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MEDIACOM BROADBAND CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our unaudited consolidated financial statements as of, and for the three and nine months ended, September 30, 2012 and 2011, and with our annual report on Form 10-K for the year ended December 31, 2011. Overview We are a wholly-owned subsidiary of Mediacom Communications Corporation ("MCC"), the nation's eighth largest cable company based on the number of video customers. As of September 30, 2012, we served approximately 567,000 video customers, 501,000 HSD customers and 189,000 phone customers, aggregating 1.26 million primary service units ("PSUs"). Through our interactive broadband network, we provide our residential and commercial customers with a wide variety of products and services, including our primary services of video, high-speed data ("HSD") and phone, which we refer to as our "triple play bundle." We also provide network and transport services to medium and large sized businesses in our service areas, including cell tower backhaul for wireless telephone providers, and sell advertising time we receive under our programming license agreements to local, regional and national advertisers. Our performance has been affected by general economic conditions and by the competition we face. We believe high unemployment levels and weakness in the housing sector and consumer spending have, in part, contributed to lower connect activity for all of our services and negatively impacted our residential customer and revenue growth. While we expect improvement as the economy recovers, a continuation or broadening of such effects may adversely impact our results of operations, cash flows and financial position. Our residential video service principally competes with direct broadcast satellite ("DBS") providers, who offer video programming substantially similar to ours. For the past several years, DBS competitors have deployed aggressive marketing campaigns, including deeply discounted promotional packages, which we believe has contributed to video customer losses in our markets. Our programming costs, particularly for sports and local broadcast programming, have risen well in excess of the inflation rate in recent years, a trend we expect to continue. Given these factors, we have generally limited our offering of discounted pricing for video-only customers, as we believe it has become uneconomic to offer a low-priced, low-margin video-only product in an attempt to match the competition's pricing. While the reduction of discounted pricing has positively impacted per-unit video revenues, we believe that it, along with weak economic conditions, has contributed to further video customer losses and, if such losses were to continue, we may experience future annual declines in video revenues. We expect to partially offset such declines through higher average unit pricing and greater penetration of our advanced video services, including video-on-demand ("VOD"), high-definition television ("HDTV") and digital video recorders ("DVRs"). Our residential HSD service competes primarily with local telephone companies, such as AT&T and CenturyLink. Such companies compete with our HSD product by offering digital subscriber line ("DSL") services. In our markets, widely-available DSL service is typically limited to downstream speeds ranging from 1.5Mbps to 3Mbps, compared to our downstream speeds ranging from 3Mbps to 105Mbps. We believe we will continue to increase HSD revenues through future growth in residential HSD customers and customers taking higher speed tiers. Our residential phone service competes with local telephone companies that offer a product substantially similar to ours, and with cellular phone services offered by national wireless providers. We expect to face pricing pressure for our phone service, which may partially or fully offset greater revenues resulting from continuing growth of residential phone customers. Certain local telephone companies, including AT&T and Verizon, have deployed fiber-based networks which allow for a triple play bundle that is comparable to ours. As of September 30, 2012, based on internal estimates, approximately 11% of our cable systems actively competed with these local telephone companies. Our commercial video, HSD and phone services face similar competition to our comparable residential services. Historically, local telephone companies have been in a better position to offer HSD services to businesses, as their networks tend to be more developed in commercial areas. However, we have recently increased our efforts to offer and market a more complete array of products and services suited to businesses, and continue to extend our distribution network further into business districts in the cities and towns we serve. Our enterprise networks business faces competition from local telephone companies and other carriers, such as metro and regional fiber providers. We believe we will continue to increase business services revenues through increasing our commercial HSD, phone and, to a lesser extent, video customer base, and continued growth of our enterprise networks business, including fees for cell tower backhaul. We face significant competition in our