<PAGE>
This prospectus is filed
pursuant to rule 424(b)(3)
of the Securities Act
of 1933
PROSPECTUS SUPPLEMENT
TO
PROSPECTUS DATED MAY 13, 1998
RCN Corporation
Common Stock, par value $1.00 per share
Attached is RCN Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 1998.
<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 June 30, 1998
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)
Delaware 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 June 30, 1998.
Common Stock 64,677,982
<PAGE>
RCN CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page Number
-----------
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations-Quarters and Six Months Ended
June 30, 1998 and 1997 3
Condensed Consolidated Balance Sheets-
June 30, 1998 and December 31, 1997 4
Condensed Consolidated Statements of
Cash Flows-Six Months Ended June 30,
1998 and 1997 5
Notes to Condensed Consolidated Financial
Statements 6-11
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial
Condition 12-23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales $ 49,808 $ 31,029 $ 89,946 $ 60,706
Costs and expenses, excluding
depreciation and amortization 59,427 30,179 107,882 55,703
Depreciation and amortization 17,031 13,265 34,722 25,455
Nonrecurring acquisition costs:
In-process technology 6,967 - 51,667 -
Other nonrecurring charges - - - 10,000
---------- ---------- ---------- ----------
Operating (loss) (33,617) (12,415) (104,325) (30,452)
Interest income 13,993 4,608 26,808 9,761
Interest expense (26,919) (3,699) (49,654) (7,129)
Other income (expense), net 251 633 (648) 600
---------- ---------- ---------- ----------
(Loss) before income taxes (46,292) (10,873) (127,819) (27,220)
Provision (benefit) for income taxes 1,789 (2,344) (9,893) (7,143)
---------- ---------- ---------- ----------
(Loss) before equity in unconsolidated
entities and minority interest (48,081) (8,529) (117,926) (20,077)
Equity in (loss) of unconsolidated entities (4,481) (756) (5,974) (1,561)
Minority interest in loss of
consolidated entities 3,468 479 7,054 1,388
---------- ---------- ---------- ----------
Net (loss) $ (49,094) $ (8,806) $ (116,846) $ (20,250)
========== ========== ========== ==========
Basic and Diluted (loss) per average
common share:
Net (loss) $ (0.84) $ (.16) $ (2.04) $ (.37)
Weighted average shares outstanding 58,410,970 54,967,538 57,313,640 54,959,270
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
RCN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
June 30, December 31,
1998 1997
----------- -----------
ASSETS
Current assets:
Cash and temporary cash investments $ 623,617 $ 222,910
Short-term investments 529,911 415,603
Accounts receivable from related parties 7,687 9,829
Accounts receivable, net of reserve for doubtful
accounts of $3,517 at June 30, 1998 and $2,134
at December 31, 1997 20,650 14,834
Material and supply inventory, at average cost 4,102 2,745
Prepayments and other 13,835 9,990
Deferred income taxes - 4,821
Investments restricted for debt service 22,650 22,500
---------- ----------
Total current assets 1,222,452 703,232
Property, plant and equipment, net of
accumulated depreciation of $135,984 at
June 30, 1998 and $107,419 at December 31, 1997 279,463 200,340
Investments 128,778 70,424
Investments restricted for debt service 30,582 39,411
Intangible assets, net of accumulated amortization
of 70,149 at June 30, 1998 and 53,388
at December 31, 1997 137,930 96,547
Deferred charges and other assets 49,302 41,038
Deferred income taxes 3,834 -
----------- ----------
Total assets $ 1,852,341 $1,150,992
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of capital lease obligations $ 1,243 $ -
Accounts payable 56,921 24,835
Accounts payable to related parties 706 3,748
Advance billings and customer deposits 27,232 7,318
Accrued taxes 19 488
Accrued interest 5,355 5,549
Accrued contract settlements 3,018 3,126
Accrued video programming expense 5,493 3,498
Accrued expenses 39,739 21,143
Deferred income tax 7,911 -
---------- ----------
Total current liabilities 147,637 69,705
Long-term debt 1,224,614 686,103
Deferred income taxes - 19,612
Other deferred credits 3,563 2,596
Minority interest 35,699 16,392
Commitments and contingencies
Preferred stock - -
Common shareholders' equity:
Common stock, par value $1 per share:
Authorized 100,000,000 shares:
Issued and outstanding 64,677,982
and 54,989,870 64,785 54,989
Additional paid-in capital 514,747 321,766
Cumulative translation adjustments (3,055) (3,055)
Unrealized appreciation on investments 786 -
Treasury stock, 107,000 shares at cost (2,473) -
Deficit (133,962) (17,116)
---------- ----------
Total common shareholders' equity 440,828 356,584
---------- ----------
Total liabilities and shareholders' equity $1,852,341 $1,150,992
========== ==========
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six Months Ended
June 30,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 15,053 $ 4,283
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant & equipment (92,788) (20,914)
Investment in unconsolidated joint venture (12,500) -
Purchase of short-term investments (211,440) -
Sales and maturities of short-term investments 97,019 42,934
Acquisitions (40,769) (30,475)
Proceeds from the sale of partnership interest - 1,900
Other 2,559 (1,423)
--------- ---------
Net cash used in investing activities (257,919) (7,978)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt 502,587 -
Repayment of long-term debt (494) -
Proceeds from the issuance of stock 113,305 -
Purchase of treasury stock (2,472) -
Payments made for debt financing costs (8,177) -
Contribution to minority interest partner (108) -
Contribution from minority interest partner 26,215 -
Proceeds from the exercise of stock options 1,592 -
Transfer from CTE - 26,496
Transfer (to) CTE - (54,547)
Decrease in restricted cash 11,125 -
Change in affiliate notes - 11,381
--------- ---------
Net cash provided by (used in) financing
activities 643,573 (16,670)
--------- ---------
Net increase (decrease) in cash and
temporary cash investments 400,707 (20,365)
Cash and temporary cash investments at
beginning of year 222,910 61,843
--------- ---------
Cash and temporary cash investments at June 30, $ 623,617 $ 41,478
--------- ---------
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of amounts capitalized) $ 48,566 $ 7,877
Income taxes $ 747 $ 588
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Data)
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-K
for the year ended December 31, 1997 together with any amendment thereto.
2. Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). 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. ("Megacable").
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.
3. The Company owns a 40% equity interest in Megacable. For the quarters
ended June 30, 1998 and 1997, 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 $(342) and $(835),
respectively. For the six months ended June 30, 1998 and 1997, 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 $(1,051) and $(1,547), respectively.
Summarized information for the financial position and results of operations of
Megacable, as of and for the six months ended June 30, 1998 and 1997, is as
follows:
1998 1997
--------- -------
Assets $ 79,186 $71,507
Liabilities 5,440 6,278
Shareholders' equity 73,746 65,229
Sales 19,062 14,245
Cost and expenses 13,082 10,051
Foreign currency transaction losses 71 -
Net income $ 5,707 $ 3,979
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 $13 and $(28) for the three and six month periods ended June 30,
1998, respectively, which are included in the condensed consolidated statement
of operations in equity in loss of unconsolidated entities.
<PAGE>
4. During the first six months of 1998, approximately 1,783,000 options
were granted, approximately 286,000 were exercised yielding cash proceeds of
$1,592 and approximately 234,000 options were canceled. At June 30, 1998,
there are approximately 8,370,094 options outstanding at exercise prices
ranging from $0.04 to $29.81 under RCN's 1997 Plan.
5. On September 30, 1997, the Yee Family Trusts, as holders of CTE's
Preferred Stock Series A and Preferred Stock Series B, filed an action against
the Company, CTE and Cable Michigan in the Superior Court of New Jersey. The
complaint alleges that CTE's distribution of the Common Stock of RCN and
Cable Michigan in connection with the Distribution constitutes a fraudulent
conveyance. The plaintiff further alleges breaches of contract and fiduciary
duties in connection with the Distribution. On December 1, 1997, the
complaint was amended to allege that CTE's distribution of the common stock of
RCN and Cable Michigan was an unlawful distribution in violation of Pa. C.S.
