** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED JUNE30, 2003**

**COMMISSION FILE NUMBER: 000-32647**

 

**KNOLOGY,INC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                                    |   | **58-2424258**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **KNOLOGY, INC.  1241 O.G. SKINNER DRIVE  WEST POINT, GEORGIA** |   | **31833**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |

** **

Registrant’s telephone number, including area code:**(706)645-8553**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.    Yes ý     Noo

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

Yes o     Noý

 

As of July 31, 2003, wehad 508,179 shares of common stock, 51,165,894 shares of Series A preferredstock, 21,180,131 shares of Series B preferred stock, 50,219,561 shares ofSeries C preferred stock, 10,684,751 shares of Series D preferred stock and21,701,279 shares of Series E preferred stock outstanding.

 

 

----

 

**KNOLOGY, INC. AND SUBSIDIARIES**

**QUARTER ENDED JUNE 30, 2003**

 

**INDEX**

 
| **PART I**   |   | **FINANCIAL INFORMATION**                                                                   |
|--------------|--------|---------------------------------------------------------------------------------------------|
|         |   |                                                                                        |
| ITEM 1       |   | FINANCIAL  STATEMENTS                                                                       |
|         |   | Condensed Consolidated Balance Sheets.                                                      |
|         |   | Condensed  Consolidated Statements of Operations.                                           |
|         |   | Condensed Consolidated Statement of Cash  Flows                                             |
|         |   | Notes  to Condensed Consolidated Financial Statements                                       |
| ITEM  2      |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
| ITEM  3      |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.                                |
| ITEM  4      |   | CONTROLS  AND PROCEDURES.                                                                   |
|         |   |                                                                                        |
| **PART  II** |   | **OTHER INFORMATION**                                                                       |
|         |   |                                                                                        |
| ITEM 1       |   | LEGAL  PROCEEDINGS.                                                                         |
| ITEM  2      |   | CHANGES IN  SECURITIES AND USE OF PROCEEDS.                                                 |
| ITEM 3       |   | DEFAULTS UPON SENIOR  SECURITIES.                                                           |
| ITEM  4      |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS.                                       |
| ITEM 5       |   | OTHER  INFORMATION.                                                                         |
| ITEM 6       |   | EXHIBITS AND REPORTS  ON FORM 8-K                                                           |

 

1

----

 

ITEM 1.  FINANCIALSTATEMENTS

 

**KNOLOGY, INC. AND SUBSIDIARIES**

** **

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

** **

**(DOLLARS IN THOUSANDS)**

 
|                                                                                                                                    |   | **June 30,  2003** |       | **December 31,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                    |   |               | ** ** |                   | ** ** |
| **ASSETS**                                                                                                                              |   |
|                                                                                                                                    |   |               |       |                   |       |
| **CURRENT ASSETS:**                                                                                                                     |   |               |       |                   |       |
| Cash  and cash equivalents (Including $9,914 and $5,745 of restricted cash as of  June 30, 2003 and December 31, 2002, respectively)    |   | $                  | 33,934     |                   | $          | 43,913 |   |
| Accounts  receivable, net (Allowance for doubtful accounts was $1,813 and $2,194 at  June 30, 2003 and December 31, 2002, respectively) |   | 14,973             |       | 14,863                 |       |
| Affiliate  receivable                                                                                                                   |   | 42                 |       | 72                     |       |
| Prepaid  expenses and other                                                                                                             |   | 1,361              |       | 996                    |       |
| Total  current assets                                                                                                                   |   | 50,310             |       | 59,844                 |       |
|                                                                                                                                    |   |               |       |                   |       |
| **PROPERTY, PLANT AND EQUIPMENT, net**                                                                                                  |   | 336,605            |       | 357,182                |       |
|                                                                                                                                    |   |               |       |                   |       |
| **INVESTMENTS**                                                                                                                         |   | 12,580             |       | 12,580                 |       |
|                                                                                                                                    |   |               |       |                   |       |
| **GOODWILL**                                                                                                                            |   | 40,834             |       | 40,834                 |       |
|                                                                                                                                    |   |               |       |                   |       |
| **INTANGIBLE AND OTHER ASSETS, net**                                                                                                    |   | 654                |       | 851                    |       |
| Total  assets                                                                                                                           |   | $                  | 440,983    |                   | $          | 471,291 |   |
|                                                                                                                                    |   |               |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                          |   |
|                                                                                                                                    |   |               |       |                   |       |
| **CURRENT LIABILITIES:**                                                                                                                |   |               |       |                   |       |
| Current  portion of notes payable                                                                                                       |   | $                  | 3,533      |                   | $          | 3,406 |   |
| Accounts  payable                                                                                                                       |   | 12,203             |       | 15,729                 |       |
| Accrued  liabilities                                                                                                                    |   | 8,034              |       | 8,441                  |       |
| Unearned  revenue                                                                                                                       |   | 9,627              |       | 8,268                  |       |
| Total  current liabilities                                                                                                              |   | 33,397             |       | 35,844                 |       |
|                                                                                                                                    |   |               |       |                   |       |
| **NONCURRENT LIABILITIES:**                                                                                                             |   |               |       |                   |       |
| Notes  payable                                                                                                                          |   | 48,708             |       | 50,490                 |       |
| Unamortized  investment tax credits                                                                                                     |   | 75                 |       | 110                    |       |
| Senior  notes                                                                                                                           |   | 211,450            |       | 198,455                |       |
| Total  noncurrent liabilities                                                                                                           |   | 260,233            |       | 249,055                |       |
| Total  liabilities                                                                                                                      |   | 293,630            |       | 284,899                |       |
|                                                                                                                                    |   |               |       |                   |       |
| **WARRANTS**                                                                                                                            |   | 1,861              |       | 1,861                  |       |
|                                                                                                                                    |   |               |       |                   |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                       |   |               |       |                   |       |
|                                                                                                                                    |   |               |       |                   |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                          |   |               |       |                   |       |
| Convertible  preferred stock                                                                                                            |   | 1,549              |       | 1,548                  |       |
| Common  stock                                                                                                                           |   | 5                  |       | 5                      |       |
| Additional  paid-in capital                                                                                                             |   | 493,924            |       | 493,046                |       |
| Accumulated  deficit                                                                                                                    |   | (349,986           | )          | (310,068               | )          |
| Total  stockholders’ equity                                                                                                        |   | 145,492            |       | 184,531                |       |
|                                                                                                                                    |   |               |       |                   |       |
| Total  liabilities and stockholders’ equity                                                                                        |   | $                  | 440,983    |                   | $          | 471,291 |   |

 

See notes tocondensed cosolidated financial statements.

 

2

----

 

**KNOLOGY, INC. AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPE****RATIONS**

**(UNAUDITED)**

** **

**(DOLLARS IN THOUSANDS)**

 
|                                                                                 |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|--------------------------------------------------------------------------------------|--------|----------------------------------|---------|--------------------------------|--------|
|                                                                                 |   | **2003**                         |    | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **OPERATING REVENUES**                                                               |   | $                                | 42,869  |                           | $      | 34,878 |   | $ | 83,556 |   | $ | 66,912 |   |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **OPERATING EXPENSES:**                                                              |   |                             |    |                           |   |   |   |   |   |
| Costs  and expenses, excluding depreciation and amortization                         |   | 34,226                           |    | 30,181                         |   | 68,555 |   | 58,679 |   |
| Depreciation  and amortization                                                       |   | 19,933                           |    | 20,604                         |   | 39,353 |   | 39,205 |   |
| Reorganization  professional fees                                                    |   | 43                               |    | 0                              |   | 43 |   | 0 |   |
| Asset  Impairment                                                                    |   | 0                                |    | 0                              |   | 0 |   | 852 |   |
| Non-cash  stock option compensation                                                  |   | 478                              |    | 0                              |   | 905 |   | 0 |   |
| Litigation  fees                                                                     |   | 411                              |    | 0                              |   | 611 |   | 0 |   |
|                                                                                 |   | 55,091                           |    | 50,785                         |   | 109,467 |   | 98,736 |   |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **OPERATING LOSS**                                                                   |   | (12,222                          | )       | (15,907                        | )      | (25,911 | ) | (31,824 | ) |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **OTHER INCOME (EXPENSE):**                                                          |   |                             |    |                           |   |   |   |   |   |
| Interest  income                                                                     |   | 96                               |    | 82                             |   | 210 |   | 211 |   |
| Interest  expense                                                                    |   | (7,324                           | )       | (11,073                        | )      | (14,304 | ) | (21,888 | ) |
| Gain  on adjustment of warrants to market                                            |   | 0                                |    | 2,865                          |   | 0 |   | 2,865 |   |
| Other  (expense) income, net                                                         |   | 0                                |    | (115                           | )      | 86 |   | (91 | ) |
|                                                                                 |   | (7,228                           | )       | (8,241                         | )      | (14,008 | ) | (18,903 | ) |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **LOSS BEFORE INCOME TAXES AND CUMULATIVEEFFECT OF CHANGE IN  ACCOUNTING PRINCIPLE** |   | (19,450                          | )       | (24,148                        | )      | (39,919 | ) | (50,727 | ) |
| **INCOME TAX PROVISION**                                                             |   | 0                                |    | (110                           | )      | 0 |   | (119 | ) |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING  PRINCIPLE**                 |   | (19,450                          | )       | (24,258                        | )      | (39,919 | ) | (50,846 | ) |
| **CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE**                              |   | 0                                |    | 0                              |   | 0 |   | (1,294 | ) |
|                                                                                 |   |                             |    |                           |   |   |   |   |   |
| **NET LOSS**                                                                         |   | $                                | (19,450 | )                              | $      | (24,258 | ) | $ | (39,919 | ) | $ | (52,140 | ) |

 

See notes tocondensed cosolidated financial statements.