advertising business from a wide range of national, regional and local competitors. We compete for advertising revenues principally against local broadcast stations, national cable and broadcast networks, radio, newspapers, magazines, outdoor display and Internet companies. Advertising revenues are sensitive to the political election cycle, and we believe advertising revenues will increase for the full year 2012, as this is an election year. 15 -------------------------------------------------------------------------------- Table of Contents Recent Developments In August 2012, we issued a new term loan in the aggregate principal amount of $200 million under our existing bank credit facility (the "credit facility") and new 6 3/8% senior notes in the aggregate principal amount of $300 million (together, the "financings"). In September 2012, we used the proceeds of the financings to purchase $74.8 million of our 8 1/2% senior notes due 2015 (the "8 1/2% Notes") through a cash tender offer, and in October 2012, we redeemed the remaining $425.2 million of 8 1/2% Notes (the "Redemption"). For more information, see "- Liquidity and Capital Resources - Capital Structure - Financing Activities" and Notes 6 and 12 in our Notes to Consolidated Financial Statements. Revenues Video Video revenues primarily represent monthly subscription fees charged to our residential video customers, which vary according to the level of service and equipment taken, and revenue from the sale of VOD content and pay-per-view events. Video revenues also include installation, reconnection and wire maintenance fees, franchise and late payment fees, and other ancillary revenues. HSD HSD revenues primarily represent monthly subscription fees charged to our residential HSD customers, which vary according to the level of HSD service taken. Phone Phone revenues primarily represent monthly subscription fees charged to our residential phone customers for our phone service. Business Services Business services revenues primarily represent monthly fees charged to our commercial video, HSD and phone customers, which vary according to the level of service taken, and fees charged to large sized businesses, including wireless providers for cell tower backhaul, for our scalable, fiber-based enterprise networks products and services. Advertising Advertising revenues primarily represent revenues received from selling advertising time we receive under our programming license agreements to local, regional and national advertisers for the placement of commercials on channels offered on our video services. Costs and Expenses Service Costs Service costs consist of the costs related to providing and maintaining services to our customers. Significant service costs are for: video programming; HSD service, including bandwidth connectivity; phone service, including leased circuits and long distance; our enterprise networks business; technical personnel who maintain our cable network, perform customer installation activities and provide customer support; our network operations center; utilities, including pole rental; and field operations, including outside contractors, vehicle fuel and maintenance and leased fiber for our regional fiber networks. Programming costs, which are generally paid on a per video customer basis, have historically represented our single largest expense. In recent years, we have experienced substantial increases in the per-unit cost of our programming, which we believe will continue to grow due to the increasing contractual rates and retransmission consent fees demanded by large programmers and independent broadcasters. Our HSD and phone service costs fluctuate depending on the level of investments we make in our cable systems and the resulting operational efficiencies. In June 2011, we completed a transition to an internal phone service platform, which greatly reduced our phone service expenses. Our other service costs generally rise as a result of customer growth and inflationary cost increases for personnel, outside vendors and other expenses. Personnel and related support costs may increase as the percentage of expenses that we capitalize declines due to lower levels of new service installations. We anticipate that our service costs, with the exception of programming expenses, will remain fairly consistent as a percentage of our revenues. Selling, General and Administrative Expenses Significant selling, general and administrative expenses are for: our call center, customer service marketing, business services, support and administrative personnel; franchise fees and other taxes; bad debt; billing; marketing; advertising; and general office administration. These expenses generally rise due to customer growth and inflationary cost increases for personnel, outside vendors and other expenses. We anticipate that our selling, general and administrative expenses will remain fairly consistent as a percentage of our revenues. 