CCI 2Q Form 10-Q
 


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
 

FORM 10-Q

 

     (Mark One) 
[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006
 
or

[  ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to _________

Commission file number:    000-27927 


Charter Communications, Inc.
(Exact name of registrant as specified in its charter) 

  Delaware
 
43-1857213
 (State or other jurisdiction of incorporation or organization) 
 
(I.R.S. Employer Identification Number)

12405 Powerscourt Drive
St. Louis, Missouri   63131
(Address of principal executive offices including zip code) 

(314) 965-0555
(Registrant's telephone number, including area code) 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

    Large accelerated filer o                     Accelerated filer þ                            Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes oNo þ 

Number of shares of Class A common stock outstanding as of June 30, 2006: 438,474,028
Number of shares of Class B common stock outstanding as of June 30, 2006: 50,000
 





Charter Communications, Inc.
Quarterly Report on Form 10-Q for the Period ended June 30, 2006

Table of Contents

PART I. FINANCIAL INFORMATION
Page 
   
Item 1. Report of Independent Registered Public Accounting Firm
4
   
Financial Statements - Charter Communications, Inc. and Subsidiaries
 
Condensed Consolidated Balance Sheets as of June 30, 2006
 
and December 31, 2005
5
Condensed Consolidated Statements of Operations for the three and six
 
months ended June 30, 2006 and 2005
6
Condensed Consolidated Statements of Cash Flows for the
 
six months ended June 30, 2006 and 2005
7
Notes to Condensed Consolidated Financial Statements
8
   
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
23
   
Item 3. Quantitative and Qualitative Disclosures about Market Risk
37
   
Item 4. Controls and Procedures
38
   
PART II. OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
39
   
Item 1A. Risk Factors
39
   
Item 6. Exhibits
50
   
SIGNATURES
51
   
EXHIBIT INDEX
52

This quarterly report on Form 10-Q is for the three and six months ended June 30, 2006. The Securities and Exchange Commission ("SEC") allows us to "incorporate by reference" information that we file with the SEC, which means that we can disclose important information to you by referring you directly to those documents. Information incorporated by reference is considered to be part of this quarterly report. In addition, information that we file with the SEC in the future will automatically update and supersede information contained in this quarterly report. In this quarterly report, "we," "us" and "our" refer to Charter Communications, Inc., Charter Communications Holding Company, LLC and their subsidiaries.





CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS:

This quarterly report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), regarding, among other things, our plans, strategies and prospects, both business and financial including, without limitation, the forward-looking statements set forth in the "Results of Operations" and "Liquidity and Capital Resources" sections under Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in this quarterly report. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions including, without limitation, the factors described under "Risk Factors" under Part II, Item 1A. Many of the forward-looking statements contained in this quarterly report may be identified by the use of forward-looking words such as "believe," "expect," "anticipate," "should," "planned," "will," "may," "intend," "estimated," "aim," "on track" and "potential" among others. Important factors that could cause actual results to differ materially from the forward-looking statements we make in this quarterly report are set forth in this quarterly report and in other reports or documents that we file from time to time with the SEC, and include, but are not limited to:

 
·
the availability, in general, of funds to meet interest payment obligations under our debt and to fund our operations and necessary capital expenditures, either through cash flows from operating activities, further borrowings or other sources and, in particular, our ability to be able to provide under the applicable debt instruments such funds (by dividend, investment or otherwise) to the applicable obligor of such debt;
  · our ability to comply with all covenants in our indentures and credit facilities, any violation of which would result in a violation of the applicable facility or indenture and could trigger a default of other obligations under cross-default provisions;
 
·
our ability to pay or refinance debt prior to or when it becomes due and/or to take advantage of market opportunities and market windows to refinance that debt through new issuances, exchange offers or otherwise, including restructuring our balance sheet and leverage position;
 
·
our ability to sustain and grow revenues and cash flows from operating activities by offering video, high-speed Internet, telephone and other services and to maintain and grow a stable customer base, particularly in the face of increasingly aggressive competition from other service providers;
 
·
our ability to obtain programming at reasonable prices or to pass programming cost increases on to our customers;
 
·
general business conditions, economic uncertainty or slowdown; and
 
·
the effects of governmental regulation, including but not limited to local franchise authorities, on our business.

All forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by this cautionary statement. We are under no duty or obligation to update any of the forward-looking statements after the date of this quarterly report.
 

 
3



PART I. FINANCIAL INFORMATION.


Item 1. Financial Statements.




Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
 
Charter Communications, Inc.:
 
We have reviewed the condensed consolidated balance sheet of Charter Communications, Inc. and subsidiaries (the Company) as of June 30, 2006, the related condensed consolidated statements of operations for the three-month and six-month periods ended June 30, 2006 and 2005, and the related condensed consolidated statements of cash flows for the six-month periods ended June 30, 2006 and 2005. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2005, and the related consolidated statements of operations, changes in shareholders’ equity (deficit), and cash flows for the year then ended (not presented herein), and in our report dated February 27, 2006, which includes explanatory paragraphs regarding the adoption, effective September 30, 2004, of EITF Topic D-108, Use of the Residual Method to Value Acquired Assets Other than Goodwill, and effective January 1, 2003, of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

St. Louis, Missouri
August 7, 2006
 

 
4


CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT SHARE DATA)

   
June 30,
 
December 31,
 
   
2006
 
2005
 
   
(Unaudited)
     
ASSETS
         
CURRENT ASSETS:
             
Cash and cash equivalents
 
$
56
 
$
21
 
Accounts receivable, less allowance for doubtful accounts of
             
$19 and $17, respectively
   
180
   
214
 
Prepaid expenses and other current assets
   
84
   
92
 
Assets held for sale
   
768
   
--
 
Total current assets
   
1,088
   
327
 
               
INVESTMENT IN CABLE PROPERTIES:
             
Property, plant and equipment, net of accumulated
             
depreciation of $7,054 and $6,749, respectively
   
5,392
   
5,840
 
Franchises, net
   
9,280
   
9,826
 
Total investment in cable properties, net
   
14,672
   
15,666
 
               
OTHER NONCURRENT ASSETS
   
385
   
438
 
               
Total assets
 
$
16,145
 
$
16,431
 
               
LIABILITIES AND SHAREHOLDERS’ DEFICIT
             
CURRENT LIABILITIES:
             
Accounts payable and accrued expenses
 
$
1,220
 
$
1,191
 
Liabilities held for sale
   
20
   
--
 
Total current liabilities
   
1,240
   
1,191
 
               
LONG-TERM DEBT
   
19,860
   
19,388
 
NOTE PAYABLE - RELATED PARTY
   
53
   
49
 
DEFERRED MANAGEMENT FEES - RELATED PARTY
   
14
   
14
 
OTHER LONG-TERM LIABILITIES
   
547
   
517
 
MINORITY INTEREST
   
189
   
188
 
PREFERRED STOCK - REDEEMABLE; $.001 par value; 1 million
             
shares authorized; 36,713 shares issued and outstanding
   
4
   
4
 
               
SHAREHOLDERS’ DEFICIT:
             
Class A Common stock; $.001 par value; 1.75 billion shares authorized;
             
438,474,028 and 416,204,671 shares issued and outstanding, respectively
   
--
   
--
 
Class B Common stock; $.001 par value; 750 million
             
shares authorized; 50,000 shares issued and outstanding
   
--
   
--
 
Preferred stock; $.001 par value; 250 million shares
             
authorized; no non-redeemable shares issued and outstanding
   
--
   
--
 
Additional paid-in capital
   
5,240
   
5,241
 
Accumulated deficit
   
(11,007
)
 
(10,166
)
Accumulated other comprehensive income
   
5
   
5
 
               
Total shareholders’ deficit
   
(5,762
)
 
(4,920
)
               
Total liabilities and shareholders’ deficit
 
$
16,145
 
$
16,431
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
5


CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA)
Unaudited
 

 
   
Three Months Ended June 30,
 
Six Months Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
REVENUES
 
$
1,383
 
$
1,266
 
$
2,703
 
$
2,481
 
                           
COSTS AND EXPENSES:
                         
Operating (excluding depreciation and amortization)
   
611
   
546
   
1,215
   
1,081
 
Selling, general and administrative
   
279
   
250
   
551
   
483
 
Depreciation and amortization
   
340
   
364
   
690
   
730
 
Asset impairment charges
   
--
   
8
   
99
   
39
 
Other operating (income) expenses, net
   
7
   
(2
)
 
10
   
6
 
                           
     
1,237
   
1,166
   
2,565
   
2,339
 
                           
Operating income from continuing operations
   
146
   
100
   
138
   
142
 
                           
OTHER INCOME AND (EXPENSES):
                         
Interest expense, net
   
(475
)
 
(451
)
 
(943
)
 
(871
)
Other income (expenses), net
   
(21
)
 
17
   
(10
)
 
49
 
                           
     
(496
)
 
(434
)
 
(953
)
 
(822
)
                           
Loss from continuing operations before income taxes
   
(350
)
 
(334
)
 
(815
)
 
(680
)
                           
INCOME TAX EXPENSE
   
(52
)
 
(25
)
 
(60
)
 
(56
)
                           
Loss from continuing operations
   
(402
)
 
(359
)
 
(875
)
 
(736
)
                           
INCOME FROM DISCONTINUED OPERATIONS,
NET OF TAX
   
20
   
4
   
34
   
29
 
                           
Net loss
   
(382
)
 
(355
)
 
(841
)
 
(707
)
                           
Dividends on preferred stock - redeemable
   
--
   
(1
)
 
--
   
(2
)
                           
Net loss applicable to common stock
 
$
(382
)
$
(356
)
$
(841
)
$
(709
)
                           
NET LOSS PER COMMON SHARE, BASIC AND DILUTED:
                         