1551 (b)(2). The plaintiffs have asked the Court to set aside the alleged
fraudulent conveyance and are seeking unspecified monetary damages alleged to
be in excess of $52,000. The Company believes that this lawsuit is without
merit and is contesting this action vigorously. On January 9, 1998, the
defendants, including RCN, filed a Motion to Dismiss, or in the Alternative,
for Summary Judgement ("the Motion"). Response and Reply Briefs have also
been filed. The Court advised the parties that a special hearing has been
tentatively scheduled for August 31, 1998.
6. Basic earnings per share is computed based on net (loss) income
divided by the weighted average number of shares of common stock outstanding
during the period.
Diluted earnings per share is computed based on net (loss) income divided by
the weighted average number of shares of common stock outstanding during the
period after giving effect to convertible securities considered to be dilutive
common stock equivalents. The conversion of stock options during the periods
in which the Company incurs a loss from continuing operations is not assumed
since the effect is anti-dilutive. The number of stock options which would
have been converted in the quarter and six months ended June 30, 1998 and have
a dilutive effect if the Company had income from continuing operations is
3,892,527 and 3,967,141, respectively.
For periods prior to October 1, 1997, during which the Company was a
wholly-owned subsidiary of C-TEC, earnings per share was calculated by dividing
net (loss) income by the number of average common shares of C-TEC outstanding,
based upon a distribution ratio of one share of Company common equity for
each share of C-TEC common equity owned.
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
-------------------------- --------------------------
1998 1997 1998 1997
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Net (loss) $ (49,094) $ (8,806) $ (116,846) $ (20,250)
Basic earnings per average common share:
Weighted average shares outstanding 58,410,970 54,967,538 57,313,640 54,959,270
Loss per average common share (.84) (.16) (2.04) (.37)
Diluted earnings per average common share:
Weighted average shares outstanding 58,410,970 54,967,538 57,313,640 54,959,270
Dilutive shares resulting from stock options - - - -
----------- ----------- ----------- -----------
Weighted average shares and common stock
equivalents outstanding 58,410,970 54,967,538 57,313,640 54,959,270
=========== =========== ============ ===========
Loss per average common share $ (.84) $ (.16) $ (2.04) $ (.37)
</TABLE>
<PAGE>
7. On February 27, 1998, RCN entered into an Agreement and Plan of Merger
("Lancit Merger Agreement") with Lancit Media Entertainment, Ltd., a New York
corporation ("Lancit"), and LME Acquisition Corporation, a New York corporation
and a wholly-owned subsidiary of RCN ("LME"). The transaction was completed in
June 1998. Pursuant to the Lancit Merger Agreement, LME was merged with and into
Lancit, with Lancit surviving the merger and becoming a wholly-owned subsidiary
of RCN (the "Lancit Merger"). Lancit is a producer of high-quality children's
programming. The total consideration for the transaction was $1 in cash and
366,596 in shares of RCN Common Stock. All options to purchase Lancit Common
Stock were canceled. In addition, approximately 660,000 warrants to purchase
Lancit Common Stock became, by their terms, warrants to purchase the number of
RCN Common Stock equal to the number the warrant holders would have received had
they exercised their warrants immediately prior to the Lancit Merger (such
number would have been approximately 33,000). The Company is conducting a study
for the purpose of allocating the purchase price paid. The Company has
preliminary allocated the excess of the purchase price paid over the book value
of the assets acquired and the liabilities assumed to goodwill. The transaction
was accounted for by the purchase method of accounting. The Company's spin-off
from C-TEC Corporation currently precludes it from utilizing the pooling method
of accounting.
8. On June 1, 1998, RCN entered into an Agreement and Plan of Merger
("Interport Merger Agreement") with Interport Communications Corp., a New York
corporation ("Interport") and INET Holding, Inc., a New York corporation and a
wholly-owned subsidiary of RCN ("INET"), and the individual stockholders of
Interport (the "Interport Stockholders"). The transaction was completed in June
1998. Pursuant to the Interport Merger Agreement, INET was merged with and into
Interport, with Interport surviving the merger and becoming a wholly-owned
subsidiary of RCN (the "Interport Merger"). Interport is New York City's largest
independent Internet service provider ("ISP") with more than 10,000 dial-up
accounts and 500 dedicated line and web hosting customers. The total
consideration for the transaction was $1,025 in cash and approximately 396,442
shares of RCN Common Stock. In addition, Interport stock options were converted
into options to purchase 25,302 shares of RCN Common Stock and 46,986 units
granting the right to deferred delivery of 46,986 shares of RCN Common Stock
were issued. The Company has preliminary allocated the excess of the purchase
price paid over the book value of the assets acquired and the liabilities
assumed to goodwill. The transaction was accounted for by the purchase method of
accounting. The Company's spin-off from C-TEC Corporation currently precludes it
from utilizing the pooling method of accounting.
Pursuant to the Interport Merger Agreement, on June 12, 1998, RCN and the
Interport Stockholders entered into a registration rights agreement ("the
Interport Registration Rights Agreement"). Under the terms of the Interport
Registration Rights Agreement, RCN agreed to register the shares of RCN Common
Stock received by the Interport Stockholders pursuant to a shelf registration
statement, and granted the Interport Stockholders piggy-back registration
rights with respect to such shares, subject to certain limitations as set
forth in the Interport Registration Rights Agreement.
9. On July 30, 1998, RCN entered into an Agreement and Plan of Merger
("JavaNet Merger Agreement") with JavaNet, Inc., a Delaware corporation
("JavaNet"), David Epstein, Zachary Julius, JNET Holding, Inc., a Delaware
corporation and a wholly-owned subsidiary of RCN ("JNET") and (with respect to
certain provisions only) John Halpern. The transaction was completed on July 23,
1998. Pursuant to the JavaNet Merger Agreement, JNET merged with and into
JavaNet, with JavaNet surviving the merger and becoming a wholly-owned
subsidiary of RCN. In connection with the transaction, RCN paid $2,370,000 in
cash and issued approximately 568,887 shares of RCN Common Stock to JavaNet
stockholders. All options to purchase JavaNet Common Stock were canceled.
JavaNet is an internet service provider with approximately 32,000 subscribers in
Connecticut, Maine and Massachusetts. The transaction will be accounted for
under the purchase method of accounting. The Company's spin-off from C-TEC
Corporation currently precludes it from utilizing the pooling method of
accounting.
10. In June 1998, the Company completed a public offering of 11% Senior
Discount Notes with an aggregate principal amount at maturity of $256,755, due
2008. The 11% Senior Discount Notes were issued at a discount and
generated gross proceeds to the Company of approximately $150,000.
The 11% Senior Discount Notes are general senior obligations of the Company.
The 11% Senior Discount Notes will not pay cash interest prior to
January 1, 2003. The yield to maturity of the 11% Senior Discount Notes,
determined on a semi-annual bond equivalent basis, will be 11% per annum.
The 11% Indenture contains certain covenants that, among other things,
limit the ability of the Company and its subsidiaries to incur indebtedness,
pay dividends, prepay subordinate indebtedness, repurchase capital stock,
engage in transactions with stockholders and affiliates, create liens, sell
assets and engage in mergers and consolidations.
<PAGE>
The 11% Senior Discount Notes are redeemable, in whole or in part, at
any time on or after July 1, 2003 at the option of the Company. The
11% Senior Discount Notes may be redeemed at redemption prices starting at
105.5% of the principal amount at maturity and declining to 100% of the
principal amount at maturity, plus any accrued and unpaid interest.
11. In June 1998, the Company completed a public offering of 6,794,500 shares
of RCN Common Stock, par value $1.00 per share, with a price to the Public
of $19.50 per share. Of the 6,794,500 shares offered 6,098,355 were offered
by the Company and 696,145 shares were offered by a Selling Stockholder. The net
proceeds to the Company were approximately $113,305, after deducting issuance
costs.
