<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition periods from to
Commission file number 0-22825
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 22-3498533
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
105 Carnegie Center
Princeton, New Jersey 08540
(Address of principal executive offices)
(Zip Code)
(609) 734-3700
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of October 31, 1997.
Common Stock 27,484,676
<PAGE>
RCN CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations-Quarters and Nine Months Ended
September 30, 1997 and 1996
Condensed Consolidated Balance Sheets-
September 30, 1997 and December 31, 1996
Condensed Consolidated Statements of
Cash Flows-Nine Months Ended September 30,
1997 and 1996
Notes to Condensed Consolidated Financial
Statements
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial
Condition
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RCN CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Dollars in Thousands Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
September 30 September 30
------------------------ -----------------------
1997 1996 1997 1996
<S> <C> <C> <C> <C>
SALES $31,148 $26,746 $91,854 $75,763
COSTS & EXPENSES, EXCLUDING
DEPRECIATION AND AMORTIZATION 35,480 17,558 91,183 54,599
NONRECURRING CHARGES - - 10,000 -
DEPRECIATION AND AMORTIZATION 13,680 9,207 39,135 27,037
-------- ------- --------- -------
OPERATING (LOSS) (18,012) (19) (48,464) (5,873)
INTEREST INCOME 3,681 6,159 13,442 19,750
INTEREST EXPENSE (3,331) (4,795) (10,460) (12,553)
OTHER INCOME (EXPENSE), NET (371) (12) 229 (473)
-------- ------- --------- -------
INCOME (LOSS) BEFORE INCOME TAXES (18,033) 1,333 (45,253) 851
(BENEFIT) FOR INCOME TAXES (4,764) (389) (11,907) (68)
-------- ------- --------- -------
INCOME (LOSS) BEFORE EQUITY IN UNCONSOLIDATED
ENTITITES AND MINORITY INTEREST (13,269) 1,722 (33,346) 919
EQUITY IN LOSS OF UNCONSOLIDATED ENTITIES (1,089) (393) (2,650) (1,692)
MINORITY INTEREST IN LOSS OF
CONSOLIDATED ENTITIES 2,543 301 3,931 211
-------- ------- --------- -------
INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE (11,815) 1,630 (32,065) (562)
EXTRAORDINARY CHARGE -DEBT PREPAYMENT PENALTY,
NET OF TAX (3,210) - (3,210) -
-------- ------- --------- -------
NET INCOME (LOSS) ($15,025) $1,630 ($35,275) $(562)
========= ======= ========= =======
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Continued)
<TABLE>
<CAPTION>
RCN CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Dollars in Thousands Except Per Share Amounts)
(Unaudited)
Quarter Ended Nine Months Ended
September 30 September 30
------------------------------------ ------------------------------------
1997 1996 1997 1996
<S> <C> <C> <C> <C>
EARNINGS (LOSS) PER AVERAGE COMMON SHARE
INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE ($0.43) $0.06 ($1.17) $(0.02)
============== ============== ============== ==============
EXTRAORDINARY CHARGE-DEBT PREPAYMENT PENALTY (0.12) - (0.12) -
============== ============== ============== ==============
NET INCOME (LOSS) TO SHAREHOLDERS ($0.55) $0.06 ($1.28) (0.02)
============== ============== ============== ==============
AVERAGE SHARES OUTSTANDING 27,484,566 27,446,167 27,481,298 27,445,167
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
RCN CORPORATION
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars) September 30 December 31
1997 1996
------------ -----------
<S> <C> <C>
ASSETS
Current Assets
Cash and temporary cash investments $183,337 $61,843
Short-term investments - 46,831
Accounts receivable from related parties 19,985 12,614
Accounts receivable, net of reserve for
doubtful accounts of $1,741 at September 30, 1997 and
$861 in 1996 20,665 11,257
Material and supply inventory, at average cost 2,428 1,140
Prepayments and other 15,796 4,556
Deferred income taxes 4,857 4,371
------------ -----------
Total current assets 247,068 142,612
------------ -----------
Notes receivable - affiliates - 155,481
Property, Plant and Equipment
Hybrid fiber/coaxial plant 173,013 161,433
Other property, plant and equipment 100,947 58,924
------------ -----------
Total property, plant and equipment 273,960 220,357
Accumulated depreciation 101,544 84,529
------------ -----------
Net property, plant and equipment 172,416 135,828
------------ -----------
Investments 71,752 76,547
Intangible Assets, Net 103,027 93,471
Deferred Charges and Other Assets 4,416 24,146
------------ -----------
Total Assets $598,679 $628,085
============ ===========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
RCN CORPORATION
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars) September 30 December 31
1997 1996
---------------- ----------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable to related parties $ 12,766 $ 4,880
Accounts payable 22,395 13,642
Advance billings and customer deposits 7,982 6,859
Accrued taxes - 1,950
Accrued interest 845 5,041
Accrued contract settlements 3,158 3,565
Accrued cable programming expense 2,231 3,188
Accrued expenses 23,064 18,167
---------------- ----------------
Total current liabilities 72,441 57,292
---------------- ----------------
Long-Term Debt 110,000 131,250
Notes Payable - affiliates - 11,854
Deferred Income Taxes 24,992 28,245
Other Deferred Credits 2,570 3,290
Minority Interest 14,916 5,389
Commitments and Contingencies
Common Shareholders' Equity 373,760 390,765
---------------- ----------------
Total Liabilities and Shareholders' Equity $598,679 $628,085
================ ================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements
<PAGE>
RCN CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
1997 1996
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 202 $ (2,607)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant & equipment (43,890) (28,383)
Purchase of loan receivable - (13,088)
Purchases of short-term investments - (66,328)
Sales and maturities of short-term investments 46,935 133,006
Acquisitions (30,490) (29,406)
Proceeds from sale of partnership interest 1,900 -
Other 4,275 2,815
---------- ----------
Net cash used in investing activities (21,270) (1,384)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of Long-term Debt 110,000 19,000
Redemption of long-term debt (131,250) (25,750)
Transfer from CTE 132,231 61,780
Transfer (to) CTE (112,046) (72,176)
Change in affiliate notes 143,627 38,832
---------- ----------
Net cash (used in) financing activities 142,562 21,686
---------- ----------
Net increase (decrease) in cash and
temporary cash investments 121,494 17,695
Cash and temporary cash investments at beginning of year 61,843 37,998
---------- ----------
Cash and temporary cash investments at September 30, $ 183,337 $ 55,693
========== ==========
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of amounts capitalized) $ 14,656 $ 15,818
========== ==========
Income taxes $ 743 $ 435
========== ==========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements
<PAGE>
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars, except per share amounts)
1. The Condensed Consolidated Financial Statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, in the opinion of the
Management of the Company, the Condensed Consolidated Financial Statements
include all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the financial information. The Condensed
Consolidated Financial Statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10
Information Statement, the date of which is September 5, 1997.
2. Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). On September 30, 1997, C-TEC distributed 100 percent of
the outstanding shares of common stock of its wholly owned subsidiaries, RCN
Corporation ("RCN") and Cable Michigan, Inc. ("Cable Michigan") to holders of
record of C-TEC's Common Stock and C-TEC's Class B Common Stock as of the close
of business on September 19, 1997 (the "Distribution") in accordance with the
terms of a Distribution Agreement dated September 5, 1997 among C-TEC, RCN and
Cable Michigan. RCN consists primarily of C-TEC's high growth, bundled
residential voice, video and Internet access operations in the Boston to
Washington, D.C. corridor, its existing New York, New Jersey and Pennsylvania
cable television operations, a portion of its long distance operations and its
international investment in Megacable, S.A. de C.V. Cable Michigan, Inc.
consists of C-TEC's Michigan Cable operations, including its 62% ownership in
Mercom, Inc. C-TEC, RCN and Cable Michigan have entered into certain agreements
providing for the Distribution, and governing various ongoing relationships
between the three companies, including a distribution agreement and a tax-
sharing agreement. The historical financial information presented herein
reflects periods during which the Company did not operate as an independent
company and accordingly, certain assumptions were made in preparing such
financial information. Such information, therefore, may not necessarily reflect
the results of operations or the financial condition of the Company which would
have resulted had the Company been an independent, public company during the
reporting periods, and are not necessarily indicative of the Company's future
operating results or financial condition. As part of C-TEC's restructuring,
C-TEC changed its name to Commonwealth Telephone Enterprises, Inc. ("CTE").
3. The Company owns a forty percent equity interest in Megacable, S.A. de C.V.
("Megacable"). For the quarters ended September 30, 1997 and 1996, the Company
recorded equity in the earnings (loss) of Megacable which consists of its
proportionate share of income and amortization of excess cost over equity in net
assets of ($930) and ($393), respectively. For the nine months ended
September 30, 1997 and 1996, the Company recorded equity in the earnings (loss)
of Megacable which consists its proportionate share of income and amortization
of excess cost over equity in net assets of ($2,477) and ($1,692), respectively.
Summarized information for the financial position and results of operations of
Megacable, as of and for the nine months ended September 30, 1997 and 1996, is
as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Assets $76,217 $70,704
Liabilities 8,055 9,696
Shareholders' equity 68,162 61,008
Sales 22,281 17,202
Cost and expenses 15,231 11,251
Foreign currency transaction losses - 8
Net income $ 6,827 $ 7,546
</TABLE>
3
<PAGE>
Effective January 1, 1997, since the three-year cumulative rate of inflation at
December 31, 1996 exceeded 100%, Mexico is being treated for accounting purposes
as having a highly inflationary economy. Therefore, the U.S. dollar is treated
as the functional currency and translation adjustments are included in income.
The Company's proportionate share of such adjustments were gains (losses) of $27
and ($19), for the three and nine month periods ended September 30, 1997,
respectively.
4. The Company has in place a $125,000 credit agreement for C-TEC Cable
Systems, Inc. comprised of two credit facilities. The first is a five year
revolving credit facility in the amount of $25,000 which provides credit
availability through June 30, 2002. Revolving loans may be repaid and reborrowed
from time to time. The second is a term credit facility in the amount of
$100,000 which is to be repaid over six years in quarterly installments from
September 30, 1999 through June 30, 2005. Interest only is due through June 30,
1999. The interest rate will be based on either a LIBOR or Base Rate option, at
the election of RCN (6.77% at September 30, 1997). The credit agreement is
unsecured. At September 30, 1997, the entire $100,000 term credit facility is
outstanding and $10,000 of the revolving credit facility is outstanding. C-TEC
Cable Systems, Inc. used the proceeds to prepay higher priced Senior Secured
Notes. The early extinguishment of the Senior Secured Notes resulted in an
extraordinary charge of $3,210, net of taxes, against third quarter earnings.