Loss from continuing operations
 
$
(1.27
)
$
(1.18
)
$
(2.76
)
$
(2.43
)
Net loss
 
$
(1.20
)
$
(1.17
)
$
(2.65
)
$
(2.34
)
                           
Weighted average common shares outstanding, basic and diluted
   
317,646,946
   
303,620,347
   
317,531,492
   
303,465,474
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
6


CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
Unaudited

   
Six Months Ended June 30,
 
   
2006
 
2005
 
           
CASH FLOWS FROM OPERATING ACTIVITIES:
             
Net loss
 
$
(841
)
$
(707
)
Adjustments to reconcile net loss to net cash flows from operating activities:
             
Depreciation and amortization
   
698
   
759
 
Asset impairment charges
   
99
   
39
 
Noncash interest expense
   
87
   
114
 
Deferred income taxes
   
60
   
43
 
Other, net
   
17
   
(45
)
Changes in operating assets and liabilities, net of effects from acquisitions and dispositions:
             
Accounts receivable
   
30
   
1
 
Prepaid expenses and other assets
   
29
   
--
 
Accounts payable, accrued expenses and other
   
26
   
(23
)
               
Net cash flows from operating activities
   
205
   
181
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
Purchases of property, plant and equipment
   
(539
)
 
(542
)
Change in accrued expenses related to capital expenditures
   
(9
)
 
45
 
Proceeds from sale of assets
   
9
   
8
 
Purchase of cable system
   
(42
)
 
--
 
Proceeds from investments
   
28
   
17
 
Other, net
   
--
   
(5
)
               
Net cash flows from investing activities
   
(553
)
 
(477
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
Borrowings of long-term debt
   
5,830
   
635
 
Repayments of long-term debt
   
(5,858
)
 
(946
)
Proceeds from issuance of debt
   
440
   
--
 
Payments for debt issuance costs
   
(29
)
 
(3
)
               
Net cash flows from financing activities
   
383
   
(314
)
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
35
   
(610
)
CASH AND CASH EQUIVALENTS, beginning of period
   
21
   
650
 
               
CASH AND CASH EQUIVALENTS, end of period
 
$
56
 
$
40
 
               
CASH PAID FOR INTEREST
 
$
791
 
$
744
 
               
NONCASH TRANSACTIONS:
             
Issuance of debt by Charter Communications Operating, LLC
 
$
37
 
$
333
 
Retirement of Renaissance Media Group LLC debt
 
$
(37
)
$
--
 
Retirement of Charter Communications Holdings, LLC debt
 
$
--
 
$
(346
)

 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
7

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)

 
Organization and Basis of Presentation

Charter Communications, Inc. ("Charter") is a holding company whose principal assets at June 30, 2006 are the 48% controlling common equity interest in Charter Communications Holding Company, LLC ("Charter Holdco") and "mirror" notes that are payable by Charter Holdco to Charter and have the same principal amount and terms as those of Charter’s convertible senior notes. Charter Holdco is the sole owner of CCHC, LLC ("CCHC"), which is the sole owner of Charter Communications Holdings, LLC ("Charter Holdings"). The condensed consolidated financial statements include the accounts of Charter, Charter Holdco, CCHC, Charter Holdings and all of their subsidiaries where the underlying operations reside, which are collectively referred to herein as the "Company." Charter has 100% voting control over Charter Holdco and had historically consolidated on that basis. Charter continues to consolidate Charter Holdco as a variable interest entity under Financial Accounting Standards Board ("FASB") Interpretation ("FIN") 46(R) Consolidation of Variable Interest Entities. Charter Holdco’s limited liability company agreement provides that so long as Charter’s Class B common stock retains its special voting rights, Charter will maintain a 100% voting interest in Charter Holdco. Voting control gives Charter full authority and control over the operations of Charter Holdco. All significant intercompany accounts and transactions among consolidated entities have been eliminated. The Company is a broadband communications company operating in the United States. The Company offers its customers traditional cable video programming (analog and digital video) as well as high-speed Internet services and, in some areas, advanced broadband services such as high definition television, video on demand, and telephone. The Company sells its cable video programming, high-speed Internet and advanced broadband services on a subscription basis. The Company also sells local advertising on satellite-delivered networks.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, certain information and footnote disclosures typically included in Charter’s Annual Report on Form 10-K have been condensed or omitted for this quarterly report. The accompanying condensed consolidated financial statements are unaudited and are subject to review by regulatory authorities. However, in the opinion of management, such financial statements include all adjustments, which consist of only normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. Interim results are not necessarily indicative of results for a full year. The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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. Areas involving significant judgments and estimates include capitalization of labor and overhead costs; depreciation and amortization costs; impairments of property, plant and equipment, franchises and goodwill; income taxes; and contingencies. Actual results could differ from those estimates.
 
ReclassificationsCertain 2005 amounts have been reclassified to conform with the 2006 presentation.
 
Liquidity and Capital Resources
 
The Company had net loss applicable to common stock of $382 million and $356 million for the three months ended June 30, 2006 and 2005, respectively, and $841 million and $709 million for the six months ended June 30, 2006 and 2005, respectively. The Company’s net cash flows from operating activities were $205 million and $181 million for the six months ended June 30, 2006 and 2005, respectively.

Recent Financing Transactions

In January 2006, CCH II, LLC ("CCH II") and CCH II Capital Corp. issued $450 million in debt securities, the proceeds of which were provided, directly or indirectly, to Charter Communications Operating, LLC ("Charter
 
 
8

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
Operating"), which used such funds to reduce borrowings, but not commitments, under the revolving portion of its credit facilities.

In April 2006, Charter Operating completed a $6.85 billion refinancing of its credit facilities including a new $350 million revolving/term facility (which converts to a term loan no later than April 2007), a $5.0 billion term loan due in 2013 and certain amendments to the existing $1.5 billion revolving credit facility. In addition, the refinancing reduced margins on Eurodollar rate term loans to 2.625% from a weighted average of 3.15% previously and margins on base rate term loans to 1.625% from a weighted average of 2.15% previously. Concurrent with this refinancing, the CCO Holdings, LLC ("CCO Holdings") bridge loan was terminated.

The Company has a significant level of debt. The Company's long-term financing as of June 30, 2006 consists of $5.8 billion of credit facility debt, $13.2 billion accreted value of high-yield notes and $848 million accreted value of convertible senior notes. For the remainder of 2006, none of the Company’s debt matures, and in 2007 and 2008, $130 million and $50 million mature, respectively. In 2009 and beyond, significant additional amounts will become due under the Company’s remaining long-term debt obligations.

The Company requires significant cash to fund debt service costs, capital expenditures and ongoing operations. The Company has historically funded these requirements through cash flows from operating activities, borrowings under its credit facilities, sales of assets, issuances of debt and equity securities and cash on hand. However, the mix of funding sources changes from period to period. For the six months ended June 30, 2006, the Company generated $205 million of net cash flows from operating activities, after paying cash interest of $791 million. In addition, the Company used approximately $539 million for purchases of property, plant and equipment. Finally, the Company had net cash flows from financing activities of $383 million.

The Company expects that cash on hand, cash flows from operating activities, proceeds from sales of assets, and the amounts available under its credit facilities will be adequate to meet its cash needs through 2007. The Company believes that cash flows from operating activities and amounts available under the Company’s credit facilities may not be sufficient to fund the Company’s operations and satisfy its interest and principal repayment obligations in 2008, and will not be sufficient to fund such needs in 2009 and beyond. The Company continues to work with its financial advisors in its approach to addressing liquidity, debt maturities and its overall balance sheet leverage.

Debt Covenants

The Company’s ability to operate depends upon, among other things, its continued access to capital, including credit under the Charter Operating credit facilities. The Charter Operating credit facilities, along with the Company’s indentures, contain certain restrictive covenants, some of which require the Company to maintain specified financial ratios, and meet financial tests and to provide annual audited financial statements with an unqualified opinion from the Company’s independent auditors. As of June 30, 2006, the Company is in compliance with the covenants under its indentures and credit facilities, and the Company expects to remain in compliance with those covenants for the next twelve months. As of June 30, 2006, the Company’s potential availability under its credit facilities totaled approximately $900 million, none of which was limited by covenant restrictions. In the past, the Company’s actual availability under its credit facilities has been limited by covenant restrictions. There can be no assurance that the Company’s actual availability under its credit facilities will not be limited by covenant restrictions in the future. However, pro forma for the closing of the asset sales on July 1, 2006, and the related application of net proceeds to repay amounts outstanding under the Company’s revolving credit facility, potential availability under the Company’s credit facilities as of June 30, 2006 would have been approximately $1.7 billion, although actual availability would have been limited to $1.3 billion because of limits imposed by covenant restrictions. Continued access to the Company’s credit facilities is subject to the Company remaining in compliance with these covenants, including covenants tied to the Company’s operating performance. If any events of non-compliance occur, funding under the credit facilities may not be available and defaults on some or potentially all of the Company’s debt obligations could occur. An event of default under any of the Company’s debt instruments could result in the acceleration of its payment obligations under that debt and, under certain circumstances, in cross-defaults under its other debt
 
9

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
 obligations, which could have a material adverse effect on the Company’s consolidated financial condition and results of operations.
 
Specific Limitations

Charter’s ability to make interest payments on its convertible senior notes, and, in 2009, to repay the outstanding principal of its convertible senior notes of $863 million, will depend on its ability to raise additional capital and/or on receipt of payments or distributions from Charter Holdco and its subsidiaries. As of June 30, 2006, Charter Holdco was owed $3 million in intercompany loans from its subsidiaries, which were available to pay interest and principal on Charter's convertible senior notes. In addition, Charter has $74 million of U.S. government securities pledged as security for the next three scheduled semi-annual interest payments on Charter’s 5.875% convertible senior notes.