12. The Company has elected to adopt Statement of Financial Accounting
Standard No. 131 - "Disclosure about Segments of an Enterprise and Related
Information" ("SFAS 131"). The Company's operations involve developing an
advanced fiber network to provide a bundled service package of voice, video
and data services to new customers in high density markets and migrating as
many customers as is economically justified which were served by the Company's
previously separate lines of business, for which profitability was separately
measurable and monitored, to the single source network. While the
Company's chief decision makers monitor the revenue streams of the various
products, operations are managed and financial performance is evaluated
based upon the delivery of multiple services to customers over a single
network. This allows the Company to leverage its network costs to maximum
profitability. As a result, there are many shared expenses generated by
the various revenue streams and management believes that any allocation of the
expenses incurred on a single network to multiple revenue streams would be
impractical and arbitrary, and management does not currently make such
allocations internally. The chief decision makers do, however, monitor
financial performance in a way which is different from that depicted in the
historical general purpose financial statements included in this Quarterly
Report.
The Company manages operations and evaluates operating financial performance
on a pro forma total RCN basis, which reflects the consolidation of all
domestic joint ventures, including those not consolidated under generally
accepted accounting principles. The same net loss results on both a historical
and pro forma total RCN basis since the outside ownership of the joint
venture, which is consolidated only in the pro forma total RCN information, is
reflected as minority interest in the pro forma total RCN information.
Such results for the quarter and six months ended June 30, 1998 and 1997
are as follows:
<PAGE>
<TABLE>
<CAPTION>
Pro Forma Total RCN
--------------------------------------------------------
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales:
Voice $ 5,192 $ 543 $ 8,707 $ 974
Video 27,882 26,623 54,589 51,219
Data 18,527 7 24,259 11
Commercial & other 7,888 3,856 14,953 8,502
----------- ----------- ----------- -----------
Total 59,489 31,029 102,508 60,706
Cost and expenses, excluding
depreciation and amortization:
Direct expenses 26,636 11,826 46,777* 23,113
Operating, selling,
general and administrative 43,236 18,353 75,747* 32,590
----------- ----------- ------------ -----------
EBITDA before nonrecurring charges (10,383) 850 (20,016) 5,003
Depreciation and amortization 25,229 13,265 42,920 25,455
Nonrecurring charge - - - 10,000
Nonrecurring acquisition costs -
In-process technology 6,967 - 51,667 -
----------- ----------- ------------ -----------
Operating (loss) (42,579) (12,415) (114,603) (30,452)
Interest income 14,193 4,608 27,239 9,761
Interest expense (26,919) (3,699) (49,654) (7,129)
Other income (expense) 734 633 (647) 600
------------ ----------- ------------ -----------
(Loss) before income taxes (54,571) (10,873) (137,665) (27,220)
Provision (benefit) for income taxes 1,789 (2,344) (9,893) (7,143)
----------- ----------- ------------ -----------
(Loss) before equity in unconsolidated entities
and minority interest (56,360) (8,529) (127,772) (20,077)
Equity in loss of unconsolidated entities (342) (756) (1,051) (1,561)
Minority interest in loss of consolidated entities 7,608 479 11,977 1,388
------------ ----------- ------------ -----------
Net (loss) $ (49,094) $ (8,806) $ (116,846) $ (20,250)
============ =========== ============ ===========
Balance sheet data (at June 30): 1998 1997
Cash, temporary cash investments ---------- -----------
and short-term investments $1,168,232 $ 45,481
Property, plant and equipment $ 441,861 $ 240,453
Accumulated depreciation 135,984 95,457
----------- -----------
Net property, plant and equipment $ 305,877 $ 144,996
Long-term debt $1,224,614 $ 131,250
</TABLE>
* Direct and operating expenses for the prior quarter have been restated to be
consistent with the quarter ended June 30, 1998.
13. In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 130 - "Reporting Comprehensive
Income" ("SFAS 130"). This statement, which establishes standards for
reporting and disclosure of comprehensive income, is effective for interim
and annual periods beginning after December 15, 1997. The Company does not
currently have any material items subject to disclosure pursuant to SFAS 130.
14. In June, 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 133 ("SFAS 133"). This statement,
which establishes accounting and reporting standards for derivative instruments
and for hedging activities, is effective for the first quarter of fiscal years
beginning after June 15, 1999. The Company does not currently have any items
subject to disclosure pursuant to SFAS 133.
15. On February 20, 1998, RCN issued 1,730,648 shares of RCN Common Stock to
certain shareholders of Erols Internet, Inc. ("Erols") in connection the merger
of Erols with and into a wholly-owned subsidiary of RCN. On February 27, 1998,
RCN issued 890,384 shares of RCN Common Stock to certain shareholders of
UltraNet Communications, Inc. ("UltraNet") in connection with the merger of
UltraNet with and into a wholly-owned subsidiary of RCN. On June 12, 1998 RCN
issued 396,442 shares of RCN Common Stock to certain shareholders of Interport
in connection with the merger of Interport with and into a wholly-owned
subsidiary of RCN. On July 23, 1998, RCN issued 568,887 shares of RCN Common
Stock to certain shareholders of JavaNet in connection with the merger of
JavaNet, Inc. with and into a wholly-owned subsidiary of RCN. These four
issuances were made pursuant to the exemption from registration under Section
4(2) of the Securities Act on the basis that each transaction involved the
issuance of securities in a transaction not involving a public offering.
16. The Company's effective tax rate is different from the federal tax rate
since in the second quarter of 1998 the tax effect of the company's cumulative
losses has exceeded the tax effect of accelerated deductions, primarily
depreciation, which the Company has taken for federal income tax purposes.
Except in unusual cases, generally accepted accounting principles do not permit
the recognition of tax benefits of such excess of losses in the financial
statements. This accounting treatment does not impact the amount of expiration
periods of actual NOL carryovers or cash flows for taxes. Additionally, the
charge for in-process technology is not deductible for tax purposes and a tax
benefit was correspondingly not recorded.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
(Dollars in Thousands, Except Per Share Data)
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.
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, 1997 included in the Company's Form 10-K together with any
amendment thereto.
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 and operating and net losses 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"). 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.
<PAGE>
Results of Operations
Historical
- ----------
Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997
On a historical basis, for the three months ended June 30, 1998, EBITDA before
nonrecurring acquisition costs was ($9,619) as compared to $850 for the same
period in 1997. Sales increased 60.5% to $49,808 for the quarter ended June 30,
1998 from $31,029 for the same period in 1997.
The Company manages operations and evaluates operating financial performance on
a pro forma total RCN basis, which reflects the consolidation of all domestic
joint ventures, including those not consolidated under generally accepted
accounting principles. The same net loss results on both a historical and pro
forma total RCN basis since the outside ownership of the joint venture, which
is consolidated only in the pro forma total RCN information, is reflected as
minority interest in the pro forma total RCN information.