The financings were provided by a syndicate of commercial banks and arranged and
underwritten by First Union National Bank. The credit agreement contains
restrictive covenants which generally require the Company to maintain certain
debt to cash flow and interest coverage ratios and place certain limitations on
additional debt and investments. The Company does not believe that these
covenants will materially restrict its activities.
Maturities of the term credit facility are as follows:
<TABLE>
<CAPTION>
Aggregate
Year Amounts
---- ---------
<S> <C>
1999 $ 3,750
2000 $11,250
2001 $16,250
2002 $17,500
2003 $19,374
Thereafter $31,876
</TABLE>
5. In August 1996, the Company acquired an 80.1% interest in Freedom New York,
L.L.C. and all related rights and liabilities ("Freedom") from Kiewit Telecom
Holdings, Inc. In March 1997, the Company paid $30,000 in connection with a
series of transactions which resulted in the Company having 100% ownership
interest in Freedom. The acquisition was accounted for as a purchase. The
purchase price exceeded the fair value of net assets acquired by $24,955, which
was recognized as goodwill with an amortization period of approximately 6 years.
Freedom was transferred to the Company in connection with the Distribution.
6. For the nine months ended September 30, 1997 nonrecurring charges of $10,000
represent costs incurred in connection with the termination of a marketing
services agreement held by Freedom.
7. In connection with and prior to the Distribution, the Company's Board of
Directors adopted the RCN Corporation 1997 Equity Incentive Plan (the "1997
Plan"), designed to provide equity based compensation opportunities to key
employees when shareholders of the Company have received a corresponding benefit
through appreciation in the value of RCN Common Stock. The following is a
summary of the 1997 Plan.
The 1997 Plan contemplates the issuance of incentive stock options within the
meaning of Section 422 of the Code, as well as stock options that are not
designated as incentive stock options, performance-based
4
<PAGE>
stock options, stock appreciation rights, performance share units, restricted
stock, phantom stock units and other stock-based awards (collectively,
"Awards"). Up to 5,000,000 shares of Common Stock may be issued pursuant to
Awards granted under the 1997 Plan. The 1997 Plan also provides that no
individual may be granted Awards representing more than 1,000,000 shares of RCN
Common Stock in any one year.
All employees and outside consultants to the Company and any of its subsidiaries
and all Directors of the Company who are not also employees of the Company are
eligible to receive discretionary Awards under the 1997 Plan.
Unless earlier terminated by the Company Board, the 1997 Plan will expire on the
10th anniversary of the Distribution. The Company Board or the Committee may,
at any time, or from time to time, amend or suspend and, if suspended,
reinstate, the 1997 Plan in whole or in part.
In connection with the Distribution, each CTE outstanding option was adjusted so
that following the distribution each holder thereof holds options to purchase
shares of CTE Common Stock, RCN Corporation Common Stock and Cable Michigan
Common Stock. The number of shares subject to, and the exercise price of, such
resulting options was adjusted to take into account the Distribution and the CTE
2 for 3 reverse stock split to ensure that the aggregate intrinsic value of the
resulting CTE, RCN and Cable Michigan Options immediately after the Distribution
was equal to the aggregate intrinsic value of the CTE options immediately prior
to the Distribution. At September 30, 1997, there are approximately 1,520,000
options outstanding at exercise prices ranging from $12.48 to $16.80 under RCN's
1997 Plan.
8. The Yee Family Trusts, as holders of the CTE's Preferred Stock Series A
and Preferred Stock Series B, have recently commenced an action against the
Company, CTE and Cable Michigan, Inc. in the Superior Court of New Jersey. The
complaint alleges that CTE's restructuring constitutes a fraudulent conveyance
and alleges breaches of contract and fiduciary duties in connection with the
restructuring. The plaintiffs are seeking to set aside the alleged fraudulent
conveyance and unspecified monetary damages. The Company believes this lawsuit
is without merit and intends to contest this action vigorously.
9. Earnings per share amounts are based on net income divided by the weighted
average number of shares outstanding during each period after giving effect to
stock options considered to be dilutive common stock equivalents.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share". This
Statement establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. This Statement is effective for financial statements issued after
December 31, 1997, earlier application is not permitted. This Statement
requires restatement of all prior-period EPS data presented. The Company is
currently evaluating the impact, if any, adoption of SFAS No. 128 will have on
its financial statements.
10. In September 1996, RCN and Boston Edison Company ("BECO"), through wholly
owned subsidiaries, entered into a letter of intent to form a joint venture to
utilize 126 fiber miles of BECO's fiber optic network to deliver RCN's
comprehensive communications package in Greater Boston. The venture, in the
form of an unregulated entity with a term expiring in the year 2060, was formed
pursuant to a joint venture agreement providing for the organization and
operation of RCN-BECOCOM, LLC ("RCN-BECOCOM"). RCN-BECOCOM is a limited
liability company organized to own and operate an advanced fiber optic
telecommunications network (the "Network") and to provide, in the market in and
around Boston, Massachusetts (the "Boston Market"), voice, video and data
services, as well as the communications support component of energy related
customer services offered by BECO (collectively, the "Boston Services"). RCN
owns 51% of the equity interest in RCN-BECOCOM and BECO owns the remaining 49%
interest.