Distributions by Charter’s subsidiaries to a parent company (including Charter, Charter Holdco and CCHC) for payment of principal on parent company notes are restricted under the indentures governing the CIH notes, CCH I notes, CCH II notes, CCO Holdings notes, and Charter Operating notes unless there is no default under the applicable indenture, each applicable subsidiary’s leverage ratio test is met at the time of such distribution and, in the case of the convertible senior notes, other specified tests are met. For the quarter ended June 30, 2006, there was no default under any of these indentures and each such subsidiary met its applicable leverage ratio tests based on June 30, 2006 financial results. Such distributions would be restricted, however, if any such subsidiary fails to meet these tests at such time. In the past, certain subsidiaries have from time to time failed to meet their leverage ratio test. There can be no assurance that they will satisfy these tests at the time of such distribution. Distributions by Charter Operating for payment of principal on parent company notes are further restricted by the covenants in the credit facilities. 

Distributions by CIH, CCH I, CCH II, CCO Holdings and Charter Operating to a parent company for payment of parent company interest are permitted if there is no default under the aforementioned indentures. However, distributions for payment of interest on the convertible senior notes are further limited to when each applicable subsidiary’s leverage ratio test is met and other specified tests are met. There can be no assurance that the subsidiary will satisfy these tests at the time of such distribution.

The indentures governing the Charter Holdings notes permit Charter Holdings to make distributions to Charter Holdco for payment of interest or principal on the convertible senior notes, only if, after giving effect to the distribution, Charter Holdings can incur additional debt under the leverage ratio of 8.75 to 1.0, there is no default under Charter Holdings’ indentures, and other specified tests are met. For the quarter ended June 30, 2006, there was no default under Charter Holdings’ indentures and Charter Holdings met its leverage ratio test based on June 30, 2006 financial results. Such distributions would be restricted, however, if Charter Holdings fails to meet these tests at such time. In the past, Charter Holdings has from time to time failed to meet this leverage ratio test. There can be no assurance that Charter Holdings will satisfy these tests at the time of such distribution. During periods in which distributions are restricted, the indentures governing the Charter Holdings notes permit Charter Holdings and its subsidiaries to make specified investments (that are not restricted payments) in Charter Holdco or Charter up to an amount determined by a formula, as long as there is no default under the indentures.  

3.
Sale of Assets

In 2006, the Company signed three separate definitive agreements to sell certain cable television systems serving a total of approximately 356,000 analog video customers in 1) West Virginia and Virginia to Cebridge Connections, Inc. (the “Cebridge Transaction”); 2) Illinois and Kentucky to Telecommunications Management, LLC, doing business as New Wave Communications (the “New Wave Transaction”) and 3) Nevada, Colorado, New Mexico and Utah to Orange Broadband Holding Company, LLC (the “Orange Transaction”) for a total of approximately $971 million. These cable systems met the criteria for assets held for sale. As such, the assets were written down to fair value less estimated costs to sell resulting in asset impairment charges during the six months ended June 30, 2006 of approximately $99 million related to the New Wave Transaction and the Orange Transaction. In the third quarter of 2006, the Company expects to record a gain of approximately $200 million on the Cebridge Transaction. In addition, assets and liabilities to be sold have been presented as held for sale. Assets held for sale on the Company's balance
 
10

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
sheet as of June 30, 2006 included current assets of approximately $6 million, property, plant and equipment of approximately $319 million and franchises of approximately $443 million. Liabilities held for sale on the Company's balance sheet as of June 30, 2006 included current liabilities of approximately $7 million and other long-term liabilities of approximately $13 million.

During the second quarter of 2006, the Company determined, based on changes in the Company’s organizational and cost structure, that its asset groupings for long lived asset accounting purposes are at the level of their individual market areas, which are at a level below the Company’s geographic clustering. As a result, the Company has determined that the West Virginia and Virginia cable systems comprise operations and cash flows that for financial reporting purposes meet the criteria for discontinued operations. Accordingly, the results of operations for the West Virginia and Virginia cable systems have been presented as discontinued operations, net of tax for the three and six months ended June 30, 2006 and all prior periods presented herein have been reclassified to conform to the current presentation.
     
Summarized consolidated financial information for the three and six months ended June 30, 2006 and 2005 for the West Virginia and Virginia cable systems is as follows:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Revenues
 
$
55
 
$
57
 
$
109
 
$
113
 
Income before income taxes
 
$
23
 
$
10
 
$
38
 
$
19
 
Income tax benefit (expense)
 
$
(3
)
$
(6
)
$
(4
)
$
10
 
Net income
 
$
20
 
$
4
 
$
34
 
$
29
 
Earnings per common share, basic and diluted
 
$
0.06
 
$
0.01
 
$
0.11
 
$
0.10
 
 
In July 2006, the Company closed the Cebridge Transaction and New Wave Transaction for net proceeds of approximately $896 million. The Company used the net proceeds from the asset sales to repay (but not reduce permanently) amounts outstanding under the Company’s revolving credit facility. The Orange Transaction is scheduled to close in the third quarter of 2006.

In 2005, the Company closed the sale of certain cable systems in Texas, West Virginia and Nebraska representing a total of approximately 33,000 analog video customers. During the six months ended June 30, 2005, certain of those cable systems met the criteria for assets held for sale. As such, the assets were written down to fair value less estimated costs to sell resulting in asset impairment charges during the three and six months ended June 30, 2005 of approximately $8 million and $39 million, respectively.

4.
Franchises and Goodwill

Franchise rights represent the value attributed to agreements with local authorities that allow access to homes in cable service areas acquired through the purchase of cable systems. Management estimates the fair value of franchise rights at the date of acquisition and determines if the franchise has a finite life or an indefinite-life as defined by Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. Franchises that qualify for indefinite-life treatment under SFAS No. 142 are tested for impairment annually each October 1 based on valuations, or more frequently as warranted by events or changes in circumstances. Franchises are aggregated into essentially inseparable asset groups to conduct the valuations. The asset groups generally represent geographical clustering of the Company’s cable systems into groups by which such systems are managed. Management believes such grouping represents the highest and best use of those assets.


11

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)

As of June 30, 2006 and December 31, 2005, indefinite-lived and finite-lived intangible assets are presented in the following table:

   
June 30, 2006
 
December 31, 2005
 
   
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated Amortization
 
Net
Carrying
Amount
 
Indefinite-lived intangible assets:
                                     
Franchises with indefinite lives
 
$
9,263
 
$
--
 
$
9,263
 
$
9,806
 
$
--
 
$
9,806
 
Goodwill
   
61
   
--
   
61
   
52
   
--
   
52
 
                                       
   
$
9,324
 
$
--
 
$
9,324
 
$
9,858
 
$
--
 
$
9,858
 
Finite-lived intangible assets:
                                     
Franchises with finite lives
 
$
23
 
$
6
 
$
17
 
$
27
 
$
7
 
$
20
 

For the six months ended June 30, 2006, the net carrying amount of indefinite-lived and finite-lived franchises was reduced by $441 million and $2 million, respectively, related to franchises reclassified as assets held for sale. For the six months ended June 30, 2006, franchises with indefinite lives also decreased $3 million related to a cable asset sale completed in the first quarter of 2006 and $99 million as a result of the asset impairment charges recorded related to assets held for sale (see Note 3). Franchise amortization expense for the three and six months ended June 30, 2006 was approximately $1 million and $1 million, respectively, and $1 million and $2 million for the three and six months ended June 30, 2005, respectively, which represents the amortization relating to franchises that did not qualify for indefinite-life treatment under SFAS No. 142, including costs associated with franchise renewals. The Company expects that amortization expense on franchise assets will be approximately $2 million annually for each of the next five years. Actual amortization expense in future periods could differ from these estimates as a result of new intangible asset acquisitions or divestitures, changes in useful lives and other relevant factors.

For the six months ended June 30, 2006, the net carrying amount of goodwill increased $9 million as a result of the Company’s purchase of certain cable systems in Minnesota from Seren Innovations, Inc. in January 2006.
 
Accounts Payable and Accrued Expenses
 
Accounts payable and accrued expenses consist of the following as of June 30, 2006 and December 31, 2005:

   
June 30,
2006
 
December 31,
2005
 
           
Accounts payable - trade
 
$
86
 
$
114
 
Accrued capital expenditures
   
64
   
73
 
Accrued expenses:
             
Interest
   
398
   
333
 
Programming costs
   
297
   
272
 
Franchise-related fees
   
55
   
67
 
Compensation
   
94
   
90
 
Other
   
226
   
242
 
               
   
$
1,220
 
$
1,191
 


12

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)

6.
Long-Term Debt

Long-term debt consists of the following as of June 30, 2006 and December 31, 2005:

   
June 30, 2006
 
December 31, 2005
 
   
Principal Amount
 
Accreted Value
 
Principal Amount
 
Accreted Value
 
Long-Term Debt
                         
Charter Communications, Inc.:
                         
4.750% convertible senior notes due 2006
 
$
--
 
$
--
 
$
20
 
$
20
 
5.875% convertible senior notes due 2009
   
863
   
848
   
863
   
843
 
Charter Communications Holdings, LLC:
                         
8.250% senior notes due 2007
   
105
   
105
   
105
   
105
 
8.625% senior notes due 2009
   
292
   
292
   
292
   
292
 
9.920% senior discount notes due 2011
   
198
   
198
   
198
   
198
 
10.000% senior notes due 2009
   
154
   
154
   
154
   
154
 
10.250% senior notes due 2010
   
49
   
49
   
49
   
49
 
11.750% senior discount notes due 2010
   
43
   
43
   
43
   
43
 
10.750% senior notes due 2009
   
131
   
131
   
131
   
131
 
11.125% senior notes due 2011
   
217
   
217
   
217
   
217
 
13.500% senior discount notes due 2011
   
94
   
94
   
94
   
94
 
9.625% senior notes due 2009
   
107
   
107
   
107
   
107
 
10.000% senior notes due 2011
   
137
   
136
   
137
   
136
 
11.750% senior discount notes due 2011
   
125
   
125
   
125
   
120
 
12.125% senior discount notes due 2012
   
113
   
106
   
113
   
100
 
CCH I Holdings, LLC:
                         
