $ 277,540 $ 11,862
========= ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. ORGANIZATION AND OPERATIONS
Teleport Communications Group Inc. ("TCG" or the "Company"), the first and
largest competitive local exchange carrier ("CLEC") in the United States,
offers comprehensive telecommunications services in major metropolitan markets
nationwide. TCG competes with incumbent local exchange carriers ("ILECs") by
providing high quality, integrated telecommunications services, primarily over
fiber optic digital networks, to meet the voice, data and video transmission
needs of its customers. TCG's customers are principally telecommunications
intensive-businesses, healthcare and educational institutions, governmental
agencies, long distance carriers and resellers, Internet service providers,
disaster recovery service providers, wireless communications companies and
financial services companies. TCG offers these customers technologically
advanced telecommunications services, as well as superior customer service,
flexible pricing and vendor and route diversity.
TCG, incorporated in March 1983, and TCG Partners, formed in December 1992,
were each owned by Cox Communications, Inc. ("Cox"), Tele-Communications, Inc.
("TCI"), Comcast Corporation ("Comcast"), and Continental Cablevision, Inc.
("Continental") (collectively the "Cable Stockholders") until June 26, 1996.
In connection with the public offerings of Class A Common Stock, Senior
Notes and Senior Discount Notes on July 2, 1996, TCG and its owners entered
into a reorganization agreement dated as of April 18, 1996 (the "TCG
Reorganization Agreement"), pursuant to which TCG Partners and certain of the
Company's unconsolidated affiliates became wholly-owned subsidiaries of TCG
and TCG acquired the minority interests of the owners of the remaining
unconsolidated affiliates.
TCG REORGANIZATION AND THE 1997 AND 1996 OFFERINGS
1997 Equity Offering
TCG filed a registration statement for a public offering (the "1997
Offering") of 17,250,000 shares of Class A Common Stock on October 10, 1997,
and the 1997 Equity Offering was consummated on November 13, 1997. Of the
17,250,000 shares, 7,304,408 were offered by the Company and 9,945,592 shares
were offered by Continental. The Company did not receive any proceeds from the
sale of shares by Continental. The net proceeds to the Company from its sale
of shares pursuant to the 1997 Equity Offering were approximately $317.4
million, after deducting the underwriting discount and estimated expenses of
approximately $11.3 million.
1996 Offerings
On July 2, 1996, the Company issued 27,025,000 shares of Class A Common
Stock which resulted in gross proceeds of approximately $432.4 million (the
"Stock Offering"), and $300 million of 9 7/8% Senior Notes due 2006 and $1,073
million of aggregated principal amount of maturity of 11 1/8% Senior Discount
Notes due 2007 ("the Notes Offerings" and, collectively, with the Stock
Offering, the "1996 Offerings") as part of an initial public offering. The
Offerings of the Senior Notes and the Senior Discount Notes resulted in
aggregate gross proceeds of approximately $925 million. In July 1996, the
Company utilized a portion of the net proceeds of the 1996 Offerings to (i)
repay $250 million of bank indebtedness plus accrued interest and (ii)
purchase 7,975,738 shares of Class B Common Stock owned by Continental for
$16.00 per share, less related expenses, for a net cost of $121 million. In
addition, a portion of the proceeds was used to loan approximately $115
million to its affiliate Comcast CAP of Philadelphia, Inc. ("Comcast CAP"), as
part of the first step in TCG's acquisition of Eastern TeleLogic Corporation.
The remaining funds were and will be used to expand and develop existing and
new networks, to repay the TCI Subordinated Note, to make acquisitions and for
general corporate and working capital purposes.
8
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
TCG Reorganization
Prior to the 1996 Offerings, the Company was owned by the Cable
Stockholders. The business was operated through TCG, and beginning in 1992,
TCG Partners, which is a New York general partnership owned prior to the TCG
Reorganization by the Cable Stockholders in the same percentages as TCG. TCG
Partners was formed to invest, with TCG, the Cable Stockholders and other
cable operators, in 14 partnerships (the "Local Market Partnerships") to
develop and operate local telecommunications networks. The Local Market
Partnerships were owned by TCG, and/or TCG Partners, certain of the Cable
Stockholders which had cable operations in the particular markets addressed by
the Local Market Partnerships, and, in some cases, other cable operators in
such markets. To simplify this complex ownership structure, the Company and
the Cable Stockholders agreed to consolidate the ownership of TCG Partners and
of the Local Market Partnerships as wholly-owned subsidiaries of TCG. As part
of this process, certain of the other cable operators agreed to sell their
interests in the Local Market Partnerships to TCG directly or through a Cable
Stockholder. The financial statements for one of the Local Market Partnerships
were previously consolidated with those of TCG. Therefore, TCG consolidated
the financial statements of the remaining 13 of the 14 Local Market
Partnerships.
Unaudited pro forma financial information for the year ended December 31,
1996, as if the TCG Reorganization had occurred at the beginning of 1996 is as
follows (in thousands, except share amounts):
<TABLE>
<S> <C>
Revenues...................................................... $ 283,383
-----------
Expenses:
Operating................................................... 172,374
Selling, general and administrative......................... 98,436
Depreciation and amortization............................... 96,260
-----------
Total expenses............................................ 367,070
-----------
Operating loss................................................ (83,687)
Interest:
Interest income............................................. 29,163
Interest expense............................................ (66,946)
-----------
Total interest............................................ (37,783)
-----------
Loss before minority interest, equity in losses of
unconsolidated affiliates and income tax provision........... (121,470)
Minority interest............................................. 4,713
Equity in losses of unconsolidated affiliates................. (7,650)
-----------
Loss before provision for income taxes........................ (124,407)
Income tax provision.......................................... (2,193)
-----------
Net loss...................................................... $ (126,600)
===========
Loss per share................................................ $ (0.86)
===========
Weighted average number of shares outstanding................. 146,423,705
===========
</TABLE>
Pro forma adjustments include the reversal of TCG's equity in the losses of
13 Local Market Partnerships, as well as amortization of the goodwill which
was recorded upon closing of the transactions and the reduction of interest
expense from the conversion to equity of subordinated debt owed by TCG to the
Cable Stockholders. The pro forma financial information presented above is not
necessarily indicative of the operating results which
9
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
would have been achieved had the transactions occurred at the beginning of the
periods presented or of the results to be achieved in the future.
As of December 31, 1997, TCI, Cox and Comcast owned 42.98%, 34.44% and
22.58%, respectively, of the Company's Class B Common Stock, representing
40.86%, 32.68% and 21.42%, respectively, of the combined voting power of the
Company's Common Stock. As of December 31, 1997, TCG was owned 28.49%, 22.37%,
14.66% and 34.48% by TCI, Cox, Comcast and public shareholders, respectively.
THE AT&T MERGER
On January 8, 1998, TCG entered into an Agreement and Plan of Merger (the
"AT&T Agreement") with AT&T Corp., a New York Corporation ("AT&T"), and TA
Merger Corp., a Delaware corporation and a wholly-owned subsidiary of AT&T
("AT&T Merger Sub"), pursuant to which, subject to satisfaction of the closing
conditions specified therein, AT&T Merger Sub would merge with and into TCG,
with TCG surviving as a wholly-owned subsidiary of AT&T (the "AT&T Merger").
In the AT&T Merger, each share of TCG Class A Common Stock (including shares
issued to former ACC stockholders in the ACC Merger, assuming that the ACC
Merger occurs prior to the AT&T Merger) and each share of the Class B Common
Stock of TCG, par value $0.01 per share (the "TCG Class B Common Stock," and,
together with the TCG Class A Common Stock, the "TCG Common Stock") will be
converted into 0.943 of a share of AT&T common stock. TCG and AT&T expect that
the exchange will be tax-free to TCG stockholders, except to the extent cash
is received in lieu of fractional shares. The AT&T Agreement contains
customary representations and warranties of the parties, which will not
survive effectiveness of the AT&T Merger. In addition, the AT&T Agreement
contains certain restrictions on the conduct of TCG's business prior to the
consummation of the AT&T Merger. Pursuant to the AT&T Agreement, TCG has
agreed, for the period prior to the AT&T Merger, to operate its business in
the ordinary course, refrain from taking various corporate actions without the
consent of AT&T, and not solicit or enter into negotiations or agreements
relating to a competing business combination.
Pursuant to a Voting Agreement among the Cable Stockholders and AT&T, each
Cable Stockholder executed and delivered to TCG a written consent in favor of
and approving the AT&T Agreement and the AT&T Merger. As a result, so long as
the AT&T Agreement is not amended and no provision of it is waived, no further
vote or meeting of TCG Stockholders is necessary to approve or consummate the
AT&T Merger.
Pursuant to the Voting Agreement, each of the Cable Stockholders, on behalf
of itself and certain of its affiliates, also agreed that (i) certain right-
of-way, colocation and similar agreements with TCG and its affiliates would be
amended as of January 8, 1998 to provide that each such agreement would remain
in effect for the longer of five years from such date and the current term of
such agreement; and (ii) certain existing facilities agreements, facilities
lease agreements or other arrangements (including arrangements relating to
future agreements) relating to the lease or other grant of right to use fiber
optic facilities between such Cable Stockholder or any of its affiliates and
TCG or any of its subsidiaries would be automatically amended as of January 8,
1998 to conform with a form of Master Facilities Agreement agreed to by AT&T,
the Cable Stockholders and TCG at the time of the execution of the AT&T
Agreement.
