As filed with the Securities and Exchange Commission on June 1, 1998
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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RCN CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 4813 22-3498533
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
105 Carnegie Center
Princeton, NJ 08540-6215
(609) 734-3700
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
Bruce Godfrey
RCN Corporation
105 Carnegie Center
Princeton, NJ 08540-6215
(609) 734-3700
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
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Copies to:
Keith L. Kearney Jonathan A. Schaffzin
Davis Polk & Wardwell Cahill Gordon & Reindel
450 Lexington Avenue 80 Pine Street
New York, New York 10017 New York, New York 10005
(212) 450-4000 (212) 701-3000
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Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this
Registration Statement.
If any of the securities being registered on this Form are to
be offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, other than securities offered only in connection with
dividend or interest reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act, check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] ____
If this Form is a post-effective amendment filed pursuant to
Rule 462(c) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ____
If this Form is a post-effective amendment filed pursuant to
Rule 462(d) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ____
If delivery of the prospectus is expected to be made pursuant
to Rule 434, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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Proposed Maximum
Title of Each Class of Aggregate Offering Amount of
Securities to be Registered Price(1) Registration Fee
- --------------------------- ------------------- ----------------
% Senior Discount Notes due 2008...... $250,000,000 $73,750
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) under the Securities Act of 1933. The Notes will
be issued at a discount to yield gross proceeds to the Company of
$250,000,000.
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The Registrant hereby amends this Registration Statement on
such date or dates as may be necessary to delay its effective date until the
Registrant shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933, as amended or until the
Registration Statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO THE REGISTRATION STATEMENT OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY
SUCH STATE.
PRELIMINARY PROSPECTUS [LOGO]
$250,000,000 Gross Proceeds
RCN Corporation
% Senior Discount Notes due 2008
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RCN Corporation (the "Company" or "RCN") is hereby offering $
aggregate principal amount at maturity of % Senior Discount Notes due 2008
(the "Notes"). The Notes will be issued at a discount to their aggregate
principal amount at maturity and will generate gross proceeds to RCN of
approximately $250 million. The yield to maturity of the Notes is %
(computed on a semi-annual bond equivalent basis), calculated from
, 1998. See "Certain U.S. Federal Income Tax Considerations."
(continued on next page)
See "Risk Factors" beginning on page 11 for a discussion of
certain factors that should be considered by prospective purchasers of the
Notes offered hereby.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Principal Amount Price to Underwriting Proceeds to
at Maturity Investors(1) Discount(2) Company(3)
----------- ------------ ----------- ----------
Per Note......... % % % %
Total............ $ $ $ $
- ----------
(1) Plus accrued original issue discount, if any, from , 1998.
(2) RCN has agreed to indemnify the Underwriters (as defined) against certain
liabilities, including liabilities under the Securities Act. See
"Underwriting."
(3) Before deducting expenses payable by the Company estimated at $ .
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The Notes are offered by the Underwriters, subject to prior sale, when,
as and if issued to and accepted by the Underwriters, and subject to approval
of certain legal matters by counsel for the Underwriters and certain other
conditions. The Underwriters reserve the right to withdraw, cancel or modify
such offer and to reject any orders in whole or in part. It is expected that
delivery of the Notes offered hereby will be made in New York, New York on or
about , 1998.
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Merrill Lynch & Co.
Donaldson, Lufkin & Jenrette
Securities Corporation
NationsBanc Montgomery Securities LLC
Salomon Smith Barney
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The date of this Prospectus is June , 1998.
(continued from cover)
Cash interest will not accrue on the Notes prior to
, 2003. Thereafter, cash interest on the Notes will accrue at a rate of
% per annum and will be payable semi-annually in arrears on and
of each year, commencing , 2003. The Notes will be
redeemable at the option of RCN, in whole or in part, at any time on or after
, 2003 at the redemption prices set forth herein, plus accrued and
unpaid interest, if any, to the date of redemption. In addition, prior to
, 2001, RCN may, at its option, use the net proceeds of one or more Public
Equity Offerings (as defined) yielding gross cash proceeds of not less than
$30 million to redeem up to an aggregate of 35% of the principal amount at
maturity of Notes originally issued at a redemption price equal to % of
the Accreted Value (as defined) at the redemption date of the Notes so
redeemed; provided that at least 65% of the principal amount at maturity of
Notes originally issued would remain outstanding immediately after giving
effect to such redemption. In the event of a Change of Control (as defined),
RCN will be required to make an offer to purchase all outstanding Notes at a
purchase price equal to 101% of the Accreted Value thereof plus accrued and
unpaid interest, if any, thereon to the date of purchase. In addition, RCN
will, subject to certain conditions, be obligated to make an offer to purchase
Notes with the Net Cash Proceeds (as defined) of certain Asset Sales (as
defined). See "Description of the Notes--Certain Covenants."
The Notes will be senior unsecured obligations of RCN. The
Notes will rank senior in right of payment to all subordinated indebtedness of
RCN and will rank pari passu in right of payment with all existing and future
indebtedness of RCN that is not by its terms subordinated in right and
priority to the Notes. In addition, claims of holders of the Notes will be
structurally subordinated to claims of holders of indebtedness of RCN's
subsidiaries. As of March 31, 1998, the Company had outstanding under the
Credit Agreement (as defined), an aggregate amount of $103 million to which
holders of Notes would have been structurally subordinated. In addition, as of
March 31, 1998, RCN had outstanding $225 million aggregate principal amount of
its 10% Senior Notes due 2007 ("10% Senior Notes"), $367 million accreted
value of its 11 1/8% Senior Discount Notes due 2007 ("11 1/8% Senior Discount
Notes" and, together with the 10% Senior Notes, the "1997 Notes") and $356
million accreted value of its 9.80% Senior Discount Notes due 2008 (the "9.8%
Senior Discount Notes" or the "1998 Notes"). The Notes will rank pari passu
with the 1997 Notes and the 1998 Notes. RCN and its subsidiaries are expected
to incur substantial additional indebtedness. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
There is no established trading market for the Notes and RCN
does not intend to apply for listing on any securities exchange. See "Plan of
Distribution."
The Company's Common Stock is traded on the Nasdaq Stock Market
("NASDAQ") under the symbol "RCNC."
Concurrently with the offering of the Notes being made hereby
(the "Offering"), the Company is offering (the "Common Stock Offering" and,
together with the Offering, the "Offerings"), by means of a separate prospectus,
10,583,032 shares of Common Stock, par value $1.00 per share (the "Common
Stock"). The consummation of the Offering is not conditioned upon the
consummation of the Common Stock Offering and there can be no assurance that the
Common Stock Offering will be consummated.
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED IN THIS PROSPECTUS UNDER "SUMMARY,"
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND "BUSINESS," IN ADDITION TO CERTAIN STATEMENTS CONTAINED
ELSEWHERE IN THIS PROSPECTUS, ARE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND ARE THUS
PROSPECTIVE. SUCH FORWARD LOOKING STATEMENTS INCLUDE, IN PARTICULAR,
STATEMENTS MADE AS TO PLANS TO DEVELOP NETWORKS AND UPGRADE FACILITIES, THE
MARKET OPPORTUNITY PRESENTED BY MARKETS TARGETED BY THE COMPANY, THE COMPANY'S
INTENTION TO CONNECT CERTAIN WIRELESS VIDEO, RESALE TELEPHONE AND INTERNET
SERVICE CUSTOMERS TO ITS ADVANCED FIBER OPTIC NETWORKS, THE DEVELOPMENT OF THE
COMPANY'S BUSINESSES, THE CURRENT AND FUTURE MARKETS FOR THE COMPANY'S
SERVICES AND PRODUCTS, THE COMPANY'S ANTICIPATED CAPITAL EXPENDITURES, THE
COMPANY'S ANTICIPATED SOURCES OF CAPITAL AND EFFECTS OF REGULATORY REFORM AND
COMPETITIVE AND TECHNOLOGICAL DEVELOPMENTS. NO ASSURANCE CAN BE GIVEN THAT THE
FUTURE RESULTS COVERED BY THE FORWARD-LOOKING STATEMENTS WILL BE ACHIEVED.
SUCH STATEMENTS ARE SUBJECT TO RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM FUTURE RESULTS EXPRESSED
OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. THE MOST SIGNIFICANT OF SUCH
RISKS, UNCERTAINTIES AND OTHER FACTORS ARE DISCUSSED UNDER THE HEADING "RISK
FACTORS," BEGINNING ON PAGE 11 OF THIS PROSPECTUS, AND PROSPECTIVE INVESTORS
ARE URGED TO CAREFULLY CONSIDER SUCH FACTORS.
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN
TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE
NOTES. SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE
OFFERING, MAY BID FOR AND PURCHASE NOTES IN THE OPEN MARKET AND MAY IMPOSE
PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
SUMMARY
The following summary is qualified in its entirety by the more
detailed information (including the financial statements and the notes
thereto) included elsewhere herein. Except as otherwise noted, all information
in this Prospectus assumes no exercise of the Underwriters' overallotment
option. All share and per share data, stock option data and market prices
(including historical trading prices) of RCN Common Stock have been restated
to reflect the one for one stock dividend (the "Stock Dividend") declared on
March 9, 1998 and paid on April 3, 1998. Unless the context indicates
otherwise, "RCN" or the "Company" means RCN Corporation and its subsidiaries
and joint ventures (including unconsolidated entities).
The Company
RCN is developing advanced fiber optic networks to provide a wide
range of telecommunications services including local and long distance
telephone, video programming and data services (including high speed Internet
access), primarily to residential customers in selected high density markets.
RCN believes that its capability to deliver multiple services (telephone, video
programming and Internet access) to any given customer on its networks will
provide it with competitive advantages over other competitors. RCN's strategy is
to become the leading single-source provider of voice, video and data services
to residential customers in each of its markets by offering individual or
bundled service options, superior customer service and competitive prices. The
Company believes that it is the only publicly-traded facilities- based provider
of bundled voice, video and data services to focus on the residential market in
the U.S., and believes that it will be the first competitive provider to its
target markets.
RCN's initial advanced fiber optic networks have been
established in selected markets in the Boston to Washington, D.C. corridor,
including New York City, Boston and its surrounding communities and in the
Washington, D.C. area. The region, one of the most densely populated in the
United States, represents approximately 4% of the geography of the U.S., but
accounts for over 26% of the telecommunications market based upon the number
of telephone access lines. In the Boston market RCN operates its advanced
fiber optic network through a joint venture with the Boston Edison Company
("BECO"). The venture is managed and 51% owned by RCN and is accounted for on
a consolidated basis. RCN and 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. In the Washington, D.C. market RCN is developing an
advanced fiber optic network through a joint venture named Starpower
Communications, LLC ("Starpower") with Pepco Communications, L.L.C. ("Pepco
Communications"), an indirect wholly owned subsidiary of Potomac Electric
Power Company ("PEPCO"). Starpower is owned 50% by RCN and 50% by Pepco
Communications and is accounted for under the equity method of accounting.
RCN believes that these joint ventures provide it with a number of important
advantages including access to rights of way and the use of existing fiber
optic facilities, the ability to enter its target markets quickly and
efficiently and a reduction in the up-front capital investment required to
develop its networks. In addition, the Company's joint venture partners
provide access to additional assets, equity capital and established customer
bases. The Company also benefits from its relationship with its largest
shareholder, Level 3 Communications, Inc. ("Level 3"), and from the experience
gained by certain of the Company's key employees who participated in the
development of MFS Communications Company, Inc.
Because it delivers multiple services, RCN reports the total
number of its various service connections (for local telephone, video
programming and Internet access) rather than the number of customers. See
"Business--RCN Services--Connections." As of March 31, 1998, the Company had
approximately 658,600 connections which were delivered through a variety of
owned and leased facilities including hybrid fiber/coaxial cable systems, a
wireless video system and advanced fiber optic networks. The Company is
deploying advanced fiber optic networks specifically designed to provide high
speed, high capacity telecommunications services for all new network facilities.
RCN also intends to upgrade certain of its hybrid fiber/coaxial cable systems to
enable them to provide the same range of voice, video and data services,
including bundled service options. See "Business--Properties." At March 31,
1998, RCN had approximately 20,300 total connections attributable to customers
connected to advanced fiber optic networks ("on-net" connections) and had
approximately 638,200 connections attributable to customers served through other
facilities ("off- net" connections). Off-net connections consist of
approximately 227,500 connections attributable to the Company's hybrid
fiber/coaxial cable systems in the states of New York (outside New York City),
New Jersey and Pennsylvania, all within 75 miles of New York City, and
approximately 325,000 Internet service customers gained upon completion of the
acquisitions of UltraNet Communications, Inc. ("UltraNet") and Erols Internet,
Inc. ("Erols") in February 1998. As a result of the Erols and UltraNet
acquisitions, RCN is a leading Internet service provider ("ISP") in the Boston
to Washington, D.C. corridor.
RCN's extensive operating experience in both the telephone and
video industries and in the design and development of telecommunications
facilities provides it with expertise in systems operation and development, an
established infrastructure for customer service and billing for both voice and
video services and established relationships with providers of equipment and
video programming. In addition, the Company's management team and board of
directors benefit from experience gained in connection with the management of
Commonwealth Telephone Enterprises Inc. ("Commonwealth Telephone") (formerly
C-TEC Corporation ("C-TEC")), which prior to September 30, 1997 owned and
operated RCN. See "Business--Relationship Among Commonwealth Telephone, RCN and
Cable Michigan." C-TEC has 100 years of experience in the telephone business and
nearly 25 years of experience in the cable television business. Both C-TEC and
certain members of management also have extensive experience in the design and
development of advanced telecommunications facilities.
RCN seeks to exploit competitive opportunities in selected
markets where population density, favorable demographics and the aging
infrastructure of the incumbent service providers' network facilities combine
to create a particularly attractive opportunity to develop advanced fiber
optic networks. The Company continues to evaluate new market areas both
within and outside of the Boston to Washington, D.C. corridor. The Company
believes that its experience in the Northeast will provide it with a key
strategic advantage if it decides to enter new markets.
Business Strategy
The Company believes that the opportunity to deploy effectively
advanced fiber optic networks and to compete with incumbent telephone and
cable television service providers results from several key factors, including
the broad deregulation of the telecommunications industry pursuant to the
Telecommunications Act of 1996, the need for more advanced, higher capacity
networks to meet growing consumer demands for new communications products and
services and the superior technology of the Company's networks. In order to
achieve its goal of becoming the leading provider of telecommunications, video
and data services to residential customers in its target markets, RCN is
pursuing the following key strategies:
Developing Advanced Fiber Optic Networks. RCN's advanced
fiber optic networks are specifically designed to provide a single source for
high speed, high capacity voice, video programming and data services. The
Company expects that the substantial growth of the Internet and demand for
high speed data service will play an important role in the demand for its
fiber optic networks. RCN believes that its high capacity advanced fiber
optic networks provide RCN with certain competitive advantages such as
increased capacity (including the ability to offer bundled voice, video and
data services) and generally superior signal quality and network reliability
relative to the typical networks of the incumbent service providers. By using
advanced fiber optic networks capable of delivering multiple services, RCN is
able to address a larger number of potential subscriber connections in its
target markets than incumbent service providers which typically provide only
single or limited services.
Focusing on Residential Customers in High-Density Markets.
RCN seeks to be the first operator of an advanced fiber optic network
providing voice, video and data services to residential customers in each of
its target markets. RCN believes that it is unique in its markets in offering
a wide range of bundled voice, video and data services to customers in
residential areas and in striving to connect residential customers directly to
its advanced fiber optic networks. The Company estimates that RCN's loop
lengths are a small fraction of the incumbents. RCN also believes that
residential customers will be attracted to lower prices, broader service
offerings, enhanced levels of customer care and consumer choice. Although the
Company's primary focus is on residential customers, RCN also serves certain
commercial accounts which are located on or in close proximity to its
networks.
Implementing Subscriber-Driven Investment Strategy. RCN
attempts to deploy efficiently its capital by tying facility development to
the procurement of customer connections. In order to promote its presence in
its markets and to develop a subscriber base for its advanced fiber optic
networks, the Company may provide selected services to customers located near
its advanced fiber networks utilizing existing facilities that are available
in advance of network construction. For example, RCN markets Internet
services and provides resold telephone services in advance of constructing or
extending its networks. RCN also provides wireless video services to
approximately 40,859 customers in New York City (as of March 31, 1998) with a
view to extending the advanced fiber optic network to service many of these
existing customers.
Utilizing Strategic Alliances and Existing Facilities to Speed
and Reduce Cost of Entry. By utilizing strategic alliances, RCN is able to
enter the market quickly and efficiently and to reduce the up-front capital
investment required to develop its networks. Through alliances with companies
such as BECO, Pepco Communications and MFS Communications Company, Inc.
("MFS/WorldCom") (which is now a subsidiary of WorldCom, Inc. ("WorldCom")),
which provide or are expected to provide RCN with extensive fiber optic
networks or other assets, by utilizing certain components of its own existing
cable television infrastructure, and through the strategic acquisitions of
UltraNet and Erols, RCN has been able to expedite and reduce the cost of
market entry and business development and has created the opportunity to
leverage existing customer relationships.
Offering Bundled Voice, Video and Data Services. RCN believes
that, as a full service voice, video and data programming provider, it will be
able to offer a single-source package of voice, video and data services,
individually or on a bundled basis, which is not yet generally available from
any incumbent telephone, cable or other service provider. In addition,
services provided over RCN's advanced fiber optic networks are generally
priced at competitive rates as compared to the incumbent service providers.
Providing Superior Customer Service. RCN seeks to provide
superior customer service as compared to incumbent service providers, with
service features such as a 24-hour-a-day call center and quality control
system, on-time service guarantees and bundled service offerings, providing
the consumer with added choice and convenience.
Network Development and Financing Plan
In developing its advanced fiber optic networks, 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. As part of this
development plan, RCN pre-markets its services by offering Internet and
resale telephone (and, in New York City, wireless video) services in areas
targeted for expansion of advanced fiber optic network facilities. 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 building its advanced
fiber optic network in additional high density target markets in the Northeast
or elsewhere can be achieved on an attractive economic basis.
The Company expects that it will require a substantial amount
of capital to fund the network development and operations in the Boston to
Washington, D.C. corridor, including funding the development of its advanced
fiber optic networks, upgrading its hybrid fiber/coaxial plant and funding
operating losses and debt service requirements. The Company currently
estimates that its capital requirements for the period from January 1, 1998
through 1999 will be approximately $785 million, which includes 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 $485 million through 1999. As a result of
more rapid deployment of its fiber optic network and the Erols and UltraNet
acquisitions, certain aspects of the Company's capital expenditure program
have been accelerated. The Company's planned capital expenditures will be
used principally to fund the buildout of the Company's fiber optic network in
high density areas in selected markets in the Boston to Washington, D.C.
corridor and to upgrade its hybrid fiber/coaxial cable systems. In addition to
its own capital requirements, the Company's joint venture partners are each
expected to contribute approximately $150 million in capital to the joint
ventures from September 1997 through 2000 in connection with development of
the Boston and Washington, D.C. markets. Immediately following the consummation
of the Offering, the Company will have approximately $1,152 million of cash
and cash equivalents and approximately $63 million of restricted cash. Such
amounts are expected to provide sufficient liquidity to meet the Company's
capital requirements through 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.
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. Due to its
subscriber driven investment strategy, should the Company encounter a
successful rollout in its initial markets and/or decide to enter additional
markets, the Company may accelerate the rollout and/or extend the reach of its
network; such acceleration could increase the Company's capital requirements.
In addition, the commencement of operations and development of any new markets
could substantially increase the Company's capital requirements. See "Risk
Factors--Further Capital Requirements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
The Distribution
Prior to September 30, 1997, the Company was operated as a
wholly-owned subsidiary of C-TEC. On September 30, 1997 (the "Distribution
Date"), C-TEC completed a spin-off transaction by distributing all of the
shares of its subsidiaries, RCN and Cable Michigan, Inc. ("Cable Michigan"),
to the holders of C-TEC Common Equity. The Company, Commonwealth Telephone
and Cable Michigan have entered into certain agreements governing various
ongoing relationships between the three companies, including a distribution
agreement and a tax sharing agreement. See "Business--Relationship Among
Commonwealth Telephone, RCN and Cable Michigan."
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The Company's principal executive offices are located at 105
Carnegie Center, Princeton, New Jersey, and its telephone number is (609)
734-3700. The Company maintains a web site at http://www.rcn.com where general
information about the Company is available. Reference to the website shall
not be deemed to incorporate the contents of the website into this Prospectus.
The Offering
Securities Offered.................. $ aggregate principal amount at
maturity of % of Senior Discount
Notes due 2008. The Notes will be
issued at a discount to their aggregate
principal amount at maturity to yield
gross proceeds of approximately
$250,000,000. The yield to maturity of
the Notes will be % (computed on a
semi-annual bond equivalent basis),
calculated from , 1998. See
"Certain U.S. Federal Income Tax
Considerations."
Maturity Date....................... , 2008.
Ranking............................. The Notes will be senior unsecured
obligations of RCN. The Notes will
rank senior in right of payment to all
subordinated indebtedness of RCN and
will rank pari passu in right of
payment with all existing and future
indebtedness of RCN that is not by its
terms subordinated in right and
priority to the Notes. In addition,
claims of holders of the Notes will be
structurally subordinated to claims of
holders of indebtedness of RCN's
subsidiaries. As of March 31, 1998, the
aggregate amount of indebtedness
outstanding under the Credit Agreement
to which holders of Notes would have
been structurally subordinated was
approximately $103 million. In
addition, as of March 31, 1998, RCN had
outstanding $225 million aggregate
principal amount of its 10% Senior
Notes, $367 million accreted value of
its 11 1/8% Senior Discount Notes and
$356 million accreted value of its
9.80% Senior Discount Notes. RCN and
its subsidiaries are expected to incur
substantial additional indebtedness.
Interest............................ Cash interest will not accrue on the
Notes prior to , 2003.
Thereafter, cash interest on the Notes
will accrue at a rate of % per
annum and will be payable semi-annually
in arrears on each and of
each year, commencing , 2003.
Original Issue Discount............. For federal income tax purposes, the
Notes will be treated as having been
issued with "original issue discount"
equal to the difference between the
issue price of the Notes and the sum of
all cash payments (whether denominated
as principal or interest) to be made
thereon. Each holder of a Note must
include as gross income for federal
income tax purposes a portion of such
original issue discount for each day
during each taxable year in which a
Note is held even though no cash
interest payments will be received
prior to , 2003. See
"Certain U.S. Federal Income Tax
Considerations."
Optional Redemption................. The Notes will be redeemable at the
option of RCN, in whole or in part, at
any time on or after , 2003 at the
redemption prices set forth under
"Description of the Notes--Redemption,"
plus accrued and unpaid interest, if any,
thereon to the date of redemption. In
addition, prior to , 2001, RCN may use
the net proceeds of one or more Public
Equity Offerings of RCN yielding gross
cash proceeds of at least $30 million to
redeem up to an aggregate of 35% of the
principal amount at maturity of the Notes
originally issued (in each case, on a pro
rata basis) at a redemption price equal
to % of the Accreted Value at the
redemption date of the Notes so redeemed.
Change of Control................... In the event of a Change of Control, RCN
will be required to make an offer to
purchase all outstanding Notes at a
purchase price equal to 101% of the
Accreted Value thereof plus accrued and
unpaid interest, if any, thereon to the
date of purchase. See "Description of the
Notes--Certain Covenants--Change of
Control" for a discussion of such
covenant.
Asset Sale Offer.................... In addition, RCN will, subject to certain
conditions, be obligated to make an offer
to purchase Notes with the Net Cash
Proceeds of certain Asset Sales at a
price of 100% of the Accreted Value
thereof plus accrued and unpaid interest,
if any, to the date of purchase. See
"Description of the Notes--Certain
Covenants--Disposition of Proceeds of
Asset Sales."
Certain Covenants................... The indenture under which the Notes
will be issued (the "Indenture") will
contain certain covenants, including (i)
limitations on additional indebtedness,
(ii) limitations on restricted
payments, (iii) limitations on liens
securing certain indebtedness, (iv)
limitations on certain guarantees, (v)
limitations on dividend and other
payment restrictions affecting
Restricted Subsidiaries or Restricted
Affiliates (as defined), (vi)
limitations on transactions with
affiliates, (vii) limitations on
issuances and sales of Preferred Stock
by Restricted Subsidiaries and
Restricted Affiliates (as defined),
(viii) limitations on the disposition
of proceeds of asset sales and (ix)
limitations on designations of
Unrestricted Subsidiaries (as defined)
and Restricted Affiliates. In addition,
the Indenture will limit the ability of
RCN to consolidate, merge or sell all
or substantially all of its assets.
These covenants are subject to
important exceptions and
qualifications. See "Description of the
Notes--Certain Covenants."
Absence of a Public Market
for the Notes....................... The Notes are new securities for
which there is currently no established
trading market. Although the
Underwriters have informed RCN that
they currently intend to make a market
in the Notes, they are not obligated to
do so and any such market making may be
discontinued at any time without
notice. Accordingly, there can be no
assurance as to the development or
liquidity of any market for the Notes.
RCN does not intend to apply for
listing of the Notes on any securities
exchange or for quotation through the
Nasdaq Stock Market.
Common Stock Offering............... Concurrently with the Offering being made
hereby, the Company is offering, by means
of a separate prospectus, 10,583,032
shares of its Common Stock. The
consummation of the Common Stock Offering
is not a condition to the Offering and
there can be no assurance that the Common
Stock Offering will be consummated.
Use of Proceeds..................... The net proceeds of the Offering will
be approximately $243 million, after
deducting estimated commissions and
offering expenses, and will be used for
expansion and development of advanced
fiber optic network facilities. See
"Use of Proceeds."
RISK FACTORS
Prospective investors should carefully consider all of the
information in this Prospectus and, in particular, should evaluate the
specific risk factors set forth under "Risk Factors," beginning on page 11.
Summary Historical Consolidated Financial Data
The table below sets forth selected historical consolidated
financial data for RCN. Prior to September 30, 1997, the Company operated as
part of C-TEC. The historical financial data presented below reflect periods
during which the Company did not operate as an independent company and,
accordingly, certain assumptions were made in preparing such financial data.
Therefore, such data may not reflect the results of operations or the
financial condition which would have resulted if the Company had operated as a
separate, independent company during such periods, and are not necessarily
indicative of the Company's future results of operation or financial condition.
The selected historical consolidated financial data for the
years ended December 31, 1994 and 1993 and as of December 31, 1995, 1994 and
1993 are derived from the Company's unaudited historical consolidated financial
statements not included in this Prospectus. The selected historical
consolidated financial data of the Company for the years ended December 31,
1997, 1996 and 1995 and as of December 31, 1997 and 1996 are derived from and
should be read in conjunction with the Company's audited historical
consolidated financial statements (the "Financial Statements") and the
Company's unaudited pro forma consolidated financial statements included
elsewhere in this Prospectus. The selected historical consolidated financial
data for the three month periods ended March 31, 1998 and 1997 and as of March
31, 1998 are derived from and should be read in conjunction with the Company's
unaudited historical consolidated financial statements included elsewhere in
this Prospectus. In the opinion of the Company's management, these three month
consolidated historical financial statements include all adjustments,
consisting of normal recurring adjustments, necessary for a fair statement of
the results for the unaudited interim periods. The results for such interim
periods are not necessarily indicative of the results for the full year. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Unaudited Pro Forma Consolidated Financial Statements" and the
Financial Statements.
<TABLE>
<CAPTION>
Three Months Ended
Year Ended December 31, March 31,
----------------------------------------------------------------- -----------------------
1993 1994 1995(1) 1996 1997 1997 1998
---- ---- ------- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Sales.................................. $49,504 $59,500 $91,997 $104,910 $127,297 $29,677 $40,138
Costs and expenses, excluding
depreciation and amortization......... 30,821 49,747 75,003 79,107 134,967 25,524 48,455
-------- -------- -------- -------- ---------- -------- ----------
EBITDA before nonrecurring charges (2). 18,683 9,753 16,994 25,803 (7,670) 4,153 (8,317)
Nonrecurring charges(3)................ -- -- -- -- 10,000 10,000 44,700
Depreciation and amortization.......... 9,922 9,803 22,336 38,881 53,205 12,191 17,691
-------- -------- -------- -------- ---------- -------- ----------
Operating (loss) income................ 8,761 (50) (5,342) (13,078) (70,875) (18,038) (70,708)
Interest income........................ 17,882 21,547 29,001 25,602 22,824 5,153 12,815
Interest expense....................... (17,127) (16,669) (16,517) (16,046) (25,602) (3,431) (22,735)
Other (expense) income, net............ 1,195 1,343 (304) (546) 131 (33) (899)
(Benefit) provision for income taxes... 167 2,340 1,119 979 (20,849) (4,800) (11,682)
Equity in loss of unconsolidated
entities(4)........................... -- -- (3,461) (2,282) (3,804) (805) (1,493)
Minority interest in loss (income) of
consolidated entities(5).............. (85) (95) (144) 1,340 7,296 910 3,586
Extraordinary charge--debt prepayment
penalty, net of tax of $1,728(6)...... -- -- -- -- (3,210) -- --
Cumulative effect of changes in
accounting principles(7).............. 1,628 (83) -- -- -- -- --
-------- -------- -------- -------- ---------- -------- ----------
Net (loss) income...................... $12,087 $3,653 $2,114 $(5,989) $(52,391) $(11,444) $(67,752)
======== ======== ======== ======== ========== ======== ==========
Balance Sheet Data (at end of period):
Total assets........................... $291,634 $568,586 (8) $649,610 $628,085 $1,150,992 $592,697 $1,578,232
Long-term debt (including
current position)..................... 181,500 154,000 161,000 131,250 686,103 131,250 1,053,324
Shareholders' equity................... 74,329 372,847 (8) 394,069 390,765 356,584 362,449 362,283
</TABLE>
- ----------
(1) Certain of the Company's businesses were acquired by C-TEC and transferred
to the Company in connection with the Distribution. In May 1995, a
subsidiary of C-TEC acquired Twin County Trans Video, Inc. ("Twin County")
and accordingly Twin County is fully consolidated in the Company's
financial statements since the date of acquisition. See Note 4 to the
Consolidated Financial Statements of the Company.
(2) EBITDA represents earnings before interest, depreciation and amortization,
and income taxes. 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.
(3) Nonrecurring charges in 1997 represent costs of $10,000 incurred with
respect to the termination of a marketing services agreement related to the
Company's wireless video services, and in 1998 represent nonrecurring costs
of $44,700 of acquisition of in-process technology relating to the
acquisitions of UltraNet and Erols.
(4) Equity in loss of unconsolidated entities primarily consists of the
Company's proportionate share of income (losses) and amortization of excess
cost over net assets of Megacable, S.A. de C.V. ("Megacable"). The Company
purchased its 40% equity interest in Megacable in January 1995 and accounts
for its investment by the equity method of accounting.
(5) In 1997, the minority interest in (income) loss of consolidated entities
consists of minority losses of the RCN-BECOCOM, LLC joint venture of $6,562,
minority losses of Freedom New York, L.L.C. ("Freedom") through March 1997
of $966 and minority income earned by a cable television partnership of
$(232). The minority interest in (income) loss of consolidated entities
primarily consists of the approximately 20% minority interest in the loss of
Freedom in 1996. Prior to 1996 the minority interest represents minority
income earned by a cable television partnership.
(6) Extraordinary charge represents the fee, net of taxes, paid in connection
with the early prepayment of 9.65% Senior Secured Notes of C-TEC Cable
Systems, Inc. (the "Senior Secured Notes"). The Senior Secured Notes were
prepaid in connection with the Company's acquisition of a new $125,000
credit agreement comprised of a five year revolving credit facility in the
amount of $25,000 and a $100,000 term credit facility which is to be repaid
over six years in quarterly installments from September 30, 1997 through
June 30, 2005.
(7) The cumulative effect of changes in accounting principles reflects the
adoption of Statement of Financial Accounting Standards No. 109 "Accounting
for Income Taxes" in 1993 and the accounting for benefits under Statement of
Financial Accounting Standards No. 112-- "Employers' Accounting for
Postemployment Benefits" in 1994.
(8) During 1994, C-TEC transferred to the Company an equity contribution of
$298,759 primarily representing net proceeds from a C-TEC common stock
rights offering.
Summary Pro Forma Financial Data
The following unaudited summary pro forma financial data
include adjustments to the historical statements of operations of the Company
for three months ended March 31, 1998 and the year ended December 31, 1997 as
if the Distribution, borrowings of $110 million under the Credit Agreement,
the offering (the "1997 Notes Offering") of the 10% Senior Notes and the
11 1/8% Senior Discount Notes, both due 2007 (the "10% Senior Notes" and
"11 1/8% Senior Discount Notes," respectively, and together, the "1997
Notes"), the acquisition of Erols (the "Acquisition"), the issuance of the
9.80% Senior Discount Notes due 2008 (the "9.80% Senior Discount Notes" or the
"1998 Notes"), the issuance of the Common Stock in the Common Stock Offering
and the issuance of the Notes in the Offering had occurred on the first day of
the respective periods. Such adjustments result primarily from changes in the
capital structure of the Company and accounting for the Acquisition. See
"Unaudited Pro Forma Consolidated Financial Statements" and the notes thereto.
The following unaudited pro forma financial data for the respective periods are
provided for information purposes only and should not be construed to be
indicative of the Company's results of operations or financial condition had
such transactions occurred on the dates assumed, may not reflect the results of
operations or financial condition which would have resulted had the Company
been operated as a separate, independent Company during such period, and are
not necessarily indicative of the Company's future results of operations or
financial condition.
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, March 31,
1997 1998
-------------- -------------
(dollars in thousands)
<S> <C> <C>
Statement of Operations Data:
Sales........................................................................... $141,273 $43,467
Costs and expenses, excluding depreciation and amortization..................... 154,032 51,664
Nonrecurring charges............................................................ 10,000 44,700
Depreciation and amortization................................................... 61,421 18,829
--------- --------
Operating (loss)................................................................ (84,180) (71,726)
Interest income................................................................. 14,138 12,815
Interest expense................................................................ (131,787) (32,728)
Other (expense) income, net..................................................... 82 (904)
--------- --------
(Loss) before income taxes...................................................... (201,747) (92,543)
(Benefit) for income taxes...................................................... (61,794) (16,155)
--------- --------
(Loss) before equity in unconsolidated entities and minority interest........... (139,953) (76,388)
Equity in loss of unconsolidated entities....................................... (17,224) (3,195)
--------- --------
(Loss) before extraordinary charge and minority interest in loss of consolidated
entities...................................................................... $(157,177) $(79,583)
========= ========
Other Data:
EBITDA before nonrecurring charges (1).......................................... $(12,759) $(8,197)
Capital expenditures............................................................ $90,392 $30,798
Connections (at end of period).................................................. 593,646 658,615
Full Time Employees (at end of period).......................................... 1,446 1,606
</TABLE>
- ----------
(1) EBITDA represents earnings before interest, depreciation and amortization,
and income taxes. 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.
RISK FACTORS
In addition to the other information contained in this
Prospectus, prospective investors should carefully review the following
factors.
This Prospectus contains certain forward-looking statements
regarding the Company's operations, economic performance and financial
condition, including, in particular, statements made as to plans to develop
networks and upgrade facilities, the market opportunity presented by markets
targeted by the Company, the Company's intention to connect certain wireless
video and resale telephone customers to its advanced fiber optic networks, the
development of the Company's businesses, the current and future markets for the
Company's services and products, the Company's anticipated capital expenditures,
the Company's anticipated sources of capital and effects of regulatory reform
and competitive and technological developments. Such forward-looking statements
are subject to known and unknown risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified in this Section and elsewhere in this Prospectus.
Such risks include, but are not limited to, the Company's ability to
successfully market its services to current and new customers, connect existing
customers to its advanced fiber optic networks, access markets, finance network
development, design and construct fiber optic networks, install or lease fiber
optic cable and other facilities, including switching electronics, and obtain
rights-of-way, building access rights and any required governmental
authorizations, franchises and permits, all in a timely manner, at reasonable
costs and on satisfactory terms and conditions, as well as regulatory,
legislative, judicial, competitive and technological developments that could
cause actual results to vary materially from the future results indicated,
expressed or implied, in such forward-looking statements.
Limited Operating History; Negative Cash Flow; Operating Losses
The Company has only recently begun operating a voice, video
and data services business and this business has only a limited operating
history upon which investors may base an evaluation of its performance. In
connection with entering this business, the Company has incurred operating and
net losses and negative cash flows to build its networks and pursue its
business plans and expects to continue to do so for the foreseeable future as
it expands its network and customer base. The extent to which the Company
continues to experience negative cash flow in the future will be affected by a
variety of factors, including the pace of its entry into new markets, the time
and expense required for building out its planned network, its success in
marketing its services, the intensity of the competition experienced by the
Company and the availability of additional capital to pursue its business
plans. The Company had operating losses after depreciation and amortization
and nonrecurring charges of $70,875,000, $13,078,000 and $5,342,000 for the
years ended December 31, 1997, 1996 and 1995 and $70,708,000 for the three
months ended March 31, 1998. On a pro forma basis, after giving effect to the
transactions described under "Unaudited Pro Forma Consolidated Financial
Statements," the Company had operating losses after depreciation and
amortization and nonrecurring charges of $84,180,000 for the year ended
December 31, 1997 and $71,726,000 for the three months ended March 31, 1998.
There can be no assurance that the Company will achieve or sustain
profitability or positive cash flows from operating activities in the future.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
Further Capital Requirements
The Company expects that it will require a substantial amount
of capital to fund the development and operations of business in the Boston to
Washington, D.C. corridor, including to fund its advanced fiber optic
networks, the upgrade of hybrid fiber/coaxial plant, the funding of operating
losses and debt service requirements. The Company currently estimates that its
capital requirements for the period from January 1, 1998 through December 31,
1999 will be approximately $785 million, which includes 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 $485 million through 1999. These capital expenditures will
be used principally to fund the buildout of the Company's fiber optic network
in high density areas in the Boston, New York and Washington, D.C. markets and
represent only the Company's proportionate share of the funding requirements
of the Boston and Washington, D.C. joint ventures. The Company is obligated to
fund its portion of any capital contributions required by the joint ventures'
annual budget or capital contribution schedule. See "--Dependence on Strategic
Relationships; Terms of Joint Venture Arrangements." The Company expects that
its joint venture partners will each contribute approximately $150 million in
capital to the joint ventures in the period from September 30, 1997 through
2000 in order to fund capital expenditures at the joint venture company level,
of which approximately $50.9 million has been contributed. RCN expects to
contribute to Starpower, the joint venture with Pepco Communications, the
subscribers acquired in the acquisition of Erols located in the Washington,
D.C. area in which Starpower operates. On February 20, 1998, approximately 61%
of all of Erols' subscribers were located in the relevant Washington, D.C.
area. RCN anticipates that Pepco Communications will make a contribution equal
to the value of such subscribers. The joint venture partners of Starpower are
currently negotiating the terms of such contribution. Failure by its joint
venture partner(s) to make anticipated capital contributions could have a
material adverse effect on the Company.
The Company believes that it has sufficient liquidity to meet
its capital requirements through 2000. The actual timing and amount of capital
required for the rollout of 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 (including those associated with adverse weather conditions),
cost overruns, engineering design changes and other technological risks or to
meet other unanticipated expenses. 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. In addition, the commencement of operations and
development of any new markets could substantially increase the Company's
capital requirements. 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Substantial Indebtedness; Effect of Financial Leverage
The Company has indebtedness that is substantial in relation to
its shareholders' equity and cash flow. As of March 31, 1998, on a pro forma
basis, after giving effect to the transactions described under "Unaudited Pro
Forma Consolidated Financial Statements," the Company had an aggregate of
approximately $1,303 million of indebtedness outstanding, representing 68.8% of
total capitalization, and the ability to borrow up to an additional $22 million
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 and there can be no assurance that the Company's
operating cash flow will be sufficient to pay interest on the 1997 Notes, the
1998 Notes or the Notes following February 15, 2003. 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 financings or may otherwise restrict
the Company's business activities.
The extent of the Company's leverage may have the following
consequences: (i) limit the ability of the Company to obtain necessary
financing in the future for working capital, capital expenditures, debt
service requirements or other purposes, (ii) require that a substantial
portion of the Company's cash flows from operations be dedicated to the
payment of principal and interest on its indebtedness and therefore not be
available for other purposes; (iii) limit the Company's flexibility in
planning for, or reacting to, changes in its business; (iv) place the Company
at a competitive disadvantage as compared with less leveraged competitors; and
(v) render the Company more vulnerable in the event of a downturn in its
business.
Holding Company Structure; Structural Subordination
RCN is a holding company with limited assets that conducts
substantially all of its operations through subsidiaries and joint ventures.
The Notes will be solely obligations of RCN and no other entity has any
obligation, contingent or otherwise, to make payments in respect of the Notes.
Accordingly, RCN will be dependent on dividends and other distributions from
its subsidiaries and joint ventures to generate the funds necessary to meet
its obligations, including the payment of principal and interest on the Notes.
The ability of the Company's subsidiaries and joint ventures to pay dividends
to RCN will be subject to, among other things, the terms of any debt
instruments and applicable law. In addition, the terms of the Company's joint
ventures require the mutual consent of the Company and its joint venture
partner to distribute or advance funds to the Company. Claims of holders of
the Notes will be effectively subordinated to the indebtedness and other
liabilities and commitments of RCN's subsidiaries and joint ventures and the
interest of RCN in its joint ventures will be limited to the extent of its
direct or indirect equity interest in such entities. Consequently, in the
event of an insolvency, liquidation, reorganization, dissolution or other
winding up of the Company's subsidiaries and joint ventures, the ability of
RCN's creditors, including holders of the Notes, will be subject to the prior
claims of those entities' creditors, including trade creditors, and any prior
or equal claim of any joint venture partner. Any distributions in respect of
RCN's equity interests in non-wholly owned subsidiaries or in joint ventures
may be expected to be made on a pro rata basis to all equity holders. The
Company expects that a majority of its cash flow in the advanced fiber optic
network business will ultimately derive from its joint venture investments. The
Indenture will permit substantial indebtedness to be incurred by subsidiaries
and joint ventures of RCN and does not, except under limited circumstances,
require a guarantee by subsidiaries of RCN. In addition, the Indenture will
permit the Company's subsidiaries and joint ventures to become parties to debt
instruments that limit such entities' ability to pay dividends or make
distributions to RCN.
Ability to Manage Growth; Risks Related to Acquisitions
The expansion and development of the Company's operations
(including the construction and development of additional networks) will depend
on, among other things, the Company's ability to access markets, design fiber
optic network backbone routes, install or lease fiber optic cable and other
facilities, including switches, and obtain rights-of-way, building access rights
and any required government authorizations, franchises and permits, all in a
timely manner, at reasonable costs and on satisfactory terms and conditions. In
addition to markets presently being developed, RCN is continually evaluating
other potential markets, both within the Boston to Washington, D.C. corridor and
in non-contiguous areas, for possible network development. As is the case in its
present markets, the Company intends to evaluate potential markets in terms of
population density and favorable demographics, and to apply a subscriber-driven
investment strategy, in developing new markets. There can be no assurance that
the Company will be able to expand its existing network or to identify and
develop new markets. Furthermore, the Company's ability to manage its expansion
effectively will also require it to continue to implement and improve its
operating and administrative systems and attract and retain qualified management
and professional and technical personnel. If the Company were not able to manage
its planned expansion effectively it could have a material adverse effect on the
Company.
The Company has experienced significant growth through
acquisitions and will continue to consider acquisition opportunities that
arise from time to time. Such acquisitions may place a significant strain on
the Company's resources, and could subject the Company to additional expenses
during the integration process. Although the Company's acquisitions of Erols
and UltraNet were consummated in February, 1998, the process of integrating
the business of the ISPs into the Company may take a significant period of
time. In addition, RCN expects that it will need to upgrade the systems and
controls of the companies being acquired. As a result, there can be no
assurance that the Company will be able to successfully integrate these ISPs
successfully or in a timely manner. See "--Risks Relating to Provision of
Internet Services."
Rapid Technological Changes
The telecommunication industry is subject to rapid and
significant changes in technology. While the Company believes that for the
foreseeable future these changes will neither materially affect the continued
use of fiber optic telecommunications networks nor materially hinder its
ability to acquire necessary technologies, the effect of technological changes
on the business of the Company cannot be predicted. There can be no assurance
that technological developments in telecommunications will not have a material
adverse effect on the Company.
Dependence on Strategic Relationships; Terms of Joint Venture Arrangements
The Company has entered into a number of strategic alliances
and relationships in order to provide it with early entry into the market for
telecommunications services. As the Company's network is further developed, it
will be dependent on these arrangements to provide the full range of its
telecommunication service offerings. The key strategic relationships include
(1) RCN's arrangements with MFS/WorldCom to, among other things, lease
portions of MFS/WorldCom's fiber optic network in New York City and Boston,
(2) RCN's joint venture with BECO under which the Company has access to BECO's
extensive fiber optic network in Greater Boston and (3) RCN's joint venture
with Pepco Communications, an indirect subsidiary of PEPCO, to develop an
advanced fiber optic network in the Washington, D.C. market. See
"Business--Strategic Relationships." The Company also has in place
arrangements to act as a reseller of Bell Atlantic local telephone services
and arrangements to lease Bell Atlantic unbundled local loop and T-1
facilities (including Bell Atlantic services previously provided by NYNEX).
Any disruption of these relationships or arrangements could have a material
adverse effect on the Company. The Company has also executed comprehensive
telephone service co-carrier interconnection agreements with Bell Atlantic and
Sprint, covering, along with the District of Columbia, ten states in the
Northeast and New England-Middle Atlantic corridor areas, which the Company
has targeted as its initial geographic markets. The Company may be required to
negotiate new interconnection agreements from time to time and as it enters
new markets in the future. There can be no assurance that the Company will
successfully negotiate such other agreements for interconnection with the
incumbent local exchange carrier ("LEC") or renewals of existing
interconnection agreements. The failure to negotiate or renew required
interconnection agreements could have a material adverse effect on the Company.
The agreements governing the Company's joint ventures with BECO
and Pepco Communications contain material provisions for the management,
governance and ownership of the Greater Boston and Washington, D. C.
businesses, respectively. The Boston Joint Venture Agreement (as defined under
"Business--Strategic Relationships") provides, among other things, that (1)
certain fundamental business actions, such as material capital expenditures,
debt incurrences and distributions to the Company and BECO, require the joint
approval of RCN and BECO; (2) neither RCN nor BECO may transfer their interests
in the joint venture for a period of three years without the other's consent
and, thereafter, may only do so while observing certain rights of first offer
and tag-along rights; (3) upon a change of control (as defined below) of RCN
Telecom Services of Massachusetts ("RCN Massachusetts") or BECOCOM, Inc.
("BECOCOM"), the other party has the right to acquire all of the equity
interest in the joint venture for fair market value; (4) following certain
deadlock events (defined generally as an inability of RCN and BECO to agree
upon certain fundamental business actions requiring mutual consent), either RCN
or BECO may offer to buy the other's interest in the joint venture or sell its
own interest in the joint venture, which gives the offeree the right to elect
to buy or sell its interest; and (5) in the event of a default by the Company
in meeting a capital call, BECO may dilute the Company's interest in the joint
venture. The Amended and Restated Operating Agreement (the "Starpower Operating
Agreement") for Starpower provides, among other things, that (1) so long as
each partner maintains a 50% interest in the joint venture, all business
actions require the approval of the operating committee; (2) subject to certain
exceptions, neither RCN nor Pepco Communications may sell any interest in
Starpower within the first four years after the execution of the Starpower
Operating Agreement nor may they thereafter sell any interest in Starpower
without satisfying certain conditions; (3) upon a change of control of RCN
Telecom Services of Washington, D.C., Inc. ("RCN Washington") or Pepco
Communications, which the other party has reason to believe will have a
material adverse effect on Starpower, the other party may offer to buy out the
entity experiencing the change of control or to sell its own interest in the
joint venture, which gives the offeree the right to elect to buy or sell its
interest or accept the change of control; (4) after three years following the
execution of the agreement, upon certain deadlock events (defined generally as
an inability of the operating committee to agree upon any business actions),
either RCN Washington or Pepco Communications may offer to buy the other's
interest in the joint venture or sell its own interest in the joint venture,
which gives the offeree the obligation to elect to buy or sell its interest;
and (5) failure to make scheduled capital contributions or to vote in favor of
certain additional capital contributions may result in dilution of equity
interests. Accordingly, certain matters beyond the control of the Company, such
as a change of control of RCN or an inability to agree on certain proposed
actions, could result in it being forced to sell its interest in the relevant
joint venture or buy out the interest of the other joint venturer. There can be
no assurance that these provisions will not have a material adverse effect upon
the Company's liquidity or future prospects or that, if necessary, the Company
will be able to raise the necessary funds to acquire the balance of the
interests in the joint venture on a timely basis and thereby maintain its
interest in the venture in question. See "Business--Strategic Relationships."
In addition, although certain covenants contained in the indentures applicable
to the 1997 Notes, the 1998 Notes and the Notes (the "Indentures") are
applicable to the joint venture companies, neither the joint venture companies
nor the Company's joint venture partners are parties to the Indentures and
accordingly are not bound to comply with the terms of the Indentures. A
disagreement with its joint venture partners over certain business actions,
including actions related to compliance with the Indentures, could give rise to
a deadlock event.
Competition
RCN competes with a wide range of service providers for each of
the services that it provides. Virtually all markets for voice and video
services are extremely competitive, and RCN expects that competition will
intensify in the future. In each of the markets in which it offers voice and
video programming services, RCN faces significant competition often from
larger, better-financed incumbent local telephone carriers and cable
companies, and RCN often competes directly with incumbent providers which have
historically dominated their respective local telephone and cable television
markets. These incumbents presently have numerous advantages as a result of
their historic monopoly control of their respective markets.
With respect to local telephone services, RCN competes with the
incumbent LECs, and alternative service providers including competitive local
exchange carriers ("CLECs") and cellular and other wireless telephone service
providers. With respect to long distance telephone services, RCN faces, and
expects to continue to face, significant competition from the interexchange
carriers ("IXCs"), including AT&T, Sprint and MCI, which account for the
majority of all long distance revenue. Certain of the IXCs, including AT&T,
MCI and Sprint, have announced their intention to offer local services in
major U.S. markets using their existing infrastructure in combination with
resale of incumbent LEC service, lease of unbundled local loops or other
providers' services.
All of the Company's video services face competition from
alternative methods of receiving and distributing television signals and from
other sources of news, information and entertainment. Among the alternative
video distribution technologies are home satellite dish earth stations,
private satellite master antenna television systems, direct broadcast
satellite services ("DBS") and wireless program distribution services such as
multi-channel multipoint distribution service systems. The Company expects
that its video programming service will face growing competition from current
and new DBS service providers.
RCN believes that among the existing competitors, the incumbent
LECs and the incumbent cable providers provide the most direct competition to
RCN in the delivery of "last mile" connections to residential consumers for
voice and video services. In each of its target markets for advanced fiber
optic networks, RCN faces, and expects to continue to face, significant
competition from the incumbent LECs (including Bell Atlantic in New York City
and Boston), which currently dominate their local telephone markets. RCN
competes with the incumbent LECs in its markets for local exchange services on
the basis of product offerings (including the ability to offer bundled voice
and video services), reliability, state-of-the-art technology and superior
customer service, as well as price. The incumbent LECs have begun to expand
the amount of fiber facilities in their networks and to prepare to re-enter
into the long distance telephone services market and, in addition, have
long-standing relationships with their customers. The Company expects that the
increased competition made possible by regulatory reform will result in
certain pricing and margin pressures in the telecommunications services
business. The recently announced merger between SBC Communications ("SBC") and
Ameritech Corporation ("Ameritech") may also potentially increase the
competitive environment in the Boston to Washington, D.C. corridor if SBC
continues to pursue a nationwide strategy.
The Telecommunications Act of 1996 (the "1996 Act") permits the
incumbent LECs and others to provide a wide variety of video services directly
to subscribers in competition with RCN. Various LECs currently are providing
video services within and outside their telephone service areas through a
variety of distribution methods, including both the deployment of broadband
wire facilities and the use of wireless transmission facilities. The Company
cannot predict the likelihood of success of video service ventures by LECs or
the impact on the Company of such competitive ventures.
Certain of RCN's video programming service businesses compete
with incumbent wireline cable companies in their respective service areas. In
particular, RCN's advanced fiber optic networks compete for cable subscribers
with the major wireline cable operators in New York City and Boston, primarily
Time Warner Cable in New York City and Cablevision in Boston. RCN's wireless
video service in New York City competes with Time Warner Cable, Cablevision
Systems and Comcast. RCN's Pennsylvania hybrid fiber/coaxial cable television
system competes with an alternate service provider, Service Electric Cable TV,
which also holds a franchise for the relevant service area.
RCN also faces, and expects to continue to face, competition
from other potential competitors in certain of the markets in which RCN offers
its services. Other CLECs, such as Teleport Communications Group, compete for
local telephone services, although they have to date focused primarily on the
market for commercial customers. In addition, potential competitors capable of
offering private line and special access services also include other smaller
long distance carriers, cable television companies, electric utilities,
microwave carriers, wireless telephone system operators and private networks
built by large end-users, including Winstar, Dualstar and New Vision.
Cellularvision, a provider of local multipoint distribution service ("LMDS"),
offers wireless Internet and video programming services in New York City and
has announced plans to offer telephone service in the future.
The market for Internet access services is extremely competitive
and highly fragmented. No significant barriers to entry exist, and accordingly
competition in this market is expected to intensify. The Company competes (or in
the future may compete) directly or indirectly with (i) national and regional
ISPs; (ii) established online services; (iii) computer software and technology
companies; (iv) national telecommunications companies; (v) LECs; (vi) cable
operators; and (vii) nonprofit or educational ISPs, and some of these present or
potential future competitors have or can be expected to have substantially
greater market presence and financial, technical, marketing and other resources
than the Company. Certain of the Company's online competitors, including America
Online, Inc. ("America Online"), the Microsoft Network and Prodigy, have
introduced unlimited access to the Internet and their proprietary content at
flat rates, and certain of the LECs have also introduced competitive flat-rate
pricing for unlimited access (without a set-up fee for at least some period of
time). Bell Atlantic has recently filed with the Federal Communications
Commission (the "FCC") a petition for an exemption from a regulation prohibiting
it from building a high-speed network. Bell Atlantic's petition requests that
such network, which would serve as an Internet backbone, not be subject to
pricing and other regulatory restriction. The network would span the states from
Maine to Virginia. There can be no assurance that competition will not lead to
pricing pressures in the Internet business. For additional information on the
competitive environment in which the Company operates, see
"Business--Competition."
Other new technologies may become competitive with services
that RCN offers. Advances in communications technology as well as changes in
the marketplace and the regulatory and legislative environment are constantly
occurring. In addition, a continuing trend toward business combinations and
alliances in the telecommunications industry may also create significant new
competitors to RCN. The Company cannot predict whether competition from such
developing and future technologies or from such future competitors will have a
material impact on its operations.
Regulation
The telephone and video programming transmission services
offered by the Company are subject to federal, state, and local government
regulation. The 1996 Act, which became effective in February 1996, introduced
widespread changes in the regulation of the communications industry, including
the local telephone, long distance telephone, data services, and television
entertainment segments in which the Company operates.
The 1996 Act eliminates many of the pre-existing legal barriers
to competition in the telephone and video programming communications
businesses, preempts many of the state barriers to local telephone service
competition that previously existed in state and local laws and regulations,
and sets basic standards for relationships between telecommunications
providers.
Among other things, the 1996 Act removes barriers to entry in
the local exchange telephone market by preempting state and local laws that
restrict competition and by requiring LECs to provide nondiscriminatory access
and interconnection to potential competitors, such as cable operators,
wireless telecommunications providers, and long distance companies. In
addition, the 1996 Act provides relief from the earnings restrictions and
price controls that have governed the local telephone business for many years.
The 1996 Act will also, once certain thresholds are met, allow Regional Bell
Operating Companies ("RBOCs") to enter the long distance market within their
own local service regions.
Regulations promulgated by the FCC under the 1996 Act require
LECs to open their telephone networks to competition by providing competitors
interconnection, access to unbundled network elements and retail services at
wholesale rates. Numerous parties appealed certain aspects of these
regulations, and the appeals were consolidated in the United States Court of
Appeals for the Eighth Circuit. On July 18, 1997, the Eighth Circuit found
constitutional challenges to certain practices implementing cost provisions of
the Telecommunications Act that were ordered by certain state public utility
commissions ("PUCs") to be premature; vacated significant portions of the
FCC's nationwide pricing rules; and confined the use of combined unbundled
network elements to instances where the requesting carrier itself would do the
combining. On October 14, 1997, the Eighth Circuit issued a decision vacating
additional FCC rules that will likely have the effect of increasing the cost
of obtaining the use of combinations of an incumbent LEC's unbundled network
elements. On January 26, 1998, the Supreme Court granted a writ of certiorari
under which it will review the July 18 Eighth Circuit decision; it is expected
(but not yet certain) that the Court will hear arguments on this case in the
fall of 1998. The Eighth Circuit decisions create uncertainty about the rules
governing pricing and terms and conditions of interconnection agreements, and
could make negotiating and enforcing such agreements more difficult and
protracted and may require renegotiation of existing agreements. Prior to the
Eighth Circuit decisions, the Company had entered into interconnection
agreements with Bell Atlantic, covering all of its target market area, that
are generally consistent with the FCC guidelines, and those agreements remain
in effect notwithstanding the reversal of the FCC rules. There can be no
assurance, however, that the Company will be able to obtain or enforce future
interconnection agreements, or obtain renewal of existing agreements, on terms
acceptable to the Company.
Certain RBOCs have also raised constitutional challenges to
restrictions in the 1996 Act preventing RBOCs from entering the long distance
market in their home region. On December 31, 1997, the U.S. District Court for
the Northern District of Texas issued a decision (the "SBC Decision") finding
that Sections 271 to 275 of the Telecommunications Act of 1996 are
unconstitutional. SBC Communications, Inc., et al. v. Federal Communications
Commission, et al., Civil Action No. 7:97-CV-163-X. These sections of the 1996
Act impose restrictions on the lines of business in which the RBOCs may
engage, including establishing the conditions they must satisfy before they
may provide in-region interLATA (local access and transport area)
telecommunications services. The District Court has stayed the SBC Decision
pending appeal. If the stay is lifted, the RBOCs (including Bell Atlantic,
which was permitted to intervene in the case) would be able to provide
interLATA services immediately without satisfying the statutory conditions.
Although the Company believes the factual assumptions and legal reasoning in
the SBC Decision are erroneous and therefore the decision will likely be
reversed on appeal, there can be no assurance of this outcome. If the SBC
Decision were upheld on appeal it may have an unfavorable effect on the
Company's business for at least two reasons. First, RBOCs currently have an
incentive to foster competition within their service areas so that they can
qualify to offer interLATA services. The SBC Decision removes this incentive
by allowing RBOCs to offer interLATA service without regard to their progress
in opening their local markets to competition. However, the SBC Decision would
not affect other provisions of the Act which create legal obligations for all
incumbent LECs to offer interconnection and network access, and therefore will
not impair the Company's ability to compete in local exchange markets. Second,
the Company is legally able to offer its customers both long distance and
local exchange services, which the RBOCs currently may not do. This ability to
offer "one-stop shopping" gives the Company a marketing advantage that it
would no longer enjoy if the SBC Decision were upheld on appeal. The Company
cannot predict either the outcome of these or future challenges to the 1996
Act, any related appeal of regulation or court decision, or the eventual
effect on its business or the industry in general.
