<PAGE>
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1997
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File No. 0-22825
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3498533
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
105 Carnegie Center, Princeton, New Jersey 08540
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: 609-734-3700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
X Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
Number of shares of the Registrant's Stock ($1.00 par value) outstanding at
February 28, 1998
28,889,584 Common Stock
Aggregate market value of Registrant's voting stock held by non-affiliates at
February 28, 1998 computed by reference to closing price as reported by NASDAQ
for Common Stock ($58.75 per share)
$ 914,684,566 Common Stock
Documents Incorporated by Reference
1. Proxy Statement for 1998 Annual Meeting of Shareholders is incorporated by
reference into Part I and Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
THE COMPANY
Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). On September 30, 1997, C-TEC distributed 100 percent of
the outstanding shares of common stock of its wholly owned subsidiaries, RCN
Corporation ("RCN" or the "Company") and Cable Michigan, Inc. ("Cable Michigan")
to holders of record of C-TEC's Common Stock and C-TEC's Class B Common Stock as
of the close of business on September 19, 1997 (the "Distribution") in
accordance with the terms of a Distribution Agreement dated September 5, 1997
among C-TEC, RCN and Cable Michigan (the "Distribution Agreement"). See
"Relationship Among RCN, CTE and Cable Michigan." RCN consists primarily of C-
TEC's high growth, bundled residential voice, video and Internet access
operations in the Boston to Washington, D.C. corridor, its existing New York,
New Jersey and Pennsylvania cable television operations, a portion of its long
distance operations and its international investment in Megacable, S.A. de C.V.
("Megacable"). Cable Michigan, Inc. consists of C-TEC's Michigan cable
television operations, including its 62% ownership in Mercom, Inc. As part of
C-TEC's restructuring, C-TEC changed its name to Commonwealth Telephone
Enterprises, Inc. ("CTE").
RCN is developing advanced fiber optic networks to provide a wide range of
telecommunications services including local and long distance telephone, video
programming and data services (including high speed Internet access), primarily
to residential customers in selected markets in the Boston to Washington, D.C.
corridor. The region, one of the most densely populated in the United States,
represents approximately 4% of the geography of the U.S., but accounts for over
26% of the telecommunications market based upon the number of telephone access
lines. The Company believes that of the estimated 22 million homes in the Boston
to Washington, D.C. corridor, approximately 9 million homes are located in high-
density urban and suburban residential areas that will support development of an
advanced fiber optic network on an attractive economic basis. RCN believes that
its capability to deliver multiple services (telephone, video programming and
Internet access) to any given customer on its networks will provide it with
competitive advantages over other competitors. RCN's strategy is to become the
leading single-source provider of voice, video and data services to residential
customers in each of its markets by offering individual or bundled service
options, superior customer service and competitive prices.
RCN's initial advanced fiber optic networks have been established in New York
City and, through a joint venture with Boston Edison Company ("BECO"), in Boston
and surrounding communities. RCN has also entered into a joint venture named
Starpower Communications, L.L.C. ("Starpower") with Pepco Communications, L.L.C.
("Pepco Communications"), an indirect wholly owned subsidiary of Potomac
Electric Power Company ("PEPCO"), to develop an advanced fiber network in the
Washington, D.C. area. In February 1998, RCN acquired Boston and Washington,
D.C.'s largest internet service providers ("ISPs"), Ultranet Communications,
Inc. ("Ultranet"), and Erols Internet, Inc. ("Erols"), respectively. RCN also
benefits from a strategic relationship with MFS Communications Company, Inc.
(now a subsidiary of WorldCom, Inc.) ("MFS/WorldCom") in New York City and
Boston and from its interconnection and resale agreements with incumbent
telephone service providers including Bell Atlantic. RCN believes that these
joint ventures and relationships provide it with a number of important
advantages including access to rights of way and use of existing fiber optic
facilities, the ability to enter its target markets quickly and efficiently and
a reduction in the up-front capital investment required to develop its networks.
In addition, the Company's joint venture partners provide access to additional
assets, equity capital and established customer bases. The Company also benefits
from its relationship with its largest shareholder, Peter Kiewit Sons', Inc.
("PKS"), the founder of MFS Communications Company, Inc. (now a subsidiary of
WorldCom, Inc., "MFS/WorldCom"), and from the experience gained by certain of
the Company's key employees who participated in the development of MFS
Communications Company, Inc.
As of December 31, 1997, the Company had approximately 267,600 connections
which were delivered through a variety of owned and leased facilities including
hybrid fiber/coaxial cable systems, a wireless video
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system and advanced fiber optic networks. In addition, the Company gained
approximately 325,000 Internet service customers as a result of the acquisitions
of Ultranet and Erols. The Company is deploying advanced fiber optic networks
specifically designed to provide high speed, high capacity telecommunications
services for all new network facilities. RCN also intends to upgrade certain of
its hybrid fiber/coaxial cable systems to enable them to provide the same range
of voice, video and data services, including bundled service options. Since it
formally commenced operation of its advanced fiber optic networks in New York
City and Boston in September 1996, RCN has built or acquired, through its joint
venture with BECO and long term lease arrangements, approximately 400 route
miles of fiber optic cable and added approximately 15,100 customer connections
to its advanced fiber optic networks. In addition, during the same period the
Company added approximately 29,700 wireless video, resold telephone and other
connections, the majority of which represent customers that RCN expects to
migrate to its advanced fiber optic networks. At December 31, 1997, RCN had
approximately 82,700 total connections attributable to customers in the New York
City and Boston markets (of which approximately 42,600 were wireless video
service and other connections and approximately 24,900 were resold telephone
connections) and had approximately 184,900 connections attributable to its
hybrid fiber/coaxial cable systems in the states of New York (outside New York
City), New Jersey and Pennsylvania, all within 75 miles of New York City.
Because it delivers multiple services, RCN reports the total number of its
various service connections (for local telephone, video programming and Internet
access) rather than the number of customers.
RCN's extensive operating experience in both the telephone and video
industries and in the design and development of telecommunications facilities
provides it with expertise in systems operation and development, an established
infrastructure for customer service and billing for both voice and video
services and established relationships with providers of equipment and video
programming. In addition, the Company's management team and board of directors
benefit from experience gained in connection with the management of C-TEC, which
prior to September 30, 1997 owned and operated RCN. C-TEC has 100 years of
experience in the telephone business and nearly 25 years of experience in the
cable television business. Both C-TEC and certain members of management also
have extensive experience in the design and development of advanced
telecommunications facilities.
RCN seeks to exploit competitive opportunities which have resulted from
widespread changes in the U.S. telecommunications industry. RCN believes that
density is a critical factor in the effective economic deployment of its
networks, and that the Boston to Washington, D.C. corridor is a particularly
attractive market for developing advanced fiber optic facilities due to
population density, favorable demographics and the aging infrastructure of the
incumbent service providers' network facilities in this region. The Company
applies a subscriber-driven investment strategy focusing on subscriber density,
proximity to the Company's advanced fiber optic networks and network development
costs, in order to determine if the number of potential connections in a target
area will permit network development on an attractive economic basis.
BUSINESS STRATEGY
The Company believes that the opportunity to effectively deploy advanced fiber
optic networks and to compete with incumbent telephone and cable television
service providers results from several key factors, including the broad
deregulation of the telecommunications industry pursuant to the
Telecommunications Act of 1996 (the "1996 Act"), the need for more advanced,
higher capacity networks to meet growing consumer demands for new communications
products and services and the superior technology of the Company's networks. In
order to achieve its goal of becoming the leading provider of
telecommunications, video and data services to residential customers in its
target markets, RCN is pursuing the following key strategies:
Developing Advanced Fiber Optic Networks. RCN's advanced fiber optic
networks are specifically designed to provide a single source for high speed,
high capacity voice, video programming and data services. RCN believes that its
high capacity advanced fiber optic networks provide RCN with certain competitive
advantages such as increased capacity (including the ability to offer bundled
voice, video and data services) and generally superior signal quality and
network reliability relative to the typical networks of the incumbent service
providers. By using advanced fiber optic networks capable of delivering multiple
services, RCN is able to address a larger number of potential subscriber
connections in its target markets than incumbent service providers which
typically provide only single or limited services.
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Focusing on Residential Customers in High-Density Markets. RCN seeks to be
the first operator of an advanced fiber optic network providing voice, video and
data services to residential customers in each of its target markets. RCN
believes that it is unique in its markets in offering a wide range of bundled
voice, video and data services to customers in residential areas and in striving
to connect residential customers directly to its advanced fiber optic networks.
RCN also believes that residential customers will be attracted to lower prices,
broader service offerings, enhanced levels of customer care and consumer choice.
Although the Company's primary focus is on residential customers, RCN also
serves certain commercial accounts which are located on or in close proximity to
its networks.
Implementing Subscriber-Driven Investment Strategy. RCN attempts to
efficiently deploy its capital by tying facility development to the procurement
of customer connections. In order to promote its presence in its markets and to
develop a subscriber base for its advanced fiber optic networks, the Company may
provide telephone services to customers located near its advanced fiber networks
by first reselling services, and then by establishing leased facilities (such as
unbundled local loops), in advance of constructing or extending its networks.
RCN also provides wireless video services to approximately 38,000 customers in
New York City with a view to extending the advanced fiber optic network to
service many of these existing customers. In addition, RCN intends to extend its
network to cover the primary areas currently served by Erols and Ultranet.
Utilizing Strategic Alliances and Existing Facilities to Speed and Reduce Cost
of Entry. By utilizing strategic alliances, RCN is able to enter the market
quickly and efficiently and to reduce the up-front capital investment required
to develop its networks. Through alliances with companies such as BECO, Pepco
Communications and MFS/WorldCom, which provide or are expected to provide RCN
with extensive fiber optic networks or other assets, by utilizing certain
components of its own existing cable television infrastructure, and through the
strategic acquisitions of Ultranet and Erols, RCN has been able to expedite and
reduce the cost of market entry and business development and has created the
opportunity to leverage existing customer relationships.
Offering Bundled Voice, Video and Data Services. RCN believes that, as a
full service voice, video and data programming provider, it will be able to
offer a single-source package of voice, video and data services, individually or
on a bundled basis, which is not yet generally available from any incumbent
telephone, cable or other service provider. In addition, services provided over
RCN's advanced fiber optic networks are generally priced at competitive rates as
compared to the incumbent service providers.
Providing Superior Customer Service. RCN seeks to provide superior customer
service as compared to incumbent service providers, with service features such
as a 24-hour-a-day call center and quality control system, on-time service
guarantees and bundled service offerings, providing the consumer with added
choice-and convenience.
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RCN SERVICES
RCN provides a wide range of local and long distance telephone, video
programming and data services, both individually and in bundled service options.
RCN provides these services through a range of facilities including its
advanced fiber optic networks in New York City and Boston, a wireless video
system in New York City, its hybrid fiber/coaxial cable systems in the states of
New York (outside New York City), New Jersey and Pennsylvania, and resale local
and long distance telephony services.
Connections. The following table summarizes the development of RCN's
subscriber base:
<TABLE>
<CAPTION>
As of
12/31/96 3/31/97 6/30/97 9/30/97 12/31/97
<S> <C> <C> <C> <C> <C>
Connections(1)
Advanced Fiber Optic Networks
Voice -- -- 370 1,909 3,214
Video -- -- 1,060 4,870 11,784
Internet -- -- 81 326 150
-------- ------- ------- ------- --------
Subtotal -- -- 1,511 7,105 15,148
Resold Voice 1,875 2,315 4,672 10,953 24,900
Wireless Video & Other(2) 40,162 43,616 46,668 46,053 42,681
-------- ------- ------- ------- --------
Total RCN Telecom 42,037 45,931 52,851 64,111 82,729
-------- ------- ------- ------- --------
Hybrid Fiber/Coaxial Cable
Operations(3) 179,932 180,169 181,790 183,145 184,938
-------- ------- ------- ------- --------
Total connections 221,969 226,100 234,641 247,256 267,667
======== ======= ======= ======= ========
</TABLE>
(1) Because RCN delivers multiple services, the Company accounts for its
customer activity by the number of individual local telephone, video
programming or Internet access services, or "connections", purchased.
Consequently, a single customer purchasing local telephone, video
programming and Internet access constitutes three connections.
(2) Includes approximately 38,000 wireless connections. RCN classifies
connections provided over advanced fiber optic networks within the "Other"
category until the relevant network is capable of providing voice, video and
data services, including local telephone service through an RCN switch.
"Other" also includes, among other things, wireline video connections
serving the University of Delaware (4,474 connections at December 31, 1997).
(3) In August 1997, RCN commenced offering resold local phone service, long
distance and Internet access to customers in the area served by its Hybrid
Fiber/Coaxial Cable Systems in the Lehigh Valley area.
Set forth below is a brief description of RCN's services:
Voice. RCN offers full-featured local exchange telephone service, including
standard dial tone access, enhanced 911 access, operator services and directory
assistance in competition with the incumbent local exchange providers and CLECs.
In addition, RCN offers a wide range of value-added services, including call
forwarding, call waiting, conference calling, speed dial, calling card, 800-
numbers and voice mail. RCN also provides Centrex service and associated
features. RCN's local telephone rates are generally competitive with the rates
charged by the incumbent providers. At December 31, 1997 RCN had approximately
3,200 telephone service connections on its advanced fiber optic networks and
approximately 24,900 customers for resold telephone service.
RCN Long Distance provides long distance telephone services, including
outbound, inbound, calling card, and operator services. These services are
offered to residential and business customers. As of December 31, 1997 RCN
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Long Distance had approximately 13,595 customers. In the future RCN intends to
offer long distance telephone service predominantly to customers whom it expects
will eventually be connected to its own facilities.
Video Services. RCN offers a diverse line-up of high quality basic, premium
and pay-per-view video programming. Depending on the system, RCN offers from 61
to 110 channels. RCN's basic video programming package provides extensive
channel selection featuring all major cable and broadcast networks. RCN's
premium services include HBO, Cinemax, Showtime and The Movie Channel, as well
as supplementary channels such as HBO 2, HBO 3 and Cinemax 2. RCN's StarCinema,
available on the Company's advanced fiber optic networks, utilizes the latest
"impulse" technology allowing convenient impulse pay-per-view ordering of the
latest hit movies and special events instantly from the customer's remote. RCN's
"Music Choice" offers 30 different commercial-free music channels delivered to
the customer's stereo in digital CD quality sound.
As of December 31, 1997, RCN had approximately 11,800 subscribers for its
video programming services provided over advanced fiber optic networks in New
York City and Boston. As of such date, RCN also had approximately 38,000
connections attributable to the wireless video system and approximately 184,900
connections attributable to the hybrid fiber/coaxial cable systems.
RCN also acts as a provider of DirecTV direct broadcast satellite service to
multiple dwelling units ("MDUs") in New York City. DirecTV allows RCN to deliver
an additional 175 channels of programming including exclusive sports
programming.
Internet Access and Data Transmission. RCN's StarPass Internet service
provides access for personal computers to RCN's advanced fiber optic network for
a reliable high speed connection to provide access to electronic mail, World
Wide Web, Internet chat lines and newsgroups and remote access and file transfer
services. RCN provides data transmission services over its advanced fiber optic
network either via two-way dial-up modem over traditional telephone lines or via
cable modem utilizing RCN's high capacity network. RCN also offers private line
point-to-point data transmission services such as DS-1 and DS-3 with the
capability to provide higher speed connections as well. Following the recent
Erols and Ultranet acquisitions, RCN believes it is the largest regional
provider of Internet services in the Northeast.
Migration of Customers to Advanced Fiber Networks
RCN provides wireless video services to customers located near its advanced
fiber optic network in New York City and provides resale telephone service with
a view to extending the advanced fiber optic network and fully activating RCN's
own telephone switches to service many of those customers. As RCN's advanced
fiber optic network is extended into these areas or buildings, customers
receiving wireless video service in New York City will be switched to the
advanced fiber optic network from the wireless video network, and the wireless
video equipment will be used to provide service to other customers in off-
network premises. Similarly, as the advanced fiber optic network is developed
and switches are deployed, voice customers will be switched to the advanced
fiber optic network from resale accounts, thereby allowing RCN to gain
additional revenue (and larger margins) from originating and terminating access
fees and to control the related services and service quality.
STRATEGIC RELATIONSHIPS
RCN has developed a number of strategic alliances and relationships in order
to provide it with early entry and to reduce the cost of entry into the market
for telecommunications services. RCN expects to continue to pursue opportunities
that may be afforded by entering into strategic alliances to facilitate network
expansion and entry into new markets.
Fiber Agreements. RCN, through its affiliates, has entered into Fiber
Agreements (the "Fiber Agreements"), each dated May 8, 1997, with MFS/WorldCom,
which owns or has the right to use certain fiber optic network facilities (the
"Fiber Optic Facilities") in the Boston, Massachusetts and Borough of Manhattan,
New York, New York markets (the "Service Areas"). Pursuant to the Fiber
Agreements, MFS/WorldCom (i) will construct and provide extensions connecting
the Fiber Optic Facilities to buildings designated by RCN (the "Extensions") and
(ii) has granted to RCN the right to use certain dedicated fibers in the Fiber
Optic Facilities and the Extensions, except
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that RCN may not use such facilities to deliver telephone services to commercial
customers in the Service Areas. In return, RCN has reimbursed MFS/WorldCom for
the costs MFS/WorldCom incurred to install, construct and acquire the Fiber
Optic Facilities constructed prior to March 31, 1997. RCN has further agreed to
pay all of the costs MFS/WorldCom incurs to (i) install, construct and acquire
the Fiber Optic Facilities constructed between March 31, 1997 and May 8, 1998
and the Extensions, and (ii) maintain, and support RCN's use of, the Fiber Optic
Facilities and the Extensions. Unless earlier terminated upon the occurrence of
certain events set forth therein, including a change of control of RCN, the
Fiber Agreements terminate by their terms on January 1, 2007, provided that (i)
at such time the parties may agree to extend the Fiber Agreements for up to 10
years or enter into other alternative arrangements, and (ii) under certain
circumstances, MFS/WorldCom is required to transfer the Extensions to RCN.
BECO Joint Venture
In September 1996, RCN and BECO, through wholly owned subsidiaries, entered
into a letter of intent to form a joint venture to utilize 126 fiber miles of
BECO's fiber optic network to deliver RCN's comprehensive communications package
in Greater Boston. The venture, in the form of an unregulated entity with a term
expiring in the year 2060, was formed pursuant to a joint venture agreement
dated December 23, 1996 (the "Boston Joint Venture Agreement") providing for the
organization and operation of RCN-BECOCOM, LLC ("RCN-BECOCOM"). RCN-BECOCOM is a
Massachusetts limited liability company organized to own and operate an advanced
fiber optic telecommunications network (the "Network") and to provide, in the
market in and around Boston, Massachusetts (the "Boston Market"), voice, video
and data services, as well as the communications support component of energy
related customer services offered by BECO (collectively, the "Boston Services").
RCN, through RCN Massachusetts, owns 51% of the equity interest in RCN-BECOCOM
and BECO, through a subsidiary, owns the remaining 49% interest. This joint
venture with BECO is reflected on RCN's financial statements on a consolidated
basis.
The closing of the transactions contemplated by the Boston Joint Venture
Agreement occurred on June 17, 1997. At the closing, (i) RCN transferred to RCN-
BECOCOM its business of providing Boston Services; (ii) BECO transferred to RCN-
BECOCOM access to and use of certain existing BECO facilities; (iii) RCN and
BECO made initial cash capital contributions to RCN-BECOCOM; and (iv) the
parties and/or their affiliates executed and delivered (a) the Amended and
Restated Operating Agreement of RCN-BECOCOM dated as of June 17, 1997 (the
"Operating Agreement"); (b) the Construction and Indefeasible Right of Use
Agreement dated as of June 17, 1997 between BECOCOM, LLC and RCN-BECOCOM (the
"IRU Agreement"); (c) the Management Agreement (the "Management Agreement")
dated as of June 17, 1997 among RCN Operating Services, Inc. and BECOCOM, Inc.;
(d) the Exchange Agreement dated as of June 17, 1997 (the "Exchange Agreement");
and (e) the Joint Investment and Noncompetition Agreement dated as of June 17,
1997 among RCN Massachusetts, BECOCOM, Inc. and RCN-BECOCOM (the "Joint
Investment Agreement").
Pursuant to the Operating Agreement, RCN and BECO are required to make any
additional capital contributions required by RCN-BECOCOM's annual budget on a
51%/49% basis. The annual budget will be prepared by RCN and is subject to
review by each member of RCN-BECOCOM. RCN will manage the business of RCN-
BECOCOM; however, certain extraordinary actions require the consent of both
parties. In addition, the Operating Agreement provides that if a deadlock arises
relating to a merger, reorganization, issuances of equity, liquidation or
bankruptcy, amendments to the organizational documents or an expansion of
operations of RCN-BECOCOM beyond those contemplated by the Operating Agreement,
the disputing party will either sell its interest or purchase the other party's
interest in the joint venture. Neither RCN nor BECO may
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transfer its interest in RCN-BECOCOM until June 17, 2000 without the other's
written consent. After such date, each party has the right to purchase the
interest proposed to be sold by the other party. If a party proposes to sell
more than 33% of its interest, the other party has "tag-along" rights to sell a
proportionate share of its interest. In the event a member's interest becomes
less than 25%, the other members have the option to purchase such interest at
fair market value. Upon a change in control of either RCN Massachusetts or
BECOCOM, the other party has the right to purchase all of the equity interest in
RCN-BECOCOM for fair market value, as determined by an appraisal proceeding.
RCN will manage the business of RCN-BECOCOM pursuant to the terms of the
Management Agreement and, in consideration therefor, will receive reimbursement
for its reasonable costs, and a performance-based fee (based on factors
including the number of subscribers and operating cash flow) to be determined by
agreement of RCN and RCN-BECOCOM. The initial term of the agreement expires on
December 31, 2001. The agreement provides for automatic successive three-year
renewal periods, unless notice is given ninety days before the end of the
period.
Pursuant to the IRU Agreement, BECO will, for certain agreed upon fees, (i)
provide construction services to build out the Network, (ii) make available to
RCN-BECOCOM (a) all of the available capacity of BECO's existing fiber backbone,
and (b) the ability to use BECO's real estate, poles, easements and other
interests for the construction and operation of the Network and (iii) maintain
the Network. BECO's construction obligations expire on June 17, 2007 and the
term of the IRU Agreement generally expires on December 31, 2060. One year
before each respective expiration date, BECO agrees to commence good-faith
negotiations to extend construction obligations beyond June 17, 2007 and to
allow continued use of BECO's facilities beyond December 31, 2060.
Under the Joint Investment Agreement, BECO will have the right to acquire up
to a 20% equity interest in any joint venture between RCN and an electric
utility company formed to provide any services similar to the Boston Services in
New England outside the Boston Market. BECO's joint investment right shall
terminate (i) upon BECO's stake in RCN-BECOCOM dropping below a 1/3 interest and
(ii) on the later to occur of (a) June 17, 2002 or (b) two years after RCN's
stake in RCN-BECOCOM falls below a 1/3 interest. The agreement also provides
that neither RCN, BECO nor their affiliates will be permitted to be involved in
any other enterprise providing services similar to the Boston Services in the
Boston Market. This covenant not to compete will survive for a period of two
years after either party is no longer a member of RCN-BECOCOM.
Pursuant to the Exchange Agreement, BECO had the right at the time of the
Distribution, and has the right every two years thereafter, to convert its
ownership interest in RCN-BECOCOM into the Common Stock of RCN pursuant to
specific terms and conditions, including exercise periods, appraisal procedures
and restrictions specifically set forth in the Exchange Agreement. Although
BECO exercised its conversion rights, BECO will remain obligated to make 49% of
all cash contributions by the parties and any cash contributions made after
conversion will result in it owning a portion of RCN-BECOCOM based on the value
of RCN-BECOCOM at the time of the contribution. BECO may exercise its conversion
rights in whole or in part from time to time. BECO has notified RCN that it has
elected to exercise its option to the full extent permitted by the Exchange
Agreement with respect to 1997. RCN and BECO are presently in discussions with
respect to the calculation of the agreed upon value for the exercise of such
option. BECO's right to convert its joint venture interest into Company Common
Stock is subject to certain limitations designed to ensure that the conversion
does not jeopardize the tax free nature of the Distribution. In the event BECO
is unable to convert any portion of its interest as a result of such
limitations, BECO has the right to require RCN to purchase such portion. Subject
to certain restrictions set forth in the Exchange Agreement, BECO will also be
entitled, upon exchanging its investment interest in RCN-BECOCOM for Company
Common Stock, to customary registration rights with respect to such shares.
<PAGE>
RCN expects to benefit from the ability to utilize BECO's large fiber optic
network, its focus on innovative technology, its sales and marketing expertise
and its reach into the market. In the future, the venture may expand into energy
management and property monitoring services. Starting in Boston, the joint
venture partners will consider further expansion into surrounding markets. RCN
anticipates that as a result of its access to the extensive BECO network, RCN's
reliance on and utilization of MFS/WorldCom facilities in Boston will be reduced
significantly.
Starpower Joint Venture
On August 1, 1997, RCN Telecom Services, Inc., a subsidiary of RCN, and
Potomac Capital Investment Corporation ("PCI"), a wholly owned subsidiary of
PEPCO, entered into a letter of intent (the "Letter of Intent") to form a joint
venture to own and operate a communications network to provide voice, video,
data and other communications services to residential and commercial customers
in the greater Washington, D.C., Virginia and Maryland area (the "Washington,
D.C. Market"). Starpower, an unregulated limited liability company with a
perpetual term, was formed on October 28, 1997 by RCN Telecom Services of
Washington, D.C., Inc. ("RCN Washington") and Pepco Communications. Starpower
was formed to construct, own, lease, operate and market a network for the
selling of voice, video, data and other telecommunications services (the
"Relevant Business") to all potential commercial and residential customers in
the Washington, D.C. Market. RCN, through RCN Washington, owns 50% of the equity
interest in Starpower and PCI, through Pepco Communications, owns the remaining
50% interest. Starpower is accounted for by RCN under the equity method of
accounting.
The closing (the "Starpower Closing") of the Starpower joint venture occurred
on December 19, 1997. At the closing, RCN Washington transferred to Starpower
all its right, title and interest in and to (i) all customer accounts of RCN
Long Distance in the Washington, D.C. Market, (ii) its business plan in the
Washington, D.C. Market and experience with respect to the Relevant Business,
(iii) all building access agreements covering any property located in the
Washington, D.C. Market, (iv) the Support Services Agreement (as described
below) and (v) the benefit of certain agreements pursuant to the Assignment of
Benefits Agreement (as described below). The documents signed at the Starpower
Closing were the Amended and Restated Operating Agreement of Starpower dated as
of December 18, 1997 by and between Pepco Communications and RCN Washington
("Amended and Restated Operating Agreement"), Fiber Use Agreement dated as of
December 18, 1997 between PEPCO and Starpower ("Fiber Use Agreement"), Agency
Agreement dated as of December 18, 1997 by and between RCN Washington, RCN
Telecom Services of Maryland, Inc., RCN Telecom Services of Virginia, Inc. and
Starpower ("Agency Agreement"), Non-competition Agreement dated as of December
18, 1997 by and among RCN Telecom Services, Inc., PCI and Starpower ("Non-
competition Agreement"), Assignment of Benefits Agreement dated as of December
18, 1997 by and between RCN Washington and Starpower ("Assignment of Benefits
Agreement"), Support Services Agreement dated as of December 18, 1997 by and
between RCN Operating Services, Inc. and Starpower ("Support Services
Agreement"), Guarantee dated as of December 18, 1997 by PCI on behalf of Pepco
Communications in favor of Starpower, Guarantee dated as of December 18, 1997
by RCN on behalf of RCN Washington and other RCN obligors in favor of Starpower
and Contribution Agreement dated as of December 18, 1997 by and between RCN
Washington and Starpower ("Contribution Agreement"). RCN Washington and Pepco
Communications also each paid $12.5 million in cash in January 1998 as their
initial capital contributions.
Pursuant to the Amended and Restated Operating Agreement, RCN Washington and
Pepco Communications are each required to make additional capital contributions
in accordance with a schedule set forth in such agreement on a 50%/50% basis.
Failure of either RCN Washington or Pepco Communications to make a scheduled
capital contribution or to vote in favor of certain additional capital
contributions may result in the recalculation of equity interests. The business
and affairs of Starpower is to be managed by RCN Washington and Pepco
Communications. So long as RCN Washington and Pepco Communications maintain a
50%/50% equity interest in the joint venture, each of RCN Washington and Pepco
Communications will appoint three members to the operating committee, the
approval of which is required for any business action. Certain fundamental
business actions, such as mergers, acquisitions, sales of substantially all of
the assets, liquidation and amendments to the certificate of organization or any
agreement signed at the Starpower Closing, require the unanimous approval of the
operating committee regardless of whether the parties continue to maintain a
50%/50% ownership interest. Failure to reach agreement may trigger a deadlock
event. In the event a deadlock arises within the first three years of the joint
venture, the proposed action shall be deemed rejected. If the deadlock arises
thereafter, the disputing party may give a notice to
<PAGE>
the other party offering to sell its membership or to purchase all membership
interests from the other party; the offeree has the obligation to elect to buy
or sell its interest. Subject to certain exceptions, neither RCN Washington nor
Pepco Communications may sell any interest in Starpower for four years.
Thereafter, RCN Washington or Pepco Communications may sell any of its
membership interests with the written consent of the other subject to a right of
first offer by the other party. RCN Washington shall be restricted from
transferring its interest if Pepco Communications can demonstrate that such
assignment would have a material adverse impact on Starpower's business. Upon a
change of control of RCN Washington or Pepco Communications, which the other
party has reason to believe will have a material adverse effect on Starpower,
the other party may offer to sell its membership interests or to acquire such
party's membership interests or accept the change of control. The offeree has
the right to elect to buy or sell its interest. If a party proposes to sell its
interest to a third party, the other party has "tag-along" rights to sell a
proportionate share of its interest. Both RCN Washington and Pepco
Communications may transfer their membership interests to certain affiliates.
Under the Fiber Use Agreement, PEPCO agreed, for certain agreed upon fees, (i)
to provide construction services to develop a network and (ii) to grant
Starpower an indefeasible right of use of certain facilities and an irrevocable
right to install, maintain, use and operate its strand fiber connections to
leased facilities. Starpower has the right, at the end of the term, to purchase
not less than the whole network at the fair market value less the amount
previously paid by Starpower with respect to such facilities. The initial term
is ten years and the agreement may be renewed four times.
Under the Support Services Agreement, a subsidiary of RCN will provide support
services including customer service, billing, marketing, and certain
administrative, accounting and technical support services, each of which shall
be provided at cost. The Support Services Agreement also contains certain
indemnity provisions.
Under the Non-competition Agreement, for so long as either RCN Washington or
Pepco Communications owns an interest in Starpower, neither party nor any of
their affiliates may compete with any Relevant Business in the Washington, D.C.
Market. Neither RCN Washington nor Pepco Communications shall attempt to
solicit, divert or accept business from the customers of Starpower for any
Relevant Business in the Washington, D.C. Market or solicit any individual who
is employed by Starpower.
Starpower agreed, in the Agency Agreement, to serve as RCN Washington's
exclusive agent for the provision of telephony services in the Washington, D.C.
Market until Starpower receives sufficient authorization for it to provide
telephony services in the Washington, D.C. Market. All revenues and customers
under this Agency Agreement belong to Starpower. Starpower must indemnify RCN
Washington for any tax liability resulting from its obligations under this
Agency Agreement. The Agency Agreement also contains certain other indemnity
provisions.
Pursuant to the Assignment of Benefits Agreement, RCN Washington assigned the
benefits of all of the agreements (the "Assigned Agreements") with suppliers of
programming and entertainment, voice, video and data services,
telecommunications equipment and other products and services useful in the
conduct of the Relevant Business in the Washington, D.C. Market to Starpower.
RCN Washington may not transfer or assign its interest in the Assigned
Agreements if doing so would have a material adverse effect on Starpower's
ability to conduct the Relevant Business in the Washington, D.C. Market. In
addition, RCN Washington may not amend, modify or assign the Assigned Agreements
without the prior written consent of Starpower and Starpower has the right to
terminate any agreement amended, modified or assigned without its consent. RCN
Washington has agreed to take all reasonable steps necessary to obtain consent
for Starpower to use programming agreements prior to the date Starpower begins
offering OVS services. The Assignment of Benefits Agreement expires on December
19, 1998 and Starpower has certain renewal rights. Starpower may terminate the
Assignment of Benefits Agreement on 60 days notice.
<PAGE>
RCN has agreed to unconditionally guarantee the due and punctual performance
and discharge all of its affiliates' material covenants, warranties,
undertakings and other obligations under the agreements signed at the Starpower
Closing. PCI has agreed to unconditionally guarantee the due and punctual
performance and discharge by Pepco Communications of all its material covenants,
warranties, undertakings and other obligations under the Operating Agreement.
RECENT ACQUISITION TRANSACTIONS
Merger with Erols Internet, Inc.
Erols is a leading regional ISP with approximately 293,000 residential and
business subscribers as of December 31, 1997 in targeted markets, including New
York City, Philadelphia, Washington, D.C. and Boston. Erols currently operates
57 physical points of presence ("POPs") throughout its geographic markets, and
also currently utilizes 32 "Virtual POPs," which permit subscribers located
adjacent to, but outside of the local calling areas of, physical POPs to dial
into the Erols network on a local basis through arrangements with the relevant
local exchange carrier ("LEC"). Erols offers a broad range of Internet-based
services, including (i) Global Trader , Erols' turn-key e-commerce product for
small businesses, (ii) Internet security services, including security consulting
and virtual private networks, and (iii) Web hosting, design and development
services.
On January 21, 1998, RCN entered into the Agreement and Plan of Merger (the
"Erols Merger Agreement") among RCN, Erols, Erol Onaran, Gold & Appel Transfer,
S.A., a British Virgin Islands corporation ("Gold & Appel"), 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. On February 20,
1998 Erols merged with and into ENET (the "Erols Merger"), with ENET as the
surviving corporation. The total consideration paid by RCN in the Erols Merger
was $29.2 million in cash, 1,730,648 shares of RCN Common Stock plus the
assumption and repayment of $5.8 million of debt (including repayment of accrued
interest). Additionally, the Company is converting approximately 999,000 Erols
stock options to approximately 699,000 RCN stock options with an average
exercise price of $3.424 per share.
The Erols Merger Agreement contains customary representations, warranties, and
covenants by each party, which representations and warranties will survive until
March 31, 1999, except for certain specified representations and warranties
which will survive indefinitely or until the expiration of the applicable
statute of limitations. Pursuant to the Erols Merger Agreement, each party has
agreed to provide indemnification from damages arising out of any
misrepresentation or breach of warranty, covenant or agreement made or to be
performed by such party pursuant to the Erols Merger Agreement. In addition,
Erol Onaran has agreed to provide indemnification from damages arising out of
any misrepresentation or breach of warranty, covenant or agreement made or to be
performed by Erols on or before the Effective Time, subject to certain
thresholds and limitations, and arising from certain matters set forth in the
Erols Merger Agreement.
Pursuant to the Erols Merger Agreement, at the Effective Time both an escrow
agreement (the "Erols Escrow Agreement") and a registration rights agreement
(the "Erols Registration Rights Agreement") were executed and delivered. Under
the terms of the Erols Escrow Agreement, RCN delivered to the Erols Escrow Agent
an aggregate of approximately $5.84 million in cash and 93,210 shares of RCN
Common Stock to be held, invested and distributed by the Erols Escrow Agent
pursuant to the Erols Escrow Agreement. Under the terms of the Erols
Registration Rights Agreement, Erol Onaran and Gold & Appel will each receive
customary demand and piggy-back registration rights, subject to certain
limitations as set forth in the Erols Registration Rights Agreement.
<PAGE>
RCN expects to contribute to Starpower, the joint venture with Pepco
Communications, the subscribers acquired in the acquisition of Erols located in
the Washington, D.C. area in which Starpower operates. The joint venture
partners of Starpower are currently negotiating the terms of such contribution.
On February 20, 1998, approximately 61% of all of Erols' subscribers were
located in the relevant Washington, D.C. area. RCN anticipates that PCI will
make a contribution equal to the value of such subscribers.
Merger With Ultranet Communications, Inc.
Ultranet is a leading ISP in the Boston area with more than 32,000 residential
and business customers in New England. Ultranet provides Internet service to
over 500 schools, and is presently building a network which will provide access
throughout New Hampshire's universities and colleges. Ultranet has a wide
network of 42 POPs. Services Ultranet offers to subscribers include (i) virtual
hosting, which gives customers a corporate presence on the Internet, (ii)
firewall security, which provides high quality control in monitoring access to
documents and visitors to the customer's websites, and (iii) UltraFax, which
allows customers to send faxes from their desktops. Ultranet also offers its
customers access to its network via an 800 number which allows access from every
major city in the world.
On January 21, 1998, RCN, UNET Holdings, Inc., a wholly-owned subsidiary of
RCN, and Ultranet entered into an Agreement and Plan of Merger (the "Ultranet
Merger Agreement"). The transaction was completed in February 1998. The total
consideration for the acquisition was approximately $7.3 million in cash,
approximately 890,384 shares of RCN Common Stock and $3.0 million in deferred
compensation. Additionally, the Company is converting approximately 63,500
Ultranet stock options to 117,052 RCN stock options at an average exercise price
of $1.825 per share and making cash payments aggregating approximately $.5
million to certain other holders of UltraNet stock options.
RCN also agrees to indemnify Ultranet and its directors, officers and
stockholders from and against liabilities or expenses incurred (i) in connection
with the severance benefits under any severance arrangement applying to any
former employee of Ultranet employed by RCN after the Ultranet Merger is
consummated, (ii) relating to a former employee's employment and/or termination
by RCN after the Ultranet Merger is consummated and (iii) incurred by an
indemnified person with respect thereto.
RCN expects to contribute to its joint venture with BECO the subscribers
acquired in the acquisition of Ultranet located in the Boston area in which the
BECO joint venture operates as well as 1.36% (or all of Erols' subscribers
located in Boston) of the subscribers acquired in the acquisition of Erols. On
February 27, 1998, approximately 27% of all of Ultranet's subscribers were
located in the relevant Boston area. RCN anticipates that BECO will make a
corresponding contribution to the joint venture in the form of a note in the
principal amount of 49/51 of the agreed value of the subscribers contributed by
RCN.
Indemnification and Noncompetition Agreement
Certain stockholders holding at least 95% of the Ultranet Common Stock, Series
A Preferred Stock and Series B Preferred Stock executed an Indemnification and
Noncompetition Agreement (the "Indemnification Agreement") which provides that
certain representations and warranties included in the Ultranet Merger Agreement
will survive the consummation of the merger. Such stockholders agree to
indemnify RCN, severally and on a pro rata basis, and RCN agrees to indemnify
the stockholders against all losses incurred by any of them arising out of any
breach of any tax representation in the Ultranet Merger Agreement insofar as
such breach causes the merger not to qualify as a reorganization or any material
failure to perform any of its covenants or agreements contained in the Ultranet
Merger Agreement. The maximum amount of indemnification by the stockholders on
one hand and by RCN on the other hand is $7.5 million plus certain amounts up to
$2.5 million with respect to breach of tax representations.
The Indemnification Agreement will provide that the stockholders will not
knowingly take any action which would cause the merger not to qualify as a
reorganization. Certain employees will also agree not to engage in any activity
which would compete with Ultranet in the geographic region identified as the
"Boston-Washington" corridor for a period ending the earlier of five years after
the consummation of the merger or one year after his or her termination (or two
years in the case of termination for cause or voluntary termination).
<PAGE>
As a result of the expansion of the Company's Internet business, the Company
is exposed to certain uncertainties regarding Internet businesses. The
Company's Internet business will depend in part upon the continuing development
and expansion of the Internet and the market for Internet access. Important
issues concerning business and personal use of the Internet (including security,
reliability, cost, ease of use, access and quality of service) remain unresolved
and may significantly affect the acceptance of the Internet for commerce and
communication and the growth of Internet use. Internet network infrastructure is
vulnerable to computer viruses and other similar disruptive problems caused by
its users, other Internet users or other third parties. Computer viruses and
other problems could lead to interruptions of, delays in, or cessation of
service, by the Company, as well as corruption of the Company's or its
subscribers' computer systems. In addition, there can be no assurance that
subscribers or others will not assert claims of liability against the Company as
a result of events such as computer viruses, other inappropriate uses or
security breaches. The Company's ability to provide Internet service will depend
in part on its ability to provide sufficient capacity, both at the level of
particular POPs (affecting only subscribers attempting to use that POP) and in
connection with system-wide services (such as e-mail and news services, which
can effect all subscribers). In addition, the Company will be dependent in part
on the availability of equipment such as modems, servers and other equipment.
Furthermore, ISPs participate in the Internet through contractual "peering
arrangements" with Internet companies. These contractual arrangements are not
subject to regulation and could be subject to revision in terms, conditions or
costs over time.
Acquisition of Lancit Media Entertainment, Ltd.
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"). Pursuant to the Lancit Merger
Agreement, LME will merge 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, which has won 11 Emmy Awards.
The consummation of the Lancit Merger is subject to customary conditions,
including the approval by Lancit shareholders of the Lancit Merger.
HYBRID FIBER/COAXIAL CABLE SYSTEMS
RCN's hybrid fiber/coaxial cable systems were operated by C-TEC prior to the
Distribution. The following table summarizes the development of the hybrid
fiber/coaxial cable systems over the last five years:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1993 1994 1995 1996 1997
<S> <C> <C> <C> <C> <C> <C>
Homes passed 118,216 119,761 282,836 283,940 290,612
Basic subscribers 87,660 92,140 176,131 179,932 184,938
Basic penetration 74.2% 76.9% 62.3% (1) 63.4% 63.6%
Average monthly revenue per
subscriber for last month $ 40.98 $ 37.67 $ 36.73 (1) $ 39.99 $ 43.08
period
</TABLE>
(1) Decline in basic penetration levels and average monthly revenue per
subscriber in 1995 reflects the acquisition of the Pennsylvania cable systems,
which are in a market in which a competing franchisee also offers service.
The service areas for these cable television networks enjoy favorable customer
demographics. The New York and New Jersey systems primarily serve high growth
affluent bedroom communities in suburban New York City, with 28,411 and 76,127
connections at December 31, 1997 respectively. The system in New York State
serves ten
<PAGE>
municipalities in Duchess, Putnam and Westchester Counties, approximately 45
miles north of New York City. The New Jersey system serves 31 contiguous
municipalities in Hunterdon, Mercer, Morris and Somerset Counties, approximately
50 miles west of Manhattan. The Pennsylvania system, which is the largest
competitive cable television system in the United States, serves Pennsylvania's
Lehigh Valley area including the cities of Allentown, Bethlehem and Easton, and
virtually all of Lehigh and Northampton Counties, and is located less than 10
miles west of the Company's New Jersey system.
INTERCONNECTION
Because access to the public switched telephone network is an essential
component of any regional or national telecommunications network,
interconnection is critical to RCN's ability to provide voice and data services.
Bell Atlantic and the other incumbent local exchange carriers ("LECs") and
independent telephone companies are required to provide interconnection to
competitive local exchange carriers ("CLECs") such as RCN pursuant to the
facilities-based interconnection requirements of Section 251 of the 1996 Act.
Under the 1996 Act, the Regional Bell Operating Companies' ("RBOC's") ability to
offer long-distance service between local access and transport areas ("LATA") is
contingent upon their ability to create an environment allowing economically-
efficient competition in their local markets for both business and residential
services.
RCN has achieved interconnection through comprehensive telephone service co-
carrier interconnection agreements with Bell Atlantic and Sprint-New Jersey
covering their service areas in ten states and the District of Columbia in the
Northeast and New England-Middle Atlantic corridor areas. These agreements will
remain in effect regardless of the outcome of the proceedings regarding Section
251 regulations of the Federal Communications Commission ("FCC"). RCN's
interconnection agreements with Bell Atlantic cover its service areas in the
states of Massachusetts, New York, Vermont, New Hampshire, Maine, Rhode Island,
Delaware, Maryland, New Jersey, Pennsylvania and Virginia and the District of
Columbia. The agreement with Sprint-New Jersey covers its service area in the
State of New Jersey. All of these agreements have been approved by the state
regulatory commissions pursuant to Section 252 of the Communications Act of
1934, as amended by the 1996 Act (the "Communications Act"). RCN believes it has
more interconnection agreements with incumbent LECs than any other company
focused primarily on the residential telecommunications market.
The terms of RCN's interconnection agreements with the incumbent LECs include
the following provisions: (i) interconnection at any technically feasible point
within their networks, equal in quality to what the incumbent LEC provides to
itself or to affiliates, (ii) exchange of all local traffic at a fully
reciprocal and identical rate; (iii) receipt by RCN of access charges for long
distance calls made to and from its customers, including full "pass through" to
RCN of such compensation on number portability; (iv) interim number portability
arrangements to allow customers to keep their telephone numbers when they switch
carriers; (v) unbundled network elements, including local loop transmission from
the incumbent LEC's central offices to the customer's premises distinct from
local switching or other services; (vi) nondiscriminatory access to 911 and
emergency 911 services; directory assistance services to allow RCN's customers
to obtain telephone numbers; operator call completion services and white pages
directory listings for RCN's customers; and (vii) access to the poles, ducts,
conduits and rights-of-way owned or controlled by the incumbent LEC at
nondiscriminatory rates. The interconnection agreements generally have an
initial term of three years and are cancelable thereafter at 90 days' notice.
RESALE ARRANGEMENTS
Resale of Bell Atlantic Local Telephone Services
RCN provides local telephone service on a resale basis to customers not
connected to the advanced fiber optic facilities. As of December 31, 1997 RCN
had 24,900 customers for local telephone services provided through agreements to
act as a reseller of Bell Atlantic local telephone services. RCN offers its
resale customers competitive telephone rates and RCN's superior customer
service. Resale customers are billed by RCN and RCN personnel provision customer
service requests by coordinating with the incumbent LECs on the customers'
behalf.
