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Mediacom 2004 Annual Report Me * lacom MEDIACOM COMMUNICATIONS CORPORATtQN::r: n"-.r~ ~- I..~:~. ,-.-. C)- ~_- ~ -(:~) :>; '..J ,.- j> =-~~ 2004 Annual Report C) (I) -n _,l,J G-) 1'0 ,'0 '.-n .-) T'l i l t \:' ..- ~ '.J ! r I ,-, '--- o MEDIACOM COMMUNICATIONS CORPORATION (dollars in thousands and unaudited) 2004 2003 2002 2001 2000 1999 1998 1997 1996(S} Revenues $1,057,226 $1,004,889 $ 923,033 $ 585,175 $ 328,258 $ 174,961 $ 129,297 $ 17,634 $ 5,411 OIBDA"( $ 413,681 $ 405,697 $ 371,251 $ 248,293 $ 127,713 $ 62,649 $ 54,055 $ 8,509 $ 2,699 Operating Income (Loss) $ 196,419 $ 132,390 $ 51,816 $ (62,492) $ (50,618) $ (38,416) $ (11,738) $ 873 $ 542 Capitol Expenditures (2( $ 181,362 $ 240,541 $ 408,314 $ 285,396 $ 183,518 $ 86,669 $ 53,721 $ 4,699 $ 671 Total Assets $3,635,655 $3,662,7 63 $3,703,974 $3,664,848 $1,379,972 $ 1 ,272,881 $451,152 $102,791 $46,560 Total Debt $3,009,632 $3,051,492 $3,019,000 $2,798,000 $ 987,000 $1,139,000 $337,905 $ 72,768 $40,529 Total Stockholders' Equity $ 293,512 $ 285,114 $ 346,541 $ 507,576 $ 261,621 $ 54,615 $ 78,651 $ 24,441 $ 4,537 Estimated Homes Passed 2,785,000 2,755,000 2,715,000 2,630,000 1,173,000 1,071,500 520,000 87,750 38,749 Basic Subscribers 1,458,000 1,543,000 1,592,000 1,595,000 779,000 719,000 354,000 64,350 27,153 Digital Customers 396,000 383,000 371,000 321 ,000 40,000 5,300 Data Customers 367,000 280,000 191,000 115,000 15,600 5,100 4,729 2,518 2,225 Total RGUs (3( 2,221,000 2,206,000 2,154,000 2,031,000 834,600 729,400 358,729 66,868 29,378 RGU Penetration ('( 80% 80% 79% 77% 71% 68% 69% 76% 76% REVENUES (dollars in thousands) OIBDAIl! (dollars in thousands) -<:J " ". C>- "- co '" co 0 '" '" 0 8 ~ M " C>- "- 00 C>- -<:J -<:J M :;:; '" 0 ; ". '" "- '" RGUs 131 0 0 0 0 0 0 0. D. 0 D. -<:J 0 '" 0 ;;; D. '" ". ". M " " D. " " '" "- '" C>- " co' '" " '" '" '" '" '" ". '" " '" "- :0 I C>- c>-. " '" 0: "- " ~ '" I '" - -<:J '" "- '" ... '" "- "- " o o '" C>-. " "- o o -<:J '" '" '" '" '" D. '" '" u ! i I '96 '97 '98 '99 '00 '01 '02 '03 '04 '" "- '" 0: " '96 '97 '98 '99 '00 '01 '02 '03 '04 C>- ~ ~ ~ '96 '97 '98 '99 '00 '01 '02 '03 '04 (1) Operating income before depreciation and omortizotion, or OIBDA, is a financial measure that is not colculated in accordance with generally accepted accounting principles (GAAP) in the United States. For an explanation of why we refer to OIBDA, and a reconciliation of OIBDA to operating income (loss). please see "Use of Non.GAAP Financial Measures" on poge 4. (2) Copital expenditures for 2003 include $9.0 million finonced thraugh copitolleoses. (3) Revenue Generating Units. or RGUs, represent the sum of bosic subscribers, digitol customers and dota customers. (4) Represents RGUs os a percentage of estimated homes passed. (5) Revenues, OIBDA, operating income (loss) and capital expenditures are for the period from the commencement of our operations on March 12, 1996 through December 31, 1996. MEDIACOM COMMUNICATIONS CORPORATION (dollars in thousands and unaudited) 2004 2003 2002 2001 2000 1999 1998 1997 1996 Revenues $1,057,226 $1,004,889 $ 923,033 $ 585,175 $ 328,258 $ 174,961 $ 129,297 $ 17,634 $ 5,411 OIBDA(1} $ 413,681 $ 405,697 $ 371,251 $ 248,293 $ 127,713 $ 62,649 $ 54,055 $ 8,509 $ 2,699 Operating Income (Loss) $ 196,419 $ 132,390 $ 51,816 $ (62,492) $ (50,618) $ (38,416) $ (11,738) $ 873 $ 542 Co pita I Expend itu res (2( $ 181,362 $ 240,541 $ 408,314 $ 285,396 $ 183,518 $ 86,669 $ 53,721 $ 4,699 $ 671 Total Assets $3,635,655 $3,662,763 $3,703,974 $3,664,848 $1,379,972 $ 1 ,272,881 $451,152 $102,791 $46,560 Total Debt $3,009,632 $3,051,492 $3,019,000 $2,798,000 $ 987,000 $1,139,000 $337,905 $ 72,768 $40,529 Total Stockholders' Equity $ 293,512 $ 285,114 $ 346,541 $ 507,576 $ 261,621 $ 54,615 $ 78,651 $ 24,441 $ 4,537 -- ------------------------ -------- ------ Eslimoled Homes Passed 2,785,000 2,155,000 2,115,000 2,630,000 I, 173,000 1,071,500 520,000 87,150 38,149 Basic Subscribers 1,458,000 1,543,000 1,592,000 1,595,000 779,000 719,000 354,000 64,350 27,153 Digital Customers 396,000 383,000 371,000 321 ,000 40,000 5,300 Data Customers 367,000 280,000 191,000 115,000 15,600 5,100 4,729 2,518 2,225 ------ --------- ---- Total RGUs 2,221,000 2,206,000 2,154,000 2,031,000 834,600 729,400 358,729 66,868 29,378 RGU Penetration (4) 80% 80% 79% 77% 71% 68% 69% 76% 76% ------------- ----------------- ----------------- REVENUES (dollars in thousands) OIBDA(ll (dollars in thousands) -<:J '" '" " '" a, '" "', " '" " '" -<:J '" o '" co -<:J '" ; RGUs (31 0 0 0 0 0 0 0. a, 0 0 -<:J ;;; 0 '" 0 0. '" '" "', M '" '" 0 '" '" '" oo oo, '" '" 0 8~ 0, '" '" '" '" " '" '" '" 00 '" '" '" oo '" oo '" '" oo' '" '" :' " ,,' '" o o "', '" '" " o o -<:J '" '" oo dU '" '" 0. '" '" u ! i I '96 '97 '98 '99 '00 '01 '02 '03 '04 oo " "'. '" '" '" '" '" ~ ~ ~ '96 '97 '98 '99 '00 '01 '02 '03 '04 '96 '97 '98 '99 '00 '01 '02 '03 '04 (1) Operating income before depreciation and omortizotion, or OIBDA, is 0 financial measure that is not calculated in accordance with generally accepted accounting principles (GAAP) in the United States. For an explanation of why we refer to OIBDA, and a reconciliation of OIBDA to operating income (loss), please see "Use of Non-GAAP Financial Measures" on page 4. (2) Capital expenditures for 2003 include $9.0 million financed through capital leases. (3) Revenue Generating Units, or RGUs, represent the sum of basic subscribers, digital customers and data customers. (4) Represents RGUs os a percentage of estimated homes passed. (5) Revenues, OIBDA, operating income (loss) and capital expenditures are for the period from the commencement of our operations on March 12, 1996 through December 31, 1996. MEDIACOM COMMUNICATIONS CORPORATION (dollars in thousands and unaudited) 2004 2003 2002 2001 2000 1999 1998 1997 1996 --------------.-.----'..----------------------- -------- Revenues $1,057,226 $1,004,889 $ 923,033 $ 585,175 $ 328,258 $ 174,961 $ 129,297 $ 17,634 $ 5,411 OIBDAI'1 $ 413,681 $ 405,697 $ 371,251 $ 248,293 $ 127,713 $ 62,649 $ 54,055 $ 8,509 $ 2,699 Operating Income (Loss) $ 196,419 $ 132,390 $ 51,816 $ (62,492) $ (50,618) $ (38,416) $ (11,738) $ 873 $ 542 Capital Expenditures 121 $ 181,362 $ 240,541 $ 408,314 $ 285,396 $ 183,518 $ 86,669 $ 53,721 $ 4,699 $ 671 Total Assets $3,635,655 $3,662,7 63 $3,703,974 $3,664,848 $1,379,972 $1,272,881 $451,152 $102,791 $46,560 Total Debt $3,009,632 $3,051,492 $3,019,000 $2,798,000 $ 987,000 $1,139,000 $337,905 $ 72,768 $40,529 Total Stockholders' Equity $ 293,512 $ 285,114 $ 346,541 $ 507,576 $ 261,621 $ 54,615 $ 78,651 $ 24,441 $ 4,537 -- -- --------- -------- Estimated Homes Passed 2,785,000 2,755,000 2,715,000 2,630,000 1,173,000 1,071,500 520,000 87,750 38,749 Basic Subscribers 1,458,000 1,543,000 1,592,000 1,595,000 779,000 719,000 354,000 64,350 27,153 Digital Customers 396,000 383,000 371,000 321 ,000 40,000 5,300 Data Customers 367,000 280,000 191,000 115,000 15,600 5,100 4,729 2,518 2,225 ------ ------ Total RGUs (3) 2,221,000 2,206,000 2,154,000 2,031,000 834,600 729,400 358,729 66,868 29,378 RGU Penetration (41 80% 80% 79% 77% 71% 68% 69% 76% 76% ------------------- ---------------------- " ---------------- REVENUES OIBDA (1) (dollars in thousands) (dollars in thousands) '" 01 01, 0- " ro co "'. a ... a a " ro 0- '" '" ~ co M a ;;: 01, ... ;:::: M RGUs (3) a a a a a a a a, a 0. ",' a ... a N a, co 01, 01 ;;; 01 01 a, 01' 01 M M a, M 01 0- co " M 0- N 00 ... 01 co ro co ro co 01 00 01 M " :;; I 0- 0-, 01, ... 0- " 01 ~ ... ~ I M '" i ... " co .... :' " ,,' 01 a a ..., 0- N " a a '" ... M ro co co 0. ... co iI ! i I '96 '97 '98 '99 '00 '01 '02 '03 '04 ro " "'- 0- N '96 '97 '98 '99 '00 '01 '02 '03 '04 0- 0- lI1I ~ ~ I '96 '97 '98 '99 '00 '01 '02 '03 '04 (1) Operating income before depreciation and amortization, or OIBDA, is a financial measure that is not colculated in accordance with generally accepted accounting principles (GAAP) in the United States. For an explanation of why we refer to OIBDA, and 0 reconciliation of OIBDA to operating income (loss), please see "Use of Non-GAAP Financial Measures" on page 4. (2) Capitol expenditures for 2003 include $9.0 million financed through copitalleases. (3) Revenue Generating Units, or RGUs, represent the sum of basic subscribers, digital customers and data customers. (4) Represents RGUs as a percentage of estimated homes passed. (5) Revenues, OIBDA, operoting income (loss) and capitol expenditures are for the period from the commencement of our operations on March 12, 1996 through December 31, 1996. 1996 !51 5,411 2,699 542 671 46,560 40,529 4,537 38,749 27,153 2,225 29,378 76% Dear Fellow Shareholders: 2 004 was a year of steady progress for us in a difficult business environment. Video competition hit us hard, but we moved fast to enrich and expand the availability of our suite of product offerings. We also worked hard to lay the groundwork for the launch of cable telephony in the second quarter of 2005. With these efforts, we strengthened our market position and set the stage for Mediacom to become a full service provider of video, high-speed data (HSD) and voice. The cumulative effects of local-into-local launches by direct broadcast satellite providers intensified competi- tive pressures in our video business during 2004. Satellite offerings of local channels are now available in over 90% of our markets, approaching saturation. We were also negatively impacted by Hurricane Ivan in the Florida panhandle region, where we not only lost customers, but also growth potential for the foreseeable future until the region fully recovers. Consequently, in 2004 we suffered a significant loss of basic subscribers. In our rapidly changing marketplace, success is driven by the ability to quickly adapt to shifts in competi- tion and consumer demand. To counter the competitive pressures in our video business, we moved aggres- sively to reposition our offerings by making them more compelling and by expanding their availability. We showcased our broadband network's ability to dramatically improve the overall viewing experience by giv- ing the customer greater control. We also completed several long-term agreements with major program- mers to gain access to richer content. Today, all of our customers can enjoy enhanced video packaging at attractive price points, and most can receive video-on-demand (VOD), high-definition television (HDTV) and digital video recorders (DVRs). We have also bundled these attractive video products more effectively with our HSD service, which continues to experience strong demand. Altogether, we now give our customers higher quality and greater value. We believe that our efforts to bolster our video business have started to produce positive results. During the fourth quarter, we limited our basic subscriber loss to 3,000 and added 28,000 revenue generating units (RGUs) through a combination of new digital television and data customers. This was our best quarterly performance in two years. For the year, we achieved financial results that were within our revised external guidance. Revenues grew 5.2% to $1,057.2 million. Our data and advertising businesses realized significant revenue increases of 34.4% and 21.8%, respectively. Operating income before depreciation and amortization(l) increased 2.0% to $413.7 million. We generated $232.0 million of unlevered free cash flow!ll, as compared to $164.7 mil- lion in the prior year. We also generated $39.3 million of free cash flow!!), an improvement over the negative $25.5 million generated in 2003. Our upgraded broadband network is the foundation of Mediacom's competitive advantage. We operate high-capacity, two-way fiber optic cable systems capable of delivering the performance and features that meet customer requirements well into the future. We have interconnected 75% of our markets with a regional fiber optic network that provides significant cost benefits in routing our video, data and voice traffic and creates meaningful revenue opportunities with commercial accounts. (1 )Operating income before depreciation and amortization, unlevered free cash flow and free cash flow are non-GMP financial measures. For an explanation of why we refer to these measures and reconciliations of historical presentations of these measures to their most directly comparable GMP measures, please see page 4. :21 - Capitalizing on our advanced network's capabilities, in short order we have rolled out an ever-expanding menu of products and services to more and more of our markets, giving our customers more choice. We now have a complete suite of video offerings that our major competitors cannot match. . VOD service is available to 65% of our digital customers and is projected to reach 80% by year-end 2005. Our VOD service gives customers on-demand access to our content library, which includes first- run movies, events, special interest programming and children's and music programming. Beginning in the second half of 2004, we re-energized our digital service by bundling premium services, such as HBO, Starzl and Showtime, with subscription VOD (SVOD) content. During the year, we quadrupled our on-demand content library to 1,200 hours of programming, largely by adding SVOD content. Customers have clearly responded to these enhancements. Our digital product category has grown at an increasing rate, the number of customers who use our VOD/SVOD service has doubled and VOD/SVOD usage per household has jumped 80%. . HDTV service, available to 77% of our digital customers, is also driving demand for our digital video service. Our customers recognize that we are the leader in providing local broadcast high-definition channels in our markets. We also provide HD channels as part of premium channel subscriptions. The acceptance rate of our HDPak, which includes ESPNHD, HDNet, Universal HD and Discovery HD, has shown rapid growth, clearly demonstrating that our HDTV customers want to watch HD content. In less than a year, the HDPak quickly achieved a penetration rate of over 25% of our HD-DVR households. . DVRs are available across our footprint, and customer demand has been strong. DVRs, with their time- shifting capability that lets our customers record and view what they want when they want to watch it, nicely complement our VOD, SVOD and HDTV services. . Our data business had another record year in 2004, with customers and revenues growing more than 31 % and 34%, respectively, year-over-year. We are focused on product development and early in the year we doubled the download and upload speeds of our flagship data product. We are developing new HSD services, including high-bandwidth, interactive applications such as gaming, which we believe will be popular with many of our customers. Our most important product news right now is the expected launch of telephony in the second quarter of 2005. It will enable us to offer a powerful bundle of broadband products in one package, on one bill, from one provider who will be the single contact for provisioning and service and at lower cost than traditional phone service. Just as important, we are confident that we can deliver this service in a capital-efficient man- ner due to the power of our broadband network and a multi-year agreement we finalized in 2004 with Sprint Corporation that allows us to leverage Sprint's resources. We are taking a cautious approach with our telephony rollout schedule to make sure that our execution is flawless and customer experience is excellent. We believe our telephony service will have an accelerated growth curve similar to what we have experienced with HSD. Moreover, because telephony is almost ubiq- uitous across our customer base today, and because we can bundle it with video and HSD as a triple play, it may well grow even faster than HSD. 2 i We are a local business. Unlike the satellite competition, we believe it is important for us to support the communities we serve. We are proud to participate in the "Mediacom Cable in the Classroom" program, where we provide more than 2,800 schools with free video service and more than 200 schools with free high-speed Internet access. We also provide free video service to over 3,000 government buildings, libraries, and not-for-profit hospitals in our franchise areas. To help foster community spirit and awareness, we produce exclusive local programming. For example, our Mediacom Connections channel in Iowa airs over 60 hours per week of programming, including high school and college sporting events as well as civic events such as town and city council meetings. Underscoring our local commitment, our employees pro- vide valuable resources and volunteer support for numerous city, town and neighborhood programs across our markets. Customer satisfaction is a top priority for our Company. That is why we have invested in virtual contact cen- ter technology that improves the quality of our customer care and technical support. This technology pro- vides customers with extensive self-service capabilities, enables us to re-route calls among our different offices to minimize hold times and gives technical service personnel instant access to billing and product information in order to promptly resolve issues. We are also driving customer satisfaction higher by our con- tinuous investment in the training and development of our locally based service representatives, who respond to calls 24 hours per day, seven days per week. Now that we have made the investment and laid the groundwork with our advanced broadband network, we see our capital spending requirements stabilizing and largely dependent on our success in growing RGUs. Our investment plans are supported by a solid capital structure. In 2004, we successfully completed a major bank refinancing, and today we have significant liquidity with over $700 million of bank borrow- ing availability, modest required debt amortization over the next few years and a reasonable cost of debt. Importantly, our capital structure gives us the ability to make sound, long-term investment decisions. I would like to thank our 3,700 hard-working employees who have positioned Mediacom well for 2005 and beyond. Because of their dedication, we continue to effectively deliver a growing portfolio of products that differentiates us further from the competition. I would also like to thank you, our shareholders, for your support. We are committed to building long-term shareholder value and we look forward to making Mediacom even stronger and better in the years ahead. f0Q~ Rocco B. Commisso Chairman and Chief Executive Officer Mediacom Communications Corporation April 29, 2005 3 ,....... Use of Non-GAAP Financial Measures "Operating income before depreciation and amortization" (OIBDA), "unlevered free cash flow," and "free cash flow" are not financial measures calculated in accordance with generally accepted accounting principles (GMP) in the United States. We define unlevered free cash flow as OIBDA less cash taxes and capital expenditures, and free cash flow as OIBDA less interest expense, net, cash taxes and capital expenditures. OIBDA is one of the primary measures used by our management to evaluate our performance and to forecast future results. We believe OIBDA is useful for investors because it enables them to assess our performance in a manner similar to the method used by management, and provides a measure that can be used to analyze, value and compare the companies in the cable television industry, which may have different depreciation and amortization policies. A limitation of this measure, however, is that it excludes depreciation and amortization, which represents the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business. Management utilizes a separate process to budget, measure and evaluate capital expenditures. Unlevered free cash flow and free cash flow are used by management to evaluate our ability to service our debt and to fund continued growth with internally generated funds. We believe unlevered free cash flow and free cash flow are useful for investors because they enable them to assess our ability to service our debt and to fund continued growth with internally generated funds in a manner similar to the method used by management, and provide measures that can be used to analyze, value and compare companies in the cable television industry. Our definitions of unlevered free cash flow and free cash flow eliminate the impact of quarterly working capital fluctuations, most notably from the timing of semi-annual cash interest payments on our senior notes. The only difference between the terms unlevered free cash flow and free cash flow is that unlevered free cash flow does not subtract interest expense, net. OIBDA, unlevered free cash flow and free cash flow should not be regarded as alternatives to either operating income, net income or net loss as indicators of operating performance or to the statement of cash flows as measures of liquidity, nor should they be considered in isolation or as substitutes for financial measures prepared in accordance with GMP. The following represents a reconciliation of historical presentations of OIBDA to operating income (loss), which is the most directly comparable GMP measure (dollars in thousands and unaudited): Year Ended December 31 , 2004 2003 2002 2001 2000 1999 1998 1997 1996 OIBDA $ 413,681 $ 405,697 $ 371,251 $ 248,293 $ 127,713 $ 62,649 $ 54,055 $ 8,509 $ 2,699 Depreciation and amortizalion (217,262) (273,307) (319,435) (310,785) (178,331) (101,065) (65,793) (7,636) (2,157) Operating income $ 196,419 $ 132,390 $ 51,816 $ (62,492) $ (50,618) $ (38,416) $(11,738) $ 873 $ 542 The following represents a reconciliation of historical presentations of unlevered free cash flow and free cash flow to net cash flows provided by operating activities, which is the most directly comparable GMP measure (dollars in thousands and unaudited): Twelve Months Ended December 31, Unlevered free cash flow Interest expense, net Free cash flow Capital expenditures Other expenses Change in assets and liabilities, net Net cash flows provided by operating activities 2004 $ 232,000 (192,740) $ 39,260 181,362 (3,093) 7,082 $ 224,611 2003 $ 164,732 (190,199) $ (25,467) 240,541 (4,764) (3,410) $ 206,900 4 ~ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15( d) of the Securities Exchange Act of 1934 For the fIScal year ended December 31, 2004 Commission File Number: 0-29227 Mediacom Communications Corporation (Exact name of Registrant as specified in its charter) d .e Delaware (State of incorporation) 06-1566067 (I.R.S. Employer Identification Number) h d 100 Crystal Run Road Middletown, New York 10941 (Address ofprindpal executive offices) Ie ~e (845) 695-2600 (Registrant's telephone number) e Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Class A Common Stock, $0.01 par value per share 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.xNo _ 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 the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form IO-K or any amendment to this Form IO-K: [Xl Indicate by check marR whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes.x No As of June 30, 2004, the aggregate market value of the Class A common stock of the Registrant held by non- affiliates of the Registrant was approximately $474.6 million. As of February 4, 2005 there were outstanding 90,399,048 shares of Class A common stock and 27,461,939 shares of Class B common stock. DOCUMENTS INCORPORATED BY REFERENCE I) II) o Portions of the Registrant's Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III. -- Item l. Item 2. Item 3. Item 4. Item 4A. Item 5. Item 6. Item 7. Item 7 A. Item 8. Item 9 Item 9A. Item 9B. Item 10. Item 11. Item 12. Item 13. Item 14. Item 15. MEDlACOM COMMUNICATIONS CORPORATION 2004 FORM 10-K ANNUAL REPORT T ABLE OF CONTENTS PART I Busi n ess ...................... ........... ............. ........... .................. ............... ........ ......................... Pro pe rties ............ ........... ........... ............. ................. ......................................... ............... Lega I Proceed i ngs .. ....... ................. .......... ....... ....... ........ ......... ...... ........... ......... ........ ...... Submission of Matters to a Vote of Security Holders............................................,..... Directors and Executive Officers of the Registrant ..................................................... PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities................................................................. Selected Fina n cia I Data .......... ..... ........ ................. ......... ........ ....... ........ ......... ........... ...... Management's Discussion and Analysis of Financial Condition and Res u Its 0 f 0 pe ra tio ns ... ...... ...... ....... .......... ................. ....... .......... ..... .... ....................... Quantitative and Qualitative Disclosures About Market Risk ................................... Financial Statements and Su pplementary Data ........................................................... Changes in and Disagreements with Accountants on Accounting and Financial Disc los u re .............. ........................ ..... .............. ..... ........ ............................ ............ ..... ..... Co n tro Is and Proced u res ..... ...... ............... ............ ...................... ........... ......................... Oth e r Info rma tio n ......... ......... ....... ...... ........... ......................... .......... .............. ............... PART III Directors and Executive Officers of the Registrant ..................................................... Exec u tive Com pensa tion ..... ..... ..................... ............... ............................ ....... ............... Security Ownership of Certain Beneficial Owners and Management and Related Stockh olde r Matters ........... ........... ....................... ................................... ...... Certain Relationships and Related Transactions......................................................... Principal Accountant Fees and Services ....................................................................... PART IV Ex h i bits, Fi nan cia I S ta tem e n t Sc h ed u Ie ................. ......... ........ ....... ........... ........ ............ 2 - Paee 4 30 30 31 31 33 34 37 57 58 83 83 83 84 84 84 84 84 85 . References in this Annual Report to "we," "us," or "our" are to Mediacom Communications Corporation and its direct and indirect subsidiaries since its initial public offering in February 2000 and to Mediacom LLC and its direct and indirect subsidiaries prior to the initial public offering, unless the context specifies or requires otherwise. Cautionary Statement Regarding Forward-Looking Statements You should carefully review the information contained in this Annual Report and in other reports or documents that we file from time to time with the Securities and Exchange Commission (the "SEC"). In this Annual Report, we state our beliefs of future events and of our future financial performance. In some cases, you can identify those so-called "forward-looking statements" by words such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or the negative of those words and other comparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks discussed in this Annual Report and other reports or documents that we file from time to time with the SEe. Those factors may cause our actual results to differ materially from any of our forward-looking statements. All forward- looking statements attributable to us or a person acting on our behalf are expressly qualified in their entirety by this cautionary statement. 3 . -- PART I ITEM 1. BUSINESS In trod uction We are currently the nation's eighth largest cable television company based on customers served and the leading cable operator focused on serving the smaller cities and towns in the United States. Through our interactive broadband network, we provide our customers with a wide array of products and services, including analog and digital video services, advanced video services such as video-on-demand ("VOD"), high-definition television ("HDTV") and digital video recorders ("DVR"), and high-speed data ("HSD"), also known as high-speed Internet access or cable modem service. We currently offer our customers a variety of options to bundle our array of video services with HSD. In the second quarter of2005 we plan to begin the rollout of cable telephony, which will enable us to offer our customers a triple-play bundle of video, HSD and voice services. As of December 31,2004, our cable systems passed an estimated 2.79 million homes and served approximately 1.46 million basic subscribers, and 2.22 million revenue generating units ("RGUs"). Approximately 65% of our customers are located within the top 1 00 television markets in the United States, with a concentration of customers in the midwest and southern regions. A basic subscriber is a customer who subscribes to a package of cable television services. RGUs represent the sum of basic subscribers, digital customers and HSD customers. We are a public company and our Class A common stock is listed on The Nasdaq National Market under the symbol "MCCC". We were founded in July 1995 by Rocco B. Commisso, our Chairman and Chief Executive Officer, who beneficially owns shares in our company representing the majority of the combined voting power of our common stock. Since commencement of our operations in March 1996, we have experienced significant growth by executing a disciplined strategy of acquiring underperforming cable systems and improving their operating and financial performance. In 2001, we acquired cable systems that served approximately 800,000 basic subscribers, more than doubling our size and enhancing our scale efficiencies in operations and capital investments in technology. Our principal executive offices are located at 100 Crystal Run Road, Middletown, New York 10941 and our telephone number at that address is (845) 695-2600. Our website is located at www.mediacomcc.com. We have made available free of charge through our website (follow the Corporate Info link to the Investor Relations tab to "Annual Reports/SEC Filings") our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such material was electronically filed with, or furnished to, the Securities and Exchange Commission. We have also made our Code of Ethics available through our website, under the heading "Corporate Information". The information on our website is not part of this Annual Report. Business Strategy Our strategy is to be the leading single-source provider of advanced video, data and voice products and services in our markets, which will allow us to deepen relationships with our existing customers, attract new customers and further diversify our revenue streams. We believe that our interactive broadband network is the superior platform today for the delivery of these products and services within our service areas. We have a local presence, with facilities and employees in the communities where our customers live. We believe that offering products and services in bundles, together with reliable customer service and our local community presence, will enable us to execute our strategy and compete effectively. Network Technology We operate high-capacity, fiber-optic cable systems, substantially all of which are activated with two-way communications capability. We have also interconnected approximately 75% of our estimated homes passed with a 4 ,.. . Copyright Our cable systems typically include in their channel line-ups local and distant television and radio broadcast signals, which are protected by the copyright laws. We generally do not obtain a license to use this programming directly from the owners of the programming, but instead comply with an alternative federal compulsory copyright licensing process. In exchange for filing certain reports and contributing a percentage of our revenues to a federal copyright royalty pool, we obtain blanket permission to retransmit the copyrighted material carried on these broadcast signals. The nature and amount of future copyright payments for broadcast signal carriage cannot be predicted at this time. In a report to Congress, the U.S. Copyright Office recommended that Congress make major revisions to both the cable television and satellite compulsory licenses. In 1999, Congress modified the satellite compulsory license in a manner that permits DBS service providers to become more competitive with cable operators. Congress recently adopted legislation extending this authority through 2009. The possible simplification, modification or elimination of the cable communications compulsory copyright license is the subject of continuing legislative review. The elimination or substantial modification of the cable compulsory license could adversely affect our ability to obtain suitable programming and could substantially increase the cost of programming that remains available for distribution to our subscribers. We are unable to predict the outcome of this legislative activity related to either the cable compulsory license or the right of direct broadcast satellite providers to deliver local broadcast signals. Copyrighted material in programming supplied to cable television systems by pay cable networks and basic cable networks is licensed by the networks through private agreements with the copyright owners. These entities generally offer through to-the-viewer licenses to the cable networks that cover the retransmission of the cable networks' programming by cable television systems to their customers. Our cable systems also utilize music in other programming and advertising that we provide to subscribers. The rights to use this music are controlled by various music performing rights organizations from which performance licenses must be obtained. Cable industry representatives negotiated standard license agreements with the largest music performing rights organizations covering locally originated programming, including advertising inserted by the cable operator in programming produced by other parties. These standard agreements require the payment of music license fees for earlier time periods, but such license fees have not had a significant impact on our business and operations. Interactive Television The FCC has issued a Notice of Inquiry covering a wide range of issues relating to interactive television ("ITV"). Examples of lTV services are interactive electronic program guides and access to a graphic interface that provides supplementary information related to the video display. In the near term, cable systems are likely to be the platform of choice for the distribution of ITV services. The FCC posed a series of questions including the definition of lTV, the potential for discrimination by cable systems in favor of affiliated ITV providers, enforcement mechanisms, and the proper regulatory classification of lTV service. Privacy The Cable Act impos..es a number of restrictions on the manner in which cable television operators can collect, disclose and retain data about individual system customers and requires cable operators to take such actions as necessary to prevent unauthorized access to such information. The statute also requires that the system operator periodically provide all customers with written information about its policies including the types of information collected; the use of such information; the nature, frequency and purpose of any disclosures; the period of retention; the times and places where a customer may have access to such information; the limitations placed on the cable operator by the Cable Act; and a customer's enforcement rights. In the event that a cable television operator is found to have violated the customer privacy provisions of the Cable Act, it could be required to pay damages, attorneys' fees and other costs. Certain of these Cable Act requirements have been modified by certain more recent 26 -- c t] u Ii o tl C cl Ir e' bi cr re at Ii1 m m Sf IS: to both license ngress tion or ;islative :ect our emains related 'oadcast Id basic entities Ie cable rs. The rmance . largest . rted by ment of usiness :Ievision ace that :0 be the tinition Ircement collect, tions as operator rmation tention; e cable lerator is amages, e recent federal laws. Other federal laws currently impact the circumstances and the manner in which we disclose certain customer information and future federal legislation may further impact our obligations. In addition, some states in which we operate have also enacted customer privacy statutes that are in some cases more restrictive than those in federal law. Cable Modem Service There are currently few laws or regulations that specifically regulate communications or commerce over the Internet. Section 230 of the Communications Act declares it to be the policy of the United States to promote the continued development of the Internet and other interactive computer services and interactive media, and to preserve the vibrant and competitive free market that presently exists for the Internet and other interactive computer services, unfettered by federal or state regulation. One area in which Congress did attempt to regulate content over the Internet involved the dissemination of obscene or indecent materials. The Digital Millennium Copyright Act is intended to reduce the liability of online service providers for listing or linking to third-party Websites that include materials that infringe copyrights or other rights or if customers use the service to publish or disseminate infringing materials. The Children's Online Protection Act and the Children's Online Privacy Protection Act are intended to restrict the distribution of certain materials deemed harmful to children and impose additional restrictions on the ability of online services to collect user information from minors. In addition, the Protection of Children From Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. A number of ISPs have asked local authorities and the FCC to give them rights of access to cable systems' broadband infrastructure so that they can deliver their services directly to cable systems' customers, which is often called open access. Many local franchising authorities have examined the issue of open access and a few have required cable operators to provide such access, although several federal courts have ruled that localities are not authorized to require open access. The FCC, in connection with its review of the AOL-Time Warner merger, imposed, together with the Federal Trade Commission, limited multiple access and other requirements related to the merged company's Internet and Instant Messaging platforms. In March of 2002, the FCC announced that it was classifying Internet access service provided through cable modems as an interstate information service, a classification that is currently under review by the United States Supreme Court. At the same time, the FCC initiated a rulemaking proceeding designed to address a number of issues resulting from this regulatory classification, including the following: . the FCC confirmed that there is no current legal requirement for cable operators to grant open access now that cable modem service is classified as an information service. The FCC is considering, however, whether it has the authority to impose open access requirements and, if so, whether it should do so, or whether to permit local authorities to impose such a requirement. . the FCC found that cable modem service is an information service, not a cable service, which has resulted in several court rulings that local franchise authorities may not collect franchise fees on cable modem service revenues under existing laws and regulations. . the FCC concluded that federal law does not permit local franchise authorities to impose additional franchise requirements on cable modem service. It is considering, however, whether local franchise authorities nonetheless have the authority to impose restrictions, requirements or fees because cable modem service is delivered over cable using public rights of way. . the FCC is considering whether cable operators providing cable modem service should be required to contribute to a "universal service fund" designed to support making service available to all consumers, including those in low income, rural and high-cost areas at rates that are reasonably comparable to those charged in urban areas. 