SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
THE SECURITIES ACT OF 1934
------------
Date of report (Date of earliest event reported)
May 8, 1998 (February 20, 1998)
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RCN CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 0-22825 22-3498533
(State or other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization) File Number) Identification No.)
105 Carnegie Center
Princeton, NJ 08540-6215
(609)-734-3700
(Address and telephone number of Registrant's principal executive offices)
(Former Name or Former Address, if Changed Since Last Report)
</TABLE>
Item 2. Acquisition or Disposition of Assets
On January 21, 1998, RCN Corporation, a Delaware corporation ("RCN"), entered
into the Agreement and Plan of Merger (the "Erols Merger Agreement") among
Erols Internet, Inc., a Delaware corporation ("Erols"), Erol Onaran, Gold &
Appel Transfer, S.A., a British Virgin Islands corporation ("Gold & Appel"),
RCN and ENET Holding, Inc., a Delaware corporation and a wholly owned
subsidiary of RCN ("ENET"), to acquire all of the outstanding shares of common
stock of Erols. Erols was merged with and into ENET (the "Erols Merger"), with
ENET as the surviving corporation. On February 20, 1998, RCN completed the
acquisition of all outstanding common shares of Erols (the "Acquisition").
The approximate total Erols Merger consideration was $29.2 million in cash,
1,730,648 shares (when adjusted for the one for one stock dividend declared on
March 9, 1998 and paid on April 3, 1998 ("Stock Dividend")) of RCN common
stock, par value $1.00 per share ("RCN Common Stock"), plus the assumption and
repayment of $5.8 million of debt (including payment of accrued interest).
Additionally, RCN is converting options to purchase approximately 999,000
shares of Erols common stock into options to purchase approximately 699,000
shares of RCN Common Stock at an average exercise price of $3.424 per share.
The purchase price was determined pursuant to arm's-length negotiations. The
shareholders of Erols at the time of the Erols Merger were Erol Onaran and
Gold & Appel. The cash and debt repayment portions of the merger
consideration were funded from RCN working capital.
Erols is an Internet service provider which currently serves more than 293,000
mostly residential customers from Boston to Washington.
Item 7. Financial Statements and Exhibits
(a) Financial statements of Erols
(continued on the next page)
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors
Erols Internet, Inc.
We have audited the accompanying balance sheets of Erols Internet, Inc. as
of December 31, 1996 and 1997, and the related statements of operations,
stockholders' deficit, and cash flows for the period from August 1, 1995
(inception) to December 31, 1995 and for the years ended December 31, 1996 and
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Erols Internet, Inc. at
December 31, 1996 and 1997, and the results of its operations and its cash flows
for the period from August 1, 1995 (inception) to December 31, 1995 and years
ended December 31, 1996 and 1997, in conformity with generally accepted
accounting principles.
/s/ ERNST & YOUNG LLP
Vienna, Virginia
January 15, 1998, except for Note 10,
as to which the date is February 20, 1998
EROLS INTERNET, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------------
1996 1997
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................................... $2,540,857 $ 103,718
Accounts receivable, less allowance of $42,000 and $161,000 at December
31, 1996 and 1997, respectively........................................... 233,508 544,051
Restricted cash.............................................................. -- 150,000
Note receivable from related parties......................................... 350,000 370,572
Prepaid expenses and other current assets.................................... 21,815 19,953
------------- -------------
Total current assets............................................................ 3,146,180 1,188,294
Property and equipment, net..................................................... 10,499,332 17,840,969
Restricted cash................................................................. 850,166 743,353
Deposits........................................................................ 63,321 395,711
------------- -------------
Total assets.................................................................... $14,558,999 $20,168,327
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities:
Accounts payable............................................................. $9,973,259 $8,651,104
Accrued expenses............................................................. 586,874 1,404,170
Current portion of unearned revenues......................................... 12,916,864 25,582,996
Notes payable................................................................ 700,000 700,000
Current portion of capital lease obligations................................. 613,506 1,466,701
Current portion of deferred gain............................................. 42,444 66,079
------------- -------------
Total current liabilities....................................................... 24,832,947 37,871,050
------------- -------------
Long-term portion of unearned revenues.......................................... 3,440,928 8,906,491
Note payable to stockholder..................................................... -- 5,000,000
Long-term portion of capital lease obligations.................................. 994,343 1,852,026
Long-term portion of deferred gain.............................................. 60,722 66,580
Deferred rent................................................................... 120,611 134,376
Commitments..................................................................... -- --
Stockholders' deficit:
Preferred Stock, $.001 par value; 10,000,000 shares authorized............... -- --
Common Stock, $.001 par value; 50,000,000 shares authorized; 5,586,492
and 5,836,779 shares issued and outstanding at December 31, 1996 and 1997,
respectively.............................................................. 5,586 5,837
Additional paid-in capital................................................... 3,127,239 4,066,088
Deferred stock compensation.................................................. (364,250) (202,361)
Accumulated deficit.......................................................... (17,659,127) (37,531,760)
------------- -----------
Total stockholders' deficit..................................................... (14,890,552) (33,662,196)
============= ===========
Total liabilities and stockholders' deficit..................................... $14,558,999 $20,168,327
============= =============
</TABLE>
See accompanying notes
EROLS INTERNET, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
August 1, 1995 Year ended December 31,
(inception) to ----------------------------------
December 31, 1995 1996 1997
----------------- -------------- ---------------
<S> <C> <C> <C>
Net revenues:
Dial access revenues....................................... $ 125,752 $10,948,863 $ 33,588,925
Other revenues............................................. -- -- 2,939,215
------------- -------------- ---------------
Total net revenues............................................ 125,752 10,948,863 36,528,140
------------- -------------- ---------------
Costs and expenses:
Cost of dial access revenues............................... 63,030 6,002,155 13,338,452
Cost of other revenues..................................... -- -- 1,198,837
Operations and customer support............................ 125,095 6,227,011 9,930,114
Sales and marketing........................................ 188,314 9,475,585 19,777,437