The discussion which follows addresses results on a pro forma total RCN
basis. Such results for the quarter and six months ended June 30, 1998 and 1997
are as follows:
<TABLE>
<CAPTION>
Pro Forma Total RCN
-------------------------------------------------------
Quarter Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales:
Voice $ 5,192 $ 543 $ 8,707 $ 974
Video 27,882 26,623 54,589 51,219
Data 18,527 7 24,259 11
Commercial & other 7,888 3,856 14,953 8,502
----------- ----------- ----------- -----------
Total 59,489 31,029 102,508 60,706
Cost and expenses, excluding
depreciation and amortization:
Direct expenses 26,636 11,826 46,777* 23,113
Operating, selling,
general and administrative 43,236 18,353 75,747* 32,590
----------- ----------- ----------- -----------
EBITDA before nonrecurring charges (10,383) 850 (20,016) 5,003
Depreciation and amortization 25,229 13,265 42,920 25,455
Nonrecurring charge - - - 10,000
Nonrecurring acquisition costs:
In-process technology 6,967 - 51,667 -
----------- ----------- ----------- -----------
Operating (loss) (42,579) (12,415) (114,603) (30,452)
Interest income 14,193 4,608 27,239 9,761
Interest expense (26,919) (3,699) (49,654) (7,129)
Other income (expense) 734 633 (647) 600
------------ ----------- ----------- -----------
(Loss) before income taxes (54,571) (10,873) (137,665) (27,220)
(Benefit) for income taxes 1,789 (2,344) (9,893) (7,143)
------------ ----------- ----------- -----------
(Loss) before equity in unconsolidated entities
and minority interest (56,360) (8,529) (127,772) (20,077)
Equity in loss of unconsolidated entities (342) (756) (1,051) (1,561)
Minority interest in loss of consolidated entities 7,608 479 11,977 1,388
----------- ----------- ----------- -----------
Net (loss) $ (49,094) $ (8,806) $ (116,846) $ (20,250)
=========== =========== =========== ===========
Balance sheet data (at June 30): 1998 1997
Cash, temporary cash investments ----------- -----------
and short-term investments $1,168,232 $ 45,481
Property, plant and equipment $ 441,861 $ 240,453
Accumulated depreciation 135,984 95,457
----------- -----------
Net property, plant and equipment $ 305,877 $ 144,996
Long-term debt $1,224,614 $ 131,250
</TABLE>
* Direct and operating expenses for the prior quarter have been restated to be
consistent with the quarter ended June 30, 1998.
<PAGE>
Sales
- -----
Video sales are comprised primarily of subscription fees for basic, premium and
pay-per-view cable television services; for both wireless and hybrid
fiber/coaxial cable customers in New York, New Jersey and Pennsylvania which
the Company expects to migrate to its advanced fiber networks over time.
Voice sales include local telephone service fees consisting primarily of
monthly line charges, local toll and special features and long-distance
telephone service fees based on minutes of traffic and tariffed rates or
contracted fees. Voice sales include both resold services and traffic
over the Company's own switches. Data sales represent Internet access fees
billed at contracted rates.
Total sales increased $28,460, or 91.7% to $59,489 for the quarter ended June
30, 1998 from $31,029 for the quarter ended June 30, 1997. The increase resulted
from higher total service connections which increased 202.1% to approximately
710,000 at June 30, 1998 from approximately 235,000 at June 30,1997. The
increase in service connections resulted from expansion of the Company's
advanced fiber network, growth in resold voice connections and the acquisitions
of Erols Internet, Inc. ("Erols") and UltraNet Communications ("UltraNet") which
provided approximately 370,000 data connections at the date of acquisition.
Advanced fiber units passed increased to approximately 123,000 units at June 30,
1998 from approximately 8,000 units at June 30, 1997.
Voice revenues increased $4,649 to $5,192 for the quarter ended June 30, 1998
from $543 for the quarter ended June 30, 1997 primarily due to an increase in
off-net connections. Off-net connections were 661,776 and 233,130 at June 30,
1998 and 1997, respectively. Partially contributing to the increase in off-net
connections was the start-up of telephony operations in the Lehigh Valley,
Pennsylvania market in the fourth quarter of 1997.
Video revenue increased $1,259, or 4.7% to $27,882 for the quarter ended June
30, 1998 from $26,623 for the quarter ended June 30, 1997. Video revenue for the
quarter ended June 30, 1997 included one time launch incentive revenue of
approximately $1,000 related to the launch of certain new channels. The increase
in 1998 was primarily due to increases of approximately 6,300 average off-net
video connections and approximately 14,300 average advanced fiber video
connections. Additionally, video rate increases in February and May in selected
markets contributed approximately $806 of the increase.
Data revenues increased $18,520 to $18,527 for the quarter ended June 30, 1998
from $7 for the quarter ended June 30, 1997 primarily due to the acquisitions of
Erols and UltraNet in February 1998.
Commercial and other revenues increased $4,032, or 104.6% to $7,888 for the
quarter ended June 30, 1998 from $3,856 for the quarter ended June 30, 1997. The
increase was due to an increase in commercial local main access lines of
approximately 9,700 over the same period in 1997, compounded by an increase in
revenue per main access line. Additionally contributing to the increase in
commercial and other revenues was higher wholesale revenue from Commonwealth
Telecom Services, Inc. ("CTSI"), a wholly-owned subsidiary of Commonwealth
Telephone Enterprises, Inc. (formerly C-TEC Corporation). CTSI is a Competitive
Local Exchange Carrier ("CLEC") which operates in areas adjacent to the
traditional service area of Commonwealth Telephone Company (also a wholly-owned
subsidiary of Commonwealth Telephone Enterprises, Inc.)
Costs and Expenses Excluding Depreciation and Amortization
- ----------------------------------------------------------
and Nonrecurring Charges
- -------------------------
Costs and expenses, excluding depreciation and amortization and nonrecurring
charges, are comprised of direct costs and operating, selling, and general
and administrative expenses.
Direct expenses include direct costs of providing services, primarily video
programming and franchise costs and network access fees.
Direct expenses increased $14,810, or 125.2% to $26,636 for the quarter ended
June 30, 1998 from $11,826 for the quarter ended June 30, 1997. The increase was
primarily due to costs associated with higher resold voice revenues. The resold
voice increase represents increases in main access lines in New York City,
Boston and Lehigh Valley, Pennsylvania with a view to extending the advanced
fiber network and fully activating RCN's own telephone switches to service many
of these customers, thereby allowing RCN to gain higher margins and additional
revenue from originating and terminating access fees and to control the related
services and service quality. Additionally, Internet access costs associated
with the increase in data revenues, primarily resulting from the acquisitions of
Erols and UltraNet, contributed to the increase in direct expenses. Also
contributing to the increase were higher network costs associated with the
increased wholesale revenue from CTSI and higher video programming costs due to
increased video connections, increased programming rates and new channel
launches.
<PAGE>
Operating, selling, general and administrative expenses primarily include
customers service costs, advertising, sales and marketing expenses,
communications network maintenance and repair ("technical expenses"), and
other corporate overhead.
Operating, selling, general and administrative costs increased $24,883, or
135.6% to $43,236 for the quarter ended June 30, 1998 from $18,353 for the
quarter ended June 30, 1997. Advertising costs increased approximately $8,100
for the quarter ended June 30, 1998 primarily due to an extensive high
visibility multi-media campaign primarily in New York City and Boston, which
commenced in June 1997, as well as to Internet service advertising expense
resulting from the acquisition of Erols in February 1998. Customer services
costs increased approximately $7,000, or 309.0% for the quarter ended June 30,
1998 primarily due to personnel increases related to the expanded customer base
resulting from the acquisition of Erols in February 1998 as well as to other
staff increases to support expanding operations in New York City, Boston and
Lehigh Valley, Pennsylvania. Telephone expense to support higher call volumes
related to expansion of the customer base, billing costs for increased customers
and facilities expense for expanded staff principally comprise the remainder of
the customer service cost increase. Technical expense increased approximately
$1,750, or 38.7%, for the quarter ended June 30, 1998. The increase was
primarily due to engineering and construction headcount additions made to plan
and execute network expansion, resale telephony installation costs, right of way
use fees, network operations control center monitoring costs and rental expense
primarily for materials storage and hub sites. The increase was offset by
approximately $1,029 of technical costs capitalized as part of the cost basis of
the communications network. The Company expects the percentage of capitalized
technical costs to total technical expense to be lower in future periods. Sales
and marketing costs increased approximately $4,500, or 123.9%, for the quarter
ended June 30, 1998. The increase resulted from additional staff, and related
commissions and benefits, to cover the increase in advanced fiber units passed,
to increase penetration in the Company's existing markets and to increase the
number of services per customer. The remaining increase in sales and marketing
expense resulted from the acquisition of Erols and higher telemarketing expense
due to increased campaigns, including the promotion of the start up of telephony
operations in Lehigh Valley, Pennsylvania.
General and administrative expenses increased approximately $3,600, or 51.8%.