27 L T- - . the FCC is considering whether it should take steps to ensure that the regulatory burdens on cable systems providing cable modem service are comparable to those of other providers of Internet access service, such as telephone companies. One method of achieving comparability would be to make cable operators subject to some of the regulations that do not now apply to them, but are applicable to telephone companies. Challenges to the FCC's classification of cable Internet access service as an information service and not a cable service or a telecommunications service have been filed in federal court. Based on a finding that it was bound by an earlier decision, an appellate courts overturned the FCC's classification and found cable Internet service to include both information service and telecommunications service components. The United States Supreme Court has agreed to hear an appeal ofthe appellate court's decision. If the lower court's decision prevails, it could result in an open access requirement and other obligations imposed on telecommunications carriers. Any such requirements could adversely affect our results of operations. Voice-Oyer-Internet Protocol Telephony The 1996 amendments to the Cable Act created a more favorable regulatory environment for cable operators to enter the phone business. Currently, numerous cable operators are exploring, planning or have commenced offering Voice-over-Internet-Protocol ("VoIP") telephony as a competitive alternative to traditional circuit-switched telephone service. Various states, including states where we operate, have adopted or are considering differing regulatory treatment, ranging from minimal or no regulation to full-blown common carrier status. As part of the proceeding to determine any appropriate regulatory obligations for VolP telephony, the FCC recently decided that alternative voice technologies, like certain types of VolP telephony, should be regulated only at the federal level, rather than by individual states. Many implementation details remain unresolved, and there are substantial regulatory changes being considered that could either benefit or harm VolP telephony as a business operation, While the final outcome of the FCC proceedings cannot be predicted, it is generally believed that the FCC favors a "light touch" regulatory approach for VoIP telephony, which might include preemption of certain state or local regulation. State and Local Regulation Our cable systems use local streets and rights-of-way. Consequently, we must comply with state and local regulation, which is typically imposed through the franchising process. Our cable systems generally are operated in accordance with non-exclusive franchises, permits or licenses granted by a municipality or other state or local government entity. Our franchises generally are granted for fixed terms and in many cases are terminable if we fail to comply with material provisions. The terms and conditions of our franchises vary materially from jurisdiction to jurisdiction. Each franchise generally contains provisions governing: . franchise fees; . franchise term; . system construction and maintenance obligations; . system channel capacity; . design and technical performance; . customer service standards; . sale or transfer of the franchise; . territory of the franchise; 28 . 1 s h . ct . indemnification of the franchising authority; . use and occupancy of public streets; and . types of cable services provided. Ie In the process of renewing franchises, a franchising authority may seek to impose new and more onerous requirements, such as upgraded facilities, increased channel capacity or enhanced services, although protections available under the Cable Act require the municipality to take into account the cost of meeting such requirements. The Cable Act also contains renewal procedures and criteria designed to protect incumbent franchisees against arbitrary denials of renewal. to 'ng ed 'ng the hat vel, . tial ion. rs a cal A number of states subject cable systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Attempts in other states to regulate cable systems are continuing and can be expected to increase. To date, other than Delaware, no state in which we operate has enacted such state-level regulation. State and local franchising jurisdiction is not unlimited; it must be exercised consistent with federal law. The Cable Act immunizes franchising authorities from most monetary damage awards arising from regulation of cable systems or decisions made on franchise grants, renewals, transfers and amendments. 29 - ITEM 2. PROPERTIES Our principal physical assets consist of cable television operating plant and equipment, including signal receiving, encoding and decoding devices, headend facilities and distribution systems and equipment at or near customers' homes for each of the systems. The signal receiving apparatus typically includes a tower, antenna, ancillary electronic equipment and earth stations for reception of satellite signals. Headend facilities are located near the receiving devices. Our distribution system consists primarily of coaxial and fiber optic cables and related electronic equipment. Customer premise equipment consists of set-top devices and cable modems. Our cable television plant and related equipment generally are attached to utility poles under pole rental agreements with local public utilities; although in some areas the distribution cable is buried in underground ducts or trenches, The physical components of the cable systems require maintenance and periodic upgrading to improve system performance and capacity. We own and lease the real property housing our regional call centers, business offices and warehouses throughout our operating regions. Our headend facilities, signal reception sites and microwave facilities are located on owned and leased parcels of land, and we generally own the towers on which certain of our equipment is located, We own most of our service vehicles. We believe that our properties, both owned and leased, are in good condition and are suitable and adequate for our operations. ITEM 3. LEGAL PROCEEDINGS On April 5,2004, a lawsuit was filed against us, MCC Georgia LLC, one of our indirect subsidiaries, and other, currently unnamed potential defendants in the United States District Court for the District of Colorado by Echostar Satellite LLC, which operates a direct broadcast satellite business under the name "Dish Network". Echostar alleges that systems operated by us and MCC Georgia LLC have used, without authorization, Dish Network satellite dishes activated under residential accounts to receive the signals of certain broadcast television stations in one or more locations in Georgia and that it has then been redistributing those signals, through its cable systems, to its subscribers. Among other claims, the complaint filed by Echostar alleges that these actions violate a provision of the Communications Act of 1934 (47 V.S.C. Sec. 605) that prohibits unauthorized interception of radio communications. The plaintiff seeks injunctive relief, actual and statutory damages, disgorgement of profits, punitive damages and litigation costs, including attorneys' fees. On June 29, 2004, Echostar amended its complaint to also allege that this conduct amounted to a breach of the contract between Echostar and one of our employees, who allegedly acted as an agent for the defendants, by which we received the Echostar satellite signal. On September 7, 2004, the V,S. District Court granted our motion to transfer the case to the Middle District of Georgia, where venue is proper and where personal jurisdiction over us exists. There have been no further proceedings since that date, We intend to vigorously defend against these claims. At the present time, we are unable to reasonably evaluate the likelihood of an unfavorable outcome or quantify the possible damages, if any, associated with these matters, or whether or not those damages would be material. We are also involved in various other legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations, cash flows or business. 30 ~ - . ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2004. . ignal near :enna, cated lated Name ITEM 4A. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Position rental cts or lprove Rocco B. Commisso Mark E. Stephan John G. Pascarelli ltalia Commisso Weinand Joseph E. Young Charles J. Bartolotta Calvin G. Craib Brian M. Walsh Craig S. Mitchell William S. Morris III Thomas V. Reifenheiser Natale S. Ricciardi Robert L. Winikoff ouses cated ated. dition . other, :hostar lieges dishes more to its 'ion of radio rotits, Age 55 48 43 51 56 50 50 39 46 70 69 56 58 Chairman and Chief Executive Officer Executive Vice President, Chief Financial Officer, Treasurer & Director Executive Vice President, Operations Senior Vice President, Programming & Human Resources Senior Vice President, General Counsel & Secretary Senior Vice President, Customer Operations Senior Vice President, Business Development Senior Vice President & Corporate Controller Director Director Director Director Director Rocco B. Commisso has 27 years of experience with the cable television industry and has served as our Chairman and Chief Executive Officer since founding our predecessor company in July 1995. From 1986 to 1995, he served as Executive Vice President, Chief Financial Officer and a director of Cablevision Industries Corporation. Prior to that time, Mr. Commisso served as Senior Vice President of Royal Bank of Canada's affiliate in the United States from 1981, where he founded and directed a specialized lending group to media and communications companies. Mr. Commisso began his association with the cable industry in 1978 at The Chase Manhattan Bank, where he managed the bank's lending activities to communications firms including the cable industry. He serves on the board of directors and executive committees of the National Cable Television Association and Cable Television Laboratories, Inc., and on the board of directors of C-SPAN. Mr. Commisso holds a Bachelor of Science in Industrial Engineering and a Master of Business Administration from Columbia Vniversity. Mark E. Stephan has 18 years of experience with the cable television industry and has served as our Executive Vice President, Chief Financial Officer and Treasurer since November 2003. Prior to that he was Senior Vice President, Chief Financial Officer and Treasurer since the commencement of our operations in March 1996. Before joining us, Mr. Stephan served as Vice President, Finance for Cablevision Industries from July 1993. Prior to that time, Mr. Stephan served as Manager of the telecommunications and media lending group of Royal Bank of Canada. John G. Pascarelli has 24 years of experience in the cable television industry and has served as our Executive Vice President, Operations since November 2003. Prior to that he was our Senior Vice President, Marketing Consumer Services from June 2000 and our Vice President of Marketing from March 1998. Before joining us in March 1998, Mr. Pascarelli served as Vice President, Marketing for Helicon Communications Corporation from January 1996 to February 1998 and as Corporate Director of Marketing for Cablevision Industries from 1988 to 1995. Prior to that time, Mr. Pascarelli served in various marketing and system management capacities for Continental Cablevision, Inc., Cablevision Systems and Storer Communications. Mr. Pascarelli is a member of the board of directors of the Cable and Telecommunications Association for Marketing. ion of Mated Italia Commisso Weinand has 28 years of experience in the cable television industry. Before joining us in April 1996, Ms. Weinand served as Regional Manager for Comcast Corporation from July 1985. Prior to that time, Ms. Weinand held various management positions with Tele-Communications, Inc., Times Mirror Cable and Time Warner, Inc. Ms. Weinand is the sister of Mr. Commisso. 31 - ............. Joseph E. Young has 20 years of experience with the cable television industry. Before joining us in November 2001 as Senior Vice President, General Counsel, Mr. Young served as Executive Vice President, Legal and Business Affairs, for LinkShare Corporation, an Internet-based provider of marketing services, from September 1999 to October 2001. Prior to that time, he practiced corporate law with Baker & Botts, LLP from January 1995 to September 1999. Previously, Mr. Young was a partner with the Law Offices of Jerome H. Kern and a partner with Shea & Gould. Charles 1. Bartolotta has 22 years of experience in the cable television industry. Before joining us in October 2000, Mr. Bartolotta served as Division President for AT&T Broadband, LLC from July 1998, where he was responsible for managing an operating division serving nearly three million customers. Prior to that time, he served as Regional Vice President of Tele-Communications, Inc. from January 1997 and as Vice President and General Manager for TKR Cable Company from 1989. Prior to that time, Mr. Bartolotta held various management positions with Cablevision Systems Corporation. Calvin G. Craib has 23 years of experience in the cable television industry and has served as our Senior Vice President, Business Development since August 200 I. Prior to that he was our Vice President, Business Development since April 1999. Before joining us in April 1999, Mr. Craib served as Vice President, Finance and Administration for Interactive Marketing Group from June 1997 to December 1998 and as Senior Vice President, Operations, and Chief Financial Officer for Douglas Communications from January 1990 to May 1997. Prior to that time, Mr. Craib served in various financial management capacities at Warner Amex Cable and Tribune Cable. Brian M. Walsh has 16 years of experience in the cable television industry and has served as our Senior Vice President and Corporate Controller since February 2005. Prior to that he was our Senior Vice President, financial Operations from November 2003, our Vice President, Finance and Assistant to the Chairman from November 2001, our Vice President and Corporate Controller from February 1998 and our Director of Accounting from November 1996. Before joining us in April 1996, Mr. Walsh held various management positions with Cablevision Industries from 1988 to 1995. Craig S. Mitchell has held various management positions with Morris Communications Company LLC for more than the past five years. He currently serves as its Senior Vice President of Finance, Treasurer and Secretary and is also a member of its board of directors. William S. Morris III has served as the Chairman and Chief Executive Officer of Morris Communications for more than the past five years. He was the Chairman of the board of directors of the Newspapers Association of America for 1999-2000. Thomas V. Reifenheiser served for more than five years as a Managing Director and Group Executive of the Global Media and Telecom Group of Chase Securities Inc. until his retirement in September 2000. He joined Chase in 1963 and had been the Global Media and Telecom Group Executive since 1977. He also had been a director of the Management Committee of The Chase Manhattan Bank. Mr. Reifenheiser is also a member of the board of directors of Cable vision Systems Corporation and Lamar Advertising Company. Natale S. Ricciardi has held various management positions with Pfizer Inc. for more than the past five years. Mr. Ricciardi joined Pfizer in 1972 and currently serves as its President/Team Leader, Global Manufacturing, with responsibility for all of Pfizer's manufacturing facilities. Robert L. Winikoffhas been a partner of the law firm of Sonnenschein Nath & Rosenthal, LLP since August 2000. Prior thereto, he was a partner of the law firm of Cooperman Levitt Winikoff Lester & Newman, P.C. for more than five years. Sonnenschein Nath & Rosenthal, LLP currently serves as our outside general counsel, and prior to such representation, Cooperman Levitt Winikoff Lester & Newman, P.c. served as our outside general counsel from 1995. 32 --. PART II ember ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our Class A common stock is traded on the Nasdaq National Market under the symbol "MCCC". The following table sets forth, for the periods indicated, the high and low closing sales prices for our Class A common stock as reported by the Nasdaq National Market: 2004 2003 High Low High Low First Quarter $ 9.99 $ 7.40 $ 10.04 $ 6.86 Second Quarter $ 8.23 $ 6.95 $ 10.79 $ 8.37 Third Quarter $ 7.85 $ 5.86 $ 10.80 $ 6.71 Fourth Quarter $ 7.11 $ 5.10 $ 8.80 $ 6.46 As of February 4, 2005, there were approximately 750 holders of record of our Class A common stock and 5 holders of record of our Class B common stock. The number of Class A stockholders does not include beneficial owners holding shares through nominee names. We have never declared or paid any dividends on our common stock. We currently anticipate that we will retain all of our future earnings for use in the expansion and operation of our business. Thus, we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Our future dividend policy will be determined by our board of directors and will depend on various factors, including our results of operations, financial condition, capital requirements and investment opportunities. r more and is The following is a summary of our repurchases of Class A common shares during 2004 under the $50.0 million repurchase program, authorized by our Board of Directors in May 2000 and reaffirmed on August 3,2004: ons for tion of Total Number of Shares Purchased as Part of Publicly Announced Program Total Number of Shares Purchased Average Price Per share Period Third Quarter 2004........ October........... ......... November................ December................. Fourth Quarter 2004....... 596,092 $ 6.13 596,092 446, I 00 $ 5.66 446, I 00 $ $ 446, 100 1,042,192 5.66 5.93 446,100 1,042,192 August .C. for el, and general 33 Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program $ $ $ $ $ $ 40,380,751 40,380,751 37,853,837 37,853,837 37,853,837 37,853,837 . ITEM 6. SELECTED FINANCIAL DATA II"""" In the table below, we provide you with selected historical consolidated financial and operating data for the years ended December 31, 2000 through 2004 and balance sheet data as of December 31, 2000 through 2004, which are derived from our audited consolidated financial statements. We have significantly expanded our business through acquisitions. In June and July 2001, we acquired cable systems serving approximately 800,000 basic subscribers for an aggregate purchase price of$2.06 billion. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Statement of Operations Data: Revenues Costs and expenses: Service costs Selling, general and administrative expenses Corporate expenses(2) Depreciation and amortization Operating income (loss) Interest expense, net Gain (loss) on derivative instruments, net Gain (loss) on sale of assets and investments, net Other (expense) income Net income (loss) before income ta"(es Provision for income ta"(es Net income (loss) before cumulative effect of accounting change Cumulative effect of accounting change(3) Net income (loss) Basic and diluted earnings (loss) per share:(4) Before cumulative effect of accounting change Cumulative effect of accounting change Basic and diluted earnings (loss) per share: Weighted average common shares outstanding (4) Basic weighted average shares outstanding Diluted weighted average share outstanding Balance Sheet Data (end of period): Total assets Total debt Total stockholders' equity 2004 $ 1,057,226 412,841 211,428 19.276 217,262 196,419 (192,740) 16,125 5,885 (12,061) 13,628 76 13,552 $ 13,552 $ 0.11 $ 0.11 1l8,533,513 118,543,126 $ 3,635,655 3,009,632 293,512 Year Ended December 31, 2003 2002 2001 (dollars in thousands, except per share data) (unaudited) $ 1,004,889 $ 923,033 $ 585,175 $ 385,129 359,737 219,479 196,826 17,237 273,307 132,390 ( 190,199) 9,057 (1,839) ( 11,460) (62,051 ) 424 173,970 18,075 319,435 51,816 (188,304 ) ( 13,877) 105,794 11,609 3 10,785 (62,492) (139,867) (8,441 ) (11,093) (161,458) 200 21,653 (189,147) 87 (62,475) (161.658) (189,234 ) $ (62,475) $ (161,658) $ ( 1,642) (190,876) $ $ (0.53) $ (1.35) $ (1.78) $ (0.02) (1.80) $ $ (0.53) $ (1.35) $ 118,627.262 118,627,262 119,607,605 119,607,605 105,779,737 105,779,737 $ 3,662,763 3,051,493 285,114 $ 3,703,974 3,019,21 ] 346,541 $ 3,664,848 2,798,000 507,576 2000(1) 328,258 110,442 55,820 34,283 178,331 (50,618) (68,955) (30,024) (149,597) 250 (149,847) (149,847) (I. 79) (1.79) 83,803,032 83,803,032 $ 1,379,972 987,000 261,621 (continued on next page) 34 T for the which usiness basic 2000(1) 328,258 I] 0.442 55,820 34,283 178,331 (50,618) (68,955) (30,024) (149,597) 250 (149,847) (149,847) (1. 79) ( 1.79) 83,803,032 83,803,032 1,379,972 987,000 261,621 t page) Year Ended December 31, 2004 2003 2002 2001 2000(1) (dollars in thousands, except per share data) (unaudited) Other Data: Operating income before depreciation and amortization(5) $ 413,68] $ 405,697 $ 371,251 $ 248,293 $ ]27,713 Operating income before depreciation and amortization margin(6) 39.1% 40.4% 40.2% 42.4% 38.9% Net cash flows provided by (used in): Operating activities $ 224,611 $ 206,900 $ 172,596 $ 258,625 $ 95,527 Investing activities (177,424) (221,444 ) (421,602) (2,402,947) (297,110) Financing activities (49,127) 9,135 216,923 2,203,477 20 I ,262 Operating Data: (end of period) Estimated homes passed(7) 2,785,000 2,755,000 2,715,000 2,63Q,000 1,173,000 Basic subscribers(8) 1,458,000 1,543,000 1,592,000 ] ,595,000 779,000 Basic penetration(9) 52.4% 56.0% 58.6% 60.6% 66.4% Digital customers(lO) 396,000 383,000 371,000 321,000 40,000 Data customers( II) 367,000 280,000 191,000 ] ]5,000 15,600 (I) Mediacom Communications Corporation was organized as a Delaware corporation in November 1999 and completed an initial public offering in February 2000. Mediacom LLC was formed as a New York limited liability company in July 1995 and since that time its taxable income or loss has been included in the federal and certain state income tax'returns of its members. Upon completion of our initial public offering, we became subject to the provisions of Subchapter C of the Internal Revenue Code. As a C corporation, we are subject to federal, state and local income taxes. (2) Represents actual corporate expenses subsequent to our initial public offering in February 2000 and fees paid to Mediacom Management Corporation, a Delaware corporation, for management services rendered to our operating subsidiaries under management agreements prior to our initial public offering. Such management agreements were terminated upon the completion of our initial public offering. At that time, Mediacom Management's employees became our employees and its corporate overhead became our corporate overhead. Corporate expenses include non-cash stock charges relating to corporate expenses as follows: . for the years ended December 31,2002 and 2001, $5.3 million and $2.9 million, respectively, resulted from the vesting of equity grants made during 1999 to certain members of our management team. . for the year ended December 31, 2000, a one-time $24.5 million charge resulting from the termination of the management agreements with Mediacom Management upon completion of our initial public offering in February 2000 and a $3.8 million charge relating to the vesting of equity grants made during 1999 to certain members of our management team. (3) Relates to our adoption of Statements of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." (4) Basic and diluted earnings (loss) per share is calculated based on the weighted average shares outstanding. Prior to our initial public offering, the weighted average shares outstanding was computed based on the conversion ratio used to exchange the Mediacom LLC's membership units for shares of Mediacom Communications Corporation Class A and Class B common stock immediately prior to our initial public offering. 35 . .............- (5) Operating income before depreciation and amortization ("OIBDA") is not a financial measure calculated in accordance with generally accepted accounting principles ("GAAP") in the United States of America. However, OIBDA is one of the primary measures used by management to evaluate our performance and to forecast future results. We believe OIBDA is useful for investors because it enables them to assess our performance in a manner similar to the method used by management, and provides a measure that can be used to analyze, value and compare the companies in the cable television industry, which may have different depreciation and amortization policies. A limitation of this measure, however, is that it excludes depreciation and amortization, which represents the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business. Management utilizes a separate process to budget, measure and evaluate capital expenditures. OIBDA should not be regarded as an alternative to either operating income or net income (loss) as an indicator of operating performance nor should it be considered in isolation or as a substitute for financial measures prepared in accordance with GAAP. We believe that operating income is the most directly comparable GAAP financial measure to OIBDA. The following represents a reconciliation of OBIDA to operating income (loss), which is the most directly comparable GAAP measure: Year Ended December 31, 2004 2003 2002 2001 2000 OIBDA $ 413,681 $ 405,697 $ 371,251 $ 248,293 $ 127,713 Depreciation and amortization (217,262) (273,307) (319,435) (310,785) (178,331) Operating income (loss) $ 196,419 $ 132,390 $ 51,816 $ (62,492) $ (50,618) (6) Represents OIBDA as a percentage of revenues. See note 5 above. (7) Represents an estimate of the number of single residence homes, apartments and condominium units passed by the cable distribution network in a cable system's service area. (8) Represents a dwelling with one or more television sets that receives a package of over-the-air broadcast stations, local access channels or certain satellite-delivered cable television services. Accounts that are billed on a bulk basis, which typically receive discounted rates, are converted into full-price equivalent basic subscribers by dividing total bulk billed basic revenues of a particular system by the applicable combined limited and expanded cable rate charged to basic subscribers in that system. Basic subscribers include connections to schools, libraries, local government offices and employee households that may not be charged for limited and expanded cable services, but may be charged for digital cable, YOD, HDTY, DYR or high-speed Internet service. Customers who exclusively purchase high-speed Internet service are not counted as basic subscribers. Our methodology of calculating the number of basic subscribers may not be identical to those used by other cable companies. (9) Represents basic subscribers as a percentage of estimated homes passed. (10) Represents customers that receive digital cable services. (II) Represents residential data customers and small to medium-sized commercial cable modem accounts billed at higher rates than residential customers. Small to medium-sized commercial accounts generally represent customers with bandwidth requirements less than 5Mbps. These commercial accounts are converted to equivalent residential data customers by dividing their associated revenues by the applicable residential rate. Our data customers exclude large commercial accounts and include an insignificant number of dial-up customers. Our methodology of calculating data customers may not be identical to those used by other cable compames. 36 -- , ed in lerica. nd to ;s our used erent :iation sed in aluate ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Reference is made to the "Risk .Factors" below for a discussion of important factors that could cause actual results to differ from expectations and any of our forward-looking statements contained herein. The following discussion should be read in conjunction with our audited consolidated financial statements as of and for the years ended December 31, 2004, 2003 and 2002. Overview icator sures AAP In 2003, we completed our planned network upgrade program that significantly increased bandwidth and enabled interactivity. As of December 31, 2004, approximately 99% of our cable network was upgraded with 550MHz to 870MHz bandwidth capacity and about 99% of our estimated homes passed were activated with two- way communications capability. As of the same date, approximately 96% of our basic subscribers were served by our 50 largest headend facilities. Expressed in megahertz, or MHz, bandwidth represents a system's capacity to deliver telecommunication services. A headend facility is the location where signals are received and processed for distribution over a cable system to our customers. irectl y 000 Our network technology allows us to offer an array of advanced video, data and voice products and services, including VOD, DVRs, HDTV, HSD and, beginning in the second quarter of2005, cable telephony. We currently otTer video and HSD bundles, and when we introduce cable telephony, we will offer triple play bundles of video, HSD and voice. Bundled products and services offer our subscribers a single provider contact for provisioning, billing and customer care. 127,713 l78,331) . 50,618) ;sed by We face increasing competition for our video programming services, most notably from DBS service providers. Since they have been permitted to deliver local television broadcast signals beginning in 1999, DIRECTV, Inc. and Echostar Communications Corporation, the two largest DBS service providers, have been increasing the number of markets in which they deliver these local television signals. As of December 31, 2004, local-to-Iocallaunches in our markets represented an estimated 92% of our basic subscribers. During 2004, competitive pressure from DBS service providers further intensified when they launched local television channels in additional markets representing an estimated 30% of our basic subscriber base. These local-into-locallaunches were usually accompanied by heavy marketing and advertising and are the primary cause of our loss of basic subscribers during the last two years. adcast , billed basic bined 'nc\ude :harged -speed basic e used In September 2004, as a result of Hurricane Ivan, our cable systems in areas of Alabama, Florida and Mississippi experienced, to varying degrees, damage to cable plant and other property and equipment, business interruption and loss of customers. This hurricane caused a temporary loss of an estimated 8,000 basic subscribers, 2,000 digital customers and 1,000 data customers in these three states. While we believe many of these customers will return to our service, there can be no assurance that they will do so. The revenue impact and the costs incurred are reflected in our consolidated financial statements, and are detailed as follows: revenues were recorded net of $2.9 million of service interruption credits issued to customers; service costs included $0.9 million of incremental costs to cover the repair of our facilities, the use of outside contractors to help repair cable plant and increased employee costs; selling, general and administrative expenses included incremental costs of $0.3 million related to additional customer service employee costs required to support customers' needs; and depreciation expense included $2.1 million due to an impairment of cable plant and other property and equipment. In addition, we incurred capital expenditures of approximately $8.1 million to replace or rebuild property, plant and equipment damaged by Hurricane Ivan. We are insured against certain losses related to the hurricane, subject to varying deductible amounts. At this time, we cannot estimate the amounts that will be ultimately recoverable under our insurance policies. illed at .present rted to al rate. dial-up r cable 37 -- ,..... Actual Results of Operations Year Ended December 31,2004 Compared to Year Ended December 31,2003 The following table sets forth the consolidated statements of operations for the years ended December 31, 2004 and 2003 (dollars in thousands and percentage changes that are not meaningful are marked NM): Year Ended December 31, 2004 2003 $ Chan2e % Chan2e Revenues $1,057,226 $1,004,889 $ 52,337 5.2% Costs and expenses: Service costs 412,841 385,129 27,712 7.2% Selling, general and administrative expenses 211,428 196,826 14,602 7.4% Corporate expenses 19,276 17,237 2,039 11.8% Depreciation and amortization 217,262 273,307 (56,045) (20.5%) Operating income 196,419 132,390 64,029 48.4% Interest expense, net (192,740) (190,199) (2,541 ) 1.3% Gain on derivatives, net 16,125 9,057 7,068 NM Gain (loss) on sale of assets and investments, net 5,885 (1,839) 7,724 NM Other expense (12,061) (1l,460) (601) 5.2% Net income (loss) before provision for income taxes 13,628 (62,051) 75,679 NM Provision for income taxes 76 424 (348) (82.1%) Net income (loss) $ 13,552 $ (62,475) $ 76,027 NM Revenues The following table sets forth revenue information for the years ended December 31,2004 and 2003 (dollars in millions): Year Ended December 31, 2004 2003 %of %of Amount Revenues Amount Revenues $ Change % Change Video................. $ 848.8 80.3% $ 845.9 84.2% $ 2.9 0.3% Data................... 156.3 14.8% 116.3 11.6% 40.0 34.4% Advertising........ 52.1 4.9% 42.7 4.2% 9.4 22.0% $ 1,057.2 100.0% $ 1,004.9 100.0% $ 52.3 5.2% Video revenues represent monthly subscription fees charged to customers for our core cable television products and services (including basic, expanded basic and analog premium programming, digital cable television programming services, wire maintenance, equipment rental and services to commercial establishments), pay-per- view charges, installation and reconnection fees, late payment fees, and other ancillary revenues. Data revenues primarily represent monthly subscription fees charged to customers for our data products and services and equipment rental fee. Franchise fees charged to customers for payment to local franchising authorities are included in their corresponding revenue category. Revenues rose 5.2%, net of service interruption credits given to customers affected by the hurricane. Excluding such credits, revenues rose 5.5%, largely attributable to an increase in broadband data customers and basic rate increases applied on our video customers, driven in large part by our own video programming cost increases, offset by a reduction in basic subscribers during the period. 