General and administrative................................. 90,880 2,092,421 5,584,224
Depreciation and amortization.............................. 16,741 2,013,967 6,360,573
------------- -------------- ---------------
Total costs and expenses...................................... 484,060 25,811,139 56,189,637
Loss from operations.......................................... (358,308) (14,862,276) (19,661,497)
Other income (expense):
Other expense, net......................................... (658,421) (1,628,201) (49,157)
Interest expense, net...................................... (1,545) (150,376) (161,979)
------------- -------------- ---------------
Net loss...................................................... $(1,018,274) $(16,640,853) $(19,872,633)
============= ============== ===============
</TABLE>
See accompanying notes
EROLS INTERNET, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Total
Common Stock Additional Deferred Stock Accumulated Stockholders'
Shares Amount Paid-in Capital Compensation Deficit Deficit
----------- --------- --------------- -------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Balance at August 1, 1995 ............. -- $ -- $ -- $ -- $ -- $ --
Net loss ........................... -- -- -- (1,018,274) (1,018,274)
--------- --------- ------------ ------------ ------------ ------------
Balance at December 31, 1995 .......... -- -- -- -- (1,018,274) (1,018,274)
Contribution of divisional equity to
Erols Internet, Inc. (Note 1) ... 424 -- 1,000 -- -- 1,000
Recapitalization of Erols Internet,
Inc. (Note 1):
Retirement of Common Stock of
Erols Computer, Inc. ........... (424) -- (1,000) -- -- (1,000)
Issuance of Common Stock of Erols
Internet, Inc. ................. 4,272,023 4,272 5,803 -- -- 10,075
Issuance of Common Stock ........... 1,314,469 1,314 2,757,186 -- -- 2,758,500
Compensatory stock options ......... -- -- 364,250 (364,250) -- --
Net loss ........................... -- -- -- -- (16,640,853) (16,640,853)
--------- --------- ------------ ------------ ------------ ------------
Balance at December 31, 1996 .......... 5,586,492 5,586 3,127,239 (364,250) (17,659,127) (14,890,552)
Issuance of Common Stock ........... 250,287 251 938,849 -- -- 939,100
Compensatory stock options ......... -- -- -- 161,889 -- 161,889
Net loss ........................... -- -- -- -- (19,872,633) (19,872,633)
--------- --------- ------------ ------------ ------------ ------------
Balance at December 31, 1997 .......... 5,836,779 $5,837 $4,066,088 $(202,361) $(37,531,760) $(33,662,196)
========= ========= ============ ============ ============ ============
</TABLE>
See accompanying notes
EROLS INTERNET, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
August 1, 1995
(Inception) to Year ended December 31,
December 31, ------------------------------
1995 1996 1997
--------------- ------------- --------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss .............................................. $(1,018,274) $(16,640,853) $(19,872,633)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization ................... 16,741 2,013,967 6,360,573
Allowance for doubtful accounts ................. -- 42,000 119,000
Gain related to sale-leaseback transactions ..... (42,444)
Stock and stock option compensation expense ..... -- -- 161,889
Changes in operating assets and liabilities:
Accounts receivable ........................... (14,764) (260,744) (450,115)
Prepaid expenses and other current assets ..... -- (21,815) 1,862
Restricted cash ............................... -- (850,166) (43,187)
Deposits ...................................... -- (63,321) (332,390)
Accounts payable .............................. 92,400 9,880,859 (1,322,155)
Accrued expenses .............................. 29,241 557,633 817,296
Unearned revenues ............................. 743,496 15,614,296 18,131,695
Deferred rent ................................. 68,105 52,506 13,765
----------- ------------ ------------
Net cash (used in) provided by operating activities ... (83,055) 10,324,362 3,543,156
INVESTING ACTIVITIES
Purchases of property and equipment ................ (416,945) (10,174,143) (11,350,440)
Proceeds from disposal of property and equipment ... -- -- 12,172
Advance under note receivable from related parties . -- (350,000) --
----------- ------------ ------------
Net cash used in investing activities ................. (416,945) (10,524,143) (11,338,268)
FINANCING ACTIVITIES
Proceeds from notes payable to bank ................ 500,000 700,000 600,000
Proceeds from notes payable to related party ....... -- -- 5,000,000
Payments of notes payable to bank .................. -- (500,000) (600,000)
Payments on obligations under capital leases ....... -- (227,937) (581,127)
Net proceeds from issuance of Common Stock ............ -- 2,768,575 939,100
----------- ------------ ------------
Net cash provided by financing activities ............. 500,000 2,740,638 5,357,973
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents .. -- 2,540,857 (2,437,139)
Cash and cash equivalents at beginning of period ...... -- -- 2,540,857
----------- ------------ ------------
Cash and cash equivalents at end of period ............ $ -- $ 2,540,857 $ 103,718
=========== ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid ......................................... $ 1,545 $ 159,196 $ 281,085
=========== ============ ============
</TABLE>
See accompanying notes
EROLS INTERNET, INC.
NOTES TO FINANCIAL STATEMENTS (continued)
1. Organization
Erols Internet, Inc. (the "Company") began operations on August 1, 1995 as
a division of OEO, Inc., which changed its name to Erols Internet, Inc. on
December 2, 1996. The Company is an Internet service provider ("ISP"), offering
a combination of low priced, high quality Internet access in targeted markets
located throughout the corridor stretching from Massachusetts to Virginia.
From its inception on August 1, 1995 through December 2, 1996, the Company
operated as a division of OEO, Inc., a company that had two divisions consisting
of the Company's ISP operations and a computer, television and video cassette
recorder repair division. On December 2, 1996, OEO, Inc. reincorporated in the
State of Delaware and changed its name to Erols Internet, Inc. Shortly
thereafter, on December 28, 1996, the assets and liabilities of the computer,
television and video cassette recorder repair division were spun-off to a newly
formed Virginia corporation named Erol's Computer & TV/VCR, Inc.
The financial statements of Erols Internet, Inc. as of and for the five
month period ended December 31, 1995 have been prepared on the basis that Erols
Internet, Inc. operated as a division of OEO, Inc. and accordingly, there are no
equity accounts such as common stock or paid in capital related to the Internet
division. The financial statements of Erols Internet, Inc. as of December 31,
1996 have been prepared on the basis that Erols Internet, Inc. operated as a
separately incorporated company and accordingly, reflect the shares of Common
Stock issued to the former stockholder of OEO, Inc. as a result of the
reincorporation and recapitalization of Erols Internet, Inc. Additionally, the
statements of operations for the period from August 1, 1995 (inception) to
December 31, 1995 and for the period from January 1, 1996 to December 28, 1996
have been prepared from the historical books and records of the Internet
division and include all amounts directly attributable and identifiable to the
Internet business as well as indirect expenses, such as physical operating costs
and management salaries. The physical operating costs and management salaries
were charged based on square feet and hours attributable to the Internet
business, respectively.
