This prospectus is filed
pursuant to rule 424(b)(3)
of the Securities Act
of 1933
PROSPECTUS SUPPLEMENT
TO
PROSPECTUS DATED MAY 13, 1998
RCN Corporation
Common Stock, par value $1.00 per share
Attached is RCN Corporation's Quarterly Report on Form 10-Q for the period ended
September 30, 1998.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition periods from to
Commission file number 0-22825
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3498533
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
105 Carnegie Center
Princeton, New Jersey 08540
(Address of principal executive offices)
(Zip Code)
(609) 734-3700
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirement for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of September 30, 1998.
Common Stock 65,201,765
RCN CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations-Quarters and Nine Months Ended
September 30, 1998 and 1997
Condensed Consolidated Balance Sheets-
September 30, 1998 and December 31, 1997
Condensed Consolidated Statements of
Cash Flows-Nine Months Ended September 30,
1998 and 1997
Notes to Condensed Consolidated Financial
Statements
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial
Condition
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales $ 58,172 $ 31,148 $ 148,118 $ 91,854
Costs and expenses, excluding
depreciation and amortization 74,750 35,480 182,632 91,183
Depreciation and amortization 22,477 13,680 57,199 39,135
Nonrecurring acquisition costs:
In-process technology - - 51,667 -
Other nonrecurring charges - - - 10,000
---------- ---------- ---------- ----------
Operating (loss) (39,055) (18,012) (143,380) (48,464)
Interest income 16,424 3,681 43,232 13,442
Interest expense (31,157) (3,331) (80,811) (10,460)
Other income (expense), net (1,299) (371) (1,947) 229
---------- ---------- ---------- ----------
(Loss) before income taxes (55,087) (18,033) (182,906) (45,253)
(Benefit) for income taxes (30) (4,764) (9,923) (11,907)
---------- ---------- ---------- ----------
(Loss) before equity in unconsolidated
entities and minority interest (55,057) (13,269) (172,983) (33,346)
Equity in (loss) of unconsolidated entities (2,195) (1,089) (8,169) (2,650)
Minority interest in loss of
consolidated entities 4,491 2,543 11,545 3,931
---------- ---------- ---------- ----------
(Loss) before extraordinary charge (52,761) (11,815) (169,607) (32,065)
Extraordinary charge - debt prepayment
penalty, net of tax - (3,210) - (3,210)
---------- ---------- ---------- ----------
Net (loss) $ (52,761) $ (15,025) $ (169,607) $ (35,275)
========== ========== ========== ==========
Basic and diluted (loss) per average
common share:
(Loss) before extraordinary charge $ (0.81) $ (0.21) $ (2.83) $ (0.58)
========== ========== ========== ==========
Extraordinary charge - debt prepayment
penalty - (0.06) - (0.06)
========== ========== ========== ==========
Net (loss) $ (0.81) $ (0.27) $ (2.83) $ (0.64)
========== ========== ========== ==========
Weighted average shares outstanding 65,090,284 54,969,132 59,905,854 54,962,596
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
RCN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary cash investments $ 439,817 $ 222,910
Short-term investments 667,952 415,603
Accounts receivable from related parties 7,033 9,829
Accounts receivable, net of reserve for doubtful
accounts of $4,830 at September 30, 1998 and $2,134
at December 31, 1997 27,834 14,834
Material and supply inventory, at average cost 5,340 2,745
Prepayments and other 14,153 9,990
Deferred income taxes - 4,821
Investments restricted for debt service 22,650 22,500
---------- ----------
Total current assets 1,184,779 703,232
Property, plant and equipment, net of
accumulated depreciation of $152,274 at
September 30, 1998 and $107,419 at December 31, 1997 350,917 200,340
Investments 126,534 70,424
Investments restricted for debt service 31,288 39,411
Intangible assets, net of accumulated amortization
of $106,385 at September 30, 1998 and $53,388 at
December 31, 1997 144,997 96,547
Deferred charges and other assets 47,883 41,038
Deferred income taxes 4,049 -
----------- ----------
Total assets $ 1,890,447 $1,150,992
=========== ==========
</TABLE>
RCN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
<TABLE>
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of capital lease obligations $ 1,201 $ -
Accounts payable 63,748 24,835
Accounts payable to related parties 5,111 3,748
Advance billings and customer deposits 26,870 7,318
Accrued taxes - 488
Accrued interest 10,969 5,549
Accrued contract settlements 3,016 3,126
Accrued video programming expense 5,861 3,498
Accrued expenses 53,694 21,143
Deferred income tax 7,905 -
---------- ----------
Total current liabilities 178,375 69,705
Long-term debt 1,248,681 686,103
Deferred income taxes - 19,612
Other deferred credits 2,687 2,596
Minority interest 58,883 16,392
Commitments and contingencies
Preferred stock - -
Common shareholders' equity:
Common stock, par value $1 per share: Authorized
100,000,000 shares: Issued and outstanding
65,201,765 and 54,989,870 65,444 54,989
Additional paid-in capital 527,723 321,766
Cumulative translation adjustments (3,055) (3,055)
Unrealized appreciation on investments 2,881 -
Treasury stock, 242,000 shares at cost (4,449) -
Deficit (186,723) (17,116)
---------- ----------
Total common shareholders' equity 401,821 356,584
---------- ----------
Total liabilities and shareholders' equity $1,890,447 $1,150,992
========== ==========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 28,046 $ 202
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant & equipment (175,657) (43,890)
Investment in unconsolidated joint venture (12,500) -
Purchases of short-term investments (387,804) -
Sales and maturities of short-term investments 135,463 46,935
Acquisitions (46,244) (30,490)
Proceeds from the sale of partnership interest - 1,900
Other 8,729 4,275
--------- ---------
Net cash used in investing activities (478,013) (21,270)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt 502,587 110,000
Repayment of long-term debt (1,118) (131,250)
Proceeds from the issuance of stock 112,836 -
Purchase of treasury stock (4,449) -
Payments made for debt financing costs (9,851) -
Contribution to minority interest partner (108) -
Contribution from minority interest partner 53,998 -
Proceeds from the exercise of stock options 1,854 -
Transfer from CTE - 132,231
Transfer (to) CTE - (112,046)
Decrease in restricted cash 11,125 -
Change in affiliate notes - 143,627
--------- ---------
Net cash provided by financing activities 666,874 142,562
--------- ---------
Net increase in cash and temporary cash investments 216,907 121,494
Cash and temporary cash investments at
beginning of year 222,910 61,843
--------- ---------
Cash and temporary cash investments at September 30, $ 439,817 $ 183,337
--------- ---------
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of amounts capitalized) $ 73,355 $ 14,656
Income taxes $ 897 $ 743
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Data)
1. The Condensed Consolidated Financial Statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, in the opinion of the
Management of the Company, the Condensed Consolidated Financial Statements
include all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the financial information. The Condensed
Consolidated Financial Statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K for
the year ended December 31, 1997 together with any amendment thereto.
2. Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). RCN consists primarily of C-TEC's high growth, bundled
residential voice, video and Internet access operations in the Boston to
Washington, D.C. corridor, its existing New York, New Jersey and Pennsylvania
cable television operations, a portion of its long-distance operations and its
international investment in Megacable, S.A. de C.V. ("Megacable"). RCN recently
announced that it intends to initiate network development in California's San
Diego to San Francisco corridor.
The historical financial information presented herein reflects periods during
which the Company did not operate as an independent company and accordingly,
certain assumptions were made in preparing such financial information. Such
information, therefore, may not necessarily reflect the results of operations
or the financial condition of the Company which would have resulted had the
Company been an independent, public company during the reporting periods, and
are not necessarily indicative of the Company's future operating results or
financial condition.
3. The Company owns a 40% equity interest in Megacable. For the quarters ended
September 30, 1998 and 1997, the Company recorded equity in the earnings (loss)
of Megacable which consists of its proportionate share of income and
amortization of excess cost over equity in net assets of $(957) and $(930),
respectively. For the nine months ended September 30, 1998 and 1997, the Company
recorded equity in the earnings (loss) of Megacable which consists of its
proportionate share of income and amortization of excess cost over equity in net
assets of $(2,008) and $(2,477), respectively.
Summarized information for the financial position and results of operations of
Megacable, as of and for the nine months ended September 30, 1998 and 1997, is
as follows:
1998 1997
-------- --------
Assets $ 86,024 $ 76,217
Liabilities $ 10,756 $ 8,055
Shareholders' equity $ 75,268 $ 68,162
Sales $ 27,938 $ 22,281
Cost and expenses $ 19,684 $ 15,231
Foreign currency transaction losses $ 2,039 $ -
Net income $ 7,240 $ 6,827
Effective January 1, 1997, since the three-year cumulative rate of inflation at
December 31, 1996 exceeded 100%, Mexico is being treated for accounting
purposes as having a highly inflationary economy. Therefore, the U.S. dollar
is treated as the functional currency and translation adjustments are included
in income. The Company's proportionate share of such adjustments were gains
(losses) of $(788) and $(816) for the three and nine month periods ended
September 30, 1998, respectively, which are included in the condensed
consolidated statement of operations in equity in loss of unconsolidated
entities.
4. During the first nine months of 1998, approximately 2,066,000 options
were granted, approximately 358,000 were exercised yielding cash proceeds of
$1,854 and approximately 317,000 options were canceled. At September 30, 1998,
there are approximately 8,498,000 options outstanding at exercise prices
ranging from $0.04 to $29.81 under RCN's 1997 Plan.