11.125% senior notes due 2014
   
151
   
151
   
151
   
151
 
9.920% senior discount notes due 2014
   
471
   
471
   
471
   
471
 
10.000% senior notes due 2014
   
299
   
299
   
299
   
299
 
11.750% senior discount notes due 2014
   
815
   
815
   
815
   
781
 
13.500% senior discount notes due 2014
   
581
   
581
   
581
   
578
 
12.125% senior discount notes due 2015
   
217
   
203
   
217
   
192
 
CCH I, LLC:
                         
11.000% senior notes due 2015
   
3,525
   
3,678
   
3,525
   
3,683
 
CCH II, LLC:
                         
10.250% senior notes due 2010
   
2,051
   
2,042
   
1,601
   
1,601
 
CCO Holdings, LLC:
                         
8¾% senior notes due 2013
   
800
   
795
   
800
   
794
 
Senior floating notes due 2010
   
550
   
550
   
550
   
550
 
Charter Communications Operating, LLC:
                         
8% senior second lien notes due 2012
   
1,100
   
1,100
   
1,100
   
1,100
 
8 3/8% senior second lien notes due 2014
   
770
   
770
   
733
   
733
 
Renaissance Media Group LLC:
                         
10.000% senior discount notes due 2008
   
--
   
--
   
114
   
115
 
Credit Facilities
                         
Charter Operating
   
5,800
   
5,800
   
5,731
   
5,731
 
   
$
19,758
 
$
19,860
 
$
19,336
 
$
19,388
 

The accreted values presented above generally represent the principal amount of the notes less the original issue discount at the time of sale plus the accretion to the balance sheet date except as follows. The accreted value of the CIH notes issued in exchange for Charter Holdings notes and the portion of the CCH I notes issued in 2005 in
 
 
13

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
exchange for the 8.625% Charter Holdings notes due 2009 are recorded at the historical book values of the Charter Holdings notes for financial reporting purposes as opposed to the current accreted value for legal purposes and notes indenture purposes (the amount that is currently payable if the debt becomes immediately due). As of June 30, 2006, the accreted value of the Company’s debt for legal purposes and notes indenture purposes is approximately $19.4 billion.

In January 2006, CCH II and CCH II Capital Corp. issued $450 million in debt securities, the proceeds of which were provided, directly or indirectly, to Charter Operating, which used such funds to reduce borrowings, but not commitments, under the revolving portion of its credit facilities.

In March 2006, the Company exchanged $37 million of Renaissance Media Group LLC 10% senior discount notes due 2008 for $37 million principal amount of new Charter Operating 8 3/8% senior second-lien notes due 2014 issued in a private transaction under Rule 144A. The terms and conditions of the new Charter Operating 8 3/8% senior second-lien notes due 2014 are identical to Charter Operating’s currently outstanding 8 3/8% senior second-lien notes due 2014. In June 2006, the Company retired the remaining $77 million principal amount of Renaissance Media Group LLC’s 10% senior discount notes due 2008.

In June 2006, the Company retired the remaining $20 million principal amount of Charter’s 4.75% convertible senior notes due 2006.

Gain (loss) on extinguishment of debt

In April 2006, Charter Operating completed a $6.85 billion refinancing of its credit facilities including a new $350 million revolving/term facility (which converts to a term loan no later than April 2007), a $5.0 billion term loan due in 2013 and certain amendments to the existing $1.5 billion revolving credit facility. In addition, the refinancing reduced margins on Eurodollar rate term loans to 2.625% from a weighted average of 3.15% previously and margins on base rate term loans to 1.625% from a weighted average of 2.15% previously. Concurrent with this refinancing, the CCO Holdings bridge loan was terminated. The refinancing resulted in a loss on extinguishment of debt for the three and six months ended June 30, 2006 of approximately $27 million included in other income (expenses), net on the Company’s condensed consolidated statements of operations.

In March and June 2005, Charter Operating consummated exchange transactions with a small number of institutional holders of Charter Holdings 8.25% senior notes due 2007 pursuant to which Charter Operating issued, in private placements, approximately $333 million principal amount of new notes with terms identical to Charter Operating's 8.375% senior second lien notes due 2014 in exchange for approximately $346 million of the Charter Holdings 8.25% senior notes due 2007. The exchanges resulted in a loss on extinguishment of debt of approximately $1 million for the three months ended June 30, 2005 and a gain on extinguishment of debt of approximately $10 million for the six months ended June 30, 2005 included in other income (expenses), net on the Company’s condensed consolidated statements of operations. The Charter Holdings notes received in the exchange were thereafter distributed to Charter Holdings and cancelled.

During the three and six months ended June 30, 2005, the Company repurchased in private transactions from a small number of institutional holders, a total of $97 million and $131 million, respectively, principal amount of its 4.75% convertible senior notes due 2006. These transactions resulted in a net gain on extinguishment of debt of approximately $3 million and $4 million for the three and six months ended June 30, 2005, respectively, included in other income (expenses), net on the Company’s condensed consolidated statements of operations.

In March 2005, Charter’s subsidiary, CC V Holdings, LLC, redeemed all of its 11.875% notes due 2008, at 103.958% of principal amount, plus accrued and unpaid interest to the date of redemption. The total cost of redemption was approximately $122 million and was funded through borrowings under the Charter Operating credit facilities. The redemption resulted in a loss on extinguishment of debt for the six months ended June 30, 2005 of approximately $5 million included in other income (expenses), net on the Company’s condensed consolidated statements of operations. Following such redemption, CC V Holdings, LLC and its subsidiaries (other than non-guarantor subsidiaries) became
 
 
14

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
guarantors under the Charter Operating credit facilities and granted a lien on their assets to the same extent as granted by the other guarantors under the credit facility.
 
Minority Interest and Equity Interest of Charter Holdco

Charter is a holding company whose primary assets are a controlling equity interest in Charter Holdco, the indirect owner of the Company’s cable systems, and $848 million and $863 million at June 30, 2006 and December 31, 2005, respectively, of mirror notes that are payable by Charter Holdco to Charter and have the same principal amount and terms as those of Charter’s convertible senior notes. Minority interest on the Company’s consolidated balance sheets as of June 30, 2006 and December 31, 2005 primarily represents preferred membership interests in CC VIII, LLC ("CC VIII"), an indirect subsidiary of Charter Holdco, of $189 million and $188 million, respectively. As more fully described in Note 19, this preferred interest is held by Mr. Allen, Charter’s Chairman and controlling shareholder, and CCHC. Approximately 5.6% of CC VIII’s income is allocated to minority interest.
 
Share Lending Agreement
 
Charter issued 94.9 million and 22.0 million shares of Class A common stock during 2005 and the six months ended June 30, 2006, respectively, in public offerings. The shares were issued pursuant to the share lending agreement, pursuant to which Charter had previously agreed to loan up to 150 million shares to Citigroup Global Markets Limited ("CGML"). Because less than the full 150 million shares covered by the share lending agreement were sold in offerings through June 30, 2006, Charter is obligated to issue until November 2006, at CGML’s request, up to an additional 33.1 million loaned shares in subsequent registered public offerings pursuant to the share lending agreement.

These offerings of Charter’s Class A common stock were conducted to facilitate transactions by which investors in Charter’s 5.875% convertible senior notes due 2009, issued on November 22, 2004, hedged their investments in the convertible senior notes. Charter did not receive any of the proceeds from the sale of this Class A common stock. However, under the share lending agreement, Charter received a loan fee of $.001 for each share that it lends to CGML.

The issuance of up to a total of 150 million shares of common stock (of which 116.9 million were issued in 2005 and 2006) pursuant to this share lending agreement is essentially analogous to a sale of shares coupled with a forward contract for the reacquisition of the shares at a future date. An instrument that requires physical settlement by repurchase of a fixed number of shares in exchange for cash is considered a forward purchase instrument. While the share lending agreement does not require a cash payment upon return of the shares, physical settlement is required (i.e., the shares borrowed must be returned at the end of the arrangement). The fair value of the 116.9 million shares lent is approximately $132 million as of June 30, 2006. However, the net effect on shareholders’ deficit of the shares lent pursuant to the share lending agreement, which includes Charter’s requirement to lend the shares and the counterparties’ requirement to return the shares, is de minimis and represents the cash received upon lending of the shares and is equal to the par value of the common stock to be issued.

The 116.9 million shares issued through June 30, 2006 pursuant to the share lending agreement are required to be returned, in accordance with the contractual arrangement, and are treated in basic and diluted earnings per share as if they were already returned and retired. Consequently, there is no impact of the shares of common stock lent under the share lending agreement in the earnings per share calculation.

9.
Comprehensive Loss

Certain marketable equity securities are classified as available-for-sale and reported at market value with unrealized gains and losses recorded as accumulated other comprehensive loss on the accompanying condensed consolidated balance sheets. Additionally, the Company reports changes in the fair value of interest rate agreements designated as hedging the variability of cash flows associated with floating-rate debt obligations, that meet the effectiveness criteria of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in accumulated other comprehensive
 
 
15

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
loss, after giving effect to the minority interest share of such gains and losses. Comprehensive loss for the three months ended June 30, 2006 and 2005 was $381 million and $355 million, respectively, and $841 million and $704 million for the six months ended June 30, 2006 and 2005, respectively.