The Company has experienced operating losses since its inception as a
result of efforts to build its network infrastructure, increase internal
staffing, develop its systems and expand into new markets. The Company expects
to continue to focus on increasing its subscriber base and geographic coverage.
Accordingly, the Company expects its cost and operating expenses and capital
expenditures to continue to increase significantly, all of which will have a
negative impact on short-term operating results. The online services and
Internet markets are highly competitive. The Company believes that existing
competitors, Internet-based services, Internet service providers, Internet
directory services and telecommunication companies are likely to enhance their
service offerings resulting in greater competition for the Company. The
competitive conditions could have the following effects: require additional
pricing programs, increase spending on marketing, limit the Company's ability to
expand its subscriber base and result in increase attrition in the existing
subscriber base. There can be no assurance that growth in the Company's revenues
or subscriber base will continue or that the Company will be able to achieve or
sustain profitability or positive cash flow.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid investments with a maturity of three months or less at the time of
purchase to be cash equivalents. On December 31, 1997, the Company had purchased
$5,125,000 of U.S. Government securities under agreements to resell on January
1, 1998. Due to the short-term nature of the agreements, the Company did not
take possession of the securities which were held by the Company's asset
managers. The market value of the securities approximated the carrying amount at
December 31, 1997.
Restricted Cash
Certain capital lease agreements generally require the Company to maintain
restricted cash deposit accounts with a bank which amounted to $850,166 and
$893,353 as of December 31, 1996 and 1997, respectively.
Impairment of Long-Lived Assets
At each balance sheet date, management determines whether any property and
equipment or any other assets have been impaired based on the criteria
established in Statement of Financial Accounting Standards No. 121 ("SFAS 121"),
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of." The Company made no adjustments to the carrying values of the
assets during the period from August 1, 1995 (inception) to December 31, 1995
and during the years ended December 31, 1996 and 1997.
Stock Compensation
The Company accounts for its stock-based compensation in accordance with
APB No. 25 "Accounting for Stock Issued to Employees" ("APB 25") using the
intrinsic value method. The Company has made pro forma disclosures required by
SFAS No. 123 "Accounting for Stock Based Compensation" ("SFAS 123") using the
fair value method.
Revenue Recognition
The Company recognizes Internet access revenue when the services are
provided. During the period from August 1, 1995 (inception) to December 31, 1995
and the years ended December 31, 1996 and 1997, the Company offered one, two and
three year contracts for Internet access that are generally paid for in advance
by customers. The Company has deferred recognizing revenue on these advance
payments and amortizes the amounts to revenue on a straight-line basis as the
services are provided.
The Company allows for cancellations of up to thirty days after service is
initiated for a full refund. Any cancellations in the period subsequent to the
first thirty days of service are refunded on a pro-rata schedule. The Company
reviews its history of cancellations periodically and, when appropriate, records
a reserve for estimated amount of returns.
The Company recognizes web page hosting revenues when the services are
rendered. During the year ended 1997, the Company offered monthly and one year
contracts to host customers' web pages. The revenues related to these contracts
were recognized on the straight line basis over the term of the contract.
Revenues from internet classes and product sales are recognized as the service
is performed or product shipped.
Costs of Revenues
Cost of dial access revenues primarily consists of telecommunication
expenses inherent in the network infrastructure. Cost of dial access revenues
also includes fees paid for lease of the Company's backbone, as well as license
fees for Web browser software based on a per user charge, other license fees
paid to third-party software vendors, product costs, and contractor fees for
distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred. During the
period from August 1, 1995 (inception) to December 31, 1995 and for the years
ended December 31, 1996 and 1997, the Company expensed $121,451, $6,530,877 and
$12,267,445, respectively, as advertising costs.
Income Taxes
Prior to December 28, 1996, the Internet Business operated as a division of
OEO, Inc. and accordingly, a consolidated tax return for OEO, Inc. was filed.
Since OEO, Inc. generated consolidated net losses for the period from August 1,
1995 to December 28, 1996, no provision for income taxes would have been
recorded for the consolidated company and, as such, no additional disclosure has
been made as to the Internet division's portion of the net losses for tax
purposes. In connection with the reincorporation of OEO, Inc. and the spin-off
of Erol's Computer & TV/VCR, Inc., the provision for income taxes and the
resulting deferred tax asset (see Note 8) for the Company using the liability
method was calculated for the period December 2, 1996 through December 31, 1996.
There was no provision for income taxes required for this period.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash, restricted cash and
accounts receivable. The cash and restricted cash are held by a high credit
quality financial institution. For accounts receivable, the Company performs
ongoing credit evaluations of its customers' financial condition and generally
does not require collateral. The Company maintains reserves for credit losses,
and such losses have been within management's expectations. The concentration of
credit risk is mitigated by the large customer base. The carrying amount of
the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other companies to
provide data communications. Although management feels alternative
telecommunications facilities could be found in a timely manner, any disruption
of these services could have an adverse effect on operating results. Although
the Company attempts to maintain multiple vendors for each required product, its
modems, terminal servers, and high-performance routers, which are important
components of its network, are currently acquired from two sources. In addition,
some of the Company's suppliers have limited resources and production capacity.
If the suppliers are unable to meet the Company's needs as it builds out its
network infrastructure, then delays and increased costs in the expansion of the
Company's network infrastructure could result, which would affect operating
results adversely.
Recent Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), "Comprehensive Income",
which is required to be adopted for the year ended December 31, 1998. SFAS 130
requires that an enterprise (a) classify items of other comprehensive income by
their nature in the financial statements and (b) display the accumulated balance
of other comprehensive income separately from retained earnings and additional
paid-in capital in the Statements of Stockholders' Deficit. The Company will be
required to restate earlier periods provided for comparative purposes. The
disclosure for comprehensive income is not expected to be material.
3. Property and Equipment
Property and equipment, including leasehold improvements, are stated at
cost. Depreciation is calculated using the straight-line method over estimated
useful lives ranging between three and seven years. Leasehold improvements are
amortized over the lesser of the related lease term or the useful life.