5. On September 30, 1997, the Yee Family Trusts, as holders of CTE's Preferred
Stock Series A and Preferred Stock Series B, filed an action against the
Company, CTE and Cable Michigan in the Superior Court of New Jersey. The
complaint alleges that CTE's distribution of the Common Stock of RCN and Cable
Michigan in connection with the Distribution constitutes a fraudulent
conveyance. The plaintiff further alleges breaches of contract and fiduciary
duties in connection with the Distribution. On December 1, 1997, the complaint
was amended to allege that CTE's distribution of the common stock of RCN and
Cable Michigan was an unlawful distribution in violation of Pa. C.S. 1551
(b)(2). The plaintiffs have asked the Court to set aside the alleged fraudulent
conveyance and are seeking unspecified monetary damages alleged to be in excess
of $52,000. The Company believes that this lawsuit is without merit and is
contesting this action vigorously. On January 9, 1998, the defendants, including
RCN, filed a Motion to Dismiss, or in the Alternative, for Summary Judgement
("the Motion"). Response and Reply Briefs have also been filed. Oral argument on
the motion was held on September 15, 1998. As a result, two counts of the
complaint were dismissed. The Company's answer was subsequently filed.
Settlement discussions are currently in process. The Company can give no
assurance that these discussions will be successful in settling this complaint.
6. Basic earnings per share is computed based on net (loss) income divided by
the weighted average number of shares of common stock outstanding during the
period.
Diluted earnings per share is computed based on net (loss) income divided by
the weighted average number of shares of common stock outstanding during the
period after giving effect to convertible securities considered to be dilutive
common stock equivalents. The conversion of stock options during the periods
in which the Company incurs a loss from continuing operations is not assumed
since the effect is anti-dilutive. The number of stock options which would
have been converted in the quarter and nine months ended September 30, 1998 and
have a dilutive effect if the Company had income from continuing operations is
2,851,159 and 3,595,147, respectively.
For periods prior to October 1, 1997, during which the Company was a
wholly-owned subsidiary of C-TEC, earnings per share was calculated by dividing
net (loss) income by the number of average common shares of C-TEC outstanding,
based upon a distribution ratio of one share of Company common equity for
each share of C-TEC common equity owned.
The following table is a reconciliation of the numerators and denominators of
the basic and diluted per share computations:
<TABLE>
<CAPTION>
Quarter Ended September 30, Nine Months Ended September 30,
---------------------------- -------------------------------
1998 1997 1998 1997
----------- ---------- ----------- ------------
<S> <C> <C> <C> <C>
Net (loss) before extraordinary charge $ (52,761) $ (11,815) $ (169,607) $ (32,065)
Basic earnings per average common share:
Weighted average shares outstanding 65,090,284 54,969,132 59,905,854 54,962,596
Loss per average common share (0.81) (0.21) (2.83) (0.58)
Diluted earnings per average common share:
Weighted average shares outstanding 65,090,284 54,969,132 59,905,854 54,962,596
Dilutive shares resulting from stock options - - - -
---------- ---------- ---------- ------------
Weighted average shares and common stock
equivalents outstanding 65,090,284 54,969,132 59,905,854 54,962,596
========== ========== ========== ============
Loss per average common share $ (0.81) $ (0.21) $ (2.83) $ (0.58)
</TABLE>
7. On February 27, 1998, RCN entered into an Agreement and Plan of Merger
("Lancit Merger Agreement") with Lancit Media Entertainment, Ltd., a New York
corporation ("Lancit"), and LME Acquisition Corporation, a New York corporation
and a wholly-owned subsidiary of RCN ("LME"). The transaction was completed
in June 1998. Pursuant to the Lancit Merger Agreement, LME was merged with
and into Lancit, with Lancit surviving the merger and becoming a wholly-owned
subsidiary of RCN (the "Lancit Merger"). Lancit is a producer of high-quality
children's programming. The total consideration for the transaction was $1
in cash and 366,596 in shares of RCN Common Stock. All options to purchase
Lancit Common Stock were canceled. In addition, approximately 660,000 warrants
to purchase Lancit Common Stock became, by their terms, warrants to purchase
the number of shares of RCN Common Stock equal to the number the warrant holders
would have received had they exercised their warrants immediately prior to the
Lancit Merger (such number would have been approximately 33,000). The Company is
conducting a study for the purpose of allocating the purchase price paid. The
Company has preliminarily allocated the excess of the purchase price paid over
the book value of the assets acquired and liabilities assumed to goodwill.
The transaction was accounted for by the purchase method of accounting. The
Company's spin-off from C-TEC Corporation currently precludes it from utilizing
the pooling method of accounting.
8. On June 1, 1998, RCN entered into an Agreement and Plan of Merger
("Interport Merger Agreement") with Interport Communications Corp., a New York
corporation ("Interport") and INET Holding, Inc., a New York corporation and a
wholly-owned subsidiary of RCN ("INET"), and the individual stockholders of
Interport (the "Interport Stockholders"). The transaction was completed in June
1998. Pursuant to the Interport Merger Agreement, INET was merged with and into
Interport, with Interport surviving the merger and becoming a wholly-owned
subsidiary of RCN (the "Interport Merger"). Interport was New York City's
largest independent Internet service provider ("ISP") with more than 10,000
dial-up accounts and 500 dedicated line and web hosting customers at the date of
acquisition. The total consideration for the transaction was $1,025 in cash and
396,442 shares of RCN Common Stock. In addition, Interport stock options were
converted into options to purchase 25,302 shares of RCN Common Stock and 46,986
units granting the right to deferred delivery of 46,986 shares of RCN Common
Stock were issued. The Company is conducting a study for the purpose of
allocating the purchase price paid. The Company has preliminarily allocated the
excess of the purchase price paid over the book value of the assets acquired and
liabilites assumed to goodwill. The transaction was accounted for by the
purchase method of accounting. The Company's spin-off from C-TEC Corporation
currently precludes it from utilizing the pooling method of accounting.
Pursuant to the Interport Merger Agreement, on June 12, 1998, RCN and the
Interport Stockholders entered into a registration rights agreement ("the
Interport Registration Rights Agreement"). Under the terms of the Interport
Registration Rights Agreement, RCN agreed to register the shares of RCN Common
Stock received by the Interport Stockholders pursuant to a shelf registration
statement, and granted the Interport Stockholders piggy-back registration
rights with respect to such shares, subject to certain limitations as set
forth in the Interport Registration Rights Agreement.
9. On June 30, 1998, RCN entered into an Agreement and Plan of Merger ("JavaNet
Merger Agreement") with JavaNet, Inc., a Delaware corporation ("JavaNet"), David
Epstein, Zachary Julius, JNET Holding, Inc., a Delaware corporation and a
wholly-owned subsidiary of RCN ("JNET") and (with respect to certain provisions
only) John Halpern. The transaction was completed on July 23, 1998. Pursuant to
the JavaNet Merger Agreement, JNET merged with and into JavaNet, with JavaNet
surviving the merger and becoming a wholly-owned subsidiary of RCN. In
connection with the transaction, RCN paid $2,370 in cash and issued
approximately 569,000 shares of RCN Common Stock to JavaNet stockholders. All
options to purchase JavaNet Common Stock were canceled. JavaNet was an internet
service provider with approximately 32,000 subscribers in Connecticut, Maine and
Massachusetts at the time of acquisition. The transaction was accounted for
under the purchase method of accounting. The Company's spin-off from C-TEC
Corporation currently precludes it from utilizing the pooling method of
accounting.
10. In June 1998, the Company completed a public offering of 11% Senior
Discount Notes with an aggregate principal amount at maturity of $256,755, due
2008. The 11% Senior Discount Notes were issued at a discount and
generated gross proceeds to the Company of approximately $150,000.
The 11% Senior Discount Notes are general senior obligations of the Company.
The 11% Senior Discount Notes will not pay cash interest prior to
January 1, 2003. The yield to maturity of the 11% Senior Discount Notes,
determined on a semi-annual bond equivalent basis, will be 11% per annum.
The 11% Indenture contains certain covenants that, among other things,
limit the ability of the Company and its subsidiaries to incur indebtedness,
pay dividends, prepay subordinate indebtedness, repurchase capital stock,
engage in transactions with stockholders and affiliates, create liens, sell
assets and engage in mergers and consolidations.
The 11% Senior Discount Notes are redeemable, in whole or in part, at
any time on or after July 1, 2003 at the option of the Company. The
11% Senior Discount Notes may be redeemed at redemption prices starting at
105.5% of the principal amount at maturity and declining to 100% of the
principal amount at maturity, plus any accrued and unpaid interest.
11. In June 1998, the Company completed a public offering of 6,794,500 shares
of RCN Common Stock, par value $1.00 per share, with a price to the Public
of $19.50 per share. Of the 6,794,500 shares offered 6,098,355 were offered
by the Company and 696,145 shares were offered by a Selling Stockholder. The
net proceeds to the Company were approximately $113,305 after deducting issuance
costs.
12. The Company has elected to adopt Statement of Financial Accounting
Standard No. 131 - "Disclosure about Segments of an Enterprise and Related
Information" ("SFAS 131"). The Company's operations involve developing an
advanced fiber network to provide a bundled service package of voice, video
and data services to new customers in high density markets and migrating as
many customers as is economically justified which were served by the Company's
previously separate lines of business, for which profitability was separately
measurable and monitored, to the single source network. While the
Company's chief decision makers monitor the revenue streams of the various
products, operations are managed and financial performance is evaluated
based upon the delivery of multiple services to customers over a single
network. This allows the Company to leverage its network costs to maximum
profitability. As a result, there are many shared expenses generated by
the various revenue streams and management believes that any allocation of the
expenses incurred on a single network to multiple revenue streams would be
impractical and arbitrary, and management does not currently make such
allocations internally. The chief decision makers do, however, monitor
financial performance in a way which is different from that depicted in the
historical general purpose financial statements included in this Quarterly
Report.
The Company manages operations and evaluates operating financial performance on
a basis which reflects the consolidation of all domestic joint ventures,
including those not consolidated under generally accepted accounting principles
("Pro Forma Total RCN" basis). The same net loss results on both a historical
and pro forma total RCN basis since the outside ownership of the joint venture,
which is consolidated only in the pro forma total RCN information, is reflected
as minority interest in the pro forma total RCN information.