 

3

----

 

**KNOLOGY,INC. AND SUBSIDIARIES**

** **

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

** **

**(DOLLARSIN THOUSANDS)**

 
|                                                                             |   | **Six Months Ended  June 30,** |    |
|----------------------------------------------------------------------------------|--------|--------------------------------|---------|
|                                                                             |   | **2003**                       |    | **2002** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                        |   |                           |    |   |   |
| Net  loss                                                                        |   | $                              | (39,919 | ) | $ | (52,140 | ) |
| Adjustments  to reconcile net loss to net cash provided by operating activities: |   |                           |    |   |   |
| Depreciation  and amortization                                                   |   | 39,353                         |    | 39,205 |   |
| Non-cash  stock option compensation                                              |   | 905                            |    | 0 |   |
| Asset  Impairment                                                                |   | 0                              |    | 852 |   |
| Write  off of investment                                                         |   | 0                              |    | 45 |   |
| Gain  on adjustment of warrants to market                                        |   | 0                              |    | (2,865 | ) |
| Accretion  of discounted debt                                                    |   | 0                              |    | 20,496 |   |
| Non-cash  bond interest expense                                                  |   | 12,995                         |    | 0 |   |
| Provision  for bad debt                                                          |   | 2,270                          |    | 1,512 |   |
| Loss  on disposition of assets                                                   |   | 4                              |    | 6 |   |
| Cumulative  effect of change in accounting principle - Goodwill impairment       |   | 0                              |    | 1,294 |   |
| Changes  in operating assets and liabilities:                                    |   |                           |    |   |   |
| Accounts  receivable                                                             |   | (2,345                         | )       | (3,300 | ) |
| Accounts  receivable - affiliate                                                 |   | 0                              |    | 516 |   |
| Prepaid  expenses and other                                                      |   | (363                           | )       | (1,724 | ) |
| Accounts  payable                                                                |   | (3,531                         | )       | 3,574 |   |
| Accrued  liabilities                                                             |   | (407                           | )       | (445 | ) |
| Unearned  revenue                                                                |   | 1,359                          |    | 1,096 |   |
| Total  adjustments                                                               |   | 50,240                         |    | 60,262 |   |
| Net  cash provided by operating activities                                       |   | 10,321                         |    | 8,122 |   |
|                                                                             |   |                           |    |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                        |   |                           |    |   |   |
| Capital  expenditures                                                            |   | (18,605                        | )       | (23,246 | ) |
| Expenditures  for intangible assets                                              |   | (76                            | )       | (312 | ) |
| Proceeds  from sale of assets                                                    |   | 60                             |    | 236 |   |
| Net  cash used in investing activities                                           |   | (18,621                        | )       | (23,322 | ) |
|                                                                             |   |                           |    |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                        |   |                           |    |   |   |
| Principal  payments on debt                                                      |   | (1,654                         | )       | 0 |   |
| Expenditures  related to reorganization equity                                   |   | (34                            | )       | 0 |   |
| Proceeds  from exercised stock options                                           |   | 9                              |    | 3 |   |
| Net  cash (used in) provided by financing activities                             |   | (1,679                         | )       | 3 |   |
|                                                                             |   |                           |    |   |   |
| **NET DECREASE IN CASH**                                                         |   | (9,979                         | )       | (15,197 | ) |
| **CASH AT BEGINNING OF PERIOD**                                                  |   | 43,913                         |    | 38,074 |   |
| **CASH AT END OF PERIOD**                                                        |   | $                              | 33,934  |   | $ | 22,877 |   |
|                                                                             |   |                           |    |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:**                            |   |                           |    |   |   |
|                                                                             |   |                           |    |   |   |
| Cash  paid during the period for interest                                        |   | $                              | 1,272   |   | $ | 1,037 |   |
| Cash  received during the period for income taxes                                |   | $                              | —  |   | $ | 346 |   |

 

See notes tocondensed cosolidated financial statements.

 

4

----

 

##### **KNOLOGY, INC. AND SUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIA****L STATEMENTS**

 

**JUNE 30, 2003**

**(UNAUDITED)**

 

**(DOLLARS IN THOUSANDS)**

 

**1.****                                      ORGANIZATIONAND NATURE OF BUSINESS**

 

Knology,Inc. (including its predecessors, “Knology” or the “Company”) offersresidential and business customers broadband communications services, includinganalog and digital cable television, local and long distance telephone,high-speed Internet access service and broadband carrier services, usingadvanced interactive broadband networks. We own, operate and manage interactivebroadband networks in seven metropolitan areas: Montgomery and Huntsville,Alabama; Columbus and Augusta, Georgia; Panama City, Florida; Charleston, SouthCarolina; and Knoxville, Tennessee. We also provide local telephone services inWest Point, Georgia, and Lanett and Valley, Alabama. Our local telephoneservice in this area is provided over a traditional copper wire network whileour cable and Internet services are provided over our broadband network.Subject to the availability of additional funding, we plan to expand toadditional mid-to-large-sized cities in the southeastern United States.

 

**2.****                                      BASISOF PRESENTATION**

 

Theaccompanying unaudited condensed consolidated financial statements of theCompany have been prepared in accordance with accounting principles generallyaccepted in the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements. In theopinion of management, all adjustments considered necessary for the fairpresentation of the financial statements have been included, and the financialstatements present fairly the financial position and results of operations forthe interim periods presented. Operating results for the three and six monthsended June 30, 2003 are not necessarily indicative of the results that may beexpected for the year ended December 31, 2003. These financial statementsshould be read in conjunction with the consolidated financial statements andnotes thereto, together with management’s discussion and analysis of financialcondition and results of operations contained in the Company’s Annual Report onForm 10-K for the year ended December 31, 2002.

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.The results of operations for the interim periods presented are not necessarilyindicative of the results to be expected for the year ending December 31, 2003,or any other interim period.

 

**3.****                                      SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

# **RECENTACCOUNTING PRONOUNCEMENTS**

 

InApril 2002, the Financial Accounting Standards Board (FASB) issued Statement ofFinancial Accounting Standards (SFAS) No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrection,” which provides for the rescission of several previously issuedaccounting standards, new accounting guidance for the accounting of certainlease modifications and various technical corrections that are not substantivein nature to existing pronouncements. Effective December 31, 2002, the Companyhas adopted SFAS No. 145 with no material impact to its financial position orresults of operations.

 

InJuly 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated withExit or Disposal Activities,” which requires companies to recognize costsassociated with exit or disposal activities when they are incurred rather thanat the date of a commitment to an exit or disposal plan. SFAS No. 146 is to beapplied prospectively to exit or disposal activities initiated after December31, 2002.  The company has adopted SFASNo. 146 with no material impact to our financial position and results ofoperations.

 

5

----

 

InNovember 2002, FASB Interpretation No. (“FIN”) 45, Guarantor’s Accounting andDisclosure Requirements for Guarantors, Including Indirect Guarantees ofIndebtedness of Others, was issued. FIN 45 requires that upon issuance of aguarantee, the guarantor must recognize a liability for the fair value of theobligation it assumes under the guarantee. Guarantors will also be required to meet expanded disclosureobligations. The initial recognition and measurement provision of FIN 45 areeffective for guarantees issued after December 31, 2002. The disclosurerequirements are effective for annual and interim financial statements that endafter December 15, 2002, and had no impact on the Company’s financial positionor results of operations.

 

InDecember 2002, the FASB issued SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure,” which amends SFAS No. 123 to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation. In addition,this Statement amends the disclosure requirements of Statement 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. Finally, this Statement amends APB OpinionNo. 28, Interim Financial Reporting, to require disclosure about those effectsin interim financial information. SFAS No. 148 is to be applied for financialstatements for fiscal years ending after December 15, 2002. In December 2002the Company elected to adopt the recognition provisions of SFAS No. 123 whichis considered the preferable accounting method for stock-based employeecompensation. The Company also elected to report the change in accountingprinciple using the prospective method in accordance with SFAS No. 148. Underthe prospective method, the recognition of compensation costs is applied to allemployee awards granted, modified or settled after the beginning of the fiscalyear in which the recognition provisions are first applied.

 

Thefollowing table illustrates the effect on net loss if Knology had applied thefair value recognition provisions of SFAS No. 123 to stock-based employeecompensation:

 
|                                                                                                                                                                                                    |   | **SIX MONTHS ENDED  JUNE 30,** |    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|---------|
|                                                                                                                                                                                                    |   | **2003**                       |    | **2002** |   |
| Net loss - as reported                                                                                                                                                                                  |   | $                              | (39,919 | ) | $ | (52,140 | ) |
| Total stock-based employee compensation cost, net  of related tax effects  included in the determination of net income as reported                                                                      |   | 905                            |    | 0 |   |
| The stock-based employee compensation cost, net of  related tax effects, that would have been included in the determinationof net income if the fair value based  method had been applied to all awards |   | (915                           | )       | (1,649 | ) |
| Pro forma net loss                                                                                                                                                                                      |   | $                              | (39,929 | ) | $ | (53,789 | ) |

 

InJanuary 2003, the Financial Accounting Standards Board (“FASB”) issued FASBInterpretation No. 46 (“FIN 46”), “Consolidation of Variable InterestEntities.” This interpretation of Accounting Research Bulletin 51,“Consolidated Financial Statements,” addresses consolidation by business enterprisesof variable interest entities that possess certain characteristics. Theinterpretation requires that if a business enterprise has a controllingfinancial interest in a variable interest entity, the assets, liabilities, andresults of the activities of the variable interest entity must be included inthe consolidated financial statements with those of the business enterprise.This interpretation applies immediately to variable interest entities createdafter January 31, 2003 and to variable interest entities in which an enterpriseobtains an interest after that date. We do not have any ownership in anyvariable interest entities as of June 30, 2003. We will apply the consolidationrequirement of the interpretation in future periods if we should own any interestin any variable interest entity.

 

InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities” which amends and clarifiesaccounting and reporting for derivative instruments, including certainderivatives imbedded in other contracts and for hedging activities as definedunder FASB statement No. 133 and FIN No. 45. SFAS No. 149 is effective for contracts entered into after June 30,2003.  We do not expect the SFAS No. 149to have a material impact on our financial position or statement of operations.

 

In May2003, the FASB issued SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity” whichestablishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify afinancial instrument that is within its scope as a liability or an asset insome circumstances.  SFAS No. 150 iseffective for the first interim period beginning after June 15, 2003. We do notexpect the SFAS No. 150 to have a material impact on our financial position,but will require the company to reclassify the warrants to non-currentliabilities.

 

6

----

 

**4.****                                      CASH**

 

As ofJune 30, 2003, the Company has $9,914 of cash that is restricted in use. Ofthis amount, $8,924 is held at the telephone operations group and is restrictedfor use by these entities. Also, the Company has pledged $990 of cash ascollateral for amounts potentially payable under certain surety bondagreements.

 

**5.****                                      GOODWILLAND INTANGIBLE ASSETS**

 

TheCompany adopted SFAS No. 142 on January 1, 2002. The Company performs agoodwill impairment test in accordance with SFAS No. 142 annually on January1.  The Company recorded an impairmentloss of $1,294 in the first quarter of 2002 as a cumulative effect of change inaccounting principle.  There was noimpairment identified as a result of the January 1, 2003 impairment test.

 

Intangibleassets as of June 30, 2003 and December 31, 2002, respectively, were asfollows:

 
|                                      |   | **JUNE 30, 2003**          |   | **DECEMBER 31, 2002**         |   |
|-------------------------------------------|--------|----------------------------|--------|-------------------------------|--------|
|                                      |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   |
|                                      |   | **(In Thousands)**         |   |
| Intangible assets subject to amortization |   | $                          | 1,276  |                          | $      | 622 |   | $ | 654 |   | $ | 1,727 |   | $ | 876 |   | $ | 851 |   |
|                                      |   |                       |   |                          |   |   |   |   |   |   |   |   |   |
| Goodwill                                  |   | 0                          |   | 0                             |   | 40,834 |   | 0 |   | 0 |   | 40,834 |   |
|                                      |   |                       |   |                          |   |   |   |   |   |   |   |   |   |
| Total intangible assets                   |   |                       |   |                          |   | $ | 41,488 |   |   |   |   |   | $ | 41,685 |   |
|                                           |        |                            |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Therewere no intangible assets reclassified to goodwill upon adoption of SFAS No.142.