The increase is primarily due to higher legal expense associated with the
procurement of additional franchises and open video systems ("OVS") agreements,
higher property taxes principally resulting from communications network
expansion, the acquisition of Erols, and staff additions, principally to support
the expansion, maintenance and upgrade of the Company's management information
systems.
Depreciation and Amortization
- ------------------------------
Depreciation and amortization is comprised principally of depreciation of the
Company's advanced fiber network, its wireless network, and its hybrid
fiber/coaxial cable systems; and amortization of subscriber lists, building
access rights and goodwill resulting primarily from its acquisitions of Freedom,
Twin County, Erols and UltraNet.
Depreciation and amortization was $25,229 for the three month period ended June
30, 1998 and $13,265 for the three month period ended June 30, 1997. The
increase of $11,964, or 90.2% was the result of a higher depreciable basis of
plant, resulting primarily from expansion of the Company's advanced fiber
network, and amortization of intangible assets arising from the acquisition of
Erols and UltraNet in February 1998. The cost basis of property, plant and
equipment on a pro forma total RCN basis, at June 30, 1998 and 1997 was $441,861
and $240,453, respectively. The basis of intangible assets, on a Pro Forma total
RCN basis was $268,919 and $161,661 at June 30, 1998 and 1997, respectively.
Nonrecurring Charge
- -------------------
Acquisition costs - In-process technology was approximately $7,000 for the
quarter ended June 30, 1998. In connection with the acquisitions of Erols and
UltraNet, the Company and an independent third party are conducting a study for
the purpose of allocating the purchase price paid for Erols and Ultranet. The
<PAGE>
preliminary results of this study indicated that approximately $51,700 will be
allocable to in-process technology. The Company recognized a charge of $44,700
during the quarter ended March 31, 1998 related to this acquired in-process
technology.
The value of in-process technology constitutes that portion of the purchase
price representing future cash flows from those new and developing technologies
expected to displace the current approaches to serving customer needs in the
Internet service field.
Interest income
- ---------------
Interest income was $14,193 and $4,608 for the three month periods ended June
30, 1998 and 1997, respectively. The increase of $9,585, or 208.0%, results from
higher cash, temporary cash investments and short-term investments, as compared
to the same period in 1997. Cash, temporary cash investments and short-term
investments, on a pro forma total RCN basis, were approximately $1,168,000 at
June 30, 1998 and approximately $45,500 at June 30, 1997. Such increase
primarily represents interest on the unused portion of the following debt and
equity financings made subsequent June 30, 1997: 10% Senior Notes, issued in
October 1997, which generated gross proceeds of $225,000 and yielded net
proceeds of $218,250; 11 1/8% Senior Discount Notes, issued in October 1997,
which generated gross proceeds of $350,001 and yielded net proceeds of $337,751;
9.8% Senior Discount Notes, issued in February 1998, which generated gross
proceeds of $350,587 and yielded net proceeds of $344,855; 11% Senior Discount
Notes, issued in June 1998, which generated gross proceeds of $149,999 and
yielded net proceeds of $147,187 and the issuance of 6,098,355 shares of the
Company's Common Stock, issued in June 1998, yielded net proceeds of $113,305.
Interest expense
- ----------------
The increase in interest expense primarily represents interest on the gross
proceeds of the debt financings mentioned above (see interest income) as well
as the interest on the $100,000 term credit facility and the outstanding
borrowings on the $25,000 revolving credit agreement ($5,000 at June 30, 1998)
of certain of the Company's subsidiaries issued in August 1997. For the
quarter ended June 30, 1998, interest expense was $26,919 as compared to $3,699
for the quarter ended June 30, 1997. The increase was partially offset by a
reduction due to the prepayment in September 1997 of $131,250 of 9.65% Senior
Secured Notes. Interest expense also includes amortization of deferred
financing costs associated with the above credit facilities.
<PAGE>
Income tax
- ----------
The Company's effective income tax rate was a provision of 3.8% for the quarter
ended June 30, 1998 and a benefit of 21.0% for the quarter ended June 30, 1997.
The tax effect of the Company's cumulative losses has exceeded the tax effect
of accelerated deductions, primarily depreciation, which the Company has taken
for federal income tax purposes. Except in unusual cases, generally accepted
accounting principles do not permit the recognition of tax benefits of such
excess losses in the financial statements. This accounting treatment does not
impact the amount or expiration periods of actual NOL carryovers or cash flows
for taxes.
Minority interest
- -----------------
On a pro forma total RCN basis, for the second quarter of 1998, minority
interest of $7,608 primarily represents the 49% interest of Boston Edison
Company ("BECO") in the loss of RCN-BECOCOM of $3,528 and the 50% interest
of Potomac Capital Investment Corporation ("PCI") in the loss of Starpower
of $4,140. On a historical basis, Starpower is accounted for under the
equity method. In the second quarter of 1997, minority interest primarily
represents the 49% interest of BECO in the loss of RCN-BECOCOM of $537.
Equity in loss of unconsolidated entities
- -----------------------------------------
On a pro forma total RCN basis, equity in the loss of unconsolidated entities
primarily represents the Company's share of the losses and amortization of
excess cost over net assets of Megacable. On a historical basis, for the
second quarter of 1998, equity in the loss of unconsolidated entities also
includes the Company's 50% interest in the loss of Starpower of $4,139.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Historical
- ----------
On a historical basis, for the six months ended June 30, 1998, EBITDA before
nonrecurring acquisition costs was $(17,936) as compared to $5,003 for the
same period in 1997. Sales increased 48.2% to $89,946 for the six months ended
June 30, 1998 from $60,706 for the same period in 1997.
Pro Forma Total RCN
- -------------------
Sales
- -----
Total sales increased $41,802, or 68.9% to $102,508 for the six months ended
June 30, 1998 from $60,706 for the six months ended June 30, 1997. The
increase resulted from higher average service connections as discussed below.
The increase in service connections resulted from expansion of the Company's
advanced fiber network, growth in resold voice connections and the acquisitions
of Erols and UltraNet which provided approximately 370,000 data connections at
the date of acquisition.
Voice revenues increased $7,733 to $8,707 for the six months ended June 30,
1998 from $974 for the six months ended June 30, 1997 primarily due to an
increase in off-net connections. Off-net connections were 661,776 and 233,130
at June 30, 1998 and 1997, respectively. Partially contributing to the increase
in off-net connections was the start-up of telephony operations in the Lehigh
Valley, Pennsylvania market in the fourth quarter of 1997.
Video revenue increased $3,370, or 6.6% to $54,589, for the six months ended
June 30, 1998 from $51,219 for the six months ended June 30, 1997. Video
revenue for the six months ended June 30, 1997 included one time launch
incentive revenue of approximately $1,000 related the launch of certain new
channels. The increase in 1998 was primarily due to increases of approximately
6,000 average off-net video connections and approximately 14,000 average
advanced fiber and wireless video connections. Additionally, video rate
increases in February and May in selected markets contributed approximately
$1,138 of the increase.
Data revenues increased $24,248 to $24,259 for the six months ended
June 30, 1998 from $11 for the six months ended June 30, 1997 primarily due
to the acquisitions of Erols and UltraNet in February 1998. At June 30, 1998,
the Company had 398,560 off-net data connections.
Commercial and other revenues increased $6,451, or 75.9% to $14,953 for
the six months ended June 30, 1998 from $8,502 for the six months ended
June 30, 1997. The increase was due to an increase in commercial local main
access lines of approximately 8,800 over the same period in 1997, compounded by
an increase in revenue per main access line. Additionally contributing to
the increase in commercial and other revenues was higher wholesale revenue from
CTSI.
<PAGE>
Costs and Expenses Excluding Depreciation and Amortization and
- -------------------------------------------------------------
Nonrecurring Charges.