10.
Accounting for Derivative Instruments and Hedging Activities

The Company uses interest rate risk management derivative instruments, such as interest rate swap agreements and interest rate collar agreements (collectively referred to herein as interest rate agreements) to manage its interest costs. The Company’s policy is to manage interest costs using a mix of fixed and variable rate debt. Using interest rate swap agreements, the Company has agreed to exchange, at specified intervals through 2007, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. Interest rate collar agreements are used to limit the Company’s exposure to and benefits from interest rate fluctuations on variable rate debt to within a certain range of rates.

The Company does not hold or issue derivative instruments for trading purposes. The Company does, however, have certain interest rate derivative instruments that have been designated as cash flow hedging instruments. Such instruments effectively convert variable interest payments on certain debt instruments into fixed payments. For qualifying hedges, SFAS No. 133 allows derivative gains and losses to offset related results on hedged items in the consolidated statement of operations. The Company has formally documented, designated and assessed the effectiveness of transactions that receive hedge accounting. For each of the three months ended June 30, 2006 and 2005, other income includes gains of $0, and for the six months ended June 30, 2006 and 2005, other income includes gains of $2 million and $1 million, respectively, which represent cash flow hedge ineffectiveness on interest rate hedge agreements arising from differences between the critical terms of the agreements and the related hedged obligations. Changes in the fair value of interest rate agreements designated as hedging instruments of the variability of cash flows associated with floating-rate debt obligations that meet the effectiveness criteria of SFAS No. 133 are reported in accumulated other comprehensive loss. For the three months ended June 30, 2006 and 2005, a gain of $1 million and $0, respectively, and for the six months ended June 30, 2006 and 2005, a gain of $0 and $9 million, respectively, related to derivative instruments designated as cash flow hedges, was recorded in accumulated other comprehensive loss and minority interest. The amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligations affects earnings (losses).

Certain interest rate derivative instruments are not designated as hedges as they do not meet the effectiveness criteria specified by SFAS No. 133. However, management believes such instruments are closely correlated with the respective debt, thus managing associated risk. Interest rate derivative instruments not designated as hedges are marked to fair value, with the impact recorded as other income in the Company’s condensed consolidated statements of operations. For the three months ended June 30, 2006 and 2005, other income includes gains of $3 million and losses of $1 million, respectively, and for the six months ended June 30, 2006 and 2005, other income includes gains of $9 million and $25 million, respectively, for interest rate derivative instruments not designated as hedges.

As of June 30, 2006 and December 31, 2005, the Company had outstanding $1.8 billion and $1.8 billion and $20 million and $20 million, respectively, in notional amounts of interest rate swaps and collars, respectively. The notional amounts of interest rate instruments do not represent amounts exchanged by the parties and, thus, are not a measure of exposure to credit loss. The amounts exchanged are determined by reference to the notional amount and the other terms of the contracts.

Certain provisions of the Company’s 5.875% convertible senior notes due 2009 are considered embedded derivatives for accounting purposes and are required to be accounted for separately from the convertible senior notes. In accordance with SFAS No. 133, these derivatives are marked to market with gains or losses recorded in interest expense on the Company’s condensed consolidated statement of operations. For the three months ended June 30, 2006 and 2005, the Company recognized gains of $0 and $8 million, respectively, and for the six months ended June 30, 2006 and 2005, the Company recognized gains of $2 million and $27 million, respectively. The gains resulted in a reduction in interest expense related to these derivatives. At June 30, 2006 and December 31, 2005, $1 million and $1 million, respectively, is recorded in accounts payable and accrued expenses relating to the short-term portion of these
 
 
16

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
derivatives and $0 and $1 million, respectively, is recorded in other long-term liabilities related to the long-term portion.
 
Revenues
 
Revenues consist of the following for the three and six months ended June 30, 2006 and 2005:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Video
 
$
853
 
$
821
 
$
1,684
 
$
1,623
 
High-speed Internet
   
261
   
218
   
506
   
425
 
Telephone
   
29
   
8
   
49
   
14
 
Advertising sales
   
79
   
73
   
147
   
135
 
Commercial
   
76
   
66
   
149
   
128
 
Other
   
85
   
80
   
168
   
156
 
                           
   
$
1,383
 
$
1,266
 
$
2,703
 
$
2,481
 

12.
Operating Expenses

Operating expenses consist of the following for the three and six months ended June 30, 2006 and 2005:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Programming
 
$
379
 
$
336
 
$
755
 
$
678
 
Service
   
205
   
186
   
408
   
356
 
Advertising sales
   
27
   
24
   
52
   
47
 
                           
   
$
611
 
$
546
 
$
1,215
 
$
1,081
 

13.
Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of the following for the three and six months ended June 30, 2006 and 2005:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
General and administrative
 
$
236
 
$
220
 
$
471
 
$
418
 
Marketing
   
43
   
30
   
80
   
65
 
                           
   
$
279
 
$
250
 
$
551
 
$
483
 

Components of selling expense are included in general and administrative and marketing expense.


17

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
14.
Other Operating (Income) Expenses, Net


Other operating (income) expenses, net consist of the following for the three and six months ended June 30, 2006 and 2005:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Loss on sale of assets, net
 
$
--
 
$
--
 
$
--
 
$
4
 
Special charges, net
   
7
   
(2
)
 
10
   
2
 
                           
   
$
7
 
$
(2
)
$
10
 
$
6
 

Special charges for the three and six months ended June 30, 2006 primarily represent severance associated with the closing of call centers and divisional restructuring. Special charges for the six months ended June 30, 2005 primarily represent severance costs as a result of reducing workforce, consolidating administrative offices and executive severance.

For the three and six months ended June 30, 2005, special charges were offset by approximately $2 million related to an agreed upon discount in respect of the portion of settlement consideration payable under the settlement terms of class action lawsuits.

15.
Other Income (Expenses), Net

Other income (expenses), net consists of the following for the three and six months ended June 30, 2006 and 2005:

   
Three Months
Ended June 30,
 
Six Months
Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Gain (loss) on derivative instruments and
hedging activities, net
 
$
3
 
$
(1
)
$
11
 
$
26
 
Gain (loss) on extinguishment of debt
   
(27
)
 
1
   
(27
)
 
8
 
Minority interest
   
(1
)
 
(3
)
 
(1
)
 
(6
)
Gain on investments
   
5
   
20
   
4
   
21
 
Other, net
   
(1
)
 
--
   
3
   
--
 
                           
   
$
(21
)
$
17
 
$
(10
)
$
49
 

Gain on investments for the three and six months ended June 30, 2005 primarily represents a gain realized on an exchange of the Company’s interest in an equity investee for an investment in a larger enterprise.

16.
Income Taxes

All operations are held through Charter Holdco and its direct and indirect subsidiaries. Charter Holdco and the majority of its subsidiaries are limited liability companies that are not subject to income tax. However, certain of these subsidiaries are corporations and are subject to income tax. All of the taxable income, gains, losses, deductions and credits of Charter Holdco are passed through to its members: Charter, Charter Investment, Inc. (“CII”) and Vulcan Cable III Inc. ("Vulcan Cable"). Charter is responsible for its share of taxable income or loss of Charter Holdco allocated to Charter in accordance with the Charter Holdco limited liability company agreement (the "LLC Agreement") and partnership tax rules and regulations.
 
 
18

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 

As of June 30, 2006 and December 31, 2005, the Company had net deferred income tax liabilities of approximately $385 million and $325 million, respectively. Approximately $213 million and $212 million of the deferred tax liabilities recorded in the condensed consolidated financial statements at June 30, 2006 and December 31, 2005, respectively, relate to certain indirect subsidiaries of Charter Holdco, which file separate income tax returns.
 
During the three and six months ended June 30, 2006, the Company recorded $55 million and $64 million of income tax expense, respectively. Income tax expense of $3 million and $4 million was associated with discontinued operations for the same periods. During the three and six months ended June 30, 2005, the Company recorded $31 million and $46 million of income tax expense, respectively. Income tax expense of $6 million and income tax benefit of $10 million was associated with discontinued operations for the same periods.  Income tax expense is recognized through increases in the deferred tax liabilities related to Charter’s investment in Charter Holdco, as well as current federal and state income tax expense and increases to the deferred tax liabilities of certain of Charter’s indirect corporate subsidiaries. Income tax expense was offset by deferred tax benefits of $21 million related to asset impairment charges recorded in the six months ended June 30, 2006, and $6 million in the six months ended June 30, 2005. The Company recorded an additional deferred tax asset of approximately $130 million and $312 million during the three and six months ended June 30, 2006, respectively, relating to net operating loss carryforwards, but recorded a valuation allowance with respect to this amount because of the uncertainty of the ability to realize a benefit from the Company’s carryforwards in the future.

The Company has deferred tax assets of approximately $4.5 billion and $4.2 billion as of June 30, 2006 and December 31, 2005, respectively, which primarily relate to financial and tax losses allocated to Charter from Charter Holdco. The deferred tax assets include approximately $2.6 billion and $2.4 billion of tax net operating loss carryforwards as of June 30, 2006 and December 31, 2005, respectively (generally expiring in years 2007 through 2026), of Charter and its indirect corporate subsidiaries. Valuation allowances of $4.0 billion and $3.7 billion as of June 30, 2006 and December 31, 2005, respectively, exist with respect to these deferred tax assets.