38 004 Video revenues rose 0.3% as a result of the aforementioned basic rate increases, substantially offset by a loss of basic subscribers from 1,543,000 to 1,458,000. Digital customers increased 3.4% to 396,000 as compared to 383,000 a year ago. Our loss in basic subscribers resulted primarily from increased competitive pressures by DBS service providers, particularly in those markets where we experienced their local-into-Iocal launches and, to a lesser extent, from our tighter customer credit policies. In an effort to reverse this video subscriber trend, we have been increasing our customer retention efforts and our emphasis on product bundling, enhancing and differentiating our video products and services with new digital packages, VOD, HDTV, DVR and more local programming. Data revenues rose 34.4%, due primarily to a 31.1 % increase in data customers from 280,000 to 367,000 and an increased contribution from our relatively new commercial enterprise business. Advertising revenues increased 22.0%, primarily as a result of higher local advertising sales, including political advertising and, to a lesser extent, the completion of an interconnect in one of our larger markets. Political advertising contributed approximately 45.0% of this increase. Also in 2004, we completed an interconnect agreement, under which we represent other cable operators to jointly sell local advertising, which accounted for 29.8% of the growth. We do not expect growth in advertising revenues to continue at the same rate in 2005, due to the likely reduction in political advertising and because we do not currently expect to enter into any new material interconnect agreements. Costs and Expenses Service costs include: fees paid to programming suppliers; expenses related to wages and salaries of technical personnel who maintain our cable network and perform customer installation activities; broadband data access costs, including costs of bandwidth connectivity, customer provisioning and technical support and plant operating costs, such as utilities and pole rental expense. Programming costs, which are payments to programmers for content and are generally paid on a per subscriber basis, have historically increased due to both increases in the rates charged for existing programming services and the introduction of new programming services to our basic subscribers. Service costs increased 7.2%, primarily due to increases in programming expenses, employee costs and plant operating costs. The largest component of service costs is programming related expense which increased 3.5%, as a result of rate increases on basic and premium services, significantly offset by a reduction in basic subscribers and an increase in launch support received from programmers in return for our carriage of their programming services. Employee and plant operating costs increased 23.7%, primarily due to increases in employee benefits, operational insurance claims and the expensing of such operational costs resulting from the continued transition from upgrade construction in 2003 to maintenance activities in 2004. Service costs as a percentage of revenues were 39.0% for the year ended December 3 I, 2004, as compared with 38.3% for the year ended December 31, 2003. Selling, general and administrative expenses include: wages and salaries for our call center, customer service and support and administrative personnel; franchise fees and taxes; and expenses related to billing, telecommunications, marketing, bad debt, advertising and office administration. ducts vision y-per- enues $ and \uded Selling, general and administrative expenses increased 7.4%, principally due to higher advertising, marketing and employee costs and higher taxes and fees, partially offset by a decrease in bad debt expense. Advertising costs increased 22.7% as a result of employee commissions on increased revenues. Employee costs increased 6.3% as a result of increases in employee compensation, benefit costs and customer service overtime, driven by higher call volumes related to the rollout of new products. Marketing costs rose 16.9% as a result of mass media campaigns to support the rollout of new advanced services, and to promote customer retention and acquisition initiatives. Taxes and fees increased 4.9% due to higher state property taxes. This increase in selling, general and administrative expenses was partly offset by a 7.6% decrease in bad debt expense as a result of improved customer credit and collection policies. Selling, general and administrative expenses as a percentage of revenues were 20.0% for the year ended December 31,2004, as compared with 19.6% for the year ended December 31,2003. luding ic rate offset We expect continued revenue growth in advanced services, which include digital video, HDTV and broadband data access and, in the second quarter of 2005, the launch of cable telephony service. As a result, we expect our service costs and selling, general and administrative expenses to increase. Corporate expenses reflect compensation of corporate employees and other corporate overhead. Corporate expenses increased 11.8%, primarily due to increases in legal and accounting fees, general insurance expenses and 39 .- ,.... employee costs offset by greater capitalization of labor and overhead costs related to increased capital activities in 2004 related to the cable telephony project. Corporate expenses as a percentage of revenues were 1.8% for the year ended December 31, 2004, as compared with 1.7% for the year ended December 31, 2003. Depreciation and amortization decreased 20.5%, primarily due to changes, effective July I, 2003, in the estimated useful lives of our cable systems and equipment in conjunction with the completion of our network upgrade and rebuild program, this was offset in part by increased depreciation for investments in our cable network and ongoing investments to continue the rollout of products and services including video-on-demand, high- definition television, digital video recorders and broadband data access. See Note 2 to our consolidated financial statements. Interest Expense, net Interest expense, net, increased by 1.3%, primarily' due to slightly higher market interest rates on variable rate debt and lower interest expense capitalization associated .with the substantial reduction of upgrade/rebuild capital expenditures, partially offset by lower indebtedness. Gain on Derivatives, net We enter into interest rate exchange agreements, or "interest rate swaps", with counterparties to fix the interest rate on a portion of our variable rate debt to reduce the potential volatility in our interest expense that would otherwise result from changes in market interest rates. As of December 31, 2004 we had interest rate swaps with an aggregate principal amount of$800.0 million. The changes in their mark-to-market values are derived from changes in market interest rates, the decrease in their time to maturity and the creditworthiness of the counterparties. As a result of the quarterly mark-to-market valuation of these interest rate swaps, we recorded a gain on derivatives amounting to $16.1 million for the year ended December 31, 2004, as compared to a gain on derivatives of $9.1 million for the year ended December 3 I, 2003. Gain (loss) on Sale of Assets and Investments, net We had a net gain on sale of assets and investments amounting to $5.9 million for the year ended December 31, 2004 as compared to a loss of $1.8 million for the year ended December 31, 2003. The net gain was principally due to the sale of a cable system in May 2004, serving approximately 3,450 subscribers, for gross proceeds of about $10.1 million. Other Expense Other expense was $12.1 million and $11.5 million for the years ended December 31, 2004 and 2003, respectively. Other expense primarily represents amortization of deferred financing costs and fees on unused credit commitments. Provision for Income Taxes Provision for income taxes was approximately $76,000 and $424,000 for the years ended December 31, 2004 and 2003, respectively. The provision for income taxes relates to state income tax liabilities. Net Income (loss) As a result of the factors described above, we generated net income for the year ended December 31, 2004 of $13.6 million, as compared to a net loss of $62.5 million for the year ended December 31, 2003. 40 ies in : year Year Ended December 31,2003 Compared to Year Ended December 31,2002 The following table sets forth the consolidated statements of operations for the years ended December 31,2003 and 2002 (dollars in thousands and percentage changes that are not meaningful are marked NM): n the twork twork high- ancial Ie rate :apital Year Ended December 31, 2003 2002 $ Chan2e % Change Revenues $ 1,004,889 $ 923,033 $ 81,856 8.9% Costs and expenses: Service costs 385,129 359,737 25,392 7.1% Selling, general and administrative expenses 196,826 173,970 22,856 13.1% Corporate expenses 17,237 18,075 (838) (4.6%) Depreciation and amortization 273,307 319,435 (46,128) (14.4%) Operating income 132,390 51,816 80,574 155.5% Interest expense, net (190,199) (188,304) (1,895) 1.0% Gain (loss) on derivatives, net 9,057 (13,877) 22,934 NM Loss on sale of assets and investments, net (1,839) (1,839) NM Other expense (11,460) (11,093) (367) 3.3% Net loss before provision for income taxes (62,051) (161,458) 99,407 NM Provision for income taxes 424 200 224 112.0% Net loss $ (62,475) $ (161,658) $ 99,183 NM Revenues terest ould 'ith an anges As a atives . $9.1 The following table sets forth revenue information for the years ended December 31, 2003 and 2002 (dollars in millions): 2003, credit Year Ended December 31, 2003 2002 %of %of Amount Revenues Amount Revenues $ Change % Change Video................. $ 845.9 84.2% $ 812.8 88.1% $ 33.1 4.1% Data................... 116.3 11.6% 70.7 7.6% 45.6 64.5% Advertising........ 42.7 4.2% 39.5 4.3% 3.2 8.1% $ 1,004.9 100.0% $ 923.0 100.0% $ 81.9 8.9% r 31, y due about 2004 Revenues rose 8.9% attributable to a 46.6% increase in high-speed data customers and basic rate increases applied on our video customers, driven in large part by our own programming cost increases. 04 of Video revenues increased 4.1 % as a result of the aforementioned basic rate increases, partially offset by a 3.0% dec1inein basic subscribers, after adjusting for, small acquisitions and divestitures during 2003. Our loss in basic subscribers resulted primarily from greater competitive pressures by DBS service providers, particularly in those markets where we experienced their local-to-Iocallaunches. Data revenues rose 64.5% due, in large part, to a 46.6% increase in data customers from 191,000 to 280,000. Advertising revenues increased 8.1 % primarily as a result of bringing in-house certain markets previously managed by third parties. Instead of receiving advertising revenues which are net of commissions paid to the third parties, we now record the full revenues from these markets with the related expenses, including in-house commissions, which are recorded as selling, general and administrative expenses. 41 ,.... Costs and Expenses Service costs increased 7.1 % over the prior year, which included $4.3 million of one-time incremental costs related to our transition to our Mediacom Online high-speed Internet access service. These costs represented the excess over the agreed-upon charges owed to our former high-speed provider that were incurred in the first quarter of 2002. Excluding these incremental costs, service costs would have increased 8.4% or $29.7 million. Approximately half of this increase was due to servicing the growth in our data customers of 89,000, with the balance primarily represented by increases in unit costs for basic programming. The increase in total programming costs, however, was partially offset by the aforementioned decline in basic subscribers as well as a decrease in premium service units. As a percentage of revenues, service costs were 38.3% for the year ended December 31, 2003, as compared with 39.0% for the year ended December 31, 2002. Selling, general and administrative expenses increased 13.1 %, principally due to higher customer support, marketing, call center and bad debt expenses, and higher taxes and fees. Customer support expenses increased 35.5% as a result of higher staffing levels and employee commissions. Marketing expenses rose 13.7% to support the digital television and data products and services, to cover the costs of advertising campaigns we deployed to counter competitive pressures from DBS, and to pay commissions to our marketing personnel. Expenses relating to our call centers, mainly customer service personnel and telecommunications, increased 9.0% as a result of increased staffing and higher call volumes experienced during the year. Bad debt expense rose 24.7% primarily as a result of higher customer chum and the implementation throughout the year of tighter customer credit controls. As a percentage ofrevenues, selling, general and administrative expenses were 19.6% for the year ended December 31, 2003, as compared with 18.8% for the year ended December 31,2002. Corporate expenses decreased 4.6%, primarily due to the recognition of$5.3 million of non-cash stock charges during the year ended December 31, 2002, which represented vesting in equity interests granted to certain members of our management team, offset by a greater number of corporate employees and increases in salaries, legal and other professional fees, and insurance premiums. As a percentage of revenues, corporate expenses were 1.7% for the year ended December 31, 2003, as compared with 2.0% for the year ended December 31, 2002. Depreciation and amortization decreased 14.4%, primarily due to changes, effective July 1, 2003, in the estimated useful lives of our cable systems and equipment in conjunction with the completion of our network upgrade and rebuild program. These changes reduced depreciation by $63.5 million for the year ended December 31, 2003. This decrease was offset in part by increased depreciation for investments in our cable network and ongoing investments to continue the rollout of products and services such as video-on-demand, high-defmition television and high-speed Internet access. See Note 2 to our consolidated fmancial statements. Interest Expense, net Interest expense, net, remained relatively flat year over year. This was primarily due to higher average indebtedness offset by a decrease in market interest rates on our variable rate debt. Gain (loss) on Derivative Instruments, net We enter into interest rate exchange agreements, or interest rate swaps, to fix the interest rate on a portion of our variable rate debt to reduce the potential volatility in our interest expense due to changes in variable market interest rates. As of December 31, 2003 we had interest rate swaps with an aggregate principal amount of $800.0 million, compared to $790.0 million as of December 31, 2002. The changes in their mark-to-market values are derived from changes in market interest rates, the decrease in their time to maturity and the creditworthiness ofthe counterparties. As a result of the quarterly mark-to-market valuation of these interest rate swaps, we recorded a gain on derivative instruments amounting to $9.1 million for the year ended December 31, 2003, as compared to loss on derivative instruments of$13.9 million for the year ended December 31,2002. 42 T Loss on Sale 0/ Assets and Investments, net 'sts he er n. he 'ng , in 31, We had a loss on the sale of assets and investments amounting to $1.8 million for the year ended December 31, 2003. The loss was principally due to a sale of a small cable system in September 2003 with approximately 1,500 subscribers for gross proceeds of $3.1 million. Other Expense Other expense was $11.5 million for the year ended December 3 1,2003, as compared to $11.1 million for the year ended December 31, 2002. Other expense primarily represents amortization of deferred financing costs and fees on unused credit commitments. Provision/or Income Taxes Provision for income taxes was approximately $424,000 and $200,000 for the years ended December 3 1,2003 and 2002, respectively. The provision for income taxes relates to state income tax liabilities. Net Loss Due to the factors described above, we generated a net loss of $62.5 million and $161.7 for the years ended December 31,2003 and 2002, respectively. ges ers . and , for Liquidity and Capital Resources the ork ber and 'tion In recent years, we have made significant capital investments in our cable systems to enhance their reliability and capacity, which allows for the introduction of new advanced broadband services. Our capital investments are now more focused on the deployment of new products and services, including VOD, DVRs, HSD and cable telephony. We also may continue to make strategic acquisitions of cable systems. Given our level of indebtedness, we also have significant amounts of interest expense to pay each year. We believe that we will meet our debt service, capital spending and other requirements through a combination of our net cash flows from operating activities, borrowing availability under our bank credit facilities and our ability to secure future external financing. Operating Activities rage Net cash flows provided by operating activities were $224.6 million for the year ended December 31,2004, as compared to $206.9 million for the prior year, and reflected primarily our operating income before depreciation and amortization and, to a much lesser extent, changes in accounts payable and accrued expenses. Investing Activities ies. 'ative 'ative Net cash flows used in investing activities were $177.4 million for the year ended December 31,2004, as compared to $221.4 million for the prior year, and principally comprised capital expenditures. For the year ended December 31, 2004, we made capital expenditures of $181.4 million, including $8.1 million to replace or rebuild property, plant and equipment damaged by Hurricane Ivan and $6.6 million to fund our cable telephony initiative. This compares to $23 1.5 million and $408.3 million we invested in 2003 and 2002, respectively, which reflected significantly higher levels of capital expenditures for network upgrade and rebuild activities than in 2004. This reduction in capital expenditures resulted primarily from the completion of our plarmed network upgrade program in 2003. A larger percentage of our capital spending in 2004 was attributable to the deployment of our advanced products and services, including VOD, HDTV and HSD, and our preparation for the launch of cable telephony. In 2004, approximately 55% of our capital expenditures was for advanced product and service deployment and cable telephony; 17% was for rebuild and upgrade activities, including modifications to our cable network; 15% was for extensions of our cable network to enter new service territories; and 13% was for outlays associated with non- network assets. This trend of spending more on the deployment of advanced products and services as compared to network improvements is expected to continue in 2005 and beyond. We plan to invest between $200 million and $2]0 million in capital expenditures in 2005. 43 . During 2004, we also acquired a small cable system for $3.4 million and received $10.6 million in proceeds from the sale of assets and investments, including the divestiture of a small cable system. Financing Activities Net cash flows used in financing activities were $49.1 million for the year ended December 31, 2004, as compared to $9.1 million of net cash flows provided by financing activities the prior year. In 2004, our principal financing activities included the repayment of bank indebtedness in the amount of $41. 9 million and repurchase of shares of our Class A common stock in the amount of $6.2 million. Description of Our Credit Facilities We own our cable systems through two principal subsidiaries, Mediacom Broadband LLC and Mediacom LLC. In October 2004, the operating subsidiaries of Mediacom LLC refinanced their two bank credit facilities (the "two prior LLC credit facilities") with a new $1.15 billion bank credit facility (the "LLC credit facility") that expires in March 2013. The LLC credit facility consists of a $400.0 million revolving credit commitment, a $200.0 million delayed-draw term loan and a $550.0 million term loan, which are subject to amortization, as applicable. Approximately $658.0 million was drawn from the LLC credit facility at closing, of which approximately $652 million was used to pay in full the outstanding indebtedness, including accrued interest, under the two prior LLC credit facilities and the balance was used to pay fees and expenses related to this new credit facility. The financial obligations of the operating subsidiaries under the two prior LLC credit facilities have been satisfied, and these credit facilities have been terminated. As of December 31, 2004, $646.0 million was outstanding under the LLC credit facility. In January 2005, we borrowed the entire amount of the $200.0 million term loan and repaid a portion of our indebtedness under our revolving credit commitments. The operating subsidiaries of Mediacom Broadband LLC have a $1.4 billion bank credit facil ity (the "Broadband credit facility") that expires in September 2010 and consists of a $600.0 million revolving credit commitment, a $300.0 million term loan and a $500.0 million term loan, which are subject to commitment reductions and amortization, as applicable. In December 2004, these operating subsidiaries amended their bank credit agreement to conform its defmitions, financial covenants, and other terms (including those relating to letters of credit, mandatory prepayment, representations and warranties, negative covenants and events of default) to those of the credit agreement of the LLC credit facility. As of December 31, 2004, $960.5 million was outstanding under the Broadband credit facility. We have entered into interest rate exchange agreements, which expire from June 2005 through March 2007, to hedge $800.0 million of floating rate debt. Under the terms of all of our interest rate exchange agreements, we are exposed to credit loss in the event of nonperformance by the counterparties to the agreements. However, due to the high creditworthiness of our counterparties, which are major banking firms with investment grade ratings, we do not anticipate their nonperformance. As of December 31, 2004, about 73.2% of the Company's outstanding indebtedness was at fixed interest rates or subject to interest rate protection. As of December 31, 2004, our total debt was approximately $3.0 billion and we were in compliance with all covenants under our debt arrangements. On that same date, our annualized cost of debt was approximately 6.8%, and we had unused revolving commitments under our credit facilities of about $908.5 million, all of which could be, borrowed and used for general corporate purposes based on the terms and conditions of our debt arrangements, including the applicable financial measures of leverage and interest coverage. The average interest rate for borrowings under the revolving commitments of our credit facilities is now LIB OR plus 1.25%. As of December 31, 2004, approximately $14.5 million of letters of credit were issued to various parties to secure our performance relating to insurance and franchise requirements. Although we have not generated earnings sufficient to cover fixed charges in the past, we have generated cash and obtained financing sufficient to meet our short-term requirements, including our debt service, working capital and capital expenditures. We expect that we will continue to be able to generate funds and obtain financing sufficient to service our long-term business plan, service our debt obligations and complete any future acquisitions if the opportunities arise. However, there can be no assurance that we will be able to obtain sufficient financing, or, if we were able to do so, that the terms would be favorable to us. 44 ion in proceeds Contractual Obligations and Commercial Commitments r 31,2004, as , our principal repurchase of The following table summarizes our contractual obligations and commercial commitments, and the effects they are expected to have on our liquidity and cash flow, for the five years subsequent to December 31, 2004 and thereafter (dollars in thousands)*: ediacom LLC. lities (the "two that expires in $200.0 million as applicable. ximately $652 two prior LLC The financial led, and these nder the LLC epaid a portion 2005........................................ $ 2006........................................ 2007........................................ 2008........................................ 2009........................................ Thereafter............................... . Total cash obligations............. $ Capital Operating Debt Leases Leases T otal(2) 40,500 $ 2,200 $ 4,296 $ 46,996 220,500 (\) 2,269 2,045 224,814 70,500 1,120 1,583 73,203 270,500 43 824 271,367 214,000 583 214,583 2,188,000 1,288 2,189,288 3,004,000 $ 5,632 $ 10,619 $ 3,020,251 * Refer to Note 7 to our consolidated financial statements for a discussion of our long-term debt, and to Note 12 for a discussion of our operating leases and other commitments and contingencies. t facility (the volving credit commitment ed their bank - ating to letters fault) to those tanding under (I) Includes $172.5 million of convertible senior notes due 2006. (2) Excludes interest expense. I Critical Accounting Policies arch 2007, to ments, we are ver, due to the gs, we do not s outstanding The foregoing discussion and analysis of our financial condition and results of operations is based upon our consolidated fmancial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Periodically, we evaluate our estimates, including those related to doubtful accounts, long-lived assets, capitalized costs and accruals. We base our estimates on historical experience and on various other assumptions that we believe are reasonable. Actual results may differ from these estimates under different assumptions or conditions. We believe that the application of the critical accounting policies discussed below requires significant judgments and estimates on the part of management. For a summary of our accounting policies, see Note 2 of our consolidated fmancial statements. iance with all imately 6.8%, hich could be arrangements, erest rate for Property, Plant and Equipment ous parties to We capitalize the costs of new construction and replacement of our cable transmission and distribution facilities and new cable service installations. Capitalized costs include all direct labor and materials as well as certain indirect costs and are based on historical construction and installation costs. Capitalized costs are recorded as additions to property, plant and equipment and depreciate over the life of the related asset. We perform periodic evaluations of the estimates used to determine the amount of costs that are capitalized. Income Taxes enerated cash rking capital in financing cquisitions if ancing, or, if We account for income taxes using the liability method as stipulated by SF AS No. 109 "Accounting for Income Taxes". This method generally provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and anticipated benefit of utilizing net operating loss carryforwards. We assess the likelihood of realization of deferred tax assets and net operating loss carryforwards by considering the scheduled reversal of deferred tax liabilities, taxable income in future periods and available prudent tax planning strategies. At December 31, 2004, we have recorded a net 45 -- deferred tax asset valuation allowance of approximately $222.8 million. We will continue to monitor the need for the deferred tax asset valuation allowance in accordance with SFAS No. 109. Should there be a change in our ability to recover our deferred tax assets, our valuation allowance would decrease or increase in the period in which we determined that the recovery of our deferred tax assets were either likely or unlikely, respectively. Intangibles Our cable systems operate under non-exclusive franchises granted by state and local governmental authorities for varying lengths of time. We acquired these cable franchises through acquisitions of cable systems and were accounted for using the purchase method of accounting. We have concluded that our cable franchise rights have an indefinite useful life since, among other things, there are no legal, regulatory, contractual, competitive, economic or other factors limiting the period over which these cable franchise rights contribute to our revenues. Accordingly, with our adoption of SF AS No. 142 we no longer amortize the cable franchise rights and other indefmite-lived assets. Instead, such assets are tested annually for impairment or more frequently if impairment indicators arise. Based on the guidance outlined in Emerging Issues Task Force or "EITF" issue No. 02-7, we determined that the unit of accounting for testing franchise value for impairment resides at a cable system cluster level. Such level reflects the financial reporting level managed and reviewed by the corporate office (Le., chief operating decision maker) as well as how we allocated capital resources and utilize the assets. Lastly, the unit reporting level reflects the level at which the purchase method of accounting for our acquisitions was originally recorded. We have three cable system clusters, or reporting units, for the purpose of applying SF AS No. 142. We assess the fair value of our franchise costs based on a discounted cash flow methodology. If the determined fair value of our franchise costs is less the carrying amount on the financial statements, an impairment charge would be recognized for the difference between the fair value and the carrying value of the assets. To test the impairment of the goodwill carried on our financial statements, the fair value of the cable system cluster's tangible and intangible assets (including franchise value) other than goodwill is deducted from the cable system cluster's fair value. The balance represents the fair value of goodwill which is then compared to the carrying value of goodwill to determine if there is any impairment. Upon adoption of SF AS No. 142, we determined that no impairment of our franchise costs and goodwill existed as of January 1, 2002. Subsequent impairment tests performed in 2002 and 2003 reflected no impairment of our franchise costs and goodwill. We completed our most recent impairment test as of October 1,2004, which reflected no impairment of our franchise costs and goodwill. Our use of discounted cash flow analyses in determining the fair value of each cable system cluster involves certain assumptions and estimates, which are consistent with the expectations of buyers and sellers of cable systems in determining fair value. Significant impairment in value resulting in impairment charges may result if these estimates and assumptions used in the fair value determination change in the future. Impairment of Long-Lived Assets In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate the recoverability and estimated lives of our long-lived assets, including property and equipment and intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed. The measurement for such impairment loss is based on the fair value of the asset, typically based upon the future cash flows discounted at a rate commensurate with the risk involved. Unless presented separately, the loss is included as a component of either depreciation expense or amortization expense, as appropriate. Derivatives We account for derivatives instruments in accordance with SF AS No. 133, SF AS No. 138 and SF AS No. 149. Our primary objective for holding derivative financial instruments is to manage interest rate risk. Our derivative instruments are recorded at fair value and are included in other current assets, other assets and other liabilities. Our accounting policies for these instruments are based on whether they meet our criteria for designation as hedging transactions. The criteria for designating a derivative as a hedge include the instrument's effectiveness in risk reduction and, in most cases, a one-to-one matching of the derivative instrument to its underlying transaction. Gains 46 , for ur ich and losses from changes in fair values of derivatives that are not designated as hedges for accounting purposes are recognized currently in earnings. During 2004, 2003 and 2002, none of our derivative financial instruments were designated as hedges. Therefore, changes in fair value for the respective periods were recognized in earnings. Recent Accounting Pronouncements les re an or ;ly, red The FASB issued SFAS No. 148, "Accountingfor Stock-Based Compensation - Transition and Disclosure," in December 2002, which amends: (i) SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation; (ii) the disclosure provisions of SF AS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock- based employee compensation; and (iii) Accounting Principles Board ("APB") Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. We adopted SFAS No. 148 on January 1, 2003. We did not change to the fair value based method of accounting for stock-based employee compensation. Accordingly, the adoption of SFAS No. 148 did not affect our financial condition or results of operations. In December 2004, the FASB issued SFAS No. 123R, "Amendment of Statement 123 on Share-Based Payment." SF AS No. 123 R requires companies to expense the value of employee stock options, stock granted through the employee stock purchase program and similar awards. SF AS No. 123R is effective for periods beginning after June 15,2005. We plan on adopting SFAS No. 123R effective July 1,2005 and expect that the adoption of SF AS No. 123R will have a material impact on our consolidated results of operations and earnings per share. lr Ie Ie There are three methods of adopting SF AS No. 123 R. The first method is called modified prospective method, which allows companies to avoid recording additional compensation expense for vested awards that are outstanding on the effective date of the SF AS No. 123R. Unvested awards outstanding on the effective date would be charged to expense over the remaining vesting period. The second method is similar to the modified prospective method, except it allows companies to restate earlier interim periods in the year of adoption using the applicable SF AS No. 123R pro forma amounts. The third method is the modified retrospective method, which directs companies to apply the modified prospective method and restate prior financial statements. We are currently evaluating these transitional methods. e In March 2004, the F ASB approved the consensus reached on the EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The Issue's objective is to provide guidance for identifYing other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the F ASB issued a F ASB Staff Position (FSP) EITF 03-1 that delays the effective date of the measurement and recognition guidance in EITF 03-1 until further notice. The disclosure requirements of EITF 03-1 are effective with this annual report for fiscal 2004. Once the F ASB reaches a final decision on the measurement and recognition provisions, we will evaluate the impact of the adoption of the accounting provision of EITF 03-1. n r In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29." The guidance in APB Opinion No. 29, "Accounting for Nonmonetary Transactions ", is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15,2005. The adoption of SF AS No. 153 is not expected to have a material impact on our financial position and results of operations. 47 - ,. Inflation and Changing Prices Our systems' costs and expenses are subject to inflation and price fluctuations. Such changes in costs and expenses can generally be passed through to subscribers. Programming costs have historically increased at rates in excess of inflation and are expected to continue to do so. We believe that under the FCC's existing cable rate regulations we may increase rates for cable television services to more than cover any increases in programming. However, competitive conditions and other factors in the marketplace may limit our ability to increase our rates. 48 Risk Factors and :s in rate ling. Risks Related to our Business We have a history of net losses. ... We have a history of net losses. Although we reported net income of $13.6 million for the year ended December 31, 2004, we reported net losses of $161. 