- ----------------------
Direct expenses increased $23,664, or 102.4% to $46,777 for the six months ended
June 30, 1998 from $23,113 for the six months ended June 30, 1997. The increase
was primarily due to higher resold voice revenues. The resold voice increase
represents increases in main access lines in New York City, Boston and Lehigh
Valley, Pennsylvania with a view to extending the advanced fiber network and
fully activating RCN's own telephone switches to service many of these
customers, thereby allowing RCN to gain higher margins and additional revenue
from originating and terminating access fees and to control the related
services and service quality. Additionally, Internet access costs associated
with the increase in data revenues, primarily resulting from the acquisitions
of Erols and UltraNet, contributed to the increase in direct expenses. Also
contributing to the increase were higher network costs associated with the
increased wholesale revenue from CTSI and higher video programming costs due
to increased video connections, increased programming rates and new channel
launches.
Operating, selling, general and administrative costs increased $43,157, or
132.4% to $75,747 for the six months ended June 30, 1998 from $32,590 for the
six months ended June 30, 1997. Advertising costs increased approximately
$14,400 for the six months ended June 30, 1998 primarily due to an extensive
high visibility multi-media campaign primarily in New York City and Boston,
which commenced in June 1997, as well as to Internet services advertising
expense resulting from the acquisition of Erols in February 1998 and to
expense incurred to promote the commencement of telephony operations in the
Lehigh Valley, Pennsylvania market. Customer services costs increased
approximately $11,100, or 252.8% for the six months ended June 30, 1998
primarily due to personnel increases related to the expanded customer base
resulting from the acquisition of Erols in February 1998 as well as to other
staff increases to support expanding operations in New York City, Boston and
Lehigh Valley, Pennsylvania. Telephone expense to support higher call volumes
related to expansion of the customer base, billing costs for increased customers
and facilities expense for expanded staff principally comprise the remainder of
the customer service cost increase. Technical expense increased approximately
$3,700, or 41.3%, for the six months ended June 30, 1998. The increase was
primarily due to engineering and construction headcount additions made to plan
and execute network expansion, resale telephony installation costs, right of
way of use fees, network operations control center monitoring costs and rental
expense primarily for materials storage and hub sites. The increase was offset
by approximately $1,029 of technical costs capitalized as part of the cost
basis of the communications network. The Company expects the percentage of
capitalized technical costs to total technical expense to be lower in future
periods. Sales and marketing costs increased approximately $8,000, or 124.9%,
for the six months ended June 30, 1998. The increase resulted from additional
staff, and related commissions and benefits, to cover the increase in advanced
fiber units passed, to increase penetration in the Company's existing markets
and to increase the number of services per customer. The remaining increase
in sales and marketing expense resulted from the acquisitions of Erols and
UltraNet and higher telemarketing expense due to increased campaigns, including
the promotion of the start up of telephony operations or Lehigh Valley,
Pennsylvania.
General and administrative expenses increased approximately $5,900 or 51.4%.
The increase is primarily due to higher legal expense associated with the
procurement of additional franchises and open video systems ("OVS") agreements,
higher property taxes principally resulting from communication network
expansion, the acquisitions of Erols and UltraNet, and staff additions,
principally to support the expansion, maintenance and upgrade of the Company's
management information systems.
Depreciation and amortization
- -----------------------------
Depreciation and amortization was $42,920 for the six month period ending
June 30, 1998 and $25,455 for the six month period ending June 30, 1997.
The increase of $17,465, or 68.6% was the result of both a higher depreciable
basis of plant, resulting primarily from expansion of the Company's advanced
fiber network, and amortization of intangible assets arising from the
acquisitions of Erols and UltraNet in February 1998. The cost basis of
property, plant and equipment on a pro forma total RCN basis at June 30, 1998
and 1997 was $441,861 and $240,453, respectively. Additionally, higher
intangibles resulted from the payment of $15,000 on March 21, 1997 of
<PAGE>
contingent consideration applicable to the Company's original purchase of an
80.1% ownership interest in Freedom and from the payment of an additional
$15,000 on March 21, 1997 to acquire the remaining 19.9% ownership in Freedom.
The intangibles resulting from these payments were depreciable for the full
six months ended June 30, 1998 but only from the date of payment for the
six months ended June 30, 1997. The basis of intangible assets, on a pro forma
total RCN basis, was $268,919 and $161,661 at June 30, 1998 and 1997,
respectively.
Nonrecurring Charge
- -------------------
Acquisition costs - In-process Technology. In connection with the acquisitions
of Erols and UltraNet, the Company and an independent third party are conducting
a study for the purpose of allocating the purchase price paid for Erols and
UltraNet. The preliminary results of this study indicate that approximately
$51,700 will be allocable to in-process technology which the Company recognized
as a charge during the six months ended June 30, 1998.
For the six months ended June 30, 1997 the nonrecurring charges of $10,000
represent costs incurred with respect to the termination of a marketing services
agreement held by Freedom.
Interest income
- ----------------
Interest income was $27,239 and $9,761 for the six month periods ended
June 30, 1998 and 1997, respectively. The increase of $17,478, or 179.1%,
results from higher cash, temporary cash investments and short-term investments
as compared to the same period in 1997. Cash, temporary cash investments and
short-term investments, on a pro forma total RCN basis, were approximately
$1,168,000 at June 30, 1998 and approximately $45,500 at June 30, 1997. Such
increase primarily results from the debt and equity financings of the company
as detailed in the discussion of interest income for the three months ended
June 30, 1998.
Interest expense
- ----------------
For the six months ended June 30, 1998, interest expense was $49,654 as
compared to $7,129 for the six months ended June 30, 1998. The increase
resulted from the debt financings referred to above that were placed
subsequent to the second quarter of 1997, offset by a reduction due to
the prepayment in September 1997 of $131,250 of 9.65% Senior Secured Notes.
Other (expense) income
- ----------------------
Other (expense) income was ($647) and $600 for the six months ended June 30,
1998 and 1997, respectively. The primary component of other (expense) income for
the six months ended June 30, 1998 was the write down of certain of the
Company's information technology assets which the Company intends to replace
within the next several months with higher capacity state of the art products in
connection with an overall internal technology upgrade.
<PAGE>
Income tax
- ----------
The Company's effective income tax rate was a benefit of 7.8% and 26.1% for
the six months ended June 30, 1998 and June 30, 1997, respectively. The
primary reasons for the difference include the charge for in-process
technology which is not deductible for tax purposes and for which a
tax benefit was correspondingly not recorded. Additionally, during 1998, the
tax effect of the Company's cumulative losses has exceeded the tax effect
of accelerated deductions, primarily depreciation, which the Company has
taken for federal income tax purposes. Except in unusual cases, generally
accepted accounting principles do not permit the recognition of tax benefits
of such excess losses in the financial statements. This accounting treatment
does not impact the amount of expiration periods of actual NOL carryovers
or cash flows for taxes.
Minority Interest
- -----------------
On a pro forma total RCN basis, for the six months ended
June 30, 1998 minority interest of $11,977 primarily represents the 49%
interest of BECO in the loss of RCN-BECOCOM of $7,173 and the 50% interest of
PCI in the loss of Starpower of $4,923. On a historical basis, Starpower is
accounted for under the equity method. In the second quarter of 1997, minority
interest primarily represents the 49% interest of BECO in the loss of
RCN-BECOCOM of $537 and the 19.9% minority interest in the loss of Freedom of
$966. The company purchased the remaining 19.9% ownership interest in Freedom
on March 21, 1997.
Equity in Loss of Unconsolidated Entities
- -----------------------------------------
On a pro forma total RCN basis, equity in the loss of unconsolidated entities
primarily represents the Company's share of the losses and amortization of
excess cost over net assets of Megacable. On a historical basis, for the six
months ended June 30, 1998, equity in the loss of unconsolidated entities also
includes the Company's 50% interest in the loss of Starpower of $4,923.