 

Amortizationexpense related to intangible assets was $213 and $407 for the six months endedJune 30, 2003 and 2002, respectively.

 

**6.****                                      COMMITMENTSAND CONTINGENCIES**

 

**LEGALPROCEEDINGS**

 

In September 2000, the City of Louisville, Kentuckygranted Knology of Louisville, Inc. a cable television franchise.  Insight filed a complaint against the City ofLouisville in state courtclaiming that Knology’s franchise was more favorable than Insight’sfranchise.  Insight’s complaintsuspended Knology’s franchise until there is a final, nonappealable order inInsight’s state court case.  In April2001 the City of Louisville moved for summary judgment in state court againstInsight.  In March 2002, the state courtruled that Insight’s complaint had no merit and the state court granted theCity’s motion to dismiss Insight’s complaint. Insight appealed the state court’s order dismissing their complaint andin June 2003 the state court of appeals upheld the lower court ruling.  Insight sought discretionary review of thecourt of appeals ruling by the Kentucky Supreme Court and that request ispending.

 

InNovember 2000, Knology filed a federal court action against Insight seekingmonetary damages, declaratory and injunctive relief from Insight and the Cityarising out of Insight’s complaint and the suspension of Knology’sfranchise.  In March 2001, the federalcourt issued an Order granting Knology’s motion for preliminary injunctiverelief and denying Insight’s motion to dismiss.  In June 2003 the federal court ruled on the parties’ crossmotions for summary judgment, resolving certain claims and setting others downfor trial. At this time it is impossible to determine with certainty theultimate outcome of the litigation.

** **

We arealso subject to other litigation in the normal course of our business. However,in our opinion, there is no legal proceeding pending against us which wouldhave a material adverse effect on our financial position, results of operationsor liquidity.  We are also a party toregulatory proceedings affecting the relevant segments of the communicationsindustry generally.

 

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**7.****                                      SEGMENTINFORMATION**

 

TheCompany follows SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” which established revised standards for the reporting offinancial and descriptive information about operating segments in financialstatements.

 

TheCompany owns and operates advanced interactive broadband networks and providesresidential and business customers broadband communications services, includinganalog and digital cable television, local and long distance telephone, andhigh-speed Internet access, which the Company refers to as video, voice, anddata services. We also provide other services including broadband carrierservices, which includes local transport services such as local Internettransport, special access, local private line, and local loop services.

 

Whilemanagement of the Company monitors the revenue generated from each of thevarious broadband services, operations are managed and financial performance isevaluated based upon the delivery of multiple services to customers over asingle network. As a result of multiple services being provided over a singlenetwork, many expenses and assets are shared related to providing the variousbroadband services to customers. Management believes that any allocation of theshared expenses or assets to the broadband services would be subjective andimpractical.

 

Revenuesby broadband communications service are as follows:

 
|                   |   | **THREE  MONTHS ENDED  JUNE 30,** |   | **SIX MONTHS  ENDED  JUNE 30,** |   |
|------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                   |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
| Video                  |   | $                                 | 17,987 |                            | $      | 15,170 |   | 35,164 |   | $ | 29,320 |   |
| Voice                  |   | 17,330                            |   | 14,288                          |   | 33,895 |   | 27,618 |   |
| Data  and other        |   | 7,552                             |   | 5,420                           |   | 14,497 |   | 9,974 |   |
| Consolidated  revenues |   | $                                 | 42,869 |                            | $      | 34,878 |   | $ | 83,556 |   | $ | 66,912 |   |
|                        |        |                                   |        |                                 |        |  |  |  |  |  |  |  |  |

# ** **

**8.****                                      SUBSEQUENTEVENTS**

 

On July 16, 2003, the Company, in association with GLANew Ventures, LLC, entered into a definitive agreement to purchase certainassets from Verizon Media Ventures, Inc. for $15.0 million cash, subject tocertain closing adjustments.  Theacquisition includes broadband assets located in Pinellas County, Florida, andcable assets located in the city of Cerritos, California. These two marketswill add approximately 291,000 marketable passings to the existing eightmarkets comprising the Knology footprint, as well as add approximately 64,000video connections and 11,000 data connections. The acquisition is subject to customary closing conditions includingregulatory approval.  The closing isexpected to occur by the end of the year.

 

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# **ITEM 2.**                    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

 

THE MANAGEMENT’S DISCUSSION AND ANALYSIS AND OTHERPORTIONS OF THIS QUARTERLY REPORT INCLUDE “FORWARD-LOOKING” STATEMENTS WITHINTHE MEANING OF THE FEDERAL SECURITIES LAWS, INCLUDING THE PRIVATE SECURITIESLITIGATION REFORM ACT OF 1995, THAT ARE SUBJECT TO FUTURE EVENTS, RISKS ANDUNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSEEXPRESSED OR IMPLIED. IMPORTANT FACTORS THAT EITHER INDIVIDUALLY OR IN THE AGGREGATECOULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED INCLUDE,WITHOUT LIMITATION, (1) THAT WE WILL NOT RETAIN OR GROW OUR CUSTOMER BASE, (2)THAT OUR SUPPLIERS AND CUSTOMERS MAY REFUSE TO CONTINUE DOING BUSINESS WITH USOR MAY REFUSE TO EXTEND TRADE CREDIT TO US, (3) THAT WE WILL FAIL TO BECOMPETITIVE WITH EXISTING AND NEW COMPETITORS, (4) THAT WE WILL NOT ADEQUATELYRESPOND TO TECHNOLOGICAL DEVELOPMENTS IMPACTING OUR INDUSTRY AND MARKETS, (5)THAT NEEDED FINANCING WILL NOT BE AVAILABLE TO US IF AND AS NEEDED, (6) THAT ASIGNIFICANT CHANGE IN THE GROWTH RATE OF THE OVERALL U.S. ECONOMY WILL OCCURSUCH THAT CONSUMER AND CORPORATE SPENDING ARE MATERIALLY IMPACTED, AND (7) THATSOME OTHER UNFORESEEN DIFFICULTIES OCCUR, AS WELL AS THOSE RISKS SET FORTH INOUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002, WHICHARE INCORPORATED HEREIN BY REFERENCE. THIS LIST IS INTENDED TO IDENTIFY ONLYCERTAIN OF THE PRINCIPAL FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLYFROM THOSE DESCRIBED IN THE FORWARD-LOOKING STATEMENTS INCLUDED HEREIN.

 

The following is a discussion of our consolidatedfinancial condition and results of operations for the three and six monthsended June 30, 2003, and certain factors that are expected to affect ourprospective financial condition. The following discussion and analysis shouldbe read in conjunction with the financial statements and related notes includedelsewhere in this Form 10-Q. 

 

**Background**

 

Knology, Inc. was formed in September 1998 to enableITC Holding Company, Inc. to complete a reorganization of some of itssubsidiaries, including Knology Broadband, Inc. or Broadband.

 

On November 6, 2002,Knology and Broadband completed a financial restructuring, pursuant to whichthe following transactions became effective:

 

•                                          Knologyreceived $39.0 million gross cash proceeds from the issuance of 13,000,000shares of Series C preferred stock in a private placement to two existinginvestors.  The proceeds were used topay transaction expenses of approximately $1.7 million and will be used forgeneral corporate purposes;

 

•                                          $379.9million aggregate principal amount at maturity of Broadband 11 7/8% seniordiscount notes due 2007 were exchanged for $193.5 million of new Knology 12%senior notes due 2009, 10,618,352 shares of Series D preferred stock and21,701,279 shares of Series E preferred stock;

 

•                                          the$15.5 million, 4-year senior secured credit facility by and among WachoviaBank, National Association, as lender, Broadband, as guarantor, and thesubsidiaries of Broadband as borrowers, was amended and restated;

 

•                                          the$40.0 million 10-year senior, secured credit facility by and among CoBank, ACB,as lender and Valley Telephone, Globe Telecommunications, Inc. and InterstateTelephone Company, as borrowers, was amended;

 

•                                          $64.2million aggregate principal amount at maturity of Broadband discount notes heldby Valley Telephone Co., Inc. were canceled in exchange for a limited guarantyby Broadband of the CoBank credit facility;

 

•                                          $15.3million owed to Knology by Broadband under two intercompany loan facilitieswere canceled in exchange for a limited guaranty by Broadband of the CoBankcredit facility; and

 

•                                          theKnology Stockholders Agreement was amended to provide the holders of Broadbanddiscount notes who received new Knology preferred stock in the restructuringwith registration rights and co-sale rights, as well to 

 

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provide holders of theSeries D preferred stock the right to nominate a director to be elected toKnology’s board of directors.

 

## **CriticalAccounting Policies**

 

Our consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States, which require us to make estimates andassumptions. We believe that the following may involve a higher degree ofjudgment and complexity.

 

*Revenue Recognition*.The Company generates recurring or multi-period operating revenues, as well asnonrecurring revenues. We recognize revenue in accordance with SEC StaffAccounting Bulletin, or SAB, No. 101, “Revenue Recognition in FinancialStatements,” as amended by SAB Nos. 101A and 101B. SAB No. 101 requires thatthe following four basic criteria must be satisfied before revenues can berecognized:

 

•**                 **there ispersuasive evidence that an arrangement exists;

 

•**                 **delivery hasoccurred or services rendered;

 

•**                 **the fee isfixed and determinable; and

 

•**                 **collectibilityis reasonably assured.

 

In regard to the first and second bullet points, webelieve that persuasive evidence of an arrangement and delivery has occurredupon installation.

 

We base our determination of the third and fourthcriteria above on our judgment regarding the fixed nature of the fee we havecharged for the services rendered and products delivered, and the prospect thatthose fees will be collected. If changes in conditions should cause us todetermine that these criteria likely will not be met for certain futuretransactions, revenue recognized for any reporting period could be materially affected.

 

We generate recurring revenues for our broadbandofferings of video, voice and data and other services. Revenues generated fromthese services primarily consist of a fixed monthly fee for access to cableprogramming, local phone services, enhanced phone services and access to theinternet. Additional fees are charged for services including pay-per-viewmovies, events such as boxing matches and concerts, long distance service andcable modem rental. Revenues are recognized as services are provided andadvance billings or cash payments received in advance of services performed arerecorded as deferred revenue.

 

*Allowance for Doubtful Accounts.*Weuse estimates to determine our allowance for bad debts. These estimates arebased on historical collection experience, current trends, credit policy and apercentage of our customer accounts receivable. In determining thesepercentages, we look at historical write-offs of our receivables.