5
<PAGE>
The joint venture began operations in June 1997. RCN has consolidated the BECO
joint venture in its financial statements as a result of its majority ownership;
day to day control as provided for in the joint venture management agreement;
and its actual exercise of control in the joint venture operations.
11. On September 8, 1997, the Company was notified by the Federal
Communications Commission ("FCC") that the FCC has ruled that certain of the
Company's upper levels of service for its New Jersey systems are regulated
levels of service and that the Company's rates for such levels of service have
exceeded the allowable rates under the FCC rate regulation rules which have been
effective since September 1993. The Company had treated these levels of service
as unregulated. The Company has had preliminary discussions with the FCC and
does not believe that the ultimate resolution of this matter will have a
material impact on its results of operations or financial condition.
12. In October 1997, the Company received proceeds of $575,000 from a
high-yield private offering (the "Offering") of $225,000 10% Senior Notes and
$350,000 11 1/8% Senior Discount Notes. Concurrently with the closing of the
Offering, the Company deposited $60,000 with an escrow agent, that, together
with the proceeds from investment thereof will be sufficient to pay when due the
first six interest payments on the Senior Notes, with any balance to be retained
by the Company.
The Senior Notes are secured to the extent described above. The Senior Discount
notes are unsecured. The Notes will rank senior in right of payment to all
subordinated indebtedness of RCN and will rank pari passu in right of payment
with all existing and future indebtedness of RCN that is not by its terms
subordinated in right and priority to the Notes. In addition, claims of holders
of the Notes will be structurally subordinated to claims of holders of
indebtedness of RCN's subsidiaries.
The Notes mature in October 2007. The Notes will be redeemable at the option of
RCN, in whole or in part, at any time on or after October 15, 2002 at redemption
prices for the Senior Notes up to 105% plus accrued and unpaid interest and at
redemption prices for the Senior Discount Notes up to 105.562% plus accrued and
unpaid interest.
The Notes contain certain covenants including limitations on additional
indebtedness. The Company does not believe that these covenants will materially
restrict its activities.
Pursuant to a registration rights agreement entered into by RCN, the Company has
agreed to file a registration statement with the Securities and Exchange
Commission with respect to an offer to exchange each issue of the Notes for
senior debt securities of RCN with terms substantially identical to such Notes
(the "Exchange Notes") (except that the Exchange Notes will not contain terms
with respect to transfer restrictions) on or prior to 45 days after the date on
which the Notes were originally issued.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Thousands of Dollars, except per share amounts)
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this Quarterly
Report is forward-looking, such as information relating to the effects of future
regulations and competition expected capital expenditures, capital contributions
to joint ventures by joint venture partners, and expected trends in operating
losses and cash flows associated with investments in new markets. Such forward
looking information involves important risks and uncertainties that could
significantly affect expected results in the future differently from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. These risks and uncertainties include, but are not limited to,
uncertainties relating to economic conditions, acquisitions and divestitures,
government and regulatory policies, the pricing and availability of equipment,
materials, inventories and programming, technological developments and changes
in the competitive environment in which the Company operates.
6
<PAGE>
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the year ended
December 31, 1996 included in the Company's Form 10 Information Statement, the
date of which is September 5, 1997.
The Company is developing networks that are capable of providing a full range of
high speed, high capacity telecommunications services, including voice, video
programming and data services including Internet access. The Company intends to
provide these services individually or in bundled service packages primarily to
residential customers in high-density areas and also seeks to serve certain
commercial accounts on or near its networks. The Company has recently commenced
providing service through advanced fiber optic network facilities in New York
City and Boston. The Company also has hybrid fiber/coaxial cable television
operations in New York (outside New York City) New Jersey and Pennsylvania
("Hybrid Fiber/Coaxial"), wireless video operations in New York City ("Wireless
Video"), and certain other operations, including long distance telephone
(collectively, "Other Operations"). The Company has historically managed its
business along these lines and the discussion which follows addresses those
lines accordingly.
Although the Company has not derived material revenue from its advanced fiber
optic networks through 1996, such revenues are expected to become an
increasingly significant component of the Company's revenues in the future.
Financial results related to advanced fiber optic networks are currently
included in the "Advanced Fiber, Wireless Video and Other Operating" segment
data. The Company expects that the operating and net losses and negative cash
flows from this business will rise in the future as it expands and develops its
network and customer base. There can be no assurance that RCN will achieve or
sustain profitability or positive cash flows from operating activities in the
future as it develops its advanced fiber optic network.
The negative operating cash flow from the Company's advanced fiber optic network
business has resulted primarily from expenditures associated with the
development of the Company's operational infrastructure and marketing expenses.
The Company expects it will continue to experience negative operating cash flow
while it continues to invest in its networks and until such time as revenue
growth is sufficient to fund operating expenses. The Company expects to achieve
positive operating margins over time by (i) increasing the number of customers
it serves, (ii) increasing the number of connections per customer by cross
marketing its services and promoting bundled service options and therefore
increasing the revenue per customer, (iii) lowering the costs associated with
new subscriber additions and (iv) reducing the cost of providing services by
capturing economies of scale. The Company expects its operating revenues will
increase in 1998 through internal growth of its current advanced fiber optic
networks; however, the Company also expects negative operating cash flow will
increase for some period of time as the Company initiates network development in
Washington, D.C. and expands its current networks. When the Company makes its
initial investment in a new market, the operating losses typically increase as
the network and sales force are expanded to facilitate growth. The Company's
ability to generate positive cash flow in the future will depend on the extent
of capital expenditures in current and additional markets, the ability of the
joint ventures to generate revenues and cash flow, competition in the Company's
markets and any potential adverse regulatory developments. The Company will be
dependent on various financing sources to fund its growth as well as continued
losses from operations. There can be no assurance that such funding will be
available, or available on terms acceptable to the Company. See " -Liquidity
and Capital Resources."
Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). On September 30, 1997, C-TEC distributed 100 percent of
the outstanding shares of common stock of its wholly owned subsidiaries, RCN
Corporation ("RCN") and Cable Michigan, Inc. ("Cable Michigan") to holders of
record of C-TEC's Common Stock and C-TEC's Class B Common Stock as of the close
of business on September 19, 1997 (the "Distribution") in accordance with the
terms of a Distribution Agreement dated September 5, 1997 among C-TEC, RCN and
Cable Michigan. RCN consists primarily of C-TEC's high growth, bundled
residential voice, video and Internet access operations in the Boston to
Washington, D.C. corridor, its existing New York, New Jersey and Pennsylvania
cable television
7
<PAGE>
operations, a portion of its long distance operations and its international
investment in Megacable, S.A. de C.V. Cable Michigan, Inc., consists of C-TEC's
Michigan Cable operations, including its 62% ownership in Mercom, Inc. C-TEC,
RCN and Cable Michigan have entered into certain agreements providing for the
Distribution, and governing various ongoing relationships between the three
companies, including a distribution agreement and a tax-sharing agreement. The
historical financial information presented herein reflects periods during which
the Company did not operate as an independent company and accordingly, certain
assumptions were made in preparing such financial information. Such information,
therefore, may not necessarily reflect the results of operations or the
financial condition of the Company which would have resulted had the Company
been an independent, public company during the reporting periods, and are not
necessarily indicative of the Company's future operating results or financial
condition.
Certain of the Company's businesses were acquired by C-TEC and transferred to
the Company in connection with the Distribution. On August 30, 1996, a
subsidiary of C-TEC acquired an 80.1% interest in Freedom New York, L.L.C. and
all related rights and liabilities ("Freedom") from Kiewit Telecom Holdings,
Inc. Freedom held the wireless cable television business of Liberty Cable
Television, Inc. The Company acquired the remaining minority interest in
Freedom in March 1997. The acquisition was accounted for as a purchase and is
reflected in the Company's consolidated financial statements since September
1996. On May 15, 1995, C-TEC Cable Systems, Inc., a wholly owned subsidiary of
C-TEC ("C-TEC Cable"), acquired 40% of the outstanding common stock of Twin
County Trans Video, Inc. ("Twin County"). Twin County is fully consolidated in
the Company's financial statements since May 1995, the date of the original
acquisition. The remaining outstanding common stock of Twin County was acquired
in September 1995. Goodwill relating to this acquisition is being amortized
over a period of approximately 10 years. In January 1995, RCN International
Holdings, Inc. (formerly C-TEC International, Inc.), a wholly owned subsidiary
of C-TEC, purchased a 40% equity position in Megacable, S.A. de C.V., the
second largest cable television provider in Mexico. The Company accounts for
its investment by the equity method of accounting and is amortizing the
original excess cost over the underlying equity in the net assets on a
straight-line basis over 15 years.
Selected segment data was as follows for the three and nine month periods ended
September 30, 1997 and 1996:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1997 1996 1997 1996
--------------------------------------------------
<S> <C> <C> <C> <C>
Sales
- -----
Hybrid Fiber/Coaxial $ 22,625 $21,087 $ 68,497 $62,524
Advanced Fiber, Wireless
Video and Other Operating 8,523 5,633 23,352 13,193
Corporate - 26 5 46
-------- ------- -------- -------
Total $ 31,148 $26,746 $ 91,854 $75,763
======== ======= ======== =======
<CAPTION>
Operating income before
depreciation and amortization and nonrecurring charge
- -------------------------------------------------------
<S> <C> <C> <C> <C>
Hybrid Fiber/Coaxial $ 9,944 $ 9,497 $ 31,211 $28,582
Advanced Fiber, Wireless
Video and Other Operating (12,550) (1,434) (25,171) (5,604)
Corporate (1,726) 1,125 (5,369) (1,814)
-------- ------- -------- -------
Total $ (4,332) $ 9,188 $ 671 $21,164
======== ======= ======== =======
</TABLE>
8
<PAGE>
Results of Operations
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30,
1996
For the nine months ended September 30, 1997, operating income before
depreciation and amortization and nonrecurring charge was $671 as compared to
$21,164 for the nine months ended September 30, 1996. Sales increased 21.2% to
$91,854 for the nine months ended September 30, 1997 from $75,763 for the same
period in 1996.