RCN has entered into agreements to act as a reseller of Bell Atlantic local
telephone services, which enable RCN to grow its subscriber base by offering
telephone services in advance of connecting the customers to an
2
<PAGE>
advanced fiber optic network. RCN's agreements with Bell Atlantic allow RCN to
purchase at a "wholesale" discount (the amount of which is determined by
regulatory commissions in each state) any telephone services that those
companies offer to their end users, such as local exchange services, vertical
features including Caller ID, Call Waiting, etc., and regional toll calls. The
agreements provide that RCN will be entitled to the most favorable terms and
conditions, including wholesale discounts, available to any telecommunications
carrier reselling similar services.
Long Distance Resale
RCN Long Distance provides long distance telephone services, including private
line, operator and calling card services, to residential and business customers
throughout the United States. Such services are provided through an owned and
leased switching network utilizing leased interconnection facilities and long
distance resale. RCN provides on network origination and termination of long
distance telephone services throughout the Mid-Atlantic and New England states.
For call origination and completion throughout the rest of the country, RCN has
various resale agreements. Specifically, RCN has contracted with Level 3
Communications, Inc. ("LCI") for 800/888 origination, Frontier for off network
origination of outbound calling and various carriers for terminating calls.
DirecTV
In October 1996, RCN signed an agreement with DirecTV to deliver DirecTV's
high-power direct broadcast satellite service to multiple dwelling units
("MDUs") in New York City. DirecTV allows RCN to offer an additional 175
channels of programming including exclusive sports programming.
CUSTOMER SERVICE AND BILLING
RCN has implemented a flexible, customer-service oriented approach which RCN
believes differentiates it from the mass-market strategy of the incumbent
providers. RCN provides customer service 24 hours a day, seven days a week from
established central call centers. The facilities utilize state of the art
technology which allows communication with subscribers, field technicians and
the Company's field offices. The largest of these facilities is located in
Dallas, Pennsylvania and handles the majority of the customer service calls.
RCN's advanced fiber optic network is continuously monitored for quality
control and capacity issues, pursuant to a control system featuring 16 alarm
monitor points per hub site and automated housekeeping alarms.
Billing services for video are provided by CableData while RCN telephony
billing services are provided by Consolidated Communications Systems and
Services. At the present time, RCN customers receive separate billing statements
for video and telephone service although RCN intends to offer a single billing
option in the future.
Account piracy is monitored by ongoing field audits and, in RCN's advanced
fiber optic networks, through use of state of the art scrambling systems.
Potential new customers are generally screened for credit history before being
authorized for service. RCN employs a full-time credit and collection staff as
well as a group that seeks to minimize toll fraud by detecting and monitoring
suspicious calling patterns.
PROGRAMMING AND SUPPLIERS
RCN has secured license arrangements with all of its desired programming
suppliers, some of which provide volume discount pricing structures and/or offer
marketing support to the Company. Many of these arrangements are extensions of
long-standing agreements entered into by or on behalf of the Company's hybrid
fiber/coaxial cable systems, and some are newly negotiated based upon RCN's
"open video system" ("OVS") certifications. RCN has generally obtained these
license arrangements on terms and conditions that it considers favorable.
RCN programming arrangements include arrangements for basic video channels,
premium channels including multi-plexing, pay-per-view movies and events, adult
entertainment, electronic program guide services and digital music services, as
well as retransmission arrangements for relevant network broadcasters.
3
<PAGE>
The Company generally pays a monthly fee per subscriber per channel for
programming purchased from its suppliers. Programming costs increase in the
ordinary course of the Company's business as a result of increases in the number
of subscribers, expansion of the number of channels provided to customers and
contractual rate increases from programming suppliers. The Company anticipates
that future contract renewals for video providers such as the Company will
result in programming costs exceeding current levels, particularly for sports
programming.
A wide range of national manufacturers are the primary sources of supplies,
equipment and materials utilized in the development and enhancement of the
Company's networks. RCN has entered into Master Purchase Agreements with certain
equipment suppliers which enable it to purchase video and switching equipment on
terms which it considers favorable. The Company anticipates that the costs for
these supplies, equipment and materials will be significant in future periods.
The amount of such costs will depend on numerous factors, many of which are
beyond the Company's control.
RCN LONG DISTANCE
RCN Long Distance Company, a wholly-owned subsidiary of RCN, provides
switched-based resale long distance services to customers on the advanced fiber
optic network as well as other customers. RCN Long Distance operates the long
distance business formerly operated by C-TEC, except within the Commonwealth
Service Territory. During 1996, RCN obtained certification in forty-seven
states. RCN Long Distance also provides local telephone service to commercial
customers. As of December 31, 1997 RCN Long Distance had approximately 13,595
long distance customers.
INTERNATIONAL
The Company owns a 40% interest in Megacable, the second largest cable
television provider in Mexico. Megacable owns 22 wireline cable systems, and one
multi-channel multipoint distribution service ("MMDS") cable system, in Mexico,
principally on the Pacific and Gulf coasts and including Guadalajara, the second
largest city in Mexico, Hermosillo, the largest city in the state of Sonora and
Veracruz, the largest city in the state of Veracruz. At December 31, 1997
Megacable's wireline systems passed approximately 635,350 homes and served
approximately 209,300 subscribers. Megacable had revenues of $23.2 million for
the years ended December 31, 1996 and $30.4 million for the year ended December
31, 1997.
Additionally, Megacable presently holds a 99% interest in Megacable
Comunicaciones de Mexico S.A. ("MCM"). MCM has received a license from the
Mexican government to allow it to build a fiber optic network in Mexico City,
Monterrey and Guadalajara. MCM intends to use this network to provide local
voice and high-speed data service in these cities, principally to commercial
customers in Mexico City.
COMPETITION
Overview
RCN competes with a wide range of service providers for each of the services
that it provides. Virtually all markets for voice and video services are
extremely competitive, and RCN expects that competition will intensify in the
future. In each of the markets in which it offers voice and video programming
services, RCN faces significant competition often from larger, better-financed
incumbent local telephone carriers and cable companies, and RCN often competes
directly with incumbent providers which have historically dominated their
respective local telephone and cable television markets. These incumbents
presently have numerous advantages as a result of their historic monopoly
control of their respective markets. However, RCN believes that most existing
and potential competitors will, at least initially, provide narrower service
offerings over limited delivery platforms as compared to the wide range of
voice, video and data services that will be provided over RCN's fiber-based
networks, thereby providing RCN with an opportunity to achieve important market
penetration.
With respect to local telephone services, RCN competes with the incumbent
LECs, and alternative service providers including CLECs. Commercial mobile radio
services providers, including cellular carriers (such as Bell
4
<PAGE>
Atlantic Mobile Services), personal communications services ("PCS") carriers
(such as Sprint Spectrum), and enhanced specialized mobile radio services
("ESMRS") providers (such as NexTel), may also become a source of competitive
local and long distance telephone service. However, RCN believes these operators
may primarily use competitive access services to transport their calls among
their radio transmitter/receiver sites through networks that avoid the incumbent
LECs with whom they compete.
With respect to long distance telephone services, RCN faces, and expects to
continue to face, significant competition from the interexchange carriers
("IXCs"), including AT&T, Sprint and MCI, which account for the majority of all
long distance revenue. The major long distance service providers benefit from
established market share and from established trade names brought about by
nationwide advertising. RCN, however, regards its long-distance service as a
complementary service rather than a principal source of revenue. Certain IXCs,
including AT&T, MCI and Sprint, have also announced their intention to offer
local services in major U.S. markets using their existing infrastructure in
combination with resale of incumbent LEC service, lease of unbundled local loops
or other providers' services.
All of the Company's video services face competition from alternative methods
of receiving and distributing television signals and from other sources of news,
information and entertainment such as off-air television broadcast programming,
newspapers, movie theaters, live sporting events, interactive online computer
services and home video products, including videotape cassette recorders. Among
the alternative video distribution technologies are home satellite dish earth
stations ("HSDs") which enable individual households to receive many of the
satellite-delivered program services formerly available only to cable
subscribers. Furthermore, the Cable Television Consumer Protection and
Competition Act of 1992 ("1992 Act") contains provisions, which the FCC has
implemented with regulations, to enhance the ability of cable competitors to
purchase and make available to HSD owners certain satellite-delivered cable
programming at competitive costs. RCN faces additional competition from private
satellite master antenna television ("SMATV") systems that serve condominiums,
apartment and office complexes and private residential developments. The FCC and
Congress have adopted policies providing a more favorable operating environment
for new and existing technologies that provide, or have the potential to
provide, substantial competition to the Company's various video distribution
systems. These technologies include, among others, DBS service whereby signals
are transmitted by satellite to receiving facilities located on customer
premises. The Company expects that its video programming services will face
growing competition from current and new DBS service providers. RCN also
competes with wireless program distribution services such as multi-channel
multipoint distribution service ("MMDS") which use low-power microwave
frequencies to transmit video programming over-the-air to subscribers. The
Company is unable to predict whether wireless video services will have a
material impact on its operations.
Other new technologies, including Internet-based services, may become
competitive with services that RCN can offer. Advances in communications
technology as well as changes in the marketplace and the regulatory and
legislative environment are constantly occurring. Thus, it is not possible to
predict the effect that ongoing or future developments might have on the video
industry or on the operations of the Company.
RCN believes that among the existing competitors, the incumbent LECs,
incumbent cable providers and the CLECs provide the most direct competition to
RCN in the delivery of "last mile" connections for voice and video services.
Incumbent LECs
In each of its target markets for advanced fiber optic networks, RCN faces,
and expects to continue to face, significant competition from the incumbent LECs
(including Bell Atlantic in New York City and Boston), which currently dominate
their local telephone markets. RCN competes with the incumbent LECs in its
markets for local exchange services on the basis of product offerings (including
the ability to offer bundled voice and video services), reliability, state-of-
the-art technology and superior customer service, as well as price. RCN believes
that its advanced fiber optic networks provide superior technology for
delivering high-speed, high-capacity voice, video and data services as compared
to the primarily copper wire based networks of the incumbent LECs. However, the
incumbent LECs have begun to expand the amount of fiber facilities in their
networks and to prepare to re-enter the long distance telephone service market
and, in addition, have long-standing relationships with their customers.
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In addition, under the 1996 Act, and ensuing federal and state regulatory
initiatives, barriers to local exchange competition are being removed. The
introduction of such competition, however, also establishes the predicate for
the incumbent RBOCs, such as Bell Atlantic, to provide in-region interexchange
long distance services. The incumbent RBOCs are currently allowed to offer
"incidental" long distance service in-region and to offer out-of-region long
distance service. Once the incumbent RBOCs are allowed to offer in-region long
distance services, they will also be in a position to offer single source local
and long distance service similar to that offered by RCN and proposed by the
three largest IXCs (AT&T, MCI and Sprint). The Company expects that the
increased competition made possible by regulatory reform will result in certain
pricing and margin pressures in the telecommunications services business.
RCN has sought, and will continue to seek, to provide a full range of local
voice services in competition with incumbent LECs in its service areas. The
Company expects that competition for local telephone services will be based
primarily on quality, capacity and reliability of network facilities, customer
service, response to customer needs, service features and price, and will not be
based on any proprietary technology. As a result of the comparatively recent
installation of RCN's advanced fiber optic networks, its dual path architecture
and the state-of-the-art technology used in its networks, RCN may have capital
cost and service quality advantages over some currently available local networks
relied upon by the incumbent LECs, as well as the competitive advantage provided
by the ability to deliver a bundled voice and video service.
The 1996 Act permits the incumbent LECs and others to provide a wide variety
of video services directly to subscribers in competition with RCN. Various LECs
currently are providing video services within and outside their telephone
service areas through a variety of distribution methods, including both the
deployment of broadband wire facilities and the use of wireless transmission
facilities. The Company cannot predict the likelihood of success of video
service ventures by LECs or the impact on the Company of such competitive
ventures.
Incumbent Cable Television Service Providers
Certain of RCN's video service businesses compete with incumbent wireline
cable companies in their respective service areas. In particular, RCN's advanced
fiber optic networks compete for cable subscribers with the major wireline cable
operators in New York City and Boston, primarily Time-Warner Cable in New York
City and Cablevision in Boston. RCN's wireless video service in New York City
competes primarily with Time-Warner Cable. RCN believes that the expanded
capacity and fiber-to-node architecture of its advanced fiber optic networks in
New York City and Boston make it better equipped to provide high-capacity
communications services than coaxial cable based networks utilizing "tree and
branch" architecture. RCN's Pennsylvania hybrid fiber/coaxial cable television
system competes with an alternate service provider, Service Electric, which also
holds a franchise for the relevant service area.
Since cable television systems generally operate pursuant to franchises
granted on a non-exclusive basis, and the 1992 Act prohibits franchising
authorities from unreasonably denying requests for additional franchises and
permits franchising authorities to operate cable systems, well-financed
businesses from outside the cable industry (such as the public utilities that
own certain of the poles on which cable is attached) may become competitors for
franchises or providers of competing services.
CLECs and Other Competitors
RCN also faces, and expects to continue to face, competition from other
potential competitors in certain of the markets in which RCN offers its
services. Other CLECs such as Teleport Communications Group, compete for local
telephone services, although they have to date focused primarily on the market
for commercial customers rather than residential customers. In addition,
potential competitors capable of offering private line and special access
services also include other smaller long distance carriers, cable television
companies, electric utilities, microwave carriers, wireless telephone system
operators and private networks built by large end-users, including Winstar,
Dualstar and New Vision. However, RCN believes that, at least initially, it is
relatively unique in its markets in offering bundled voice, video and data
services to customers in residential areas, and in striving to connect
residential customers directly to its advanced fiber optic network.
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Internet Services
The market for Internet access services is extremely competitive and highly
fragmented. No significant barriers to entry exist, and accordingly competition
in this market is expected to intensify. The Company competes (or in the future
may compete) directly or indirectly with (i) national and regional ISPs; (ii)
established online services; (iii) computer software and technology companies;
(iv) national telecommunications companies; (v) LECs; (vi) cable operators; and
(vii) nonprofit or educational ISPs, and some of these present or potential
future competitors have or can be expected to have substantially greater market
presence and financial, technical, marketing and other resources than the
Company. Certain of the Company's online competitors, including America Online,
the Microsoft Network and Prodigy, have introduced unlimited access to the
Internet and their proprietary content at flat rates, and certain of the LECs
have also introduced competitive flat-rate pricing for unlimited access (without
a set-up fee for at least some period of time). Bell Atlantic has recently filed
with the Federal Communications Commission (the "FCC") a petition for an
exemption from a regulation prohibiting it from building a high-speed network.
Bell Atlantic's petition requests that such network, which would serve as an
Internet backbone, not be subject to pricing and other regulatory restriction.
The network would span the states from Maine to Virginia. There can be no
assurance that competition will not lead to pricing pressures in the Internet
business.
New Technologies
Other new technologies may become competitive with services that RCN can
offer. Cellularvision, a provider of local multipoint distribution service
("LMDS"), recently began offering wireless Internet and video programming
services in New York City and has announced plans to offer telephone service in
the future. Advances in communications technology as well as changes in the
marketplace and the regulatory and legislative environment are constantly
occurring. In addition, a continuing trend toward business combinations and
alliances in the telecommunications industry may also create significant new
competitors to RCN. The Company cannot predict whether competition from such
developing and future technologies or from such future competitors will have a
material impact on its operations.
REGULATION
The telephone and video programming transmission services offered by the
Company are subject to federal, state and local government regulation. The 1996
Act, which became effective in February 1996, introduced widespread changes in
the regulation of the communications industry, including the local telephone,
long distance telephone, data services, and television entertainment segments in
which the Company operates. The 1996 Act was intended to promote competition and
decrease regulation of these segments of the industry. The law delegates to both
the FCC and the states broad regulatory and administrative authority to
implement the 1996 Act.
Telecommunications Act of 1996
The 1996 Act eliminates many of the pre-existing legal barriers to competition
in the telephone and video programming communications businesses, preempts many
of the state barriers to local telephone service competition that previously
existed in state and local laws and regulations, and sets basic standards for
relationships between telecommunications providers.
Among other things, the 1996 Act removes barriers to entry in the local
exchange telephone market by preempting state and local laws that restrict
competition and by requiring LECs to provide nondiscriminatory access and
interconnection to potential competitors, such as cable operators, wireless
telecommunications providers, and long distance companies. In addition, the 1996
Act provides relief from the earnings restrictions and price controls that have
governed the local telephone business for many years. The 1996 Act will also,
once certain thresholds are met, allow incumbent RBOCs to enter the long
distance market within their own local service regions.
Regulations promulgated by the FCC under the 1996 Act require LECs to open
their telephone networks to competition by providing competitors
interconnection, access to unbundled network elements and retail services at
wholesale rates. As a result of these changes, companies such as RCN are now
able to interconnect with the incumbent LECs in order to provide local exchange
services. Numerous parties appealed certain aspects of these
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regulations, and the appeals were consolidated in the United States Court of
Appeals for the Eighth Circuit. On July 18, 1997, the Eighth Circuit found
constitutional challenges to certain practices implementing cost provisions of
the Telecommunications Act that were ordered by certain state PUCs to be
premature; vacated significant portions of the FCC's nationwide pricing rules;
and confined the use of combined unbundled network elements to instances where
the requesting carrier itself would do the combining. On October 14, 1997, the
Eighth Circuit issued a decision vacating additional FCC rules that will likely
have the effect of increasing the cost of obtaining the use of combinations of
an incumbent LEC's unbundled network elements. On January 26, 1998, the Supreme
Court granted a writ of certiorari under which it will review the July 18 Eighth
Circuit decision; it is expected (but not yet certain) that the Court will hear
arguments on this case in the fall of 1998. The Eighth Circuit decisions create
uncertainty about the rules governing pricing and terms and conditions of
interconnection agreements, and could make negotiating and enforcing such
agreements more difficult and protracted and may require renegotiation of
existing agreements. Prior to the Eighth Circuit decisions, the Company had
entered into interconnection agreements with Bell Atlantic, covering all of its
target market area, that are generally consistent with the FCC guidelines, and
those agreements remain in effect notwithstanding the reversal of the FCC rules.
There can be no assurance, however, that the Company will be able to obtain or
enforce future interconnection agreements, or obtain renewal of existing
agreements, on terms acceptable to the Company.
Certain Bell Operating Companies ("BOCs") have also raised constitutional
challenges to restrictions in the 1996 Act preventing BOCs from entering the
long distance market in their home region. On December 31, 1997, the U.S.
District Court for the Northern District of Texas issued a decision (the "SBC
Decision") finding that Sections 271 to 275 of the 1996 Act are
unconstitutional. SBC Communications, Inc., et al. v. Federal Communications
Commission, et al., Civil Action No. 7:97-CV-163-X. These sections of the Act
impose restrictions on the lines of business in which the RBOCs may engage,
including establishing the conditions they must satisfy before they may provide
in-region interLATA telecommunications services. The District Court has stayed
the SBC Decision pending appeal. If the stay is lifted, the RBOCs (including
Bell Atlantic, which was permitted to intervene in the case) would be able to
provide interLATA services immediately without satisfying the statutory
conditions. Although the Company believes the factual assumptions and legal
reasoning in the SBC Decision are erroneous and therefore the decision will
likely be reversed on appeal, there can be no assurance of this outcome. If the
SBC Decision were upheld on appeal it may have an unfavorable effect on the
Company's business for at least two reasons. First, RBOCs currently have an
incentive to foster competition within their service areas so that they can
qualify to offer interLATA services. The SBC Decision removes this incentive by
allowing RBOCs to offer interLATA service without regard to their progress in
opening their local markets to competition. However, the SBC Decision would not
affect other provisions of the Act which create legal obligations for all ILECs
to offer interconnection and network access, and therefore will not impair the
Company's ability to compete in local exchange markets. Second, the Company is
legally able to offer its customers both long distance and local exchange
services, which the RBOCs currently may not do. This ability to offer "one-stop
shopping" gives the Company a marketing advantage that it would no longer enjoy
if the SBC Decision were upheld on appeal. The Company cannot predict either the
outcome of these or future challenges to the 1996 Act, any related appeal of
regulation or court decision, or the eventual effect on its business or the
industry in general.
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The 1996 Act also makes far-reaching changes in the regulation of the video
programming transmission services offered by RCN, including changes to the
regulations applicable to video operators, the elimination of restrictions on
telephone company entry into the video business, and the establishment of a new
OVS regulatory structure for telephone companies and others to offer such
services. Under the 1996 Act, local telephone companies, including both
incumbent LECs such as Bell Atlantic, and CLECs such as RCN, may provide service
as traditional cable television operators subject to municipal cable television
franchises, or they may opt to provide their programming over non-franchised
open video systems subject to certain conditions, including, but not limited to,
making available a portion of their channel capacity for use by unaffiliated
program distributors and satisfying certain other requirements, including
providing capacity for public, educational and government channels, and payment
of a gross receipts fee equivalent to the franchise fee paid by the incumbent
cable television operator. RCN is one of the first CLECs to provide television
programming over an advanced fiber optic network pursuant to the OVS regulations
implemented by the FCC under the 1996 Act. As discussed below, RCN is currently
providing OVS service in the City of Boston, in the City of New York and in a
number of communities surrounding Boston. Starpower is negotiating similar
agreements in Washington and surrounding communities.
Regulation of Voice Services
RCN's voice business is subject to regulation by the FCC at the federal level
with respect to interstate telephone services (i.e., those that originate in one
state and terminate in a different state). State regulatory commissions have
jurisdiction over intrastate communications (i.e., those that originate and
terminate in the same state).
State Regulation of Intrastate Local and Long Distance Telephone Services.
RCN's intrastate telephone services in Boston, New York City, and the Lehigh
Valley are (and Starpower's similar services in the Washington area will be)
regulated by the public service commissions or comparable agencies of the
various states in which these services are offered. RCN subsidiaries have
received either permanent or interim authority to offer intrastate telephone
services, including local exchange service, in Massachusetts, New York,
Pennsylvania, Maryland, the District of Columbia, and Virginia (as well as in
some neighboring jurisdictions where the Company does not currently operate but
may expand in the future). Starpower has filed separately applications for
similar authority in Maryland, the District of Columbia, and Virginia.
Starpower's application in Maryland has been granted. RCN's resale agreements
with Bell Atlantic have been approved, pursuant to Section 252 of the
Communications Act, by state regulatory commissions in Delaware, the District of
Columbia, Maine, Maryland, Massachusetts, New York, New Jersey, New Hampshire,
Pennsylvania, Rhode Island, Vermont, and Virginia.
RCN Long Distance Company is authorized to offer intrastate long distance
services in Pennsylvania, New York and Massachusetts and, in addition, has
received state regulatory authority to offer such services in 45 other states
nationwide. Pursuant to such authorizations, RCN Long Distance Company is
permitted to resell intrastate long distance services both to other carriers,
including RCN's local operating subsidiaries and Starpower for resale to their
end user subscribers, and to its own end user customers.
FCC Regulation of Interstate and International Telephone Services. RCN,
through several of its subsidiaries, including RCN Long Distance Company, may
also provide domestic interstate telephone services nationwide pursuant to
tariffs on file at the FCC, and has been authorized by the FCC under Section 214
of the 1996 Act to offer worldwide international services as well. RCN is
authorized to resell in-state long-distance services in 48 states (all except
Alaska and Hawaii), and, where required, has registered with or obtained
licenses or certificates from state regulatory agencies for the provision of
this service.
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Local Regulation of Telephone Services. Municipalities also regulate limited
aspects of RCN's voice business by, for example, imposing various zoning
requirements and, in some instances, requiring telecommunications licenses,
franchise agreements and/or installation permits for access to local streets and
rights-of-way. In New York City, for example, RCN will be required to obtain a
telephone franchise in order to provide voice services using its advanced fiber
optic network facilities located in the streets of New York City (although
services may be provided over certain leased or resold facilities pending
receipt of a franchise).
Regulation of Video Services
Open Video Systems. In February 1997, RCN subsidiaries were certified to
operate OVS networks in the five boroughs of New York City and, as part of the
BECO joint venture, in Boston and 47 surrounding communities. Initiation of OVS
services is subject to completion of an open enrollment period for non-
affiliated video programmers to seek capacity on the systems and upon
negotiation of certain agreements with local governments. The initial open
enrollment period for both the New York City and Boston area systems has
expired. RCN executed an agreement with the City of Boston on June 2, 1997, and
initiated OVS service in the City on that day. Pursuant to its agreement with
the City of Boston, RCN will be required to pay a fee to the City equal to 5% of
video revenues. RCN has entered into similar OVS agreements or is in the process
of negotiating agreements with certain other Boston-area municipalities, either
to offer OVS services or franchised cable television services. RCN executed an
agreement with the City of New York on December 29, 1997, and has initiated OVS
service in the Borough of Manhattan pursuant to that agreement.
In areas where it offers video programming services as an OVS operator, RCN is
required to hold a 90-day open enrollment period every three years, during which
times RCN will be required to offer capacity on its network to other VPPs. Under
the OVS regulations, RCN must offer at least two-thirds of its capacity to
unaffiliated parties, if demand for such capacity exists during the open
enrollment period. In certain areas, RCN is in discussions with local municipal
authorities to explore the feasibility of obtaining a cable franchise in lieu of
an OVS agreement, and will consider providing RCN video service pursuant to
franchise agreements rather than OVS certification, if franchise agreements can
be obtained on terms and conditions acceptable to RCN. However, RCN will
consider the relative benefits of OVS certification versus local franchise
agreements, including the possible imposition of universal service requirements,
before making any such decisions. In addition, the current FCC rules concerning
OVS are subject to appeal in the United States Court of Appeals and, to the
extent that certain favorable aspects of the FCC's rules are overturned on
appeal, the determination of whether to operate as an OVS provider versus as a
franchised cable television operator may be affected. Moreover, the incumbent
cable television provider in Boston, Cablevision Systems, has requested that the
FCC permit it to obtain capacity on RCN's Boston area OVS network, and Time
Warner, the incumbent cable television provider in certain communities in the
Boston area, has made a similar filing at the FCC with respect to its request
for capacity on the Boston OVS network. RCN will continue to oppose these
requests, but to the extent that the FCC were to grant any such request(s), such
a result would likely affect the Company's determination as to whether to
operate as an OVS provider versus as a franchised cable television operator.
Prior to its certification as an OVS provider, RCN offered limited video
programming services using the video dial tone ("VDT") services offered by
MFS/WorldCom in Manhattan and the City of Boston. In February 1997, the FCC held
that MFS/WorldCom's facilities did not qualify as video dialtone facilities
entitled to an extension of time to comply with the newly adopted OVS rules;
nonetheless, the FCC did not direct MFS/WorldCom and RCN to cease video
programming distribution operations over the MFS/WorldCom platform. One of the
incumbent cable television companies in New York City has filed a complaint with
the New York Public Service Commission challenging the former (pre-OVS)
operations of RCN and WorldCom under the VDT framework, which remains pending
before that Commission.
Wireless Video Services. RCN's 18 GHz wireless video services in New York
City are distributed using microwave facilities provided by Bartholdi Cable
pursuant to temporary authorizations issued to Bartholdi Cable by the FCC.
Bartholdi Cable has agreed to provide transmission services to RCN until RCN has
either converted the wireless video subscribers to its advanced fiber optic
network facilities or has obtained FCC authority to provide such services
pursuant to its own wireless radio licenses. In addition, Bartholdi Cable has
agreed to transfer to RCN the transmission equipment on demand. Bartholdi
Cable's obligation to provide transmission services is subject to
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Bartholdi Cable having licenses from the FCC to provide such services. The
qualifications of Bartholdi Cable to hold certain of the licenses needed to
provide transmission services to RCN are at issue in an FCC proceeding in which
an Initial Decision was released on March 6, 1998. In the Initial Decision, the
Administrative Law Judge found Bartholdi unqualified with respect to 15 such
licenses. The Initial Decision will become effective 50 days after its release
unless Bartholdi, as expected, files exceptions to the Initial Decision within
30 days of its release or the Commission elects to review the case on its own
motion. Because of the uncertainty as to Bartholdi Cable's right in the future
to offer transmission services to RCN, the Company filed its own license
applications at the FCC for all of the microwave transmission paths which are
currently being used by Bartholdi Cable to provide transmission services to RCN
and, in light of the increased uncertainties resulting from the Initial Decision
in the FCC proceeding involving certain of Bartholdi's licenses, the Company
expects now actively to pursue its license applications. While the Company
expects to receive authorizations to transmit over these microwave paths, there
can be no assurance that RCN will be able to offer wireless video services
pursuant to its own FCC licenses or that the FCC's investigation will be
resolved favorably. The failure to obtain such license or resolve such
proceedings would materially adversely affect the Company's wireless video
operations in New York City.
There can be no assurance that RCN will be able to obtain or retain all
necessary authorizations needed to construct advanced fiber optic network
facilities, to convert its wireless video subscribers to an advanced fiber optic
network or to offer wireless video services pursuant to its own FCC licenses.
Hybrid Fiber/Coaxial Cable. RCN's hybrid fiber/coaxial cable systems are
subject to regulation under the Cable Television Consumer Protection and
Competition Act of 1992, as amended (the "1992 Act"), which provides, among
other things, for rate regulation for cable services in communities that are not
subject to "effective competition," certain programming requirements, and
broadcast signal carriage requirements that allow local commercial television
broadcast stations to require a cable system to carry the station. Local
commercial television broadcast stations may elect once every three years to
require a cable system to carry the station ("must-carry"), subject to certain
exceptions, or to withhold consent and negotiate the terms of carriage
("retransmission consent"). A cable system generally is required to devote up to
one-third of its activated channel capacity for the carriage of local commercial
television stations whether pursuant to the mandatory carriage or retransmission
consent requirements of the 1992 Act. Local non-commercial television stations
are also given mandatory carriage rights. The FCC recently issued rules
establishing standards for digital television ("DTV"). Among other provisions,
the FCC's rules require television stations to simulcast their NTSC and DTV
signals for a period of years. During this simulcast period, it is unclear
whether must-carry rules will apply to DTV signals. The Communications Act
permits franchising authorities to require cable operators to set aside certain
channels for public, educational and governmental access programming. Cable
systems with 36 or more channels must designate a portion of their channel
capacity for commercial leased access by third parties to provide programming
that may compete with services offered by the cable operator.
On September 8, 1997, the Company was notified by the FCC that it has ruled
that certain of the Company's upper levels of service for its New Jersey systems
are regulated levels of service and that the Company's rates for such levels of
service have exceeded the allowable rates under the FCC rate regulation rules
which have been effective since September 1993. The Company had treated these
levels of service as unregulated. The Company intends to contest this decision.
The Company does not believe that the ultimate resolution of this matter will
have a material impact on its results of operations or financial condition.
Because a cable communications system uses local streets and rights-of-way,
such cable systems are generally subject to state and local regulation,
typically imposed through the franchising process. The terms and conditions of
state or local government franchises vary materially from jurisdiction to
jurisdiction and generally contain provisions governing cable service rates,
franchise fees, franchise term, system construction and maintenance obligations,
customer service standards, franchise renewal, sale or transfer of the
franchise, territory of the franchisee and use and occupancy of public streets
and types of cable services provided. Local franchising authorities (state or
local, depending on the practice in individual states) may award one or more
franchises within their jurisdictions and prohibit non-grandfathered cable
systems from operating without a franchise in such jurisdictions. The
Communications Act also provides that in granting or renewing franchises, local
authorities may establish requirements for cable-related facilities and
equipment, but not for video programming or information services other than in
broad categories. The Communications Act limits the payment of franchise fees to
5%
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of revenues derived from cable operations and permits the cable operator to
obtain modification of franchise requirements by the franchise authority or
judicial action if warranted by changed circumstances.
RCN's ability to provide franchised cable television services is dependent to
a large extent on its ability to obtain and renew its franchise agreements from
local government authorities on generally acceptable terms. RCN currently has 91
franchise agreements relating to the hybrid fiber/coaxial cable systems in New
York (outside New York City), New Jersey and Pennsylvania. These franchises
typically contain many conditions, such as time limitations on commencement and
completion of construction, conditions of service, including the number of
channels, the provision of free service to schools and certain other public
institutions, and the maintenance of insurance and indemnity bonds. These
franchises provide for the payment of fees to the issuing authorities and
generally range from 3% to 5% of revenues. The duration of these outstanding
franchises presently varies up to the year 2011. To date, all of RCN's cable
franchises have been renewed or extended, generally at or prior to their stated
expirations and on acceptable terms. Approximately 39 of RCN's hybrid
fiber/coaxial cable systems' franchises are due for renewal within the next
three years. No assurance can be given that RCN will be able to renew its
franchises on acceptable terms. No one franchise accounts for more than 7% of
RCN's total revenue. RCN's five largest franchises account for approximately 27%
of RCN's total revenue.
The hybrid fiber/coaxial cable systems are also subject to certain service
quality standards and other obligations imposed by the FCC and, where effective
competition has not been demonstrated to exist, to rate regulation by the FCC as
well. RCN's cable television system in Pennsylvania has been operating in a
competitive cable environment for almost 30 years, with approximately 80% of the
homes passed having access to an alternate cable operator, Service Electric
Cable TV. As a result, the Company's Pennsylvania cable system is exempt from
many FCC cable television regulations, including rate regulation. Its other
cable television systems in New York State and New Jersey currently remain
subject to FCC rate regulation. With the passage of the 1996 Act, however, all
cable systems rates will be deregulated as effective competition is shown to
exist in the franchise area, or by March 31, 1999, whichever date is sooner. RCN
anticipates that the remaining provisions of the 1992 Act that do not relate to
rate regulation, such as the provisions relating to retransmission consent and
customer service standards, will remain in place and may serve to reduce the
future operating margins of RCN's hybrid fiber/coaxial cable television
businesses as video programming competition develops in its cable television
service markets.
The Communications Act requires the FCC to regulate the rates, terms and
conditions imposed by public utilities for cable systems' use of utility pole
and conduit space unless state authorities can demonstrate that they adequately
regulate pole attachment rates. In the absence of state regulation, the FCC
administers pole attachment rates on a formula basis. In some cases, utility
companies have increased pole attachment fees for cable systems that have
installed fiber optic cables and that are using such cables for the distribution
of non-video services. The FCC concluded that, in the absence of state
regulation, it has jurisdiction to determine whether utility companies have
justified their demand for additional rental fees and that the Communications
Act does not permit disparate rates based on the type of service provided over
the equipment attached to the utility's pole. The 1996 Act and the FCC's
implementing regulations modify the current pole attachment provisions of the
Communications Act by immediately permitting certain providers of
telecommunications services to rely upon the protections of the current law and
by requiring that utilities provide cable systems and telecommunications
carriers with nondiscriminatory access to any pole, conduit or right-of-way
controlled by the utility. The FCC has recently adopted new regulations to
govern the charges for pole attachments used by companies provided
telecommunications services, including cable operators. These new pole
attachment rate regulations will become effective five years after enactment of
the 1996 Act, and any increase in attachment rates resulting from the FCC's new
regulations will be phased in equal annual increments over a period of five
years beginning on the effective date of the new FCC regulations. The ultimate
outcome of these rulemakings and the ultimate impact of any revised FCC rate
formula or of any new pole attachment rate regulations on the Company or its
businesses cannot be determined at this time.
The 1992 Act, the 1996 Act and FCC regulations preclude any satellite video
programmer affiliated with a cable company, or with a common carrier providing
video programming directly to its subscribers, from favoring an affiliated
company over competitors and require such programmers to sell their programming
to other multichannel video distributors. These provisions limit the ability of
program suppliers affiliated with cable companies or with common carriers
providing satellite delivered video programming directly to their subscribers to
offer exclusive programming arrangements to their affiliates. The Communications
Act also includes provisions, among others,
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concerning horizontal and vertical ownership of cable systems, customer service,
subscriber privacy, marketing practices, equal employment opportunity, obscene
or indecent programming, regulation of technical standards and equipment
compatibility.
In addition to the FCC regulations noted above, there are other FCC
regulations covering such areas as equal employment opportunity, syndicated
program exclusivity, network program non-duplication, registration of cable
systems, maintenance of various records and public inspection files, microwave
frequency usage, lockbox availability, sponsorship identification, antenna
structure notification, tower marking and lighting, carriage of local sports
broadcast programming, application of rules governing political broadcasts,
limitations on advertising contained in non-broadcast children's programming,
consumer protection and customer service, ownership of home wiring, indecent
programming, programmer access to cable systems, programming agreements,
technical standards, consumer electronics equipment compatibility and closed
captioning. The FCC has the authority to enforce its regulations through the
imposition of substantial fines, the issuance of cease and desist orders and/or
the imposition of other administrative sanctions, such as the revocation of FCC
licenses needed to operate certain transmission facilities often used in
connection with cable operations.
Other bills and administrative proposals pertaining to cable television have
previously been introduced in Congress or considered by other governmental
bodies over the past several years. It is probable that there will be
legislative proposals in the future by Congress and other governmental bodies
relating to the regulation of communications services.
Cable television systems are subject to federal compulsory copyright licensing
covering the retransmission of television and radio broadcast signals. In
exchange for filing certain reports and contributing a percentage of their basic
revenues to a federal copyright royalty pool, cable operators can obtain blanket
licenses to retransmit the copyrighted material on broadcast signals.
The data services business, including Internet access, is largely unregulated
at this time (apart from federal, state, and local laws and regulations
applicable to businesses in general). However, there can be no assurance that
this business will not become subject to regulatory restraints. Some
jurisdictions have sought to impose taxes and other burdens on providers of data
services, and to regulate content provided via the Internet and other
information services. RCN expects that proposals of this nature will continue to
be debated in Congress and state legislatures in the future. In addition,
although the FCC has on several occasions rejected proposals to impose
additional costs on providers of Internet access service and other data services
to the extent they use local exchange telephone network facilities for access to
their customers, similar proposals may well be considered by the FCC or Congress
in the future.
The foregoing does not purport to describe all present and proposed federal,
state, and local regulations and legislation affecting the telephone, video
programming and internet access industries. Other existing federal regulations,
copyright licensing, and, in many jurisdictions, state and local franchise
requirements, are currently the subject of judicial proceedings, legislative
hearings and administrative proposals which could change, in varying degrees,
the manner in which communications companies operate. The ultimate outcome of
these proceedings, and the ultimate impact of the 1996 Act or any final
regulations adopted pursuant to the new law on RCN or its businesses cannot be
determined at this time.
RELATIONSHIP AMONG RCN, CTE AND CABLE MICHIGAN
The Distribution Agreement defines certain aspects of the relationship among
CTE, RCN and Cable Michigan and provides for the allocation of certain assets
and liabilities among CTE, RCN and Cable Michigan. CTE, RCN and Cable Michigan
have also entered into a Tax Sharing Agreement dated as of September 5, 1997
(the "Tax Sharing Agreement") to define certain aspects of their relationship
with respect to taxes and to provide for the allocation of tax assets and
liabilities.
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Indemnification
RCN, CTE and Cable Michigan have agreed to indemnify one another against
certain liabilities. RCN has agreed to indemnify CTE and its subsidiaries at
the time of the Distribution (collectively, the "CTE Group") and the respective
directors, officers, employees and affiliates of each person in the CTE Group
(collectively, the "CTE Indemnitees") and Cable Michigan and its subsidiaries at
the time of the Distribution (collectively, the "Cable Michigan Group") and the
respective directors, officers, employees and affiliates of each person in the
Cable Michigan Group (collectively, the "Cable Michigan Indemnitees") from and
against any and all damage, loss, liability and expense ("Losses") incurred or
suffered by any of the CTE Indemnitees or the Cable Michigan Indemnitees,
respectively, (i) arising out of, or due to the failure of RCN or any of its
subsidiaries at the time of the Distribution (collectively, the "RCN Group") to
pay, perform or otherwise discharge any of the RCN Liabilities (as defined
below), (ii) arising out of the breach by any member of the RCN Group of any
obligation under the Distribution Agreement or any of the other Distribution
Documents and (iii) in the case of the CTE Indemnitees, arising out of the
provision by the CTE Group of the services described below to the RCN Group
except to the extent that such Losses result from the gross negligence or
willful misconduct of a CTE Indemnitee. "RCN Liabilities" refers to (i) all
liabilities of the RCN Group under the Distribution Agreement or any of the
other Distribution Documents, (ii) all other liabilities of RCN, CTE or Cable
Michigan (or their respective subsidiaries), except as specifically provided in
the Distribution Agreement or any of the other Distribution Documents and
whether arising before, on or after the Distribution Date, to the extent such
liabilities arise primarily from or relate primarily to the management or
conduct of the RCN Businesses prior to the effective time of the Distribution
(the liabilities in clauses (i) and (ii) collectively, the "True RCN
Liabilities") and (iii) 30% of the Shared Liabilities (as defined below).
Cable Michigan has agreed to indemnify the RCN Group and the respective
directors, officers, employees and affiliates of each person in the RCN Group
(collectively, the "RCN Indemnitees") and the CTE Indemnitees from and against
any and all Losses incurred or suffered by any of the RCN Indemnitees or the CTE
Indemnitees, respectively, (i) arising out of, or due to the failure of any
person in the Cable Michigan Group to pay, perform or otherwise discharge any of
the Cable Michigan Liabilities (as defined below), (ii) arising out of the
breach by any member of the Cable Michigan Group of any obligation under the
Distribution Agreement or any of the other Distribution Documents, (iii) in the
case of the CTE Indemnitees, arising out of the provision by the CTE Group of
services to the Cable Michigan Group except to the extent that such Losses
result from the gross negligence or willful misconduct of a CTE Indemnitee and
(iv) in the case of the RCN Indemnitees, arising out of the provision by RCN of
the services described below to the Cable Michigan Group except to the extent
that such Losses result from the gross negligence or willful misconduct of an
RCN Indemnitee. "Cable Michigan Liabilities" refers to (i) all liabilities of
the Cable Michigan Group under the Distribution Agreement or any of the other
Distribution Documents, (ii) all other liabilities of the Cable Michigan, RCN or
CTE (or their respective subsidiaries), except as specifically provided in the
Distribution Agreement or any of the other Distribution Documents and whether
arising before, on or after the Distribution Date, to the extent such
liabilities arise primarily from or relate primarily to the management or
conduct of the business of the Cable Michigan Group prior to the effective time
of the Distribution (the liabilities in clauses (i) and (ii) collectively, the
"True Cable Michigan Liabilities") and (iii) 20% of the Shared Liabilities (as
defined below).
CTE has agreed to indemnify the Cable Michigan Indemnitees and the RCN
Indemnitees from and against any and all Losses incurred or suffered by any of
the Cable Michigan Indemnitees or the RCN Indemnitees, respectively, (i) arising
out of, or due to the failure of any person in the CTE Group to pay, perform or
otherwise discharge any of the CTE Liabilities (as defined below), (ii) arising
out of the breach by any member of the CTE Group of any obligation under the
Distribution Agreement or any of the other Distribution Documents and (iii) in
the case of the RCN Indemnitees, arising out of the provision by RCN of the
services described below to the CTE Group except to the extent that such Losses
result from the gross negligence or willful misconduct of an RCN Indemnitee.
"CTE Liabilities" refers to (i) all liabilities of the CTE Group under the
Distribution Agreement or any of the other Distribution Documents, (ii) all
other liabilities of Cable Michigan, RCN or CTE (or their respective
subsidiaries), except as specifically provided in the Distribution Agreement or
any of the other Distribution Documents and whether arising before, on or after
the Distribution Date, to the extent such liabilities arise primarily from or
relate primarily to the management or conduct of the business of the CTE Group
prior to the effective time
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of the Distribution (the liabilities in clauses (i) and (ii) collectively, the
"True CTE Liabilities") and (iii) 50% of the Shared Liabilities (as defined
below).
"Shared Liability" means any liability (whether arising before, on or after
the Distribution Date) of CTE, RCN or Cable Michigan or their respective
subsidiaries which (i)(a) arises from the conduct of the corporate overhead
function with respect to CTE and its subsidiaries prior to the effective time of
the Distribution with certain exceptions or (b) is one of certain fees and
expenses incurred in connection with the Restructuring and (ii) is not a True
CTE Liability, a True RCN Liability or a True Cable Michigan Liability.
RCN, Cable Michigan and CTE have also generally agreed to indemnify each other
and each other's affiliates and controlling persons from certain liabilities
under the securities laws in connection with certain information provided to
shareholders in connection with the Distribution.
The Distribution Agreement also includes procedures for notice and payment of
indemnification claims and provides that the indemnifying party may assume the
defense of claims or suits brought by third parties for non-Shared Liabilities
and may participate in the defense of claims or suits brought by third parties
for Shared Liabilities. RCN is entitled to assume the defense of claims or
suits brought by third parties for Shared Liabilities. Any indemnification paid
under the foregoing indemnities is to be paid net of the amount of any insurance
or other amounts that would be payable by any third party to the indemnified
party in the absence of such indemnity.
The Company does not believe that any of the foregoing indemnities will have a
material adverse effect on the business, financial condition or results of
operations of the Company.
Employee Matters
Under the Distribution Agreement, RCN, Cable Michigan and CTE agreed generally
to assume employee benefits-related liabilities with respect to its current and,
in some cases, former employees. Each of RCN, Cable Michigan and CTE also agreed
to an allocation of employee-related liabilities arising out of certain shared
operations prior to the Distribution on the same basis as Shared Liabilities are
allocated.
Services and Other Arrangements
RCN has agreed to provide or cause to be provided to the CTE Group the
following services: (i) accounting, (ii) payroll, (iii) management supervision,
(iv) cash management, (v) human resources and benefit plan administration, (vi)
insurance administration, (vii) legal, (viii) tax, (ix) internal audit, (x)
investor and public relations and (xi) other miscellaneous administrative
services. The fee per year for these services will be 3.5% of the first $175
million of revenue of the CTE Group and 1.75% of any additional revenue.
RCN has also agreed to provide or cause to be provided to the Cable Michigan
Group certain specified services for a transitional period after the
Distribution. The transitional services to be provided are the following: (i)
customer service, (ii) marketing, (iii) accounting, (iv) payroll, (v) management
supervision, (vi) cash management, (vii) human resources and benefit plan
administration, (viii) insurance administration, (ix) legal, (x) tax, (xi)
internal audit, (xii) programming administration, (xiii) billing, (xiv) monthly
cable guides, (xv) investor and public relations, (xvi) provision of third party
programming, and (xvii) other miscellaneous administrative services. Subject to
certain limitations, the fee per year for services listed in items (ii)-(xiii),
(xv) and (xvii) will be 4.0% of the revenues of the Cable Michigan Group plus a
direct allocation of certain consolidated cable administration functions. The
fee for customer service listed in item (i) along with the billing service
listed in item (xiii) will be a pro rata share (based on the relative number of
subscribers) of the fees and expenses incurred by RCN to provide such customer
billing services and fees to the RCN Group and the Cable Michigan Group. The
third party expense incurred by RCN to obtain third party programming and
monthly cable guides for Cable Michigan referred to in items (xiv) and (xvi)
above, are reimbursed to RCN by Cable Michigan and no additional fee is charged
with respect thereto.