Property and equipment consisted of the following:
December 31,
---------------------------
1996 1997
----------- -----------
Computer equipment ............................. $11,570,218 $24,517,954
Furniture, fixtures, and office equipment ...... 721,218 1,378,768
Leasehold improvements ......................... 238,604 335,528
----------- -----------
12,530,040 26,232,250
Less accumulated depreciation .................. 2,030,708 8,391,281
----------- -----------
$10,499,332 $17,840,969
=========== ===========
4. Notes Payable
Pursuant to a promissory note agreement dated December 20, 1995, the
Company owed $500,000 to a financial institution as of December 31, 1995. The
loan bore interest at an annual rate of 1.5% plus prime rate (10% at December
31, 1995). Prior to the repayment of the loan balance, the loan was
collateralized by certain assets of the Company and was guaranteed by an officer
and stockholder of the Company. During 1996, the Company repaid the balance of
the note plus unpaid interest totaling $16,131.
As of December 31, 1996 and 1997, the Company had a short-term line of
credit arrangement with a bank which allowed for aggregate borrowings up to
$700,000. As of December 31, 1996 and 1997, $700,000 was outstanding under this
arrangement. The line of credit bears interest at the bank prime rate plus
1-1/2% per annum (10% as of December 31, 1997). As of December 31, 1996 and
1997, the Company has accrued $2,051 and $7,158, respectively, of interest
related to this line of credit. The note is due on September 25, 1998. The line
of credit is personally guaranteed by an officer and stockholder of the Company.
See Note 6.
During December 1997, the Company entered into a subordinated revolving
line of credit agreement, with a maximum borrowing amount of $5,000,000, and a
$5,000,000 subordinated note payable agreement with a stockholder. The Company
received the proceeds from the $5,000,000 note payable in December 1997 and
utilized the proceeds to repay certain accounts payable. The subordinated
revolving line of credit and note payable bear interest at a fluctuating rate
equal to the greater of 11% per annum or 4-1/2 per annum over the prime rate.
The subordinated revolving line of credit agreement provides for an unused
facility fee equal to 1/2% of the difference between the average daily balance
outstanding and the $5,000,000 maximum borrowing amount, payable quarterly. The
revolving line of credit and the note payable are secured by certain assets of
the Company. The balance of the note payable, as well as any outstanding
borrowings under the line of credit facility, are due upon the acquisition of
more than 50% of the Company's outstanding Common Stock or the sale in an
underwritten public offering of debt or equity securities issued by the Company.
5. Commitments
Operating Leases
The Company leases office space and various office and computer equipment
under non-cancelable operating lease agreements. The leases generally provide
for renewal terms and the Company is required to pay a portion of the common
areas' expenses including maintenance, real estate taxes and other expenses.
Rent expense for the period from August 1, 1995 (inception) to December 31, 1995
and for the years ended December 31, 1996 and 1997, was $12,601, $843,615 and
$2,236,183, respectively. The Company is also required to pay additional rent
based on certain percentages of revenues recorded by the various stores (kiosks)
when the revenues exceed certain predetermined amounts. The Company has not
incurred any significant additional rent charges to date.
As of December 31, 1997, payments due under non-cancelable operating
leases are as follows:
1998................................ $ 1,301,609
1999................................ 914,082
2000................................ 578,203
2001................................ 461,561
2002................................ 314,831
---------------
$ 3,570,286
===============
Capital Leases
The Company leases certain office and computer equipment as a result of
sales-leaseback agreements, which will be accounted for as capital leases. The
Company recorded approximately $192,000 of deferred gain related to the
difference between the sale price of the equipment and present value of the
minimum lease payments. The Company will amortize the deferred gain to other
income over the lease term. Computer equipment held under capital leases at
December 31, 1996 and 1997 amounted to $1,956,407 and $4,320,349, respectively.
Accumulated amortization related to this equipment amounted to $480,384 and
$1,329,551 at December 31, 1996 and 1997, respectively. Amortization related to
capital leased equipment is included in depreciation and amortization expense.
The non-cash portion of these transactions has been excluded from the Statements
of Cash Flows.
As of December 31, 1997, future minimum lease payments under the capital
leases are as follows:
1998............................................... $ 1,805,933
1999............................................... 1,487,236
2000............................................... 536,826
----------------
3,829,995
Less interest...................................... (511,268)
----------------
Present value of net minimum payments.............. 3,318,727
Less current portion............................... 1,466,701
----------------
$ 1,852,026
================
Letters of Credit
During 1996 and 1997, in connection with capital lease agreements, the
Company obtained several letters of credit with a financial institution in the
amounts of the lease obligations. As collateral for these letters of credit, the
financial institution required that the Company invest certain amounts in
certificate of deposits at the financial institution. The total amount of cash
restricted in connection with these letters of credit is approximately $905,000
and $837,000 at December 31, 1996 and 1997, respectively. The certificates of
deposit bear interest at a rate of 4.7%, mature in one year and are renewable at
the option of the financial institution. The letters of credit expire in 1998
and will be automatically renewed, subject to certain withdrawal privileges by
the Company, by the financial institution for an additional one year period for
each year under which the capital lease obligations are outstanding.
Employment Agreements
During 1996 and 1997, the Company executed employment agreements with
certain key executives under which the Company is required to pay the following
base salaries annually over the next two years:
1998...................................... $ 840,000
1999...................................... 225,000
----------------
$ 1,065,000
================
Other Commitments
Effective January 31, 1997, the Company entered into an ISP License
Agreement with a vendor. The Company agreed to license a minimum of 1,000,000
software mailbox products in exchange for $3,000,000, which is to be paid in
quarterly installments over the next three years. After exceeding the 1,000,000
software mail box products, the Company may license additional mailbox products
for a fee of $3.00 per mailbox.
6. Related Party Transactions
Since inception, the Company has shared common facilities and operating
costs such as executive management salaries, accounting, supplies, marketing,
etc., with Erol's Computer & TV/VCR, Inc. (the "Affiliated Company") which
shares common ownership with the Company. During the period from August 1, 1995
(inception) to December 31, 1995 and the years ended December 31, 1996 and 1997,
$11,530, $721,557 and $0 were charged to operations related to shared facilities
and operating costs, respectively.