7 million and $62.5 million for the years ended December 31, 2002 and 2003, respectively. The principal reasons for our prior net losses include the depreciation and amortization expenses associated with our acquisitions, the capital expenditures related to expanding and upgrading our cable systems and interest costs on borrowed money. If we are unsuccessful in implementing our growth strategy, our business and results of operations could be adversely affected. We currently expect that a substantial portion of our future growth in revenues will come from the expansion of relatively new services and the introduction of additional new services. Relatively new services include HSD, VOD, DVRs and HDTV. We plan to offer cable telephony service to our subscribers beginning with certain markets in the second quarter of 2005 and expanding to an additional 1.6 million homes in our markets within twelve months of our initial market launch. We may not be able to successfully expand existing services or introduce cable telephony due to unpredictable technical, operational or regulatory challenges. It is also possible that these services will not generate significant revenue growth. Our programming costs are increasing, and our business and results of operations will be adversely affected if we cannot pass through a sufficient part of the additional costs to subscribers. Our programming costs have been, and are expected to continue to be, one of our largest single expense items. In recent years, the cable and satellite video industries have experienced a rapid increase in the cost of programming, particularly sports programming. This increase in programming costs is expected to continue, and we may not be able to pass all programming cost increases on to our customers. In addition, as we add programming to our basic and expanded basic programming tiers, we may not be able to pass all of our costs of the additional programming on to our customers without the potential loss of basic subscribers. To the extent that we may not be able to pass increased or additional programming costs, particularly sports programming, through to subscribers, our business and results of operations will be adversely affected. We also expect to be subject to increasing financial and other demands by broadcasters to obtain the required consents for the transmission of broadcast programming to our subscribers. We cannot predict the impact of these negotiations on our business and results of operations or the effect on our subscribers should we be required to suspend the carriage of this programming. We operate in a highly competitive business environment, which affects our ability to attract and retain customers and can adversely affect our business and operations. We have lost a significant number of customers to direct broadcast satellite competition, and further loss of customers could have a material negative impact on our business. The industry in which we operate is highly competitive and is often subject to rapid and significant changes and developments in the marketplace and in the regulatory and legislative environment. In some instances, we compete against companies with fewer regulatory burdens, easier access to financing, greater resources and operating capabilities, greater brand name recognition and long-standing relationships with regulatory authorities and customers. Our video business faces competition primarily from OBS service providers. Our principal competitor in the HSD business, in markets where it is available, is telephone service, or OSL. The two largest OBS companies, DIRECTV, Inc. and EchoStar Communications, are each among the four largest providers of multichannel video programming services based on reported customers. In addition, D1RECTV's affiliation with News Corporation could strengthen that company's competitive positioning, as News Corporation also owns Fox Television Network 49 r and several cable programming services. Competition from OBS has had an adverse effect on our ability to retain customers. OBS has grown rapidly over the past several years and continues to do so. We have lost a significant number of customers to OBS competition, and will continue to face significant challenges from DBS providers. Local telephone companies, electric utilities and other municipal organizations are capable of offering video and other services in competition with us and they may increasingly do so in the future. Certain telephone companies have begun to deploy fiber more extensively in their networks and some have announced plans to deploy broadband services, including video programming services, in a manner to avoid the same regulatory burdens imposed on our business. These deployments will enable them to begin providing video services, as well as telephone and Internet access services, to residential and business customers. New laws or regulations at the federal or state level may clarify the ability of the local telephone companies to provide their senices without obtaining state or local cable franchises. If local telephone companies are not required to obtain local cable franchises comparable to ours, it would be adverse to our business. We also face competition from over-the-air television and radio broadcasters and from other communications and entertainment media such as movie theaters, live entertainment and sports events, newspapers and home video products. Further losses of customers to DBS or other alternative video and HSO services could. have a material adverse effect on our business. In our HSO business, we face competition primarily from telephone companies and other providers of "dial-up" and OSL OSL service is competitive with HSO service over cable systems. Telephone companies (which already have telephone lines into the household, an existing customer base and other operational functions in place) and other companies offer DSL service. In addition, certain DBS providers are currently offering two-way broadband data access services, which compete with our ability to offer bundled services to our customers. Our HSD business may also face competition in the future from registered utility holding companies and subsidiaries. In 2004, the FCC adopted rules: (i) that affirmed the ability of electric service providers to provide broadband Internet access services over their distribution systems; and (ii) that seek to avoid interference with existing services. Electric utilities could be formidable competitors to us. Some of our competitors, including franchised, wireless or private cable operators, satellite television providers and local exchange carriers, may benefit from permanent or temporary business combinations such as mergers, joint ventures and alliances and the potential repeal of certain ownership rules, either through access to financing, resources or efficiencies of scale, or the ability to provide multiple services in direct competition with us. If we are unable to keep pace with technological change, our business and results of operations could be adversely affected. Our industry is characterized by rapid technological change and the introduction of new products and services. We cannot assure you that we will be able to fund the capital expenditures necessary to keep pace with future technological developments. We also cannot assure you that we will successfully anticipate the demand of our customers for products and services requiring new technology. This type of rapid technological change could adversely affect our ability to maintain, expand or upgrade our systems and respond to competitive pressures. An inability to maintain and expand our systems and provide advanced services in a timely manner, or to anticipate the demands of the market place, could adversely affect our ability to compete and our results of operations. The loss of key personnel could have a material adverse effect on our business. Our success is substantially dependent upon the retention and continued performance of our key personnel, including Rocco B. Commisso, our Chairman and Chief Executive Officer. We have not entered into a long-term employment agreement with Mr. Commisso. If Mr. Commisso or any of our other key personnel cease to be employed by us for any reason, our business could be materially adversely affected. We do not currently maintain key man life insurance on Mr. Commisso or other key personnel. 50 -. We may not be able to obtain critical items at a reasonable cost or when required, which could adversely affect business, financial condition and results of operations. We depend on third-party suppliers for equipment, software, services and other items that are critical for the operation of our cable systems and the provision of advanced services, including digital set-top converter boxes, digital video recorders and routers, fiber-optic cable, telephone circuits, software, the "backbone" telecommunicatio~etwork for our high-speed data service and construction services for expansion and upgrades of our cable systems. These items are available from a limited number of suppliers. Demand for these items has increased with the general growth in demand for Internet and telecommunications services. We typically do not carry significant inventories of equipment. Moreover, if there are no suppliers that are able to provide set-top converter boxes that comply with evolving Internet and telecommunications standards or that are compatible with other equipment and software that we use, our business, financial condition and results of operations could be materially adversely affected. If we are unable to obtain critical equipment, software, services or other items on a timely basis and at an acceptable cost, our ability to offer our products and services and roll out advanced services may be impaired, and our business, financial condition and results of operations could be materially adversely affected. Risks Related to Indebtedness of us and our Operating Subsidiaries We are a holding company with no operations and we depend on our operating subsidiaries for cash to fund our obligations. As a holding company, we do not have any operations or hold any assets other than our investments in and our advances to our operating subsidiaries. Consequently, our subsidiaries conduct all of our consolidated operations and own substantially all of our consolidated assets. The only source of cash we have to pay interest on, and repay the principal of, our indebtedness and to meet our other obligations is the cash that our subsidiaries generate from their operations and their borrowings. Our subsidiaries are not obligated to make funds available to us. Our subsidiaries' ability to make payments to us will depend upon their operating results and will be subject to applicable laws and contractual restrictions, including the agreements governing our subsidiary credit facilities and other indebtedness. Those agreements permit our subsidiaries to distribute cash to us under certain circumstances, but only so long as there is no default under any of such agreements. We have substantial existing debt and have significant interest payment requirements, which could adversely affect our ability to obtain financing in the future and require our operating subsidiaries to apply a substantial portion of their cash flow to debt service. Our total debt as of December 31, 2004 was approximately $3.0] billion. Our interest expense for the year ended December 31,2004 was $] 92.7 million. We cannot assure you that our business will generate sufficient cash flows to permit us, or our subsidiaries, to repay indebtedness or that refinancing of that indebtedness will be possible on commercially reasonable terms or at all. This high level of debt and our debt service obligations could have material consequences, including that: . our ability to access new sources of financing for working capital, capital expenditures, acquisitions or other purposes may be limited; . we may need to use a large portion of our revenues to pay interest on borrowings under our subsidiary credit facilities and our senior notes, which will reduce the amount of money available to fmance our operations, capital expenditures and other activities; el, . some of our debt has a variable rate of interest, which may expose us to the risk of increased interest rates; be ain · we may be more vulnerable to economic downturns and adverse developments in our business; . we may be less flexible in responding to changing business and economic conditions, including increased competition and demand for new products and services; . we may be at a disadvantage when compared to those of our competitors that have less debt; and 5] .- .,........- .J . we may not be able to fully implement our business strategy. A default under our indentures or our subsidiary credit facilities could result in an acceleration of our indebtedness and other material adverse effects. The agreements and instruments governing our own and our subsidiaries' indebtedness contain numerous financial and operating covenants. The breach of any of these covenants could cause a default, which could result in the indebtedness becoming immediately due and payable. If this were to occur, we would be unable to adequately finance our operations. In addition, a default could result in a default or acceleration of our other indebtedness subject to cross-default provisions. If this occurs, we may not be able to pay our debts or borrow sufficient funds to refmance them. Even if new financing is available, it may not be on terms that are acceptable to us. The membership interests of our operating subsidiaries are pledged as collateral under our respective subsidiary credit facilities. A default under one of our subsidiary credit facilities could result in a foreclosure by the lenders on the membership interests pledged under that facility. Because we are dependent upon our operating subsidiaries for all of our revenues, a foreclosure would have a material adverse effect on our business, financial condition and results of operations. The terms of our indebtedness could materially limit our financial and operating flexibility. Several of the covenants contained in the agreements and instruments governing our own and our subsidiaries' indebtedness could materially limit our financial and operating flexibility by restricting, among other things, our ability and the ability of our operating subsidiaries to: . incur additional indebtedness; . create liens and other encumbrances; . pay dividends and make other payments, investments, loans and guarantees; . enter into transactions with related parties; . sell or otherwise dispose of assets and merge or consolidate with another entity; . repurchase or redeem capital stock, other equity interests or debt; . pledge assets; and . issue capital stock or other equity interests. Complying with these covenants could cause us to take actions that we otherwise would not take or cause us not to take actions that we otherwise would take. We may not be able to obtain additional capital to continue the development of our business. We have invested substantial capital for the upgrade, expansion and maintenance of our cable systems and the launch and expansion of new or additional products and services. While we have completed our planned system upgrades, if there is accelerated growth in our video, HSD and voice products and services, or we decide to introduce other new advanced products and services, or the cost to provide these products and services increases, we may need to make unplanned additional capital expenditures. We may not be able to obtain the funds necessary to finance additional capital requirements through internally generated funds, additional borrowings or other sources. If we are unable to obtain these funds, we would not be able to implement our business strategy and our results of operations would be adversely affected. 52 ur lUS :in ely ess ; to rhe ~dit the 'all Its 'es' our not d the Istem e to Risks Related to Legislative and Regulatory Matters Our cable television business is subject to extensive governmental regulation. The cable television industry is subject to extensive legislation and regulation at the federal and local levels, and, in some instances, at the state level. Many aspects of such regulation are currently the subject of judicial and administrative proceedings and legislative and administrative proposals. We expect that court actions and regulatory proceedings will continue to refine our rights and obligations under applicable federal, state and local laws. The results of these judicial and administrative proceedings and legislative activities may materially affect our business operations. Local authorities grant us non-exclusive franchises that permit us to operate our cable systems. We renew or renegotiate these franchises from time to time. Local franchising authorities may demand concessions, or other commitments, as a condition to renewal, and these concessions or other commitments could be costly. The Communications Act contains renewal procedures and criteria designed to protect incumbent franchisees against arbitrary denials of renewal, and although such Act requires the local franchising authorities to take into account the costs of meeting such concessions or commitments, there is no assurance that we will not be compelled to meet their demands in order to obtain renewals. We cannot predict whether any of the markets in which we operate will expand the regulation of our cable systems in the future or the impact that any such expanded regulation may have upon our business. Similarly, due to the increasing popularity and use of commercial online services and the Internet, certain aspects have become subject to regulation at the federal and state level such as collection of information online from children, disclosure of certain subscriber information to governmental agencies, commercial emails or "spam," privacy, security and distribution of material in violation of copyrights. In addition to the possibility that additional federal laws and regulations may be adopted with respect to commercial online services and the Internet, it is possible that individual states may also impose such restrictions, potentially creating an intricate patchwork of laws and regulations. Future federal and/or state laws may cover such issues as privacy, access to some types of content by minors, pricing, encryption standards, consumer protection, electronic commerce, taxation of e-commerce, copyright infringement and other intellectual property matters. The adoption of such laws or regulations in the future may decrease the growth of such services and the Internet, which could in turn decrease the demand for our cable modem service, increase our costs of providing such service or have other adverse effects on our business, financial condition and results of operations. Changes in channel carriage regulations could impose significant additional costs on us. Cable operators face significant regulation of their channel carriage. Currently, they can be required to devote substantial capacity to the carriage of programming that they would not carry voluntarily, including certain local broadcast signals, local public, educational and government access programming, and unaffiliated commercial leased access programming. If the FCC or Congress were to require cable systems to carry both the analog and digital versions of local broadcast signals or to carry multiple program streams included with a single digital broadcast transmission, this carriage burden would increase substantially. Recently, the FCC reaffirmed that cable operators need only carry one programming service of each television broadcaster to fulfill its must-carry obligation. Our franchises are non-exclusive and local franchising authorities may grant competing franchises in our markets. Our cable systems are operated under non-exclusive franchises granted by local franchising authorities. As a result, competing operators of cable systems and other potential competitors, such as municipal utility providers, may be granted franchises and may build cable systems in markets where we hold franchises. Any such competition could adversely affect our business. The existence of multiple cable systems in the same geographic area is generally referred to as an "overbuild." As of the filing date of this report, approximately 12.4% of the estimated homes passed by our cable systems were overbuilt by other cable operators. We cannot assure you that competition from overbuilders will not develop in other markets that we now serve or will serve after any future acquisitions. 53 . r-- Pending FCC and court proceedings could adversely affect our HSD service. The legal and regulatory status of providing high-speed Internet access service by cable television companies is uncertain. The adoption of new rules by the FCC or rulings in court proceedings could place additional costs and regulatory burdens on us, reduce our anticipated revenues or increase our anticipated costs for this service, complicate the franchise renewal process, result in greater competition or otherwise adversely affect our busin~ss. The FCC has issued a declaratory ruling that cable modem service, as it is currently offered, is properly classified as an interstate information service that is not subject to common carrier regulation. However, the FCC is still considering the following: whether to require cable companies to provide capacity on their systems to other entities to deliver high-speed Internet directly to customers, also known as open access; whether certain other regulatory requirements do or should apply to cable modem service; and whether and to what extent cable modem service should be subject to local franchise authorities' regulatory requirements or franchise fees. There can be no assurance that regulatory authorities will not impose open access or similar requirements on us as part of an industry-wide requirement. Such requirements could have a negative impact on our business and results of operations. Challenges to the FCC's classification of cable Internet access service as an information service and not a cable service or a telecommunications service have been addressed by a federal appellate court. Based on a finding that it was bound by an earlier decision, the appellate court overturned the FCC's classification and found cable Internet service to include both information service and telecommunications service components. The United States Supreme Court has agreed to review the appellate court's decision. If the appellate court's decision prevails, it could result in an open access requirement and other obligations imposed on telecommunications carriers, which would be adverse to us. We may be subject to legal liability because of the acts of our HSD customers or because of our own negligence. Our HSD service enables individuals to access the Internet and to exchange information, generate content, conduct business and engage in various online activities on an international basis. The law relating to the liability of providers of these online services for activities of their users is currently unsettled both within the United States and abroad, Potentially, third parties could seek to hold us liable for the actions and omissions of our cable modem service customers, such as defamation, negligence, copyright or trademark infringement, fraud or other theories based on the nature and content of information that our customers use our service to post, download or distribute. We also could be subject to similar claims based on the content of other Websites to which we provide links or third-party products, services or content that we may offer through our Internet service. Due to the global nature of the Web, it is possible that the governments of other states and foreign countries might attempt to regulate its transmissions or prosecute us for violations of their laws. It is also possible that information provided directly by us will contain errors or otherwise be negligently provided to users, resulting in third parties making claims against us. For example, we offer Web-based email services, which expose us to potential risks, such as liabilities or claims resulting from unsolicited email, lost or misdirected messages, illegal or fraudulent use of email, or interruptions or delays in email service, Additionally, we host website "portal pages" designed for use as a home page by, but not limited to, our HSD customers. These portal pages offer a wide variety of content from third parties which could contain errors or other material that could give rise to liability. To date, no one has filed such a claim against us. However, in the future someone may file such a claim against us in either a domestic or international jurisdiction and may succeed in imposing liability on us. Our defense of any such actions could be costly and involve significant distraction of our management and other resources. If we are held or threatened with significant liability, we may decide to take actions to reduce our exposure to this type of liability. This may requite us to spend significant amounts of money for new equipment and may also require us to discontinue offering some features or our cable modem service. Since we launched our proprietary Mediacom Online(SM) HSD service in February 2002, from time to time, we receive notices of claimed infringements by our cable modem service users. The owners of copyrights and trademarks have been increasingly active in seeking to prevent use of the Internet to violate their rights. In many cases, their claims of infringement are based on the acts of customers of an Internet service provider--for example, a customer's use of an Internet service or the resources it provides to post, download or disseminate copyrighted music, movies, software or other content without the consent of the copyright owner or to seek to profit from the use 54 is is and of the goodwill associated with another person's trademark. In some cases, copyright and trademark owners have sought to recover damages from the Internet service provider, as well as or instead of the customer. The law relating to the potential liability of Internet service providers in these circumstances is unsettled. In 1996, Congress adopted the Digital Millennium Copyright Act, which is intended to grant ISPs protection against certain claims of copyright infringement re~ting from the actions of customers, provided that the ISP complies with certain requirements. So far, Congress hasnot adopted similar protections for trademark infringement claims. . Ice, ss. as till ies ~ry 'ice no an of We may be required to provide access to our networks to other Internet service providers, which could significantly increase our competition and adversely affect our ability to provide new products and services. ble t it met tes , it ich Local authorities and the FCC have been asked to require cable operators to provide non-discriminatory access over their cable systems to other Internet service providers. A federal court in each of California, Virginia and Florida has struck down these open-access requirements imposed by a variety of franchising authorities as unlawful. Each of these courts used different legal grounds to strike down the open-access requirements. However, an appellate court has found that cable modem service is part telecommunications service and part information service. The U.S. Supreme Court has agreed to hear an appeal of that decision. If not overturned, the decision could potentially result in open access being imposed on us. If we are required to provide access in this manner, it could have a significant adverse impact on our financial results, including by: (i) increasing competition; (ii) increasing the expenses we incur to maintain our systems; and/or (iii) increasing the expense of upgrading and/or expanding our systems. We may become subject to additional regulatory burdens when we offer cable telephony service. wn The regulatory obligations of VolP are currently under consideration by the FCC and state authorities. If our planned cable telephony service is deemed by regulators to be a telecommunications service or a state-regulated telephone service, such service could subject us to significant regulation as well as higher fees for pole attachments. The additional regulatory requirements could cause us to incur additional costs and we may not be able to meet them in a timely manner. nt, 'of nd fpm Hes te. or , of its Itly ail or Ily, "se Illd Actions by pole owners might subject us to significantly increased pole attachment costs. Our cable facilities are often attached to or use public utility poles, ducts or conduits. Historically, cable system attachments to public utility poles have been regulated at the federal or state level. Generally this regulation resulted in favorable pole attachment rates for attachments used to provide cable service. The FCC clarified that the provision of Internet access does not endanger a cable operator's favorable pole rates; this approach ultimately was upheld by the Supreme Court of the United States. However, an appellate court has subsequently held that cable modem service is not cable service but is part telecommunications service and part information service, which possibly could lead to higher pole attachment rates. The U.S. Supreme Court has agreed to hear an appeal of the lower court's decision. As a result of this uncertainty, utility pole owners in many areas are attempting to raise pole attachment rates and impose additional costs on cable operators and others. In addition, utility companies can increase the favorable pole attachment rates afforded cable operators under federal law if the operator provides telecommunications services, as well as cable service, over plant attached to utility poles. Our financial results could suffer a material adverse impact from any significant increased costs, and such increased pole attachment costs could discourage system upgrades and the introduction of new products and services. Risks related to our Chairman and Chief Executive Officer's Controlling Position nst my nre of ,to Our Chairman and Chief Executive Officer has the ability to control all major corporate decisions, and a sale of his stock could result in a change of control that would have unpredictable effects. ~e md my Rocco B. Commisso, our Chairman and Chief Executive Officer, beneficially owned our common stock representing approximately 75.9% of the combined voting power as of December 31, 2004. As a result, Mr. Commisso will generally have the ability to control the outcome of all matters requiring stockholder approval, including the election of our entire board of directors, the approval of any merger or consolidation and the sale of all or substantially all of our assets. In addition, Mr. Commisso's voting power may have the effect of discouraging offers to acquire Mediacom because any such acquisition would require his consent. :, a We cannot assure you that Mr. Commisso will maintain all or any portion of his ownership or that he would continue as an officer or director if he sold a significant part of his stock. The disposition by Mr. Commisso of a ed use 55 . sufficient number of shares could result in a change in control of our company, and we cannot assure you that a change of control would not adversely affect our business, financial condition or results of operations. As noted above, it could also result in a default under our subsidiary credit agreements and could also trigger a variety of federal, state and local regulatory consent requirements. 56 r _ l ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, we use interest rate exchange agreements ("interest rate swaps") with counterparties to fix the interest rate on a portion of our variable interest rate debt. As of December 31, 2004, we had $800.0 million of interest rate swaps with various banks with a weighted average fixed rate of approximately 3.3%. The fixed rates of the interest rate swaps are offset against the applicable three-month London Interbank Offering Rate to determine the related interest expense. Under the terms of the interest rate exchange agreements, which expire from 2005 through 2007, we are exposed to credit loss in the event of nonperformance by the other parties. However, due to the high creditworthiness of our counterparties, which are major banking firms with investment grade ratings, we do not anticipate their nonperformance. At December 31,2004, based on the mark-to- market valuation, we would have received approximately $0.3 million, including accrued interest, if we terminated these agreements. The table below provides the expected maturity and estimated fair value of our debt as of December 3 I, 2004 (all dollars in thousands). See Note 7 to our consolidated financial statements. Bank Credit Capital Lease Senior Notes Facilities Obligations Total Expected Maturity: January 1,2005 to December 31, 2005........ $ $ 40,500 $ 2,200 $ 42,700 January 1,2006 to December 31,2006........ 172,500 (I) 48,000 2,269 222,769 January 1,2007 to December 31, 2007........ 70,500 1,120 71,620 January 1,2008 to December 31,2008........ 200,000 70,500 43 270,543 January 1,2009 to December 31,2009........ 214,000 214,000 Thereafter.................................................... . 1,025,000 1,163,000 2,188,000 Total............................................................ . $ 1,397,500 $ 1,606,500 $ 5,632 $ 3,009,632 Fair Value. ................... ................ ................ $ 1,427,881 $ 1,606,500 $ 5,632 $ 3,040,013 Weighted Average Interest Rate.................. 9.1% 4.4% 3.1% 6.6% (I) Represents convertible senior notes due July 2006. 57 ,.... ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MEDIACOM COMMUNICA nONS CORPORA nON AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Contents Pa2e Report ofIndependent Registered Public Accounting Firm-PricewaterhouseCoopers LLP............................ 59 Consolidated Balance Sheets as of December 31,2004 and 2003.................................................................... 61 Consolidated Statements of Operations for the Years Ended December 31,2004,2003 and 2002................. 62 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended........................................ December 31,2004,2003 and 2002.......................................................................................................... 63 Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002................ 64 Notes to Consolidated Financial Statements.................................................................................................... 65 Financial Statement Schedule: Schedule II-Valuation and QualifYing Accounts............................................ 82 58 - -- ... Report of Independent Registered Public Accounting Firm To the Shareholders of Mediacom Communications Corporation: We have completed an integrated audit of Mediacom Communications Corporation's 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements and financial statement schedule In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Mediacom Communications Corporation and its subsidiaries (the "Company") at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the consolidated fmancial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated fmancial statements. These consolidated fmancial statements and consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit of the financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Internal control over financial reporting Also, in our opinion, management's assessment, included in management's report on internal control over fmancial reporting, appearing in Item 9A, that the Company maintained effective internal control over fmancial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control- Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of intemal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over fmancial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of fmancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable 59 -.- assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York March 15,2005 60 r I I _ 1.._ MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (All dollar amounts in thousands) may December 3 t, 2004 2003 ASSETS CURRENT ASSETS Cash and cash equivalents $ 23,875 $ 25,815 Investments 1,987 1,987 Subscriber accounts receivable, net of allowance for doubtful accounts of$3,659 and $3,524, respectively 58,253 56,706 Prepaid expenses and other current assets 12,757 13,214 Deferred tax asset 7,024 7,804 Total current assets 103,896 105,526 Investment in cable television systems: Property, plant and equipment, net of accumulated depreciation of $1,040,289 and $844,519, respectively 1,443,090 1,465,362 Intangible assets, net of accumulated amortization of $299,098 and $289,906, respectively 2,042,110 2,050,095 Total investment in cable television systems 3,485,200 3,515,457 Other assets, net of accumulated amortization of$25,266 and $23,823, respectively 46,559 41,780 Total assets $ 3,635,655 $ 3,662,763 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 261,223 $ 247,728 Deferred revenue 38,707 36,634 Current portion of long-tenn debt 42,700 12,570 Total current liabilities 342,630 296,932 Long-tenn debt, less current portion 2,966,932 3,038,922 Other non-current liabilities 32,581 41,795 Total liabilities 3,342,143 3,377,649 STOCKHOLDERS' EQUITY Class A common stock, $.01 par value; 300,000,000 shares authorized; 92,978,134 shares issued and 90,399,198 shares outstanding as of December 31, 2004 and 91,345,346 shares issued and 89,808,602 shares outstanding as of December 3 I, 2003 930 913 Class B common stock, $.0 I par value; 100,000,000 shares authorized; 27,461,939 and 28,913,145 shares issued and outstanding as of December 31, 2004 and December 31, 2003, respectively 274 289 Additional paid-in capital 983,417 982,390 Accumulated deficit (678,963) (692,515) Treasury stock, at cost, 2,578,936 and 1,536,744 shares of Class A common stock, as of December 31, 2004 and December 31, 2003, respectively (12,146) (5,963) Total stockholders' equity 293,512 285,114 Total liabilities and stockholders' equity $ 3,635,655 $ 3,662,763 The accompanying notes to the consolidated fmancial statements are an integral part of these statements. 