CTE has agreed to provide or cause to be provided to the RCN Group and the
Cable Michigan Group financial data processing applications, lockbox services,
storage facilities, LAN and WAN support services, building maintenance and other
miscellaneous administrative services for a transitional period after the
Distribution. The
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fees for such services and arrangements will be an allocated portion (based on
relative usage) of the cost incurred by CTE to provide such services and
arrangements to all three groups.
The services will terminate upon 60 days notice by either the service provider
or the relevant service recipient, except that the billing, customer service,
programming administration and provision of third party programming services
provided by RCN to Cable Michigan may not be terminated by RCN on less than one
year advance notice to Cable Michigan. A service recipient may also terminate
individual services by giving 60 days notice to the applicable service provider.
The aforementioned arrangements are not the result of arm's length negotiation
between unrelated parties as Cable Michigan, CTE and RCN have certain common
officers and directors. Although the transitional service arrangements in such
agreements are designed to reflect arrangements that would have been agreed upon
by parties negotiating at arm's length, there can be no assurance that Cable
Michigan would not be able to obtain similar services at a lower cost from
unrelated third parties. Additional or modified agreements, arrangements and
transactions may be entered into between the Cable Michigan and either or both
of CTE and RCN after the Distribution, which will be negotiated at arm's length.
Miscellaneous
The Distribution Agreement also contains provisions concerning access to
information and records and rights to technology, software, intellectual
property, know-how or other proprietary rights owned, licensed or held for use
by the respective Groups. The Distribution Agreement provides that any dispute
arising out of or in connection with the Distribution Agreement will be
submitted to arbitration in accordance with the procedures described in the
Agreement.
There exist relationships among CTE, RCN and Cable Michigan that may lead to
conflicts of interest. Each of CTE, RCN and Cable Michigan is effectively
controlled by Kiewit Telecom. In addition, the majority of the Company's named
executive officers will also be acting as directors and/or executive officers of
one or more group companies. See "Item 10: Directors and Executive Officers of
the Registrant." The success of the Company may be affected by the degree of
involvement of its officers and directors in the Company's business and the
abilities of the Company's officers, directors and employees in managing both
the Company and the operations of other group companies. Potential conflicts of
interest will be dealt with on a case-by-case basis taking into consideration
relevant factors including the requirements of NASDAQ and prevailing corporate
practices.
Tax Sharing Agreement
The Tax Sharing Agreement governs contingent tax liabilities and benefits, tax
contests and other tax matters with respect to tax returns filed with respect to
tax periods, in the case of Cable Michigan, ending or deemed to end on or before
the Distribution Date. Under the Tax Sharing Agreement, Adjustments (as defined
in the Tax Sharing Agreement) to taxes that are clearly attributable to the
Cable Michigan Group, the RCN Group, or the CTE Group will be allocated solely
to such group. Adjustments to all other tax liabilities will generally be
allocated 50% to CTE, 20% to Cable Michigan and 30% to RCN.
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EMPLOYEES
As of December 31, 1997, the Company had 1,150 full-time employees including
general office and administrative personnel. The Company considers relations
with its employees to be good.
INDUSTRY SEGMENTS
Financial information regarding the Registrant's industry segments is set
forth in Note 2 to the consolidated financial statements included herein.
ITEM 2. PROPERTIES
Overview of Advanced Fiber Optic Networks
RCN's advanced fiber optic networks in Boston and New York City are, and RCN
expects that its future networks will be, designed to support voice, video and
data services via a switched, fiber-rich network architecture. The Company's
full service advanced fiber optic networks in Boston and New York City consist
of owned or leased fiber optic cables, local and long distance digital switches,
video headends, video and voice transmission and distribution equipment and
associated wiring and network termination equipment. The Company's local
telephone switching network (consisting of Lucent 5ESS-2000 switches) is
installed and fully operational in Boston and in New York City. The networks'
leased fiber optic cables make up the fiber backbone, which acts as the common
signal transport medium for both digital signals (voice and data) and analog
signals (video). In both New York City and Boston, the digital backbone
transmission network utilizes synchronous optical network ("SONET") self-healing
rings that provide high speed, redundant connections for the delivery of RCN's
voice and data services. Facility connections from the backbone network to
individual buildings or service areas are provided by either leased facilities
provided by MFS/WorldCom, BECO or the incumbent LEC, or through RCN-owned fiber.
This fiber backbone includes over 5,267 fiber miles in New York City and over
9,347 fiber miles in Boston. RCN owns two switches (one in Boston and one in New
York City) and two General Instrument video headends that are installed and in
service in both Boston and New York City. As of December 31, 1997, RCN had
connected 493 buildings (424 in NYC and 69 in Boston) to its facilities.
Fiber optic systems are suitable for transmission of digitized voice, data,
video or a combination of these types of information. The main benefits of
deploying fiber in place of traditional coaxial cable or copper wire result from
its greater capacity, increased functionality, smaller size and decreased
requirements for periodic amplification of the signal. These factors contribute
to lower installation and maintenance costs and increase the variety and quality
of the service offerings. The inherent bandwidth limitations of twisted pair
copper wire historically used in telephone networks present a substantial
obstacle to the use of existing telephone networks to provide video programming
services. Although coaxial cable provides substantially greater bandwidth than
twisted pair copper wire, fiber optic cable provides substantially greater
bandwidth than coaxial cable. Consequently, newly constructed fiber networks
such as RCN's provide a superior platform for delivering high speed, high
capacity voice, video and data services as compared to systems based on copper
wire or coaxial cable networks.
The fiber cable utilized by RCN's networks has the increased capacity and
bandwidth necessary for complex data and video transmission. The fiber optic
cable typically contains between 12 and 288 fiber strands, each of which is
capable of providing many telecommunications channels or "circuits". Depending
on transmission electronics, a single pair of glass fibers on RCN's networks
currently can transmit tens of thousands of simultaneous voice conversations,
whereas even with multiplexing equipment a typical pair of copper wires can
carry a maximum of 24 simultaneous conversations. Although the LECs commonly use
copper wire in their networks, they are currently deploying fiber optic cable to
upgrade portions of their copper based network, particularly in areas served by
RCN. RCN expects that continuing development in communications equipment will
increase the capacity of each optical fiber, thereby providing even more
capacity at relatively low incremental cost.
As the Company's network is further developed, it will be dependent on certain
strategic alliances and other arrangements in order to provide the full range of
its telecommunication service offerings. These relationships include RCN's
arrangements with MFS/WorldCom to lease portions of MFS/WorldCom's fiber optic
network in
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New York City and Boston, RCN's joint venture with BECO under which
the Company has access to BECO's extensive fiber optic network in Greater
Boston, the Starpower joint venture with Pepco Communications, a subsidiary of
PEPCO, and RCN's arrangements to lease Bell Atlantic unbundled local loop and T-
1 facilities. See "Strategic Relationships" and "Voice Services Advanced Fiber
OpticNetworks." Any disruption of these arrangements and relationships could
have a material adverse effect on the Company.
Voice Services
Advanced Fiber Optic Networks. The Company's advanced fiber optic networks
in New York City and Boston utilize a voice network that supports both switched
and non-switched (private line) services. Individual buildings are connected to
the network backbone via fiber extensions that are generally terminated on SONET
equipment, which provide redundant and fail-safe interconnection between the
building and the RCN central office or switch location. In situations where
fiber extensions are not yet available, interim facility connections can be
provided by leasing special access facilities through a leasing arrangement with
MFS/WorldCom or the incumbent LEC. In this regard, RCN has in place arrangements
which allow it to lease certain facilities owned by the incumbent LECs
(unbundled local loops and T-1 facilities) to provide voice services. This
enables RCN to provide voice and data services to off-net subscribers who are
not physically connected to RCN's advanced fiber optic network. As RCN's network
expands to reach more areas within a target market, subscribers served by these
temporary connections will be migrated to RCN's advanced fiber optic network.
Within a building (or small grouping of buildings) a voice service hub is
established by installing an Integrated Digital Loop Carrier ("IDLC") device,
which acts as the point of interface between the SONET backbone facility and the
intra-building wiring. Each IDLC is installed with a standby power system and is
capable of serving up to 672 lines. The IDLC is capable of supporting a wide
range of both non-switched services (DS-1, digital data) and switched voice
services and features including ISDN, Custom Calling and CLASS features. Within
each building, internal wiring (twisted pair copper cable) connects the IDLC to
the customer premises and the customer-owned telephone equipment. In certain
instances, voice service is extended to other buildings in the building group or
cluster via either fiber optic cable or twisted pair copper cable. At the time
of initial wiring, RCN generally installs wiring in excess of its initial
requirements, in order to meet future subscriber demand.
Video Programming
Advanced Fiber Optic Networks. There are presently two video headend
locations within RCN's advanced fiber optic networks in New York City and
Boston. The video headends consist of optical transmitters, optical receivers,
satellite receivers, signal processors, modulators, encoding equipment and
network status monitoring and automated tape distribution equipment. From the
headend, the video signal is distributed to individual fiber nodes or receivers
via the same fiber cable backbone used to deliver the voice and data service.
The fiber cable terminates in a fiber optic receiver within an individual
building or service area. From the fiber node, coaxial cable and related
distribution equipment is used to distribute the video signals to the customer
premises. The bandwidth of the video distribution is a minimum of 750 MHZ, which
is capable of supporting a minimum of 110 video channels. This distribution
plant is specifically designed to be predominantly fiber-based, which increases
the reliability and improves the quality of the services delivered compared to
traditional cable television distribution architectures.
Wireless Video. RCN also owns and operates a "wireless video" television
system (which was formerly operated as Liberty Cable Television of New York, the
operations of which were acquired by RCN in 1996) using point-to-point 18GHz
microwave technology. RCN is utilizing this system in New York City as an
alternate platform for delivering television programming to buildings that are
not yet connected to the advanced fiber optic network. RCN expects that the
majority of the buildings currently served by the wireless service will
ultimately be connected to the network, to the extent that connection is
feasible. As buildings are connected to the RCN network, RCN will reuse the
microwave equipment to provide service to other customers in off-network
premises. The transmission equipment and microwave services used to provide
RCN's wireless service are provided by Bartholdi Cable, which formerly operated
Liberty Cable Television of New York. Bartholdi Cable has agreed to provide
transmission services to RCN until RCN has either converted the subscribers to
its advanced fiber optic network or has obtained FCC authority to provide such
services pursuant to its own licenses. In addition, Bartholdi Cable has agreed
to transfer to RCN the transmission equipment on demand. Bartholdi Cable's
obligation to provide transmission services is subject to Bartholdi Cable having
authority to provide such services. The qualifications of
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Bartholdi Cable to hold certain of the licenses needed to provide transmission
services to RCN are at issue in an FCC proceeding in which an Initial Decision
was released on March 6, 1998. In the Initial Decision, the Administrative Law
Judge found Bartholdi Cable unqualified with respect to 15 such licenses. The
Initial Decision will become effective 50 days after its release unless
Bartholdi Cable, as expected, files exceptions to the Initial Decision within 30
days of its release or the FCC elects to review the case on its own motion.
Because of the uncertainty as to Bartholdi Cable's right in the future to offer
transmission services to RCN, the Company has filed its own license applications
at the FCC for all of the microwave transmission paths which are currently being
used by Bartholdi Cable to provide transmission services to RCN and, in light of
the increased uncertainties resulting from the Initial Decision in the FCC
proceeding involving certain of Bartholdi Cable's licenses, the Company expects
now actively to pursue its license applications. There can be no assurance that
RCN will be able to obtain its own FCC license.
Hybrid Fiber/Coaxial Cable Systems. RCN owns and operates hybrid
fiber/coaxial cable television networks in Pennsylvania, New Jersey and New York
State (outside of New York City), all within 75 miles of New York City. These
networks offer expanded bandwidth and a platform for two-way services, and have
an aggregate of 658 route miles of fiber optic cable, including separate high
capacity fiber optic rings with a minimum 84 fibers in Pennsylvania (covering
approximately 69 route miles) designed and constructed as competitive telephony
networks. The New York system includes 211 route miles of fiber optic cable
serving 98 nodes from one head-end. Approximately 70% of the New York system is
two-way active 750 MHz plant with 84 active channels of programming. The New
Jersey system has deployed 144 route miles of fiber optic cable (over 30 miles
of which is two-way active) from two head-ends, and generally operates a 400/450
MHz plant providing 62 channels of video programming. The Pennsylvania system
operates 2,649 miles of coaxial cable and over 234 route miles of fiber with 43
nodes from one headend, operating at 550 MHz with 84 active channels. All of the
Company's hybrid fiber/coaxial cable systems are 100% one-way addressable.
These fiber-rich networks provide a basic fiber optic platform capable of
enhancement for supporting two-way services, such as high-speed Internet
services, in the future. RCN is presently expanding the fiber capacity of
certain of these fiber/coaxial cable television networks so that they will be
capable of delivering switched two-way services in the future. In August 1997,
RCN commenced offering resold local phone service, long distance and Internet
access to customers in the area served by its Hybrid Fiber/Coaxial Cable Systems
in Pennsylvania.
Data Services. RCN's Internet access and data transmission services are
currently provided over the advanced fiber optic network via dial-up modems
facilitated through the RCN voice network in on-net subscriber applications. In
off-net situations, subscribers use conventional dial-up modems through the
incumbent LEC network to access RCN's Internet transmission network. RCN is
beginning to offer Internet and data transmission services via cable modems.
Cable modems, which utilize the broadband coaxial plant, offer higher speed
access for data transmission than the speeds achieved by conventional telephone
dial-up technology.
Erols provides high quality Internet access services to businesses by
utilizing high-speed access via ISDN, frame relay, fractional T-1, T-1 and T-3
circuits. Erols' network infrastructure currently supports modems with dial-
access speeds of up to 56 Kbps. Erols provides new dial-access subscribers with
its easy-to-install proprietary access software package, which incorporates a
telephone dialer, an e-mail platform, a Web browser (either Netscape
Communication Corporation's ("Netscape") Navigator (a registered trademark of
Netscape) or Microsoft Corp.'s Microsoft(R) Internet Explorer) and SurfWatchTM
software for parental control over Internet content access. This software
package permits simplified access to the Internet through a "point and click"
graphical user interface. After installation, the subscriber has a direct
connection to the Internet using Point-to-Point Protocol and access to all of
the Internet's resources, including e-mail, the World Wide Web, Usenet News
service and Internet Relay Chat. Access software automatically displays the
Erols World Wide Web site each time a subscriber logs on, providing Erols with
the opportunity to communicate with its subscribers at the start of each
session. Erols maintains "24 x 7" subscriber and technical support 365 days a
year.
Erols' services currently rely on the widespread commercial use of
Transmission Control Protocol/Internet Protocol ("TCP/IP"). Alternative open and
proprietary protocol standards that compete with TCP/IP, including proprietary
protocols developed by International Business Machines Corporation ("IBM") and
Novell, Inc. have
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been or are being developed. The adoption of such new industry standards could
render the Company's existing services obsolete and unmarketable or require
reduction in the fees charged therefor.
Erols relies on a combination of copyright, trademark and trade secret laws
and contractual restrictions to establish and protect its proprietary
technology. However, there can be no assurance that Erols' technology will not
be misappropriated or that equivalent or superior technologies will not be
developed. In addition, there can be no assurance that third parties will not
assert that the Erols' services or its users' content infringe their proprietary
rights. The Company has obtained authorization, typically in the form of a
license, to distribute third-party software incorporated in the Erols access
software product for Windows 3.1, Windows 95, Windows NT and Macintosh
platforms. The Company plans to maintain or negotiate renewals of existing
software licenses and authorizations. The Company may want or need to license
other applications in the future.
Ultranet utilizes K56Flex protocol to support its points of presence ("POPs"),
a result of a major mid-1997 upgrade in Ultranet transmission equipment. This
advancement has empowered users to gain access to two to four times more quickly
to equipment that is also more reliable. The new infrastructure takes advantage
of Rockwell technology that supports the K56Flex modems (speeds up to 56 Kbps)
and ISDN (speeds up to 128 Kbps). By connecting users to the Internet faster,
downloading time is decreased, and in turn, telephone costs and time online.
RCN intends to extend its network to cover most of the areas currently served
by Erols and Ultranet and ultimately to migrate most of those customers to RCN's
advanced fiber optic network, subject to certain regulatory approvals and the
approval of RCN's joint venture partners.
ITEM 3. LEGAL PROCEEDINGS
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 and certain present and former directors of CTE
in the Superior Court of New Jersey, Chancery Division. The complaint alleges
that CTE's restructuring constituted a fradulent conveyance and alleges breaches
of contract and fiduciary duties and of the convenant of good faith and fair
dealing in connection with the restructuring. On December 1, 1997, the complaint
was amended to allege that CTE's distribution of the common stock of the Company
and Cable Michigan was an unlawful distribution in violation of 15 Pa.CS.
1551(b)(2). The plaintiffs are seeking to set aside the alleged fraudulent
conveyance and unspecified monetary damages. The Company believes this lawsuit
is without merit and intends to contest this action vigorously. On January 9,
1998, CTE filed a Motion to Dismiss, or in the Alternative, for Summary
Judgment. The plaintiffs filed their response on March 9, 1998. The Company's
reply brief is due on April 6, 1998 and argument on the motion is set for April
17, 1998.
In the normal course of business, there are various legal proceedings
outstanding. In the opinion of management, these proceedings will not have a
material adverse effect on the results of operations or financial condition of
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the Registrant
during the fourth quarter of the Registrant's 1997 fiscal year.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of Form 10-K, the following list is
included as an un-numbered Item in Part I of this Report in lieu of being
included in the definitive proxy statement relating to the Registrant's Annual
Meeting of Shareholders to be filed by Registrant with the Commission pursuant
to Section 14(A) of the Securities Exchange Act of 1934 (the "1934 Act").
Executive Officers of the Registrant
David C. McCourt,41, has been the Chairman and Chief Executive Officer of the
Company as well as a Director since September 1997. Mr. McCourt has served as a
Director and Chairman and Chief Executive Officer of Cable Michigan since
September 30, 1997. In addition, he is a Director and Chairman and Chief
Executive Officer of Commonwealth Telephone Enterprises, Inc. ("CTE") positions
he has held since October 1993. Mr. McCourt has also been President and Chief
Executive Officer, as well as a Director of Kiewit Telecom Holdings, Inc. He has
also been Chairman and Chief Executive Officer as well as a Director of Mercom
since October 1993, Director of MFS Communications Company, Inc. from July 1990
to December 1996, President and a Director of Metropolitan Fiber
Systems/McCourt, Inc., a subsidiary of MFS Telecom, Inc., since 1988, a Director
of Cable Satellite Public Affairs Network ("C-SPAN") since June 1995, a Director
of WorldCom, Inc. since December 1996 and a Director of Kiewit Diversified
Group, Inc. now Level 3 Communications, Inc. since August 1997.
Michael J. Mahoney, 47, has been the President and Chief Operating Officer, as
well as a Director of the Company since September 1997. Mr. Mahoney is also a
Director of CTE, a position he has held since May 1995. Mr. Mahoney was
President and Chief Operating Officer of CTE from February 1994 to September
1997, President and Chief Operating Officer of Mercom from February 1994 to
October 1997 and a Director of Mercom since January 1994. In addition, he was
Executive Vice President of Cable Television Group from June 1991 to March 1994
and Executive Vice President of Mercom from December 1991 to March 1994.
Dennis J. Spina, 53, has served as Director, Vice-Chairman and President of
Internet Services of the Company since February 1998. Previously, he served as
Chief Executive Officer of Erol's Internet Services, Inc. ("Erol's") from
August 1996 to February 1998. From January 1996 until July 1996, he worked as
an independent consultant in the service and distribution industry. From
November 1994 to December 1995, he served as President and Chief Executive
Officer of International Service systems, a company engaged in the business of
janitorial and energy management. From August 1990 to October 1994, he served
as President and Chief Executive Officer of Suburban Propane, Inc. ("Suburban
Propane"), a division of Hanson PLC. He was hired in a turnaround capacity and
also served as President and Chief Executive Officer of Petrolane, Inc.
("Petrolane"), a propane distribution company managed by Suburban Propane, from
August 1990 until its sale in July 1993. From 1973 to 1990, he worked at
Federal Express Corporation, ultimately serving as Vice President and Officer.
Bruce C. Godfrey, 42, has been the Executive Vice President, Chief Financial
Officer, Corporate Secretary and Director of the Company since September 1997.
Mr. Godfrey has also been a Director of Cable Michigan as well as its Secretary
since such date. Mr. Godfrey has been a Director of CTE since November 1996,
Executive Vice President and Chief Financial Officer of CTE since April 1994. He
has also been Executive Vice President and Chief Financial Officer of Mercom
from April 1994 to October 1997 and a Director of Mercom since May 1994 and
Corporate Secretary since October 1997. Mr. Godfrey was also Senior Vice
President and Principal of Daniels and Associates from January 1984 to April
1994.
21
<PAGE>
Salvatore M. Quadrino, 51, has been Chief Administrative Officer of the
Company since February 1998. Previously he served as Vice President, Treasurer
and Chief Financial Officer since joining Erol's in September 1997. From
October 1996 to August 1997, he worked as an independent financial consultant in
the service and distribution industry. From October 1994 to September 1996, he
served as President and Chief Executive Officer of Suburban Propane, a division
of Hanson PLC, which conducted its initial public offering in March 1996, and
from March to October 1996 he served as a member of Suburban Propane's Board of
Supervisors. Mr. Quadrino initially was hired in a turn around capacity, served
as Vice President and Chief Financial Officer of Suburban Propane from October
1990 to September 1994 and as Vice President, Chief Financial Officer and
Treasurer of Petrolane from August 1990 until its sale in July 1993.
Michael A. Adams, 40, has been the President of Technology and Network
Development Group of the Company and Executive Vice President of the Company
since September 1997. Mr. Adams held the corresponding position at CTE from
November 1996 to September 1997. Prior to that date, Mr. Adams held the
following positions: Executive Vice President of Technology and Strategic
Development of CTE from August 1996 to November 1996, Executive Vice President
of CTE's Communications Service Group from September 1994 to June 1996, Vice
President of Technology from November 1993 to September 1994, Vice President of
Engineering for RCN Telecom Services Inc., a wholly owned subsidiary of RCN,
from September 1992 to October 1993.
Mark Haverkate, 43, has been the Executive Vice President, Business
Development of the Company since September 1997. Mr. Haverkate has also been
President and Chief Operating Officer and a Director of Cable Michigan since
such date. He has been President and Chief Operating Officer of Mercom, since
October 1997. He was the President of RCN Development (a division of RCN) from
June 1997 to September 1997 and Executive Vice President of Business Development
at CTE from May 1997 to September 1997. Previously, he was President for
Business Operations of RCN Telecom Services, Inc. from November 1996 to June
1997, Executive Vice President of RCN Telecom Services, Inc. from August 1996 to
November 1996, Executive Vice President of CTE's Cable Television Group from
July 1995 to August 1996, Executive Vice President of Development for CTE from
February 1995 to July 1995, Executive Vice President for Development at Mercom
from November 1995 to February 1996, Vice President of Development for CTE from
December 1993 to February 1995, Vice President for Development at Mercom from
December 1993 to February 1995, Vice President of CTE's Cable Television Group
from October 1989 to December 1993.
22
<PAGE>
Ralph S. Hromisin, CPA 37, has been Vice President and Chief Accounting
Officer of the Company since September 1997. He also has been Vice President and
Chief Accounting Officer of Cable Michigan, Inc. and CTE since September 1997.
He served as Vice President and Corporate Controller of CTE from August 1994 to
September 1997. Mr. Hromisin has been Vice President and Corporate Controller
for Mercom since October 1996, Director of Corporate Accounting for CTE from
March 1992 to August 1994. He also held various positions, most recently Audit
Manager for Parente, Randolph, Orlando, Carey & Associates, CPA's from November
1982 to March 1992.
Kenneth R. Knudsen, 51, has been Senior Vice President of Sales & Marketing
of RCN since June 1997 and Vice President of Sales and General Manager of RCN
Telecom Services, Inc. from January 1996 to May 1997. Previously, Mr. Knudsen
served as Chief Executive Officer and Partner of KCI Consulting, Inc. from 1994
to January 1996 and Senior Vice President of Ryan Management Group from 1993 to
1994. From 1970 to 1996 he also held Officer and Senior Management positions at
Nabisco, Ocean Spray Cranberries, Frito-lay, Inc. and Procter and Gamble
Company.
Paul E. Sigmund, 33, Executive Vice President of the Company since
September 1997 and Executive Vice President of RCN International Holdings since
1996. Previously, Mr. Sigmund was a Vice President at Smith Barney, Inc. from
1994 to 1996; an Associate at the law firm of Skadden, Arps, Slate, Meagher &
Flom from 1993 to 1994 and an Investment Associate at the International Finance
Corporation/ World Bank from 1986 to 1989.
Timothy J. Stoklosa, 37, has been the Senior Vice President and Treasurer
of the Company since September 1997. He also has been as Executive Vice
President and Chief Financial Officer and a Director of Cable Michigan since
such date. Mr. Stoklosa has been Senior Vice President of Finance of CTE since
February 1997, Treasurer of CTE since August 1994 and Executive Vice President
and Chief Financial Officer of Mercom since October 1997. Previously, Mr.
Stoklosa was Vice President of Finance of CTE from May 1995 to February 1997,
Manager of Mergers and Acquisitions at Peter Kiewit Sons, Inc. from October 1991
to August 1994 and Senior Financial Analyst of Corporate Development at Citizens
Utilities Co. from February 1990 to October 1991.
23
<PAGE>
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters
There were approximately 2,201 holders of Registrant's Common Stock on
February 28, 1997. The Company maintains a no cash dividend policy. The
Company does not intend to alter this policy in the foreseeable future. Other
information required under Item 5 of Part II is set forth in Note 18 to the
consolidated financial statements included in Part IV Item 14(a)(1) of this Form
10-K.
In March 1998, the Company's Board of Directors approved a two-for-one stock
split, payable in the form of a 100% stock dividend. The record date for the
stock split is March 20, 1998, Stockholders of record at the market close on
that date will receive an additional share of RCN common stock for each share
held. The distribution date for the stock dividend will be April 3, 1998. All
share and per share data, stock option data, and market prices of the Company's
common stock have been restated to reflect this stock split.
On February 20, 1998, RCN issued 1,730,648 shares of RCN Common Stock in
connection with the merger of Erols Internet, Inc. with and into a wholly-owned
subsidiary of RCN. On February 27, 1998, RCN issued 90,384 shares of RCN
common stock in connection with the merger of Utranet Communications, Inc. with
and into a wholly-owned subsidiary of RCN. Both of these issuances were made
pursuant to the exemption from registration under Section 4(2) of the Securities
Act.
Item 6. Selected Financial Data
Information required under Item 6 of Part II is set forth in Part IV
Item 14(a)(1) of this Form 10-K.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Information required under Item 7 of Part II is set forth in Part IV
Item 14(a)(1) of this Form 10-K.
Item 8. Financial Statements and Supplementary Data.
The consolidated financial statements and supplementary data required under
Item 8 of Part II are set forth in Part IV Item 14(a)(1) of this Form 10-K.
Item 9. Disagreements on Accounting and Financial Disclosure.
During the two years preceding December 31, 1997, there has been neither a
change of accountants of the Registrant nor any disagreement on any matter of
accounting principles, practices, or financial statement disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required under Item 10 of Part III with respect to the
Directors of Registrant is set forth in the definitive proxy statement relating
to Registrant's Annual Meeting of Shareholders to be filed by the Registrant
with the Commission pursuant to Section 14(a) of the 1934 Act and is hereby
specifically incorporated herein by referenced thereto.
The information required under Item 10 of Part III with respect to the
executive officers of the Registrant is set forth at the end of Part I hereof.
Item 11. Executive Compensation
The information required under Item 11 of Part III is set forth in the
definitive Proxy Statement relating to Registrant's Annual Meeting of
Shareholders to be filed by the Registrant with the Commission pursuant to
Section 14(a) of the 1934 Act, and is hereby specifically incorporated herein by
reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required under Item 12 of Part III is included in the
definitive Proxy Statement relating to Registrant's Annual Meeting of
Shareholders to be filed by Registrant with the Commission pursuant to Section
14(a) of the 1934 Act, and is hereby specifically incorporated herein by
reference thereto.
Item 13. Certain Relationships and Related Transactions
24
<PAGE>
The information required under Item 13 of Part III is included in the
definitive Proxy Statement to Registrant's Annual Meeting of Shareholders to be
filed by Registrant with the Commission pursuant to Section 14 (a) of the 1934
Act, and is hereby specifically incorporated herein by reference thereto.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Report on form 8-K.
Item 14 (a)(1) Financial Statements:
Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995.
Consolidated Statements of Cash Flows for Years Ended December 31, 1997,
1996 and 1995.
Consolidated Balance Sheets - December 31, 1997 and 1996.
Consolidated Statements of Changes in Common Shareholders' Equity for
Years Ended December 31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements
Report of Independent Accountants
Item 14 (a)(2) Financial Statement Schedules:
Description
Condensed Financial Information of Registrant for the Year Ended
December 31, 1997. (Schedule I)
Valuation and Qualifying Accounts and Reserves for the Years Ended
December 31, 1997, 1996 and 1995 (Schedule II)
All other financial statement schedules not listed have been omitted
since the required information is included in the consolidated financial
statements or the notes thereto, or are not applicable or required.
Item 14 (a)(3) Exhibits:
Exhibits marked with an asterisk are filed herewith and are listed in the
index to exhibits of this Form 10-K. The remainder of the exhibits have been
filed with the Commission and are incorporated herein by reference.
(2) Plan of acquisition, reorganization, arrangement and Report on Form 8-K
(a) Form of Distribution Agreement among C-TEC Corporation, Cable Michigan,
Inc. and the Registrant is incorporated herein by reference to Exhibit 2.1
to the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
(b) 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. (incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K ("Form 8-K") filed on March 6, 1998)
(Commission No. 0-22825.)
(c) Amendment No. 1 to 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. (incorporated by reference to
Exhibit 2.2 to the Company's Form 8-K) (Commission File No. 0-22825.)
(3) Articles of Incorporation and By-laws
(a) Form of Amended and Restated Articles of Incorporation of the Registrant
are incorporated herein by reference to Exhibit 3.1 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
(b) Form of Amended and Restated Bylaws of the Registrant are incorporated
herein by reference to Exhibit 3.2 to the Company's Amendment No. 2 to
Form 10/A filed September 5, 1997 (Commission File No. 0-22825.)
(4) Instruments defining the rights of security holders, including indentures
(a) Credit Agreement dated as of July 1, 1997 among C-TEC Cable Systems, Inc.,
ComVideo Systems, Inc., C-TEC Cable Systems of New York, Inc. and First
Union National Bank, as agent is incorporated herein
25
<PAGE>
by reference to Exhibit 4.1 to the Company's Amendment No. 2 to Form 10/A
filed September 5, 1997 (Commission File No. 0-22825.)
4(b) 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 ("1998 Form S-4") filed on
March 23, 1998) (Commission File No. 0-22825.)
4(c) Form of 9.80% Senior Discount Notes due 2008, Series B (included in
Exhibit 4.1) (incorporated by reference to Exhibit 4.2 to the Company's
1998 Form S-4) (Commission File No. 0-22825.)
4(d) Registration Rights Agreement dated as of February 6, 1998 by and among
the Company and Merrill Lynch, Pierce, Fenner & Smith Incorporated,
Salomon Brothers Inc. and NationsBanc Montgomery Securities, Inc., as
Initial Purchasers (incorporated by reference to Exhibit 4.3 to the
Company's 1998 Form S-4) (Commission File No. 0-22825.)
4(e) Indenture dated as of October 17, 1997 between the Company, as Issuer, and
The Chase Manhattan Bank, as Trustee, with respect to the 10% Senior Notes
due 2007 (incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-4 ("Form S-4") filed on November 26,
1997) (Commission File No. 0-22825.)
4(f) Form of the 10% Senior Exchange Notes due 2007 (included in Exhibit 4.4)
(incorporated by reference to Exhibit 4.2 to the Company's Form S-4)
(Commission File No. 0-22825.)
4(g) Indenture dated as of October 17, 1997 between the Company, as Issuer, and
The Chase Manhattan Bank, as Trustee, with respect to the 11 1/8% Senior
Discount Notes due 2007 (incorporated by reference to Exhibit 4.3 to the
Company's Form S-4) (Commission File No. 0-22825.)
4(h) Form of the 11 1/8% Senior Discount Exchange Notes due 2007 (included in
Exhibit 4.6) (incorporated by reference to Exhibit 4.4 to the Company's
Form S-4) (Commission File No. 0-22825.)
4(i) Escrow Agreement dated as of October 17, 1997 among The Chase Manhattan
Bank, as escrow agent, The Chase Manhattan Bank, as Trustee under the
Indenture (as defined therein), and the Company (incorporated by reference
to Exhibit 4.6 to the Company's Form S-4) (Commission File No. 0-22825.)
(10) Material Contracts
(a) Tax Sharing Agreement by and among C-TEC Corporation, Cable Michigan, Inc.
and the Registrant is incorporated herein by reference to Exhibit 10.1 to
the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
(b) Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan Fiber
Systems/McCourt, Inc. and RCN Telecom Services of Massachusetts, Inc. is
incorporated herein by reference to Exhibit 10.2 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
(c) Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan Fiber
Systems of New York, Inc. and RCN Telecom Services of New York, Inc. is
incorporated herein by reference to Exhibit 10.3 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
(d) Telephone Service to Reseller Agreement for Boston among Metropolitan
Fiber Systems/McCourt, Inc. and RCN Telecom Services of Massachusetts,
Inc. is incorporated herein by reference to Exhibit 10.4 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
(e) Telephone Service to Reseller Agreement for New York among Metropolitan
Fiber Systems of New York, Inc. and RCN Telecom Services of New York, Inc.
is incorporated herein by reference to Exhibit 10.5 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
(f) OVS Agreement dated May 8, 1997 between RCN Telecom Services, Inc. and MFS
Communication Company, Inc. is incorporated herein by reference to Exhibit
10.6 to the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
(g) Joint Venture Agreement dated as of December 23, 1996 between RCN Telecom
Services, Inc. and Boston Energy Technology Group, Inc. is incorporated
herein reference by Exhibit 10.7 to the Company's Amendment No. 2 to Form
10/A filed September 5, 1997 (Commission File No. 0-22825.)
(h) Amended and Restated Operating Agreement of RCN-BecoCom, LLC dated as of
June 17, 1997 is incorporated herein by reference to Exhibit 10.8 to the
Company's Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission
File No. 0-22825.)
(i) Management Agreement dated as of June 17, 1997 among RCN Operating
Services, Inc. and BecoCom, Inc. is incorporated herein by reference to
Exhibit 10.9 to the Company's Amendment No.2 to Form 10/A filed September
5, 1997 (Commission File No. 0-22825.)
(j) Construction and Indefeasible Right of Use Agreement dated as of June 17,
1997 between BecoCom, Inc. and RCN-BecoCom, LLC is incorporated herein by
reference to Exhibit 10.10 to the Company's Amendment No. 2 to Form 10/A
filed September 5, 1997 (Commission File No. 0-22825.)
(k) License Agreement dated as of June 17, 1997 between Boston Edison Company
and BecoCom, Inc. is incorporated herein by reference to Exhibit 10.11 to
the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
(l) Joint Investment and Non-Competition Agreement dated as of June 17, 1997
among RCN Telecom Services of Massachusetts, Inc., BecoCom, Inc. and RCN-
BecoCom, LLC is incorporated herein by reference to Exhibit 10.12 to the
Company's Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission
File No. 0-22825.)
* (m) Amended and restated Operating Agreement of Starpower Communications,
L.L.C. by and between Pepco Communications, L.L.C. and RCN Telecom
Services of Washington, D.C. Inc. dated October 28, 1997.
26
<PAGE>
*(21) Subsidiaries of the Registrant
*(23) Consent of Independent Accountants
*(24) Powers of Attorney
*(27) Financial Data Schedule
Item 14.(b) Reports on Form 8-K
No reports on Form 8-K have been filed by the Registrant during the last
quarter of the period covered by this Report on Form 10-K.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 31, 1998 RCN Corporation
By: \s\ David C. McCourt
-------------------------
David C. McCourt
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
PRINCIPAL EXECUTIVE AND ACCOUNTING OFFICERS:
\s\ David C. McCourt Chairman and Chief March 31, 1998
- -------------------------- Executive Officer
David C. McCourt
\s\ Michael J. Mahoney President and Chief March 31, 1998
- -------------------------- Operating Officer
Michael J. Mahoney
\s\ Bruce C. Godfrey Executive Vice President March 31, 1998
- -------------------------- and Chief Financial Officer
Bruce C. Godfrey
\s\ Ralph S. Hromisin Vice President and March 31, 1998
- -------------------------- Chief Accounting Officer
Ralph S. Hromisin
31
<PAGE>
DIRECTORS:
\s\ David C. McCourt March 31, 1998
- -------------------------
David C. McCourt
March 31, 1998
\s\ James Q. Crowe
- -------------------------
James Q. Crowe
\s\ Walter E. Scott, Jr. March 31, 1998
- -------------------------
Walter E. Scott, Jr.
\s\ Richard R. Jaros March 31, 1998
- -------------------------
Richard R. Jaros
\s\ Thomas May March 31, 1998
- -------------------------
Thomas May
\s\ Alfred Fasola March 31, 1998
- -------------------------
Alfred Fasola
\s\ Thomas P. O'Neill, III March 31, 1998
- -------------------------
Thomas P. O'Neill, III
\s\ Eugene Roth March 31, 1998
- -------------------------
Eugene Roth
\s\ Stuart E. Graham March 31, 1998
- -------------------------
Stuart E. Graham
\s\ Michael B. Yanney March 31, 1998
- -------------------------
Michael B. Yanney
32
<PAGE>
\s\ Michael J. Mahoney March 31, 1998
- -------------------------
Michael J. Mahoney
\s\ Bruce C. Godfrey March 31, 1998
- -------------------------
Bruce C. Godfrey
33
<PAGE>
SCHEDULE 1
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(THOUSANDS OF DOLLARS)
Sales $40
Costs and expenses, excluding
depreciation and amortization 498
----------
Gross Profit (Loss) (458)
Depreciation and amortization -
----------
Operating income (loss) (458)
Interest income 661
Interest expense (12,791)
Other income/(expense), net -
----------
(Loss) income before income taxes (12,588)
(Benefit) provision for income taxes (4,388)
Equity in (loss) of
consolidated entities (44,191)
----------
Net (loss) $ (52,391)
==========
Earnings (loss) per average common share:
Net (loss) to shareholders $ (0.95)
Average shares outstanding 54,965,716
<PAGE>
SCHEDULE 1
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
DECEMBER 31, 1997
(THOUSANDS OF DOLLARS)
ASSETS
Current assets
Cash and temporary cash investments $ -
Accounts receivable from related parties 3,291
Accounts receivable 1,977
Prepayments & other 211
Investments restricted for debt service 22,500
---------------
Total current assets 27,979
Investments restricted for debt service 39,411
Investments 859,271
Debt issuance cost 19,188
Deferred charges and other assets 2,877
---------------
Total assets $948,726
===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable 4,034
Accrued interest 4,687
Accrued expenses 318
---------------
Total current assets 9,039
Long-term debt 583,103
Common stock 27,495
Retained earnings (17,116)
Additional paid in capital 349,261
Cumulative translation adjustment (3,056)
---------------
Total liabilities and shareholders' equity $948,726
===============
<PAGE>
SCHEDULE 1
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997
(THOUSANDS OF DOLLARS)
YTD 1997
--------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) ($52,391)
Deferred income taxes and investment tax credits (2,877)
Working capital 2,749
Equity in loss of consolidated entity 44,191
Noncash accretion of discounted senior notes 8,103
--------------
Net cash (used in) operating activities (225)
--------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions 167
Other 17
--------------
Net Cash Provided by Investing Activities 184
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt 575,000
(Increase) in cash restricted for debt service (61,250)
Financing costs (19,188)
Transfer (to) CTE (494,751)
Proceeds from exercise of stock options 230
--------------
Net cash provided by financing activities 41
--------------
Net increase/(decrease) in cash and temporary cash investments 0
Beginning cash & temporary cash investments 0
--------------
Ending cash & temporary cash investments $0
==============
<PAGE>
RCN CORPORATION SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
---------- ------------ ---------- ---------- ----------
ADDITION
----------------------------
BALANCE AT CHARGED CHARGED BALANCE AT
BEGINNING OF TO COSTS TO OTHER END OF
DESCRIPTION PERIOD AND EXPENSE ACCOUNTS DEDUCTIONS PERIOD
- ----------- ------ ----------- -------- ---------- ------
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS-
DEDUCTED FROM ACCOUNTS RECEIVABLE
IN THE CONSOLIDATED BALANCE SHEETS
1997 $861 $2,732 $997 $2,456 $2,134
1996 $607 $1,788 ($556) $978 $861
1995 $809 $614 ($619) $197 $607
ALLOWANCE FOR DEFERRED TAX ASSETS-
DEDUCTED FROM DEFERRED TAX ASSETS
IN THE CONSOLIDATED BALANCE SHEETS
1997 3,691 5,777 -- 1,064 8,404
1996 2,022 1,921 26 278 3,691
1995 1,474 649 -- 101 2,022
</TABLE>
<PAGE>
RCN CORPORATION
SELECTED FINANCIAL DATA
Thousands of Dollars Except Per Share Amounts
For the Years Ended December 31,
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Sales $ 127,297 $104,910 $ 91,997 $ 59,500 $ 49,504
Income (loss) from continuing operations (52,391) (5,989) 2,114 3,653 12,087
Income (loss) per average common share
from continuing operations $ (0.95) $ (0.77) $ 0.04 ($1.74) ($1.50)
Dividends per share - - - - -
Total assets 1,150,992 628,085 649,610 568,586 291,634
Long-term debt, net of current maturities 686,103 131,250 135,250 154,000 181,500
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)
Certain statements contained in this annual report are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 and are thus prospective. Such forward-looking statements include, in
particular, statements made as to plans to develop networks and upgrade
facilities, the market opportunity presented by markets targeted by the Company,
the Company's intention to connect certain wireless video resale telephone and
Internet service customers to its advanced fiber optic networks, the development
of the Company's businesses, the markets for the Company's services and
products, the Company's anticipated capital expenditures, the Company's
anticipated sources of capital and effects of regulatory reform and competitive
and technological developments. No assurance can be given that the future
results covered by the forward-looking statements will be achieved. Such
statements are subject to risks, uncertainties and other factors which could
cause actual results to differ materially from future results expressed or
implied by such forward-looking statements.
The following discussion should be read in conjunction with the Company's
historical Consolidated Financial Statements and Notes thereto:
GENERAL
The Company is developing networks that are capable of providing a full range of
high speed, high capacity telecommunications services, including voice, video
programming and data services including Internet access. The Company intends to
provide these services individually or in bundled service packages primarily to
residential customers in high-density areas and also seeks to serve certain
commercial accounts on or near its networks. In 1997, the Company commenced
providing service through advanced fiber optic network facilities in New York
City and Boston. The Company also has hybrid fiber/coaxial cable television
operations in New York (outside New York City), New Jersey and Pennsylvania
("Hybrid Fiber/Coaxial"), wireless video operations in New York City ("Wireless
Video"), and certain other operations, including long distance telephone
(collectively, "Other Operations"). The Company has historically managed its
business along these lines and the discussion which follows addresses those
lines accordingly.
Financial results related to advanced fiber optic networks and from provision of
Internet services are currently included in the "Advanced Fiber, Wireless Video
and Other Operating" segment data. The Company may present separate segment
information with respect to the advanced fiber optic networks and Internet
business in future periods in connection with the Company's adoption of
Statement of Financial Accounting Standards No. 131 - "Disclosure about Segments
of an Enterprise and Related Information". The Company expects that the
operating and net losses and negative cash flows from its advanced fiber optic
network business will rise in the future as it expands and develops its network
and customer base.
<PAGE>
There can be no assurance that RCN will achieve or sustain profitability or
positive cash flows from operating activities in the future as it develops its
advanced fiber optic network.
The negative operating cash flow from the Company's advanced fiber optic network
business has resulted primarily from expenditures associated with the
development of the Company's operational infrastructure and marketing expenses.
The Company expects it will continue to experience negative operating cash flow
while it continues to invest in its networks and until such time as revenue
growth is sufficient to fund operating expenses. The Company expects to achieve
positive operating margins over time by (i) increasing the number of customers
it serves, (ii) increasing the number of connections per customer by cross
marketing its services and promoting bundled service options and therefore
increasing the revenue per customer, (iii) lowering the costs associated with
new subscriber additions and (iv) reducing the cost of providing services by
capturing economies of scale. The Company expects its operating revenues will
increase in 1998 through internal growth of its current advanced fiber optic
networks; however, the Company also expects negative operating cash flow will
increase for some period of time as the Company initiates network development in
Washington, D.C. and expands its current networks. When the Company makes its
initial investment in a new market, the operating losses typically increase as
the network and sales force are expanded to facilitate growth. The Company's
ability to generate positive cash flow in the future will depend on the extent
of capital expenditures in current and additional markets, the ability of the
joint ventures to generate revenues and cash flow, competition in the Company's
markets and any potential adverse regulatory developments. The Company will be
dependent on various financing sources to fund its growth as well as continued
losses from operations. There can be no assurance that such funding will be
available, or available on terms acceptable to the Company. See - "Liquidity
and Capital Resources."