 

*Valuation of Long-Lived andIntangible Assets and Goodwill*.  We assess the impairment of identifiable long-lived assets andrelated goodwill whenever events or changes in circumstances indicate that thecarrying value may not be recoverable in accordance with Statement of FinancialAccounting Standards, or SFAS No. 144. Factors we consider important and that could trigger an impairmentreview include the following:

 

•**                 **significantunderperformance of our assets relative to historical or projected futureoperating results;

 

•**                 **significantchanges in the manner in which we use our asset or in our overall businessstrategy; and

 

•**                 **significantnegative industry or economic trends.

 

We adopted SFAS No. 142 on January 1, 2002 and haveperformed a goodwill impairment test annually on January 1, since adoption, inaccordance with SFAS No. 142. Based on the results of the goodwill impairmenttest, we recorded an impairment loss of $1.3 million in the first quarter of2002 as a cumulative effect of change in accounting principle.  There was no impairment identified as ofJanuary 1, 2003.

 

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and

 

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Disclosure,” which amendsFASB Statement No. 123 to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation. In addition, SFAS No. 148 amends the disclosurerequirements of SFAS No. 123 to require prominent disclosures in both annualand interim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results.Finally, SFAS No. 148 amends APB Opinion No. 28, “Interim Financial Reporting,”to require disclosure about those effects in interim financial information.SFAS No. 148 is to be applied for financial statements for fiscal years endingafter December 15, 2002. In December 2002, we elected to adopt the recognitionprovisions of SFAS No. 123. We also elected to report the change in accountingprinciple using the prospective method in accordance with SFAS No. 148. Underthe prospective method, the recognition of compensation costs is applied to allemployee awards granted, modified or settled after the beginning of the fiscalyear in which the recognition provisions are first applied.

 

The foregoing list in not intended to be acomprehensive list of all of our accounting policies. In many cases, theaccounting treatment of a particular transaction is specifically dictated byaccounting principles generally accepted in the United States, with no need forus to judge the application. There are also areas in which our judgment inselecting any available alternative would not produce a materially differentresult. See our consolidated financial statements and related notes theretoincluded elsewhere in this quarterly report, which contain accounting policiesand other disclosures required by accounting principles generally accepted inthe United States.

 

**Recent Accounting Pronouncements**

 

In April 2002, the Financial Accounting StandardsBoard (FASB) issued SFAS No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrection,” which provides for the rescission of several previously issuedaccounting standards, new accounting guidance for the accounting of certainlease modifications and various technical corrections that are not substantivein nature to existing pronouncements. The Company adopted SFAS No. 145 onJanuary 1, 2003. The adoption of SFAS No. 145 required that theextraordinary gain on extinguishment of debt of $31.9 million be reclassifiedto operating expenses. Excluding the reclassification, the adoption of SFAS No.145 did not have a material impact on our financial position and results ofoperations.

 

In July 2002, the FASBissued SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities,” which requires companies to recognize costs associated with exitor disposal activities when they are incurred rather than at the date of acommitment to an exit or disposal plan. SFAS No. 146 is to be appliedprospectively to exit or disposal activities initiated after December 31, 2002.We do not expect SFAS No. 146 to have a material impact on our financial positionand results of operations.

 

In November 2002, FASBInterpretation No. (FIN) 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantors, Including Indirect Guarantees of Indebtedness ofOthers,” was issued. FIN 45 requires that upon issuance of a guarantee, theguarantor must recognize a liability for the fair value of the obligation itassumes under the guarantee.  Guarantorswill also be required to meet expanded disclosure obligations. The initial recognitionand measurement provision of FIN 45 are effective for guarantees issued afterDecember 31, 2002. The disclosure requirements are effective for annual andinterim financial statements that end after December 15, 2002, and had noimpact on the Company’s financial position or results of operations.

 

In January 2003, the FASBissued FASB Interpretation No. (FIN) 46, “Consolidation of Variable InterestEntities.” This interpretation of Accounting Research Bulletin 51,“Consolidated Financial Statements,” addresses consolidation by business enterprisesof variable interest entities that possess certain characteristics. Theinterpretation requires that if a business enterprise has a controllingfinancial interest in a variable interest entity, the assets, liabilities, andresults of the activities of the variable interest entity must be included inthe consolidated financial statements with those of the business enterprise.This interpretation applies immediately to variable interest entities createdafter January 31, 2003 and to variable interest entities in which an enterpriseobtains an interest after that date. We do not have any ownership in anyvariable interest entities as of June 30, 2003. We will apply the consolidationrequirement of the interpretation in future periods if we should own anyinterest in any variable interest entity.

 

In April 2003, the FASBissued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments andHedging Activities,” which amends and clarifies accounting and reporting forderivative instruments, including certain derivatives imbedded in othercontracts and for hedging activities as defined under FASB statement No. 133and FIN No. 45.  SFAS No. 149 iseffective for contracts entered into after June 30, 2003.  We do not expect the SFAS No. 149 to have amaterial impact on our financial position or statement of operations.

 

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In May 2003, the FASBissued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity,” which establishes standardsfor how an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument thatis within its scope as a liability or an asset in some circumstances.  SFAS No. 150 is effective for the firstinterim period beginning after June 15, 2003. We do not expect the SFAS No. 150 to have a material impact on ourfinancial position.

 

## **Revenues andExpenses**

 

We can group our revenues into the followingcategories:

 

•**                       ***Video revenues*.  Our video revenues consist of fixed monthly fees for expandedbasic, premium and digital cable television services, as well as fees frompay-per-view movies, fees for Video on Demand (VOD) and events such as boxingmatches and concerts, that involve a charge for each viewing. Video revenuesaccounted for approximately 42.0% and 42.1% of our consolidated revenues forthe three and six months ended June 30, 2003 compared to 43.5% and 43.8% for thethree and six months ended June 30, 2002. In providing video services wecurrently compete with Comcast, Time Warner Cable, Mediacom and Charter. Wealso compete with satellite television providers DirecTV and Echostar; othercable television providers; and broadcast television stations. We expect in thefuture to compete with telephone companies providing cable television servicewithin their service areas and with wireless cable companies.

 

•*                        Voicerevenues*.  Our voice revenuesconsist primarily of fixed monthly fees for local service, enhanced services,such as call waiting and voice mail, and usage fees for long-distance service.Voice revenues accounted for approximately 40.4% and 40.6% of our consolidatedrevenues for the three and six months ended June 30, 2003 compared to 41.0% and41.3% for the three and six months ended June 30, 2002. In providing local andlong-distance telephone services, we compete with the incumbent local phonecompany and various wireless long distance providers in each of our markets.BellSouth is the incumbent local and long distance phone company and is aparticularly strong competitor in our current markets and throughout thesoutheastern United States. We also compete with long-distance phone companiessuch as AT&T, WorldCom, BellSouth and Sprint.

 

•*                        Datarevenues and other revenues.*Our data revenues consist primarily of fixedmonthly fees for Internet access service and rental of cable modems. Otherrevenues result principally from broadband carrier services and video productionservices. These combined revenues accounted for approximately 17.6% and 17.3%of our consolidated revenues for the three and six months ended June 30, 2003compared to 15.5% and 14.9% for the three and six months ended June 30, 2002.Providing data services is a rapidly growing business and competition isincreasing in each of our markets. Some of our competitors, traditional dial-upproviders in particular, have competitive advantages such as greaterexperience, resources, marketing capabilities and stronger name recognition. Inproviding data services, we compete with traditional dial-up Internet serviceproviders; incumbent local exchange providers that provide digital subscriberlines, or DSL; providers of satellite-based Internet access services;long-distance telephone companies; and cable television companies. We alsoexpect to compete in the future with providers of wireless high-speed dataservices.

 

As we continue to sell bundled services, we expectthat our voice and data and other revenues will continue to increase at ahigher rate compared to video revenues. Accordingly, we expect that our voiceand data and other revenues will represent a higher percentage of consolidatedrevenues in the future.

 

Our operating expenses include cost of services,selling, operations and administrative expenses and depreciation andamortization.

 

Cost of services include:

 

•*                        Video costof services.*Video cost of services consists primarily of monthly fees tothe National Cable Television Cooperative and other programming providers andare generally based on the average number of subscribers to each program.Programming costs as a percentage of video revenue were approximately 44.5% and46.2% for the three and six months ended June 30, 2003 compared to the 47.1%and 47.4% for the three and six months ended June 30, 2002.  The decrease in programming costs as apercentage of revenue for the three and six months ended June 30, 2003 resultedfrom price increases for our video products in 2003 in excess of cost increases.  Programming costs are our largest singlecost and we expect this to continue. Since programming cost is partially basedon numbers of subscribers, it will increase as we add more subscribers.Additionally, programming cost will

 

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increase as costs perchannel increase over time.

 

•*                        Voice costof services.*Voice cost of services consists primarily of transport costand network access fees. The voice cost of services as a percentage of voicerevenues were approximately 16.3% and 17.0% for the three and six months endedJune 30, 2003 compared to 17.5% and 17.9% for the three and six months endedJune 30, 2002.  The decrease in voicecost of services as a percentage of revenue for the three and six months endedJune 30, 2003 resulted from price increases for our voice products in 2003 andthe grooming of our network for increased capacity at reduced costs.

 

•*                        Data andother cost of services.*Data and other cost of services consist primarilyof transport cost and network access fees. The data and other cost of servicesas a percentage of data and other revenue were 5.8% and 5.8% for the three andsix months ended June 30, 2003 compared to 9.8% and 8.6% for the three and sixmonths ended June 30, 2002.  The decreasein data cost of services as a percentage of revenue for the three and sixmonths ended June 30, 2003 resulted from price increases for our data productsin 2003 and the grooming of our network for increased capacity at reducedcosts.

 

We expect the growth of new video connections todecrease as the video segment matures in our current markets. While the numberof new video connections may decrease, management feels that opportunity toincrease revenue and video margins is available with the introduction of newproducts and new technology. New voice and data connections are expected toincrease with sales and marketing efforts directed at selling customers abundle of services, penetrating untapped market segments and offering newservices. Relative to our current product mix, voice and data revenue willbecome larger percentages of our overall revenue, and potentially will providehigher margins. Based on the anticipated changes in our revenue mix, we expectthat our consolidated cost of services as a percentage of our consolidatedrevenues will decrease.

 

Selling, operations and administrative expensesinclude:

 

•**                 ***Sales and marketing expenses*. Sales andmarketing expenses include the cost of sales and marketing personnel andadvertising and promotional expenses.

 

•***                 ****Network operations and maintenance expenses*.Network operations and maintenance expenses include payroll and departmentalcosts incurred for network design, maintenance monitoring and maintenance.

 

•*                  Service andinstallation expenses*. Service and installation expenses include payrolland departmental cost incurred for customer installation and service personnel.

 

•*                  Customer serviceexpenses*. Customer service expenses include payroll and departmental costsincurred for customer service representatives and management.

 

•*                  General andadministrative expenses*. General and administrative expenses consist ofcorporate and subsidiary management and administrative costs.

 

Depreciation and amortization expenses includedepreciation of our interactive broadband networks and equipment andamortization of costs in excess of net assets and other intangible assetsrelated to acquisitions. For periods beginning after January 1, 2002, we nolonger amortize goodwill related to acquisitions in accordance with SFAS 142.