61 . r MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (All dollar amounts in thousands, except per share amounts) Year Ended December 31, 2004 2003 2002 Revenues $ 1,057,226 $ 1,004,889 $ 923,033 Costs and expenses: Service costs (exclusive of depreciation and amortization of$217,262, $273,307 and $319,435, respectively, shown separately below) 412,841 385,129 359,737 Selling, general and administrative expenses 211,428 196,826 173,970 Corporate expenses 19,276 17,237 18,075 Depreciation and amortization 217,262 273,307 319,435 Operating income 196,419 132,390 51,816 Interest expense, net (192,740) (190, I 99) (188,304) Gain (loss) on derivatives, net 16,125 9,057 (13,877) Gain (loss) on sale of assets and investments, net 5,885 (1,839) Other expense (12,061) (11,460) (Il,093) Net income (loss) before provision for income taxes 13,628 (62,051) (161,458) Provision for income taxes 76 424 200 Net income (loss) $ 13,552 $ (62,475) $ (161,658) Basic weighted average shares outstanding 118,534 118,627 119,608 Basic earnings (loss) per share $ O.Il $ (0.53) $ ( 1.35) Diluted weighted average shares outstanding I 18,543 118,627 I 19,608 Diluted earnings (loss) per share $ 0.11 $ (0.53) $ (1.35) The accompanying notes to the consolidated financial statements are an integral part of these statements. 62 MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (All dollar amounts in thousands) Class A Class B Additional Common Common Paid-In Accumulated Treasury 3 Stock Stock Capital Deficit Stock Total Balance, December 31, 2001 $ 905 $ 293 $ 974,760 $ (468,382) $ $ 507,576 Net loss (161,658) (161,658) Issuance of common stock in employee stock purchase plan 3 1,260 1,263 Vesting of equity granted to management, net offorfeiture 5,323 5,323 Transfer of stock 3 (3) Treasury stock, at cost (5,963) (5,963 ) 16 Balance, December 31, 2002 $ 911 $ 290 $ 981,343 $ (630,040) $ (5,963) $ 346,541 Net loss (62,475) (62,475) ,04) Issuance of common stock in :77) employee stock purchase plan 1,047 1,048 Transfer of stock (I) Balance, December 31,2003 $ 913 $ 289 $ 982,390 $ (692,515) $ (5,963) $ 285,114 Net income 13,552 13,552 Issuance of common stock in employee stock purchase plan 2 1,027 1,029 Transfer of stock 15 ( 15) Treasury stock, at cost (6,183) (6,183) Balance, December 31, 2004 $ 930 $ 274 $ 983,417 $ (678,963) $ ( 12,146) $ 293,512 The accompanying notes to the consolidated financial statements are an integral part of these statements. 63 . I I MEDIACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (All dollar amounts in thousands) CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization (Gain) loss on derivatives, net Vesting of management stock (Gain) loss on sale of assets and investments, net Amortization of deferred financing costs Deferred income taxes Changes in assets and liabilities, net of effects from acquisitions: Subscriber accounts receivable, net Prepaid expenses and other current assets Accounts payable and accrued expenses Deferred revenue Other non-current liabilities Net cash flows provided by operating activities CASH FLOWS USED IN INVESTING ACTIVITIES: Capital expenditures Acquisition of cable television systems Proceeds from sale of assets and investments Other investing activities Net cash flows used in investing activities CASH FLOWS (USED IN) PROVIDED BY FINANCING ACTIVITIES: New borrowings Repayment of debt Repurchases of Class A common stock Proceeds from issuance of common stock in employee stock purchase plan Financing costs Other financing activities - book overdrafts Net cash flows (used in) provided by fmancing activities Net decrease in cash and cash equivalents CASH AND CASH EQUIVALENTS, beginning of period CASH AND CASH EQUIVALENTS, end of period SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest, net of amounts capitalized SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Capital expenditures fmanced through capital [eases Year Ended December 31, 2004 2003 2002 $ 13,552 $ (62,475) $(161,658) 217,262 273,307 319,435 (16,[25) (9,057) 13,877 5,323 (5,885) l,839 8,725 6,696 7,183 780 748 (5,375) (1,043) (501) (10,601) 457 (3,951 ) 3,400 6,961 (2,620) (4,080) 2,073 10,372 3,855 (2,146) (7,458) 1,237 224,611 206,900 172,596 (181,362) (231,505) (408,314) (3,372) (7,374) (6,548) 10,556 15,409 (3,246) 2,026 (6,740) (177,424) (221,444) (421,602) 247,872 302,594 539,750 (289,732) (279,348) (318,750) (6,183) (5,963) 1,029 1,048 1,263 (8,147) (520) (984 ) 6,034 (14,639) 1,607 (49,127) 9,135 216,923 (1,940) (5,409) (32,083) 25,815 31,224 63,307 $ 23,875 $ 25,815 $ 31,224 186,835 196,253 194,497 $ $ 9,036 $ The accompanying notes to the consolidated financial statements are an integral part of these statements. 64 .-- MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Organization Mediacom Communications Corporation ("MCC," and collectively with its direct and indirect subsidiaries, the "Company") was organized in November 1999 and is involved in the acquisition and development of cable systems serving smaller cities and towns in the United States. Through these cable systems, the Company provides entertainment, information and telecommunications services to its subscribers. As of December 31, 2004, the Company was operating cable systems in 23 states, principally Alabama, California, Delaware, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Minnesota, Missouri, North Carolina and South Dakota. (2) Summary of Significant Accounting Policies Basis of Preparation of Consolidated Financial Statements ,183 ,375) The consolidated financial statements include the accounts of MCC and its subsidiaries. All significant intercompany transactions and balances have been eliminated. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America 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. The accounting estimates that require management's most difficult and subjective judgments include assessment and valuation of intangibles, useful lives of property, plant and equipment, and the recognition and measurement of income tax assets and liabilities and the valuation of programming liabilities. Actual results could differ from those and other estimates. 601) 400 ,080) ,855 . ,237 ,596 Change in Estimate :,314) .i,548) ,740) 1,602) Effective July 1, 2003, the Company changed the estimated useful lives of its cable systems and equipment. The changes in estimated useful lives were made to reflect management's evaluation of the longer economic lives of the Company's upgraded and rebuilt network. The new asset lives are consistent with those used by companies in the cable television industry. The weighted average useful lives of such fixed assets changed from approximately 7 years to approximately 12 years. These changes were made on a prospective basis and resulted in an increase in net income of approximately $130.3 million or $1.10 per share for the year ended December 31, 2004 and a decrease in net loss of approximately $63.5 million or $0.54 per share for the year ended December 31,2003. Revenue Recognition Revenues include amounts billed to customers for services provided, installations, advertising and other services. Revenues from video and data services are recognized when the services are provided to the customers. Installation revenues are less than direct installation costs. Therefore, installation revenues are recognized as connects are completed. Advertising sales are recognized in the period that the advertisements are exhibited. Franchise fees are collected on a monthly basis and are periodically remitted to local franchise authorities. Franchise fees collected and paid are reported as revenues and expenses as a component of seIling, general and administrati ve. 14,497 Allowance for Doubtful Accounts The allowance for doubtful accounts represents the Company's best estimate of probable losses in the accounts receivable balance. The allowance is based on the number of days outstanding, customer balances, historical experience and other currently available information. Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. 65 . MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Concentration of Credit Risk The Company's accounts receivable are comprised of amounts due from subscribers in varying regions throughout the United States. Concentration of credit risk with respect to these receivables is limited due to the large number of customers comprising the Company's customer base and their geographic dispersion. The Company invests its cash with high quality financial institutions. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Additions to property, plant and equipment generally include material, labor and indirect costs. Depreciation is calculated on a straight-line basis over the following useful lives: Buildings............................................................................................... . Leasehold improvements......... .................... ........... ... ...... ... .... ................ Cable systems and equipment and subscriber devices............................ Vehicles........ ....... ... ...... ... .... .......... ...... .......... ......... ... ............... ... ....... .... Furniture, fixtures and office equipment................................................. 40 years Life of respective lease 4 to 20 years 5 years 5 years The Company capitalizes improvements that extend asset lives and expenses repairs and maintenance as incurred. At the time of retirements, sales or other dispositions of property, the original cost and related accumulated depreciation are removed from the respective accounts and the gains or losses are presented as a separate component on the statement of operations. The Company capitalizes the costs associated with the construction of cable transmission and distribution facilities, new customer installations and indirect costs associated with our telephony product. Costs include direct labor and material, as well as certain indirect costs including interest. The Company performs periodic evaluations of certain estimates used to determine the amount and extent that such costs that are capitalized. Any changes to these estimates, which may be significant, are applied in the period in which the evaluations were completed. The costs of disconnecting service at a customer's dwelling or reconnecting to a previously installed dwelling are charged as expense in the period incurred. Costs associated with subsequent installations of additional services not previously installed at a customer's dwelling are capitalized to the extent such costs are incremental and directly attributable to the installation of such additional services. Capitalized Software Costs The Company accounts for internal-use software development and related costs in accordance with AICPA Statement of Position No. 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Software development and other related costs consist of external and internal costs incurred in the application development stage to purchase and implement the software that will be used in the Company's telephony business. Costs incurred in the development of application and infrastructure of the software is capitalized and will be amortized over its respective estimated useful life. During the year ended December 31, 2004 and 2003, the Company capitalized approximately $3.6 million and $0.7 million, respectively of software development costs. Amortization will begin when the Company launches its telephony product. Intangible Assets In accordance with F ASB No. 142 "Goodwill and Other Intangible Assets," the amortization of goodwill and indefinite-lived intangible assets is prohibited and requires such assets to be tested annually for impairment, or more frequently if impairment indicators arise. The Company has determined that its cable franchise costs and goodwill are indefinite-lived assets and therefore not amortizable. Other finite-lived intangible assets, which consist primarily 66 MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of subscriber lists and covenants not to compete, continue to be amortized over their useful lives of 5 to 10 years and 5 years, respectively. Other Assets Other assets, net, include fmancing costs incurred to raise debt, which are deferred and amortized as other expense over the expected term of such financings. Segment Reporting SF AS No. 131, "Disclosure about Segments of an Enterprise and Related Information," requires the disclosure of factors used to identify an enterprise's reportable segments. The Company's operations are organized and managed on the basis of cable system clusters that represent operating segments responsible for certain geographical regions. Each operating segment derives its revenues from the delivery of similar products and services to a customer base that is also similar. Each operating segment deploys similar technology to deliver our products and services and operates within a similar regulatory environment. In addition, each operating segment has similar economic characteristics. Management evaluated the criteria for aggregation of the geographic operating segments under SF AS No. 131 and believes the Company meets each of the respective criteria set forth. Accordingly, management has identified broadband services as the Company's one reportable segment. Accounting for Derivative Instruments The Company accounts for derivative instruments in accordance with SFAS No. 133, SFAS No. 138 and SFAS No. 149. These pronouncements require that all derivative instruments be recognized on the balance sheet at fair value. The Company's stated strategy is to manage its interest expense using a combination of fixed and variable interest rate debt. The Company enters into interest rate exchange agreements to fix the interest rate on a portion of its variable interest rate debt to reduce the potential volatility in its interest expense that would otherwise result from changes in market interest rates. The Company's derivative instruments are recorded at fair value and are included in other current assets, other assets and other liabilities. The Company's accounting policies for these instruments are based on whether they meet the Company's criteria for designation as hedging transactions. The criteria for designating a derivative as a hedge include the instrument's effectiveness in risk reduction and, in most cases, a one- to-one matching of the derivative instrument to its underlying transaction. Gains and losses from changes in fair values of derivatives that are not designated as hedges for accounting purposes are recognized currently in earnings. During 2004, 2003 and 2002, none of the Company's derivative financial instruments were designated as hedges. Therefore, changes in fair value for the respective periods were recognized in earnings. Accounting for Asset Retirement The Company adopted SF AS No. 143, "Accounting for Asset Retirement Obligations", on January I, 2003. SF AS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company reviewed its asset retirement obligations to determine the fair value of such liabilities and if a reasonable estimate of fair value could be made. This entailed the review of leases covering tangible long-lived assets as well as the Company's rights-of-way under franchise agreements. In determining the fair value of the Company's asset retirement obligation, consideration was given to the Cable Communications Policy Act of 1984, which generally entitles the cable operator to the "fair market value" for the cable system covered by a franchise, if renewal is denied and the franchising authority acquires ownership of the cable system or effects a transfer of the cable system to another person. Changes in these assumptions based on future information could result in adjustments to estimated liabilities. Upon adoption of SF AS No. 143, the Company determined that in certain instances, it is obligated by contractual terms or regulatory requirements to remove facilities or perform other remediation activities upon the retirement of its assets. The Company has recorded a $7.8 million asset in property, plant and equipment and a corresponding liability of $7.8 million. 67 . T I I MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounting for Long-Lived Assets In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company periodically evaluates the recoverability and estimated lives of its long-lived assets, including property and equipment and intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed. The measurement for such impairment loss is based on the fair value of the asset, typically based upon the future cash flows discounted at a rate commensurate with the risk involved. Unless presented separately, the loss is included as a component of either depreciation expense or amortization expense, as appropriate. Income Taxes The Company provides for income taxes using the liability method in accordance with SF AS No. 109, "Accounting for Income Taxes," which requires an asset and liability based approach in accounting for income taxes. The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and expected benefits of utilizing net operating loss carryforwards. The Company periodically assesses the likelihood of the realization of deferred tax assets and net operating loss carryforwards by considering the scheduled reversal of deferred tax liabilities, projected taxable income in future periods and the evaluation of available prudent tax planning strategies. Reclassifications Certain reclassifications have been made to prior year's amounts to conform to the current year's presentation. Recent Accounting Pronouncements The FASB issued SFAS No. 148, "Accountingfor Stock-Based Compensation - Transition and Disclosure," in December 2002, which amended: (i) SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation; (ii) the disclosure provisions of SF AS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock- based employee compensation; and (iii) APB Opinion No. 28, "Interim Financial Reporting, " to require disclosure about those effects in interim financial information. The Company adopted SF AS No. 148 on January 1,2003. The Company did not change to the fair value-based expense recognition method of accounting for stock-based employees' compensation. Accordingly, the adoption of SF AS No. 148 did not affect the Company's financial condition or results of operations. However, SF AS No. 148 requires that information be provided as if the Company had accounted for employee stock options under the fair value method of this statement, including disclosing pro forma information regarding net income (loss) and net income (loss) per share beginning with the first quarter of 2003. The Company accounts for stock-based compensation in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," as permitted by SF AS No. 123. Compensation expense 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 the employee must pay to acquire the stock. In December 2004, the FASB issued SFAS No. 123R, "Amendment of Statement /23 on Share-Based Payment." SFAS No. 123R requires companies to expense the value of employee stock options, stock granted through the employee stock purchase program and similar awards. SF AS No. 123R is effective for periods beginning after June 15,2005. The Company plans on adopting SFAS No. 123R effective July 1,2005 and expects that the adoption of SFAS No. 123R will have a material impact on its consolidated results of operations and earnings per share. 68 MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS There are three methods of adopting SF AS No. 123R. The first method is called modified prospective method, which allows companies to avoid recording additional compensation expense for vested awards that are outstanding on the effective date of the SF AS No. 123R. Unvested awards outstanding on the effective date would be charged to expense over the remaining vesting period. The second method is similar to the modified prospective method, except it allows companies to restate earlier interim periods in the year of adoption using the applicable SF AS No. 123R pro forma amounts. The third method is the modified retrospective method, which directs companies to apply the modified prospective method and to restate prior financial statements. The Company is currently evaluating these transitional methods. In March 2004, the F ASB approved the consensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The Issue's objective is to provide guidance for identifying other-than-temporarily impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the F ASB issued a F ASB Staff Position (FSP) EITF 03-1 that delays the effective date of the measurement and recognition guidance in EIFT 03-1 until further notice. The disclosure requirements of EITF 03-1 are effective with this annual report for fiscal 2004. Once the F ASB reaches a final decision on the measurement and recognition provisions, the Company will evaluate the impact of the adoption of the accounting provision of EIFT 03-1. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29." The guidance in APB Opinion No. 29, "Accounting for Nonmonetary Transactions ", is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SF AS No. 153 is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15,2005. The adoption of SF AS No. 153 is not expected to have a material impact on the Company's financial position and results of operations. (3) Earnings per Share The Company calculates earnings per share in accordance with SFAS No. 128, "Earnings per Share." SFAS No. 128 computes basic earnings (loss) per share by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period plus the effects of any dilutive securities. Diluted earnings per share considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti- dilutive effect. The Company's potentially dilutive securities include common shares which may be issued upon exercise of its stock options or conversion of convertible senior notes. Diluted earnings per share for the years ended December 3 1, 2004, 2003 and 2002 exclude potential common shares of approximately 20.5 million, 19.4 million and 19.4 million, respectively, primarily related to the Company's outstanding stock options and convertible senior notes, because the assumed issuance of such potential common shares is antidilutive. For the year ended December 31, 2004, diluted weighted average common shares includes approximately 9,500 potential common shares assuming the exercise of stock options. 69 . T I MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Company's calculation of basic and diluted earnings (loss) per share for the years ended December 31, 2004, 2003 and 2002 (amounts in thousands, except per share amounts): Net income (loss).................................................................... Basic weighted average common shares outstanding.............. Basic earnings (loss) per share................................................ Diluted weighted average common shares outstanding........... Diluted earnings (loss) per share............................................. (4) Property, Plant and Equipment 2004 $ 13,552 118,534 $ 0.11 118,543 $ 0.11 2003 2002 $ (62,475) $ (161,658) 118,627 119,608 $ (0.53) $ (1.35) 118,627 119,608 $ (0.53) $ (1.35) As of December 31, 2004 and 2003, property, plant and equipment consisted of (dollars in thousands): Land and land improvements.................................................. Buildings and leasehold improvements................................... Cable systems, equipment and subscriber devices.................. Vehicles............... ............ ........ .'. ............... ..... .......... ........... ..... Furniture, ftxtures and office equipment................................. Accumulated depreciation....................................................... Property, plant and equipment, net.......................................... 2004 $ 7,089 39,898 2,342,220 60,754 33,417 2,483,379 ( I ,040,289) $ 1,443,090 2003 $ 7,059 41,273 2,172,953 63,023 25,573 2,309,881 (844,519) $ 1,465,362 Depreciation expense for the years ended December 31, 2004, 2003 and 2002 was approximately $206.2 million, $258.4 million and $286.4 million, respectively. As of December 31, 2004 and 2003 the Company had property under capitalized leases of $1 0.1 million and $10.7 million, respectively, before accumulated depreciation, and $7.4 million and $8.9 million, respectjvely, net of accumulated depreciation. During the years ended December 31, 2004 and 2003, the Company incurred gross interest expense of $195.7 million and $197.2 million, respectively of which $3.0 million and $7.0 million was capitalized. See Note 2 to our consolidated ftnancial statements. (5) Intangible Assets The Company operates its cable systems under non-exclusive cable franchises that are granted by state or local government authorities for varying lengths of time. As of December 31, 2004, the company held 1,380 franchises in areas located throughout the United States. The Company acquired these cable franchises through acquisitions of cable systems and were accounted for using the purchase method of accounting. On January 1,2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets", which eliminates amortization of goodwill and certain intangibles that have indeftnite lives but requires that such assets be tested for impairment at least annually. The Company evaluated the expected useful life of its cable franchises, also referred to as franchise costs, upon adoption of SF AS No. 142 and determined that all of its cable franchises have an indefinite useful life. As such, the Company ceased amortizing its cable franchises effectjve January I, 2002. The Company has assessed franchise value for impairment under SF AS No. 142 by utilizing a discounted cash flow methodology. In performing an impairment test in accordance with SF AS No. 142, the Company considers the guidance contained in EITF Issue No. 02-7, "Recognition of Customer Relationship Intangible Assets acquired in a Business Combination, .. whereby the Company considers assumptions, such as future cash flow expectations and 70 MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS other future benefits related to the intangible assets, when measuring the fair value of each cable systems other net assets. If the determined fair value of the Company's franchise costs is less the carrying amount on the financial statements, an impairment charge would be recognized for the difference between the fair value and the carrying value of the assets. To test the impairment of the goodwill carried on the Company's fmancial statements, the fair value of the cable system cluster's tangible and intangible assets (includes franchise costs) other than goodwill is deducted from the cable system cluster's fair value. The balance represents the fair value of goodwill which is then compared to the carrying value of goodwill to determine if there is any impairment. The Company completed its last impairment test in accordance with SF AS No. 142 as of October 1, 2004, which reflected no impairment of franchise costs or goodwill. There have been no events since then that would require an analysis to be completed before the next annual test date. The following table summarizes the net asset value for each intangible asset category as of December 31, 2004 and 2003 (dollars in thousands): Gross Asset Accumulated Net Asset 2004 Value Amortization Value Franchise costs........ ...................................... ................. $ 1,944,918 $ 140,947 $ 1,803,971 Goodwill.... ... ...... ......................... ............... ... ...... ........... 224,614 3,232 221,382 Subscriber Lists........................ ...................................... 165,981 149,277 16,704 Covenants not to compete.............................................. 5,695 5,642 53 $ 2,341,208 $ 299,098 $ 2,042,110 Gross Asset Accumulated Net Asset 2003 Value Amortization Value Franchise costs.......... ..................................................... $ 1,943,010 $ 141,167 $ 1,801,843 Goodwill... ... .......... ................. .... ............. ..... ...... ... ......... 224,281 3,232 221,049 Subscriber Lists................................... ........................... 167,015 140,030 26,985 Covenants not to compete.............................................. 5,695 5,477 218 $ 2,340,00 I $ 289,906 $ 2,050,095 Amortization expense for the years ended December 31, 2004, 2003 and 2002 was approximately $11.1 million, $14.9 million and $33.0 million, respectively. The Company's estimated aggregate amortization expense for 2005 through 2008 and beyond are $2.8 million, $2.1 million, $2.1 million, $2.1 million and $7.7 million, respectively. The net asset value as of December 31,2004 decreased approximately $8.0 million from December 31,2003, primarily due to the recording of amortization expense and the purchase and sale of cable system assets during the period. n f h 71 -- T MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (6) Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consist of the following as of December 31, 2004 and December 31, 2003 (dollars in thousands): Accounts payable Book overdrafts (1) Accrued interest Accrued payroll and benefits Accrued programming costs Accrued property, plant and equipment Accrued taxes and fees Other accrued expenses December 31, 2004 December 31, 2003 $ $ 2,374 4,189 55,053 23,524 77 ,296 25,463 26,513 33,316 247,728 14,097 10,223 61,910 24,314 62,049 18,261 27,777 42,592 261,223 $ $ (1) Book overdrafts represent outstanding checks in excess of funds on deposit at the Company's disbursement accounts. (7) Debt As of December 31, 2004 and 2003, debt consisted of (dollars in thousands): Bank credit fac ilities............................................................................... 8 Y2% senior notes.................................................................................. 7 Ys% senior notes.................................................................................. 9 Y2% senior notes.................................................................................. 11 % senior notes.................................................................................... 5 '/.% convertible senior notes................................................................ Cap itallease obligations......................................................................... Less: Current portion......................... ........ .............. ............ ......... ......... T otallong-term debt.................. .................. ........... ............ .................... Bank Credit Facilities 2004 2003 $ 1,606,500 $ 1,646,500 200,000 200,000 125,000 125,000 500,000 500,000 400,000 400,000 172,500 172,500 5,632 7,492 $ 3,009,632 $ 3,051,492 42,700 12,570 $ 2,966,932 $ 3,038,922 On October 21, 2004, the operating subsidiaries of Mediacom LLC, one of the Company's two principal subsidiaries, refinanced their two credit facilities with a new $1.15 billion senior secured credit facility (the "LLC credit facility"). The LLC credit facility consists of a revolving credit facility (the "LLC revolver") with a $400.0 million revolving credit commitment, a $200.0 million delayed-draw term loan (the "LLC term loan A") and a $550.0 million term loan (the "LLC term loan B"). The LLC revolver expires on September 30, 20 II and its commitment amount is not subject to scheduled reductions prior to maturity. The LLC term loan A matures on September 30, 2012 and beginning on March 31, 2008 will be subject to quarterly reductions ranging from 2.50% to 9.00% of the original amount. The LLC term loan B matures on March 31, 2013 and will be subject to quarterly reductions of 0.25% from March 31, 2005 to December 31,2012, and 92.00% on maturity, of the original amount. 72 31, 1, 74 189 53 524 296 463 513 ,316 ,728 ement 3 6,500 0,000 5,000 0,000 00,000 72,500 7,492 51,492 12,570 38,922 principal the "LLC a $400.0 ") and a II and its atures on 2.50% to quarterly al amount. MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2004, the maximum commitment available under the LLC revolver was $400.0 million and the revolver had an outstanding balance of $96.0 million, the LLC term loan B had an outstanding balance of $550.0 million, and the LLC term loan A had not been drawn. The credit agreement of the LLC credit facility (the "LLC credit agreement") provides for interest at varying rates based upon various borrowing options and certain financial ratios, and for commitment fees of Y2% to %% per annum on the unused portion of the available revolving credit commitment. Interest on outstanding LLC revolver and LLC term loan A balances are payable at either the Eurodollar rate plus a floating percentage ranging from 1.00% to 2.00% or the base rate plus a floating percentage ranging from 0% to 1.00%. Interest on the LLC term loan B is payable at either the Eurodollar rate plus 2.25% or the base rate plus 1.25%. For the year ended December 31,2005, the LLC term loan B will be reduced by $5.5 million or 1.00% of the original amount. The operating subsidiaries of Mediacom Broadband LLC, the Company's other principal subsidiary, maintain a $1.4 billion senior secured credit facility (the "Broadband credit facility") consisting of a revolving credit facility (the "Broadband revolver") with an initial commitment of $600 million, a $300 million term loan A (the "Broadband term loan A") and a $500 million term loan B (the "Broadband term loan B"). On December 16,2004, the operating subsidiaries of Mediacom Broadband LLC amended the credit agreement of the Broadband credit facility (the "Broadband credit agreement") to conform its definitions, financial covenants and other terms (including those relating to letters of credit, mandatory prepayment, representations and warranties, negative covenants and events of default) to those of the LLC credit agreement. The Broadband revolver expires on March 31, 2010 and, beginning on December 31, 2004, its commitments were subject to quarterly reductions ranging from 2.00% to 8.00% of the original commitment amount. The Broadband term loan A matures on March 31, 20 10 and, beginning on September 30, 2004, has been subject to quarterly reductions ranging from 1.00% to 8.00% of the original amount. The Broadband term loan B matures on September 30, 20 I 0 and is subject to quarterly reductions of 0.25% from September 30, 2004 to June 30, 2010, and 94.00% on maturity, of the original amount. As of December 31, 2004, the maximum commitment available under the Broadband revolver was $588.0 million and the revolver had an outstanding balance of $169.0 million, the Broadband term loan A had an outstanding balance of $294.0 million, and the Broadband term loan B had an outstanding balance of $497.5 million. The Broadband credit agreement provides for interest at varying rates based upon various borrowing options and certain financial ratios, and for commitment fees of'Ys% to %% per annum on the unused portion of the available revolving credit commitment. Interest on outstanding Broadband revolver and Broadband term loan A balances are payable at either the Eurodollar rate plus a floating percentage ranging from 1.00% to 2.50% or the base rate plus a floating percentage ranging from 0.25% to 1.50%. Interest on the Broadband term loan B is payable at either the Eurodollar rate plus a floating percentage ranging from 2.50% to 2.75% or the base rate plus a floating percentage ranging from 1.50% to 1.75%. For the year ended December 31, 2005, the maximum commitment amount under the Broadband revolver will be reduced by $60.0 million or 10.0% of the original commitment amount, the outstanding debt under the Broadband term loan A will be reduced by $30.0 million or 10.0% of the original amount, and the Broadband term loan B will be reduced by $5.0 million or 1.0% of the original amount. The LLC and Broadband credit agreements require compliance with certain financial covenants including, but not limited to, leverage, interest coverage and debt service coverage ratios, as defined therein. The credit agreements also require compliance with other covenants including, but not limited to, limitations on mergers and acquisitions, consolidations and sales of certain assets, liens, the incurrence of additional indebtedness, certain restricted payments, and certain transactions with affiliates. The Company was in compliance with all covenants of the LLC and Broadband credit agreements as of and for all periods in the year ended December 31, 2004. The LLC credit agreement is collateralized by Mediacom LLC's pledge of all its ownership interests in its operating subsidiaries and is guaranteed by Mediacom LLC on a limited recourse basis to the extent of such ownership interests. The Broadband credit agreement is collateralized by Mediacom Broadband LLC's pledge of all its ownership interests in its operating subsidiaries and is guaranteed by Mediacom Broadband LLC on a limited recourse basis to the extent of such ownership interests. 