Consummation of the AT&T Merger is subject to certain closing conditions,
including TCG and AT&T obtaining certain required regulatory approvals and
other related consents. Accordingly, there can be no assurance that the AT&T
Merger will be successfully consummated or, if successfully completed, when it
might be completed.
10
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation--The 1997 consolidated balance sheet and statements of
operations and of cash flows include the accounts of TCG and all wholly-owned
subsidiaries. The 1996 consolidated balance sheet includes the accounts of TCG
and all wholly-owned subsidiaries. The 1996 consolidated statements of
operations and of cash flows include equity in losses of unconsolidated
affiliates for all the Local Market Partnerships through June 30, 1996 except
for TCG St. Louis which was consolidated for the year. As of July 1, 1996, the
statements of operations and of cash flows consolidate the operations of the
former Local Market Partnerships. For the year ended December 31, 1995, the
statements of operations and of cash flows include the combined accounts of
TCG and TCG Partners. Investments in which TCG holds less than a 50% interest
are accounted for under the equity method. All material intercompany
transactions and balances have been eliminated in the financial statements
presented.
Basis of Accounting--The accompanying financial statements have been
prepared on the accrual basis of accounting.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash Equivalents--Cash equivalents consist principally of fixed income
securities, U.S. Treasury bills, commercial paper, floating rate notes and
certificates of deposit with a maturity date of three months or less when
purchased.
Marketable Securities--Marketable securities consist principally of fixed
income securities, U.S. Treasury bills, commercial paper, floating rate notes,
federal agency notes, federal agency discount notes, corporate medium-term
notes, corporate notes, bank notes and certificates of deposit with a maturity
date greater than three months when purchased and are stated at market value.
Market value is determined by the most recently traded price of the security
at the balance sheet date. TCG invests primarily in high-grade marketable
securities. All marketable securities are classified as available for sale
securities under the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" and unrealized holding gains and
losses are reflected as part of stockholders' equity. Net realized gains and
losses are determined on the specific identification cost method.
Depreciation and Amortization--Depreciation and amortization are computed on
the straight-line basis over the estimated useful lives of the assets or the
length of the lease, whichever is shorter. Estimated useful lives are five to
25 years for the communications network and three to five years for other
fixed assets, except for buildings which are 40 years.
When depreciable assets are replaced or retired, the amounts at which such
assets were carried are removed from the respective accounts and charged to
accumulated depreciation and any gains or losses on disposition are amortized
over the remaining original asset lives in accordance with industry practice.
During 1995, TCG completed a review of the useful lives of its fixed assets.
TCG determined that the lives of certain electronics equipment were longer
than industry standard, while the lives of other electronics equipment were
shorter than industry standard. Therefore, TCG adjusted the estimated useful
lives of certain
11
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
electronics equipment to conform with industry standard, effective December 1,
1995. The effect of these changes increased depreciation expense for the year
ended December 31, 1995 by approximately $0.7 million.
Financial Instruments--Financial instruments which potentially subject the
Company to concentrations of credit risk consist principally of cash and cash
equivalents, marketable securities and accounts receivable. The Company places
its temporary cash and cash equivalents and marketable securities with high-
quality institutions and, by policy, limits the amount of credit exposure to
any one institution. Concentrations of credit risk with respect to accounts
receivable are limited due to the dispersion of TCG's customer base among
different industries and geographic areas in the United States, by credit
granting policies adopted by TCG and by remedies provided by terms of
contracts, tariffs and statutes.
Fair Value of Financial Instruments--The estimated fair value amounts have
been determined by the Company, using available market information and
appropriate valuation methodologies. However, considerable judgment is
required in interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company could realize in a current market exchange. The
use of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
Investments In and Advances to Unconsolidated Affiliates--Investments in and
advances to unconsolidated affiliates at December 31, 1997 represents TCG's
interest in three companies which TCG accounts for under the cost method of
accounting. At December 31, 1996 it is comprised of TCG's advance to ETC and
its 49.9% interest in BizTel.
Goodwill and Other Intangibles--Goodwill represents the excess purchase
price paid over the net assets received in the acquisitions of ETC, CERFnet,
and the excess purchase price paid over the net assets associated with the
purchase of the remaining partnership interests in Teleport Communications,
Teleport Communications Boston ("TCB"), TCG Florida, TCG Detroit and TCG San
Francisco, as well as goodwill recorded in the financial statements of TCG
Pittsburgh, which is included in the consolidated financial statements of TCG
after the TCG Reorganization. Goodwill is amortized on a straight-line basis
not to exceed 40 years for all entities. The goodwill amortization recorded in
1997, 1996 and 1995 was $7.9 million, $2.2 million and $1.4 million,
respectively.
The carrying value of intangible assets is periodically reviewed and
impairments are recognized when the undiscounted expected future cash flows,
computed after interest expense derived from the related operations, is less
than their carrying value.
Licenses--FCC Licenses, acquired in the BizTel acquisition, are amortized
over a 40 year period in accordance with industry practice. The amortization
recorded in 1997 was $0.2 million.
Deferred Charges--Deferred charges primarily represent advanced payments
made by TCG for rights-of-way and node rents, and are expensed over a maximum
period of five years. The current portions of $4.6 million and $1.6 million at
December 31, 1997 and 1996, respectively, are included in other current assets
and the non-current portions, $8.9 million and $8.9 million at December 31,
1997 and 1996, respectively, are included in other assets.
Deferred Credits--Deferred credits principally represent advance payments
received from customers for long-term fiber optic service, and are amortized
into income over the life of the related contracts. The current portions, $6.7
million and $2.4 million at December 31, 1997 and 1996, respectively, are
included in other current liabilities and the non-current portions, $15.0
million and $9.9 million at December 31, 1997 and 1996, respectively, are
included in other liabilities.
12
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Revenue Recognition--Revenue on dedicated line, switch, data, and Internet
services is recognized in accordance with the terms of the underlying customer
contracts or tariffs and over the period in which the services are provided.
Income Taxes--TCG accounts for income taxes in accordance with the Statement
of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes," pursuant to which deferred income tax assets and liabilities are
determined based on the difference between the financial statement and tax
bases of assets and liabilities, using enacted tax rates currently in effect.
State and local taxes are based on factors other than income.
Net Loss Per Share--In 1997, TCG has adopted SFAS No. 128, "Earnings per
Share", which had no effect on its computation of loss per share. Net loss per
share is determined by dividing net loss by the weighted average number of
common shares outstanding for the period. The computation of fully diluted net
loss per share was antidilutive in each of the periods presented; therefore,
the amounts reported as primary and fully diluted are the same. As part of the
TCG Reorganization, TCG declared a 42,000 to one stock split. All per share
amounts and numbers of shares have been restated to reflect the stock split
retroactive for the periods presented.
Recently Issued Accounting Pronouncements
Comprehensive Income--In June 1997, the Financial Accounting Standards Board
("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This statement
is effective for financial statements issued for periods beginning after
December 15, 1997. Management has evaluated the effect on its financial
reporting of the adoption of this statement and has found the majority of
required disclosures not to be applicable and the remainder not to be
significant.
Segments of an Enterprise and Related Information--In June 1997, the FASB
issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information." This statement is effective for fiscal years beginning after
December 15, 1997. SFAS No. 131 requires the reporting of profit and loss,
specific revenue and expense items, and assets for reportable segments. It
also requires the reconciliation of total segment revenues, total segment
profit or loss, total segment assets, and other amounts disclosed for
segments, in each case to the corresponding amounts in the general purpose
financial statements. The Company has not yet determined what additional
disclosures may be required in connection with adopting SFAS No. 131.
3. ACQUISITIONS
BizTel Communications, Inc.
On October 29, 1997, the Company acquired the remaining 50.1% equity
interest in BizTel Communications, Inc. ("BizTel") not owned by the Company in
exchange for the issuance of 1,667,624 shares of the Company's Class A Common
Stock. The Company had previously acquired a 49.9% interest in BizTel, in
February 1996. The total acquisition cost was $40.0 million. BizTel is a
holder of Federal Communications Commission ("FCC") licenses to provide
telecommunications services utilizing 38 GHz digital milliwave transmission in
over 200 geographic areas, which include more than 95 of the 100 largest
metropolitan markets and all markets where TCG operates. BizTel's 38 GHz
milliwave services can be used to economically connect customers to the
Company's fiber optic networks, to provide network redundancy, diverse routing
or quick temporary installations and to provide stand-alone facilities where
the Company does not have fiber optic networks. As of November 1, 1997, TCG
consolidates BizTel's results with its wholly-owned subsidiaries.
TCG evaluated the acquired assets and liabilities of BizTel, and as a result
of the evaluation, TCG ascribed a value to the FCC Licenses of $39.7 million.
Such amount is being amortized over 40 years and is reported in the statement
of operations in depreciation and amortization expense. Amortization expense
related to such FCC Licenses for the year ended December 31, 1997 was $0.2
million.