The Company executed a promissory note agreement with an Individual (the
"Individual"), an officer and stockholder of the Company, and the Affiliated
Company, whereby the Company agreed to loan $350,000 to the Individual and the
Affiliated Company. The note bears annual interest at a rate equivalent to the
federal rate, defined by the Internal Revenue Code. The balance of the note plus
compounded interest will become due to the Company three weeks after the date on
which the short-term line of credit arrangement expires and the Individual has
been released as a guarantor of the line of credit arrangement with the bank.
Since inception in August 1995 through December 31, 1996, Erols Internet
paid certain expenses related to the Affiliated Company on behalf of the
Affiliated Company. These expenses amounted to $658,422 and $1,645,511 during
the period from August 1, 1995 (inception) to December 31, 1995 and during the
year ended December 31, 1996, respectively. Since there is no intention to repay
these amounts to the Company, the Company has written off the receivable and has
included the amount in other expense in the Statements of Operations.
Effective January 1, 1997, the Company entered into a five year management
agreement with Erol's Computer & VCR (the "Affiliated Company"). Pursuant to
this agreement, the Company will provide office space, general and
administrative services, sales services and print advertising services to the
Affiliated Company in exchange for a management fee. The management fee is based
on actual direct labor charges to the Affiliated Company and an allocation of
facilities costs based on square feet used by the Affiliated Company. During the
year ended December 31, 1997, the management fee amounted to $58,784. The
$58,784 is included in accounts receivable as of December 31, 1997. During
December 1997, the parties agreed to terminate the agreement effective December
31, 1997.
The Company purchased computer equipment for resale and internal use from
the Affiliated Company. During the year ended December 31, 1997, purchases
amounted to $532,714.
7. Stockholders' Deficit
Equity transactions
During 1995, the Company operated as a division of OEO, Inc. and
accordingly, had no Common Stock outstanding. During 1996, as a part of the
reorganization, the sole common stockholder was issued 4,272,023 shares of
voting Common Stock, par value $0.001 in Erols Internet, Inc.
In December 1996, the Company completed a private placement to raise total
proceeds of approximately $3,000,000 from an outside investor (the "Minority
Stockholder"). The Company sold 1,314,469 shares of voting Common Stock at $2.29
per share.
In May 1997, the Company completed a private placement to raise total
proceeds of approximately $500,000 from the Minority Stockholder. The Company
sold 131,447 shares of voting Common Stock at $3.80 per share.
In September 1997, the Company completed a private placement to raise total
proceeds of approximately $500,000 from the Minority Stockholder. The Company
sold 114,600 shares of voting Common Stock at $4.36 per share.
On December 4, 1997, the Board of Directors and stockholders of the Company
approved a 1 for 2.3583672 reverse stock split of the Company's $0.001 par value
voting Common Stock, which became effective on December 5, 1997. In addition,
the Company eliminated the authorized non-voting Common Stock. All references in
the accompanying financial statements to the number of shares of Common Stock
and per-share amounts have been restated to reflect these transactions.
Stock Option Plan
During 1996, the Company adopted a stock option plan (the "Option Plan")
which permits the Company to grant up to 657,234 voting Common Stock options to
employees, board members and others who contribute materially to the success of
the Company. During 1997, the Company increased the number of options available
for grant under the plan to 826,843. Stock options are generally granted at
prices which the Company's Board of Directors believes approximates the fair
market value of its Common Stock at the date of grant. Individual grants
generally become exercisable ratably over a period of three years from the date
of hire. The contractual term of the options is ten years from the date of
grant.
In December 1996, the Company issued 328,617 options to a certain officer
at an exercise price of $1.18 which was considered to be below fair market value
at the time of the option grant. Accordingly, the Company recorded deferred
stock compensation of $364,250 which will be amortized to expense over the
vesting period of three years beginning in January 1997, of which $161,889 was
recognized as expense during 1997.
Common stock option activity was as follows:
Year ended December 31,
1996 1997
------------------- ---------------------
Weighted Weighted
Number Average Average
of Exercise Exercise
Shares Price Shares Price
------- -------- ---------- ---------
Outstanding at beginning of year .... -- $ -- 455,823 $ 1.49
Options granted ..................... 455,823 1.49 675,611 3.04
Options exercised ................... -- -- (4,240) 3.32
Options canceled or expired ......... -- -- (75,333) 2.29
------- ----- --------- ------
Outstanding at end of year .......... 455,823 $1.49 1,051,861 $ 2.42
======= ===== ========= ======
Exercisable at year-end ............. -- $ -- 264,278 $ 1.91
======= ===== ========= ======
As of December 31, 1997, there were 95,119 options available for future
grants under the Option Plan.
The following table summarizes information about fixed-price stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- -----------------------------
Number Average Weighted- Number Weighted-
Outstanding at Remaining Average Exercisable at Average
December 31, Contractual Exercise December 31, Exercise
Range of Exercise Prices 1997 Life Price 1997 Price
- ------------------------ ------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Lss than $2.30................................. 784,238 9.0 $ 1.82 253,332 $ 1.81
$2.30 - $4.75................................... 267,623 9.0 4.18 10,946 4.17
--------- ---- ------- ----
$1.18 - $4.55................................... 1,051,861 2.42 264,278 1.91
========= ======= ======= ======
</TABLE>
Had compensation expense related to the stock option plan been determined
based on the fair value at the grant date for options granted during the period
from August 1, 1995 to December 31, 1995 and for the years ended December 31,
1996 and 1997 consistent with the provisions of SFAS 123, the Company's net loss
would have been as follows:
Period from
August 1, 1995
(inception) to Years Ended December 31,
December 31,
1995 1996 1997
-------------- --------------- ----------------
Net loss--pro forma......... $ (1,018,274) $ (16,690,399) $ (20,086,156)
============ ============= =============
The effect of applying SFAS 123 on 1995, 1996 and 1997 pro forma net loss
as stated above is not necessarily representative of the effects on reported net
loss for future years due to, among other things, the vesting period of the
stock options and the fair value of additional stock options in future years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing fair value model with the following
weighted-average assumptions used for grants in 1996 and 1997: dividend yield of
0%, expected volatility of 70%; risk-free interest rate of 6.5%; and expected
terms from 3 to 4 years. The weighted average fair values of the options granted
in 1996 and 1997 with a stock price equal to the exercise price is $1.31 and
$1.79, respectively. The weighted average fair value of the options granted in
1996 with a stock price greater than the exercise price in 1996 is $0.38.