Sales
Sales are primarily comprised of subscription fees for basic, premium and pay
per view cable television services, long distance telephone service fees based
on minutes of traffic and tariffed rates or contracted fees, and Internet access
fees billed at contracted rates. For the nine months ended September 30, 1997,
sales were $91,854, an increase of $16,091 due to higher Hybrid Fiber/Coaxial
sales of $5,973 and higher Advance Fiber, Wireless Video and Other Operating
sales of $10,159. The increase in Hybrid Fiber/Coaxial sales principally
results from higher basic service revenue resulting from approximately 4,700
additional average monthly subscribers over the same period in 1996, the effects
of a rate increase in the first quarter of 1997, and cash incentives related to
the launch of certain new channels. Advanced Fiber, Wireless Video and Other
Operating sales increased primarily due to the acquisition of Freedom in August
1996 (the "Freedom Acquisition"), which resulted in higher basic and premium
video revenue. Additionally, higher voice revenue of approximately $1,200
resulted from higher voice and resold voice connections. The increase in
Advanced Fiber, Wireless Video and Other Operating Sales also includes increases
of approximately $1,000 related to the long distance business.
Costs and Expenses, Excluding Depreciation and Amortization and Nonrecurring
Charges
Cost and expenses, excluding depreciation and amortization and nonrecurring
charges, are comprised of direct costs of providing services, primarily cable
programming and franchise costs, network access fees, video transmission
licensing fees, salaries and benefits, and customer services costs; sales and
marketing costs; and general and administrative expenses. For the nine months
ended September 30, 1997, costs and expenses, excluding depreciation,
amortization, and nonrecurring charges, were $91,183, an increase of $36,584 or
67% as compared to the same period in 1996. The increase is primarily
attributable to higher Advanced Fiber, Wireless Video and Other Operating costs
and expenses, excluding depreciation and amortization, of approximately $30,000
resulting principally from the Freedom Acquisition in August 1996 and expansion
of the business in the Boston and New York City markets. The most significant
increases occurred in personnel and related costs, origination and programming
costs, and advertising expenses. Expansion of the long distance business
contributed approximately $3,900 of the remaining increase in Advanced Fiber,
Wireless Video and Other Operating costs and expenses, excluding depreciation
and amortization. Hybrid Fiber/Coaxial costs and expenses, excluding
depreciation and amortization, increased approximately $3,300 primarily due to
higher basic programming costs resulting from higher rates, additional channels
and subscribers increases. The remaining increase in costs and expenses,
excluding depreciation and amortization, is primarily due to costs associated
with the spin-off of the Company from C-TEC.
Depreciation and Amortization
Depreciation and amortization is comprised principally of depreciation relating
to the Company's Hybrid Fiber/Coaxial facilities and amortization of subscriber
lists, building access rights and goodwill. Depreciation and amortization
increased $12,098 or 44.7% to $39,135 for the nine months ended September 30,
1997 as compared to $27,037 for the comparable period in 1996. The increase is
due to the additional depreciation and amortization resulting from the Freedom
Acquisition and depreciation related to the Company's advanced fiber optic
networks in New York City and Boston.
9
<PAGE>
In future periods, depreciation and amortization are expected to exceed amounts
recorded in 1996 and during the nine months ended September 30, 1997 due to
Freedom Acquisition (as well as the acquisition in March 1997 of the remaining
19.9% ownership interest in Freedom), and depreciation with respect to the
Company's advanced fiber optic networks in New York City and Boston.
Nonrecurring Charges
Nonrecurring charges of $10,000 represent costs incurred with respect to the
termination of a marketing services agreement held by Freedom.
Interest Income
For the nine months ended September 30, 1997, interest income was $13,442, a
decrease of $6,308, or 31.9%, primarily due to lower average cash balances and
lower average notes receivable and related parties. Average cash balances
decreased principally as a result of the Freedom Acquisition in August 1996 (as
well as the acquisition in March 1997 of the remaining 19.9% ownership interest
in Freedom) and capital expenditures.
Interest Expense
For the nine months ended September 30, 1997 interest expense was $10,460 a
decrease of $2,093 or 16.7% primarily due to the required principal payment of
$18,750 on 9.65% Senior Secured Notes in December 1996. Additionally, the
Company paid $940 to Kiewit Telecom Holdings in connection with the Company's
August 1996, acquisition of Kiewit Telecom Holdings' 80.1% interest in Freedom.
This portion of the consideration represents an amount to compensate Kiewit
Telecom Holdings for forgone interest on the amount which it had invested in
Freedom.
Income Tax
Benefit for income taxes increased $11,839 primarily due to the increase of
$42,591 in operating loss.
Minority Interest
Minority interest in the loss of consolidated entities increased $3,720
primarily as a result of the minority share of the losses of the BECO joint
venture (Note 10), which began operations in June 1997. Additionally, the
minority share of the losses of Freedom from January 1 through March 21, at
which time the Company acquired the remaining 19.9% ownership interest, was
$966.
Three Months Ended September 30, 1997 Compared to Three Months Ended September
30, 1996
For the three months ended September 30, 1997, operating income before
depreciation and amortization and nonrecurring charge was ($4,332) as compared
to $9,188 for the three months ended September 30, 1996. Sales increased 16.5%
to $31,148 for the three months ended September 30, 1997 from $26,746 for the
same period in 1996.
Sales
For the three months ended September 30, 1997, sales were $31,148, an increase
of $4,402 due to higher Hybrid Fiber/Coaxial sales of $1,538 and higher Advance
Fiber, Wireless Video and Other Operating sales of $2,890. The increase in
Hybrid Fiber/Coaxial sales principally results from higher basic service revenue
resulting from approximately 4,700 additional average monthly subscribers over
the same period in 1996, and the effects of a rate increase in the first quarter
of 1997. Advanced Fiber, Wireless Video and Other Operating sales increased
primarily due to the acquisition of Freedom in August 1996 (the "Freedom
Acquisition"), which resulted in higher basic and premium video revenue.