13
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Eastern TeleLogic Corporation
Effective as of March 1, 1997, TCG completed its acquisition of Eastern
TeleLogic Corporation ("ETC"). In the first of two steps, on October 25, 1996,
employees of ETC exercised their stock options and then ETC redeemed the
shares of its stock (approximately 47%) not held by Comcast CAP, a corporation
owned 51% by Comcast and 49% by TCG. Comcast CAP borrowed at a market interest
rate approximately $115 million from TCG as a short-term loan and, in turn,
loaned this amount to ETC to effect the redemption. In the second step, TCG
acquired Comcast's 51% stock interest in Comcast CAP in exchange for 2,757,083
shares of the Company's Class A Common Stock, resulting in ETC becoming a
wholly-owned subsidiary of TCG. After the acquisition, the name of ETC was
changed to TCG Delaware Valley, Inc. TCG assumed $52.6 million of debt in this
acquisition. TCG retained an independent third party to fully evaluate certain
acquired assets of ETC.
The total acquisition cost for ETC was $178.7 million. The goodwill recorded
with this investment, which represented the excess of the Company's investment
over the underlying net assets of ETC, was approximately $167.8 million. Such
amount is being amortized over 40 years and is reported in the statement of
operations in depreciation and amortization expense. Amortization expense
related to such goodwill for the year ended December 31, 1997 was $4.2
million.
CERFnet Services, Inc.
On February 4, 1997, the Company acquired from General Atomics and General
Atomic Technologies Corporation all of the outstanding capital stock of
CERFnet Services, Inc. ("CERFnet"), a leading regional provider of Internet-
related services to businesses, including dial-up and dedicated Internet
access, World Wide Web hosting, and colocation services and Internet training.
TCG issued 2,100,000 shares of its Class A Common Stock to CERFnet's former
controlling stockholder and granted to it certain registration rights with
respect to such shares of Class A Common Stock. After the acquisition, the
name of CERFnet was changed to TCG CERFnet, Inc.
TCG retained an independent third party to evaluate certain of the acquired
assets of CERFnet, and as a result of the evaluation, TCG expensed acquired
in-process research and development costs of $22.0 million.
The goodwill recorded with this investment, which represented the excess of
the Company's investment over the underlying net assets of CERFnet was
approximately $19.9 million. Such amount is being amortized over 10 years and
is reported in the statement of operations in depreciation and amortization
expense. Amortization expense related to such goodwill for the year ended
December 31, 1997 was approximately $1.8 million.
Summarized Financial Information
Summarized financial information for the Company's investments, which
include BizTel and ETC and six months of the revenues and net losses of the
Local Market Partnerships except for TCG St. Louis as of and for the year
ended December 31, 1996, is as follows (in thousands):
<TABLE>
<S> <C>
Total assets..................................................... $ 68,053
Total liabilities................................................ 185,820
Total revenues................................................... 63,940
Net loss......................................................... (52,311)
</TABLE>
ACC Merger
On November 26, 1997, TCG entered into an Agreement and Plan of Merger (the
"ACC Agreement") by and among TCG, TCG Merger Co., Inc., a Delaware
corporation and a wholly-owned subsidiary of TCG
14
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
("MergerCo"), and ACC Corp., a Delaware corporation ("ACC"), providing for the
merger of MergerCo with and into ACC (the "ACC Merger"), with ACC becoming a
wholly-owned subsidiary of TCG. ACC is a switch-based provider of
telecommunications services to businesses, residential customers, and
educational institutions in the United States, United Kingdom and Canada. ACC
has recently commenced operations in Germany. The ACC Agreement provides that
ACC's stockholders will receive approximately that number of shares of TCG
Class A Common Stock for each ACC share, equal to $50 divided by the average
per share closing price of TCG Class A Common Stock for a ten-day trading
period prior to closing of the transaction. In the event, however, that the
average per share closing price of TCG Class A Common Stock during the ten-day
trading period prior to closing is below $45, the exchange ratio is fixed at
1.11111 shares of TCG Class A Common Stock for each ACC share, and, if the
average per share closing price of TCG Class A Common Stock during the ten-day
trading period prior to closing is above $55, the exchange ratio is fixed at
0.90909 of a share of TCG Class A Common Stock for each ACC share. The total
aggregate amount of consideration to be received by the ACC stockholders is
expected to be approximately $1.0 billion.
ACC is presently in the process of acquiring US WATS, Inc., ("US WATS") a
domestic U.S. long distance reseller. The US WATS acquisition is expected to
be complete in early 1998. ACC has agreed that it will not change the
agreement governing the acquisition of US WATS without TCG's consent.
TCG and ACC expect the transaction to be completed by mid-1998, subject to,
among other things, approval by a majority of the holders of ACC's outstanding
shares. Under the ACC Agreement, ACC has agreed not to solicit or take other
actions with respect to any competing proposal, subject to compliance with
fiduciary duties. ACC agreed to pay TCG $32.5 million, plus up to $7.5 million
for expenses, if the ACC Agreement is terminated under certain circumstances.
Upon execution of the ACC Agreement, ACC amended its shareholder rights plan
to exempt TCG from the 7.5% threshold by which the rights become exercisable.
This amendment will remain in effect until December 31, 1998. In the event
that the ACC Merger is completed, the underlying rights granted under the ACC
shareholder rights plan will be redeemed by ACC.
Consummation of the ACC Merger is subject to certain closing conditions,
including TCG and ACC obtaining required regulatory approvals and other
related consents. Accordingly, there can be no assurance that the ACC Merger
will be successfully consummated or, if successfully completed, when it might
be completed.
Kansas City Fiber Network, L.P.
On December 1, 1997, TCG agreed to acquire the assets and customer base of
Kansas City Fiber Network, L.P. ("KCFN"), a leading competitive local exchange
carrier in the Kansas City metropolitan area owned by TCI and Time Warner
Communications for approximately $55 million in cash and the assumption of
certain liabilities. KCFN currently operates a fiber optic network over 580
route miles which connects to more than 200 on-net buildings. This acquisition
is subject to approval from regulatory authorities which is expected in the
second quarter of 1998. On June 1, 1997, TCG entered into a Technical Services
Agreement with KCFN whereby TCG assumed managerial oversight of the day-to-day
operations of KCFN. TCG has recorded the results of operations of KCFN
subsequent to that date.
15
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Pro Forma Financial Information
Unaudited pro forma financial information for the years ended December 31,
1997 and 1996 as if the TCG Reorganization and the acquisitions of ETC,
CERFnet, BizTel, ACC (including US WATS), and KCFN had occurred at January 1,
1996, is as follows (in thousands, except share amounts):
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Revenue......................................... $ 931,500 $ 670,312
Net loss........................................ $ (238,279) $ (167,652)
Loss per share.................................. $ (1.26) $ (0.96)
Weighted average number of shares outstanding... 188,747,431 173,811,002
</TABLE>
Pro forma adjustments for the year ended December 31, 1997 include the
reversal of TCG's equity in the losses of ETC and BizTel as well as
amortization of the intangible assets relating to the aforementioned
acquisition. Pro forma adjustments for the year ended December 31, 1996
include (i) the reversal of TCG's equity in the losses of the 13 Local Market
Partnerships and ETC, (ii) amortization of the intangible assets relating to
the aforementioned acquisitions and (iii) the reduction of interest expense
from the conversion of subordinated debt to parents to equity. The pro forma
net loss for the year ended December 31, 1996 excludes the effect of the one-
time nonrecurring charge for acquired in-process research and development. The
pro forma financial information presented above is not necessarily indicative
of the operating results which would have been achieved had the transactions
occurred at the beginning of the periods presented or of the results to be
achieved in the future.
Cox Fibernet Affiliates
Pursuant to the terms of three Operator Managed Ventures Services Agreements
between TCG and certain affiliates of Cox, TCG has options to acquire up to a
35% interest in the competitive access business conducted by such affiliates
of Cox in New Orleans, Oklahoma City and the Hampton Roads, Virginia area. To
the extent the Cox competitive access provider has derived revenue from any
contract entered into by TCG as a result of sales efforts engaged in by TCG on
behalf of such Cox operations, the purchase price shall be the ratio of the
annual TCG generated revenue to total annual revenue of the Cox operation
multiplied by the book value of the assets of the Cox operation. If such ratio
is less than 35%, TCG may purchase the balance, up to 35%, of that Cox
operation for the fair market value (as determined in accordance with the
Operator Managed Ventures Services Agreements) of the operation. There is no
cap or maximum purchase price under the terms of the Operator Managed Ventures
Services Agreements. In November 1996, TCG notified Cox of its intention to
exercise its option to purchase a 35% interest in Cox's Hampton Roads,
Virginia operations. The Company's options to acquire 35% interests in Cox's
New Orleans and Oklahoma City operations do not mature until 1999. Cox and TCG
engaged in discussions concerning the calculation of the purchase price
formula for Hampton Roads, Virginia, and a possible renegotiation and
restructuring of their respective rights and obligations of the parties under
each of the Operator Managed Ventures Services Agreements. However, in
connection with the AT&T Merger, Cox and TCG agreed to suspend their
negotiations and to toll the option period until the later of six months after
the effective time of the AT&T Merger and the contractual trigger date.