The 1996 Act also makes far-reaching changes in the regulation
of the video programming transmission services offered by RCN, including
changes to the regulations applicable to video operators, the elimination of
restrictions on telephone company entry into the video business, and the
establishment of a new "open video systems" ("OVS") regulatory structure for
telephone companies and others to offer such services. Under the 1996 Act,
local telephone companies, including both incumbent LECs such as Bell
Atlantic, and CLECs such as RCN, may provide service as traditional cable
television operators subject to municipal cable television franchises, or they
may opt to provide their programming over non-franchised open video systems
subject to certain conditions, including, but not limited to, making available
a portion of their channel capacity for use by unaffiliated program
distributors and satisfying certain other requirements, including providing
capacity for public, educational and government channels, and payment of a
gross receipts fee equivalent to the franchise fee paid by the incumbent cable
television operator. RCN is one of the first CLECs to provide television
programming over an advanced fiber optic network pursuant to the OVS
regulations implemented by the FCC under the 1996 Act. As discussed below, RCN
is currently providing OVS service in the City of Boston and the City of New
York, and has entered into an OVS agreement to allow it to provide OVS
services in a number of communities surrounding Boston. Starpower is
negotiating similar agreements in Washington and surrounding communities.
RCN's voice business is subject to regulation by the FCC at the
federal level with respect to interstate telephone services (i.e., those that
originate in one state and terminate in separate states). State regulatory
commissions have jurisdiction over intrastate communications (i.e., those that
originate and terminate in the same state). See "Business--Regulation--
Regulation of Voice Services." Municipalities also regulate limited aspects of
RCN's voice business by, for example, imposing various zoning requirements and,
in some instances, requiring telecommunications licenses, franchise agreements
and/or installation permits for access to local streets and rights-of-way. In
New York City, for example, RCN will be required to obtain a telephone franchise
in order to provide voice services using its advanced fiber optic network
facilities located in the streets of New York City.
In February 1997, RCN subsidiaries were certified to operate
OVS networks in the five boroughs of New York City and, as part of a joint
venture with Boston Edison, in Boston and 47 surrounding communities.
Initiation of OVS services is subject to negotiation of certain agreements
with local governments. RCN executed an agreement with the City of Boston on
June 2, 1997, and initiated OVS service in the City on that day. Pursuant to
its agreement with the City of Boston, RCN will be required to pay a fee to
the City equal to 5% of video revenues. RCN has entered into similar OVS
agreements or is in the process of negotiating agreements with certain other
Boston-area municipalities, either to offer OVS services or franchised cable
television services. It executed an agreement with the City of New York on
December 29, 1997, and has initiated OVS service in the Borough of Manhattan
pursuant to that agreement.
In areas where it offers video programming services as an OVS
operator, RCN is required to hold a 90-day open enrollment period every three
years, during which times RCN will be required to offer capacity on its
network to other video programming providers ("VPPs"). Under the OVS
regulations, RCN must offer at least two-thirds of its capacity to
unaffiliated parties, if demand for such capacity exists during the open
enrollment period. In certain areas, RCN is in discussions with local
municipal authorities to explore the feasibility of obtaining a cable
franchise in lieu of an OVS agreement, and will consider providing RCN video
service pursuant to franchise agreements rather than OVS certification, if
franchise agreements can be obtained on terms and conditions acceptable to
RCN. RCN will consider the relative benefits of OVS certification versus local
franchise agreements, including the possible imposition of universal service
requirements, before making any such decisions. In addition, the current FCC
rules concerning OVS are subject to appeal in the United States Court of
Appeals for the Fifth Circuit; if certain aspects of the FCC's rules are
overturned on appeal, the determination of whether to operate as an OVS
provider versus as a franchised cable television operator may be affected.
Moreover, the incumbent cable television provider in Boston, Cablevision
Systems, has requested that the FCC permit it to obtain capacity on and
information about RCN's Boston area OVS network, and Time Warner, the
incumbent cable television provider in certain communities in the Boston area,
has made a similar filing at the FCC with respect to its request for capacity
on and information about the Boston OVS network. In a Memorandum Opinion
Order released on April 28, 1998, the FCC's Cable Services Bureau granted in
part and denied in part Time Warner's petition. RCN has notified the FCC that
it will seek review of certain aspects of this order. RCN will continue to
oppose these requests made to the FCC, but to the extent that the FCC were to
grant any such request(s), such a result would likely affect the Company's
determination as to whether to operate as an OVS provider versus as a
franchised cable television operator.
Prior to its certification as an OVS provider, RCN offered
limited video programming services using the video dialtone ("VDT") services
offered by MFS/WorldCom in Manhattan and the City of Boston. In February,
1997, the FCC held that MFS/WorldCom's facilities did not qualify as video
dialtone facilities entitled to an extension of time to comply with the
newly-adopted OVS rules; nonetheless, the FCC did not direct MFS/WorldCom and
RCN to cease video programming distribution operations over the MFS/WorldCom
platform. One of the incumbent cable television companies in New York City has
filed a complaint with the New York Public Service Commission challenging the
former (pre-OVS) operations of RCN and WorldCom under the VDT framework, which
remains pending before that commission.
RCN's 18 GHz wireless video services in New York City are
distributed using microwave facilities provided by Bartholdi Cable Company
("Bartholdi Cable") pursuant to temporary authorizations issued to Bartholdi
Cable by the FCC. Bartholdi Cable has agreed to provide transmission services
to RCN until RCN has either converted the wireless video subscribers to its
advanced fiber optic network facilities or has obtained FCC authority to
provide such services pursuant to its own wireless radio licenses. In
addition, Bartholdi Cable has agreed to transfer to RCN the transmission
equipment on demand. Bartholdi Cable's obligation to provide transmission
services is subject to Bartholdi Cable having licenses from the FCC to provide
such services. The qualifications of Bartholdi Cable to hold certain of the
licenses needed to provide transmission services to RCN are at issue in an FCC
proceeding in which an initial decision (the "Initial Decision") was released
on March 6, 1998. In the Initial Decision, the Administrative Law Judge found
Bartholdi Cable unqualified with respect to 15 such licenses. The
Administrative Law Judge declared that the Initial Decision would become
effective 50 days after its release unless Bartholdi Cable filed exceptions to
the Initial Decision within 30 days of its release or the FCC elected to
review the case on its own motion. Bartholdi Cable filed exceptions to the
Initial Decision on April 7, 1998. Because of the uncertainty as to Bartholdi
Cable's right in the future to offer transmission services to RCN, the Company
filed its own license applications at the FCC for all of the microwave
transmission paths which are currently being used by Bartholdi Cable to
provide transmission services to RCN and, in light of the increased
uncertainties resulting from the Initial Decision in the FCC proceeding
involving certain of Bartholdi Cable's licenses, the Company expects now
actively to pursue its license applications. While the Company expects to
receive authorizations to transmit over these microwave paths, there can be no
assurance that RCN will be able to offer wireless video services pursuant to
its own FCC licenses or that the FCC's investigation will be resolved
favorably. The failure to obtain such license or resolve such proceedings
would materially adversely affect the Company's wireless video operations in
New York City.
There can be no assurance that RCN will be able to obtain or
retain all necessary authorizations needed to construct advanced fiber optic
network facilities in order to convert its wireless video subscribers to an
advanced fiber optic network.
RCN's hybrid fiber/coaxial cable systems are subject to
regulation under the Cable Television Consumer Protection and Competition Act
of 1992, as amended (the "1992 Act"), which provides, among other things, for
rate regulation for cable services in communities that are not subject to
"effective competition." On September 8, 1997, the Company was notified by the
FCC that it has ruled that certain of the Company's upper levels of service
for its New Jersey systems are regulated levels of service and that the
Company's rates for such levels of service have exceeded the allowable rates
under the FCC rate regulation rules which have been effective since September
1993. The Company had treated these levels of service as unregulated. The
Company is contesting this decision. The Company does not believe that the
ultimate resolution of this matter will have a material impact on its results
of operations or financial condition. With the passage of the 1996 Act all
cable systems rates will be deregulated as effective competition is shown to
exist in the franchise area, or by March 31, 1999, whichever date is sooner.
RCN anticipates that the remaining provisions of the 1992 Act that do not
relate to rate regulation, such as the provisions relating to retransmission
consent and customer service standards, will remain in place and may serve to
reduce the future operating margins of RCN's hybrid fiber/coaxial cable
television businesses as video programming competition develops in its cable
television service markets. Federal requirements also impose certain broadcast
signal carriage requirements that allow local commercial television broadcast
stations to require a cable system to carry the station, and that require
cable operators to set aside certain channels for public, educational and
governmental access programming. Because a cable communications system uses
local streets and rights-of-way, such cable systems are generally subject to
state and local regulation, typically imposed through the franchising process.
The terms and conditions of state or local government franchises vary
materially from jurisdiction to jurisdiction and generally contain provisions
governing cable service rates, franchise fees, franchise term, system
construction and maintenance obligations, customer service standards,
franchise renewal, sale or transfer of the franchise, territory of the
franchisee and use and occupancy of public streets and types of cable services
provided.
RCN's ability to provide franchised cable television services
is dependent on its ability to obtain and renew its franchise agreements from
local government authorities on generally acceptable terms. As at the date of
this Prospectus, RCN has 91 franchise agreements relating to the hybrid
fiber/coaxial cable systems' networks in New York (outside New York City), New
Jersey and Pennsylvania. These franchises typically contain many conditions,
such as time limitations on commencement and completion of construction,
conditions of service, including the number of channels, the provision of free
service to schools and certain other public institutions, and the maintenance
of insurance and indemnity bonds. These franchises provide for the payment of
fees to the issuing authorities and generally range from 3% to 5% of revenues.
The duration of these outstanding franchises presently varies up to the year
2011. To date, all of RCN's cable franchises have been renewed or extended,
generally at or prior to their stated expirations and on acceptable terms.
Approximately 39 of RCN's hybrid fiber/coaxial cable system's franchises are
due for renewal within the next three years. No assurances can be given that
RCN will be able to renew its franchises on acceptable terms. No one franchise
accounts for more than 7% of RCN's total revenue. RCN's five largest
franchises account for approximately 27% of RCN's total revenue.
The data services business, including Internet access, is
largely unregulated at this time (apart from Federal, state, and local laws
and regulations applicable to businesses in general). However, there can be no
assurance that this business will not become subject to regulatory restraints.
Some jurisdictions have sought to impose taxes and other burdens on providers
of data services, and to regulate content provided via the Internet and other
information services. RCN expects that proposals of this nature will continue
to be debated in Congress and state legislatures in the future. In addition,
although the FCC has on several occasions rejected proposals to impose
additional costs on providers of Internet access service and other data
services to the extent they use local exchange telephone network facilities for
access to their customers, similar proposals may well be considered by the FCC
or Congress in the future. See "--Potential Liabilities Associated with
Internet Businesses."
The foregoing does not purport to describe all present and
proposed federal, state, and local regulations and legislation affecting the
telephone and video programming industries. Other existing federal
regulations, copyright licensing, and, in many jurisdictions, state and local
franchise requirements, are currently the subject of judicial proceedings,
legislative hearings and administrative proposals which could change, in
varying degrees, the manner in which communications companies operate. The
ultimate outcome of these proceedings, and the ultimate impact of the 1996 Act
or any final regulations adopted pursuant to the new law on RCN or its
businesses cannot be determined at this time. For additional information on
the regulatory environment in which the Company operates, see
"Business--Regulation."
Need to Obtain and Maintain Permits, Building Access Agreements and
Rights-of-Way
In order to develop its networks, the Company must obtain local
franchises and other permits, as well as building access agreements and rights
to utilize underground conduit and pole space and other rights-of-way and
fiber capacity from entities such as incumbent LECs and other utilities,
railroads, long distance companies, state highway authorities, local
governments and transit authorities. There can be no assurance that the
Company will be able to maintain its existing franchises, permits and rights
or to obtain and maintain the other franchises, permits, building access
agreements and rights needed to implement its business plan on acceptable
terms. Although the Company does not believe that any of the existing
arrangements will be canceled or will not be renewed as needed in the near
future, cancellation or non-renewal of certain of such arrangements could
materially adversely affect the Company's business in the affected area. In
addition, the failure to enter into and maintain any such required
arrangements for a particular network, including a network which is already
under development, may affect the Company's ability to acquire or develop that
network.
Ability to Procure Programming Services
The Company's video programming services are dependent upon
management's ability to procure programming that is attractive to its
customers at reasonable commercial rates. The Company is dependent upon third
parties for the development and delivery of programming services. These
programming suppliers charge the Company for the right to distribute the
channels to the Company's customers. The costs to the Company for programming
services is determined through negotiations with these programming suppliers.
Management believes that the availability of sufficient programming on a
timely basis will be important to the Company's future success. There can be
no assurance that the Company will have access to programming services or that
management can secure rights to such programming on commercially acceptable
terms.
Liabilities for Unearned Revenues
Erols offers one-, two- and three-year subscriptions for Internet
access, which generally are paid for in advance. Such subscriptions are subject
to cancellation with a full refund for the first 30 days and to cancellation
with a pro-rated refund thereafter. Such revenues will be recognized over the
term of each such subscription, resulting in material short- and long-term
liabilities for unearned revenues. As of December 31, 1996, Erols had short- and
long-term liabilities for unearned revenues of approximately $12.9 million and
$3.4 million, respectively and, as of December 31, 1997, of approximately $25.6
million and $8.9 million, respectively. Cancellation by a significant number of
the subscribers under such contracts could require cash payment of material
sums.
Variability of Operating Results
As a result of factors such as the significant expenses
associated with the development of its networks and services, the Company
anticipates that its operating results could vary significantly from period to
period.
Risks Relating to Provision of Internet Services
Dependence on the Internet; Uncertain Acceptance of the
Internet as a Medium of Commerce and Communication. The Company's Internet
business will depend in part upon the continuing development and expansion of
the Internet and the market for Internet access. Important issues concerning
business and personal use of the Internet (including security, reliability,
cost, ease of use, access and quality of service) remain unresolved and may
significantly affect the growth of Internet use. Acceptance of the Internet
for commerce and communications generally requires that potential users accept
a new way of conducting business and exchanging information, industry
participants continue to provide new and compelling content and applications,
and the Internet provide a reliable and secure computer platform. A diminution
in the growth of demand for Internet services or an absolute decrease in such
demand could have a material adverse effect on the Company's Internet
business.
Evolving Industry Standards. New industry standards have the
potential to replace or provide lower-cost alternatives to existing services.
The adoption of such new industry standards could render the Company's existing
services obsolete and unmarketable or require reduction in the fees charged
therefor. For example, Erols' services currently rely on the widespread
commercial use of Transmission Control Protocol/Internet Protocol ("TCP/IP").
Alternative open and proprietary protocol standards that compete with TCP/IP,
including proprietary protocols developed by International Business Machines
Corporation ("IBM") and Novell, Inc., have been or are being developed.
ISPs participate in the Internet through contractual "peering
arrangements" with Internet companies. These contractual arrangements are not
subject to regulation and could be subject to revision in terms, conditions or
costs over time.
Constraints on Capacity and Supply of Equipment. The Company's
ability to provide Internet service will depend in part on its ability to
provide sufficient capacity, both at the level of particular point of presence
(each a "POP") (affecting only subscribers attempting to use that POP) and in
connection with system-wide services (such as e-mail and news services, which
can affect all subscribers). In addition, the Company will be dependent in
part on the availability of equipment such as modems, servers and other
equipment. Any shortage of such equipment or capacity of servers could result
in a strain on incoming access lines during peak times, causing busy signals
and/or delays for subscribers.
Reliance on Network Infrastructure; Risk of System Failure;
Security Risks. Internet network infrastructure is vulnerable to computer
viruses and other similar disruptive problems caused by its users, other
Internet users or other third parties. Computer viruses and other problems
could lead to interruptions of, delays in, or cessation of service, by the
Company, as well as corruption of the Company's or its subscribers' computer
systems. In addition, there can be no assurance that subscribers or others
will not assert claims of liability against the Company as a result of events
such as computer viruses, other inappropriate uses or security breaches.
The Company's interconnection agreements with Bell Atlantic and
other incumbent LECs entitle it, among other things, to collect reciprocal
compensation payments from the incumbent LECs for local telephone calls
terminating on the Company's facilities (as well as obligating the Company to
make similar payments for outbound local calls it delivers to the incumbent
LECs). However, Bell Atlantic and other incumbent LECs have challenged the
application of these reciprocal compensation provisions to calls terminating
at ISP points of presence, based on the argument that Internet traffic is
inherently interstate, not local, in nature. To date, 18 state PUCs have
issued final orders on this issue (some of which are subject to court
appeals), and every such order has affirmed (based on prior FCC decisions) that
local calls to ISPs are subject to reciprocal compensation. In the Bell
Atlantic region, the New York, Pennsylvania, Maryland, and Virginia PUCs have
issued such orders, and a similar case is pending in Massachusetts. However,
there can be no assurance that other state PUCs will not issue contrary
rulings, or that the FCC decisions on which the favorable rulings are based
will not be changed as a result of regulatory, legislative, or judicial
action. In addition, there can be no assurance that the current reciprocal
compensation arrangements will be renewed on their existing terms when they
expire (in most cases, in mid-1999).
Proprietary Rights; Risk of Infringement. The Company relies
on a combination of copyright, trademark and trade secret laws and contractual
restrictions to establish and protect its proprietary technology. However,
there can be no assurance that the Company's technology will not be
misappropriated or that equivalent or superior technologies will not be
developed. In addition, there can be no assurance that third parties will not
assert that the Company's services or its users' content infringe their
proprietary rights.
The Company has obtained authorization, typically in the form
of a license, to distribute third-party software incorporated in the Erols
access software product for Windows 3.1, Windows 95, Windows NT and Macintosh
platforms. The Company plans to maintain or negotiate renewals of existing
software licenses and authorizations. The Company may want or need to license
other applications in the future.
State and Local Taxes on Internet Services. The Company is
currently subject to certain state and local taxes on certain of its
telecommunications, data and Internet access services. The Company may become
subject to additional state and local taxes on such services as it continues
to expand and develop more services to customers throughout the United States
and as more state and local taxing authorities become familiar with such
services. Recognizing the problem of discriminatory and multiple state
taxation for telecommunication or Internet services, various federal
legislative proposals are currently pending before Congress that, if enacted,
would limit the ability of the state or local governments to impose, assess,
or attempt to collect any tax on such services. The most recent version of
the Internet Tax Freedom Act proposes to impose a three-year national
moratorium on certain state and local taxation of electronic and Internet
services and trade and to create a federally-led task force to develop
recommendations for a national solution to the problem of discriminatory and
multiple state taxation for on-line services. The National Governors'
Association has proposed that, among other things, a single statewide sales
tax rate be established on all taxable electronic commerce under the Internet
Development Act. The Company believes that either of these proposals, if
enacted, could reduce certain state or local taxes currently imposed on or may
later be imposed on the Company's telecommunications, data and Internet access
services. However, there can be no assurance as to whether or in what form
any legislation will be enacted. In addition, there can be no assurance as to
the extent that any such legislation, if enacted, would relieve the state or
local taxes currently imposed, or would reduce the future state or local taxes
that may be imposed, on the Company's telecommunication, data and Internet
access services.
Potential Liabilities Associated with Internet Businesses
Prior to the enactment of the Communications Decency Act of
1996 (the "CDA"), which is Title V of the 1996 Act, a federal district court
held that an online service provider could be found liable for defamation, on
the ground that the service provider exercised active editorial control over
postings to its service. The CDA contains a provision which, one court has
held, shields ISPs from such liability for material posted to the Internet by
their subscribers or other third parties. Other courts have held that online
service providers and ISPs may, under certain circumstances, be subject to
damages for copying or distributing copyrighted materials.
As enacted, the CDA imposed fines on any entity that (i) by
means of a telecommunications device, knowingly sends indecent or obscene
material to a minor; (ii) by means of an interactive computer service, sends
or displays indecent material to a minor; or (iii) permits any
telecommunications facility under such entity's control to be used for the
foregoing purposes. That provision, as applied to indecent materials, has been
declared unconstitutional by the United States Supreme Court. While the
Clinton Administration has announced that it will not seek passage of similar
legislation to replace this provision, action by Congress in this area remains
possible. At present, the Company intends to exercise editorial control over
Internet postings to the extent of blocking Web sites and Usenet News groups
when the Company becomes aware that such sites or groups offer child
pornography.
As the law in this area develops, the potential that liability
might be imposed on the Company for information carried on and disseminated
through its network could require the Company to implement measures to comply
with applicable law and reduce its exposure to such liability, which could
require the expenditure of substantial resources or the discontinuation or
modification of certain service offerings.
Reliance on Key Personnel
The Company believes that its continued success will depend in
large part on its ability to attract and retain highly skilled and qualified
personnel. The Company believes that the Distribution will, among other
things, permit the Company to offer equity-based compensation that is more
directly linked to the Company's performance, which the Company believes will
facilitate the attraction, retention and motivation of highly skilled and
qualified personnel. In this regard, the Company has implemented an Employee
Stock Ownership Plan ("ESOP") and makes available competitive employee benefit
programs providing benefits substantially comparable to benefits provided
immediately prior to the Distribution. There can be no assurance that the
Company will retain or, as necessary, attract qualified management personnel.
Control by Level 3 Telecom Holdings, Inc.; Conflicts of Interest
Level 3 Telecom Holdings, Inc. ("Level 3 Telecom"), formerly
Kiewit Telecom Holdings, Inc., beneficially owns approximately 46% of the RCN
Common Stock. Consequently, Level 3 Telecom effectively has the power to
elect a majority of the Company's directors and to determine the outcome of
substantially all matters to be decided by a vote of shareholders. The
control of the Company by Level 3 Telecom may tend to deter non-negotiated
tender offers or other efforts to obtain control of the Company and thereby
deprive shareholders of opportunities to sell shares at prices higher than
those prevailing in the market. Moreover, a disposition by Level 3 Telecom of
a significant portion of its RCN Common Stock, or the perception that such a
disposition may occur, could affect the trading price of the RCN Common Stock
and could affect the control of the Company. The common stock of Level 3
Telecom is owned 90% by Level 3 and 10% by David C. McCourt, the Chairman and
Chief Executive Officer of the Company. Mr. McCourt is a member of the Board
of Directors of Level 3.
As a result of the Distribution, there exist relationships that
may lead to conflicts of interest. Level 3 Telecom effectively controls the
Company, Commonwealth Telephone and Cable Michigan. In addition, the majority
of the Company's named executive officers are also directors and/or executive
officers of Commonwealth Telephone or Cable Michigan. See "Management." In
particular, David C. McCourt, Chairman and Chief Executive Officer of the
Company, also serves as a director and Chairman and Chief Executive Officer of
Cable Michigan and as a director and Chairman and Chief Executive Officer of
Commonwealth Telephone. Mr. McCourt expects to devote approximately 70% of his
time to managing the affairs of the Company. In addition, Michael J. Mahoney,
who has been President and Chief Operating Officer, as well as a director, of
the Company since the Distribution, is also a director of Commonwealth
Telephone. Mr. Mahoney expects to devote approximately 85-90% of his time to
managing the affairs of the Company. The Company's other named executive
officers expect to devote the following approximate portions of their time to
managing the affairs of the Company: Mr. Godfrey (80%); Mr. Haverkate (75%)
and Mr. Adams (100%). In addition, Dennis Spina, Director and President of
Internet Services of RCN, is expected to devote approximately 85-90% of his
time to the affairs of RCN. The success of the Company may be affected by the
degree of involvement of its officers and directors in the Company's business
and the abilities of the Company's officers, directors and employees in
managing both the Company and the operations of Cable Michigan and/or
Commonwealth Telephone. Potential conflicts of interest will be dealt with on
a case-by-case basis taking into consideration relevant factors including the
requirements of NASDAQ and prevailing corporate practices.
In connection with the Distribution, Commonwealth Telephone has
agreed to provide or cause to be provided to the Company and to Cable Michigan
certain specified services for a transitional period after the Distribution.
The fees for such services will be an allocated portion (based on relative
usage) of the cost incurred by Commonwealth Telephone to provide such services
to the Company, Cable Michigan and Commonwealth Telephone. See
"Business--Relationship Among Commonwealth Telephone, RCN and Cable Michigan."
The aforementioned arrangements were not the result of arm's length
negotiation between unrelated parties as the Company and Commonwealth
Telephone have certain common officers and directors. Although the
transitional service arrangements in such agreements are designed to reflect
arrangements that would have been agreed upon by parties negotiating at arm's
length, there can be no assurance that the Company would not be able to obtain
better terms from unrelated third parties. Additional or modified agreements,
arrangements and transactions may be entered into between the Company and
either or both of Commonwealth Telephone and Cable Michigan, which will be
negotiated at arm's length.
Absence of Public Market for the Notes
The Notes are new securities for which there currently is no
established trading market. Although the Underwriters have informed the
Company that they currently intend to make a market in the Notes they are not
obligated to do so, and any such market-making may be discontinued at any time
without notice. Accordingly, there can be no assurance as to the development
or liquidity of any market for the Notes The Company does not intend to apply
for listing of the Notes on any securities exchange or for quotation through
the Nasdaq Stock Market.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the Notes and
Common Stock are estimated to be $243 million and $229 million ($265 million
if the overallotment option relating to the Common Stock Offering is
exercised), respectively, after deducting the Underwriters' discounts and
commissions and estimated expenses payable by the Company. The net proceeds
from the sale of the Notes will be used to fund and support the expansion and
interconnection of existing networks and services and the development and
operation of new advanced fiber optic networks. The consummation of the
Common Stock Offering is not a condition to the Offering and there can be no
assurance that the Common Stock Offering will be consummated.
CAPITALIZATION
The following table sets forth the capitalization of the
Company as of March 31, 1998, (i) on an unaudited historical basis and (ii) on
an as adjusted basis, giving effect to the consummation of the Offering and
the Common Stock Offering. The capitalization table below should be read in
conjunction with the historical Consolidated Financial Statements and Notes
thereto included elsewhere in this Prospectus, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Unaudited Pro
Forma Consolidated Statement of Operations." The unaudited pro forma
capitalization presented below is provided for informational purposes only and
should not be construed as indicative of the Company's capitalization or
financial condition had the transactions reflected thereby been consummated on
the date assumed, and may not reflect the capitalization or financial
condition which would have resulted had the Company been operated as a
separate, independent company during such period, and are not necessarily
indicative of the Company's future capitalization or financial condition.
<TABLE>
<CAPTION>
March 31, 1998
-----------------------------------
As Adjusted
for the Offering
and the
Common Stock
Historical Offering
(dollars in thousands)
<S> <C> <C>
Cash, temporary cash investments and short-term investments........... $ 923,000 $ 1,394,664
============ ============
Cash restricted for debt service...................................... $ 63,619 $ 63,619
============ ============
Credit Agreement(1)................................................... $ 103,000 $ 103,000
10% Senior Notes due 2007............................................. 225,000 225,000
11 1/8% Senior Discount Notes due 2007(2).......................... 367,720 367,720
9.80% Senior Discount Notes due 2008(2)............................... 355,752 355,752
10% Senior Discount Notes due 2008.................................... -- 250,000
Capital lease obligations............................................. 1,852 1,852
------------ ------------
Total long-term debt.................................................. 1,053,324 1,303,324
------------ ------------
Shareholders' equity.................................................. 362,283 591,447
------------ ------------
Total capitalization................................................. $ 1,415,607 $ 1,894,771
============ ============
</TABLE>
- ----------
(1) As of July 1, 1997, three of RCN's direct and indirect subsidiaries
entered into a credit agreement providing for an aggregate of $125,000 in
availability, comprised of a $25,000 revolving credit facility and a
$100,000 eight year term credit facility. As of March 31, 1998, $3,000 had
been borrowed thereunder. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(2) These notes were originally recorded at their initial issue price and the
amount reported represents such original issue price plus a ratable portion
of the accrual of the original issue discount.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
Prior to September 30, 1997, the Company was operated as part
of C-TEC. The following Unaudited Pro Forma Consolidated Statements of
Operations set forth the historical statements of operations of the Company
for the year ended December 31, 1997 and the three months ended March 31, 1998
and as adjusted for the Distribution, the acquisition of the 19.9% minority
interest in Freedom, the 1997 Notes Offering, the Erols Acquisition, the 1998
Notes Offering, the Offering and the Common Stock Offering and the related
transactions and events described in the notes thereto, as if such
transactions and events had been consummated on the first day of each
respective period.
Management believes that the assumptions used provide a
reasonable basis on which to present such Unaudited Pro Forma Statements of
Operations. The Unaudited Pro Forma Statements of Operations should be read in
conjunction with the historical Financial Statements and notes thereto included
elsewhere in this Prospectus and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The Unaudited Pro Forma
Statements of Operations are provided for information purposes only and should
not be construed to be indicative of the Company's results of operations had the
Distribution and the transactions and events described above been consummated on
the dates assumed, may not reflect the results of operations or financial
condition which would have resulted had the Company been operated as a separate,
independent company during such period, and are not necessarily indicative of
the Company's future results of operations or financial condition.
RCN CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
Year ended December 31, 1997
($ in thousands, except per share amounts and number of shares)
<TABLE>
<CAPTION>
Adjustments
for Issuance
Adjustments Liberty/Freedom of the 1997
RCN for Acquisition and 1998
Historical Distribution Adjustments Notes
------------ ---------------- ----------------- --------------
<S> <C> <C> <C> <C>
Sales ............................... $ 127,297 -- -- --
Cost and expenses, excluding
depreciation and amortization ..... 134,967 -- -- --
Nonrecurring charges ................ 10,000 -- -- --
Depreciation and amortization ....... 53,205 -- $1,250 (1) --
------------ ------------ ------------ ------------
Operating (loss) income ............. (70,875) -- (1,250) --
Interest income ..................... 22,824 $ (8,686)(2) -- --
Interest expense .................... (25,602) (5,654)(3) -- $ (85,179)(4)
-- 10,460 (5) -- --
Other (expense) income, net ......... 131 -- -- --
------------ ------------ ------------ ------------
(Loss) income before income taxes ... (73,522) (3,880) (1,250) (85,179)
(Benefit) for income taxes .......... (20,849) (1,358)(6) (437)(7) (29,812)(4)
------------ ------------ ------------ ------------
(Loss) income before equity in
unconsolidated entities and
minority interest ................. (52,673) (2,522) (813) (55,367)
Equity in (loss) of unconsolidated
entities .......................... (3,804) -- -- --
------------ ------------ ------------ ------------
(Loss) income before extraordinary
charge and minority interest in
loss of consolidated entities ..... $ (56,477) $ (2,522) (813) $ (55,367)
============ ============ ============ ============
Unaudited pro forma (loss) before
extraordinary charge and minority
interest per common share ......... $ (1.03) -- -- --
Weighted average number of common
shares and common stock equivalents
outstanding ....................... 54,965,716 -- -- --
Adjustments
for the
Offering and
Acquisition the Common
Erols Adjustments Stock
Historical(8) for Erols Offering Pro Forma
------------- ---------------- ------------------ ------------
<S> <C> <C> <C> <C>
Sales ............................... $ 36,528 $ (22,552)(9) -- $ 141,273
Cost and expenses, excluding
depreciation and amortization ..... 49,829 (30,764)(9) -- 154,032
Nonrecurring charges ................ -- -- -- 10,000
Depreciation and amortization ....... 6,360 606 (10) -- 61,421
------------ ------------ ------------ ------------
Operating (loss) income ............. (19,661) 7,606 -- (84,180)
Interest income ..................... -- -- -- 14,138
Interest expense .................... (162) 100 $ (25,750)(14) (131,787)
-- -- -- --
Other (expense) income, net ......... (49) -- -- 82
------------ ------------ ------------ ------------
(Loss) income before income taxes ... (19,872) 7,706 (25,750) (201,747)
(Benefit) for income taxes .......... -- (9,338)(11) -- (61,794)
------------ ------------ ------------ ------------
(Loss) income before equity in
unconsolidated entities and
minority interest ................. (19,872) 17,044 (25,750) (139,953)
Equity in (loss) of unconsolidated
entities .......................... -- (13,420)(9) -- (17,224)
------------ ------------ ------------ ------------
(Loss) income before extraordinary
charge and minority interest in
loss of consolidated entities ..... $ (19,872) $ 3,624 $ (25,750) $ (157,177)
============ ============ ============ ============
Unaudited pro forma (loss) before
extraordinary charge and minority
interest per common share ......... -- -- -- $ (2.34)
Weighted average number of common
shares and common stock equivalents
outstanding ....................... -- 1,730,648 (12) 10,583,032 (13) 67,279,396
</TABLE>
See Notes to Unaudited Pro Forma Statement of Operations
RCN CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
Three months ended March 31, 1998
($ in thousands, except per share amounts and number of shares)
<TABLE>
<CAPTION>
Adjustments Erols
for Issuance Historical
RCN of the 1997 1/1/98-
Historical and 1998 Notes 2/28/98(8)
---------- -------------- ----------
<S> <C> <C> <C>
Sales ...................................... $ 40,138 -- $ 8,700
Cost and expenses, excluding
depreciation and amortization ............ 48,455 -- 8,388
Nonrecurring acquisition costs:
In-process technology .................... 44,700 -- --
Depreciation and amortization .............. 17,691 -- 1,478
------------ ------------ ------------
Operating (loss) income .................... (70,708) -- (1,166)
Interest income ............................ 12,815 -- --
Interest expense ........................... (22,735) $ (3,492)(4) (164)
Other (expense), net........................ (899) -- (5)
------------ ------------ ------------
(Loss) income before income taxes .......... (81,527) (3,492) (1,335)
(Benefit) for income taxes.................. (11,682) (1,222)(4) --
------------ ------------ ------------
(Loss) income before equity in
unconsolidated entities and
minority interest ........................ (69,845) (2,270) (1,335)
Equity in (loss) of unconsolidated entities. (1,493) -- --
------------ ------------ ------------
(Loss) before extraordinary charge and
minority interest in loss of consolidated
entities ................................. $ (71,338) $ (2,270) $ (1,335)
============ ============ ============
Unaudited pro forma (loss) before
extraordinary charge and minority
interest per common share ................ $ (1.27) -- --
Weighted average number of common
shares and common stock equivalents
outstanding .............................. 56,216,310 -- --
Adjustments
for the
Offering and
Acquisition the Common
Adjustments Stock
for Erols Offering Pro Forma
--------- -------- ---------
<S> <C> <C> <C>
Sales ...................................... $ (5,371)(9) -- $ 43,467
Cost and expenses, excluding
depreciation and amortization ............ (5,179)(9) -- 51,664
Nonrecurring acquisition costs:
In-process technology .................... -- -- 44,700
Depreciation and amortization .............. (340)(10) -- 18,829
------------ ------------ ------------
Operating (loss) income .................... 148 -- (71,726)
Interest income ............................ -- -- 12,815
Interest expense ........................... 101 $ (6,438)(14) (32,728)
Other (expense), net........................ -- -- (904)
------------ ------------ ------------
(Loss) income before income taxes .......... 249 (6,438) (92,543)
(Benefit) for income taxes.................. (998)(11) (2,253)(14) (16,155)
------------ ------------ ------------
(Loss) income before equity in
unconsolidated entities and
minority interest ........................ 1,247 (4,185) (76,388)
Equity in (loss) of unconsolidated entities. (1,702)(9) -- (3,195)
------------ ------------ ------------
(Loss) before extraordinary charge and
minority interest in loss of consolidated
entities ................................. $ (455) $ (4,185) $ (79,583)
============ ============ ============
Unaudited pro forma (loss) before
extraordinary charge and minority
interest per common share ................ -- -- $ (1.19)
Weighted average number of common
shares and common stock equivalents
outstanding .............................. -- 10,583,032 66,799,342
</TABLE>
See Notes to Unaudited Pro Forma Statement of Operations
RCN CORPORATION
NOTES TO UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
(dollars in thousands)
The Unaudited Pro Forma Consolidated Statement of Operations assumes that the
Company was an autonomous entity rather than a wholly owned subsidiary of
C-TEC for the periods shown. The Pro Forma adjustments, as described below,
are keyed to the corresponding amounts shown in the relevant statement. All
share and per share data of RCN Common Stock have been restated to reflect the
Stock Dividend.
(1) Adjustment to reflect the additional depreciation and
amortization of $1,250 in 1997 resulting from the acquisition of the minority
interest of Freedom in March 1997 and to present the information as if the
acquisition of the minority interest of Freedom had occurred at the beginning
of 1997. See Note 4 to the Consolidated Financial Statements in the Company's
Form 10-K for the year ended December 31, 1997.
(2) Adjustment to eliminate interest income of $8,686 for the
year ended December 31, 1997, net of income taxes of $(3,040) on outstanding
intercompany notes payable owed to the Company of which $110,000 was repaid and
the remaining balance was treated as capital contributions from the Company to
the borrower.
(3) Adjustment to reflect interest expense and amortization of
debt issuance costs of $5,654 for the year ended December 31, 1997, net of
income taxes of $(1,979) on new third party debt of $110,000 which was
incurred.
(4) Adjustment to reflect interest expense and amortization of
debt issuance costs related to the issuance of the 1997 and 1998 Notes
aggregating $3,492 and $85,179 for the three months ended March 31, 1998 and
for the year ended December 31, 1997, respectively, net of income taxes of
$1,222 and $29,812 for the three months ended March 31, 1998 and for the year
ended December 31, 1997, respectively. Interest expense on the 1997 Notes is
already included in the Company's historical results for the entire three
months ended March 31, 1998, therefore the pro forma adjustment is
correspondingly lower than the ratable portion of the adjustment for the year
ended December 31, 1997.
(5) Adjustment to eliminate interest expense and amortization of
debt issuance costs of $10,460 for the year ended December 31, 1997 and
related income taxes of $3,661 on existing outstanding third party debt that
was repaid and on outstanding intercompany notes payable owned by the Company
which were treated as capital contributions to the Company from the borrower.
(6) Income tax effects for the distribution adjustments are
summarized as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
1997
------------
Benefit
(provision)
<S> <C>
Elimination of interest expense and amortization of debt issuance costs on existing outstanding third
party debt (see Note 5).................................................................................... $ 3,661
Incurrence of interest expense and amortization of debt issuance costs on new third party debt (see
Note 3).................................................................................................... (1,979)
Elimination of interest income on outstanding intercompany notes (see Note 2)............................... (3,040)
-----------
Total...................................................................................................... $ (1,358)
===========
</TABLE>
(7) Adjustments to income taxes of $(437) relating to additional
depreciation and amortization in 1997 due to the acquisition of a 19.9%
minority interest in Freedom in March 1997 (see Note 1).
(8) On February 20, 1998, the Company completed the acquisition
of Erols, Washington, D.C.'s largest Internet service provider, for $29,200 in
cash, 1,730,648 newly issued shares of RCN Common Stock plus the assumption and
repayment of $5,800 of debt (including payment of accrued interest).
Additionally, the Company is converting approximately 999,000 stock options
for Erols common stock into options to purchase 699,104 shares of RCN Common
Stock at an average exercise price of $3.424 per share. The Company accounted
for this transaction under the purchase method of accounting and accordingly,
the financial statements of Erols are not consolidated with the Company's
historical financial statements as of and for the year ended December 31,
1997. In 1998, the financial results of Erols also are not consolidated with
the Company's historical financial statements for the period prior to February
20, 1998. The financial information of Erols was provided by Erols.
(9) Such adjustments include a pro forma allocation of
historical operating results of Erols to the joint venture with PEPCO (see
below) based upon the relationship of the number of subscribers expected to be
contributed to the joint venture to the total number of subscribers acquired
in the merger. The Company's share of such operating results, including the
depreciation and amortization effects of the allocation of a portion of the
total purchase price to the joint venture, representing the assumed value of
the subscribers to be contributed to the joint venture, are included in the
adjustment for "equity in the loss of unconsolidated entities."
A subsidiary of the Company is a party to a joint venture with
a subsidiary of PEPCO, to provide the greater Washington, D.C. area residents
and businesses local and long-distance telephone, cable television, and
Internet services as a package from a single source. As a result of this
joint venture, the Company expects to contribute to the joint venture the
subscribers acquired in the merger with Erols which are located in the
relevant joint venture market. The joint venture partners of Starpower are
currently negotiating the terms of such contribution. The value of such
contribution for accounting purposes is estimated to be approximately $51,937.
The joint venture is accounted for under the equity method of accounting.
Additionally, the Company expects that Starpower will assume the liability for
the unearned revenue related to the subscribers contributed to Starpower.
(10) Such adjustment reflects the change in depreciation and
amortization for the effect of the fair value adjustment of the net assets of
Erols acquired. Amortization of such excess over a five year period has been
assumed, although a shorter life may result based on the study discussed
below. Also, as discussed below, at least $31,600 is expected to be allocated
to certain in-process technology projects which has resulted in a ratable
reduction of pro forma amortization expense. The Company allocated the
purchase price for Erols (see Note 8) on the basis of the fair market value of
the assets acquired and liabilities assumed. The Company has undertaken a
study to determine such fair market values, including in-process technology.
Such fair market values may differ from the allocations assumed in the pro
forma financial statements. The impact on deferred tax balances was included
in the above-referenced fair value adjustments. Erols' historical property,
plant and equipment has been adjusted to its estimated fair value based upon
its depreciated cost. The remaining excess of consideration over the
historical book value of Erols net assets acquired has been preliminarily
allocated to subscriber base, goodwill and other intangible assets. The
amounts preliminarily allocated to subscriber base, goodwill and other
intangible assets have been ratably reduced by the portion of the purchase
price preliminarily allocated to in-process technology of $31,600, which was
recognized as a charge for the quarter ended March 31, 1998. The final
allocation to in-process technology may differ from the preliminary estimate.
(11) Adjustment to reflect the tax effect of the pro forma
adjustments, including the tax effect of the historical results of operations
of Erols.
(12) Represents adjustment for shares to be issued in connection
with the acquisition of Erols. (See Note 8.)
(13) Represents adjustment for 10,583,032 additional shares from
the issuance of the Common Stock based upon assumed gross proceeds of $240,764
and using the closing price of the Company's Common Stock on May 19, 1998.
(14) Adjustment to reflect interest expense and amortization of
debt issuance costs related to the issuance of the Notes aggregating $6,438
and $25,750 for the three months ended March 31, 1998 and for the year ended
December 31, 1997, respectively, and related income taxes of ($2,253) for the
three months ended March 31, 1998. No tax benefit was assumed for the year
ended December 31, 1997 since such benefit would result in a material pro
forma net deferred tax asset, the realization of which would be uncertain.
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The table below sets forth selected historical consolidated
financial data for the Company. Prior to September 30, 1997, the Company and
the RCN Businesses were operated as part of C-TEC. The historical consolidated
financial data presented below reflect periods during which the Company did
not operate as an independent company and, accordingly, certain assumptions
reflect the results of operations or the financial condition which would have
resulted if the Company had operated as a separate, independent company during
such periods, and are not necessarily indicative of the Company's future
results of operation or financial condition.
The selected historical consolidated financial data for the
year ended December 31, 1994 and 1993 and as of December 31, 1995, 1994 and
1993 are derived from the Company's unaudited historical consolidated financial
statements not included in this Prospectus. The selected historical
consolidated financial data of the Company for the years ended December 31,
1997, 1996 and 1995 and as of December 31, 1997 and 1996 are derived from and
should be read in conjunction with the Company's audited historical
consolidated financial statements included elsewhere in this Prospectus. The
selected historical consolidated financial data for the three month periods
ended March 31, 1997 and 1998 and as of March 31, 1998 and 1997 are derived
from and should be read in conjunction with the Company's unaudited historical
consolidated financial statements included elsewhere in this Prospectus. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements.
<TABLE>
<CAPTION>
Three Months ended
Year Ended December 31, March 31,
--------------------------------------------------------- -----------------------
1993 1994 1995 1996 1997 1997 1998
---- ---- ---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Sales................................ $49,504 $59,500 $91,997 $104,910 $127,297 $29,677 $40,138
Costs and expenses, excluding
depreciation and amortization...... 30,821 49,747 75,003 79,107 134,967 25,524 48,455
-------- -------- -------- -------- ---------- -------- ----------
EBITDA before nonrecurring
charges (1)........................ 18,683 9,753 16,994 25,803 (7,670) 4,153 (8,317)
Nonrecurring charges(2).............. -- -- -- -- 10,000 10,000 44,700
Depreciation and amortization........ 9,922 9,803 22,336 38,881 53,205 12,191 17,691
-------- -------- -------- -------- ---------- -------- ----------
Operating (loss) income.............. 8,761 (50) (5,342) (13,078) (70,875) (18,038) (70,708)
Interest income...................... 17,882 21,547 29,001 25,602 22,824 5,153 12,815
Interest expense..................... (17,127) (16,669) (16,517) (16,046) (25,602) (3,431) (22,735)
Other (expense) income, net.......... 1,195 1,343 (304) (546) 131 (33) (899)
(Benefit) provision for income taxes. 167 2,340 1,119 979 (20,849) (4,800) (11,682)
Equity in loss of unconsolidated
entities........................... -- -- (3,461) (2,282) (3,804) (805) (1,493)
Minority interest in loss (income)
of consolidated entities........... (85) (95) (144) 1,340 7,296 910 3,586
Extraordinary charge--debt
prepayment penalty, net of tax
of $1,728.......................... -- -- -- -- (3,210) -- --
Cumulative effect of changes in
accounting principles................ 1,628 (83) -- -- -- -- --
-------- -------- -------- -------- ---------- -------- ----------
Net (loss) income.................... $12,087 $3,653 $2,114 $(5,989) $(52,391) $(11,444) $(67,752)
======== ======== ======== ======== ========== ======== ==========
Ratio of earnings to fixed
charges(3)......................... 10.11x 1.36x 1.41x 0.75x -- N/A --
Balance Sheet Data (at end of period):
Total assets......................... $291,634 $568,586 $649,610 $628,085 $1,150,992 $592,697 $1,578,232
Long-term debt (including
current portion)................... 181,500 154,000 161,000 131,250 686,103 131,250 1,053,324
Shareholders' equity................. 74,329 372,847 394,069 390,765 356,584 362,449 362,283
</TABLE>
(1) EBITDA represents earnings before interest, depreciation and amortization,
and income taxes. 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.
(2) Nonrecurring charges in 1997 represent costs of $10,000 incurred with
respect to the termination of a marketing services agreement related to the
Company's wireless video services, and in 1998 represent nonrecurring costs
of $44,700 of acquisition of in-process technology relating to the
acquisitions of UltraNet and Erols.
(3) The deficiency of earnings to fixed charges is based on income from
continuing operations and has been computed on a total enterprise basis.
Earnings represent income before income taxes, and fixed charges. Fixed
charges consist of interest expense and debt amortization costs. The
Company's earnings were insufficient to cover fixed charges by $73.5
million for the year ended December 31, 1998 and by $81.5 million for the
three months ended March 31, 1998.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Prospectus are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and are thus prospective. Such forward-looking
statements include, in particular, statements made as to plans to develop
networks and upgrade facilities, the market opportunity presented by markets
targeted by the Company, the Company's intention to connect certain wireless
video, resale telephone and Internet service customers to its advanced fiber
optic networks, the development of the Company's businesses, the markets for
the Company's services and products, the Company's anticipated capital
expenditures, the Company's anticipated sources of capital and effects of
regulatory reform and competitive and technological developments. No
assurance can be given that the future results covered by the forward-looking
statements will be achieved. Such statements are subject to risks,
uncertainties and other factors which could cause actual results to differ
materially from future results expressed or implied by such forward-looking
statements.
The following discussion should be read in conjunction with the
Company's historical Consolidated Financial Statements and Notes thereto:
General
The Company is developing networks that are capable of
providing a full range of high speed, high capacity telecommunications
services, including voice, video programming and data services including high
speed Internet access. The Company intends to provide these services
individually or in bundled service packages primarily to residential customers
in high density areas and also seeks to serve certain commercial accounts on
or near its networks. In 1997, the Company commenced providing service
through advanced fiber optic network facilities in New York City and Boston,
and the Company is developing an advanced fiber network in Washington, D.C.
The Company also has hybrid fiber/coaxial cable television operations in New
York (outside New York City), New Jersey and Pennsylvania, wireless video
operations in New York City, and certain other operations, including Internet
as well as local and long distance telephone.
The negative operating cash flow from the Company's advanced
fiber optic network business has resulted primarily from expenditures
associated with the development of the Company's operational infrastructure
and marketing expenses. The Company expects it will continue to experience
negative operating cash flow while it continues to invest in its networks and
until such time as revenue growth is sufficient to fund operating expenses.
The Company expects to achieve positive operating margins over time by (i)
increasing the number of customers it serves, (ii) increasing the number of
connections per customer by cross marketing its services and promoting bundled
service options and therefore increasing the revenue per customer, (iii)
lowering the costs associated with new subscriber additions and (iv) reducing
the cost of providing services by capturing economies of scale. The Company
expects its operating revenues will increase in 1998 through internal growth
of its current advanced fiber optic networks; however, the Company also
expects negative operating cash flow will increase for some period of time as
the Company initiates network development in Washington, D.C. and expands its
current networks. When the Company makes its initial investment in a new
market, the operating losses typically increase as the network and sales force
are expanded to facilitate growth. The Company's ability to generate positive
cash flow in the future will depend on the extent of capital expenditures in
current and additional markets, the ability of the joint ventures to generate
revenues and cash flow, competition in the Company's markets and any potential
adverse regulatory developments. The Company will be dependent on various
financing sources to fund its growth as well as continued losses from
operations. There can be no assurance that such funding will be available, or
available on terms acceptable to the Company. See "Liquidity and Capital
Resources."
The terms of the Company's joint ventures require the mutual
consent of the Company and its joint venture partner to distribute or advance
funds to the Company. The Company's debt agreements allow subsidiaries and
joint ventures to incur indebtedness for network buildout costs, which
indebtedness may contain limitations on the subsidiaries' and the joint
venture's ability to pay dividends and distributions to the Company. Although
the joint ventures have not had a significant impact on the Company's cash
flows in the periods presented, cash flows available to the Company in future
periods will be affected by the extent to which operations are conducted
through joint ventures. Due to the degree of control that the Company has in
the joint ventures, RCN accounts for the BECO joint venture on a consolidated
basis and Starpower under the equity method of accounting.
RCN Corporation is a holding company with limited assets that
conducts substantially all of its operations through subsidiaries and joint
ventures. Accordingly, RCN will be dependent on dividends and other
distributions from its subsidiaries and joint ventures to generate the funds
necessary to meet its obligations, including the payment of principal and
interest on the 1997 Notes and the 1998 Notes. The ability of RCN
Corporations's subsidiaries and joint ventures to pay dividends to RCN will be
subject to, among other things, the terms of any debt instruments and
applicable law. In addition, the terms of the Company's joint ventures
require the mutual consent of the Company and its joint venture partner to
distribute or advance funds to the Company. The Indentures allow subsidiaries
and joint ventures to incur indebtedness for network buildout costs, which
indebtedness may contain limitations on the subsidiaries' and joint ventures'
ability to pay dividends and distributions to RCN Corporation.
Prior to September 30, 1997, the Company was operated as part
of C-TEC. On September 30, 1997, C-TEC distributed 100% of the outstanding
shares of common stock of its wholly owned subsidiaries, RCN and Cable
Michigan, to holders of record of C-TEC's Common Stock and C-TEC's Class B
Common Stock as of the close of business on September 19, 1997 in accordance
with the terms of a Distribution Agreement dated September 5, 1997 among
C-TEC, RCN and Cable Michigan (the "Distribution Agreement"). RCN consists
primarily of C-TEC's bundled residential voice, video and Internet access
operations in the Boston to Washington, D.C. corridor, its existing New York,
New Jersey and Pennsylvania cable television operations, a portion of its long
distance operations and its international investment in Megacable.
Commonwealth Telephone, RCN and Cable Michigan have entered into certain
agreements providing for the Distribution, and governing various ongoing
relationships between the three companies, including a distribution agreement
and a tax-sharing agreement. The historical financial information presented
herein reflects periods during which the Company did not operate as an
independent company and accordingly, certain assumptions were made in
preparing such financial information. Such information, therefore, may not
necessarily reflect the results of operations or the financial condition of
the Company which would have resulted had the Company been an independent,
public company during the reporting periods, and are not necessarily
indicative of the Company's future operating results or financial condition.
Certain of the Company's businesses were acquired by C-TEC and
transferred to the Company in connection with the Distribution. On August 30,
1996, a subsidiary of C-TEC acquired an 80.1% interest in Freedom and all
related rights and liabilities from Level 3 Telecom. Freedom held the
wireless cable television business of Liberty Cable Television, Inc. ("Liberty
Cable"). The Company acquired the remaining minority interest in Freedom in
March 1997. The acquisition was accounted for as a purchase and is reflected
in the Company's consolidated financial statements since September 1996. On
May 15, 1995, C-TEC Cable Systems, Inc., a wholly owned subsidiary of C-TEC
("RCN Cable"), acquired 40% of the outstanding common stock of Twin County.
The remaining shares were subject to an escrow agreement, pending completion
of the merger, and were required to be voted under the direction of the
Company. As of May 15, 1995, the Company also assumed management of Twin
County. As a result, the Company had control of Twin County and accordingly
has fully consolidated Twin County in the Company's financial statements since
May 1995, the date of the original acquisition. The remaining outstanding
common stock of Twin County was acquired in September 1995. Goodwill relating
to this acquisition is being amortized over a period of approximately 10
years. In January 1995, RCN International Holdings, Inc. (formerly C-TEC
International, Inc.), a wholly owned subsidiary of C-TEC, purchased a 40%
equity position in Megacable, the second largest cable television provider in
Mexico. The Company accounts for its investment by the equity method of
accounting and is amortizing the original excess cost over the underlying
equity in the net assets on a straight-line basis over 15 years.
During the first quarter of 1998, the majority of the Company's advanced
fiber construction activity was concentrated in Somerville, MA, and, to a
lesser extent, New York City. The majority of such construction was scheduled
to be performed by crews of Boston Edison, the Company's joint venture partner
in the Boston market. During the first quarter of 1998, severe ice storms in
nearby territories diverted the crews of utilities such as Boston Edison as
well as most independent contractors in and around those territories from
approximately mid-January until mid-February in order to provide emergency
services for power restoration. The Company is not able to quantify the
effect, if any, that this construction delay will have on its connections and
corresponding results of operations for the immediately succeeding quarterly
periods. The Company's construction activities have expanded to multiple
markets and multiple towns within those markets, and as such, the Company is
less susceptible to delays in executing its operating plan resulting from
weather, political or other external influences; however, there can be no
assurance that such delays will not occur.
Supplemental Unaudited Financial Data
RCN conducts portions of its business through joint ventures,
including its joint venture with BECO (which is consolidated in RCN's
historical results of operations) and Starpower (which is accounted for under
the equity method in RCN's historical results of operations). The
supplemental unaudited financial information set forth below presents RCN's
results of operations as if all domestic joint ventures were fully
consolidated (hereinafter referred to as "Pro Forma Total RCN"), and shows the
ownership share of its domestic joint venture partners as minority interests.
The Company believes that this supplemental unaudited financial data provides
useful disclosure in analyzing its business.
<TABLE>
Pro Forma Total RCN
Year Ended Pro Forma Total RCN
December 31, Quarter Ended March 31,
------------------------------------------- ----------------------------
1995 1996 1997 1997 1998
<S> <C> <C> <C> <C> <C>
Sales:
Voice....................................... $237 $830 $4,007 431 3,515
Video....................................... 65,699 87,470 103,371 24,596 26,707
Data........................................ -- 4 41 4 5,732
Commercial and other........................ 26,061 16,606 19,878 4,646 7,065
------- ------- -------- -------- --------
Total sales.................................. 91,997 104,910 127,297 29,677 43,019
Costs and expenses, excluding depreciation
and amortization:
Direct expenses............................. 39,604 35,226 51,757 11,287 18,837
Operating, selling, general and
administrative.......................... 35,399 43,881 83,422 14,237 33,815
------- ------- -------- -------- --------
EBITDA before nonrecurring charges........... 16,994 25,803 (7,882) 4,153 (9,633)
Depreciation and amortization................ 22,336 38,881 53,205 12,191 17,691
Nonrecurring charges......................... -- -- 10,000 10,000 44,700
------- ------- -------- -------- --------
Operating (loss)............................. (5,342) (13,078) (71,087) (18,038) (72,024)
Interest income.............................. 29,001 25,602 22,824 5,153 13,046
Interest expense............................. (16,517) (16,046) (25,602) (3,431) (22,735)
Other income(expense), net................... (304) (546) 131 (33) (1,381)
------- ------- -------- -------- --------
(Loss) income before income taxes............ 6,838 (4,068) (73,734) (16,349) (83,094)
(Benefit) provision for income taxes......... 1,119 979 (20,849) (4,800) (11,682)
------- ------- -------- -------- --------
(Loss) income before equity in
unconsolidated entities, minority interest
and extraordinary item...................... 5,719 (5,047) (52,885) (11,549) (71,412)
Equity in loss of unconsolidated entities.... (3,461) (2,282) (3,698) (805) (709)
Minority interest in loss (income) of
consolidated entities....................... (144) 1,340 7,402 910 4,369
------- ------- -------- -------- --------
(Loss) income before extraordinary item...... 2,114 (5,989) (49,181) $(11,444) $(67,752)
Extraordinary charge -- debt prepayment
penalty..................................... -- -- (3,210) -- --
------- ------- -------- -------- --------
Net (loss) income............................ $2,114 $(5,989) $(52,391) $(11,444) $(67,752)
======= ======= ======== ======== ========
</TABLE>
Pro Forma Total RCN
At March 31,
-------------------------
1997 1998
--------- ------------
Balance sheet data:
Cash, temporary cash investments and short-
term investments............................ $ 53,137 $ 942,304
Property, plant and equipment................ $227,635 $ 373,587
Accumulated depreciation..................... $ 89,948 $ 119,040
Net property, plant and equipment............ $137,687 $ 254,547
Long-term debt............................... $131,250 $1,054,418
Results of Operations
The Company has elected to adopt Statement of Financial
Accounting Standards No. 131 - "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS 131") in the first quarter of 1998. 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
to the single source network, including customers which were served by the
Company's previously separate lines of business, for which profitability was
separately measurable and monitored. 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; because
management believes that any allocation of the expenses incurred on a single
network to multiple revenue streams would be impractical and arbitrary,
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 Prospectus.
The Company manages operations and evaluates operating
financial performance on a pro forma total RCN basis (shown in the table
captioned "Supplemental Unaudited Financial Data" above), which reflects the
consolidation of all domestic joint ventures, including those not consolidated
under generally accepted accounting principles. The same net loss results on
both a historical and pro forma total RCN basis since the outside ownership of
the joint venture, which is consolidated only in the pro forma total RCN
information, is reflected as minority interest in the pro forma total RCN
information. The discussion which follows addresses results on a pro forma
total RCN basis.
Pro Forma Total RCN Three Months ended March 31, 1998 Compared
to Three Months ended March 31, 1997
On a historical basis for the three months ended March 31, 1998
EBITDA before nonrecurring charge and in-process technology was $(8,317) as
compared to $4,153 for the same period in 1997. Sales increased 35.3% to $40,138
for the quarter ended March 31, 1998 from $29,677 for the same period in 1997.
Sales. Video sales are comprised primarily of subscription fees
for basic, premium and pay-per-view cable television services; for both wireless
and hybrid fiber/coaxial cable customers in New York, New Jersey and
Pennsylvania which the Company expects to migrate to its advanced fiber networks
over time. Voice sales include local telephone service fees consisting
primarily of monthly line charges, local toll and special features and long
distance telephone service fees, based on minutes of traffic and tariffed rates
or contracted fees. Voice sales include both resold services and traffic over
the Company's own switches. Data sales represent Internet access fees billed at
contracted rates.
Total sales increased $13,342, or 45% to $43,019 for the quarter
ended March 31, 1998 from $29,677 for the quarter ended March 31, 1997. The
increase was fueled by higher total service connections which increased 191.3%
to approximately 660,000 at March 31, 1998 from approximately 226,000 at March
31, 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 and UltraNet, which provided approximately 370,000 data
connections. Advanced fiber units passed increased 698.3% to approximately
63,000 units at March 31, 1998 from approximately 8,000 units at March 31, 1997.