Reserve for Issuance
As of December 31, 1997, the Company had reserved 11,151,220, respectively,
shares of non-voting common stock, preferred stock and voting Common Stock
options.
8. Income Taxes
Net deferred income tax assets are as follows:
December 31,
-------------------------------
1996 1997
-------------- --------------
Unearned revenue $ 1,307,553 $ 7,766,210
Operating loss carryforwards 1,913,864 2,793,213
Provision for bad debts 15,960 61,305
Accrued vacation -- 50,005
Deferred rent -- 51,009
Stock options -- 61,452
Depreciation (228,000) (267,131)
-------------- --------------
Deferred tax assets 3,009,377 10,516,063
Valuation allowance (3,009,377) (10,516,063)
-------------- --------------
Net deferred tax assets $ -- $ --
============== ==============
At December 31, 1997, the Company has net operating loss carryforwards
amounting to approximately $7,358,305. Operating loss carryforwards expire in
2010 and 2011.
9. Contingencies
On September 1, 1997, a motion for judgment was filed against the Company
in Virginia state court by the Company's former Vice President, Marketing. The
motion for judgment alleges breach of contract and wrongful termination and
seeks punitive and compensatory damages of approximately $1,000,000.
Additionally, the Company's former Vice President, Marketing seeks to exercise
certain stock options. Discovery has just been initiated and, therefore, it is
premature to reach an opinion on liability or the extent of exposure. However,
the Company believes that it has a meritorious defense and is conducting a
vigorous defense. The Company doesn't believe that the conclusion of this matter
will materially affect the Company's financial position or results of
operations.
10. Subsequent Event
On January 21, 1998, the Company entered into an Agreement and Plan of
Merger with RCN Corporation ("RCN"). In the transaction, RCN will issue common
stock and replacement stock options valued at $48,500,000 and pay $35,000,000 in
cash, including the assumption and repayment of the $5,700,000 note payable, in
exchange for all of the outstanding equity securities of Erols Internet, Inc.
The Agreement and Plan of Merger was closed on February 20, 1998.
In conjunction with the merger agreement with RCN, certain outstanding
options held by two employees of the Company became fully vested. Additionally,
all outstanding options held by non-employees will fully vest and be repurchased
by the Company at a price equal to the difference between $14 and the option
exercise price multiplied by the number of outstanding options.
(b) Pro Forma Financial Information
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Prior to September 30, 1997, RCN was operated as part of C-
TEC Corporation ("C-TEC"). The following Unaudited Pro Forma Consolidated
Statement of Operations sets forth the historical statements of operations
of RCN for the year ended December 31, 1997 and as adjusted for the
distribution by C-TEC of all of its interest in the RCN businesses to its
stockholders on September 30, 1997 (the "Distribution"), the acquisition
(the "Freedom Acquisition") of the 19.9% minority interest in Freedom New
York, L.L.C. ("Freedom"), the offering (the "1997 Notes Offering") of the
10% Senior Notes due 2007 and of the 11(1)/(8)% Senior Discount Notes due
2007 (together, the "1997 Notes"), the acquisition (the "Acquisition") of
Erols, and the offering (the "Notes Offering") of the 9.80% Senior
Discount Notes due 2008 (the "Notes"), and the related transactions and
events described in the notes thereto, as if such transactions and events
had been consummated on the first day of the period. The following
Unaudited Pro Forma Consolidated Balance Sheet sets forth the historical
balance sheet of RCN as of December 31, 1997, and as adjusted for the
transactions and events described in the notes thereto as if such
transactions and events had been consummated on December 31, 1997.
Management believes that the assumptions used provide a
reasonable basis on which to present such Unaudited Pro Forma Consolidated
Financial Statements. The Unaudited Pro Forma Consolidated Financial
Statements should be read in conjunction with the historical Financial
Statements and notes thereto. The Unaudited Pro Forma Consolidated Financial
Statements are provided for information purposes only and should not be
construed to be indicative of RCN's results of operations or financial
condition had the Distribution and the transactions and events described above
been consummated on the dates assumed, may not reflect the results of
operations or financial condition which would have resulted had RCN been
operated as a separate, independent company during such period, and are not
necessarily indicative of RCN's future results of operations or financial
condition.