16
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
4. MARKETABLE SECURITIES
The following is a summary of TCG's marketable securities and cash
equivalents at December 31, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997
----------------------------------------
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Commercial paper................... $124,246 $ 4 $ (4) $124,246
Federal agency discount notes...... 33,750 -- (1) 33,749
Federal agency notes............... 54,524 9 (4) 54,529
Certificates of deposit............ 55,987 3 (6) 55,984
Corporate medium term notes........ 93,114 108 (2) 93,220
Corporate notes.................... 15,000 39 -- 15,039
Bank notes......................... 19,993 18 -- 20,011
-------- ---- ----- --------
396,614 181 (17) 396,778
Less: Cash equivalents............. 89,950 -- -- 89,950
-------- ---- ----- --------
Marketable securities.............. $306,664 $181 $ (17) $306,828
======== ==== ===== ========
<CAPTION>
1996
----------------------------------------
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAIN LOSS VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Commercial paper................... $338,390 $ -- $ (83) $338,307
U.S. Treasury bills................ 47,894 33 -- 47,927
Federal agency notes............... 139,481 11 (29) 139,463
Corporate medium term notes........ 118,825 60 (33) 118,852
Floating rate notes................ 19,984 16 -- 20,000
-------- ---- ----- --------
664,574 120 (145) 664,549
Less: Cash equivalents............. 223,743 -- -- 223,743
-------- ---- ----- --------
Marketable securities.............. $440,831 $120 $(145) $440,806
======== ==== ===== ========
</TABLE>
The amortized cost and estimated fair value by maturity date as of December
31, 1997 is as follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED COST MARKET VALUE
-------------- ------------
<S> <C> <C>
Due in one year................................ $313,490 $313,505
Due after one year through five years.......... 83,124 83,273
-------- --------
Total........................................ $396,614 $396,778
======== ========
</TABLE>
Proceeds from the sale of investments during 1997 and 1996 were $479.5
million and $664.8 million, respectively. Gross gains of $117 thousand and $57
thousand and gross losses of $13 thousand and $2 thousand were realized on
these sales in 1997 and 1996, respectively. The change in the net unrealized
holding gain from 1997 to 1996 on available-for-sale securities is $189
thousand.
17
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
5. FIXED ASSETS
The following is a summary of the Company's fixed assets as of December 31,
1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Communications network.............................. $1,470,081 $ 875,152
Construction in progress............................ 252,012 336,770
Other............................................... 150,990 92,307
---------- ----------
1,873,083 1,304,229
Less: Accumulated depreciation and amortization... (379,987) (236,967)
---------- ----------
Fixed assets--net................................. $1,493,096 $1,067,262
========== ==========
</TABLE>
6. LONG-TERM DEBT AND FINANCIAL INSTRUMENTS
Long-term debt outstanding as of December 31, 1997 and 1996 consisted of the
following (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Senior Notes, 9.875%, due 2006.......................... $ 300,000 $300,000
Senior Discount Notes, net of discount of $338,622 and
$414,039 in 1997 and 1996, respectively, 11.125% due
2007................................................... 734,984 659,567
TCI Subordinated Note, 7.5% due 2001, repaid December
31, 1997............................................... -- 27,007
---------- --------
Total................................................. $1,034,984 $986,574
========== ========
</TABLE>
All long-term debt matures subsequent to 2002.
Senior Notes and Senior Discount Notes
On July 2, 1996, TCG issued $300 million principal amount of Senior Notes
due 2006 and $1,073 million aggregate principal amount at maturity of Senior
Discount Notes due 2007 (collectively the "Notes"). The Senior Notes were
issued pursuant to an indenture (the "Senior Notes Indenture") between TCG and
the United States Trust Company of New York, as trustee, and the Senior
Discount Notes were issued pursuant to an Indenture (the "Senior Discount
Notes Indenture") and, together with the Senior Notes Indenture (the
"Indentures") between the Company and the United States Trust Company of New
York, as trustee. The Indentures contain certain restrictive covenants which
impose limitations on TCG and certain of its subsidiaries' ability to, among
other things: (i) incur additional indebtedness, (ii) pay dividends or make
certain other distributions and investments, (iii) create liens, (iv) create
dividend and other payment restrictions on subsidiaries, (v) incur certain
guarantees, (vi) enter into certain asset sale transactions, (vii) enter into
certain transactions with affiliates (including the Cable Stockholders) and
(viii) merge, consolidate or transfer substantially all of the Company's
assets. Under the terms of the Indentures, TCG currently is not able to pay
dividends. TCG is currently in compliance with the terms of these covenants.
The Senior Discount Notes were issued at a discount to their aggregate
principal amount to generate gross proceeds of approximately $625 million. The
Senior Discount Notes accrete at a rate of 11.125% compounded semi-annually,
to an aggregate principal amount of $1,073 million by July 1, 2001.
Thereafter, interest on the Senior Discount Notes will accrue at the rate of
11.125% per annum and will be payable semi-annually on January 1 and July 1,
commencing on January 1, 2002; provided that at any time prior to July 1,
2001, TCG
18
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
may elect to commence the accrual of cash interest on the Senior Discount
Notes, in which case the outstanding principal amount on such Notes will be
reduced to their accreted value as of the date of such election and cash
interest shall become payable thereafter.
The Notes will be subject to redemption at the option of TCG, in whole or in
part, at any time on or after July 1, 2001, initially at 104.938% of their
principal amount in the case of the Senior Notes, and 105.563% in the case of
the Senior Discount Notes and declining to 100% of their principal amount on
or after July 1, 2004, in all cases plus accrued and unpaid interest thereon
to the applicable redemption date. The incurrence of long-term indebtedness by
TCG is subject to approval by the New York Public Service Commission (the
"NYPSC") and the New Jersey Board of Public Utilities (the "NJPBU"). Both the
NYPSC and NJBPU have authorized TCG to issue long-term debt in amounts not to
exceed $4 billion.
The fair value of TCG's long-term debt is estimated based on the quoted
market price for the same or similar issues or on borrowing rates currently
available to TCG for debt with similar terms and maturities. The fair value of
TCG's long-term debt was $1.2 billion and $1.1 billion at December 31, 1997
and 1996, respectively. The total interest expense for the Notes was $105.0
million and $49.3 million for the years ended December 31, 1997 and 1996,
respectively.
The Revolving Credit Agreement
On May 22, 1995, TCG entered into a Loan Agreement (the "Revolving Credit
Agreement") with Toronto Dominion (Texas), Inc., as administrative agent,
Chemical Bank, as documentation agent, and the Banks (as defined in the
Revolving Credit Agreement) to finance capital expenditures and working
capital needs of TCG's subsidiaries and of the Local Market Partnerships and
to repay debt of TCG and its subsidiaries to the Cable Stockholders.
Borrowings of $250 million were utilized for the growth of TCG. The $250
million of indebtedness under the Revolving Credit Agreement was repaid in
July 1996 from the proceeds of the 1996 Offerings.
On July 28, 1997, TCG, through a wholly-owned subsidiary, TCG New York, Inc.
("TCGNY") amended its $250 million Revolving Credit Agreement to a $400
million Revolving Credit Agreement (the "Revolving Credit Agreement"). The
Revolving Credit Agreement is secured by (i) the stock of the following
wholly-owned subsidiaries of TCGNY: TC New York Holdings I, Inc., TC New York
Holdings II, Inc., TC Systems, Inc., TCG Payphones, Inc. and the partnership
interests in Teleport Communications, (ii) a negative pledge with respect to
the assets and a pledge of the stock of each existing and future subsidiary of
TCGNY, (iii) a negative pledge with respect to the contracts that relate to
TCGNY operations, (iv) upstream guarantees from any existing and future
subsidiaries of TCGNY, and (v) a lien on all present and future intercompany
indebtedness owed to TCGNY from TCG and all of its subsidiaries. The Revolving
Credit Agreement provides for interest based upon either the base rate or
London Interbank Offered Rate ("LIBOR"), adjusted as defined in the Revolving
Credit Agreement. In addition, TCGNY must pay a commitment fee equal to 0.375%
per annum on the unused commitment amount. There was no outstanding balance as
of December 31, 1997 and 1996. The total interest expense for amounts borrowed
and commitment fees under the Revolving Credit Agreement were $1.2 million,
$6.3 million and $3.0 million for the years ended December 31, 1997, 1996 and
1995, respectively. At December 31, 1997, the amount available under the
Revolving Credit Agreement was $344.4 million.
19
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The commitment will be reduced in equal quarterly installments according to
the following schedule:
<TABLE>
<CAPTION>
YEAR AMOUNT
---- -------------
(IN MILLIONS)
<S> <C>
2000................................ $ 12.5
2001................................ 35.0
2002................................ 55.0
2003................................ 70.0
2004................................ 90.0
2005................................ 100.0
2006................................ 37.5
------
$400.0
======
</TABLE>
The shares of capital stock owned by TCG in certain of the wholly-owned
subsidiaries of TCG (TC New York Holdings I, Inc., TC New York Holdings II,
Inc., TCG Payphones, Inc., and TC Systems, Inc., collectively the "Restricted
Subsidiaries") were and remain pledged as collateral to secure loans pursuant
to, and may not be pledged to any other party under the terms of, the
Revolving Credit Agreement.