Realization of any benefit from the Company’s tax net operating losses is dependent on: (1) Charter and its indirect corporate subsidiaries’ ability to generate future taxable income and (2) the absence of certain future "ownership changes" of Charter's common stock. An "ownership change" as defined in the applicable federal income tax rules, would place significant limitations, on an annual basis, on the use of such net operating losses to offset any future taxable income the Company may generate. Such limitations, in conjunction with the net operating loss expiration provisions, could effectively eliminate the Company’s ability to use a substantial portion of its net operating losses to offset any future taxable income. Future transactions and the timing of such transactions could cause an ownership change. Such transactions include additional issuances of common stock by the Company (including but not limited to the issuance of up to a total of 150 million shares of common stock (of which 116.9 million were issued through June 30, 2006) under the share lending agreement), the issuance of shares of common stock upon future conversion of Charter’s convertible senior notes, reacquisition of the borrowed shares by Charter, or acquisitions or sales of shares by certain holders of Charter’s shares, including persons who have held, currently hold, or accumulate in the future five percent or more of Charter’s outstanding stock (including upon an exchange by Mr. Allen or his affiliates, directly or indirectly, of membership units of Charter Holdco into CCI common stock). Many of the foregoing transactions are beyond management’s control.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Because of the uncertainties in projecting future taxable income of Charter Holdco, valuation allowances have been established except for deferred benefits available to offset certain deferred tax liabilities.

Charter Holdco is currently under examination by the Internal Revenue Service for the tax years ending December 31, 2002 and 2003. The Company’s results (excluding Charter and the indirect corporate subsidiaries) for these years are subject to this examination. Management does not expect the results of this examination to have a material adverse effect on the Company’s condensed consolidated financial condition or results of operations.


19

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
17.
Contingencies
 
Charter is a party to lawsuits and claims that arise in the ordinary course of conducting its business. The ultimate outcome of all of these legal matters pending against the Company or its subsidiaries cannot be predicted, and although such lawsuits and claims are not expected individually to have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity, such lawsuits could have, in the aggregate, a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.

18.
Stock Compensation Plans

The Company has stock option plans (the “Plans”) which provide for the grant of non-qualified stock options, stock appreciation rights, dividend equivalent rights, performance units and performance shares, share awards, phantom stock and/or shares of restricted stock (not to exceed 20,000,000 shares of charter Class A common stock), as each term is defined in the Plans. Employees, officers, consultants and directors of the Company and its subsidiaries and affiliates are eligible to receive grants under the Plans. Options granted generally vest over four to five years from the grant date, with 25% generally vesting on the anniversary of the grant date and ratably thereafter. Generally, options expire 10 years from the grant date. The Plans allow for the issuance of up to a total of 90,000,000 shares of Charter Class A common stock (or units convertible into Charter Class A common stock).

The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted average assumptions were used for grants during the three months ended June 30, 2006 and 2005, respectively: risk-free interest rates of 5.0% and 3.8%; expected volatility of 91.0% and 70.1%; and expected lives of 6.25 years and 4.5 years, respectively. The following weighted average assumptions were used for grants during the six months ended June 30, 2006 and 2005, respectively: risk-free interest rates of 4.6% and 3.8%; expected volatility of 91.6% and 71.3%; and expected lives of 6.25 years and 4.5 years, respectively. The valuations assume no dividends are paid. During the three and six months ended June 30, 2006, the Company granted 0.1 million and 4.9 million stock options, respectively, with a weighted average exercise price of $1.02 and $1.07, respectively. As of June 30, 2006, the Company had 28.6 million and 10.7 million options outstanding and exercisable, respectively, with weighted average exercise prices of $3.97 and $7.27, respectively, and weighted average remaining contractual lives of 8 years and 6 years, respectively.

On January 1, 2006, the Company adopted revised SFAS No. 123, Share - Based payment, which addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for (a) equity instruments of that company or (b) liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Because the Company adopted the fair value recognition provisions of SFAS No. 123 on January 1, 2003, the revised standard did not have a material impact on its financial statements. The Company recorded $3 million and $4 million of option compensation expense which is included in general and administrative expense for the three months ended June 30, 2006 and 2005, respectively, and $7 million and $8 million for the six months ended June 30, 2006 and 2005, respectively.

In February 2006, the Compensation and Benefits Committee of Charter’s Board of Directors approved a modification to the financial performance measures under Charter's Long-Term Incentive Program ("LTIP") required to be met for the performance shares to vest. After the modification, management believes that approximately 2.5 million of the performance shares are likely to vest. As such, expense of approximately $3 million will be amortized over the remaining two year service period. During the six months ended June 30, 2006, Charter granted an additional 8.0 million performance shares under the LTIP. The impacts of such grant and the modification of the 2005 awards was $1 million for the six months ended June 30, 2006.

19.
Related Party Transactions

The following sets forth certain transactions in which the Company and the directors, executive officers and affiliates of the Company are involved. Unless otherwise disclosed, management believes that each of the transactions
 
 
20

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
described below was on terms no less favorable to the Company than could have been obtained from independent third parties.

CC VIII, LLC

As part of the acquisition of the cable systems owned by Bresnan Communications Company Limited Partnership in February 2000, CC VIII, LLC, Charter’s indirect limited liability company subsidiary, issued, after adjustments, 24,273,943 Class A preferred membership units (collectively, the "CC VIII interest") with an initial value and an initial capital account of approximately $630 million to certain sellers affiliated with AT&T Broadband, subsequently owned by Comcast Corporation (the "Comcast sellers"). Mr. Allen granted the Comcast sellers the right to sell to him the CC VIII interest for approximately $630 million plus 4.5% interest annually from February 2000 (the "Comcast put right"). In April 2002, the Comcast sellers exercised the Comcast put right in full, and this transaction was consummated on June 6, 2003. Accordingly, Mr. Allen became the holder of the CC VIII interest, indirectly through an affiliate. In the event of a liquidation of CC VIII, the owners of the CC VIII interest would be entitled to a priority distribution with respect to a 2% priority return (which will continue to accrete). Any remaining distributions in liquidation would be distributed to CC V Holdings, LLC and the owners of the CC VIII interest in proportion to their capital accounts (which would have equaled the initial capital account of the Comcast sellers of approximately $630 million, increased or decreased by Mr. Allen's pro rata share of CC VIII’s profits or losses (as computed for capital account purposes) after June 6, 2003). 

An issue arose as to whether the documentation for the Bresnan transaction was correct and complete with regard to the ultimate ownership of the CC VIII interest following consummation of the Comcast put right. Thereafter, the board of directors of Charter formed a Special Committee of independent directors to investigate the matter and take any other appropriate action on behalf of Charter with respect to this matter. After conducting an investigation of the relevant facts and circumstances, the Special Committee determined that a "scrivener’s error" had occurred in February 2000 in connection with the preparation of the last-minute revisions to the Bresnan transaction documents and that, as a result, Charter should seek the reformation of the Charter Holdco limited liability company agreement, or alternative relief, in order to restore and ensure the obligation that the CC VIII interest be automatically exchanged for Charter Holdco units.

As of October 31, 2005, Mr. Allen, the Special Committee, Charter, Charter Holdco and certain of their affiliates, agreed to settle the dispute, and execute certain permanent and irrevocable releases pursuant to the Settlement Agreement and Mutual Release agreement dated October 31, 2005 (the "Settlement"). Pursuant to the Settlement, CII has retained 30% of its CC VIII interest (the "Remaining Interests"). The Remaining Interests are subject to certain transfer restrictions, including requirements that the Remaining Interests participate in a sale with other holders or that allow other holders to participate in a sale of the Remaining Interests, as detailed in the revised CC VIII Limited Liability Company Agreement. CII transferred the other 70% of the CC VIII interest directly and indirectly, through Charter Holdco, to a newly formed entity, CCHC (a direct subsidiary of Charter Holdco and the direct parent of Charter Holdings). Of the 70% of the CC VIII interest, 7.4% has been transferred by CII to CCHC for a subordinated exchangeable note with an initial accreted value of $48 million, accreting at 14% per annum, compounded quarterly, with a 15-year maturity (the "Note"). The remaining 62.6% has been transferred by CII to Charter Holdco, in accordance with the terms of the settlement for no additional monetary consideration. Charter Holdco contributed the 62.6% interest to CCHC.

As part of the Settlement, CC VIII issued approximately 49 million additional Class B units to CC V in consideration for prior capital contributions to CC VIII by CC V, with respect to transactions that were unrelated to the dispute in connection with CII’s membership units in CC VIII. As a result, Mr. Allen’s pro rata share of the profits and losses of CC VIII attributable to the Remaining Interests is approximately 5.6%.

The Note is exchangeable, at CII’s option, at any time, for Charter Holdco Class A Common units at a rate equal to the then accreted value, divided by $2.00 (the "Exchange Rate"). Customary anti-dilution protections have been provided that could cause future changes to the Exchange Rate. Additionally, the Charter Holdco Class A Common units received will be exchangeable by the holder into Charter common stock in accordance with existing agreements
 
 
21

CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in millions, except share and per share amounts and where indicated)
 
between CII, Charter and certain other parties signatory thereto. Beginning February 28, 2009, if the closing price of Charter common stock is at or above the Exchange Rate for a certain period of time as specified in the Exchange Agreement, Charter Holdco may require the exchange of the Note for Charter Holdco Class A Common units at the Exchange Rate.

CCHC has the right to redeem the Note under certain circumstances, for cash in an amount equal to the then accreted value. Such amount, if redeemed prior to February 28, 2009, would also include a make whole provision up to the accreted value through February 28, 2009. CCHC must redeem the Note at its maturity for cash in an amount equal to the initial stated value plus the accreted return through maturity.

The Board of Directors has determined that the transferred CC VIII interest will remain at CCHC for the present time, but there are currently no contractual or other obligations of CCHC that would prevent the contribution of those assets to a subsidiary of CCHC.

20.
Recently Issued Accounting Standards

In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109, which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits. The Company will adopt FIN 48 effective January 1, 2007. The Company is currently assessing the impact of FIN 48 on its financial statements.