The terms of the Company's joint ventures require the mutual consent of the
Company and its joint venture partner to distribute or advance funds to the
Company. The Company's debt agreements allow subsidiaries and joint ventures to
incur indebtedness for network buildout costs, which indebtedness may contain
limitations on the subsidiaries' and the joint venture's ability to pay
dividends and distributions to the Company. Although the joint ventures have
not had a significant impact on the Company's cash flows in the periods
presented, cash flows available to the Company in future periods will be
affected by the extent to which operations are conducted through joint ventures.
Due to the degree of control that the Company has in the joint ventures, RCN
accounts for the BECO joint venture on a consolidated basis and Starpower under
the equity method of accounting.
Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation. On September 30, 1997, C-TEC distributed 100% of the outstanding
shares of common stock of its wholly owned subsidiaries, RCN Corporation ("RCN")
and Cable Michigan, Inc. ("Cable Michigan") to holders of record of C-TEC's
Common Stock and C-TEC's Class B Common Stock as of the close of business on
September 19, 1997 (the "Distribution") in accordance with the terms of a
Distribution Agreement dated September 5, 1997 among C-TEC, RCN and Cable
Michigan. RCN consists primarily of C-TEC's high growth, bundled residential
voice, video and Internet access operations in the Boston to Washington, D.C.
corridor, its existing New York, New Jersey and Pennsylvania cable television
operations, a portion of its long distance operations and its international
investment in Megacable, S.A. de C.V. C-TEC, RCN and Cable Michigan have
entered into certain agreements providing for the Distribution, and governing
various ongoing relationships between the three companies, including a
distribution agreement and a tax-sharing agreement. The historical financial
information presented herein reflects periods during which the Company did not
operate as an independent company and accordingly, certain assumptions were made
in preparing such financial information. Such information, therefore, may not
necessarily reflect the results of operations or the financial condition of the
Company which would have resulted had the Company been an independent, public
company during the reporting periods, and are not necessarily indicative of the
Company's future operating results or financial condition.
Certain of the Company's businesses were acquired by C-TEC and transferred to
the Company in connection with the Distribution. On August 30, 1996, a
subsidiary of C-TEC acquired an 80.1% interest in Freedom New York, L.L.C.
("Freedom") and all related rights and liabilities from Kiewit Telecom
<PAGE>
Holdings. Freedom held the wireless cable television business of Liberty Cable
Television, Inc. The Company acquired the remaining minority interest in Freedom
in March 1997. The acquisition was accounted for as a purchase and is reflected
in the Company's consolidated financial statements since September 1996. On May
15, 1995, C-TEC Cable Systems, Inc., a wholly owned subsidiary of C-TEC ("RCN
Cable"), acquired 40% of the outstanding common stock of Twin County Trans
Video, Inc. ("Twin County"). The remaining shares were subject to an escrow
agreement, pending completion of the merger, and were required to be voted under
the direction of the Company. As of May 15, 1995, the Company also assumed
management of Twin County. As a result, the Company had control of Twin County
and accordingly has fully consolidated Twin County in the Company's financial
statements since May 1995, the date of the original acquisition. The remaining
outstanding common stock of Twin County was acquired in September 1995. Goodwill
relating to this acquisition is being amortized over a period of approximately
10 years. In January 1995, RCN International Holdings, Inc. (formerly C-TEC
International, Inc.), a wholly owned subsidiary of C-TEC, purchased a 40% equity
position in Megacable, S.A.de C.V., the second largest cable television provider
in Mexico. The Company accounts for its investment by the equity method of
accounting and is amortizing the original excess cost over the underlying equity
in the net assets on a straight-line basis over 15 years.
Results of Operations
Selected segment data was as follows for the years ended December 31, 1997, 1996
and 1995:
<TABLE>
<CAPTION>
Sales: Year ended December 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C>
Hybrid Fiber/Coaxial $ 92,100 $ 84,096 $66,404
Advanced Fiber, Wireless Video and Other Operating 35,111 20,768 25,528
Corporate 86 46 65
-------- -------- -------
Total $127,297 $104,910 $91,997
======== ======== =======
</TABLE>
Operating Income Before Depreciation and Amortization and Nonrecurring Charge:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------
1997 1996 1995
-------- -------- -------
(dollars in thousands)
<S> <C> <C> <C>
Hybrid Fiber/Coaxial $ 39,767 $ 40,094 $28,458
Advanced Fiber, Wireless Video and Other Operating (39,882) (11,711) (8,416)
Corporate (7,555) (2,580) (3,048)
-------- -------- -------
Total ($7,670) $ 25,803 $16,994
======== ======== =======
</TABLE>
<PAGE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996:
For the year ended December 31, 1997, operating income before depreciation and
amortization and nonrecurring charge was ($7,670) as compared to $25,803 for the
year ended December 31, 1996. Sales increased 21.3% to $127,297 for the year
ended December 31, 1997 from $104,910 for the same period in 1996.
Sales
Sales are primarily comprised of subscription fees for basic, premium and pay
per view cable television services; local telephone service fees consisting
primarily of monthly line charges, local toll and special features; long
distance telephone service fees based on minutes of traffic and tariffed rates
or contracted fees; and Internet access fees billed at contracted rates. For
the year ended December 31, 1997, sales were $127,297, an increase of $22,387
due to higher Hybrid Fiber/Coaxial sales of $8,004 and higher Advanced Fiber,
Wireless Video and Other Operating sales of $14,343. The increase in Hybrid
Fiber/Coaxial sales principally results from higher basic service revenue
resulting from approximately 4,850 additional average monthly subscribers over
1996, the effects of a rate increase in the first quarter of 1997 and cash
incentives related to the launch of certain new channels. Advanced Fiber,
Wireless Video and Other Operating sales increased primarily due to the
acquisition of Freedom in August 1996 (the "Freedom Acquisition"), which
resulted in higher basic and premium video revenue. Additionally, higher voice
revenue of approximately $3,200 resulted from higher advanced fiber optic voice
connections and higher resold voice connections. The increase in Advanced
Fiber, Wireless Video and Other Operating sales also includes increases of
approximately $3,300 related to the long distance business.
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 of providing services, primarily cable
programming and franchise costs, network access fees, video transmission
licensing fees, salaries and benefits, and customer service costs; sales and
marketing costs; and general and administrative expenses. For the year ended
December 31, 1997, costs and expenses, excluding depreciation, amortization, and
nonrecurring charges, were $134,967, an increase of $55,860 or 70.6% as compared
to 1996. The increase is primarily attributable to higher Advanced Fiber,
Wireless Video and Other Operating costs and expenses, excluding depreciation
and amortization, of approximately $42,500, resulting principally from the
Freedom acquisition in August 1996 and expansion of the business in the Boston
and New York City markets. The most significant increases occurred in personnel
and related costs, due to increased headcount primarily in operations, marketing
and customer service to support the expansion of the business, origination and
programming cost associated with an increase in video connections, and
advertising expenses of approximately $9,000 associated with a high visibility
campaign. The long distance business contributed approximately $6,100 of the
remaining increase in Advanced Fiber, Wireless Video and Other Operating costs
and expenses, excluding depreciation and amortization. Hybrid Fiber/Coaxial
costs and expenses, excluding depreciation and amortization, increased
approximately $8,300 primarily due to higher basic programming costs resulting
from higher rates, additional channels and subscriber increases. Additionally,
in connection with the Distribution (Note 1), C-TEC completed a comprehensive
study of its employee benefit plans in 1996. As a result of this study,
effective December 31, 1996, in general, employees of RCN no longer accrued
benefits under the defined benefit pension plan, but became fully vested in
their benefit accrued through that date. C-TEC notified affected participants
in December 1996. In December 1996, C-TEC allocated pension plan assets of
$6,984 to a separate plan for employees who no longer accrue benefits after
December 31, 1996 (the "curtailed plan"). The underlying liabilities were also
allocated. The allocation of assets and liabilities resulted in a
curtailment/settlement gain attributable to Hybrid Fiber/Coaxial cable
operations of approximately $1,500. Such gain did not recur in 1997. The
remaining increase in costs and expenses, excluding depreciation and
amortization, of approximately $5,000 is primarily due to costs associated with
the spin-off of the Company from C-TEC.
Depreciation and Amortization
<PAGE>
Depreciation and amortization is comprised principally of depreciation relating
to the Company's Hybrid Fiber/Coaxial facilities, advanced fiber and wireless
video network and amortization of subscriber lists, building access rights and
goodwill. Depreciation and amortization increased $14,324, or 36.8% to $53,205
for the year ended December 31, 1997 as compared to $38,881 for 1996. The
increase is principally due to the additional depreciation and amortization
resulting from the Freedom acquisition and depreciation related to the Company's
advanced fiber optic networks in New York City and Boston.
In future periods, depreciation and amortization are expected to exceed amounts
recorded in 1997 due to depreciation with respect to the Company's advanced
fiber optic networks in New York City and Boston and due to depreciation and
amortization with respect to the Company's acquisitions in February 1998 of
Erols Internet, Inc. and Ultranet Communications, Inc. (Note 19).
Nonrecurring Charges
Nonrecurring charges of $10,000 represent costs incurred with respect to the
termination of a marketing services agreement held by Freedom.
Interest Income
For the year ended December 31, 1997, interest income was $22,824, a decrease of
$2,778, or 10.9% primarily due to lower average cash balances and lower average
notes receivable with related parties. Average cash balances decreased
principally as a result of the Freedom acquisition in August 1996 (as well as
the acquisition in March 1997 of the remaining 19.9% ownership interest in
Freedom) and capital expenditures, partially offset by the proceeds of the
Company's high yield debt offering in October 1997 (Note 10).
Interest Expense
For the year ended December 31, 1997, interest expense was $25,602, an increase
of $9,556, or 59.6% primarily due to interest expense on the Company's $225,000
of 10% Senior Notes and $601,045 aggregate principal amount at maturity of 11
1/8% Senior Discount Notes placed in October 1997 (Note 10). This was partially
offset by lower interest expense resulting from the required principal payment
of $18,750 on 9.65% Senior Secured Notes in December 1996. Additionally, the
Company paid $922 to Kiewit Telecom in 1996 in connection with the Company's
August 1996 acquisition of Kiewit Telecom's 80.1% interest in Freedom. This
portion of the consideration represents an amount to compensate Kiewit Telecom
for forgone interest on the amount which it had invested in Freedom.
Income Tax
Benefit for income taxes increased $21,828 primarily due to the increase of
$65,020 in loss before taxes. For an analysis of the change in income taxes,
see the reconciliation of the effective income tax rate in Note 11 to the
Consolidated Financial Statements.
Minority Interest
Minority interest in the loss of consolidated entities increased $5,956
primarily as a result of the minority share of the losses of the BECO joint
venture (Note 7), which began operations in June 1997. Additionally, the
minority share of the losses of Freedom from January 1 through March 21, at
which time the Company acquired the remaining 19.9% ownership interest, was
$966.
Equity in loss of Unconsolidated Entities
The Company's equity in the (loss) of unconsolidated entities was ($3,804) in
1997 and ($2,282) in 1996, and is comprised principally of the Company's share
of the operating results of Megacable. In January 1995, the Company purchased a
forty percent equity position in Megacable, a Mexican cable television provider,
for cash of $84,115. The Company is exposed to foreign currency translation
adjustments resulting from translation into U.S. dollars of the financial
statements of Megacable, which through December 1996 utilized the peso as the
local and functional currency. Such adjustments have historically been included
as a separate component of shareholders' equity. Effective January 1, 1997,
since the three year cumulative rate of inflation at December 31, 1996 exceeded
100% , Mexico is being treated for
<PAGE>
accounting purposes under Statement of Financial Accounting Standards No. 52 -
"Foreign Currency Translation" as having a highly inflationary economy. As a
result, the financial statements of Megacable are remeasured as if the
functional currency were the U.S. dollar. The remeasurement of the Mexican peso
into U.S. dollars creates translation adjustments which are included in net
income. The Company is also exposed to foreign currency transaction losses
resulting from transactions of Megacable which are made in currencies different
from its own. The Company's proportionate share of transaction gains (losses)
are included in income as they occur. The Company does not hedge its foreign
currency exchange risk and it is not possible to determine what effect future
currency fluctuations will have on the Company's operating results. Exchange
gains (losses) of ($12), $247, and ($932) in 1997, 1996, and 1995, respectively,
including translation losses in 1997, are included in the respective statements
of operations through the Company's proportionate share of losses of Megacable.
In 1997, Megacable had sales of $30,441, operating income before depreciation
and amortization of $10,504 and net income of $6,653. In 1996, Megacable had
sales of $23,225, operating income before depreciation and amortization of
$10,183 and net income of $10,226. Year end subscriber counts were 211,627 at
December 31, 1997 as compared to 178,664 at December 31, 1996. In 1997 and
1996, the Company's share of the income of Megacable was $2,411 and $4,090,
respectively, which includes the exchange gains (losses) as discussed above.
The Company's investment in Megacable exceeded its underlying equity in the net
assets of Megacable when acquired by approximately $94,000, which
goodwill is being amortized on a straight-line basis over 15 years. In 1997 and
1996, amortization of the Company's excess purchase price over the net assets of
Megacable when acquired was $6,280 in each year.
<PAGE>
Extraordinary Charge
In September 1997, the Company prepaid Senior Secured Notes with the proceeds of
new credit facilities (Note 10). The early extinguishment of the Senior Secured
Notes resulted in an extraordinary charge of $3,210, net of taxes.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
For the year ended December 31, 1996, operating income before depreciation and
amortization was $25,803 as compared to $16,994 for the year ended December 31,
1995. Sales increased 14.0% to $104,910 for 1996 from $91,997 in 1995. The
improvement in operating income before depreciation and amortization of $8,809
was offset by higher depreciation and amortization of $16,545, as discussed
below, resulting in a net loss of ($5,989) for the year ended December 31, 1996
as compared to net income of $2,114 in 1995.
Sales
For 1996, sales were $104,910, an increase of $12,913, or 14.0% due to higher
Hybrid Fiber/Coaxial sales partially offset by lower Advanced Fiber, Wireless
Video and Other Operating sales, principally long distance. Hybrid
Fiber/Coaxial sales increased $17,692, or 26.6%, primarily due to the
acquisition of the Pennsylvania cable system (formerly Twin County Trans Video,
Inc.) in May 1995, which resulted in $13,530 of the increase in Hybrid
Fiber/Coaxial sales in 1996. The Pennsylvania cable system serves approximately
74,000 subscribers in the Greater Lehigh Valley area of Pennsylvania. The 14.0%
increase in sales in 1996 was lower than the increase of 54.6% in 1995,
principally due to the consolidation of the Pennsylvania cable system for seven
months (from acquisition in May 1995). Since the Pennsylvania cable system was
consolidated for seven months in 1995, consolidation for a full year in 1996
reflects only an incremental five months revenue as compared to an incremental
seven months revenue in 1995. Additionally, long distance revenues decreased
approximately 30% from 1995 to 1996, principally as a result of termination of
AT&T Tariff 12 production in 1996, as compared to increases of 77% from 1994 to
1995, which resulted from the resale of AT&T Tariff 12 long distance services
and increases in long distance switched business and 800 services sales in 1995.
The remaining increase in Hybrid Fiber/Coaxial sales is due to higher basic
service revenues resulting from an increase in average subscribers of 4,995 or
5.3% and the full year impact, in 1996, of the 9.6% rate increase in April 1995
and the impact of 5.9% rate increase in February 1996. These increases were
partially offset by lower Advanced Fiber, Wireless Video and Other Operating
sales of $4,760 primarily resulting from the termination in the second quarter
of 1995 of an agreement for the resale of AT&T Tariff 12 long distance services
to another long distance reseller. Included in Advanced Fiber, Wireless Video
and Other Operating sales for 1996 were Wireless Video sales of $3,532, compared
to zero for 1995 reflecting the Freedom Acquisition.
Cost and Expenses, Excluding Depreciation and Amortization
In 1996, costs and expenses, excluding depreciation and amortization, were
$79,107, an increase of $4,104 or 5.5% as compared to 1995. Hybrid
Fiber/Coaxial programming expense increased $3,930 due to license fee increases,
channel additions, and subscriber growth, primarily due to the acquisition of
the Pennsylvania cable system. Additionally, Hybrid Fiber/Coaxial salaries and
benefits expense increased $1,862 primarily due to the acquisition of the
Pennsylvania cable system. Corporate costs and expenses, excluding depreciation
and amortization, decreased $487. This decrease is primarily due to the
corporate allocable share of the gain on the partial curtailment and settlement
of C-TEC's defined benefit pension plan of $992 (See Note 13 to the Consolidated
Financial Statements) partially offset by the Company's allocable portion of
costs associated with the investigation of the feasibility of various
restructuring alternatives to enhance shareholder value. Advanced Fiber,
Wireless Video and Other Operating costs and expenses, excluding depreciation
and amortization, decreased $1,465 primarily due to lower expenses associated
with the 97% reduction in AT&T Tariff 12 long distance revenues partially offset
by an increase of $2,320 representing costs associated with the development of
the Company's advanced fiber optic networks in New York City and Boston and
Wireless Video costs and expenses of $8,303 in 1996 compared to zero in 1995
reflecting the Freedom Acquisition.
<PAGE>
Depreciation and Amortization
For 1996, depreciation and amortization expense was $38,881, an increase of
$16,545 or 74.1% as compared to 1995 primarily due to purchase accounting
effects of the acquisition of the Pennsylvania cable system in May 1995 and the
Freedom acquisition on August 30, 1996. (See Note 4 to the Consolidated
Financial Statements.) In addition, the Company incurred $3,756 in depreciation
related to the Company's advanced fiber optic networks in New York City and
Boston.
Interest Income
For the year ended December 31, 1996, interest income was $25,602, a decrease of
$3,399, or 11.7% due primarily to a reduction in average cash balances in 1996
as compared to 1995 and a decrease in the average yield on invested cash,
partially offset by interest income of $2,222 accrued on a $13,088 note
receivable acquired from Mazon Corporativo S.A. de C.V. in January 1996.
Average cash balances decreased in 1996 primarily due to cash used in the
Freedom acquisition and the purchase of the loan receivable from Mazon
Corporativo S. A. de C.V. Additionally, lower balances on notes receivable-
affiliates contributed to the decrease.
Interest Expense
Interest expense for 1996 was $16,046, a decrease of $471, or 2.9% in 1996 as
compared to 1995. This decrease is due to lower average rates on outstanding
debt and includes approximately $922 paid to Kiewit Telecom, the Company's
controlling shareholder, in connection with the Freedom acquisition. This
portion of the consideration represents an amount to compensate Kiewit Telecom
for forgone interest on the amount invested in Freedom.
Income Taxes
The Company's effective income tax rate was (19.5%) in 1996 and 34.6% in 1995.
For an analysis of the change in income taxes, see the reconciliation of the
effective income tax rate in Note 11 to the Consolidated Financial Statements.
Minority Interest
As a result of the Freedom acquisition, Freedom's financial results are
consolidated with the Company since August 30, 1996, the date of acquisition.
This resulted in minority interest in the loss of Freedom of $1,546 for 1996.
Additionally, the 20% minority interest in the income of HomeLink Limited
Partnership, a Hybrid Fiber/Coaxial subsidiary, was ($206) in 1996 as compared
to ($144) in 1995.
Equity in loss of Unconsolidated Entities
In 1996, Megacable had sales of $23,225, operating income before depreciation
and amortization of $10,183 and net income of $10,226. In 1995, Megacable had
sales of $20,841, operating income before depreciation and amortization of
$8,154 and net income of $5,802. Year end subscriber counts were 178,664 at
December 31, 1996 as compared to 177,317 at December 31, 1995. In 1996 and
1995, the Company's share of the income of Megacable was $4,090 and $2,696,
respectively, which includes foreign currency transaction losses as noted in the
1997 discussion. In 1996 and 1995, amortization of the Company's excess
purchase price over the net assets of Megacable when acquired was $6,280 and
$5,757, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects that it will require a substantial amount of capital to fund
the network development and operations in the Boston to Washington, D.C.
corridor, including funding the development of its advanced fiber optic
networks, upgrading its Hybrid Fiber/Coaxial plant, funding operating losses and
debt service requirements. The Company currently estimates that its capital
requirements for the period from January 1, 1998 through 1999 will be
approximately $785,000, which includes capital expenditures (including
connection costs which will only be incurred as the Company obtains revenue-
generating customer connections) of approximately $300,000 in 1998 and
approximately $485,000 in 1999. These capital expenditures will be used
principally to fund the buildout of the Company's fiber optic network in
<PAGE>
high density areas in the Boston, New York and Washington, D.C. markets and to
upgrade its Hybrid Fiber/Coaxial cable systems. To build out these areas on an
efficient basis, the Company undertakes a subscriber-driven capital expenditure
strategy whereby it (i) closely monitors development of its subscriber base in
order to tailor network development in each target market, and (ii) seeks to
establish a customer base in advance of or concurrently with its network
deployment. For example, the Company offers resale telephone services on an
interim basis to customers located near its advanced fiber optic networks.
Depending upon factors such as subscriber density, proximity to the advanced
fiber optic network and development costs and the degree of success achieved in
its initial markets, the Company will determine whether extending its advanced
fiber optic network to additional high density target markets can be achieved on
an attractive economic basis. In addition to its own capital requirements, the
Company's joint venture partners are 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 through 2000.
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
principal amount of 10% Senior Notes and $601,000 principal amount at maturity
of 11 1/8% Senior Discount Notes, both due in 2007. The proceeds include
$61,045 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 9.8% Senior Discount Notes, due in 2008. The Company expects to
have sufficient liquidity to meet its capital requirements through mid-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, the Company may accelerate the expansion and
extend the reach of its network. Conversely, should the Company be less
successful than anticipated, the operating losses associated with the installed
network may be higher than anticipated. The Company presently intends to judge
the success of its initial rollout in deciding whether to undertake additional
capital expenditures to rollout the network to additional areas. Since the
Company anticipates that, if it is successful, it will continue to extend its
network coverage into additional areas within the Boston-Washington, D.C.
corridor, it expects to continue to experience losses and negative cash flow on
an aggregate basis for an extended period of time.
The Company's current joint venture agreements reduce the amount of expenditures
required by RCN to develop the network due both to access to the joint venture
partners' existing facilities and to the anticipated joint venture partners'
equity contributions. However, the joint venture 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.
Sources of funding for the Company's further financing requirements may include
vendor financing, public offering 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.
RCN Cable and certain of its subsidiaries 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
<PAGE>
by a single credit agreement dated as of July 1, 1997 (the "Credit Agreement").
As of December 31,1997, $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 December 31, 1997, $3,000 principal was outstanding
under the Revolving Credit Facility. Revolving loans may be repaid and
reborrowed from time to time.
The Company has indebtedness that is substantial in relation to its
shareholders' equity and cash flow. At December 31, 1997, after giving effect to
the 1998 Notes Offering, the Company had an aggregate of approximately
$1,036,000 of indebtedness outstanding, and the ability to borrow up to an
additional $22,000 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 for
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
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.
For the year ended December 31, 1997, the Company's net cash provided by
operating activities was $1,661, comprised primarily of a net loss of ($52,391)
adjusted by non-cash depreciation and amortization of $53,205, other non-cash
items totaling ($611), working capital changes of $377 and changes in other
deferred expenses of $1,081. Net cash used in investing activities of $475,860
consisted primarily of purchases of short-term investments of $445,137,
additions to property, plant and equipment of $79,042 and acquisitions of
$30,490 (primarily acquisition of the minority interest of Freedom) partially
offset by sales and maturities of short-term investments of $76,923. Net cash
provided by financing activities of $635,266 consisted primarily of issuance of
long-term debt of $688,000, change in affiliate notes of $97,624 and transfers
from C-TEC of $89,324 partially offset by redemption of long-term debt of
$141,250, transfers to C-TEC of $23,474, payments made for debt financing costs
of $19,743 and an increase related to cash restricted for debt service of
$61,250.
For the year ended December 31, 1996, the Company's net cash provided by
operating activities was $23,831 comprised primarily of a net loss of $5,989
adjusted by non-cash depreciation and amortization of $38,881 and other non-cash
items totaling ($7,184). Net cash used in investing activities of $9,377
consisted primarily of additions to property, plant and equipment of $40,369,
the purchase of a loan receivable of $13,088 and acquisitions of $30,090
(primarily the Freedom acquisition), partially offset by net sales and
maturities of short-term investments of $73,995. Net cash provided by financing
activities of $9,391 included the issuance of long-term debt of $19,000 and
change in affiliate notes of $32,802 partially offset by the redemption of long-
term debt of $44,750.
Impact of the Year 2000 Issue
The Company has certain financial, administrative and operational systems which
are subject to Year 2000 exposures. The Company has performed a study to
identify those specific systems which require remediation and developed a plan
to correct such situations in a timely fashion. The Company's plan is proceeding
on target. The plan includes ensuring that those systems for which the Company
is dependent on external vendors, such as certain billing systems, will be Year
2000 compliant by the end of 1999 based on the status of external vendors'
remediation efforts. For those internal systems that require corrective action,
the Company has contracted with its information systems services provider to
rewrite the relevant
<PAGE>
programming code. Finally, the Company is well along on a conversion of its
suite of financial systems to a state-of-the-art Oracle system. Such system is
expected to ensure Year 2000 compliance in financial applications, enable the
Company to process and report its financial transactions more efficiently and
provide a greater level of detailed information to facilitate management's
analysis which is critical to its business decisions.
The Company is employing a team approach across its MIS, financial and
operational groups in addressing the above issues, as well as utilizing the
assistance of external consultants in the case of the Oracle implementation.
Such team approach facilitates a consistent progress along plans without
disruption of other areas of the business.
There is no assurance that the Company's plans will continue to progress as
intended. The Company estimates that its cost of Year 2000 remediation will not
be material.
<PAGE>
<TABLE>
<CAPTION>
RCN Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Thousands of Dollars Except Per Share Amounts) For the Years Ended December 31,
1997 1996 1995
-------------------------------------------
<S> <C> <C> <C>
Sales $127,297 $104,910 $91,997
Costs and expenses, excluding depreciation and amortization 134,967 79,107 75,003
Nonrecurring charges 10,000 - -
Depreciation and amortization 53,205 38,881 22,336
-------------------------------------------
Operating (loss) (70,875) (13,078) (5,342)
Interest income 22,824 25,602 29,001
Interest expense (25,602) (16,046) (16,517)
Other income (expense), net 131 (546) (304)
-------------------------------------------
(Loss) income before income taxes (73,522) (4,068) 6,838
(Benefit) provision for income taxes (20,849) 979 1,119
-------------------------------------------
(Loss) income before minority interest and equity in
unconsolidated entities (52,673) (5,047) 5,719
Minority interest in loss (income) of consolidated entities 7,296 1,340 (144)
Equity in (loss) of unconsolidated entities (3,804) (2,282) (3,461)
-------------------------------------------
(Loss) income before extraordinary item (49,181) (5,989) 2,114
Extraordinary charge - debt prepayment penalty, net of tax of $1,728 (3,210) - -
-------------------------------------------
Net (loss) income ($52,391) ($5,989) $2,114
===========================================
Basic earnings per average common share:
Income (loss) before extraordinary charge ($0.89) ($0.11) $0.04
Extraordinary charge - debt prepayment penalty ($0.06) - -
Net income (loss) to shareholders ($0.95) ($0.11) $0.04
Weighted average shares outstanding 54,965,716 54,918,394 54,890,334
Diluted earnings per average common share:
Income (loss) before extraordinary charge ($0.89) ($0.11) $0.04
Extraordinary charge - debt prepayment penalty ($0.06) - -
Net income (loss) to shareholders ($0.95) ($0.11) $0.04
Weighted average shares and common stock equivalents outstanding 54,965,716 54,918,394 54,890,334
See accompanying notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
RCN Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars) December 31,
1997 1996
---------------------
<S> <C> <C>
ASSETS
Current assets
Cash and temporary cash investments $222,910 $61,843
Short-term investments 415,603 46,831
Accounts receivable from related parties 9,829 12,614
Accounts receivable, net of reserve for doubtful accounts
of $2,134 in 1997 and $861 in 1996 17,815 10,413
Unbilled revenues 1,695 844
Material and supply inventory, at average cost 2,745 1,140
Prepayments and other 5,314 4,556
Deferred income taxes 4,821 4,371
Investments restricted for debt service 22,500 -
---------------------
Total current assets 703,232 142,612
---------------------
Notes receivable - affiliates - 155,481
Property, plant and equipment, net of accumulated depreciation
of $107,419 in 1997 and $84,529 in 1996 200,340 135,828
Investments restricted for debt service 39,411 -
Investments 70,424 76,547
Intangible assets, net 96,547 93,471
Deferred charges and other assets 41,038 24,146
---------------------
Total assets $1,150,992 $628,085
=====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable to related parties $3,748 $4,880
Accounts payable 24,835 13,642
Advance billings and customer deposits 7,318 6,859
Accrued taxes 488 1,950
Accrued interest 5,549 5,041
Accrued contract settlements 3,126 3,565
Accrued cable programming expense 3,498 3,188
Accrued expenses 21,143 18,167
---------------------
Total current liabilities 69,705 57,292
---------------------
Long-term debt 686,103 131,250
Notes payable - affiliates - 11,854
Deferred income taxes 19,612 28,245
Other deferred credits 2,596 3,290
Minority interest 16,392 5,389
Commitments and contingencies
Preferred stock - -
Common shareholders' equity 356,584 390,765
---------------------
Total liabilities and shareholders' equity $1,150,992 $628,085
=====================
See accompanying notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
For the Years Ended December 31,
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss) ($52,391) ($5,989) $2,114
Gain on pension curtailment/settlement - (3,437) -
Accretion of discounted debt 8,103 - -
Gain on sale of partnership interest (661) - -
Extraordinary item - debt prepayment penalty 3,210 - -
Depreciation and amortization 53,205 38,881 22,336
Deferred income taxes and investment tax credits, net (10,503) (6,477) 6,696
Provision for losses on accounts receivable 2,732 1,788 614
Equity in loss of unconsolidated entities 3,804 2,282 3,461
Minority interest (7,296) (1,340) 144
Net change in certain assets and liabilities, net of business acquisitions:
Accounts receivable and unbilled revenues (14,979) (3,780) (5,550)
Material and supply inventory (1,605) (814) 777
Accounts payable 11,193 2,954 3,983
Accrued expenses 3,353 4,283 2,783
Accounts receivable from related parties 3,180 1,572 11,860
Accounts payable to related parties (1,132) (5,448) (419)
Other, net 367 597 529
Other 1,081 (1,241) (769)
-----------------------------------------
Net cash provided by operating activities 1,661 23,831 48,559
-----------------------------------------
Cash flows from investing activities:
Additions to property, plant and equipment (79,042) (38,548) (29,854)
Purchase of short-term investments (445,137) (75,091) (238,257)
Sales and maturities of short-term investments 76,923 149,086 245,112
Acquisitions, net of cash acquired (30,490) (30,090) (121,147)
Purchase of loan receivable - (13,088) -
Proceeds from sale of partnership interest 1,900 - -
Other (14) (1,646) (2,057)
-----------------------------------------
Net cash used in investing activities (475,860) (9,377) (146,203)
-----------------------------------------
Cash flows from financing activities
Redemption of long-term debt (141,250) (44,750) (28,741)
Issuance of long-term debt 688,000 19,000 19,300
Change in affiliate notes, net 97,624 32,802 (6,130)
Extraordinary item - debt prepayment penalty (3,210) - -
Payments made for debt financing costs (19,743) - -
Cash contribution from joint venture partner 9,016 - -
(Increase) related to investments restricted for debt service (61,250) - -
Proceeds from issuance of stock 230 - -
Transfers from C-TEC 89,323 78,550 132,707
Transfers (to) C-TEC (23,474) (76,211) (148,339)
-----------------------------------------
Net cash provided by (used in) financing activities 635,266 9,391 (31,203)
-----------------------------------------
Net increase (decrease) in cash and temporary cash investments 161,067 23,845 (128,847)
Cash and temporary cash investments at beginning of year 61,843 37,998 166,845
-----------------------------------------
Cash and temporary cash investments at end of year $222,910 $61,843 $37,998
=========================================
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Income taxes $1,090 $549 $497
========================================
Interest (net of amounts capitalized) $16,536 $16,046 $16,404
========================================
See accompanying notes to Consolidated Financial Statements
</TABLE>
<PAGE>
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
Supplemental Schedule of Non-Cash Investing and Financing Activities
In March 1997, the Company acquired the portion of Freedom which it
did not already own. The transaction was accounted for as a purchase.
A summary of the transaction is as follows:
Cash paid $40,000
Non-capitalizable costs (10,000)
Reduction of minority interest (3,812)
---------
Fair value of assets acquired $26,188
=========
In 1996, C-TEC acquired an 80.1% interest in Freedom New York, L.L.C.
The acquisition was accounted for as a purchase.
A summary of the acquisition is as follows:
Cash paid $28,906
Liabilities assumed 7,621
Deferred tax asset recognized (167)
Minority interest recognized 6,188
---------
Fair value of assets acquired $42,548
=========
In 1995, C-TEC acquired all the outstanding Common Stock of Twin County
Trans Video, Inc. and a related covenant not to compete.
The consideration for the acquisition was as follows:
Cash paid (including $1,000 deposit in 1994) $37,313
Issuance of 5% Promissory Note 4,000
Capital contribution by stockholder 39,493
Liabilities assumed 16,364
Deferred tax liability incurred 33,797
---------
Fair value of assets acquired $130,967
=========
In 1996, the $4,000 promissory note was canceled and the Company paid cash
of $500 in settlement of certain purchase price adjustments.
Certain intercompany accounts receivable and payable and intercompany note
balances were transferred to Shareholders' Net Investment in connection
with the Distribution.
BECO's contribution of the IRU to the RCN-BECOCOM joint venture (Note 7(a))
is reflected as "Advanced Fiber Plant" at its fair value.
See accompanying notes to Consolidated Financial Statements
<PAGE>
<TABLE>
<CAPTION>
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 1997, 1996 and 1995
(Thousands of Dollars)
Common Additional Shareholder's Cumulative Total
Shares Issued Common Paid Net Translation Shareholders'
and Outstanding Stock in Capital Deficit Investment Adjustment Equity
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 1,400 $ 1 $ - $ - $372,846 $ - $372,847
Net income 2,114 2,114
Transfers from C-TEC 21,714 21,714
Cumulative translation adjustment (2,606) (2,606)
---------------------------------------------------------------------------------------------
Balance, December 31, 1995 1,400 1 - - 396,674 (2,606) 394,069
Net loss (5,989) (5,989)
Transfers from C-TEC 3,134 3,134
Cumulative translation adjustments (449) (449)
---------------------------------------------------------------------------------------------
Balance, December 31, 1996 1,400 1 - - 393,819 (3,055) 390,765
Net loss from 1/1/97 through 9/30/97 (35,275) (35,275)
Net loss from 10/1/97 through 12/31/97 (17,116) (17,116)
Transfers from C-TEC 17,980 17,980
Common stock issued in connection
with the distribution 54,967,952 54,968 321,556 (376,524) -
Stock plan transactions 20,518 20 210 230
---------------------------------------------------------------------------------------------
Balance, December 31, 1997 54,989,870 $54,989 $321,766 ($17,116) $ - ($3,055) $356,584
=============================================================================================
See accompanying notes to Consolidated Financial Statements
</TABLE>
<PAGE>
RCN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(THOUSANDS OF DOLLARS EXCEPT PER SHARE DATA)
1. BACKGROUND AND BASIS OF PRESENTATION
Prior to September 30, 1997, RCN Corporation (the "Company" or "RCN") was
operated as part of C-TEC Corporation ("C-TEC"). On September 30, 1997, C-TEC
distributed 100 percent of the outstanding shares of common stock of its wholly
owned subsidiaries, RCN Corporation ("RCN") and Cable Michigan, Inc. ("Cable
Michigan") to holders of record of C-TEC's Common Stock and C-TEC's Class B
Common Stock as of the close of business on September 19, 1997 (the
"Distribution") in accordance with the terms of a Distribution Agreement dated
September 5, 1997 among C-TEC, RCN and Cable Michigan. RCN consists primarily of
C-TEC's 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"). Cable Michigan, Inc. consists of C-TEC's Michigan cable
operations, including its 62% ownership in Mercom, Inc. In connection with the
Distribution, C-TEC changed its name to Commonwealth Telephone Enterprises, Inc.
("CTE").
The consolidated financial statements have been prepared using the historical
basis of assets and liabilities and historical results of operations of all
wholly and majority owned subsidiaries. However, 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, financial condition or cash flows
of the Company in the future or what they would have been had the Company been
an independent, public company during the reporting periods. All material
intercompany transactions and balances have been eliminated. Investments
accounted for by the equity method include a 40% interest in Megacable, a
Mexican cable television system operator. Joint ventures which the Company
controls and in which the minority investors do not possess significant veto
rights are consolidated. Other joint ventures are accounted for by the equity
method.
C-TEC's corporate services group has historically provided substantial support
services such as finance, cash management, legal, human resources, insurance and
risk management and its financial statements are included in the consolidated
financial statements of the Company. Prior to the Distribution, the corporate
office allocated the cost for these services pro rata among the business units
supported primarily based on assets; contribution to consolidated earnings
before interest, depreciation, amortization, and income taxes; and number of
employees. In the opinion of management, the method of allocating these costs is
reasonable; however, the costs of these services remaining with the Company
after allocation to C-TEC's other business units are not necessarily indicative
of the costs that would have been incurred by the Company on a stand-alone
basis. Also included in the Company's consolidated financial statements are the
financial statements of the corporate financial services company which invests
excess cash of, and advances funds to the Company and prior to the Distribution,
C-TEC. The financial services company charges interest expense on outstanding
advances and pays interest income on excess cash invested for affiliates.
CTE, RCN and Cable Michigan have entered into certain agreements providing for
the Distribution, and governing various ongoing relationships, including the
provision of support services, between the three companies, including a
distribution agreement and a tax-sharing agreement.
2. SEGMENT INFORMATION
The Company is developing advanced fiber optic networks to provide a wide range
of telecommunications services including local and long distance telephone,
video programming and data services (including high speed Internet access),
primarily to residential customers in selected high density markets in the
Boston to
<PAGE>
Washington, D.C. corridor. The Company also seeks to serve certain commercial
accounts on or near its networks. RCN's initial advanced fiber optic networks
have been established in New York City and, through a joint venture with the
Boston Edison Company ("BECO"), in Boston and surrounding communities. RCN has
also entered into a joint venture named Starpower Communications, LLC
("Starpower") with Pepco Communications, LLC ("Pepco Communications"), an
indirect wholly owned subsidiary of Potomac Electric Power Company ("PEPCO"), to
develop an advanced fiber network in the Washington, D.C. area. In February
1998, RCN acquired Boston's and Washington, D.C.'s largest Internet service
providers ("ISP"), Ultranet Communications, Inc. ("Ultranet") and Erols
Internet, Inc. ("Erols"), respectively. The Company also has hybrid
fiber/coaxial operations in New York (outside New York City), New Jersey and
Pennsylvania, wireless video operations in New York City and certain other
operations, including long distance telephone.
<TABLE>
<CAPTION>
For the Year Ended December 31,
1997 1996 1995
------------ --------- ---------
<S> <C> <C> <C>
Hybrid Fiber/Coaxial
- --------------------
Sales $ 92,100 $ 84,096 $ 66,404
Operating income before depreciation
and amortization 39,767 40,094 28,458
Depreciation and amortization 33,713 33,131 20,723
Operating income 6,054 6,963 7,735
Additions of property, plant and equipment 19,258 14,010 19,226
Identifiable assets 159,763 335,285 359,401
Advanced Fiber, Wireless Video and
- ----------------------------------
Other Operating
- -----------------
Sales $ 35,111 $ 20,768 $ 25,528
Operating loss before depreciation
and amortization (39,882) (11,711) (8,416)
Depreciation and amortization 18,480 4,970 904
Operating loss (58,362) (16,681) (9,320)
Additions of property, plant and equipment 56,454 23,714 6,453
Identifiable assets 166,478 87,419 14,491
Corporate
- ---------
Sales $ 86 $ 46 $ 65
Operating loss before depreciation
and amortization and nonrecurring charge (7,555) (2,580) (3,048)
Nonrecurring charge 10,000 - -
Depreciation and amortization 1,012 780 709
Operating loss (18,567) (3,360) (3,757)
Additions of property, plant and equipment 3,330 824 4,175
Identifiable assets 824,751 205,381 275,718
Consolidated
- ------------
Sales $ 127,297 $104,910 $ 91,997
Operating loss before depreciation
and amortization and nonrecurring charge (7,670) 25,803 16,994
Nonrecurring charge 10,000 - -
Depreciation and amortization 53,205 38,881 22,336
Operating loss (70,875) (13,078) (5,342)
Additions of property, plant and equipment 79,042 38,548 29,854
Identifiable assets 1,150,992 628,085 649,610
</TABLE>
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of 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 Temporary Cash Investments - For purposes of reporting cash flows, the
- -----------------------------------
Company considers all highly liquid investments purchased with an original
maturity of three months or less to be temporary cash investments. Temporary
cash investments are stated at cost which approximates market.
Short Term Investments and Investments Restricted for Debt Service - Management
- ------------------------------------------------------------------
determines the appropriate classification of its investments in debt and equity
securities at the time of purchase and reevaluates such determination at each
balance sheet date in accordance with Statement of Financial Accounting
Standards No. 115 - "Accounting for Certain Investments in Debt and Equity
Securities." At December 31, 1997 and 1996, marketable debt and equity
securities have been categorized as available for sale. The Company states its
short term investments at cost, which approximates market. Investments
restricted for debt service have been categorized as held to maturity.
Property, Plant and Equipment and Depreciation - Property, plant and equipment
- ----------------------------------------------
reflects the original cost of acquisition or construction, including payroll and
related costs such as taxes, pensions and other fringe benefits, and certain
general administrative costs.
Depreciation is provided on the straight-line method based on the useful lives
of the various classes of depreciable property. The average estimated lives of
depreciable property, plant and equipment are:
Lives
-----
Hybrid fiber/coaxial plant 5-22 years
Advanced fiber plant 10-15 years
Wireless & other plant 5 years
Buildings and leasehold improvements 5-45 years
Furniture, fixtures and vehicles 3-10 years
Other 3 years
Repairs of all property, plant and equipment and minor replacements and renewals
are charged to expense as incurred. Major replacements and betterments are
capitalized. Gain or loss is recognized on major retirements and dispositions.
Intangible Assets - Intangible assets are amortized on a straight-line basis
- -----------------
over the expected period of benefit ranging from 2 to 15 years.
Accounting for Impairments - The Company follows the provisions of Statement of
- --------------------------
Financial Accounting Standards No. 121 - "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed of " ("SFAS 121"). SFAS
121 requires that long-lived assets and certain identifiable intangibles to be
held and used by an entity be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for recoverability, the Company estimates
the future cash flows expected to result from the use of the asset and its
eventual disposition. If the sum of the expected net future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
the asset, an impairment loss is recognized. Measurement of an impairment loss
for long-lived assets and identifiable intangibles expected to be held and used
is based on the fair value of the asset.
<PAGE>
No impairment losses have been recognized by the Company pursuant to SFAS 121.
Revenue Recognition - Local telephone service revenue is recorded as earned
- -------------------
based on tariffed rates. Long distance telephone service revenue is recorded
based on minutes of traffic processed and tariffed rates or contracted fees.
Revenues from cable programming services are recorded in the month the service
is provided. Internet access service revenues are recorded based on contracted
fees.
Advertising Expense - Advertising costs are expensed as incurred. Advertising
- -------------------
expense charged to operations was $12,203, $1,441 and $862 in 1997, 1996 and
1995, respectively.
Stock Based Compensation - The Company applies Accounting Principles Board
- ------------------------
Opinion No. 25 - "Accounting for Stock Issued to Employees" ("APB 25") in
accounting for its stock plans. The Company has adopted the disclosure - only
provisions of Statement of Financial Accounting Standards No. 123 - "Accounting
for Stock-Based Compensation" ("SFAS 123").
Earnings (loss) per share - The Company has adopted Statement of Financial
- -------------------------
Accounting Standards No. 128 - Earnings Per Share ("SFAS 128"). Basic earnings
(loss) per share is computed based on net income (loss) divided by the weighted
average number of shares of common stock outstanding during the period.
Diluted earnings (loss) per share is computed based on net income (loss) 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 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 1997 and have a dilutive effect if the Company had income from
continuing operations is 517,506.
For periods prior to October 1, 1997, during which the Company was a wholly
owned subsidiary of C-TEC, earnings (loss) per share was calculated by dividing
net income (loss) 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>
Years Ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Income (loss) before extraordinary charge $ (49,181) $ (5,989) $ 2,114
=========== =========== ===========
Basic earnings per average common share:
Average shares outstanding 54,965,716 54,918,394 54,890,334
(Loss) income per average common share $ (0.89) $ (0.11) $ 0.04
Diluted earnings per average common share:
Average shares outstanding 54,965,716 54,918,394 54,890,334
Dilutive shares resulting from stock options - - -
----------- ----------- -----------
54,965,716 54,918,394 54,890,334
=========== =========== ===========
(Loss) income per average common share $ (0.89) $ (0.11) $ 0.04
</TABLE>
Income Taxes - The Company and its subsidiaries report income for federal tax
- ------------
purposes on a consolidated basis. Prior to the Distribution, the Company and its
subsidiaries were included in the consolidated federal income tax return of C-
TEC. Income tax expense is allocated to subsidiaries on a separate return basis
except that the Company's subsidiaries receive benefit for the utilization of
net operating losses and
<PAGE>
investment tax credits included in the consolidated return even if such losses
and credits could not have been used on a separate return basis. The Company
accounts for income taxes using Statement of Financial Accounting Standards No.
109 - "Accounting for Income Taxes." The statement requires the use of an asset
and liability approach for financial reporting purposes. The asset and liability
approach requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between financial
reporting basis and tax basis of assets and liabilities. If it is more likely
than not that some portion or all of a deferred tax asset will not be realized,
a valuation allowance is recognized.
Investment tax credits ("ITC") for the Company have been deferred in prior years
and are being amortized over the average lives of the applicable property.