 

As our sales and marketing efforts continue and ournetworks expand, we expect to add customer connections resulting in increasedrevenue. We also expect our operating expenses, including depreciation andamortization, to increase as we expand our networks and business.

 

We have experienced operating losses as a result ofthe expansion of our advanced broadband communications networks and servicesinto new and existing markets. We expect to continue to focus on increasing ourcustomer base and expanding our broadband operations. Accordingly, we expectthat our operating expenses and capital expenditures will continue to increaseas we extend our interactive broadband networks in existing and new markets inaccordance with our business plan.

 

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**Connections**

 

The following table sets forth the number ofconnections and marketable homes passed as of June 30, 2003 and 2002. Theinformation provided in the table reflects revenue-generating connections. Becausewe deliver multiple services to our customers, we report the total number ofrevenue-generating service connections for video, voice and data rather thanthe total number of customers. For example, a single customer who purchasescable television, local telephone and Internet access services would count asthree connections.

 

|                        |   | **AS OF JUNE 30,** |
|-----------------------------|--------|--------------------|
|                        |   | **2003******       |   | **2002****** |   |
| Connections:(1)             |   |               |   |   |   |
| Video                       |   | 132,163            |   | 124,707 |   |
| Voice:                      |   |               |   |   |   |
| On-net                      |   | 115,268            |   | 94,969 |   |
| Off-net                     |   | 5,332              |   | 5,895 |   |
| Data                        |   | 58,031             |   | 41,464 |   |
|                        |   |               |   |   |   |
| Total  connections          |   | 310,794            |   | 267,035 |   |
|                        |   |               |   |   |   |
| Marketable  homes passed(2) |   | 443,159            |   | 429,399 |   |

** **

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(1) All of our video and data connections are providedover our networks. Our voice connections consist of both “On-net” and “Off-net”connections. On-net refers to lines provided over our networks. It includes25,371 and 23,899 lines as of June 30, 2003 and 2002, respectively, usingtraditional copper telephone lines. Off-net refers to telephone connectionsprovided over telephone lines leased from third parties.

 

(2) Marketable homes passed are the number of businessand residential units, such as single residence homes, apartments andcondominium units, passed by our broadband networks and listed in our recordsdatabase other than those we believe are covered by exclusive arrangements withother providers of competing services.

 

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**RESULTS OF OPERATIONS**

 

**SIXMONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002**

 

The following table setsforth financial data as a percentage of operating revenues for the six monthsended June 30, 2003 and 2002.

 
|                                                                              |   | **SIX MONTHS ENDED JUNE 30,** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                              |   | **2003**                      |   | **2002** |   |
| Operating  revenues:                                                              |   |                          |   |   |   |
| Video                                                                             |   | 42                            | %      | 44 | % |
| Voice                                                                             |   | 41                            |   | 41 |   |
| Data                                                                              |   | 17                            |   | 15 |   |
| Total                                                                             |   | 100                           |   | 100 |   |
| Cost  of Service:                                                                 |   |                          |   |   |   |
| Video                                                                             |   | 19                            |   | 21 |   |
| Voice                                                                             |   | 7                             |   | 8 |   |
| Data                                                                              |   | 1                             |   | 1 |   |
| Total                                                                             |   | 27                            |   | 30 |   |
| Margin                                                                            |   |                          |   |   |   |
| Video                                                                             |   | 23                            |   | 23 |   |
| Voice                                                                             |   | 34                            |   | 33 |   |
| Data                                                                              |   | 16                            |   | 14 |   |
| Total                                                                             |   | 73                            |   | 70 |   |
| Operating  expenses:                                                              |   |                          |   |   |   |
| Selling,  operating and administrative                                            |   | 55                            |   | 58 |   |
| Depreciation  and amortization                                                    |   | 47                            |   | 59 |   |
| Reorganization  professional fees                                                 |   | 0                             |   | 0 |   |
| Asset  impairment                                                                 |   | 0                             |   | 1 |   |
| Non-cash  stock option compensation                                               |   | 1                             |   | 0 |   |
| Litigation  fees                                                                  |   | 1                             |   | 0 |   |
| Total                                                                             |   | 104                           |   | 118 |   |
|                                                                              |   |                          |   |   |   |
| Operating  loss                                                                   |   | (31                           | )      | (48 | ) |
| Other  income and (expense)                                                       |   | (17                           | )      | (28 | ) |
| Loss  before income taxes and cumulative effect of change in accounting principle |   | (48                           | )      | (76 | ) |
|                                                                              |   |                          |   |   |   |
| Income  tax benefit (provision)                                                   |   | 0                             |   | 0 |   |
|                                                                              |   |                          |   |   |   |
| Cumulative  effect of change in accounting principle                              |   | 0                             |   | (2 | ) |
| Net  loss                                                                         |   | (48                           | )%     | (78 | )% |

 

*Revenues.*   Operatingrevenues increased 24.9% from $66.9 million for the six months ended June 30,2002, to $83.6 million for the six months ended June 30, 2003.  Operating revenues from video servicesincreased 19.9% from $29.3 million for the six months ended June 30, 2002 to$35.2 million for the same period in 2003. Operating revenues from voice services increased 22.7% from $27.6million for the six months ended June 30, 2002 to $33.9 million for the sameperiod in 2003. Operating revenue from data and other services increased 45.3%from $10.0 million for the six months ended June 30, 2002 to $14.5 million forthe same period in 2003.

 

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The increased revenuesfor video, voice and data and other services are primarily due to rateincreases and an increase in the number of connections, from 267,035 as of June30, 2002 to 310,794 as of June 30, 2003. The additional connections resulted primarily from:

 

•      New plans specificallymarketed to increase sales from existing customers.  Penetration increased 7.9% from 62.2% at June 30, 2002 to 70.1%at June 30, 2003.

 

•      Salesof voice and data services accounted for approximately 84% of the additionalconnections added from June 30, 2002 through June 30, 2003.  We gained these connections by offeringcompetitive plans with the focus on bundling customers.  In addition, we launched the new “IntroNet”product in March, 2002, which is exclusively available to bundle customers.

 

•      The continued constructionof the broadband network in the Knoxville market.

 

We expect the growth inthe number of new video connections to decrease as the video segment matures inour current markets. While the number of new video connections may decrease, webelieve that the opportunity to increase revenue and video margins is availablewith the introduction of new products and new technology. New voice and dataconnections are expected to increase with sales and marketing efforts directedat selling customers a bundle of services, penetrating untapped market segmentsand offering new services. Relative to our current product mix, voice and datarevenue will become larger percentages of our overall revenue, and potentiallywill provide higher margins. Based on the anticipated changes in our revenuemix, we expect that our consolidated cost of services as a percentage ofconsolidated revenues will decrease.

 

*Costof Services*.    Cost of servicesincreased 15.8% from $19.7 million for the six months ended June 30, 2002, to$22.8 million for the six months ended June 30, 2003.  Cost of services for video services increased 16.8% from $13.9million for the six months ended June 30, 2002, to $16.2 million for the sameperiod in 2003.  Cost of services forvoice services increased 16.1% from $5.0 million for the six months ended June30, 2002, to $5.7 million for the same period in 2003.  Cost of services for data and other servicesdecreased 2.0% from $858,000 for the six months ended June 30, 2002, to$841,000 for the same period in 2003. We expect our cost of services tocontinue to increase as we add more connections. Programming costs, which areour largest single expense item, have been increasing over the last severalyears on an aggregate basis due to an increase in subscribers and on a persubscriber basis due to an increase in costs per program channel. We expectthis trend to continue. We may not be able to pass these higher costs on tocustomers because of competitive forces, which would adversely affect our cashflow and operating margins.

 

*OperatingMargins*.    Margins increased 28.7% from$47.2 million for the six months ended June 30, 2002, to $60.7 million for thesix months ended June 30, 2003.  Marginsfor video services increased 22.7% from $15.4 million for the six monthsended June 30, 2002, to $18.9 million for the same period in 2003.  Margins for voice services increased 24.2%from $22.7 million for the six months ended June 30, 2002, to $28.1 million forthe same period in 2003.  Margins fordata and other services increased 49.8% from $9.1 million for the six monthsended June 30, 2002, to $13.7 million for the same period in 2003.

 

*OperatingExpenses*.    Operating expenses,excluding depreciation and amortization, increased 17.3% from $39.0 million forthe six months ended June 30, 2002, to $45.7 million for the six months endedJune 30, 2003.  The increase in ouroperating expenses is consistent with the growth in revenues and connections,and is a result of the continued expansion of our operations.  Selling, operations and administrativeexpenses will increase operating expenses as we expand our markets.

 

Depreciation andamortization increased from $39.2 million for the six months ended June 30,2002, to $39.4 million for the six months ended June 30, 2003. We expectdepreciation and amortization expense to increase as we make capitalexpenditures to extend our existing networks and build additionalnetworks.  We have ceased amortizationof goodwill in accordance with the adoption of SFAS No. 142.

 

We expensed $43,000 ofreorganization professional fees associated with our financialrestructuring.  We recognized $852,000in asset impairment for the six months ended June 30, 2002.  We adopted SFAS No. 123 and recorded anon-cash stock option compensation expense of $905,000 for the six months endedJune 30, 2003.  We expensed $611,000 forthe six months ended June 30, 2003 in litigation fees arising from a federalcourt action against Insight Communications Company, Inc.

 

*OtherIncome and Expense, Including Interest Income and Interest Expense.*    Ourtotal other expense decreased from $18.9 million for the six months ended June30, 2002 to $14.0 million for the six months ended June 30, 2003.  Interest income was $211,000 for the six monthsended June 30, 2002, compared to $210,000 for the same period in 2003.  The decrease in 

 

16

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interest income primarilyreflects the lower average cash balances in interest bearing accounts for thesix months ended June 30, 2003 compared to the six months ended June 30,2002.  Interest expense decreased from$21.9 million for the six months ended June 30, 2002, to $14.3 million for thesix months ended June 30, 2003.  Theinterest expense is principally the in-kind interest on the new Knologynotes.  We expect interest expense in2003 to be significantly lower than in prior years as a result of our financialrestructuring.  Although the interestrate payable on the new Knology notes is comparable to the rate payable on thecanceled Broadband notes, the aggregate amount of the notes outstanding issubstantially lower.  Gain on adjustment of warrants to market was$2.9 million for the six months ended June 30, 2002.  Other income/expenses, net decreased fromexpense of $91,000 for the six months ended June 30, 2002 to income of $86,000for the six months ended June 30, 2003. The expense for the six months ended June, 30 2002 consisted of thewrite-off of investment and leasehold improvement balances.  The income for the six months ended June 30,2003 consisted of dividends received from CoBank.

 

*IncomeTax Provision.*  We recorded a tax provision of$119,000 for the six months ended June 30, 2002, compared to no income taxprovision for the same period in 2003, representing a state tax provisionrelated to the telephone operations group subsidiaries.