22


 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

General

Charter Communications, Inc. ("Charter") is a holding company whose principal assets as of June 30, 2006 are a 48% controlling common equity interest in Charter Communications Holding Company, LLC ("Charter Holdco") and "mirror" notes that are payable by Charter Holdco to Charter and have the same principal amount and terms as Charter’s convertible senior notes. "We," "us" and "our" refer to Charter and its subsidiaries.

We are a broadband communications company operating in the United States. We offer our customers traditional cable video programming (analog and digital video) as well as high-speed Internet services and, in some areas, advanced broadband services such as high definition television, video on demand, telephone and interactive television. We sell our cable video programming, high-speed Internet and advanced broadband services on a subscription basis.

The following table summarizes our customer statistics for analog and digital video, residential high-speed Internet and residential telephone as of June 30, 2006 and 2005:

   
Approximate as of
 
   
June 30,
 
June 30,
 
   
2006 (a)
 
2005 (a)
 
           
Cable Video Services:
             
Analog Video:
             
Residential (non-bulk) analog video customers (b)
   
5,600,300
   
5,683,400
 
Multi-dwelling (bulk) and commercial unit customers (c)
   
275,800
   
259,700
 
Total analog video customers (b)(c)
   
5,876,100
   
5,943,100
 
               
Digital Video:
             
Digital video customers (d)
   
2,889,000
   
2,685,600
 
               
Non-Video Cable Services:
             
Residential high-speed Internet customers (e)
   
2,375,100
   
2,022,200
 
Residential telephone customers (f)
   
257,600
   
67,800
 

 
(a)
"Customers" include all persons our corporate billing records show as receiving service (regardless of their payment status), except for complimentary accounts (such as our employees). At June 30, 2006 and 2005, "customers" include approximately 55,900 and 45,100 persons whose accounts were over 60 days past due in payment, approximately 14,300 and 8,200 persons whose accounts were over 90 days past due in payment, and approximately 8,900 and 4,500 of which were over 120 days past due in payment, respectively.

(b)  
"Analog video customers" include all customers who receive video services (including those who also purchase high-speed Internet and telephone services) but excludes approximately 296,500 and 248,400 customers at June 30, 2006 and 2005, respectively, who receive high-speed Internet service only or telephone service only and who are only counted as high-speed Internet customers or telephone customers.

 
(c)
Included within "video customers" are those in commercial and multi-dwelling structures, which are calculated on an equivalent bulk unit ("EBU") basis. EBU is calculated for a system by dividing the bulk price charged to accounts in an area by the most prevalent price charged to non-bulk residential customers in that market for the comparable tier of service. The EBU method of estimating analog video customers is consistent with the methodology used in determining costs paid to programmers and has been consistently applied year over year. As we increase our effective analog prices to residential customers without a corresponding increase in the prices charged to commercial service or multi-dwelling customers, our EBU count will decline even if there is no real loss in commercial service or multi-dwelling customers.
 
 
23


 
 
(d)
"Digital video customers" include all households that have one or more digital set-top terminals. Included in "digital video customers" on June 30, 2006 and 2005 are approximately 8,400 and 9,700 customers, respectively, that receive digital video service directly through satellite transmission.

 
(e)
"Residential high-speed Internet customers" represent those customers who subscribe to our high-speed Internet service.

 
(f)
"Residential telephone customers" include all households receiving telephone service.

Overview of Operations

We have a history of net losses. Our net losses are principally attributable to insufficient revenue to cover the combination of operating costs and interest costs we incur because of our high level of debt and depreciation expenses that we incur resulting from the capital investments we have made and continue to make in our cable properties. We expect that these expenses will remain significant, and we therefore expect to continue to report net losses for the foreseeable future. We had net losses of $841 million and $707 million for the six months ended June 30, 2006 and 2005, respectively.
 
For the three months ended June 30, 2006 and 2005, our operating income from continuing operations was $146 million and $100 million, respectively, and for the six months ended June 30, 2006 and 2005, our operating income from continuing operations was $138 million and $142 million, respectively. Operating income from continuing operations includes depreciation and amortization expense and asset impairment charges but excludes interest expense. We had operating margins of 11% and 8% for the three months ended June 30, 2006 and 2005, respectively, and 5% and 6% for the six months ended June 30, 2006 and 2005, respectively. The increase in operating income from continuing operations and operating margins for the three months ended June 30, 2006 compared to 2005 was principally due to lower asset impairment charges and a decrease in depreciation and amortization expense. We incurred asset impairment charges of $8 million during the three months ended June 30, 2005 that did not recur during the three months ended June 30, 2006. Depreciation and amortization decreased during the three months ended June 30, 2006 compared to the corresponding prior period primarily as a result of assets becoming fully depreciated. 
 
Historically, our ability to fund operations and investing activities has depended on our continued access to credit under our credit facilities. We expect we will continue to borrow under our credit facilities from time to time to fund cash needs. The occurrence of an event of default under our credit facilities could result in borrowings from these credit facilities being unavailable to us and could, in the event of a payment default or acceleration, also trigger events of default under the indentures governing our outstanding notes and would have a material adverse effect on us. See "— Liquidity and Capital Resources."

Sale of Assets

In 2006, we signed three separate definitive agreements to sell certain cable television systems serving a total of approximately 356,000 analog video customers in 1) West Virginia and Virginia to Cebridge Connections, Inc. (the “Cebridge Transaction”); 2) Illinois and Kentucky to Telecommunications Management, LLC, doing business as New Wave Communications (the “New Wave Transaction”) and 3) Nevada, Colorado, New Mexico and Utah to Orange Broadband Holding Company, LLC (the “Orange Transaction”) for a total of approximately $971 million. These cable systems met the criteria for assets held for sale. As such, the assets were written down to fair value less estimated costs to sell resulting in asset impairment charges during the six months ended June 30, 2006 of approximately $99 million related to the New Wave Transaction and the Orange Transaction. In the third quarter of 2006, we expect to record a gain of approximately $200 million on the Cebridge Transaction. In addition, assets and liabilities to be sold have been presented as held for sale. We have also determined that the West Virginia and Virginia cable systems comprise operations and cash flows that for financial reporting purposes meet the criteria for discontinued operations. Accordingly, the results of operations for the West Virginia and Virginia cable systems have been presented as discontinued operations, net of tax for the three and six months ended June 30, 2006 and all prior periods presented herein have been reclassified to conform to the current presentation.


24


Critical Accounting Policies and Estimates

For a discussion of our critical accounting policies and the means by which we develop estimates therefore, see "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" in our 2005 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

The following table sets forth the percentages of revenues that items in the accompanying condensed consolidated statements of operations constituted for the periods presented (dollars in millions, except per share and share data):

   
Three Months Ended June 30,
 
   
2006
 
2005
 
                   
Revenues
 
$
1,383
   
100
%
$
1,266
   
100
%
                           
Costs and expenses:
                         
Operating (excluding depreciation and amortization)
   
611
   
44
%
 
546
   
43
%
Selling, general and administrative
   
279
   
20
%
 
250
   
19
%
Depreciation and amortization
   
340
   
25
%
 
364
   
29
%
Asset impairment charges
   
--
   
--
   
8
   
1
%
Other operating (income) expenses, net
   
7
   
--
   
(2
)
 
--
 
                           
     
1,237
   
89
%
 
1,166
   
92
%
                           
Operating income from continuing operations
   
146
   
11
%
 
100
   
8
%
                           
Interest expense, net
   
(475
)
       
(451
)
     
Other income (expenses), net
   
(21
)
       
17
       
                           
     
(496
)
       
(434
)
     
                           
Loss from continuing operations before income taxes
   
(350
)
       
(334
)
     
                           
Income tax expense
   
(52
)
       
(25
)
     
                           
Loss from continuing operations
   
(402
)
       
(359
)
     
                           
Income from discontinued operations, net of tax
   
20
         
4
       
                           
Net loss
   
(382
)
       
(355
)
     
                           
Dividends on preferred stock - redeemable
   
--
         
(1
)
     
                           
Net loss applicable to common stock
 
$
(382
)
     
$
(356
)
     
                           
Loss per common share, basic and diluted:
                         
Loss from continuing operations
 
$
(1.27
)
     
$
(1.18
)
     
Net loss
 
$
(1.20
)
     
$
(1.17
)
     
                           
Weighted average common shares outstanding, basic and diluted
   
317,646,946
         
303,620,347
       

Revenues. The overall increase in revenues from continuing operations in 2006 compared to 2005 is principally the result of an increase from June 30, 2005 of 343,800 high-speed Internet customers, 194,300 digital video customers and 189,800 telephone customers, as well as price increases for video and high-speed Internet services, and is offset partially by a decrease of 41,400 analog video customers. Our goal is to increase revenues by improving customer service, which we believe will stabilize our analog video customer base, implementing price increases on certain services and packages and increasing the number of customers who purchase high-speed Internet services, digital
 
 
25

 
video and advanced products and services such as telephone, video on demand ("VOD"), high definition television and digital video recorder service.

Average monthly revenue per analog video customer increased to $81.54 for the three months ended June 30, 2006 from $74.07 for the three months ended June 30, 2005 primarily as a result of incremental revenues from advanced services and price increases. Average monthly revenue per analog video customer represents total quarterly revenue, divided by three, divided by the average number of analog video customers during the respective period.