73 MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The average interest rate on debt outstanding under the LLC and Broadband credit agreements was 4.4% and 3.0% for the years ended December 31, 2004 and 2003, respectively, before giving effect to the interest rate exchange agreements discussed below. As of December 31, 2004, the Company had approximately $908.5 million of unused bank commitments under the LLC and Broadband credit agreements. The Company uses interest rate exchange agreements in order to fix the interest rate on its floating rate debt. As of December 31, 2004, the Company had interest rate exchange agreements with various banks pursuant to which the interest rate on $800.0 million is fixed at a weighted average rate of approximately 3.3%, plus the average applicable margin over the Eurodollar rate option under the Company's bank credit agreements. Under the terms of the interest rate exchange agreements, which expire from 2005 through 2007, the Company is exposed to credit loss in the event of nonperformance by the other parties. However, due to the high creditworthiness of its counterparties, which are major banking firms with investment grade ratings, the Company does not anticipate their nonperformance. The fair value of the interest rate exchange agreements is the estimated amount that the Company would receive or pay to terminate such agreements, taking into account market interest rates, the remaining time to maturities and the creditworthiness of the Company's counterparties. At December 31, 2004, based on the mark-to-market valuation, the Company recorded an investment in derivatives of $4.0 million, offset by a $3.7 derivative liability. As a result of the quarterly mark-to-market valuations of these interest rate swaps, the Company recorded a gain on derivative instruments amounting to $16.1 million and $9.1 million for the years ended December 31, 2004 and 2003, respectively. Senior Notes On April I, 1998, Mediacom LLC and its wholly-owned subsidiary, Mediacom Capital Corporation, a New York corporation, jointly issued $200.0 million aggregate principal amount of 8Y2% senior notes due on April 2008 (the "8WYO Senior Notes"). The 8Y2% Senior Notes are unsecured obligations of Mediacom LLC, and the indenture for the 8WYO Senior Notes stipulates, among other things, restrictions on incurrence of indebtedness, distributions, mergers and asset sales and has cross-default provisions related to other debt of Mediacom LLC. The 8Y2% Senior Notes are redeemable at 102.833% of par value through April 14, 2005, 10 1.417% of par value from April 15, 2005 through April 14,2006, and at par value thereafter. On February 26, 1999, Mediacom LLC and Mediacom Capital Corporation jointly issued $125.0 million aggregate principal amount of 7%% senior notes due on February 2011 (the "7Ys% Senior Notes"). The 7Ys% Senior Notes are unsecured obligations of Mediacom LLC, and the indenture for the 7%% Senior Notes stipulates, among other things, restrictions on incurrence of indebtedness, distributions, mergers and asset sales and has cross-default provisions related to other debt of Mediacom LLC. On January 24, 2001, Mediacom LLC and its wholly-owned subsidiary, Mediacom Capital Corporation, completed an offering of $500.0 million of 9Y2% senior notes due January 2013 (the "9WYo Senior Notes"). The 9Y2% Senior Notes are unsecured obligations of Mediacom LLC, and the indenture for the 9Y2% Senior Notes stipulates, among other things, restrictions on incurrence of indebtedness, distributions, mergers, and asset sales and has cross-default provisions related to other debt of Mediacom LLC. On June 29, 2001, Mediacom Broadband LLC and its wholly-owned subsidiary, Mediacom Broadband Corporation, a Delaware corporation, completed an offering of $400.0 million in aggregate principal amount of 11% senior notes due July 2013 (the "11% Senior Notes"). The 11% Senior Notes are unsecured obligations of Mediacom Broadband, and the indenture for the 11 % Senior Notes stipulates, among other things, restrictions of incurrence of indebtedness, distributions, mergers and assets sales and has cross-default provisions related to other debt of Mediacom Broadband. Mediacom LLC and Mediacom Broadband LLC were each in compliance with the indentures governing their respective Senior Notes as of and for all periods in the year ended December 31, 2004. 74 -r- I I I I I I I I I I MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Convertible Senior Notes The Company maintains $172.5 million aggregate principal amount of 5Y4% convertible senior notes ("Convertible Senior Notes") due July 2006. The Convertible Senior Notes are convertible at any time at the option of the holder into the Company's Class A common stock at an initial conversion rate of 53.4171 shares per $1,000 principal amount of notes, which is equivalent to a price of $18.72 per share. The conversion rate is subject to adjustment as specified in the indenture governing the Convertible Senior Notes. The Company may redeem the Convertible Senior Notes at 101.313% of par value from July 5, 2004 through June 30, 2005 and at par value thereafter. Fair Value and Debt Maturities The fair values of the Company's bank credit facilities approximated their carrying values at December 31, 2004. On that same date, the fair values of the 8!ti% Senior Notes, the 7%% Senior Notes, the 9!ti% Senior Notes and the 11% Senior Notes were approximately $204.0 million, $122.5 million, $501.9 million and $430.0 million, respectively. The fair value on that same date of the Convertible Senior Notes was approximately $169.5 million. The stated maturities of all debt outstanding as of December 31, 2004 are as follows (dollars in thousands): 2005........................................................................................................................... $ 2006........................................................................................................................... 2007............................................................................................................................ 2008........................................................................................................................... 2009........................................................................................................................... Thereafter.................................................................................................................. . 42,700 222,769 71,620 270,543 214,000 2,188,000 3,009,632 $ r 5 (8) Stockholders' Equity g It The Company has authorized 300,000,000 shares of Class A common stock, $0.0 I par value and 100,000,000 shares of Class B common stock, $0.0 I par value. The holders of Class A and Class B common stock are entitled to vote as a single class on each matter in which the shareholders of the Company are entitled to vote. Each Class A share is entitled to one vote and each Class B share is entitled to ten votes. n r n, During 2002, the Company repurchased approximately 1.5 million shares of its Class A common stock for an aggregate cost of approximately $6.0 million at share prices ranging from $3.59 to $4.29 per share. d % of of er During the second half of 2004, the Company repurchased approximately 1.0 million shares of its Class A common stock for an aggregate cost of approximately $6.2 million at share prices ranging from $5.55 to $6.29 per share. These repurchases were completed under the $50.0 million Class A stock repurchase program authorized by the Board of Directors in May 2000. As of the filing of this report, approximately $37.9 million of the original $50.0 million authorized remains available under the Class A stock repurchase program. eir 75 - r MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (9) Income Tax Income tax expense relates to minimum state and local taxes and capital taxes that the Company is required to pay in certain jurisdictions. The reconciliation of the income tax expense at the United States federal statutory rate to the actual income tax expense is as follows (dollars in thousands): 2004 2003 2002 Tax provision (benefit) at the United States statutory rate $ 4,770 $ (21,718) $ (56,510) State taxes, net of federal tax benefit 49 276 130 Valuation allowance (4,750) 21,697 56,683 Other 7 169 (103 ) Total income tax expense $ 76 $ 424 $ 200 The Company's net deferred tax liability consists of the following (dollars in thousands): 2004 2003 Current deferred tax assets: Unrealized loss on investments $ 5,600 $ 5,600 Accrued liabilities 3,891 6,858 Allowance for doubtful accounts 1,442 1,386 Total current deferred tax assets 10,933 13,844 Less: Valuation allowance (3,909) (6,040) Current deferred tax assets, net $ 7,024 $ 7,804 Long-term deferred tax assets: Net operating loss 595,293 492,906 Other assets 16,824 16,320 Valuation allowance (218,863) (222,161) Long-term deferred tax assets, net $ 393,254 $ 287,065 Long-term deferred tax liabilities: Investment in cable television systems 400,278 294,869 Long-term deferred tax liabilities, net $ 7,024 $ 7,804 At December 31, 2004, the Company had pre-tax net operating loss carryforwards of approximately $1.5 billion for federal and state purposes, which will expire in the years 2020 through 2024. The valuation allowance used in calculating the deferred tax liabilities decreased from 2004 to 2003 by approximately $5.4 million, primarily due to the net increase in deferred tax liabilities as of December 31, 2004. The Company assesses the likelihood of realization of deferred tax assets and net operating loss carryforwards by considering the scheduled reversal of deferred tax liabilities, taxable income in future periods and the availability of prudent tax planning strategies. The Company will continue to monitor the need for the deferred tax asset valuation allowance. (10) Related Party Transactions Mediacom Management Corporation ("Mediacom Management"), a Delaware corporation, holds a I % direct ownership interest in Mediacom California LLC, which in turn holds a I % interest in Mediacom Arizona LLC. These ownership interests represent less than I % of the Company's total revenues. Mediacom Management is wholly-owned by the Chairman and CEO ofMCC. 76 T MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS One of the Company's directors is a partner ofa law firm that performs various legal services for the Company. For the years ended December 31, 2004, 2003 and 2002, the Company paid this law firm approximately $0.8 million, $1.0 million and $1.3 million, respectively, for services performed. (11) Employee Benefit Plans Substantially all employees of the Company are eligible to participate in a defined contribution plan pursuant to the Internal Revenue Code Section 401(k) (the "Plan"). Under such Plan, eligible employees may contribute up to 15% of their current pre-tax compensation. The Plan permits, but does not require, matching contributions and non- matching (profit sharing) contributions to be made by the Company up to a maximum dollar amount or maximum percentage of participant contributions, as determined annually by the Company. The Company presently matches 50% on the first 6% of employee contributions. The Company's contributions under the Plan totaled approximately $1.8 million for the years ended December 31,2004,2003 and 2002. (12) Commitments and Contingencies Under various lease and rental agreements for offices, warehouses and computer terminals, the Company had rental expense of approximately $4.4 million, $5.4 million and $5.0 million for the years ended December 31,2004, 2003 and 2002, respectively. Future minimum annual rental payments are as follows (dollars in thousands): 2005..............................;............................................................................................ 2006........................................................................................................................... 2007........................................................................................................................... 2008........................................................................................................................... 2009........................................................................................................................... Thereafter................................................................................................................. .. $ 4,296 2,045 1,583 824 583 1,288 10,619 $ In addition, the Company rents utility poles in its operations generally under short-term arrangements, but the Company expects these arrangements to recur. Total rental expense for utility poles was approximately $9.6 million, $8.5 million and $7.0 million for the years ended December 31,2004,2003 and 2002, respectively. :1 As of December 31, 2004, approximately $14.5 million of letters of credit were issued to various parties to secure the Company's performance relating to insurance and franchise requirements. The fair value of such letters of credit was not material. of If e Legal Proceedings IS On April 5, 2004, a lawsuit was filed against the Company, MCC Georgia LLC, an indirect subsidiary of the Company, and other, currently unnamed potential defendants in the United States District Court for the District of Colorado by Echostar Satellite LLC, which operates a direct broadcast satellite business under the name "Dish Network". Echostar alleges that systems operated by MCC Georgia LLC have used, without authorization, Dish Network satellite dishes activated under residential accounts to receive the signals of certain broadcast television stations in one or more locations in Georgia and that it has then been redistributing those signals, through its cable systems, to its subscribers. Among other claims, the complaint filed by Echostar alleges that these actions violate a provision of the Communications Act of 1934 (47 U .S.c. Sec. 605) that prohibits unauthorized interception of radio communications. The plaintiff seeks injunctive relief, actual and statutory damages, disgorgement of profits, punitive damages and litigation costs, including attorneys' fees. 77 - ~ MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On June 29,2004, Echostar amended its complaint to also allege that this conduct amounted to a breach of the contract between Echostar and one of the Company's employees, who allegedly acted as an agent for the defendants, by which the Company received the Echostar satellite signal. On September 7, 2004, the U.S. District Court granted the Company's motion to transfer the case to the Middle District of Georgia, where venue is proper and where personal jurisdiction over the Company exists. There have been no further proceedings since that date. The Company intends to vigorously defend against these claims. The Company is unable to reasonably evaluate the likelihood of an unfavorable outcome or quantify the possible damages, if any, associated with these matters, or whether or not the those damages would be material. The Company is also involved in various other legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated ftnancial position, results of operations, cash flows or business. (13) Stock Options / Employee Stock Purchase Program In April 2003, MCC's Board of Directors adopted the Company's 2003 Incentive Plan, or "2003 Plan", which amended and restated the Company's 1999 Stock Option Plan and incorporated into the 2003 Plan options that were previously granted outside the 1999 Stock Option Plan. The 2003 Plan was approved by MCC's stockholders in June 2003. The 2003 Plan provides for the grant of incentive stock options, nonqualified stock options, restricted shares, and other stock-based awards, in addition to annual incentive awards. The 2003 plan has 21,000,000 shares of common stock available for issuance in settlement of awards. As of December 31, 2004, under the 2003 plan. options for 11,617,109 shares had been granted, consisting of 3,534,347 shares of Class A common stock and 8,082,762 of Class B common stock. The following table summarizes information concerning stock option activity for the years ended December 31, 2004, 2003 and 2002: Outstanding at December 31,200 I.............................. Granted........................................................................ . Exercised..................................................................... . Forfeited...................................................................... . Outstanding at December 31, 2002.............................. Granted........................................................................ . Exerc ised...................................................................... Forfeited..................................................................... .. Outstanding at December 31,2003.............................. Granted........................................................................ . Exercised.............................. ........................................ Forfeited...................................................................... . Outstanding at December 31, 2004.............................. Shares 10,508,595 604,735 Weighted Average Exercise Price $ 18.81 II. 97 (216,775) 10,896,555 1,009,000 $ 16.69 18.47 7.93 (162,240) 11,743,315 167,000 $ 15.78 17.60 8.14 (293,206) 11,617,109 $ 16.94 17.54 The Company had options exercisable on underlying shares amounting to 10,022,444,9,437,629 and 8,934,584, with average prices of $18.44, $18.83 and $18.94 at December 31, 2004, 2003 and 2002, respectively. The weighted average fair value of options granted was $3.91, $3.82 and $6.04 per share for the years ended December 31,2004,2003 and 2002, respectively. 78 . MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes information concerning stock options outstanding as of December 31, 2004: Options Outstanding Options Exercisable Number Weighted Number Range of Outstanding at Average Weighted Exercisable at Weighted Exercise December 31, Remaining Average December 31, Average Prices 2004 Contractual Life Exercise Price 2004 Exercise Price $ 6.94 to $12.00... 1,653,415 8.34 years $ 9.05 507,511 $ 9.41 $12.01 to $18.00... 554,624 6.29 years 16.87 349,575 16.80 $18.0 I to $22.00... 9,409,070 1.3 I years 19.00 9,165,358 19.00 11,617,109 2.55 years $ 17.54 10,022,444 $ 18.44 The Company accounts for its stock option plans and employee stock purchase program under APB No. 25. Accordingly, no compensation expense has been recognized for any option grants in the accompanying consolidated statements of operations since the price of the options was at their fair market value at the date of grant. SF AS No. 148 requires that information be determined as if the Company had accounted for employee stock options under the fair value method of this statement, including disclosing pro forma information regarding net income (loss) and income (loss) per share. The weighted average fair value of all of the employee options was estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions: (i) risk free average interest rate of 3.8%, 3.6% and 5.0% for the years ended December 31, 2004, 2003 and 2002, respectively; (ii) expected dividend yields of 0%; (iii) expected lives of 6 years; and (iv) expected volatility of 45%. Had compensation expense been recorded for the employee options under SF AS No. 148, the compensation expense would have been $5. I million, $4.6 million, and $8.0 million for the years ended December 31,2004,2003 and 2002, respectively. The Company maintains an employee stock purchase plan ("ESPP"). Under the plan, all employees are allowed to participate in the purchase of MCC's Class A Common Stock at a 15% discount on the date of the allocation. Shares purchased by employees amounted to 172,531, 191,335 and 176,634 in 2004, 2003 and 2002 respectively. The net proceeds to the Company were approximately $1.0 million, $1.0 million and $1.3 million in 2004, 2003 and 2002 respectively. Compensation expense was not recorded on the distribution of these shares in accordance with APB No. 25. The weighted average fair value of all of the stock issued under the ESPP was estimated on the purchase date using the Black-Scholes model with the following assumptions: (i) discount rate equal to the six year bond rate on the stock purchase date; (ii) expected dividend yields of 0%; (iii) expected lives of six months; and (iv) expected volatility of 45%. Had compensation expense been recorded for the stock issued for the ESPP under SF AS No. 148, the compensation costs would have been approximately $325,000, $325,000 and $420,000 for the years ended December 31,2004,2003 and 2002, respectively. Had the Company applied the fair value recognition provisions of SF AS No. 123 to stock-based compensation, MCC's net income (loss) and basic and diluted earnings (loss) per share would have been changed from the "as reported" amounts to the "pro forma" amounts as follows (dollars in thousands, except per share data): ~, Net income (loss), as reported............................................................ Deduct: Total stock based compensation expense determined under fair value based method of all awards.............................. Pro forma, net income (loss).............................................................. Basic and diluted earnings (loss) per share: As reported..................................................................................... Pro forma. .... ... .......... ... ............... ..... ............ ... ............ ............. ....... 2004 2003 2002 $ 13,552 $ (62,475) $(161,658) (5,380) (4,938) (8,455) $ 8,172 $ (67,413) $(170,113) $ 0.11 $ (0.53 ) $ (1.35) $ 0.07 $ (0.57) $ ( 1.42) e ~r 79 - -...,....-- MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (14) Hurricane Losses In September 2004, Hurricane Ivan impacted the Company's systems in Alabama, Florida and Mississippi. As a result, for the year ended December 31, 2004, the Company: (i) recorded revenues net of $2.9 million of service interruption credits issued to customers; (ii) incurred additional service costs of approximately $0.9 million; (iii) incurred additional selling, general and administrative costs of approximately $0.3 million; (iv) recorded an increase in depreciation expense of $2.1 million due to the impairment of cable plant and equipment; and (v) spent approximately $8.1 million of capital expenditures to replace or rebuild property, plant and equipment. The Company is insured against certain losses related to the hurricane, subject to varying deductible amounts. The Company cannot estimate at this time the amounts that will be ultimately recoverable under its insurance policies. (15) Sale of Assets and Investments The Company had a net gain on sale of assets and investments amounting to $5.9 million for the year ended December 31, 2004. This was principally due to the sale of a cable system in May 2004, serving approximately 3,450 subscribers, for gross proceeds of about $10.1 million. (16) Subsequent Events On January 25, 2005, the Company borrowed the full amount of the LLC term loan A, the proceeds of which were used to reduce outstandings under the Company's revolving credit facilities. In February 2005, the Company filed form S-8, registering 12.0 million shares of the Company's Class A common stock. These shares are issuable in accordance with the terms of the Company's 2003 Incentive Plan. 80 -- ~ - MEDIACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (17) Selected Quarterly Financial Data (all dollar amounts in thousands, except per share data): First Second Third Fourth Quarter Quarter Quarter Quarter (unaudited) 2004 Revenues ........ ................. ............ ....... ........ $ 263,439 $ 267,599 $ 261,025 $ 265,163 Operating income ....................................... 51,564 52,932 42,876 49,047 Net (loss) income ....................................... (5,739) 30,129 ( 12,807) 1,969 Basic and diluted net (loss) income per share ................................................. $ (0.05) $ 0.25 $ (0.11 ) $ 0.02 Basic weighted average common shares outstanding .................................. 118,723 118,806 118,523 118,088 Diluted weighted average common shares outstanding .................................. 118,723 128,065 118,523 118,088 2003 Revenues ............... .............. ..... ....... ........... $ 242,775 $ 252,194 $ 251,107 $ 258,813 Operating income ....................................... 19,029 2 1,400 44,134 47,827 Net (loss) income ....................................... (33,366) (38,158) 1,937 7,112 Basic and diluted net (loss) income per share ................................................. $ (0.28) $ (0.32) $ 0.02 $ 0.06 Basic weighted average common shares outstanding .................................. 118,525 118,632 118,633 118,71 7 Diluted weighted average common shares outstanding .................................. 118,525 118,632 118,698 118,753 2002 Revenues ............... ... ......... ..... ..... ....... ........ $ 219,547 $ 230,792 $ 233,723 $ 238,971 Operating income ....................................... 11,997 13,722 21,584 4,513 Net loss ...................................................... (35,190) (37,487) (39,940) (49,041) Basic and diluted loss per share ................. $ (0.29) $ (0.31 ) $ (0.33) $ (0.41 ) Basic weighted average common shares outstanding.................................. 119,892 119,942 119,943 118,662 Diluted weighted average common shares outstanding .................................. 119,892 119,942 119,943 118,662 81 ~ ~ Schedule II MEDlACOM COMMUNICATIONS CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (All dollar amounts in thousands) Additions Deductions Balance at Charged to Charged to Charged to Charged to beginning of costs other costs other Balance at period and expenses accounts and expenses accounts end of period December 31,2002 Allowance for doubtful accounts Current receivables........................ $ 3,243 $ 13,685 $ $ 13,139 $ $ 3,789 Acquisition reserves(l) Accrued expenses.......................... $ 36,579 $ $ 427 $ 4,613 $ 31,966 $ 427 December 31, 2003 Allowance for doubtful accounts Current receivables........................ $ 3,789 $ 6,477 $ $ 6,742 $ $ 3,524 Acquisition reserves Accrued expenses.......................... $ 427 $ $ $ $ 127 $ 300 December 31, 2004 Allowance for doubtful accounts Current receivables........................ $ 3,524 $ 1,658 $ 347 $ 1,870 $ $ 3,659 Acquisition reserves Accrued expenses.......................... $ 300 $ $ $ $ $ 300 (I) Additions were charged in connection with purchase accounting. 82 . ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of December 31, 2004. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15( d) under the Exchange Act that occurred during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over [mancial reporting. Management's Report on Internal Control Over Financial Reporting Management of our company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(t) and 15d-15(t) under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company's principal executive and principal financial officers and effected by the company's board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: I I I . pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; . provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and . provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of our company's internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, management determined that, as of December 31, 2004, our company's internal control over financial reporting was effective. Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31,2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein. ITEM 98. OTHER INFORM A TlON None 83 .. ............- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information called for by Item 10 is set forth under the heading "Directors and Executive Officers of the Registrant" in Item 4A of this annual report and in "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in our proxy statement relating to the 2005 Annual Meeting of Stockholders (the "Proxy Statement"), which information is incorporated herein by this reference. ITEM 11. EXECUTIVE COMPENSATION Information called for by Item II is set forth under the heading "Executive Compensation" in our Proxy Statement, which information is incorporated herein by this reference. Notwithstanding the foregoing, the information provided under the sub-headings "Report of the Compensation Committee" and the "Performance Graph" in the 2005 Proxy Statement is not incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information called for by Item 12 is set forth under the heading "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" in our Proxy Statement, which information is incorporated herein by this reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information called for by Item 13 is set forth under the heading "Certain Relationships and Related Transactions" in our Proxy Statement, which information is incorporated herein by this reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information called for by Item 14 is set forth under the heading "Ratification of Appointment of Independent Auditors" in our Proxy Statement, which information is incorporated herein by this reference. 84 -- PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULE (a) Financial Statements Our financial statements as set forth in the Index to Consolidated Financial Statements under Part II, Item 8 of this Form 1 O-K are hereby incorporated by reference. (b) Exhibits The following exhibits, which are numbered in accordance with Item 601 of Regulation S-K, are filed herewith or, as noted, incorporated by reference herein: Exhibit Number 10.1 10.2 10.3* lOA Exhibit DescriDtion 3.1 Restated Certificate ofIncorporation of Mediacom Communications Corporation (I) 3.2 By-laws of Mediacom Communications Corporation (I) 4.1 Form of certificate evidencing share of C lass A common stock( 1) 4.2 Indenture relating to 8Yz% senior notes due 2008 of Mediacom LLC and Mediacom Capital Corporation (2) 4.3 Indenture relating to T/8% senior notes due 2011 of Mediacom LLC and Mediacom Capital Corporation (3) 4.4 Indenture relating to 9Yz% senior notes due 2013 of Mediacom LLC and Mediacom Capital Corporation (4) 4.5 Indenture relating to 11% senior notes due 2013 of Mediacom Broadband LLC and Mediacom Broadband Corporation (2) 4.6 Indenture relating to 5.25% Convertible Senior Note due 2006 (5) 4.7 Indenture Supplement No.1, dated as of August 6, 2002, to the Indenture relating to II % senior notes due 2013 of Mediacom Broadband LLC and Mediacom Broadband Corporation. (6) Indenture Supplement No.1, dated as of August 6, 2002, to the Indenture relating to 5.25% convertible senior notes due 2006 of the Company. (6) Credit Agreement, dated as of October 21, 2004, among the operating subsidiaries of Mediacom LLC, the lenders thereto and JPMorgan Chase Bank, as administrative agent for the lenders. (7) 4.8 Amendment and Restatement of Credit Agreement, dated as of December 16, 2004, among the operating subsidiaries of Mediacom Broadband LLC, the lenders thereto and IPMorgan Chase Bank, as administrative agent for the lenders. Form of Amended and Restated Registration Rights Agreement by and among Mediacom Communications Corporation, Rocco B. Commisso, BMO Financial, Inc., CB Capital Investors, L.P., Chase Manhattan Capital, L.P., Morris Communications Corporation, Private Market Fund, L.P. and U.S. Investor, Inc. (I) Fifth Amended and Restated Operating Agreement of Mediacom LLC (8) 85 II -..,..-- Exhibit Number Exhibit DescriDtion 10.5 Amended and Restated Limited Liability Company Operating Agreement of Mediacom Broadband LLC (9) 10.6 1999 Employee Stock Purchase Plan (I) 10.7 2001 Employee Stock Purchase Plan (10) 10.8* 2003 Incentive Plan (11) 21.1 Subsidiaries of Mediacom Communications Corporation(12) 23.1 Consent of PricewaterhouseCoopers LLP 31 Rule 13a-14(a) Certifications 32 Section 1350 Certifications (c) financial Statement Schedule The financial statement schedule - Schedule II - Valuation and Qualifying Accounts - is part of this Form IO-K and is on page 80. * Compensatory Plan (I) Filed as an exhibit to the Registration Statement on Form S-I (File No. 333-90879) of Mediacom Communications Corporation and incorporated herein by reference. (2) Filed as an exhibit to the Registration Statement on Form S-4 (File No. 333-57285) of Mediacom LLC and Mediacom Capital Corporation and incorporated herein by reference. (3) Filed as an exhibit to the Registration Statement on Form S-4 (File No. 333-85893) of Mediacom LLC and Mediacom Capital Corporation and incorporated herein by reference. (4) Filed as an exhibit to the Annual Report on Form IO-K for the fiscal year ended December 31, 2000 of Mediacom Communications Corporation and incorporated herein by reference. (5) Filed as an exhibit to Amendment No. I of the Current Report on Form 8-K, dated lune 22, 2001, of Mediacom Communications Corporation and incorporated herein by reference. (6) Filed as an exhibit to the Quarterly Report on Form IO-Q for the quarterly period ended June 30, 2002 of Mediacom Communications Corporation and incorporated herein by reference. (7) Filed as an exhibit to the Quarterly Report on Form IO-Q for the quarterly period ended September 30, 2004 of Mediacom Communications Corporation and incorporated herein by reference. (8) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year ended December 31, 1999 of Mediacom Communications Corporation and incorporated herein by reference. (9) Filed as an exhibit to the Registration Statement on Form S-4 (File No. 333-72440) of Mediacom Broadband LLC and Mediacom Broadband Corporation and incorporated herein by reference. (10) Filed as an exhibit to the Registration Statement on Form S-8 (File No. 333-68306) of Mediacom Communications Corporation and incorporated herein by reference. 86 I (II) Filed as Exhibit A to the definitive Proxy Statement of Mediacom Communications Corporation filed with the SEC on April 30, 2003 and incorporated herein by reference. (12) Filed as an exhibit to the Annual Report on Fonn 10-K for the fiscal year ended December 31, 2001 of Mediacom Communications Corporation and incorporated herein by reference. 87 -- SIGNA TURES Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Mediacom Communications Corporation March 15,2005 By: Isl Rocco B. Commisso Rocco B. Commisso Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Silzoature Title Date Isl Rocco B. COMMISSO Rocco B. Commisso Chairman and Chief Executive Officer (principal executive officer) March 15, 2005 Isl MARK E. STEPHAN Mark E. Stephan Executive Vice President, Chief Financial Officer, Treasurer and Director (principal financial officer and principal accounting officer) March IS, 2005 IsI WILLIAM S. MORRIS III William S. Morris III Director March 15, 2005 Isl CRAIG S. MITCHELL Craig S. Mitchell Director March 15,2005 IsI THOMAS V. REIFENHEISER Thomas V. Reifenheiser Director March IS, 2005 Is/NATALE S. RICCIARDI Natale S. Ricciardi Director March 15, 2005 Isl ROBERT L. WINIKOFF Robert L. Winikoff Director March 15,2005 88 --..-- -- I l Exhibit 31 CERTIFICATIONS I, Rocco B. Commisso, certify that: (1) I have reviewed this report on Form 10-K of Mediacom Communications Corporation; (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; (3) Based 'on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(t) and 15d-15(t)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over fmancial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over fmancial reporting. March 15, 2005 By: Isl Rocco B. COMMISSO Rocco B. Commisso Chief Executive Officer 89 . Exhibit 31 I, Mark E. Stephan, certify that: (I) I have reviewed this report on Form 10-K of Mediacom Communications Corporation; (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light ofthe circumstances under which such statements were made, not misleading with respect to the period covered by this report; (3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(t) and 15d-15(t)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of fmancial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over fmancial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 15, 2005 By: Isl MARK E. STEPHAN Mark E. Stephan Chief Financial Officer 90 . I I I I I I I i I , I 1 Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.c. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Mediacom Communications Corporation (the "Company") on Form 10-K for the period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Rocco B. Commisso, Chief Executive Officer, and Mark E. Stephan, Chief financial Officer of the Company, certify, pursuant to 18 D.S.C. ~ 1350, as adopted pursuant to ~ 906 of the Sarbanes-Oxley Act of 2002, that: (I) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the finaricial condition and results of operations of the Company. March 15,2005 By: Isl Rocco B. COMMISSO Rocco B. Commisso Chief Executive Officer By: Isl MARK E. STEPHAN Mark E. Stephan Chief financial Officer 91 ;;.