Such results for the quarter and nine months ended September 30, 1998 and 1997
are as follows:
<TABLE>
<CAPTION>
Pro Forma Total RCN (as defined above)
--------------------------------------------------------
Quarter Ended Nine Months Ended
September 30, September 30,
--------------------------- -------------------------
1998 1997 1998 1997
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Sales:
Voice $ 7,256 $ 895 $ 15,963 $ 1,869
Video 28,800 25,677 83,389 76,896
Data 23,261 14 47,520 25
Commercial & other 9,305 4,562 24,258 13,064
----------- ------------ ---------- -----------
Total 68,622 31,148 171,130 91,854
Cost and expenses, excluding
depreciation and amortization:
Direct expenses 29,942 12,000 76,719 35,113
Operating, selling,
general and administrative 51,429 23,480 127,176 56,070
----------- ------------ ----------- -----------
EBITDA before nonrecurring charges (12,749) (4,332) (32,765) 671
Depreciation and amortization 28,893 13,680 71,813 39,135
Nonrecurring charge - - - 10,000
Nonrecurring acquisition costs -
In-process technology - - 51,667 -
----------- ------------ ----------- -----------
Operating (loss) (41,642) (18,012) (156,245) (48,464)
Interest income 16,569 3,681 43,808 13,442
Interest expense (31,157) (3,331) (80,811) (10,460)
Other income (expense) (1,331) (371) (1,978) 229
----------- ------------ ----------- -----------
(Loss) before income taxes (57,561) (18,033) (195,226) (45,253)
(Benefit) for income taxes (30) (4,764) (9,923) (11,907)
----------- ------------ ----------- -----------
(Loss) before equity in unconsolidated entities
and minority interest (57,531) (13,269) (185,303) (33,346)
Equity in loss of unconsolidated entities (957) (1,089) (2,008) (2,650)
Minority interest in loss of consolidated entities 5,727 2,543 17,704 3,931
----------- ------------ ----------- -----------
(Loss) before extraordinary charge (52,761) (11,815) (169,607) (32,065)
Extraordinary charge - debt prepayment
penalty, net of tax - (3,210) - (3,210)
----------- ------------ ----------- -----------
Net (loss) $ (52,761) $ (15,025) $ (169,607) $ (35,275)
=========== ============ =========== ===========
<CAPTION>
Balance sheet data (at September 30): 1998 1997
----------- ------------
<S> <C> <C>
Cash, temporary cash investments
and short-term investments $1,117,238 $ 183,337
Property, plant and equipment $ 533,250 $ 273,960
Accumulated depreciation 152,293 101,544
----------- ------------
Net property, plant and equipment $ 380,957 $ 172,416
Long-term debt $1,248,681 $ 110,000
</TABLE>
Operating income before depreciation and amortization ("EBITDA") is commonly
used in the communications industry to analyze companies on the basis of
operating performance, leverage and liquidity. EBITDA is not intended to
represent cash flows for the period and should not be considered as an
alternative to cash flows from operating, investing or financing activities as
determined in accordance with U.S. GAAP. EBITDA is not a measurement under U.S.
GAAP and may not be comparable with other similarly titled measures of other
companies.
13. In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 130 - "Reporting Comprehensive
Income" ("SFAS 130"). This statement, which establishes standards for
reporting and disclosure of comprehensive income, is effective for interim
and annual periods beginning after December 15, 1997. The amount of other
comprehensive loss for the nine months ended September 30, 1998 was ($174).
14. In June, 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 133 ("SFAS 133"). This
statement, which establishes accounting and reporting standards for derivative
instruments and for hedging activities, is effective for the first quarter of
fiscal years beginning after June 15, 1999. The Company does not currently
have any items subject to disclosure pursuant to SFAS 133.
15. On February 20, 1998, RCN issued 1,730,648 shares of RCN Common Stock to
certain shareholders of Erols Internet, Inc. ("Erols") in connection with the
merger of Erols with and into a wholly-owned subsidiary of RCN. On February
27, 1998, RCN issued 890,384 shares of RCN Common Stock to certain shareholders
of UltraNet Communications, Inc. ("UltraNet") in connection with the merger of
UltraNet with and into a wholly-owned subsidiary of RCN. On June 12, 1998 RCN
issued 396,442 shares of RCN Common Stock to certain shareholders of Interport
in connection with the merger of Interport with and into a wholly-owned
subsidiary of RCN. On July 23, 1998, RCN issued 568,887 shares of RCN
Common Stock to certain shareholders of JavaNet in connection with the merger
of JavaNet, Inc. with and into a wholly-owned subsidiary of RCN. These four
issuances were made pursuant to the exemption from registration under Section
4(2) of the Securities Act on the basis that each transaction involved the
issuance of securities in a transaction not involving a public offering.
16. The Company's effective tax rate is different from the federal tax rate
since in the third quarter of 1998, the tax effect of the Company's cumulative
losses has exceeded the tax effect of accelerated deductions, primarily
depreciation, which the Company has taken for federal income tax purposes.
Except in unusual cases, generally accepted accounting principles do not permit
the recognition of tax benefits of such excess losses in the financial
statements. This accounting treatment does not impact the amount or expiration
periods of actual NOL carryovers or cash flows for taxes. Additionally, the
charge for in-process technology is not deductible for tax purposes and a tax
benefit was correspondingly not recorded.
17. 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 $5,100 of debt.
Additionally, the Company converted approximately 999,000 of Erols stock options
to 699,104 of RCN stock options at an average exercise price of $3.424 per
share. The transaction was accounted for under the purchase method of
accounting. In connection with the acquisition of Erols, the Company and an
independent third party are conducting a study for the purpose of allocating the
purchase price paid for Erols. The preliminary results of this study indicate
that approximately $36,000 will be allocated to in-process technology, which the
Company recorded as a charge in the first six months of 1998.
RCN expects to contribute to Starpower approximately 60% of the subscribers
acquired in the acquisition of Erols.
18. 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 approximately $7,000 in cash, 890,384 shares of RCN
Common Stock, and $3,000 in deferred compensation. Additionally, the Company
converted 63,500 of Ultranet stock options to 117,052 of RCN stock options at an
average exercise price of $1.825 per share and made cash payments aggregating
approximately $503 to certain holders of Ultranet stock options. The transaction
was consummated on February 27, 1998. The transaction was accounted for under
the purchase method of accounting. In connection with the acquisition of
Ultranet, the Company and an independent third party are conducting a study for
the purpose of allocating the purchase price paid for Ultranet. The preliminary
results of this study indicate that approximately $16,000 will be allocated to
in-process technology, which the Company recorded as a charge in the first six
months of 1998.
RCN expects to contribute to RCN-BECOCOM approximately 30% of the subscribers
acquired in the acquisition of Ultranet.
19. Associated with acquisitions occuring earlier this year, RCN calculated
that approximately $36 million of the purchase price of Erol's and $16 million
of the purchase price of Ultranet would qualify for immediate write-off as
acquired in-process research & development. Since the time these calculations
took place, the SEC has critically examined this issue, and in the case of
challenges to accounting practices of two other public communications companies,
substantial downward revisions were made to previous calculations of acquired
in-process R&D.
The Company's previous calculation was conducted in accordance with all
appropriate accounting procedures and interpretations, most significantly
considering the tests of technological feasibility and alternative future use as
applied to the acquired R&D projects. At present, the SEC accounting staff
appears to be requiring consideration of additional factors for financial
reports filed with the SEC, most importantly the percentage of completion of
acquired projects, and appears to be embracing write-offs representing the value
of that portion of the development effort completed at acquisition, rather than
the discounted value of benefits from the entire acquired project.
At present, the Company is evaluating these new requirements and is examining
the prior calculations to assess their potential impact upon the previously
computed estimates of acquired in-process R&D. These calculations are incomplete
but the Company estimates that if it is required to apply a downward revision in
calculated in-process R&D it may be of a comparable magnitude to the publicly-
disclosed adjustments for other communications companies discussed above. The
Company's previous calculation could be reduced by up to approximately half.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
(Dollars in Thousands, Except Per Share Data)
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this Quarterly
Report is forward-looking, such as information relating to the effects of future
regulations and competition, the impact of the Year 2000 issue, expected capital
expenditures, capital contributions to joint ventures by joint venture partners,
and expected trends in operating losses and cash flows associated with
investments in new markets. Such forward-looking information involves important
risks and uncertainties that could significantly affect expected results in the
future differently from those expressed in any forward-looking statements made
by, or on behalf of, the Company. These risks and uncertainties include, but are
not limited to, uncertainties relating to economic conditions, acquisitions and
divestitures, government and regulatory policies, the pricing and availability
of equipment, materials, inventories and programming, technological developments
and changes in the competitive environment in which the Company operates.
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the year ended
December 31, 1997 included in the Company's Form 10-K together with any
amendment thereto.
The negative operating cash flow from the Company's advanced fiber optic network
business has resulted primarily from expenditures associated with the
development of the Company's operational infrastructure and marketing expenses.
The Company expects it will continue to experience negative operating cash flow
and operating and net losses while it continues to invest in its networks and
until such time as revenue growth is sufficient to fund operating expenses. The
Company expects to achieve positive operating margins over time by (i)
increasing the number of customers it serves, (ii) increasing the number of
connections per customer by cross marketing its services and promoting bundled
service options and therefore increasing the revenue per customer, (iii)
lowering the costs associated with new subscriber additions and (iv) reducing
the cost of providing services by capturing economies of scale. The Company
expects its operating revenues will increase 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 expands its current networks and initiates network development in
Washington, D.C., Philadelphia and California's San Francisco to San Diego
corridor. When the Company makes its initial investment in a new market, the
operating losses typically increase as the network and sales force are expanded
to facilitate growth. The Company's ability to generate positive cash flow in
the future will depend on the extent of capital expenditures in current and
additional markets, the ability of the joint ventures to generate revenues and
cash flow, competition in the Company's markets and any potential adverse
regulatory developments. The Company will be dependent on various financing
sources to fund its growth as well as continued losses from operations. There
can be no assurance that such funding will be available, or available on terms
acceptable to the Company. See " - Liquidity and Capital Resources."
Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). The historical financial information presented herein
reflects periods during which the Company did not operate as an independent
company and accordingly, certain assumptions were made in preparing such
financial information. Such information, therefore, may not necessarily
reflect the results of operations or the financial condition of the Company
which would have resulted had the Company been an independent, public company
during the reporting periods, and are not necessarily indicative of the
Company's future operating results or financial condition.
Results of Operations
The Company manages operations and evaluates operating financial performance on
a basis which reflects the consolidation of all domestic joint ventures,
including those not consolidated under generally accepted accounting principles
("Pro Forma Total RCN" basis). The same net loss results on both a historical
and pro forma total RCN basis since the outside ownership of the joint venture,
which is consolidated only in the pro forma total RCN information, is reflected
as minority interest in the pro forma total RCN information.
Except as noted, the discussion which follows addresses results on a pro forma
total RCN basis. Such results for the quarter and nine months ended
September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Pro Forma Total RCN (as defined above)
-------------------------------------------------------
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1998 1997 1998 1997
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales:
Voice $ 7,256 $ 895 $ 15,963 $ 1,869
Video 28,800 25,677 83,389 76,896
Data 23,261 14 47,520 25
Commercial & other 9,305 4,562 24,258 13,064
--------- ----------- ----------- -----------
Total 68,622 31,148 171,130 91,854
Cost and expenses, excluding
depreciation and amortization:
Direct expenses 29,942 12,000 76,719 35,113
Operating, selling,
general and administrative 51,429 23,480 127,176 56,070
--------- ----------- ----------- -----------
EBITDA before nonrecurring charges (12,749) (4,332) (32,765) 671
Depreciation and amortization 28,893 13,680 71,813 39,135
Nonrecurring charge - - - 10,000
Nonrecurring acquisition costs:
In-process technology - - 51,667 -
--------- ----------- ----------- -----------
Operating (loss) (41,642) (18,012) (156,245) (48,464)
Interest income 16,569 3,681 43,808 13,442
Interest expense (31,157) (3,331) (80,811) (10,460)
Other income (expense) (1,331) (371) (1,978) 229
--------- ----------- ----------- -----------
(Loss) before income taxes (57,561) (18,033) (195,226) (45,253)
(Benefit) for income taxes (30) (4,764) (9,923) (11,907)
--------- ----------- ----------- -----------
(Loss) before equity in unconsolidated entities
and minority interest (57,531) (13,269) (185,303) (33,346)
Equity in loss of unconsolidated entities (957) (1,089) (2,008) (2,650)
Minority interest in loss of consolidated entities 5,727 2,543 17,704 3,931
--------- ----------- ----------- -----------
(Loss) before extraordinary charge (52,761) (11,815) (169,607) (32,065)
Extraordinary charge - debt prepayment penalty,
net of tax - (3,210) - (3,210)
--------- ----------- ----------- -----------
Net (loss) $ (52,761) $ (15,025) $ (169,607) $ (35,275)
========= =========== =========== ===========
<CAPTION>
Balance sheet data (at September 30): 1998 1997
---------- -----------
<S> <C> <C>
Cash, temporary cash investments
and short-term investments $1,117,238 $ 183,337
Property, plant and equipment $ 533,250 $ 273,960
Accumulated depreciation 152,293 101,544
---------- -----------
Net property, plant and equipment $ 380,957 $ 172,416
Long-term debt $1,248,681 $ 110,000
</TABLE>
Operating income before depreciation and amortization ("EBITDA") is commonly
used in the communications industry to analyze companies on the basis of
operating performance, leverage and liquidity. EBITDA is not intended to
represent cash flows for the period and should not be considered as an
alternative to cash flows from operating, investing or financing activities as
determined in accordance with U.S. GAAP. EBITDA is not a measurement under U.S.
GAAP and may not be comparable with other similarly titled measures of other
companies.
Historical
- ----------
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
On a historical basis, for the three months ended September 30, 1998, EBITDA
before nonrecurring acquisition costs was ($16,578) as compared to ($4,332)
for the same period in 1997. For the three months ended September 30, 1998,
operating loss before non-recurring charges was ($39,055) as compared to
($18,012) for the same period in 1997. Sales increased 86.8% to $58,172 for the
quarter ended September 30, 1998 from $31,148 for the same period in 1997.
Pro Forma Total RCN
- -------------------
Sales
- -----
Video sales are comprised primarily of subscription fees for basic, premium and
pay-per-view cable television services; for both wireless and hybrid
fiber/coaxial cable customers in New York, New Jersey and Pennsylvania which
the Company expects to migrate to its advanced fiber networks over time as
well as for approximately 58,000 advanced fiber customers, primarily in
Allentown, New York City and Boston.
Voice sales include local telephone service fees consisting primarily of monthly
line charges, local toll and special features and long-distance telephone
service fees based on minutes of traffic and tariffed rates or contracted fees.
Voice sales include both resold services and traffic over the Company's own
switches.
Data sales represent Internet access fees billed at contracted rates.
Total sales increased $37,474, or 120.3% to $68,622 for the quarter ended
September 30, 1998 from $31,148 for the quarter ended September 30, 1997. The
increase resulted from higher total service connections which increased 227.1%
to approximately 808,000 at September 30, 1998 from approximately 247,000 at
September 30,1997. The increase in service connections resulted from expansion
of the Company's advanced fiber network, growth in resold voice connections and
the acquisitions of Erols Internet, Inc. ("Erols") and UltraNet Communications
("UltraNet") which provided approximately 370,000 data connections at the date
of acquisition. Advanced fiber units passed increased to approximately 214,000
units at September 30, 1998 from approximately 26,000 units at September 30,
1997.
Voice revenues increased $6,361 to $7,256 for the quarter ended September 30,
1998 from $895 for the quarter ended September 30, 1997 primarily due to an
increase in off-net voice connections. Off-net voice connections were 58,093
and 10,953 at September 30, 1998 and 1997, respectively. Partially
contributing to the increase in off-net connections was the start-up of
telephony operations in the Lehigh Valley, Pennsylvania market in the fourth
quarter of 1997. Advanced fiber voice connections were 20,857 and 1,909 at
September 30, 1998 and 1997, respectively.
Video revenue increased $3,123 or 12.2% to $28,800 for the quarter ended
September 30, 1998 from $25,677 for the quarter ended September 30, 1997.
The increase in 1998 was primarily due to increases of approximately 20,000
average video connections as compared to the same period in 1997. Additionally,
video rate increases in February and May in selected markets contributed
approximately $1,296 of the increase.
Data revenues increased $23,247 to $23,261 for the quarter ended September 30,
1998 from $14 for the quarter ended September 30, 1997 primarily due to the
acquisitions of Erols and UltraNet in February 1998. The Company had
approximately 450,000 average data connections for the quarter ended September
30, 1998 as compared to approximately 200 average data connections for the
quarter ended September 30, 1997.
Commercial and other revenues increased $4,743, or 104.0% to $9,305 for the
quarter ended September 30, 1998 from $4,562 for the quarter ended September 30,
1997. The increase was due to an increase in average commercial main access
lines of approximately 10,800 over the same period in 1997, compounded by an
increase in revenue per main access line. The increase in commercial main access
lines contributed approximately $1,200 to the increase while the increase in
revenue per main access line contributed approximately $1,300. Additionally
contributing approximately $1,700 to the increase in commercial and other
revenues was higher wholesale long distance revenue from Commonwealth Telecom
Services, Inc. ("CTSI"), a wholly-owned subsidiary of Commonwealth Telephone
Enterprises, Inc. (formerly C-TEC Corporation). CTSI is a Competitive Local
Exchange Carrier ("CLEC") which operates in areas adjacent to the traditional
service area of Commonwealth Telephone Company (also a wholly-owned subsidiary
of Commonwealth Telephone Enterprises, Inc.).
Costs and Expenses Excluding Depreciation and Amortization and Nonrecurring
- ---------------------------------------------------------------------------
Charges
- -------
Costs and expenses, excluding depreciation and amortization and nonrecurring
charges, are comprised of direct costs and operating, selling, and general and
administrative expenses.
Direct expenses include direct costs of providing services, primarily video
programming and franchise costs and network access fees.
Direct expenses increased $17,942, or 149.5% to $29,942 for the quarter ended
September 30, 1998 from $12,000 for the quarter ended September 30, 1997. The
increase was primarily due to costs associated with higher resold voice
revenues. The resold voice increase represents increases in main access lines in
New York City, Boston and Lehigh Valley, Pennsylvania with a view to extending
the advanced fiber network and fully activating RCN's own telephone switches to
service many of these customers, thereby allowing RCN to gain higher margins and
additional revenue from originating and terminating access fees and to control
the related services and service quality. Additionally, higher Internet access
costs of approximately $6,400 associated with the increase in data revenues,
primarily resulting from the acquisitions of Erols and UltraNet, contributed to
the increase in direct expenses. Also contributing to the increase were higher
commercial and other direct costs of approximately $1,300 primarily associated
with the increased wholesale revenue from CTSI and higher video programming
costs of approximately $1,600 due to increased video connections, increased
programming rates and new channel launches.
Operating, selling, general and administrative expenses primarily include
customer service costs, advertising, sales and marketing expenses,
communications network maintenance and repair ("technical expenses"), and other
corporate overhead.
Operating, selling, general and administrative costs increased $27,949, or
119.0% to $51,429 for the quarter ended September 30, 1998 from $23,480 for the
quarter ended September 30, 1997. Advertising costs increased approximately
$2,700 for the quarter ended September 30, 1998 primarily due to Internet
service advertising expense resulting from the acquisition of Erols in
February 1998. Customer service costs increased approximately $7,900, or 277.6%
for the quarter ended September 30, 1998. Increases of approximately $3,900
primarily personnel related, were due to the expanded customer base resulting
from the acquisition of Erols in February 1998. Other staff and temporary labor
increases to support expanding operations in New York City, Boston and Lehigh
Valley, Pennsylvania contributed approximately $1,800 to the increase. Higher
telephone expense of approximately $400 to support higher call volumes related
to expansion of the customer base, higher billing costs of approximately $1,200
for increased customers and higher facilities and supplies expense of
approximately $200 for expanded staff principally comprise the remainder of the
customer service cost increase. Technical expense increased approximately
$4,500, or 93.6%, for the quarter ended September 30, 1998. Technical expense
increases of approximately $1,900 were due to engineering and construction
headcount and contract labor additions made to plan and execute network
expansion and network operations control center monitoring. Resale telephony
installation costs contributed approximately $400 to the increase. Rental
expense primarily for materials and hubsites increased approximately $300.