 

*Loss Before Cumulative Effect ofChange in Accounting Principle*.  We incurred a loss before cumulative effect of change inaccounting principle of $50.8 million for the six months ended June 30, 2002,compared to income before cumulative effect of change in accounting principleof $39.9 million for the six months ended June 30, 2003.

 

*Cumulative Effect of Change inAccounting Principle.  *We adopted SFAS No. 142 onJanuary 1, 2002. We performed a goodwill impairment test in accordance withSFAS 142 and based on the results of this test we recorded an impairment lossof $1.3 million for the six months ended June 30, 2002.

 

*NetLoss.*  We incurred a net loss of $52.1 million forthe six months ended June 30, 2002, compared to a net loss of $39.9 million forthe six months ended June 30, 2003.  Weexpect net losses to continue.

 

# **THREEMONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002**

 

The following table setsforth financial data as a percentage of operating revenues for the three monthsended June 30, 2003 and 2002.

 

|                                                                              |   | **THREE  MONTHS ENDED  JUNE 30,** |   |
|-----------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                              |   | **2003**                          |   | **2002** |   |
| Operating  revenues:                                                              |   |                              |   |   |   |
| Video                                                                             |   | 42                                | %      | 44 | % |
| Voice                                                                             |   | 40                                |   | 41 |   |
| Data  and other                                                                   |   | 18                                |   | 15 |   |
|                                                                              |   |                              |   |   |   |
| Total                                                                             |   | 100                               |   | 100 |   |
| Operating  expenses:                                                              |   |                              |   |   |   |
| Cost  and expenses, excluding depreciation and amortization                       |   | 80                                |   | 86 |   |
| Depreciation  and amortization                                                    |   | 46                                |   | 59 |   |
| Non-cash  stock option compensation                                               |   | 1                                 |   | 0 |   |
| Litigation  Fees                                                                  |   | 1                                 |   | 0 |   |
| Total                                                                             |   | 128                               |   | 145 |   |
| Operating  loss                                                                   |   | (28                               | )      | (45 | ) |
| Other  income and expenses, net                                                   |   | (17                               | )      | (24 | ) |
| Loss  before income taxes and cumulative effect of change in accounting principle |   | (45                               | )      | (69 | ) |
| Income  tax provision                                                             |   | (0                                | )      | (1 | ) |
| Loss  before cumulative effect of change in accounting principle                  |   | (45                               | )      | (70 | ) |
|                                                                              |   |                              |   |   |   |
| Net  loss                                                                         |   | (45                               | )%     | (70 | )% |

 

*Revenues*. Operating revenues increased 22.9% from$34.9 million for the three months ended June 30, 2002, to $42.9 million forthe three months ended June 30, 2003. Operating revenues from video servicesincreased 18.6% from $15.2 million 

 

17

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for the three months ended June 30, 2002 to $18.0 million for the sameperiod in 2003. Operating revenues from voice services increased 21.3% from$14.3 million for the three months ended June 30, 2002 to $17.3 million for thesame period in 2003. Operating revenue from data and other services increased39.3% from $5.4 million for the three months ended June 30, 2002 to $7.6million for the same period in 2003.

 

*Cost ofServices*.  Cost of services increased 10.6% from $10.2million for the three months ended June 30, 2002, to $11.2 million for thethree months ended June 30, 2003. Cost of services for video services increased12.0% from $7.1 million for the three months ended June 30, 2002, to $8.0million for the same period in 2003. Cost of services for voice servicesincreased 12.8 % from $2.5 million for the three months ended June 30, 2002, to$2.8 million for the same period in 2003. Cost of services for data and otherservices decreased 18.0 % from $531,000 for the three months ended June 30,2002, to $436,000 for the same period in 2003. Management expects our cost ofservices to continue to increase as we add more connections. Programming costs,which are our largest single expense item, have been increasing over the lastseveral years on an aggregate basis due to an increase in subscribers and on aper subscriber basis due to an increase in costs per program channel.Management expects this trend to continue. We may not be able to pass thesehigher costs on to customers because of competitive forces, which wouldadversely affect our cash flow and operating margins.

 

*OperatingMargins*.  Margins increased 28.0% from $24.7 millionfor the three months ended June 30, 2002, to $31.6 million for the three monthsended June 30, 2003. Margins for video services increased 24.4% from $8.0million for the three months ended June 30, 2002, to $10.0 million for the sameperiod in 2003.  Margins for voiceservices increased 23.1% from $11.8 million for the three months ended June 30,2002, to $14.5 million for the same period in 2003.  Margins for data and other services increased 45.6% from $4.9million for the three months ended June 30, 2002, to $7.1 million for the sameperiod in 2003.

 

*OperatingExpenses*.  Operating expenses, excluding depreciationand amortization, increased 14.8% from $20.0 million for the three months endedJune 30, 2002, to $23.0 million for the three months ended June 30, 2003.  The increase in our operating expenses isconsistent with the growth in revenues and connections, and is a result of thecontinued expansion of our operations. Selling, operations and administrative expenses will increase operatingexpenses as we expand into additional markets.

 

Depreciation andamortization was $20.6 million for the three months ended June 30, 2002 and$19.9 million for the three months ended June 30, 2003.

 

We expensed $43,000 ofreorganization professional fees associated with our financialrestructuring.  We adopted SFAS No. 123and recorded a non-cash stock option compensation expense of $478,000 for thethree months ended June 30, 2003.  Weexpensed $411,000 for the three months ended June 30, 2003 in litigation feesarising from a federal court action against Insight Communications Company,Inc.

 

*OtherIncome and Expense*.  Other income and expense, including interestincome and interest expense.  Our totalother expense decreased from $8.2 million for the three months ended June 30,2002 to $7.2 million for the three months ended June 30, 2003. Interest incomewas $82,000 for the three months ended June 30, 2002, compared to $96,000 forthe same period in 2003. Interest expense decreased from $11.1 million for thethree months ended June 30, 2002, to $7.3 million for the three months endedJune 30, 2003.  Gain on adjustment ofwarrants to market was $2.9 million for the three months ended June 30, 2002.Other expenses, net decreased from $115,000 for the three months ended June 30,2002 to no expense for the three months ended June 30, 2003.  The 2002 expense is primarily due to thewrite-off of investment and leasehold improvement balances.

 

*Income TaxProvision*.  We recorded $110,000 tax provision for thethree months ended June 30, 2002, compared to no income tax provision for thesame period in 2003, representing a state tax provision related to ourtelephone operations group subsidiaries.

 

*Net Loss.*  Weincurred a net loss of $24.3 million for the three months ended June 30, 2002,compared to a net loss of $19.5 million for the three months ended June 30,2003.  We expect net losses to continue.

 

**Liquidityand Capital Resources**

 

As of June 30, 2003, wehad net working capital of $16.9 million, compared to net working capital of$24.0 million as of December 31, 2002. The change in working capital from December 31, 2002, to June 30, 2003,is primarily due to a decrease in cash and an increase in unearned revenuepartially offset by a decrease in accrued liabilities and accounts payable.

 

18

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Net cash provided byoperations totaled $8.1 million and $10.3 million for the six months ended June30, 2002 and 2003, respectively.  Thenet cash flow activity related to operations consists primarily of changes inoperating assets and liabilities and adjustments to net income for non-cashtransactions including:

 

•                  depreciation andamortization;

 

•                  non-cash stockoptions compensation;

 

•                  non-cash bondinterest expense;

 

•                  cumulativeeffect of change in accounting principle;

 

•                  provision forbad debt; and

 

•                  loss ondisposition of assets.

 

Net cash used for investingactivities was $23.3 million and $18.6 million for the six months ended June30, 2002 and 2003, respectively. Our investing activities for the six monthsended June 30, 2002, consisted of $23.2 million of capital expenditures and$312,000 of franchise expenditures partially offset by $236,000 in proceedsfrom the sale of assets.  Investingactivities for the six months ended June 30, 2003, consisted of $18.6 millionof capital expenditures and $76,000 of franchise expenditures partially offsetby $60,000 of proceeds from the sale of assets.

 

Net cash provided by financing activities was $3,000and net cash used for financing activities was $1.7 million for the six monthsended June 30, 2002 and 2003, respectively. Financing activities for the six months ended June 30, 2002, consistedof $3,000 of proceeds from exercised stock options.  Financing activities for the six months ended June 30, 2003,consisted primarily of $1.7 million of principal payments on debt.

 

**Funding to Date**

 

Knology has raised equity capital and borrowed moneyto finance a significant portion of its operating, investing and financingactivities in the development of its business.

 

*Debt Financings*.On October 22, 1997, Broadband received net proceeds of $242.4 million from theoffering of units consisting of the Broadband discount notes and warrants topurchase Broadband preferred stock. The Broadband discount notes were sold at asubstantial discount from their principal amount at maturity, and there was nopayment of cash interest on the Broadband discount notes scheduled prior toApril 15, 2003. The Broadband discount notes outstanding (excluding those heldby Valley Telephone) fully accreted to a face value of $379.9 million onOctober 15, 2002. From and after October 15, 2002, the Broadband discount notesbore interest, which would have been payable in cash, at a rate of 11 7/8% perannum on April 15 and October 15 of each year, commencing April 15, 2003. In November1999, Knology completed an exchange in which Knology received the Broadbandwarrants, issued in connection with the Broadband discount notes in 1997, inexchange for warrants to purchase shares of Knology Series A preferred stock.

 

In September 2001, Knology’s subsidiary, ValleyTelephone, repurchased Broadband discount notes with a face amount of$58.5 million and a carrying amount of $50.5 million as of the repurchasedate for approximately $20.3 million in cash. The transaction resulted in a gainof $29.4 million, consisting of a gain of $30.2 million due to the discount,offset by the write-off of $0.8 million in issue costs associated with theoriginal issuance of the Broadband discount notes in October 1997. In October2001, Valley Telephone repurchased Broadband discount notes with a face amountof $5.7 million for approximately $2.5 million in cash. Valley Telephoneused funds borrowed by its telephone operations group under the CoBank creditfacility to purchase the Broadband discount notes.  In total, Valley Telephone used approximately $22.8 million incash to repurchase $64.2 million aggregate principal amount, at maturity, ofBroadband discount notes during 2002.

 

On November 6, 2002, Knology and Broadband completed afinancial restructuring pursuant to a prepackaged plan of reorganization. Underthe plan, $379.9 million aggregate principal amount at maturity of Broadbanddiscount notes were exchanged for $193.5 million of new Knology notes,10,618,352 shares of Series D preferred stock and 21,701,279 shares of Series Epreferred stock.  The $64.2 million ofBroadband discount notes held by Valley Telephone were canceled in exchange fora limited guaranty by Broadband of the CoBank credit facility.