In December 1995, the capital stock of the wholly-owned Restricted
Subsidiaries of TCG was transferred, subject to the pledge, to TCG New York,
Inc., a wholly-owned subsidiary of TCG. TCG New York, Inc. assumed all
obligations under the Revolving Credit Agreement as of the date of transfer.
TCG New York, Inc. is permitted under the terms of the Revolving Credit
Agreement to advance funds to TCG. When made, such advances are to be
evidenced by notes from TCG to TCG New York, Inc. which will be pledged as
collateral under the Revolving Credit Agreement.
The Revolving Credit Agreement contains various covenants and conditions,
including restrictions on additional indebtedness, maintenance of certain
financial ratios and limitations on capital expenditures. TCG is currently in
compliance with the terms of these covenants. None of these covenants
negatively impact TCG's liquidity or capital resources at this time.
In 1995, TCG entered into interest rate swap agreements to mitigate the
impact of changes in interest rates on its long-term bank debt. TCG had no
interest rate swaps with commercial banks at December 31, 1997 and 1996. The
average fixed interest rate was 5.93% in 1995. These agreements effectively
fixed TCG's interest rate exposure on various LIBOR based floating rate notes
(which ranged from 5.87% to 5.94%). During July 1996, TCG repaid $250 million
of bank indebtedness with the proceeds of the 1996 Offerings. Due to this
repayment, TCG is not currently required under its Revolving Credit Agreement
to enter into interest rate swap arrangements. Accordingly, during 1996, TCG
terminated four interest rate swap arrangements which were due to mature in
1997, for a gain of approximately $1.5 million.
TCI Subordinated Note
In connection with the 1996 Offerings, the Cable Stockholders contributed to
TCG $269.0 million aggregate principal amount of indebtedness, plus accrued
interest from May 1995, except that TCI retained a $26 million subordinated
note of TCG, in exchange for Class B Common Stock issued to the Cable
Stockholders. The loan agreement was terminated in connection with the TCG
Reorganization. Interest and principal on the TCI Subordinated Note were
payable in 2001. The TCI Subordinated note was repaid on December 31, 1997 at
a discounted value of approximately $25.1 million.
20
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Cable Stockholders Loan Agreement
TCG had a loan agreement with the Cable Stockholders aggregating $349.6
million ($269.0 million outstanding at December 31, 1995). Borrowings bore
interest at 75 basis points above the one-month London Interbank Offered Rate
("LIBOR"). Total interest expense for this loan was $0, $8.4 million and $17.6
million for the years ended December 31, 1997, 1996 and 1995, respectively.
ETC Facility
In the acquisition of ETC, TCG assumed ETC's credit facility which was
entered into in October 1995 with CoreStates Bank, N.A. and certain other
lenders (the "ETC Facility"). The ETC Facility is a $60.0 million credit
facility. The ETC Facility provides for interest based upon either the base
rate, or LIBOR, adjusted as defined in the ETC Facility (7.4375% at December
31, 1997), which is payable quarterly. The balance outstanding is due on
September 30, 1998. Borrowings under the ETC Facility are collateralized by
substantially all of the assets and outstanding common stock of TCG Delaware
Valley, Inc. In addition, the ETC Facility contains certain restrictive
covenants which, among other things, require TCG Delaware Valley to maintain
certain debt service coverage ratios and limit the payment of dividends and
capital expenditures. TCG is currently in compliance with terms of these
covenants. In addition, TCG Delaware Valley is required to pay .375% per year
on the available portion of the ETC Facility. The total outstanding balance at
December 31, 1997, was $52.6 million.
7. STOCKHOLDERS' EQUITY
1997 Equity Offering
Continental acquired its interest in TCG in May 1993. On November 15, 1996,
Continental was acquired by U S WEST. In connection with such acquisition, on
November 5, 1996, the U.S. Department of Justice announced, and on February
28, 1997, a final judgment was entered (the "Final Judgment") with respect to
a settlement with U S WEST and Continental pursuant to which Continental was
required to reduce its ownership in TCG below 10% by June 30, 1997, and was
required to eliminate such ownership entirely by December 31, 1998. On
February 19, 1997, pursuant to the Amended and Restated Stockholders'
Agreement dated June 26, 1996, between TCG and the Cable Stockholders (the
"Amended Stockholders' Agreement"), Continental converted 4,000,000 shares of
Class B Common Stock into 4,000,000 shares of Class A Common Stock and, in
accordance with the provisions of Rule 144 promulgated by the Commission under
the Securities Act, transferred these shares to one or more third parties.
Thereafter, Continental converted an additional 4,500,000 shares of Class B
Common Stock, pursuant to the Amended Stockholders' Agreement, and in
accordance with the provisions of Rule 144 transferred 3,840,000 of such
shares to one or more third parties.
TCG filed a registration statement for a public offering (the "1997 Equity
Offering") of 17,250,000 shares of Class A Common Stock on October 10, 1997,
and the 1997 Offering was consummated on November 13, 1997. Of the 17,250,000
shares, 7,304,408 were offered by the Company and 9,945,592 shares were
offered by Continental. The Company did not receive any proceeds from the sale
of shares by Continental. The net proceeds
21
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
to the Company from its sale of shares pursuant to the 1997 Equity Offering
were approximately $317.4 million, after deducting the underwriting discount
and expenses of approximately $11.3 million.
8. EMPLOYEE BENEFIT PLANS
Teleport Communications Group Retirement Savings Plan--TCG has a Retirement
Savings Plan (the "Plan") with a retirement savings component covering
substantially all eligible employees of TCG with one or more years of service
and a 401(k) savings component covering substantially all eligible employees
of TCG. Under the retirement component of the Plan, TCG contributes an amount
based on years of service and annual eligible compensation. Under the 401(k)
component of the Plan, participants may make pre-tax contributions and TCG
matches 50% of the first 6% of annual eligible compensation to a maximum
company contribution of $1,500 per employee for employees with more than one
year of service. Participants with less than one year of service may make pre-
tax contributions without a company match.
Effective November 1, 1996, the Plan offers TCG's Class A Common Stock as an
investment option. The Plan purchases shares on the open market. As of
December 31, 1997 and 1996, respectively, 113,553 and 36,186 shares, with a
total market value of $6.2 million and $1.1 million, had been purchased under
the Plan.
In 1997, 1996 and 1995, TCG made matching contributions of $1.5 million,
$1.1 million, and $0.7 million, respectively, as required by the 401(k)
component and $2.2 million, $1.4 million, and $1.0 million, respectively,
under the retirement component of the plan.
TCG has established a non-qualified, funded, deferred compensation Make-Up
Plan of Teleport Communications Group Inc. (the "Make-Up Plan") for the
Teleport Communications Group Inc. Retirement Savings Plan. The purpose of the
Make-Up Plan is to provide certain eligible participants benefits which would
have been payable under the Retirement Savings Plan, but were limited by the
maximum company match of $1,500, as well as compensation limits set forth by
the IRS. Expenses incurred in connection with the Make-Up Plan were
approximately $0.9 million in 1997 and were insignificant in 1996 and 1995.
Teleport Communications Group Unit Appreciation Plan--TCG has established
the Teleport Communications Group Unit Appreciation Plan (the "UAP") for 1992
and 1993. During the years ended December 31, 1993 and 1992, TCG made awards
of deferred compensation in the form of units (the "Units"), pursuant to the
UAP, to certain eligible employees of TCG. Benefits under the UAP are equal to
the value of the Units on the date the employee terminates employment or is
fully vested in the Units, less the initial base price of the Units. The
initial base price of each Unit as of January 1, 1993 and 1992 was $34.85 and
$30.00, respectively. Each Unit is equal to 8.4 shares of Class A Common
Stock. Except for awards to a certain employee, the appreciation of any Unit
is limited to 200% of the initial base price. Pursuant to an employee's
employment agreement, there is no limit on the appreciation he may receive
under the 1992 UAPs. Awards under the UAP are subject to a five-year vesting
schedule, pursuant to which the Units granted were 60% vested as of December
31, 1995 and December 31, 1994, respectively, and fully vested no later than
December 31, 1997 and December 31, 1996, respectively, subject to certain
exceptions provided therein. The 1992 UAPs were fully vested December 31, 1996
and were paid early in 1997. In connection with the UAP, TCG recognized
compensation expense of $15 thousand, $1.4 million and $2.5 million for the
years ended December 31, 1997, 1996 and 1995, respectively. In January 1996,
TCG adopted a plan which permits the awards under the UAP to be deferred in
whole or in part at the election of the participants for periods of up to five
years or, with the Administrative Committee's consent, until termination of
employment.