Additionally, higher voice revenue of approximately $900 resulted from higher
voice and resold voice connections.
Costs and Expenses, Excluding Depreciation and Amortization and Nonrecurring
Charges
For the three months ended September 30, 1997, costs and expenses, excluding
depreciation, amortization, and nonrecurring charges, were $35,480, an increase
of $18,376 or 102.1% as compared to the same period
10
<PAGE>
in 1996. The increase is primarily attributable to higher Advanced Fiber,
Wireless Video and Other Operating costs and expenses, excluding depreciation
and amortization, of approximately $14,000 resulting principally from the
Freedom Acquisition in August 1996 and expansion of the business in the Boston
and New York City markets. The most significant increases occurred in market
development costs, including personnel and related costs, origination and
programming costs, and advertising expenses. Expansion of the long distance
business contributed approximately $1,100 of the remaining increase in Advanced
Fiber, Wireless Video and Other Operating costs and expenses, excluding
depreciation and amortization. Hybrid Fiber/Coaxial costs and expenses,
excluding depreciation and amortization, increased approximately $1,100
primarily due to higher basic programming costs resulting from higher rates,
additional channels and subscribers increases. The remaining increase in costs
and expenses, excluding depreciation and amortization, is primarily due to costs
associated with the spin-off of the Company from C-TEC.
Depreciation and Amortization
Depreciation and amortization is comprised principally of depreciation relating
to the Company's Hybrid Fiber/Coaxial facilities and amortization of subscriber
lists, building access rights and goodwill. Depreciation and amortization
increased $4,473 or 48.6% to $13,680 for the three months ended September 30,
1997 as compared to $9,207 for the comparable period in 1996. The increase is
due to the additional depreciation and amortization resulting from the Freedom
Acquisition and depreciation related to the Company's advanced fiber optic
networks in New York City and Boston.
In future periods, depreciation and amortization are expected to exceed amounts
recorded in 1996 and during the nine months ended September 30, 1997 due to
Freedom Acquisition (as well as the acquisition in March 1997 of the remaining
19.9% ownership interest in Freedom), and depreciation with respect to the
Company's advanced fiber optic networks in New York City and Boston.
Interest Income
For the three months ended September 30, 1997, interest income was $3,681, a
decrease of $2,478, or 40.2%, primarily due to lower average cash balances and
lower average notes receivable - related parties. Average cash balances
decreased principally as a result of the Freedom Acquisition in August 1996 (as
well as the acquisition in March 1997 of the remaining 19.9% ownership interest
in Freedom) and capital expenditures.
Interest Expense
For the three months ended September 30, 1997 interest expense was $3,331 a
decrease of $1,464 or 30.5% primarily due to the required principal payment of
$18,750 on 9.65% Senior Secured Notes in December 1996. Additionally, the
Company paid $940 to Kiewit Telecom Holdings in connection with the Company's
August 1996, acquisition of Kiewit Telecom Holdings 80.1% interest in Freedom.
This portion of the consideration represents an amount to compensate Kiewit
Telecom Holdings for forgone interest on the amount which it had invested in
Freedom.
Income Tax
Benefit for income taxes increased $4,375 primarily due to the increase of
$17,993 in operating loss.
Minority Interest
Minority interest in the loss of consolidated entities increased $2,242
primarily as a result of the minority share of the losses of the BECO joint
venture (Note 10), which began operations in June 1997.
Liquidity and Capital Resources
The Company expects that it will require a substantial amount of capital to fund
the network development and operations in the Boston to Washington, D.C.
corridor, including funding the development of its advanced fiber optic
networks, upgrading its Hybrid Fiber/Coaxial plant, funding operations losses
and debt service requirements. The Company currently estimates that its capital
requirements for the period from September 30, 1997 through mid-1999 will be
approximately $380 million, which includes capital expenditures (including
connection costs which will only be incurred as the Company obtains revenue-
11
<PAGE>
generating customer connections) of approximately $40 million in the last
quarter of 1997, approximately $190 million in 1998 and approximately $150
million through mid-1999. These capital expenditures will be used principally to
fund the buildout of the Company's fiber optic network in high density areas in
the Boston, New York and Washington, D.C. markets and to upgrade its hybrid
fiber/coaxial cable systems. To build out these areas on an efficient basis, the
Company undertakes a subscriber-driven capital expenditure strategy whereby it
(i) closely monitors development of its subscriber base in order to tailor
network development in each target market, and (ii) seeks to establish a
customer base in advance of or concurrently with its network deployment. For
example, the Company offers resale telephone services on an interim basis to
customers located near its advanced fiber optic networks. Depending upon factors
such as subscriber density, proximity to the advanced fiber optic network and
development costs and the degree of success achieved in its initial markets, the
Company will determine whether extending its advanced fiber optic network to
additional high density target markets can be achieved on an attractive economic
basis. In addition to its own capital requirements, the Company's joint venture
partners are expected to contribute approximately $150 million in capital to the
joint ventures in connection with development of the Boston and Washington, D.C.
markets through mid-1999. There can be no assurance that RCN will enter into its
proposed joint venture with PCI; in the event that the joint venture is not
established, RCN would be required to secure rights of way and network
facilities, which could include substantial costs of construction of a fiber
backbone, in order to establish a network in the Washington,D.C. area.