16 -------------------------------------------------------------------------------- Table of Contents Service costs and selling, general and administrative expenses exclude depreciation and amortization, which is presented separately. Management Fee Expense Management fee expense reflects compensation paid to MCC for the performance of services it provides our operating subsidiaries in accordance with management agreements between MCC and our operating subsidiaries. Use of Non-GAAP Financial Measures "OIBDA" is not a financial measure calculated in accordance with generally accepted accounting principles ("GAAP") in the United States. We define OIBDA as operating income before depreciation and amortization. OIBDA has inherent limitations as discussed below. 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 methods used by management, and provides a measure that can be used to analyze value and compare the companies in the cable industry. A limitation of OIBDA, 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 uses a separate process to budget, measure and evaluate capital expenditures. In addition, OIBDA may not be comparable to similarly titled measures used by other companies, which may have different depreciation and amortization policies. OIBDA should not be regarded as an alternative to operating income or net income (loss) as an indicator of operating performance, or to the statement of cash flows as a measure of liquidity, 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. 17 -------------------------------------------------------------------------------- Table of Contents Actual Results of Operations Three Months Ended September 30, 2012 compared to Three Months Ended September 30, 2011 The table below sets forth our consolidated statements of operations and OIBDA for the three months ended September 30, 2012 and 2011 (dollars in thousands and percentage changes that are not meaningful are marked NM): Three Months Ended September 30, 2012 2011 $ Change % Change Revenues $ 223,865 $ 220,244 $ 3,621 1.6 % Costs and expenses: Service costs (exclusive of depreciation and amortization) 89,176 88,566 610 0.7 % Selling, general and administrative expenses 45,964 44,872 1,092 2.4 % Management fee expense 3,450 3,414 36 1.1 % Depreciation and amortization 37,645 35,578 2,067 5.8 % Operating income 47,630 47,814 (184 ) (0.4 %) Interest expense, net (29,904 ) (27,897 ) (2,007 ) 7.2 % Loss on derivatives, net (6 ) (17,159 ) 17,153 NM Loss on early extinguishment of debt (2,376 ) - (2,376 ) NM Other expense, net (458 ) (456 ) (2 ) 0.4 % Net income $ 14,886 $ 2,302 $ 12,584 NM OIBDA $ 85,275 $ 83,392 $ 1,883 2.3 % The table below represents a reconciliation of OIBDA to operating income, which is the most directly comparable GAAP measure (dollars in thousands): Three Months Ended September 30, 2012 2011 $ Change % Change OIBDA $ 85,275 $ 83,392 $ 1,883 2.3 % Depreciation and amortization (37,645 ) (35,578 ) (2,067 ) 5.8 % Operating income $ 47,630 $ 47,814 $ (184 ) (0.4 %) 18 -------------------------------------------------------------------------------- Table of Contents Revenues The tables below set forth our revenues and selected customer and average monthly revenue statistics as of, and for the three months ended, September 30, 2012 and 2011 (dollars in thousands, except per customer and per unit data): Three Months Ended September 30, 2012 2011 $ Change % Change Video $ 114,519 $ 119,884 $ (5,365 ) (4.5 %) HSD 56,250 53,239 3,011 5.7 % Phone 16,962 17,011 (49 ) (0.3 %) Business services 21,634 18,054 3,580 19.8 % Advertising 14,500 12,056 2,444 20.3 % Total $ 223,865 $ 220,244 $ 3,621 1.6 % September 30, Increase/ 2012 2011 (Decrease) % Change Video customers 567,000 612,000 (45,000 ) (7.4 %) HSD customers 501,000 467,000 34,000 7.3 % Phone customers 189,000 179,000 10,000 5.6 % Primary service units (PSUs) 1,257,000 1,258,000 (1,000 ) (0.1 %) Digital customers 445,000 403,000 42,000 10.4 % Revenue generating units 1,702,000 1,661,000 41,000 2.5 % Average total monthly revenue per video customer (1) $ 130.23 $ 117.84 $ 12.39 10.5 % Average total monthly revenue per PSU (2) $ 59.18 $ 57.83 $ 1.35 2.3 % (1) Represents average total monthly revenues for the period divided by average video customers for such period. (2) Represents average total monthly revenues for the period divided by average PSUs for such period. Revenues increased 1.6%, primarily due to higher business services, HSD and advertising revenues, offset in part by lower video revenues. Average total monthly revenue per video customer increased 10.5% to $130.23, and average total monthly revenue per PSU increased 2.3% to $59.18. Video revenues declined 4.5%, mainly due to residential video customer losses, offset in part by higher unit pricing. During the three months ended September 30, 2012, we lost 12,000 video customers, compared to 22,000 in the prior year period. As of September 30, 2012, we served 567,000 video customers, or 38.1% of our estimated homes passed. As of the same date, 78.5% of our video customers were digital customers, and 46.3% of our digital customers were taking our DVR and/or HDTV services. HSD revenues grew 5.7%, principally due to a greater residential HSD customer base and, to a lesser extent, higher unit pricing. During the three months ended September 30, 2012, we gained 8,000 HSD customers, compared to a loss of 3,000 in the prior year period. As of September 30, 2012, we served 501,000 HSD customers, or 33.6% of our estimated homes passed. Phone revenues were 0.3% lower, largely a result of lower unit pricing, mostly