22
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The following table provides additional information concerning the Unit
Appreciation Plan awards:
<TABLE>
<CAPTION>
NUMBER OF
NUMBER NUMBER UNITS NUMBER NUMBER
OF UNITS OF UNITS VALUE OF OUTSTANDING OF UNITS VALUE OF UNITS
OUTSTANDING VESTED UNITS AT VESTED OF UNITS OUTSTANDING
INITIAL AT AT VESTED AT DECEMBER AT VESTED AT AT
YEAR OF NUMBER DECEMBER 31, DECEMBER 31, DECEMBER 31, 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
AWARD OF UNITS 1997 1997 1997 1996 1996 1996 1995
------- -------- ------------ ------------ ------------ ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1993.................. 36,000 5,300 5,300 $369,410 5,300 4,240 $ 295,528 23,700
1992.................. 170,850 -- -- -- 63,250 63,250 7,695,373 139,200
------- ----- ----- -------- ------ ------ ---------- -------
Total................ 206,850 5,300 5,300 $369,410 68,550 67,490 $7,990,901 162,900
======= ===== ===== ======== ====== ====== ========== =======
</TABLE>
Teleport Communications Group Inc. 1996 Equity Incentive Plan--TCG
established the Teleport Communications Group Inc. 1996 Equity Incentive Plan
(the "Equity Incentive Plan") effective June 27, 1996, to provide
opportunities for certain employees of TCG to participate in the appreciation
in the value of TCG after the initial public offering. The Board of Directors
authorized the issuance of up to 637,792 shares of Class A Common Stock under
the Equity Incentive Plan. The Equity Incentive Plan is administered by the
Compensation Committee which has full and discretionary power to award shares
under the Equity Incentive Plan.
Under the Equity Incentive Plan, each employee who had an award under the
1992 UAP or the 1993 UAP, whether or not the employee had elected to defer
receipt of the payment of benefits thereunder and who is employed by TCG as of
June 27, 1996, had the right to waive his/her interest in all or any portion
of the employee's benefit in the 1992 UAP or the 1993 UAP. In exchange
therefore, the employee was granted a number of shares under the Equity
Incentive Plan equal to the value of the portion of the employee's benefit
waived (determined as of June 27, 1996) multiplied by 120% and divided by the
initial public offering price per share of Class A Common Stock. No employee
could receive more than 54,000 shares under the Equity Incentive Plan, and a
certain employee was not eligible to participate. One share under the Equity
Incentive Plan is equivalent in value to one share of Class A Common Stock.
Thus, the value of the benefit payable under the Equity Incentive Plan will
fluctuate in accordance with the fair market value of the Class A Common
Stock.
Shares under the Equity Incentive Plan granted in exchange for 1992 UAP
benefits are subject to a two-year vesting schedule, with 70% of the shares
becoming vested as of June 27, 1997 and the remaining 30% becoming vested as
of the June 27, 1998. Shares granted in exchange for the 1993 UAP benefits are
subject to a three-year vesting schedule, with 70% of the shares becoming
vested as of June 27, 1998 and the remaining 30% becoming vested as of June
27, 1999. A participant shall become 100% vested in his/her shares in the
event of death, total disability or a change in control. In the event a
participant's employment is terminated for cause, his/her interest in each and
every share awarded under the Equity Incentive Plan shall be forfeited.
Shares under the Equity Incentive Plan will be paid to a participant either
in one lump sum cash payment or in shares of Class A Common Stock, as
determined at the discretion of the Compensation Committee, on the payment
date elected by the participant at the time he/she elects to participate in
the Equity Incentive Plan. In general, the payment date elected may be the
last business day of any calendar quarter during the period commencing June
30, 1998 and ending June 30, 2001.
At December 31, 1997 and 1996, respectively, 409,983 and 421,233 shares were
outstanding under the Equity Incentive Plan.
Teleport Communications Group Inc. Stock Option Plan--TCG established the
Teleport Communications Group Stock Option Plan (the "SOP") effective
September 26, 1993. The SOP is administered at the discretion
23
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
of the Compensation Committee, which has made long-term incentive compensation
awards in the form of non-qualified and incentive stock options to eligible
employees. Stock options were granted with exercise prices at or above the
fair market value of the shares on the date of grant, and no compensation
expense has been recognized in connection with the options. The Compensation
Committee may permit the exercise price to be paid in cash, through delivery
of other shares of Class A Common Stock, by delivering irrevocable
instructions to a financial institution to deliver promptly to TCG the portion
of sale or loan proceeds sufficient to pay the exercise price, or through an
election to have shares withheld from the shares otherwise to be received by
the option holder.
The following table provides additional information concerning the SOP:
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
-------------------------
AVAILABLE FOR
GRANT OUTSTANDING EXERCISE PRICE
------------- ----------- --------------
<S> <C> <C> <C>
Balance, January 1, 1995............ 2,888,046 2,495,304 $ 6.90--10.39
Authorized........................ -- -- --
Granted........................... (285,096) 285,096 14.22
Exercised......................... -- (27,115) 6.90
Forfeited......................... 215,225 (215,225) 6.90--14.22
---------- ---------
Balance, December 31, 1995.......... 2,818,175 2,538,060 $ 6.90--14.22
Authorized........................ 5,547,683 -- --
Granted........................... (2,003,462) 2,003,462 17.46--21.60
Exercised......................... -- (55,355) 6.90
Forfeited......................... 173,443 (173,443) 6.90--21.60
---------- ---------
Balance, December 31, 1996.......... 6,535,839 4,312,724 $ 6.90--21.60
Authorized........................ -- -- --
Granted........................... (1,935,068) 1,935,068 24.48--55.02
Exercised......................... -- (285,332) 6.90--10.39
Forfeited......................... 155,944 (155,944) 6.90--49.00
---------- ---------
Balance, December 31, 1997.......... 4,756,715 5,806,516 $ 6.90--55.02
========== =========
</TABLE>
Teleport Communications Group Inc. Employee Stock Purchase Plan (1997)--TCG
adopted the Teleport Communications Group Inc. Employee Stock Purchase Plan
(the "1997 Stock Purchase Plan"), effective July 1, 1997. The 1997 Stock
Purchase Plan is administered by the Compensation Committee of the Board of
Directors (the "Committee"). As of the first day of each calendar quarter each
eligible employee will be granted the option to purchase as of the last day of
each calendar quarter, a number of shares determined under a uniform formula
specified by the Committee. Each eligible employee was given an option to
purchase the number of shares equal to 10% of such employee's compensation
plus bonus paid in that calendar quarter, divided by the purchase price per
share under the option. No employee can receive options for more than $25,000
worth of shares in any calendar year. The purchase price for one share of
Class A Common Stock is 15% below the average closing price of the last ten
trading days of the calendar quarter. The Committee authorized the issuance of
1,500,000 shares of Class A Common Stock under the 1997 Stock Purchase Plan.
The expense recorded for the year ended December 31, 1997 related to options
issued was approximately $0.3 million.
Teleport Communications Group Inc. Employee Stock Purchase Plan (1996)--TCG
adopted the Teleport Communications Group Inc. Employee Stock Purchase Plan
(the "1996 Stock Purchase Plan"), effective June 27, 1996. The 1996 Stock
Purchase Plan is administered by the Committee. Each eligible
24
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
employee was given an option to purchase a number of shares of Class A Common
Stock up to 10% of such employee's compensation plus bonus paid for the
calendar year preceding the year the option is awarded, divided by the
purchase price per share under the option. No employee can receive options for
more than $25,000 worth of shares in any calendar year. The purchase price for
one share of Class A Common Stock is 15% below the initial offering price of
$16, or $13.60. The Board of Directors has authorized the issuance of 745,000
shares under the 1996 Stock Purchase Plan. The options expired on June 27,
1997. Options related to 584,686 shares of Class A Common Stock were
exercised.
The expense recorded in each of the years ended December 31, 1997 and 1996
related to the options issued was approximately $0.7 million.
The following table provides additional information concerning the 1996 and
1997 Employee Stock Purchase Plans:
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
-------------------------
AVAILABLE FOR
GRANT OUTSTANDING EXERCISE PRICE
------------- ----------- --------------
<S> <C> <C> <C>
Balance, January 1, 1996............ -- -- $ --
Authorized........................ 745,000 -- 13.60
Granted........................... (623,894) 623,894 13.60
Exercised......................... -- -- --
Forfeited......................... 41,001 (41,001) 13.60
--------- --------
Balance, December 31, 1996.......... 162,107 582,893 $ 13.60
Authorized........................ 1,500,000 -- --
Granted........................... (109,975) 109,975 35.54
Exercised......................... -- (609,651) 13.60--35.54
Forfeited......................... 83,217 (83,217) 13.60
--------- --------
Balance, December 31, 1997.......... 1,635,349 -- $ --
========= ========
</TABLE>
Stock-Based Compensation--In October 1995, the FASB issued SFAS No. 123,
"Accounting for Stock-Based Compensation" which encourages but does not
require companies to record compensation cost for stock-based compensation
plans at fair value.
TCG has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion
("APB") No. 25 "Accounting for Stock Issued to Employees," and its related
interpretations. Accordingly, no compensation expense has been recorded for
its stock awards and employee stock purchase plans, but rather, the Company
has determined the pro forma net loss and net loss per share amounts for 1997,
1996 and 1995, as if compensation expense had been recorded for options
granted during those years under the fair value method described in SFAS No.
123. Compensation cost for stock options is measured as the excess, if any, of
the quoted market price of the Company's stock at the date of the grant over
the amount an employee must pay to acquire the stock. Compensation cost for
stock appreciation rights and performance equity units is recorded quarterly
based on the quoted market price of TCG's stock at the end of the period.
The Company utilized the Black-Scholes option pricing model to estimate the
fair value at the date of grant of options granted during 1997, 1996 and 1995.