Foreign Currency Translation - The Company has a 40% interest in Megacable. For
- ----------------------------
purposes of determining its equity in the earnings of Megacable, the Company
translates the revenues and expenses of Megacable into U.S. dollars at the
average exchange rates that prevailed during the period. Assets and liabilities
are translated into U.S. dollars at the rates in effect at the end of the fiscal
period. Prior to 1997, the Company's share of the gains or losses that result
from this process are shown in the cumulative translation adjustment account in
the common shareholders' equity section of the balance sheet. Effective January
1, 1997, since the three-year cumulative rate of inflation at December 31, 1996
exceeded 100%, Mexico is treated for accounting purposes as having a highly
inflationary economy. As a result, the financial statements of Megacable are
remeasured as if the functional currency were the U.S. dollar. The
remeasurement of the Mexican peso into U.S. dollars creates translation
adjustments which are included in net income. The Company's proportionate share
of gains and losses resulting from transactions of Megacable, which are made in
currencies different from its own, are included in income as they occur.
4. BUSINESS COMBINATIONS
The following business combinations were transacted by wholly owned subsidiaries
of C-TEC. The acquired businesses were transferred to the Company in connection
with the Distribution.
On August 30, 1996, FNY Holding Company, Inc., formerly a wholly owned
subsidiary of C-TEC ("FNY") acquired from Kiewit Telecom Holdings, C-TEC's
controlling shareholder at the time, an 80.1% interest in Freedom New York, LLC
and all related rights and liabilities ("Freedom") for cash consideration of
approximately $29,000. In addition, FNY assumed liabilities of approximately
$7,600. (In March 1996, Freedom had acquired the wireless cable television
business of Liberty Cable Television). The acquisition was accounted for as a
purchase, and accordingly, Freedom is included in the Company's consolidated
financial statements since September 1996. The full fair value of assets
acquired and liabilities assumed has been reflected in the Company's financial
statements with minority interest reflecting the separate 19.9% ownership.
FNY allocated the purchase price paid on the basis of the fair value of
property, plant and equipment and identifiable intangible assets acquired and
liabilities assumed. There was no excess cost over fair value of net assets
acquired.
Contingent consideration of $15,000 was payable in cash and was to be based upon
the number of net eligible subscribers, as defined in the Acquisition Agreement,
in excess of 16,563 delivered to the Company. The contingent consideration is
not included in the acquisition cost total above but was to have been recorded
when and if the future delivery of subscribers occurred. In addition, FNY paid
$922 to Kiewit Telecom Holdings which represents compensation for foregone
interest on the amount invested by Kiewit Telecom Holdings in Freedom. This
amount has been charged to operations.
On March 21, 1997, the Company paid $15,000 in full satisfaction of contingent
consideration payable for the original acquisition of Freedom. Additionally,
pursuant to the terms of the Freedom Operating Agreement, the assets of RCN
Telecom Services of New York, Inc., a wholly-owned subsidiary of RCN, were
contributed to Freedom, in which the Company had an 80.1% ownership interest
prior to such
<PAGE>
contribution. Subsequent to this contribution, the Company paid $15,000 to
acquire the minority ownership of Freedom. These amounts were primarily
allocated to excess cost over fair value of net assets acquired and are being
amortized over a period of approximately six years. The Company also paid
$10,000 to terminate a marketing services agreement between Freedom and an
entity controlled by Freedom's former minority owners. The Company charged this
amount to operations for the quarter ended March 31, 1997.
On May 15, 1995, C-TEC Cable Systems, Inc., ("RCN Cable") formerly a wholly
owned subsidiary of C-TEC, acquired 40% of the outstanding common stock of Twin
County Trans Video, Inc. ("Twin County") in exchange for cash of approximately
$26,300, including a $1,000 deposit made in 1994, and a $4,000, 5% promissory
note of RCN Cable. In addition, RCN Cable paid $11,000 in consideration of a
noncompete agreement and assumed liabilities of approximately $16,400. The
remaining shares were subject to an escrow agreement, pending completion of the
merger, and were required to be voted under the direction of RCN Cable. As of
May 15, 1995, RCN Cable also assumed management of Twin County. As a result, RCN
Cable had control of Twin County and accordingly Twin County is consolidated in
the Company's financial statements since May 1995, the date of the original
acquisition. The remaining outstanding common stock of Twin County was acquired
in September 1995 in exchange for $52,000 stated value redeemable convertible
preferred stock of C-TEC. The preferred stock has a stated dividend rate of 5%,
beginning January 1, 1996. The fair value of the preferred stock, as determined
by an independent appraiser was $39,500 which was recorded as additional paid-in
capital to the Company. In 1996, the $4,000 promissory note was canceled and RCN
Cable paid cash of $500 in settlement of certain purchase price adjustments.
RCN Cable has allocated the purchase price paid for Twin County on the basis of
the fair value of property, plant and equipment and identifiable intangible
assets acquired and liabilities assumed. The excess of the consideration for
the acquisition over the fair value of the net assets acquired of approximately
$16,700 has been allocated to goodwill and is being amortized over a period of
approximately 10 years.
In January 1995, RCN International Holdings, Inc. (formerly C-TEC International,
Inc.), formerly a wholly owned subsidiary of C-TEC, purchased a 40% equity
position in Megacable. The aggregate consideration for the purchase was cash of
$84,115. The Company accounts for its investment by the equity method of
accounting. The original excess cost over the underlying equity in the net
assets acquired is approximately $94,000, which is being amortized on a
straight-line basis over 15 years.
In January 1995, RCN Cable purchased the assets of Higgins Lake Cable, Inc. for
cash of approximately $4,750.
In June 1995, C-TEC invested approximately $2,220 for a one-third interest in a
partnership which intends to provide alternative access telephone service to
commercial subscribers. C-TEC transferred this investment to RCN Cable in 1996
at net book value of $1,977. The Company disposed of its investment in 1997 and
realized a gain of $661.
In November 1995, the Company purchased the assets used in the provision of
residential telephone services in New York by RealCom Office Communications,
Inc. for cash of approximately $1,050.
<PAGE>
The following unaudited pro forma summary presents information as if the
acquisitions of Freedom and Twin County had occurred at the beginning of 1996.
The pro forma information is provided for information purposes only. It is based
on historical information and does not necessarily reflect the actual results
that would have occurred nor is it necessarily indicative of future results of
operations of the consolidated entities.
<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996
(Unaudited)
<S> <C> <C>
Sales $127,297 $110,116
(Loss) from continuing operations before extraordinary items $(72,245) $(20,189)
Net (loss) $(53,831) $(16,807)
Pro Forma Earnings Per Share:
(Loss) from continuing operations before extraordinary items $ (1.31) $ (.37)
Net (loss) $ (.98) $ (.31)
</TABLE>
5. SHORT-TERM INVESTMENTS
Short-term investments, stated at cost, include the following at December 31,
1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Federal Agency notes $110,966 $ -
Commercial Paper 43,859 8,823
Corporate debt securities 222,785 38,008
Certificates of deposit 37,993 -
-------- --------
Total $415,603 $ 46,831
======== ========
</TABLE>
At December 31, 1997, short term investments with an amortized cost of $329,714
have contractual maturities of one to three years. All remaining short term
investments have contractual maturities under one year.
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at December 31,
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Hybrid fiber/coaxial plant $ 157,652 $148,172
Advanced fiber plant 76,572 29,226
Wireless & other plant 4,771 4,245
Buildings, leasehold improvements and land 16,607 10,989
Furniture, fixtures and vehicles 23,399 18,119
Construction in process 28,195 9,013
Other 563 593
--------- --------
Total property, plant and equipment 307,759 220,357
Less accumulated depreciation (107,419) (84,529)
--------- --------
Property, plant and equipment, net $ 200,340 $135,828
========= ========
</TABLE>
Depreciation expense was $24,257, $19,372 and $13,236 for the years ended
December 31, 1997, 1996 and 1995, respectively.
<PAGE>
7. INVESTMENTS AND JOINT VENTURES
Investments at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- -------
<S> <C> <C>
Megacable $70,363 $74,232
Partnership - 2,315
Other 61 -
------- -------
Total Investments $70,424 $76,547
======= =======
</TABLE>
Investments carried on the equity method consist of the following at
December 31:
<TABLE>
<CAPTION>
Percentage Owned
1997 1996
------- -------
<S> <C> <C>
Megacable 40.00% 40.00%
Partnership Interest - 33.33%
Starpower Communications, LLC 50.00% -
</TABLE>
a. In September 1996, RCN and Boston Edison Company ("BECO"), through wholly
owned subsidiaries, entered into a letter of intent to form a joint venture to
utilize 126 fiber miles of BECO's fiber optic network to deliver RCN's
comprehensive communications package in Greater Boston. The venture, in the form
of an unregulated entity with a term expiring in the year 2060, was formed
pursuant to a joint venture agreement dated December 23, 1996 (the "Boston Joint
Venture Agreement") providing for the organization and operation of RCN-BECOCOM,
LLC ("RCN-BECOCOM"). RCN-BECOCOM was organized to own and operate an advanced
fiber optic telecommunications network and to provide, in the market in and
around Boston, Massachusetts, voice, video and data services, as well as the
communications support component of energy related customer services offered by
BECO. RCN owns 51% of the equity interest in RCN-BECOCOM and BECO, owns the
remaining 49% interest. Future capital contributions are required to be made on
a 51% and 49% basis for RCN and BECO, respectively.
The closing of the transactions contemplated by the Boston Joint Venture
Agreement occurred on June 17, 1997. RCN will manage the business of RCN-BECOCOM
pursuant to the terms of the Management Agreement and, in consideration
therefor, will receive reimbursement for its reasonable costs, and a performance
- -based fee (based on factors including the number of subscribers and operating
cash flow) to be determined by agreement of RCN and RCN-BECOCOM. The initial
term of the agreement expires on December 31, 2001. The agreement provides for
automatic successive three-year renewal periods, unless notice is given ninety
days before the end of the period. As a result of its ownership, management and
control, this joint venture with BECO is consolidated in RCN's financial
statements.
Pursuant to an Indefeasible Right of Use Agreement ("IRU Agreement") , BECO
will, for certain agreed upon fees, (i) provide construction services to build
out the Network, (ii) make available to RCN-BECOCOM (a) all of the available
capacity of BECO's existing fiber backbone, and (b) the ability to use BECO's
real estate, poles, easements and other interests for the construction and
operation of the Network and (iii) maintain the Network. BECO's construction
obligations expire on June 17, 2007 and the term of the IRU Agreement expires on
December 31, 2060. One year before each respective expiration date, BECO agrees
to commence good-faith negotiations to extend construction obligations beyond
June 17, 2007 and to allow continued use of BECO's facilities beyond December
31, 2060. The fair value of the IRU transferred by BECO to the joint venture is
reflected as "Advanced Fiber Plant" in property, plant and equipment.
<PAGE>
BECO will have the right at the time of the Distribution and every two years
thereafter to convert its ownership interest in RCN-BECOCOM into the Common
Stock of RCN pursuant to specific terms and conditions. If BECO exercises its
conversion rights, BECO will remain obligated to make 49% of all cash
contributions by the parties and any cash contributions made after conversion
will result in it owning a portion of RCN-BECOCOM based on the value of RCN-
BECOCOM at the time of the contribution. BECO may exercise its conversion rights
in whole or in part from time to time. In January 1998, BECO notified RCN that
it has elected to exercise its option to the full extent permitted by the
Exchange Agreement with respect to 1997. RCN and BECO are presently in
discussions with respect to the calculation of the agreed upon value for the
exercise of such option.
b. On August 1, 1997, RCN and Potomac Capital Investment Corporation ("PCI"), a
wholly owned subsidiary of PEPCO, entered into a letter of intent (the "Letter
of Intent") to form a joint venture which will own and operate a communications
network to provide voice, video, data and other communications services to
residential and commercial customers in the greater Washington, D.C., Virginia
and Maryland area (the "Washington, D.C. Market"). Starpower, an unregulated
limited liability company with a perpetual term, was formed on October 28, 1997
to construct, own, lease, operate and market a network for the selling of voice,
video, data and other telecommunications services to all potential commercial
and residential customers in the Washington, D.C. Market. RCN owns 50% of the
equity interest in Starpower and PCI owns the remaining 50% interest.
The closing of the Starpower joint venture (the "Starpower Closing") occurred on
December 19, 1997.
Pursuant to the Amended and Restated Operating Agreement, RCN and Pepco
Communications are each required to make additional capital contributions in
accordance with a schedule set forth in such agreement on a 50%/50% basis.
Failure of either RCN or Pepco Communications to make a scheduled capital
contribution or to vote in favor of certain additional capital contributions may
result in the recalculation of equity interests. The business and affairs of
Starpower is to be managed by RCN and Pepco Communications. So long as RCN and
Pepco Communications maintain a 50%/50% equity interest in the joint venture,
each of RCN and Pepco Communications will appoint three members to the operating
committee, the approval of which is required for any business action. Certain
fundamental business actions, such as mergers, acquisitions, sales of
substantially all of the assets, liquidation and amendments to the certificate
of organization or any agreement signed at the Starpower Closing, require the
unanimous approval of the operating committee regardless of whether the parties
continue to maintain a 50%/50% ownership interest. As a result of the joint
control, Starpower is accounted for under the equity method of accounting.
A subsidiary of RCN will provide support services including customer service,
billing, marketing and certain administrative, accounting and technical support
services, each of which shall be provided at cost.
c. The basis of the Company's investment in Megacable exceeded its underlying
equity in the net assets of Megacable when acquired by approximately $94,000
which excess is being amortized on a straight-line basis over 15 years. At
December 31, 1997, the unamortized excess over the underlying equity in the net
assets was $75,886. The Company recorded its proportionate share of (losses) and
amortization of excess cost over net assets of ($3,869), ($2,190) and ($3,061)
in 1997, 1996 and 1995, respectively.
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
under Statement of Financial Accounting Standards No. 52 - "Foreign Currency
Translation", as having a highly inflationary economy. As a result, the
financial statements of Megacable are remeasured as if the functional currency
were the U.S. dollar. The remeasurement of the Mexican peso into U.S. dollars
creates translation adjustments which are included in net income. Exchange
gains (losses) of $(12), $247, and $(932) in 1997, 1996, and 1995, respectively,
including translation losses in 1997, are included in the respective statements
of operations through the Company's proportionate share of losses of Megacable.
<PAGE>
The following table reflects the summarized financial position and results of
operations of Megacable as of and for the years ended December 31, 1997 and
1996:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Assets $ 76,323 $ 67,672
Liabilities $ 8,347 $ 6,455
Stockholders' equity $ 67,976 $ 61,217
Sales $ 30,441 $ 23,225
Costs and expenses $ 23,389 $ 15,689
Foreign currency transaction gains (losses) $ (31) $ 618
Net income $ 6,653 $ 10,226
</TABLE>
8. INTANGIBLE ASSETS
Intangible assets consist of the following at December 31,
<TABLE>
<CAPTION>
Amortization period 1997 1996
------------------- -------- --------
<S> <C> <C> <C>
Franchises and subscriber lists 2-10.5 years $ 79,273 $ 78,720
Noncompete agreements 5-8 years 11,209 11,209
Goodwill 5-10 years 42,787 16,830
Building access rights 3-4 years 15,197 14,920
Other intangible assets 5-15 years 1,469 520
-------- --------
Total intangible assets 149,935 122,199
Less accumulated amortization (53,388) (28,728)
-------- --------
Intangible assets, net $ 96,547 $ 93,471
======== ========
</TABLE>
Amortization expense charged to operations in 1997, 1996 and 1995 was $28,948,
$19,509 and $9,100, respectively.
<PAGE>
9. DEFERRED CHARGES AND OTHER ASSETS
Deferred charges and other assets consist of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Note and interest receivable - Mazon Corporativo, S.A. de C.V. $17,682 $15,310
Debt issuance costs 19,743 309
Prepaid pension costs - 2,967
Prepaid professional services 938 3,439
Other 2,675 2,121
------- -------
Total $41,038 $24,146
======= =======
</TABLE>
10. DEBT
a. Long-term debt
Long-term debt outstanding at December 31 is as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Senior Secured Notes 9.65% due 1999 $ - $131,250
Revolving Credit Agreement 3,000 -
Term Credit Agreement 100,000 -
Senior Notes 10% due 2007 225,000 -
Senior Discount Notes 11 1/8% due 2007 358,103 -
-------- --------
Total 686,103 131,250
Due within one year - -
-------- --------
Total Long-Term Debt $686,103 $131,250
======== ========
</TABLE>
In October 1997, pursuant to Rule 144A of the Securities Exchange Act of 1933,
the Company completed an offering of 10% Senior Notes with an aggregate
principal amount of $225,000 and 11 1/8% Senior Discount Notes with an aggregate
principal amount at maturity of $601,045, both due 2007, to qualified
institutional buyers as defined in Rule 144A. The Senior Discount Notes were
issued at a discount and generated gross proceeds to the Company of $350,000. In
December 1997, the Company commenced an SEC registered Exchange Offer of its 10%
Senior Notes due 2007, Series B for any and all outstanding 10% Senior Notes due
2007, Series A and its 11 1/8% Senior Discount Notes due 2007, Series B for any
and all outstanding 11 1/8% Senior Discount Notes due 2007 Series A. The
Exchange Offer closed in January of 1998. All outstanding notes were exchanged.
The 10% Senior Notes were issued under an indenture dated October 17, 1997 (the
"10% Indenture") between the Company and The Chase Manhattan Bank, as Trustee.
The 10% Senior Notes are general senior obligations of the Company which mature
on October 15, 2007 and are collateralized by a pledge of the Escrow Account
which contains approximately $61,000 of the net proceeds from the sale of the
10% Senior Notes plus approximately $1,000 of aggregate interest, representing
funds that, together with the future proceeds from the investment thereof, will
be sufficient to pay interest on the 10% Senior Notes for six scheduled interest
payments. Interest on the 10% Senior Notes is payable in cash semi-annually in
arrears on each April 15 and October 15, commencing April 15, 1998.
The 10% Indenture contains certain covenants that, among other things, limit the
ability of the Company and its subsidiaries to incur indebtedness, pay
dividends, prepay subordinated indebtedness, repurchase
<PAGE>
capital stock, engage in transactions with stockholders and affiliates, create
liens, sell assets and engage in mergers and consolidations.
The 10% Senior Notes are redeemable, in whole or in part, at any time on or
after October 15, 2002 at the option of the Company. The 10% Senior Notes have
redemption prices starting at 105% of the principal amount and declining to 100%
of the principal amount, plus any accrued interest.
The 11 1/8% Senior Discount Notes were issued under an indenture dated October
17, 1997 (the "11 1/8% Indenture") between the Company and The Chase Manhattan
Bank, as Trustee. The 11 1/8% Senior Discount Notes are general senior
obligations of the Company, limited to $601,045 aggregate principal amount at
maturity and will mature on October 15, 2007. The 11 1/8% Senior Discount Notes
were issued at a discount to yield gross proceeds of $350,000. The 11 1/8%
Senior Discount Notes will not bear cash interest prior to October 15, 2002.
The 11 1/8% Indenture contains certain covenants that, among other things, limit
the ability of the Company 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.
The 11 1/8% Senior Discount Notes are redeemable, in whole or in part, at any
time on or after October 15, 2002 at the option of the Company. The 11 1/8%
Senior Discount Notes have 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 interest.
Certain subsidiaries of the Company, including RCN Cable, have in place a
$125,000 credit agreement comprised of two credit facilities. The first is a
five year revolving credit facility in the amount of $25,000 which provides
credit availability through June 30, 2002. Revolving loans may be repaid and
reborrowed from time to time. The second is a term credit facility in the amount
of $100,000 which is to be repaid over six years in quarterly installments from
September 30, 1999 through June 30, 2005. Interest only is due through June 30,
1999. The interest rate is based on either a LIBOR or Base Rate option, at the
election of the Company (6.82% at December 31, 1997). The credit agreement is
collateralized by a pledge by the Company of its stock in RCN Cable and may, in
the future, be secured by pledges of stock of subsidiaries of the Company. At
December 31, 1997, the entire $100,000 term credit facility is outstanding and
$3,000 of the revolving credit facility is outstanding. RCN Cable used a portion
of its initial borrowings under the credit facilities to prepay higher priced
Senior Secured Notes. The early extinguishment of the Senior Secured Notes
resulted in an extraordinary charge of $3,210, net of taxes of $1,728. The
credit agreement contains restrictive covenants which, among other things,
require the Company to maintain certain debt to cash flow and interest coverage
ratios and place certain limitations on additional debt and investments. The
Company does not believe that these covenants will materially restrict its
activities.
In 1989, in order to complete the August 29, 1989 Michigan Cable Television
acquisition, RCN Cable entered into a private placement of Senior Secured Notes
for $150,000 and a $70,000 Revolving Secured Credit Agreement, which was
voluntarily reduced to $60,000 in 1990 and which, in accordance with its terms,
reduced on a quarterly basis, through original scheduled maturity in September
1996. In August 1996, RCN Cable obtained an amendment and waiver related to this
Revolving Secured Credit Agreement which extended final maturity to December
1996 and increased the amount of available borrowings. Additionally, the
restrictive covenant relating to limitations on the amount of capital
expenditures was waived for the year ending December 31, 1996. The Senior
Secured Notes were collateralized by the stock of certain cable subsidiaries of
the Company. On September 1, 1996 and on each September 1 thereafter, a
mandatory principal repayment was required on the Senior Secured Notes. The
Senior Secured Notes contained restrictive convenants which, among other things,
required maintenance of a specified debt to cash flow ratio. These notes were
prepaid in 1997 as discussed above. The Senior
<PAGE>
Secured Notes were classified as long-term at December 31, 1996 since the
Company had the intent and the ability to refinance this obligation on a long-
term basis through the above credit facilities.
In connection with the acquisition of Twin County Trans Video, Inc., RCN Cable
issued a $4,000 promissory note at 5% due in May 2003. The note was unsecured.
In September 1996, the note was canceled in settlement of certain purchase price
adjustments.
Contractual maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year Ending December 31, Aggregate Amounts
<S> <C>
1998 $ -
1999 $ 3,750
2000 $11,250
2001 $16,250
2002 $20,500
</TABLE>
b. Short-term debt
At December 31, 1997, the Company had unused lines of credit for $5,500 at prime
(8.50% at December 31, 1997). Short-term unsecured borrowings may be made under
these lines of credit. The amounts available under these lines of credit are
reduced by outstanding letters of credit ($3,060 at December 31,1997). All
unused lines of credit are cancelable at the option of the banks. There are no
commitment or facility fees associated with maintaining availability of the
above-mentioned lines of credit.
11. INCOME TAXES
The (benefit) provision for income taxes is reflected in the Consolidated
Statements of Operations as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- -------- --------
<S> <C> <C> <C>
Current:
Federal $ (11,795) $ 5,730 $(5,713)
State 1,449 1,102 375
--------- ------- -------
Total Current (10,346) 6,832 (5,338)
---------- ------- -------
Deferred:
Federal (10,161) (4,751) 7,016
State (342) (1,000) (377)
--------- ------- -------
Total Deferred (10,503) (5,751) 6,639
--------- ------- -------
Amortization of ITC - (102) (182)
--------- ------- -------
Provision (benefit) for income taxes:
Before extraordinary item (20,849) 979 1,119
Extraordinary item (1,728) - -
--------- ------- -------
Total (benefit) provision for income taxes $ (22,577) $ 979 $ 1,119
========= ======= =======
</TABLE>
At December 31, 1997 and 1995, the Company had tax related balances due from
affiliates of $3,186 and $501, respectively. At December 31, 1996, the Company
had tax related balances due to affiliates of $817.
<PAGE>
Temporary differences that give rise to a significant portion of deferred tax
assets and liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Net operating loss carryforwards $ 10,078 $ 2,130
Alternative minimum tax credits 167 219
Employee benefit plans 1,031 882
Reserve for bad debt 844 693
Start-up costs 586 959
Investment in unconsolidated entity 3,985 4,771
Accruals for nonrecurring charges and contract settlements 2,368 2,299
Other, net 1,823 1,888
-------- --------
Total deferred tax assets 20,882 13,841
-------- --------
Property, plant and equipment (14,759) (15,019)
Intangible assets (11,253) (17,776)
All other (1,257) (1,229)
-------- --------
Total deferred liabilities (27,269) (34,024)
-------- --------
Subtotal (6,387) (20,183)
Valuation allowance (8,404) (3,691)
-------- --------
Total deferred taxes $(14,791) $(23,874)
======== ========
</TABLE>
In the opinion of management, based on the future turnaround of existing
temporary differences for the consolidated taxpaying group, primarily
depreciation, the Company will more likely than not be able to realize
substantially all of its deferred tax assets.
A valuation allowance has been provided for the portion of deferred tax assets
which, in the opinion of management is uncertain as to their realization. The
valuation allowance relates primarily to state net operating loss carryforwards
generated by certain subsidiaries.
The net change in the valuation allowance for deferred tax assets during 1997
was an increase of $4,713.
Net operating losses will expire as follows:
<TABLE>
<CAPTION>
Federal State
<S> <C> <C>
1999 $ 2,793
2000 3,087
2001 14,532
2002 3,141
2003 10,244
2004 3,767
2011 38,116
2012 8,028
2017 $8,218 -
------ -------
Total $8,218 $83,708
====== =======
</TABLE>
<PAGE>
The provision (benefit) for income taxes is different from the amounts computed
by applying the U.S. statutory federal tax rate of 35%. The differences are as
follows:
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1997 1996 1995
---------- -------- --------
<S> <C> <C> <C>
(Loss) income before (benefit) provision for income taxes and
extraordinary item $(70,030) $(5,010) $3,233
======== ======= ======
Federal income tax benefit at statutory rate $(24,511) $(1,753) $1,131
State income taxes net of federal income tax benefit 719 66 (33)
Investment tax credits amortized - (102) (50)
Amortization of goodwill 830 779 388
Estimated nondeductible expenses 1,913 1,564 (93)
Adjustment to prior year accrual (197) 421 (161)
Other, net 397 4 (63)
-------- ------- ------
Total (benefit) provision for income taxes $(20,849) $ 979 $1,119
======== ======= ======
</TABLE>
In 1995, C-TEC received official notification of final settlement from the
Internal Revenue Service relating to the examination of C-TEC's consolidated
federal income tax returns for 1989, 1990 and 1991. The most significant
adjustment relates to the disallowance of the claimed amortization of certain
intangible assets. As a result of the disallowance, the Company's taxes payable
for prior years increased approximately $580. The amount accrued in previous
years was sufficient to satisfy the above adjustment. No additional accrual
during 1995 was required.
In 1997 and 1996, estimated non-deductible expenses relate primarily to charges
in connection with the restructuring of the Company.
12. STOCKHOLDERS' EQUITY AND STOCK PLANS
The Company has authorized 100,000,000 shares of $1 par value common stock and
200,000,000 shares of $1 par value Class B nonvoting common stock. The Company
also has authorized 25,000,000 shares of $1 par value preferred stock. At
December 31, 1997, 54,989,870 shares of common stock are issued and outstanding.
In March 1998, the Company's Board of Directors approved a two-for-one stock
split, payable in the form of a 100% stock dividend. The record date for the
stock split is March 20, 1998. Stockholders of record at the market close on
that date will receive an additional share of RCN common stock for each share
held. The distribution date for the stock dividend will be April 3, 1998. All
share and per share data, stock option data, and market prices of the Company's
common stock have been restated to reflect this stock split.
In connection with the Distribution, the Company Board adopted the 1997 RCN
Corporation Stock Option Plan ("the 1997 Plan"), designed to provide equity
based compensation opportunities to key employees when shareholders of the
Company have received a corresponding benefit through appreciation in the value
of RCN Common Stock.
The 1997 Plan contemplates the issuance of incentive stock options, as well as
stock options that are not designated as incentive stock options, performance-
based stock options, stock appreciation rights, performance share units,
restricted stock, phantom stock units and other stock-based awards
(collectively, "Awards"). Up to 5,000,000 shares of Common Stock, plus 3,040,100
shares of Common Stock issuable in connection with the Distribution related
option adjustments, may be issued pursuant to Awards granted under the 1997
Plan.
<PAGE>
Unless earlier terminated by the Company Board, the 1997 Plan will expire on the
tenth anniversary of the Distribution. The Company Board or the Compensation
Committee may, at any time, or from time to time, amend or suspend and, if
suspended, reinstate, the 1997 Plan in whole or in part.
Prior to the Distribution, certain employees of RCN were granted stock option
awards under C-TEC's stock option plans. In connection with the Distribution
3,040,100 options covering Common Stock were issued. Each C-TEC option was
adjusted so that each holder would currently hold options to purchase shares of
CTE Common Stock, RCN Common Stock and Cable Michigan Common Stock. The number
of shares subject to, and the exercise price of, such options were adjusted to
take into account the Distribution and to ensure that the aggregate intrinsic
value of the resulting RCN, Cable Michigan and CTE options immediately after the
Distribution was equal to the aggregate intrinsic value of the C-TEC options
immediately prior to the Distribution.
Information relating to stock options is as follows:
<TABLE>
<CAPTION>
Weighted
Number of Average
Shares Exercise
--------- --------
<S> <C> <C>
Price
Outstanding December 31, 1994 1,431,000
Granted 1,257,000
Exercised -
Canceled 280,000
---------
Outstanding December 31, 1995 2,408,000
Granted 190,000
Exercised 58,000
Canceled 272,000
---------
Outstanding December 31, 1996 2,268,000 $ 7.10
Granted 4,862,100 $14.31
Exercised 20,000 $ 8.07
Canceled 3,000 $ 8.36
--------- ------
Outstanding December 31, 1997 7,107,100 $11.95
========= ======
Shares exercisable December 31, 1997 1,221,000 $ 7.05
</TABLE>
The following table summarizes stock options outstanding and exercisable at
December 31, 1997:
<TABLE>
<CAPTION>
Stock Options Stock Options
Outstanding Exercisable
----------------------------------------------------- -------------------------------
Weighted Average
Range of Exercise Remaining Weighted Average Weighted Average
Prices Shares Contractual Life Exercise Price Shares Exercise Price
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$6.24 to $8.40 3,017,100 7.5 Years $ 7.36 1,221,000 $7.05
$15.32 to $16.82 4,090,000 9.8 Years 15.33 - -
--------- ---------
Total 7,107,100 1,221,000
========= =========
</TABLE>
<PAGE>
No compensation expense related to stock option grants was recorded in 1997 as
the option exercise prices were equal to fair market value on the date granted.
Pro forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if the Company had accounted for its stock
options under the fair value method of SFAS 123. The fair value for these
options was estimated at the date of grant using a Black Scholes option pricing
model with weighted average assumptions for dividend yield of 0% for 1997, 1996
and 1995; expected volatility of 38.6% prior to the Distribution and 49.8%
subsequent to the Distribution for 1997 39.5% for 1996, and 35.9% for 1995;
risk-free interest rate of 6.52%, 5.95% and 6.32% for 1997, 1996 and 1995,
respectively; and expected lives of 5 years for 1997,1996 and 1995.
The weighted-average fair value of options granted during 1997 was $7.46.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma net earnings and earnings per share were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- ------
<S> <C> <C> <C>
Net earnings - as reported $(52,391) $(5,989) $2,114
Net earnings - pro forma $(54,419) $(6,612) $1,695
Basic earnings per share - as reported $ (0.95) $ (0.11) $ 0.04
Basic earnings per share - pro forma $ (0.99) $ (0.12) $ 0.03
Diluted earnings per share - as reported $ (0.95) $ (0.11) $ 0.04
Diluted earnings per share - pro forma $ (0.99) $ (0.12) $ 0.03
</TABLE>
In November 1996, the C-TEC shareholders approved a stock purchase plan for
certain key executives (the C-TEC "Executive Stock Purchase Plan" or "C-TEC
ESPP"). Under the C-TEC ESPP, participants may purchase shares of C-TEC Common
Stock in an amount of between 1% and 20% of their annual base compensation and
between 1% and 100% of their annual bonus compensation provided, however, that
in no event shall the participant's total contribution exceed 20% of the sum of
their annual compensation, as defined by the C-TEC ESPP. Participant's accounts
are credited with the number of share units derived by dividing the amount of
the participant's contribution by the average price of a share of C-TEC Common
Stock at approximately the time such contribution is made. The share units
credited to a participant's account do not give such participant any rights as a
shareholder with respect to, or any rights as a holder or record owner of, any
shares of C-TEC Common Stock. Amounts representing share units that have been
credited to a participant's account will be distributed, either in a lump sum or
in installments, as elected by the participant, following the earlier of the
participant's termination of employment or three calendar years following the
date on which the share units were initially credited to the participant's
account. It is anticipated that, at the time of distribution, a participant will
receive one share of C-TEC Common Stock for each share unit being distributed.
Following the crediting of each share unit to a participant's account, a
matching share of Common Stock is issued in the participant's name. Each
matching share is subject to forfeiture as provided in the C-TEC ESPP. The
issuance of matching shares will be subject to the participant's execution of an
escrow agreement. A participant will be deemed to be the holder of, and may
exercise all the rights of a record owner of, the matching shares issued to such
participant while such matching shares are held in escrow.
Shares of restricted C-TEC Common Stock awarded under the C-TEC Executive Stock
Purchase Plan and share units awarded under the C-TEC ESPP that relate to C-TEC
Common Stock were adjusted so that following the Distribution, each such
participant was credited with an aggregate equivalent value of restricted shares
of common stock of Commonwealth Telephone Enterprises, the Company and Cable
Michigan. In 1997, the Company's Board of Directors approved the RCN Corporation
Executive Stock Purchase Plan (the "RCN ESPP"), with terms substantially the
same as the C-TEC ESPP. The number of
<PAGE>
shares which may be distributed under the RCN ESPP as matching shares or in
payment of share units is 250,000. At December 31, 1997, 61,412 matching shares
have been issued under the RCN ESPP, none of which are vested. The Company
recognizes the cost of the matching shares over the vesting period. Expense
recognized in 1997 and 1996 was $80 and $145, respectively.
13. PENSIONS AND EMPLOYEE BENEFITS
Prior to the Distribution, the Company's financial statements reflect the costs
experienced for its employees and retirees while included in the C-TEC plans.
Through December 31, 1996, substantially all employees of the Company were
included in a trusteed noncontributory defined benefit pension plan, maintained
by C-TEC. Upon retirement, employees are provided a monthly pension based on
length of service and compensation. C-TEC funds pension costs to the extent
necessary to meet the minimum funding requirements of ERISA. Substantially, all
employees of C-TEC's Pennsylvania cable television operations (formerly Twin
County Trans Video, Inc.) were covered by an underfunded plan which was merged
into C-TEC's overfunded plan on February 28, 1996.
The information that follows relates to the entire C-TEC noncontributory defined
benefit plan. The components of C-TEC's pension cost are as follows:
<TABLE>
<CAPTION>
1996 1995
-------- ---------
<S> <C> <C>
Benefits earned during the year (service cost) $ 2,365 $ 1,656
Interest cost on projected benefit obligation 3,412 3,083
Actual return on plan assets (3,880) (12,897)
Other components - net (1,456) 8,482
------- --------
Net periodic pension cost $ 441 $ 324
======= ========
</TABLE>
The following assumptions were used in the determination of the consolidated
projected benefit obligation and net periodic pension cost:
<TABLE>
<CAPTION>
December 31,
1996 1995
------ ------
<S> <C> <C>
Discount rate 7.5% 7.0%
Expected long-term rate of return on plan assets 8.0% 8.0%
Weighted average long-term rate of compensation increases 6.0% 6.0%
</TABLE>
The Company's allocable share of the consolidated net periodic pension costs,
based on the Company's proportionate share of consolidated annualized salaries
as of the valuation date, was approximately $158 and $251 for 1996 and 1995,
respectively. These amounts are reflected in operating expenses. As discussed
below, no pension cost (credit) was recognized in 1997.
In connection with the restructuring, C-TEC completed a comprehensive study of
its employee benefit plans in 1996. As a result of this study, effective
December 31, 1996, in general, employees of the Company no longer accrue
benefits under the defined benefit pension plans and became fully vested in
their benefit accrued through that date. C-TEC notified affected participants in
December 1996. In December 1996, C-TEC allocated pension plan assets of $6,984
and the related liabilities to a separate plan for employees who no longer
accrue benefits after lump sum distributions. The allocation of assets and
liabilities resulted in a curtailment/settlement gain of $4,292. The Company's
allocable share of this gain was $3,437. This gain results primarily from the
reduction of the related projected benefit obligation. The curtailed plan has
assets in excess of the projected benefit obligation. Such excess amounts to
$3,917 which, along with unrecognized items of $1,148 results in prepaid pension
cost of $2,769, which is included in "Prepayments and other" in the accompanying
1997 and 1996 consolidated balance sheets.
<PAGE>
The following table sets forth the plans' funded status and amounts recognized
in C-TEC's balance sheet at December 31, 1996:
<TABLE>
<CAPTION>
<S> <C>
Plan assets at fair value $ 55,325
Actuarial present value of benefit obligations:
Accumulated benefit obligations:
Vested 32,372
Nonvested 1,704
--------
Total 34,076
Effect of increases in compensation 6,042
--------
Plan assets in excess of (less than) projected benefit obligation 15,207
Unrecognized transition asset (3,463)
Unrecognized prior service cost 2,438
Unrecognized net gain (11,215)
--------
Prepaid pension cost $ 2,967
========
</TABLE>
C-TEC's pension plan has assets in excess of the accumulated benefit obligation.
Plan assets include cash, equity, fixed income securities and pooled funds under
management by an insurance company. Plan assets include common stock of C-TEC
with a fair value of approximately $5,835 at December 31, 1996.
Prepaid pension cost is included in "Deferred Charges and Other Assets" in the
accompanying 1996 consolidated balance sheet. The prepaid pension asset was
transferred to CTE in connection with the Distribution in 1997.
C-TEC sponsors a 401(k) savings plan covering substantially all employees of the
Company who are not covered by collective bargaining agreements. Contributions
made by the Company to the 401(k) plan are based on a specific percentage of
employees contributions. Contributions charged to expense were $354 and $268 in
1996 and 1995, respectively. Contributions charged to expense in 1997 prior to
the Distribution were $515.
In connection with the Distribution, RCN established a qualified savings plan
under Section 401(k) of the Code that will also qualify as an ESOP under
Sections 401(a) and 4975(e)(7) of the Code (the "ESOP"). Eligible active
employees under the ESOP, employees of the Company Businesses who make Section
401(k) contributions and certain other employees will be allocated shares of
Company Common Stock. Contributions charged to expense in 1997 were $306.
The Company provides certain postemployment benefits to former or inactive
employees of the Company who are not retirees. These benefits are primarily
short-term disability salary continuance. The Company accrues the cost of
postemployment benefits over employees' service lives. The Company uses the
services of an enrolled actuary to calculate the expense. Prior to the
Distribution, C-TEC allocated the cost of these benefits to the Company based on
the Company's proportionate share of consolidated annualized salaries. The
Company reimbursed C-TEC for its allocable share of the consolidated
postemployment benefit cost. The net periodic postemployment benefit cost
(credit) was approximately $458, $539 and ($106) in 1997, 1996 and 1995,
respectively.
<PAGE>
14. COMMITMENTS AND CONTINGENCIES
a. The Company had various purchase commitments at December 31, 1997 related to
its 1998 construction budget.
b. Total rental expense, primarily for office space and pole rentals, was
$3,505, $3,632 and $2,846 for 1997, 1996 and 1995, respectively. At December 31,
1997, rental commitments under noncancelable leases, excluding annual pole
rental commitments of approximately $794 that are expected to continue
indefinitely, are as follows:
<TABLE>
<CAPTION>
Year Aggregate Amounts
<S> <C>
1998 $3,725
1999 $3,314
2000 $2,939
2001 $2,826
2002 $2,848
Thereafter $8,501
</TABLE>
c. The Company has outstanding letters of credit aggregating $3,060 at December
31, 1997.
d. The Company has entered into various noncancelable contracts for network
services. Future obligations under these agreements are as follows:
<TABLE>
<CAPTION>
Year Network Services
<S> <C>
1998 $3,026
1999 $3,064
2000 $3,012
2001 $2,762
2002 $ 12
Thereafter $ 14
</TABLE>
e. The Company is subject to the provisions of the Cable Television Consumer
Protection and Competition Act of 1992, as amended, and the Telecommunications
Act of 1996. The Company has either settled challenges or accrued for
anticipated exposures related to rate regulation. However, there is no
assurance that there will not be additional challenges to its rates.
f. In the normal course of business, there are various legal proceedings
outstanding. In the opinion of management, these proceedings will not have a
material adverse effect on the financial position or results of operations or
liquidity of the Company.
g. The Company has agreed to indemnify Cable Michigan and CTE and their
respective subsidiaries against any and all liabilities which arise primarily
from or relate primarily to the management or conduct of the business of the
Company prior to the effective time of the Distribution. The Company has also
agreed to indemnify Cable Michigan and CTE and their respective subsidiaries
against 30% of any liability which arises from or relates to the management or
conduct prior to the effective time of the Distribution of the businesses of C-
TEC and its subsidiaries and which is not a true CTE liability, a true Cable
Michigan liability or a true Company liability.
The Tax Sharing Agreement, by and among the Company, Cable Michigan and CTE (the
"Tax Sharing Agreement"), governs contingent tax liabilities and benefits, tax
contests and other tax matters with respect to tax returns filed with respect to
tax periods, in the case of the Company, ending or deemed to end on or before
the Distribution Date. Under the Tax Sharing Agreement, Adjustments (as defined
in the Tax Sharing Agreement) to taxes that are clearly attributable to the
Company Group, the Cable Michigan
<PAGE>
Group, or the CTE Group will be borne solely by such group. Adjustments to all
other tax liabilities will be borne 50% by CTE, 30% by the Company and 20% by
Cable Michigan.
Notwithstanding the above, if as a result of the acquisition of all or a portion
of the Capital stock or assets of the Company, the Distribution fails to qualify
as a tax-free distribution under Section 355 of the Code, then the Company will
be liable for any and all increases in tax attributable thereto.
h. Under the Starpower Amended and Restated Operating Agreement, the Company is
committed to make quarterly capital contributions aggregating the following in
the years ended December 31:
<TABLE>
<CAPTION>
<S> <C>
1998 $56,250
1999 $68,750
2000 $25,000
</TABLE>
i. If, within five years after the Distribution, the ESOP portion of the 401(k)
Plan does not hold shares representing at least 3% of the number of shares of
Company Common Stock outstanding immediately after the Distribution as increased
by the number of shares issuable to BECO pursuant to the Exchange Agreement
(collectively, "Outstanding Company Common Stock") with a market value at such
time of not less than $24,000, RCN will issue to the ESOP, in exchange for a
note from the ESOP (the "ESOP Note"), the amount of Company Common Stock
necessary to increase the ESOP's holdings of Company Common Stock to that level,
provided, however, that RCN is not obligated to issue shares to the ESOP in
excess of 5% of the number of shares of Outstanding Company Common Stock.
<PAGE>
15. AFFILIATE AND RELATED PARTY TRANSACTIONS
The Company had the following transactions with affiliates during the years
ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Corporate office costs allocated to affiliates $12,091 $12,362 $10,009
Cable staff and customer service costs allocated to
Cable Michigan 3,489 3,577 2,952
Interest income on affiliate notes 8,688 15,119 17,340
Interest expense on affiliate notes 537 354 279
Long-distance terminating access charge expense from CTE 1,312 728 862
Royalty fees charged by CTE 669 859 533
Revenue from engineering services - 296 2,169
Other affiliate revenues 1,576 - 6
Other affiliate expenses 2,199 1,980 2,090
</TABLE>
At December 31, 1997 and 1996, the Company has accounts receivable from related
parties of $9,829 and $12,614, respectively, for these transactions. At
December 31, 1997 and 1996, the Company has accounts payable to related parties
of $3,748 and $4,880, respectively, for these transactions.
The Company had notes receivable of $7,914 in 1996 from advances by the
Company's corporate financial services company to CTE. The Company also had
notes receivable of $147,567 at December 31, 1996, from Cable Michigan, Inc.
primarily related to the acquisition of the Michigan cable operations and
subsequent operations. All intercompany notes receivable were settled in
connection with the Distribution.
The Company had notes payable of $11,854 in 1996 from excess cash advanced by
CTE to the Company's corporate financial services company for investment. All
intercompany notes payable were settled in connection with the Distribution.
16. OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Certain financial instruments potentially subject the Company to concentrations
of credit risk. These financial instruments consist primarily of trade
receivables, cash and temporary cash investments, and short-term investments.
The Company places its cash and temporary investments with high credit quality
financial institutions and limits the amount of credit exposure to any one
financial institution. The Company also periodically evaluates the
creditworthiness of the institutions with which it invests. The Company does,
however, maintain unsecured cash and temporary cash investment balances in
excess of federally insured limits.
The Company's trade receivables reflect a customer base primarily centered in
the Boston to Washington, D.C. corridor of the United States. The Company
routinely assesses the financial strength of its customers. As a consequence,
concentrations of credit risk are limited.
17. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
a. Cash and temporary cash investments
The carrying amount approximates fair value because of the short maturity of
these instruments.
b. Short-term investments
<PAGE>
Short-term investments consist of commercial paper, corporate debt securities,
certificates of deposit and federal agency notes. Short-term investments are
carried at amortized cost which approximates fair value due to the short period
of time to maturity.
c. Long-term investments
Long-term investments consist of investments accounted for under the equity
method for which disclosure of fair value is not required. The note and
interest receivable are carried at cost plus accrued interest which management
believes approximates fair value.
d. Investments restricted for debt service
Investments restricted for debt service consists of an amount placed in escrow
from the proceeds of the 10% Senior Notes which, together with the proceeds from
the investment thereof, will be sufficient to pay interest on the 10% Senior
Notes for six scheduled interest payments. Investments restricted for debt
service are carried at amortized cost.
e. Long-term debt
The fair value of fixed rate long-term debt was estimated based on the Company's
current incremental borrowing rate for debt of the same remaining maturities.
The fair value of floating rate debt is considered to be equal to the carrying
value since the debt reprices at least every six months and the Company believes
that its credit risk has not changed from the time the floating rate debt was
borrowed and therefore, it would obtain similar rates in the current market.
f. Letter of credit
The contract amount of letters of credit represents a reasonable estimate of
their value since such instruments reflect fair value as a condition of their
underlying purpose and are subject to fees competitively determined in the
marketplace.