offset by a greater residential phone customer base. During the three months ended September 30, 2012, we lost 4,000 phone customers, compared to an increase of 2,000 in the prior year period. As of September 30, 2012, we served 189,000 phone customers, or 12.7% of our estimated homes passed. Business services revenues rose 19.8%, primarily due to an increase in commercial HSD and phone customers and greater revenues from our enterprise networks business, principally for cell tower backhaul. Advertising revenues were 20.3% higher, principally due to higher levels of political and, to a lesser extent, automotive advertising. Costs and Expenses Service costs increased 0.7%, primarily due to greater field operating, and to a lesser extent, phone and HSD service costs, offset in part by lower programming and, to a lesser extent, utilities expenses. Field operating costs grew 18.9%, largely as a result of a greater 19-------------------------------------------------------------------------------- Table of Contents use of outside contractors and, to a lesser extent, higher fiber lease and equipment maintenance expenses. Phone service costs rose 19.9%, primarily due to a larger phone customer base. HSD service costs increased 18.8%, principally due to a larger HSD customer base and, to a lesser extent, increased bandwidth usage and maintenance agreements. Programming costs decreased 1.9%, mainly due to a lower video customer base, mostly offset by higher contractual rates charged by our programming vendors and, to a lesser extent, greater retransmission consent fees. Utilities expenses were 12.0% lower, primarily due to a reduction in electric utility and, to a lesser extent, pole rental expenses. Service costs as a percentage of revenues were 39.8% and 40.2% for the three months ended September 30, 2012 and 2011, respectively. Selling, general and administrative expenses grew 2.4%, primarily due to higher employee costs, offset in part by lower bad debt expense. Employee costs increased 9.2%, largely as a result of increased business services marketing and, to a lesser extent, customer service and direct sales staffing levels. Bad debt expense was 5.9% lower, principally due to a lower number of written-off accounts. Selling, general and administrative expenses as a percentage of revenues were 20.5% and 20.4% for the three months ended September 30, 2012 and 2011, respectively. Management fee expense increased 1.1%, reflecting higher overhead costs charged by MCC. Management fee expense as a percentage of revenues was 1.5% and 1.6% for the three months ended September 30, 2012 and 2011, respectively. Depreciation and amortization increased 5.8%, largely as a result of the depreciation of investments in shorter-lived customer premise equipment and our internal phone service platform. OIBDA OIBDA grew 2.3%, primarily due to greater revenues, offset in part by higher selling, general and administrative expenses and service costs. Operating Income Operating income decreased 0.4%, as higher depreciation and amortization was mostly offset by the growth in OIBDA. Interest Expense, Net Interest expense, net, increased 7.2%, due to greater average outstanding indebtedness and a higher average cost of debt. Loss on Derivatives, Net As of September 30, 2012, we had interest rate exchange agreements (which we refer to as "interest rate swaps") with an aggregate notional amount of $1.5 billion, of which $800 million were forward-starting interest rate swaps. These interest rate swaps have not been designated as hedges for accounting purposes, and the changes in their mark-to-market values are derived primarily from changes in market interest rates and the decrease in their time to maturity. As a result of changes to the mark-to-market valuation of these interest rate swaps, based upon information provided by our counterparties, we recorded a net loss on derivatives of $0 for the three months ended September 30, 2012, compared to a net loss on derivatives of $17.2 million for the three months ended September 30, 2011. Other Expense, Net Other expense, net, was $0.5 million for each of the three months ended September 30, 2012 and 2011. During the three months ended September 30, 2012, other expense, net, consisted of $0.3 million of revolving credit facility commitment fees and $0.2 million of other fees. During the three months ended September 30, 2011, other expense, net, consisted of $0.4 million of revolving credit facility commitment fees and $0.1 million of other fees. Net Income As a result of the factors described above, we recognized net income of $14.9 million for the three months ended September 30, 2012, compared to $2.3 million for the three months ended September 30, 2011. 