Technical expense increases associated with acquisitions in 1998 were
approximately $1,900. The increase was partially offset by approximately $1,400
of technical costs capitalized as part of the cost basis of the communications
network. Sales and marketing costs increased approximately $4,900, or 121.7%,
for the quarter ended September 30, 1998. The increase resulted from additional
staff, contract labor and related commissions and benefits, aggregating
approximately $1,100, to cover the increase in marketable homes, to increase
penetration in the Company's existing markets and to increase the number of
services per customer. Telemarketing expense increased approximately $1,100 due
to increased campaigns. Sales and marketing increases associated with
acquisitions in 1998, primarily Erols, were approximately $2,300. General and
administrative expenses increased approximately $8,000, or 110.4%. Acquisitions
in 1998 contributed approximately $3,100 to the increase. In addition, as
disclosed in Note 13 to the Company's 1997 report on Form 10-K, in connection
with the Distribution, RCN established a qualified savings plan under Section
401(k) of the Internal Revenue Code that will also qualify as an ESOP under
Sections 401(a) and 4975 (e)(7) of the Code (the "ESOP"). The Company accrued a
contribution to the ESOP of approximately $2,200 during the third quarter of
1998. Higher bad debt expense of approximately $600 was associated with the
$37,474 increase in sales. Higher gross receipts taxes and property taxes
resulting from expansion of the communications network aggregated approximately
$470. Legal expense increased approximately $250 primarily as a result of the
procurement of additional franchises and open video systems ("OVS") agreements.
Higher salaries and benefits of approximately $900 were due to staff additions,
primarily to support the expansion, maintenance and upgrade of the Company's
management information systems, new product development and integration of
acquisitions.
Depreciation and amortization
- ------------------------------
Depreciation and amortization is comprised principally of depreciation of the
Company's advanced fiber network, its wireless network, and its hybrid
fiber/coaxial cable systems; and amortization of subscriber lists, building
access rights and goodwill resulting primarily from its acquisitions of Freedom,
Twin County, Erols and UltraNet.
Depreciation and amortization was $28,893 for the three month period ended
September 30, 1998 and $13,680 for the three month period ended September 30,
1997. The increase of $15,213, or 111.2% was the result of both a higher
depreciable basis of plant, resulting primarily from expansion of the Company's
advanced fiber network, and amortization of intangible assets arising from the
acquisition of Erols and UltraNet in February 1998. The cost basis of property,
plant and equipment on a pro forma total RCN basis, at September 30, 1998 and
1997 was $533,250 and $273,960, respectively. The basis of intangible assets, on
a Pro Forma total RCN basis was $312,332 and $150,283 at September 30, 1998 and
1997, respectively.
Interest income
- ---------------
Interest income was $16,569 and $3,681 for the three month periods ended
September 30, 1998 and 1997, respectively. The increase of $12,888, or 350.1%,
results from higher cash, temporary cash investments and short-term investments,
as compared to the same period in 1997. Cash, temporary cash investments and
short-term investments, on a pro forma total RCN basis, were approximately
$1,117,000 at September 30, 1998 and approximately $183,000 at September 30,
1997. Such increase primarily represents interest on the unused portion of the
following debt and equity financings made subsequent to September 30, 1997: 10%
Senior Notes, issued in October 1997, which generated gross proceeds of $225,000
and yielded net proceeds of $218,250; 11 1/8% Senior Discount Notes, issued in
October 1997, which generated gross proceeds of $350,001 and yielded net
proceeds of $337,751; 9.8% Senior Discount Notes, issued in February 1998, which
generated gross proceeds of $350,587 and yielded net proceeds of $344,855; 11%
Senior Discount Notes, issued in June 1998, which generated gross proceeds of
$149,999 and yielded net proceeds of $147,187 and the issuance of 6,098,355
shares of the Company's Common Stock, issued in June 1998, which yielded net
proceeds of $113,305.
Interest expense
- ----------------
The increase in interest expense primarily represents interest on the gross
proceeds of the debt financings mentioned above (see interest income) as well as
the interest on the $100,000 term credit facility and the outstanding borrowings
on the $25,000 revolving credit agreement ($5,000 at September 30, 1998) of
certain of the Company's subsidiaries issued in August 1997. For the quarter
ended September 30, 1998, interest expense was $31,157 as compared to $3,331 for
the quarter ended September 30, 1997. The increase was partially offset by a
reduction due to the prepayment in September 1997 of $131,250 of 9.65% Senior
Secured Notes. Interest expense also includes amortization of deferred financing
costs associated with the above credit facilities.
Income tax
- ----------
The Company's effective income tax rate was zero for the quarter ended September
30, 1998 and a benefit of 28.7% for the quarter ended September 30, 1997.
The tax effect of the Company's cumulative losses has exceeded the tax effect of
accelerated deductions, primarily depreciation, which the Company has taken for
federal income tax purposes. Except in unusual cases, generally accepted
accounting principles do not permit the recognition of tax benefits of such
excess losses in the financial statements. This accounting treatment does not
impact the amount or expiration periods of actual NOL carryovers or cash flows
for taxes.
Minority interest
- -----------------
On a pro forma total RCN basis, for the third quarter of 1998, minority interest
of $5,727 primarily represents the 49% interest of Boston Edison Company
("BECO") in the loss of RCN-BECOCOM of $4,630 and the 50% interest of Potomac
Capital Investment Corporation ("PCI") in the loss of Starpower of $1,236. On a
historical basis, Starpower is accounted for under the equity method. In the
second quarter of 1997, minority interest primarily represents the 49% interest
of BECO in the loss of RCN-BECOCOM of $2,602.
Equity in loss of unconsolidated entities
- -----------------------------------------
On a pro forma total RCN basis, equity in the loss of unconsolidated entities
primarily represents the Company's share of the losses and amortization of
excess cost over net assets of Megacable of $957 and $930 for the quarters ended
September 30, 1998 and 1997, respectively. On a historical basis, for the third
quarter of 1998, equity in the loss of unconsolidated entities also includes the
Company's 50% interest in the loss of Starpower of $1,238.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
Historical
- ----------
On a historical basis, for the nine months ended September 30, 1998, EBITDA
before nonrecurring costs was ($34,514) as compared to $671 for the same period
in 1997. Operating loss before non-recurrng charges for the nine months ended
September 30, 1998 was ($91,713) as compared to ($38,464) for the same period in
1997. Sales increased 61.3% to $148,118 for the nine months ended September 30,
1998 from $91,854 for the same period in 1997.
Pro Forma Total RCN Sales
- -------------------------
Total sales increased $79,276, or 86.3% to $171,130 for the nine months ended
September 30, 1998 from $91,854 for the nine months ended September 30, 1997.
The increase resulted from higher average service connections as discussed
below. The increase in service connections resulted from expansion of the
Company's advanced fiber network, growth in resold voice connections and the
acquisitions of Erols and UltraNet which provided approximately 370,000 data
connections at the date of acquisition.
Voice revenues increased $14,094 to $15,963 for the nine months ended September
30, 1998 from $1,869 for the nine months ended September 30, 1997 primarily due
to an increase in off-net voice connections. Off-net voice connections were
58,093 and 10,953 at September 30, 1998 and 1997, respectively. Partially
contributing to the increase in off-net voice connections was the start-up of
telephony operations in the Lehigh Valley, Pennsylvania market in the fourth
quarter of 1997. Advanced fiber voice connections were 20,857 and 1,909 at
September 30, 1998 and 1997, respectively.
Video revenue increased $6,493, or 8.4% to $83,389, for the nine months ended
September 30, 1998 from $76,896 for the nine months ended September 30, 1997.
Video revenue for the nine months ended September 30, 1997 included one time
launch incentive revenue of approximately $1,000 related to the launch of
certain new channels. The increase in 1998 was primarily due to increases of
approximately 21,000 additional video connections, at September 30, 1998 as
compared to the same period in 1997. Additionally, video rate increases in
February and May in selected markets contributed approximately $2,720 of the
increase. On-net video connections grew to 58,324 at September 30, 1998 from
4,870 at September 30, 1997. Off-net video connections were 196,776 and 229,198
at September 30, 1998 and 1997, respectively. Growth in on-net connections
includes connections that are attributable to migration of off-net customers.
Data revenues increased $47,495 to $47,520 for the nine months ended September
30, 1998 from $25 for the nine months ended September 30, 1997 primarily due to
the acquisitions of Erols and UltraNet in February 1998. At September 30, 1998,
the Company had 470,466 off-net data connections and 3,661 advanced fiber data
connections.
Commercial and other revenues increased $11,194, or 85.7% to $24,258 for the
nine months ended Septmeber 30, 1998 from $13,064 for the nine months ended
September 30, 1997. The increase was due to an increase in average commercial
main access lines of approximately 9,400 over the same period in 1997,
compounded by an increase in revenue per main access line. The increase in
commercial main access lines contributed approximately $3,000 to the increase
while the increase in revenue per main access line contributed approximately
$3,100. Additionally contributing approximately $5,000 to the increase in
commercial and other revenues was higher wholesale long distance revenue from
CTSI.
Costs and Expenses Excluding Depreciation and Amortization and Nonrecurring
- ---------------------------------------------------------------------------
Charges.