Under the Black-Scholes model, the volatility factor ranged from 25.0% to
26.4% was used for options granted on or after the date of the 1996 Offerings
and the minimum value method was used for options granted prior to the date of
the 1996 Offerings, as if there was no market for the
25
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Company's common stock in which to monitor stock price volatility. Had TCG
adopted SFAS No. 123, net loss and loss per share would have increased as
indicated below (in thousands, except share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Net loss--as reported................ $ (222,667) $ (114,850) $ (53,804)
=========== =========== ==========
Net loss--pro forma.................. $ (225,625) $ (116,398) $ (53,929)
=========== =========== ==========
Loss per share--as reported.......... $ (1.34) $ (1.00) $ (0.77)
=========== =========== ==========
Loss per share--pro forma............ $ (1.36) $ (1.02) $ (0.77)
=========== =========== ==========
Weighted average number of shares
outstanding......................... 165,728,059 114,443,695 70,000,140
=========== =========== ==========
</TABLE>
Valuation Assumptions--The fair value of options at the date of grant was
established using the Black-Scholes model with the following weighted average
input assumptions:
<TABLE>
<CAPTION>
ANNUAL
EXPECTED EXERCISE STOCK PRICE RISK FREE DIV. FORFEITURE
LIFE PRICE AT GRANT VOLATILITY INT. RATE YIELD RATE
-------- --------- ----------- ---------- --------- ----- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
1996 Employee Stock
Purchase Plan Grants... 1.00 $13.60 $16.00 25.0% 5.81% 0% 4.89%
1995, 1996 and 1997
Stock Option Grants.... 5.00 to $14.22 to $14.22 to 0.1% to 5.80% to 0% 0% to
7.00 $46.98 $46.98 26.4% 6.73% 5.00%
</TABLE>
The following table summarizes information concerning the remaining options
outstanding as of December 31, 1997 for the 1997, 1996 and 1995 option grants
and the 1997 Employee Stock Purchase Plan:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- --------------------
WEIGHTED AVG. WEIGHTED WEIGHTED
RANGE OF NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE SHARES CONTRACTUAL EXERCISE SHARES EXERCISE
PRICES OUTSTANDING LIFE PRICES EXERCISABLE PRICES
--------- ----------- ------------- --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
1995, 1996 and 1997
Stock Option Grants and
1997 Employee Stock
Purchase Plan.......... $14.22 to 4,011,154 5.00 to $14.22 to 2,313 $14.22
$55.02 7.00 $46.98
</TABLE>
Employment Agreements--TCG has employment agreements with certain of its
executive officers and senior management personnel. These agreements are
effective through dates ending from June 30, 1998 to December 31, 2000, unless
terminated earlier by the executive or TCG, and provide for annual salaries,
cost-of-living adjustments, additional compensation in the form of bonuses
based on the performance of TCG and the executive, and participation in the
various benefit plans of TCG. The agreements contain certain benefits to the
executive if TCG terminates the executive's employment without cause or if the
executive terminates his employment as a result of change in ownership of TCG.
The salary and bonus expense related to these employment agreements for the
years ended December 31, 1997, 1996 and 1995 approximated $3.6 million, $2.9
million and $2.1 million, respectively. TCG's remaining aggregate commitments
for salaries under such agreements is approximately $4.9 million. The
commitments for bonuses under these agreements is approximately $1.9 million.
In the event TCG terminates the executive without cause or the executive
terminates his/her employment as a result of a change in control, the
agreements provide for continued vesting in deferred compensation and long
term incentive awards as well as the payment of a base salary for each
executive plus an annual bonus for the duration of the agreement. The annual
bonus is an amount not less than 30% of such base salary, except for a
26
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
certain employee whose minimum annual bonus is 50% of base salary. Each
executive is entitled to these severance benefits for at least six months
following such termination, except for a certain employee whose minimum
entitlement period is 30 months.
9. INCOME TAXES
There are no current income taxes payable based on TCG's operating loss. The
current state and local tax expense are based on factors other than income.
The following temporary differences compose the net deferred income tax
payable (in thousands):
<TABLE>
<CAPTION>
1997 1996
--------- --------
<S> <C> <C>
Deferred income tax liabilities:
Depreciation, amortization and excess credits......... $ 73,868 $ 43,072
Other................................................. 553 --
--------- --------
74,421 43,072
--------- --------
Deferred income tax assets:
Operating loss........................................ (192,433) (81,578)
Deferred revenue...................................... (2,403) (2,361)
Assets recorded for tax purposes...................... (3,575) (3,368)
Incentive compensation................................ (6,434) (4,579)
Equity in losses of unconsolidated subsidiaries....... (142) (138)
Other................................................. (248) --
--------- --------
(205,235) (92,024)
Less: valuation allowance 131,778 49,874
--------- --------
Total deferred tax assets............................... (73,457) (42,150)
--------- --------
Deferred income taxes payable--net...................... $ 964 $ 922
========= ========
</TABLE>
In 1997, 1996 and 1995, the net income tax benefits of approximately $81.9
million, $29.6 million and $10.9 million, respectively, have been offset by
increases in the valuation allowance of $81.9 million, $29.6 million and $10.9
million, respectively, due to the uncertainty of realizing the benefit of the
loss carry-forwards.
At December 31, 1997, TCG had operating loss carry-forwards for federal
income tax purposes of approximately $523.0 million, expiring principally in
2003 through 2013. Approximately $49.0 million of the net operating loss
carryforwards are carryovers related to the acquisitions of BizTel and ETC.
The net operating losses related to these acquisitions will be subject to
various limitations.
A reconciliation of the statutory federal income tax rate and TCG's
effective income tax rate is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Statutory federal income tax rate................... 35.00% 35.00% 35.00%
State and local taxes, less federal benefit......... 0.75 2.36 1.30
Unutilized tax benefit due to net operating loss.... (30.04) (31.80) (33.30)
Permanent differences and other..................... (4.96) (3.20) (1.70)
------ ------ ------
Effective rate...................................... 0.75% 2.36% 1.30%
====== ====== ======
</TABLE>
27
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
10. RELATED PARTY TRANSACTIONS
In 1996 TCG entered into a preliminary agreement with TCI which provided for
the provision of certain services by TCG to TCI in connection with the
development by TCI of residential telephony service offerings in Hartford,
Connecticut, San Francisco, California and Arlington Heights, Illinois and
possibly other locations. TCI has agreed to reimburse TCG for certain costs
and cost of capital in connection with these services. TCG is also in the
process of negotiating a market based agreement for the provision of telephony
services for TCI in multiple dwelling units at various locations. TCI and TCG
are continuing negotiations to reach a definitive agreement for both
offerings. At December 31, 1997 and 1996, the amounts due to TCG for this
reimbursement were $1.0 million and $1.1 million, respectively, and are
included in accounts receivable--related parties. TCG has entered into an
agreement with Comcast to support a Comcast residential service offering to be
conducted in Maryland and Florida.
TCG also provides management services to certain affiliates of Cox under
three Operator Managed Ventures Services Agreements, including billing
services, network monitoring and accounts receivable functions. Under the
terms of the agreements, TCG retains 8% of the collected revenues from Cox
customers as a royalty fee. Royalty fees recorded from Cox were approximately
$0.6 million, $0.3 million and $0.1 million for the years ended December 31,
1997, 1996 and 1995, respectively. Included in accounts receivable--trade are
approximately $1.0 million and $0.4 million at December 31, 1997 and 1996,
respectively, for amounts owed by Cox customers. At December 31, 1997 and
1996, the amounts due to Cox affiliates under the agreements were $1.7 million
and $1.1 million, respectively.
In 1997 and 1996, TCG purchased cable on behalf of certain of the Cable
Stockholders, which it then sold to them at cost. The amount receivable from
the owners was $1.1 million and $1.5 million as of December 31, 1997 and 1996,
respectively.
Sprint Spectrum, a partnership owned 60% by TCI, Comcast and Cox, entered
into preliminary agreements or letters of intent with a number of wholly-owned
subsidiaries of TCG providing for the construction of special facilities and
the provision of services to Sprint Spectrum by TCG. TCG and Sprint Spectrum
have continued this service relationship throughout 1997. The amount
receivable from Sprint Spectrum at December 31, 1997 and 1996, respectively,
was $1.6 million and $0.3 million.
In connection with the management of the Local Market Partnerships, TCG
entered into management services agreements. Under the terms of such
agreements, TCG provided certain operating and administrative services to such
entities, for which it earned management fees. Management fees earned were
approximately $0, $21.8 million and $29.6 million in 1997, 1996 and 1995,
respectively. After July 2, 1996, such management fee revenue is no longer
recorded because the previously unconsolidated partnerships are now
consolidated.
Related to the acquisition of KCFN, TCG is liable to fund the operations
until the closing. Such liability for KCFN as of December 31, 1997 is $2.3
million which is included in accounts payable and accrued liabilities. The
liability associated with the acquisition of KCFN of approximately $55 million
is included in accounts payable and accrued liabilities.