20-------------------------------------------------------------------------------- Table of Contents Actual Results of Operations Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011 The table below sets forth our consolidated statements of operations and OIBDA for the nine months ended September 30, 2012 and 2011 (dollars in thousands and percentage changes that are not meaningful are marked NM): Nine Months Ended September 30, 2012 2011 $ Change % Change Revenues $ 668,949 $ 655,660 $ 13,289 2.0 % Costs and expenses: Service costs (exclusive of depreciation and amortization) 270,078 267,677 2,401 0.9 % Selling, general and administrative expenses 134,010 130,117 3,893 3.0 % Management fee expense 10,535 11,075 (540 ) (4.9 %) Depreciation and amortization 112,746 106,855 5,891 5.5 % Operating income 141,580 139,936 1,644 1.2 % Interest expense, net (86,346 ) (83,549 ) (2,797 ) 3.3 % Gain (loss) on derivatives, net 1,060 (21,363 ) 22,423 NM Loss on early extinguishment of debt (2,376 ) - (2,376 ) NM Other expense, net (1,111 ) (1,641 ) 530 (32.3 %) Net income $ 52,807 $ 33,383 $ 19,424 58.2 % OIBDA $ 254,326 $ 246,791 $ 7,535 3.1 % The table below represents a reconciliation of OIBDA to operating income, which is the most directly comparable GAAP measure (dollars in thousands): Nine Months Ended September 30, 2012 2011 $ Change % Change OIBDA $ 254,326 $ 246,791 $ 7,535 3.1 % Depreciation and amortization (112,746 ) (106,855 ) (5,891 ) 5.5 % Operating income $ 141,580 $ 139,936 $ 1,644 1.2 % Revenues The table below sets forth our revenues for the nine months ended, September 30, 2012 and 2011 (dollars in thousands): Nine Months Ended September 30, 2012 2011 $ Change % Change Video $ 350,112 $ 366,275 $ (16,163 ) (4.4 %) HSD 168,349 155,182 13,167 8.5 % Phone 50,124 50,252 (128 ) (0.3 %) Business services 61,342 48,618 12,724 26.2 % Advertising 39,022 35,331 3,691 10.4 % Total $ 668,949 $ 655,658 $ 13,291 2.0 % 21 -------------------------------------------------------------------------------- Table of Contents Revenues increased 2.0%, primarily due to higher HSD and business services revenues, offset in part by lower video revenues. Average total monthly revenue per video customer increased 11.9% to $127.82, and average total monthly revenue per PSU increased 4.2% to $59.44. Video revenues declined 4.4%, as residential video customer losses were partly offset by higher unit pricing. During the nine months ended September 30, 2012, we lost 29,000 video customers, compared to a loss of 51,000 in the prior year period. HSD revenues grew 8.5%, primarily due to higher unit pricing and, to a lesser extent, a greater residential HSD customer base. During the nine months ended September 30, 2012, we gained 33,000 HSD customers, compared to an increase of 8,000 in the prior year period. Phone revenues declined 0.3%, largely as a result of lower unit pricing, mostly offset by a greater residential phone customer base. During the nine months ended September 30, 2012, we gained 9,000 phone customers, compared to an increase of 4,000 in the prior year period. Business services revenues rose 26.2%, primarily due to an increase in commercial HSD and phone customers and greater revenues from our enterprise networks business, principally for cell tower backhaul. Advertising revenues were 10.4% higher, principally due to higher levels of political and, to a lesser extent, automotive advertising. Costs and Expenses Service costs increased 0.9%, primarily due to greater field operating and employee costs and, to a lesser extent, HSD service costs, mostly offset by lower programming and phone service expenses. Field operating costs grew 15.4%, largely as a result of a greater use of outside contractors and, to a lesser extent, higher fiber lease and cable location costs. Employee costs increased 5.0%, principally due to higher staffing levels and, to a lesser extent, unfavorable employee benefit adjustments. HSD service costs grew 17.3%, principally due to a larger HSD customer base and, to a lesser extent, increased bandwidth usage and maintenance agreements. Programming expenses declined 0.9%, largely as a result of a lower video customer base, mostly offset by higher contractual rates charged by our programming vendors and, to a lesser extent, greater retransmission consent fees. Phone service expenses fell 15.3%, substantially due to cost savings resulting from our transition from a third-party provider to an internal phone service platform. Service costs as a percentage of revenues were 40.4% and 40.8% for the nine months ended September 30, 2012 and 2011, respectively. Selling, general and administrative expenses grew 3.0%, principally as a result of higher employee and marketing costs, offset in part by lower bad debt expense and taxes and fees. Employee costs were 10.3% higher, largely as a result of increased business services marketing and customer service staffing levels. Marketing costs increased 8.0%, primarily due to costs related to our rebranding and greater spending on direct mail advertising. Bad debt fell by 8.2%, principally due to a lower number of written-off accounts. Taxes and fees decreased 3.1%, mainly due to lower franchise fees and, to a lesser extent, property taxes. Selling, general and administrative expenses as a percentage of revenues were 20.0% and 19.8% for the nine months ended September 30, 2012 and 2011, respectively. Management fee expense decreased 4.9%, reflecting lower overhead costs charged by MCC. Management fee expense as a percentage of revenues was 1.6% and 1.7% for the nine months ended September 30, 2012 and 2011, respectively. Depreciation and amortization increased 5.5%, largely as a result of the depreciation of investments in shorter-lived customer premise equipment and our internal phone