 

The completion of the restructuring enabled Knology tosignificantly lower its debt service requirements, which has improved itsliquidity and financial condition. After giving effect to the completion of therestructuring, Knology’s first interest 

 

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payment on the newKnology notes will be due two years after issuance (Knology presently intendsto pay interest incurred for the first 18 months in kind through the issuanceof additional notes) in the amount of $14.1 million, with consistent semiannualinterest payments due through the seventh anniversary of the issuance of thenew Knology notes. The old Broadband discount notes would have matured onOctober 15, 2007 with an aggregate amount due at maturity of $444.1 million.The new Knology notes will increase to the amount due of $235.5 million,assuming payment in kind of interest incurred during the first 18 months of thenew notes.

 

The indenture governing the new Knology notes placescertain restrictions on the ability of Knology and its subsidiaries to takecertain actions including the following:

 

•                  paydividends or make other restricted payments;

 

•                  incuradditional debt or issue mandatorily redeemable equity;

 

•**                 **create orpermit to exist certain liens;

 

•**                 **incurrestrictions on the ability of its subsidiaries to pay dividends or otherpayments;

 

•**                 **consolidate,merge or transfer all or substantially all its assets;

 

•**                 **enter intotransactions with affiliates;

 

•**                 **utilizerevenues except for specified uses;

 

•**                 **utilizeexcess liquidity except for specified uses;

 

•**                 **make capitalexpenditures for Knology of Knoxville, Inc.; and

 

•**                 **permit theexecutive officers of Knology to serve as executive officers or employees ofother entities in competition with Knology.

 

These covenants are subject to a number of exceptionsand qualifications.

 

On December 22, 1998, Broadband entered into a $50million four-year senior secured credit facility with Wachovia Bank, NationalAssociation (formerly First Union National Bank). The Wachovia credit facility,as amended and restated pursuant to the restructuring, allows Broadband toborrow approximately $15.5 million. The Wachovia credit facility may be usedfor working capital and other purposes, including capital expenditures andpermitted acquisitions. At Broadband’s option, interest will accrue based oneither the prime or federal funds rate plus applicable margin or the LIBOR rateplus applicable margin. The applicable margin may vary from 4.0% for Base RateLoans to 5.0% for LIBOR Rate Loans. The Wachovia credit facility contains anumber of covenants that restrict the ability of Broadband and its subsidiariesto take many actions, including the ability to:

 

•**                 **incurindebtedness;

 

•**                 **createliens;

 

•**                 **paydividends;

 

•**                 **makedistributions or stock repurchases;

 

•**                 **make investments;

 

•**                 **engage intransactions with affiliates;

 

•**                 **sell assets;and

 

•**                 **engage inmergers and acquisitions.

 

20

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The Wachovia credit facility also includes covenantsrequiring compliance with operating and financial ratios on a consolidatedbasis, including total leverage ratio and debt service coverage ratio.Broadband is currently in compliance with these covenants. Should Broadband notbe in compliance with the covenants, Broadband would be in default and wouldrequire a waiver from the lender. In the event the lender would not provide awaiver, amounts outstanding under the Wachovia credit facility could be payableto the lender on demand. A change of control of Broadband, as defined in theWachovia credit facility, would constitute a default under the covenants. TheWachovia credit facility allows Knology to make scheduled quarterly principalpayments beginning in the third quarter of 2004 with a final payment due in thesecond quarter of 2006.

 

The maximum amount available under the Wachovia creditfacility as of June 30, 2003, was approximately $15.5 million.  As of June 30, 2003, approximately $15.5million had been drawn against the facility.

 

Knology obtained an aggregate of approximately $39.4million in loans from ITC Holding and its subsidiary InterCall during November1999 and January 2000. Approximately $9.6 million was advanced to Knology inNovember 1999. This loan was converted into 2,029,724 shares of Series Apreferred stock in November 1999. Another $29.7 million loan was made inJanuary 2000. The loan bore interest at an annual rate of 11 7/8% and had amaturity date of March 31, 2000. In February 2000, the loan was converted intooptions to purchase up to 6,258,036 shares of Series A preferred stock, andKnology issued to ITC Holding a note under which it will pay ITC Holding anyproceeds from option exercises received by Knology. The options weredistributed to ITC Holding’s option holders on February 4, 2000.

 

On June 29, 2001, Knology through its wholly ownedsubsidiaries, Globe Telecommunications, Interstate Telephone and ValleyTelephone, entered into the credit facility with CoBank, a $40 million,10-year, secured master loan agreement. The CoBank credit facility, as amendedpursuant to the restructuring, allows the borrowers to make one or moreadvances in an amount not to exceed $38 million. The loan proceeds may be usedto finance capital expenditures, working capital and for general corporatepurposes of the borrowers. Interest is payable quarterly and will accrue, atKnology’s option, based on either a variable rate established by CoBank, afixed quoted rate established by CoBank or a LIBOR rate plus applicable margin.The applicable margin may vary from 1.5% to 3.0% based on the leverage ratio ofthe borrowers. The amended CoBank credit facility contains a number ofcovenants that restrict the ability of the borrowers to take many actions,including the ability to:

 

•**                 **incurindebtedness;

 

•**                 **createliens;

 

•**                 **merge orconsolidate with any other entity;

 

•**                 **makedistributions or stock repurchases;

 

•**                 **makeinvestments;

 

•**                 **engage intransactions with affiliates; and

 

•**                 **sell ortransfer assets.

 

The CoBank credit facility also includes covenantsrequiring compliance with certain operating and financial ratios of theborrowers on a consolidated basis, including a total leverage ratio and a debtservice coverage ratio. The borrowers are currently in compliance with thesecovenants, but there can be no assurances that the borrowers will remain incompliance. Should the borrowers not be in compliance with the covenants, theborrowers would be in default and would require a waiver from CoBank. In theevent CoBank would not provide a waiver, amounts outstanding under the CoBankcredit facility could be payable on demand.

 

As of June 30, 2003, Knology had $36.3 millionoutstanding under the CoBank credit facility.

 

On January 1, 2002, Knology extended to Broadband a$34.5 million subordinated intercompany loan facility. The intercompany loanfacility was guaranteed by the subsidiaries of Broadband and secured by asecond-priority lien and security interest in substantially all of the assetsof Broadband and its subsidiaries. The intercompany loan facility wassubordinated to the Wachovia credit facility. As a part of the restructuring, all indebtedness and obligations owingby Broadband to Knology, including all principal of, and accrued and unpaidinterest on, the intercompany loan facility and the unsecured note, wasdischarged and extinguished in full in exchange for a limited guaranty byBroadband of the CoBank credit facility.

 

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*Equity Financings*.   In connection with Knology’s spin-off from ITC Holding in February2000, Knology entered into an agreement with ITC Holding in which Knologyagreed to covenants that restricted its ability to issue additional shares ofcapital stock. In connection with its private placement of 31,166,667 shares ofits Series C preferred stock in January, 2001, ITC Holding agreed torelease Knology from these covenants pursuant to the agreement. Accordingly,Knology is no longer restrained by the ITC Holding agreement with respect tothe issuance of additional shares of capital stock.

 

In February 2000, Knology issued to accreditedinvestors in a private placement 21,180,131 shares of its Series B preferredstock at a purchase price of $4.75 per share, for aggregate proceeds of $100.6million.

 

On January 12, 2001, Knology issued to a group ofaccredited investors in a private placement 31,166,667 shares of its Series Cpreferred stock at a purchase price of $3.00 per share, for aggregate proceedsof $93.5 million. On March 30, 2001, Knology completed another privateplacement of 1,885,996 shares of Series C preferred stock to a group ofaccredited investors for approximately $5.7 million. On April 13, 2001, Knologycompleted another private placement of 2,621,930 shares of Series C preferredstock to a group of accredited investors for approximately $7.9 million. On June29, 2001, Knology completed another private placement of 1,544,970 shares ofSeries C preferred stock to a group of accredited investors for approximately$4.6 million. In connection with the completion of these private placements,Knology amended its amended and restated certificate of incorporation to adjustthe ratios at which Series A preferred stock and Series B preferred stockconvert into common stock. Prior to the completion of the private placements ofSeries C preferred stock, both the shares of Series A preferred stock andshares of Series B preferred stock converted into shares of common stock on aone-to-one basis. As amended, the conversion ratio for each share of Series Apreferred stock was adjusted to one-to-1.0371 and the conversion ratio for eachshare of Series B preferred stock was adjusted to one-to-1.4865, subject tofurther customary anti-dilution adjustments. With respect to the amendment ofthe conversion prices of the Series A preferred stock and Series Bpreferred stock, Knology recognized a non-cash dividend in the approximateamount of $36.6 million in the first quarter of 2001.

 

On November 6, 2002, Knology received $39.0 milliongross cash proceeds from the issuance of 13 million shares of Series Cpreferred stock in a private placement to two existing investors. Also onNovember 6, 2002, Knology issued 10,618,352 shares of Series D preferred stockand 21,701,279 shares of Series E preferred stock in exchange for a portion ofthe old Broadband discount notes and issued 66,399 shares of Series D preferredstock in payment to the financial advisor to the former holders of theBroadband discount notes.

 

**Future Funding**

 

In July 2003, Knology, through a wholly-ownedsubsidiary, entered into a definitive agreement to purchase certain assets fromVerizon Media Ventures, Inc. (“Verizon Media”) for $15.0 million cash, subjectto certain closing adjustments.  Pendingregulatory approvals, the transaction is expected to close by the end of theyear.  We have also entered into anagreement to issue to GLA New Ventures, LLC (“GLA”), warrants to purchase 10million shares of Knology, Inc. common stock as compensation for the release ofan agreement with Verizon Media granting GLA exclusive rights to negotiate withrespect to the purchase of the Verizon Media assets.  The purchase may be funded through equity infusions or additionalequity offerings, although there is no assurance that we will be successfulobtaining funding through these sources on terms acceptable to theCompany.  However, certain existingshareholders have provided a binding commitment to fund the purchase of theVerizon Media assets, if necessary.

 

We currently expect to spend approximately $50.0million - $60.0 million through 2005 to operate and upgrade the acquirednetworks.  These expenditures areexpected to be funded through internally generated cash flow, equity infusionsfrom certain existing shareholders and additional equity offerings.  There can be no assurance that we will besuccessful securing the funding necessary to complete our operating plan andupgrade.

 

Excluding the funding needs related to thecontemplated acquisition as described above, Knology, in 2003, expects to spendapproximately $40.0 million for capital expenditures, of which $14.1million relates to network construction and the remainder relates to thepurchase of customer premise equipment, such as cable set-top boxes and cablemodems, network equipment, including switching and transport equipment, andbilling and information systems. Knology has sufficient cash on hand andinternally generated cash flow to cover its planned operating expenses andcapital expenditures during 2003.  IfKnology decides to build additional or new broadband network, this would requireadditional funding to operate and for the capital expenditures necessary tofinance the construction and purchase of subscriber equipment.