The estimated carrying fair value of the Company's financial instruments are as
follows at December 31:
<TABLE>
<CAPTION>
1997 1996
-------------------- -------------------
Carrying Carrying
Amount Fair value Amount FairValue
-------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and temporary cash investments $222,910 $222,910 $ 61,843 $ 61,843
Short-term investments $415,603 $415,603 $ 46,831 $ 46,831
Note and interest receivable $ 17,682 $ 17,682 $ 15,310 $ 15,310
Investments restricted for debt service $ 61,911 $ 61,911 - -
Financial Liabilities:
Fixed rate long-term debt:
Senior Secured Notes $ - $ - $131,250 $137,459
Senior Notes 10% $225,000 $233,438 - -
Senior Discount Notes 11.125% $358,103 $377,156 - -
Floating rate long-term debt:
Revolving Credit Agreement $ 3,000 $ 3,000 - -
Term Credit Agreement $100,000 $100,000 - -
Unrecognized financial instruments:
Letters of credit $ 3,060 $ 3,060 $ 3,060 $ 3,060
</TABLE>
<PAGE>
18. QUARTERLY INFORMATION (Unaudited)
<TABLE>
<CAPTION>
1997 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 29,677 $ 31,029 $ 31,148 $ 35,443
Operating income (loss) before depreciation,
amortization and nonrecurring charges $ 4,153 $ 850 ($4,332) ($8,341)
Operating (loss) $(18,037) $(12,416) $(18,011) $(22,411)
Loss before extraordinary charge N/A N/A N/A $(17,116)
Loss before extraordinary charge per
average common share N/A N/A N/A $ (0.31)
Common Stock
High N/A N/A $ 16.63 $ 21.63
Low N/A N/A $ 12.44 $ 12.50
1996 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Sales $ 24,165 $ 24,852 $ 26,746 $ 29,147
Operating income before depreciation
and amortization $ 4,199 $ 7,777 $ 9,188 $ 4,639
Operating (loss) $ (4,621) $ (1,233) $ (19) $ (7,205)
</TABLE>
19. SUBSEQUENT EVENTS
a. In February 1998, the Company completed an offering of 9.8% Senior Discount
Notes with an aggregate principal amount at maturity of $567,000, due February
2008. The 9.8% Senior Discount Notes were issued at a discount and generated
gross proceeds to the Company of $350,587.
The 9.8% Senior Discount Notes are general senior obligations of the Company,
limited to $567,000 aggregate principal amount at maturity and will mature on
February 15, 2008. The 9.8% Senior Discount Notes were issued at a discount to
yield gross proceeds of $350,587. The 9.8% Senior Discount Notes will not pay
cash interest prior to February 15, 2003. The yield to maturity of the 9.8%
Senior Discount Notes, determined on a semi-annual bond equivalent basis, will
be 9.8% per annum.
The 9.8% 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.
The 9.8% Senior Discount Notes are redeemable, in whole or in part, at any time
on or after February 15, 2003 at the option of the Company. The 9.8% Senior
Discount Notes may be redeemed at redemption prices starting at 104.9% of the
principal amount at maturity and declining to 100% of the principal amount at
maturity, plus any accrued and unpaid interest.
b. On January 21, 1998, RCN entered into the Agreement and Plan of Merger (the
"Erols Merger Agreement") among RCN, Erols Internet, Inc. ("Erols"), Erol
Onaran, Gold & Appel Transfer, S.A., a British Virgin Islands corporation ("Gold
& Appel"), and ENET Holdings, Inc., a Delaware corporation and a wholly owned
subsidiary of RCN ("ENET"), to acquire all of the outstanding shares of common
stock of Erols. The merger was consummated on February 20, 1998. Erols merged
with and into ENET (the "Erols Merger"), with ENET as the surviving corporation.
The approximate total Erols Merger consideration was $29,200 in cash, 1,730,648
shares of RCN common stock plus the assumption and repayment of $5,800 of debt.
Additionally, the Company is converting approximately 999,000 Erols stock
options to 699,104 RCN stock options at an average exercise price of $3.424 per
share. The transaction was accounted for under the purchase method of
accounting.
<PAGE>
RCN expects to contribute to Starpower approximately 60% of the subscribers
acquired in the acquisition of Erols.
c. On January 21, 1998, RCN, UNET Holdings, Inc., a wholly owned subsidiary of
RCN, and Ultranet Communications, Inc. ("Ultranet") entered into an Agreement
and Plan of Merger (the "Ultranet Merger Agreement"). The total consideration
for the acquisition was 7,368 in cash, 890,384 shares of RCN common stock, and
$3,000 in deferred compensation. Additionally, the Company is converting 63,500
UltraNet stock options to 117,052 RCN stock options at an average exercise price
of $1.825 per share and making cash payments aggregating approximately $503 to
certain other holders of UltraNet stock options. The transaction was
consummated on February 27, 1998. The transaction was accounted for under the
purchase method of accounting.
RCN expects to contribute to RCN-BECOCOM approximately 30% of the subscribers
acquired in the acquisition of Ultranet.
d. RCN paid $12,500 in cash in January 1998 as its initial capital contribution
to Starpower.
e. In January 1998, BECO notified RCN that it has elected to exercise its
option to the full extent permitted by the Exchange Agreement (Note 7) with
respect to 1997. RCN and BECO are presently in discussions with respect to the
calculation of the agreed upon value for the exercise of such option.
f. On February 27, 1998, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Lancit Media Entertainment, Ltd. ("Lancit")
and LME Acquisition Corporation ("MergerSub"), a wholly owned subsidiary of RCN.
Pursuant to the terms of the Merger Agreement, MergerSub will be merged with and
into Lancit (the "Merger") such that immediately following the Merger, Lancit
will be a wholly-owned subsidiary of RCN. The consummation of the Merger is
subject to customary conditions, including the adoption and approval of the
Merger and the Merger Agreement by the stockholders of Lancit in accordance
with the provisions of applicable law and the filing and effectiveness of a
registration statement of RCN. There is no assurance that this transaction will
be consummated.
<PAGE>
REPORT OF MANAGEMENT
The integrity and objectivity of the financial information presented in these
financial statements is the responsibility of the management of RCN Corporation.
The financial statements report on management's accountability for Company
operations and assets. To this end, management maintains a system of internal
controls and procedures designed to provide reasonable assurance that the
Company's assets are protected and that all transactions are accounted for in
conformity with generally accepted accounting principles. The system includes
documented policies and guidelines, augmented by a comprehensive program of
internal and independent audits conducted to monitor overall accuracy of
financial information and compliance with established procedures.
Coopers & Lybrand, L.L.P., independent accountants, conduct a review of internal
accounting controls to the extent required by generally accepted auditing
standards and perform such tests and procedures as they deem necessary to arrive
at an opinion on the fairness of the financial statements presented herein.
The Board of Directors meets its responsibility for the Company's financial
statements through its Audit Committee which is comprised exclusively of
directors who are not officers or employees of the Company. The Audit Committee
recommends to the Board of Directors the independent auditors for election by
the shareholders. The Committee also meets periodically with management and the
independent and internal auditors to review accounting, auditing, internal
accounting controls and financial reporting matters. As a matter of policy, the
internal auditors and the independent auditors periodically meet alone with, and
have access to, the Audit Committee.
\s\ Bruce C. Godfrey
- --------------------
Bruce C. Godfrey
Executive Vice President
Chief Financial Officer
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To Shareholders of RCN Corporation:
We have audited the consolidated financial statements and financial statement
schedules of RCN Corporation and Subsidiaries listed in Item 14(a) of this Form
10-K. These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedules 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of RCN
Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedules referred to above, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material respects,
the information required to be included therein.
\s\ Coopers & Lybrand L.L.P.
- ----------------------------
COOPERS & LYBRAND, L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 13, 1998
<PAGE>
EXHIBIT 10.M
AMENDED AND RESTATED
OPERATING AGREEMENT
OF
STARPOWER COMMUNICATIONS, LLC
This AMENDED AND RESTATED OPERATING AGREEMENT OF STARPOWER COMMUNICATIONS, LLC
(this "Agreement") is made and entered into effective as of __________, 1997
(the "Effective Date"), by and between Pepco Communications, L.L.C. ("PCI-Sub")
and RCN Telecom Services of Washington, D.C., Inc. ("RCN-Sub").
WHEREAS the Members have entered into an initial LLC operating agreement dated
as of October 28, 1997 (the "Initial Operating Agreement") and desire to amend
and restate the Initial Operating Agreement, in its entirety.
FOR AND IN CONSIDERATION OF the mutual covenants, rights, and obligations set
forth in this Agreement, the benefits to be derived therefrom, and other good
and valuable consideration, the receipt and the sufficiency of which each Member
acknowledges, the Members agree that the Initial Operating Agreement is hereby
amended in its entirety as follows:
ARTICLE 1
DEFINITIONS
-----------
1.1 CERTAIN DEFINITIONS. As used in this Agreement, the following terms have
the following meanings:
"Act" means the Delaware Limited Liability Company Act.
"Adjusted Capital Account Deficit" means, with respect to any Member, the
deficit balance, if any, in such Member's Capital Account as of the end of the
relevant fiscal year of the Company (i) increased by an amount equal to the sum
---------
of such Member's allocable share of the Company's Minimum Gain attributable to
Company Nonrecourse Liabilities and such Member's allocable share of the
Company's Minimum Gain attributable to Member Nonrecourse Debt, in each case as
computed on the last day of such fiscal year in accordance with applicable
Regulations and (ii) reduced by all reasonably expected adjustments,
-------
allocations and distributions described in Regulations Sections 1.704 -
1(b)(2)(ii)(d)(4), (5) and (6). This definition of Adjusted Capital Account
Deficit is intended to comply with the provisions of Regulations Section 1.704-
1(b)(2)(ii)(d) and shall be interpreted consistently therewith.
"Affiliate" means, with respect to any Person or Entity, any other Person
directly or indirectly through one or more intermediaries, Controlling,
Controlled by, or under common Control with that first Person.
<PAGE>
"Agency Agreement" means the Agency Agreement by and among RCN-Sub, RCN
Telecom Services of Maryland, Inc., RCN Telecom Services of Virginia, Inc. and
the Company dated as of the date hereof and attached hereto as Exhibit A.
"Agents" has the meaning, solely for the purpose of Section 13.8, given that
term in Section 13.8.
"Agreed Value" of any Contributed Property means the fair market value of
such property or other consideration as determined by agreement of all of the
Members using such reasonable method of valuation as they may adopt for that
Contributed Property contributed after the date hereof.
"Agreement" has the meaning given that term in the introductory paragraph
hereof.
"Assignment of Benefits Agreement" means the Assignment of Benefits
Agreement, dated as of the date hereof, between RCN-Sub and the Company and
attached hereto as Exhibit B.
"Bankrupt Member" means any Member:
(a) that (i) makes a general assignment for the benefit of creditors, (ii)
files a voluntary bankruptcy petition, (iii) becomes the subject of an
order for relief or is declared a bankrupt or insolvent in any federal
or state bankruptcy or insolvency proceeding, (iv) files a petition or
answer seeking for such Member a reorganization, arrangement,
composition, readjustment, liquidation, dissolution, or similar relief
under any law, statute or regulation, (v) files an answer or other
pleading admitting or failing to contest the material allegations of a
petition filed against such Member in a proceeding of the type
described in clauses (i)-(iv), (vi) seeks, consents to, or acquiesces
in the appointment of a trustee, receiver, or liquidator of the Member
or of all or any substantial part of the Member's properties, or
(b) with respect to which (i) a proceeding is commenced seeking
reorganization, arrangement, composition, readjustment, liquidation,
dissolution, or similar relief under any law, statute or regulation,
and 120 days have expired without the proceeding being dismissed, or
(ii) without that Member's consent or acquiescence, a trustee,
receiver, or liquidator is appointed of that Member or of all or any
substantial part of its properties and 90 days have expired without
the appointment being vacated or stayed, or if stayed, 90 days have
expired after
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<PAGE>
the date of expiration of a stay, unless the appointment
has been vacated.
"Baltimore Gas Merger" shall mean the merger of PEPCO and Baltimore Gas and
Electric Company ("BGE") into Constellation Energy Company, a newly formed
company, pursuant to a merger agreement entered into between PEPCO and BGE, to
create an integrated, non-holding company structure. The companies are awaiting
regulatory approvals before the merger can be completed. The exact structure of
the subsidiaries of the companies has not yet been determined. In the event the
Baltimore Gas Merger does not occur, a strategic alliance between PCI and a BGE
entity may occur.
"Basic Agreements" means this Agreement, the Non-Competition Agreement, the
IRU Agreement, the Support Services Agreement, the Assignment of Benefits
Agreement, the PCI Guarantee, the RCN Guarantee, the Overhead Attachment
Agreements, the Agency Agreement and the Contribution Agreement.
"Business Day" means any day other than a Saturday, a Sunday or a holiday on
which banks in the District of Columbia generally are closed.
"Business Plan" has the meaning given that term in Section 7.17.
"Capital Account" means the capital accounts maintained with respect to
Membership Interests pursuant to Section 6.1.
"Capital Calls" has the meaning given that term in Section 4.2(b).
"Capital Contribution" means contributions of capital to the Company as set
forth in Schedule I and any other contribution of capital, whether in cash
or in kind, made in accordance with this Agreement except Non-Cash Capital
Contributions.
"Carrying Value" means, with respect to any asset, the asset's adjusted tax
basis for federal income tax purposes except as follows:
(a) The initial Carrying Value of any asset contributed to the Company by a
Member shall be the Agreed Value of such asset;
(b) Consistent with the provisions of Section 1.704-1(b)(2)(iv)(f) of the
Regulations, the Carrying Value of all Company assets shall be adjusted to equal
their respective gross fair market values upon the happening of any of the
following events: (i) issuance of additional Membership Interests to new or
existing Members for more than a de minimis amount of cash or Contributed
Property, (ii) immediately prior to a distribution
-3-
<PAGE>
to a Member of more than a de minimis amount of Company property (other than a
distribution solely of cash that is not in redemption or retirement of a
Membership Interest) in consideration for an interest in the Company and (iii)
the liquidation of the Company within the meaning of Regulations Section 1.704-
1(b)(2)(ii)(g).
(c) The Carrying Values of Company assets shall be increased or decreased to
reflect any adjustments to the adjusted basis of such assets pursuant to Section
734(b) or Section 743(b) of the Code, but only to the extent that such
adjustments are taken into account in determining Capital Accounts pursuant to
Regulations Section 1.704-1(b)(2)(iv)(m), Section 6.2(b)(vii) hereof and
paragraph (e) of the definition of Net Income or Net Loss.
If the Carrying Value of an asset has been determined or adjusted pursuant
to subparagraphs (a), (b) or (c) of the definition for Carrying Value, such
Carrying Value shall be adjusted thereafter by the Depreciation taken into
account with respect to such asset for purposes of computing the amount of Net
Income or Net Loss.
"Certificate" has the meaning given that term in Section 2.1.
"Change of Control" of a Member shall be deemed to have occurred when the
Member Parent of such Member or a Wholly Owned Affiliate of such Member Parent
shall no longer (i) beneficially own, directly or indirectly, more than 50% of
the outstanding voting interests in such Member entitled to vote generally in
the election of directors, managers or other members of the management group of
such Member or (ii) otherwise control the management of such Member; provided,
--------
however, that the Baltimore Gas Merger shall not be deemed a Change of
Control for the purposes of this Agreement.
"Change of Control Member" has the meaning given that term in Section 3.3.
"Change of Control Member's Interest" has the meaning given that term in
Section 3.3.
"Change of Control Notice" has the meaning given that term in Section
3.3(b)(ii).
"Code" means the Internal Revenue Code of 1986 and any successor statute, as
amended from time to time.
"Company" means Starpower Communications, LLC, a Delaware limited liability
company.
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<PAGE>
"Company Nonrecourse Deductions" means the amount of deductions, losses and
expenses attributable to Company Nonrecourse Liabilities, as determined in
accordance with applicable Regulations.
"Company Nonrecourse Liabilities" means nonrecourse liabilities (or portions
thereof) of the Company for which no Member (or any Person related to a
Member) bears the Economic Risk of Loss.
"Contributed Property" means each property or other asset, in such form as
may be permitted by the Act, but excluding cash, contributed to the Company.
"Contribution Agreement" means the Contribution Agreement, of even date
herewith, by and between RCN-Sub and the Company.
"Control" (including the terms "Controlling", "Controlled by" and "under
common Control with") of an Entity means the power to direct or cause the
direction of the management or policies of such Entity, whether through the
ownership of voting securities, by agreement or otherwise.
"Cost" shall mean reasonable costs incurred including (a) all costs directly
related to the relevant transactions and (b) indirect project/departmental,
general and administrative overheads which have an agreed upon relationship to
the Company and can be allocated on an agreed upon fair basis at their cost, but
no element of markup or profit by a Member Parent, subsidiary or any Affiliate,
shall be included in any costs charged to the Company unless agreed to in
advance in writing by the Members. The direct costs of a Member resulting from
transactions with its Member Parent, or any subsidiary or Affiliate, shall
reflect a consistent and fair transfer pricing methodology at its cost and
agreed to by the Members. Cost shall not exceed the fair market price for
identical or substantially similar transactions. Notwithstanding anything herein
to the contrary, the facilities and services provided pursuant to the IRU
Agreement, the Master Facility Lease Agreement and the Pole Attachment
Agreements shall be provided at the value as set forth therein.
"Covenant Violation" has the meaning given that term in Section 7.11.
"Deadlock Event" has the meaning given that term in Section 7.15.
"Default Interest Rate" means the prime rate charged by Citibank, N.A., plus
5%.
"Delinquency Notice" has the meaning given that term in Section 4.3(a).
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<PAGE>
"Delinquent Member" with respect to a Capital Contribution means a Member
who fails to pay its portion of such Capital Contribution at the time and in the
amount required under this Agreement following notice and an opportunity to cure
such failure in accordance with Section 4.3 hereof.
"Depreciation" means, for each fiscal year or other relevant period, an
amount equal to the depreciation, amortization or other cost recovery deduction
allowable with respect to an asset for such year or other relevant period,
except that if the Carrying Value of an asset differs from its adjusted basis
for federal income tax purposes at the beginning of such year, Depreciation
shall be an amount which bears the same ratio to such beginning Carrying Value
as the federal income tax depreciation, amortization or other cost recovery
deduction for such year bears to such beginning adjusted tax basis; provided,
however, that if the adjusted basis for federal income tax purposes of an asset
at the beginning of such year is zero, Depreciation shall be determined with
reference to such beginning Carrying Value using any reasonable method selected
by the Tax Matters Partner.
"Disapproving Member" has the meaning given that term in Section 7.11.
"Disapproving Member Loan" has the meaning given that term in Section
7.11(d)(ii).
"Dispose," "Disposing," or "Disposition" means a sale, assignment, transfer,
exchange, pledge, grant of a security interest, or other disposition or
encumbrance, or the acts thereof.
"Disputing Member" has the meaning given that term in Section 7.15(b)(i).
"Dispute Notice" has the meaning given that term in Section 7.15(b)(i).
"Dispute Price" has the meaning given that term in Section 7.15(b)(i).
"Economic Risk of Loss" has the meaning ascribed to it in Section 1.752-2 of
the Regulations.
"Effective Date" has the meaning given that term in the introductory
paragraph hereof.
"Electing Member" has the meaning given that term in Section 3.2(b)(vi).
-6-
<PAGE>
"Entity" means any corporation, limited liability company, general
partnership, limited partnership, venture, trust, business trust, estate or
other entity.
"Estimated Value has the meaning given that term in Section 3.3(b)(ii).
"Forecast Member Tax Requirements" means an annual amount computed by taking
the taxable income to be reported by a Member as a result of its Sharing Ratio
in the Company for any fiscal year multiplied by the highest, then applicable,
federal income tax rate and the estimated average, then applicable, state income
tax rate which would be applied to the taxable income reported by such Member
for that fiscal year of the Company, reduced by any tax credits or other
benefits available to such Member solely as a result of the operations of the
Company, but irrespective of such Member's separate net operating loss, tax
credit or other tax benefit which may be available to such Member for that
fiscal year.
"GAAP" means the generally accepted accounting principles in the United
States of America in effect from time to time.
"General Interest Rate" means a rate per annum equal to the lesser of (a) a
varying rate per annum that is equal to the interest rate publicly quoted by
Citibank, N.A. from time to time as its prime commercial or similar reference
interest rate, with adjustments in that varying rate to be made on the same date
as any change in that rate, and (b) the maximum rate permitted by applicable
law.
"Governmental Entity" has the meaning given that term in Section
2.5(a)(iii).
"Holding Company" means a Holding Company as defined in Section 2(a)(7) of
PUHCA.
"Initial LLC Agreement" means that certain operating agreement, dated as of
October 31, 1997, entered into by RCN-Sub and PCI-Sub and attached hereto as
Exhibit C.
"IRU Agreement" means that certain Fiber Use Agreement entered into by the
Company and PEPCO of even date herewith in the form attached hereto as
Exhibit D.
"Majority Interest" means, in combination, Membership Interests of one or
more Members which, in the aggregate, are entitled to a combined Sharing Ratio
of more than 50%.
"Major Cost Categories" has the meaning given that term in Section 7.13.
-7-
<PAGE>
"Manager" has the meaning given that term in Section 7.2.
"Marks" has the meaning given that term in Section 2.14(a).
"Member" means any Person executing this Agreement as of the date hereof as
a member or hereafter substituted or admitted to the Company as a Member as
provided in this Agreement, but does not include any Person who has ceased to be
a Member in the Company. For purposes of this Agreement, all consents, elections
or other actions by a Member shall be acted upon by such Member and any of its
Affiliates who are also Members, acting as a single Member for purposes of any
such consent, elections or other actions hereunder.
"Members Committee" has the meaning given that term in Section 7.1.
"Member Nonrecourse Debt" means any nonrecourse debt of the Company for
which any Member (or any Person related to a Member) bears the Economic Risk of
Loss, as determined in accordance with applicable Regulations.
"Member Nonrecourse Deductions" means, with respect to Member Nonrecourse
Debt, the amount of deductions, losses and expenses equal to the net increase
during the year in Minimum Gain attributable to Member Nonrecourse Debt, reduced
(but not below zero) by the proceeds, if any, of such Member Nonrecourse Debt
distributed during the year to the Members who bear the Economic Risk of Loss
for such debt, as determined in accordance with applicable Regulations.
"Member Parent" means, with respect to RCN-Sub, RCN,and, with respect to
PCI-Sub, PCI, and their respective successors and assigns, whether by means of
merger, spinoff or otherwise, provided that, (a) if PCI-Sub becomes a subsidiary
of another Entity following compliance with Section 3.3 hereof, then the Member
Parent with respect to PCI-Sub shall mean such other Entity and (b) if RCN-Sub
becomes a subsidiary of another Entity following compliance with Section 3.3
hereof, then the Member Parent with respect to RCN-Sub shall mean such other
Entity.
"Membership Interest" means the interest of a Member in the Company,
including, without limitation, such rights to distributions (liquidating or
otherwise), allocations, information and to consent or approve as shall be
provided by law or by this Agreement.
"Minimum Gain" means (i) with respect to Company Nonrecourse Liabilities,
the amount of gain that would be realized by the Company if it disposed of (in a
taxable transaction) all Company properties that are subject to Company
Nonrecourse Liabilities
-8-
<PAGE>
in full satisfaction of such liabilities, computed in accordance with applicable
Regulations or (ii) with respect to each Member Nonrecourse Debt, the amount of
gain that would be realized by the Company if it disposed of (in a taxable
transaction) the Company property that is subject to such Member Nonrecourse
Debt in full satisfaction of such debt, computed in accordance with applicable
Regulations.
"Net Agreed Value" means (i) in the case of any Contributed Property, the
Agreed Value of such property reduced by any liabilities either assumed by the
Company upon such contribution or to which such property is subject when
contributed and (ii) in the case of any property distributed to a Member by the
Company, the Company's Carrying Value of such property (as adjusted pursuant to
clause (b)(ii) of the definition of Carrying Value) at the time such property is
distributed, reduced by any liabilities either assumed by such Member upon such
distribution or to which such property is subject at the time of distribution,
in either case, as determined under Section 752 of the Code and any other
applicable provisions of the Code.
"Net Income" or "Net Loss" means, for each fiscal year or other period, the
taxable income or loss of the Company, as determined in accordance with Section
703 of the Code, with the following adjustments:
(a) Any income of the Company that is exempt from federal income tax and
not otherwise taken into account in computing Net Income or Net Loss
shall be added to such taxable income or loss;
(b) Any expenditures of the Company described in Section 705(a)(2)(B) of
the Code or treated as Code Section 705(a)(2)(B) expenditures pursuant
to Regulations Section 1.704-1(b)(2)(iv)(i) and not otherwise taken
into account in computing Net Income or Net Loss shall be subtracted
from such taxable income or loss;
(c) In the event that the Carrying Value of any Company asset is adjusted
pursuant to paragraph (b) of the definition for Carrying Value, the
amount of such adjustment shall be taken into account as gain or loss
from the disposition of such asset for purposes of computing Net
Income or Net Loss;
(d) Gain or loss resulting from any disposition of property with respect
to which gain or loss is recognized for federal income tax purposes
shall be computed by reference to the Carrying Value of the property
disposed of, notwithstanding that the adjusted tax basis of such
property differs from its Carrying Value;
-9-
<PAGE>
(e) To the extent that an adjustment to the adjusted tax basis of any
Company asset pursuant to Section 734(b) or Section 743(b) of the Code
is required pursuant to Regulations Section 1.704-1(b)(2)(iv)(m)(4) to
be taken into account in determining Capital Accounts as a result of a
distribution other than in complete liquidation of a Member's
Membership Interest, the amount of such adjustment shall be treated as
an item of gain (if the adjustment increases the basis of the asset)
or loss (if the adjustment decreases the basis of the asset) from the
disposition of the asset and shall be taken into account for purposes
of computing Net Income or Net Loss;
(f) In lieu of depreciation, amortization and other cost recovery
deductions taken into account in computing such taxable income or
loss, Depreciation shall be taken into account.
(g) Any items which are specially allocated pursuant to Section 6.2(b)
hereof shall not be taken into account in computing Net Income or Net
Loss.
"Net Operating Available Cash" means at the time of determination, (a) all
cash and cash equivalents on hand in the Company, plus (b) for the twelve month
----
period following the date of determination, forecast net income of the Company,
plus the sum of forecast depreciation, amortization and other non-cash charges
- ----
to income, in each case to the extent deducted in determining such net income,
plus the forecast cash proceeds of dispositions of assets (net of expenses),
- ----
plus an amount equal to the forecast net proceeds of debt financings, less (c)
- ---- ----
the Forecast Cash Requirement, if any, of the Company, as determined by the
Members. For purposes of this definition, Forecast Cash Requirement means, for
the twelve-month period following the date of determination, projected capital
expenditures, cash contributions to other entities and other cash investments,
cash payments in connection with acquisitions, cash income tax payments and debt
service (including principal and interest) requirements and other non-cash
credits to income, plus forecast cash reserves for future operations or other
----
requirements.
"1998 Business Plan" has the meaning given that term in Section 7.17.
"Non-Cash Capital Contribution" has the meaning given that term in Section
5.2.
"Non-Competition Agreement" means that certain Non-Competition Agreement
entered into by PCI and RCN of even date herewith in the form attached hereto as
Exhibit E.
"Nondelinquent Member" as the meaning given that term in Section 4.3(a).
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<PAGE>
"Other Member" has the meaning given that term in Section 3.3(b)(ii).
"Overhead Attachment Agreements" means those certain Overhead Attachment
Agreements entered into by the Company and PEPCO of even date herewith in the
forms attached hereto as Exhibits F and G.
"PCI" means Potomac Capital Investment Corporation, Inc., a Delaware
corporation.
"PCI Guarantee" means that certain Guarantee of even date herewith granted
by PCI on behalf of PCI-Sub in favor of the Company in the form attached hereto
as Exhibit H.
"PCI-Sub" means PEPCO Communications, LLC, a Delaware limited liability
company and a wholly-owned subsidiary of PCI.
"PCI-Sub Non-Cash Capital Contribution" has the meaning given that term in
Section 5.2.
"PEPCO" means Potomac Electric Power Company, a District of Columbia and
Virginia corporation.
"Person" means any natural person or Entity.
"Phase I Business Plan" has the meaning given that term in Section 7.17.
"Profits Distributions" shall mean net income of the Company for any fiscal
year determined in accordance with GAAP increased by the sum of depreciation,
amortization and any non-cash charges to income and reduced by the sum of any
non-cash credits to income for such fiscal year.
"Proposed Funding" has the meaning given that term in Section 7.11.
"PUHCA" means the Public Utility Holding Company Act of 1935, as amended
from time to time, 15 U.S.C. (S)(S)79-792-6.
"Purchasing Member" has the meaning given that term in Section 11.2.
"Purchasing Price" has the meaning given that term in Section 3.3(b)(ii).
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<PAGE>
"RCN" means RCN Telecom Services, Inc., a Delaware corporation.
"RCN Corporation" means RCN Corporation, a Delaware corporation.
"RCN Guarantee" means that certain Guarantee of even date herewith granted
by RCN Corporation on behalf of RCN-Sub and certain other RCN Entities in favor
of the Company in the form attached hereto as Exhibit I.
"RCN-Operating" means RCN Operating Services, Inc., a New Jersey
corporation.
"RCN Services" means RCN Telecom Services, Inc., a Delaware corporation.
"RCN-Sub" means RCN Telecom Services of Washington, D.C., Inc., a District
of Columbia corporation and wholly-owned subsidiary of RCN.
"RCN-Sub Non-Cash Capital Contribution" has the meaning set forth in Section
5.1(a).
"Regulations" means the final and temporary Income Tax Regulations
promulgated under the Code, as amended from time to time, and including
corresponding provisions of succeeding regulations.
"Regulatory Allocations" has the meaning given that term in Section
6.2(b)(viii).
"Relevant Business" means the selling of voice, video, data and other
telecommunications services set forth on Schedule II to all potential commercial
and residential customers in the Relevant Market.
"Relevant Market" means that specific service territory as set forth on
Schedule III.
"Secretary of State" means the Secretary of State of the State of Delaware.
"Selling Price" has the meaning given that term in Section 3.3(b)(ii).
"Sharing Ratio" means, subject to adjustments on account of Dispositions
(pursuant to Section 3.2), or Capital Contributions or Capital Calls
(pursuant to Sections
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<PAGE>
4.3 and 7.11), with respect to a particular Member, the percentage set
forth opposite such Member's name on Schedule IV.
"Shortfall Amount" has the meaning given that term in Section 7.11(a).
"Shortfall Funding" has the meaning given that term in Section 7.11(d)(ii).
"Support Services Agreement" means the Support Services Agreement between
RCN-Operating and the Company dated as of the date hereof and attached hereto as
Exhibit J as the same may be modified and amended from time to time.
"Tax Matters Partner" means PCI-Sub.
"Third Party Sale" has the meaning given that term in Section 3.2(b)(v).
"Unrealized Gain" or "Unrealized Loss" attributable to any item of Company
property means, as of any date of determination, the excess or shortfall,
respectively, of (a) the fair market value of such property as of such date (as
determined under Section 6.1(d)) over (b) the Carrying Value of such property as
of such date (prior to any adjustment to be made pursuant to the definition of
Carrying Value as of such date).
"Wholly Owned Affiliate" means as to any Entity, an Affiliate all of the
equity interests of which are owned, directly or indirectly, by a Member, by
another Wholly Owned Affiliate, or by the Member Parent thereof.
0.1 OTHER DEFINITIONS. Other terms defined herein have the meanings so given
them.
0.2 CONSTRUCTION. Whenever the context requires, the gender of all words
used in this Agreement includes the masculine, feminine, and neuter. All
references to Articles and Sections refer to articles and Sections of this
Agreement, and all references to Exhibits are to Exhibits attached hereto, each
of which is made a part hereof for all purposes.
ARTICLE 1
ORGANIZATION
------------
1.1 ORGANIZATION. The Company was organized on October 28, 1997 pursuant to
a Certificate of Formation filed in the office of the Secretary of State (the
"Certificate").
1.2 NAME. The name of the Company is "Starpower Communications, LLC" and all
Company business must be conducted in that name or such other names that comply
with
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<PAGE>
applicable law as the Members may select from time to time.
1.3 REGISTERED OFFICE; REGISTERED AGENT; PRINCIPAL OFFICE IN THE UNITED
STATES; OTHER OFFICES. The registered office of the Company in the State of
Delaware shall be the initial registered office designated in the Certificate or
such other office (which need not be a place of business of the Company) as the
Members may designate from time to time in the manner provided by law. The
registered agent of the Company in the State of Delaware shall be the initial
registered agent designated in the Certificate, or such other Person or Persons
as the Members may designate from time to time in the manner provided by law.
The principal office of the Company in the United States shall be at 1130
Connecticut Avenue, N.W. Suite 400, Washington, D.C. 20036 or such other
place(s) as the Members may designate from time to time, which need not be in
the State of Delaware but shall be in the District of Columbia. The Company may
have such other offices as the Members may determine appropriate.
1.4 PURPOSE. The business purpose of the Company is (i) to construct, own,
lease and operate a network to conduct the Relevant Business(es), (ii) to market
the Relevant Business(es) to business and residential customers in the Relevant
Market, and (iii) to engage in and carry on any lawful business purpose or
activity which is required to conduct the Relevant Business in the Relevant
Market that is not prohibited by the Act or other applicable law.
1.5 COMPANY POWERS.
(a) In furtherance of the business purpose specified in Section 2.4 hereof,
but subject to the limitations and restrictions set forth in this Agreement, the
Company shall be empowered to do or cause to be done, or omit to do or cause to
be done, any and all acts deemed to be necessary or advisable in furtherance of
the business purpose of the Company, including, without limitation, the power
and authority to:
(i) Have, maintain or close one or more offices within or without the
State of Delaware and in connection therewith to rent or acquire office space
and to engage personnel;
(ii) Open, maintain and close bank and money market accounts, including
the power to draw checks or other orders for the payment of moneys, and to
invest such funds as are temporarily not required for Company purposes in
short-term investments;
(iii) Bring and defend actions and proceedings at law or equity
before any domestic or foreign governmental or regulatory authority,
agency or commission (each, a "Governmental Entity");
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(iv) Have outstanding at any time any indebtedness (including any
indebtedness of subsidiaries) for money borrowed, guarantee the obligations
of others or otherwise become contingently liable with respect to any
indebtedness or obligations of others (collectively, "Company Debt"), and in
connection therewith to grant security interests, if and only if the Company
Debt was incurred in connection with, or for the purpose of entering into,
the financing of the operations of the business of or for other business
purposes of the Company; provided that "Company Debt" shall, for purposes
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of this Agreement, be deemed to include all interest, fees (including
commitment, guaranty and facility fees), expenses thereon and all other
amounts due in respect thereof;
(v) Enter into, perform and carry out contracts and agreements of every
kind necessary or incidental to the accomplishment of the Company's
purposes, and to take or omit to take such other action in connection with
the business of the Company as may be necessary or desirable to further the
purposes of the Company; and
(vi) Carry on any other activities necessary to, in connection with, or
incidental to any of the foregoing or the Company's business.
(b) Notwithstanding anything in Section 2.5(a) to the contrary, the Company
will not take any action, nor will any Member or officer or employee of the
Company take any action, which, in each such case, would cause the Company to be
in violation of any applicable statute, rule or regulation of any Governmental
Entity.
1.6 FOREIGN QUALIFICATION GOVERNMENTAL FILINGS. Prior to the Company's
conducting business in any jurisdiction other than the State of Delaware, the
Members shall cause the Company to comply, to the extent procedures are
available, with all requirements necessary to qualify the Company as a foreign
limited liability company in such jurisdiction. Each Member shall execute,
acknowledge and deliver all certificates and other instruments conforming to
this Agreement that are necessary or appropriate to qualify, or, as appropriate,
to continue or terminate such qualification of, the Company as a foreign limited
liability company in all such jurisdictions in which the Company may conduct
business.
1.7 REGULATORY APPROVALS. The Members agree to use all commercially
reasonable efforts to cooperate in obtaining all regulatory, third party and
other approvals which may be necessary to form the Company and operate the
Relevant Business of the Company in the Relevant Market as is intended herein.
1.8 EFFORTS. Upon the terms and subject to the conditions of this Agreement
and the other Basic Agreements, documents and instruments pursuant to which the
transactions contemplated hereby are to be consummated, PCI-Sub and RCN-Sub will
use their respective
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commercially reasonable efforts to take, and to cause their Affiliates to take,
all other actions, and to do, or cause to be done, all other things necessary,
proper or advisable to carry out their obligations under this Agreement and to
consummate and make effective the transactions contemplated hereby and by the
Basic Agreements, including, without limitation,
(i) as soon as practicable following the execution of this Agreement, to
make all applications and filings and to use their respective commercially
reasonable efforts to obtain all other authorizations and consents required
to be obtained by each Member or its Affiliates in connection with the
consummation of the transactions contemplated by this Agreement and by the
other Basic Agreements;
(ii) in the event any changes in the structure or the terms of the
transactions or agreements contemplated by this Agreement or by any of the
other Basic Agreements are required to facilitate obtaining the
authorizations required in order to achieve the purposes of the Company, to
use their respective commercially reasonable efforts to accommodate such
changes to the extent they would not adversely affect such Member's rights or
obligations hereunder (or under any other agreement, document or instrument
contemplated hereby), or have an adverse effect on the Relevant Business in
the Relevant Market; and
(iii) Subject to Section 13.1(e), in the event any claim, action, suit,
investigation or other proceeding by any governmental authority or other
person is commenced which questions the validity or legality of any of the
transactions contemplated hereby or by any of the other Basic Agreements or
any injunction or other order is issued in any such proceeding, to cooperate
with the Company or the other Member hereto regarding the defense of such
proceedings and the removal of any such impediment to the consummation of
such transactions and to use its commercially reasonable efforts to have such
injunction or other order dissolved.
1.9 TERM. The Company commenced on the date the Certificate for the Company
was filed with the Secretary of State, and shall continue in existence in
perpetuity unless terminated in accordance with Article 12.
1.10 NO STATE-LAW PARTNERSHIP. The Members intend that the Company not be a
general partnership or limited partnership, and that no Member be a partner of
any other Member, for any purposes other than federal, state and local income
tax purposes, and this Agreement shall not be construed to suggest otherwise.
1.11 ACTIVITIES OF THE MEMBERS. Except as expressly restricted by the Non-
Competition Agreement, each Member and its Affiliates may engage in or hold
interests in other business ventures and activities of any nature, including,
without limitation, ventures and activities similar to those of the Company, and
neither the Company nor the other Members
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shall, by virtue of this Agreement, have any interest or rights in or to such
other ventures or business or any liability or obligation with respect thereto.
1.12 BRANDING. Each Member shall cause its respective appropriate Affiliate
to grant to the Company a non-exclusive, worldwide, royalty-free license,
without right of sublicense, to use the name of such Member in connection with
the Relevant Business in the Relevant Market, for so long as such Member remains
a Member. The Company will not attempt to register any marks which include the
name of such Member. Upon termination of the license granted hereunder, the
Company will cease all use of the name of such Member, subject to a reasonable
transition license not to exceed six months in duration from the date such
Member ceases to be a Member.
1.13 NO UNILATERAL ACTION. The Members agree that neither Member nor any of
their respective affiliates will take any action on its own behalf to bind or
obligate the Company or restrict the operations of the Company in any way that
would have a material adverse effect on the Company.
1.14 TRADEMARK USAGE. (a) The Company recognizes that RCN Services is the
owner of all right, title, and interest in the trademarks and/or service marks
listed on Schedule 2.14 (the "Marks"). The parties agree that the Company may
prominently use the Marks, but only in combination with a separate name to be
determined by the Company. In furtherance thereof, RCN Services hereby grants to
the Company a non-exclusive, worldwide, royalty-free license, with right of
sublicense solely for the purpose of use by resellers of the Company's services,
to use the Marks in combination with the name of the Company in connection with
the Relevant Business in the Relevant Market. RCN Services will have the right
to set reasonable quality standards with respect to the use of the Marks,
including reasonable rights of inspection with respect thereto, in order to
preserve the validity of the Marks as trademarks and/or service marks of RCN
Services.
(b) The Company will not attempt to register any marks which include the
Marks. Notwithstanding the foregoing, all trademark or service mark rights which
may accrue in the Company name which is used with the Marks shall belong to the
Company and the Company may seek registrations for the separate name, so long as
such registrations do not include the Marks. Upon termination of RCN-Sub's or
any RCN Entities' membership in the Company, the license to use those certain
Marks which are or have been utilized by the Company shall continue for a period
of seven years from the date RCN-Sub or any RCN Entity is no longer a Member of
the Company.
1.15 ALLOCATION OF COSTS. The Members agree that all costs incurred by any
Member prior to the date hereof shall be borne solely by such Member and not
passed through to the
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Company unless otherwise agreed to by the Members.
1.16 ALLOCATION OF REVENUES. The Members agree that the Company will be
compensated for the use of any Company facilities used by or leased by any RCN-
Sub affiliate or PCI-Sub affiliate to 1) originate or terminate
telecommunications services (including, but not limited to, voice, video or data
services) in the Relevant Market; or 2) transport telecommunications services
(including, but not limited to, voice, video or data services ) through the
Relevant Market. The compensation will be negotiated on an individual case basis
between the Company and such affiliate and will be based on factors including,
but not limited to, the market rate for similar services, the type of facility
provided, mileage of the facility in the Relevant Market, and construction and
other costs.
ARTICLE 2
MEMBERS; DISPOSITIONS OF INTERESTS
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2.1 MEMBERS. The Members of the Company are the Persons executing this
Agreement and/or Persons admitted as substitute or additional Members as
permitted by this Article 3. No additional Members may be admitted as such
without the consent of PCI-Sub and RCN-Sub. At such time as any additional
Member is to be admitted, this Agreement shall be amended to reflect the terms
agreed to by the Members. Any assignee pursuant to a transfer of all of a
Member's Interest in accordance with this Agreement shall automatically be
admitted as a Member.
2.2 RESTRICTIONS ON THE DISPOSITION OF AN INTEREST.
(a) Except as provided in this Section 3.2, a Disposition by a Member of
all or any part of a Membership Interest may be effected only with the
prior express written consent of the other Member. Any attempted
Disposition by a Person of a Membership Interest, or any part thereof,
other than in accordance with this Section 3.2 is void and the Company
shall not recognize it.
(b) Subject to the provisions of Section 3.2(c)-(h), from and after the
date that is four years from the Effective Date (the "Standstill Period"),
a Member may Dispose of part or all of its Membership Interest to a bona
fide third party purchaser provided that the Member who wishes to Dispose
of its Membership Interest (an "Offeror") first offers such Membership
Interest to the other Member (the "Offeree") and Disposes of such
Membership Interest in accordance with the following procedures:
(i) The Offeror shall give written notice of the terms of the offer,
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including but not limited to the price, terms of payment, the Sharing
Ratio of such Offeror's Membership Interest offered and the Sharing
Ratios of all Membership Interests then held by the Offeror (an "Offer
Notice") to the Offeree and the Company.
(ii) The Offeree shall have 60 days, commencing with the date on which
it has received the Offer Notice, to purchase all of the Membership
Interest offered.
(iii) The Offeree may exercise this election to purchase
the Membership Interest by giving the Offeror and the Company written
notice thereof within 60 days of Offeree's receipt of the Offer Notice,
and the Company shall then specify the date and time of the closing of
the purchase at the Company's principal office, which shall be
reasonably acceptable to the Offeror and the Offeree, but shall not be
later than 10 days following the Offeree's exercise of its election to
purchase the Membership Interest (unless the Offeree and the Offeror
agree upon another time and/or place of closing).
(iv) At the closing, the purchasing Offeree (if any) shall purchase
the Membership Interest at the price and on the terms set forth in the
Offer Notice, and the Offeror shall execute and deliver such usual and
customary documents and instruments of transfer and conveyance as are
required to provide clear title in the transferred Membership Interest
to the Offeree, including all deeds, assignments, releases,
agreements, receipts or other documents necessary to consummate the
transfer of the Membership Interest being sold and delivered upon
payment by the Offeree.
(v) Should the Offeree fail to purchase all of the offered Membership
Interests specified in the Offer Notice, then the Offeror shall not be
required to Dispose of any of its Membership Interest to the Offeree,
but shall be permitted to Dispose of all of the offered Membership
Interest specified in the Offer Notice to a third party on terms no more
favorable to the third party than the terms set forth in the Offer
Notice (a "Third Party Sale"), provided that the Third Party Sale is
consummated within 120 days of the date of the Offer Notice.
(vi) If an Offeror proposes to sell any part of its Membership Interest
in one or a series of related Third Party Sales, the Offeror shall give
notice to the Offeree and the Company, not less than 30 and not more
than 60 days prior to the consummation of the Third Party Sale, of the
material terms of the Third Party Sale, including the price, terms of
payment, and the Sharing Ratio of such
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Offeror's Membership Interest offered and the Sharing Ratios of all
Membership Interests then held by the Offeror, which terms shall be the
same or better to the Offeree than the terms offered to Offeree pursuant
to Section 3.2(b)(i) hereof. The Offeree who so elects by written notice
(an "Electing Member") to the Company and the Offeror within 15 days
thereafter shall be entitled to sell a portion of its Membership
Interest in the Third Party Sale that is equal to the proportion that
the Sharing Ratio of the Membership Interest being sold bears to the
Sharing Ratio of the entire Membership Interest owned by the Offeror.
(vii) Should an Offeror fail or choose not to sell its
Membership Interest at the terms previously presented to the Offeree,
but rather proposes to sell such Membership Interest to a third party on
new terms more favorable than such previously presented terms, such
Offeror shall offer again to sell its Membership Interest to the Offeree
on such new terms, in compliance with this Section 3.2.