service platform. OIBDA OIBDA grew 3.1%, primarily due to greater revenues, offset in part by higher selling, general and administrative expenses and service costs. Operating Income Operating income was 1.2% higher, as the growth in OIBDA was mostly offset by higher depreciation and amortization. Interest Expense, Net Interest expense, net, increased 3.3%, due to a higher cost of debt and greater average outstanding indebtedness. Gain (Loss) on Derivatives, Net As a result of changes to the mark-to-market valuation of our interest rate swaps, based upon information provided by our counterparties, we recorded a net gain on derivatives of $1.1 million for the nine months ended September 30, 2012, compared to a net loss on derivatives of $21.4 million for the nine months ended September 30, 2011. Other Expense, Net Other expense, net, was $1.1 million and $1.6 million for the nine months ended September 30, 2012 and 2011, respectively. During the nine months ended September 30, 2012, other expense, net, consisted of $0.7 million of revolving credit facility commitment fees and $0.4 million of other fees. During the nine months ended September 30, 2011, other expense, net, consisted of $1.1 million of revolving credit facility commitment fees and $0.5 million of other fees. 22 -------------------------------------------------------------------------------- Table of Contents Net Income As a result of the factors described above, we recognized net income of $52.8 million for the nine months ended September 30, 2012, compared to $33.4 million for the nine months ended September 30, 2011. Liquidity and Capital Resources Our net cash flows provided by operating activities are primarily used to fund investments in the capacity and reliability of our network and the further expansion of our products and services, as well as scheduled repayments of our indebtedness and periodic contributions to MCC. As of September 30, 2012, our near-term liquidity requirements included scheduled term loan amortization of $4.0 million during the remainder of 2012 and $16.0 million in each of the years ending December 31, 2013 and 2014. As of September 30, 2012, our sources of liquidity included $213.1 million of cash and cash equivalents and $205.4 million of unused and available commitments under our revolving credit commitments (the "revolver"). As of the same date, after giving effect to the redemption of our remaining $425.2 million of 8 1/2% Notes (see "Capital Structure - Redemption"), our sources of liquidity would have included $10.0 million of cash and cash equivalents and $73.3 million of unused and available commitments under the revolver. We believe that cash generated by or available to us will meet our anticipated capital and liquidity needs for the foreseeable future. In the longer term, specifically 2015 and beyond, we do not expect to generate sufficient net cash flows from operations to fund our maturing term loans and senior notes. If we are unable to obtain sufficient future financing on similar terms as we currently experience, or at all, we may need to take other actions to conserve or raise capital that we would not take otherwise. However, we have accessed the debt markets for significant amounts of capital in the past, and expect to continue to be able to access these markets in the future as necessary. Net Cash Flows Provided by Operating Activities Net cash flows provided by operating activities were $173.5 million for the nine months ended September 30, 2012, primarily due to OIBDA of $254.3 million and, to a much lesser extent, the $4.8 million net change in our operating assets and liabilities, offset in part by interest expense of $86.3 million. The net change in our operating assets and liabilities was primarily due to an increase in accounts payable, accrued expenses and other current liabilities of $4.9 million, a decrease in accounts receivable, net, of $3.8 million and, to a lesser extent, an increase in deferred revenue of $1.1 million, which were offset in part by an increase in prepaid expenses and other assets of $3.6 million and an increase in accounts receivable from affiliates of $1.3 million. Net cash flows provided by operating activities were $215.0 million for the nine months ended September 30, 2011, primarily due to OIBDA of $246.8 million and, to a much lesser extent, the $50.1 million net change in our operating assets and liabilities, offset in part by interest expense of $83.5 million. The net change in our operating assets and liabilities was primarily due to an increase in accounts payable, accrued expenses and other current liabilities of $29.9 million and a decrease in accounts receivable from affiliates of $28.8 million, offset in part by an increase in prepaid expenses and other assets of $5.4 million and an increase in accounts receivable, net, of $4.4 million. Net Cash Flows Used in Investing Activities Capital expenditures continue to be our primary use of capital resources and the majority of our net cash flows used in investing activities. Net cash flows used in investing activities were $121.5 million for the nine months ended September 30, 2012, compared to $107.6 million in the prior year period. The $13.9 million increase in net cash flows used in investing