Voice revenues increased $3,084 to $3,515 for the quarter ended
March 31, 1998 from $431 for the quarter ended March 31, 1997 primarily, due
to an increase in off-net connections. Off-net connections were 40,447 and
2,315 at March 31, 1998 and 1997, respectively.
Video revenue increased $2,111 or 8.6% to $26,707 for the
quarter ended March 31, 1998 from $24,596 for the quarter ended March 31,
1997. The increase is primarily due to increases of approximately 5,800
average hybrid/fiber coaxial cable connections and approximately 15,600
advanced fiber video connections.
Data revenues increased $5,728 to $5,732 for the quarter ended
March 31, 1998 from $4 for the quarter ended March 31, 1997 primarily due to
the acquisitions of Erols and UltraNet on February 20, 1998 and February 27,
1998 respectively. At March 31, 1998, with the acquisitions of Erols and
UltraNet, the Company had 370,271 off-net data connections.
Commercial and other revenues increased $2,419, or 52.1% to
$7,065 for the quarter ended March 31, 1998 from $4,646 for the quarter ended
March 31, 1997. Commercial long distance revenues increased to approximately
$5,500 for the three months ended March 31, 1998 from $4,646 for the same
period in 1997. The increase primarily results from terminating access
provided to Commonwealth Telecom Services, Inc. ("CTSI"), a subsidiary of
Commonwealth Telephone. CTSI is a CLEC which operates in areas adjacent to
the traditional service area of Commonwealth Telephone Company (also a wholly
owed subsidiary of Commonwealth Telephone). Additionally, commercial and
other revenues increased approximately $1,300 primarily due to an increase in
commercial local main access lines of approximately 8,600 over the same period
in 1997.
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, general and administrative expenses.
Direct expenses include direct costs of providing services,
primarily video programming and franchise costs, network access fees, and
video transmission licensing fees. Direct expenses increased $7,550, or 66.9%
to $18,837 for the quarter ended March 31, 1998 from $11,287 for the quarter
ended March 31, 1997. The increase was the result of both higher sales and a
change in the overall revenue mix to a higher volume of resold voice, which
has a lower margin than the Company's other products. The resold voice
increase represents planned marketing in areas ahead of construction of the
advanced fiber network to build a customer base which is intended to be
migrated to the advanced fiber network. Additionally, direct expenses
increased as a result of higher video programming rates and channel launches.
Operating, selling, general and administrative expenses
primarily include customers service costs, advertising, sales and marketing
expenses, plant maintenance and repair ("technical expenses"), salaries and
benefits, and other corporate overhead. Operating, selling, general and
administrative costs increased $19,578, or 137.5% to $33,815 for the quarter
ended March 31, 1998 from $14,237 for the quarter ended March 31, 1997.
Advertising costs increased approximately $6,300 for the quarter ended March
31, 1998 primarily due to an extensive high visibility multi-media campaign
primarily in New York City and Boston. Customer services costs increased
approximately $4,100 or 193.2% for the quarter ended March 31, 1998 primarily
due to increased staff required to support expanding markets and new service
offerings. Telephone expense to support higher call volumes related to
expansion of the customer base, billing costs for increased customers and
facilities expense for expanded staff comprise the remainder of the customer
service cost increase. Technical expense increased approximately $3,300, or
73%, for the quarter ended March 31, 1998. The increase was primarily due to
expenses associated with the commencement of telephony operations in the Lehigh
Valley, Pennsylvania market and engineering and construction headcount
additions made to plan and execute network expansion. Sales and marketing
costs increased approximately $3,500, or 126.1% for the quarter ended March
31, 1998. The increase resulted from additional staff, and related
commissions and benefits, to cover the Company's expanding market. The
remaining increase represents higher telemarketing expenses, principally in
the Lehigh Valley, Pennsylvania market for campaigns related to the
commencement of telephony services.
Depreciation and Amortization. Depreciation and amortization
is comprised principally of depreciation related to 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 $17,691 for the three month
period ending March 31, 1998 and $12,191 for the three month period ending
March 31, 1997. The increase of $5,500, or 45.1% was the result of a higher
depreciable basis of plant resulting primarily from expansion of the
Company's advanced fiber network. The cost basis of property, plant and
equipment on a pro forma total RCN basis, at March 31, 1998 and 1997 was
$373,587 and $227,635, respectively. Additionally, higher intangible assets
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
intangible assets resulting from these payments were depreciable for the full
quarter ended March 31, 1998 but only from the date of payment for the quarter
ended March 31, 1997. The basis of intangible assets, on a pro forma total
RCN basis, was $180,791 and $150,272 at March 31, 1998 and 1997, respectively.
Nonrecurring Charge-Acquisition Costs - In-Process Technology.
Acquisition costs -- In-process technology was $44,700 for the quarter ended
March 31, 1998. In connection with the acquisitions of Erols and UltraNet,
the Company and an independent third party are conducting a study for the
purpose of allocating the purchase price paid for Erols and UltraNet. The
preliminary results of this study indicate that at least $44,700 will be
allocable to in-process technology.
The value of in-process technology constitutes that portion of
the purchase price representing future cash flows from those new and
developing technologies expected to displace the current approaches to serving
customer needs in the Internet service field.
Interest Income. Interest income was $13,046 and $5,153 for the
three month periods ended March 31, 1998 and 1997, respectively. The increase
of $7,893, or 153.2% 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 $942,000 at March 31, 1998 and approximately $53,000 at March
31, 1997. Such increase was due to proceeds from the Company's borrowings
subsequent to March 31, 1997.
Interest Expense. Interest expense primarily represents
interest on the Company's $225,000 of 10% Senior Notes issued in October 1997,
its $601,045 of 11 (1)/(8)% Senior Discount Notes issued in October 1997, the
$25,000 revolving credit agreement and the $100,000 term credit facility of
certain of the Company's subsidiaries issued in August 1997, and the Company's
$567,000 of 9.8% Senior Discount Notes issued in February 1998, along with
amortization of debt acquisition costs related to these financing
arrangements. For the quarter ended March 31, 1998, interest expense was
$22,735 as compared to $3,431 for the quarter ended March 31, 1997. The
increase resulted from the financings placed subsequent to the first quarter
of 1997, described above, offset by a reduction due to the prepayment in
September 1997 of $131,250 of 9.65% Senior Secured Notes.
Other Expense. Other expense was $1,381 and $33 for the
quarterly periods ended March 31, 1998 and 1997, respectively. The primary
component of other expense for the quarter ended March 31, 1998 was the write
down of certain of the Company's information technology assets which the
Company intends to replace within the next several months with higher capacity
state of the art products in connection with an overall internal technology
upgrade.
Income Tax. The Company's effective income tax rate was a
benefit of 14.7% and 29.5% for the quarters ended March 31, 1998 and March 31,
1997, respectively. The primary reason for the difference was the charge for
in process technology for which a benefit is not realizable and
correspondingly was not recorded.
Minority Interest. On a pro forma total RCN basis, for the
first quarter of 1998 minority interest of $4,369 primarily represents the 49%
interest of BECO in the loss of RCN-BECOCOM of $3,645 and the 50% interest of
PCI in the loss of Starpower of $783. On a historical basis, Starpower is
accounted for under the equity method. In the first quarter of 1997, minority
interest primarily represents the 19.9% minority interest in the loss of
Freedom of $966. The Company purchased the remaining 19.9% ownership interest
in Freedom on March 21, 1997.
Equity in Loss of Unconsolidated Entities. On a pro forma
total RCN basis equity in the loss of unconsolidated entities primarily
represents the Company's share of the losses and amortization of excess cost
over net assets of Megacable. On a historical basis, for the first quarter of
1998, equity in the loss of unconsolidated entities also includes the
Company's 50% interest in the loss of Starpower of $784.
Pro Forma Total RCN Year Ended December 31, 1997 Compared to Year Ended
December 31, 1996:
On a historical basis, for the year ended December 31, 1997,
operating income before depreciation and amortization and nonrecurring charge
was ($7,670) as compared to $25,803 for the year ended December 31, 1996.
Sales increased 21.3% to $127,297 for the year ended December 31, 1997 from
$104,910 for the same period in 1996.
Sales. For the year ended December 31, 1997, total sales were
$127,297, an increase of $22,387 or 21.3%, from $104,910 for the year ended
December 31, 1996, primarily due to higher total service connections which
increased 20.6% to approximately 268,000 at December 31, 1997 from
approximately 222,000 at December 31, 1996. The increase is due to the
commencement of service through advanced fiber optic network facilities as
well as growth in resold voice and off-net video connections.
Voice revenues increased $3,177 to $4,007 for the year ended
December 31, 1997 from $830 for the year ended December 31, 1996. The
increase was primarily due to an increase in off-net connections. Off-net
connections were 24,900 and 1,875 at December 31, 1997 and 1996, respectively.
Video revenue increased $15,901 or 18.2% to $103,371 for the
year ended December 31, 1997 from $87,470 for the year ended December 31,
1996. The increase was due to an increase in off-net video sales principally
resulting from higher basic service revenue resulting from approximately 4,850
additional average monthly subscribers over 1996, the effects of a rate
increase in the first quarter of 1997 and cash incentives related to the
launch of certain new channels. Additionally, other video sales increased
primarily due to the acquisition of Freedom on August 30, 1996 (the "Freedom
Acquisition"), which resulted in approximately 38,000 wireless video
connections for a full year in 1997 as compared to four months in 1996. The
Company also began providing video service over its advanced fiber network
during 1997 and had approximately 11,800 advanced fiber connections at
December 31, 1997.
Commercial and other revenues increased $3,272, or 19.7% to
$19,878 for the year ended December 31, 1997 from $16,606 for the year ended
December 31, 1996. The increase primarily results from terminating access
provided to CTSI. An increase in commercial main access lines of
approximately 5,200 over 1996 accounted for approximately $1,100 of the
increase in commercial and other revenue.
Cost and Expenses, Excluding Depreciation and Amortization and
Nonrecurring Charges. For the year ended December 31, 1997, direct expenses
were $51,757, an increase of $16,531 or 46.9% as compared to direct expenses
of $35,226 in 1996. The increase is primarily attributable to higher sales
and a change in overall revenue mix to a higher volume of resold voice, which
has a lower margin than the Company's other products. The resold voice
increase represents planned marketing primarily in the Boston and New York
City markets ahead of construction of the advanced fiber network to build a
customer base which is intended to be migrated to the advanced fiber network.
Origination and programming costs increased approximately $7,200 primarily due
to higher video connections, rate increases and additional channels. The
remaining increase in direct costs and expenses is principally attributable to
higher commercial long distance network capacity in anticipation of volume
growth in the Company's markets resulting in higher recurring costs.
Operating, selling, general and administrative expenses
primarily include customers service costs, advertising, sales and marketing
expenses, plant maintenance and repair ("technical expenses"), salaries and
benefits, and other corporate overhead.
Operating, selling, general and administrative expenses
increased $39,541 or 90.1% to $83,422 for the year ended December 31, 1997
from $43,881 for the year ended December 31, 1996. Advertising costs
increased approximately $9,000 for the year ended December 31, 1997 primarily
due to a high visibility multi-media campaign to promote name recognition
primarily in New York City and Boston. Customer service costs increased
approximately $4,100, or 60.3% primarily related to headcount additions to
support the increase in the customer base and to meet the Company's objectives
for world class customer service. Technical expense increased approximately
$8,300, or 75.1% for the year ended December 31, 1997. The increase is
primarily related to salaries and benefits associated with increased network
engineering staff, responsible for planning the development and construction
of the advanced fiber network, and increased installation and repair
technicians. Sales and marketing costs increased approximately $8,500, or
116.7%, for the year ended December 31, 1997. The increase relates to higher
sales staff to increase penetration in the Company's markets, higher marketing
staff to monitor and coordinate the Company's direct advertising efforts and
plan sales promotions and to higher telemarketing expenses. The remaining
increase in operating, selling, general and administrative expenses is
attributable to several factors including costs associated with the spin-off
of the Company from C-TEC. Additionally, in connection with the Distribution
(Note 1), C-TEC completed a comprehensive study of its employee benefit plans
in 1996. As a result of this study, effective December 31, 1996, in general,
employees of RCN no longer accrued benefits under the defined benefit pension
plan, but became fully vested in their defined pension benefits accrued
through that date. C-TEC notified affected participants in December 1996. In
December 1996, C-TEC allocated pension plan assets of $6,984 to a separate
plan for employees who no longer accrue benefits after December 31, 1996. The
underlying liabilities were also allocated. The allocation of assets and
liabilities resulted in a curtailment/settlement gain of $4,292. The
Company's allocable share of this gain was $3,437. Such gain did not recur in
1997.
Depreciation and Amortization. Depreciation and amortization
increased $14,324, or 36.8% to $53,205 for the year ended December 31, 1997 as
compared to $38,881 for 1996. The increase is principally due to the additional
depreciation and amortization resulting from the Freedom Acquisition and
depreciation related to the Company's advanced fiber optic networks in New
York City and Boston.
In future periods, depreciation and amortization are expected
to exceed amounts recorded in 1997 due to depreciation with respect to the
Company's advanced fiber optic networks in New York City and Boston and due to
depreciation and amortization with respect to the Company's acquisitions in
February 1998 of Erols and UltraNet (Note 19).
Nonrecurring Charges. Nonrecurring charges of $10,000 in 1997
represent costs incurred with respect to the termination of a marketing
services agreement held by Freedom.
Interest Income. For the year ended December 31, 1997,
interest income was $22,824, a decrease of $2,778, or 10.9% primarily due to
lower average cash balances and lower average notes receivable with related
parties. Average cash balances decreased principally as a result of the
Freedom Acquisition in August 1996 (as well as the acquisition in March 1997
of the remaining 19.9% ownership interest in Freedom) and capital
expenditures, partially offset by the proceeds of the Company's high yield
debt offering in October 1997 (Note 10).
Interest Expense. For the year ended December 31, 1997,
interest expense was $25,602, an increase of $9,556, or 59.6% primarily due to
interest expense on the Company's $225,000 of 10% Senior Notes and $601,045
aggregate principal amount at maturity of 11 1/8% Senior Discount Notes placed
in October 1997 (Note 10). This was partially offset by lower interest
expense resulting from the required principal payment in December 1996 of
$18,750 on the 9.65% Senior Secured Notes. Additionally, the Company paid
$922 to Level 3 Telecom Holdings, Inc. ("Level 3 Telecom") in 1996 in
connection with the Company's August 1996 acquisition of Level 3 Telecom's
80.1% interest in Freedom. This portion of the consideration represents an
amount to compensate Level 3 Telecom for forgone interest on the amount which
it had invested in Freedom.
Income Tax. Benefit for income taxes increased $21,828
primarily due to the increase of $65,020 in loss after minority interest and
equity in unconsolidated entities before income taxes. For an analysis of the
change in income taxes, see the reconciliation of the effective income tax
rate in Note 11 to the Consolidated Financial Statements.
Minority Interest. Minority interest in the loss of
consolidated entities increased $6,062 primarily as a result of the minority
share of the losses of the BECO joint venture (Note 7), which began operations
in June 1997. Additionally, the minority share of the losses of Freedom from
January 1 through March 21, at which time the Company acquired the remaining
19.9% ownership interest, was $966 and the minority share of the losses of the
PEPCO joint venture which began operations in 1997, and which is consolidated
in the pro forma total RCN statements but not the historical statements, was
$106.
Equity in loss of Unconsolidated Entities. The Company's
equity in the (loss) of unconsolidated entities was ($3,698) in 1997 and
($2,282) in 1996, and is comprised principally of the Company's share of the
operating results of Megacable. In January 1995, the Company purchased a
forty percent equity position in Megacable, a Mexican cable television
provider, for cash of $84,115. The Company is exposed to foreign currency
translation adjustments resulting from translation into U.S. dollars of the
financial statements of Megacable, which through December 1996 utilized the
peso as the local and functional currency. Such adjustments have historically
been included as a separate component of shareholders' equity. Effective
January 1, 1997, since the three year cumulative rate of inflation at December
31, 1996 exceeded 100% , Mexico is being treated for accounting purposes under
Statement of Financial Accounting Standards No. 52 - "Foreign Currency
Translation" as having a highly inflationary economy. As a result, the
financial statements of Megacable are remeasured as if the functional currency
were the U.S. dollar. The remeasurement of the Mexican peso into U.S. dollars
creates translation adjustments which are included in net income. The Company
is also exposed to foreign currency transaction losses resulting from
transactions of Megacable which are made in currencies different from
Megacable's own. The Company's proportionate share of transaction gains
(losses) are included in income as they occur. The Company does not hedge its
foreign currency exchange risk and it is not possible to determine what effect
future currency fluctuations will have on the Company's operating results.
Exchange gains (losses) of ($12), $247, and ($932) in 1997, 1996, and 1995,
respectively, including translation losses in 1997, are included in the
respective statements of operations through the Company's proportionate share
of losses of Megacable.
In 1997, Megacable had sales of $30,441, operating income
before depreciation and amortization of $10,504 and net income of $6,653. In
1996, Megacable had sales of $23,225, operating income before depreciation and
amortization of $10,183 and net income of $10,226. Year end subscriber counts
were 211,627 at December 31, 1997 as compared to 178,664 at December 31, 1996.
In 1997 and 1996, the Company's share of the income of Megacable was $2,411
and $4,090, respectively, which includes the exchange gains (losses) as
discussed above. The Company's investment in Megacable exceeded its
underlying equity in the net assets of Megacable when acquired by
approximately $94,000, which goodwill is being amortized on a straight-line
basis over 15 years. In 1997 and 1996, amortization of the Company's excess
purchase price over the net assets of Megacable when acquired was $6,280 in
each year.
Extraordinary Charge. In September 1997, the Company prepaid
Senior Secured Notes with the proceeds of new credit facilities (Note 10).
The early extinguishment of the Senior Secured Notes resulted in an
extraordinary charge of $3,210, net of taxes.
Pro Forma Total RCN Year Ended December 31, 1996 Compared to Year Ended
December 31, 1995
On a historical basis, for the year ended December 31, 1996,
operating income before depreciation and amortization was $25,803 as compared
to $16,994 for the year ended December 31, 1995. Sales increased 14.0% to
$104,910 for 1996 from $91,997 in 1995. The improvement in operating income
before depreciation and amortization of $8,809 was offset by higher
depreciation and amortization of $16,545, as discussed below, resulting in a
net loss of ($5,989) for the year ended December 31, 1996 as compared to net
income of $2,114 in 1995.
Sales. For the year ended December 31, 1996, total sales were
$104,910, an increase of $12,913 or 14.0% from $91,997 for the year ended
December 31, 1995. Video sales increased $21,771, or 33.1% to $87,470 in 1996
from $65,699 in 1995, primarily due to the acquisition of the Pennsylvania
cable system (formerly Twin County Trans Video, Inc.) in May 1995, which
resulted in $13,530 of the increase in sales in 1996. The Pennsylvania cable
system serves approximately 74,000 subscribers in the Greater Lehigh Valley
area of Pennsylvania. The remaining increase in video sales is due to higher
basic service revenues resulting from an increase in average subscribers of
4,995 or 5.3% and the full year impact, in 1996, of the 9.6% rate increase in
April 1995 and the impact of 5.9% rate increase in February 1996. The 14.0%
increase in total sales in 1996 was lower than the increase of 54.6% in 1995,
principally due to the consolidation of the Pennsylvania cable system for
seven months (from acquisition in May 1995). Since the Pennsylvania cable
system was consolidated for seven months in 1995, consolidation for a full
year in 1996 reflects only incremental five months revenue as compared to
incremental seven months revenue in 1995.
Commercial and other revenues decreased $9,455, or 36.3%, to
$16,606 in 1996 from $26,061 in 1995 principally as a result of termination of
AT&T Tariff 12 resale services in the second quarter of 1995.
Cost and Expenses, Excluding Depreciation and Amortization and
Nonrecurring Charges. For the year ended December 31, 1996, direct expenses
were $35,226, a decrease of $4,378 or 11.1% as compared to direct expenses of
$39,604 in 1995. Lower costs associated with the reduction in AT&T Tariff 12
resale services were partially offset primarily by higher origination,
programming and franchise costs principally resulting from the acquisition of
the Pennsylvania cable system, the Freedom Acquisition, other subscriber
growth, channel additions and programming fee increases.
Operating, selling, general and administrative expenses
increased $8,482 or 24.0% to $43,881 for the year ended December 31, 1996 from
$35,399 for the year ended December 31, 1995. Customer service costs increased
approximately $2,700 or 66.1% primarily due to increased staff to support the
start-up and expected growth of bundled service operations in New York City
and Boston. Technical expenses increased approximately $3,000 or 38.3%
primarily as a result of the Freedom Acquisition in August 1996.
Additionally, technical expense increased as a result of the acquisition of
the Pennsylvania cable system in May 1995, resulting in consolidation for
seven months in 1995 as compared to a full year in 1996. Sales and marketing
costs increased approximately $1,500 or 26.6% for the year ended December 31,
1996. The increase is primarily related to the Freedom Acquisition and the
start-up of sales and marketing efforts for the bundled service product in New
York City and Boston. The remaining increase in operating, selling, general
and administrative expenses is comprised of an increase of approximately $250
in advertising, the Company's allocable share of costs associated with
investigation of the feasibility of various restructuring alternatives of
C-TEC to enhance shareholder value, and other increases in general and
administrative expenses of approximately $3,900 resulting from the Freedom
Acquisition. These other increases were partially offset by the Company's
allocable share of the gain on the partial curtailment and settlement of
C-TEC's defined benefit pension plan of $3,437.
Depreciation and Amortization. For 1996, depreciation and
amortization expense was $38,881, an increase of $16,545 or 74.1% as compared
to 1995 primarily due to purchase accounting effects of the acquisition of the
Pennsylvania cable system in May 1995 and the Freedom Acquisition on August
30, 1996. (See Note 4 to the Consolidated Financial Statements.) In addition,
the Company incurred $3,756 in depreciation related to the Company's advanced
fiber optic networks in New York City and Boston.
Interest Income. For the year ended December 31, 1996,
interest income was $25,602, a decrease of $3,399, or 11.7% due primarily to a
reduction in average cash balances in 1996 as compared to 1995 and a decrease
in the average yield on invested cash, partially offset by interest income of
$2,222 accrued on a $13,088 note receivable acquired from Mazon Corporativo
S.A. de C.V. in January 1996. Average cash balances decreased in 1996
primarily due to cash used in the Freedom Acquisition and the purchase of the
loan receivable from Mazon Corporativo S. A. de C.V. Additionally, lower
balances on notes receivable-affiliates contributed to the decrease.
Interest Expense. Interest expense for 1996 was $16,046, a
decrease of $471, or 2.9% in 1996 as compared to 1995. This decrease is due
to lower average rates on outstanding debt and includes approximately $922
paid to Level 3 Telecom, the Company's controlling shareholder, in connection
with the Freedom Acquisition. This portion of the consideration represents an
amount to compensate Level 3 Telecom for forgone interest on the amount
invested in Freedom.
Income Taxes. The Company's effective income tax rate was
(19.5%) in 1996 and 34.6% in 1995. For an analysis of the change in income
taxes, see the reconciliation of the effective income tax rate in Note 11 to
the Consolidated Financial Statements.
Minority Interest. As a result of the Freedom Acquisition,
Freedom's financial results are consolidated with the Company since August 30,
1996, the date of acquisition. This resulted in minority interest in the loss
of Freedom of $1,546 for 1996. Additionally, the 20% minority interest in the
income of HomeLink Limited Partnership, a Hybrid Fiber/Coaxial subsidiary, was
($206) in 1996 as compared to ($144) in 1995.
Equity in loss of Unconsolidated Entities. In 1996, Megacable
had sales of $23,225, operating income before depreciation and amortization of
$10,183 and net income of $10,226. In 1995, Megacable had sales of $20,841,
operating income before depreciation and amortization of $8,154 and net income
of $5,802. Year end subscriber counts were 178,664 at December 31, 1996 as
compared to 177,317 at December 31, 1995. In 1996 and 1995, the Company's
share of the income of Megacable was $4,090 and $2,696, respectively, which
includes foreign currency transaction losses as noted in the 1997 discussion.
In 1996 and 1995, amortization of the Company's excess purchase price over the
net assets of Megacable when acquired was $6,280 and $5,757, respectively.
Liquidity and Capital Resources
The Company expects that it will require a substantial amount
of capital to fund the network development and operations in the Boston to
Washington, D.C. corridor, including funding the development of its advanced
fiber optic networks, upgrading its Hybrid Fiber/Coaxial plant, funding
operating losses and debt service requirements. The Company currently
estimates that its capital requirements for the period from January 1, 1998
through 1999 will be approximately $785,000, which includes capital
expenditures (including connection costs which will only be incurred as the
Company obtains revenue-generating customer connections) of approximately
$300,000 in 1998 and approximately $485,000 in 1999. The Company's capital
expenditure plan has been accelerated due to more rapid deployment of its
network development plan, in part due to the Erols and UltraNet acquisitions.
These capital expenditures will be used principally to fund the buildout of
the Company's fiber optic network in high density areas in the Boston, New
York and Washington, D.C. markets and to upgrade its Hybrid Fiber/Coaxial
cable systems. To build out these areas on an efficient basis, the Company
undertakes a subscriber-driven capital expenditure strategy whereby it (i)
closely monitors development of its subscriber base in order to 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 $50,900 has been contributed.
The Company expects to have sufficient liquidity to meet its
capital requirements through 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. In
addition, the commencement of operations and buildout in new markets would
substantially increase the Company's capital requirements. 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-Washington, D.C. corridor, it
expects to continue to experience losses and negative cash flow on an
aggregate basis for an extended period of time.
The Company's current joint venture agreements reduce the
amount of expenditures required by RCN to develop the network due both to
access to the joint venture partners' existing facilities and to the
anticipated joint venture partners' equity contributions. However, the joint
venture arrangements will also reduce the potential cash flows to be realized
from operation of the networks in the markets in which the joint ventures
operate and restrict the Company's access to cash flow generated by the joint
ventures (which will be paid in the form of dividends). The Company may enter
into additional joint ventures in the future as the Company begins to develop
new markets. RCN and 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 $601,000
principal amount at maturity of 11 1/8% Senior Discount Notes, both due in
2007. The proceeds include $61,045 of restricted cash to be used to fund the
Escrow Account to pay interest on the 10% Senior Notes for three years. In
February 1998, the Company raised $350,587 in gross proceeds from an offering
of $567,000 principal amount at maturity of 9.80% Senior Discount Notes, due
in 2008. The Indentures which govern the 1997 Notes and the 1998 Notes contain
similar provisions. The Chase Manhattan Bank acts as Trustee for each of the
Indentures. The 1997 Notes and the 1998 Notes are general senior unsecured
obligations of RCN. The 9.80% Senior Discount Notes will mature on February
15, 2008. The 9.80% Senior Discount Notes will not bear cash interest prior to
February 15, 2003. The 1997 Notes will mature on October 15, 2007. Interest
on the 10% Senior Notes are payable in cash at a rate of 10% per annum
semi-annually in arrears on each April 15 and October 15, commencing April 15,
1998. The 11 1/8% Senior Discount Notes will not bear cash interest prior
to October 15, 2002.
The 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.
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 then outstanding at a premium.
The Indentures contain certain covenants 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 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 March 31,1998, $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 March 31,
1998, $3,000 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 the 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, making of 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 March 31, 1998, the Company had an
aggregate of approximately $1,053,000 of indebtedness outstanding, and the
ability to borrow up to an additional $22,000 under the Credit Agreement. As
a result of the substantial indebtedness of the Company, the Company's fixed
charges are expected to exceed its earnings for the foreseeable future. In
addition, the Company will require substantial additional indebtedness
particularly in connection with the buildout of the Company's networks and the
introduction of its telecommunications services to new markets. The leveraged
nature of the Company could limit its ability to effect future financing or
may otherwise restrict the Company's business activities.
The extent of the Company's leverage may have the following
consequences: (i) limit the ability of the Company to obtain necessary
financing in the future for working capital, capital expenditures, debt
service requirements or other purposes; (ii) require that a substantial
portion of the Company's cash flows from operations be dedicated to the
payment of principal and interest on its indebtedness and therefore not be
available for other purposes; (iii) limit the Company's flexibility in
planning for, or reacting to, changes in its business; (iv) place the Company
at a competitive disadvantage as compared with less leveraged competitors; and
(v) render the Company more vulnerable in the event of a downturn in its
business.
On a historical basis, for the quarter ended March 31, 1998, the
Company's net cash provided by operating activities was $8,277 comprised
primarily of a net loss of $(67,752) adjusted by non-cash depreciation and
amortization of $17,691, other non-cash items totaling $46,310, working capital
changes of $8,592 and changes in long-term unearned revenue of $2,248. Net cash
used in investing activities of $(76,279) consisted primarily of purchase of
short-term investments of $77,614, additions to property, plant and equipment of
$28,064, an investment in an unconsolidated joint venture of $12,500 and
acquisitions of $40,717 (primarily the acquisitions of Erols and UltraNet),
partially offset by sales and maturities of short-term investments of $82,014.
Net cash provided by financing activities of $356,854 consisted primarily of the
issuance of long-term debt of $350,588 and contributions from a minority
interest partner of $11,025, partially offset by payments made for debt
financing costs of $5,652.
On a historical basis, for the year ended December 31, 1997,
the Company's net cash provided by operating activities was $1,661, comprised
primarily of a net loss of ($52,391) adjusted by non-cash depreciation and
amortization of $53,205, other non-cash items totaling ($611) , working
capital changes of $377 and changes in other deferred expenses of $1,081. Net
cash used in investing activities of $475,860 consisted primarily of purchases
of short-term investments of $445,137, additions to property, plant and
equipment of $79,042 and acquisitions of $30,490 (primarily acquisition of the
minority interest of Freedom) partially offset by sales and maturities of
short-term investments of $76,923. Net cash provided by financing activities
of $635,266 consisted primarily of issuance of long-term debt of $688,000,
change in affiliate notes of $97,624 and transfers from C-TEC of $89,324
partially offset by redemption of long-term debt of $141,250, transfers to
C-TEC of $23,474, payments made for debt financing costs of $19,743 and an
increase related to cash restricted for debt service of $61,250.
On a historical basis, for the year ended December 31, 1996,
the Company's net cash provided by operating activities was $23,831 comprised
primarily of a net loss of $5,989 adjusted by non-cash depreciation and
amortization of $38,881 and other non-cash items totaling ($7,184). Net cash
used in investing activities of $9,377 consisted primarily of additions to
property, plant and equipment of $38,548, the purchase of a loan receivable of
$13,088 and acquisitions of $30,090 (primarily the Freedom Acquisition),
partially offset by net sales and maturities of short-term investments of
$73,995. Net cash provided by financing activities of $9,391 included the
issuance of long-term debt of $19,000 and change in affiliate notes of $32,802
partially offset by the redemption of long-term debt of $44,750.
Impact of the Year 2000 Issue
The Company has certain financial, administrative and
operational systems which are subject to Year 2000 exposures. The Company has
performed a study to identify those specific systems which require remediation
and developed a plan to correct such situations in a timely fashion. The
Company's plan is proceeding on target. The plan includes ensuring that those
systems for which the Company is dependent on external vendors, such as
certain billing systems, will be Year 2000 compliant by the end of 1999 based
on the status of external vendors' remediation efforts. For those internal
systems that require corrective action, the Company has contracted with its
information systems services provider to rewrite the relevant programming
code. Finally, the Company is well along on a conversion of its suite of
financial systems to a state-of-the-art Oracle system. Such system is
expected to ensure Year 2000 compliance in financial applications, enable the
Company to process and report its financial transactions more efficiently and
provide a greater level of detailed information to facilitate management's
analysis which is critical to its business decisions.
The Company is employing a team approach across its management
information systems, financial and operational groups in addressing the above
issues, as well as utilizing the assistance of external consultants in the
case of the Oracle implementation. Such team approach facilitates a
consistent progress along plans without disruption of other areas of the
business.
There is no assurance that the Company's plans will continue to
progress as intended. The Company estimates that its cost of Year 2000
remediation will not be material.
BUSINESS
Overview
RCN is developing advanced fiber optic networks to provide a
wide range of telecommunications services including local and long distance
telephone, video programming and data services (including high speed Internet
access), primarily to residential customers in selected high density markets.
RCN believes that its capability to deliver multiple services (telephone,
video programming and Internet access) to any given customer on its networks
will provide it with competitive advantages over other competitors. RCN's
strategy is to become the leading single-source provider of voice, video and
data services to residential customers in each of its markets by offering
individual or bundled service options, superior customer service and
competitive prices. The Company believes that it is the only publicly-traded
facilities-based provider of bundled voice, video and data services to focus
on the residential market in the U.S., and believes that it will be the first
competitive provider to its target markets.
RCN's initial advanced fiber optic networks have been
established in selected markets in the Boston to Washington, D.C. corridor,
including New York City, Boston and its surrounding communities and in the
Washington, D.C. area. The region, one of the most densely populated in the
United States, represents approximately 4% of the geography of the U.S., but
accounts for over 26% of the telecommunications market based upon the number of
telephone access lines. In the Boston market RCN operates its advanced fiber
optic network through a joint venture with BECO. The venture is managed and
51% owned by RCN and is accounted for on a consolidated basis. RCN and 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. In the
Washington, D.C. market RCN is developing an advanced fiber optic network
through a joint venture named Starpower with Pepco Communications, an indirect
wholly owned subsidiary of PEPCO. Starpower is owned 50% by RCN and 50% by
Pepco Communications and is accounted for under the equity method of
accounting. RCN believes that these joint ventures provide it with a number
of important advantages including access to rights of way and the use of
existing fiber optic facilities, the ability to enter its target markets
quickly and efficiently and a reduction in the up-front capital investment
required to develop its networks. In addition, the Company's joint venture
partners provide access to additional assets, equity capital and established
customer bases. The Company also benefits from its relationship with its
largest shareholder, Level 3, and from the experience gained by certain of the
Company's key employees who participated in the development of MFS
Communications Company, Inc.
Because it delivers multiple services, RCN reports the total
number of its various service connections (for local telephone, video
programming and Internet access) rather than the number of customers. See
"Business--RCN Services--Connections." As of March 31, 1998, the Company had
approximately 658,600 connections which were delivered through a variety of
owned and leased facilities including hybrid fiber/coaxial cable systems, a
wireless video system and advanced fiber optic networks. The Company is
deploying advanced fiber optic networks specifically designed to provide high
speed, high capacity telecommunications services for all new network facilities.
RCN also intends to upgrade certain of its hybrid fiber/coaxial cable systems to
enable them to provide the same range of voice, video and data services,
including bundled service options. See "Business--Properties." At March 31,
1998, RCN had approximately 20,300 total connections attributable to customers
connected to advanced fiber optic networks ("on-net" connections) and had
approximately 638,200 connections attributable to customers served through other
facilities ("off-net" connections). Off-net corrections consist of approximately
227,500 connections attributable to the Company's fiber/coaxial cable systems in
the states of New York (outside New York City), New Jersey and Pennsylvania, all
within 75 miles of New York City, and approximately 325,000 Internet service
customers gained upon completion of the acquisitions of UltraNet and Erols in
February 1998. As a result of the Erols and UltraNet acquisitions, RCN is a
leading ISP in the Boston to Washington, D.C. corridor.
RCN's extensive operating experience in both the telephone and
video industries and in the design and development of telecommunications
facilities provides it with expertise in systems operation and development, an
established infrastructure for customer service and billing for both voice and
video services and established relationships with providers of equipment and
video programming. In addition, the Company's management team and board of
directors benefit from experience gained in connection with the management of
C-TEC, which prior to September 30, 1997 owned and operated RCN. See
"--Relationship Among Commonwealth Telephone, RCN and Cable Michigan." C-TEC
has 100 years of experience in the telephone business and nearly 25 years of
experience in the cable television business. Both C-TEC and certain members of
management also have extensive experience in the design and development of
advanced telecommunications facilities.
RCN seeks to exploit competitive opportunities in selected
markets where population density, favorable demographics and the aging
infrastructure of the incumbent service providers' network facilities combine
to create a particularly attractive opportunity to develop advanced fiber
optic networks. The Company continues to evaluate new market areas both
within and outside of the Boston to Washington, D.C. corridor. The Company
believes that its experience in the Northeast will provide it with a key
strategic advantage if it decides to enter new markets.
Business Strategy
The Company believes that the opportunity to deploy effectively
advanced fiber optic networks and to compete with incumbent telephone and
cable television service providers results from several key factors, including
the broad demand for of the telecommunications industry pursuant to the
Telecommunications Act of 1996, the need for more advanced, higher capacity
networks to meet growing consumer demands for new communications products and
services and the superior technology of the Company's networks. In order to
achieve its goal of becoming the leading provider of telecommunications, video
and data services to residential customers in its target markets, RCN is
pursuing the following key strategies:
Developing Advanced Fiber Optic Networks. RCN's advanced
fiber optic networks are specifically designed to provide a single source for
high speed, high capacity voice, video programming and data services. The
Company expects that the substantial growth of the Internet and demand for
high speed data service will play an important role in the demand for its
fiber optic networks. RCN believes that its high capacity advanced fiber
optic networks provide RCN with certain competitive advantages such as
increased capacity (including the ability to offer bundled voice, video and
data services) and generally superior signal quality and network reliability
relative to the typical networks of the incumbent service providers. By using
advanced fiber optic networks capable of delivering multiple services, RCN is
able to address a larger number of potential subscriber connections in its
target markets than incumbent service providers which typically provide only
single or limited services.
Focusing on Residential Customers in High-Density Markets.
RCN seeks to be the first operator of an advanced fiber optic network
providing voice, video and data services to residential customers in each of
its target markets. RCN believes that it is unique in its markets in offering
a wide range of bundled voice, video and data services to customers in
residential areas and in striving to connect residential customers directly to
its advanced fiber optic networks. The Company estimates that RCN's loop
lengths are a small fraction of that of the incumbents. RCN also believes that
residential customers will be attracted to lower prices, broader service
offerings, enhanced levels of customer care and consumer choice. Although the
Company's primary focus is on residential customers, RCN also serves certain
commercial accounts which are located on or in close proximity to its
networks.
Implementing Subscriber-Driven Investment Strategy. RCN
attempts to deploy efficiently its capital by tying facility development to
the procurement of customer connections. In order to promote its presence in
its markets and to develop a subscriber base for its advanced fiber optic
networks, the Company may provide selected services to customers located near
its advanced fiber networks utilizing existing facilities that are available
in advance of network construction. For example, RCN markets Internet services
and provides resold telephone services in advance of constructing or extending
its networks. RCN also provides wireless video services to approximately
40,859 customers in New York City (as of March 31, 1998) with a view to
extending the advanced fiber optic network to service many of these existing
customers.
Utilizing Strategic Alliances and Existing Facilities to Speed
and Reduce Cost of Entry. By utilizing strategic alliances, RCN is able to
enter the market quickly and efficiently and to reduce the up-front capital
investment required to develop its networks. Through alliances with companies
such as BECO, Pepco Communications and MFS/WorldCom, which provide or are
expected to provide RCN with extensive fiber optic networks or other assets,
by utilizing certain components of its own existing cable television
infrastructure, and through the strategic acquisitions of UltraNet and Erols,
RCN has been able to expedite and reduce the cost of market entry and business
development and has created the opportunity to leverage existing customer
relationships.
Offering Bundled Voice, Video and Data Services. RCN believes
that, as a full service voice, video and data programming provider, it will be
able to offer a single-source package of voice, video and data services,
individually or on a bundled basis, which is not yet generally available from
any incumbent telephone, cable or other service provider. In addition,
services provided over RCN's advanced fiber optic networks are generally
priced at competitive rates as compared to the incumbent service providers.
Providing Superior Customer Service. RCN seeks to provide
superior customer service as compared to incumbent service providers, with
service features such as a 24-hour-a-day call center and quality control
system, on-time service guarantees and bundled service offerings, providing
the consumer with added choice and convenience.
Network Development and Financing Plan
In developing its advanced fiber optic networks, 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. As part of this
development plan, RCN pre-markets its services by offering Internet and
resale telephone (and, in New York City, wireless video) services in areas
targeted for expansion of advanced fiber optic network facilities. 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 building its advanced
fiber optic network in additional high density target markets in the Northeast
or elsewhere can be achieved on an attractive economic basis.
The Company expects that it will require a substantial amount
of capital to fund the network development and operations in the Boston to
Washington, D.C. corridor, including funding the development of its advanced
fiber optic networks, upgrading its hybrid fiber/coaxial plant and funding
operating losses and debt service requirements. The Company currently
estimates that its capital requirements for the period from January 1, 1998
through 1999 will be approximately $785 million, which includes 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 $485 million through 1999. As a result of
more rapid deployment of its fiber optic network and the Erols and UltraNet
acquisitions, certain aspects of the Company's capital expenditure program
have been accelerated. The Company's planned capital expenditures will be
used principally to fund the buildout of the Company's fiber optic network in
high density areas in selected markets in the Boston to Washington, D.C.
corridor and to upgrade its hybrid fiber/coaxial cable systems. In addition to
its own capital requirements, the Company's joint venture partners are each
expected to contribute approximately $150 million in capital to the joint
ventures from September 1997 through 2000 in connection with development of
the Boston and Washington, D.C. markets. Immediately following the consummation
of the Offering, the Company will have approximately $1,152 million of cash
and cash equivalents and approximately $63 million of restricted cash. Such
amounts are expected to provide sufficient liquidity to meet the Company's
capital requirements through 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.
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. Due to its subscriber
driven investment strategy, should the Company encounter a successful rollout
in its initial markets and/or decide to enter additional markets, the Company
may accelerate the rollout and/or extend the reach of its network; such
acceleration could increase the Company's capital requirements. In addition,
the commencement of operations and development of any new markets would
substantially increase the Company's capital requirements. See "Risk
Factors--Further Capital Requirements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
RCN Services
RCN provides a wide range of local and long distance telephone,
video programming and data services, both individually and in bundled service
options.
RCN provides these services through a range of facilities
including its advanced fiber optic networks in New York City and Boston, a
wireless video system in New York City, its hybrid fiber/coaxial cable systems
in the states of New York (outside New York City), New Jersey and
Pennsylvania, and resale local and long distance telephony services.
Connections. The following table summarizes the development
of RCN's subscriber base:
As of
-----------------------------------------
6/30/97 9/30/97 12/31/97 3/31/98
------- ------- -------- -------
Service Connections(1)
Advanced Fiber:
Voice...................... 370 1,909 3,214 4,473
Video...................... 1,060 4,870 11,784 15,599
Data....................... 81 326 150 267
------- ------- ------- -------
Subtotal On-Net............. 1,511 7,105 15,148 20,339
------- ------- ------- -------
Other(2):
Voice(3)................... 4,672 10,953 24,900 40,447
Video(4)................... 228,458 229,198 227,619 227,558
Data....................... -- -- -- 370,271
------- ------- ------- -------
Subtotal Off-Net............ 233,130 240,151 252,519 632,276
------- ------- ------- -------
Total Service Connections... 234,641 247,256 267,667 658,615
======= ======= ======= =======
Advanced Fiber Units Passed. 7,940 26,083 44,045 63,386
- ----------
(1) Because RCN delivers multiple services, the Company accounts for its
customer activity by the number of individual local telephone, video
programming or Internet access services, or "connections," purchased.
Consequently, a single customer purchasing local telephone, video
programming and Internet access constitutes three connections.
(2) RCN classifies connections within the "Other" category until the relevant
network is capable of providing voice, video and data services, including
local telephone service through an RCN switch.
(3) In August 1997, RCN commenced offering resold local phone service, long
distance and Internet access to customers in the area served by its Hybrid
Fiber/Coaxial Cable Systems in the Lehigh Valley area.
(4) Includes approximately 40,859 wireless connections. "Other" also includes,
among other things, wireline video connections serving the University of
Delaware (4,000 connections at March 31, 1998).
Set forth below is a brief description of RCN's services:
Voice. RCN offers full-featured local exchange telephone
service, including standard dial tone access, enhanced 911 access, operator
services and directory assistance in competition with the incumbent local
exchange providers and CLECs. In addition, RCN offers a wide range of
value-added services, including call forwarding, call waiting, conference
calling, speed dial, calling card, 800-numbers and voice mail. RCN also
provides Centrex service and associated features. RCN's local telephone rates
are generally competitive with the rates charged by the incumbent providers.
At March 31, 1998, RCN had approximately 4,473 telephone service connections
on its advanced fiber optic networks and approximately 40,447 customers for
resold telephone service.
RCN Long Distance Company provides long distance telephone
services, including outbound, inbound, calling card and operator services.
These services are offered to residential and business customers. As of March
31, 1998, RCN Long Distance Company had approximately 13,100 customers. In
the future RCN intends to offer long distance telephone service predominantly
to customers whom it expects will eventually be connected to its own
facilities.
Video Services. RCN offers a diverse line-up of high quality
basic, premium and pay-per-view video programming. Depending on the system,
RCN offers from 61 to 110 channels. RCN's basic video programming package
provides extensive channel selection featuring all major cable and broadcast
networks. RCN's premium services include HBO, Cinemax, Showtime and The Movie
Channel, as well as supplementary channels such as HBO 2, HBO 3 and Cinemax 2.
RCN's StarCinema, available on the Company's advanced fiber optic networks,
utilizes the latest "impulse" technology allowing convenient impulse
pay-per-view ordering of the latest hit movies and special events instantly
from the customer's remote. RCN's "Music Choice" offers 30 different
commercial-free music channels delivered to the customer's stereo in digital
CD quality sound.
As of March 31, 1998, RCN had approximately 15,599 subscribers
for its video programming services provided over advanced fiber optic
networks. As of such date, RCN also had approximately 40,859 connections
attributable to the wireless video system and approximately 187,000
connections attributable to the hybrid fiber/coaxial cable systems.
Internet Access and Data Transmission. RCN's StarPass
Internet service provides access for personal computers to RCN's advanced
fiber optic network for a reliable high speed connection to provide access to
electronic mail, World Wide Web, Internet chat lines and newsgroups and remote
access and file transfer services. RCN provides data transmission services
over its advanced fiber optic network either via two-way dial-up modem over
traditional telephone lines or via cable modem utilizing RCN's high capacity
network. RCN expects to commence offering a high-speed Internet access service
in certain markets during the second quarter of 1998. RCN also offers private
line point-to-point data transmission services such as DS-1 and DS-3 with the
capability to provide higher speed connections as well. Following the recent
Erols and UltraNet acquisitions, RCN believes it is the largest regional
provider of Internet services in the Northeast. As of March 31, 1998, RCN had
approximately 370,271 Internet subscribers.
Migration of Customers to Advanced Fiber Networks
RCN provides wireless video services to customers located near
its advanced fiber optic network in New York City and provides internet
services and resale telephone service with a view to extending the advanced
fiber optic network and fully activating RCN's own telephone switches to
service many of those customers. As RCN's advanced fiber optic network is
extended into these areas or buildings, customers receiving wireless video
service in New York City will be switched to the advanced fiber optic network
from the wireless video network, and the wireless video equipment will be used
to provide service to other customers in off-network premises. Similarly, as
the advanced fiber optic network is developed and switches are deployed, voice
customers will be switched to the advanced fiber optic network from resale
accounts, thereby allowing RCN to gain additional revenue (and larger margins)
from originating and terminating access fees and to control the related
services and service quality.
Strategic Relationships
RCN has developed a number of strategic alliances and
relationships in order to provide it with early entry and to reduce the cost
of entry into the market for telecommunications services. RCN expects to
continue to pursue opportunities that may be afforded by entering into
strategic alliances to facilitate network expansion and entry into new markets.
Fiber Agreements with MFS/WorldCom. RCN, through its
affiliates, has entered into Fiber Agreements (the "Fiber Agreements"), each
dated May 8, 1997, with MFS/WorldCom, which owns or has the right to use
certain fiber optic network facilities (the "Fiber Optic Facilities") in the
Boston, Massachusetts and Borough of Manhattan, New York, New York markets
(the "Service Areas"). Pursuant to the Fiber Agreements, MFS/WorldCom (i) will
construct and provide extensions connecting the Fiber Optic Facilities to
buildings designated by RCN (the "Extensions") and (ii) has granted to RCN the
right to use certain dedicated fibers in the Fiber Optic Facilities and the
Extensions, except that RCN may not use such facilities to deliver telephone
services to commercial customers in the Service Areas. In return, RCN has
reimbursed MFS/WorldCom for the costs MFS/WorldCom incurred to install,
construct and acquire the Fiber Optic Facilities constructed prior to March
31, 1997. RCN has further agreed to pay all of the costs MFS/WorldCom incurs
to (i) install, construct and acquire the Fiber Optic Facilities constructed
between March 31, 1997 and May 8, 1998 and the Extensions, and (ii) maintain,
and support RCN's use of, the Fiber Optic Facilities and the Extensions.
Unless earlier terminated upon the occurrence of certain events set forth
therein, including a change of control of RCN, the Fiber Agreements terminate
by their terms on January 1, 2007, provided that (i) at such time the parties
may agree to extend the Fiber Agreements for up to 10 years or enter into
other alternative arrangements, and (ii) under certain circumstances,
MFS/WorldCom is required to transfer the Extensions to RCN.
BECO Joint Venture
In September 1996, RCN and BECO, through wholly owned
subsidiaries, entered into a letter of intent to form a joint venture to utilize
126 fiber miles of BECO's fiber optic network to deliver RCN's comprehensive
communications package in Greater Boston. The venture, in the form of an
unregulated entity with a term expiring in the year 2060, was formed pursuant to
a joint venture agreement dated December 23, 1996 (the "Boston Joint Venture
Agreement") providing for the organization and operation of RCN-BECOCOM, LLC
("RCN-BECOCOM"). RCN-BECOCOM is a Massachusetts limited liability company
organized to own and operate an advanced fiber optic telecommunications network
(the "Network") and to provide, in the market in and around Boston,
Massachusetts (the "Boston Market"), voice, video and data services, as well as
the communications support component of energy related customer services offered
by BECO (collectively, the "Boston Services"). RCN, through RCN Massachusetts,
owns 51% of the equity interest in RCN-BECOCOM and BECO, through a subsidiary,
owns the remaining 49% interest. This joint venture with BECO is reflected on
RCN's financial statements on a consolidated basis.
The closing of the transactions contemplated by the Boston
Joint Venture Agreement occurred on June 17, 1997. At the closing, (i) RCN
transferred to RCN-BECOCOM its business of providing Boston Services; (ii) BECO
transferred to RCN-BECOCOM access to and use of certain existing BECO
facilities; (iii) RCN and BECO made initial cash capital contributions to
RCN-BECOCOM; and (iv) the parties and/or their affiliates executed and
delivered (a) the Amended and Restated Operating Agreement of RCN-BECOCOM (the
"BECO Operating Agreement"); (b) the Construction and Indefeasible Right of
Use Agreement (the "IRU Agreement"); (c) the Management Agreement (the
"Management Agreement"); (d) the Exchange Agreement (the "Exchange
Agreement"); and (e) the Joint Investment and Noncompetition Agreement (the
"Joint Investment Agreement").
Pursuant to the BECO Operating Agreement, RCN and BECO are
required to make any additional capital contributions required by RCN-BECOCOM's
annual budget on a 51%/49% basis. The annual budget will be prepared by RCN and
is subject to review by each member of RCN-BECOCOM. RCN will manage the business
of RCN-BECOCOM; however, certain extraordinary actions require the consent of
both parties. In addition, the BECO Operating Agreement provides that if a
deadlock arises relating to a merger, reorganization, issuances of equity,
liquidation or bankruptcy, amendments to the organizational documents or an
expansion of operations of RCN-BECOCOM beyond those contemplated by the BECO
Operating Agreement, the disputing party will either sell its interest to the
other party or purchase the other party's interest in the joint venture. In the
event of a deadlock relating to other fundamental business actions or relating
to the annual budget, the matter will be submitted to arbitration. Neither RCN
nor BECO may transfer its interest in RCN-BECOCOM until June 17, 2000 without
the other's written consent. After such date, each party has the right to
purchase the interest proposed to be sold by the other party. If a party
proposes to sell more than 33% of its interest, the other party has "tag-along"
rights to sell a proportionate share of its interest. In the event a member's
interest becomes less than 25%, the other members have the option to purchase
such interest at fair market value. Upon a change in control of either RCN
Massachusetts or BECOCOM, the other party has the right to purchase all of the
equity interest in RCN-BECOCOM for fair market value, as determined by an
appraisal proceeding.
RCN will manage the business of RCN-BECOCOM pursuant to the terms
of the Management Agreement and, in consideration therefor, will receive
reimbursement for its reasonable costs, and a performance-based fee (based on
factors including the number of subscribers and operating cash flow) to be
determined by agreement of RCN and RCN-BECOCOM. The initial term of the
agreement expires on December 31, 2001. The agreement provides for automatic
successive three-year renewal periods, unless notice is given ninety days before
the end of the period.
Pursuant to the IRU Agreement, BECO will, for certain agreed
upon fees, (i) provide construction services to build out the Network, (ii)
make available to RCN-BECOCOM (a) all of the available capacity of BECO's
existing fiber backbone, and (b) the ability to use BECO's real estate, poles,
easements and other interests for the construction and operation of the
Network and (iii) maintain the Network. BECO's construction obligations expire
on June 17, 2007 and the term of the IRU Agreement generally expires on
December 31, 2060. One year before each respective expiration date, BECO
agrees to commence good-faith negotiations to extend construction obligations
beyond June 17, 2007 and to allow continued use of BECO's facilities beyond
December 31, 2060.
Under the Joint Investment Agreement, BECO will have the right
to acquire up to a 20% equity interest in any joint venture between RCN and an
electric utility company formed to provide any services similar to the Boston
Services in New England outside the Boston Market. BECO's joint investment
right shall terminate (i) upon BECO's stake in RCN-BECOCOM dropping below a
(1)/3 interest and (ii) on the later to occur of (a) June 17, 2002 or (b) two
years after RCN's stake in RCN-BECOCOM falls below a (1)/3 interest. The
agreement also provides that neither RCN, BECO nor their affiliates will be
permitted to be involved in any other enterprise providing services similar to
the Boston Services in the Boston Market. This covenant not to compete will
survive for a period of two years after either party is no longer a member of
RCN-BECOCOM.
Pursuant to the Exchange Agreement, BECO had the right at the
time of the Distribution, and has the right every two years thereafter, to
convert its ownership interest in RCN-BECOCOM into the Common Stock of RCN
pursuant to specific terms and conditions, including exercise periods,
appraisal procedures and restrictions specifically set forth in the Exchange
Agreement. Although BECO exercised its conversion right, BECO remains
obligated to make 49% of all cash contributions by the parties and any cash
contributions made after conversion will result in it owning a portion of
RCN-BECOCOM based on the value of RCN-BECOCOM at the time of the contribution.
BECO may exercise its conversion rights in whole or in part from time to time.
BECO has notified RCN that it has elected to exercise its option to the full
extent permitted by the Exchange Agreement with respect to 1997. RCN and BECO
are presently in discussions with respect to the calculation of the agreed
upon value for the exercise of such option. BECO's right to convert its joint
venture interest into Company Common Stock is subject to certain limitations
designed to ensure that the conversion does not jeopardize the tax free nature
of the Distribution. In the event BECO is unable to convert any portion of its
interest as a result of such limitations, BECO has the right to require RCN to
purchase such portion. Subject to certain restrictions set forth in the
Exchange Agreement, BECO will also be entitled, upon exchanging its investment
interest in RCN-BECOCOM for Company Common Stock, to customary registration
rights with respect to such shares.
RCN expects to benefit from the ability to utilize BECO's large
fiber optic network, its focus on innovative technology, its sales and
marketing expertise and its reach into the market. In the future, the venture
may expand into energy management and property monitoring services. Starting
in Boston, the joint venture partners will consider further expansion into
surrounding markets. RCN anticipates that as a result of its access to the
extensive BECO network, RCN's reliance on and utilization of MFS/WorldCom
facilities in Boston will be reduced significantly.
Starpower Joint Venture
On August 1, 1997, RCN Telecom Services, Inc., a subsidiary of
RCN, and Potomac Capital Investment Corporation ("PCI"), a wholly owned
subsidiary of PEPCO, entered into a letter of intent (the "Letter of Intent")
to form a joint venture which will own and operate a communications network to
provide voice, video, data and other communications services to residential
and commercial customers in the greater Washington, D.C., Virginia and
Maryland area (the "Washington, D.C. Market"). Starpower, an unregulated
limited liability company with a perpetual term, was formed on October 28,
1997 by RCN Washington and Pepco Communications. Starpower was formed to
construct, own, lease, operate and market a network for the selling of voice,
video, data and other telecommunications services (the "Relevant Business") to
all potential commercial and residential customers in the Washington, D.C.
Market. RCN, through RCN Washington, owns 50% of the equity interest in
Starpower and PCI, through Pepco Communications, owns the remaining 50%
interest. Starpower is accounted for under the equity method of accounting.
The closing (the "Starpower Closing") of the Starpower joint
venture occurred on December 19, 1997. At the Starpower Closing, RCN
Washington transferred to Starpower all its right, title and interest in and
to (i) all customer accounts of RCN Long Distance in the Washington, D.C.
Market, (ii) its business plan in the Washington, D.C. Market and experience
with respect to the Relevant Business, (iii) all building access agreements
covering any property located in the Washington, D.C. Market, (iv) the Support
Services Agreement (as described below) and (v) the benefit of certain
agreements pursuant to the Assignment of Benefits Agreement (as described
below). The documents signed at the Starpower Closing were the Starpower
Operating Agreement, Fiber Use Agreement dated as of December 18, 1997 between
PEPCO and Starpower ("Fiber Use Agreement"), Agency Agreement dated as of
December 18, 1997 by and between RCN Washington, RCN Telecom Services of
Maryland, Inc., RCN Telecom Services of Virginia, Inc. and Starpower ("Agency
Agreement"), Non-competition Agreement dated as of December 18, 1997 by and
among RCN Telecom Services, Inc., PCI and Starpower ("Non-competition
Agreement"), Assignment of Benefits Agreement dated as of December 18, 1997 by
and between RCN Washington and Starpower ("Assignment of Benefits Agreement"),
Support Services Agreement dated as of December 18, 1997 by and between RCN
Operating Services, Inc. and Starpower ("Support Services Agreement"),
Guarantee dated as of December 18, 1997 by PCI on behalf of Pepco
Communications in favor of Starpower, Guarantee dated as of December 18, 1997
by RCN on behalf of RCN Washington and other RCN obligors in favor of
Starpower and Contribution Agreement dated as of December 18, 1997 by and
between RCN Washington and Starpower ("Contribution Agreement"). RCN
Washington and Pepco Communications also each paid $12.5 million in cash in
January 1998 as their initial capital contributions.
Pursuant to the Starpower Operating Agreement, RCN Washington
and Pepco Communications are each required to make additional capital
contributions in accordance with a schedule set forth in such agreement on a
50%/50% basis. Failure of either RCN Washington or Pepco Communications to
make a scheduled capital contribution or to vote in favor of certain
additional capital contributions may result in the recalculation of equity
interests. The business and affairs of Starpower is to be managed by RCN
Washington and Pepco Communications. So long as RCN Washington and Pepco
Communications maintain a 50%/50% equity interest in the joint venture, each
of RCN Washington and Pepco Communications will appoint three members to the
operating committee, the approval of which is required for any business
action. Certain fundamental business actions, such as mergers, acquisitions,
sales of substantially all of the assets, liquidation and amendments to the
certificate of organization or any agreement signed at the Starpower Closing,
require the unanimous approval of the operating committee regardless of
whether the parties continue to maintain a 50%/50% ownership interest. Failure
to reach agreement may trigger a deadlock event. In the event a deadlock
arises within the first three years of the joint venture, the proposed action
shall be deemed rejected. If the deadlock arises thereafter, the disputing
party may give a notice to the other party offering to sell its membership or
to purchase all membership interests from the other party; the offeree has the
obligation to elect to buy or sell its interest. Subject to certain
exceptions, neither RCN Washington nor Pepco Communications may sell any
interest in Starpower for four years. Thereafter, RCN Washington or Pepco
Communications may sell any of its membership interests with the written
consent of the other subject to a right of first offer by the other party. RCN
Washington shall be restricted from transferring its interest if Pepco
Communications can demonstrate that such assignment would have a material
adverse impact on Starpower's business. Upon a change of control of RCN
Washington or Pepco Communications, which the other party has reason to
believe will have a material adverse effect on Starpower, the other party may
offer to sell its membership interests to the other party or to acquire such
party's membership interests or accept the change of control. The offeree has
the right to elect to buy or sell its interest. If a party proposes to sell
its interest to a third party, the other party has "tag-along" rights to sell
a proportionate share of its interest. Both RCN Washington and Pepco
Communications may transfer their membership interests to certain affiliates.