- -------
Direct expenses increased $41,606, or 118.5% to $76,719 for the nine months
ended September 30, 1998 from $35,113 for the nine months ended September 30,
1997. The increase was primarily due to costs associated with higher resold
voice revenues. The resold voice increase represents increases in main access
lines in New York City, Boston and Lehigh Valley, Pennsylvania with a view to
extending the advanced fiber network and fully activating RCN's own telephone
switches to service many of these customers, thereby allowing RCN to gain higher
margins and additional revenue from originating and terminating access fees and
to control the related services and service quality. Additionally, higher
Internet access costs of approximately $14,500 associated with the increase in
data revenues, primarily resulting from the acquisitions of Erols and UltraNet,
contributed to the increase in direct expenses. Also contributing to the
increase were higher commercial and other direct costs of approximately $3,100
associated with the increased wholesale revenue from CTSI and higher video
programming costs of approximately $2,700 due to increased video connections,
increased programming rates and new channel launches.
Operating, selling, general and administrative costs increased $71,106, or
126.8% to $127,176 for the nine months ended September 30, 1998 from $56,070 for
the quarter ended September 30, 1997. Advertising costs increased approximately
$17,000 for the nine months ended September 30, 1998. Costs associated with an
extensive high visibility multi-media campaign primarily in New York City and
Boston, which commenced in June 1997, increased approximately $8,600 over the
comparable period in 1997. Internet service advertising expense resulting from
the acquisition of Erols in February 1998 increased approximately $6,400.
Expenses incurred to promote the commencement of telephony operations in the
Lehigh Valley, Pennsylvania market increased approximately $900. The remaining
increase in advertising costs was primarly due to costs incurred for various
sales and promotional materials and event marketing. Customer service costs
increased approximately $19,000, or 262.6% for the nine months ended September
30, 1998. Increases of approximately $8,000 primarily personnel related, were
due to the expanded customer base resulting from the acquisition of Erols in
February 1998. Other staff and temporary labor increases to support expanding
operations in New York City, Boston and Lehigh Valley, Pennsylvania contributed
approximately $5,100 to the increase. Higher telephone expense of approximately
$850 to support higher call volumes related to expansion of the customer base,
higher billing costs of approximately $3,700 for increased customers and higher
facilities and supplies expense of approximately $500 for expanded staff
principally comprise the remainder of the customer service cost increase.
Technical expense increased approximately $8,200, or 59.5%, for the nine months
ended September 30, 1998. Technical expense increases of approximately $4,700
were due to engineering and construction headcount and contract labor additions
made to plan and execute network expansion and network operations control center
monitoring. Resale telephony installation costs contributed approximately $1,300
to the increase. Rental expense primarily for materials and hub sites increased
approximately $700. Technical expense increases associated with acquisitions in
1998 were approximately $2,500. The increase was partially offset by
approximately $4,000 of technical costs capitalized as part of the cost basis of
the communications network. Sales and marketing costs increased approximately
$13,000, or 123.6%, for the nine months ended September 30, 1998. The increase
resulted from additional staff, contract labor and related commissions and
benefits, aggregating approximately $1,700, to cover the increase in marketable
homes, to increase penetration in the Company's existing markets and to increase
the number of services per customer. Telemarketing expense increased
approximately $3,300 due to increased campaigns. Sales and marketing increases
associated with acquisitions in 1998, primarily Erols, were approximately
$5,300.
General and administrative expenses increased approximately $13,800, or 74.2%.
Acquisitions in 1998 contributed approximately $5,200 to the increase. In
addition, the Company accrued a contribution to the ESOP of approximately $2,200
during the third quarter of 1998. Higher bad debt expense of approximately
$1,400 was associated with the $79,276 increase in sales. Higher gross receipts
taxes and property taxes resulting from expansion of the communications network
aggregated approximately $1,100.
Legal expense increased approximately $1,300 primarily as a result of the
procurement of additional franchises and OVS agreements. Higher salaries and
benefits of approximately $3,500 were due to staff additions, primarily to
support the expansion, maintenance and upgrade of the Company's management
information systems, new product development and integration of acquisitions.
The Company is in the process of developing information technology systems which
will provide a sophisticated customer care infrastructure. The Company expects
associated G&A charges to increase during the fourth quarter.
Depreciation and amortization
- -----------------------------
Depreciation and amortization was $71,813 for the nine month period ending
September 30, 1998 and $39,135 for the nine month period ending September 30,
1997. The increase of $32,678, or 83.5% was the result of both a higher
depreciable basis of plant, resulting primarily from expansion of the Company's
advanced fiber network, and amortization of intangible assets arising from the
acquisitions of Erols and UltraNet in February 1998. The cost basis of property,
plant and equipment on a pro forma total RCN basis at September 30, 1998 and
1997 was $533,250 and $273,960, respectively. Additionally, higher intangibles
resulted from the payment of $15,000 on March 21, 1997 of contingent
consideration applicable to the Company's original purchase of an 80.1%
ownership interest in Freedom and from the payment of an additional $15,000 on
March 21, 1997 to acquire the remaining 19.9% ownership in Freedom. The
intangibles resulting from these payments were depreciable for the full nine
months ended September 30, 1998 but only from the date of payment for the nine
months ended September 30, 1997. The basis of intangible assets, on a pro forma
total RCN basis, was $312,332 and $150,283 at September 30, 1998 and 1997,
respectively.
Nonrecurring charge
- -------------------
Associated with acquisitions occuring earlier this year, RCN calculated
that approximately $36 million of the purchase price of Erol's and $16 million
of the purchase price of Ultranet would qualify for immediate write-off as
acquired in-process research & development. Since the time these calculations
took place, the SEC has critically examined this issue, and in the case of
challenges to accounting practices of two other public communications companies,
substantial downward revisions were made to previous calculations of acquired
in-process R&D.
The Company's previous calculation was conducted in accordance with all
appropriate accounting procedures and interpretations, most significantly
considering the tests of technological feasibility and alternative future use as
applied to the acquired R&D projects. At present, the SEC accounting staff
appears to be requiring consideration of additional factors for financial
reports filed with the SEC, most importantly the percentage of completion of
acquired projects, and appears to be embracing write-offs representing the value
of that portion of the development effort completed at acquisition, rather than
the discounted value of benefits from the entire acquired project.
At present, the Company is evaluating these new requirements and is examining
the prior calculations to assess their potential impact upon the previously
computed estimates of acquired in-process R&D. These calculations are incomplete
but the Company estimates that if it is required to apply a downward revision in
calculated in-process R&D it may be of a comparable magnitude to the publicly-
disclosed adjustments for other communications companies discussed above. The
Company's previous calculation could be reduced by up to approximately half.
Interest income
- ----------------
Interest income was $43,808 and $13,442 for the nine month periods ended
September 30, 1998 and 1997, respectively. The increase of $30,366, or 225.9%,
results from higher cash, temporary cash investments and short-term investments
as compared to the same period in 1997. Cash, temporary cash investments and
short-term investments, on a pro forma total RCN basis, were approximately
$1,117,000 at September 30, 1998 and approximately $183,000 at September 30,
1997. Such increase primarily results from the debt and equity financings of the
company as detailed in the discussion of interest income for the three months
ended September 30, 1998.
Interest expense
- ----------------
For the nine months ended September 30, 1998, interest expense was $80,811 as
compared to $10,460 for the nine months ended September 30, 1998. The increase
resulted from the debt financings referred to above that were placed subsequent
to the second quarter of 1997, offset by a reduction due to the prepayment in
September 1997 of $131,250 of 9.65% Senior Secured Notes.
Other (expense) income
- ----------------------
Other (expense) income was ($1,978) and $229 for the nine months ended September
30, 1998 and 1997, respectively. For the nine months ended September 30, 1998,
approximately $2,500 represents the write down of certain of the Company's
information technology assets which the Company is in process of upgrading with
higher capacity state of the art products in connection with an overall internal
technology upgrade.
Income tax
- ----------
The Company's effective income tax rate was a benefit of 5.5% and 27.1% for the
nine months ended September 30, 1998 and September 30, 1997, respectively. The
primary reasons for the difference include the charge for in-process technology
which is not deductible for tax purposes and for which a tax benefit was
correspondingly not recorded. Additionally, during 1998, the tax effect of the
Company's cumulative losses has exceeded the tax effect of accelerated
deductions, primarily depreciation, which the Company has taken for federal
income tax purposes. Except in unusual cases, generally accepted accounting
principles do not permit the recognition of tax benefits of such excess losses
in the financial statements. This accounting treatment does not impact the
amount or expiration periods of actual NOL carryovers or cash flows for taxes.
Minority interest
- -----------------
On a pro forma total RCN basis, for the nine months ended September 30, 1998,
minority interest of $17,704 primarily represents the 49% interest of BECO in
the loss of RCN-BECOCOM of $11,803 and the 50% interest of PCI in the loss of
Starpower of $6,159. On a historical basis, Starpower is accounted for under the
equity method. For the nine months ended September 30, 1997, minority interest
primarily represents the 49% interest of BECO in the loss of RCN-BECOCOM of
$3,139 and the 19.9% minority interest in the loss of Freedom of $966. The
company purchased the remaining 19.9% ownership interest in Freedom on March 21,
1997.
Equity in loss of unconsolidated entities
- -----------------------------------------
On a pro forma total RCN basis, equity in the loss of unconsolidated entities
primarily represents the Company's share of the losses and amortization of
excess cost over net assets of Megacable of $2,008 and $2,479 for the nine
months ended September 30, 1998 and 1997, respectively. On a historical basis,
for the nine months ended September 30, 1998, equity in the loss of
unconsolidated entities also includes the Company's 50% interest in the loss of
Starpower of $6,161.