- II I II This page left intentionally blank. - Board of Directors Rocco B. Commisso Chairman and Chief Executive Officer, Mediacom Communications Corporation Craig S. Mitchell Senior Vice President of Finance, Treasurer and Secretary, Morris Communications Company, LLC William S. Morris III Chairman and Chief Executive Officer, Morris Communications Company, LLC Thomas V. Reifenheiser Retired Managing Director, JP Margan Chase & Co. Natale S. Ricciardi President/Team Leader, Global Manufacturing, Pfizer Inc. Mark E. Stephan Executive Vice President, Chief Financial Officer and Treasurer, Mediacom Communications Corporation Robert L. Winikoff Partner, Sonnenschein Nath & Rosenthal LLP MediacoiTi1 Officers and Key Management Rocco B. Commisso Chairman and Chief Executive Officer Charles J. Bartolotta Senior Vice President, Customer Operations James M. Carey Senior Vice President, Divisional Operations, South Central Division Italia Commisso Weinand Senior Vice President, Pragramming and Human Resources Calvin G. Craib Senior Vice President, Business Development Sonja L. Farrand Senior Vice President, Advertising Sales, OnMedia Division Charles F. King Senior Vice President, Divisional Operations, North Central Division John G. Pascarelli Executive Vice President, Operations Michael Rahimi Senior Vice President, Marketing and Consumer Services Mark E. Stephan Executive Vice President, Chief Financial Officer and Treasurer Brian M. Walsh Senior Vice President, Corporate Controller Joseph E. Young Senior Vice President, General Counsel and Secretary - :!I Mediacom) Corporate Headquarters 100 Crystal Run Road Middletown, New York 10941 845-695-2600 www.mediacomcc.com PART I ITEM 1. BUSINESS Introduction We are currently the nation's eighth largest cable television company based on customers served and the leading cable operator focused on serving the smaller cities and towns in the United States. Through our interactive broadband network, we provide our customers with a wide array of products and services, including analog and digital video services, advanced video services such as video-on-demand ("VOD"), high-definition television ("HDTV") and digital video recorders ("DVR"), and high-speed data ("HSD"), also known as high-speed Internet access or cable modem service. We currently offer our customers a variety of options to bundle our array of video services with HSD. In the second quarter of2005 we plan to begin the rollout of cable telephony, which will enable us to offer our customers a triple-play bundle of video, HSD and voice services. As of December 31, 2004, our cable systems passed an estimated 2.79 million homes and served approximately 1.46 million basic subscribers, and 2.22 million revenue generating units ("RGUs"). Approximately 65% of our customers are located within the top I 00 television markets in the United States, with a concentration of customers in the midwest and southern regions. A basic subscriber is a customer who subscribes to a package of cable television services. RGUs represent the sum of basic subscribers, digital customers and HSD customers. We are a public company and our Class A common stock is listed on The Nasdaq National Market under the symbol "MCCC". We were founded in July 1995 by Rocco B. Commisso, our Chairman and Chief Executive Officer, who beneficially owns shares in our company representing the majority of the combined voting power of our common stock. Since commencement of our operations in March 1996, we have experienced significant growth by executing a disciplined strategy of acquiring underperforming cable systems and improving their operating and financial performance. In 2001, we acquired cable systems that served approximately 800,000 basic subscribers, more than doubling our size and enhancing our scale efficiencies in operations and capital investments in technology. Our principal executive offices are located at 100 Crystal Run Road, Middletown, New York 10941 and our telephone number at that address is (845) 695-2600. Our website is located at www.mediacomcc.com. We have made available free of charge through our website (follow the Corporate Info link to the Investor Relations tab to "Annual Reports/SEC Filings") our annual report on Form 10-K, quarterly reports on Form IO-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such material was electronically filed with, or furnished to, the Securities and Exchange Commission. We have also made our Code of Ethics available through our website, under the heading "Corporate Information". The information on our website is not part of this Annual Report. Business Strategy Our strategy is to be the leading single-source provider of advanced video, data and voice products and services in our markets, which will allow us to deepen relationships with our existing customers, attract new customers and further diversify our revenue streams. We believe that our interactive broadband network is the superior platform today for the delivery of these products and services within our service areas. We have a local presence, with facilities and employees in the communities where our customers live. We believe that offering products and services in bundles, together with reliable customer service and our local community presence, will enable us to execute our strategy and compete effectively. Network Technology We operate high-capacity, fiber-optic cable systems, substantially all of which are activated with two-way communications capability. We have also interconnected approximately 75% of our estimated homes passed with a 4 regional fiber network. In 2005, we plan to add synchronous optical network ("SONET") technology to our regional fiber network to create full redundancy. SONET is a fiber-optic transmission system for high-speed digital traffic which uses a self-healing ring architecture to reroute traffic if a break in communications occurs. We believe that our broadband network's extended reach and robust capabilities facilitate launches of new products such as cable telephony. Product Development and New Applications and the teractive alog and television Internet I of video ,ill enable Our network technology allows us to offer an array of advanced video, data and voice products and services. As of December 31, 2004, our digital cable service was available to substantially all of our basic subscribers, and we served approximately 396,000 digital customers. Our VOD and HDTV services were available to approximately 65% and 77% of our digital customers, respectively, and DVRs were available to our entire digital customer base. As of the same date, HSD was marketed to substantially all of the estimated homes passed by our cable systems, and we served approximately 367,000 data customers. We will continue to capitalize on the capabilities of our network technology to develop new products and services that will further differentiate us from our competitors. ximately % of our :ustomers of cable Bundling of Broadband Products and Services under the xecutive power of t growth ating and scribers, ments in We believe that bundled products and services offer our customers the convenience of having a single provider contact for ordering, scheduling, provisioning, billing and customer care. Our customers can also realize greater value through bundle discounts as they obtain additional products and services from us. We currently offer video and HSD bundles, and when we introduce cable telephony in the second quarter of 2005, we will offer triple-play bundles of video, HSD and voice. We also believe that, as we become more effective in bundling products and services, it will help us to attract new customers and reduce customer churn. Customer Service I and our We have ns tab to ports on 'ecurities with, or ough our Annual Attaining higher levels of customer satisfaction is critical to our success in the increasingly competitive environment we face today. We continue to invest in our customer care personnel and call center technology to improve our capabilities in customer service and have attained internal customer service measures that generally meet or exceed those standards established by the National Cable and Telecommunications Association on a 24 hour per day, seven day per week basis. In 2004, we completed our investment in virtual contact center technology across our call centers and, as a result, raised our level of customer service and improved the productivity of our call center personnel. Community Presence Historically, one of our key objectives was to bridge the "digital divide," or technology gap, that had developed between the smaller cities and towns and the large urban markets in the United States. Today, due to the significant investments we have made in our cable systems, substantially all of the communities we serve now have access to the latest in broadband products and services. services ers and platform ce, with .ucts and Ie us to We continue"our efforts to build good relationships with the communities we serve by participating in a wide range of local educational and community service initiatives. Our major company-wide programs include the "Mediacom Cable in the Classroom" program which provides more than 2,800 schools with free video service and more than 200 schools with free high-speed Internet access. We also provide free cable service to over 3,000 government buildings, libraries, and not-for-profit hospitals in our franchise areas. We develop and offer exclusive local programming in our communities in an effort to foster community awareness. For example, in the communities we serve in Iowa, the Mediacom Connections channel currently airs 60 to 70 hours of programming per week, including high school and college sporting events and statewide public affairs programs. o-way d with a 5 --- - Products and Services Video We receive a majority of our revenues from video subscription services. Subscribers typically pay us on a monthly basis and generally may discontinue services at any time. We design our channel line-ups for each system according to demographics, programming preferences, channel capacity, competition, price sensitivity and local regulation. Monthly subscription rates and related charges vary according to the type of service selected and the type of equipment used by subscribers. Our video services include the following: Basic Service. Our basic service includes, for a monthly fee, local broadcast channels, network and independent stations, limited satellite-delivered programming, and local public, government, home-shopping and leased access channels. Expanded Basic Service. Our expanded basic service includes, for an additional monthly fee, various satellite- delivered channels such as CNN, MTV, USA Network, ESPN, Lifetime, Nickelodeon and TNT. Pay-Per-View Service. Our pay-per-view services allow customers to pay to view a single showing ofa feature film, live sporting event, concert and other special event, on an unedited, commercial-free basis. Digital Cable Service. Customers who subscribe to our digital cable offerings receive up to 230 digital channels in many of our cable systems. We currently offer several digital cable programming packages that include digital basic channels, multichannel premium services, pay-per-view movie and sports channels, digital music channels, and an interactive on-screen program guide. Our digital offerings of multichannel premium services include premium channels in HD format and unlimited access to subscription-based VOD ("SVOD"). We believe that these offerings highlight bOth the value of our digital cable services and our technologically advanced broadband network, and encourage basic subscribers to upgrade to digital cable service. Customers pay a monthly fee for digital cable service, which varies according to the level of service and the number of digital converters selected by the subscriber. A digital converter or cable card is required to receive our digital cable service. Video-On-Demand Our VOD service provides on-demand access to approximately 1,200 hours of movies, special events and general interest titles stored at our headend facilities. With this service, our customers enjoy full functionality, including the ability to pause, rewind and fast forward selected programming. Our VOD service is either free of charge, offered as part of an SVOD premium package, such as Starz!, Showtime or HBO, or ordered on a pay-per-view basis. We currently offer VOD service to approximately 65% of our digital customers. During 2005, we plan to make VOD service available in additional cable systems representing another 15% of our digital customers and increase the amount ofavailable content, including additional children's and music programming. High-Definition Television. HDTV features improved, high-resolution picture quality, improved audio quality and a wide-screen, theater-like display. Our HDTV service includes high definition signals for local broadcast stations that make these signals available to us, and, as part of premium channel subscriptions, Starz! HD, Showtime HD and HBO HD. We also provide, as part of our HD Pak tier for an additional monthly fee, certain premium HDTV programming, such as ESPNHD, HDNet, HDNet Movies, Universal HD and Discovery HD. As of December 31, 2004, 77 local broadcast channels in our service areas were transmitting in HDTV, and we had secured agreements to carry 44 of them. We currently offer HDTV service in markets serving approximately 77% of our digital customers. During 2005, we plan to make HDTV service available in additional cable systems, representing another 13% of our digital customers, and to increase the amount of available HDTV content, including more local broadcast channels and other HDTV content. Our HDTV service requires the use of an advanced digital converter for which we charge a monthly fee. Digital Video Recorders. We offer our customers digital converters that have digital video recording capability. Using the interactive program guide, our customers with DVRs can record programming on the hard drive component of the digital converter and view the recorded programming using the play, pause, rewind and fast forward functions. The DVR can also pause live television, and rewind or fast-forward it, as well as record one show while watching another, or record two shows simultaneously. The DVRs we provide our customers are HDTV-capable. We began deploying DVRs in certain of our cable systems in March 2004 and expanded this offering to all of our cable systems by the end of2004. 6 High-Speed Data We offer several packages of HSD services with differing speeds and prices. Our HSD services are always activated, and as a result, the customer does not need to dial into an Internet service provider and await authorization. Our HSD services include our interactive portal, which provides multiple e-mail addresses and personal webspace for customers, as well as local content, such as community chamber of commerce news, which we solicit and support. Commercial Data Through our network technology, we provide a range of advanced data and communications services for the commercial market. We leverage our existing cable systems and cable modem services to offer small and medium- sized businesses a range of high-speed data access products. For larger enterprise customers, we capitalize on the broad reach and capabilities of our regional fiber network, with nearly 9,000 route miles of high-capacity fiber optic cable, to build customized solutions, which may include transparent LAN services, virtual private networks, and high-volume, high-speed data access. Telephony In the second quarter of 2005, we plan to begin the rollout of our cable telephony service in certain of our cable systems. Our service will use technology that makes it possible to have a telephone conversation over a dedicated Internet Protocol ("IP") network instead of dedicated voice transmission lines. This allows the elimination of circuit switching and the associated waste of bandwidth. Instead, packet switching is used, where IP packets with voice data are sent over the network only when data needs to be sent, i.e. when a caller is talking. Its advantages over traditional telephony include: lower costs per call, especially for long-distance calls; lower infrastructure costs because once the IP infrastructure is installed, no or little additional telephony infrastructure is needed; and new advanced features. Our telephony service will compete primarily with the phone service offered by the incumbent local phone company. Its features will include: unlimited local and long-distance calling throughout the U.S. and North America; the ability to keep existing phone number where local number portability is supported; the ability to access enhanced Emergency 911 dialing; and the ability to use existing phones and in-home wiring. In 2004, we entered into an agreement with Sprint Corporation whereby Sprint assists us with provisioning capabilities and provides us with switching and termination of traffic to the public switched telephone network, delivery of enhanced emergency 911 service, local number portability and operator and directory services. We expect to offer cable telephony service to approximately 1.6 million homes in our markets within twelve months of our initial market launch. Advertising We generate revenues ,from the sale of advertising time on up to 36 satellite-delivered channels such as CNN, Lifetime, Discovery, ESPN, TBS and USA. We have an advertising sales infrastructure that includes in-house production facilities, production and administrative employees and a locally based sales workforce. In 2004, we completed the process of extending our advertising infrastructure to our cable systems that previously had third- party advertising agreements. In many of our markets, we have entered into agreements with other cable operators to jointly sell local advertising, simplifying our prospective clients' purchase of local advertising and expanding the reach of advertising they purchase. In some of these markets, we represent the advertising sales efforts of other cable operators; in other markets, other cable operators represent us. 7 -.- III Description of Our Cable Systems Overview The following table provides an overview of selected operating and cable network data for our cable systems for the years ended: 2004 2003 2002 2001 2000 Operating Data: Core Video Estimated homes passed(l) 2,785,000 2,755,000 2,715,000 2,630,000 1,173,000 Basic subscribers(2) 1,458,000 1,543,000 1,592,000 1,595,000 779,000 Basic penetration(3) 52.4% 56.0% 58.6% 60.6% 66.4% Digital Cable Digital customers(4) 396,000 383,000 371,000 321,000 40,000 Digital penetration(5) 27.2% 24.8% 23.3% 20.1% 5.1% Data Data customers(6) 367,000 280,000 191,000 115,000 15,600 Data penetration(7) 13.2% 10.2% 7.0% 4.4% 1.3% Revenue Generating Units (8) 2,221,000 2,206,000 2,154,000 2,031,000 834,600 Customer Relationships (9) 1,495,000 1,570,000 1,611,000 1,607,000 N/A Cable Network Data: Miles of plant 46,900 45,900 45,000 44,100 24,500 Density(lO) 59 60 60 60 48 (1) Represents the estimated number of single residence homes, apartments and condominium units passed by the cable distribution network in a cable system's service area. Represents a dwelling with one or more television sets that receives a package of over-the-air broadcast stations, local access channels or certain satellite-delivered cable television services. Accounts that are billed on a bulk basis, which typically receive discounted rates, are converted into full-price equivalent basic subscribers by dividing total bulk billed basic revenues of a particular system by the most prevalent combined limited and expanded cable rate charged to basic subscribers in that system. Basic subscribers include connections to schools, libraries, local government offices and employee households that may not be charged for limited and expanded cable services, but may be charged for digital cable, VOD, HDTV, DVR or high-speed Internet service. Customers who exclusively purchase high-speed Internet service are not counted as basic subscribers. Our methodology of calculating the number of basic subscribers may not be identical to those used by other cable companies. Represents basic subscribers as a percentage of estimated homes passed. Represents customers that receive digital cable services. Represents digital customers as a percentage of basic subscribers. Represents residential data customers and small to medium-sized commercial cable modem accounts billed at higher rates than residential customers. Small to medium-sized commercial accounts generally represent customers with bandwidth requirements less than 5Mbps. These commercial accounts are converted to equivalent residential data customers by dividing their associated revenues by the applicable residential rate. Our data customers exclude large commercial accounts and include an insignificant number of dial-up customers. Our methodology of calculating data customers may not be identical to those used by other cable companies. Represents the number of total data customers as a percentage of estimated homes passed. Represents the sum of basic subscribers, digital customers and data customers. Represents the total number of customers that receive at least one level of service, encompassing video and data services, without regard to which service(s) customers purchase. This information is not available for periods prior to 2001. (10) Represents estimated homes passed divided by miles of plant. (2) (3) (4) (5) (6) (7) (8) (9) 8 - Selected Operating Data :ems Our systems are organized into two geographic operating divisions. The following table sets forth the principal states served by such divisions, and their respective basic subscribers, digital customers and data customers as of December 31, 2004: Basic Di2ital Data Division States Subscribers Customers Customers North Central Illinois, Iowa, Minnesota, South Dakota 712,000 185,000 195,000 South Central Alabama, California, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Missouri, North Carolina 746,000 211,000 172,000 Total 1,458,000 396,000. 367,000 Approximately 65% of our subscribers are in the top 100 Nielsen Media Research designated market areas ("DMAs"), in the United States. We are the leading provider of broadband services in Iowa, and control the three largest Iowa markets that are in the top 50 to 100 DMAs: Des Moines - Ames; Cedar Rapids - Waterloo - Iowa City & Dubuque; and Davenport - Rock Island. The following table provides a partial list of the markets in which we provide cable service: able 2 3 14 35 63 73 78 79 82 88 94 Designated Market Area Los Angeles, CA Chicago,IL Minneapolis - St. Paul, MN Greenville - Spartanburg, SC Mobile, AL - Pensacola, FL Des Moines - Ames, IA Springfield, MO Paducah, KY - Cape Girardeau, MO - Harrisburg - Mt. Vernon, IL Champaign & Springfield - Decatur, IL Cedar Rapids - Waterloo - Iowa City & Dubuque, IA Davenport, IA - Rock Island - Moline, IL DMA Rank local 'hich ,illed Technology Overview ates idth by .unts It be We believe in investing in our broadband network, our facilities and other equipment to improve our competitive position. During our planned network upgrade, which was completed in 2003, we made substantial investments in our cable network. The primary features of our network are: . hybrid fiber-optic coaxial, or HFC, architecture; . 99% of the network miles with bandwidth capacity of 550MHz to 870M Hz; ces. . 99% of estimated homes passed wjth two-way communications capability; . 130 headend facilities, the 50 largest of which serve 96% of our basic subscribers; and . the ability to provide advanced broadband services across virtually our entire footprint. 9 T A central feature of our cable network is the deployment of high capacity, HFC architecture. The HFC architecture combines the use of fiber optic cable, which can carry hundreds of video, data and voice channels over extended distances, with coaxial cable, which requires more extensive signal amplification in order to obtain the desired levels for delivering channels. In most systems, we deliver our signals via fiber optic cable to individual nodes serving an average of350 homes or commercial buildings. A node is a single connection to a cable system's main, high-capacity fiber optic cable. Coaxial cable is then connected from each node to the individual homes or buildings. Our network design generally provides for six strands of fiber to each node, with two strands active and four strands reserved for future services. We believe that our design provides high capacity and superior signal quality, as well as providing reserve capacity for the addition of future services. The following table describes the technological state of our cable network as of December 31, 2004: Percentage of Cable Network Less than 550MHz ].5% Standard 550MHz 4.9% Enhanced 550M Hz 9.4% Greater Than 550MHz 84.2% Two-Way Capable 99% As of December 31, 2004, our 550MHz systems consisted of standard 550MHz and enhanced 550MHz systems. Our enhanced 550MHz cable systems benefit from fiber-to-the-node construction to increase their capacity, enabling them to deliver the same broadband video, data and voice services as our systems with bandwidths greater than 550MHz. As a result, we have the ability to provide digital cable television, VOD, HDTV, HSD access and other telecommunications services across virtually our entire footprint. In 2005, we plan to upgrade a portion of our 550MHz cable systems. As of December 31, 2004, our cable systems were operated from 130 headend facilities. Fiber optics and advanced transmission technologies made it cost effective to consolidate our headend facilities, allowing us to realize operating efficiencies and resulting in lower fixed capital costs on a per home basis as we introduce new products and services. Approximately 96% of our basic subscribers are now served by our 50 largest headend facilities. As part of our headend consolidation program, which was substantially completed in 2003, we deployed nearly 9,000 route miles of fiber optic cable, creating a large regional fiber network with the potential to provide advanced telecommunications services to approximately 70% of our estimated homes passed. In 2005, we plan to add SONET technology to our regional fiber network in order to create full redundancy. SONET is a fiber-optic transmission system for high-speed digital traffic which uses a self-healing ring architecture to reroute traffic if a break in communications occurs. This regional network has excess fiber optic capacity to accommodate new and expanded products and services, such as our commercial data business. Its ability to reach more subscribers from a single headend also makes it more efficient, in terms of capital investment, to introduce new and advanced services. Programming Supply We have various fixed-term contracts to obtain, directly and indirectly, programming for our cable systems from programming suppliers whose compensation is typically based on a fixed monthly fee per customer. We negotiate programming contract renewals both directly and through a programming cooperative of which we are a member. Most of our contracts are secured directly due to the need to tailor contracts to our specific business concerns. We attempt to secure longer-term programming contracts which may include marketing support and incentives from programming suppliers. We expect our programming costs to remain our largest single expense item for the foreseeable future. In recent years, we have experienced a substantial increase in the cost of our programming, particularly sports programming, well in excess of the inflation rate or the change in the consumer price index. Our programming costs will continue to rise in the future due to increased costs to purchase programming and as we provide additional programming to our customers. IO HFC We also have various retransmission consent arrangements with commercial broadcast stations, which generally expire in December 2005. In some cases, retransmission consents have been contingent upon our carriage of satellite delivered cable programming offered by companies affiliated with the stations' owners or the broadcast network carried by such stations. es or e and signal Customer Service System reliability, a motivated and productive workforce and customer satisfaction are cornerstones of our business strategy. We expect that investments in our cable network and our regional contact centers significantly strengthen customer service, enhance the reliability of our cable network and allow us to introduce new services to our customers. We benefit from locally-based customer technical support staff who are available to visit customers' premises if problems arise. We maintain three regional contact centers staffed with dedicated customer service representatives, or CSRs, and technical service representatives, or TSRs, who are available to respond to customer calls 24 hours a day, seven days a week. We believe our regional contact centers allow us to effectively manage resources and reduce response times to customer inquiries. TSRs handle our HSD customers, ensuring prompt, efficient resolution of technical inquiries or issues. In 2004, we completed the implementation of virtual contact center technology to provide customers with extensive self-service capabilities, such as making a payment and verifying service appointments, and to enable us to re-route customer calls among our three regional contact centers and other satellite offices to minimize hold times. Our virtual contact centers also give our CSRs and TSRs instant access to the calling customer's file and our products and services in the customer's market. We believe our virtual contact centers will help us ensure the most efficient utilization of our call center personnel and the most effective customer interactions. Reinforcing our commitment to customer service, we have attained customer service standards that meet or exceed those standards established by the National Cable and Telecommunications Association. Also in 2004, we completed the rollout of interactive voice response, or IVR, technology, and today over 25% of all inbound calls to our customer contact centers are handled through the IVR, further enhancing the efficiencies of our customer service operations. sand us to 'e new . adend nearly anced o add -optic ]c if a :w and oma ices. We continue to invest in personnel, equipment and technology to improve our customer care, In 2004, we implemented a web-based customer service platform called e-Care for bill presentment purposes, and we are currently expanding our e-Care capabilities to include customer self-fulfillment. Community Relations We are dedicated to fostering strong community relations in the communities served by our cable systems. We support local charities and community causes in various ways, including staged events and promotional campaigns to raise funds and supplies for persons in need and in-kind donations that include production services and free airtime on cable networks, We participate in the "Cable in the Classroom" program, which provides more than 2,800 schools with free video service and more than 200 schools with free high-speed Internet service. We also provide free cable television service to over 3,000 government buildings, libraries and not-for-profit hospitals in our franchise areas. stems ", We are a siness rt and e. In sports costs litional We also develop and offer exclusive local programming to our communities, a capability not available to direct broadcast satellite service providers, our primary competition in the video business. Several of our cable systems have production facilities to create local programming, which includes local school sports events, fund-raising telethons by local chapters of national charitable organizations, local concerts and other entertainment. In Iowa, we are the exclusive broadcaster of city council meetings, the Little League Championships in Des Moines and the Iowa High School State Football Championships. We believe increasing our emphasis on local programming builds customer loyalty, II T - Franchises Cable systems are generally 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 construction; conditions of service, including number of channels, types of programming and the provision of free service to schools and other public institutions; and the maintenance or posting of insurance or indemnity bonds by the cable operator. Many of the provisions of local franchises are subject to federal regulation under the Communications Act of 1934, or Communications Act, as amended. As of December 31,2004, we held 1,380 cable television franchises. These franchises provide for the payment of fees to the issuing authority. In most of the cable systems, such franchise fees are passed through directly to the customers. The Cable Communications Policy Act of 1984, or 1984 Cable Act, prohibits franchising authorities from imposing franchise fees in excess of 5% of gross revenues from specified cable services and also permits the cable operator to seek renegotiation and modificatioR of franchise requirements if warranted by changed circumstances. Substantially all of the basic subscribers of our cable systems are in service areas that require a franchise. The table below groups the franchises of our cable systems by year of expiration and presents the approximate number and percentage of basic subscribers for each group as of December 31, 2004. Year of Franchise Expiration 2005 through 2008...............:.... 2009 and thereafter.................... Total...........,..,.....,......,........... Number of Franchises 440 940 1,380 Percentage of Total Franchises 32.0% 68.0% 100.0% Number of Basic Subscribers 694,000 764,000 1,458,000 Percentage of Total Basic Subscribers 47.6% 52.4% 100,0% We have never had a franchise revoked or failed to have a franchise renewed. In addition, substantially all of our franchises eligible for renewal have been renewed or extended prior to their stated expirations, and no franchise community has refused to consent to a franchise transfer to us. The 1984 Cable Act provides, among other things, for an orderly franchise renewal process in which franchise renewal will not be unreasonably withheld or, if renewal is denied and the franchising authority acquires ownership of the cable system or effects a transfer of the cable system to another person, the cable operator generally is entitled to the "fair market value" for the cable system covered by such franchise. In addition, the 1984 Cable Act established comprehensive renewal procedures, which require that an incumbent franchisee's renewal application be assessed on its own merits and not as part of a comparative process with competing applications. We believe that we have satisfactory relationships with our franchising communities. Competition We face intense competition from various communications and entertainment providers. Our competitive positioning is significantly influenced by several factors, such as changes in technology and regulation and the corporate size and affiliations of our competitors. We operate in a constantly changing technological environment, and new technologies may give rise to new products and services that compete against our own. Recent regulatory policies have created a more favorable operating environment for new and existing technologies that provide, or may provide, both opportunities and threats. Acquisitions or combinations that significantly change a company's size, or permanent and temporary alliances also impact competitiveness as these may provide benefits, such as improved access to resources (including financing, content and equipment), efficiencies of scale and the ability to provide multiple services, We expect the number and types of our competitors to increase as the expansion of our products and services brings us into new businesses and as new providers of alternative products and services enter our markets. We are unable to predict the effects, if any, of such future developments on our business. 12 -......--. ~ In video services our principal competitors are direct broadcast satellite ("DBS") services. In high-speed data we compete with digital subscriber line ("DSL") services in markets where it has been made available by telephone companies. Telephone companies now bundle voice and data and have recently entered into marketing alliances that allow them to add DBS video to their bundles. Major telephone companies have also begun to carry out their announced plans to construct new fiber networks over the next several years, which will allow them to offer video services over their networks. These phone companies may become significant direct video competitors if they deploy new fiber networks on a large scale in our markets. With our planned launch of cable telephony in the second quarter of 2005, we will compete with providers of various types of telephone services, including providers of traditional circuit switched and wireless telephony. We seek to compete effectively by using our broadband network to continue to provide a rich variety of video programming and new products and services, including VOD, HDTV, DVRs, HSD and, beginning this year, cable telephony. We believe our ability to deliver multiple services from a single platform and to bundle these services strengthens our competitive position. We also believe it is important for us to continue to provide high quality customer service and foster good community relationships through our locally-based personnel and facilities. Video Direct Broadcast Satellite Providers DBS service providers are the cable industry's most significant competitors, having grown their customer base rapidly over the past several years, far exceeding the basic subscriber growth rate of the cable industry. According to recent industry reports, DBS service providers currently deliver video programming services to over 24 million customers in the United States of America. The two largest DBS companies, DIRECTV, Inc., or DIRECTV and EchoStar Communications Corporation, or Echostar, provide service to substantially all of these DBS customers and are each among the four largest providers of multichannel video programming services based on reported customers. The News Corporation Limited, or News Corporation, which acquired a controlling interest in DIRECTV in 2003, owns the Fox Television Network and several cable programming services, as well as DBS operations in Europe, Asia and Latin America. Affiliation with News Corporation could provide DIRECTV with access to financial, programming and other resources that strengthen its competitive position. In early 2005, Echostar entered into a definitive agreement to acquire from Cablevision Systems Corporation the broadcast satellite and certain related assets of VOOM, a recently launched DBS service offering primarily HDTV services on a national basis. DBS service providers have also entered into alliances with certain telephone companies that allow the telephone companies to bundle DBS video with their voice and data services. 