Under the Fiber Use Agreement, PEPCO agreed, for certain agreed
upon fees, (i) to provide construction services to develop a network and (ii)
to grant Starpower an indefeasible right of use of certain facilities and an
irrevocable right to install, maintain, use and operate its strand fiber
connections to leased facilities. Starpower has the right, at the end of the
term, to purchase not less than the whole network at the fair market value
less the amount previously paid by Starpower with respect to such facilities.
The initial term is ten years and the agreement may be renewed four times.
Under the Support Services Agreement, a subsidiary of RCN will
provide support services including customer service, billing, marketing, and
certain administrative, accounting and technical support services, each of
which shall be provided at cost. The Support Services Agreement also contains
certain indemnity provisions.
Under the Non-competition Agreement, for so long as either RCN
Washington or Pepco Communications owns an interest in Starpower, neither
party nor any of their affiliates may compete with any Relevant Business in the
Washington, D.C. Market. Neither RCN Washington nor Pepco Communications shall
attempt to solicit, divert or accept business from the customers of Starpower
for any Relevant Business in the Washington, D.C. Market or solicit any
individual who is employed by Starpower.
Starpower agreed, in the Agency Agreement, to serve as RCN
Washington's exclusive agent for the provision of telephony services in the
Washington, D.C. Market until Starpower receives sufficient authorization for
it to provide telephony services in the Washington, D.C. Market. All revenues
and customers under this Agency Agreement belong to Starpower. Starpower must
indemnify RCN Washington for any tax liability resulting from its obligations
under this Agency Agreement. The Agency Agreement also contains certain other
indemnity provisions.
Pursuant to the Assignment of Benefits Agreement, RCN
Washington assigned the benefits of all of the agreements (the "Assigned
Agreements") with suppliers of programming and entertainment, voice, video and
data services, telecommunications equipment and other products and services
useful in the conduct of the Relevant Business in the Washington, D.C. Market
to Starpower. RCN Washington may not transfer or assign its interest in the
Assigned Agreements if doing so would have a material adverse effect on
Starpower's ability to conduct the Relevant Business in the Washington, D.C.
Market. In addition, RCN Washington may not amend, modify or assign the
Assigned Agreements without the prior written consent of Starpower and
Starpower has the right to terminate any agreement amended, modified or
assigned without its consent. RCN Washington has agreed to take all reasonable
steps necessary to obtain consent for Starpower to use programming agreements
prior to the date Starpower begins offering OVS services. The Assignment of
Benefits Agreement expires on December 19, 1998 and Starpower has certain
renewal rights. Starpower may terminate the Assignment of Benefits Agreement
on 60 days' notice.
RCN has agreed to unconditionally guarantee the due and
punctual performance and discharge all of its affiliates' material covenants,
warranties, undertakings and other obligations under the agreements signed at
the Starpower Closing. PCI has agreed to unconditionally guarantee the due and
punctual performance and discharge by Pepco Communications of all its material
covenants, warranties, undertakings and other obligations under the Starpower
Operating Agreement.
Recent Acquisition Transactions
Merger with Erols Internet, Inc.
Erols is a leading regional ISP serving residential and
business subscribers in targeted markets, including New York City,
Philadelphia, Washington, D.C. and Boston. At the date of the Erols
Acquisition, Erols had approximately 293,000 subscribers. Erols currently
operates 57 POPs throughout its geographic markets, and also currently utilizes
32 "Virtual POPs," which permit subscribers located adjacent to, but outside
of the local calling areas of, physical POPs to dial into the Erols network on
a local basis through arrangements with the relevant LEC. Erols offers a broad
range of Internet-based services, including (i) Global Trader[SM], Erols'
turn-key e-commerce product for small businesses, (ii) Internet security
services, including security consulting and virtual private networks, and
(iii) Web hosting, design and development services.
On January 21, 1998, RCN entered into the Agreement and Plan of
Merger (the "Erols Merger Agreement") among RCN, Erols, Erol Onaran, Gold &
Appel Transfer, S.A., a British Virgin Islands corporation ("Gold & Appel"),
and ENET Holding, Inc., a Delaware corporation and a wholly owned subsidiary
of RCN ("ENET"), to acquire all of the outstanding shares of common stock of
Erols. On February 20, 1998, Erols merged with and into ENET (the "Erols
Merger"), with ENET as the surviving corporation. The transaction was
completed in February 1998. The approximate total Erols Merger consideration
was $29.2 million in cash, 1,730,648 shares of RCN Common Stock plus the
assumption and repayment of approximately $5.8 million of debt (including
payment of accrued interest). Additionally, the Company is converting
approximately 999,000 stock options to stock options to purchase approximately
699,000 shares of RCN Common Stock with an average exercise price of $3.424
per share.
The Erols Merger Agreement contains customary representations,
warranties, and covenants by each party, which representations and warranties
will survive until March 31, 1999, except for certain specified
representations and warranties which will survive indefinitely or until the
expiration of the applicable statute of limitations. Pursuant to the Erols
Merger Agreement, each party has agreed to provide indemnification from
damages arising out of any misrepresentation or breach of warranty, covenant
or agreement made or to be performed by such party pursuant to the Erols
Merger Agreement. In addition, Erol Onaran has agreed to provide
indemnification from damages arising out of any misrepresentation or breach of
warranty, covenant or agreement made or to be performed by Erols on or before
the consummation of the Erols Merger, subject to certain thresholds and
limitations, and arising from certain matters set forth in the Erols Merger
Agreement.
Pursuant to the Erols Merger Agreement, at the effective time
of the Erols Merger both an escrow agreement (the "Erols Escrow Agreement")
and a registration rights agreement (the "Erols Registration Rights
Agreement") were executed and delivered. Under the terms of the Erols Escrow
Agreement, RCN delivered to the Erols Escrow Agent an aggregate of
approximately $5.84 million in cash and 93,210 shares of RCN Common Stock to
be held, invested and distributed by the Erols Escrow Agent pursuant to the
Erols Escrow Agreement. Under the terms of the Erols Registration Rights
Agreement, Erol Onaran and Gold & Appel each received customary demand and
piggy-back registration rights, subject to certain limitations as set forth in
the Erols Registration Rights Agreement.
RCN expects to contribute to Starpower, the joint venture with
Pepco Communications, the subscribers acquired in the acquisition of Erols
located in the Washington, D.C. area in which Starpower operates. On February
20, 1998, approximately 61% of all of Erols' subscribers were located in the
relevant Washington, D.C. area. RCN anticipates that Pepco Communications will
make a contribution equal to the value of such subscribers. The joint venture
partners of Starpower are currently negotiating the terms of such
contribution.
Merger With UltraNet Communications, Inc.
UltraNet is a leading ISP in the Boston area serving
residential and business customers in New England. At the date of RCN's
acquisition of UltraNet, UltraNet had approximately 32,000 subscribers.
UltraNet provides Internet service to over 500 schools, and is presently
building a network which will provide access throughout New Hampshire's
universities and colleges. UltraNet has a wide network of 42 POPs. Services
UltraNet offers to subscribers include (i) virtual hosting, which gives
customers a corporate presence on the Internet, (ii) firewall security, which
provides high quality control in monitoring access to documents and visitors
to the customer's websites, and (iii) UltraFax, which allows customers to send
faxes from their desktops. UltraNet also offers its customers access to its
network via an 800 number which allows access from every major city in the
world.
On January 21, 1998, RCN, Holding and UltraNet entered into the
UltraNet Merger Agreement. The transaction was completed in February 1998.
The total consideration for the acquisition was approximately $7.9 million in
cash, approximately 890,384 shares of RCN Common Stock and $3 million in
deferred compensation. Additionally, the Company is converting approximately
63,500 UltraNet stock options to stock options to purchase 117,052 shares of
RCN Common Stock at an average exercise price of $1.825 per share.
RCN also agreed to indemnify UltraNet and its directors,
officers and stockholders from and against liabilities or expenses incurred
(i) in connection with the severance benefits under any severance arrangement
applying to any former employee of UltraNet employed by RCN after the UltraNet
Merger is consummated, (ii) relating to a former employee's employment and/or
termination by RCN after the UltraNet Merger is consummated and (iii) incurred
by an indemnified person with respect thereto.
Pursuant to the UltraNet Merger Agreement, on February 27,
1998, the UltraNet Registration Rights Agreement was executed and delivered.
Under the terms of the UltraNet Registration Rights Agreement, certain former
shareholders of UltraNet received registration rights, subject to certain
limitations as set forth in the UltraNet Registration Rights Agreement.
RCN contributed to its joint venture with BECO the subscribers
acquired in the acquisition of UltraNet located in the Boston area as well as
1.36% (or all of Erols' subscribers located in the relevant Boston area) of
the subscribers acquired in the acquisition of Erols. On February 27, 1998,
approximately 27% of all of UltraNet's subscribers were located in the
relevant Boston area. BECO has made a corresponding contribution to the joint
venture in the form of a note in the principal amount of (49)/(51) of the
agreed value of the subscribers contributed by RCN.
Indemnification and Noncompetition Agreement
Certain stockholders holding at least 95% of the UltraNet
common stock, Series A Preferred Stock and Series B Preferred Stock executed
an Indemnification and Noncompetition Agreement (the "Indemnification
Agreement") which provides that certain representations and warranties
included in the UltraNet Merger Agreement will survive the consummation of the
merger. Such stockholders agree to indemnify RCN, severally and on a pro rata
basis, and RCN agrees to indemnify the stockholders against all losses
incurred by any of them arising out of any breach of any tax representation in
the UltraNet Merger Agreement insofar as such breach causes the merger not to
qualify as a reorganization or any material failure to perform any of its
covenants or agreements contained in the UltraNet Merger Agreement. The
maximum amount of indemnification by the stockholders on the one hand and by
RCN on the other hand is $7.5 million plus certain amounts up to $2.5 million
with respect to breach of tax representations.
The Indemnification Agreement provides that the stockholders
will not knowingly take any action which would cause the merger not to qualify
as a reorganization. Certain employees also agree not to engage in any
activity which would compete with UltraNet in the geographic region identified
as the "Boston-Washington" corridor for a period ending the earlier of five
years after the consummation of the merger or one year after his or her
termination (or two years in the case of termination for cause or voluntary
termination).
Merger With Lancit Media Entertainment, Ltd.
On February 27, 1998, RCN entered into an Agreement and Plan of
Merger ("Lancit Merger Agreement") with Lancit Media Entertainment, Ltd., a
New York corporation ("Lancit"), and LME Acquisition Corporation, a New York
corporation and a wholly owned subsidiary of RCN ("LME"). Pursuant to the
Lancit Merger Agreement, LME will merge with and into Lancit, with Lancit
surviving the merger and becoming a wholly owned subsidiary of RCN (the
"Lancit Merger"). Lancit is a producer of high-quality children's
programming, for which it has won 11 Emmy Awards. The consummation of the
Lancit Merger is subject to customary conditions, including the approval by
Lancit shareholders of the Lancit Merger.
Hybrid Fiber/Coaxial Cable Systems
RCN's hybrid fiber/coaxial cable systems were operated by C-TEC
prior to the Distribution. The following table summarizes the development of
the hybrid fiber/coaxial cable systems over the last five years:
<TABLE>
<CAPTION>
Three
Months
Ended
As of December 31, March 31,
------------------------------------------------------------------ ----------
1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Homes Passed...... 118,216 119,761 282,836 283,940 290,612 293,146
Basic Subscribers. 87,660 92,140 176,131 179,932 184,938 186,699
</TABLE>
The service areas for these cable television networks enjoy
favorable customer demographics. The New York and New Jersey systems primarily
serve affluent bedroom communities in suburban New York City. The system in New
York State serves ten municipalities in Duchess, Putnam and Westchester
Counties, approximately 45 miles north of New York City. The New Jersey system
serves 31 contiguous municipalities in Hunterdon, Mercer, Morris and Somerset
Counties, approximately 50 miles west of Manhattan. The Pennsylvania system,
which is the largest competitive cable television system in the United States,
serves Pennsylvania's Lehigh Valley area including the cities of Allentown,
Bethlehem and Easton, and virtually all of Lehigh and Northampton Counties,
and is located less than 10 miles west of the Company's New Jersey system.
Certain of the Company's Hybrid Fiber/Coaxial Cable systems are being upgraded
to enable such networks to provide voice, video and data services, including
local telephone service, through an RCN switch. When such conversion is
completed, customers served by such networks will be included within
the"on-net connections" category. In August 1997, RCN commenced offering
resold local phone service, long distance and Internet access to customers in
the area served by its Hybrid Fiber/Coaxial Cable System in the Lehigh Valley
area. The Company expects that certain customers served by such system will
be migrated to "on-net" connections over time.
Interconnection
Because access to the public switched telephone network is an
essential component of any regional or national telecommunications network,
interconnection is critical to RCN's ability to provide voice and data
services. Bell Atlantic and the other incumbent LECs and independent telephone
companies are required to provide interconnection to CLECs such as RCN
pursuant to the facilities-based interconnection requirements of Section 251
of the 1996 Act. Under the 1996 Act, the RBOC's ability to offer interLATA
long distance service is contingent upon their ability to create an
environment allowing economically-efficient competition in their local markets
for both business and residential services.
RCN has achieved interconnection through comprehensive
telephone service co-carrier interconnection agreements with Bell Atlantic and
Sprint-New Jersey covering their service areas in ten states and the District
of Columbia in the Northeast and New England-Middle Atlantic corridor areas.
These agreements will remain in effect regardless of the outcome of the
proceedings regarding the FCC's Section 251 regulations. RCN's interconnection
agreements with Bell Atlantic cover its service areas in the states of
Massachusetts, New York, Vermont, New Hampshire, Maine, Rhode Island,
Delaware, Maryland, New Jersey, Pennsylvania and Virginia and the District of
Columbia. The agreement with Sprint-New Jersey covers its service area in the
State of New Jersey. All of these agreements have been approved by the state
regulatory commissions pursuant to Section 252 of the Communications Act of
1934, as amended by the 1996 Act (the "Communications Act"). RCN believes it
has more interconnection agreements with incumbent LECs than any other company
focused primarily on the residential telecommunications market.
The terms of RCN's interconnection agreements with the
incumbent LECs include the following provisions: (i) interconnection at any
technically feasible point within their networks, equal in quality to what the
incumbent LEC provides to itself or to affiliates, (ii) exchange of all local
traffic at a fully reciprocal and identical rate; (iii) receipt by RCN of
access charges for long distance calls made to and from its customers,
including full "pass through" to RCN of such compensation on number
portability; (iv) interim number portability arrangements to allow customers
to keep their telephone numbers when they switch carriers; (v) unbundled
network elements, including local loop transmission from the incumbent LEC's
central offices to the customer's premises distinct from local switching or
other services; (vi) nondiscriminatory access to 911 and emergency 911
services; directory assistance services to allow RCN's customers to obtain
telephone numbers; operator call completion services and white pages directory
listings for RCN's customers; and (vii) access to the poles, ducts, conduits
and rights-of-way owned or controlled by the incumbent LEC at
nondiscriminatory rates. The interconnection agreements generally have an
initial term of three years and are cancellable thereafter at 90 days' notice.
Resale Arrangements
Resale of Bell Atlantic Local Telephone Services
RCN provides local telephone service on a resale basis to
customers not connected to the advanced fiber optic facilities. As of March
31, 1998, RCN had 40,447 customers for local telephone services provided
through agreements to act as a reseller of Bell Atlantic local telephone
services. RCN offers its resale customers competitive telephone rates and
RCN's superior customer service. Resale customers are billed by RCN and RCN
personnel provision customer service requests by coordinating with the
incumbent LECs on the customers' behalf.
RCN has entered into agreements to act as a reseller of Bell
Atlantic local telephone services, which enable RCN to grow its subscriber
base by offering telephone services in advance of connecting the customers to
an advanced fiber optic network. RCN's agreements with Bell Atlantic allow RCN
to purchase at a "wholesale" discount (the amount of which is determined by
regulatory commissions in each state) any telephone services that those
companies offer to their end users, such as local exchange services, vertical
features including Caller ID, Call Waiting, etc., and regional toll calls. The
agreements provide that RCN will be entitled to the most favorable terms and
conditions, including wholesale discounts, available to any telecommunications
carrier reselling similar services.
Long Distance Resale
RCN Long Distance Company provides long distance telephone
services, including private line, operator and calling card services, to
residential and business customers throughout the United States. Such services
are provided through an owned and leased switching network utilizing leased
interconnection facilities and long distance resale. RCN provides on network
origination and termination of long distance telephone services throughout the
Mid-Atlantic and New England states. For call origination and completion
throughout the rest of the country, RCN has various resale agreements.
Specifically, RCN has contracted with Level 3 for 800/888 origination,
Frontier for off network origination of outbound calling and various carriers
for terminating calls.
DirecTV
In October 1996, RCN signed an agreement with DirecTV to
deliver DirecTV's high-power direct broadcast satellite service to MDUs in New
York City. DirecTV allows RCN to offer an additional 175 channels of
programming including exclusive sports programming.
Customer Service and Billing
RCN has implemented a flexible, customer-service oriented
approach which RCN believes differentiates it from the mass-market strategy of
the incumbent providers. RCN provides customer service 24 hours a day, seven
days a week from established central call centers. The facilities utilize
state of the art technology which allows communication with subscribers, field
technicians and the Company's field offices. The largest of these facilities
is located in Dallas, Pennsylvania and handles the majority of the customer
service calls.
RCN's advanced fiber optic network is continuously monitored
for quality control and capacity issues, pursuant to a control system
featuring 16 alarm monitor points per hub site and automated housekeeping
alarms.
Billing services for video are provided by CableData while RCN
telephony billing services are provided by Consolidated Communications Systems
and Services. At the present time, RCN customers receive separate billing
statements for video and telephone service although RCN intends to offer a
single billing option in the future.
Account piracy is monitored by ongoing field audits and, in
RCN's advanced fiber optic networks, through use of state of the art
scrambling systems. Potential new customers are generally screened for credit
history before being authorized for service. RCN employs a full-time credit
and collection staff as well as a group that seeks to minimize toll fraud by
detecting and monitoring suspicious calling patterns.
Programming and Suppliers
RCN has secured license arrangements with all of its desired
programming suppliers, some of which provide volume discount pricing
structures and/or offer marketing support to the Company. Many of these
arrangements are extensions of long-standing agreements entered into by or on
behalf of the Company's hybrid fiber/coaxial cable systems, and some are newly
negotiated based upon RCN's OVS certifications. RCN has generally obtained
these license arrangements on terms and conditions that it considers
favorable.
RCN's programming arrangements include arrangements for basic
video channels, premium channels including multi-plexing, pay-per-view movies
and events, adult entertainment, electronic program guide services and digital
music services, as well as retransmission arrangements for relevant network
broadcasters.
The Company generally pays a monthly fee per subscriber per
channel for programming purchased from its suppliers. Programming costs
increase in the ordinary course of the Company's business as a result of
increases in the number of subscribers, expansion of the number of channels
provided to customers and contractual rate increases from programming
suppliers. The Company anticipates that future contract renewals for video
providers such as the Company will result in programming costs exceeding
current levels, particularly for sports programming.
A wide range of national manufacturers are the primary sources
of supplies, equipment and materials utilized in the development and
enhancement of the Company's networks. RCN has entered into Master Purchase
Agreements with certain equipment suppliers which enable it to purchase video
and switching equipment on terms which it considers favorable. The Company
anticipates that the costs for these supplies, equipment and materials will be
significant in future periods. The amount of such costs will depend on
numerous factors, many of which are beyond the Company's control.
RCN Long Distance Company
RCN Long Distance Company, a wholly owned subsidiary of RCN,
provides switched-based resale long distance services to customers on the
advanced fiber optic network as well as other customers. RCN Long Distance
Company operates the long distance business formerly operated by C-TEC, except
within the territory serviced by Commonwealth Telephone. During 1996, RCN
obtained certification in forty-seven states. RCN Long Distance Company also
provides local telephone service to commercial customers. As of March 31,
1998, RCN Long Distance Company had approximately 13,100 long distance
customers.
International
The Company owns a 40% interest in Megacable, the second
largest cable television provider in Mexico. Megacable owns 22 wireline cable
systems, and one multi-channel multipoint distribution service ("MMDS") cable
system, in Mexico, principally on the Pacific and Gulf coasts and including
Guadalajara, the second largest city in Mexico, Hermosillo, the largest city
in the state of Sonora and Veracruz, the largest city in the state of
Veracruz. At March 31, 1998 their wireline systems passed approximately 64,000
homes and served approximately 202,400 subscribers. Megacable had revenues of
$30.4 million and $23.2 million for the years ended December 31, 1997 and
1996, respectively and $9.2 million for the three months ended March 31, 1998.
Additionally, Megacable presently holds a 99% interest in
Megacable Comunicaciones de Mexico S.A. ("MCM"). MCM has received a license
from the Mexican government to allow it to build a fiber optic network in
Mexico City, Monterrey and Guadalajara. MCM intends to use this network to
provide local voice and high-speed data service in these cities, principally
to commercial customers in Mexico City.
Relationship Among Commonwealth Telephone, RCN and Cable Michigan
The Distribution Agreement defines certain aspects of the
relationship among Commonwealth Telephone, RCN and Cable Michigan and provides
for the allocation of certain assets and liabilities among Commonwealth
Telephone, RCN and Cable Michigan. Commonwealth Telephone, RCN and Cable
Michigan have also entered into a Tax Sharing Agreement dated as of September
5, 1997 (the "Tax Sharing Agreement" and together with the Distribution
Agreement, the "Distribution Documents") to define certain aspects of their
relationship with respect to taxes and to provide for the allocation of tax
assets and liabilities.
Indemnification
Commonwealth Telephone, RCN and Cable Michigan have agreed to
indemnify one another against certain liabilities. RCN has agreed to
indemnify Commonwealth Telephone and its subsidiaries at the time of the
Distribution (collectively, the "Commonwealth Telephone Group") and the
respective directors, officers, employees and affiliates of each person in the
Commonwealth Telephone Group (collectively, the "Commonwealth Telephone
Indemnitees") and Cable Michigan and its subsidiaries at the time of the
Distribution (collectively, the "Cable Michigan Group") and the respective
directors, officers, employees and affiliates of each person in the Cable
Michigan Group (collectively, the "Cable Michigan Indemnitees") from and
against any and all damage, loss, liability and expense ("Losses") incurred
or suffered by any of the Commonwealth Telephone Indemnitees or the Cable
Michigan Indemnitees, respectively, (i) arising out of, or due to the failure
of RCN or any of its subsidiaries at the time of the Distribution
(collectively, the "RCN Group") to pay, perform or otherwise discharge any of
the RCN Liabilities (as defined below), (ii) arising out of the breach by any
member of the RCN Group of any obligation under the Distribution Agreement or
any of the other Distribution Documents and (iii) in the case of the
Commonwealth Telephone Indemnitees, arising out of the provision by the
Commonwealth Telephone Group of the services described below to the RCN Group
except to the extent that such Losses result from the gross negligence or
willful misconduct of a Commonwealth Telephone Indemnitee. "RCN Liabilities"
refers to (i) all liabilities of the RCN Group under the Distribution
Agreement or any of the other distribution documents, (ii) all other
liabilities of Commonwealth Telephone, RCN or Cable Michigan (or their
respective subsidiaries), except as specifically provided in the Distribution
Agreement or any of the other Distribution Documents and whether arising
before, on or after the Distribution Date, to the extent such liabilities
arise primarily from or relate primarily to the management or conduct of the
RCN Businesses prior to the effective time of the Distribution (the
liabilities in clauses (i) and (ii) collectively, the "True RCN Liabilities")
and (iii) 30% of the Shared Liabilities (as defined below).
Cable Michigan has agreed to indemnify the RCN Group and the
respective directors, officers, employees and affiliates of each person in the
RCN Group (collectively, the "RCN Indemnitees") and the Commonwealth Telephone
Indemnitees from and against any and all Losses incurred or suffered by any of
the RCN Indemnitees or the Commonwealth Telephone Indemnitees, respectively,
(i) arising out of, or due to the failure of any person in the Cable Michigan
Group to pay, perform or otherwise discharge any of the Cable Michigan
Liabilities (as defined below), (ii) arising out of the breach by any member
of the Cable Michigan Group of any obligation under the Distribution Agreement
or any of the other distribution documents, (iii) in the case of the
Commonwealth Telephone Indemnitees, arising out of the provision by the
Commonwealth Telephone Group of services to the Cable Michigan Group except
to the extent that such Losses result from the gross negligence or willful
misconduct of a Commonwealth Telephone Indemnitee and (iv) in the case of the
RCN Indemnitees, arising out of the provision by RCN of the services described
below to the Cable Michigan Group except to the extent that such Losses result
from the gross negligence or willful misconduct of an RCN Indemnitee. "Cable
Michigan Liabilities" refers to (i) all liabilities of the Cable Michigan
Group under the Distribution Agreement or any of the other distribution
documents, (ii) all other liabilities of the Cable Michigan, RCN or
Commonwealth Telephone (or their respective subsidiaries), except as
specifically provided in the Distribution Agreement or any of the other
Distribution Documents and whether arising before, on or after the
Distribution Date, to the extent such liabilities arise primarily from or
relate primarily to the management or conduct of the business of the Cable
Michigan Group prior to the effective time of the Distribution (the
liabilities in clauses (i) and (ii) collectively, the "True Cable Michigan
Liabilities") and (iii) 20% of the Shared Liabilities (as defined below).
Commonwealth Telephone has agreed to indemnify the Cable
Michigan Indemnitees and the RCN Indemnitees from and against any and all
Losses incurred or suffered by any of the Cable Michigan Indemnitees or the RCN
Indemnitees, respectively, (i) arising out of, or due to the failure of any
person in the Commonwealth Telephone Group to pay, perform or otherwise
discharge any of the Commonwealth Telephone Liabilities (as defined below),
(ii) arising out of the breach by any member of the Commonwealth Telephone
Group of any obligation under the Distribution Agreement or any of the other
Distribution Documents and (iii) in the case of the RCN Indemnitees, arising
out of the provision by RCN of the services described below to the
Commonwealth Telephone Group except to the extent that such Losses result from
the gross negligence or willful misconduct of an RCN Indemnitee.
"Commonwealth Telephone Liabilities" refers to (i) all liabilities of the
Commonwealth Telephone Group under the Distribution Agreement or any of the
other distribution documents, (ii) all other liabilities of Cable Michigan,
RCN or Commonwealth Telephone (or their respective subsidiaries), except as
specifically provided in the Distribution Agreement or any of the other
Distribution Documents and whether arising before, on or after the
Distribution Date, to the extent such liabilities arise primarily from or
relate primarily to the management or conduct of the business of the
Commonwealth Telephone Group prior to the effective time of the Distribution
(the liabilities in clauses (i) and (ii) collectively, the "True Commonwealth
Telephone Liabilities") and (iii) 50% of the Shared Liabilities (as defined
below).
"Shared Liability" means any liability (whether arising before,
on or after the Distribution Date) of Commonwealth Telephone, RCN or Cable
Michigan or their respective subsidiaries which (i)(a) arises from the conduct
of the corporate overhead function with respect to Commonwealth Telephone and
its subsidiaries prior to the effective time of the Distribution with certain
exceptions or (b) is one of certain fees and expenses incurred in connection
with the Restructuring and (ii) is not a True Commonwealth Telephone
Liability, a True RCN Liability or a True Cable Michigan Liability.
RCN, Cable Michigan and Commonwealth Telephone have also
generally agreed to indemnify each other and each other's affiliates and
controlling persons from certain liabilities under the securities laws in
connection with certain information provided to shareholders in connection
with the Distribution.
The Distribution Agreement also includes procedures for notice
and payment of indemnification claims and provides that the indemnifying party
may assume the defense of claims or suits brought by third parties for
non-Shared Liabilities and may participate in the defense of claims or suits
brought by third parties for Shared Liabilities. RCN is entitled to assume
the defense of claims or suits brought by third parties for Shared
Liabilities. Any indemnification paid under the foregoing indemnities is to
be paid net of the amount of any insurance or other amounts that would be
payable by any third party to the indemnified party in the absence of such
indemnity.
The Company does not believe that any of the foregoing
indemnities will have a material adverse effect on the business, financial
condition or results of operations of the Company.
Employee Matters
Under the Distribution Agreement, RCN, Cable Michigan and
Commonwealth Telephone agreed generally to assume employee benefits-related
liabilities with respect to its current and, in some cases, former employees.
Each of RCN, Cable Michigan and Commonwealth Telephone also agreed to an
allocation of employee-related liabilities arising out of certain shared
operations prior to the Distribution on the same basis as Shared Liabilities
are allocated.
Services and Other Arrangements
RCN has agreed to provide or cause to be provided to the
Commonwealth Telephone Group the following services: (i) accounting, (ii)
payroll, (iii) management supervision, (iv) cash management, (v) human
resources and benefit plan administration, (vi) insurance administration,
(vii) legal, (viii) tax, (ix) internal audit, (x) investor and public
relations and (xi) other miscellaneous administrative services. The fee per
year for these services will be 3.5% of the first $175 million of revenue of
the Commonwealth Telephone Group and 1.75% of any additional revenue. The fee
for 1997 was $8,332,000.
RCN has also agreed to provide or cause to be provided to the
Cable Michigan Group certain specified services for a transitional period
after the Distribution. The transitional services to be provided are the
following: (i) customer service, (ii) marketing, (iii) accounting, (iv)
payroll, (v) management supervision, (vi) cash management, (vii) human
resources and benefit plan administration, (viii) insurance administration,
(ix) legal, (x) tax, (xi) internal audit, (xii) programming administration,
(xiii) billing, (xiv) monthly cable guides, (xv) investor and public
relations, (xvi) provision of third party programming, and (xvii) other
miscellaneous administrative services. Subject to certain limitations, the
fee per year for services listed in items (ii)-(xiii), (xv) and (xvii) will be
4.0% of the revenues of the Cable Michigan Group plus a direct allocation of
certain consolidated cable administration functions. The fee for customer
service listed in item (i) along with the billing service listed in item
(xiii) will be a pro rata share (based on the relative number of subscribers)
of the fees and expenses incurred by RCN to provide such customer billing
services and fees to the RCN Group and the Cable Michigan Group. The total
charge to Cable Michigan for such services rendered in 1997 was $6,740,000.
The third party expense incurred by RCN to obtain third party programming and
monthly cable guides for Cable Michigan referred to in items (xiv) and (xvi)
above, are reimbursed to RCN by Cable Michigan and no additional fee is
charged with respect thereto.
Commonwealth Telephone has agreed to provide or cause to be
provided to the RCN Group and the Cable Michigan Group financial data
processing applications, lockbox services, storage facilities, LAN and WAN
support services, building maintenance and other miscellaneous administrative
services for a transitional period after the Distribution. The fees for such
services and arrangements will be an allocated portion (based on relative
usage) of the cost incurred by Commonwealth Telephone to provide such services
and arrangements to all three groups.
The services will terminate upon 60 days notice by either the
service provider or the relevant service recipient, except that the billing,
customer service, programming administration and provision of third party
programming services provided by RCN to Cable Michigan may not be terminated
by RCN on less than one year advance notice to Cable Michigan. A service
recipient may also terminate individual services by giving 60 days notice to
the applicable service provider.
The aforementioned arrangements are not the result of arm's
length negotiation between unrelated parties as Cable Michigan, Commonwealth
Telephone and RCN have certain common officers and directors. Although the
transitional service arrangements in such agreements are designed to reflect
arrangements that would have been agreed upon by parties negotiating at arm's
length, there can be no assurance that Cable Michigan would not be able to
obtain similar services at a lower cost from unrelated third parties.
Additional or modified agreements, arrangements and transactions may be
entered into between the Cable Michigan and either or both of Commonwealth
Telephone and RCN after the Distribution, which will be negotiated at arm's
length.
Miscellaneous
The Distribution Agreement also contains provisions concerning
access to information and records and rights to technology, software,
intellectual property, know-how or other proprietary rights owned, licensed or
held for use by the respective Groups. The Distribution Agreement provides
that any dispute arising out of or in connection with the Distribution
Agreement will be submitted to arbitration in accordance with the procedures
described in the Agreement.
There exist relationships among Commonwealth Telephone, RCN and
Cable Michigan that may lead to conflicts of interest. Each of Commonwealth
Telephone, RCN and Cable Michigan is effectively controlled by Level 3 Telecom.
In addition, the majority of the Company's named executive officers will also be
acting as directors and/or executive officers of one or more group companies.
See "Risk Factors -- Control by Level 3 Telecom Holding, Inc.; Conflicts of
Interest." The success of the Company may be affected by the degree of
involvement of its officers and directors in the Company's business and the
abilities of the Company's officers, directors and employees in managing both
the Company and the operations of other group companies. Potential conflicts of
interest will be dealt with on a case-by-case basis taking into consideration
relevant factors including the requirements of NASDAQ and prevailing corporate
practices.
Tax Sharing Agreement
The Tax Sharing Agreement governs contingent tax liabilities
and benefits, tax contests and other tax matters with respect to tax returns
filed with respect to tax periods, in the case of Cable Michigan, ending or
deemed to end on or before the Distribution Date. Under the Tax Sharing
Agreement, Adjustments (as defined in the Tax Sharing Agreement) to taxes that
are clearly attributable to the Cable Michigan Group, the RCN Group, or the
Commonwealth Telephone Group will be allocated solely to such group.
Adjustments to all other tax liabilities will generally be allocated 50% to
Commonwealth Telephone, 20% to Cable Michigan and 30% to RCN.
Competition
Overview
RCN competes with a wide range of service providers for each of
the services that it provides. Virtually all markets for voice and video
services are extremely competitive, and RCN expects that competition will
intensify in the future. In each of the markets in which it offers voice and
video programming services, RCN faces significant competition often from
larger, better-financed incumbent local telephone carriers and cable
companies, and RCN often competes directly with incumbent providers which have
historically dominated their respective local telephone and cable television
markets. These incumbents presently have numerous advantages as a result of
their historic monopoly control of their respective markets. However, RCN
believes that most existing and potential competitors will, at least initially,
provide narrower service offerings over limited delivery platforms as compared
to the wide range of voice, video and data services that will be provided over
RCN's fiber-based networks, thereby providing RCN with an opportunity to
achieve important market penetration.
With respect to local telephone services, RCN competes with the
incumbent LECs, and alternative service providers including CLECs. Commercial
mobile radio services providers, including cellular carriers (such as Bell
Atlantic Mobile Services), personal communications services ("PCS") carriers
(such as Sprint Spectrum), and enhanced specialized mobile radio services
("ESMRS") providers (such as NexTel), may also become a source of competitive
local and long distance telephone service. However, RCN believes these
operators may primarily use competitive access services to transport their
calls among their radio transmitter/receiver sites through networks that avoid
the incumbent LECs with whom they compete.
With respect to long distance telephone services, RCN faces,
and expects to continue to face, significant competition from the IXCs,
including AT&T, Sprint and MCI, which account for the majority of all long
distance revenue. The major long distance service providers benefit from
established market share and from established trade names brought about by
nationwide advertising. RCN, however, regards its long-distance service as a
complementary service rather than a principal source of revenue. Certain IXCs,
including AT&T, MCI and Sprint, have also announced their intention to offer
local services in major U.S. markets using their existing infrastructure in
combination with resale of incumbent LEC service, lease of unbundled local
loops or other providers' services.
All of the Company's video services face competition from
alternative methods of receiving and distributing television signals and from
other sources of news, information and entertainment such as off-air
television broadcast programming, newspapers, movie theaters, live sporting
events, interactive online computer services and home video products,
including videotape cassette recorders. Among the alternative video
distribution technologies are home satellite dish earth stations ("HSDs")
which enable individual households to receive many of the satellite-delivered
program services formerly available only to cable subscribers. Furthermore,
the 1992 Act contains provisions, which the FCC has implemented with
regulations, to enhance the ability of cable competitors to purchase and make
available to HSD owners certain satellite-delivered cable programming at
competitive costs. RCN faces additional competition from private satellite
master antenna television ("SMATV") systems that serve condominiums, apartment
and office complexes and private residential developments. The FCC and
Congress have adopted policies providing a more favorable operating
environment for new and existing technologies that provide, or have the
potential to provide, substantial competition to the Company's various video
distribution systems. These technologies include, among others, DBS service
whereby signals are transmitted by satellite to receiving facilities located
on customer premises. The Company expects that its video programming services
will face growing competition from current and new DBS service providers. RCN
also competes with wireless program distribution services such as MMDS which
use low-power microwave frequencies to transmit video programming over-the-air
to subscribers. The Company is unable to predict whether wireless video
services will have a material impact on its operations.
Other new technologies, including Internet-based services, may
become competitive with services that RCN can offer. Advances in
communications technology as well as changes in the marketplace and the
regulatory and legislative environment are constantly occurring. Thus, it is
not possible to predict the effect that ongoing or future developments might
have on the voice, video and data industries or on the operations of the
Company.
RCN believes that among the existing competitors, the incumbent
LECs, incumbent cable providers and the CLECs provide the most direct
competition to RCN in the delivery of "last mile" connections for voice and
video services.
Incumbent LECs
In each of its target markets for advanced fiber optic
networks, RCN faces, and expects to continue to face, significant competition
from the incumbent LECs (including Bell Atlantic in New York City and Boston),
which currently dominate their local telephone markets. RCN competes with the
incumbent LECs in its markets for local exchange services on the basis of
product offerings (including the ability to offer bundled voice and video
services), reliability, state-of-the-art technology and superior customer
service, as well as price. RCN believes that its advanced fiber optic networks
provide superior technology for delivering high-speed, high-capacity voice,
video and data services as compared to the primarily copper wire based
networks of the incumbent LECs. However, the incumbent LECs (which have
long-standing relationships with their customers) have begun to expand the
amount of fiber facilities in their networks and to prepare to re-enter the
long distance telephone service market. The recently announced merger between
SBC and Ameritech may also potentially increase the competitive environment in
the Boston and Washington, D.C. corridor if SBC continues to pursue a
nationwide strategy.
In addition, under the 1996 Act, and ensuing federal and state
regulatory initiatives, barriers to local exchange competition are being
removed. The introduction of such competition, however, also establishes the
predicate for the incumbent RBOCs, such as Bell Atlantic, to provide in-region
interexchange long distance services. The incumbent RBOCs are currently
allowed to offer "incidental" long distance service in-region and to offer
out-of-region long distance service. Once the incumbent RBOCs are allowed to
offer in-region long distance services, they will also be in a position to
offer single source local and long distance service similar to that offered by
RCN and proposed by the three largest IXCs (AT&T, MCI and Sprint). The Company
expects that the increased competition made possible by regulatory reform will
result in certain pricing and margin pressures in the telecommunications
services business.
RCN has sought, and will continue to seek, to provide a full
range of local voice services in competition with incumbent LECs in its
service areas. The Company expects that competition for local telephone
services will be based primarily on quality, capacity and reliability of
network facilities, customer service, response to customer needs, service
features and price, and will not be based on any proprietary technology. As a
result of the comparatively recent installation of RCN's advanced fiber optic
networks, its dual path architecture and the state-of-the-art technology used
in its networks, RCN may have capital cost and service quality advantages over
some currently available local networks relied upon by the incumbent LECs, as
well as the competitive advantage provided by the ability to deliver a bundled
voice and video service.
The 1996 Act permits the incumbent LECs and others to provide a
wide variety of video services directly to subscribers in competition with
RCN. Various LECs currently are providing video services within and outside
their telephone service areas through a variety of distribution methods,
including both the deployment of broadband wire facilities and the use of
wireless transmission facilities. The Company cannot predict the likelihood of
success of video service ventures by LECs or the impact on the Company of such
competitive ventures.
Incumbent Cable Television Service Providers
Certain of RCN's video service businesses compete with
incumbent wireline cable companies in their respective service areas. In
particular, RCN's advanced fiber optic networks compete for cable subscribers
with the major wireline cable operators in New York City and Boston, primarily
Time-Warner Cable in New York City and Cablevision in Boston. RCN's wireless
video service in New York City competes primarily with Time-Warner Cable. RCN
believes that the expanded capacity and fiber-to-node architecture of its
advanced fiber optic networks in New York City and Boston make it better
equipped to provide high-capacity communications services than coaxial cable
based networks utilizing "tree and branch" architecture. RCN's Pennsylvania
hybrid fiber/coaxial cable television system competes with an alternate
service provider, Service Electric, which also holds a franchise for the
relevant service area.
Since cable television systems generally operate pursuant to
franchises granted on a non-exclusive basis, and the 1992 Act prohibits
franchising authorities from unreasonably denying requests for additional
franchises and permits franchising authorities to operate cable systems,
well-financed businesses from outside the cable industry (such as the public
utilities that own certain of the poles on which cable is attached) may become
competitors for franchises or providers of competing services.
CLECs and Other Competitors
RCN also faces, and expects to continue to face, competition
from other potential competitors in certain of the markets in which RCN offers
its services. Other CLECs, such as Teleport Communications Group, compete for
local telephone services, although they have to date focused primarily on the
market for commercial customers rather than residential customers. In
addition, potential competitors capable of offering private line and special
access services also include other smaller long distance carriers, cable
television companies, electric utilities, microwave carriers, wireless
telephone system operators and private networks built by large end-users,
including Winstar, Dualstar and New Vision. However, RCN believes that, at
least initially, it is relatively unique in its markets in offering bundled
voice, video and data services to customers in residential areas, and in
striving to connect residential customers directly to its advanced fiber optic
network.
Internet Services
The market for Internet access services is extremely
competitive and highly fragmented. No significant barriers to entry exist, and
accordingly competition in this market is expected to intensify. The Company
competes (or in the future may compete) directly or indirectly with (i)
national and regional ISPs; (ii) established online services; (iii) computer
software and technology companies; (iv) national telecommunications companies;
(v) LECs; (vi) cable operators; and (vii) nonprofit or educational ISPs, and
some of these present or potential future competitors have or can be expected
to have substantially greater market presence and financial, technical,
marketing and other resources than the Company. Certain of the Company's
online competitors, including America Online, the Microsoft Network and
Prodigy, have introduced unlimited access to the Internet and their
proprietary content at flat rates, and certain of the LECs have also
introduced competitive flat-rate pricing for unlimited access (without a
set-up fee for at least some period of time). Bell Atlantic has recently filed
with the FCC a petition for an exemption from a regulation prohibiting it from
building a high-speed network. Bell Atlantic's petition requests that such
network, which would serve as an Internet backbone, not be subject to pricing
and other regulatory restriction. The network would span the states from Maine
to Virginia. There can be no assurance that competition will not lead to
pricing pressures in the Internet business. For additional information on the
competitive environment in which the Company operates, see
"Business--Competition."
Other new technologies may become competitive with services
that RCN can offer. Cellularvision, a provider of LMDS, recently began
offering wireless Internet and video programming services in New York City and
has announced plans to offer telephone service in the future. Advances in
communications technology as well as changes in the marketplace and the
regulatory and legislative environment are constantly occurring. In addition,
a continuing trend toward business combinations and alliances in the
telecommunications industry may also create significant new competitors to
RCN. The Company cannot predict whether competition from such developing and
future technologies or from such future competitors will have a material
impact on its operations.
Regulation
The telephone and video programming transmission services
offered by the Company are subject to federal, state and local government
regulation. The 1996 Act, which became effective in February 1996, introduced
widespread changes in the regulation of the communications industry, including
the local telephone, long distance telephone, data services, and television
entertainment segments in which the Company operates. The 1996 Act was
intended to promote competition and decrease regulation of these segments of
the industry. The law delegates to both the FCC and the states broad
regulatory and administrative authority to implement the 1996 Act.
Telecommunications Act of 1996
The 1996 Act eliminates many of the pre-existing legal barriers
to competition in the telephone and video programming communications
businesses, preempts many of the state barriers to local telephone service
competition that previously existed in state and local laws and regulations,
and sets basic standards for relationships between telecommunications
providers.
Among other things, the 1996 Act removes barriers to entry in
the local exchange telephone market by preempting state and local laws that
restrict competition and by requiring LECs to provide nondiscriminatory access
and interconnection to potential competitors, such as cable operators,
wireless telecommunications providers, and long distance companies. In
addition, the 1996 Act provides relief from the earnings restrictions and
price controls that have governed the local telephone business for many years.
The 1996 Act will also, once certain thresholds are met, allow incumbent RBOCs
to enter the long distance market within their own local service regions.
Regulations promulgated by the FCC under the 1996 Act require
LECs to open their telephone networks to competition by providing competitors
interconnection, access to unbundled network elements and retail services at
wholesale rates. As a result of these changes, companies such as RCN are now
able to interconnect with the incumbent LECs in order to provide local
exchange services. Numerous parties appealed certain aspects of these
regulations, and the appeals were consolidated in the United States Court of
Appeals for the Eighth Circuit. On July 18, 1997, the Eighth Circuit found
constitutional challenges to certain practices implementing cost provisions of
the Telecommunications Act that were ordered by certain state PUCs to be
premature; vacated significant portions of the FCC's nationwide pricing rules;
and confined the use of combined unbundled network elements to instances where
the requesting carrier itself would do the combining. On October 14, 1997, the
Eighth Circuit issued a decision vacating additional FCC rules that will
likely have the effect of increasing the cost of obtaining the use of
combinations of an incumbent LEC's unbundled network elements. On January 26,
1998, the Supreme Court granted a writ of certiorari under which it will
review the July 18 Eighth Circuit decision; it is expected (but not yet
certain) that the Court will hear arguments on this case in the fall of 1998.
The Eighth Circuit decisions create uncertainty about the rules governing
pricing and terms and conditions of interconnection agreements, and could make
negotiating and enforcing such agreements more difficult and protracted and
may require renegotiation of existing agreements. Prior to the Eighth Circuit
decisions, the Company had entered into interconnection agreements with Bell
Atlantic, covering all of its target market area, that are generally
consistent with the FCC guidelines, and those agreements remain in effect
notwithstanding the reversal of the FCC rules. There can be no assurance,
however, that the Company will be able to obtain or enforce future
interconnection agreements, or obtain renewal of existing agreements, on terms
acceptable to the Company.
Certain RBOCs have also raised constitutional challenges to
restrictions in the 1996 Act preventing BOCs from entering the long distance
market in their home region. On December 31, 1997, the U.S. District Court for
the Northern District of Texas issued the SBC Decision finding that Sections
271 to 275 of the 1996 Act are unconstitutional. These sections of the Act
impose restrictions on the lines of business in which the RBOCs may engage,
including establishing the conditions they must satisfy before they may
provide in-region interLATA telecommunications services. The District Court
has stayed the SBC Decision pending appeal. If the stay is lifted, the RBOCs
(including Bell Atlantic, which was permitted to intervene in the case) would
be able to provide interLATA services immediately without satisfying the
statutory conditions. Although the Company believes the factual assumptions
and legal reasoning in the SBC Decision are erroneous and therefore the
decision will likely be reversed on appeal, there can be no assurance of this
outcome. If the SBC Decision were upheld on appeal it may have an unfavorable
effect on the Company's business for at least two reasons. First, RBOCs
currently have an incentive to foster competition within their service areas so
that they can qualify to offer interLATA services. The SBC Decision removes
this incentive by allowing RBOCs to offer interLATA service without regard to
their progress in opening their local markets to competition. However, the SBC
Decision would not affect other provisions of the Act which create legal
obligations for all incumbent LECs to offer interconnection and network
access, and therefore will not impair the Company's ability to compete in local
exchange markets. Second, the Company is legally able to offer its customers
both long distance and local exchange services, which the RBOCs currently may
not do. This ability to offer "one-stop shopping" gives the Company a
marketing advantage that it would no longer enjoy if the SBC Decision were
upheld on appeal. The Company cannot predict either the outcome of these or
future challenges to the 1996 Act, any related appeal of regulation or court
decision, or the eventual effect on its business or the industry in general.
The 1996 Act also makes far-reaching changes in the regulation
of the video programming transmission services offered by RCN, including
changes to the regulations applicable to video operators, the elimination of
restrictions on telephone company entry into the video business, and the
establishment of a new OVS regulatory structure for telephone companies and
others to offer such services. Under the 1996 Act, local telephone companies,
including both incumbent LECs such as Bell Atlantic, and CLECs such as RCN,
may provide service as traditional cable television operators subject to
municipal cable television franchises, or they may opt to provide their
programming over non-franchised open video systems subject to certain
conditions, including, but not limited to, making available a portion of their
channel capacity for use by unaffiliated program distributors and satisfying
certain other requirements, including providing capacity for public,
educational and government channels, and payment of a gross receipts fee
equivalent to the franchise fee paid by the incumbent cable television
operator. RCN is one of the first CLECs to provide television programming over
an advanced fiber optic network pursuant to the OVS regulations implemented by
the FCC under the 1996 Act. As discussed below, RCN is currently providing OVS
service in the City of Boston, in the City of New York and in a number of
communities surrounding Boston. Starpower is negotiating similar agreements in
Washington and surrounding communities.
Regulation of Voice Services
RCN's voice business is subject to regulation by the FCC at the
federal level with respect to interstate telephone services (i.e., those that
originate in one state and terminate in a different state). State regulatory
commissions have jurisdiction over intrastate communications (i.e., those that
originate and terminate in the same state).
State Regulation of Intrastate Local and Long Distance
Telephone Services. RCN's intrastate telephone services are regulated by the
public service commissions or comparable agencies of the various states in
which these services are offered. RCN subsidiaries have received either
permanent or interim authority to offer intrastate telephone services,
including local exchange service, in Massachusetts, New York, Pennsylvania,
Maryland, the District of Columbia, and Virginia (as well as in some
neighboring jurisdictions where the Company does not currently operate but may
expand in the future) and RCN has applied for authority to offer such services
in New Hampshire. Starpower has separately obtained similar authority in
Maryland, Virginia and the District of Columbia. RCN's resale agreements with
Bell Atlantic have been approved, pursuant to Section 252 of the
Communications Act, by state regulatory commissions in Delaware, the District
of Columbia, Maine, Maryland, Massachusetts, New York, New Jersey, New
Hampshire, Pennsylvania, Rhode Island, Vermont, and Virginia.
RCN Long Distance Company is authorized to offer intrastate
long distance services in Pennsylvania, New York, Massachusetts and 45 other
states nationwide. Pursuant to such authorizations, RCN Long Distance Company
is permitted to resell intrastate long distance services both to other
carriers, including RCN's local operating subsidiaries and Starpower for
resale to their end user subscribers, and to its own end user customers.
FCC Regulation of Interstate and International Telephone
Services. RCN, through several of its subsidiaries, including RCN Long
Distance Company, may also provide domestic interstate telephone services
nationwide pursuant to tariffs on file at the FCC, and has been authorized by
the FCC under Section 214 of the 1996 Act to offer worldwide international
services as well.
Local Regulation of Telephone Services. Municipalities also
regulate limited aspects of RCN's voice business by, for example, imposing
various zoning requirements and, in some instances, requiring
telecommunications licenses, franchise agreements and/or installation permits
for access to local streets and rights-of-way. In New York City, for example,
RCN will be required to obtain a telephone franchise in order to provide voice
services using its advanced fiber optic network facilities located in the
streets of New York City (although services may be provided over certain
leased or resold facilities pending receipt of a franchise).
Regulation of Video Services
Open Video Systems. In February 1997, RCN subsidiaries were
certified to operate OVS networks in the five boroughs of New York City and,
as part of the BECO joint venture, in Boston and 47 surrounding communities.
Initiation of OVS services is subject to completion of an open enrollment
period for non-affiliated video programmers to seek capacity on the systems
and upon negotiation of certain agreements with local governments. The initial
open enrollment period for both the New York City and Boston area systems has
expired. RCN executed an agreement with the City of Boston on June 2, 1997,
and initiated OVS service in the City on that day. Pursuant to its agreement
with the City of Boston, RCN will be required to pay a fee to the City equal
to 5% of video revenues. RCN has entered into similar OVS agreements or is in
the process of negotiating agreements with certain other Boston-area
municipalities, either to offer OVS services or franchised cable television
services. RCN executed an agreement with the City of New York on December 29,
1997 and has initiated OVS service in the Borough of Manhattan pursuant to
that agreement.
In areas where it offers video programming services as an OVS
operator, RCN is required to hold a 90-day open enrollment period every three
years, during which times RCN will be required to offer capacity on its
network to other VPPs. Under the OVS regulations, RCN must offer at least
two-thirds of its capacity to unaffiliated parties, if demand for such
capacity exists during the open enrollment period. In certain areas, RCN is in
discussions with local municipal authorities to explore the feasibility of
obtaining a cable franchise in lieu of an OVS agreement, and will consider
providing RCN video service pursuant to franchise agreements rather than OVS
certification, if franchise agreements can be obtained on terms and conditions
acceptable to RCN. The Company will consider the relative benefits of OVS
certification versus local franchise agreements, including the possible
imposition of universal service requirements, before making any such
decisions. In addition, the current FCC rules concerning OVS are subject to
appeal in the United States Court of Appeals for the Fifth Circuit; if certain
aspects of the FCC's rules are overturned on appeal, the determination of
whether to operate as an OVS provider versus as a franchised cable television
operator may be affected. Moreover, the incumbent cable television provider in
Boston, Cablevision Systems, has requested that the FCC permit it to obtain
capacity on and information about RCN's Boston area OVS network, and Time
Warner, the incumbent cable television provider in certain communities in the
Boston area, has made a similar filing at the FCC with respect to its request
for capacity on and information about the Boston OVS network. In a Memorandum
Opinion Order released on April 28, 1998, the FCC's Cable Services Bureau
granted in part and denied in part Time Warner's petition. RCN has notified
the FCC that it will seek review of certain aspects of this order. RCN will
continue to oppose these requests, but to the extent that the FCC were to
grant any such request(s), such a result would likely affect the Company's
determination as to whether to operate as an OVS provider versus as a
franchised cable television operator.
Prior to its certification as an OVS provider, RCN offered
limited video programming services using the VDT services offered by
MFS/WorldCom in Manhattan and the City of Boston. In February 1997, the FCC
held that MFS/WorldCom's facilities did not qualify as video dialtone
facilities entitled to an extension of time to comply with the newly adopted
OVS rules; nonetheless, the FCC did not direct MFS/WorldCom and RCN to cease
video programming distribution operations over the MFS/WorldCom platform. One
of the incumbent cable television companies in New York City has filed a
complaint with the New York Public Service Commission challenging the former
(pre-OVS) operations of RCN and WorldCom under the VDT framework, which
remains pending before that commission.
Wireless Video Services. RCN's 18 GHz wireless video services
in New York City are distributed using microwave facilities provided by
Bartholdi Cable pursuant to temporary authorizations issued to Bartholdi Cable
by the FCC. Bartholdi Cable has agreed to provide transmission services to RCN
until RCN has either converted the wireless video subscribers to its advanced
fiber optic network facilities or has obtained FCC authority to provide such
services pursuant to its own wireless radio licenses. In addition, Bartholdi
Cable has agreed to transfer to RCN the transmission equipment on demand.
Bartholdi Cable's obligation to provide transmission services is subject to
Bartholdi Cable having licenses from the FCC to provide such services. The
qualifications of Bartholdi Cable to hold certain of the licenses needed to
provide transmission services to RCN are at issue in an FCC proceeding in
which an Initial Decision was released on March 6, 1998. In the Initial
Decision, the Administrative Law Judge found Bartholdi Cable unqualified with
respect to 15 such licenses. The Administrative Law Judge declared that the
Initial Decision would become effective 50 days after its release unless
Bartholdi Cable filed exceptions to the Initial Decision within 30 days of its
release or the FCC elected to review the case on its own motion. Bartholdi
Cable filed exceptions to the Initial Decision on April 7, 1998. Because of
the uncertainty as to Bartholdi Cable's right in the future to offer
transmission services to RCN, the Company filed its own license applications
at the FCC for all of the microwave transmission paths which are currently
being used by Bartholdi Cable to provide transmission services to RCN and, in
light of the increased uncertainties resulting from the Initial Decision in
the FCC proceeding involving certain of Bartholdi Cable's licenses, the
Company expects now actively to pursue its license applications. While the
Company expects to receive authorizations to transmit over these microwave
paths, there can be no assurance that RCN will be able to offer wireless video
services pursuant to its own FCC licenses or that the FCC's investigation will
be resolved favorably. The failure to obtain such license or resolve such
proceedings would materially adversely affect the Company's wireless video
operations in New York City.
There can be no assurance that RCN will be able to obtain or
retain all necessary authorizations needed to construct advanced fiber optic
network facilities, to convert its wireless video subscribers to an advanced
fiber optic network or to offer wireless video services pursuant to its own
FCC licenses.
Hybrid Fiber/Coaxial Cable. RCN's hybrid fiber/coaxial cable
systems are subject to regulation under the 1992 Act, which provides, among
other things, for rate regulation for cable services in communities that are
not subject to "effective competition," certain programming requirements, and
broadcast signal carriage requirements that allow local commercial television
broadcast stations to require a cable system to carry the station. Local
commercial television broadcast stations may elect once every three years to
require a cable system to carry the station ("must-carry"), subject to certain
exceptions, or to withhold consent and negotiate the terms of carriage
("retransmission consent"). A cable system generally is required to devote up
to one-third of its activated channel capacity for the carriage of local
commercial television stations whether pursuant to the mandatory carriage or
retransmission consent requirements of the 1992 Act. Local non-commercial
television stations are also given mandatory carriage rights. The FCC recently
issued rules establishing standards for digital television ("DTV"). Among
other provisions, the FCC's rules require television stations to simulcast
their NTSC and DTV signals for a period of years. During this simulcast
period, it is unclear whether must-carry rules will apply to DTV signals. The
Communications Act permits franchising authorities to require cable operators
to set aside certain channels for public, educational and governmental access
programming. Cable systems with 36 or more channels must designate a portion
of their channel capacity for commercial leased access by third parties to
provide programming that may compete with services offered by the cable
operator.
On September 8, 1997, the Company was notified by the FCC that
it has ruled that certain of the Company's upper levels of service for its New
Jersey systems are regulated levels of service and that the Company's rates
for such levels of service have exceeded the allowable rates under the FCC
rate regulation rules which have been effective since September 1993. The
Company had treated these levels of service as unregulated. The Company
intends to contest this decision. The Company does not believe that the
ultimate resolution of this matter will have a material impact on its results
of operations or financial condition.
Because a cable communications system uses local streets and
rights-of-way, such cable systems are generally subject to state and local
regulation, typically imposed through the franchising process. The terms and
conditions of state or local government franchises vary materially from
jurisdiction to jurisdiction and generally contain provisions governing cable
service rates, franchise fees, franchise term, system construction and
maintenance obligations, customer service standards, franchise renewal, sale
or transfer of the franchise, territory of the franchisee and use and occupancy
of public streets and types of cable services provided. Local franchising
authorities (state or local, depending on the practice in individual states)
may award one or more franchises within their jurisdictions and prohibit
non-grandfathered cable systems from operating without a franchise in such
jurisdictions. The Communications Act also provides that in granting or
renewing franchises, local authorities may establish requirements for
cable-related facilities and equipment, but not for video programming or
information services other than in broad categories. The Communications Act
limits the payment of franchise fees to 5% of revenues derived from cable
operations and permits the cable operator to obtain modification of franchise
requirements by the franchise authority or judicial action if warranted by
changed circumstances.