In October 1997, the Company announced that it had raised $575,000 in proceeds
from a high-yield private offering of two tranches of debt securities.
The offering was comprised of $225,000 10% Senior Notes and $350,000 11 1/8%
Senior Discount Notes, both due in 2007. The proceeds include $60 million of
restricted cash to be used to fund the Escrow Account to pay interest on the
Senior Notes for three years. Such amounts, along with cash on hand of
approximately $183,000 at September 30, 1997, are expected to provide sufficient
liquidity to meet the Company's capital requirements through 1999. After 1999,
the Company will continue to require additional capital for planned increases in
network coverage and other capital expenditures, working capital, debt service
requirements, and anticipated further operating losses. The actual timing and
amount of capital required to roll out the Company's network and to fund
operating losses may vary materially from the Company's estimates and additional
funds will be required in the event of significant departures from the current
business plan, unforeseen delays, cost overruns, engineering design changes and
other technological risks or other unanticipated expenses. Due to its subscriber
driven investment strategy, should the Company encounter a successful rollout in
its initial markets, the Company may accelerate the expansion and extend the
reach of its network. Conversely, should the Company be less successful than
anticipated, the operating losses associated with the installed network may be
higher than anticipated. The Company presently intends to judge the success of
its initial rollout in deciding whether to undertake additional capital
expenditures to rollout the network to additional areas. Since the Company
anticipates that, if it is successful, it will continue to extend its network
coverage into additional areas within the Boston-Washington, D.C. corridor, it
expects to continue to experience losses and negative cash flow on an aggregate
basis for an extended period of time.
The Company's current joint venture agreements reduce the amount of expenditures
required by RCN to develop the network due both to access to the joint venture
partners' existing facilities and to the anticipated joint venture partners'
equity contributions. However, the joint venture arrangement will also reduce
the potential cash flows to be realized from operation of the network in the
market in which the joint venture operates and restricts the Company's access to
cash flow generated by a joint venture (which will be paid in the form of
dividends). The Company may enter into additional joint ventures in the future
as the Company begins to develop new markets.
Sources of funding for the Company's further financing requirements may include
vendor financing, public offerings or private placements of equity and/or debt
securities, and bank loans. There can be no assurance that additional financing
will be available to the Company or, if available, that it can be obtained on a
timely basis and on acceptable terms. Failure to obtain such financing could
result in the delay or curtailment of the Company's development and expansion
plans and expenditures. Any of these events
12
<PAGE>
could impair the Company's ability to meet its debt service requirements and
could have a material adverse effect on its business.
RCN Cable Systems, Inc. and certain of its subsidiaries have in place secured
credit facilities comprised of a five-year revolving credit facility in the
amount of $25 million (the "Revolving Credit Facility") and an eight-year term
credit facility in the amount of $100 million (the "Term Credit Facility"), both
of which facilities are governed by a single credit agreement dated as of July
1, 1997. As of September 30, 1997, $100 million of the Term Credit Facility was
outstanding. The term loan must be repaid over six years in quarterly
installments, at the end of September, December, March and June of each year
from September 30, 1999 through June 30, 2005. As of September 30, 1997, $10
million principal was outstanding under the Revolving Credit Facility.
Revolving loans may be repaid and reborrowed from time to time.
For the nine months ended September 30, 1997, the Company's net cash provided by
operating activities was $7,019, comprised primarily of a net loss of $35,275
adjusted by non-cash depreciation and amortization of $39,135, other non-cash
items totaling $(641) and working capital changes of $78. Net cash used in
investing activities of $28,087 consisted primarily of additions to property,
plant and equipment of $43,890 and acquisitions of $30,490 (primarily
acquisition of the minority interest of Freedom) partially offset by sales and
maturities of short-term investments of $46,935. Net cash provided by financing
activities of $146,493 consisted of transfers to C-TEC of $20,185 partially
offset by a change in affiliate notes of $143,627.
13
<PAGE>
PART II - Other Information
---------------------------
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
(27) Financial Data Schedule
(b.) Reports on Form 8-K
No reports on Form 8-K were filed during the third quarter of
1997.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: November 14, 1997
----------------------------------
Bruce C. Godfrey
Executive Vice President and
Chief Financial Officer
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER
30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 183,337
<SECURITIES> 0
<RECEIVABLES> 22,406
<ALLOWANCES> 1,741
<INVENTORY> 2,428
<CURRENT-ASSETS> 247,068
<PP&E> 273,960
<DEPRECIATION> 101,544
<TOTAL-ASSETS> 598,679
<CURRENT-LIABILITIES> 72,441
<BONDS> 110,000
0
0
<COMMON> 27,485
<OTHER-SE> 346,275
<TOTAL-LIABILITY-AND-EQUITY> 598,679
<SALES> 0
<TOTAL-REVENUES> 91,854
<CGS> 0
<TOTAL-COSTS> 127,934
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,327
<INTEREST-EXPENSE> 10,460
<INCOME-PRETAX> (45,253)
<INCOME-TAX> (11,907)
<INCOME-CONTINUING> (32,065)
<DISCONTINUED> 0
<EXTRAORDINARY> (3,210)
<CHANGES> 0
<NET-INCOME> (35,275)
<EPS-PRIMARY> (1.28)
<EPS-DILUTED> (1.28)
</TABLE>