(c) The Company may not recognize for any purpose any purported Disposition of
all or part of a Membership Interest unless and until the other applicable
provisions of this Section 3.2 have been satisfied and the non-Disposing
Member has received, on behalf of the Company, a document
(i) executed by both the Member effecting the Disposition and the Person
to which the Membership Interest or part thereof is Disposed,
(ii) including the notice address of any Person to be admitted to the
Company as a Member and its agreement to be bound by this Agreement in
respect of the Membership Interest or part thereof being obtained,
(iii)setting forth the Sharing Ratios after the
Disposition of the Member effecting the Disposition and the Person to
which the Membership Interest or part thereof is Disposed (which
together must total the sum of the Sharing Ratios of such Person and
the Member effecting the Disposition before the Disposition),
(iv) containing representations and warranties by such Person and such
Member as may be reasonably requested by the non-Disposing Member that
the Disposition was made in accordance with all applicable laws and
regulations (including securities laws), that any necessary regulatory
approvals have been obtained, including representations concerning its
solvency and regarding its ability to carry out all obligations of the
Offeror to the Company, including its Capital Contribution
obligations, and
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(v) containing a condition to closing requiring a certificate, dated as of
the date of the Disposition, duly executed by such Person, to the
effect that the representations and warranties in Section 3.2 are true
and correct with respect to that Person, and that all actions have
been taken as are required to provide clear title in the transferred
Membership Interest to the Offeree, including all deeds, assignments,
releases, agreements, receipts or other documents necessary to
consummate the transfer of the Membership Interest being sold and
delivered upon payment by the Offeree.
Each Disposition complying with the provisions of this Section 3.2(c) is
effective as of the first day of the calendar month immediately succeeding the
month in which all requirements of this Section 3.2 have been met so long as the
closing of the purchase and sale pursuant to this Section 3.2(c) shall occur no
later than 60 days following the receipt of the election by the non-Disposing
Member or the later receipt of all required regulatory and other approvals and
in no event later than 180 days following receipt of such election. Such closing
shall be subject to (i) the receipt of all required regulatory and other
approvals and in no event later than 180 days following receipt of such election
and (ii) the satisfaction of all amounts due hereunder in connection with the
disposition by the Disposing Party or the Person being admitted as a Member.
(d) Notwithstanding the foregoing, the provisions of this Section 3.2 shall
not apply to any transfer from a Member to its Member Parent, or a direct or
indirect wholly owned subsidiary of its Member Parent, provided that such Member
Parent guarantees the performance of all of such Member's obligations to the
Company, and provided further that such transferee shall comply with all of the
requirements of Section 3.2(c) hereof.
(e) For the right of a Member to Dispose of a Membership Interest or any
part thereof and of any Person to be admitted to the Company in connection
therewith to exist or be exercised (if applicable), either (i) the Membership
Interest or part thereof subject to the Disposition or admission must be
registered under the Securities Act of 1933, as amended, and any applicable
state securities laws or (ii) the Company must receive a favorable opinion of
the Company's legal counsel or of other legal counsel reasonably acceptable to
each non-Disposing Member to the effect that the Disposition or admission is
exempt from registration under those laws and regarding compliance with laws.
Each non-Disposing Member, however, may waive the requirements of this Section
3.2(e).
(f) In the event that (i) a Member effects a Disposition, or (ii) an Offeror
determines not to Dispose of its Membership Interest after having delivered an
Offer Notice to the other Members, the Member effecting such Disposition and any
Person admitted to the Company in connection with such Disposition or the
Offeror, as the case may be, shall pay, or
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reimburse the Company and the other Member for, all reasonable, documented costs
incurred by the Company and the other Member in connection with the Disposition,
admission or evaluation of the Offer (including, without limitation, the legal
fees reasonably incurred in connection with the legal opinions referred to in
Section 3.2(e)) on or before the 10th Business Day after the receipt of the
Company's and the other Member's invoices for the amount due by that Person. If
payment is not made by the date due, the Person owing such amount shall pay
interest on the unpaid amount from the date due until paid at a rate per annum
equal to the Default Interest Rate, and such amount may be withheld from any
future distributions. In addition to the foregoing, the Member effecting such
Disposition and any Person admitted to the Company in connection with such
Disposition hereby agrees to indemnify and hold the other Member harmless from
and against any material adverse affect on such other Member's present or future
allocable share of Company income or loss in respect of its Membership Interest
as compared to such other Member's present or future allocable share of Company
income or loss in respect of its Membership Interest if there had not been such
Disposition.
(g) Notwithstanding anything herein to the contrary, RCN-Sub may not
transfer or assign its Membership Interest to a third party after the Standstill
Period if PCI-Sub can reasonably demonstrate that the failure of the benefits of
one or more of the RCN Agreements to survive such transfer or assignment would
have a material adverse impact on the ability of the Company to conduct the
Relevant Business in the Relevant Market.
(h) The Members and any Offeree acquiring a Member's Membership Interest in
the Company agree that the obligations under the Support Services Agreement and
the PCI Support Services Agreement, as the case may be, shall, at the option of
the non-Disposing Member, survive the transfer or assignment of the transferring
Member's equity interest in the Company for a minimum of five years thereafter.
Each of the Members agrees that the benefits of the use of the IRU Agreement,
the Master Facility Lease Agreement and the Overhead Attachment Agreements (in
the event PCI-Sub is the Disposing Member) and the Assignment of Benefits
Agreement (in the event RCN-Sub is the Disposing Member) will, at the option of
the non-Disposing Member, continue under the terms and conditions thereof.
2.3 CHANGE OF CONTROL. (a) Upon any Change of Control of either RCN-Sub or
PCI-Sub, the Member subject to the Change of Control (the "Change of Control
Member") shall promptly give notice thereof to the other Member. If reasonably
practicable, the Member subject to the Change of Control will give notice to the
other Member prior to such Change of Control. Such Change of Control shall not
affect the affected Member's status as a Member so long as such Change of
Control does not have a material adverse effect on the Company.
(b) In the event that, in the reasonable judgment of the other Member, the
Change of Control of a Member will have a material adverse effect on the
Company:
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(i) such Member shall so notify the Change of Control Member within five
days of its receiving notice of the Change of Control.
(ii) The Change of Control Member shall submit a notice (a "Change of
Control Notice") to the other Member (the "Other Member") within 60 days after
receipt of such notice of material adverse effect. The Change of Control Notice
shall set forth an estimated value (the "Estimated Value") for the Company as of
the date of the Change of Control Notice. The Estimated Value multiplied by the
Change of Control Member's Sharing Ratio shall be the price (the "Selling
Price") at which the Change of Control Member is willing to sell its Membership
Interest to the Other Member. The Estimated Value multiplied by the Other
Member's Sharing Ratio shall be the price (the "Purchasing Price") at which the
Change of Control Member is willing to purchase the Other Member's Membership
Interest.
(iii) Within 60 days after the Other Member's receipt of the Change of
Control Notice, the Other Member shall signify in writing its election, whether
to buy the Change of Control Member's Interest at the Selling Price or to sell
its Membership Interest at the Purchasing Price. If the Other Member fails to
make such election within such 60 day period, the Change of Control shall be
deemed to have been accepted by the Other Member.
(iv) Each Member agrees to execute and deliver all deeds, assignments,
releases, agreements, receipts or other documents necessary to either (A)
consummate the transfer of the Membership Interest being sold and delivered upon
payment by the purchasing Member of the consideration provided for in the Change
of Control Notice or (B) affirm and ratify the Change of Control Member's status
as a Member.
(v) Subject to the receipt of all required regulatory and other approvals,
the closing of the purchase and sale pursuant to this Section 3.3(b) shall occur
no later than 60 days following the receipt of the election by the Other
Members.
2.4 INTERESTS IN A MEMBER. Notwithstanding any provision of this Agreement
to the contrary, without the prior express written consent of each other Member,
no Member shall Dispose of all or any part of its Membership Interest in such a
manner that, after the meaning of Section 708 of the Code if such termination
would result in material adverse tax consequences to the non-
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transferring Members or (ii) the Company would become an association taxable as
a corporation for federal income tax purposes.
2.5 LIABILITY TO THIRD PARTIES. No Member shall have any personal obligation
for any liabilities of the Company, whether such liabilities arise in contract,
tort or otherwise, except to the extent that any such liabilities are expressly
assumed in writing by such Member; provided, however, that nothing in this
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Section 3.5 shall be construed as an agreement by the Company to indemnify or
hold harmless any Member.
ARTICLE 3
CAPITAL CONTRIBUTIONS
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3.1 INITIAL CAPITAL CONTRIBUTIONS. Within 30 days of the execution of this
Agreement, each Member shall make the Initial Capital Contribution set forth
opposite such Member's name on Schedule I.
3.2 ADDITIONAL CAPITAL CONTRIBUTIONS.
(a) Each Member shall be required to make Additional Capital Contributions
in the amounts and on the dates set forth opposite such Member's name on
Schedule I unless otherwise agreed to unanimously by the Members.
(b) In addition, upon 30 days prior written notice to the Members, the
Company may, from time to time require the Members to make additional
contributions of capital to the Company in proportion to their respective
Sharing Ratios ("Capital Calls"), as may be unanimously agreed by the Members.
Capital Calls specifically referred to in any annual Business Plan may be made
by the general manager of the Company.
3.3 FAILURE TO PAY A CAPITAL CONTRIBUTION OR CAPITAL CALL.
(a) If any Member (the "Delinquent Member") fails to make payment when due
of all or any portion of its share of any Capital Contribution set forth in
Schedule I hereto, the secretary of the Company shall immediately give written
notice of the failure to such Member, with a copy to the other Member (the
"Nondelinquent Member"). If the Delinquent Member fails to pay the amount due
within 10 days following receipt of notice, the secretary shall promptly give
notice of such failure (the "Delinquency Notice") to the Non-Delinquent Member.
At any time within 15 days following receipt of the Delinquency Notice, then,
unless the Nondelinquent Member elects to make Capital Contributions in
accordance with Section 4.3(b) hereof, (i) the amount contributed by the
Nondelinquent Member pursuant to the Capital Contribution or Capital Call shall
be treated as a loan to the Company for a term to be specified
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by such Nondelinquent Member not to exceed one year, bearing interest payable
quarterly at the Default Interest Rate, and (ii) the Nondelinquent Member may
make an additional loan to the Company for a term to be specified by such
Nondelinquent Member not to exceed one year, also bearing interest payable
quarterly at the Default Interest Rate, in an amount equal to all or any portion
of the contribution unpaid by the Delinquent Member.
(b) If the Nondelinquent Member so elects, then in lieu of making loans to
the Company in accordance with Section 4.3(a) hereof, (A) the amount contributed
by such Nondelinquent Member pursuant to the Capital Contribution shall be
treated as a contribution to the capital of the Company in exchange for an
additional interest in the Company and (B) upon receipt of the Delinquency
Notice, the Nondelinquent Member may make an additional contribution of capital
to the Company in exchange for an additional interest in the Company in an
amount equal to all or any portion of the contribution unpaid by the Delinquent
Member.
(c) The amounts contributed pursuant to Section 4.3(b) hereof shall increase
the Capital Accounts of the contributing Member in accordance with the terms of
this Agreement. In addition, the Sharing Ratios shall be recalculated (and such
recalculated Sharing Ratios shall thereafter apply for all purposes of this
Agreement) such that the Sharing Ratios of each Member shall equal the ratio of
its aggregate Capital Contributions to the aggregate Capital Contributions of
all of the Members.
(d) Notwithstanding anything in this Agreement to the contrary, a
Nondelinquent Member shall have the right to refer the matter to any court of
competent jurisdiction for specific performance of obligations of a Delinquent
Member pursuant to this Article 4 (and each Member hereby waives any defense
that money damages would be a satisfactory remedy for such breach).
3.4 RETURN OF CONTRIBUTIONS. A Member is not entitled to the return of any
part of its Capital Contributions or Capital Calls or to be paid interest in
respect of either its Capital Account, its Capital Contributions or its Capital
Calls. An unrepaid Capital Contribution or Capital Call is not a liability of
the Company or of the other Members. A Member is not required to contribute or
to lend any cash or property to the Company to enable the Company to return the
other Member's Capital Contributions or Capital Calls.
3.5 NO OTHER CONTRIBUTIONS. Except as otherwise set forth in this Article 4,
Article 5 or Section 7.11, no capital contributions other than Capital
Contributions as set forth in Schedule I or Capital Calls, whether in cash or in
kind, shall be made by any Member without the written consent of all the other
Members and agreement among the Members as to the value of such contributions.
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ARTICLE 4
NON-CASH CAPITAL CONTRIBUTIONS AND BASIC AGREEMENTS
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4.1 RCN-SUB NON-CASH CAPITAL CONTRIBUTIONS.
(a) On the Effective Date, RCN-Sub shall contribute, and shall cause RCN or
its Affiliate to contribute, to the Company all its right, title and interest in
and to (i) all of the customer accounts of RCN Long Distance in the Relevant
Market (such accounts are listed on Schedule 5.1(a)1 hereto) (any of which
entered into subsequent to the Effective Date shall be executed in the name of
the Company), provided, however, that RCN will have up to 60 days after the
Effective Date to transition such customer accounts to the Company from an
operational basis and RCN-Sub hereby represents that none of such accounts has
been pledged by RCN and RCN has no notice of any pledge, lien or encumbrance by
any other person, (ii) its business plan in the Relevant Market and experience
with respect to the provision of integrated voice, video, data and related
services to residential and commercial customers, (iii) all building access
agreements covering any property located in the Relevant Market prior to the
Effective Date, copies of which have been delivered to the Company, as set forth
on Schedule 5.1(a)2 hereto (any of which entered into subsequent to the
Effective Date shall be executed in the name of the Company and any of which are
entered into prior to the date of this Agreement shall be automatically assigned
to the Company upon the execution of this Agreement), none of which are subject
to any claims by third parties as to which RCN has notice, (iv) the Support
Services Agreement and (v) the benefit of the RCN Agreements (as defined in the
Assignment of Benefits Agreement) pursuant to the Assignment of Benefits
Agreement (collectively, the "RCN-Sub Non-Cash Capital Contribution"). RCN-Sub
shall also contribute, or shall cause RCN or its Affiliate to contribute, all
agreements which it or they enter into after the execution of this Agreement
with third parties which are of the same nature as those agreements described in
clause (iii) above, and such agreements shall also be included as RCN-Sub Non-
Cash Capital Contributions. Such RCN-Sub Non-Cash Capital Contributions shall be
at RCN's Cost on terms that are cost-effective, reasonably acceptable to the
Company and commercially reasonable so as to facilitate timely network
deployment and provision of service.
(b) To the extent RCN-Sub or its Affiliates are required to recognize any
taxable income or reduce any net operating loss currently generated or net
operating loss carryforwards solely as a result of the contribution of the
customer accounts listed on Schedule 5.1(a)1 to the Company, the Company agrees
to reimburse RCN-Sub or the respective Affiliates an amount sufficient to pay
such federal and state income tax or to reimburse RCN-Sub and its respective
Affiliates for the deemed tax resulting from the loss of use of its federal and
state net operating loss, but in no event shall the Company be responsible to
reimburse more than $200,000 in the aggregate on account of such tax or deemed
tax. This reimbursement shall be
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treated as a distribution to RCN-Sub.
4.2 PCI NON-CASH CAPITAL CONTRIBUTIONS. From and after the Closing Date,
PCI-Sub shall contribute, and shall cause PCI to contribute its efforts with
respect to a fair value (i) IRU Agreement and (ii) Overhead Attachment
Agreements with PEPCO (collectively, the "PCI-Sub Non-Cash Capital Contribution"
and, together with the RCN-Sub Non-Cash Contribution, the "Non-Cash Capital
Contributions"). The PCI-Sub Non-Cash Capital Contribution is to be on terms and
conditions that are cost-effective, reasonably acceptable to the Company and
commercially reasonable so as to enable the Company to facilitate timely network
deployment and provision of service.
4.3 VALUE OF NON-CASH CAPITAL CONTRIBUTIONS. PCI-Sub and RCN-Sub agree that
the RCN-Sub Non-Cash Capital Contribution and the PCI-Sub Non-Cash Capital
Contribution are of equal but non-quantifiable value to the Company but will be
reflected in the Capital Accounts at zero value and will not affect the Sharing
Ratios of the Members.
4.4 BASIC AGREEMENTS. Upon the Effective Date hereof, as applicable, each of
the Members shall have executed the Basic Agreements and shall deliver a copy of
each Basic Agreement to the Company.
ARTICLE 5
MEMBER ACCOUNTS; ALLOCATIONS OF PROFIT AND LOSS; DISTRIBUTIONS
--------------------------------------------------------------
5.1 CAPITAL ACCOUNTS.
(a) A Capital Account shall be established and maintained for each Member,
and such Capital Account shall be increased by (i) the amount of cash and
---------
the Net Agreed Value of all property transferred to the Company as Capital
Contributions with respect to such Member's Membership Interest pursuant to
this Agreement and (ii) the amount of Net Income (and items thereof)
allocated to the Member pursuant to Article 6 hereof, and decreased by
---------
(iii) the amount of cash and the Net Agreed Value of all actual and deemed
distributions of cash or property made with respect to such Member's
Membership Interest pursuant to this Agreement and (iv) the amount of Net
Loss (and items thereof) allocated to the Member pursuant to Article 6
hereof.
(b) A transferee of a Membership Interest shall succeed to a pro rata
portion of the Capital Account of the transferor relating to the Membership
Interest so transferred; provided, however, that, if the transfer causes a
termination of the Company under Section 708(b)(1)(B) of the Code, the
rules under the Regulations promulgated under Section 708 of the Code shall
govern the treatment of the Company and the Members upon a termination of
the
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Company pursuant to Section 708 of the Code.
(c) To the extent not provided for in this Section 6.1, the Capital
Accounts of the Members shall be adjusted and maintained in accordance with
applicable Regulations, but only if and to the extent that such adjustment
and maintenance do not have a material adverse effect on the economic
interests of the Members.
(d) No Member shall be required to pay to the Company or to any other
Member the amount of any deficit balance in such Member's Capital Account.
5.2 ALLOCATIONS FOR CAPITAL ACCOUNT AND TAX PURPOSES.
(a) ALLOCATIONS OF NET INCOME OR NET LOSSES TO CAPITAL ACCOUNTS. After
giving effect to the special allocations set forth in Section 6.2(b), Net
Income and Net Loss for each taxable period shall be allocated to Capital
Accounts as set forth below.
(i) Net Income shall be allocated between the Members in the following
manner:
(A) First, to each Member having a deficit balance in its Capital
Account, in the proportion that such deficit balance bears to the
total deficit balances in the Capital Accounts of all Members,
until each such Member has been allocated Net Income equal to any
such deficit balance in its Capital Account;
(B) Second, to the Members previously allocated Net Loss under
Section 6.2(a)(ii)(A) pro rata to the extent of such Net Loss
previously allocated and not otherwise previously recouped under
Section 6.2(a)(i)(A) or this Section 6.2(a)(i)(B);
(C) Third, to the Members in accordance with their respective
Sharing Ratios.
(ii) Net Loss shall be allocated to the Members in the following
manner:
(A) First, to the Members in proportion to, and to the extent of,
the positive balances in their respective Capital Accounts; and
(B) Second, the balance, if any, to the Members in accordance
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with their respective Sharing Ratios.
(iii) Notwithstanding Section 6.2(a)(ii), no allocation of Net Losses
(or items thereof) shall be made to any Member to the extent that such
allocation would create or increase an Adjusted Capital Account Deficit.
(iv) If, upon the dissolution and termination of the Company pursuant
to Article 12 and after all other allocations to Capital Accounts provided
for in Section 6.2 have been tentatively made as if this Section
6.2(a)(iv) were not in this Agreement, a distribution to the Members under
Section 12.2 would be different from a distribution to the Members under
Section 6.3, then Net Income (and items thereof) and Net Losses (and items
thereof) for the taxable period in which the Company dissolves and
terminates pursuant to Article 12 shall be allocated among the Members in
a manner such that the Capital Account balance of each Member, immediately
after giving effect to such allocation, is, as nearly as possible, equal
(proportionately) to the amount of the distributions that would be made to
such Member during such last taxable period pursuant to Section 6.3. The
Tax Matters Partner may apply the principles of this Section 6.2(a)(iv) to
any taxable period preceding the taxable period in which the Company
dissolves and terminates (including through application of Section 761(c)
of the Code) if delaying application of the principles of this Section
6.2(a)(iv) would likely result in distributions under Section 12.2 that
are materially different from distributions under Section 6.3 in the
taxable period in which the Company dissolves and terminates.
(b) REGULATORY ALLOCATIONS TO CAPITAL ACCOUNTS. Notwithstanding any other
provision of this Section 6.2, the following special allocations to Capital
Accounts shall be made in the following order:
(i) COMPANY'S MINIMUM GAIN CHARGEBACK. Except as provided in
Regulations Section 1.704-2(f), notwithstanding any other provision of
this Section 6.2, if there is a net decrease in Minimum Gain attributable
to Company Nonrecourse Liabilities during any Company taxable period, each
Member shall be allocated items of Company income and gain for such period
(and, if necessary, subsequent periods) in the manner and amounts provided
for in the applicable provisions of Regulations Sections 1.704-2(f), (g)
and (j). This Section 6.2(b)(i) is intended to comply with the
"partnership minimum gain chargeback" requirement in Regulations Section
1.704-2(f) and shall be interpreted consistently therewith.
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(ii) CHARGEBACK OF MEMBER NONRECOURSE DEBT MINIMUM GAIN. Except as
otherwise provided in Regulations Section 1.704-2(i)(4),
notwithstanding the other provisions of this Section 6.2 (other than
Section 6.2(b)(i)), if there is a net decrease in Minimum Gain
attributable to Member Nonrecourse Debt during any Company taxable period,
any Member with a share of Minimum Gain attributable to such Member
Nonrecourse Debt at the beginning of such taxable period shall be
allocated items of Company income and gain for such period (and, if
necessary, subsequent periods) in the manner and amounts provided for in
the applicable provisions of Regulations Sections 1.704-2(i) and (j). This
Section 6.2(b)(ii) is intended to comply with the chargeback of items of
income and gain requirement in Regulations Section 1.704-2(i)(4) and shall
be interpreted consistently therewith.
(iii) QUALIFIED INCOME OFFSET. In the event any Member unexpectedly
receives any adjustments, allocations or distributions described in
Sections 1.704-1(b)(2)(ii)(d)(4), 1.704-1(b)(2)(ii)(d)(5) or 1.704-
1(b)(2)(ii)(d)(6) of the Regulations, items of Company income and gain
shall be specially allocated to such Member in an amount and manner
sufficient to eliminate, to the extent required by the Regulations
promulgated under Section 704(b) of the Code, its Adjusted Capital Account
Deficit created by such adjustments, allocations or distributions as
quickly as possible; provided, that an allocation pursuant to this Section
6.2(b)(iii) shall be made only if and to the extent that such Member would
have such an Adjusted Capital Account Deficit after all other allocations
provided for in this Section 6.2 have been tentatively made as if this
Section 6.2(b)(iii) were not in this Agreement.
(iv) GROSS INCOME ALLOCATIONS. In the event any Member has a deficit
balance in its Capital Account at the end of any Company taxable period in
excess of the amount such Member is deemed to be obligated to restore
pursuant to the penultimate sentences of Regulations Section 1.704-2(g)(1)
and Section 1.704-2(i)(5), such Member shall be specially allocated items
of Company gross income and gain in the amount of such excess as quickly
as possible; provided, that an allocation pursuant to this Section
6.2(b)(iv) shall be made only if and to the extent that such Member would
have a deficit balance in its Capital Account after all other allocations
provided for in this Section 6.2 have been tentatively made as if Section
6.2(b)(iii) and this Section 6.2(b)(iv) were not in this Agreement.
(v) COMPANY NONRECOURSE DEDUCTIONS. Company Nonrecourse Deductions for
any taxable period shall be allocated to the Members in accordance with
their respective Sharing Ratios. If the Members determine in their good
faith
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discretion that the Company's Nonrecourse Deductions must be allocated in
a different ratio to satisfy the safe harbor requirements of the
Regulations promulgated under Section 704(b) of the Code, the Members are
authorized to revise the prescribed ratio to the numerically closest ratio
that satisfies such requirements.
(vi) MEMBER NONRECOURSE DEDUCTIONS. Member Nonrecourse Deductions for
any taxable period shall be allocated 100% to the Member that bears the
Economic Risk of Loss with respect to the Member Nonrecourse Debt to which
such Member Nonrecourse Deductions are attributable in accordance with
Section 1.704-2(i) of the Regulations. If more than one Member bears the
Economic Risk of Loss with respect to a Member Nonrecourse Debt, such
Member Nonrecourse Deductions attributable thereto shall be allocated
between or among such Members in accordance with the ratios in which they
share such Economic Risk of Loss.
(vii) CODE SECTION 754 ADJUSTMENTS. To the extent an adjustment to the
adjusted tax basis of any Company asset pursuant to Section 734(b) or
743(b) of the Code is required, pursuant to Regulations Section 1.704-
1(b)(2)(iv)(m), to be taken into account in determining Capital Accounts,
the amount of such adjustment to the Capital Accounts shall be treated as
an item of gain (if the adjustment increases the basis of the asset), or
loss (if the adjustment decreases such basis), and such item of gain or
loss shall be specially allocated to the Members in a manner consistent
with the manner in which their Capital Accounts are required to be
adjusted pursuant to such Section of the Regulations.
(viii) The allocations set forth in Sections 6.2(a)(iii) and 6.2(b)(i)
through (vii) (collectively, the "Regulatory Allocations") are intended to
comply with certain requirements of the Regulations. It is the intent of
the Members that, to the extent possible, all Regulatory Allocations shall
be offset either with other Regulatory Allocations or with special
allocations of other items of Company income, gain, loss or deduction
pursuant to this Section 6.2(b)(viii). Therefore, notwithstanding any
other provision of this Section 6.2 (other than the Regulatory
Allocations), the Tax Matters Partner shall make such offsetting special
allocations of Company income, gain, loss or deduction in whatever manner
it determines appropriate so that, after such offsetting allocations are
made, each Member's Capital Account balance is, to the extent possible,
equal to the Capital Account balance such Member would have had if the
Regulatory Allocations were not part of this Agreement and all Partnership
items were allocated pursuant to Section 6.2(a) (determined without regard
to Section 6.2(a)(iii)). In exercising its
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discretion under this Section 6.2(b)(viii), the Tax Matters Partner shall
take into account future Regulatory Allocations under Sections 6.2(b)(i)
and 6.2(b)(ii) that, although not yet made, are likely to offset other
Regulatory Allocations previously made under Sections 6.2(b)(v) and
6.2(b)(vi).
(c) ALLOCATIONS FOR TAX PURPOSES.
(i) Except as otherwise provided in Section 6.2(c)(ii), items of
Company income, gain, loss, deduction and expense shall be allocated for
federal, state and local income tax purposes among the Members in the same
manner as the income, gain, loss, deduction and expense of which such
items are components were allocated pursuant to Section 6.2(a) and (b).
(ii) All items of income, gain, loss and deduction in respect of
Contributed Property for federal income tax purposes shall be allocated
among the Members in the manner provided under Section 704(c) of the Code
that takes into account the variation between the Agreed Value of such
property and its adjusted tax basis at the time of contribution. In the
event that the Carrying Value of any Company asset is adjusted pursuant to
paragraph (b) of the definition of Carrying Value hereof, subsequent
allocations of income, gain, loss and deduction with respect to such asset
shall take account any variation between the adjusted tax basis of such
asset and its Carrying Value in the same manner as under Section 704(c) of
the Code and the Regulations thereunder.
(iii) For purposes of Section 1.752-3(a)(3) of the Regulations, the
Members agree that Company Nonrecourse Liabilities in excess of the sum of
(A) the amount of Minimum Gain attributable to Company Nonrecourse
Liabilities and (B) the total amount of taxable gain, if any, that would
be allocated to the Members under Section 704(c) of the Code if the
Company were to dispose of all Company assets (in a taxable transaction)
subject to one or more Company Nonrecourse Liabilities in full
satisfaction thereof shall be allocated among the Members in accordance
with their respective Sharing Ratios.
(iv) Allocations pursuant to this Section 6.2(c) are solely for
federal, state and local tax purposes and shall not affect, or in any way
be taken into account in computing, any Member's Capital Account or share
of income, gain, loss, deduction and expense described in Section 6.2(a)
or (b) or distributions pursuant to any provision of this Agreement.
(v) The Members are aware of the tax consequences of the allocations
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made by this Section 6.2(c) and hereby agree to be bound by the provisions
of this Section 6.2(c) in reporting their shares of items of Company
income, gain, loss, deduction and expense.
(d) DETERMINATION BY TAX MATTERS PARTNER. All matters concerning the
computation of Capital Accounts, the allocation of items of Company income,
gain, loss, deduction and expense for all purposes of this Article 6 and
the adoption of any accounting procedures not expressly provided for by the
terms of this Agreement shall be determined by the Tax Matters Partner,
which shall act, or shall refrain from acting, on behalf of the Company and
in accordance with the directions of the Members, and shall make no
election, declaration or statement, settle or compromise any audit matter
or dispute, or execute or file any tax return, tax filing or other tax
document on behalf of the Company without the prior approval of the
Members, unless otherwise required by applicable tax laws.
5.3 DISTRIBUTIONS.
(a) DISTRIBUTIONS OF NET OPERATING AVAILABLE CASH. Except as otherwise
provided in Section 12.2, the Company shall distribute to the Members from time
to time, in proportion to their Sharing Ratios, the sum of (i) Forecast Member
Tax Requirements and (ii) Profits Distributions, but only to the extent of Net
Operating Available Cash. Notwithstanding the foregoing and except as otherwise
provided in Section 12.2, the Company shall not distribute any unexpended
Capital Contributions unless unanimously agreed by the Members. In addition, the
Company shall make such additional distributions to the Members, in proportion
to their Sharing Ratios, at such times and in such amounts as may be determined
by the Members.
(b) DISTRIBUTIONS IN KIND. In the event that at any time or from time to
time the Members shall determine to make a nonliquidating distribution of
property other than cash, (i) such property shall be deemed to be sold for its
Carrying Value, (ii) any gain or loss associated with such deemed sale shall be
allocated to the relevant Capital Accounts of the Members in accordance with
Section 6.2, and (iii) such property shall be distributed to the relevant
Members in the manner set forth in Section 6.3(a).
(c) WITHHOLDING. Notwithstanding anything expressed or implied to the
contrary in this Agreement, the Tax Matters Partner is authorized to take any
action that it determines to be necessary or appropriate to cause the Company to
comply with any foreign or United States federal, state or local withholding
requirement with respect to any allocation, payment or distribution by the
Company to any Member or other Person. All amounts so withheld, and, in the
manner determined by the Tax Matters Partner (which shall act, or shall refrain
from acting, on behalf of the Company in accordance with the directions of the
Members), amounts withheld
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with respect to any allocation, payment or distribution by any Person to the
Company, shall be treated as distributions to the applicable Members under the
applicable provision of this Agreement. If any such withholding requirement with
respect to any Member exceeds the amount distributable to such Member under this
Agreement, or if any such withholding requirement was not satisfied with respect
to any amount previously allocated, paid or distributed to such Member, such
Member or any successor or assignee with respect to such Membership Interest
hereby indemnifies and agrees to hold harmless the other Members and the Company
for such excess amount or such withholding requirement, as the case may be.
ARTICLE 6
MANAGEMENT
----------
6.1 MEMBERS COMMITTEE. The business and affairs of the Company shall be
managed under the direction of the Members Committee (the "Members Committee");
and all powers of the Company, except those specifically reserved or granted to
the Members by this Agreement, are hereby granted to and vested in the Members
Committee. The Members Committee shall have the power to delegate authority to
such officers, employees, agents and representatives of the Company as it may
from time to time deem appropriate. Any delegation of authority to take any
action must be approved in the same manner as would be required for the Members
Committee to directly approve such action. No Member shall take any action in
the name of or on behalf of the Company, including, without limitation, assuming
any obligation or responsibility on behalf of the Company, unless such action,
and the taking thereof by such Member, shall have been expressly authorized in
writing by the Members Committee or shall be expressly and specifically
authorized by this Agreement. Each Member, by execution of this Agreement,
agrees to, consents to, and acknowledges the delegation of power and authority
to the members of the Members Committee hereunder and to the actions and
decisions of the members of the Members Committee within the scope of such
authority.
6.2 EMPLOYEES OF THE COMPANY. With the exception of work performed on behalf
of the Company under contract under the Basic Agreements and any other
agreements entered into by the Company, all of the activities of the Company
shall be carried out by employees of the Company. The Members Committee shall
appoint employees to serve at its direction and discretion, including a general
manager, a director of franchising/community relations, a director of technical
operations, a sales director, a general counsel, a human resources specialist,
and a director of finance. Other employees may be appointed by the Members
Committee or by such persons to whom it may delegate such powers. Such
management positions are set forth on the organizational chart attached hereto
as Schedule 7.2.
6.3 NUMBER OF MANAGERS AND TERM OF OFFICE. Initially there shall be six
managers (the "Managers") serving on the Members Committee. Each of the Members
shall have the right
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to designate Managers to serve on the Members Committee in proportion to each
Member's respective Sharing Ratio, except that in the event any Member acquires
a Majority Interest, such Member shall have the right to designate one more
Manager than Members without a Majority Interest. Members shall designate
Managers to serve on the Members Committee by delivering written notice to the
secretary of the Company and to each other Member. Each Member shall elect from
among the designated Managers one Co-Chair each year, provided, however, that,
so long as any Member shall be in breach of its obligations pursuant to Article
4 hereof, a Manager selected by the non-breaching Member shall serve as sole
Chair until such breach is cured. Except as set forth in the immediately
preceding sentence, the Co-Chairs shall alternate presiding over the meetings of
the Members Committee. Each Manager shall be an officer or employee of a Member
or an Affiliate thereof but may not be a current employee of the Company. Former
officers or employees of a Member shall not serve on the Members Committee
without the consent of the other Member.
6.4 RESIGNATIONS AND REMOVALS OF MANAGERS. Any Manager serving on the
Members Committee may resign at any time by giving written notice to the
secretary of the Company and the Member that appointed such Manager. Such
resignation shall take effect on the date shown on or specified in such notice
or, if such notice is not dated, at the date of the receipt of such notice by
the secretary of the Company. No acceptance of such resignation shall be
necessary to make it effective. Any Member may at any time, and from time to
time, remove or replace any or all of the Managers designated by such Member,
and shall give written notice to the secretary of the Company and to each other
Member of any such removal or replacement. The Member that appointed a resigning
or removed Manager shall be entitled to appoint a Manager to fill the vacancy
created by such resignation or removal by written notice to the secretary of the
Company and to each other Member. Effective upon a Member ceasing to be a Member
of the Company, the Managers serving on the Members Committee appointed by such
Member shall cease to be Managers.
6.5 PLACE OF MEETING OF MEMBERS COMMITTEE. The Members Committee may hold
its meetings at such place or places within or outside the State of Delaware as
the Members Committee may from time to time determine or as may be designated in
the notice calling the meeting. If a meeting place is not so designated, the
meeting shall be held at the Company's principal office. Managers may
participate in meetings of the Members Committee by means of a conference
telephone or similar communications equipment by means of which all persons
participating can hear each other, and such participation shall constitute
presence in person at the meeting.
6.6 REGULAR MEETINGS OF MEMBERS COMMITTEE. Regular meetings of the Members
Committee may be held without notice at such time and place as shall be
designated from time to time by resolution of the Members Committee, but such
meetings shall be held at least monthly
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for the twelve months immediately following the initial execution of this
Agreement. After such time, the Members Committee shall agree on the frequency
of regular meetings, provided, however, that the regular meetings will continue
on a monthly basis if the Members cannot so agree. If the date fixed for any
such regular meeting is a Saturday, Sunday or legal holiday under the laws of
the state where such meeting is to be held, then the meeting shall be held on
the next succeeding business day or at such other time as may be determined by
resolution of the Members Committee. At such meetings Members Committee shall
transact such business as may properly be brought before the meeting.
6.7 SPECIAL MEETINGS OF MEMBERS COMMITTEE. Special meetings of the Members
Committee may be called by any Co-Chair serving on the Members Committee or by
the general manager of the Company. Notice of each such meeting shall be given
to each Manager serving on the Members Committee by telephone, telecopy,
telegram or similar method (in which case notice shall be given at least three
days before the time of the meeting) or sent by first-class mail (in which case
notice shall be given at least three days before the meeting), unless otherwise
specified by the Members Committee. Each such notice shall state the time, place
and purpose of the meeting to be so held.
6.8 MANAGER COMPENSATION; REIMBURSEMENT. Managers serving on the Members
Committee shall receive no compensation for performing their duties under this
Agreement; provided, however, that each of the Managers shall be entitled to
receive, out of Company funds available therefor, reimbursement of all amounts
expended by such Manager in payment of reasonable expenses incurred by such
Manager in attending meetings of the Members Committee.
6.9 VOTING BY MANAGERS. The Manager or Managers who are present (in person
or by written proxy) at any meeting of the Members Committee (or who are acting
by written consent in lieu of a meeting) shall be entitled to act on behalf of
such Members. If only one Manager appointed by a given Member is present at a
meeting, such Manager shall be entitled to vote the entire voting power held by
all Managers appointed by such Member. If more than one Manager appointed by a
given Member is present at a meeting or if an Affiliate of a Member is also
represented by a Manager at a meeting, such Managers shall vote such Member's or
Members' entire voting power as a single unit. In the event of a disagreement at
a meeting among Managers appointed by a single Member as to how to vote on any
matter, the vote of the Manager designated by such Member as its Co-Chair shall
be controlling and the vote of the other Manager or Managers representing such
Member shall be disregarded with respect to such matter. In the event of a
dispute or claim under any agreement entered into, other than a decision to
enter into or amend such an agreement, between the Company and either of PCI-Sub
or RCN-Sub or any of their respective Affiliates (including a determination to
enforce the PCI Guarantee or the RCN Guarantee), the Member which is (or whose
Affiliate is) a party to such
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agreement or guarantee shall not vote in respect of such dispute, claim or
determination, and the Company may take such action as may be directed by the
other Member.
6.10 MANNER OF ACTING AND ADJOURNMENT OF MEMBERS COMMITTEE. Any action of
the Members Committee shall require the affirmative vote of all of the Managers
serving on the Members Committee (subject to Section 7.9 above) so long as the
Sharing Ratio of each Member is 50%; in the event that the Sharing Ratios of the
Members are no longer 50% each, decisions taken by the Members Committee shall
require the affirmative vote of Members holding a majority of the Sharing
Ratios, with the exception of the approval of fundamental business actions
provided for in Section 7.12 below and except as otherwise set forth in this
Agreement or in the Basic Agreements. The presence at a duly called meeting of
the Members Committee of a majority of the number of Managers fixed by or in
accordance with this Agreement shall constitute a quorum. If a quorum shall not
be present at any meeting of the Members Committee, the Managers serving on the
Members Committee present thereat may adjourn the meeting from time to time,
without notice other than announcement at the meeting, until a quorum shall be
present.
6.11 APPROVAL OF CAPITAL CONTRIBUTIONS. In the event either Member (a
"Disapproving Member") either disapproves or fails to vote in favor of, or fails
to consummate, a proposed borrowing or Capital Contribution (other than any
Capital Contribution contemplated by Schedule I hereto) in the amount of
$500,000 or more (a "Proposed Funding") the Disapproving Member shall provide to
the Remaining Member within thirty days of the vote in respect of such Proposed
Funding, a certificate of the independent public accountants of the Disapproving
Member's parent entity, showing that after giving effect to the making of the
Proposed Funding and the proposed use of proceeds thereof, and all other pending
transactions by the Disapproving Member and its Affiliates, such Proposed
Funding and the proposed use of proceeds thereof would not (whether
automatically, with the giving of notice or the passage of time) be in violation
of any indenture, credit agreement, lease or other agreement or instrument by
which the Disapproving Member or its Affiliates are bound (a "Covenant
Violation"). If the Disapproving Member fails to deliver such certificate:
(a) The Disapproving Member shall, to the extent the same would not result
in a Covenant Violation, make a Disapproving Member Loan (as defined below)
in an amount (the "Shortfall Amount") equal to the full amount of any debt
contemplated by a Proposed Funding (less any portion of such Proposed
Funding obtained in accordance with paragraph (c) below) or such
Disapproving Member's pro rata share of any Capital Contribution
contemplated by a Proposed Funding.
(b) If the Disapproving Member fails to make a Disapproving Member Loan
within forty-five days of the vote in respect of the Proposed Funding, the
remaining Member
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shall have the right, but not the obligation, to make a Shortfall Funding
(as defined below) to the Company in an amount equal to the Shortfall
Amount. The Disapproving Member shall have a period of 180 days from the
date of the making of a Shortfall Funding to take such action to make
available to the Company the Shortfall Amount in accordance with the
Proposed Funding, plus an amount equal to all accrued dividends payable by
the Company in respect of such Shortfall Funding, the proceeds of which
will be used to repay the Shortfall Funding and all accrued dividends
payable thereon. In the event the Disapproving Member fails to cause such
replacement and repayment of the Shortfall Funding within such 180 day
period, the Sharing Ratios shall be recalculated as of the close of
business on the last day of such 180 day period (and such recalculated
Sharing Ratios shall thereafter apply for all purposes of this Agreement)
such that the Sharing Ratios of each Member shall equal the ratio of its
aggregate Capital Contributions to the aggregate Capital Contributions of
all of the Members, provided that, so long as any Disapproving Member Loan
-------- ----
or Shortfall Funding remains outstanding, no adjustment of Sharing Ratios
shall be made on account of any Capital Contributions made in connection
with such Disapproving Member Loan or Shortfall Funding until the earlier
of (i) the elimination of such Disapproving Member Loan or Shortfall
Funding in accordance with this Section 7.11 or (ii) 180 days from the
making of such Shortfall Funding.
(c) If the Proposed Funding is indebtedness, the Company shall have the
right to consummate the Proposed Funding or any portion thereof, provided
that (i) the same does not result in a Covenant Violation, and (ii) the
proceeds thereof shall be applied to reduce the amount required for any
Disapproving Member Loan or Shortfall Funding required in connection
therewith.
(d) For the purposes of this Section 7.11,
(i) "Disapproving Member Loan" shall mean a loan to the Company by a
Disapproving Member in respect of a Proposed Funding, bearing
interest at the lesser of (i) the General Interest Rate and (ii)
the interest rate the Company could have obtained for the
proposed borrowing from an unaffiliated lender. Disapproving
Member Loans shall be unsecured, non-recourse as to any Member,
not subject to default or acceleration, and shall be payable in a
single installment of principal and accrued interest only if and
at such time as the Capital Contribution or proposed loan which
such Disapproving Member Loan was made in lieu of is effected
without resulting in a Covenant Violation, and if the
Disapproving Member Loan is made in lieu of a Capital
Contribution, the Disapproving Member has reimbursed the Company
for all interest costs associated with such Disapproving Member
Loan. In the event a Disapproving Member Loan does not mature
prior to
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liquidation or dissolution of the Company, such
Disapproving Member Loan shall, upon liquidation or dissolution,
be automatically converted into a Capital Contribution by the
applicable Member, and such member shall be obligated to
reimburse the Company for all interest accrued on such
Disapproving Member Loan.
(ii) "Shortfall Funding" shall mean the portion of a Proposed
Funding which is made available to the Company by the
remaining Member (other than such Member's pro rata share of
any Capital Contribution included in such Proposed Funding).
Any Shortfall Funding shall be made as a Capital
Contribution and shall accrue dividends at a rate equal to
the General Interest Rate.
6.12 FUNDAMENTAL BUSINESS ACTIONS. The following actions may not be taken by
the Company without the prior unanimous approval of the Members Committee:
(a) a merger, consolidation or reorganization of the Company or a
disposition of substantially all of its assets;
(b) the issuance by the Company of any equity or equity-like instruments
including effecting an initial public offering of equity securities;
(c) voluntary liquidation, dissolution or winding-up of the Company,
except as specifically provided in this Agreement, or voluntary initiation by
and with respect to the Company of bankruptcy or similar proceedings; or
(d) amendments to the Company's Certificate, this Agreement, or any of the
Basic Agreements; or
(e) any lease or sub-lease by the Company to third parties of dark fiber.
6.13 ACTIONS REQUIRING MEMBERS COMMITTEE APPROVAL. It is the understanding
and intent of the Members that the Company shall operate, as an independent
Company for the purpose of conducting the Relevant Business. The Members
Committee will make all policy decisions and approve all deployment,
construction, marketing, financing, business, pricing and other plans and
budgets and all amendments thereto and deviations therefrom, and will otherwise
manage and direct operations of the Company. The Members Committee will agree on
the delegation of authority to employees. Notwithstanding anything herein to the
contrary, no approval of the Members Committee shall be required for the
following:
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(a) individual expenditures of less than 15% above the amount set forth
for major cost categories (the "Major Cost Categories") identified and
established as such in the annual Business Plan (but only to the extent that
expenditures for other Major Cost Categories are reduced such that the overall
annual Business Plan is not exceeded); and
(b) any agreement for services of less than $50,000 or which is approved
in the annual Business Plan for the Company (including, among other things,
accounting services, advertising, cash management and legal services).
6.14 CONTRACTING SUPPORT SERVICES. The Members Committee shall determine
what services shall be or continue to be performed for or on behalf of the
Company by RCN-Operating pursuant to the Support Services Agreement upon the
expiration of the term for any services provided thereunder or the extension of
the term in accordance with the provisions of the Support Services Agreement on
the basis of a determination by the Members Committee that the contracting or
continued contracting of such services is commercially preferable and in the
best interests of the Company.
6.15 DISPUTE RESOLUTION. Upon the inability of the Members Committee to
reach agreement on any actions, either Co-Chair of the Members Committee shall
declare in writing that a deadlock has occurred. Thereafter, so long as RCN-Sub
and PCI-Sub each have Sharing Ratios of 50%, the Co-Chairs of the Members
Committee shall attempt to resolve the deadlock. If, after 30 days, the Co-
Chairs of the Members Committee cannot reach a mutually satisfactory solution (a
"Deadlock Event"), the Members shall resolve such Deadlock Event as provided
herein:
(a) If the Deadlock Event occurs within the three year period immediately
following the execution of this Agreement, the proposed action will be
deemed rejected and the Company will operate in accordance with the most
recently agreed upon actions, plans and funding levels until the Deadlock
Event is resolved by mutual agreement of all of the Members.