activities was due to a $6.2 million redemption of restricted cash and cash equivalents in the prior year period, a $5.5 million net change in accrued property, plant and equipment and a $2.2 million increase in capital expenditures. The increase in capital expenditures largely reflects greater spending on customer premise equipment and other costs associated with our ongoing digital transition, offset in part by reduced outlays for investments in our phone and HSD service platforms. Net Cash Flows Provided by (Used in) Financing Activities Net cash flows provided by financing activities were $149.4 million for the nine months ended September 30, 2012, primarily due to a $300.0 million issuance of new senior notes, net borrowings of $43.5 million under the credit facility and capital contributions from MCC of $18.5 million, offset in part by capital distributions to MCC of $112.1 million, a $74.8 million purchase of senior notes, dividend payments on preferred members' interest of $13.5 million and financing costs of $13.0 million. For more information, see "- Capital Structure - Financing Activities" and Notes 6 and 12 in our Notes to Consolidated Financial Statements. Net cash flows used in financing activities were $133.4 million for the nine months ended September 30, 2011, primarily due to capital distributions to MCC of $250.7 million and, to a much lesser extent, dividend payments on preferred members' interest of $13.5 million, offset in part by net borrowings of $132.0 million under the credit facility. 23-------------------------------------------------------------------------------- Table of Contents Capital Structure As of September 30, 2012, our total indebtedness was $2.266 billion, of which approximately 63% was at fixed interest rates or subject to interest rate protection. During the nine months ended September 30, 2012, we paid cash interest of $71.2 million, net of capitalized interest. As of the same date, after giving effect to the Redemption, our outstanding total indebtedness would have been $1.973 billion. Bank Credit Facility As of September 30, 2012, we maintained a $1.757 billion credit facility, comprising $1.541 billion of term loans with maturities ranging from January 2015 to January 2020, and a $216.0 million revolver, which is scheduled to expire on December 31, 2016. As of the same date, we had no outstanding balance under the revolver and $205.4 million of unused commitments, all of which were available be borrowed and used for general corporate purposes, after giving effect to $10.6 million of letters of credit issued thereunder to various parties as collateral. As of September 30, 2012, after giving effect to the Redemption, we would have had $73.3 million of unused commitments under the revolver, all of which were available to be borrowed and used for general corporate purposes, after giving effect to $132.1 million of outstanding loans and $10.6 million of letters of credit. The credit facility is collateralized by our ownership interests in our operating subsidiaries, and is guaranteed by us on a limited recourse basis to the extent of such ownership interests. As of September 30, 2012, the credit agreement governing the credit facility required us to maintain a total leverage ratio (as defined) of no more than 6.0 to 1.0 and an interest coverage ratio (as defined) of no less than 1.75 to 1.0. The total leverage ratio covenant will be reduced to 5.5 to 1.0 commencing on April 1, 2013, and will be further reduced to 5.0 to 1.0 commencing on April 1, 2014. Interest Rate Exchange Agreements We use interest exchange agreements (which we refer to as "interest rate swaps") in order to fix the variable portion of debt under the credit facility to reduce the potential volatility in our interest expense that would otherwise result from changes in market interest rates. As of September 30, 2012, we had interest rate swaps with various banks pursuant to which the rate on $700 million of floating rate debt was fixed at a weighted average rate of 3.3%. As of the same date, we also had $800 million of forward starting interest rate swaps with a weighted average fixed rate of approximately 2.9%. Including the effects of these interest rate swaps, the average interest rates on outstanding debt under the credit facility as of September 30, 2012 and 2011 were 4.5% and 4.3%, respectively. Senior Notes As of September 30, 2012, we had $725.2 million of outstanding senior notes, consisting of $425.2 million of 8 1/2% Notes, which were scheduled to mature in October 2015 and $300.0 million of 6 3/8% Notes were scheduled to mature in April 2023. In October 2012, we redeemed the remaining $425.2 million of 8 1/2% Notes outstanding (see "- Redemption" below). Our senior notes are unsecured obligations, and the indenture governing our senior notes limits the incurrence of additional indebtedness based upon a maximum debt to operating cash flow ratio (as defined) of 8.5 to 1.0. Financing Activities For additional information on the financing activities discussed below, see Notes 6 and 12 in our Notes to Consolidated Financial Statements. New Financings On August 20, 2012, our operating subsidiaries entered into an amended and restated credit agreement that provides for a new term loan ("Term Loan G") under the credit facility in the principal amount of $200.0 million. Net proceeds from Term Loan G of $192.3 million, after giving effect to financing costs of $7.7 million, were used to repay all outstanding debt under the revolver, without any reduction in our revolving credit commitments, and were used to fund a $70.0 million capital distribution to parent. On August 28, 2012, we issued the 6 3/8% Notes in the aggregate principal amount of $300.0 million. Net proceeds from such notes of $294.7 million, after giving effect to $5.3 million of financing costs, were used to fund the purchase of $74.8 million of 8 1/2% Notes, a $26.0 million capital distribution to parent, with the balance for general corporate purposes. 