Liquidity and Capital Resources
- -------------------------------
The Company expects that it will require a substantial amount of capital to
fund the network development and operations in its target markets (including
markets in the Boston to Washington, D.C. corridor and new markets in the
western United States), including funding the development of its advanced fiber
optic networks, upgrading its hybrid fiber/coaxial plant and funding operating
losses and debt service requirements. On June 4, 1998 RCN announced its
intention to commence developing advanced fiber optic networks in selected
high density markets outside of the Boston to Washington, D.C. corridor. The
Company is targeting selected markets in the western United States which
represent approximately 2% of the geography of the U.S. but account for
approximately 12% of the U.S. telecommunications market based upon the
number of telephone access lines. The Company expects that its initial west
coast network will be developed in the San Francisco Bay Area, a market that
benefits from high density, high per capita income and the highest Internet
usage in the United States. RCN has submitted an application for CLEC status in
California, has obtained an OVS certification from the FCC for the City of San
Francisco and surrounding Counties and has held initial meetings with several
municipalities in the San Francisco Bay Area to discuss network deployment. The
Company also expects its expansion to include selected markets in or near
Southern California, Las Vegas and Phoenix. As is the case in its existing
markets, the Company intends to focus on high density markets with favorable
demographics, and to apply a subscriber-driven investment strategy, in
developing new markets. The Company believes that its experience in the
Northeast will provide it with a key strategic advantage. Subject to obtaining
requisite regulatory approvals, the Company expects to commence initial network
construction in the San Francisco Bay Area in 1999. The Company currently
estimates that its capital expenditure requirements for the period from January
1, 1998 through 1999 will be approximately $850 million, which represents
capital expenditures (including connection costs which will only be incurred as
the Company obtains revenue-generating customer connections) of approximately
$300 million in 1998 and approximately $550 million in 1999. Additional funds
will be required to fund operating losses during the period. As a result of more
rapid deployment of its fiber optic network, the Erols and UltraNet
acquisitions, and the anticipated development of new markets
<PAGE>
outside the Boston to Washington, D.C. corridor, certain aspects of the
Company's capital expenditure program are being accelerated. To build out
its target markets 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 direct
network deployment 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 Internet and 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 each expected to
contribute approximately $150,000 in capital to the joint ventures in
connection with development of the Boston and Washington, D.C. markets from
September 1997 through 2000, of which approximately $61,700 has been
contributed.
The Company expects to have sufficient liquidity to meet its capital
requirements through early 2000. 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, and/or decide to enter new
markets, the Company may accelerate the rollout and/or extend the reach of
its network; such acceleration could increase the Company's capital
requirements. The proposed development of new networks in selected markets
in the western United States will substantially increase the Company's
capital requirements. The Company's inital network development plan for
expansion into its target market markets in the western United States will
require funding of approximately $350 million (including operating losses)
through the year 2000; however, the actual timing and amount of capital
required may vary materially from the Company's initial estimates. 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 captial 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 and potentially beyond the Boston to 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 redue 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 anitcipated joint venture partners'
equity contributions. However, the joint venture arrangements will also reduce
the potential cash flows to be realized from operation of the networks in the
markets in which the joint ventures operate and restrict the Company's access
to cash flow generated by the joint ventures (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. RCN and Boston Edison Company
("BECO") are presently in discussions with respect to the conversion of a
portion of BECO's interest in the BECO joint venture into RCN Common Stock.
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 could impair the Company's ability
to meet its debt service requirements and could have a material adverse effect
on its business.
In October 1997, the Company raised $575,000 in gross proceeds from an offering
of two tranches of debt securities. The offering was comprised of $225,000
<PAGE>
principal amount of 10% Senior Notes and $601,045 principal amount at maturity
of 11 1/8% Senior Discount Notes, both due in 2007. The proceeds include $61,000
of restricted cash to be used to fund the Escrow Account to pay interest on the
10% Senior Notes for three years. In February 1998, the Company raised $350,587
in gross proceeds from an offering of $567,000 principal amount at maturity of
9.80% Senior Discount Notes, due in 2008. In June 1998, the Company raised
$149,999 in gross proceeds from an offering of $256,755 principal amount at
maturity of 11% Senior Discount Notes, due 2008, also in June 1998, the Company
raised 113,305 in net proceeds from an offering of 6,098,355 shares of the
Company's Common Stock. The preceeding Indentures all contain similar
provisions. The Chase Manhattan Bank acts as Trustee for each of the Indentures.
All the aforementioned Notes are general senior unsecured obligations of RCN.
The 9.80% Senior Discount Notes will mature on February 15, 2008. The 9.80%
Senior Discount Notes will not bear cash interest prior to February 15, 2003.
The 10% and 11 1/8% Notes (the "1997 Notes") will mature on October 15, 2007.
Interest on the 10% Senior Notes are payable in cash at a rate of 10% per annum
semi-annually in arrears on each April 15 and October 15, commencing April 15,
1998. The 11 1/8% Senior Discount Notes will not bear cash interest prior to
October 15, 2002. The 11% Senior Discount Notes will not bear cash interest
prior to January 1, 2003. Thereafter, cash interest on the notes will accrue at
a rate of 11% per annum and will be payable semi-annually in arrears on January
1 and July 1 of each year, commencing July 1, 2003.
The 9.80% Senior Discount Notes are redeemable, in whole or in part, at any
time on or after February 15, 2003 at the option of RCN. The 9.80% Senior
Discount Notes may be redeemed at redemption prices starting at 104.900% of
the principle amount at maturity and declining to 100% of the principal
amount at maturity, plus any accrued and unpaid interest. The 1997 Notes are
redeemable, in whole or in part, at any time on or after October 15, 2002 at the
option of RCN. The 10% Senior Notes may be redeemed at redemption prices
starting at 105% of the principal amount and declining to 100% of the principal
amount, plus any accrued and unpaid interest. The 11 1/8% Senior Discount Notes
may be redeemed at redemption prices starting at 105.562% of the principal
amount at maturity and declining to 100% of the principal amount at maturity,
plus any accrued and unpaid interest. The 11% Senior Discount Notes will be
redeemable, in whole or in part, at any time on or after July 1, 2003 at the
option of RCN. The 11% Senior Discount Notes may be redeemed at redemption
prices starting at 105.5% of the principle amount at maturity and declining to
100% of the principle amount at maturity, plus accrued and unpaid interest.
RCN may, at its option, use the net proceeds of certain offerings of RCN
Common Stock to redeem up to an aggregate of 35% of the aggregate principal
amount at maturity of the debt securities issued under the Indentures at a
certain premium. Upon the occurrence of a change of control, RCN must make
an offer to purchase all of the debt securities issued under the Indentures
than outstanding at a premium.
The Indentures contain certain convenants that, among other things, limit the
ability of RCN and its subsidiaries to incur indebtedness, pay dividends,
prepay subordinated indebtedness, repurchase capital stock, engage in
transactions with stockholders and affiliates, create liens, sell assets and
engage in mergers and consolidations.
RCN Cable and certain of its subsidiaries ("Borrowers") have in place secured
credit facilities comprised of a five-year revolving credit facility in the
amount of $25,000 (the "Revolving Credit Facility") and an eight-year term
credit facility in the amount of $100,000 (the "Term Credit Facility"), both
of which facilities are governed by a single credit agreement dated as of
July 1, 1997 (the "Credit Agreement"). As of June 30, 1998, $100,000 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
June 30, 1998, $5,000 principal was outstanding under the Revolving Credit
Facility. Revolving loans may be repaid and reborrowed from time to time.
All borrowings under the Credit Agreement will be pari passu and will be
secured under a common collateral package.
The interest rate on the Credit Agreement is, at the election of the Borrowers,
based on either a LIBOR or a Base Rate option (each as defined in the Credit
Agreement). In the case of LIBOR option, the interest rate includes a spread
that varies, based on RCN Cable's Leverage Ration (defined as the ratio of
Total Debt at the last day of the most recently ended fiscal quarter to
Operating Cash Flow for the four fiscal quarters then ended), from 50
basis points to 125 basis points. In the case of the Revolving Credit
<PAGE>
Facility, a fee of 20 basis points on the unused revolving commitment accrues
and is payable quarterly in arrears.