 

22

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Following are the cash obligations for maturities oflong-term debt for each of the next five years as of June 30, 2003:

 
|                                |   | **In millions** |   |
|-------------------------------------|--------|----------------------|--------|
| 2003                                |   | $                    | 2.6    |   |
| 2004                                |   | 23.3                 |   |
| 2005                                |   | 42.0                 |   |
| 2006                                |   | 39.1                 |   |
| 2007                                |   | 33.8                 |   |
| Thereafter                          |   | 259.6                |   |
| Total  maturities of long-term debt |   | $                    | 400.4  |   |

 

Knology leases office space, utility poles, and otherassets for varying periods. Leases that expire are generally expected to berenewed or replaced by other leases. Future minimum rental payments requiredunder the operating leases that have initial or remaining non-cancelable leaseterms in excess of one year as of June 30, 2003 are as follows:

 
|                          |   | **In millions** |   |
|-------------------------------|--------|----------------------|--------|
| 2003                          |   | $                    | 1.0    |   |
| 2004                          |   | 1.6                  |   |
| 2005                          |   | 1.5                  |   |
| 2006                          |   | 1.2                  |   |
| 2007                          |   | 0.8                  |   |
| Thereafter                    |   | 3.0                  |   |
| Total  minimum lease payments |   | $                    | 9.1    |   |

 

Knology has received franchises to build networks inNashville, Tennessee and Louisville, Kentucky, although its franchise inLouisville is currently being contested by the incumbent cable provider.Knology spent approximately $6.6 million to obtain franchise agreements andperform preliminary construction activity in Nashville and Louisville. Amongthe covenants included in the indenture governing the new Knology notes is acovenant limiting the ability of Knology to fund expansion into new markets,including Nashville and Louisville, from operating cash flows or newborrowings. Knology does not intend to expand into Nashville, Louisville orother markets until the required funding is available.  Knology estimates the cost of constructingnetworks and funding initial subscriber equipment in these new cities as wellas others at approximately $750 to $1,000 per home. The actual costs of eachnew market may vary significantly from this range and will depend on the numberof miles of network to be constructed, the geographic and demographiccharacteristics of the city, population density, costs associated with thecable franchise in each city, the number of subscribers in each city, the mixof services purchased, the cost of subscriber equipment Knology pays for orfinances, utility requirements and other factors.

 

Knology has entered intocontracts with various entities to provide programming to be aired on Knology’snetworks. We pay a monthly fee as cost for the programming services, generallybased on the number of average subscribers to the program, although some feesare adjusted based on the total number of subscribers to the system and/or thesystem penetration percentage. Certain contracts have minimum monthly fees. Weestimate that we will pay approximately $34.7 million in programming fees underthese contracts during 2003.

 

**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to marketrisk from changes in interest rates. We manage our exposure to this market riskthrough our regular operating and financing activities. Derivative instrumentsare not currently used and, if used, are employed as risk management tools andnot for trading purposes.

 

We have no derivativefinancial instruments outstanding to hedge interest rate risk. Our onlyborrowings subject to market conditions are our borrowings under our creditfacilities, which are based on either a prime or federal funds rate plusapplicable margin or LIBOR plus applicable margin. Any changes in these rateswould affect the rate at which we could borrow funds under our bank creditfacilities. A hypothetical 10% increase in interest rates on our variable ratebank debt for the duration of one year would increase interest expense by animmaterial amount.

 

23

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**ITEM 4. CONTROLAND PROCEDURES**

 

Based on an evaluation carried out, as of the end ofthe period covered by this report, under the supervision and with theparticipation of the Company's management, including its Chief ExecutiveOfficer and Chief Financial Officer, the Chief Executive Officer and ChiefFinancial Officer have concluded that the Company's disclosure controls andprocedures (as defined in Rule 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934) are effective.  Asof the end of the period covered by this report, there have been no significantchanges in the Company's internal control over financial reporting that havematerially affected, or are reasonably likely to materially affect, theCompany's internal control over financial reporting.

 

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**PART II. OTHERINFORMATION**

 

**ITEM 1. LegalProceedings**

 

InSeptember 2000, the City of Louisville, Kentucky granted Knology of Louisville,Inc. a cable television franchise. Insight filed a complaint against the City of Louisville in state courtclaiming that Knology’s franchise was more favorable than Insight’sfranchise.  Insight’s complaintsuspended Knology’s franchise until there is a final, nonappealable order inInsight’s state court case.  In April2001 the City of Louisville moved for summary judgment in state court againstInsight.  In March 2002, the state courtruled that Insight’s complaint had no merit and the state court granted theCity’s motion to dismiss Insight’s complaint. Insight appealed the state court’s order dismissing their complaint andin June 2003 the state court of appeals upheld the lower court ruling.  Insight sought discretionary review of thecourt of appeals ruling by the Kentucky Supreme Court and that request ispending.

 

In November 2000, Knologyfiled a federal court action against Insight seeking monetary damages,declaratory and injunctive relief from Insight and the City arising out ofInsight’s complaint and the suspension of Knology’s franchise.  In March 2001, the federal court issued anOrder granting Knology’s motion for preliminary injunctive relief and denyingInsight’s motion to dismiss.  In June2003 the federal court ruled on the parties’ cross motions for summaryjudgment, resolving certain claims and setting others down for trial. At thistime it is impossible to determine with certainty the ultimate outcome of thelitigation.

 

**We are alsosubject to other litigation in the normal course of our business. However, inour opinion, there is no legal proceeding pending against us which would have amaterial adverse effect on our financial position, results of operations orliquidity. We are also a party to regulatory proceedings affecting the relevantsegments of the communications industry generally.**

 

# **ITEM 2. Changes in Securities and Use ofProceeds**

 

None

 

**ITEM 3. Default upon Senior Securities**

 

None

 

**ITEM 4. Submissionof Matters to a Vote of Security Holders**

 

At the 2003 annual meeting ofstockholders held on June 19, 2003, the holders of our common stock, Series Apreferred stock, Series B preferred stock, Series C preferred stock and SeriesD preferred stock, voting together as a single class on an as-converted basis,voted to re-elect Richard S. Bodman and L. Charles Hilton as Class I directorsfor a term to expire at the annual meeting of stockholders to be held in 2006,and the holders of our Series B preferred stock, voting as a separate class,re-elected William Laverack, Jr. and Bret D. Pearlman as Series B directors fora one-year term to expire at the annual meeting of stockholders to be held in 2004.

 

Each of Messrs. Bodman and Hilton waselected by 96,668,283 shares out of 146,008,842 shares of our common stock, onan as-converted basis, outstanding on the record date of June 19, 2003.  Each of Messrs. Laverack and Pearlman waselected by 17,167,894 shares out of 21,180,131 shares of our Series B preferredstock outstanding on the record date of June 19, 2003.

 

**ITEM 5. OtherInformation**

 

None

 

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**ITEM 6. Exhibits andReports on Form 8-K**

 

*(A)  EXHIBITS*

** **
| **Exhibit****No.** |                                                                                                                                                                                                                                                                                          | **Exhibit  Description**                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.1                |                                                                                                                                                                                                                                                                                          | Joint  Plan of Reorganization of Knology Broadband, Inc. filed with the United  States Bankruptcy Court for the Northern District of Georgia, Newnan  Division, by Knology, Inc. and Knology Broadband, Inc., on September 18,  2002, confirmed on October 22, 2002 and effective on November 6, 2002  (Incorporated herein by reference to Exhibit 2.1 to Knology, Inc.’s  Annual Report on Form 10-K for the year ended December 31, 2002.). |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.2*               |                                                                                                                                                                                                                                                                                          | Asset Purchase  Agreement, dated as of July 15, 2003, by and between Verizon Media Ventures,  Inc. and Knology New Media, Inc.                                                                                                                                                                                                                                                                                                                           |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.3*               |                                                                                                                                                                                                                                                                                          | Side Letter Agreement,  dated as of July 15, 2003, by and between Verizon Media Ventures Inc. and  Knology New Media, Inc.                                                                                                                                                                                                                                                                                                                               |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.4*               |                                                                                                                                                                                                                                                                                          | Agreement, dated as of July  15, 2003, between GLA New Ventures, LLC and Knology, Inc.                                                                                                                                                                                                                                                                                                                                                                   |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.1                |                                                                                                                                                                                                                                                                                          | Amended  and Restated Certificate of Incorporation of Knology, Inc. (Incorporated  herein by reference to Exhibit 4.1 to Knology Inc.’s Registration Statement  on Form S-8 (File No. 333-103248)).                                                                                                                                                                                                                                                 |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.2                |                                                                                                                                                                                                                                                                                          | Bylaws of Knology, Inc.  (Incorporated herein by reference to Exhibit 3.2 to Knology Inc. Registration  Statement on Form S-1 (File No. 333-89179)).                                                                                                                                                                                                                                                                                                     |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.1               |                                                                                                                                                                                                                                                                                          | Certification of President  and Chief Executive Officer of Knology, Inc. pursuant to Securities  Exchange Act Rules 13a-15(e) and 15d-15(e) (Section 302 of the  Sarbanes-Oxley Act of 2002).                                                                                                                                                                                                                                                  |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 31.2               |                                                                                                                                                                                                                                                                                          | Certification of Chief  Financial Officer of Knology, Inc. pursuant to Securities Exchange Act Rules 13a-15(e) and  15d-15(e) (Section 302 of the Sarbanes-Oxley Act of 2002).                                                                                                                                                                                                                                                                 |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 32.1               |                                                                                                                                                                                                                                                                                          | Statement of the Chief  Executive Officer of Knology, Inc. pursuant to 18 U.S.C. § 1350 (Section 906  of the Sarbanes-Oxley Act of 2002).                                                                                                                                                                                                                                                                                                           |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 32.2               |                                                                                                                                                                                                                                                                                          | Statement of the Chief  Financial Officer of Knology, Inc. pursuant to 18 U.S.C. § 1350 (Section 906  of the Sarbanes-Oxley Act of 2002).                                                                                                                                                                                                                                                                                                           |
|               |                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|                    |
| *                  | Confidential treatment  has been requested pursuant to Rule 24b-2 of the Securities Exchange Act of  1934, as amended. The copy on file as an exhibit omits the information  subject to the confidentiality request. Such omitted information has been  filed separately with the Commission. |
|                    |                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  |

** **

*(B)  REPORTS ON FORM8-K*

 

On May 13, 2003, Knologyfurnished pursuant to Item 9 a Current Report on Form 8-K, which included apress release announcing its 2003 first quarter results.

 

On July 18, 2003, Knologyfurnished pursuant to Item 9 a Current Report on Form 8-K, which included apress release announcing it has entered into a definitive agreement to purchasecertain assets from Verizon New Media Ventures, Inc.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|            | **KNOLOGY, INC.** |
|-----------------|-------------------|
|            |              |   |
| August 13, 2003 | By:               |   /s/ Rodger L. Johnson |
|            |              |   Rodger L. Johnson |
|            |              |   President and Chief Executive Officer |
|            |              |   |
|            |              |   |
| August 13, 2003 | By:               |   /s/ Robert K. Mills |
|            |              |   Robert K. Mills |
|            |              |   Chief Financial Officer |
|            |              |   (Principal Financial Officer) |

 

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