Revenues by service offering were as follows (dollars in millions):

   
Three Months Ended June 30,
 
   
2006
 
2005
 
2006 over 2005
 
   
 
Revenues
 
% of
Revenues
 
 
Revenues
 
% of
Revenues
 
 
Change
 
% Change
 
                           
Video
 
$
853
   
62
%
$
821
   
65
%
$
32
   
4
%
High-speed Internet
   
261
   
19
%
 
218
   
17
%
 
43
   
20
%
Telephone
   
29
   
2
%
 
8
   
1
%
 
21
   
263
%
Advertising sales
   
79
   
6
%
 
73
   
6
%
 
6
   
8
%
Commercial
   
76
   
5
%
 
66
   
5
%
 
10
   
15
%
Other
   
85
   
6
%
 
80
   
6
%
 
5
   
6
%
                                       
   
$
1,383
   
100
%
$
1,266
   
100
%
$
117
   
9
%

Video revenues consist primarily of revenues from analog and digital video services provided to our non-commercial customers. Approximately $28 million of the increase was the result of price increases and incremental video revenues from existing customers and approximately $14 million was the result of an increase in digital video customers. The increases were offset by decreases of approximately $10 million related to a decrease in analog video customers.

Approximately $37 million of the increase in revenues from high-speed Internet services provided to our non-commercial customers related to the increase in the average number of customers receiving high-speed Internet services, whereas approximately $6 million related to the increase in average price of the service.

Revenues from telephone services increased primarily as a result of an increase of 189,800 telephone customers in 2006.

Advertising sales revenues consist primarily of revenues from commercial advertising customers, programmers and other vendors. Advertising sales revenues increased primarily as a result of an increase in local advertising sales. For the three months ended June 30, 2006 and 2005, we received $4 million and $3 million, respectively, in advertising sales revenues from programmers.

Commercial revenues consist primarily of revenues from video and high-speed Internet services provided to our commercial customers. Commercial revenues increased primarily as a result of an increase in commercial high-speed Internet revenues.

Other revenues consist of revenues from franchise fees, equipment rental, customer installations, home shopping, dial-up Internet service, late payment fees, wire maintenance fees and other miscellaneous revenues. For the three months ended June 30, 2006 and 2005, franchise fees represented approximately 52% and 54%, respectively, of total other revenues. The increase in other revenues was primarily the result of an increase in franchise fees of $2 million, installation revenue of $2 million and wire maintenance fees of $2 million.


26


Operating Expenses. Programming costs represented 62% of operating expenses for each of the three months ended June 30, 2006 and 2005, respectively. Key expense components as a percentage of revenues were as follows (dollars in millions):

   
Three Months Ended June 30, 2006,
 
   
2006
 
2005
 
2006 over 2005
 
   
 
Expenses
 
% of
Revenues
 
 
Expenses
 
% of
Revenues
 
 
Change
 
% Change
 
                           
Programming
 
$
379
   
27
%
$
336
   
26
%
$
43
   
13
%
Service
   
205
   
15
%
 
186
   
15
%
 
19
   
10
%
Advertising sales
   
27
   
2
%
 
24
   
2
%
 
3
   
13
%
                                       
   
$
611
   
44
%
$
546
   
43
%
$
65
   
12
%

Programming costs consist primarily of costs paid to programmers for analog, premium, digital channels, VOD and pay-per-view programming. The increase in programming costs was primarily a result of rate increases and increases in digital customers. Programming costs were offset by the amortization of payments received from programmers in support of launches of new channels of $4 million and $9 million for the three months ended June 30, 2006 and 2005, respectively.

Our cable programming costs have increased in every year we have operated in excess of customary inflationary and cost-of-living increases. We expect them to continue to increase due to a variety of factors, including annual increases imposed by programmers and additional programming being provided to customers as a result of system rebuilds and bandwidth reallocation, both of which increase channel capacity. In 2006, programming costs have increased and we expect will continue to increase at a higher rate than in 2005. These costs will be determined in part on the outcome of programming negotiations in 2006 and may be subject to offsetting events. Our increasing programming costs have resulted in declining operating margins on our video services because we have been unable to pass on all cost increases to our customers. We expect to partially offset the resulting margin compression on our traditional video services with revenue from advanced video services, increased telephone revenues, high-speed Internet revenues, advertising revenues and commercial service revenues.

Service costs consist primarily of service personnel salaries and benefits, franchise fees, system utilities, costs of providing high-speed Internet service and telephone service, maintenance and pole rent expense. The increase in service costs resulted primarily from increased costs of providing high-speed Internet and telephone service of $7 million, increased labor and maintenance costs to support improved service levels and our advanced products of $4 million, higher fuel and utility prices of $4 million and franchise fees of $2 million. Advertising sales expenses consist of costs related to traditional advertising services provided to advertising customers, including salaries, benefits and commissions. Advertising sales expenses increased primarily as a result of increased salary, benefit and commission costs.
 
Selling, General and Administrative Expenses. Key components of expense as a percentage of revenues were as follows (dollars in millions):

   
Three Months Ended June 30,
 
   
2006
 
2005
 
2006 over 2005
 
   
 
Expenses
 
% of
Revenues
 
 
Expenses
 
% of
Revenues
 
 
Change
 
 
% Change
 
                           
General and administrative
 
$
236
   
17
%
$
220
   
17
%
$
16
   
7
%
Marketing
   
43
   
3
%
 
30
   
2
%
 
13
   
43
%
                                       
   
$
279
   
20
%
$
250
   
19
%
$
29
   
12
%

General and administrative expenses consist primarily of salaries and benefits, rent expense, billing costs, customer care center costs, internal network costs, bad debt expense and property taxes. The increase in general and administrative expenses resulted primarily from a rise in salaries and benefits of $12 million, bad debt expense of $5
 
 
27

 
million, billing costs of $5 million, computer maintenance of $3 million and telephone expense of $2 million offset by decreases in consulting services of $8 million and property taxes of $1 million.

Marketing expenses increased as a result of increased spending in targeted marketing campaigns consistent with management’s strategy to increase revenues.

Depreciation and Amortization. Depreciation and amortization expense decreased by $24 million for the three months ended June 30, 2006 compared to the three months ended June 30, 2005. The decrease in depreciation was primarily the result of assets becoming fully depreciated.

Asset Impairment Charges. Asset impairment charges for the three months ended June 30, 2005 represent the write-down of assets related to cable asset sales to fair value less costs to sell. See Note 3 to the condensed consolidated financial statements.

Other Operating (Income) Expenses, Net. Other operating expenses increased $9 million from other operating income of $2 million for the three months ended June 30, 2005 to other operating expense of $7 million for the three months ended June 30, 2006 as a result of a $9 million increase in special charges primarily related to severance associated with closing call centers and divisional restructuring.

Interest Expense, Net. Net interest expense increased by $24 million, or 5%, for the three months ended June 30, 2006 compared to the three months ended June 30, 2005. The increase in net interest expense was a result of an increase in our average borrowing rate from 8.92% in the three months ended June 30, 2005 to 9.40% in the three months ended June 30, 2006 and an increase of $1.2 billion in average debt outstanding from $19.2 billion for the three months ended June 30, 2005 compared to $20.4 billion for the three months ended June 30, 2006.

Other Income (Expenses), Net. Other income decreased from $17 million for the three months ended June 30, 2005 to other expense of $21 million for the three months ended June 30, 2006 primarily as a result of a $27 million loss on extinguishment of debt for the three months ended June 30, 2006 related to the Charter Operating credit facility refinancing in April 2006. In addition, the three months ended June 30, 2005 included a $20 million gain on investments recognized as a result of a gain realized on an exchange of our interest in an equity investee for an investment in a larger enterprise which did not recur in 2006. See Note 6 to the condensed consolidated financial statements. Other income also includes the 2% accretion of the preferred membership interests in our indirect subsidiary, CC VIII, and the pro rata share of the profits and losses of CC VIII.

Income Tax Expense. Income tax expense was recognized through increases in deferred tax liabilities related to our investment in Charter Holdco, as well as through current federal and state income tax expense and increases in the deferred tax liabilities of certain of our indirect corporate subsidiaries.

Income From Discontinued Operations, Net of Tax.  Income from discontinued operations, net of tax increased from $4 million for the three months ended June 30, 2005 to $20 million for the three months ended June 30, 2006 primarily due to a decrease in depreciation for the three months ended June 30, 2006 as we ceased recognizing depreciation on the West Virginia and Virginia cable systems when we classified them as assets held for sale in the first quarter of 2006.

Net Loss. Net loss increased by $27 million, or 8%, for the three months ended June 30, 2006 compared to the three months ended June 30, 2005 as a result of the factors described above.

Preferred Stock Dividends. On August 31, 2001, Charter issued 505,664 shares (and on February 28, 2003 issued an additional 39,595 shares) of Series A Convertible Redeemable Preferred Stock in connection with the Cable USA acquisition, on which Charter pays or accrues a quarterly cumulative cash dividend at an annual rate of 5.75% if paid or 7.75% if accrued on a liquidation preference of $100 per share. Beginning January 1, 2005, Charter accrues the dividend on its Series A Convertible Redeemable Preferred Stock. In November 2005, we repurchased 508,546 shares of our Series A Convertible Redeemable Preferred Stock. Following the repurchase, 36,713 shares of preferred stock remain outstanding.

Net Loss Per Common Share. Loss per common share increased by $0.03, or 3%, for the three months ended June 30, 2006 compared to the three months ended June 30, 2005 as a result of the factors described above.
 
28

 
Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

The following table sets forth the percentages of revenues that items in the accompanying condensed consolidated statements of operations constituted for the periods presented (dollars in millions, except per share and share data):

<
   
Six Months Ended June 30,
 
   
2006
 
2005
 
                   
Revenues
 
$
2,703
   
100
%
$
2,481
   
100
%
                           
Costs and expenses:
                         
Operating (excluding depreciation and amortization)
   
1,215
   
45
%
 
1,081
   
44
%
Selling, general and administrative
   
551
   
20
%
 
483
   
19
%
Depreciation and amortization
   
690
   
26
%
 
730
   
29
%
Asset impairment charges
   
99
   
4
%
 
39
   
2
%
Other operating expenses, net
   
10
   
--
   
6
   
--
 
                           
     
2,565