RCN CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
Year ended December 31, 1997
($ in thousands, except per share amounts and number of shares)
<TABLE>
<CAPTION>
Liberty/ Adjustments
Adjustments Pro Forma Freedom for Issuance
RCN for for Acquisitions of the 1997
Historical Distribution Distribution Adjustments Notes
----------- -------------- ---------------- --------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales......................... $ 127,297 $ 127,297
Cost and expenses, excluding
depreciation and
amortization.............. 134,967 134,967
Nonrecurring charges.......... 10,000 10,000
Depreciation and
amortization.............. 53,205 53,205 $ 1,250 (1)
----------- -------- ----------- ------ ---------
Operating (loss).............. (70,875) (70,875) (1,250)
Interest income............... 22,824 $ (8,686)(2) 14,138
Interest expense.............. (25,602) (5,654)(3) (20,796) $ (50,221)(4)
10,460 (5)
Other (expense) income, net... 131 131
----------- -------- ----------- ------ ---------
(Loss) before income taxes.... (73,522) (3,880) (77,402) (1,250) (50,221)
(Benefit) for income taxes.... (20,849) (1,358)(6) (22,207) (437)(7) (17,577)(4)
----------- -------- ----------- ------ ---------
(Loss) before equity in
unconsolidated entities
and minority interest..... (52,673) (2,522) (55,195) (813) (32,644)
Equity in (loss) of
unconsolidated entities... (3,804) (3,804)
----------- -------- ----------- ------ ---------
Income (loss) before
extraordinary charge and
minority interest in
loss of consolidated
entities.................. $ (56,477) $ (2,522) $ (58,999) $ (813) $ (32,644)
=========== ======== =========== ====== =========
Unaudited pro forma (loss)
before extraordinary
charge and minority
interest per
common share.............. $ (1.03) $ (1.07)
Weighted average number of
common shares and
common stock equivalents
outstanding............... 54,965,716 54,965,716
<CAPTION>
Adjustments
Acquisition for Issuance
Erols Adjustments of the 1998
Historical(8) for Erols Notes Pro Forma
-------------- -------------- ---------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Sales......................... $ 36,528 $ (22,552)(9) $ 141,273
Cost and expenses, excluding
depreciation and
amortization.............. 49,829 (30,764)(9) 154,032
Nonrecurring charges.......... 10,000
Depreciation and
amortization.............. 6,360 606 (10) 61,421
-------- ---------- --------- ----------
Operating (loss).............. (19,661) 7,606 (84,180)
Interest income............... 14,138
Interest expense.............. (162) 100 $ (34,958)(12) (106,037)
Other (expense) income, net... (49) 82
-------- ---------- --------- ----------
(Loss) before income taxes.... (19,872) 7,706 (34,958) (175,997)
(Benefit) for income taxes.... (9,338)(11) (12,235)(12) (61,794)
-------- ---------- --------- ----------
(Loss) before equity in
unconsolidated entities
and minority interest..... (19,872) 17,044 (22,723) (114,203)
Equity in (loss) of
unconsolidated entities... (13,420) (9) (17,224)
-------- ---------- --------- ----------
Income (loss) before
extraordinary charge and
minority interest in
loss of consolidated
entities.................. $(19,872) $ 3,624 $ (22,723) $ (131,427)
======== ========== ========= ==========
Unaudited pro forma (loss)
before extraordinary
charge and minority
interest per
common share.............. $ (2.32)
Weighted average number of
common shares and
common stock equivalents
outstanding............... 1,730,648 (18) 56,696,364
See Notes to Unaudited Pro Forma Consolidated Financial Statements
</TABLE>
RCN CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
December 31, 1997
($ in thousands)
<TABLE>
<CAPTION>
Adjustments
for Adjustments
RCN Erols Acquisition for Issuance of
Historical Historical(8) of Erols the Notes Pro Forma
----------- -------------- ------------- ----------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Current Assets
Cash and temporary cash
investments.................. $222,910 $104 $(35,000)(13) $344,587 (17) $ 532,601
Short term investments......... 415,603 415,603
Accounts receivable from
related parties.............. 9,829 9,829
Accounts receivable, net of
reserve for doubtful
accounts..................... 17,815 544 18,359
Unbilled revenues.............. 1,695 1,695
Material and supply
inventory, at average cost... 2,745 2,745
Prepayments and other.......... 5,314 390 5,704
Investments restricted for
debt service................. 22,500 150 22,650
Deferred income taxes.......... 4,821 4,821
---------- ------- -------- -------- ----------
Total current assets............ 703,232 1,188 (35,000) 344,587 1,014,007
---------- ------- -------- -------- ----------
Property, plant and equipment... 307,759 26,232 333,991
Accumulated depreciation........ 107,419 8,391 (8,391)(14) 107,419
---------- ------- -------- -------- ----------
Net property, plant and
equipment.................... 200,340 17,841 8,391 226,572
Investments..................... 70,424 51,937 (15) 122,361
Investments restricted for debt
service........................ 39,411 743 40,154
Intangible assets, net.......... 96,547 9,169 (14) 105,716
Deferred charges and other
assets.......................... 41,038 396 6,000 (17) 47,434
---------- ------- -------- -------- ----------
Total Assets.................... $1,150,992 $20,168 $ 34,497 $350,587 $1,556,244
========== ======= ======== ======== ==========
See Notes to Unaudited Pro Forma Consolidated Financial Statements
</TABLE>
RCN CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
December 31, 1997
($ in thousands)
<TABLE>
<CAPTION>
Adjustments
Erols for Adjustments
RCN Historical Acquisition for Issuance of
Historical (8) of Erols the Notes Pro Forma
----------- -------------- ------------- -------------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable to related
parties.......................... $3,748 $3,748
Accounts payable................... 24,835 $8,651 33,486
Advance billings and customer
deposits......................... 7,318 25,583 $(15,624)(15) 17,277
Accrued interest................... 5,549 5,549
Accrued contract settlements....... 3,126 3,126
Accrued cable programming
expense.......................... 3,498 3,498
Accrued expenses and other......... 21,631 1,470 (100)(13) 23,001
Current maturities of debt......... 2,167 (700)(13) 1,467
---------- ------- ------- -------- ----------
Total current liabilities........... 69,705 37,871 (16,424) 91,152
---------- ------- ------- -------- ----------
Long-term debt...................... 686,103 6,852 (5,000)(13) $350,587 (17) 1,038,542
Deferred income taxes............... 19,612 14,626 (14) 34,238
Other deferred credits.............. 2,596 9,107 (5,439)(15) 6,264
Minority interest................... 16,392 16,392
Commitments and contingencies
Common shareholders' equity......... 356,584 (33,662) 46,734 (16) 369,656
---------- ------- ------- -------- ----------
Total liabilities and shareholders'
equity............................. $1,150,992 $20,168 $34,497 $350,587 $1,556,244
========== ======= ======= ======== ==========
See Notes to Unaudited Pro Forma Consolidated Financial Statements
</TABLE>
RCN CORPORATION NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL
STATEMENTS
(dollars in thousands)
The Unaudited Pro Forma Consolidated Statement of Operations
and Balance Sheet of RCN assume that RCN was an autonomous entity rather
than a wholly owned subsidiary of C-TEC for the periods shown. The Pro
Forma adjustments, as described below, are keyed to the corresponding
amounts shown in the relevant statement. All share and per share data of
RCN Common Stock have been restated to reflect the Stock Dividend.
(1) Adjustment to reflect the additional depreciation and
amortization of $1,250 in 1997 resulting from the acquisition of the
minority interest of Freedom in March 1997 and to present the information
as if the acquisition of the minority interest of Freedom had occurred at
the beginning of 1997. See Note 4 to the Consolidated Financial
Statements.
(2) Adjustment to eliminate interest income of $8,686 for the
year ended December 31, 1997, net of income taxes of $(3,040) on
outstanding intercompany notes payable owed to RCN of which $110,000 was
repaid and the remaining balance was treated as capital contributions from
RCN to the borrower.