Liquidity and capital resources
- -------------------------------
The Company expects that it will require a substantial amount of capital to fund
the network development and operations in its target markets (including markets
in the Boston to Washington, D.C. corridor and new markets in the San Francisco
to San Diego corridor), including funding the development of its advanced fiber
optic networks, upgrading its hybrid fiber/coaxial plant and funding operating
losses and debt service requirements. On June 4, 1998 RCN announced its
intention to commence developing advanced fiber optic networks in selected high
density markets outside of the Boston to Washington, D.C. corridor. The Company
is targeting selected markets in the San Francisco to San Diego corridor which
represent approximately 2% of the geography of the U.S. but account for
approximately 12% of the U.S. telecommunications market based upon the number of
telephone access lines. The Company expects that its initial west coast network
will be developed in the San Francisco Bay Area, a market that benefits from
high density, high per capita income and the highest Internet usage in the
United States. RCN has obtained CLEC status in California, has obtained an OVS
certification from the FCC for the City of San Francisco and surrounding
Counties and has held initial meetings with several municipalities in the San
Francisco Bay Area to discuss network deployment. The Company also expects its
expansion to include selected markets in or near Southern California, Las Vegas
and Phoenix. As is the case in its existing markets, the Company intends to
focus on high density markets with favorable demographics, and to apply a
subscriber-driven investment strategy, in developing new markets. The Company
believes that its experience in the Northeast will provide it with a key
strategic advantage. Subject to obtaining requisite regulatory approvals, the
Company expects to commence initial network construction in the San Francisco
Bay Area in 1999. The Company currently estimates that its capital expenditure
requirements for the period from January 1, 1998 through 1999 will be
approximately $850 million, which represents capital expenditures (including
connection costs which will only be incurred as the Company obtains revenue-
generating customer connections) of approximately $300 million in 1998 and
approximately $550 million in 1999. Additional funds will be required to fund
operating losses during the period. As a result of more rapid deployment of its
fiber optic network, the Erols and UltraNet acquisitions, and the anticipated
development of new markets outside the Boston to Washington, D.C. corridor,
certain aspects of the Company's capital expenditure program are being
accelerated. To build out its target markets on an efficient basis, the Company
undertakes a subscriber-driven capital expenditure strategy whereby it (i)
closely monitors development of its subscriber base in order to direct network
deployment in each target market, and (ii) seeks to establish a customer base in
advance of or concurrently with its network deployment. For example, the Company
offers Internet and resale telephone services on an interim basis to customers
located near its advanced fiber optic networks. Depending upon factors such as
subscriber density, proximity to the advanced fiber optic network and
development costs and the degree of success achieved in its initial markets, the
Company will determine whether extending its advanced fiber optic network to
additional high density target markets can be achieved on an attractive economic
basis. In addition to its own capital requirements, the Company's joint venture
partners are each expected to contribute approximately $150,000 in capital to
the joint ventures in connection with development of the Boston and Washington,
D.C. markets from September 1997 through 2000, of which approximately $89,500
has been contributed.
The Company expects to have sufficient liquidity to meet its capital
requirements through early 2000. The Company will continue to require additional
capital for planned increases in network coverage and other capital
expenditures, working capital, debt service requirements, and anticipated
further operating losses. The actual timing and amount of capital required to
roll out the Company's network and to fund operating losses may vary materially
from the Company's estimates and additional
funds will be required in the event of significant departures from the current
business plan, unforeseen delays, cost overruns, engineering design changes and
other technological risks or other unanticipated expenses. Due to its
subscriber-driven investment strategy, should the Company encounter a successful
rollout in its initial markets, and/or decide to enter new markets, the Company
may accelerate the rollout and/or extend the reach of its network; such
acceleration could increase the Company's capital requirements. The proposed
development of new networks in selected markets in the western United States
will substantially increase the Company's capital requirements. The Company's
initial network development plan for expansion into its target market markets in
the western United States will require funding of approximately $250 million
(including operating losses) through the year 2000; however, the actual timing
and amount of capital required may vary materially from the Company's initial
estimates. Conversely, should the Company be less successful than anticipated,
the operating losses associated with the installed network may be higher than
anticipated. The Company presently intends to judge the success of its initial
rollout in deciding whether to undertake additional 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 and potentially beyond the Boston to Washington, D.C.
corridor, it expects to continue to experience losses and negative cash flow on
an aggregate basis for an extended period of time.
The Company's current joint venture agreements redue the amount of expenditures
required by RCN to develop the network due both to access to the joint venture
partners' existing facilities and to the 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. RCN and Boston Edison Company
("BECO") are presently in discussions with respect to the conversion of a
portion of BECO's interest in the BECO joint venture into RCN Common Stock.
Sources of funding for the Company's further financing requirements may include
vendor financing, public offerings or private placements of equity and/or debt
securities, and bank loans. There can be no assurance that additional financing
will be available to the Company or, if available, that it can be obtained on a
timely basis and on acceptable terms. Failure to obtain such financing could
result in the delay or curtailment of the Company's development and expansion
plans and expenditures. Any of these events could impair the Company's ability
to meet its debt service requirements and could have a material adverse effect
on its business.
In October 1997, the Company raised $575,000 in gross proceeds from an offering
of two tranches of debt securities. The offering was comprised of $225,000
principal amount of 10% Senior Notes and $601,045 principal amount at maturity
of 11 1/8% Senior Discount Notes, both due in 2007. The proceeds include $61,000
of restricted cash to be used to fund the Escrow Account to pay interest on the
10% Senior Notes for three years. In February 1998, the Company raised $350,587
in gross proceeds from an offering of $567,000 principal amount at maturity of
9.80% Senior Discount Notes, due in 2008. In June 1998, the Company raised
$149,999 in gross proceeds from an offering of $256,755 principal amount at
maturity of 11% Senior Discount Notes, due 2008. Also in June 1998, the Company
raised 113,305 in net proceeds from an offering of 6,098,355 shares of the
Company's Common Stock. The preceding Indentures all contain similar provisions.
The Chase Manhattan Bank acts as Trustee for each of the Indentures. All the
aforementioned Notes are general senior unsecured obligations of RCN. The 9.80%
Senior Discount Notes will mature on February 15, 2008. The 9.80% Senior
Discount Notes will not bear cash interest prior to February 15, 2003.
Thereafter, cash interest on the notes will accrue at 9.8% per annum and will be
payable semi-annually in arrears on February 15 and August 15 of each year,
commencing February 15, 2003. The 10% and 11 1/8% Notes (the "1997 Notes") will
mature on October 15, 2007. Interest on the 10% Senior Notes is payable in cash
at a rate of 10% per annum semi-annually in arrears on each April 15 and October
15, commencing April 15, 1998. The 11 1/8% Senior Discount Notes will not bear
cash interest prior to
October 15, 2002. Thereafter, cash interest on the notes will accrue at a rate
of 11 1/8% per annum and will be payable semi-annually in arrears on April 15
and October 15 of each year, commencing April 15, 2002. The 11% Senior Discount
Notes will not bear cash interest prior to January 1, 2003. Thereafter, cash
interest on the notes will accrue at a rate of 11% per annum and will be payable
semi-annually in arrears on January 1 and July 1 of each year, commencing July
1, 2003.
The 9.80% Senior Discount Notes are redeemable, in whole or in part, at any time
on or after February 15, 2003 at the option of RCN. The 9.80% Senior Discount
Notes may be redeemed at redemption prices starting at 104.900% of the principal
amount at maturity and declining to 100% of the principal amount at maturity,
plus any accrued and unpaid interest. The 1997 Notes are redeemable, in whole or
in part, at any time on or after October 15, 2002 at the option of RCN. The 10%
Senior Notes may be redeemed at redemption prices starting at 105% of the
principal amount and declining to 100% of the principal amount, plus any accrued
and unpaid interest. The 11 1/8% Senior Discount Notes may be redeemed at
redemption prices starting at 105.562% of the principal amount at maturity and
declining to 100% of the principal amount at maturity, plus any accrued and
unpaid interest. The 11% Senior Discount Notes will be redeemable, in whole or
in part, at any time on or after July 1, 2003 at the option of RCN. The 11%
Senior Discount Notes may be redeemed at redemption prices starting at 105.5% of
the principal amount at maturity and declining to 100% of the principal amount
at maturity, plus accrued and unpaid interest.
RCN may, at its option, use the net proceeds of certain offerings of RCN Common
Stock to redeem up to an aggregate of 35% of the aggregate principal amount at
maturity of the debt securities issued under the Indentures at a certain
premium. Upon the occurrence of a change of control, RCN must make an offer to
purchase all of the debt securities issued under the Indentures than outstanding
at a premium.
The Indentures contain certain convenants that, among other things, limit the
ability of RCN and its subsidiaries to incur indebtedness, pay dividends, prepay
subordinated indebtedness, repurchase capital stock, engage in transactions with
stockholders and affiliates, create liens, sell assets and engage in mergers and
consolidations.
RCN Cable and certain of its subsidiaries ("Borrowers") have in place secured
credit facilities comprised of a five-year revolving credit facility in the
amount of $25,000 (the "Revolving Credit Facility") and an eight-year term
credit facility in the amount of $100,000 (the "Term Credit Facility"), both of
which facilities are governed by a single credit agreement dated as of July 1,
1997 (the "Credit Agreement"). As of September 30, 1998, $100,000 of the Term
Credit Facility was outstanding. The term loan must be repaid over six years in
quarterly installments, at the end of September, December, March and June of
each year from September 30, 1999 through June 30, 2005. As of September 30,
1998, $5,000 principal was outstanding under the Revolving Credit Facility.
Revolving loans may be repaid and reborrowed from time to time. All borrowings
under the Credit Agreement will be pari passu and will be secured under a common
collateral package.
The interest rate on the Credit Agreement is, at the election of the Borrowers,
based on either a LIBOR or a Base Rate option (each as defined in the Credit
Agreement). In the case of LIBOR option, the interest rate includes a spread
that varies, based on RCN Cable's Leverage Ratio (defined as the ratio of Total
Debt at the last day of the most recently ended fiscal quarter to Operating Cash
Flow for the four fiscal quarters then ended), from 50 basis points to 125 basis
points. In the case of the Revolving Credit Facility, a fee of 20 basis points
on the unused revolving commitment accrues and is payable quarterly in arrears.
The Credit Agreement contains customary covenants for facilities of this nature,
including covenants limiting debt, liens, investments, consolidations, mergers,
acquisitions and sales of assets, payment of dividends and other distributions,
capital expenditures and transactions with affiliates. In addition, the
Borrowers are subject to a prohibition on granting negative pledges and the
Borrowers must apply certain cash proceeds realized from certain asset sales,
certain payments under insurance policies and
certain incurrences of additional debt to repay the Revolving Credit Facility.