'e DBS differs from cable television in certain areas that impact competitiveness. DBS service providers use high- powered satellites to offer their customers services with typically more than 300 channels of programming. DBS service can be received virtually anywhere in the continental United States through the installation ofa small rooftop or side-mounted antenna, with the only requirement being an unobstructed view of the southern sky. DBS service providers do not pay the franchise fees of up to 5% of revenues and property taxes that cable operators are required by many localities to pay. These fundamental differences allow DBS providers to offer uniform nationwide service, pricing and branding, giving them greater operating efficiencies overall and allowing them to compete effectively. Furthermore, the initial investment by a DBS customer for equipment has decreased substantially with offers by DBS service providers of discounted or free equipment, installation and multiple units. Ie t, DBS service providers have also benefited meaningfully from a change in legislation in 1999 that allowed them to deliver local broadcast signals, eliminating a significant competitive advantage which we and other cable system operators had over them. As of December 31, 2004, DBS service providers delivered local broadcast stations in markets representing an estimated 92% of our basic subscribers, an increase of 30% from the prior year-end. The technological limitations of DBS give us and other cable operators certain advantages. DBS technology has limited two-way interactivity, which restricts its ability to compete in interactive video, HSD and voice services. In contrast, our broadband network allows full two-way interactivity and greater varieties of advanced services. In video, we are able to offer VOD, SVOD and DVR products and services while DBS is limited to DVRs. We also believe our cable-delivered VOD and SVOD services are superior to DBS DVR service, as our VOD/SVOD 13 As discussed above, certain major telephone companies are currently constructing new fiber networks. These companies have indicated that this will create a new platform that will allow them to offer significantly faster high- speed data services compared to the offerings available under current DSL technology. t ( \ DBS service providers are currently offering two alternatives of satellite-delivered high-speed data. The first is a one-way service that utilizes a telephone return path, in contrast to our two-way, high-speed service, which does not require a telephone line. The other alternative is a two-way, high-speed service, which requires additional equipment purchases by the customer and is offered at higher prices than our own equivalent service. Due to these differences we believe our high-speed data service is superior to the satellite-delivered service. Some Internet service providers, or ISPs, offer dial-up Internet access service over standard telephone lines in our markets. Dial-up service operates at much lower speeds than cable modem service and is therefore not competitive with our high-speed data service. A number of these ISPs have asked local authorities and the FCC to give them rights of access to cable systems' broadband infrastructure so that they can deliver their services directly to cable systems' customers. This kind of access is often called "open access". Many local franchising authorities have examined the issue of open access and a few have required cable operators to provide such access. Several Federal courts have ruled that localities are not authorized to require open access. The FCC has classified cable modem service as an "information service," not as a "telecommunications service." As an information service, the FCC has held that cable systems are not required to open their networks for use by others to provide ISP services. The 9th Circuit Court of Appeals has issued a contrary decision that finds cable modem services to include both telecommunications service and information service components. If the 9th Circuit's decision (which is on appeal) prevails, it could result in an open access requirement. If we were required to provide open access to ISPs as a result of FCC action or court decisions, other companies could use our cable system infrastructure to offer Internet services competitive with our own. Certain telecommunications companies are seeking to provide high-speed broadband services, including interactive online services, using wireless technologies that may transcend present service boundaries and avoid certain regulatory restrictions. Moreover, some electric utilities have announced plans to deliver broadband services over their electrical distribution networks. The FCC has an on-going rulemaking which, to date, appears limited to basic regulations to avoid technical interference with existing services. If electric utilities provide broadband services over their existing electrical distribution networks, they could become formidable competitors given their resources. Cable Telephony We plan to roll out our cable telephony service in certain markets beginning in the second quarter of2005 and expanding to additional markets in subsequent years. Our planned telephony service will provide both local and long distance calling. As such, it will directly compete with the incumbent local phone company and long-distance service providers. Other competitors include competitive local exchange carriers, which are non-incumbent local phone companies that provide local services and access to long distance services over their own networks or over leased networks, wireless telephone carriers and IP-based service providers. IP phone is becoming more widely deployed by an increasing number of telecommunication service providers, which may result in heightened competition for our cable telephony service. We believe the addition of cable telephony to our video and data service bundles will help us compete with other providers of bundled services, including telephone companies that bundle DBS video with their voice and data services, and the new providers of IP phone service. Other Competition Advances in communications technology, as well as changes in the marketplace and the regulatory and legislative environment, are constantly occurring. The FCC has authorized a new interactive television service that permits non-video transmission of information between an individual's home and entertainment and information service providers. This service, which can be used by DBS systems, television stations and other video programming distributors, including cable systems, is an alternative technology for the delivery of interactive video services. It does not appear at the present time that this service will have a material impact on the operations of cable systems. 16 hese high- The FCC has allocated spectrum in the 280Hz range for a new multichannel wireless service called Local Multipoint Distribution Service that can be used to provide video and telecommunications services. The FCC completed the process of awarding licenses to use this spectrum via a market-by-market auction. We do not know whether such a service would have a material impact on the operations of cable television systems. lrst is I does ional these The 1996 Telecom Act directed the FCC to establish, and the FCC has adopted, regulations and policies for the issuance of licenses for digital television to incumbent television broadcast licensees. Digital television can deliver high-definition television pictures and multiple digital-quality program streams, as well as CD-quality audio programming and advanced digital services, such as data transfer or subscription video. The FCC also has authorized television broadcast stations to transmit text and graphic information that may be useful to both consumers and businesses. The FCC also permits commercial and non-commercial FM stations to use their subcarrier frequencies to provide non-broadcast services, including data transmission. The quality of real-time or streaming of video over the Internet and into homes and businesses continues to improve. These services are also becoming more available as the use of high speed Internet access becomes more widespread. In the future, it is possible that video streaming will compete with the video services offered by cable operators and other providers of video services. For instance, programming suppliers may market their content directly to consumers through video streaming over the Internet, bypassing cable operators or DBS providers as video distributors, although the cable operators may remain as the providers of high speed Internet access service. Employees uding avoid Ices ed to band I their As of December 31, 2004, we employed 3,749 full-time employees and 118 part-time employees. Approximately 30 of our employees have organized but are not covered by a collective bargaining agreement. We consider our relations with our employees to be satisfactory. 5 and I and 'tance local over idely Itened data s that and e that ation video video ns of 17 --.- -- Legislation and Regulation General Federal, state and local laws regulate the development and operation of cable communications systems. In the following paragraphs, we summarize the federal laws and regulations materially affecting us and other cable operators and the level of competition that we face. We also provide a brief description of certain relevant state and local laws. Currently few laws or regulations apply to Internet services. Existing federal, state and local laws and regulations and state and local franchise requirements are currently the subject of judicial proceedings, legislative hearings and administrative proceedings that could change, in varying degrees, the manner in which cable systems operate. Neither the outcome of these proceedings nor their impact upon the cable industry or our business or operations can be predicted at this time. Federal Regulation The principal federal statutes governing the cable industry, the Communications Act of 1934, as amended by the Cable Communications Policy Act of 1984, the Cable Television Consumer Protection and Competition Act of 1992 and the Telecommunications Act of 1996 (collectively, the "Cable Act"), establish the federal regulatory framework for the industry. The Cable Act allocates principal responsibility for enforcing the federal policies among the Federal Communications Commission, or FCC and state and local governmental authorities. The Cable Act and the regulations and policies of the FCC affect significant aspects of our cable system operations, including: . subscriber rates; . the content of the programming we offer to subscribers, as well as the way we sell our program packages to subscribers; . the use of our cable systems by the local franchising authorities, the public and other unrelated companies; . our franchise agreements with local governmental authorities; . cable system ownership limitations and prohibitions; and . our use of utility poles and conduit. The FCC and some state regulatory agencies regularly conduct administrative proceedings to adopt or amend regulations implementing the statutory mandate of the Cable Act. At various times, interested parties to these administrative proceedings challenge the new or amended regulations and policies in the courts with varying levels of success. Further court actions and regulatory proceedings may occur that might affect the rights and obligations of various parties under the Cable Act. The results of these judicial and administrative proceedings may materially affect the cable industry and our business and operations. Subscriber Rates The Cable Act and the FCC's regulations and policies limit the ability of cable systems to raise rates for basic services and customer equipment. No other rates are subject to regulation. Federal law exempts cable systems from all rate regulation in communities that are subject to effective competition, as defmed by federal law and where affirmatively declared by the FCC. Federal law defines effective competition as existing in a variety of circumstances that historically were rarely satisfied but are increasingly likely to be satisfied with the recent increase in DBS penetration and the announced plans of some local phone companies to offer comparable video service. Although the FCC is conducting a proceeding that may streamline the process for obtaining effective competition 18 determinations, neither the outcome of this proceeding nor its impact upon the cable industry or our business or operations can be predicted at this time. the ble and and ive ms or Where there is no effective competition to the cable operator's services, federal law gives local franchising authorities the ability to regulate the rates charged by the operator for: . the lowest level of programming service offered by the cable operator, typically called basic service, which includes, at a minimum, the local broadcast channels and any public access or governmental channels that are required by the operator's franchise; . the installation of cable service and related service calls; and . the installation, sale and lease of equipment used by subscribers to receive basic service, such as converter boxes and remote control units. I by t of ory ies Local franchising authorities who wish to regulate basic service rates and related equipment rates must first affirmatively seek and obtain FCC certification to regulate by following a simplified FCC certification process and agreeing to follow established FCC rules and policies when regulating the cable operator's rates. Currently, the majority of the communities we serve have not sought such certification to regulate our rates. Several years ago, the FCC adopted detailed rate regulations, guidelines and rate forms that a cable operator and the local franchising authority must use in connection with the regulation of basic service and equipment rates. The FCC adopted a benchmark methodology as the principal method of regulating rates. However, if this methodology produces unacceptable rates, the operator may also justify rates using either a detailed cost-of-service methodology or an add-on to the benchmark rate based on the additional capital cost and certain operating expenses resulting from qualifying upgrades to the cable plant. The Cable Act and FCC rules also allow franchising authorities to regulate equipment rates on the basis of actual cost plus a reasonable profit, as defmed by the FCC. s to s' , If the local franchising authority concludes that a cable operator's rates are too high under the FCC's rate rules, the local franchising authority may require the cable operator to reduce rates and to refund overcharges to subscribers, with interest. The cable operator may appeal adverse local rate decisions to the FCC. The FCC's regulations allow a cable operator to modify regulated rates on a quarterly or annual basis to account for changes in: . the number of regulated channels; . inflation; and . certain external costs, such as franchise and other governmental fees, copyright and retransmission consent fees, taxes, programming fees and franchise-imposed obligations. The Cable Act and/or the FCC's regulations also: . require cable operators to charge uniform rates throughout each franchise area that is not subject to effective competition; ic ,om ere of ase ice. ion . prohibit regulation of non-predatory bulk discount rates offered by cable operators to subscribers in multiple dwelling units; and . permit regulated equipment rates to be computed by aggregating costs of broad categories of equipment at the franchise, system, regional or company level. The FCC recently conducted an inquiry into the advisability of mandating the a la carte offering of programming, as opposed to the cable industry's practice of packaging numerous channels into tiers. Although the 19 ~ - FCC recommended against an a la carte mandate, it is possible that in the future rate regulation on the cable industry could be expanded to include new restrictions on the retail pricing or packaging of cable programming. Such restrictions could adversely impact our business. Content Requirements Must Carry and Retransmission Consent The FCC's regulations contain broadcast signal carriage requirements that allow local commercial television broadcast stations to elect once every three years whether to require a cable system: . to carry the station, subject to certain exceptions; or . to negotiate the terms by which the cable system may carry the station on its cable systems, commonly called retransmission consent. The Cable Act and the FCC's regulations require a cable operator to devote up to one-third of its activated channel capacity for the carriage of local commercial television stations. The Cable Act and the FCC's rules also give certain local non-commercial, educational television stations mandatory carriage rights, but not the option to negotiate retransmission consent. Additionally, cable systems must obtain retransmission consent for carriage of: . all distant commercial television stations, except for certain commercial satellite-delivered independent superstations such as WGN; . commercial radio stations; and . certain low-power television stations. Under legislation enacted in 1999, Congress barred broadcasters from entering into exclusive retransmission consent agreements (through 2006) and required that broadcasters negotiate retransmission consent agreements in "good faith." In November 2004, Congress extended the ban on exclusive retransmission consent agreements to cover all multi-channel video programming distributors, including cable operators. The FCC has opened an inquiry into the impact on competition in the multichannel video programming distribution market of the Cable Act's provisions and the FCC's rules on retransmission consent, network nonduplication, syndicated exclusivity and sports blackouts. The FCC's inquiry will form the basis for a report to Congress mandated by the Satellite Home Viewer Extension and Reauthorization Act of 2004 ("SHVERA"), which is due September 8, 2005. The FCC also recently opened a rulemaking to implement the requirement in SHVERA that extends the good faith retransmission consent bargaining requirements from broadcasters to multichannel video programming providers, including cable operators. Neither the outcome of these proceedings nor their impact upon subsequent legislation, FCC regulations or the cable industry or our business or operations can be predicted at this time. Must-carry obligations may decrease the attractiveness of the cable operator's overall programming offerings by including less popular programming on the channel line-up, while cable operators may need to provide some form of consideration to broadcasters to obtain retransmission consent to carry more popular programming. We carry both broadcast stations based on must-carry obligations and others that have granted retransmission consent. The FCC has issued a decision that effectively requires mandatory carriage of local television stations that surrender their analog channel and broadcast only digital signals. These stations are entitled to request carriage in their choice of digital or converted analog format. Stations transmitting in both digital and analog formats ("Dual Format Broadcast Stations"), which is permitted during the current several-year transition period, have no carriage rights for the digital format during the transition unless and until they turn in their analog channel. The FCC has recently reaffirmed that cable operators are not required to carry the digital signal of Dual Format Broadcast Stations that currently have must-carry rights for their analog signals. In addition to rejecting a "dual carriage" requirement 20 -- ustry Such during the transition, the FCC also confIrmed that a cable operator need only carry a broadcaster's "primary video" service (rather than all of the digital "multi-cast" services), both during and after the transition. In addition, in November 2004, Congress passed a non-binding resolution urging that legislation be considered in 2005 that would set a firm date for the broadcasters to'return their analog spectrum. The adoption, by legislation or FCC regulation, of additional must-carry requirements would have a negative impact on us because it would reduce available channel capacity and thereby could require us to either discontinue other channels of programming or restrict our ability to carry new channels of programming that may be more desirable to our customers. fision Tier Buy Through The Cable Act and the FCC's regulations require our cable systems, other than those systems which are subject to effective competition, to permit subscribers to purchase video programming we offer on a per channel or a per program basis without the necessity of subscribing to any tier of service other than the basic service tier. only Program Access To increase competition between cable operators and other video program distributors, the Cable Act and the FCC's regulations: . preclude any satellite video programmer affiliated with a cable company, or with a common carrier providing video programming directly to its subscribers, from favoring an affiliated company over competitors; ndent . require such programmers to sell their programming to other unaffiliated video program distributors; and . limit the ability of such programmers to offer exclusive programming arrangements to their related parties. Other Programming tission nts in nts to Federal law actively regulates other aspects of our programming, involving such areas as: . our use of syndicated and network programs and local sports broadcast programming; ming twork ort to which ERA I video .t upon at this . advertising in children's programming; . political advertising; . origination cablecasting; . adult programming; . sponsorship identification; and erings some . We "ent. . closed captioning of video programming. Use of Our Cable Systems by the Government and Unrelated Third Parties ns that 'iage in ("Dual :arriage C has "tations jrement The Cable Act allows local franchising authorities and unrelated third parties to obtain access to a portion of our cable systems' channel capacity for their own use. For example, the Cable Act: . permits franchising authorities to require cable operators to set aside channels for public, educational and governmental access programming; and 21 - - . requires a cable system with 36 or more activated channels to designate a significant portion of its channel capacity for commercial leased access by third parties to provide programming that may compete with services offered by the cable operator. The FCC regulates various aspects of third party commercial use of channel capacity on our cable systems, including: . the maximum reasonable rate a cable operator may charge for third party commercial use of the designated channel capacity; . the tenns and conditions for commercial use of such channels; and . the procedures for the expedited resolution of disputes concerning rates or commercial use of the designated channel capacity, Franchise Matters We have non-exclusive franchises in virtually every community in which we operate that authorize us to construct, operate and maintain our cable systems. Although franchising matters are nonnally regulated at the local level through a franchise agreement and/or a local ordinance, the Cable Act provides oversight and guidelines to govern our relationship with local franchising authorities. For example, the Cable Act and/or FCC regulations and detenninations: Provide guidelines for the exercise of local regulatory authority that: . affinn the right of franchising authorities, which may be state or local, depending on the practice in individual states, to award one or more franchises within their jurisdictions; . generally prohibit us from operating in communities without a franchise; . pennit local authorities, when granting or renewing our franchises, to establish requirements for cable- related facilities and equipment, but prohibit franchising authorities from establishing requirements for specific video programming or infonnation services other than in broad categories; and . pennit us to obtain modification of our franchise requirements from the franchise authority or by judicial action if warranted by commercial impracticability. Generally prohibit franchising authorities from: . imposing requirements during the initial cable franchising process or during franchise renewal that require, prohibit or restrict us from providing telecommunications services; . imposing franchise fees on revenues we derive from providing telecommunications or information services over our cable systems; . restricting our use of any type of subscriber equipment or transmission technology; and . requiring payment of franchise fees to the local franchising authority in excess of 5.0% of our gross revenues derived from providing cable services over our cable system. Encourage competition with existing cable systems by: . allowing municipalities to operate their own cable systems without franchises; and 22 . ~ el 'th . preventing franchising authorities from granting exclusive franchises or from unreasonably refusing to award additional franchises covering an existing cable system's service area. s, Provide renewal procedures: he . The Cable Act contains renewal procedures designed to protect us against arbitrary denials of renewal of our franchises although, under certain circumstances, the franchising authority could deny us a franchise renewal. Moreover, even if our franchise is renewed, the franchising authority may seek to impose upon us new and more onerous requirements, such as significant upgrades in facilities and services or increased franchise fees as a condition of renewal to the extent permitted by law. Similarly, if a franchising authority's consent is required for the purchase or sale of our cable system or franchise, the franchising authority may attempt to impose more burdensome or onerous franchise requirements on the purchaser in connection with a request for such consent. Historically, cable operators providing satisfactory services to their subscribers and complying with the terms of their franchises have almost always obtained franchise renewals. We believe that we have generally met the terms of our franchises and have provided quality levels of service. We anticipate that our future franchise renewal prospects generally will be favorable. ed , to cal to . Various courts have considered whether franchising authorities have the legal right to limit the number of franchises awarded within a community and to impose substantive franchise requirements. These decisions have been inconsistent and, until the U.S. Supreme Court rules definitively on the scope of cable operators' First Amendment protections, the legality of the franchising process generally and of various specific franchise requirements is likely to be in a state of flux. in The Cable Act and the FCC allow cable operators to pass franchise fees on to subscribers and to separately itemize them on subscriber bills. In 2003 an appellate court affirmed an FCC ruling that franchise fees paid by cable operators on non-subscriber related revenue (such as cable advertising revenue and home shopping commissions) may be passed through to subscribers and itemized on subscriber bills regardless of the source of the revenues on which they were assessed. ble- , for In connection with its decision in March 2002 classifying high-speed Internet services provided over a cable system as interstate information services, the FCC stated that revenues derived from cable operators' Internet services should not be included in the revenue base from which franchise fees are calculated. In 2003 an appellate court vacated the FCC's decision classifying cable operators' Internet services as an interstate "information service" and not a "telecommunications service"; however, the United States Supreme Court has agreed to hear the FCC's appeal of the appellate court decision. Because of the FCC's decision, we are no longer collecting and remitting franchise fees on our high-speed Internet service revenues. We are unable to predict the ultimate resolution of these matters but do not expect that any additional franchise fees we may be required to pay will be material to our business and operations. .icial uire, Ownership Limitations ices The FCC previously adopted nationwide limits on the number of subscribers under the control of a cable operator and on the number of channels which can be occupied on a cable system by video programming in which the cable operator has an interest. The U.S. Court of Appeals for the District of Columbia Circuit overturned the FCC's rules implementing these statutory provisions and remanded the case to the FCC for further proceedings. oss The 1996 amendments to the Cable Act eliminated the statutory prohibition on the common ownership, operation or control of a cable system and a television broadcast station in the same service area. The identical FCC regulation has been invalidated by a federal appellate court. The FCC has eliminated its regulatory restriction on cross-ownership of cable systems and national broadcasting networks. 23 - The 1996 amendments to the Cable Act made far-reaching changes in the relationship between local telephone companies and cable service providers. These amendments: . eliminated federal legal barriers to competition in the local telephone and cable communications businesses, including allowing local telephone companies to offer video services in their local telephone service areas; . preempted legal barriers to telecommunications competition that previously existed in state and local laws and regulations; . set basic standards for relationships between telecommunications providers; and . generally limited acquisitions and prohibited joint ventures between local telephone companies and cable operators in the same market. Pursuant to these changes in federal law, local telephone companies may now provide service as traditional cable operators with local franchises or they may opt to provide their programming over open video systems, subject to certain conditions, including, but not limited to, setting aside a portion of their channel capacity for use by unaffiliated program distributors on a non-discriminatory basis. Open video systems are exempt from certain regulatory obligations that currently apply to cable operators. The decision as to whether an operator of an open video system must obtain a local franchise is left to each community. The 1996 amendments to the Cable Act allow registered uti lity holding companies and subsidiaries to provide telecommunications services, including cable television, notwithstanding the Public Utilities Holding Company Act of 1935, as amended. In 2004, the FCC adopted rules: 1) that affirmed the ability of electric service providers to provide broadband Internet access services over their distribution systems; and 2) that seek to avoid interference with existing services. Electric utilities could be formidable competitors to cable system operators. The Cable Act generally prohibits us from owning or operating a satellite master antenna television system or multichannel multipoint distribution system in any area where we provide franchised cable service and do not have effective competition, as defined by federal law. We may, however, acquire and operate a satellite master antenna television system in our existing franchise service areas if the programming and other services provided to the satellite master antenna television system subscribers are offered according to the terms and conditions of our local franchise agreement. Cable Equipment The Cable Act and FCC regulations seek to promote competition in the delivery of cable equipment by gIVIng consumers the right to purchase set-top converters from third parties as long as the equipment does not harm the network, does not interfere with services purchased by other customers and is not used to receive unauthorized services. Over a multi-year phase-in period, the rules also require multichannel video programming distributors, other than direct broadcast satellite operators, to separate security from non-security functions in set-top converters to allow third party vendors to provide set-tops with basic converter functions. Beginning July 1, 2006 cable operators will be prohibited from leasing digital set-top terminals that integrate security and basic navigation functions. To promote compatibility of cable television systems and consumer electronics equipment the FCC recently adopted rules implementing "plug and play" specifications for one-way digital televisions. The rules require cable operators to provide "CableCard" security modules and support for digital televisions equipped with built-in set-top functionality. Pole Attachment Regulation The Cable Act requires certain public utilities, defined to include all local telephone companies and electric utilities except those owned by municipalities and co-operatives, to provide cable operators and telecommunications carriers with nondiscriminatory access to poles, ducts, conduit and rights-of-way at just and reasonable rates. This 24 . ions one right to access is beneficial to us. Federal law also requires the FCC to regulate the rates, terms and conditions imposed by such public utilities for cable systems' use of utility pole and conduit space unless state authorities have demonstrated to the FCC that they adequately regulate pole attachment rates, as is the case in certain states in which we operate. In the absence of state regulation, the FCC will regulate pole attachment rates, terms and conditions only in response to a formal complaint. The FCC adopted a new rate formula that became effective in 2001 which governs the maximum rate certain utilities may charge for attachments to their poles and conduit by companies providing telecommunications services, including cable operators. laws able Increases in attachment rates due to the FCC's new rate formula are phased in over a five-year period in equal annual increments, beginning in February 2001. This new formula will result in higher attachment rates than at present, but they will apply only to cable television systems which elect to offer telecommunications services. The FCC ruled that the provision of Internet services will not, in and of itself, trigger use of the new formula. The Supreme Court affirmed this decision and also held that the FCC's authority to regulate rates for attachments to utility poles extended to attachments by cable operators and telecommunications carriers that are used to provide Internet service or for wireless telecommunications service. The United States Supreme Court will review an appellate court decision classifying Internet services provided over cable systems to include a telecoInmunications service component. If the Supreme Court affrrms the appellate court's decision, it may subject our pole attachments to higher rates. Other Regulatory Requirements of the Cable Act and the FCC .ovide .IY Act ers to rence The FCC has adopted cable inside wiring rules to provide a more specific procedure for the disposition of residential home wiring and internal building wiring that belongs to an incumbent cable operator that is forced by the building owner to terminate its cable services in a building with multiple dwelling units. The Cable Act and/or FCC rules include provisions, among others, regulating other parts of our cable operations, involving such areas as: em or It have tenna to the local . equal employment opportunity; . consumer protection and customer service; . technical standards and testing of cable facilities; . consumer electronics equipment compatibility; giving .rm the OTized butors, Iverters cable 'igation . registration of cable systems; . maintenance of various records and public inspection files; . microwave frequency usage; and . antenna structure notification, marking and lighting. 'ecently e cable set -top The FCC may enforce its regulations through the imposition of fines, the issuance of cease and desist orders or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate transmission facilities often used in connection with cable operations. The FCC routinely conducts rulemaking proceedings that may change its existing rules or lead to new regulations. We are unable to predict the impact that any further FCC rule changes may have on our business and operations. electric ications .s. This 25 ..~