RCN's ability to provide franchised cable television services
is dependent to a large extent on its ability to obtain and renew its
franchise agreements from local government authorities on generally acceptable
terms. RCN currently has 91 franchise agreements relating to the hybrid
fiber/coaxial cable systems in New York (outside New York City), New Jersey
and Pennsylvania. These franchises typically contain many conditions, such as
time limitations on commencement and completion of construction, conditions of
service, including the number of channels, the provision of free service to
schools and certain other public institutions, and the maintenance of
insurance and indemnity bonds. These franchises provide for the payment of
fees to the issuing authorities and generally range from 3% to 5% of revenues.
The duration of these outstanding franchises presently varies up to the year
2011. To date, all of RCN's cable franchises have been renewed or extended,
generally at or prior to their stated expirations and on acceptable terms.
Approximately 39 of RCN's hybrid fiber/coaxial cable systems' franchises are
due for renewal within the next three years. No assurance can be given that
RCN will be able to renew its franchises on acceptable terms. No one franchise
accounts for more than 7% of RCN's total revenue. RCN's five largest
franchises account for approximately 27% of RCN's total revenue.
The hybrid fiber/coaxial cable systems are also subject to
certain service quality standards and other obligations imposed by the FCC
and, where effective competition has not been demonstrated to exist, to rate
regulation by the FCC as well. RCN's cable television system in Pennsylvania
has been operating in a competitive cable environment for almost 30 years,
with approximately 80% of the homes passed having access to an alternate cable
operator, Service Electric Cable TV. As a result, the Company's Pennsylvania
cable system is exempt from many FCC cable television regulations, including
rate regulation. Its other cable television systems in New York State and New
Jersey currently remain subject to FCC rate regulation. With the passage of
the 1996 Act, however, all cable systems rates will be deregulated as
effective competition is shown to exist in the franchise area, or by March 31,
1999, whichever date is sooner. RCN anticipates that the remaining provisions
of the 1992 Act that do not relate to rate regulation, such as the provisions
relating to retransmission consent and customer service standards, will remain
in place and may serve to reduce the future operating margins of RCN's hybrid
fiber/coaxial cable television businesses as video programming competition
develops in its cable television service markets.
The Communications Act requires the FCC to regulate the rates,
terms and conditions imposed by public utilities for cable systems' use of
utility pole and conduit space unless state authorities can demonstrate that
they adequately regulate pole attachment rates. In the absence of state
regulation, the FCC administers pole attachment rates on a formula basis. In
some cases, utility companies have increased pole attachment fees for cable
systems that have installed fiber optic cables and that are using such cables
for the distribution of non-video services. The FCC concluded that, in the
absence of state regulation, it has jurisdiction to determine whether utility
companies have justified their demand for additional rental fees and that the
Communications Act does not permit disparate rates based on the type of service
provided over the equipment attached to the utility's pole. The 1996 Act and
the FCC's implementing regulations modify the current pole attachment
provisions of the Communications Act by immediately permitting certain
providers of telecommunications services to rely upon the protections of the
current law and by requiring that utilities provide cable systems and
telecommunications carriers with nondiscriminatory access to any pole, conduit
or right-of-way controlled by the utility. The FCC has recently adopted new
regulations to govern the charges for pole attachments used by companies
provided telecommunications services, including cable operators. These new
pole attachment rate regulations will become effective five years after
enactment of the 1996 Act, and any increase in attachment rates resulting from
the FCC's new regulations will be phased in equal annual increments over a
period of five years beginning on the effective date of the new FCC
regulations. The ultimate outcome of these rulemakings and the ultimate impact
of any revised FCC rate formula or of any new pole attachment rate regulations
on the Company or its businesses cannot be determined at this time.
The 1992 Act, the 1996 Act and FCC regulations preclude any
satellite video programmer affiliated with a cable company, or with a common
carrier providing video programming directly to its subscribers, from favoring
an affiliated company over competitors and require such programmers to sell
their programming to other multichannel video distributors. These provisions
limit the ability of program suppliers affiliated with cable companies or with
common carriers providing satellite delivered video programming directly to
their subscribers to offer exclusive programming arrangements to their
affiliates. The Communications Act also includes provisions, among others,
concerning horizontal and vertical ownership of cable systems, customer
service, subscriber privacy, marketing practices, equal employment
opportunity, obscene or indecent programming, regulation of technical
standards and equipment compatibility.
In addition to the FCC regulations noted above, there are other
FCC regulations covering such areas as equal employment opportunity,
syndicated program exclusivity, network program non-duplication, registration
of cable systems, maintenance of various records and public inspection files,
microwave frequency usage, lockbox availability, sponsorship identification,
antenna structure notification, tower marking and lighting, carriage of local
sports broadcast programming, application of rules governing political
broadcasts, limitations on advertising contained in non-broadcast children's
programming, consumer protection and customer service, ownership of home
wiring, indecent programming, programmer access to cable systems, programming
agreements, technical standards, consumer electronics equipment compatibility
and closed captioning. The FCC has the authority to enforce its regulations
through the imposition of substantial fines, the issuance of cease and desist
orders and/or the imposition of other administrative sanctions, such as the
revocation of FCC licenses needed to operate certain transmission facilities
often used in connection with cable operations.
Other bills and administrative proposals pertaining to cable
television have previously been introduced in Congress or considered by other
governmental bodies over the past several years. It is probable that there
will be legislative proposals in the future by Congress and other governmental
bodies relating to the regulation of communications services.
Cable television systems are subject to federal compulsory
copyright licensing covering the retransmission of television and radio
broadcast signals. In exchange for filing certain reports and contributing a
percentage of their basic revenues to a federal copyright royalty pool, cable
operators can obtain blanket licenses to retransmit the copyrighted material
on broadcast signals.
The data services business, including Internet access, is
largely unregulated at this time (apart from Federal, state, and local laws
and regulations applicable to businesses in general). However, there can be no
assurance that this business will not become subject to regulatory restraints.
Some jurisdictions have sought to impose taxes and other burdens on providers
of data services, and to regulate content provided via the Internet and other
information services. RCN expects that proposals of this nature will continue
to be debated in Congress and state legislatures in the future. In addition,
although the FCC has on several occasions rejected proposals to impose
additional costs on providers of Internet access service and other data
services to the extent they use local exchange telephone network facilities for
access to their customers, similar proposals may well be considered by the FCC
or Congress in the future.
The foregoing does not purport to describe all present and
proposed federal, state, and local regulations and legislation affecting the
telephone and video programming industries. Other existing federal
regulations, copyright licensing, and, in many jurisdictions, state and local
franchise requirements, are currently the subject of judicial proceedings,
legislative hearings and administrative proposals which could change, in
varying degrees, the manner in which communications companies operate. The
ultimate outcome of these proceedings, and the ultimate impact of the 1996 Act
or any final regulations adopted pursuant to the new law on RCN or its
businesses cannot be determined at this time.
Employees
As of March 31, 1998, the Company had 1,606 full-time employees
including general office and administrative personnel. The Company considers
relations with its employees to be good.
Properties
Overview of Advanced Fiber Optic Networks
RCN's advanced fiber optic networks in Boston and New York City
are, and RCN expects that its future networks will be, designed to support
voice, video and data services via a switched, fiber-rich network
architecture. The Company's full service advanced fiber optic networks in
Boston and New York City consist of owned or leased fiber optic cables, local
and long distance digital switches, video headends, video and voice
transmission and distribution equipment and associated wiring and network
termination equipment. The Company's local telephone switching network
(consisting of Lucent 5ESS-2000 switches) is installed and fully operational
in Boston and in New York City. The networks' leased fiber optic cables make
up the fiber backbone, which acts as the common signal transport medium for
both digital signals (voice and data) and analog signals (video). In both New
York City and Boston, the digital backbone transmission network utilizes
synchronous optical network ("SONET") self-healing rings that provide high
speed, redundant connections for the delivery of RCN's voice and data
services. Facility connections from the backbone network to individual
buildings or service areas are provided by either leased facilities provided
by MFS/WorldCom, BECO or the incumbent LEC, or through RCN-owned fiber. This
fiber backbone includes over 5,267 fiber miles in New York City and over 9,347
fiber miles in Boston. RCN owns two switches (one in Boston and one in New York
City) and two General Instrument video headends that are installed and in
service in both Boston and New York City. As of December 31, 1997, RCN had
connected 493 buildings (424 in NYC and 69 in Boston) to its facilities.
Fiber optic systems are suitable for transmission of digitized
voice, data, video or a combination of these types of information. The main
benefits of deploying fiber in place of traditional coaxial cable or copper
wire result from its greater capacity, increased functionality, smaller size
and decreased requirements for periodic amplification of the signal. These
factors contribute to lower installation and maintenance costs and increase
the variety and quality of the service offerings. The inherent bandwidth
limitations of twisted pair copper wire historically used in telephone networks
present a substantial obstacle to the use of existing telephone networks to
provide video programming services. Although coaxial cable provides
substantially greater bandwidth than twisted pair copper wire, fiber optic
cable provides substantially greater bandwidth than coaxial cable.
Consequently, newly constructed fiber networks such as RCN's provide a
superior platform for delivering high speed, high capacity voice, video and
data services as compared to systems based on copper wire or coaxial cable
networks.
The fiber cable utilized by RCN's networks has the increased
capacity and bandwidth necessary for complex data and video transmission. The
fiber optic cable typically contains between 12 and 288 fiber strands, each of
which is capable of providing many telecommunications channels or "circuits."
Depending on transmission electronics, a single pair of glass fibers on RCN's
networks currently can transmit tens of thousands of simultaneous voice
conversations, whereas even with multiplexing equipment a typical pair of
copper wires can carry a maximum of 24 simultaneous conversations. Although
the LECs commonly use copper wire in their networks, they are currently
deploying fiber optic cable to upgrade portions of their copper based network,
particularly in areas served by RCN. RCN expects that continuing development
in communications equipment will increase the capacity of each optical fiber,
thereby providing even more capacity at relatively low incremental cost.
As the Company's network is further developed, it will be
dependent on certain strategic alliances and other arrangements in order to
provide the full range of its telecommunication service offerings. These
relationships include RCN's arrangements with MFS/WorldCom to lease portions
of MFS/WorldCom's fiber optic network in New York City and Boston, RCN's joint
venture with BECO under which the Company has access to BECO's extensive fiber
optic network in Greater Boston, the Starpower joint venture with Pepco
Communications, a subsidiary of PEPCO, and RCN's arrangements to lease Bell
Atlantic unbundled local loop and T-1 facilities. See "--Strategic
Relationships" and "--Voice Services-- Advanced Fiber Optic Networks." Any
disruption of these arrangements and relationships could have a material
adverse effect on the Company.
Voice Services
Advanced Fiber Optic Networks. The Company's advanced fiber
optic networks in New York City and Boston utilize a voice network that
supports both switched and non-switched (private line) services. Individual
buildings are connected to the network backbone via fiber extensions that are
generally terminated on SONET equipment, which provide redundant and fail-safe
interconnection between the building and the RCN central office or switch
location. In situations where fiber extensions are not yet available, interim
facility connections can be provided by leasing special access facilities
through a leasing arrangement with MFS/WorldCom or the incumbent LEC. In this
regard, RCN has in place arrangements which allow it to lease certain
facilities owned by the incumbent LECs (unbundled local loops and T-1
facilities) to provide voice services. This enables RCN to provide voice and
data services to off-net subscribers who are not physically connected to RCN's
advanced fiber optic network. As RCN's network expands to reach more areas
within a target market, subscribers served by these temporary connections will
be migrated to RCN's advanced fiber optic network. Within a building (or small
grouping of buildings) a voice service hub is established by installing an
Integrated Digital Loop Carrier ("IDLC") device, which acts as the point of
interface between the SONET backbone facility and the intra-building wiring.
Each IDLC is installed with a standby power system and is capable of serving
up to 672 lines. The IDLC is capable of supporting a wide range of both
non-switched services (DS-1, digital data) and switched voice services and
features including ISDN, Custom Calling and CLASS features. Within each
building, internal wiring (twisted pair copper cable) connects the IDLC to the
customer premises and the customer-owned telephone equipment. In certain
instances, voice service is extended to other buildings in the building group
or cluster via either fiber optic cable or twisted pair copper cable. At the
time of initial wiring, RCN generally installs wiring in excess of its initial
requirements, in order to meet future subscriber demand.
Video Programming
Advanced Fiber Optic Networks. There are presently two video
headend locations within RCN's advanced fiber optic networks in New York City
and Boston. The video headends consist of optical transmitters, optical
receivers, satellite receivers, signal processors, modulators, encoding
equipment and network status monitoring and automated tape distribution
equipment. From the headend, the video signal is distributed to individual
fiber nodes or receivers via the same fiber cable backbone used to deliver the
voice and data service. The fiber cable terminates in a fiber optic receiver
within an individual building or service area. From the fiber node, coaxial
cable and related distribution equipment is used to distribute the video
signals to the customer premises. The bandwidth of the video distribution is
a minimum of 750 MHZ, which is capable of supporting a minimum of 110 video
channels. This distribution plant is specifically designed to be predominantly
fiber-based, which increases the reliability and improves the quality of the
services delivered compared to traditional cable television distribution
architectures.
Wireless Video. RCN also owns and operates a "wireless video"
television system (which was formerly operated as Liberty Cable Television of
New York, the operations of which were acquired by RCN in 1996) using
point-to-point 18GHz microwave technology. RCN is utilizing this system in New
York City as an alternate platform for delivering television programming to
buildings that are not yet connected to the advanced fiber optic network. RCN
expects that the majority of the buildings currently served by the wireless
service will ultimately be connected to the network, to the extent that
connection is feasible. As buildings are connected to the RCN network, RCN
will reuse the microwave equipment to provide service to other customers in
off-network premises. The transmission equipment and microwave services used
to provide RCN's wireless service are provided by Bartholdi Cable, which
formerly operated Liberty Cable Television of New York. Bartholdi Cable has
agreed to provide transmission services to RCN until RCN has either converted
the subscribers to its advanced fiber optic network or has obtained FCC
authority to provide such services pursuant to its own licenses. In addition,
Bartholdi Cable has agreed to transfer to RCN the transmission equipment on
demand. Bartholdi Cable's obligation to provide transmission services is
subject to Bartholdi Cable having authority to provide such services. The
qualifications of Bartholdi Cable to hold certain of the licenses needed to
provide transmission services to RCN are at issue in an FCC proceeding in
which an Initial Decision was released on March 6, 1998. In the Initial
Decision, the Administrative Law Judge found Bartholdi Cable unqualified with
respect to 15 such licenses. The Administrative Law Judge declared that the
Initial Decision would become effective 50 days after its release unless
Bartholdi Cable filed exceptions to the Initial Decision within 30 days of its
release or the FCC elected to review the case on its own motion. Bartholdi
Cable filed exceptions to the Initial Decision on April 7, 1998. Because of
the uncertainty as to Bartholdi Cable's right in the future to offer
transmission services to RCN, the Company filed its own license applications
at the FCC for all of the microwave transmission paths which are currently
being used by Bartholdi Cable to provide transmission services to RCN and, in
light of the increased uncertainties resulting from the Initial Decision in
the FCC proceeding involving certain of Bartholdi Cable's licenses, the Company
expects now actively to pursue its license applications. There can be no
assurance that RCN will be able to obtain its own FCC license.
Hybrid Fiber/Coaxial Cable Systems. RCN owns and operates
hybrid fiber/coaxial cable television networks in Pennsylvania, New Jersey and
New York State (outside of New York City), all within 75 miles of New York
City. These networks offer expanded bandwidth and a platform for two-way
services, and have an aggregate of 658 route miles of fiber optic cable,
including separate high capacity fiber optic rings with a minimum 84 fibers in
Pennsylvania (covering approximately 69 route miles) designed and constructed
as competitive telephony networks. The New York system includes 211 route
miles of fiber optic cable serving 98 nodes from one head-end. Approximately
70% of the New York system is two-way active 750 MHZ plant with 84 active
channels of programming. The New Jersey system has deployed 144 route miles of
fiber optic cable (over 30 miles of which is two-way active) from two
head-ends, and generally operates a 400/450 MHZ plant providing 62 channels of
video programming. The Pennsylvania system operates 2,649 miles of coaxial
cable and over 234 route miles of fiber with 43 nodes from one headend,
operating at 550 MHZ with 84 active channels. All of the Company's hybrid
fiber/coaxial cable systems are 100% one-way addressable.
These fiber-rich networks provide a basic fiber optic platform
capable of enhancement for supporting two-way services, such as high-speed
Internet services, in the future. RCN is presently expanding the fiber
capacity of certain of these fiber/coaxial cable television networks so that
they will be capable of delivering switched two-way services in the future. In
August 1997, RCN commenced offering resold local phone service, long distance
and Internet access to customers in the area served by its Hybrid
Fiber/Coaxial Cable Systems in Pennsylvania.
Data Services
RCN's Internet access and data transmission services are
currently provided over the advanced fiber optic network via dial-up modems
facilitated through the RCN voice network in on-net subscriber applications.
In off-net situations, subscribers use conventional dial-up modems through the
incumbent LEC network to access RCN's Internet transmission network. RCN is
beginning to offer Internet and data transmission services via cable modems.
Cable modems, which utilize the broadband coaxial plant, offer higher speed
access for data transmission than the speeds achieved by conventional
telephone dial-up technology.
Erols provides high quality Internet access services to
businesses by utilizing high-speed access via ISDN, frame relay, fractional
T-1, T-1 and T-3 circuits. Erols' network infrastructure currently supports
modems with dial-access speeds of up to 56 Kbps. Erols provides new
dial-access subscribers with its easy-to-install proprietary access software
package, which incorporates a telephone dialer, an e-mail platform, a Web
browser (either Netscape Communication Corporation's ("Netscape") Navigator (a
registered trademark of Netscape) or Microsoft Corp.'s Microsoft[Registered]
Internet Explorer) and SurfWatch(TM) software for parental control over
Internet content access. This software package permits simplified access to
the Internet through a "point and click" graphical user interface. After
installation, the subscriber has a direct connection to the Internet using
Point-to-Point Protocol and access to all of the Internet's resources,
including e-mail, the World Wide Web, Usenet News service and Internet Relay
Chat. Access software automatically displays the Erols World Wide Web site
each time a subscriber logs on, providing Erols with the opportunity to
communicate with its subscribers at the start of each session. Erols maintains
"24 x 7" subscriber and technical support 365 days a year.
UltraNet utilizes K56Flex protocol to support its POPs, a
result of a major mid-1997 upgrade in UltraNet transmission equipment. This
advancement has empowered users to gain access to two to four times more
quickly to equipment that is also more reliable. The new infrastructure takes
advantage of Rockwell technology that supports the K56Flex modems (speeds up
to 56 Kbps) and ISDN (speeds up to 128 Kbps). By connecting users to the
Internet faster, downloading time is decreased, and in turn, telephone costs
and time online.
RCN intends to extend its network to cover most of the areas
currently served by Erols and UltraNet and ultimately to migrate most of those
customers to RCN's advanced fiber optic network, subject to certain regulatory
approvals and the approval of RCN's joint venture partners.
Legal Proceedings
On September 30, 1997, the Yee Family Trusts, as holders of
C-TEC's Preferred Stock Series A and Preferred Stock Series B, filed an action
against the Company, Commonwealth Telephone and Cable Michigan in the Superior
Court of New Jersey, Chancery Division. The complaint alleges that
Commonwealth Telephone's distribution of the common stock of RCN and Cable
Michigan in connection with the Distribution (1) constituted a fraudulent
conveyance; (2) breached the terms of a contract between plaintiffs and
Commonwealth; (3) breached the covenant of good faith and fair dealing
allegedly owed plaintiffs; and (4) breached fiduciary duties allegedly owed
plaintiffs. On December 1, 1997, the complaint was amended to allege that
Commonwealth Telephone's distribution of the common stock of RCN and Cable
Michigan was an unlawful distribution in violation of 15 Pa.C.S. 1551(b)(2).
The plaintiffs are seeking to set aside the alleged fraudulent conveyance and
unspecified monetary damages alleged to be in excess of $52 million. The
Company believes this lawsuit is without merit and intends to contest this
action vigorously. On January 9, 1998, the defendants, including RCN, filed a
Motion to Dismiss, or in the Alternative, for Summary Judgment. Plaintiffs
filed their response on March 9, 1998 and defendants filed their reply on
April 6, 1998. The New Jersey court has not yet scheduled argument on the
motion.
In the normal course of business, there are various legal
proceedings outstanding, including both commercial and regulatory litigation.
In the opinion of management, these proceedings will not have a material
adverse effect on the results of operations or financial condition of the
Company.
MANAGEMENT
Structure of RCN's Board of Directors
The Company Board is divided into three classes of directors
and currently consists of 13 directors. The term of office of Class I
Directors will expire at the 2001 annual meeting, the term of office of Class
II Directors will expire at the 1999 annual meeting and the term of office of
Class III Directors will expire at the 2000 annual meeting. At each annual
meeting of stockholders held after September 30, 1997, a class of directors
will be elected for a three year term to replace the class whose term has then
expired.
The Company Board has established an executive committee which
will, among other things, have all the powers of the Company Board in the
management of the business and affairs of the Company at all times when the
Company Board is not in session. Members are Messrs. McCourt (Chairman),
Scott, Mahoney and Crowe.
The Company Board has established a compensation pension
committee which will make recommendations to the Company Board on matters
related to employee compensation and plans concerning the orderly succession
of officers and key management personnel. Members are Messrs. Roth (Chairman),
Yanney and Fasola.
The Company Board has also established an audit committee which
will, among other things, consider the overall scope and approach of the
annual audit and recommendations from the audit performed by the independent
accountants; recommend the appointment of the independent accountants;
consider significant accounting methods adopted or proposed to be adopted; and
consider procedures for internal controls. Members are Messrs. Fasola
(Chairman), O'Neill, May and Graham.
Executive Officers and Directors
The following table sets forth certain information as of May
18, 1998 concerning the directors and executive officers of RCN:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
David C. McCourt................... 41 Director (Class III), Chairman and Chief Executive Officer
Michael J. Mahoney................. 47 Director (Class I), President and Chief Operating Officer
Bruce C. Godfrey................... 42 Director (Class II), Executive Vice President and Chief
Financial Officer
Mark Haverkate..................... 43 Executive Vice President, Business Development
Michael A. Adams................... 40 President, Technology and Network Development Group, and
Executive Vice President
Dennis J. Spina.................... 53 Director (Class I), Vice Chairman and President, Internet
Services
James Q. Crowe..................... 48 Director (Class III)
Alfred Fasola...................... 48 Director (Class II)
Stuart E. Graham................... 52 Director (Class I)
Richard R. Jaros................... 46 Director (Class II)
Thomas J. May...................... 50 Director (Class I)
Thomas P. O'Neill, III............. 53 Director (Class I)
Eugene Roth........................ 62 Director (Class III)
Walter Scott, Jr................... 66 Director (Class III)
Michael B. Yanney.................. 64 Director (Class II)
Ralph S. Hromisin.................. 37 Vice President and Chief Accounting Officer
Kenneth R. Knudsen................. 51 Senior Vice President, Sales and Marketing
Salvatore M. Quadrino.............. 51 Chief Administrative Officer
Paul E. Sigmund.................... 33 Executive Vice President
Timothy J. Stoklosa................ 37 Senior Vice President and Treasurer
</TABLE>
David C. McCourt, 41, has been the Chairman and Chief Executive
Officer of the Company as well as a Director since September 1997. Mr. McCourt
has served as a Director, Chairman and Chief Executive Officer of Cable
Michigan since September 1997. In addition, he is a Director, Chairman and
Chief Executive Officer of Commonwealth Telephone, positions he has held since
October 1993. Mr. McCourt has also been President and, a Director of Level 3
Telecom. He has also been Chairman and Chief Executive Officer, as well as a
Director, of Mercom since October 1993, Director of MFS/WorldCom from July
1990 to December 1996, President and a Director of Metropolitan Fiber
Systems/McCourt, Inc., a subsidiary of MFS Telecom, Inc., since 1988, a
Director of Cable Satellite Public Affairs Network ("C-SPAN") since June 1995,
a Director of WorldCom from December 1996 to March 1998 and a Director of
Level 3 since January 1998.
Michael J. Mahoney, 47, has been the President and Chief
Operating Officer, as well as a Director, of the Company since September 1997.
Mr. Mahoney is also a Director of Commonwealth Telephone, a position he has
held since May 1995. Mr. Mahoney was President and Chief Operating Officer of
Commonwealth Telephone from February 1994 to September 1997, President and
Chief Operating Officer of Mercom from February 1994 to September 1997 and a
Director of Mercom since January 1994. In addition, he was Executive Vice
President of Commonwealth Telephone's Cable Television Group from June 1991 to
February 1994, and Executive Vice President of Mercom from December 1991 to
February 1994.
Bruce C. Godfrey, 42, has been the Executive Vice President,
Chief Financial Officer, Corporate Secretary and a Director of the Company
since September 1997. Mr. Godfrey has also been a Director of Cable Michigan
as well as its Secretary since such date. Mr. Godfrey has been a Director of
Commonwealth Telephone since 1995 and has been Executive Vice President and
Chief Financial Officer of Commonwealth Telephone since April 1994 and
Corporate Secretary since September 1997. He has also been Executive Vice
President and Chief Financial Officer of Mercom from April 1994 to October
1997 and a Director of Mercom since May 1994 and Corporate Secretary of Mercom
since October 1997. Mr. Godfrey was also Senior Vice President and Principal
of Daniels and Associates from January 1984 to April 1994.
Mark Haverkate, 43, has been the Executive Vice President,
Business Development of the Company since September, 1997. Mr. Haverkate has
also been President and Chief Operating Officer and a director of Cable
Michigan since such date. He was the President of RCN Development from June
1997 to September 1997 and Executive Vice President of Business Development at
Commonwealth Telephone from May 1997 to September 1997. Previously, he was
President for Business Operations at RCN Telecom Services, Inc. from November
1996 to June 1997, Executive Vice President of RCN Telecom Services, Inc. from
August 1996 to November 1996, Executive Vice President of Commonwealth
Telephone's Cable Television Group from July 1995 to August 1996, Executive
Vice President of Development for Commonwealth Telephone from February 1995 to
July 1995, Executive Vice President for Development at Mercom from November
1995 to February 1996, Vice President of Development for Commonwealth
Telephone from December 1993 to February 1995, Vice President of Development
at Mercom from December 1993 to February 1995, Vice President of Commonwealth
Telephone's Cable Television Group from October 1989 to December 1993.
Michael A. Adams, 40, has been the President, Technology and
Network Development Group of the Company and Executive Vice President of the
Company since September, 1997. Mr. Adams held the corresponding position at
Commonwealth Telephone from November 1996 to September 1997. Prior to that
date, Mr. Adams held the following positions: Executive Vice President of
Technology and Strategic Development of Commonwealth Telephone from August
1996 to November 1996, Executive Vice President of the Communications Services
Group from September 1994 to June 1996, Vice President of Technology from
November 1993 to September 1994 and Vice President of Engineering for RCN
Telecom Services from September 1992 to October 1993.
Dennis J. Spina, 53, has served as Director, Vice-Chairman and
President of Internet Services of the Company since February 1998.
Previously, he served as Chief Executive Officer of Erols from August 1996 to
February 1998. From January 1996 until July 1996, he worked as an independent
consultant in the service and distribution industry. From November 1994 to
December 1995, he served as President and Chief Executive Officer of
International Service Systems, a company engaged in the business of janitorial
and energy management. From August 1990 to October 1994, he served as
President and Chief Executive Officer of Suburban Propane, Inc. ("Suburban
Propane"), a division of Hanson PLC. He was hired in a turnaround capacity
and also served as President and Chief Executive Officer of Petrolane, Inc.
("Petrolane"), a propane distribution company managed by Suburban Propane,
from August 1990 until its sale in July 1993. From 1973 to 1990, he worked at
Federal Express Corporation, ultimately serving as Vice President and Officer.
James Q. Crowe, 48, has been a Director of the Company since
September 1997. Mr. Crowe has been the President and Chief Executive Officer
of Level 3 since August 1997 and a Director of Level 3 since June 1993. Mr.
Crowe is also a Director of Commonwealth Telephone, a position he has held
since 1993. Mr. Crowe has served as Chairman of the Board of Directors of
MFS/WorldCom from 1992 to 1996 and President and Chief Executive Officer of
MFS/WorldCom from June 1993 to June 1997. Mr. Crowe has been a Director of
Inacom Communications, Inc. since 1997. Mr. Crowe was Chairman of the Board
of Directors of WorldCom from December 1996 to June 1997.
Alfred Fasola, 48, has been a Director of the Company since
September 1997. Mr. Fasola has served as Chairman and Chief Executive Officer
of Hot Spots, LLC since 1995 and served as Chief Operating Officer of
Purolater Courier Corp. from 1986 to 1987, Mr. Fasola was Chief Executive
Officer of Pilot Freight Carriers, Inc., from 1987 to 1989, Chairman and Chief
Executive Officer of Circle Express/Internet from 1990 to 1992 and Chief
Executive Officer of Herman's Sporting Goods from 1992 to 1995.
Stuart E. Graham, 52, has been a Director of the Company since
September 1997. Mr. Graham is also a Director of Commonwealth Telephone, a
position he has held since 1990. Mr. Graham has been President of Skanska USA
Inc. since 1994. Previously he was Chief Executive Officer of several Skanska
USA subsidiaries including Sordoni Skanska, Slattery Skanska and Skanska E & C.
Richard R. Jaros, 46, has been a Director of the Company since
September 1997. Mr. Jaros is a member of the Board of Directors of WorldCom,
Level 3, CalEnergy Company, Inc. ("CECI") and Commonwealth Telephone. From
1980 to 1992 and from 1994 to 1997, Mr. Jaros served as President of Kiewit
Diversified Group and Executive Vice President and Chief Financial Officer of
Old PKS. He served as Chairman of CECI from 1993 to 1994 and as President from
1992 to 1993.
Thomas J. May, 50, has been a Director of the Company since
September 1997. Mr. May has been Chairman, President and Chief Executive
Officer of BECO since 1994. Previously, Mr. May served as President and Chief
Operating Officer of BECO from 1993 to 1994 and as an Executive Vice President
from 1990 to 1993.
Thomas P. O'Neill, III, 53, has been a Director of the Company
since September 1997. Mr. O'Neill is the Chairman and founder of
McDermott/O'Neill & Associates. Prior to forming McDermott/O'Neill in 1991,
Mr. O'Neill founded Bay State Investors, Inc. in 1983.
Eugene Roth, 62, has been a Director of the Company since
September 1997. Mr. Roth is also a Director of Commonwealth Telephone, a
position he has held since October 1993. Mr. Roth has been a Senior Partner
at Rosenn, Jenkins and Greenwald L.L.P. since 1964 and is also a Director of
the Pennsylvania Regional Board of Directors of First Union National Bank.
Walter Scott, Jr., 66, has been a Director of the Company since
September 1997. Mr. Scott is also a Director of Commonwealth Telephone, a
position he has held since 1979. Mr. Scott has been Chairman of the Board of
Directors and Chief Executive Officer of Old PKS for over nineteen years,
Chairman of Level 3 since 1979 and Director since 1964. He is also a Director
of Berkshire Hathaway Inc., Burlington Resources, Inc., CECI, ConAgra, Inc.,
US Bancorp, and Valmont Industries, Inc., and Level 3 Telecom. Mr. Scott was a
Director of WorldCom from December 1996 to July 1997.
Michael B. Yanney, 64, has been a Director of the Company since
September 1997. Mr. Yanney has been Chairman and Chief Executive Officer of
America First Companies, L.L.C. since 1984 and is also a Director of
Burlington Northern Santa Fe Corporation, Lozier Corporation, Forest Oil
Corporation, Freedom, Mid-America Apartment Communities, PKS Information
Services, Inc. and Level 3. Mr. Yanney was a Director of WorldCom from
December 1996 to July 1997 and Commonwealth Telephone from August 1996 to
September 1997.
Ralph S. Hromisin, 37, has been Vice President and Chief
Accounting Officer of the Company since September 1997. He has also been Vice
President and Chief Accounting Officer of Cable Michigan since September 1997
and of Commonwealth Telephone since August 1994. Mr. Hromisin has been Vice
President and Corporate Controller for Mercom since October 1996, Director of
Corporate Accounting for Commonwealth Telephone from March 1992 to August
1994. He also held various positions, most recently Audit Manager for Parente,
Randolph, Orlando, Carey & Associates, CPA's from November 1982 to March 1992.
Kenneth R. Knudsen, 51, has been Senior Vice President of Sales
& Marketing of the Company since June 1997 and Vice President of Sales and
General Manager of RCN Telecom Services, Inc. from January 1996 to May 1997.
Previously, Mr. Knudsen served as Chief Executive Officer and Partner of KCI
Consulting, Inc. from 1994 to January 1996 and Senior Vice President of Ryan
Management Group from 1993 to 1994. From 1970 to 1988 he also held Officer and
Senior Management positions at Nabisco, Ocean Spray Cranberries, Frito-lay,
Inc. and Procter and Gamble Company.
Salvatore M. Quadrino, 51, has been Chief Administrative
Officer of the Company since February 1998. Previously he served as Vice
President, Treasurer and Chief Financial Officer of Erols from September 1997
to February 1998. From October 1996 to August 1997, he worked as an
independent financial consultant in the service and distribution industry.
From October 1994 to September 1996, he served as President and Chief
Executive Officer of Suburban Propane, a division of Hanson PLC, which
conducted its initial public offering in March 1996, and from March to October
1996 he served as a member of Suburban Propane's Board of Supervisors. Mr.
Quadrino initially was hired in a turn around capacity, served as Vice
President and Chief Financial Officer of Suburban Propane from October 1990 to
September 1994 and as Vice President, Chief Financial Officer and Treasurer of
Petrolane from August 1990 until its sale in July 1993.
Paul E. Sigmund, 33, has been Executive Vice President of the
Company since September 1997 and Executive Vice President of RCN International
Holdings, Inc. since 1996. Previously, Mr. Sigmund was a Vice President at
Smith Barney, Inc. from 1994 to 1996, an Associate at the law firm of Skadden,
Arps, Slate, Meagher & Flom from 1993 to 1994 and an Investment Associate at
the International Finance Corporation/World Bank from 1986 to 1989.
Timothy J. Stoklosa, 37, has been the Senior Vice President and
Treasurer of the Company since September 1997. He has also served as Executive
Vice President and Chief Financial Officer and a Director of Cable Michigan
since such date. Mr. Stoklosa has been Senior Vice President of Finance of
Commonwealth Telephone since February 1997, Treasurer of Commonwealth
Telephone since August 1994 and Executive Vice President and Chief Financial
Officer of Mercom since October 1997. Previously, Mr. Stoklosa was Vice
President of Finance of Commonwealth Telephone from May 1995 to February 1997,
Manager of Mergers and Acquisitions at Old PKS from October 1991 to August
1994 and Senior Financial Analyst of Corporate Development at Citizens
Utilities Co. from February 1990 to October 1991.
Executive Compensation
The following table sets forth certain information regarding
the compensation paid for the periods indicated to the Chief Executive Officer
of RCN and the four other most highly compensated executive officers of RCN
(collectively, the "Named Executive Officers"). As previously stated, all
share and per share data, stock option data and market prices (including
historical trading prices) of RCN Common Stock have been restated to reflect
the Stock Dividend.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------------------- --------------------------------------
Awards Payouts Total
------------ ---------- ----------
Other
Annual Restricted Securities All Other
Name and Salary Compensation Stock Underlying LTIP Compensation
Principal Position Year ($)(1) Bonus($) ($)(1) Awards($)(2) Options(#) Payouts($) ($)(3)
- ------------------ ---- ------ -------- ------ ------------ ---------- ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
David C. McCourt..... 1997 $500,000 $1,400,000 -- $380,000 1,000,000 -- $2,703 $1,902,703
Chairman and Chief 1996 491,154 700,000 -- 238,333 -- -- 5,478 1,196,632
Executive Officer 1995 397,885 700,000 -- 220,000 500,000 -- 5,612 1,103,497
Michael J. Mahoney... 1997 $248,654 $500,000 -- $149,731 400,000 -- $5,871 $754,525
President and Chief 1996 235,027 175,000 -- 67,017 -- -- 5,478 415,505
Operating Officer 1995 222,462 100,000 -- 65,000 -- -- 5,952 328,414
Bruce C. Godfrey..... 1997 $243,077 $500,000 -- $148,615 400,000 -- $5,763 $748,840
Executive Vice 1996 221,462 165,000 -- 74,333 -- -- 4,965 391,427
President and 1995 183,731 150,000 -- 67,000 -- -- 4,790 338,521
Chief Financial
Officer
Mark Haverkate....... 1997 $205,192 $100,000 -- $61,038 80,000 -- $16,045 $308,177
Executive Vice 1996 158,231 135,000 -- 51,667 -- -- 3,641 296,872
President, 1995 137,952 100,000 -- 48,000 70,000 -- 5,058 243,010
Business
Development
Michael A. Adams..... 1997 $203,269 $150,000 -- $70,654 230,000 -- $16,045 $369,314
President, 1996 138,673 155,000 -- 36,950 -- -- 3,853 297,526
Technology 1995 122,885 46,000 -- 34,200 40,000 -- 3,991 172,876
and Network
Development
</TABLE>
- ----------
(1) The only type other Annual Compensation for each of the Named Executive
Officers was in the form of perquisites and was less than the level
required for reporting.
(2) Represents the market value on the date of grant of restricted stock
awards. In connection with the Distribution, shares of restricted C-TEC
Common Stock purchased under the C-TEC Executive Stock Purchase Plan ("C-TEC
ESPP") and share units awarded under the C-TEC ESPP that relate to C-TEC
Common Stock were adjusted so that following the Distribution, each such
participant was credited with an aggregate equivalent value of restricted
shares of common stock of Commonwealth Telephone, RCN and Cable Michigan.
After the Distribution RCN created its own Executive Stock Purchase Plan
("ESPP") which has terms substantially similar to the C-TEC ESPP.
(3) Includes the following amounts for the last fiscal year: (i) David
McCourt: $486 - Company paid life insurance; $2,217 - 401(k) Company match;
(ii) Bruce Godfrey: $486 - Company paid life insurance; $5,277 - 401(k)
Company match; (iii) Michael Mahoney: $486 - Company paid life insurance;
$5,385 - 401(k) Company match; (iv) Mark Haverkate: $486 - Company paid life
insurance; $2,499 - 401(k) Company match; (v) Michael Adams: $483 - Company
paid life insurance; $3,675 - 401(k) Company match; $11,887 - Relocation
costs.
The following amounts are for 1996 fiscal year: (i) David McCourt: $396 -
Company paid life insurance; $5,082 - 401(k) Company match; (ii) Bruce
Godfrey: $396 - Company paid life insurance; $4,569 - 401(k) Company match;
(iii) Michael Mahoney: $396 - Company paid life insurance; $5,082 - 401(k)
Company match; (iv) Mark Haverkate: $392 - Company paid life insurance;
$3,249 - 401(k) Company match; (v) Michael Adams: $363 - Company paid life
insurance; $3,490 - 401(k) Company match.
The following amounts are for 1995 fiscal year: (i) David McCourt: $530 -
Company paid life insurance; $5,082 - 401(k) Company match; (ii) Bruce
Godfrey: $510 - Company paid life insurance; $4,280 - 401(k) Company match;
(iii) Michael Mahoney: $870 - Company paid life insurance; $5,082 - 401(k)
Company match; (iv) Mark Haverkate: $861 - Company paid life insurance;
$4,197 - 401(k) Company match; (v) Michael Adams: $253 - Company paid life
insurance; $3,738 - 401(k) Company match.
Does not include amounts paid to certain senior offices listed for
relocation expenses incurred in moving said senior officers and their
families to the Company's new executive offices in Princeton, New Jersey.
As of December 31, 1997, the aggregate holdings and value of restricted
stock awards for RCN Common Stock were as follows:
<TABLE>
<CAPTION>
RCN
Corporation Shares Aggregate Value
------------------ ---------------
<S> <C> <C>
David C. McCourt........ 50,249.00 $851,242
Michael J. Mahoney...... 17,586.00 $301,155
Bruce C. Godfrey........ 18,065.00 $309,359
Mark Haverkate.......... 9,496.00 $162,615
Michael Adams........... 8,960.00 $153,442
</TABLE>
Vesting of restricted shares is accelerated upon a change in control of the
Company. Dividends, if any, are paid on restricted shares. Subject to continued
employment, restricted share units credited to participants' accounts vest in
three calendar years following the date on which the share units were initially
credited to the participant's account.
RCN Options/SAR Grants in Fiscal Year 1997
<TABLE>
<CAPTION>
Number % of Options
Securities Granted to Potential Realizable Value at
Underlying Employees in Total Exercise Assumed Annual Rates of
Options Fiscal Year or Base Price Expiration Stock Price Appreciation for
Name Granted(#) 1997 ($/sh) Date Option Term
- ---- ---------- ------------- --------------- ------------ --------------------------------
5%($) 10%($)
-------------- -----------
<S> <C> <C> <C> <C> <C> <C>
David C. McCourt... 1,000,000 20.86% 15.315 10/30/2007 $9,627,500 $24,402,500
Michael J. Mahoney. 400,000 8.34% 15.315 10/30/2007 $3,851,000 $9,761,000
Bruce C. Godfrey... 400,000 8.34% 15.315 10/30/2007 $3,851,000 $9,761,000
Mark Haverkate..... 20,000 0.42% 8.360 2/12/2007 $105,910 $266,490
Mark Haverkate..... 60,000 1.25% 15.315 10/30/2007 $577,650 $1,464,150
Michael A. Adams... 30,000 0.63% 8.360 2/21/2007 $157,785 $399,735
Michael A. Adams... 200,000 4.17% 15.315 10/30/2007 $1,925,500 $4,880,500
</TABLE>
The following table sets forth the fiscal year-end value of
unexercised options held by each Named Executive Officer.
Aggregate Option Exercises in Last Fiscal Year and
Fiscal Year-End Option Values(1)
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised In-the-
Unexercised Options at December Money Options at December 31,
31, 1997(2) 1997(2)(3)
------------------------------------- -------------------------------------
Exercisable(#) Unexercisable(#) Exercisable($) Unexercisable($)
-------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C>
David C. McCourt......... 500,000 1,500,000 $5,116,300 $6,971,950
Michael J. Mahoney....... 120,000 1,200,000 1,207,200 1,529,800
Bruce C. Godfrey......... 84,000 456,000 845,040 1,288,360
Mark Haverkate........... 58,000 282,000 578,128 1,140,527
Michael A. Adams......... 58,000 142,000 574,114 893,711
</TABLE>
- ----------
(1) No RCN stock options were exercised by the Named Executive Officers during
the fiscal year ended December 31, 1997.
(2) Denominated in shares of RCN Common Stock.
(3) The fair market value of RCN Common Stock at December 31, 1997 was $17.125
per share.
Effect of Distribution on Equity-Related Benefits
In connection with the Distribution, each C-TEC option held by
the Named Executive Officers and all other holders of such options was
adjusted so that each such executive officer and other holder currently holds
options to purchase shares of Commonwealth Telephone Common Stock, RCN Common
Stock and Cable Michigan Common Stock, respectively. The number of shares
subject to, and the exercise price of, such options were adjusted to take into
account the Distribution and to ensure that the aggregate intrinsic value of
the resulting RCN, Cable Michigan and Commonwealth Telephone options
immediately after the Distribution was equal to the aggregate intrinsic value
of the C-TEC options immediately prior to the Distribution. Shares of
restricted C-TEC Common Stock awarded under the C-TEC ESPP and share units
awarded under the C-TEC ESPP that relate to C-TEC Common Stock were adjusted so
that following the Distribution, each such participant was credited with an
aggregate equivalent value of restricted shares of common stock of
Commonwealth Telephone, the Company and Cable Michigan. See Note (4) to
"Security Ownership of Certain Beneficial Owners and Management."
Pension Benefits
C-TEC completed a comprehensive study of its employee benefit
plans in 1996. As a result of this study, effective after December 31, 1996,
in general, employees other than those of the Commonwealth Telephone Group (as
defined below) no longer accrue benefits under the C-TEC defined benefit
pension plan, but became fully vested in their benefits accrued through that
date. Such benefits, for the Named Executive Officers affected by this event,
computed as the present value at July 31, 1997 of a life annuity beginning at
age 65, are as follows: Mr. McCourt, $11,679; Mr. Mahoney, $29,124; Mr.
Godfrey, $10,874; Mr. Haverkate, $41,894; and Mr. Adams, $7,249.
Directors' Compensation
Non-employee Directors of the Company will receive a retainer of
$900 per month and will be paid $1,000 for each board meeting attended. The
Committee Chairmen and other committee members will be paid $1,500 and $1,000,
respectively, for each committee meeting attended. Pursuant to the RCN
Corporation 1997 Stock Plan for Non-Employee Directors, the retainer will be
paid in shares of RCN Common Stock and each non-employee director will receive
an annual grant of a non-qualified option covering 4,000 shares of RCN Common
Stock.
Compensation Committee Interlocks and Insider Participation
The Company has established a Compensation Committee, all the
members of which are non-employee directors.
One of the members, Eugene Roth, Esq., is a partner at Rosen,
Jenkins and Greenwald, which serves as counsel to RCN from time to time.
Transactions with Management and Certain Concerns
David C. McCourt, Chairman, Chief Executive Officer and
Director of RCN, is a director of C-SPAN. In 1997, paid $236,563 to C-SPAN
for programming services.
David C. McCourt served as a Director of MFS/WorldCom from
December 1996 to March 1998. In 1997, RCN paid $2,959,306 to MFS/WorldCom for
telephone usage, circuit charges and network access charges. RCN earned
$519,485 in revenue from MFS/WorldCom, primarily for engineering and
construction management services.
In September 1996, RCN and BECO, through wholly owned
subsidiaries, entered into a joint venture to utilize 126 fiber miles of
BECO's fiber optic network to deliver RCN's comprehensive communications
package in Greater Boston. In 1997, RCN paid $91,674 to BECO for utility
expenses.
Each of Commonwealth Telephone, RCN and Cable Michigan is
effectively controlled by Level 3. In addition, the majority of RCN's
directors and executive officers are also directors and/or executive officers
of Commonwealth Telephone and/or Cable Michigan. RCN provides certain
services to Commonwealth Telephone and Cable Michigan. See "Business --
Relationship Among Commonwealth Telephone, RCN and Cable Michigan."
SECURITY OWNERSHIP OF MANAGEMENT, PRINCIPAL STOCKHOLDERS
AND SELLING STOCKHOLDERS
Set forth in the table below is information as of April 1, 1998
with respect to the number of shares of RCN Common Stock beneficially owned by
(i) each person or entity known by the Company to own more than five percent
of the outstanding RCN Common Stock, (ii) each director of the Company, (iii)
each of the Named Executive Officers of the Company, (iv) all directors and
executive officers of the Company as a group and (v) each Selling Stockholder.
To the Company's knowledge, unless otherwise indicated, each person or entity
has sole voting and investment power with respect to the shares set forth
opposite the person's or entity's name. As previously stated, all share, per
share and stock option data of RCN Common Stock have been restated to reflect
the Stock Dividend.
<TABLE>
<CAPTION>
RCN Common Stock
------------------------------------------------------------------------------
Number of Number of
Shares Percent of Shares Percent of
Beneficially Outstanding Beneficially Outstanding
Owned Prior Shares Prior Shares Being Owned Shares After
Name of Beneficial Owner to Offering(1) to Offering(1) Offered After Offering Offering
- ------------------------ -------------- -------------- ------- -------------- --------
<S> <C> <C> <C> <C> <C>
Directors and Named Executive Officers
Michael A. Adams (2)....................... 23,578 * 23,578 *
James Q. Crowe............................. 1,464 * 1,464 *
Alfred Fasola.............................. 798 * 798 *
Bruce C. Godfrey (2)....................... 54,832 * 54,832 *
Stuart E. Graham........................... 10,806 * 10,806 *
Mark Haverkate (2)......................... 66,708 * 66,708 *
Richard R. Jaros........................... 6,638 * 6,638 *
Michael J. Mahoney (2)..................... 63,180 * 63,180 *
Thomas J. May.............................. 2,798 * 2,798 *
David C. McCourt (2)(3).................... 186,204 * 186,204 *
Thomas P. O'Neill, III..................... 2,798 * 2,798 *
Eugene Roth................................ 14,240 * 14,240 *
Walter Scott, Jr........................... 1,464 * 1,464 *
Dennis Spina............................... -- -- -- --
Michael B. Yanney.......................... 5,520 * 5,520 *
All Directors and Executive Officers as
a Group (20 persons)(2)(3)................ 445,835 * 445,835 *
5% Stockholders
Level 3 Telecom Holdings, Inc.(4).......... 26,640,970 46 26,640,970 46
Selling Stockholders
Commonwealth Telephone Enterprises Inc.
Employees' Retirement Plan................ 375,816 * 375,816 -- *
Robert A. Lanford.......................... 24,272 * 12,000 12,272 *
John A. Taverna............................ 12,134 * 2,612 9,522 *
Christopher W. Walsh....................... 31,182 * 15,550 15,632 *
</TABLE>
- ----------
* Less than 1% of outstanding shares.
(1) Includes shares of Company Common Stock acquired in respect of Matching
Shares (defined below) but excludes RCN Share Units (defined below).
(2) Under the ESPP, participating executive officers who forgo current
compensation are credited with "Share Units," the value of which is based
on the value of a share of Company Common Stock. ESPP participants who
elect to receive Share Units in lieu of current compensation are also
credited with restricted "Matching Shares," which vest over a period of 3
years from the grant date, subject to continued employment. Matching
Shares, unless forfeited, have voting and dividend rights. In connection
with the Distribution, Share Units and Matching Shares were adjusted in an
equitable manner so that participants were credited with an aggregate
equivalent value of restricted shares of Commonwealth Telephone, RCN and
Cable Michigan Common Stock. The holdings indicated include Share Units and
Matching Shares.
The table below shows in respect of each Named Executive Officer the number of
shares of RCN Common Stock purchased outright, Share Units relating to RCN
Common Stock acquired by each such Named Executive Officer in lieu of current
compensation, and the forfeitable Matching Shares of RCN Common Stock held by
each such Named Executive Officer:
<TABLE>
<CAPTION>
Share Unit Total Purchased
Acquired Under and Acquired
Shares the ESPP in Total Shares Restricted and Restricted
Purchased Lieu of Current Purchased and Matching Matching
Outright Compensation Acquired Shares Shares
--------- --------------- ------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
Michael A. Adams........ 1,834 10,872 12,706 10,872 23,578
Bruce C. Godfrey........ 14,636 20,098 34,734 20,098 54,832
David C. McCourt........ 76,788 54,708 131,496 54,708 186,204
Michael J. Mahoney...... 23,732 19,724 43,456 19,724 63,180
Mark Haverkate.......... 46,416 10,146 56,562 10,146 66,708
</TABLE>
(3) Includes 450 shares of Company Common Stock which are owned
by Mr. McCourt's wife. Mr. McCourt disclaims beneficial ownership of
such shares.
(4) Level 3 owns 90% of the common stock and all of the
preferred stock of Level 3 Telecom. Level 3 is the successor to an
entity known as Peter Kiewit Sons' Inc. See "Level 3 Communications,
Inc." below. David C. McCourt, Chairman and Chief Executive Officer of
Commonwealth Telephone and RCN, owns the remaining 10% of the common
stock of Level 3 Telecom. The address for Level 3 Telecom and Level 3 is
1000 Kiewit Plaza, Omaha, Nebraska 68131.
The information set forth above does not give effect to the
ownership of Company securities by Level 3 Telecom. Certain executive
officers or directors of the Company are directly or indirectly affiliated
with Level 3 Telecom. For information with respect to the beneficial
ownership of securities by Level 3 Telecom, see "Security of Ownership Certain
Beneficial Owners and Management."
Level 3 Communications, Inc.
Set forth below is certain information regarding the beneficial
ownership of equity securities of Level 3 as of April 1, 1998, by each
director, the Named Executive Officers and by all persons, as a group, who are
currently directors or executive officers of the Company. On March 31, 1998,
the entity known as Peter Kiewit Sons' Inc. ("Old PKS") prior to such date
separated its construction and mining management business ("Construction
Group") from its other businesses (the "PKS Split-Off"). In conjunction with
the PKS Split-Off, Level 3 merged into Old PKS which changed its name to Level
3 Communications, Inc. As a result of the PKS Split-Off, Level 3 no longer
owns any interest in the Construction Group whose business is now held in a
company which changed its name to Peter Kiewit Sons' Inc. ("New PKS").
Number of Percent of
Name of Beneficial Owner Shares Shares
- ------------------------ ------ ------
Michael A. Adams................................ -- --
James Q. Crowe.................................. 5,666,360 3.9%
Alfred Fasola................................... -- --
Bruce C. Godfrey................................ -- --
Stuart E. Graham................................ -- --
Mark Haverkate.................................. -- --
Richard R. Jaros................................ 748,749(1) *
Michael J. Mahoney.............................. 1,000 --
Thomas J. May................................... -- --
David C. McCourt................................ 57,500 *
Thomas P. O'Neill, III.......................... -- --
Eugene Roth..................................... -- --
Walter Scott, Jr................................ 17,636,397 12.0%
Dennis Spina.................................... -- --
Michael B. Yanney............................... 50,000 --
All Directors and Executive Officers as a Group
(20 persons).............................. 24,162,161 16.4%
- ----------
* Less than 1% of the outstanding of the class.
(1) Includes 185,000 shares in the Jaros Family Limited Partnership.
DESCRIPTION OF CERTAIN INDEBTEDNESS
This section of the Prospectus describes the terms and
conditions of the Credit Agreement that certain subsidiaries of the Company
have in place and of the 10% Senior Notes, the 11 1/8% Senior Discount Notes
and the 9.80% Senior Discount Notes which RCN has outstanding. The following
descriptions do not purport to be complete and is subject to, and is qualified
in its entirety by reference to, all of the provisions of the Credit Agreement
and to the provisions of the documents governing the 10% Senior Notes, the
11 1/8% Senior Discount Notes and the 9.80% Senior Discount Notes, which are
filed as exhibits to the Company's Registration Statement on Form S-1, of
which this Prospectus constitutes a part, filed with the Commission.
Credit Agreement
Capitalized terms used in this Section and not otherwise
defined herein are used as defined in the Credit Agreement.
Certain of the Company's direct and indirect subsidiaries,
namely, RCN Cable and its subsidiaries RCN of New Jersey, Inc. (formerly
ComVideo Systems, Inc.; "ComVideo") and RCN of Southeast New York, Inc.
(formerly C-TEC Cable Systems of New York, Inc.; "Cable Systems New York" and
together with ComVideo, the "Borrowers"), have in place two secured credit
facilities (the "Credit Facilities") pursuant to a single credit agreement
with a group of lenders for which First Union National Bank acts as agent (the
"Credit Agreement"), which was effective as of July 1, 1997 (the "Closing
Date"). The first is a five-year revolving credit facility in the amount of
$25 million (the "Revolving Credit Facility"). The second is an eight-year
term credit facility in the amount of $100 million (the "Term Credit
Facility").
Borrowings under the Credit Facilities are available for the
following purposes: (i) to refinance existing indebtedness of the Borrowers,
(ii) to finance an equity investment by RCN Cable in RCN Telecom Services,
Inc. (a member of the RCN Group), (iii) to finance permitted acquisitions, and
(iv) for capital expenditures, working capital and general corporate purposes.
Borrowings under the Credit Agreement are subject to the conditions that there
can be no default or event of default under the Credit Agreement and that the
representations and warranties of the Borrowers contained in the Credit
Agreement and related pledge agreements must be true. Each Borrower is jointly
and severally liable for all borrowings and other obligations under the Credit
Facilities.
The interest rate on the Credit Facilities 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 the 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 entire amount of the Revolving Credit Facility is available
to the Borrowers until June 30, 2002. As of March 31, 1998, $3 million of
principal was outstanding thereunder. Revolving loans may be repaid and
reborrowed from time to time.
The entire $100 million of the Term Credit Facility was
borrowed, all of which remained outstanding as of March 31, 1998. The Term
Credit Facility 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. The aggregate annual installments payable on the
term loan are as follows:
1999.............................. $ 3,750,000
2000.............................. $11,250,000
2001.............................. $16,250,000
2002.............................. $17,500,000
2003.............................. $19,374,000
2004.............................. $21,250,000
2005.............................. $10,626,000
The Borrowers have the option to repay the Term Credit Facility
in whole or in part at any time, without penalty, subject to customary
"breakage" charges. Any amount of the Term Credit Facility that is repaid may
not be reborrowed.
The Borrowers are required to apply 100% of the net cash
proceeds realized from certain asset sales, certain payments under insurance
policies and certain incurrences of additional debt to repay the Revolving
Credit Facility. Any excess amounts of such net cash proceeds not applied to
repay Revolving Credit Facility are applied to reduce the scheduled
installments of the Term Credit Facility on a pro rata basis.
All borrowings under the Credit Facilities will be pari passu,
and will be secured under a common collateral package including (i) a first
priority pledge by RCN Cable of 100% of the stock in ComVideo (which will be
given only after approval from the appropriate regulatory authority in New
Jersey is granted) and in Cable Systems New York; (ii) a first priority pledge
by ComVideo of 100% of its partnership interests in Home Link Communications of
Princeton, L.P. ("Home Link") at such time that ComVideo has acquired 100% of
the partnership interests in Home Link (at which time Home Link will become a
Borrower) and subject also to approval of the appropriate regulatory authority
in New Jersey being granted; (iii) a first priority pledge by each Borrower of
100% of the stock owned by it in each other material subsidiary of such
Borrower created after the Closing Date; and (iv) a first priority pledge by
RCN of 100% of the stock of RCN Cable. In addition, the Borrowers are subject
to a prohibition on granting other negative pledges to other parties on the
assets of RCN Cable and certain of its subsidiaries (subject to customary
exceptions). The stock and assets of RCN Telecom Services of Pennsylvania,
Inc. (formerly C-TEC Cable Systems of Pennsylvania, Inc.), RCN Telecom
Services, Inc. and RCN International Holdings, Inc. are excluded from the
security arrangements.
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, making of capital expenditures
and transactions with affiliates. The Credit Agreement requires the Borrowers,
Home Link and all subsidiaries of the Borrowers created after the Closing Date
on a combined basis 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 includes customary events of default. Upon
the occurrence of any event of default, the lenders may accelerate the
outstanding loans and cancel any unborrowed commitment. These events of
default include payment and covenant defaults (subject in certain cases to a
grace period), misrepresentations, cross default to certain other debt,
bankruptcy, ERISA and judgment defaults and a change of control default. For
this purpose, "change of control" is defined to mean any time that (A) LCI,
formerly known as PKS, shall cease to hold, either directly or indirectly
through one or more LCI entities, shares of RCN constituting at least thirty
percent (30%) of the number of outstanding common shares or at least thirty
percent (30%) of the voting power represented by the outstanding voting shares
of RCN (in each case, outstanding shares excluding shares issued after the
Distribution Date (i) for cash, (ii) in consideration for the acquisition of
any investment or property or the provision of services, (iii) upon the
exercise of any warrant, option, convertible security or similar instrument
issued after the Distribution Date for consideration described in clauses (i)
and (ii) or (iv) in connection with an employee stock option plan and similar
benefit arrangement adopted after the Distribution Date by RCN or any of its
wholly owned subsidiaries), (B) any person (other than LCI or an LCI entity)
or group of persons shall have acquired in one or more series of transactions
beneficial ownership of more than fifty-one percent (51%) of the outstanding
common stock or of the voting power represented by the outstanding voting
shares of RCN or (C) RCN shall cease to hold, directly or indirectly, all of
the outstanding shares of capital stock of RCN Cable.
1997 Notes Offering
10% Senior Notes due 2007
The 10% Senior Notes were issued under an indenture dated October
17, 1997 between RCN and The Chase Manhattan Bank, as Trustee (the "10%
Indenture"). The 10% Senior Notes are general senior obligations of RCN, limited
to $225 million aggregate principal amount and will mature on October 15, 2007.