The Credit Agreement requires the Borrowers to maintain the following financial
ratios: (i) the ratio of Total Debt at any fiscal quarter end to Operating Cash
Flow for the trailing four fiscal quarters is not to exceed 5.0:1 initially,
adjusting over time to 4.0:1; (ii) the ratio of Operating Cash Flow to Interest
Expense for any four consecutive fiscal quarters is not to fall below 2.75:1 for
periods ending during the first 3 years after the Closing Date, adjusting to
3.0:1 thereafter; and (iii) the ratio of Operating Cash Flow (minus certain
capital expenditures, cash taxes and cash dividends) to Fixed Charges (defined
as scheduled principal payments and interest expense) for any four consecutive
quarters is not to fall below 1.0:1 for periods ending on or before December 31,
2000 and adjusting to 1.05:1 thereafter. The Credit Agreement also includes
customary events of default.
The Company has indebtedness that is substantial in relation to its
shareholders' equity and cash flow. At September 30, 1998 the Company has an
aggregate of approximately $1,249,000 of indebtedness outstanding, and the
ability to borrow up to an additional $20,000 under the Credit Agreement.
As a result of the substantial indebtedness of the Company, the Company's fixed
charges are expected to exceed its earnings for the foreseeable future. In
addition, the Company will require substantial additional indebtedness
particularly in connection with the buildout of the Company's networks and the
introduction of its telecommunications services to new markets. The leveraged
nature of the Company could limit its ability to effect future financing or may
otherwise restrict the Company's business activities.
The extent of the Company's leverage may have the following consequences: (i)
limit the ability of the Company to obtain necessary financing in the future of
working capital, capital expenditures, debt service requirements or other
purposes; (ii) require that a substantial portion of the Company's cash flows
from operations be dedicated to the payment of principal and interest on its
indebtedness and therefore not be available for other purposes; (iii) limit the
the Company's flexibility in planning for, or reacting to, changes in its
business; (iv) place the Company at a competitive disadvantage as compared with
less leveraged competitors; and (v) render the Company more vulnerable in the
event of a downturn in its business.
On a historical basis, for the nine months ended September 30, 1998, the
Company's net cash provided by operating activities was $28,046 comprised
primarily of a net loss of $(169,607) adjusted by non-cash depreciation and
amortization of $57,199, other non-cash items totaling $99,050 (primarily
includes the write-off of acquired research and development and accretion of
Senior Discount Notes), and working capital changes of $44,420. Net cash used in
investing activities of $(478,013) consisted primarily of purchase of short-term
investments of $387,804, additions to property, plant and equipment of $175,657,
an investment in an unconsolidated joint venture of $12,500 and acquisitions of
$46,244 (primarily the acquisitions of Interport Communications Corp., Lancit
Media Entertainment, Ltd., Erols, UltraNet and JavaNet), partially offset by
sales and maturities of short-term investments of $135,463. Net cash provided by
financing activities of $666,874 consisted primarily of the issuance of long-
term debt of $502,587, the issuance of Common Stock of 112,836, a decrease in
restricted cash of $11,125 and contributions from a minority interest partner of
$53,998, partially offset by payments made for debt financing costs of $9,851.
Impact of the Year 2000 Issue
State of Readiness
- ------------------
The Company has certain information technology systems and non-information
technology systems which are subject to Year 2000 exposures and require
remediation. The Company has established a Year 2000 Program Office which is
being staffed with a team of Year 2000 personnel who are being hired to address,
on a full-time and ongoing basis, the Year 2000 issue. This group is led by a
full-time Year 2000 director and reports in the organization, on a daily basis,
directly to the Chief Information Officer and, on a periodic basis, to a Year
2000 Steering Committee comprised of the Chairman, President, Chief Financial
Officer, Chief Administrative Officer, Chief Information Officer and General
Counsel of the Company. The Program Office personnel will work with subject
matter experts consisting of current employees from various disciplines across
the Company to specifically identify these systems and implement a plan for
remediation. This plan (the Year 2000 Compliance Program) includes a 5 step
process of remediation as follows: inventory, planning, assessment, repair and
integration. Based upon its process of prioritization, the Company is in
different stages of this Project for its various systems.
For business reasons unrelated to Year 2000 issues, the Company is replacing its
financial, billing, operational support, and customer services systems. The
replacement systems will be Year 2000 compliant at installation.
The financial system replacement involves converting the current suite of
systems to a state of the art Oracle system. The Oracle system went into
production use on November 1st.
The replacement of the billing, operational support and customer service systems
is in process and includes substantial risk. To manage this risk, the Company is
assuming that the replacement systems will not be available before the Year
2000. To insure business continuity, the Company is renovating the current
billing, operational support and customer service systems as a contingency
strategy.
The Company's switches and head-ends are also critical systems and are either
currently Year 2000 compliant or are expected to be Year 2000 compliant with the
next vendor software upgrade.
The Company expects all renovations to all IT systems, to be completed by May
31, 1999, with thorough integration testing to be completed by June 30, 1999.
The Company is currently in the process of obtaining an inventory of any non-IT
systems which must be remediated.
The Company recognizes the importance of communication with third parties to
determine their plans for becoming Year 2000 compliant. The Company believes it
has approximately 300 critical vendors and is sending surveys regarding the Year
2000 remediation to those vendors. The Company intends to vigorously pursue the
timely receipt of relevant information from these vendors. The Company will
assess its remediation plans based on those responses.
No other IT projects have been deferred due to the Year 2000 remediation
efforts.
Cost
- ----
Based upon its current assessment, the total cost associated with the Company's
Year 2000 Compliance Program is not expected to be material to the Company's
results of operations or financial position. The estimated total cost of the
Company's Year 2000 Compliance Program is approximately $3,600. This is
comprised of approximately $1,600 for salaries, facilities and consulting
services; approximately $1,000 for program code remediation; approximately $500
for equipment replacement and approximately $500 for testing. Approximately $250
has been incurred through September 30, 1998.
The cost of converting to the Oracle financial system is not included in the
above estimate. Similarly the cost for replacing systems which had been planned,
and for which the timeline for replacement was not accelerated due to Year 2000
issues, have not been included.
Risks and Contingencies
- -----------------------
The Company does not believe it is exposed to significant Year 2000 risk with
respect to its critical systems, other than would be caused by substantial
deviation from the plans and time frames set forth above in particular with
respect to our ability to bill customers, track collections of receivables and
provision new orders. The Company is currently in the process of identifying its
other systems requiring remediation and intends to apply its five step process
as outlined above to these systems based on each system's priority in
operations.
The Company is not currently able to assess the most significant risk associated
with vendor non-compliance.
Part II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
The information required under Item 1 of Part II is included in Note 5 to the
financial statements set forth in Part I hereof and is specifically incorporated
herein by referenced thereto.
Item 2. Changes in Securities
On February 20, 1998, RCN issued 1,730,648 shares of RCN Common Stock to certain
shareholders of Erols Internet, Inc. ("Erols") in connection with the merger of
Erols with and into a wholly-owned subsidiary of RCN. On February 27, 1998, RCN
issued 890,384 shares of RCN Common Stock to certain shareholders of UltraNet
Communications, Inc. ("UltraNet") in connection with the merger of UltraNet with
and into a wholly-owned subsidiary of RCN. On June 12, 1998 RCN issued 396,442
shares of RCN Common Stock to certain shareholders of Interport in connection
with the merger of Interport with and into a wholly-owned subsidiary of RCN. On
July 23, 1998, RCN issued 568,887 shares of RCN Common Stock to certain
shareholders of JavaNet in connection with the merger of JavaNet, Inc. with and
into a wholly-owned subsidiary of RCN. These four issuances were made pursuant
to the exemption from registration under Section 4(2) of the Securities Act on
the basis that each transaction involved the issuance of securities in a
transaction not involving a public offering.
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
(27-27.1) Financial Data Schedules
(b.) Reports on Form 8-K
No reports on Form 8-k were filed during the third quarter of
1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: November 16, 1998
/s/ Bruce C. Godfrey
------------------------
Bruce C. Godfrey
Executive Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 439,817
<SECURITIES> 667,952
<RECEIVABLES> 32,664
<ALLOWANCES> 4,830
<INVENTORY> 5,340
<CURRENT-ASSETS> 1,184,779
<PP&E> 503,191
<DEPRECIATION> 152,274
<TOTAL-ASSETS> 1,890,447
<CURRENT-LIABILITIES> 178,375
<BONDS> 1,248,681
0
0
<COMMON> 65,444
<OTHER-SE> 336,377
<TOTAL-LIABILITY-AND-EQUITY> 1,890,447
<SALES> 0
<TOTAL-REVENUES> 148,118
<CGS> 0
<TOTAL-COSTS> 116,807
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,880
<INTEREST-EXPENSE> 80,811
<INCOME-PRETAX> (182,906)
<INCOME-TAX> (9,923)
<INCOME-CONTINUING> (169,607)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (169,607)
<EPS-PRIMARY> (2.83)
<EPS-DILUTED> (2.83)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 511,762
<SECURITIES> 411,238
<RECEIVABLES> 22,241<F1>
<ALLOWANCES> 3,427
<INVENTORY> 2,613
<CURRENT-ASSETS> 989,202
<PP&E> 366,157
<DEPRECIATION> 119,039
<TOTAL-ASSETS> 1,578,232
<CURRENT-LIABILITIES> 106,506
<BONDS> 1,053,324
0
0
<COMMON> 57,811
<OTHER-SE> 304,472
<TOTAL-LIABILITY-AND-EQUITY> 1,578,232
<SALES> 0
<TOTAL-REVENUES> 40,138
<CGS> 0
<TOTAL-COSTS> 32,041<F1>
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 765
<INTEREST-EXPENSE> 22,735
<INCOME-PRETAX> (81,527)
<INCOME-TAX> (11,682)
<INCOME-CONTINUING> (67,752)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (67,752)
<EPS-PRIMARY> (1.21)
<EPS-DILUTED> (1.21)
<FN>
<F1> Receivables and total costs have been restated to conform with the December
1997 reporting format.
</FN>
</TABLE>