(b) If the Deadlock Event occurs after the three year period immediately
following the execution of this Agreement, the parties agree that such
Deadlock Event will not be referred to any court but that one Member or an
Affiliate thereof shall purchase the entire Membership Interest of the
other Member in accordance with the provisions of this Section 7.15.
(i) Either Member (the "Disputing Member") shall submit a notice (a
"Dispute Notice") to the other Member (the "Non-Disputing Member") within
60 days of the date the matter becomes a Deadlock Event. The Dispute Notice
shall set forth, in reasonable detail, the nature of the dispute and the
price (which price shall be determined
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by selecting a value for the entire Company, and pro-rating such amount by
the Sharing Ratio of the Membership Interest to be purchased or sold;
hereinafter, the "Dispute Price") at which the Disputing Member is willing
to either sell its Membership Interest to the Non-Disputing Member or
purchase all Membership Interests from the Non-Disputing Member.
(ii) Within 60 days after the Non-Disputing Member's receipt of the
Dispute Notice, the Non-Disputing Member will signify in writing its
election, whether to buy the Disputing Member's Membership Interest at the
Dispute Price or to sell its Membership Interest at the Dispute Price. If
the Non-Disputing Member fails to make such election within such 60 day
period, the Disputing Member may, within 15 days thereafter, elect to buy
the Non-Disputing Member's Membership Interest at the Dispute Price.
(iii) Each Member agrees to execute and deliver all deeds,
assignments, releases, agreements, receipts or other documents necessary to
consummate the transfer of the Membership Interest being sold and delivered
upon payment by the purchasing Member of the consideration provided for in
the Dispute Notice.
(iv) Subject to the receipt of all regulatory approvals required, if
any, the closing of the purchase and sale pursuant to this Section 7.15
shall occur no later than 30 days following the receipt of the election by
the Disputing Member or the Non-Disputing Member, as the case may be.
(v) Until the closing of the purchase and sale of the Membership
Interest pursuant to this Section 7.15, the Company shall operate in
accordance with the most recently agreed upon actions, plans and funding
levels.
(vi) Notwithstanding anything herein to the contrary, if RCN-Sub
invokes the deadlock resolution mechanism set forth in this Section 7.15
and, as a result, PCI-Sub acquires RCN-Sub's Membership Interest, RCN-Sub
agrees to provide the services provided under the Support Services
Agreement for a period no longer than two years from the date PCI-Sub
acquires RCN-Sub's Membership Interest.
6.16 INDEMNIFICATION.
(a) Subject to paragraph (c) below, the Company shall indemnify any
Person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by or on behalf
of a Member) by reason of the fact that he is or was a
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Manager, officer or employee of the Company, or is or was an officer or employee
of the Company serving at the request of the Company as a manager, director,
officer, employee or agent of another Entity against expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with such action, suit or proceeding if
he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the Company, and, with respect to any criminal
action or proceeding, had no reasonable cause to believe his conduct was
unlawful. The termination of any action, suit or proceeding by judgment, order,
settlement, conviction, or upon a plea of nolo contendere or its equivalent,
shall not, of itself, create a presumption that the Person did not act in good
faith and in a manner which he reasonably believed to be in or not opposed to
the best interests of the Company, and, with respect to any criminal action or
proceeding, had reasonable cause to believe that his conduct was unlawful.
(b) Subject to paragraph (c) below, the Company shall indemnify any
Person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action or suit by or on behalf of a Member to
procure a judgment in its favor by reason of the fact that he is or was a
Manager or officer of the Company, or is or was an officer of the Company
serving at the request of the Company as a manager, director, officer, employee
or agent of another Entity against expenses (including attorneys' fees) actually
and reasonably incurred by him in connection with the defense or settlement of
such action or suit if he acted in good faith and in a manner he reasonably
believed to be in or not opposed to the best interests of the Company; except
that no indemnification shall be made in respect of any claim, issue or matter
as to which such person shall have been adjudged to be liable unless and only to
the extent that the court in which such action or suit was brought shall
determine upon application that, despite the adjudication of liability but in
view of all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the court shall deem proper.
(c) Any indemnification under this Section 7.16 (unless ordered by a
court) shall be made by the Company only as authorized in the specific case upon
a determination that indemnification of the Manager or officer is proper in the
circumstances because he has met the applicable standard of conduct set forth in
paragraphs (a) or (b) above. Such determination shall be made (i) by a majority
vote of the Members, or (ii) or if the Members Committee so directs, by
independent legal counsel in a written opinion. To the extent, however, that a
Manager or officer of the Company has been successful on the merits or otherwise
in defense of any action, suit or proceeding described above, or in defense of
any claim, issue or matter therein, he shall be indemnified against expenses
(including attorneys' fees) actually and reasonably incurred by him in
connection therewith, without the necessity of authorization in the specific
case.
(d) For purposes of any determination under this Section 7.16, a
person shall be deemed to have acted in good faith and in a manner he reasonably
believed to be in or not opposed to the best interests of the Company, or, with
respect to any criminal action or proceed-
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ing, to have had no reasonable cause to believe his conduct was unlawful, if his
action is based on the records or books of account of the Company or another
enterprise, or on information supplied to him by the officers of the Company or
another enterprise in the course of their duties, or on the advice of legal
counsel for the Company or another enterprise or on information or records given
or reports made to the Company or another enterprise by an independent certified
public accountant or by an appraiser or other expert selected with reasonable
care by the Company or another enterprise. The term "another enterprise" as used
in this paragraph (d) shall mean any Entity which such person is or was serving
at the request of the Company.
(e) Notwithstanding the foregoing, any Manager or officer may apply to
any court of competent jurisdiction in the State of Delaware for indemnification
to the extent otherwise permissible under paragraphs (a) and (b) above by reason
of the fact that he has met the applicable standard of conduct. If successful,
in whole or in part, the Manager or officer seeking indemnification shall also
be entitled to be paid the expense of prosecuting such application.
(f) Expenses incurred by a Manager or officer in defending or
investigating a threatened or pending action, suit or proceeding shall be paid
by the Company in advance of the final disposition thereof upon receipt of an
undertaking to repay such amount if it shall ultimately be determined that he is
not entitled to be indemnified by the Company as authorized in this Section
7.16.
(g) The indemnification and advancement of expenses in this Section
7.16 shall not be deemed exclusive of any other rights which may apply, it being
the policy of the Company that indemnification of the persons specified in
paragraphs (a) and (b) above shall be made to the fullest extent permitted by
law. The provisions of this Section 7.16 shall not preclude the indemnification
of any person who is not specified herein but whom the Company has the power or
obligation to indemnify under the Act, or otherwise.
(h) The Company may purchase and maintain insurance on behalf of the
persons specified in Section 7.16(a) against any liability asserted against him
and incurred by him in any such capacity, or arising out of his status as such,
whether or not the Company would have the power or the obligation to indemnify
him under this Section 7.16.
(i) The indemnification and advancement of expenses provided by this
Section 7.16 shall, unless otherwise provided when authorized or ratified,
continue as to a person who has ceased to be a Manager or officer and shall
inure to the benefit of the heirs, executors and administrators of such a
person.
(j) Except for proceedings to enforce rights to indemnification (which
shall be governed by paragraph (e) above), the Company shall not be obligated to
indemnify any
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Manager or officer in connection with a proceeding (or part thereof) initiated
by such person unless such proceeding (or part thereof) was authorized or
consented to by the Members Committee.
6.17 BUSINESS PLAN; BUDGET.
(a) The Company shall prepare an initial detailed business plan for the
fiscal year ended December 31, 1998, to be based upon the Phase I business plan
attached hereto as Exhibit K (the "Phase I Business Plan"), unless otherwise
agreed upon by the Members, and presented to the Members Committee within 30
days of the Effective Date. The Company shall also prepare an annual Business
Plan for each year thereafter based upon the Phase I Business Plan, unless
otherwise agreed upon by the Members. Each such annual Business Plan shall
include the following: (i) an annual operating budget; (ii) an annual budget for
capital expenditures; (iii) a budget for capital contributions required from the
Members; (iv) a sales and marketing plan and (v) pro-forma financial balance
sheet, income statement and statement of cash flows (clauses (i) through (v) are
collectively referred to herein as the "Business Plan", and for 1998 shall be
referred to as the "1998 Business Plan"). It is the intention of the Members
that the 1998 Business Plan and each succeeding Business Plan be prepared so as
to conduct the Company's business in accordance with the details contained in
the Phase I Business Plan. Each annual Business Plan, including the 1998
Business Plan, must be approved by the Members Committee.
(b) Each annual Business Plan shall set forth the operations of the
Company between January 1 to December 31 of the applicable year and shall be
prepared or caused to be prepared by the Company. A preliminary business plan
shall be delivered to the Members by the Company no later than October 1 of the
previous year. The Company shall consult with Members, as it deems appropriate,
in the process of preparing such preliminary business plan. Each Member shall
thereafter have 30 days to review the preliminary business plan and to propose
revisions. The Company shall then have an additional 30 days to resolve any
differences in and to finalize the Business Plan. If, after such additional 30
day period, the Members Committee cannot agree or any line item of such
preliminary budget, the matter shall be considered a Deadlock Event, to be
resolved in accordance with the provisions set forth in Section 7.15. Pending
the resolution of such Deadlock Event, (i) all line items not in dispute in the
preliminary business plan shall take effect and (ii) the amount budgeted in the
previous year will be in effect, as if restated in the new annual Business Plan,
for those line items in dispute.
(c) At such time as all disputes on the preliminary business plan have
been resolved, the preliminary business plan as so resolved shall become the
annual Business Plan.
6.18 BUSINESS REVIEW. After five years from the initial execution of this
Agreement,
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the Members shall review their mutual business goals and objectives and will
evaluate strategies for maximizing value to the Members including, without
limitation, an initial public offering.
ARTICLE 7
RIGHTS OF MEMBERS
-----------------
7.1 ACCESS TO INFORMATION. In addition to the other rights specifically set
forth in this Agreement, each Member shall have access to all information to
which a Member is entitled to have access pursuant to the Act and such other
information regarding the Company and its business and affairs, as it may
reasonably request from time to time.
ARTICLE 8
TAXES
-----
8.1 TAX RETURNS. The Tax Matters Partner shall cause to be prepared and filed
all necessary federal and state income tax returns for the Company, including
making the elections described in Section 9.2 at the direction of the Members
Committee. Each other Member shall furnish to the Tax Matters Partner all
pertinent information in its possession relating to Company operations that is
necessary to enable the Company's income tax returns to be prepared and filed.
The Tax Matters Partner shall prepare all federal and state tax returns on a
timely basis and shall furnish to each other Member copies of returns that are
actually filed promptly after their filing.
8.2 TAX ELECTIONS. The Company shall make such elections on tax returns as are
deemed appropriate by the Tax Matters Partner. It is the intent of the Members
that the Company be treated as a partnership for federal, state and local income
and other tax purposes, and the Company will make any election necessary to
achieve that status. Neither the Company nor any Member may make an election for
the Company to be excluded from the application of the provisions of subchapter
K of chapter 1 of subtitle A of the Code or any similar provisions of applicable
state or local law, and no provision of this Agreement (including, without
limitation, Section 2.8) shall be construed to sanction or approve such an
election.
8.3 TAX MATTERS PARTNER. The Tax Matters Partner shall take such action as may
be necessary to cause each other Member to become a "notice partner" within the
meaning of Section 6223 of the Code. The Tax Matters Partner shall inform each
other Member of all significant matters that may come to its attention in its
capacity as tax matters partner by giving notice thereof on or before the fifth
Business Day after becoming aware thereof and, within that time, shall forward
to each other Member copies of all significant written communications it may
receive in that capacity. The Tax Matters Partner may take any action
contemplated by Sections 6222 through 6232 of the Code without the consent of
each other Member, but this sentence does
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not authorize the Tax Matters Partner to take any action left to the
determination of an individual Member under Sections 6222 through 6232 of the
Code. The Tax Matters Partner shall act, or shall refrain from acting, on behalf
of the Company and in accordance with the directions of the Members, and shall
make no election, declaration or statement, settle or compromise any audit
matter or dispute, or execute or file any tax return, tax filing or other tax
document on behalf of the Company without the prior approval of the Members,
unless otherwise required by applicable tax laws.
ARTICLE 9
BOOKS, RECORDS, REPORTS, AND BANK ACCOUNTS
------------------------------------------
9.1 ACCOUNTING. Except as may be otherwise agreed to by the Members or
required by law, the Company will maintain books and records for tax purposes in
accordance with federal income tax accounting principles utilizing the accrual
method of accounting, and for accounting purposes in accordance with GAAP. In
addition, the Company shall cause to be prepared with respect to each fiscal
year of the Company financial statements based on GAAP. Appropriate records will
be kept so that upon each closing of the Company books it is possible to
determine, among other items defined in this Agreement, (i) the amount of
capital (whether in cash or in kind) actually contributed by each Member; (ii)
the amount of cash or other property distributed to each Member; (iii) the
effect of all Company items of income, gain, loss, deduction or expense on each
Member's Capital Account; and (iv) all pertinent expenses and cash disbursement
accounts.
9.2 FISCAL YEAR. Except as may be otherwise determined by the Members, and
subject to applicable Federal income tax law, the fiscal year of the Company
shall be the twelve months ending December 31 of each year. The initial fiscal
year of the Company shall commence on the date of execution of this Agreement
and end on December 31, 1997.
9.3 STATEMENTS AND REPORTS. Except as may be otherwise determined by all of
the Members, as soon as practicable, but in no event later than 60 days after
the close of each fiscal year of the Company, the Company will cause to be
prepared and will have furnished to each of the Members, with respect to such
period, (i) a profit and loss statement, (ii) a statement of cash flows, (iii) a
Company balance sheet as of the close of such period, and (iv) such other
statements showing in reasonable detail each Member's interest in each of the
items described in Section 10.1. The foregoing statements will be prepared in
accordance with GAAP, consistently applied, and audited by an independent
certified public accounting firm of national reputation which shall be
designated by the Members, and the cost of preparing the statements and of each
such audit will be paid for by the Company. In addition, an income statement and
balance sheet shall be prepared monthly and furnished to each Member no later
than 30 days from the end of the prior month. For year-end reporting purposes, a
reliable estimate of December results shall
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be provided to each Member within 10 days of December 31.
9.4 INSPECTION. The Company shall maintain or cause to be maintained complete
and accurate books and records with respect to its business. All books of
account and all other records of the Company including an executed counterpart
of this Agreement and all amendments hereto) will at all times be kept at the
Company's principal place of business. Any Member and its representatives may
inspect the books and records of the Company. The Company shall provide, during
regular business hours, access to the facilities, systems and books and records
of the Company to the extent reasonably necessary for such inspection. Whenever
any such inspection is conducted by any Member and its representatives, such
Member shall advise the other Members and permit the other Members and their
representatives to be present during such inspection.
9.5 BANK ACCOUNTS. The Company shall maintain appropriate accounts at one or
more financial institutions approved by the Members Committee for all funds of
the Company. Such accounts shall be used solely on the business of the Company.
Withdrawals or transfers from such accounts shall be made only upon the approval
of those persons authorized in writing by the Members.
ARTICLE 10
WITHDRAWAL, EXPULSION, BANKRUPTCY, ETC.
---------------------------------------
10.1 WITHDRAWAL. Each Member agrees that it will not resign or withdraw from
the Company without the consent of each other Member. If a Member attempts or
purports to resign or withdraw from the Company in breach of this Section 11.1,
the other Member may (i) recover damages from such breaching Member, including,
without limitation, the reasonable cost of obtaining replacement of the services
that such breaching Member is obligated to perform (if any), (ii) seek specific
performance of such breaching Member's obligations to the Company (and each
Member hereby waives any defense that money damages would be a satisfactory
remedy for such breach), (iii) pursue any other remedies available under
applicable law, if any, and (iv) effect recovery of damages by offsetting those
damages against the amount otherwise distributable to such Member.
10.2 BANKRUPT MEMBERS. Subject to the provisions of Section 12.1 hereof, this
Section 11.2 shall apply if any Member becomes a Bankrupt Member. In such event,
the other Member (the "Purchasing Member"), shall have the option (but not the
obligation), exercisable by notice to the Bankrupt Member (or its
representative) at any time prior to the 90th day after receipt of notice or
obtaining actual knowledge of the occurrence of the event causing such Member to
become a Bankrupt Member, to buy or cause their designee, including any
Affiliate of the Purchasing Member, to buy, and on the exercise of this option
the Bankrupt Member (or
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its representative) shall sell, its Membership Interest. The purchase price
shall be an amount equal to the fair market value of the Membership Interest
determined by agreement by the Bankrupt Member (or its representative) and the
Purchasing Member; however, if those Persons do not agree on the fair market
value on or before the 30th day following the exercise of the option, such fair
market value shall be determined by an independent appraiser mutually
satisfactory to the Bankrupt Member and the Purchasing Member. If the Bankrupt
Member and the Purchasing Member are unable to agree upon a mutually
satisfactory independent appraiser, each such Member shall appoint an
independent appraiser to determine the fair market value; if the valuations of
each of such independent appraisers does not differ by greater than fifteen
percent (15%), then the fair market value shall be determined by taking the
arithmetic average of the two valuations. If the valuations of each of such
independent appraisers differs by greater than fifteen percent (15%), then a
third independent appraiser shall be selected by mutual agreement of the two
independent appraisers and fair market value shall be determined by such third
independent appraiser. The Purchasing Member shall pay the fair market value as
so determined in four equal cash installments, the first due on closing and the
remainder (together with accumulated interest on the amount unpaid at the
General Interest Rate) due on each of the first three anniversaries of the
closing. The payment to be made to the Bankrupt Member or its representative
under this Section 11.2 is in complete liquidation and satisfaction of all the
rights and interest of the Bankrupt Member and its representative (and of all
Persons claiming by, through, or under the Bankrupt Member and its
representative) in and in respect of the Company, including, without limitation,
any Membership Interest, any rights in specific Company property, any rights
with respect to the management, control or operation of the Company and any
rights against the Company and (insofar as the affairs of the Company are
concerned) against the Members.
ARTICLE 11
TERMINATION, DISSOLUTION AND LIQUIDATION OF THE COMPANY
------------------------------------------------------
11.1 TERMINATION AND DISSOLUTION.
Except as provided below in this Section 12.1, the Company shall
terminate and dissolve upon the earliest to happen of any of the following
events:
(a) A decision unanimously approved by the Members to dissolve the
Company; or
(b) The happening of any other event, act or omission causing the
dissolution of the Company under the Act or any other laws of the State of
Delaware with the exception of the death, retirement, resignation, expulsion,
bankruptcy or dissolution of a Member.
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The dissolution of the Company shall be effective on the day on which the
event occurs giving rise to the dissolution, unless (and only if and to the
extent permitted by the Act), Members holding Sharing Ratios of the sum of not
less than a majority of the remaining Sharing Ratios elect to continue the
Company in the manner provided by the Act. Any necessary certificate of
dissolution shall be filed under the Act upon the dissolution and the
commencement of winding up of the Company; provided, however, that the Company
shall not terminate until the assets of the Company have been distributed as
provided in Section 12.2.
11.2 LIQUIDATION.
(a) As soon as practicable after the dissolution of the Company, the
Liquidator (as defined in Section 12.2(f)) shall notify Members of such fact
and shall prepare a plan as to whether and in what manner the assets of the
Company shall be liquidated.
(b) The Liquidator shall take full account of the Company's assets and
liabilities. The Company's assets shall be liquidated as promptly as is
consistent with obtaining the fair market value thereof and after the allocation
of Net Income or Net Loss in accordance with Article 6 above, the proceeds of
liquidation shall be applied and distributed in the following order and
priority:
(i) First, to secured creditors (including Members and their
affiliates) in accordance with the priority of their security interests;
(ii) Next, to the payment of debts and liabilities of the Company to
general unsecured creditors including Members and their affiliates;
(iii) Next, to the establishment of any reserves which are
reasonably necessary for contingent, unmatured, unliquidated, disputed,
or unforeseen liabilities and obligations of the Company;
(iv) Last, to the Members in accordance with the positive balances
in their respective Capital Accounts, after taking into account all
adjustments to Capital Accounts for all periods and including
allocations under Article 6 for the interim period from the end of the
prior fiscal year to the date of the liquidating distribution.
(c) The amount of any reserves established pursuant to Section
12.2(b)(iii) above shall be determined with the approval of the Members who are,
or may be, liable for any liabilities or obligations of the Company for which
such reserves are being established. If any or all of the amount of the reserves
are no longer required by the Company and become available
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for distribution to the Members, such amounts shall be distributed to the
Members in accordance with Section 12.2(b)(iv) above.
(d) Distributions to Members pursuant to this Section 12.2 may be made
pursuant to a trust established for the benefit of the Members for the purpose
of liquidating the assets of the Company, collecting amounts owed to the
Company, and paying any contingent or unforeseen liabilities or obligations of
the Company. The assets of any such trust shall be distributed to the Members
from time to time, in the reasonable discretion of the Liquidator, in the same
proportions as would have applied pursuant to this Agreement to liquidating
distributions by the Company to the Members.
(e) If the Liquidator decides pursuant to this Section 12.2 to make a
distribution of property in kind to the Members upon dissolution and winding up
of the Company, (i) the properties in question shall be deemed to be sold on the
date of distribution for their respective Carrying Values, (ii) any gain or loss
associated with such deemed sales shall be allocated to the relevant Capital
Accounts of the Members in accordance with Section 6.2, and (iii) such
properties shall be distributed to the relevant Members in the manner set forth
in this Section 12.2.
(f) For the purposes of this Agreement, the "Liquidator" shall be
appointed by the Members from among their number; provided, however that if upon
the dissolution of the Company there is no Member willing or permitted to serve
as Liquidator, the trustee, receiver or other fiduciary who is appointed or is
otherwise authorized by consent of Members holding Sharing Ratios aggregating
more than 50% to act on behalf of the Company in its dissolution, winding up and
liquidation, shall act as Liquidator.
ARTICLE 12
GENERAL PROVISIONS
------------------
12.1 REPRESENTATIONS. Each Member hereby represents and warrants to the
Company and each other Member and the other Member, in agreeing to enter into
this Agreement, has relied upon such representations and warranties that:
(a) If such Member is not a natural person, it is duly organized,
validly existing and in good standing under the laws of its jurisdiction of
organization and is duly qualified to conduct business in all jurisdictions
where such qualification is required.
(b) It has the power and authority (corporate or otherwise) to execute,
deliver and perform its obligations under this Agreement. Such execution,
delivery and performance have been duly authorized by all necessary action on
the part of such Member and do not and will not contravene the organizational
documents of such Member or conflict with, result in a
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breach of, or entitle any party (with due notice or lapse of time or both) to
terminate, accelerate or call a default with respect to, any agreement or
instrument to which such Member is a party or by which such Member is bound and
will not create, violate or conflict with any lien upon or with respect to any
of the properties of the Members. The execution, delivery and performance by
such Member of this Agreement will not result in any violation by such Member of
any law, rule or regulation applicable to such Member. Such Member is not a
party to, nor subject to or bound by, any judgment, injunction or decree of any
court or other Governmental Entity which may restrict or interfere with the
performance of this Agreement by such Member. This Agreement is a valid and
binding obligation of such Member enforceable against such Member in accordance
with its terms, except that (i) such enforcement may be subject to bankruptcy,
insolvency, reorganization, moratorium or other similar laws now or hereafter in
effect relating to creditors' rights generally or general principles of equity
and (ii) the remedy of specific performance and injunctive relief may be subject
to equitable defenses and to the discretion of the court before which any
proceeding therefor may be brought.
(c) Except as set forth on Schedule 13.1(c), no consent, waiver,
approval, authorization or order of, or registration, qualification or filing
with, any court or other Governmental Entity is required for the execution,
delivery and performance by such Member of this Agreement and the consummation
by such Member of the transactions contemplated hereby. No consent or waiver of
any party to any contract to which such Member is a party or by which it is
bound is required for the execution, delivery and performance by such Member of
this Agreement.
(d) Such Member is acquiring the Membership Interest hereunder for its
own account for investment and not with a view to the distribution thereof, and
such Member shall not offer to sell or otherwise dispose of any of the
Membership Interests so acquired by it in violation of the registration
requirements of the Securities Act or applicable state securities laws. Such
Member has such knowledge and experience in financial, business and tax matters
that such Member is capable of evaluating the merits and risks relating to such
Member's Membership Interest and is capable of bearing the risk of loss of its
entire investment in the Company.
(e) There is no action, suit, grievance, arbitration or proceeding
pending or, to the knowledge of such Member, threatened against or affecting
such Member at law or in equity, before any federal, state, municipal or other
governmental court, department, commission, board, arbitrator, bureau, agency or
instrumentality which prohibits or impairs its ability to execute and deliver
this Agreement or the other Basic Agreements or to consummate any of the
transactions contemplated hereby or thereby. To the knowledge of such Member, it
has not received written notice of any pending or threatened investigation,
inquiry or review by any Governmental Entity.
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<PAGE>
(f) No broker, finder or investment banker is entitled to any brokerage,
finder's or other fee or commission, or to the reimbursement of any of its
expenses, in connection with the transactions contemplated by this Agreement
based upon arrangements made by it or on its behalf.
(g) Such Member has no obligation or agreement, either actual or
contingent, to share any portion of its interest in the Company with any Person.
(h) Such Member is not a Holding Company or otherwise subject to
regulation under PUHCA and the execution and delivery of the Basic Agreements do
not cause such Member to become a Holding Company or otherwise subject to PUHCA.
(i) Such Member has or will have sufficient resources to make Capital
Contributions to the Company in accordance with Schedule I hereto.
(j) In the case of RCN-Sub, such Member and its Affiliates have
sufficient experience to be able to carry out the Relevant Business activities
of the Company in the Relevant Market and to engage in activities required of
them in accordance with the Basic Agreements.
12.2 OFFSET. Whenever the Company is to pay any sum to any Member, any amounts
such Member owes the Company may be deducted from that sum before payment.
12.3 NOTICES. All notices, request and other communication hereunder shall be
deemed to have been duly delivered, given or made to or upon any party hereto if
in writing and delivered by hand against receipt, or by certified or registered
mail, postage prepaid, return receipt requested, or to a courier who guarantees
next Business Day delivery or sent by telecopy (with confirmation) to such party
at its address set forth below or to such other address as such party may at any
time, or from time to time, direct by notice given in accordance with this
Section 13.3.
if to RCN-Sub:
RCN Telecom Services of Washington, D.C., Inc.
105 Carnegie Center
Princeton, New Jersey 08540
Fax: (609) 734-0974
Attention: Michael J. Mahoney
and
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<PAGE>
RCN Telecom Service, Inc.
105 Carnegie Center
Princeton, New Jersey 08540
Fax: (609) 734-0974 and (609) 734-3830
Attention: Michael J. Mahoney and Raymond B. Ostroski, Esq.
with a copy to:
Skadden, Arps, Slate, Meagher & Flom LLP
919 Third Avenue
New York, New York 10022
Fax: (212) 735-2000
Attention: Stephen M Banker, Esq.
if to PCI-Sub:
Pepco Communications, L.L.C
1801 K Street, N.W. Suite 900
Washington, D.C. 20006
Attention: John D. McCallum and Janet Heck Doyle, Esq.
with a copy to:
Dickstein Shapiro Morin & Oshinsky LLP
2101 L Street, N.W.
Washington, DC 20037-1526
Attention: Emanuel Faust, Jr., Esq.
if to the Company:
Starpower Communications, LLC
1130 Connecticut Avenue, N.W.
Suite 400
Washington, D.C. 20036
Attention: Michael J. Mahoney and John D. McCallum
The date of delivery of any such notice, request or other communication shall be
the earlier of (i) the date of actual receipt or (ii) three Business Days after
such notice, request or other communication is sent if sent by certified or
registered mail, (iii) if sent by courier who guarantees next Business Day
delivery, the Business Day next following the day such notice, request or other
communication is actually delivered to the courier or (iv) the date of written
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<PAGE>
confirmation of receipt if telecopied.
12.4 ENTIRE AGREEMENT; SUPERSEDURE. This Agreement constitutes the entire
agreement of the Members relating to the Company and supersedes all prior
contracts or agreements with respect to the Company, whether oral or written,
except the Basic Agreements.
12.5 EFFECT OF WAIVER OR CONSENT. A waiver or consent, express or implied, to
or of any breach or default by any Person in the performance by that Person of
its obligations with respect to the Company is not a consent or waiver to or of
any other breach or default in the performance by that Person of the same or any
other obligations of that Person with respect to the Company. Failure on the
part of a Person to complain of any act of any Person or to declare any Person
in default with respect to the Company, irrespective of how long that failure
continues, does not constitute a waiver by that Person of its rights with
respect to that default until the applicable limitations period has expired.
12.6 AMENDMENT OR MODIFICATION. This Agreement may be amended or modified from
time to time only by a written instrument executed by all of the Members.
12.7 PUBLIC ANNOUNCEMENTS. Except as required by law, any governmental agency
or any securities exchange, the parties hereto agree to obtain the prior
approval of each other before issuing (or allowing their Affiliates to issue)
any press release, public disclosure or other announcement with respect to this
Agreement or any of the transactions contemplated by this Agreement. In the
event either party hereto is so required by law, any governmental agency or any
securities exchange to make a public disclosure or other announcement as
aforesaid, it shall use its best efforts to afford the other a reasonable
opportunity to review the form and content of the announcement or disclosure
prior to making same.
12.8 CONFIDENTIALITY. Each of the parties hereto will hold, and will use its
reasonable, good faith efforts to cause its respective shareholders, partners,
members, directors, officers, employees, accountants, counsel, consultants,
agents and financial or other advisors (collectively "Agents") to hold, in
confidence, all information (whether oral or written), including this Agreement
and the documents contemplated herein, concerning the transactions contemplated
by this Agreement furnished to such party by or on behalf of any other party in
connection with such transactions, unless legally compelled (by deposition,
interrogatory, request for documents, subpoena, civil investigative demand or
similar process, or by order of a court or tribunal of competent jurisdiction,
or in order to comply with applicable rules or requirements of any stock
exchange, government department or agency or other regulatory authority, or by
requirements of any securities law or regulation or other legal requirement) to
disclose any such information or documents, and except to the extent that such
information or documents can be shown to have been (a) previously known on a
nonconfidential basis by such party, (b) in the public domain
-54-
<PAGE>
through no fault of such party or (c) acquired by such party on a
nonconfidential basis from sources not known by such party to be bound by any
obligation of confidentiality in relation thereto. Notwithstanding the foregoing
provisions of this Section 13.8, each party may disclose such information to its
Agents in connection with the transactions contemplated by this Agreement or any
of the other Basic Agreements and to its lenders in connection with obtaining
the financing for the transactions contemplated by this Agreement so long as
such Agents and lenders are informed by such party of the confidential nature of
such information and are directed by such party to treat such information
confidentially and to certain governmental agencies in connection with the
procurement of the governmental authorizations contemplated by this Agreement.
The obligation of each party to hold any such information in confidence shall be
satisfied if such party exercises the same care with respect to such information
as it would take to preserve the confidentiality of its own similar information.
If this Agreement is terminated, each party will, and will use its reasonable,
good faith efforts to cause its respective Agents and lenders to, destroy or
deliver to the other party, upon request, all documents and other materials, and
all copies thereof, obtained by such party or on its behalf from the other party
hereto in connection with this Agreement that are subject to such confidence.
12.9 BINDING EFFECT. Subject to the restrictions on Dispositions set forth in
this Agreement, this Agreement is binding on and inures to the benefit of the
Members and their respective heirs, legal representatives, successors, and
assigns.
12.10 GOVERNING LAW; SEVERABILITY. THIS AGREEMENT IS GOVERNED BY AND SHALL BE
CONSTRUED IN ACCORDANCE WITH THE LAW OF THE STATE OF DELAWARE, EXCLUDING ANY
CONFLICT-OF-LAWS RULE OR PRINCIPLE THAT MIGHT REFER THE GOVERNANCE OR THE
CONSTRUCTION OF THIS AGREEMENT TO THE LAW OF ANOTHER JURISDICTION. If any
provision of this Agreement or its application to any Person or circumstance is
held invalid or unenforceable to any extent, the remainder of this Agreement and
the application of such provision to other Persons or circumstances is not
affected and such provision shall be enforced to the greatest extent permitted
by law.
12.11 SPECIFIC PERFORMANCE. The Members agree that irreparable damage will
result if this Agreement is not performed in accordance with its terms, and the
Members agree that any damages available at law for a breach of this Agreement
would not be an adequate remedy. Therefore, the provisions hereof and the
obligations of the Members hereunder shall be enforceable in a court of equity,
or other tribunal with jurisdiction, by a decree of specific performance, and
appropriate injunctive relief may be applied for and granted in connection
therewith. Such remedies and all other remedies provided for in this Agreement
shall, however, be cumulative and not exclusive and shall be in addition to any
other remedies that a Member may have under this Agreement, at law or in equity.
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<PAGE>
12.12 FURTHER ASSURANCES. In connection with this Agreement and the
transactions contemplated by it, each Member shall execute and deliver any
additional documents and instruments and perform any additional acts that may be
necessary or appropriate to effectuate and perform the provisions of this
Agreement and such transactions.
12.13 COUNTERPARTS. This Agreement may be executed in any number of
counterparts with the same effect as if all signatories had signed the same
document. All counterparts shall be construed together and constitute the same
instrument.
12.14 INTERPRETATION. In the event of any dispute concerning the construction
or interpretation of any provision of this Agreement or any ambiguity thereof,
there shall be no presumption that this Agreement or any provision hereof be
construed against the party who drafted this Agreement
12.15 WAIVER OF PARTITION. Each of the Members hereby irrevocably waives any
and all rights that such Member may have to maintain any action for partition of
any of the Company's property.
12.16 SURVIVAL. All indemnities and reimbursement obligations made pursuant to
this Agreement shall survive dissolution and liquidation of the Company until
expiration of the longest applicable statute of limitations (including
extensions and waivers) with respect to the matter for which a party would be
entitled to be indemnified or reimbursed, as the case may be.
12.17 GENERAL. For purposes of paragraph (b) of the definition of Carrying
Value under Section 1.1, the parties agree that the Carrying Value of the Non-
Cash Capital Contributions shall not be adjusted pursuant to such paragraph (b).
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<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
MEMBERS:
RCN TELECOM SERVICES OF
WASHINGTON, D.C., INC.
By:
---------------------------------
Name:
Title:
PEPCO COMMUNICATIONS, LLC
By:
---------------------------------
Name:
Title:
Accepted and Agreed Only
with Respect to Section 5.1
RCN CORPORATION
By:__________________________
Name:
Title:
Accepted and Agreed Only
with Respect to Section 2.14
RCN TELECOM SERVICES, INC.
By:__________________________
Name:
Title:
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<PAGE>
SCHEDULE I
CASH CAPITAL CONTRIBUTIONS
--------------------------
Period Total RCN-Sub PCI-Sub
------ ----- ------- -------
4th Quarter 1997 (Initial
Capital Contribution) $25,000,000 $12,500,000 $12,500,000
1st Quarter 1998 $15,000,000 $ 7,500,000 $ 7,500,000
2nd Quarter 1998 $ 7,500,000 $ 7,500,000 $15,000,000
3rd Quarter 1998 $20,000,000 $10,000,000 $10,000,000
4th Quarter 1998 $37,500,000 $18,750,000 $18,750,000
1st Quarter 1999 $37,500,000 $18,750,000 $18,750,000
2nd Quarter 1999 $37,500,000 $18,750,000 $18,750,000
3rd Quarter 1999 $37,500,000 $18,750,000 $18,750,000
4th Quarter 1999 $25,000,000 $12,500,000 $12,500,000
1st Quarter 2000 $20,000,000 $10,000,000 $10,000,000
2nd Quarter 2000 $10,000,000 $20,000,000 $10,000,000
3rd Quarter 2000 $10,000,000 $ 5,000,000 $ 5,000,000
----------- ----------- -----------
Total Cash Capital
Contribution $300,000,000 $150,000,000 $150,000,000
============ ============ ============
The payments (after the first payment) are due on the first working day of the
respective quarter.
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<PAGE>
SCHEDULE II
RELEVANT BUSINESS
-----------------
. Long Distance
. Local Phone
. Wireless Phone
. Internet Services
. Paging
. Video (Wireline and Wireless)
. Broadband Services (Wholesale Voice and Data)
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<PAGE>
SCHEDULE III
RELEVANT MARKET
---------------
The following outlines the geographic area included in the Relevant Market
I. Washington, D.C.
Montgomery Country, Maryland
Prince Georges County, Maryland
II. Baltimore County and City, Maryland
Anne Arundel, Maryland
Howard County, Maryland
Carroll County, Maryland
Harford County, Maryland
III. Fairfax and Arlington County, Virginia
Loudoun County, Virginia
Frederick County, Maryland
Prince William County, Virginia
Stafford County, Virginia
Charles County, Maryland
Saint Mary's County, Maryland
Calvert County, Maryland
Queen Anne's County, Maryland
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<PAGE>
SCHEDULE IV
SHARING RATIO
-------------
RCN-Sub 50%
PCI-Sub 50%
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<PAGE>
RCN CORPORATION
LIST OF SUBSIDIARIES Exhibit 21
State of PERCENTAGE
Name Incorporation OWNED
- -------------------------------------------------- ------------- ----------
RCN Services, Inc PA 100%
TEC Air, Inc. DE 100%
RCN Financial Management, Inc. DE 100%
ENET Holding, Inc. DE 100%
UNET Holding, Inc. DE 100%
LME Acquisition Corporation NY 100%
C-TEC Financial Services, Inc. NV 100%
C-TEC Cable Systems, Inc. DE 100%
C-TEC Cable System Services, Inc. PA 100%
RCN of New Jersey, Inc. PA 100%
RCN of Southeast New York, Inc. PA 100%
RCN Telecom Services of Pennsylvania, Inc. PA 100%
RCN Telecom Services of Southeast New York, Inc. NY 100%
Fiberfone of Pennsylvania, Inc PA 100%
Fiberfone of New Jersey, Inc. NJ 100%
Fiberfone of Michigan, Inc. MI 100%
C-TEC Fiber Systems of New Jersey, Inc. NJ 100%
RCN Long Distance Company PA 100%
RCN International Holdings, Inc. DE 100%
RCN Telecom Services, Inc. DE 100%
RCN Operating Services, Inc. NJ 100%
RCN Telecom Services of Illinois, Inc. IL 100%
RCN Telecom Services of Maryland, Inc. MD 100%
RCN Telecom Services of Massachusetts, Inc. MA 100%
RCN Telecom Services of Michigan, Inc. MI 100%
RCN Telecom Services of New York, Inc. NY 100%
RCN Telecom Services of Washington, Inc. WA 100%
RCN Telecom Services of Delaware, Inc. DE 100%
RCN Telecom Services of California, Inc. CA 100%
RCN Telecom Services of Philadelphia, Inc. PA 100%
RCN Telecom Services of New Jersey, Inc. NJ 100%
RCN Telecom Services of Virginia, Inc. VA 100%
RCN Telecom Services of Washington, D.C., Inc. DC 100%
RCN Telecom Services of Maine, Inc. ME 100%
RCN Telecom Services of New Hampshire, Inc. NH 100%
RCN Telecom Services of Vermont, Inc. VT 100%
RCN Telecom Services of Rhode Island, Inc. RI 100%
RCN Telecom Services of Connecticut, Inc. CT 100%
FNY Holding Company, Inc. NY 100%
RCN Corporate Services, Inc. NJ 100%
RCN Financial Services, Inc. DE 100%
Freedom New York L.L.C. DE 100%
RCN-BecoCom, LLC MA 51%
Starpower Communications, LLC DE 50%
Homelink Limited Partnership NJ 80.355%
1
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
RCN Corporation on Form S-8 (File Nos. 333-37959 and 333-38137) of our report
dated March 13, 1998, on our audits of the consolidated financial statements and
financial statement schedules of RCN Corporation and Subsidiaries as of December
31, 1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995,
which report is included in this Annual Report on Form 10-K.
/s/ Coopers & Lybrand L.L.P.
- ----------------------------
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 31, 1998
<PAGE>
Exhibit 24
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Thomas P. O'Neill, III do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998 and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998.
/s/ Thomas P. O'Neill, III (SEAL)
--------------------------------
Thomas P. O'Neill, III
Witness:
/s/ Christine M. Walsh
- ----------------------------
Christine M. Walsh
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, James Q. Crowe do make, constitute
and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial Officer, as my
true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998
/s/ James Q. Crowe (SEAL)
-----------------------
James Q. Crowe
Witness:
/s/ Dinah Sink
- -----------------------------
Dinah Sink
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, David C. McCourt do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998.
/s/ David C. McCourt (SEAL)
------------------------
David C. McCourt
Witness:
/s/ Blair Turner
- ---------------------------
Blair Turner
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Michael B. Yanney do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 27th day of March,
1998.
/s/ Michael B. Yanney (SEAL)
----------------------------
Michael B. Yanney
Witness:
/s/ C.L. Buckingham
- -----------------------------
C.L. Buckingham
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Richard R. Jaros do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998 and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 27th day of March,
1998.
/s/ Richard R. Jaros (SEAL)
------------------------
Richard R. Jaros
Witness:
/s/ Lori Jaros
- ---------------------------
Lori Jaros
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Alfred Fasola do make, constitute
and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial Officer, as my
true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th of
March, 1998.
/s/ Alfred Fasola (SEAL)
-------------------------
Alfred Fasola
Witness:
/s/ Susan Fasola
- --------------------------
Susan Fasola
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Stuart E. Graham do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998 and such spe cific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998.
/s/ Stuart E. Graham (SEAL)
----------------------------
Stuart E. Graham
Witness:
/s/ Camille D'Alessandro
- ------------------------------
Camille D'Alessandro
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Eugene Roth do make, constitute and
appoint Bruce C. Godfrey, RCN Corporation's Chief Financial Officer, as my true
and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 24th day of March,
1998.
/s/ Eugene Roth (SEAL)
-------------------------
Eugene Roth
Witness:
/s/ Janet Kaye
- ---------------------------
Janet Kaye
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Thomas J. May do make, constitute
and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial Officer, as my
true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 27th day of March,
1998.
/s/ Thomas J. May (SEAL)
-------------------------
Thomas J. May
Witness:
/s/ Carol O'Rourke
- --------------------------
Carol O'Rourke
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Walter Scott, Jr. do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998.
/s/ Water Scott, Jr. (SEAL)
--------------------------
Walter Scott, Jr.
Witness:
/s/ Julie Haack
- -----------------------------
Julie Haack
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Michael J. Mahoney do make,
constitute and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial
Officer, as my true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I may deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 23rd day of March,
1998.
/s/ Michael J. Mahoney (SEAL)
---------------------------
Michael J. Mahoney
Witness:
/s/ Kathleen Sparrowe
- -------------------------
Kathleen Sparrowe
<PAGE>
SPECIFIC POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, Dennis Spina do make, constitute
and appoint Bruce C. Godfrey, RCN Corporation's Chief Financial Officer, as my
true and lawful attorney for me and in my name:
1. I authorize said attorney in fact to specifically execute in my name
and in my behalf the RCN Corporation Form 10-K for the fiscal year ended
December 31, 1997, and to file said form to the Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549, and relative
instruments in writing which I deem requisite or proper to effectuate
specifically the execution and delivery of the above-mentioned form with the
same validity as I could, if personally present, and I hereby ratify and affirm
that my said attorney as I m ay deem to act for me, shall do, by virtue of these
presents, herein set forth by me.
2. All rights, powers and authority of said attorney in fact to exercise
any and all of the specific rights and powers herein granted shall commence and
be in full force and effect as of March 30, 1998, and such specific rights,
powers and authority shall remain in full force and effect thereafter until
termination in writing by me.
3. I give to said attorney in fact full power and authority to appoint a
substitute to perform all such of the acts that said attorney in fact is by this
instrument authorized to perform, with the right to revoke such appointment of
substitute at pleasure.
IN WITNESS WHEREOF, I hereunto set my hand and seal this 26th day of March,
1998.
/s/ Dennis Spina (SEAL)
---------------------------
Dennis Spina
Witness:
/s/ Taara C. Young
- -------------------------
Taara C. Young
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 222,910
<SECURITIES> 415,603
<RECEIVABLES> 19,949
<ALLOWANCES> 2,134
<INVENTORY> 2,745
<CURRENT-ASSETS> 703,232
<PP&E> 307,759
<DEPRECIATION> 107,419
<TOTAL-ASSETS> 1,150,992
<CURRENT-LIABILITIES> 69,705
<BONDS> 686,103
0
0
<COMMON> 54,989
<OTHER-SE> 301,595
<TOTAL-LIABILITY-AND-EQUITY> 1,150,992
<SALES> 0
<TOTAL-REVENUES> 127,297
<CGS> 0
<TOTAL-COSTS> 184,949
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,732
<INTEREST-EXPENSE> 25,602
<INCOME-PRETAX> (73,522)
<INCOME-TAX> (20,849)
<INCOME-CONTINUING> (49,181)
<DISCONTINUED> 0
<EXTRAORDINARY> (3,210)
<CHANGES> 0
<NET-INCOME> (52,391)
<EPS-PRIMARY> (0.95)
<EPS-DILUTED> (0.95)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 183,337
<SECURITIES> 0
<RECEIVABLES> 22,406
<ALLOWANCES> 1,741
<INVENTORY> 2,428
<CURRENT-ASSETS> 247,068
<PP&E> 273,960
<DEPRECIATION> 101,544
<TOTAL-ASSETS> 598,679
<CURRENT-LIABILITIES> 72,441
<BONDS> 110,000
0
0
<COMMON> 54,970
<OTHER-SE> 318,790
<TOTAL-LIABILITY-AND-EQUITY> 598,679
<SALES> 0
<TOTAL-REVENUES> 91,854
<CGS> 0
<TOTAL-COSTS> 127,934
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,327
<INTEREST-EXPENSE> 10,460
<INCOME-PRETAX> (45,253)
<INCOME-TAX> (11,907)
<INCOME-CONTINUING> (32,065)
<DISCONTINUED> 0
<EXTRAORDINARY> (3,210)
<CHANGES> 0
<NET-INCOME> (35,275)
<EPS-PRIMARY> (0.64)
<EPS-DILUTED> (0.64)
</TABLE>