The 10% Senior Notes will be collateralized, pending disbursement pursuant to
the Escrow and Security Agreement dated as of October 17, 1997 among RCN, The
Chase Manhattan Bank, as Trustee, and The Chase Manhattan Bank, as Escrow Agent
(the "Escrow Agreement"), by a pledge of the Escrow Account (as defined in the
Escrow Agreement), which was funded with approximately $61 million of the net
proceeds from the sale of the 10% Senior Notes, representing funds that,
together with the proceeds from the investment thereof, will be sufficient to
pay interest on the 10% Senior Notes for six scheduled interest payments.
Interest on the 10% Senior Notes will be 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 10% Indenture contains provisions which are substantially
similar to the ones which will be contained in the indenture governing the
Notes, including certain covenants 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.
The 10% Senior 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.
11 1/8% Senior Discount Notes due 2007
The 11 1/8% Senior Discount Notes were issued under an indenture
dated October 17, 1997 between RCN and The Chase Manhattan Bank, as Trustee (the
"11 1/8% Indenture"). The 11 1/8% Senior Discount Notes are general senior
obligations of RCN, limited to $601,045,000 aggregate principal amount at
maturity and will mature on October 15, 2007. The 11 1/8% Senior Discount Notes
were issued at a discount to yield gross proceeds of $350,000,524. The 11 1/8%
Senior Discount Notes will not bear cash interest prior to October 15, 2002. The
yield to maturity of the 9.808% Senior Discount Notes, determined on a
semi-annual bond equivalent basis, will be 11 1/8% per annum.
The 11 1/8% Indenture contains provisions which are substantially
similar to the ones which will be contained in the indenture governing the
Notes, including certain covenants 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.
The 11 1/8% Senior Discount Notes are redeemable, in whole or
in part, at any time on or after October 15, 2002 at the option of RCN. 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.
1998 Notes Offering
9.80% Senior Discount Notes due 2008
The 9.80% Senior Discount Notes were issued under an indenture
dated February 6, 1998 between RCN and The Chase Manhattan Bank, as Trustee
(the "9.80% Indenture"). The 9.80% Senior Discount Notes are general senior
obligations of RCN, limited to $567,000,000 aggregate principal amount at
maturity and will mature on February 15, 2008. The 9.80% Senior Discount Notes
were issued at a discount to yield gross proceeds of $350,587,440. The 9.80%
Senior Discount Notes will not bear cash interest prior to February 15, 2003.
The yield to maturity of the 9.80% Senior Discount Notes, determined on a
semi-annual bond equivalent basis, will be 9.80% per annum.
The 9.80% Indenture contains provisions which are substantially
similar to the ones which will be contained in the indenture governing the
Notes, including certain covenants 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.
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.
DESCRIPTION OF THE NOTES
The Notes will be issued under an Indenture (the "Indenture")
dated as of , 1998 between RCN and The Chase Manhattan Bank, as
trustee (in such capacity, the "Trustee"). The Indenture has been filed as an
exhibit to the Registration Statement of which this Prospectus constitutes a
part. The Indenture will be subject to the Trust Indenture Act of 1939, as
amended (the "Trust Indenture Act"). The following summary of certain
provisions of the Indenture does not purport to be complete and is subject to,
and is qualified in its entirety by reference to all of the provisions of the
Indenture, including the definitions of certain terms therein and those terms
made a part of the Indenture by reference to the Trust Indenture Act of 1939,
as in effect on the date of such Indenture, and to the Trust Indenture Act,
in the case of the Notes. Whenever particular provisions or definitions of the
Indenture, the Notes or the terms defined therein are referred to herein, such
provisions or definitions are incorporated herein by reference. As used in this
section, "Company" refers to RCN Corporation. The definitions of certain
capitalized terms used in the following summary are set forth below under
"--Certain Definitions."
General
The Notes will be issued only in registered form, without
coupons, in denominations of $1,000 and integral multiples of $1,000. See
"Book-Entry; Delivery and Form." Principal of, premium, if any, and interest
on the Notes are payable, and the Notes are exchangeable and transferable, at
the office or agency of RCN in the City of New York maintained for such
purposes (which initially will be the corporate trust office of the Trustee).
See "Book-Entry; Delivery and Form." No service charge will be made for any
registration of transfer, exchange or redemption of the Notes, except in
certain circumstances for any tax or other governmental charge that may be
imposed in connection therewith.
Maturity, Interest and Principal
The Notes will be general senior unsecured obligations of RCN,
limited to $ aggregate principal amount at maturity, and will
mature on , 2008. See "--Ranking." The Notes will be issued at
a discount to yield gross proceeds of $250,000,000. See "Certain U.S. Federal
Income Tax Considerations." The Notes will not bear cash interest prior to
, 2003. Commencing on , 2003, interest on the Notes
will be payable, in cash at a rate of % per annum, semi-annually in
arrears on each and to the holders of record of Notes at
the close of business on the and immediately preceding
such interest payment date. Interest will accrue from the most recent interest
payment date to which interest has been paid or duly provided for or, if no
interest has been paid or duly provided for, from , 1998. Interest
will be computed on the basis of a 360-day year of twelve 30-day months.
Interest on overdue principal and, to the extent permitted by law, on overdue
installments of interest will accrue at the rate of interest borne by the
Notes. The yield to maturity of the Notes, determined on a semi-annual bond
equivalent basis, will be % per annum.
Redemption
Optional Redemption by RCN. The Notes will be redeemable, in
whole or in part, at any time on or after , 2003 at the option of
RCN, upon not less than 30 nor more than 60 days' notice, at the redemption
prices (expressed as percentages of principal amount at maturity) set forth
below, plus accrued and unpaid interest to the redemption date, if redeemed
during the 12-month period beginning of the years indicated below:
Year Redemption Price
- ---- ----------------
2003................................... %
2004................................... %
2005................................... %
2006 and thereafter.................... 100.00%
Redemption Following Public Equity Offerings. Notwithstanding
the foregoing, on or prior to , 2001, RCN may, at its option, use
the net proceeds of one or more Public Equity Offerings (as defined below)
yielding gross cash proceeds of not less than $30 million to redeem up to an
aggregate of 35% of the aggregate principal amount at maturity of Notes
originally issued, in each case on a pro rata basis (or as nearly pro rata as
practicable), at a redemption price of % of the Accreted Value of Notes;
provided that not less than 65% of the originally issued aggregate principal
amount at maturity of Notes would remain outstanding immediately after such
redemption. To effect the foregoing redemption, RCN must mail a notice of
redemption not later than 60 days after the consummation of the Public Equity
Offering that resulted in the requisite gross proceeds.
As used above, "Public Equity Offering" means an underwritten
public offering of Common Stock of RCN effected on a primary basis and
registered with the Commission under the Securities Act.
Selection; Effect of Redemption Notice. Notice of an optional
redemption must be given no less than 30 nor more than 60 days prior to the
applicable redemption date. In the case of a partial redemption of an issue of
Notes, selection of the Notes for redemption will be made by lot, pro rata or
by such other method as the applicable Trustee in its sole discretion deems
fair and appropriate or in such manner as complies with the requirements of
the principal securities exchange, if any, on which the applicable Notes being
redeemed are listed and of the Depository Trust Company ("DTC"); provided that
any redemption following one or more Public Equity Offerings will be made on a
pro rata or on as nearly a pro rata basis as practicable (subject to the
procedures of DTC). Upon giving of a redemption notice, interest on Notes
called for redemption will cease to accrue from and after the date fixed for
redemption (unless RCN defaults in providing the funds for such redemption)
and, upon redemption on such redemption date, such Notes will cease to be
outstanding.
Mandatory Redemption
Sinking Fund. RCN will not be required to make any mandatory
sinking fund payments in respect of the Notes.
Offers to Purchase upon Change of Control and Certain Asset
Sales. Following the occurrence of a Change of Control, RCN will be required
to make an offer to purchase all outstanding Notes at a price of 101% of the
Accreted Value thereof plus accrued and unpaid interest, if any, to the date
of purchase, and purchase all Notes validly tendered pursuant thereto. In
addition, RCN may be obligated to make an offer to purchase Notes with a
portion of the Net Cash Proceeds of certain Asset Sales at a price of 100% of
the Accreted Value thereof plus accrued and unpaid interest, if any, to the
date of purchase. See "--Certain Covenants--Change of Control" and "--Certain
Covenants--Disposition of Proceeds of Asset Sales," respectively.
Ranking
The indebtedness of RCN evidenced by the Notes will rank senior
in right of payment to all subordinated indebtedness of RCN and pari passu in
right of payment with all other existing and future unsubordinated indebtedness
of RCN. RCN is a holding company with limited assets and no business
operations of its own. RCN operates its business through its subsidiaries. Any
right of RCN and its creditors, including holders of the Notes, to participate
in the assets of any of RCN's subsidiaries upon any liquidation or
administration of any such subsidiary will be subject to the prior claims of
the subsidiary's creditors, including trade creditors. For a discussion of
certain adverse consequences of RCN being a holding company and of the terms
of potential future indebtedness of RCN and its subsidiaries, see "Risk
Factors--Holding Company Structure; Structural Subordination."
Certain Covenants
Set forth below are certain covenants that are contained in the
Indenture.
Limitation on Additional Indebtedness. The Indenture provides
that RCN will not, and will not permit any Restricted Subsidiary or Restricted
Affiliate to, directly or indirectly, create, incur, assume, issue, guarantee
or in any manner become directly or indirectly liable for or with respect to,
contingently or otherwise, the payment of (collectively, to "incur") any
Indebtedness (including any Acquired Indebtedness), except for Permitted
Indebtedness; provided that (A) (i) RCN will be permitted to incur
Indebtedness (including Acquired Indebtedness and Buildout Indebtedness) and
(ii) a Restricted Subsidiary or Restricted Affiliate will be permitted to
incur Acquired Indebtedness or Buildout Indebtedness, if, in either case,
after giving pro forma effect to such incurrence (including the application
of the net proceeds therefrom), either (X) the ratio of Total Consolidated
Indebtedness to Consolidated Pro Forma Operating Cash Flow would not be
greater than or equal to 5.5:1.0 if such Indebtedness is incurred prior to
October 15, 2000 or 5.0:1.0 if such Indebtedness is incurred on or after
October 15, 2000 or (Y) the ratio of Total Consolidated Indebtedness to Total
Invested Equity Capital would not exceed 2.0:1.0 and (B) on or after October
15, 2002, a Restricted Affiliate will be permitted to incur Acquired
Indebtedness or Buildout Indebtedness, if, after giving pro forma effect to
such incurrence (including the application of the net proceeds therefrom), the
ratio of Total Affiliate Indebtedness to Affiliate Pro Forma Operating Cash
Flow of such Restricted Affiliate would not be greater than or equal to
4:0:1.0.
Limitation on Restricted Payments. The Indenture provides
that RCN will not, and will not permit any of the Restricted Subsidiaries or
Restricted Affiliates to, make, directly or indirectly, any Restricted Payment
unless:
(i) no Default shall have occurred and be continuing at the time
of or after giving effect to such Restricted Payment;
(ii) immediately after giving effect to such Restricted Payment,
RCN would be able to incur $1.00 of Indebtedness under clause (A)(X) of the
proviso of the covenant described under "Limitation on Additional
Indebtedness"; and
(iii) immediately after giving effect to such Restricted Payment,
the aggregate amount of all Restricted Payments declared or made on or
after the Issue Date and all Designation Amounts does not exceed an amount
equal to the sum of, without duplication, (a) 50% of cumulative
Consolidated Net Income accrued on a cumulative basis during the period
beginning on June 30, 1998 and ending on the last day of the fiscal quarter
of RCN immediately preceding the date of such proposed Restricted Payment
(or, if such cumulative Consolidated Net Income for such period is a
deficit, minus 100% of such deficit) plus (b) the aggregate net cash
proceeds received by RCN from the issue or sale (other than to a Restricted
Subsidiary or to a Restricted Affiliate) of its Capital Stock (other than
Disqualified Stock) on or after the Issue Date (including, without
duplication, upon the exercise of options, warrants or rights) plus (c) the
aggregate net proceeds received by RCN from the issuance (other than to a
Restricted Subsidiary or to a Restricted Affiliate) on or after the Issue
Date of its Capital Stock (other than Disqualified Stock) upon the
conversion of, or exchange for, Indebtedness of RCN or a Restricted
Subsidiary plus (d) in the case of the disposition or repayment of any
Investment constituting a Restricted Payment (other than an Investment made
pursuant to clause (v), (vi) or (vii) of the following paragraph) made
after the Issue Date an amount equal to the lesser of the return of capital
with respect to such Investment and the cost of such Investment, in either
case, less the cost of the disposition of such Investment plus (e) in the
case of the Revocation of the Designation of a Subsidiary as an
Unrestricted Subsidiary, an amount equal to the consolidated net Investment
in such Subsidiary on the date of Revocation but not in an amount exceeding
the net amount of any Investments constituting Restricted Payments made (or
deemed made) in such Subsidiary after the Issue Date plus (f) in the case
of the JV Designation after the Issue Date of a New Joint Venture as a
Restricted Affiliate, an amount equal to the consolidated net Investment in
such New Joint Venture on the date of such JV Designation but not in an
amount exceeding the net amount of any Investments constituting Restricted
Payments made (or deemed made) in such New Joint Venture after the Issue
Date. For purposes of the preceding clauses (b) and (c) and without
duplication, the value of the aggregate net cash proceeds received by RCN
upon the issuance of Capital Stock either upon the conversion of
convertible Indebtedness or in exchange for outstanding Indebtedness or
upon the exercise of options, warrants or rights will be the net cash
proceeds received upon the issuance of such Indebtedness, options, warrants
or rights plus the incremental amount received by RCN upon the conversion,
exchange or exercise thereof.
For purposes of determining the amount expended for Restricted
Payments, cash distributed shall be valued at the face amount thereof and
property other than cash shall be valued at its Fair Market Value.
The provisions of this covenant shall not prohibit: (i) the
payment of any dividend or other distribution within 60 days after the date of
declaration thereof, if at such date of declaration such payment would comply
with the provisions of the Indenture; (ii) so long as no Default shall have
occurred and be continuing, the purchase, redemption, retirement or other
acquisition of any shares of Capital Stock of RCN (A) in exchange for or
conversion into or (B) out of the net cash proceeds of the substantially
concurrent issue and sale (other than to a Restricted Subsidiary or to a
Restricted Affiliate) of shares of Capital Stock of RCN (other than
Disqualified Stock); provided that any such net cash proceeds pursuant to the
immediately preceding subclause (B) are excluded from clause (iii)(b) of the
preceding paragraph; (iii) so long as no Default shall have occurred and be
continuing, the purchase, redemption, defeasance or other acquisition or
retirement for value of Subordinated Indebtedness made by exchange for
(including any such exchange pursuant to the exercise of a conversion right or
privilege in which cash is paid in lieu of fractional shares or scrip), or out
of the net cash proceeds of, a substantially concurrent issue or sale (other
than to a Restricted Subsidiary or to a Restricted Affiliate) of (A) Capital
Stock (other than Disqualified Stock) of RCN; provided that any such net cash
proceeds, to the extent so used, are excluded from clause (iii)(b) of the
preceding paragraph, and/or (B) other Subordinated Indebtedness, having an
Average Life to Stated Maturity that is equal to or greater than the Average
Life to Stated Maturity of the Subordinated Indebtedness being purchased,
redeemed, defeased or otherwise acquired or retired; (iv) so long as no
Default shall have occurred and be continuing, any Investment constituting a
Restricted Payment made by RCN or any Restricted Subsidiary in any Restricted
Affiliate to fund the capital requirements for financing or supporting a
Permitted Business of such Restricted Affiliate; (v) so long as no Default
shall have occurred and be continuing, Investments constituting a Restricted
Payment made by RCN or any Restricted Subsidiary in any person (including any
Unrestricted Subsidiary or a Restricted Affiliate) in an amount not to exceed
$10 million in the aggregate at any time outstanding; (vi) so long as no
Default shall have occurred and be continuing, the making of a direct or
indirect Investment constituting a Restricted Payment out of the proceeds of
the issue or sale (other than to a Subsidiary or to a Restricted Affiliate) of
Capital Stock (other than Disqualified Stock) of RCN; provided that any such
net cash proceeds are excluded from clause (iii)(b) of the preceding
paragraph; or (vii) so long as no Default shall have occurred and be
continuing, any Investment constituting a Restricted Payment made in Megacable
S.A. de C.V. not to exceed $20 million in the aggregate at any time
outstanding. Restricted Payments of the type set forth in the preceding clauses
(v) and (vii) shall be included in making the determination of available
amounts under clause (iii) of the preceding paragraph to the extent they are
outstanding.
In no event shall a Restricted Payment made on the basis of
consolidated financial statements prepared in good faith in accordance with
GAAP be subject to rescission or constitute a Default by reason of any
requisite subsequent restatement of such financial statements which would have
made such Restricted Payment prohibited at the time that it was made.
Limitation on Business. The Indenture provides that RCN will
not, and will not permit any of the Restricted Subsidiaries or Restricted
Affiliates to, engage in a business which is not substantially a Permitted
Business.
Limitation on Liens Securing Certain Indebtedness. The
Indenture provides that RCN will not, and will not permit any Restricted
Subsidiary or Restricted Affiliate to, create, incur, assume or suffer to
exist any Liens of any kind against or upon any property or assets of RCN or
any Restricted Subsidiary or Restricted Affiliate, whether now owned or
hereafter acquired, or any proceeds therefrom, which secure either (x)
Subordinated Indebtedness unless the Notes issued thereunder are secured by a
Lien on such property, assets or proceeds that is senior in priority to the
Liens securing such Subordinated Indebtedness or (y) Senior Debt Securities
unless the Notes issued thereunder are equally and ratably secured with the
Liens securing such Senior Debt Securities other than the Lien on the escrow
account in favor of the escrow agent and the trustee under the indenture
governing the 10% Senior Notes.
Limitation on Certain Guarantees and Indebtedness of Restricted
Subsidiaries and Restricted Affiliates. The Indenture provides that RCN will
not permit any Restricted Subsidiary or Restricted Affiliate directly or
indirectly, to assume, guarantee or in any other manner become liable, whether
as issuer, guarantor or co-obligor, with respect to (i) any Subordinated
Indebtedness or (ii) any Senior Debt Securities, unless, in each case, such
Restricted Subsidiary or Restricted Affiliate, as the case may be,
simultaneously executes and delivers a supplemental indenture providing for
the guarantee of payment of the Notes by such Restricted Subsidiary or
Restricted Affiliate, as the case may be, on a basis senior to any such
Subordinated Indebtedness or pari passu with any such Senior Debt Securities,
as the case may be. Each guarantee of the Notes created pursuant to such
provisions is referred to as a "Guarantee" and the issuer of each such
Guarantee, so long as the Guarantee remains outstanding, is referred to as a
"Guarantor."
Notwithstanding the foregoing, in the event of the
unconditional release of any Guarantor from its obligations in respect of the
Indebtedness which gave rise to the requirement that a Guarantee be given,
such Guarantor shall be released from all obligations under its Guarantee. In
addition, upon any sale or disposition (by merger or otherwise) of any
Guarantor by RCN or a Restricted Subsidiary to any person that is not an
Affiliate of RCN or any of the Restricted Subsidiaries which is otherwise in
compliance with the terms of the Indenture and as a result of which such
Guarantor ceases to be a Restricted Subsidiary of RCN, such Guarantor will be
deemed to be automatically and unconditionally released from all obligations
under its Guarantee; provided that each such Guarantor is sold or disposed of
in accordance with the "Disposition of Proceeds of Asset Sales" covenant.
Change of Control. Upon the occurrence of a Change of Control
(the date of such occurrence being the "Change of Control Date"), RCN shall
make an offer to purchase (the "Change of Control Offer"), on a business day
(the "Change of Control Payment Date") not later than 60 days following the
Change of Control Date, all Notes then outstanding at a purchase price equal
to 101% of the Accreted Value thereof plus accrued and unpaid interest, if any,
to any Change of Control Payment Date. Notice of a Change of Control Offer
shall be given to holders of Notes, not less than 25 days nor more than 45
days before the Change of Control Payment Date. The Change of Control Offer is
required to remain open for at least 20 business days and until the close of
business on the Change of Control Payment Date.
If a Change of Control Offer is made, there can be no assurance
that RCN will have available funds sufficient to pay for all of the Notes that
might be delivered by holders of Notes seeking to accept the Change of Control
Offer. RCN shall not be required to make a Change of Control Offer following a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements
applicable to a Change of Control Offer made by RCN and purchases all Notes
validly tendered and not withdrawn under such Change of Control Offer.
If RCN is required to make a Change of Control Offer, RCN will
comply with all applicable tender offer laws and regulations, including, to
the extent applicable, Section 14(e) and Rule 14e-1 under the Exchange Act,
and any other applicable securities laws and regulations.
Limitation on Dividend and Other Payment Restrictions Affecting
Restricted Subsidiaries or Restricted Affiliates. The Indenture provides that
RCN will not, and will not permit any Restricted Subsidiary or Restricted
Affiliate to, directly or indirectly, create or otherwise enter into or cause
to become effective any consensual encumbrance or consensual restriction of
any kind on the ability of any Restricted Subsidiary or Restricted Affiliate
to (a) pay dividends, in cash or otherwise, or make any other distributions on
its Capital Stock or any other interest or participation in, or measured by,
its profits to the extent owned by RCN or any Restricted Subsidiary or
Restricted Affiliate, (b) pay any Indebtedness owed to RCN or any Restricted
Subsidiary or Restricted Affiliate, (c) make any Investment in RCN or any
Restricted Subsidiary or Restricted Affiliate or (d) transfer any of its
properties or assets to RCN or to any Restricted Subsidiary or Restricted
Affiliate, except for (i) any encumbrance or restriction in existence on the
Issue Date, (ii) customary non-assignment provisions, (iii) any encumbrance or
restriction pertaining to an asset subject to a Lien to the extent set forth
in the security documentation governing such Lien, (iv) any encumbrance or
restriction applicable to a Restricted Subsidiary or Restricted Affiliate at
the time that it becomes a Restricted Subsidiary or Restricted Affiliate that
is not created in contemplation thereof, (v) any encumbrance or restriction
existing under any agreement that refinances or replaces an agreement
containing a restriction permitted by clause (iv) above; provided that the
terms and conditions of any such encumbrance or restriction are not materially
less favorable to the holders of Notes than those under or pursuant to the
agreement being replaced or the agreement evidencing the Indebtedness
refinanced, (vi) any encumbrance or restriction imposed upon a Restricted
Subsidiary or Restricted Affiliate pursuant to an agreement which has been
entered into for the sale or disposition of all or substantially all of the
Capital Stock or assets of such Restricted Subsidiary or Restricted Affiliate
or any Asset Sale to the extent limited to the Capital Stock or assets in
question, and (vii) any customary encumbrance or restriction applicable to a
Restricted Subsidiary or Restricted Affiliate that is contained in an
agreement or instrument governing or relating to Indebtedness contained in any
Permitted Credit Facility; provided that (subject to customary net worth,
leverage, invested capital and other financial covenants) the provisions of
such agreement permit the payment of interest and principal and mandatory
repurchases pursuant to the terms of the Indenture and the Notes and other
indebtedness that is solely an obligation of RCN; provided, further, that such
agreement may contain customary covenants regarding the merger of or sale of
all or any substantial part of the assets of RCN or any Restricted Subsidiary
or Restricted Affiliate, customary restrictions on transactions with
affiliates, and customary subordination provisions governing indebtedness owed
to RCN or any Restricted Subsidiary or Restricted Affiliate.
Disposition of Proceeds of Asset Sales. The Indenture
provides that RCN will not, and will not permit any Restricted Subsidiary or
Restricted Affiliate to, make any Asset Sale unless (a) RCN or such Restricted
Subsidiary or Restricted Affiliate, as the case may be, receives consideration
at the time of such Asset Sale at least equal to the Fair Market Value of the
shares or assets sold or otherwise disposed of and (b) at least 75% of such
consideration consists of cash or Cash Equivalents; provided that the amount
of any liabilities (other than Subordinated Indebtedness or Indebtedness of a
Restricted Subsidiary that would not constitute Restricted Subsidiary
Indebtedness) that are assumed by the transferee of any such assets pursuant
to an agreement that unconditionally releases RCN or such Restricted
Subsidiary or Restricted Affiliate, as the case may be, from further liability
shall be treated as cash for purposes of this covenant. RCN or the applicable
Restricted Subsidiary, as the case may be, may (i) apply the Net Cash Proceeds
from any such Asset Sale by RCN or a Restricted Subsidiary and the Net Cash
Proceeds of any Asset Sale by a Restricted Affiliate to the extent distributed
to RCN or a Restricted Subsidiary within 365 days of the receipt thereof to
repay an amount of Indebtedness (other than Subordinated Indebtedness) of RCN
in an amount not exceeding the Other Senior Debt Pro Rata Share and elect to
permanently reduce the amount of the commitments thereunder by the amount of
the Indebtedness so repaid, (ii) apply the Net Cash Proceeds from any such
Asset Sale by RCN or a Restricted Subsidiary and the Net Cash Proceeds of any
Asset Sale by a Restricted Affiliate to the extent distributed to RCN or a
Restricted Subsidiary to repay any Restricted Subsidiary Indebtedness and
elect to permanently reduce the commitments thereunder by the amount of the
Indebtedness so repaid or (iii) apply the Net Cash Proceeds from any Asset
Sale by RCN or a Restricted Subsidiary and the Net Cash Proceeds of any Asset
Sale by a Restricted Affiliate to the extent distributed to RCN or a
Restricted Subsidiary within 365 days thereof, to an investment in properties
and assets that will be used in a Permitted Business (or in Capital Stock and
other securities of any person that will become a Restricted Subsidiary or
Restricted Affiliate as a result of such investment to the extent such person
owns properties and assets that will be used in a Permitted Business) of RCN
or any Restricted Subsidiary ("Replacement Assets"). Notwithstanding anything
herein to the contrary, in the event of any Asset Sale of all or substantially
all of the properties or assets of any Restricted Affiliate Group, whether in
a single transaction or series of related transactions, the Restricted
Affiliate Group shall be required to distribute the Net Cash Proceeds
therefrom, after providing for all Indebtedness and other liabilities of such
Restricted Affiliate Group, to RCN or a Restricted Subsidiary and the Other
Partner on a pro rata basis in accordance with their respective equity
interests. Any Net Cash Proceeds from any Asset Sale that are neither used to
repay, and permanently reduce the commitments under, any Restricted Subsidiary
Indebtedness as set forth in clause (ii) of the preceding sentence or invested
in Replacement Assets within the 365-day period as set forth in clause (iii)
shall constitute "Excess Proceeds." Any Excess Proceeds not used as set forth
in clause (i) of the second preceding sentence shall constitute "Offer Excess
Proceeds" subject to disposition as provided below.
When the aggregate amount of Offer Excess Proceeds equals or
exceeds $10 million, RCN shall make an offer to purchase (an "Asset Sale
Offer"), from all holders of Notes issued under the Indenture, that aggregate
principal amount of Notes as can be purchased by application of such Offer
Excess Proceeds at a price in cash equal to 100% of the outstanding Accreted
Value thereof plus accrued and unpaid interest, if any, to the purchase date.
Each Asset Sale Offer shall remain open for a period of 20 business days or
such longer period as may be required by law. To the extent that the aggregate
purchase price for the Notes tendered pursuant to an Asset Sale Offer is less
than the Offer Excess Proceeds, RCN or any Restricted Subsidiary may use such
deficiency for general corporate purposes. If the aggregate purchase price for
the Notes validly tendered and not withdrawn by holders thereof exceeds the
amount of Notes which can be purchased with the Offer Excess Proceeds, Notes
to be purchased will be selected on a pro rata basis. Upon completion of such
Asset Sale Offer, the amount of Offer Excess Proceeds shall be reset to zero.
Notwithstanding the two immediately preceding paragraphs, RCN,
the Restricted Subsidiaries and the Restricted Affiliates will be permitted to
consummate an Asset Sale without complying with such paragraphs to the extent
(i) at least 75% of the consideration of such Asset Sale constitutes
Replacement Assets, cash or Cash Equivalents (including obligations deemed to
be cash under this covenant) and (ii) such Asset Sale is for Fair Market
Value; provided that any consideration constituting (or deemed to constitute)
cash or Cash Equivalents received by RCN, any of the Restricted Subsidiaries
or any of the Restricted Affiliates in connection with any Asset Sale
permitted to be consummated under this paragraph shall constitute Net Cash
Proceeds subject to the provisions of the two preceding paragraphs.
If RCN is required to make an Asset Sale Offer, RCN will comply
with all applicable tender offer rules, including, to the extent applicable,
Section 14(e) and Rule 14e-1 under the Exchange Act, and any other applicable
securities laws and regulations.
Limitation on Issuances and Sales of Preferred Stock by
Restricted Subsidiaries and Restricted Affiliates. The Indenture provides
that RCN (i) will not permit any Restricted Subsidiary to issue any Preferred
Stock (other than to RCN or a Restricted Subsidiary) and (ii) will not permit
any person (other than RCN or a Restricted Subsidiary) to own any Preferred
Stock of any Restricted Subsidiary. In addition, RCN (i) will not permit any
Restricted Affiliate to issue any Preferred Stock (other than (x) to RCN or a
Restricted Subsidiary or (y) to the holders of Common Stock in such Restricted
Affiliate on a pro rata basis based upon their ownership of Common Stock) or
(ii) will not permit any person not referred to in the preceding parenthetical
of clause (i) of this sentence to own any Preferred Stock of any Restricted
Affiliate.
Limitation on Transactions with Affiliates. The Indenture
provides that RCN will not, and will not permit, cause or suffer any
Restricted Subsidiary to, conduct any business or enter into any transaction
(or series of related transactions which are similar or part of a common plan)
with or for the benefit of any of their respective Affiliates or any
beneficial holder of 10% or more of the Common Stock of RCN or any officer or
director of RCN (each, an "Affiliate Transaction"), unless the terms of the
Affiliate Transaction are set forth in writing, and are fair and reasonable to
RCN or such Restricted Subsidiary, as the case may be. Each Affiliate
Transaction involving aggregate payments or other Fair Market Value in excess
of $5 million shall be approved by a majority of the Board, such approval to
be evidenced by a Board Resolution stating that the Board has determined that
such transaction or transactions comply with the foregoing provisions. In
addition to the foregoing, each Affiliate Transaction involving aggregate
consideration of $10 million or more shall be approved by a majority of the
Disinterested Directors; provided that, in lieu of such approval by the
Disinterested Directors, RCN may obtain a written opinion from an Independent
Financial Advisor stating that the terms of such Affiliate Transaction to RCN
or the Restricted Subsidiary, as the case may be, are fair from a financial
point of view. In addition, the Indenture provides that a Restricted Affiliate
will not enter into any transaction (or series of related transactions which
are similar or part of a common plan) with or for the benefit of the Other
Partner, unless the terms of such transaction or transactions are in writing,
and are fair and reasonable to such Restricted Affiliate. For purposes of this
covenant, any Affiliate Transaction approved by a majority of the
Disinterested Directors or as to which a written opinion has been obtained
from an Independent Financial Advisor, on the basis set forth in the preceding
sentence, shall be deemed to be on terms that are fair and reasonable to RCN
and the Restricted Subsidiaries, as the case may be, and therefore shall be
permitted under this covenant.
Notwithstanding the foregoing, the restrictions set forth in
this covenant shall not apply to (i) transactions with or among, or solely for
the benefit of, RCN and/or any of the Restricted Subsidiaries, (ii)
transactions pursuant to agreements and arrangements existing on the Issue
Date, (iii) transactions among any of RCN or the Restricted Subsidiaries, on
the one hand, and any of the Restricted Affiliates, on the other hand,
provided that such transactions are in the ordinary course of business and are
related to or in furtherance of a Permitted Business, (iv) dividends paid by
RCN pursuant to and in compliance with the covenant "Limitation on Restricted
Payments," (v) customary directors' fees, indemnification and similar
arrangements, consulting fees, employee salaries bonuses, employment agreements
and arrangements, compensation or employee benefit arrangements or legal fees
and (vi) grants of customary registration rights with respect to securities of
RCN.
Reports. The Indenture provides that, whether or not RCN has
a class of securities registered under the Exchange Act, RCN shall furnish
without cost to each holder of record of Notes issued thereunder (in
sufficient quantities for distribution to beneficial holders) and file with
the Trustee and the Commission, (i) within the applicable time period required
under the Exchange Act, after the end of each fiscal year of RCN, the
information required by Form 10-K (or any successor form thereto) under the
Exchange Act with respect to such period, (ii) within the applicable time
period required under the Exchange Act after the end of each of the first
three fiscal quarters of each fiscal year of RCN, the information required by
Form 10-Q (or any successor form thereto) under the Exchange Act with respect
to such period and (iii) any current reports on Form 8-K (or any successor
forms) required to be filed under the Exchange Act.
Designations of Unrestricted Subsidiaries. The Indenture
provides that RCN will not designate any Subsidiary of RCN (other than a newly
created Subsidiary in which no Investment has previously been made) as an
"Unrestricted Subsidiary" under the Indenture (a "Designation") unless:
(a) no Default shall have occurred and be continuing at the time
of or after giving effect to such Designation;
(b) except in the case of a Permitted Investment or an Investment
made pursuant to clause (iii) or (iv) of the second paragraph of the
covenant "Limitation on Restricted Payments," immediately after giving
effect to such Designation, RCN would be able to incur $1.00 of
Indebtedness under clause (A)(X) of the proviso of the covenant "Limitation
on Additional Indebtedness"; and
(c) RCN would not be prohibited under the Indenture from making
an Investment at the time of such Designation (assuming the effectiveness
of such Designation) in an amount (the "US Designation Amount") equal to
the Fair Market Value of the net Investment of RCN or any other Restricted
Subsidiary in such Subsidiary on such date. In the event of any such
Designation, RCN shall be deemed to have made an Investment constituting a
Restricted Payment pursuant to the covenant "Limitation on Restricted
Payments" for all purposes of the Indenture in the US Designation Amount.
The Indenture further provides that neither RCN nor any Restricted
Subsidiary shall at any time (x) provide a guarantee of, or similar credit
support to, any Indebtedness of any Unrestricted Subsidiary (including any
undertaking, agreement or instrument evidencing such Indebtedness);
provided that RCN may pledge Capital Stock or Indebtedness of any
Unrestricted Subsidiary on a nonrecourse basis such that the pledgee has no
claim whatsoever against RCN other than to obtain such pledged property,
(y) be directly or indirectly liable for any Indebtedness of any
Unrestricted Subsidiary or (z) be directly or indirectly liable for any
other Indebtedness which provides that the holder thereof may (upon notice,
lapse of time or both) declare a default thereon (or cause the payment
thereof to be accelerated or payable prior to its final scheduled maturity)
upon the occurrence of a default with respect to any other Indebtedness
that is Indebtedness of an Unrestricted Subsidiary (including any
corresponding right to take enforcement action against such Unrestricted
Subsidiary), except in the case of clause (x) or (y) to the extent
permitted under the covenants "Limitation on Restricted Payments" and
"Limitation on Transactions with Affiliates."
The Indenture further provides that RCN will not revoke any
Designation of a Subsidiary as an Unrestricted Subsidiary (a "Revocation")
unless:
(a) no Default shall have occurred and be continuing at the time
of and after giving effect to such Revocation; and
(b) all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately following such Revocation would, if incurred at
such time, have been permitted to be incurred for all purposes of the
Indenture.
All Designations and Revocations must be evidenced by Board
Resolutions delivered to the Trustee certifying compliance with the foregoing
provisions.
Designations of Restricted Affiliates. The Indenture provides
that RCN will not designate any Joint Venture (other than a newly created
Joint Venture in which no Investment has previously been made) and each of its
Subsidiaries as a "Restricted Affiliate" under the Indenture (a "JV
Designation") unless:
(a) no Default shall have occurred and be continuing at the time
of and after giving effect to such JV Designation; and
(b) all Liens and Indebtedness of such Joint Venture outstanding
immediately following such JV Designation would, if incurred at such time,
have been permitted to be incurred for all purposes of the Indenture.
Notwithstanding the foregoing, the BECO Joint Venture and the
Starpower Joint Venture shall initially constitute Restricted Affiliates at
the Issue Date. RCN and the Restricted Subsidiaries shall at all times
maintain a Restricted Affiliate so that it qualifies as a Joint Venture under
clauses (a) and (b) of the definition thereof, unless either (1) RCN is able
to, and does in fact, make an effective JV Revocation under the provisions set
forth below at the time of such event or (2) the Restricted Affiliate ceases
to qualify as a Joint Venture by reason of an Asset Sale by RCN or a
Restricted Subsidiary of all of RCN's or such Restricted Subsidiary's interest
in the Capital Stock of such Restricted Affiliate to any person other than RCN
or a Restricted Subsidiary or any of their respective Affiliates, which, in the
case of this clause (2), shall be deemed an effective JV Revocation.
The Indenture further provides that RCN will not revoke any JV
Designation of a Joint Venture as a Restricted Affiliate (a "JV Revocation")
unless:
(a) no Default shall have occurred and be continuing at the time
of or after giving effect to such JV Revocation;
(b) except in the case of a Permitted Investment or an Investment
made pursuant to clause (v) or (vi) of the second paragraph of the covenant
"Limitation on Restricted Payments" and except in the case in which the
Restricted Affiliate will become a Restricted Subsidiary, immediately after
giving effect to such JV Revocation, RCN would be able to incur $1.00 of
Indebtedness under the proviso of clause (A)(X) of the covenant "Limitation
on Additional Indebtedness"; and
(c) RCN would not be prohibited under the Indenture from making
an Investment at the time of such JV Revocation (assuming the effectiveness
of such JV Revocation) in an amount (the "JV Revocation Amount") equal to
the Fair Market Value of the net Investment of RCN or any other Restricted
Subsidiary in such Restricted Subsidiary on such date. In the event of any
such JV Revocation, except in the case in which the Restricted Affiliate
will become a Restricted Subsidiary, RCN shall be deemed to have made an
Investment constituting a Restricted Payment pursuant to the covenant
"Limitation on Restricted Payments" for all purposes of the Indenture in
the JV Revocation Amount.
All JV Designations and JV Revocations must be evidenced by
Board Resolutions delivered to the Trustee certifying compliance with the
foregoing provisions.
Consolidation, Merger, Sale of Assets, Etc.
The Indenture provides that RCN will not (i) consolidate or
combine with or merge with or into or, directly or indirectly, sell, assign,
convey, lease, transfer or otherwise dispose of all or substantially all of
its properties and assets to any person or persons in a single transaction or
through a series of transactions, or (ii) permit any of the Restricted
Subsidiaries to enter into any such transaction or series of transactions if
it would result in the disposition of all or substantially all of the
properties or assets of RCN and the Restricted Subsidiaries on a consolidated
basis, unless, in the case of either (i) or (ii), (a) RCN shall be the
continuing person or, if RCN is not the continuing person, the resulting,
surviving or transferee person (the "surviving entity") shall be a company
organized and existing under the laws of the United States or any State or
territory thereof; (b) the surviving entity shall expressly assume all of the
obligations of RCN under the Notes and the Indenture, and shall, if required
by law to effectuate such assumption, execute a supplemental indenture to
effect such assumption which supplemental indenture shall be delivered to the
Trustee and shall be in form and substance reasonably satisfactory to the
Trustee; (c) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or in
respect of such transaction or series of transactions), RCN or the surviving
entity (assuming such surviving entity's assumption of RCN obligations under
the Notes and Indenture), as the case may be, would be able to incur $1.00 of
Indebtedness under clause (A)(X) of the proviso of the covenant "Limitation on
Additional Indebtedness"; (d) immediately after giving effect to such
transaction or series of transactions on a pro forma basis (including, without
limitation, any Indebtedness incurred or anticipated to be incurred in
connection with or in respect of such transaction or series of transactions),
no Default shall have occurred and be continuing; and (e) RCN or the surviving
entity, as the case may be, shall have delivered to the Trustee an Officers'
Certificate stating that such transaction or series of transactions, and, if a
supplemental indenture, is required in connection with such transaction or
series of transactions to effectuate such assumption, such supplemental
indenture complies with this covenant and that all conditions precedent in the
Indenture relating to the transaction or series of transactions have been
satisfied.
Upon any consolidation or merger or any sale, assignment,
conveyance, lease, transfer or other disposition of all or substantially all
of the assets of RCN in accordance with the foregoing in which RCN or the
Restricted Subsidiary, as the case may be, is not the continuing corporation,
the successor corporation formed by such a consolidation or into which RCN or
such Restricted Subsidiary is merged or to which such transfer is made will
succeed to, and be substituted for, and may exercise every right and power of,
RCN or such Restricted Subsidiary, as the case may be, under the Indenture
with the same effect as if such successor corporation had been named as RCN or
such Restricted Subsidiary therein; and thereafter, except in the case of (i)
any lease or (ii) any sale, assignment, conveyance, transfer, lease or other
disposition to a Restricted Subsidiary of RCN, RCN shall be discharged from
all obligations and covenants under the Indenture and the Notes issued
thereunder.
The Indenture provides that for all purposes of the Indenture
and the Notes (including the provision of this covenant and the covenants
"Limitation on Additional Indebtedness," "Limitation on Restricted Payments"
and "Limitation on Liens"), Subsidiaries of any surviving entity will, upon
such transaction or series of related transactions, become Restricted
Subsidiaries or Unrestricted Subsidiaries as provided pursuant to the covenant
"Limitation on Designations of Unrestricted Subsidiaries" and all
Indebtedness, and all Liens on property or assets, of RCN and the Restricted
Subsidiaries in existence immediately prior to such transaction or series of
related transactions will be deemed to have been incurred upon such
transaction or series of related transactions.
Events of Default
The following are "Events of Default" under the Indenture:
(i) default in the payment of interest on the Notes when it
becomes due and payable and continuance of such default for a period of 30
days or more; or
(ii) default in the payment of the principal of, or premium, if
any, on the Notes when due; or
(iii) default in the performance, or breach, of any covenant
described under "--Certain Covenants--Change of Control," "--Disposition of
Proceeds of Asset Sales" or "--Consolidation, Merger, Sale of Assets,
Etc."; or
(iv) default in the performance, or breach, of any covenant in
the Indenture (other than defaults specified in clause (i), (ii) or (iii)
above) and continuance of such default or breach for a period of 30 days or
more after written notice to RCN by the Trustee or to RCN and the Trustee
by the holders of at least 25% in Accreted Value of the outstanding Notes
(when such notice is deemed received in accordance with the Indenture); or
(v) failure to perform any term, covenant, condition or provision
of one or more classes or issues of Indebtedness in an aggregate principal
amount of $10 million or more under which RCN or a Material Restricted
Subsidiary is obligated, and either (a) such Indebtedness is already due
and payable in full or (b) such failure results in the acceleration of the
maturity of such Indebtedness; or
(vi) any holder of at least $10 million in aggregate principal
amount of Indebtedness of RCN or any Material Restricted Subsidiary shall
commence judicial proceedings or take any other action to foreclose upon,
or dispose of, assets of RCN or any Material Restricted Subsidiary having
an aggregate Fair Market Value, individually or in the aggregate, of $10
million or more or shall have exercised any right under applicable law or
applicable security documents to take ownership of any such assets in lieu
of foreclosure; provided that, in any such case, RCN or any Material
Restricted Subsidiary shall not have obtained, prior to any such
foreclosure or disposition of assets, a stay of all such actions that
remains in effect; or
(vii) one or more final non-appealable judgments, orders or
decrees for the payment of money of $10 million or more, either
individually or in the aggregate, shall be entered against RCN or any
Material Restricted Subsidiary or any of their respective properties and
shall not be discharged and there shall have been a period of 60 days or
more during which a stay of enforcement of such judgment or order, by
reason of pending appeal or otherwise, shall not be in effect; or
(viii) certain events of bankruptcy, insolvency, reorganization,
administration or similar proceedings with respect to RCN or any Material
Restricted Subsidiary shall have occurred.
If an Event of Default (other than an Event of Default
specified in clause (viii) with respect to RCN) under the Indenture occurs and
is continuing, then the Trustee thereunder or the holders of at least 25% in
Accreted Value of the outstanding Notes may by written notice, and the Trustee
upon request of the holders of not less than 25% in Accreted Value of the
outstanding Notes shall, declare the Default Amount of the outstanding Notes
issued thereunder to be due and payable immediately, together with all accrued
and unpaid interest and premium, if any, thereon. Upon any such declaration,
the Default Amount shall become due and payable immediately. If an Event of
Default under the Indenture specified in clause (viii) with respect to RCN
occurs and is continuing, then the Default Amount will ipso facto become and
be immediately due and payable without any declaration or other act on the
part of the Trustee or any holder.
After a declaration of acceleration or any ipso facto
acceleration pursuant to clause (viii) under the Indenture, the holders of a
majority in Accreted Value of outstanding Notes may, by notice to the
applicable Trustee, rescind such declaration of acceleration and its
consequences if all existing Events of Default, other than nonpayment of the
principal of, and accrued and unpaid interest on, such Notes that has become
due solely as a result of such acceleration, have been cured or waived and if
the rescission of acceleration would not conflict with any judgment or decree.
The holders of a majority in Accreted Value of the outstanding Notes also have
the right to waive past defaults, except a default in the payment of the
principal of, or any interest on, any outstanding Note, or in respect of a
covenant or a provision that cannot be modified or amended without the consent
of all holders of the Notes.
No holder of any of the Notes issued under the Indenture has
any right to institute any proceeding with respect to such Indenture or any
remedy thereunder, unless the holders of at least 25% in Accreted Value of the
outstanding Notes have made written request, and offered reasonable indemnity,
to the Trustee to institute such proceeding as Trustee, the Trustee has failed
to institute such proceeding within 60 days after receipt of such notice and
the Trustee has not within such 60-day period received directions inconsistent
with such written request by holders of a majority in Accreted Value of the
outstanding Notes. Such limitations do not apply, however, to a suit
instituted by a holder of a Note for the enforcement of the payment of the
principal of, premium, if any, or any accrued and unpaid interest on, such
Note on or after the respective due dates expressed in such Note.
During the existence of an Event of Default under the
Indenture, the Trustee is required to exercise such rights and powers vested
in it under such Indenture and use the same degree of care and skill in its
exercise thereof as a prudent person would exercise under the circumstances in
the conduct of such person's own affairs. Subject to the provisions of the
Indenture relating to the duties of the Trustee, if an Event of Default shall
occur and be continuing, the Trustee is not under any obligation to exercise
any of its rights or powers under the Indenture at the request or direction of
any of the holders unless such holders shall have offered to the Trustee
reasonable security or indemnity. Subject to certain provisions concerning the
rights of the Trustee, the holders of a majority in Accreted Value of the
outstanding Notes have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Trustee, or
exercising any trust, or power conferred on the Trustee.
The Indenture provides that the Trustee will, within 45 days
after the occurrence of any Default, give to the holders of the Notes notice
of such Default known to it, unless such Default shall have been cured or
waived; provided that, except in the case of a Default in payment of principal
of or premium, if any, on any Note when due or in the case of any Default in
the payment of any interest on the Notes or in the case of any Default arising
from the occurrence of any Change of Control, the Trustee shall be protected
in withholding such notice if it determines in good faith that the withholding
of such notice is in the interest of such holders.
RCN is required to furnish to the Trustee annually a statement
as to compliance with all conditions and covenants under the Indenture.
Satisfaction and Discharge of the Indenture; Defeasance
RCN may terminate its obligations under the Indenture, when (1)
either: (A) all Notes issued thereunder that have been theretofore
authenticated and delivered have been delivered to the Trustee for
cancellation, or (B) all such Notes issued thereunder that have not
theretofore delivered to the Trustee for cancellation will become due and
payable (a "Discharge") under irrevocable arrangements satisfactory to the
Trustee for the giving of notice of redemption by such Trustee in the name,
and at the expense, of RCN, and RCN has irrevocably deposited or caused to be
deposited with such Trustee funds in an amount sufficient to pay and discharge
the entire indebtedness on such issue of Notes, not theretofore delivered to
the Trustee for cancellation, for principal of, premium, if any, on and
interest to the date of deposit or maturity or date of redemption; (2) RCN has
paid or caused to be paid all other sums then due and payable under the
Indenture by RCN; and (3) RCN has delivered to the Trustee an officers'
certificate and an opinion of counsel, each stating that all conditions
precedent under the Indenture relating to the satisfaction and discharge of the
Indenture have been complied with.
RCN may elect, at its option, to have its obligations under the
Indenture discharged with respect to the outstanding Notes ("legal
defeasance"). Such defeasance means that RCN will be deemed to have paid and
discharged the entire indebtedness represented by the outstanding Notes under
the Indenture, except for (1) the rights of holders of Notes to receive
payments in respect of the principal of and any premium and interest on the
Notes when payments are due, (2) RCN's obligations with respect to the Notes
concerning issuing temporary Notes, registration of transfer of Notes,
mutilated, destroyed, lost or stolen Notes and the maintenance of an office or
agency for payment and money for security payments held in trust, (3) the
rights, powers, trusts, duties and immunities of the Trustee, and (4) the
defeasance provisions of the Indenture. In addition, RCN may elect, at its
option, to have its obligations released with respect to certain covenants in
the Indenture, including covenants relating to Asset Sales and Changes of
Control ("covenant defeasance"), and any omission to comply with such
obligation shall not constitute a Default or an Event of Default with respect
to the Notes under such Indenture. In the event covenant defeasance occurs,
certain events (not including non-payment, bankruptcy and insolvency events)
described under "Events of Default" will no longer constitute an Event of
Default with respect to such Notes.
In order to exercise either legal defeasance or covenant
defeasance with respect to outstanding Notes: (1) RCN must irrevocably have
deposited or caused to be deposited with the Trustee as trust funds in trust
for the purpose of making the following payments, specifically pledged as
security for, and dedicated solely to the benefits of the holders of the
Notes: (A) money in an amount, or (B) U.S. Government Obligations which
through the scheduled payment of principal and interest in respect thereof in
accordance with their terms will provide, not later than the due date of any
payment, money in an amount, or (C) a combination thereof, in each case
sufficient without reinvestment, in the opinion of an internationally
recognized firm of independent public accountants expressed in a written
certification thereof delivered to the Trustee to pay and discharge, and which
shall be applied by the Trustee to pay and discharge, the entire Indebtedness
in respect of the principal of and premium, if any, and interest on the Notes
on the maturity thereof or (if RCN has made irrevocable arrangements
satisfactory to the Trustee for the giving of notice of redemption by the
Trustee in the name and at the expense of RCN) the redemption date thereof, as
the case may be, in accordance with the terms of such Indenture and Notes; (2)
in the case of legal defeasance under the Indenture, RCN shall have delivered
to the Trustee an opinion of counsel stating that, under then applicable
Federal income tax law, the holders of the Notes will not recognize gain or
loss for federal income tax purposes as a result of the deposit, defeasance and
discharge to be effected with respect to the Notes and will be subject to
federal income tax on the same amount, in the same manner and at the same
times as would be the case if such deposit, defeasance and discharge were not
to occur; (3) in the case of covenant defeasance under the Indenture, RCN
shall have delivered to the Trustee an opinion of counsel to the effect that
the holders of such outstanding Notes will not recognize gain or loss for U.S.
federal income tax purposes as a result of the deposit and covenant defeasance
to be effected with respect to the Notes and will be subject to U.S. federal
income tax on the same amount, in the same manner and at the same times as
would be the case if such deposit and covenant defeasance were not to occur;
(4) no Default with respect to the outstanding Notes shall have occurred and
be continuing at the time of such deposit after giving effect thereto or, in
the case of legal defeasance, no Default relating to bankruptcy or insolvency
shall have occurred and be continuing at any time on or prior to the 91st day
after the date of such deposit (it being understood that this condition shall
not be deemed satisfied until after such 91st day); (5) such legal defeasance
or covenant defeasance shall not cause the applicable Trustee to have a
conflicting interest within the meaning of the Trust Indenture Act (assuming
all Notes were in default within the meaning of such Act); (6) such defeasance
or covenant defeasance shall not result in a breach or violation of, or
constitute a default under, any other agreement or instrument to which RCN is
a party or by which it is bound; (7) such legal defeasance or covenant
defeasance shall not result in the trust arising from such deposit
constituting an investment company within the meaning of the Investment
Company Act of 1940, as amended, unless such trust shall be registered under
such Act or exempt from registration thereunder; and (8) RCN shall have
delivered to the Trustee an officers' certificate and an opinion of counsel
stating that all conditions precedent with respect to such defeasance or
covenant defeasance have been complied with.
Amendment and Waivers
From time to time, RCN, when authorized by resolutions of the
Board, and the Trustee, without the consent of the holders of Notes, may
amend, waive or supplement the Indenture and the Notes for certain specified
purposes, including, among other things, curing ambiguities, defects or
inconsistencies, to provide for the assumption of RCN's obligations to holders
of the Notes in the case of a merger or consolidation, to make any change that
would provide any additional rights or benefits to the holders of the Notes,
to add Guarantors with respect to the Notes, to secure the Notes, to maintain
the qualification of the Indenture under the Trust Indenture Act or to make
any change that does not adversely affect the rights of any holder. Other
amendments and modifications of the Indenture or the Notes issued thereunder
may be made by RCN and the Trustee with the consent of the holders of not less
than a majority of the aggregate Accreted Value of the outstanding Notes;
provided that no such modification or amendment may, without the consent of
the holder of each outstanding Note affected thereby, (i) reduce the principal
amount of, or extend the fixed maturity of the Notes, or alter or waive the
redemption provisions of the Notes (other than, subject to clause (vii) below,
provisions relating to repurchase of Notes upon the occurrence of an Asset
Sale or a Change of Control) or change the calculation of "Accreted Value",
(ii) change the currency in which any Notes or any premium or the accrued
interest thereon is payable, (iii) reduce the percentage in Accreted Value
outstanding of Notes which must consent to an amendment, supplement or waiver
or consent to take any action under the Indenture or the Notes, (iv) impair the
right to institute suit for the enforcement of any payment on or with respect
to the Notes, (v) waive a default in payment with respect to the Notes or any
Guarantee, (vi) reduce the rate or extend the time for payment of interest on
the Notes, (vii) following the occurrence of an Asset Sale or a Change of
Control, alter the obligation to purchase Notes as a result thereof in
accordance with the Indenture or waive any default in the performance thereof,
(viii) adversely affect the ranking of the Notes, or (ix) release any
Guarantor from any of its obligations under its Guarantee or the Indenture,
except in compliance with the terms of the Indenture.
Regarding the Trustee
The Chase Manhattan Bank will serve as Trustee. The Indenture
provides that, except during the continuance of an Event of Default, the
Trustee will perform only such duties as are specifically set forth in the
Indenture. If an Event of Default has occurred and is continuing, the Trustee
will exercise such rights and powers vested in it under the Indenture and use
the same degree of care and skill in its exercise as a prudent person would
exercise under the circumstances in the conduct of such person's own affairs.
The Indenture and provisions of the Trust Indenture Act
incorporated by reference therein contain limitations on the rights of the
Trustee, should it become a creditor of RCN, to obtain payment of claims in
certain cases or to realize on certain property received by it in respect of
any such claims, as security or otherwise. The Trustee is permitted to engage
in other transactions; provided that if he acquires any conflicting interest
(as defined) he must eliminate such conflict or resign.
Governing Law
The Indenture provides that the Indenture and Notes are
governed by and construed in accordance with laws of the State of New York
without giving effect to principles of conflicts of law.
Certain Definitions
Set forth below is a summary of certain defined terms used in
the Indenture, unless otherwise noted. Reference is made to the Indenture for
the full definition of all such terms, as well as any other capitalized terms
used herein for which no definition is provided.
"Accreted Value" means, as of any date (the "Specified Date")
with respect to each $1,000 principal amount at maturity of the Notes:
(i) if the Specified Date is one of the following dates (each a
"Semi-Annual Accrual Date"), the amount set forth opposite such date below:
Semi-Annual
Accrual Date
------------
Issue Date................................. $
, 1998.............. $
, 1999.............. $
, 1999.............. $
, 2000.............. $
, 2000.............. $
, 2001.............. $
, 2001.............. $
, 2002.............. $
, 2002.............. $
, 2003.............. $1,000.00
(ii) if the Specified Date occurs between two Semi-Annual Accrual
Dates, the sum of (A) the Accreted Value for the Semi-Annual Accrual Date
immediately preceding the Specified Date and (B) an amount equal to the
product of (i) the Accreted Value for the immediately following Semi-Annual
Date less the Accreted Value for the immediately preceding Semi-Annual
Accrual Date and (ii) a fraction, the numerator of which is the number of
days actually elapsed from the immediately preceding Semi-Annual Accrual
Date to the Specified Date and the denominator of which is 180 days; and
(iii) if the Specified Date is on or after , 2003,
$1,000.
"Acquired Indebtedness" means Indebtedness of a person existing
at the time such person becomes a Restricted Subsidiary or Restricted
Affiliate or assumed in connection with an Asset Acquisition by such person
and not incurred in connection with, or in anticipation of, such person
becoming a Restricted Subsidiary or Restricted Affiliate or such Asset
Acquisition; provided that Indebtedness of such person which is redeemed,
defeased, retired or otherwise repaid at the time of or immediately upon
consummation of the transactions by which such person becomes a Restricted
Subsidiary or Restricted Affiliate or such Asset Acquisition shall not
constitute Acquired Indebtedness.
"Affiliate" of any specified person means any other person
which, directly or indirectly, controls, is controlled by or is under direct
or indirect common control with, such specified person. For the purposes of
this definition, "control" when used with respect to any person means the
power to direct the management and policies of such person, directly or
indirectly, whether through the ownership of voting securities, by contract or
otherwise, and the terms "affiliated," "controlling" and "controlled" have
meanings correlative to the foregoing.
"Affiliate Income Tax Expense" means, with respect to any
period and any Restricted Affiliate, the aggregate provision for United States
corporation, local, foreign and other income taxes of such Restricted
Affiliate and its Subsidiaries for such period as determined on a consolidated
basis in accordance with GAAP.
"Affiliate Interest Expense" means, with respect to any period
and any Restricted Affiliate, without duplication, the sum of (i) the interest
expense of such Restricted Affiliate and its Subsidiaries for such period as
determined on a consolidated basis in accordance with GAAP, including, without
limitation, (a) any amortization of debt discount, (b) the net cost under
Interest Rate Obligations (including any amortization of discounts), (c) the
interest portion of any deferred payment obligation, (d) all commissions,
discounts and other fees and charges owed with respect to letters of credit
and bankers' acceptance financing and similar transactions and (e) all accrued
interest, (ii) the interest component of Capitalized Lease Obligations paid,
accrued and/or scheduled to be paid or accrued during such period as determined
on a consolidated basis in accordance with GAAP and (iii) the amount of
dividends in respect of Disqualified Stock paid during such period.
"Affiliate Net Income" means, with respect to any period and
any Restricted Affiliate, the net income of such Restricted Affiliate and its
Subsidiaries for such period as determined on a consolidated basis in
accordance with GAAP, adjusted, to the extent included in calculating such net
income of such Restricted Affiliate and its Subsidiaries, by excluding,
without duplication, (i) all extraordinary, unusual or nonrecurring gains or
losses of such person (net of fees and expenses relating to the transaction
giving rise thereto) for such period, (ii) income of such Restricted Affiliate
and its Subsidiaries derived from or in respect of all unconsolidated
Investments, except to the extent of any dividends or distributions actually
received by such Restricted Affiliate or any of its Subsidiaries, (iii) net
income (or loss) of any other person combined with such Restricted Affiliate
or any of its Subsidiaries on a "pooling of interests" basis attributable to
any period prior to the date of combination, (iv) any gain or loss, net of
taxes, realized by such person upon the termination of any employee pension
benefit plan during such period, and (v) gains or losses in respect of any
Asset Sales (net of fees and expenses relating to the transaction giving rise
thereto) during such period.