11. COMMITMENTS AND CONTINGENCIES
Operating Leases
Under the terms of contracts with various parties, TCG is obligated to pay
franchise fees, office rents, node rents and rights-of-way fees in connection
with its fiber optic network through 2022. These contracts provide for
28
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
certain scheduled increases and for possible escalation of basic rentals based
on a change in the cost of living or on other factors. TCG expects to enter
into other contracts for additional franchise fees, office rents, node rents,
rights-of-way, facilities, equipment, and maintenance services in the future.
A summary of such fixed commitments at December 31, 1997 is as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS AMOUNT
----- --------
<S> <C>
1998..................................... $ 34,079
1999..................................... 32,286
2000..................................... 29,986
2001..................................... 27,908
2002..................................... 25,723
Thereafter............................... 65,814
--------
Total.................................. $215,796
========
</TABLE>
Rent expense under operating leases was approximately $31.4 million, $18.0
million and $11.8 million for the years ended December 31, 1997, 1996 and
1995, respectively.
Capital Leases
Communications network includes assets acquired under capital leases of
approximately $154.1 million and $114.1 million (including approximately
$111.6 million and $96.0 million with related parties) at December 31, 1997,
and 1996, respectively. The related accumulated depreciation and amortization
was approximately $18.9 million and $12.1 million, respectively.
The following is a schedule, by year, of future minimum payments under the
leases, together with the present value of the net minimum payments as of
December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
YEARS AMOUNT
----- -------
<S> <C>
1998...................................... $38,218
1999...................................... 12,545
2000...................................... 4,860
2001...................................... 844
2002...................................... 534
Thereafter................................ 4,130
-------
Total minimum lease payments.............. 61,131
Less amount representing interest......... 8,312
-------
Total obligations under capital leases.... $52,819
=======
</TABLE>
Retention Incentive
As part of the AT&T Merger, TCG has offered a retention incentive
compensation package to all employees as of January 8, 1998. These amounts are
payable in four installments, the closing date of the proposed AT&T Merger,
the first anniversary of the closing date, the second anniversary of the
closing date and thereafter to all employees still employed at TCG. Such
amounts are currently estimated at $14.4 million, $14.4 million, $10.4 million
and $.8 million, respectively. There are no assurances that the AT&T Merger
will be consummated.
29
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Revenue Sharing Agreements
Teleport Communications is subject to a revenue sharing agreement with The
Port Authority of New York and New Jersey (the "Port Authority"). Based on the
agreement, Teleport Communications is obligated to pay to the Port Authority
5% of its gross revenues, and may be required to pay a "net return rental
fee," as defined, to the extent its cumulative net return exceeds the
entitlement amount. For the years ended December 31, 1997, 1996 and 1995 the
payments made were $300,000 in each year. Teleport Communications is required
to remit to the Port Authority a minimum payment currently equal to $300,000
annually.
Teleport Communications entered into a 15-year franchise agreement with the
City of New York during 1994, which among other things, requires a payment
based on certain gross revenues, as defined in the agreement. The franchise
provides for the payment of 10% of certain gross revenues in 1995 and 1996, 6%
in 1997 and 5% thereafter, all subject to certain setoffs, reductions and
adjustments. The franchise also provides that commencing with calendar year
1995, payment to the City will be no less than $200,000 per year. For the
years ended December 31, 1997, 1996 and 1995 the payments made to the City
under the franchise were $1.1 million, $0.8 million and $0.3 million,
respectively.
Litigation
In April 1997, a complaint seeking damages in an unspecified amount was
filed against the Company in the Circuit Court of Cook County, Illinois by two
former customers of the Company and an alleged class purporting to consist of
investors in one of the customers, alleging fraud and breach of contract. The
initial complaint was dismissed in September 1997 and an amended complaint was
refiled by the plaintiffs in October 1997. The Company, upon consultation with
counsel, believes that the allegations are without merit and that it possess
meritorious counterclaims for damages arising from breach of contract. The
Company additionally believes that any costs arising from this lawsuit will
not have a material adverse effect on its financial condition, results of
operations or cash flows.
On December 16, 1997, prior to public announcement of the AT&T Merger, an
action was filed by one TCG public stockholder in the Delaware Court of
Chancery against TCG, TCG's directors and the Cable Stockholders. The
plaintiff's complaint alleges that, based on public reports, TCG's directors,
management and controlling stockholders were negotiating the sale of TCG to
AT&T on a preferential basis. This sale on a preferential basis, the complaint
alleges, would offer little or no premium over the current market price of TCG
Class A Common Stock and is therefore unfair and inadequate to TCG's public
stockholders. The plaintiff seeks to enjoin the merger of TCG and AT&T or,
alternatively, to rescind the transaction and/or recover damages in the event
that the transaction is consummated. The complaint seeks to have the action
certified for class action status and to appoint the plaintiff as the class
representative.
On January 12, 1998, an action was filed by two TCG public stockholders in
the Delaware Court of Chancery against TCG, certain TCG directors and
officers, the Cable Stockholders and AT&T. The complaint alleges that the
exchange ratio in the AT&T Merger represents an inadequate premium for
stockholders of TCG Class A Common Stock. The complaint further alleges that
the actions of the TCG directors, officers and Cable Stockholders in
connection with the AT&T Merger constitute a breach of various fiduciary
duties owed to the stockholders of TCG Class A Common Stock. The plaintiffs
seek to enjoin the merger of TCG and AT&T or, alternatively, to rescind the
transaction and/or recover damages in the event that the transaction is
consummated. The complaint seeks to have the action certified for class action
status and to appoint the plaintiffs as the class representatives.
On January 28, 1998, an action was filed by a TCG public stockholder in the
Delaware Court of Chancery against TCG, certain TCG directors and officers,
and the Cable Stockholders. The complaint alleges that the exchange ratio in
the AT&T Merger represents an inadequate premium for stockholders of TCG Class
A
30
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Common Stock. The complaint further alleges that the actions of the TCG
directors, officers and Cable Stockholders in connection with the AT&T Merger
constitute a breach of various duties owed to the stockholders of TCG Class A
Common Stock. The plaintiffs seek to enjoin the merger of TCG and AT&T or,
alternatively, to rescind the transaction and/or recover damages and fees in
the event that the transaction is consummated. The complaint seeks to have the
action certified for class action status and to appoint the plaintiff as the
class representative.
Plaintiffs' counsel in the above three putative stockholder class action
proceedings have agreed (i) to defer the obligation of the defendants to
answer the actions and (ii) to consolidate the actions by filing an amended
consolidated complaint. As of the end of February 1998, the amended
consolidated complaint had not been filed. The Company believes that these
proceedings, individually and in the aggregate, are without merit and that any
associated costs will not have a material adverse effect on TCG's financial
condition, results of operations or cash flows.
In the ordinary course of business, TCG is involved in various litigation
and regulatory matters, proceedings and claims. In the opinion of TCG's
management, after consultation with counsel, the outcome of such proceedings
will not have a materially adverse effect on TCG's financial position, results
of operations or cash flows.
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest and non-cash investing and financing activities for
the years ended December 31, 1997, 1996 and 1995 were as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Cash paid during the year for interest............ $ 43,008 $ 7,818 $ 8,675
======== ======== =======
Fixed assets acquired under capital leases........ $ 38,244 $ 14,034 $15,151
======== ======== =======
Compensation paid in stock........................ $ 4,772 -- --
======== ======== =======
Rights-of-way obtained in exchange for cable
installation..................................... $ -- $ -- $ 1,330
======== ======== =======
Conversion of subordinated debt to parents plus
accrued interest................................. $ -- $263,602 $ --
======== ======== =======
Conversion and stock split of $1 par value common
stock to 139,250,370 shares of Class B Common
Stock as part of the TCG Reorganization.......... $ -- $213,099 $ --
======== ======== =======
Acquisition of subsidiaries....................... $131,246 $ -- $ --
-------- -------- -------
Cash acquired in acquisitions..................... 1,203 -- --
Common stock issued............................... 123,334 -- --
-------- -------- -------
124,537 -- --
-------- -------- -------
Cash paid to acquire subsidiaries................. $ 6,709 $ -- $ --
======== ======== =======
</TABLE>
31
<PAGE>
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
13. SELECTED QUARTERLY INFORMATION (UNAUDITED)
Summarized below is quarterly financial information for the years ended
December 31, 1997 and 1996 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
1997 CONSOLIDATED CONSOLIDATED CONSOLIDATED CONSOLIDATED TOTAL
---- ------------ ------------ ------------ ------------ ---------
<S> <C> <C> <C> <C> <C>
Revenues................ $ 96,844 $115,664 $131,406 $150,390 $ 494,304
Net loss................ (45,028) (51,332) (53,784) (72,523) (222,667)
Loss per common share... $ (0.28) $ (0.31) $ (0.33) $ (.42) $ (1.34)
<CAPTION>
1996 COMBINED COMBINED CONSOLIDATED CONSOLIDATED TOTAL
---- ------------ ------------ ------------ ------------ ---------
<S> <C> <C> <C> <C> <C>
Revenues................ $ 50,435 $ 57,087 $ 72,749 $ 87,398 $ 267,669
Net loss................ (18,693) (19,743) (33,705) (42,709) (114,850)
Loss per common share... $ (0.25) $ (0.27) $ (0.21) $ (0.27) $ (1.00)
</TABLE>
32