(3) Adjustment to reflect interest expense and amortization of
debt issuance costs of $5,654 for the year ended December 31, 1997 net of
income taxes of $(1,979) on new third party debt of $110,000 which was
incurred.
(4) Adjustment to reflect interest expense and amortization of
debt issuance costs related to the issuance of the 1997 Notes aggregating
$50,221 for the year ended December 31, 1997, net of income taxes of
$17,577.
(5) Adjustment to eliminate interest expense and amortization of
debt issuance costs of $10,460 for the year ended December 31, 1997 and
related income taxes of $3,661 on existing outstanding third party debt
that was repaid and on outstanding intercompany notes payable owned by RCN
which were treated as capital contributions to RCN from the borrower.
(6) Income tax effects for the distribution adjustments are
summarized as follows:
Year Ended
December 31,1997
Benefit (provision)
-------------------
Elimination of interest expense and amortization of debt
issuance costs on existing outstanding third party debt
(see Note 5).............................................. $3,661
Incurrence of interest expense and amortization of debt
issuance costs on new third party debt (see Note 3)....... (1,979)
Elimination of interest income on outstanding
intercompany notes (see Note 2)........................... 3,040)
Total..................................................... $(1,358)
(7) Adjustments to income taxes of $(437) relating to additional
depreciation and amortization in 1997 due to the acquisition of a 19.9%
minority interest in Freedom in March 1997 (see Note 1).
(8) In February 1998, RCN completed the acquisition of Erols,
Washington, D.C.'s largest Internet service provider, for $29,200 in cash,
1,730,648 newly issued shares of RCN Common Stock plus the assumption and
repayment of $5,800 of debt (including payment of accrued interest).
Additionally, RCN is converting approximately 998,719 stock options for
Erols common stock into options to purchase 699,104 shares of RCN Common
Stock at an average exercise price of $3.424 per share. RCN accounted for
this transaction under the purchase method of accounting and accordingly,
the financial statements of Erols are not consolidated with RCN's
historical financial statements as of and for the year ended December 31,
1997. The financial information of Erols was provided by Erols.
(9) Such adjustments include a pro forma allocation of
historical operating results of Erols to the joint venture with Potomoc
Electric Power Company ("PEPCO") (see Note 15) based upon the relationship
of the number of subscribers expected to be contributed to the joint
venture to the total number of subscribers acquired in the merger. RCN's
share of such operating results, including the depreciation and
amortization effects of the allocation of a portion of the total purchase
price to the joint venture, representing the assumed value of the
subscribers to be contributed to the joint venture, are included in the
adjustment for "equity in the loss of unconsolidated entities."
(10) Such adjustment reflects the increase in depreciation and
amortization for the effect of the fair value adjustment of the net assets
of Erols acquired. (See Note 14.) Amortization of such excess over a five
year period has been assumed, although a shorter life may result based on
the study discussed in Note 14. Also, as discussed in Note 14, a portion
of the excess is expected to be allocated to certain in-process research
and development projects which has resulted in a ratable reduction of pro
forma amortization expense. The final allocation to in-process research
and development may differ from the preliminary estimate.
(11) Adjustment to reflect the tax effect of the pro forma
adjustments, including the tax effect of the historical results of
operations of Erols.
(12) Adjustment to reflect interest expense and amortization of
debt issuance costs related to the issuance of the Notes aggregating
$34,958 for the year ended December 31, 1997, net of income taxes of
$12,235.
(13) Adjustment to reflect $29,200 cash portion of the
consideration for the merger, $5,800 of debt (including accrued interest)
of Erols outstanding at December 31, 1997 which RCN repaid at closing and
other capitalized transaction costs.
(14) RCN allocated the purchase price for Erols (see Note 8) on
the basis of the fair market value of the assets acquired and liabilities
assumed. RCN has undertaken a study to determine such fair market values,
including in-process research and development. Such fair market values may
differ from the allocations assumed in the pro forma financial statements.
The impact on deferred tax balances was included in the above-referenced
fair value adjustments. Erols' historical property, plant and equipment
has been adjusted to its estimated fair value based upon its depreciated
cost. The remaining excess of consideration over the historical book value
of Erols net assets acquired has been preliminarily allocated to subscriber
base, goodwill and other intangible assets. The amounts preliminarily
allocated to subscriber base, goodwill and other intangible assets have
been ratably reduced by the portion of the purchase price expected to be
allocated to in-process research and development. Such acquired research
and development would result in a charge which would initially be
recognized in the period in which the RCN/Erols merger occurred.
(15) A subsidiary of RCN is a party to a joint venture with a
subsidiary of PEPCO, to provide the greater Washington, D.C. area residents
and businesses local and long-distance telephone, cable television, and
Internet services as a package from a single source. As a result of this
joint venture, RCN expects to contribute to the joint venture the
subscribers acquired in the merger with Erols which are located in the
relevant joint venture market. The joint venture partners of Starpower
Communications, LLC ("Starpower") are currently negotiating the terms of
such contribution. The value of such contribution for accounting purposes
is estimated to be approximately $51,937. The joint venture is accounted
for under the equity method of accounting. As a result, RCN's contribution
is reflected as an increase in "Investments." Additionally, RCN expects
that Starpower will assume the liability for the unearned revenue related
to the subscribers contributed to Starpower.
(16) Adjustment to reflect the elimination of Erols' deficit,
the issuance of 1,730,648 shares of RCN stock as a portion of the
consideration for the merger and the estimated write-off of acquired in-
process research and development. (See Note 8.)
(17) Adjustment to reflect the issuance in February 1998 of
$350,587 of the Notes. The debt issuance costs of $6,000 are included in
"deferred charges and other assets" and are amortized over the term of the
Notes.
(18) Represents adjustment for shares to be issued in connection
with the acquisition of Erols. (See Note 8.)
(c) Exhibits (previously filed)
2.1 Agreement and Plan of Merger dated as of January 21, 1998 among
Erols Internet, Inc., Erol Onaran, Gold & Appel Transfer, S.A., RCN
Corporation and ENET Holding, Inc.
2.2 Amendment No. 1 to Merger Agreement
99 Press release announcing the closing of the Erols acquisition
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York,
New York, on this 8th day of May, 1998.
RCN CORPORATION
By: /s/ Bruce C. Godfrey
----------------------------------
Bruce C. Godfrey
Executive Vice President and Chief
Financial Officer