"Affiliate Operating Cash Flow" means, with respect to any
period and any Restricted Affiliate, the Affiliate Net Income of such
Restricted Affiliate and its Subsidiaries on a consolidated basis for such
period increased, only to the extent deducted in arriving at Affiliate Net
Income for such period, by the sum of (i) the Affiliate Income Tax Expense
accrued according to GAAP for such period (other than taxes attributable to
extraordinary gains or losses and gains and losses from Asset Sales); (ii)
Affiliate Interest Expense for such period; (iii) depreciation of such
Restricted Affiliate for such period; (iv) amortization of such Restricted
Affiliate and its Subsidiaries for such period, including, without limitation,
amortization of capitalized debt issuance costs for such period, all
determined in accordance with GAAP; and (v) other non-cash charges decreasing
Affiliate Net Income.
"Affiliate Pro Forma Operating Cash Flow" means Affiliate
Operating Cash Flow for the latest four fiscal quarters for which consolidated
financial statements of the applicable Restricted Affiliate are available. For
purposes of this definition, "Affiliate Operating Cash Flow" shall be
calculated after giving effect on a pro forma basis for the applicable four
fiscal quarter period to, without duplication, any Asset Sales or Asset
Acquisitions (including, without limitation, any Asset Acquisition giving rise
to the need to make such calculation as a result of the Restricted Affiliate
or any of its Subsidiaries incurring Acquired Indebtedness) occurring during
the period commencing on the first day of such four fiscal quarter period to
and including the date of the transaction giving rise to the need to calculate
"Affiliate Pro Forma Operating Cash Flow" as if such Asset Sale or Asset
Acquisition occurred on the first day of such period.
"Asset Acquisition" means (i) any capital contribution (by
means of transfers of cash or other property to others or payments for
property or services for the account or use of others, or otherwise) by RCN or
any Restricted Subsidiary or Restricted Affiliate to any other person, or any
acquisition or purchase of Capital Stock of any other person by RCN or any
Restricted Subsidiary or Restricted Affiliate, in either case pursuant to
which such person shall (a) become a Restricted Subsidiary or Restricted
Affiliate or (b) shall be merged with or into RCN or any Restricted Subsidiary
or Restricted Affiliate or (ii) any acquisition by RCN or any Restricted
Subsidiary or Restricted Affiliate of the assets of any person which
constitute substantially all of an operating unit or line of business of such
person or which is otherwise outside of the ordinary course of business.
"Asset Sale" means any direct or indirect sale, conveyance,
transfer or lease (that has the effect of a disposition and is not for
security purposes) or other disposition (that is not for security purposes) to
any person other than RCN or a Restricted Subsidiary, in one transaction or a
series of related transactions, of (i) any Capital Stock of any Restricted
Subsidiary (other than customary stock option programs) or any Restricted
Affiliate, (ii) any assets of RCN or any Restricted Subsidiary or any
Restricted Affiliate which constitute substantially all of an operating unit
or line of business of RCN and the Restricted Subsidiaries and the Restricted
Affiliates or (iii) any other property or asset of RCN or any Restricted
Subsidiary or any Restricted Affiliates outside of the ordinary course of
business. For the purposes of this definition, the term "Asset Sale" shall not
include (i) any disposition of properties and assets of RCN and/or the
Restricted Subsidiaries that is governed under "--Consolidation, Merger, Sale
of Assets, Etc." above, (ii) sales of property or equipment that have become
worn out, obsolete or damaged or otherwise unsuitable for use in connection
with the business of RCN or any Restricted Subsidiary or Restricted Affiliate,
as the case may be, and (iii) for purposes of the covenant "Disposition of
Proceeds of Asset Sales," any sale, conveyance, transfer, lease or other
disposition of any property or asset, whether in one transaction or a series
of related transactions occurring within one year, either (x) involving assets
with a Fair Market Value not in excess of $500,000 or (y) which constitutes the
incurrence of a Capitalized Lease Obligation.
"Average Life to Stated Maturity" means, with respect to any
Indebtedness, as at any date of determination, the quotient obtained by
dividing (i) the sum of the products of (a) the number of years from such date
to the date or dates of each successive scheduled principal payment
(including, without limitation, any sinking fund requirements) of such
Indebtedness multiplied by (b) the amount of each such principal payment by
(ii) the sum of all such principal payments; provided that, in the case of any
Capitalized Lease Obligation, all calculations hereunder shall give effect to
any applicable options to renew in favor of RCN or any Restricted Subsidiary
or Restricted Affiliate.
"BECO Joint Venture" means RCN-BECOCOM, LLC, a Massachusetts
limited liability company formed under the terms of a Joint Venture Agreement
dated as of December 23, 1996 between RCN Telecom Services, Inc. and Boston
Energy Technology Group, Inc.
"Board" means the Board of Directors of RCN.
"Board Resolution" means a copy of a resolution certified by
the Secretary or an Assistant Secretary of RCN to have been duly adopted by
the Board and to be in full force and effect on the date of such
certification, and delivered to the Trustee.
"Buildout Costs" means the cost of the construction, expansion,
development or acquisition (other than an Asset Acquisition of any person that
is not a Restricted Affiliate on the Issue Date) of properties or assets
(tangible or intangible) to be utilized, directly or indirectly, for the
design, development, construction, installation, integration, management or
provision of a Permitted Business.
"Buildout Indebtedness" means Indebtedness incurred by RCN
and/or any Restricted Subsidiary and/or any Restricted Affiliate to the extent
the proceeds thereof are used to finance or support Buildout Costs in respect
of a Permitted Business of RCN and/or any Restricted Subsidiary and/or
Restricted Affiliate.
"Capital Stock" means, with respect to any person, any and all
shares, interests, participations, rights in, or other equivalents (however
designated and whether voting and/or non-voting) of, such person's capital
stock, whether outstanding on the Issue Date or issued after the Issue Date,
and any and all rights (other than any evidence of Indebtedness), warrants or
options exchangeable for or convertible into such capital stock.
"Capitalized Lease Obligation" means any obligation to pay rent
or other amounts under a lease of (or other agreement conveying the right to
use) any property (whether real, personal or mixed, immovable or movable) that
is required to be classified and accounted for as a capitalized lease
obligation under GAAP, and, for the purpose of the Indenture, the amount of
such obligation at any date shall be the capitalized amount thereof at such
date, determined in accordance with GAAP.
"Cash Equivalents" means (i) any evidence of Indebtedness
(with, for purposes of the covenant "Disposition of Proceeds of Asset Sales"
only, a maturity of 365 days or less) issued or directly and fully guaranteed
or insured by the United States or any agency or instrumentality thereof
(provided that the full faith and credit of the United States is pledged in
support thereof or such Indebtedness constitutes a general obligation of such
country); (ii) deposits, certificates of deposit or acceptances (with, for
purposes of the covenant "Disposition of Proceeds of Asset Sales" only, a
maturity of 365 days or less) of any financial institution that is a member of
the Federal Reserve System, in each case having combined capital and surplus
and undivided profits (or any similar capital concept) of not less than $500.0
million and whose senior unsecured debt is rated at least "A-1" by S& P or
"P-1" by Moody's; (iii) commercial paper with a maturity of 365 days or less
issued by a corporation (other than an Affiliate of RCN) organized under the
laws of the United States or any State thereof and rated at least "A-1" by S&
P or "P-1" by Moody's; (iv) repurchase agreements and reverse repurchase
agreements relating to marketable direct obligations issued or unconditionally
guaranteed by the United States Government or issued by any agency thereof and
backed by the full faith and credit of the United States Government maturing
within 365 days from the date of acquisition; and (v) money market funds which
invest substantially all of their assets in securities described in the
preceding clauses (i) through (iv).
"Change of Control" is defined to mean the occurrence of any of
the following events: (a) any "person" or "group" (as such terms are used in
Sections 13(d) and 14(d) of the Exchange Act), excluding the Kiewit Holders,
is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5
under the Exchange Act, except that a person shall be deemed to have
"beneficial ownership"of all securities that such person has the right to
acquire, whether such right is exercisable immediately or only after the
passage of time), directly or indirectly, of more than 50% of the total Voting
Stock of RCN; or (b) RCN consolidates with, or merges with or into, another
person or sells, assigns, conveys, transfers, leases or otherwise disposes of
all or substantially all of its assets to any person, or any person
consolidates with, or merges with or into, RCN, in any such event pursuant to
a transaction in which the outstanding Voting Stock of RCN is converted into
or exchanged for cash, securities or other property, other than any such
transaction where (i) the outstanding Voting Stock of RCN is converted into or
exchanged for (1) Voting Stock (other than Disqualified Stock) of the
surviving or transferee corporation or its parent corporation and/or (2) cash,
securities and other property in an amount which could be paid by RCN as a
Restricted Payment under the Indenture and (ii) immediately after such
transaction no "person" or "group" (as such terms are used in Sections 13( d)
and 14(d) of the Exchange Act), excluding the Kiewit Holders, is the
"beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act,
except that a person shall be deemed to have "beneficial ownership" of all
securities that such person has the right to acquire, whether such right is
exercisable immediately or only after the passage of time), directly or
indirectly, of more than 50% of the total Voting Stock of the surviving or
transferee corporation or its parent corporation, as applicable; or (c) during
any consecutive two-year period, individuals who at the beginning of such
period constituted the Board (together with any new directors whose election
by the Board or whose nomination for election by the stockholders of RCN was
approved by a vote of a majority of the directors then still in office who
were either directors at the beginning of such period or whose election or
nomination for election was previously so approved) cease for any reason (other
than by action of the Kiewit Holders) to constitute a majority of the Board
then in office.
"Common Stock" means, with respect to any person, any and all
shares, interest or other participations in, and other equivalents (however
designated and whether voting or nonvoting) of such person's common stock
whether outstanding at the Issue Date, and includes, without limitation, all
series and classes of such common stock.
"Consolidated Income Tax Expense" means, with respect to any
period, the aggregate provision for United States corporation, local, foreign
and other income taxes of RCN and the Restricted Subsidiaries for such period
as determined on a consolidated basis in accordance with GAAP and of each of
the Restricted Affiliates for such period as determined on a consolidated
basis in accordance with GAAP.
"Consolidated Interest Expense" means, with respect to any
period, without duplication, the sum of (i) the interest expense of RCN and
the Restricted Subsidiaries and the Restricted Affiliates for such period as
determined on a consolidated basis in accordance with GAAP, including, without
limitation, (a) any amortization of debt discount, (b) the net cost under
Interest Rate Obligations (including any amortization of discounts), (c) the
interest portion of any deferred payment obligation, (d) all commissions,
discounts and other fees and charges owed with respect to letters of credit
and bankers' acceptance financing and similar transactions and (e) all accrued
interest, (ii) the interest component of Capitalized Lease Obligations paid,
accrued and/or scheduled to be paid or accrued during such period as determined
on a consolidated basis in accordance with GAAP and (iii) the amount of
dividends in respect of Disqualified Stock paid during such period.
"Consolidated Net Income" means, with respect to any period,
the consolidated net income of RCN and the Restricted Subsidiaries for such
period in accordance with GAAP, adjusted, without duplication, (A) to include
the consolidated net income of the Restricted Affiliates only to the extent of
the equity interest of RCN and the Restricted Subsidiaries and (B) adjusted,
to the extent included in calculating such adjusted consolidated net income of
RCN and the Restricted Subsidiaries, by excluding, without duplication, (i)
all extraordinary, unusual or nonrecurring gains or losses of such person (net
of fees and expenses relating to the transaction giving rise thereto) for such
period, (ii) subject to clause (A) above, income of RCN and the Restricted
Subsidiaries and the Restricted Affiliates derived from or in respect of all
unconsolidated Investments, except to the extent of any dividends or
distributions actually received by RCN or any Restricted Subsidiary, (iii) the
portion of net income (or loss) of such person allocable to minority interests
in Restricted Subsidiaries and Restricted Affiliates for such period, (iv) net
income (or loss) of any other person combined with RCN or any Restricted
Subsidiary or Restricted Affiliate on a "pooling of interests" basis
attributable to any period prior to the date of combination, (v) any gain or
loss, net of taxes, realized by such person upon the termination of any
employee pension benefit plan during such period, (vi) gains or losses in
respect of any Asset Sales (net of fees and expenses relating to the
transaction giving rise thereto) during such period and (vii) except to the
extent permitted by clause (vii) of the covenant "Limitation on Dividends and
Other Payment Restrictions Affecting Restricted Subsidiaries," the net income
of any Restricted Subsidiary or Restricted Affiliate for such period to the
extent that the declaration of dividends or similar distributions by that
Restricted Subsidiary or Restricted Affiliate of that income is not at the
time permitted, directly or indirectly, by operation of the terms of its
charter or any agreement, instrument, judgment, decree, order, statute, rule
or governmental regulations applicable to that Restricted Subsidiary or
Restricted Affiliate or its stockholders.
"Consolidated Operating Cash Flow" means, with respect to any
period, the Consolidated Net Income for such period increased, only to the
extent (which, in the case of the Restricted Affiliates, means to the extent
of the equity interest of RCN and the Restricted Subsidiaries) deducted in
arriving at Consolidated Net Income for such period, by the sum of (i) the
Consolidated Income Tax Expense accrued according to GAAP for such period
(other than taxes attributable to extraordinary gains or losses and gains and
losses from Asset Sales); (ii) Consolidated Interest Expense for such period;
(iii) depreciation of RCN and the Restricted Subsidiaries and the Restricted
Affiliates for such period; (iv) amortization of RCN and the Restricted
Subsidiaries and the Restricted Affiliates for such period, including, without
limitation, amortization of capitalized debt issuance costs for such period,
all determined on a consolidated basis in accordance with GAAP; and (v) other
non-cash charges decreasing Consolidated Net Income.
"Consolidated Pro Forma Operating Cash Flow" means Consolidated
Operating Cash Flow for the latest four fiscal quarters for which consolidated
financial statements of RCN are available. For purposes of calculating
"Consolidated Operating Cash Flow" for any four fiscal quarters for purposes
of this definition, (i) any Subsidiary of RCN that is a Restricted Subsidiary
on the date of the transaction giving rise to the need to calculate
"Consolidated Pro Forma Operating Cash Flow" (the "Transaction Date") (or
would become a Restricted Subsidiary in connection with the transaction that
requires determination of such amount) shall be deemed to have been a
Restricted Subsidiary at all times during such four fiscal quarters, (ii) any
Joint Venture that is a Restricted Affiliate on the Transaction Date (or would
become a Restricted Affiliate in connection with the transaction that requires
the determination of such amount) shall be deemed to have been a Restricted
Affiliate at all times during such four fiscal quarters, (iii) any Subsidiary
of RCN that is not a Restricted Subsidiary on the Transaction Date (or would
cease to be a Restricted Subsidiary in connection with the transaction that
requires the determination of such amount) shall be deemed not to have been a
Restricted Subsidiary at any time during such four fiscal quarters and (iv)
any Joint Venture that is not a Restricted Affiliate on the Transaction Date
(or would cease to be a Restricted Affiliate in connection with the
transaction that requires the determination of such amount) shall be deemed
not to have been a Restricted Affiliate at any time during such four fiscal
quarters. In addition to and without limitation of the foregoing, for purposes
of this definition, "Consolidated Operating Cash Flow" shall be calculated
after giving effect on a pro forma basis for the applicable four fiscal quarter
period to, without duplication, any Asset Sales or Asset Acquisitions
(including, without limitation, any Asset Acquisition giving rise to the need
to make such calculation as a result of RCN's or one of the Restricted
Subsidiaries' or Restricted Affiliates' (including any person who becomes a
Restricted Subsidiary or Restricted Affiliate as a result of the Asset
Acquisition) incurring Acquired Indebtedness) occurring during the period
commencing on the first day of such four fiscal quarter period to and
including the Transaction Date, as if such Asset Sale or Asset Acquisition
occurred on the first day of such period.
"consolidation" means (i) with respect to RCN, the
consolidation of the accounts of the Restricted Subsidiaries with those of
RCN, all in accordance with GAAP; provided that "consolidation" will not
include consolidation of the accounts of any Unrestricted Subsidiary or
Restricted Affiliate with the accounts of RCN and (ii) with respect to any
Restricted Affiliate, the consolidation of the accounts of the Subsidiaries of
such Restricted Affiliate with those of such Restricted Affiliate, all in
accordance with GAAP. The term "consolidated" has a correlative meaning to the
foregoing.
"Default" means any event that is, or after notice or passage
of time or both would be, an Event of Default.
"Default Amount" means, the Accreted Value, premium, if any,
and accrued and unpaid interest, if any, in respect of the Notes.
"Designation Amounts" means, at any date of determination, the
sum of all US Designation Amounts and all JV Revocation Amounts.
"Designation" has the meaning set forth under "--Certain
Covenants--Designations of Unrestricted Subsidiaries."
"Disinterested Director" means, with respect to any transaction
or series of related transactions, a member of the Board of Directors of RCN
other than a director who (i) has any material direct or indirect financial
interest in or with respect to such transaction or series of related
transactions or (ii) is an employee or officer of RCN or an Affiliate that is
itself a party to such transaction or series of transactions or an Affiliate
of a party to such transaction or series of related transactions.
"Disqualified Stock" means, with respect to any person, any
Capital Stock which, by its terms (or by the terms of any security into which
it is convertible or for which it is exchangeable), or upon the happening of
any event, matures or becomes mandatorily redeemable, pursuant to a sinking
fund obligation or otherwise, or becomes exchangeable for Indebtedness at the
option of the holder thereof, or becomes redeemable at the option of the
holder thereof, in whole or in part, on or prior to the final maturity date of
the Notes; provided such Capital Stock shall only constitute Disqualified
Stock to the extent it so matures or becomes so redeemable or exchangeable on
or prior to the final maturity date of the applicable Notes; provided,
further, that any Capital Stock that would not constitute Disqualified Stock
but for provisions thereof giving holders thereof the right to require such
person to repurchase or redeem such Capital Stock upon the occurrence of an
"asset sale" or "change of control" occurring prior to the final maturity date
of the Notes shall not constitute Disqualified Stock if the "asset sale" or
"change of control" provisions applicable to such Capital Stock are no more
favorable to the holders of such Capital Stock than the provisions contained in
"Disposition of Proceeds of Asset Sales" and "Change of Control" covenants
described above and such Capital Stock specifically provides that such person
will not repurchase or redeem any such stock pursuant to such provision prior
to RCN's repurchase of such Notes as are required to be repurchased pursuant
to the "Disposition of Proceeds of Asset Sales" and "Change of Control"
covenants described above and at all times subject to the covenant "Limitation
on Restricted Payments."
"Exchange Act" means the Securities Exchange Act of 1934, as
amended, together with the rules and regulations promulgated thereunder.
"Fair Market Value" means, with respect to any asset or
property, the price that could be negotiated in an arms-
length free market transaction, for cash, between a willing seller and a
willing buyer, neither of whom is under pressure or compulsion to complete the
transaction. Any Asset Sale pursuant to the terms of the deadlock event
"buy-sell" arrangements in Section 7.8 of the Amended and Restated Operating
Agreement of RCN-BECOCOM, LLC, as in effect on the Issue Date, or Section 7.15
of the Amended and Restated Operating Agreement of Starpower Communications,
LLC, as in effect on the Issue Date, shall be deemed to have been made for
Fair Market Value. Unless otherwise specified in the Indenture, Fair Market
Value shall be determined by the Board acting in good faith and shall be
evidenced by a Board Resolution.
"GAAP" means, at any date of determination, generally accepted
accounting principles in effect in the United States and which are applicable
as of the date of determination and which are consistently applied for all
applicable periods.
"guarantee" means, as applied to any obligation, (i) a
guarantee (other than by endorsement of negotiable instruments for collection
in the ordinary course of business), direct or indirect, in any manner, of any
part or all of such obligation and (ii) an agreement, direct or indirect,
contingent or otherwise, the practical effect of which is to assure in any way
the payment or performance (or payment of damages in the event of
non-performance) of all or any part of such obligation, including, without
limiting the foregoing, the payment of amounts drawn down by letters of credit.
"Indebtedness" means, with respect to any person, without
duplication, (i) any liability, contingent or otherwise, of such person (A)
for borrowed money (whether or not the recourse of the lender is to the whole
of the assets of such person or only to a portion thereof) or (B) evidenced by
a note, debenture or similar instrument or letter of credit (including a
purchase money obligation) or (C) for the payment of money relating to a
Capitalized Lease Obligation or other obligation relating to the deferred
purchase price of property or (D) in respect of an Interest Rate Obligation
or currency agreement; or (ii) any liability of others of the kind described
in the preceding clause (i) which the person has guaranteed or which is
otherwise its legal liability; or (iii) any obligation secured by a Lien
(other than Liens on Capital Stock or Indebtedness of any Unrestricted
Subsidiary) to which the property or assets of such person are subject,
whether or not the obligations secured thereby shall have been assumed by or
shall otherwise be such person's legal liability (the amount of such
obligation being deemed to be the lesser of the value of such property or
asset or the amount of the obligation so secured); (iv) all Disqualified Stock
valued at the greater of its voluntary or involuntary maximum fixed repurchase
price plus accrued and unpaid dividends; and (v) any and all deferrals,
renewals, extensions and refundings of, or amendments, modifications or
supplements to, any liability of the kind described in any of the preceding
clauses (i), (ii), (iii) or (iv). In no event shall "Indebtedness" include
trade payables and accrued liabilities that are current liabilities incurred
in the ordinary course of business, excluding the current maturity of any
obligation which would otherwise constitute Indebtedness. For purposes of the
covenants "Limitation on Additional Indebtedness" and "Limitation on
Restricted Payments" and the definition of "Events of Default," in determining
the principal amount of any Indebtedness to be incurred by RCN or a Restricted
Subsidiary or which is outstanding at any date, the principal amount of any
Indebtedness which provides that an amount less than the principal amount at
maturity thereof shall be due upon any declaration of acceleration thereof
shall be the accreted value thereof at the date of determination. Indebtedness
of any person that becomes a Restricted Subsidiary shall be deemed incurred at
the time that such person becomes a Restricted Subsidiary.
"Independent Financial Advisor" means a United States
investment banking, consulting or accounting firm of national standing in the
United States (i) which does not, and whose directors, officers and employees
or Affiliates do not have, a material direct or indirect financial interest in
RCN or any of its Subsidiaries or Affiliates and (ii) which, in the judgment
of the Board, is otherwise independent and qualified to perform the task for
which it is to be engaged.
"Interest Rate Obligations" means the obligations of any person
pursuant to any arrangement with any other person whereby, directly or
indirectly, such person is entitled to receive from time to time periodic
payments calculated by applying either a floating or a fixed rate of interest
on a stated notional amount and shall include without limitation, interest
rate swaps, caps, floors, collars, forward interest rate agreements and
similar agreements.
"Investment" means, with respect to any person, any advance,
loan, account receivable (other than an account receivable arising in the
ordinary course of business), or other extension of credit (including, without
limitation, by means of any guarantee) or any capital contribution to (by
means of transfers of property to others, payments for property or services
for the account or use of others, or otherwise), or any purchase or ownership
of any stocks, bonds, notes, debentures or other securities of, any other
person. Notwithstanding the foregoing, in no event shall any issuance of
Capital Stock (other than Disqualified Stock) of RCN in exchange for Capital
Stock, property or assets of another person constitute an Investment by RCN in
such other person.
"Issue Date" means the original date of issuance of the Notes.
"JV Designation" has the meaning set forth under "--Certain
Covenants--Designation of Restricted Affiliates."
"JV Designation Amount" has the meaning set forth under
"--Certain Covenants--Designation of Restricted Affiliates."
"JV Revocation" has the meaning set forth under "--Certain
Covenants--Designation of Restricted Affiliates."
"Joint Venture" means any person engaged in a Permitted
Business in which RCN or one of the Restricted Subsidiaries (the "RCN
Partner") owns not less than 50% of the Voting Stock and not less than 50% of
each class of Capital Stock and in respect of which (a) there are no more than
five other beneficial holders of Capital Stock and Voting Stock (the "Other
Partners"), (b) all of its Subsidiaries are wholly owned by such person and
(c) the RCN Partner and the Other Partners have entered into contractual
arrangements that require their joint consent to take actions in respect of
any of the following: (1) the payment or distribution of any dividends,
whether in cash or other property, by such person or any of its Subsidiaries
to the RCN Partner; (2) the making of any advance or loan of any cash or other
property by such person or any of its Subsidiaries to RCN or any of the
Restricted Subsidiaries; (3) the incurrence of any Indebtedness by such person
or any of its Subsidiaries; or (4) any other material operating or financial
decision with respect to the business of such person or any of its
Subsidiaries; provided that customary financial and other restrictive
covenants in any loan or advances made by the RCN Partner and the Other
Partners to such person or any of its Subsidiaries and not entered into with
the purpose of influencing the management of such person or any of its
Subsidiaries shall not, by itself, cause such person to not constitute a Joint
Venture.
"Kiewit Holders" means Peter Kiewit Sons' Inc., Level 3
Communications, Inc. and Level 3 Telecom Holdings, Inc. and any of their
respective controlled Affiliates.
"Lien" means any mortgage, charge, pledge, lien (statutory or
other), security interest, hypothecation, assignment for security, claim, or
preference or priority or other encumbrance upon or with respect to any
property of any kind. A person shall be deemed to own subject to a Lien any
property which such person has acquired or holds subject to the interest of a
vendor or lessor under any conditional sale agreement, capital lease or other
title retention agreement.
"Material Restricted Subsidiary" means any Restricted
Subsidiary of RCN, which, at any date of determination, is a "Significant
Subsidiary" (as that term is defined in Regulation S-X issued under the
Securities Act), but shall, in any event, include (x) any Guarantor or (y) any
Restricted Subsidiary of RCN which, at any date of determination, is an
obligor under any Indebtedness in an aggregate principal amount equal to or
exceeding $10 million.
"Moody's" means Moody's Investors Service.
"Net Cash Proceeds" means, with respect to any Asset Sale, the
proceeds thereof in the form of cash (including assumed liabilities and other
items deemed to be cash under the proviso to the first sentence of the covenant
"Disposition of Proceeds of Asset Sales") or Cash Equivalents including
payments in respect of deferred payment obligations when received in the form
of cash or Cash Equivalents (except to the extent that such obligations are
financed or sold with recourse to RCN or any Restricted Subsidiary or
Restricted Affiliate) net of (i) brokerage commissions and other fees and
expenses (including fees and expenses of legal counsel, accountants,
consultants and investment bankers) related to such Asset Sale, (ii)
provisions for all taxes payable as a result of such Asset Sale, (iii) amounts
required to be paid to any person (other than RCN or any Restricted Subsidiary
or any Restricted Affiliate) owning a beneficial interest in or having a
Permitted Lien on the assets subject to the Asset Sale and (iv) appropriate
amounts to be provided by RCN or any Restricted Subsidiary or any Restricted
Affiliate, as the case may be, as a reserve required in accordance with GAAP
against any liabilities associated with such Asset Sale and retained by RCN
or any Restricted Subsidiary or any Restricted Affiliate, as the case may be,
after such Asset Sale, including, without limitation, pension and other
post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated with
such Asset Sale, all as reflected in an Officers' Certificate delivered to the
Trustee.
"New Joint Venture" means any Joint Venture (excluding in any
event the BECO Joint Venture and the Starpower Joint Venture) formed after the
Issue Date and in which no Investment has been made on or prior to the Issue
Date.
"Other Partners" has the meaning set forth in the definition of
"Joint Venture."
"Other Senior Debt Pro Rata Share" means under the Indenture
the amount of the applicable Excess Proceeds obtained by multiplying the
amount of such Excess Proceeds by a fraction, (i) the numerator of which is
the aggregate accreted value and/or principal amount, as the case may be, of
all Indebtedness (other than (x) the Notes and (y) Subordinated Indebtedness)
of RCN outstanding at the time of the applicable Asset Sale with respect to
which RCN is required to use Excess Proceeds to repay or make an offer to
purchase or repay and (ii) the denominator of which is the sum of (a) the
aggregate principal amount of all Notes that are outstanding at the time of
the offer to purchase or repay with respect to the applicable Asset Sale and
(b) the aggregate principal amount or the aggregate accreted value, as the
case may be, of all other Indebtedness (other than Subordinated Indebtedness)
of RCN outstanding at the time of the applicable Asset Sale Offer with respect
to which RCN is required to use the applicable Excess Proceeds to offer to
repay or make an offer to purchase or repay.
"Permitted Business" means any telecommunications business
(including, without limitation, the development and provision of voice, video
and data transmission products, services and systems), and any business
reasonably related to the foregoing.
"Permitted Credit Facility" means (i) any senior commercial
term loan and/or revolving credit facility (including any letter of credit
subfacility) entered into principally with commercial banks and/or other
financial institutions typically party to commercial loan agreements and (ii)
any senior credit facility entered into with any vendor or supplier (or any
financial institution acting on behalf of or for the purpose of directly
financing purchases from such vendor or supplier) to the extent the
Indebtedness thereunder is incurred for the purpose of financing the cost
(including the cost of design, development, construction, manufacture or
acquisition) of personal property or fixtures used, or to be used, in a
Permitted Business.
"Permitted Indebtedness" means the following Indebtedness (each
of which shall be given independent effect):
(a) Indebtedness under the Notes and the Indenture;
(b) Indebtedness of RCN and/or any Restricted Subsidiary and/or
any Restricted Affiliate outstanding on the Issue Date;
(c) (i) Indebtedness of any Restricted Subsidiary or Restricted
Affiliate owed to and held by RCN or a Restricted Subsidiary or Restricted
Affiliates and (ii) Indebtedness of RCN, not secured by any Lien, owed to
and held by any Restricted Subsidiary or Restricted Affiliate; provided
that an incurrence of Indebtedness shall be deemed to have occurred upon
(x) any sale or other disposition (excluding assignments as security to
financial institutions) of any Indebtedness of RCN or a Restricted
Subsidiary or Restricted Affiliate referred to in this clause (c) to a
person (other than RCN or a Restricted Subsidiary or Restricted Affiliate)
or (y) any sale or other disposition by RCN or any Restricted Subsidiary of
Capital Stock of a Restricted Subsidiary or Restricted Affiliate, or
Designation of an Unrestricted Subsidiary or JV Revocation of a Restricted
Affiliate, which holds Indebtedness of RCN or another Restricted Subsidiary
or Restricted Affiliate such that such Restricted Subsidiary or Restricted
Affiliate, in any such case, ceases to be a Restricted Subsidiary or
Restricted Affiliate, as the case may be;
(d) Interest Rate Obligations of RCN and/or any Restricted
Subsidiary and/or any Restricted Affiliate relating to Indebtedness of RCN
and/or such Restricted Subsidiary and/or such Restricted Affiliate, as the
case may be (which Indebtedness (x) bears interest at fluctuating interest
rates and (y) is otherwise permitted to be incurred under the "Limitation
on Additional Indebtedness" covenant), but only to the extent that the
notional principal amount of such Interest Rate Obligations does not exceed
the principal amount of the Indebtedness (and/or Indebtedness subject to
commitments) to which such Interest Rate Obligations relate;
(e) Indebtedness of RCN and/or any Restricted Subsidiary and/or
any Restricted Affiliate in respect of performance bonds of RCN or any
Restricted Subsidiary or Restricted Affiliate or surety bonds provided by
RCN or any Restricted Subsidiary or Restricted Affiliate incurred in the
ordinary course of business;
(f) Indebtedness of RCN and/or any Restricted Subsidiary and/or
any Restricted Affiliate to the extent it represents a replacement,
renewal, refinancing or extension (a "Refinancing") of outstanding
Indebtedness of RCN and/or of any Restricted Subsidiary and/or any
Restricted Affiliate incurred or outstanding pursuant to clause (a), (b),
(g) or (h) of this definition or the proviso of the covenant "Limitation on
Additional Indebtedness"; provided that (1) Indebtedness of RCN may not be
Refinanced to such extent under this clause (f) with Indebtedness of any
Restricted Subsidiary or Restricted Affiliate, (2) Indebtedness of a
Restricted Affiliate may not be Refinanced with Indebtedness of RCN or a
Restricted Subsidiary in an amount exceeding the RCN Share of such
Indebtedness and (3) any such Refinancing shall only be permitted under
this clause (f) to the extent that (x) it does not result in a lower
Average Life to Stated Maturity of such Indebtedness as compared with the
Indebtedness being Refinanced and (y) it does not exceed the sum of the
principal amount (or, if such Indebtedness provides for a lesser amount to
be due and payable upon a declaration of acceleration thereof, an amount no
greater than such lesser amount) of the Indebtedness being Refinanced plus
the amount of accrued interest thereon and the amount of any reasonably
determined prepayment premium necessary to accomplish such Refinancing and
such reasonable fees and expenses incurred in connection therewith;
(g) Buildout Indebtedness (including under one or more Permitted
Credit Facilities); provided that no Indebtedness may be incurred under
this clause (g) on any date on or after October 15, 2002;
(h) Indebtedness of RCN and/or any Restricted Subsidiary and/or
any Restricted Affiliate incurred under one or more Permitted Credit
Facilities, and any Refinancings (whether an initial Refinancing or one or
more successive Refinancings) of the foregoing otherwise incurred in
compliance with clause (f), such that the aggregate principal amount of the
Indebtedness of RCN and the Restricted Subsidiaries and the RCN Share of
any Indebtedness of a Restricted Affiliate does not exceed $150 million at
any time outstanding; provided, however, such amount shall be increased to
$200 million if RCN shall designate as a Restricted Affiliate pursuant to
the covenant "Designations of Restricted Affiliates" a Joint Venture formed
to develop a Permitted Business in a Metropolitan Statistical Area which
contains greater than 400,000 households;
(i) Subordinated Indebtedness of any Restricted Affiliate owed to
and held by any of the Other Partners in such Restricted Affiliate to the
extent (x) such Indebtedness is incurred to fund the proportionate share
(based upon equity ownership) of RCN or any Restricted Subsidiary of any
mandatory capital call made by such Restricted Affiliate and in respect of
which RCN or such Restricted Subsidiary has defaulted and (y) such
Indebtedness is not secured by any Lien; and
(j) in addition to the items referred to in clauses (a) through
(j) above, Indebtedness of RCN and/or the Restricted Subsidiaries having an
aggregate principal amount not to exceed $10 million at any time
outstanding.
"Permitted Investments" means (a) Cash Equivalents; (b)
Investments in prepaid expenses, negotiable instruments held for collection
and lease, utility and workers' compensation, performance and other similar
deposits; (c) Interest Rate Obligations incurred in compliance with the
covenant "Limitation on Additional Indebtedness"; and (d) Investments in RCN
or any Restricted Subsidiary or Investments made in any person as a result of
which such person becomes a Restricted Subsidiary.
"Preferred Stock" means, with respect to any person, any and
all shares, interests, participations or other equivalents (however
designated) of such person's preferred or preference stock whether now
outstanding, or issued after the Issue Date, and including, without
limitation, all classes and series of preferred or preference stock of such
person.
"RCN Share" means, with respect to the Indebtedness of any
Restricted Affiliate, an amount of such Indebtedness determined by reference
to the percentage common equity interest of RCN and the Restricted
Subsidiaries in such Restricted Affiliate.
"Refinancing" has the meaning set forth in clause (f) of the
definition of "Permitted Indebtedness."
"Restricted Affiliate" means any Joint Venture designated as
such pursuant to and in compliance with the covenant "Designation of
Restricted Affiliates," until an effective JV Revocation in respect thereof
has been made.
"Restricted Affiliate Group" means, collectively, any
Restricted Affiliate whose Capital Stock is owned directly by RCN or a
Restricted Subsidiary and all of its Subsidiaries.
"Restricted Payment" means any of the following: (i) the
declaration or payment of any dividend or any other distribution on Capital
Stock of RCN or any payment made to the direct or indirect holders (in their
capacities as such) of Capital Stock of RCN (other than dividends or
distributions payable solely in Capital Stock (other than Disqualified Stock)
of RCN or in options, warrants or other rights to purchase Capital Stock
(other than Disqualified Stock) of RCN; (ii) the purchase, redemption or other
acquisition or retirement for value of any Capital Stock of RCN (other than any
such Capital Stock owned by RCN or a Wholly Owned Restricted Subsidiary);
(iii) the purchase, redemption, defeasance or other acquisition or retirement
for value prior to any scheduled repayment, sinking fund or maturity of any
Subordinated Indebtedness (other than any Subordinated Indebtedness held by a
Wholly Owned Restricted Subsidiary); or (iv) the making by RCN or any
Restricted Subsidiary or any Restricted Affiliate of any Investment (other
than a Permitted Investment) in any person.
"Restricted Subsidiary" means any Subsidiary of RCN that has
not been designated by the Board, by a Board Resolution delivered to the
Trustee, as an Unrestricted Subsidiary pursuant to and in compliance with the
covenant "Designations of Unrestricted Subsidiaries." Any such designation may
be revoked by a Board Resolution delivered to the Trustee, subject to the
provisions of such covenant.
"Restricted Subsidiary Indebtedness" means Indebtedness of any
Restricted Subsidiary (i) which is not subordinated to any other Indebtedness
of such Restricted Subsidiary and (ii) in respect of which RCN is not also
obligated (by means of a guarantee or otherwise) other than, in the case of
this clause (ii), Indebtedness under any Permitted Credit Facilities.
"Revocation" has the meaning set forth under "--Certain
Covenants--Designations of Unrestricted Subsidiaries."
"S&P" means Standard & Poor's Corporation.
"Senior Debt Securities" means any unsubordinated debt
securities (including any guarantee of such securities) issued by RCN and/or
any Restricted Subsidiary and/or any Restricted Affiliate, whether in a public
offering or a private placement; it being understood that the term "Senior
Debt Securities" shall not include any Permitted Credit Facility or other
commercial bank borrowings or similar borrowings, recourse transfers of
financial assets, capital leases or other types of borrowings issued in a
manner not customarily viewed as a "securities offering."
"Starpower Joint Venture" means Starpower Communications LLC,
an unregulated limited liability company organized on October 28, 1997
pursuant to a Certificate of Formation and governed by an Amended and Restated
Operating Agreement dated as of December 18, 1997 between RCN Telecom Services
of Washington, Inc. and Pepco Communications, L.L.C.
"Subordinated Indebtedness" means any Indebtedness of RCN or
any Guarantor which is expressly subordinated in right of payment to any other
Indebtedness of RCN or such Guarantor; provided that, for purposes of the
covenants "Limitation on Liens Securing Certain Indebtedness" and "Limitation
on Certain Guarantees and Indebtedness of Restricted Subsidiaries and
Restricted Affiliates," "Subordinated Indebtedness" means any Indebtedness of
RCN or any Restricted Subsidiary or Restricted Affiliate that is expressly
subordinated in right of payment to any other Indebtedness of such person.
"Subsidiary" means, with respect to any person, (i) any
corporation of which the outstanding Capital Stock having at least a majority
of the votes entitled to be cast in the election of directors shall at the
time be owned, directly or indirectly, by such person, or (ii) any other
person of which at least a majority of voting interest is at the time, directly
or indirectly, owned by such person. In no event shall "Subsidiary" include
any Joint Venture.
"Total Affiliate Indebtedness" means, at any date of
determination, with respect to any Restricted Affiliate, the aggregate
consolidated amount of all Indebtedness of such Restricted Affiliate and its
Subsidiaries outstanding as of the date of determination.
"Total Consolidated Indebtedness" means, at any date of
determination, an amount equal to the sum of (i) the aggregate amount of all
Indebtedness of RCN and the Restricted Subsidiaries and (ii) the sum of the
RCN Share of the Indebtedness of each of the Restricted Affiliates, in each
case outstanding as of the date of determination and determined on a
consolidated basis.
"Total Invested Equity Capital" means, at any time of
determination, the sum of, without duplication, (i) $216.6 million plus (ii)
the aggregate cash proceeds received by RCN from capital contributions in
respect of existing Capital Stock (other than Disqualified Stock) or the
issuance or sale of Capital Stock (other than Disqualified Stock but including
Capital Stock issued upon conversion of convertible Indebtedness or from the
exercise of options, warrants or rights to purchase Capital Stock (other than
Disqualified Stock)) on or subsequent to the Issue Date, other than to a
Restricted Subsidiary or to a Restricted Affiliate; plus (iii) the aggregate
cash proceeds received by RCN or any Restricted Subsidiary from the sale,
disposition or repayment of any Investment made after the Issue Date and
constituting a Restricted Payment (other than any Investments made pursuant to
clause (iv) of the second paragraph of the covenant "Limitation on Restricted
Payments") in an amount equal to the lesser of (a) the return of capital with
respect to such Investment and (b) the initial amount of such Investment, in
either case, less the cost of the disposition of such Investment, plus (iv) in
the case of the Revocation of the Designation of a Subsidiary as an
Unrestricted Subsidiary, an amount equal to the consolidated Net Investment in
such Subsidiary on the date of Revocation but not in an amount exceeding the
net amount of any Investments constituting Restricted Payments made (or deemed
made) in such Subsidiary after the Issue Date plus (v) in the case of the JV
Designation after the Issue Date of a New Joint Venture as a Restricted
Affiliate, an amount equal to the consolidated net Investment in such New
Joint Venture on the date of such JV Designation but not in an amount
exceeding the net amount of any Investments constituting Restricted Payments
made (or deemed made) in such New Joint Venture after the Issue Date minus
(vi) the aggregate amount of all Restricted Payments (other than Restricted
Payments referred to in clause (iv) or clause (iii)( B) of the second
paragraph of the covenant "Limitation on Restricted Payments") declared or
made on and after the Issue Date.
"Unrestricted Subsidiary" means any Subsidiary of RCN
designated as such pursuant to and in compliance with the covenant
"Designations of Unrestricted Subsidiaries." Any such designation may be
revoked by a Board Resolution delivered to the applicable Trustee, subject to
the provisions of such covenant.
"US Designation Amount" has the meaning set forth under
"--Certain Covenants--Designation of Unrestricted Subsidiaries."
"U.S. Government Securities" means securities that are direct
obligations of the United States of America for the payment of which its full
faith and credit is pledged.
"Voting Stock" means, with respect to any person, the Capital
Stock of any class or kind ordinarily having the power to vote for the
election of directors or other members of the governing body of such person.
"Wholly Owned Restricted Subsidiary" means any Restricted
Subsidiary in which all of the outstanding Capital Stock is owned by RCN or
another Wholly Owned Restricted Subsidiary. For the purposes of this
definition, any directors' qualifying shares or investments by foreign
nationals mandated by applicable law shall be disregarded in determining the
ownership of a Restricted Subsidiary.
Book-entry; Delivery and Form
The Notes will be represented by one or more permanent global
notes in definitive, fully registered book-entry form (the "Global
Securities") which will be registered in the name of a nominee of the
Depository Trust Company ("DTC") and deposited on behalf of purchasers of the
Notes represented thereby with a custodian for DTC for credit to the
respective accounts of the purchasers (or to such other accounts as they may
direct) at DTC.
The Global Securities. The Company expects that pursuant to
procedures established by DTC (a) upon issuance of the Global Securities, DTC
or its custodian will credit on its internal system portions of the Global
Securities which shall be comprised of the corresponding respective amounts of
the Global Securities to the respective accounts of persons who have accounts
with such depositary and (b) ownership of the Notes will be shown on, and the
transfer of ownership thereof will be effected only through, records
maintained by DTC or its nominee (with respect to interests of Participants
(as defined below)) and the records of Participants (with respect to interests
of persons other than Participants). Ownership of beneficial interests in the
Global Securities will be limited to persons who have accounts with DTC
("Participants") or persons who hold interests through Participants.
So long as DTC or its nominee is the registered owner or holder
of any of the Notes, DTC or such nominee will be considered the sole owner or
holder of such Notes represented by the Global Securities for all purposes
under the Indenture and under the Notes represented thereby. No beneficial
owner of an interest in the Global Securities will be able to transfer such
interest except in accordance with the applicable procedures of DTC in
addition to those provided for under the Indenture.
Payments of the principal of, premium, if any, and interest on
the Notes represented by the Global Securities will be made to DTC or its
nominee, as the case may be, as the registered owner thereof. None of the
Company, the Trustee or any paying agent under the Indenture will have any
responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests in the Global
Securities or for maintaining, supervising or reviewing any records relating
to such beneficial ownership interest.
The Company expects that DTC or its nominee, upon receipt of
any payment of the principal of, premium, if any, and interest on the Notes
represented by the Global Securities, will credit Participants' accounts with
payments in amounts proportionate to their respective beneficial interests in
the Global Securities as shown on the records of DTC or its nominee. The
Company also expects that payments by Participants to owners of beneficial
interests in the Global Securities held through such Participants will be
governed by standing instructions and customary practice as is now the case
with securities held for the accounts of customers registered in the names of
nominees for such customers. Such payment will be the responsibility of such
Participants.
Transfers between Participants in DTC will be effected in
accordance with DTC rules and will be settled in immediately available funds.
If a holder requires physical delivery of a Certificated Security for any
reason, including to sell Notes to persons in states which require physical
delivery of such securities or to pledge such securities, such holder must
transfer its interest in the Global Securities in accordance with the normal
procedures of DTC and in accordance with the procedures set forth in the
Indenture.
Any beneficial interest in one of the Global Securities that is
transferred to a person who takes delivery in the form of an interest in the
other Global Security will, upon transfer, cease to be an interest in such
Global Security and, accordingly, will thereafter be subject to all transfer
restrictions, if any, and other procedures applicable to beneficial interests
in such other Global Security for as long as it remains such an interest.
DTC has advised the Company that DTC will take any action
permitted to be taken by a holder of Notes (including the presentation of
Notes for exchange as described below) only at the direction of one or more
Participants to whose account the DTC interests in the Global Securities are
credited and only in respect of the aggregate principal amount of as to which
such Participant or Participants has or have given such direction. However, if
there is an Event of Default under the Indenture, DTC will exchange the Global
Securities for Certificated Securities, which it will distribute to its
Participants.
DTC has advised the Company as follows: DTC is a limited
purpose trust company organized under the laws of the State of New York, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the Uniform Commercial Code and a "clearing agency" registered
pursuant to the provisions of Section 17A of the Exchange Act. DTC was created
to hold securities for its Participants and facilitate the clearance and
settlement of securities transactions between Participants through electronic
book-entry changes in accounts of its Participants, thereby eliminating the
need for physical movement of certificates. Participants include securities
brokers and dealers, banks, trust companies and clearing corporations and
certain other organizations. Indirect access to the DTC system is available to
others such as banks, brokers, dealers and trust companies that clear through
or maintain a custodial relationship with a Participant, either directly or
indirectly.
Although DTC is expected to follow the foregoing procedures in
order to facilitate transfers of interests in the Global Securities among
Participants of DTC, it is under no obligation to perform such procedures, and
such procedures may be discontinued at any time. Neither RCN nor either
Trustee will have any responsibility for the performance by DTC or its direct
or indirect participants of their respective obligations under the rules and
procedures governing their operations.
Certificated Securities. Interests in the Global Securities
will be exchanged for Certificated Securities if (i) DTC notifies the Company
that it is unwilling or unable to continue as depositary for the Global
Securities, or DTC ceases to be a "Clearing Agency" registered under the
Exchange Act, and a successor depositary is not appointed by the Company
within 90 days, or (ii) an Event of Default has occurred and is continuing
with respect to the Notes. Upon the occurrence of any of the events described
in the preceding sentence, the Company will cause the appropriate Certificated
Securities to be delivered.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material United States
federal income tax consequences of the ownership and disposition of the Notes
to initial purchasers who are U.S. Holders (as defined below). This summary
is based on the Internal Revenue Code of 1986, as amended to the date hereof
(the "Code"), administrative pronouncements, judicial decisions and existing
and proposed Treasury Regulations, changes to any of which subsequent to the
date of this Offering Memorandum may affect the tax consequences described
herein, possibly with retroactive effect. This summary discusses only Notes
held as capital assets within the meaning of Section 1221 of the Code. It
does not discuss all of the tax consequences that may be relevant to a holder
in light of his particular circumstances or to holders subject to special
rules, such as persons who are not U.S. Holders, certain financial
institutions, insurance companies, dealers in securities and holders who hold
the Notes as part of a straddle or a hedging or conversion transaction.
Persons considering the purchase of the Notes should consult their tax
advisors with regard to the application of the United States federal income
tax laws to their particular situations as well as any tax consequences
arising under the laws of any state, local or foreign taxing jurisdiction.
As used herein, the term "U.S. Holder" means a beneficial owner
of a Note that for United States federal income tax purposes is (i) a citizen
or resident of the United States, (ii) a corporation, partnership or other
entity created or organized in or under the laws of the United States or of
any political subdivision thereof, or (iii) an estate the income of which is
subject to United States federal income taxation regardless of its source or
(iv) a trust if a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more United States
persons have the authority to control all substantial decisions of the trust.
The term also includes certain former citizens or residents of the United
States.
Original Issue Discount
The excess of a Note's "stated redemption price at maturity"
over its "issue price" will generally constitute OID for federal income tax
purposes. The stated redemption price at maturity of a Note will equal the
sum of all cash payments (whether denominated as principal or interest)
payable on the Notes. The issue price of a Note is equal the first price to
the public (not including bond houses, brokers, or similar persons or
organizations acting in the capacity of underwriters, placement agents, or
wholesalers) at which a substantial amount of the Notes is sold for money.
Regardless of their method of accounting, U.S. Holders of the Notes will be
required to include such OID in income for federal income tax purposes as it
accrues, in accordance with a constant yield method based on a compounding of
interest, before the receipt of cash payments attributable to such income.
Under this method, U.S. Holders of the Notes generally will be required to
include in income increasingly greater amounts of OID in successive accrual
periods. Payments of stated interest on a Note will not be separately
included in income, but rather will reduce a U.S. Holder's basis in a Note, as
described below under "Sale, Exchange or Retirement of the Notes."
The Company does not intend to treat the possibility of an
optional redemption or repurchase of the Notes as giving rise to any
additional accrual of OID or recognition of ordinary income upon redemption,
sale or exchange of a Note. U.S. Holders may wish to consider that United
States Treasury Regulations regarding the treatment of certain contingencies
were recently issued and may wish to consult their tax advisers in this regard.
Market Discount and Premium
If a U.S. Holder purchased a Note for an amount that was less
than its "adjusted issue price", the amount of the difference would be treated
as "market discount" for federal income tax purposes, unless such difference
was less than a specified de minimis amount. The adjusted issue price of a
Note is defined as the sum of the issue price of the Note and the aggregate
amount of previously accrued OID, less any prior principal and interest
payments on the Note.
Under the market discount rules of the Code, a U.S. Holder will
be required to treat any prior payment on, or any gain on the sale, exchange,
retirement or other disposition of, a Note as ordinary income to the extent of
the market discount which has not previously been included in income (pursuant
to an election by the Holder to include such market discount in income as it
accrues) and is treated as having accrued on such Note at the time of such
payment or disposition. If such Note is disposed of in a nontaxable
transaction (other than as provided in Code Sections 1276(c) and (d)), accrued
market discount will be includible as ordinary income to the U.S. Holder as if
such Holder had sold the Note at its then fair market value. In addition, the
U.S. Holder may be required to defer, until the maturity of the Note or its
earlier disposition (including a nontaxable transaction other than as provided
in Code Sections 1276(c) and (d)), the deduction of all or a portion of the
interest expense on any indebtedness incurred or maintained to purchase or
carry such Note.
A U.S. Holder who purchased a Note for an amount that was
greater than its adjusted issue price but less than its stated redemption
price at maturity would be considered to have purchased such Note at an
"acquisition premium". Under the acquisition premium rules of the Code and the
regulations thereunder, unless such Holder makes the election described under
"Election to Treat all Interest as Original Issue Discount" below, the amount
of OID which such Holder must include in its gross income with respect to such
Note for any taxable year will be reduced by the portion of such acquisition
premium properly allocable to such year.
Election to Treat All Interest as Original Issue Discount
A U.S. Holder may elect to include in gross income all interest
that accrues on a Note using the constant-yield method described above under
the heading "Original Issue Discount", with the modifications described below.
For purposes of this election, interest includes stated interest, OID, de
minimis OID, market discount, de minimis market discount and unstated
interest, as adjusted by any acquisition premium.
In applying the constant-yield method to a Note with respect to
which this election has been made, the issue price of the Note will equal the
electing U.S. Holder's adjusted basis in the Note immediately after its
acquisition and the issue date of the Note will be the date of its acquisition
by the electing U.S. Holder. This election will generally apply only to the
Note with respect to which it is made and may not be revoked without the
consent of the Internal Revenue Service.
If the election to apply the constant-yield method to all
interest on a Note is made with respect to a Note with market discount, the
electing U.S. Holder will be treated as having made the election discussed
above under "Market Discount" to include market discount in income currently
over the life of all debt instruments held or thereafter acquired by such U.S.
Holder.
Applicable High Yield Discount Obligations
The Notes will be "applicable high yield discount obligations"
("AHYDOs"), as defined in the Code, if the yield to maturity of such Notes
exceeds the "applicable Federal rate" in effect at the time of their issuance
(the "AFR") plus five percentage points. Under the rules applicable to
AHYDOs, if the Notes are AHYDOs, a portion of the OID that accrues on the
Notes may not be deductible by the Company at any time. The non-deductible
portion of the OID will be an amount that bears the same ratio to such OID as
(i) the excess of the yield to maturity of the Notes over the AFR plus six
percentage points bears to (ii) the yield to maturity of the Notes. To the
extent that the non-deductible portion of OID would have been treated as a
dividend if it had been distributed with respect to the Company's stock, it
will be treated as a dividend to holders of the Notes for purposes of the
rules relating to the dividends received deduction for corporate holders. In
addition, if the Notes are AHYDOs, any remaining OID on the Notes will not be
deductible by the Company until such OID is paid.
Sale, Exchange or Retirement of the Notes
Upon the sale, exchange or retirement of a Note, a U.S. Holder
will recognize taxable gain or loss equal to the difference between the amount
realized on the sale, exchange or retirement and such U.S. Holder's adjusted
tax basis in the Note. A U.S. Holder's adjusted tax basis in a Note will
generally equal the cost of such Note to the Holder, increased by the amount
of any market discount and OID previously included in income by such U.S.
Holder with respect to such Note and reduced by any principal and interest
payments received by the U.S. Holder. Except as otherwise described under
"Market Discount and Premium" above, gain or loss realized on the sale,
exchange or retirement of a Note will be capital gain or loss. Recently
enacted legislation includes substantial changes to the federal taxation of
capital gains recognized by individuals, including a 20% maximum tax rate for
certain gains from the sale of capital assets held for more than 18 months.
The deduction of capital losses is subject to certain limitations.
Prospective investors should consult their tax advisors regarding the
treatment of capital gains and losses.
Backup Withholding and Information Reporting
Certain noncorporate U.S. Holders may be subject to backup
withholding at a rate of 31% on payments of principal, premium and interest
(including OID) on, and the proceeds of a disposition of, a Note. Backup
withholding will apply only if the U.S. Holder (i) fails to furnish its
Taxpayer Identification Number ("TIN") which, in the case of an individual,
would be his or her Social Security Number, (ii) furnishes an incorrect TIN,
(iii) is notified by the IRS that it has failed to properly report payments of
interest and dividends or (iv) under certain circumstances, fails to certify,
under penalty of perjury, that it has furnished a correct TIN and has not been
notified by the IRS that it is subject to backup withholding. U.S. Holders
should consult their tax advisors regarding their qualification for exemption
from backup withholding and the procedure for obtaining such an exemption if
applicable.
The amount of any backup withholding from a payment to a U.S.
Holder will be allowed as a credit against such U.S. Holder's United States
federal income tax liability and may entitle such U.S. Holder to a refund,
provided that the required information is furnished to the IRS.
The Company will furnish annually to the IRS and to record
holders of the Notes (other than with respect to certain exempt holders)
information relating to the stated interest and the OID accruing during the
calender year. Such information will be based on the amount of OID that would
have accrued to a U.S. Holder who acquired the Note on original issue.
UNDERWRITING
Subject to the terms and conditions set forth in the
Underwriting Agreement (the "Underwriting Agreement") among RCN and Merrill
Lynch, Pierce, Fenner & Smith Incorporated, Donaldson, Lufkin & Jenrette
Securities Corporation, NationsBanc Montgomery Securities, Inc. and Salomon
Brothers Inc (together, the "Underwriters"), RCN has agreed to sell to each of
the Underwriters and each of the Underwriters has agreed to purchase from RCN
the aggregate principal amount at maturity of the Notes set forth opposite its
name below. The Underwriters will be obligated to purchase all the Notes, if
any are purchased.
<TABLE>
<CAPTION>
Principal Amount at
Underwriters Maturity of the Notes
------------ ---------------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.......................... $
Donaldson, Lufkin & Jenrette Securities Corporation..
NationsBanc Montgomery Securities, Inc...............
Salomon Brothers Inc.................................
---------------------
Total............................................... $
=====================
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters to pay for and accept delivery of the Notes are subject to, among
other conditions, the delivery of certain legal opinions by their counsel.
The Underwriters propose to offer part of the Notes offered
hereby directly to the public at the public offering price set forth on the
cover page hereof and part to certain dealers at a price that represents a
concession not in excess of $ of the principal amount of the Notes.
Any Underwriter may allow, and such dealers may reallow, a concession not in
excess of $ of the principal amount of the Notes to other Underwriters
or to certain other dealers. After the Offering, the offering price and other
selling terms may from time to time be varied by the Underwriters.
The Underwriting Agreement provides that RCN will indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and will contribute to payments that the Underwriters may be
required to make in respect thereof.
In connection with the Offering, certain persons participating
in the Offering may engage in transactions that stabilize, maintain or
otherwise affect the price of the Notes and after the Offering. Specifically,
the Underwriters may bid for and purchase the Notes in the open market to
stabilize the price of the Notes. The Underwriters may also overallot the
Offering, creating a syndicate short position, and may bid for and purchase
the Notes in the open market to cover the syndicate short position. In
addition, the Underwriters may bid for and purchase the Notes in market-
making transactions and impose penalty bids. These activities may stabilize
or maintain the market price of the Notes above market levels that may
otherwise prevail. The Underwriters are not required to engage in these
activities and, if commenced, may end these activities at any time.
The Company has agreed that it will not, for a period of 120
days from the date of the Offering Memorandum, without the prior written
consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated, directly or
indirectly, offer, sell, grant any option to purchase or otherwise dispose of
any debt securities of the Company or any of its subsidiaries.
Certain of the Representatives and their affiliates have
provided and are currently providing investment banking and related services
to the Company and its affiliates, for which they have received or are
receiving customary compensation, and may continue to do so in the future.
Each of Merrill Lynch, Pierce, Fenner & Smith Incorporated, NationsBanc
Montgomery Securities LLC and Salomon Brothers Inc acted as initial purchasers
in the offering of the 1997 Notes and the 1998 Notes and received customary
discounts and commissions in connection therewith.
Prior to the Offering, there has been no active market for the
Notes and there can be no assurance as to the development or liquidity of any
market for the Notes. The Underwriters have indicated to RCN that they intend
to make a market in the Notes, but they are under no obligation to do so and
such market-making could be discontinued at any time without notice, at their
sole discretion.
LEGAL MATTERS
The validity of the Notes offered hereby is being passed on for
the Company by Davis Polk & Wardwell, New York, New York. Certain legal
matters relating to the Notes will be passed upon for the Underwriters by
Cahill Gordon & Reindel (a partnership including a professional corporation),
New York, New York.
EXPERTS
The consolidated financial statements of RCN Corporation as of
December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996
and 1995, appearing in this Prospectus and Registration Statement (defined
below) have been audited by Coopers & Lybrand L.L.P., independent accountants,
as set forth in their report thereon appearing elsewhere herein and in the
Registration Statement and have been so included in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
The financial statements of Erols Internet, Inc. at December
31, 1996 and 1997 and for the period from August 1, 1995 (inception) to
December 31, 1995 and for the years ended December 31, 1996 and 1997,
appearing in this Prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration
Statement on Form S-1 (together with all amendments and exhibits thereto, the
"Registration Statement") under the Securities Act, with respect to the Notes
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits and schedules thereto.