The Credit Agreement contains customary covenants for facilities of this nature,
including covenants limiting debt, liens, investments, consolidations, mergers,
acquisitions and sales of assets, payment of dividends and other distributions,
capital expenditures and transactions with affiliates. In addition, the
Borrowers are subject to a prohibition on granting negative pledges and the
Borrowers must apply certain cash proceeds realized from certain asset sales,
certain payments under insurance policies and certain incurrences of additional
debt to repay the Revolving Credit Facility. The Credit Agreement requires the
Borrowers to maintain the following financial ratios: (i) the ratio of Total
Debt at any fiscal quarter end to Operating Cash Flow for the trailing four
fiscal quarters is not to exceed 5.0:1 initially, adjusting over time to 4.0:1;
(ii) the ratio of Operating Cash Flow to Interest Expense for any four
consecutive fiscal quarters is not to fall below 2.75:1 for periods ending
during the first 3 years after the Closing Date, adjusting to 3.0:1 thereafter;
and (iii) the ratio of Operating Cash Flow (minus certain capital expenditures,
cash taxes and cash dividends) to Fixed Charges (defined as scheduled principal
payments and interest expense) for any four consecutive quarters is not to fall
below 1.0:1 for periods ending on or before December 31, 2000 and adjusting to
1.05:1 thereafter. The Credit Agreement also includes customary events of
default.
The Company has indebtedness that is substantial in relation to its
shareholders' equity and cash flow. At June 30, 1998 after giving effect
to the Offering, the Company has an aggregate of approximately $1,225,000 of
indebtedness outstanding, and the ability to borrow up to an additional $20,000
under the Credit Agreement.
As a result of the substantial indebtedness of the Company, the Company's
fixed charges are expected to exceed its earnings for the foreseeable future.
In addition, the Company will require substantial additional indebtedness
particularly in connection with the buildout of the Company's networks and
the introduction of its telecommunications services to new markets. The
leveraged nature of the Company could limit its ability to effect future
financing or may otherwise restrict the Company's business activities.
The extent of the Company's leverage may have the following consequences: (i)
limit the ability of the Company to obtain necessary financing in the future of
working capital, capital expenditures, debt service requirements or other
purposes; (ii) require that a substantial portion of the Company's cash flows
from operations be dedicated to the payment of principal and interest on its
indebtedness and therefore not be available for other purposes; (iii) limit the
the Company's flexibility in planning for, or reacting to, changes in its
business; (iv) place the Company at a competitive disadvantage as compared with
less leveraged competitors; and (v) render the Company more vulnerable in the
event of a downturn in its business.
On a historical basis, for the six months ended June 30, 1998, the Company's net
cash provided by operating activities was $15,053 comprised primarily of a net
loss of $(116,846) adjusted by non-cash depreciation and amortization of
$34,722, other non-cash items totaling $75,137 (primarily includes the write-off
of acquired research and development and accretion of senior discount notes),
and working capital changes of $24,570. Net cash used in investing activities of
$(257,919) consisted primarily of purchase of short-term investments of
$211,440, additions to property, plant and equipment of $92,788, an investment
in an unconsolidated joint venture of $12,500 and acquisitions of $40,769
(primarily the acquisitions of Interport Communications Corp. and Lancit Media
Entertainment, Ltd., Erols and UltraNet), partially offset by sales and
maturities of short-term investments of $97,019. Net cash provided by financing
activities of $643,573 consisted primarily of the issuance of long-term debt of
$502,587, the issuance of Common Stock of 113,305, a decrease in restricted cash
of $11,125 and contributions from a minority interest partner of $26,215,
partially offset by payments made for debt financing costs of $8,177.
<PAGE>
Part II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
The information required under Item 1 Part II is included in Note 5 to the
financial statements set forth in Part I hereof and is specifically incorporated
herein by reference thereto.
Item 2. Changes in Securities
On February 20, 1998, RCN issued 1,730,648 shares of RCN Common Stock to
certain shareholders of Erols Internet, Inc. ("Erols") in connection the merger
of Erols with and into a wholly-owned subsidiary of RCN. On February 27, 1998,
RCN issued 890,384 shares of RCN Common Stock to certain shareholders of
UltraNet Communications, Inc. ("UltraNet") in connection with the merger of
UltraNet with and into a wholly-owned subsidiary of RCN. On June 12, 1998 RCN
issued 396,442 shares of RCN Common Stock to certain shareholders of Interport
in connection with the merger of Interport with and into a wholly-owned
subsidiary of RCN. On July 23, 1998, RCN issued 568,887 shares of RCN Common
Stock to certain shareholders of JavaNet in connection with the merger of
JavaNet, Inc. with and into a wholly-owned subsidiary of RCN. These four
issuances were made pursuant to the exemption from registration under Section
4(2) of the Securities Act on the basis that each transaction involved the
issuance of securities in a transaction not involving a public offering.
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
(3.1) Amended and Restated Articles of Incorporation of the
Company (incorporated by Reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1 (Commission
File No. 333-61223)).
(4.1) Indenture dated June 24, 1998 between the Company, as
Issuer, and The Chase Manhattan Bank, as Trustee, with
respect to the 11% Senior Discount Notes due 2008
(incorporated by Reference to Exhibit 4.8 to the Company's
Registration Statement on Form S-1 (Commission File No. 333-
55673)).
(4.2) Form of 11% Senior Discount Note due 2008 (included in
Exhibit 4.2) (incorporated by reference to Exhibit 4.8 to
the Company's Registration Statement on Form S-1 (Commission
File No. 333-55673)).
(4.3) Indenture dated as of February 6, 1998 between the Company,
as Issuer, and The Chase Manhattan Bank, as Trustee, with
respect to the 9.80% Senior Discount Notes due 2008
(incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-4 (Commission File No. 333-
48487) ("1998 Form S-4") filed on March 23, 1998)
(4.4) Form of the 9.80% Senior Discount Notes due 2008 (included
in Exhibit 4.3) (incorporated by reference to Exhibit 4.2 to
the Company's 1998 Form S-4)
(27) Financial Data Schedule
(b.) Reports on Form 8-K
On May 8, 1998 the Company filed an 8-K to file the required
financial statements and the pro forma financial statements
related to the Erols acquisition.
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: August 14, 1998
/s/ Bruce C. Godfrey
------------------------
Bruce C. Godfrey
Executive Vice President and
Chief Financial Officer
<PAGE>
[ARTICLE] 5
[LEGEND]
This schedule contains summary financial information extracted from financial
statements as of and for the six months ended June 30, 1998, and is qualified in
its entirety by reference to such financial statements.
[/LEGEND]
[MULTIPLIER] 1,000
[TABLE]
[S] [C]
[PERIOD-TYPE] 6-MOS
[FISCAL-YEAR-END] DEC-31-1998
[PERIOD-START] JAN-01-1998
[PERIOD-END] JUN-30-1998
[CASH] 623,617
[SECURITIES] 529,911
[RECEIVABLES] 24,167
[ALLOWANCES] 3,517
[INVENTORY] 4,102
[CURRENT-ASSETS] 1,222,452
[PP&E] 415,447
[DEPRECIATION] 135,984
[TOTAL-ASSETS] 1,852,341
[CURRENT-LIABILITIES] 147,637
[BONDS] 1,224,614
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 64,785
[OTHER-SE] 376,043
[TOTAL-LIABILITY-AND-EQUITY] 1,852,341
[SALES] 0
[TOTAL-REVENUES] 89,946
[CGS] 0
[TOTAL-COSTS] 71,907
[OTHER-EXPENSES] 0
[LOSS-PROVISION] 1,704
[INTEREST-EXPENSE] 49,654
[INCOME-PRETAX] (127,819)
[INCOME-TAX] (9,893)
[INCOME-CONTINUING] (116,846)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (116,846)
[EPS-PRIMARY] (2.04)
[EPS-DILUTED] (2.04)
[/TABLE]