24-------------------------------------------------------------------------------- Table of Contents Tender Offer On August 14, 2012, we commenced a cash tender offer (the "Tender Offer") for up to $300.0 million of our outstanding 8 1/2% Notes, and we increased the Tender Offer to $350.0 million on August 20, 2012. Pursuant to the Tender Offer, on August 28, 2012 and September 12, 2012, we purchased $74.8 million in aggregate principal amount of our 8 1/2% Notes. The Tender Offer was funded with proceeds from the 6 3/8% Notes. Redemption On October 15, 2012, we redeemed $425.2 million in aggregate principal amount of our 8 1/2% Notes outstanding, representing the entire outstanding balance of such notes. These 8 1/2% Notes were redeemed at a price equal to $1,014.17 for each $1,000 principal amount outstanding, for an aggregate redemption price of $431.2 million. The redemption was funded with $203.1 million of cash and cash equivalents, borrowings of $132.0 million under the revolver and a $96.0 million capital contribution from parent. Covenant Compliance and Debt Ratings For all periods through September 30, 2012, we were in compliance with all of the covenants under the credit facility and senior note arrangements. We do not believe that we will have any difficulty complying with any of the applicable covenants in the near future. Our future access to the debt markets and the terms and conditions we receive are influenced by our debt ratings. MCC's corporate credit rating is B1, with a stable outlook, by Moody's, and B+, with a stable outlook, by Standard and Poor's. Our senior unsecured credit rating is B3 by Moody's, with a stable outlook, and B-, with a stable outlook, by Standard and Poor's. We cannot assure you that Moody's and Standard and Poor's will maintain their ratings on MCC and us. A negative change to these credit ratings could result in higher interest rates on future debt issuance than we currently experience, or adversely impact our ability to raise additional funds. Contractual Obligations and Commercial Commitments There have been no material changes to our contractual obligations and commercial commitments as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011. This includes consideration of our financing transactions described above in "New Financings," "Tender Offer" and "Redemption." Critical Accounting Policies The preparation of our 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 requires significant judgments and estimates on the part of management. For a summary of our critical accounting policies, please refer to our annual report on Form 10-K for the year ended December 31, 2011. Goodwill and Other Intangible Assets In accordance with the Financial Accounting Standards Board's Accounting Standards Codification No. 350 Intangibles - Goodwill and Other ("ASC 350"), 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. We have determined that our cable franchise rights and goodwill are indefinite-lived assets and therefore not amortizable. In accordance with Accounting Standards Update 2010-28 ("ASU 2010-28") - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force), we have evaluated the qualitative factors surrounding our Mediacom Broadband reporting unit, which has negative equity carrying value. We do not believe that it is "more likely than not" that a goodwill impairment exists. As such, we have not performed Step 2 of the goodwill impairment test. The economic conditions currently affecting the U.S. economy and the long-term impact on the fundamentals of our business may have a negative impact on the fair values of the assets in our reporting units. This may result in the recognition of an impairment loss in the future. Because we believe there has not been a meaningful change in the long-term fundamentals of our business during the first nine months of 2012, we have determined that there has been no triggering event under ASC 350, and as such, no interim impairment test was required as of September 30, 2012. 25-------------------------------------------------------------------------------- Table of Contents Inflation and Changing Prices Our costs and expenses are subject to inflation and price fluctuations. Such changes in costs and expenses can generally be passed through to customers. Programming costs have historically increased at rates in excess of inflation and are expected to continue to do so. We believe that under the Federal Communications Commission'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. |