For further information with respect to the Company and the Shares, reference
is hereby made to such Registration Statement and the exhibits and schedules
thereto. Statements contained in this Prospectus as to the contents of any
contract or other document are not necessarily complete and, in each instance,
reference is made to the copy of such contract or document filed as exhibit to
the Registration Statement, each such statement being qualified in all
respects by such reference.
The Company is subject to the informational requirements of the
Exchange Act, and, in accordance therewith is required to file reports and
other information with the Commission. The Registration Statement, as well as
such reports and other information filed by the Company with the Commission,
may be inspected without charge at the public reference facilities maintained
by the Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549
and at the Commission's regional offices located at Seven World Trade Center,
13th Floor, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can be
obtained by mail from the Commission's Public Reference Section at 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission
maintains a Web site (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants, including
the Company, that file electronically with the Commission. In addition, such
reports and other information concerning the Company may also be inspected at
the offices of the National Association of Securities Dealers Automated
Quotation at 1735 K Street, N.W., Washington, D.C. 20006.
INDEX TO FINANCIAL STATEMENTS
RCN Corporation
Report of Independent Accountants...........................................F-1
Consolidated Statements of Operations for the three years
ended December 31, 1997, 1996 and 1995....................................F-2
Consolidated Balance Sheets at December 31, 1997 and 1996...................F-3
Consolidated Statements of Cash Flows for the three years
ended December 31, 1997, 1996 and 1995....................................F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995......................F-7
Notes to Consolidated Financial Statements..................................F-8
Condensed Consolidated Statements of Operations--Quarters
Ended March 31, 1998 and 1997............................................F-32
Condensed Consolidated Balance Sheets March 31, 1998
and December 31, 1997....................................................F-33
Condensed Consolidated Statements of Cash Flows--Quarters
Ended March 31, 1998 and 1997............................................F-34
Notes to Condensed Consolidated Financial Statements.......................F-36
Erols Internet, Inc.
Report of Ernst & Young LLP, Independent Auditors..........................F-41
Balance Sheets as of December 31, 1996 and 1997............................F-42
Statements of Operations for the period from August 1, 1995
(inception) to December 31, 1995 and the years ended
December 31, 1996 and 1997...............................................F-43
Statements of Stockholders' Deficit for the period
from August 1, 1995 (inception) to December 31, 1995
and the years ended December 31, 1996 and 1997...........................F-44
Statements of Cash Flows for the period from
August 1, 1995 (inception) to December 31, 1995 and
the years ended December 31, 1996 and 1997...............................F-45
Notes to Financial Statements..............................................F-46
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of RCN Corporation:
We have audited the accompanying consolidated balance sheets of
RCN Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of RCN Corporation and Subsidiaries as of December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 13, 1998
(except Note 2, as to which
the date is May 20, 1998)
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Thousands of Dollars Except Per Share Amounts)
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Sales.................................................................. $127,297 $104,910 $91,997
Costs and expenses, excluding depreciation and amortization............ 134,967 79,107 75,003
Nonrecurring charges................................................... 10,000 -- --
Depreciation and amortization.......................................... 53,205 38,881 22,336
-------- -------- -------
Operating (loss)....................................................... (70,875) (13,078) (5,342)
Interest income........................................................ 22,824 25,602 29,001
Interest expense....................................................... (25,602) (16,046) (16,517)
Other income (expense), net................................................... 131 (546) (304)
-------- -------- -------
(Loss) income before income taxes...................................... (73,522) (4,068) 6,838
(Benefit) provision for income taxes................................... (20,849) 979 1,119
( -------- -------- -------
Loss) income before minority interest and equity in unconsolidated
entities.............................................................. (52,673) (5,047) 5,719
Minority interest in loss (income) of consolidated entities............ 7,296 1,340 (144)
Equity in (loss) of unconsolidated entities............................ (3,804) (2,282) (3,461)
-------- -------- -------
(Loss) income before extraordinary item................................ (49,181) (5,989) 2,114
Extraordinary charge - debt prepayment penalty, net of tax of $1,728... (3,210) -- --
-------- -------- -------
Net (loss) income...................................................... $(52,391) $ (5,989) $2,114
======== ======== =======
Basic earnings per average common share:
Income (loss) before extraordinary charge.............................. $ (0.89) $ (0.11) $ 0.04
Extraordinary charge - debt prepayment penalty......................... $ (0.06) -- --
Net income (loss) to shareholders...................................... $ (0.95) $ (0.11) $ 0.04
Weighted average shares outstanding.................................... 54,965,716 54,918,394 54,890,334
Diluted earnings per average common share:
Income (loss) before extraordinary charge.............................. $ (0.89) $ (0.11) $ 0.04
Extraordinary charge - debt prepayment penalty......................... $ (0.06) -- --
Net income (loss) to shareholders...................................... $ (0.95) $ (0.11) $ 0.04
Weighted average shares and common stock equivalents outstanding 54,965,716 54,918,394 54,890,334
</TABLE>
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1996
---------- --------
<S> <C> <C>
ASSETS
Current assets
Cash and temporary cash investments......................................................... $222,910 $61,843
Short-term investments...................................................................... 415,603 46,831
Accounts receivable from related parties.................................................... 9,829 12,614
Accounts receivables, net of reserve for doubtful accounts of $2,134 in 1997 and $861
in 1996................................................................................... 17,815 10,413
Unbilled revenues........................................................................... 1,695 844
Material and supply inventory, at average cost.............................................. 2,745 1,140
Prepayments and other....................................................................... 5,314 4,556
Deferred income taxes....................................................................... 4,821 4,371
Investments restricted for debt service..................................................... 22,500 --
---------- --------
Total current assets 703,232 142,612
---------- --------
Notes receivable - affiliates................................................................ -- 155,481
Property, plant and equipment, net of accumulated depreciation of $107,419 in 1997
and $84,529 in 1996......................................................................... 200,340 135,828
Investments restricted for debt service...................................................... 39,411 --
Investments.................................................................................. 70,424 76,547
Intangible assets, net....................................................................... 96,547 93,471
Deferred charges and other assets............................................................ 41,038 24,146
---------- --------
Total assets................................................................................. $1,150,992 $628,085
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable to related parties......................................................... $3,748 $4,880
Accounts payable............................................................................ 24,835 13,642
Advance billings and customer deposits...................................................... 7,318 6,859
Accrued taxes............................................................................... 488 1,950
Accrued interest............................................................................ 5,549 5,041
Accrued contract settlements................................................................ 3,126 3,565
Accrued cable programming expense........................................................... 3,498 3,188
Accrued expenses............................................................................ 21,143 18,167
---------- --------
Total current liabilities.................................................................... 69,705 57,292
---------- --------
Long-term debt............................................................................... 686,103 131,250
Notes payable - affiliates................................................................... -- 11,854
Deferred income taxes........................................................................ 19,612 28,245
Other deferred credits....................................................................... 2,596 3,290
Minority interest............................................................................ 16,392 5,389
Commitments and contingencies................................................................
Preferred stock.............................................................................. -- --
Common shareholders' equity.................................................................. 356,584 390,765
---------- --------
Total liabilities and shareholders' equity................................................... $1,150,992 $628,085
========== ========
</TABLE>
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash Flows from operating activities
Net income (loss)........................................................... $(52,391) $(5,989) $2,114
Gain on pension curtailment/settlement...................................... -- (3,437) --
Accretion of discounted debt................................................ 8,103 -- --
Gain on sale of partnership interest........................................ (661) -- --
Extraordinary item - debt prepayment penalty................................ 3,210 -- --
Depreciation and amortization............................................... 53,205 38,881 22,336
Deferred income taxes and investment tax credits, net....................... (10,503) (6,477) 6,696
Provision for losses on accounts receivable................................. 2,732 1,788 614
Equity in loss of unconsolidated entities................................... 3,804 2,282 3,461
Minority interest........................................................... (7,296) (1,340) 144
Net change in certain assets and liabilities, net of business acquisitions:
Accounts receivable and unbilled revenues................................. (14,979) (3,780) (5,550)
Material and supply inventory............................................. (1,605) (814) 777
Accounts payable.......................................................... 11,193 2,954 3,983
Accrued expenses.......................................................... 3,353 4,283 2,783
Accounts receivable from related parties.................................. 3,180 1,572 11,860
Accounts payable to related parties....................................... (1,132) (5,448) (419)
Other, net................................................................ 367 597 529
Other....................................................................... 1,081 (1,241) (769)
--------- -------- --------
Net cash provided by operating activities.................................... 1,661 23,831 48,559
--------- -------- --------
Cash flows from investing activities
Additions to property, plant and equipment.................................. (79,042) (38,548) (29,854)
Purchase of short-term investments.......................................... (445,137) (75,091) (238,257)
Sales and maturities of short-term investments.............................. 76,923 149,086 245,112
Acquisitions, net of cash acquired.......................................... (30,490) (30,090) (121,147)
Purchase of loan receivable................................................. -- (13,088) --
Proceeds from sale of partnership interest.................................. 1,900 -- --
Other....................................................................... (14) (1,646) (2,057)
--------- -------- --------
Net cash used in investing activities........................................ (475,860) (9,377) (146,203)
--------- -------- --------
Cash flows from financing activities
Redemption of long-term debt................................................ (141,250) (44,750) (28,741)
Issuance of long-term debt.................................................. 688,000 19,000 19,300
Change in affiliate notes, net.............................................. 97,624 32,802 (6,130)
Extraordinary item - debt prepayment penalty................................ (3,210) -- --
Payments made for debt financing costs...................................... (19,743) -- --
Cash contribution from joint venture partner................................ 9,016 -- --
(Increase) related to investments restricted for debt service............... (61,250) -- --
Proceeds from issuance of stock............................................. 230 -- --
Transfers from C-TEC........................................................ 89,323 78,550 132,707
Transfers (to) C-TEC........................................................ (23,474) (76,211) (148,339)
--------- -------- --------
Net cash provided by (used in) financing activities.......................... 635,266 9,391 (31,203)
--------- -------- --------
Net increase (decrease) in cash and temporary cash investments............... 161,067 23,845 (128,847)
Cash and temporary cash investments at beginning of year..................... 61,843 37,998 166,845
--------- -------- --------
Cash and temporary cash investments at end of year........................... $ 222,910 $ 61,843 $ 37,998
========= ======== ========
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Income taxes................................................................ $ 1,090 $ 549 $ 497
========= ======== ========
Interest (net of amounts capitalized)....................................... $ 16,536 $ 16,046 $ 16,404
========= ======== ========
</TABLE>
Supplemental Schedule of Non-Cash Investing and Financing Activities
In March 1997, the Company acquired the portion of Freedom which it did not
already own. The transaction was accounted for as a purchase. A summary of the
transaction is as follows:
Cash paid.................................................... $40,000
Non-capitalizable costs ..................................... (10,000)
Reduction of minority interest............................... (3,812)
--------
Fair value of assets acquired................................ $26,188
========
In 1996, C-TEC acquired an 80.1% interest in Freedom New York, L.L.C. The
acquisition was accounted for as a purchase. A summary of the acquisition is as
follows:
Cash paid..................................................... $28,906
Liabilities assumed........................................... 7,621
Deferred tax asset recognized................................. (167)
Minority interest recognized.................................. 6,188
--------
Fair value of assets acquired................................. $42,548
========
In 1995, C-TEC acquired all the outstanding Common Stock of Twin County Trans
Video, Inc. and a related covenant not to compete. The consideration for the
acquisition was as follows:
Cash paid (including $1,000 deposit in 1994).................. $37,313
Issuance of 5% Promissory Note................................ 4,000
Capital contribution by stockholder........................... 39,493
Liabilities assumed........................................... 16,364
Deferred tax liability incurred............................... 33,797
--------
Fair value of assets acquired................................. $130,967
========
In 1996, the $4,000 promissory note was canceled and the Company paid cash of
$500 in settlement of certain purchase
price adjustments.
Certain intercompany accounts receivable and payable and intercompany note
balances were transferred to Shareholders' Net Investment in connection with the
Distribution.
BECO's contribution of the IRU to the RCN-BECOCOM joint venture (Note 7(a)) is
reflected as "Advanced Fiber Plant" as its fair value.
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 1997, 1996 and 1995
(Thousands of Dollars)
<TABLE>
<CAPTION>
Common Shares Additional Cumulative Total
Issued and Common Paid Shareholder's Translation Shareholder's
Outstanding Stock in Capital Deficit Net Investment Adjustment Equity
------------- --------- ----------- ---------- --------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance December 31, 1994 ......... 1,400 $ 1 $ $ -- $ 372,846 $ -- $ 372,847
Net Income ...................... 2,114 2,114
Transfers from C-TEC ............ 21,714 21,714
Cumulative translation adjustment (2,606) (2,606)
---------- --------- -------- --------- ----------- ----------- -----------
Balance, December 31, 1995 ........ 1,400 1 396,674 (2,606) 394,069
Net loss ........................ (5,989) (5,989)
Transfers from C-TEC ............ 3,134 3,134
Cumulative translation adjustment (449) (449)
---------- --------- -------- --------- ----------- ----------- -----------
Balance, December 31, 1996 ........ 1,400 1 -- -- 393,819 (3,055) 390,765
Net loss from 1/1/97 through
9/30/97 ....................... (35,275) 35,275
Net loss from 10/1/97 through
12/31/97 ...................... (17,116) (17,116)
Transfers from C-TEC ............ 17,980 17,980
Common stock issued in connection
with the distribution ......... 54,967,952 54,968 321,556 (376,524) --
Issuance of common stock ........ 20,518 20 210 230
---------- --------- -------- --------- ----------- ----------- -----------
Balance, December 31, 1997 ........ 54,989,870 $ 54,989 $321,766 $ (17,116) $ -- $ (3,055) $ 356,584
========== ========= ======== ========= =========== =========== ===========
</TABLE>
RCN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Per Share Data)
1. BACKGROUND AND BASIS OF PRESENTATION
Prior to September 30, 1997, RCN Corporation (the "Company" or
"RCN") was operated as part of C-TEC Corporation ("C-TEC"). On September 30,
1997, C-TEC distributed 100 percent of the outstanding shares of common stock of
its wholly owned subsidiaries, RCN Corporation ("RCN") and Cable Michigan, Inc.
("Cable Michigan") to holders of record of C-TEC's Common Stock and C-TEC's
Class B Common Stock as of the close of business on September 19, 1997 (the
"Distribution") in accordance with the terms of a Distribution Agreement dated
September 5, 1997 among C-TEC, RCN and Cable Michigan. RCN consists primarily of
C-TEC's bundled residential voice, video and Internet access operations in the
Boston to Washington, D.C. corridor, its existing New York, New Jersey and
Pennsylvania cable television operations, a portion of its long distance
operations and its international investment in Megacable, S.A. de C.V.
("Megacable"). Cable Michigan, Inc. consists of C-TEC's Michigan cable
operations, including its 62% ownership in Mercom, Inc. In connection with the
Distribution, C-TEC changed its name to Commonwealth Telephone Enterprises, Inc.
("CTE").
The consolidated financial statements have been prepared using
the historical basis of assets and liabilities and historical results of
operations of all wholly and majority owned subsidiaries. However, the
historical financial information presented herein reflects periods during
which the Company did not operate as an independent company and accordingly,
certain assumptions were made in preparing such financial information. Such
information, therefore, may not necessarily reflect the results of operations,
financial condition or cash flows of the Company in the future or what they
would have been had the Company been an independent, public company during the
reporting periods. All material intercompany transactions and balances have
been eliminated. Investments accounted for by the equity method include a 40%
interest in Megacable, a Mexican cable television system operator. Joint
ventures which the Company controls and in which the minority investors do not
possess significant veto rights are consolidated. Other joint ventures are
accounted for by the equity method.
C-TEC's corporate services group has historically provided
substantial support services such as finance, cash management, legal, human
resources, insurance and risk management and its financial statements are
included in the consolidated financial statements of the Company. Prior to
the Distribution, the corporate office allocated the cost for these services
pro rata among the business units supported primarily based on assets;
contribution to consolidated earnings before interest, depreciation,
amortization, and income taxes; and number of employees. In the opinion of
management, the method of allocating these costs is reasonable; however, the
costs of these services remaining with the Company after allocation to C-TEC's
other business units are not necessarily indicative of the costs that would
have been incurred by the Company on a stand-alone basis. Also included in
the Company's consolidated financial statements are the financial statements
of the corporate financial services company which invests excess cash of, and
advances funds to the Company and prior to the Distribution, C-TEC. The
financial services company charges interest expense on outstanding advances
and pays interest income on excess cash invested for affiliates.
CTE, RCN and Cable Michigan have entered into certain
agreements providing for the Distribution, and governing various ongoing
relationships, including the provision of support services, between the three
companies, including a distribution agreement and a tax-sharing agreement.
2. SEGMENT INFORMATION
The Company has elected to adopt Statement of Financial
Accounting Standards No. 131-- "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS 131") in the first quarter of 1998 and has
retroactively restated its segment disclosures.
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 to the single source network, including customers which
were served by the Company's previously separate lines of business for which
profitability was separately measurable and monitored. 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; because management believes that any allocation of the expenses
incurred on a single network to multiple revenue streams would be impractical
and arbitrary, 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 Company's historical general
purpose financial statements.
The Company manages operations and evaluates operating
financial performance on a pro forma total RCN basis, which reflects the
consolidation of all domestic joint ventures, including those not consolidated
under generally accepted accounting principles. The same net loss results on
both a historical and pro forma total RCN basis since the outside ownership of
the joint venture, which is consolidated only in the pro forma total RCN
information, is reflected as minority interest in the pro forma total RCN
information. Such results are as follows:
<TABLE>
<CAPTION>
Pro Forma Total RCN
Year Ended
December 31,
-----------------------------------
1997 1996 1995
<S> <C> <C> <C>
Sales:
Voice........................................................................ $4,007 $830 $237
Video........................................................................ 103,371 87,470 65,699
Data......................................................................... 41 4 --
Commercial and other......................................................... 19,878 16,606 26,061
------- ------- -------
Total Sales................................................................... 127,297 104,910 91,997
Costs and expenses, excluding depreciation and amortization:
Direct expenses.............................................................. 51,757 35,226 39,604
Operating, selling, general and administrative............................... 83,422 43,881 35,399
------- ------- -------
EBITDA before nonrecurring charge............................................. (7,882) 25,803 16,994
Depreciation and amortization................................................. 53,205 38,881 22,336
Nonrecurring charge........................................................... 10,000 -- --
------- ------- -------
Operating loss................................................................ (71,087) (13,078) (5,342)
Interest income............................................................... 22,824 25,602 29,001
Interest expense.............................................................. (25,602) (16,046) (16,517)
Other (expense), net.......................................................... 131 (546) (304)
------- ------- -------
(Loss) income before income taxes............................................. (73,734) (4,068) 6,838
(Benefit) provision for income taxes.......................................... (20,849) 979 1,119
------- ------- -------
(Loss) income before equity in unconsolidated entities, minority interest
and extraordinary item....................................................... (52,885) (5,047) 5,719
Equity in loss of unconsolidated entities..................................... (3,698) (2,282) (3,461)
Minority interest in loss (income) of consolidated entity..................... 7,402 1,340 (144)
------- ------- -------
(Loss) income before extraordinary item....................................... (49,181) (5,989) 2,114
Extraordinary charge -- debt prepayment penalty............................... (3,210) -- --
------- ------- -------
Net (loss) income............................................................. $(52,391) $(5,989) $2,114
======= ======= ======
</TABLE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and Temporary Cash Investments - For purposes of reporting
cash flows, the Company considers all highly liquid investments purchased with
an original maturity of three months or less to be temporary cash investments.
Temporary cash investments are stated at cost which approximates market.
Short Term Investments and Investments Restricted for Debt
Service - Management determines the appropriate classification of its
investments in debt and equity securities at the time of purchase and
reevaluates such determination at each balance sheet date in accordance with
Statement of Financial Accounting Standards No. 115 -- "Accounting for Certain
Investments in Debt and Equity Securities." At December 31, 1997 and 1996,
marketable debt and equity securities have been categorized as available for
sale. The Company states its short term investments at cost, which
approximates market. Investments restricted for debt service have been
categorized as held to maturity.
Property, Plant and Equipment and Depreciation - Property,
plant and equipment reflects the original cost of acquisition or construction,
including payroll and related costs such as taxes, pensions and other fringe
benefits, and certain general administrative costs.
Depreciation is provided on the straight-line method based on
the useful lives of the various classes of depreciable property. The average
estimated lives of depreciable property, plant and equipment are:
Lives
-----
Hybrid fiber/coaxial plant 5-22 years
Advanced fiber plant 10-15 years
Wireless & other plant 5 years
Buildings and leasehold improvements 5-45 years
Furniture, fixtures and vehicles 3-10 years
Other 3 years
Repairs of all property, plant and equipment and minor
replacements and renewals are charged to expense as incurred. Major
replacements and betterments are capitalized. Gain or loss is recognized on
major retirements and dispositions.
Intangible Assets - Intangible assets are amortized on a
straight-line basis over the expected period of benefit ranging from 2 to 15
years.
Accounting for Impairments - The Company follows the provisions
of Statement of Financial Accounting Standards No. 121 -- "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of "
("SFAS 121"). SFAS 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In performing the review
for recoverability, the Company estimates the future cash flows expected to
result from the use of the asset and its eventual disposition. If the sum
of the expected net future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset, an impairment loss is
recognized. Measurement of an impairment loss for long-lived assets and
identifiable intangibles expected to be held and used is based on the fair
value of the asset.
No impairment losses have been recognized by the Company
pursuant to SFAS 121.
Revenue Recognition - Local telephone service revenue is
recorded as earned based on tariffed rates. Long distance telephone service
revenue is recorded based on minutes of traffic processed and tariffed rates
or contracted fees. Revenues from cable programming services are recorded in
the month the service is provided. Internet access service revenues are
recorded based on contracted fees.
Advertising Expense - Advertising costs are expensed as
incurred. Advertising expense charged to operations was $12,203, $1,441 and
$862 in 1997, 1996 and 1995, respectively.
Stock Based Compensation - The Company applies Accounting
Principles Board Opinion No. 25 -- "Accounting for Stock Issued to Employees"
("APB 25") in accounting for its stock plans. The Company has adopted the
disclosure - only provisions of Statement of Financial Accounting Standards
No. 123 -- "Accounting for Stock-Based Compensation" ("SFAS 123").
Earnings (loss) per share - The Company has adopted statement
of Financial Accounting Standards No. 128 -- "Earnings Per Share" ("SFAS
128"). Basic earnings (loss) per share is computed based on net income (loss)
divided by the weighted average number of shares of common stock outstanding
during the period.
Diluted earnings (loss) per share is computed based on net
income (loss) divided by the weighted average number of shares of common stock
outstanding during the period after giving effect to convertible securities
considered to be dilutive common stock equivalents. The conversion of stock
options during periods in which the Company incurs a loss from continuing
operations is not assumed since the effect is anti-dilutive. The number of
stock options which would have been converted in 1997 and have a dilutive
effect if the Company had income from continuing operations is 517,506.
For periods prior to October 1, 1997, during which the Company
was a wholly owned subsidiary of C-TEC, earnings (loss) per share was calculated
by dividing net income (loss) by the number of average common shares of C-TEC
outstanding, based upon a distribution ratio of one share of Company common
equity for each share of C-TEC common equity owned.
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Income (loss) before extraordinary charge.............. $(49,181) $(5,989) $2,114
Basic earnings per average common share:
Average shares outstanding............................. 54,965,716 54,918,394 54,890,334
(Loss) income per average common share................. $ (0.89) $ (0.11) $ (0.04)
Diluted earnings per average common share:
Average shares outstanding............................. 54,965,716 54,918,394 54,890,334
Dilutive shares resulting from stock options........... -- -- --
------------ ------------ ------------
54,965,716 54,918,394 54,890,334
============ ============ ============
(Loss) income per average common share................. $ (0.89) $ (0.11) $ (0.04)
</TABLE>
Income Taxes - The Company and its subsidiaries report income
for federal tax purposes on a consolidated basis. Prior to the Distribution,
the Company and its subsidiaries were included in the consolidated federal
income tax return of C-TEC. Income tax expense is allocated to subsidiaries
on a separate return basis except that the Company's subsidiaries receive
benefit for the utilization of net operating losses and investment tax credits
included in the consolidated return even if such losses and credits could not
have been used on a separate return basis. The Company accounts for income
taxes using Statement of Financial Accounting Standards No. 109 -- "Accounting
for Income Taxes." The statement requires the use of an asset and liability
approach for financial reporting purposes. The asset and liability approach
requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between financial
reporting basis and tax basis of assets and liabilities. If it is more likely
than not that some portion or all of a deferred tax asset will not be
realized, a valuation allowance is recognized.
Investment tax credits ("ITC") for the Company have been
deferred in prior years and are being amortized over the average lives of the
applicable property.
Foreign Currency Translation - The Company has a 40% interest
in Megacable. For purposes of determining its equity in the earnings of
Megacable, the Company translates the revenues and expenses of Megacable into
U.S. dollars at the average exchange rates that prevailed during the period.
Assets and liabilities are translated into U.S. dollars at the rates in effect
at the end of the fiscal period. Prior to 1997, the Company's share of the
gains or losses that result from this process are shown in the cumulative
translation adjustment account in the common shareholders' equity section of
the balance sheet. Effective January 1, 1997, since the three-year cumulative
rate of inflation at December 31, 1996 exceeded 100%, Mexico is treated for
accounting purposes as having a highly inflationary economy. As a result, the
financial statements of Megacable are remeasured as if the functional currency
were the U.S. dollar. The remeasurement of the Mexican peso into U.S. dollars
creates translation adjustments which are included in net income. The
Company's proportionate share of gains and losses resulting from transactions
of Megacable, which are made in currencies different from its own, are
included in income as they occur.
4. BUSINESS COMBINATIONS
The following business combinations were transacted by wholly
owned subsidiaries of C-TEC. The acquired businesses were transferred to the
Company in connection with the Distribution.
On August 30, 1996, FNY Holding Company, Inc., formerly a
wholly owned subsidiary of C-TEC ("FNY") acquired from Kiewit Telecom
Holdings, C-TEC's controlling shareholder at the time, an 80.1% interest in
Freedom New York, LLC and all related rights and liabilities ("Freedom") for
cash consideration of approximately $29,000. In addition, FNY assumed
liabilities of approximately $7,600. (In March 1996, Freedom had acquired the
wireless cable television business of Liberty Cable Television). The
acquisition was accounted for as a purchase, and accordingly, Freedom is
included in the Company's consolidated financial statements since September
1996. The full fair value of assets acquired and liabilities assumed has been
reflected in the Company's financial statements with minority interest
reflecting the separate 19.9% ownership.
FNY allocated the purchase price paid on the basis of the fair
value of property, plant and equipment and identifiable intangible assets
acquired and liabilities assumed. There was no excess cost over fair value of
net assets acquired.
Contingent consideration of $15,000 was payable in cash and was
to be based upon the number of net eligible subscribers, as defined in the
Acquisition Agreement, in excess of 16,563 delivered to the Company. The
contingent consideration is not included in the acquisition cost total above
but was to have been recorded when and if the future delivery of subscribers
occurred. In addition, FNY paid $922 to Kiewit Telecom Holdings which
represents compensation for foregone interest on the amount invested by Kiewit
Telecom Holdings in Freedom. This amount has been charged to operations.
On March 21, 1997, the Company paid $15,000 in full
satisfaction of contingent consideration payable for the original acquisition
of Freedom. Additionally, pursuant to the terms of the Freedom Operating
Agreement, the assets of RCN Telecom Services of New York, Inc., a
wholly-owned subsidiary of RCN, were contributed to Freedom, in which the
Company had an 80.1% ownership interest prior to such contribution.
Subsequent to this contribution, the Company paid $15,000 to acquire the
minority ownership of Freedom. These amounts were primarily allocated to
excess cost over fair value of net assets acquired and are being amortized
over a period of approximately six years. The Company also paid $10,000 to
terminate a marketing services agreement between Freedom and an entity
controlled by Freedom's former minority owners. The Company charged this
amount to operations for the quarter ended March 31, 1997.
On May 15, 1995, C-TEC Cable Systems, Inc, ("RCN Cable")
formerly a wholly owned subsidiary of C-TEC, acquired 40% of the outstanding
common stock of Twin County Trans Video, Inc. ("Twin County") in exchange for
cash of approximately $26,300, including a $1,000 deposit made in 1994, and a
$4,000, 5% promissory note of RCN Cable. In addition, RCN Cable paid $11,000 in
consideration of a noncompete agreement and assumed liabilities of approximately
$16,400. The remaining shares were subject to an escrow agreement, pending
completion of the merger, and were required to be voted under the direction of
RCN Cable. As of May 15, 1995, RCN Cable also assumed management of Twin
County. As a result, RCN Cable had control of Twin County and accordingly Twin
County is consolidated in the Company's financial statements since May 1995, the
date of the original acquisition. The remaining outstanding common stock of
Twin County was acquired in September 1995 in exchange for $52,000 stated value
redeemable convertible preferred stock of C-TEC. The preferred stock has a
stated dividend rate of 5%, beginning January 1, 1996. The fair value of the
preferred stock, as determined by an independent appraiser was $39,500 which was
recorded as additional paid-in capital to the Company. In 1996, the $4,000
promissory note was canceled and RCN Cable paid cash of $500 in settlement of
certain purchase price adjustments.
RCN Cable has allocated the purchase price paid for Twin County
on the basis of the fair value of property, plant and equipment and
identifiable intangible assets acquired and liabilities assumed. The excess
of the consideration for the acquisition over the fair value of the net assets
acquired of approximately $16,700 has been allocated to goodwill and is being
amortized over a period of approximately 10 years.
In January 1995, RCN International Holdings, Inc. (formerly
C-TEC International, Inc.), formerly a wholly owned subsidiary of C-TEC,
purchased a 40% equity position in Megacable. The aggregate consideration
for the purchase was cash of $84,115. The Company accounts for its investment
by the equity method of accounting. The original excess cost over the
underlying equity in the net assets acquired is approximately $94,000, which
is being amortized on a straight-line basis over 15 years.
In January 1995, RCN Cable purchased the assets of Higgins
Lake Cable, Inc. for cash of approximately $4,750.
In June 1995, C-TEC invested approximately $2,220 for a
one-third interest in a partnership which intends to provide alternative
access telephone service to commercial subscribers. C-TEC transferred this
investment to RCN Cable in 1996 at net book value of $1,977. The Company
disposed of its investment in 1997 and realized a gain of $661.
In November 1995, the Company purchased the assets used in the
provision of residential telephone services in New York by RealCom Office
Communications, Inc. for cash of approximately $1,050.
The following unaudited pro forma summary presents information
as if the acquisitions of Freedom and Twin County had occurred at the
beginning of 1996. The pro forma information is provided for information
purposes only. It is based on historical information and does not necessarily
reflect the actual results that would have occurred nor is it necessarily
indicative of future results of operations of the consolidated entities.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
---- ----
(Unaudited)
<S> <C> <C>
Sales.................................................................... $127,297 $110,116
(Loss) from continuing operations before extraordinary items............. $(72,245) $(20,189)
Net (loss)............................................................... $(53,831) $(16,807)
Pro Forma Earnings Per Share:
(Loss) from continuing operations before extraordinary items............. $ (1.31) $ (0.37)
Net (loss)............................................................... $ (0.98) $ (0.31)
</TABLE>
5. SHORT-TERM INVESTMENTS
Short-term investments, stated at cost, include the following
at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Federal Agency notes................ $110,966 $ --
Commercial Paper.................... 43,859 8,823
Corporate debt securities........... 222,785 38,008
Certificates of deposit............. 37,993 --
-------- -------
Total............................... $415,603 $46,831
======== =======
</TABLE>
At December 31, 1997, short term investments with an amortized
cost of $329,714 have contractual maturities of one to three years. All
remaining short term investments have contractual maturities under one year.
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at
December 31,
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Hybrid fiber/coaxial plant.................... $157,652 $148,172
Advanced fiber plant.......................... 76,572 29,226
Wireless & other plant........................ 4,771 4,245
Buildings, leasehold improvements and land.... 16,607 10,989
Furniture, fixtures and vehicles.............. 23,399 18,119
Construction in process....................... 28,195 9,013
Other......................................... 563 593
-------- --------
Total property, plant and equipment........... 307,759 220,357
Less accumulated depreciation................. (107,419) (84,529)
-------- --------
Property, plant and equipment, net............ $200,340 $135,828
======== ========
</TABLE>
Depreciation expense was $24,257, $19,372 and $13,236 for the
years ended December 31, 1997, 1996 and 1995, respectively.
7. INVESTMENTS AND JOINT VENTURES
Investments at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Megacable..................... $70,363 $74,232
Partnership................... -- 2,315
Other......................... 61 --
------- -------
Total Investments............. $70,424 $76,547
======= =======
</TABLE>
Investments carried on the equity method consist of the
following at December 31:
<TABLE>
<CAPTION>
Percentage Owned
---------------------------
1997 1996
---- ----
<S> <C> <C>
Megacable........................ 40.00% 40.00%
Partnership Interest............. -- 33.33%
Starpower Communications, LLC.... 50.00% --
</TABLE>
a. In September 1996, RCN and Boston Edison Company ("BECO"),
through wholly owned subsidiaries, entered into a letter of intent to form a
joint venture to utilize 126 fiber miles of BECO's fiber optic network to
deliver RCN's comprehensive communications package in Greater Boston. The
venture, in the form of an unregulated entity with a term expiring in the year
2060, was formed pursuant to a joint venture agreement dated December 23, 1996
(the "Boston Joint Venture Agreement") providing for the organization and
operation of RCN-BECOCOM, LLC ("RCN-BECOCOM"). RCN-BECOCOM was organized to own
and operate an advanced fiber optic telecommunications network and to provide,
in the market in and around Boston, Massachusetts , voice, video and data
services, as well as the communications support component of energy related
customer services offered by BECO. RCN owns 51% of the equity interest in
RCN-BECOCOM and BECO, owns the remaining 49% interest. Future capital
contributions are required to be made on a 51% and 49% basis for RCN and BECO,
respectively.
The closing of the transactions contemplated by the Boston
Joint Venture Agreement occurred on June 17, 1997. RCN will manage the
business of RCN-BECOCOM pursuant to the terms of the Management Agreement and,
in consideration therefor, will receive reimbursement for its reasonable
costs, and a performance-based fee (based on factors including the number of
subscribers and operating cash flow) to be determined by agreement of RCN and
RCN-BECOCOM. The initial term of the agreement expires on December 31, 2001.
The agreement provides for automatic successive three-year renewal periods,
unless notice is given ninety days before the end of the period. As a result
of its ownership, management and control, this joint venture with BECO is
consolidated in RCN's financial statements.
Pursuant to an Indefeasible Right of Use Agreement ("IRU
Agreement") , BECO will, for certain agreed upon fees, (i) provide
construction services to build out the Network, (ii) make available to
RCN-BECOCOM (a) all of the available capacity of BECO's existing fiber
backbone, and (b) the ability to use BECO's real estate, poles, easements and
other interests for the construction and operation of the Network and (iii)
maintain the Network. BECO's construction obligations expire on June 17, 2007
and the term of the IRU Agreement expires on December 31, 2060. One year
before each respective expiration date, BECO agrees to commence good-faith
negotiations to extend construction obligations beyond June 17, 2007 and to
allow continued use of BECO's facilities beyond December 31, 2060. The fair
value of the IRU transferred by BECO to the joint venture is reflected as
"Advanced Fiber Plant" in property, plant and equipment.
BECO will have the right at the time of the Distribution and
every two years thereafter to convert its ownership interest in RCN-BECOCOM
into the Common Stock of RCN pursuant to specific terms and conditions. If
BECO exercises its conversion rights, BECO will remain obligated to make 49%
of all cash contributions by the parties and any cash contributions made after
conversion will result in it owning a portion of RCN-BECOCOM based on the
value of RCN-BECOCOM at the time of the contribution. BECO may exercise its
conversion rights in whole or in part from time to time. In January 1998,
BECO notified RCN that it has elected to exercise its option to the full
extent permitted by the Exchange Agreement with respect to 1997. RCN and BECO
are presently in discussions with respect to the calculation of the agreed
upon value for the exercise of such option.
b. On August 1, 1997, RCN and Potomac Capital Investment
Corporation ("PCI"), a wholly owned subsidiary of PEPCO, entered into a letter
of intent (the "Letter of Intent") to form a joint venture which will own and
operate a communications network to provide voice, video, data and other
communications services to residential and commercial customers in the greater
Washington, D.C., Virginia and Maryland area (the "Washington, D.C. Market").
Starpower, an unregulated limited liability company with a perpetual term, was
formed on October 28, 1997 to construct, own, lease, operate and market a
network for the selling of voice, video, data and other telecommunications
services to all potential commercial and residential customers in the
Washington, D.C. Market. RCN owns 50% of the equity interest in Starpower and
PCI owns the remaining 50% interest.
The closing of the Starpower joint venture (the "Starpower
Closing") occurred on December 19, 1997.
Pursuant to the Amended and Restated Operating Agreement, RCN
and Pepco Communications are each required to make additional capital
contributions in accordance with a schedule set forth in such agreement on a
50%/50% basis. Failure of either RCN or Pepco Communications to make a
scheduled capital contribution or to vote in favor of certain additional
capital contributions may result in the recalculation of equity interests. The
business and affairs of Starpower is to be managed by RCN and Pepco
Communications. So long as RCN and Pepco Communications maintain a 50%/50%
equity interest in the joint venture, each of RCN and Pepco Communications
will appoint three members to the operating committee, the approval of which
is required for any business action. Certain fundamental business actions,
such as mergers, acquisitions, sales of substantially all of the assets,
liquidation and amendments to the certificate of organization or any agreement
signed at the Starpower Closing, require the unanimous approval of the
operating committee regardless of whether the parties continue to maintain a
50%/50% ownership interest. As a result of the joint control, Starpower is
accounted for under the equity method of accounting.
A subsidiary of RCN will provide support services including
customer service, billing, marketing and certain administrative, accounting
and technical support services, each of which shall be provided at cost.
c. The basis of the Company's investment in Megacable exceeded
its underlying equity in the net assets of Megacable when acquired by
approximately $94,000 which excess is being amortized on a straight-line basis
over 15 years. At December 31, 1997, the unamortized excess over the
underlying equity in the net assets was $75,886. The Company recorded its
proportionate share of (losses) and amortization of excess cost over net
assets of ($3,869), ($2,190) and ($3,061) in 1997, 1996 and 1995, respectively.
Effective January 1, 1997, since the three-year cumulative rate
of inflation at December 31, 1996 exceeded 100%, Mexico is being treated for
accounting purposes under Statement of Financial Accounting Standards No. 52
- -- "Foreign Currency Translation", as having a highly inflationary economy.
As a result, the financial statements of Megacable are remeasured as if the
functional currency were the U.S. dollar. The remeasurement of the Mexican
peso into U.S. dollars creates translation adjustments which are included in
net income. Exchange gains (losses) of $(12), $247, and $(932) in 1997, 1996,
and 1995, respectively, including translation losses in 1997, are included in
the respective statements of operations through the Company's proportionate
share of losses of Megacable.
The following table reflects the summarized financial position
and results of operations of Megacable as of and for the years ended December
31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Assets.......................................... 76,323 67,672
Liabilities..................................... 8,347 6,455
Stockholders' equity............................ 67,976 61,217
Sales........................................... 30,441 23,225
Costs and expenses.............................. 23,389 15,689
Foreign currency transaction gains (losses)..... (31) 618
Net income...................................... 6,653 10,226
</TABLE>
8. INTANGIBLE ASSETS
Intangible assets consist of the following at December 31,
<TABLE>
<CAPTION>
Amortization
Period 1997 1996
------ ---- ----
<S> <C> <C> <C>
Franchises and subscriber lists.. 2-10.5 years $79,273 $78,720
Noncompete agreements............ 5-8 years 11,209 11,209
Goodwill......................... 5-10 years 42,787 16,830
Building access rights........... 3-4 years 15,197 14,920
Other intangible assets.......... 5-15 years 1,469 520
------- -------
Total intangible assets.......... 149,935 122,199
Less accumulated amortization.... (53,388) (28,728)
------- -------
Intangible assets, net........... $96,547 $93,471
======= =======
</TABLE>
Amortization expense charged to operations in 1997, 1996 and
1995 was $28,948, $19,509 and $9,100, respectively.
9. DEFERRED CHARGES AND OTHER ASSETS
Deferred charges and other assets consist of the following at
December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Note and interest receivable - Mazon Corporativo, S.A. de C.V................. $17,682 $15,310
Debt issuance costs........................................................... 19,743 309
Prepaid pension costs......................................................... -- 2,967
Prepaid professional services................................................. 938 3,439
Other......................................................................... 2,675 2,121
------- -------
Total......................................................................... $41,038 $24,146
======= =======
</TABLE>
10. DEBT
a. Long-term debt
Long-term debt outstanding at December 31 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Senior Secured Notes 9.65% due 1999........... $ -- $131,250
Revolving Credit Agreement.................... 3,000 --
Term Credit Agreement......................... 100,000 --
Senior Notes 10% due 2007..................... 225,000 --
Senior Discount Notes 11 1/8% due 2007..... 358,103 --
-------- --------
Total......................................... 686,103 131,250
Due within one year........................... -- --
-------- --------
Total Long -Term Debt......................... $686,103 $131,250
======== ========
</TABLE>
In October 1997, pursuant to Rule 144A of the Securities
Exchange Act of 1933, the Company completed an offering of 10% Senior Notes
with an aggregate principal amount of $225,000 and 11 1/8% Senior Discount
Notes with an aggregate principal amount at maturity of $601,045, both due
2007, to qualified institutional buyers as defined in Rule 144A. The Senior
Discount Notes were issued at a discount and generated gross proceeds to the
Company of $350,000. In December 1997, the Company commenced an SEC
registered Exchange Offer of its 10% Senior Notes due 2007, Series B for any
and all outstanding 10% Senior Notes due 2007, Series A and its 11 1/8%
Senior Discount Notes due 2007, Series B for any and all outstanding
11 1/8% Senior Discount Notes due 2007 Series A. The Exchange Offer closed
in January of 1998. All outstanding notes were exchanged.
The 10% Senior Notes were issued under an indenture dated
October 17, 1997 (the "10% Indenture") between the Company and The Chase
Manhattan Bank, as Trustee. The 10% Senior Notes are general senior
obligations of the Company which mature on October 15, 2007 and are
collateralized by a pledge of the Escrow Account which contains approximately
$61,000 of the net proceeds from the sale of the 10% Senior Notes plus
approximately $1,000 of aggregate interest, representing funds that, together
with the future proceeds from the investment thereof, will be sufficient to
pay interest on the 10% Senior Notes for six scheduled interest payments.
Interest on the 10% Senior Notes is payable in cash semi-annually in arrears
on each April 15 and October 15, commencing April 15, 1998.
The 10% Indenture contains certain covenants that, among other
things, limit the ability of the Company and its subsidiaries to incur
indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, engage in transactions with stockholders and affiliates, create
liens, sell assets and engage in mergers and consolidations.
The 10% Senior Notes are redeemable, in whole or in part, at
any time on or after October 15, 2002 at the option of the Company. The 10%
Senior Notes have redemption prices starting at 105% of the principal amount
and declining to 100% of the principal amount, plus any accrued interest.
The 11 1/8% Senior Discount Notes were issued under an
indenture dated October 17, 1997 (the "11 1/8% Indenture") between the
Company and The Chase Manhattan Bank, as Trustee. The 11 1/8% Senior
Discount Notes are general senior obligations of the Company, limited to
$601,045 aggregate principal amount at maturity and will mature on October 15,
2007. The 11 1/8% Senior Discount Notes were issued at a discount to yield
gross proceeds of $350,000. The 11 1/8% Senior Discount Notes will not
bear cash interest prior to October 15, 2002.
The 11 1/8% Indenture contains certain covenants that, among
other things, limit the ability of the Company and its subsidiaries to incur
indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, engage in transactions with stockholders and affiliates, create
liens, sell assets and engage in mergers and consolidations.
The 11 1/8% Senior Discount Notes are redeemable, in whole
or in part, at any time on or after October 15, 2002 at the option of the
Company. The 11 1/8% Senior Discount Notes have redemption prices starting
at 105.562% of the principal amount at maturity and declining to 100% of the
principal amount at maturity, plus any accrued interest.
Certain subsidiaries of the Company, including RCN Cable, have
in place a $125,000 credit agreement comprised of two credit facilities. The
first is a five year revolving credit facility in the amount of $25,000 which
provides credit availability through June 30, 2002. Revolving loans may be
repaid and reborrowed from time to time. The second is a term credit facility
in the amount of $100,000 which is to be repaid over six years in quarterly
installments from September 30, 1999 through June 30, 2005. Interest only is
due through June 30, 1999. The interest rate is based on either a LIBOR or
Base Rate option, at the election of the Company (6.82% at December 31, 1997).
The credit agreement is collateralized by a pledge by the Company of its stock
in RCN Cable and may, in the future, be secured by pledges of stock of
subsidiaries of the Company. At December 31, 1997, the entire $100,000 term
credit facility is outstanding and $3,000 of the revolving credit facility is
outstanding. RCN Cable used a portion of its initial borrowings under the
credit facilities to prepay higher priced Senior Secured Notes. The early
extinguishment of the Senior Secured Notes resulted in an extraordinary charge
of $3,210, net of taxes of $1,728. The credit agreement contains restrictive
covenants which, among other things, require the Company to maintain certain
debt to cash flow and interest coverage ratios and place certain limitations on
additional debt and investments. The Company does not believe that these
covenants will materially restrict its activities.
In 1989, in order to complete the August 29, 1989 Michigan
Cable Television acquisition, RCN Cable entered into a private placement of
Senior Secured Notes for $150,000 and a $70,000 Revolving Secured Credit
Agreement, which was voluntarily reduced to $60,000 in 1990 and which, in
accordance with its terms, reduced on a quarterly basis, through original
scheduled maturity in September 1996. In August 1996, RCN Cable obtained an
amendment and waiver related to this Revolving Secured Credit Agreement which
extended final maturity to December 1996 and increased the amount of available
borrowings. Additionally, the restrictive covenant relating to limitations on
the amount of capital expenditures was waived for the year ending December 31,
1996. The Senior Secured Notes were collateralized by the stock of certain
cable subsidiaries of the Company. On September 1, 1996 and on each September
1 thereafter, a mandatory principal repayment was required on the Senior
Secured Notes. The Senior Secured Notes contained restrictive covenants
which, among other things, required maintenance of a specified debt to cash
flow ratio. These notes were prepaid in 1997 as discussed above. The Senior
Secured Notes were classified as long-term at December 31, 1996 since the
Company had the intent and the ability to refinance this obligation on a
long-term basis through the above credit facilities.
In connection with the acquisition of Twin County Trans Video,
Inc., RCN Cable issued a $4,000 promissory note at 5% due in May 2003. The
note was unsecured. In September 1996, the note was canceled in settlement of
certain purchase price adjustments.
Contractual maturities of long-term debt are as follows:
Year Ending December 31, Aggregate Amounts
----------------------------------------- ------------------
1998..................................... $ --
1999..................................... $ 3,750
2000..................................... $11,250
2001..................................... $16,250
2002..................................... $20,500
b. Short-term debt
At December 31, 1997, the Company had unused lines of credit
for $5,500 at prime (8.50% at December 31, 1997). Short-term unsecured
Borrowings may be made under these lines of credit. The amounts available
under these lines of credit are reduced by outstanding letters of credit
($3,060 at December 31,1997). All unused lines of credit are cancellable at
the option of the banks. There are no commitment or facility fees associated
with maintaining availability of the above-mentioned lines of credit.
11. INCOME TAXES
The (benefit) provision for income taxes is reflected in the
Consolidated Statements of Operations as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current:
Federal................................... $(11,795) $5,730 $(5,713)
State..................................... 1,449 1,102 375
-------- ------ -------
Total Current.............................. (10,346) 6,832 (5,338)
-------- ------ -------
Deferred:
Federal................................... (10,161) (4,751) 7,016
State..................................... (342) (1,000) (377)
-------- ------ -------
Total Deferred............................. (10,503) (5,751) 6,639
-------- ------ -------
Amortization of ITC........................ -- (102) (182)
-------- ------ -------
Provision (benefit) for income taxes:
Before extraordinary item................. (20,849) 979 1,119
Extraordinary item........................ (1,728) -- --
-------- ------ -------
Total (benefit) provision for income taxes. $(22,577) $979 $1,119
======== ====== =======
</TABLE>
At December 31, 1997 and 1995, the Company had tax related
balances due from affiliates of $3,186 and $501, respectively. At December
31, 1996, the Company had tax related balances due to affiliates of $817.
Temporary differences that give rise to a significant portion
of deferred tax assets and liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
------- --------
<S> <C> <C>
Net operating loss carryforwards.......................................... $10,078 $ 2,130
Alternative minimum tax credits........................................... 167 219
Employee benefit plans.................................................... 1,031 882
Reserve for bad debt...................................................... 844 693
Start-up costs............................................................ 586 959
Investment in unconsolidated entity....................................... 3,985 4,771
Accruals for nonrecurring charges and contract settlements................ 2,368 2,299
Other, net................................................................ 1,823 1,888
------- --------
Total deferred tax assets................................................. 20,882 13,841
------- --------
Property, plant and equipment............................................. (14,759) (15,019)
Intangible assets......................................................... (11,253) (17,776)
All other................................................................. (1,257) (1,229)
------- --------
Total deferred liabilities................................................ (27,269) (34,024)
------- --------
Subtotal.................................................................. (6,387) (20,183)
Valuation allowance....................................................... (8,404) (3,691)
------- --------
Total deferred taxes...................................................... $(14,791) $(23,874)
======== ========
</TABLE>
In the opinion of management, based on the future turnaround of
existing temporary differences for the consolidated taxpaying group, primarily
depreciation, the Company will more likely than not be able to realize
substantially all of its deferred tax assets.
A valuation allowance has been provided for the portion of
deferred tax assets which, in the opinion of management is uncertain as to
their realization. The valuation allowance relates primarily to state net
operating loss carryforwards generated by certain subsidiaries.
The net change in the valuation allowance for deferred tax
assets during 1997 was an increase of $4,713.
Net operating losses will expire as follows:
<TABLE>
<CAPTION>
Federal State
------- -----
<S> <C> <C>
1999.................. $2,793
2000.................. 3,087
2001.................. 14,532
2002.................. 3,141
2003.................. 10,244
2004.................. 3,767
2011.................. 38,116
2012.................. 8,028
2017.................. $8,218 --
------ -------
Total................. $8,218 $83,708
====== =======
</TABLE>
The provision (benefit) for income taxes is different from the
amounts computed by applying the U.S. statutory federal tax rate of 35%. The
differences are as follows:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
(Loss) income before (benefit) provision for the income taxes and
extraordinary item.................................................. $(70,030) $(5,010) $3,233
======== ======= ======
Federal income tax benefit at statutory rate.......................... $(24,511) $(1,753) $1,131
State income taxes net of federal income tax benefit.................. 719 66 (33)
Investment tax credits amortized...................................... -- (102) (50)
Amortization of goodwill.............................................. 830 779 388
Estimated nondeductible expenses...................................... 1,913 1,564 (93)
Adjustment to prior year accrual...................................... (197) 421 (161)
Other, net............................................................ 397 4 (63)
-------- ------- ------
Total (benefit) provision for income taxes............................ $(20,849) $979 $1,119
======== ======= ======
</TABLE>
In 1995, C-TEC received official notification of final
settlement from the Internal Revenue Service relating to the examination of
C-TEC's consolidated federal income tax returns for 1989, 1990 and 1991. The
most significant adjustment relates to the disallowance of the claimed
amortization of certain intangible assets. As a result of the disallowance,
the Company's taxes payable for prior years increased approximately $580. The
amount accrued in previous years was sufficient to satisfy the above
adjustment. No additional accrual during 1995 was required.
In 1997 and 1996, estimated non-deductible expenses relate
primarily to charges in connection with the restructuring of the Company.
12. STOCKHOLDERS' EQUITY AND STOCK PLANS
The Company has authorized 100,000,000 shares of $1 par value
common stock and 200,000,000 shares of $1 par value Class B nonvoting
common stock. The Company also has authorized 25,000,000 shares of $1 par
value preferred stock. At December 31, 1997, 54,989,870 shares of common
stock are issued and outstanding.
In March 1998, the Company's Board of Directors approved a
two-for-one stock split, payable in the form of a 100% stock dividend. The
record date for the stock split is March 20, 1998. Stockholders of record at
the market close on that date will receive an additional share of RCN common
stock for each share held. The distribution date for the stock dividend will
be April 3, 1998. All share and per share data, stock option data, and market
prices of the Company's common stock have been restated to reflect this stock
split.
In connection with the Distribution, the Company Board adopted
the 1997 RCN Corporation Stock Option Plan ("the 1997 Plan"), designed to
provide equity based compensation opportunities to key employees when
shareholders of the Company have received a corresponding benefit through
appreciation in the value of RCN Common Stock.
The 1997 Plan contemplates the issuance of incentive stock
options, as well as stock options that are not designated as incentive stock
options, performance-based stock options, stock appreciation rights,
performance share units, restricted stock, phantom stock units and other
stock-based awards (collectively, "Awards"). Up to 5,000,000 shares of Common
Stock, plus 3,040,100 shares of Common Stock issuable in connection with the
Distribution related option adjustments, may be issued pursuant to Awards
granted under the 1997 Plan.
Unless earlier terminated by the Company Board, the 1997 Plan
will expire on the tenth anniversary of the Distribution. The Company Board
or the Compensation Committee may, at any time, or from time to time, amend
or suspend and, if suspended, reinstate, the 1997 Plan in whole or in part.
Prior to the Distribution, certain employees of RCN were granted
stock option awards under C-TEC's stock option plans. In connection with the
Distribution 3,040,100 options covering Common Stock were issued. Each C-TEC
option was adjusted so that each holder would currently hold options to purchase
shares of CTE Common Stock, RCN Common Stock and Cable Michigan Common Stock.
The number of shares subject to, and the exercise price of, such options were
adjusted to take into account the Distribution and to ensure that the aggregate
intrinsic value of the resulting RCN, Cable Michigan and CTE options immediately
after the Distribution was equal to the aggregate intrinsic value of the C-TEC
options immediately prior to the Distribution.
Information relating to stock options is as follows:
<TABLE>
<CAPTION>
Weighted
Number of Average
Shares Exercise Price
------ --------------
<S> <C> <C>
Outstanding December 31, 1994.......... 1,431,000
Granted............................... 1,257,000
Exercised............................. --
Canceled.............................. 280,000
---------
Outstanding December 31, 1995.......... 2,408,000
Granted............................... 190,000
Exercised............................. 58,000
Canceled.............................. 272,000
---------
Outstanding December 31, 1996.......... 2,268,000 $7.10
Granted............................... 4,862,100 $14.31
Exercised............................. 20,000 $8.07
Canceled.............................. 3,000 $8.36
---------
Outstanding December 31, 1997.......... 7,107,100 $11.95
=========
Shares exercisable December 31, 1997... 1,221,000 $7.05
</TABLE>
The following table summarizes stock options outstanding and
exercisable at December 31, 1997:
<TABLE>
<CAPTION>
Stock Options Outstanding Stock Options Exercisable
----------------------------------------------------------- ---------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Exercise Average Exercise
Exercise Prices Shares Contractual Life Price Shares Price
- --------------------- ----------- ----------------- -------------------- -------------- ------------------
<S> <C> <C> <C> <C> <C>
$6.24 to $8.40 3,017,100 7.5 years $7.36 1,221,000 $7.05
$15.32 to $16.82 4,090,000 9.8 years 15.33 -- --
--------- ---------
7,107,100 1,221,000
========= =========
Total
</TABLE>
No compensation expense related to stock option grants was
recorded in 1997 as the option exercise prices were equal to fair market value
on the date granted.
Pro forma information regarding net income and earnings per
share is required by SFAS 123, and has been determined as if the Company had
accounted for its stock options under the fair value method of SFAS 123. The
fair value for these options was estimated at the date of grant using a Black
Scholes option pricing model with weighted average assumptions for dividend
yield of 0% for 1997, 1996 and 1995; expected volatility of 38.6% prior to the
Distribution and 49.8% subsequent to the Distribution for 1997, 39.5% for
1996, and 35.9% for 1995; risk-free interest rate of 6.52%, 5.95% and 6.32%
for 1997, 1996 and 1995, respectively; and expected lives of 5 years for 1997,
1996 and 1995.
The weighted-average fair value of options granted during 1997
was $7.46.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized to expense over the options' vesting period. The
Company's pro forma net earnings and earnings per share were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net earnings - as reported............... $ (52,391) $ (5,989) $ 2,114
Net earnings - pro forma................. $ (54,419) $ (6,612) $ 1,695
Basic earnings per share - as reported... $ (0.95) $ (0.11) $ 0.04
Basic earnings per share - pro forma..... $ (0.99) $ (0.12) $ 0.03
Diluted earnings per share - as reported. $ (0.95) $ (0.11) $ 0.04
Diluted earnings per share - pro forma... $ (0.99) $ (0.12) $ 0.03
</TABLE>
In November 1996, the C-TEC shareholders approved a stock
purchase plan for certain key executives (the C-TEC "Executive Stock Purchase
Plan" or "C-TEC ESPP"). Under the C-TEC ESPP, participants may purchase shares
of C-TEC Common Stock in an amount of between 1% and 20% of their annual base
compensation and between 1% and 100% of their annual bonus compensation
provided, however, that in no event shall the participant's total contribution
exceed 20% of the sum of their annual compensation, as defined by the C-TEC
ESPP. Participant's accounts are credited with the number of share units derived
by dividing the amount of the participant's contribution by the average price of
a share of C-TEC Common Stock at approximately the time such contribution is
made. The share units credited to a participant's account do not give such
participant any rights as a shareholder with respect to, or any rights as a
holder or record owner of, any shares of C-TEC Common Stock. Amounts
representing share units that have been credited to a participant's account will
be distributed, either in a lump sum or in installments, as elected by the
participant, following the earlier of the participant's termination of
employment or three calendar years following the date on which the share units
were initially credited to the participant's account. It is anticipated that, at
the time of distribution, a participant will receive one share of C-TEC Common
Stock for each share unit being distributed.
Following the crediting of each share unit to a participant's
account, a matching share of Common Stock is issued in the participant's
name. Each matching share is subject to forfeiture as provided in the C-TEC
ESPP. The issuance of matching shares will be subject to the participant's
execution of an escrow agreement. A participant will be deemed to be the
holder of, and may exercise all the rights of a record owner of, the matching
shares issued to such participant while such matching shares are held in
escrow.
Shares of restricted C-TEC Common Stock awarded under the C-TEC
Executive Stock Purchase Plan and share units awarded under the C-TEC ESPP
that relate to C-TEC Common Stock were adjusted so that following the
Distribution, each such participant was credited with an aggregate equivalent
value of restricted shares of common stock of Commonwealth Telephone
Enterprises, the Company and Cable Michigan. In 1997, the Company's Board of
Directors approved the RCN Corporation Executive Stock Purchase Plan (the "RCN
ESPP"), with terms substantially the same as the C-TEC ESPP. The number of
shares which may be distributed under the RCN ESPP as matching shares or in
payment of share units is 250,000. At December 31, 1997, 61,412 matching
shares have been issued under the RCN ESPP, none of which are vested. The
Company recognizes the cost of the matching shares over the vesting period.
Expense recognized in 1997 and 1996 was $80 and $145, respectively.
13. PENSIONS AND EMPLOYEE BENEFITS
Prior to the Distribution, the Company's financial statements
reflect the costs experienced for its employees and retirees while included in
the C-TEC plans.
Through December 31, 1996, substantially all employees of the
Company were included in a trusteed noncontributory defined benefit pension
plan, maintained by C-TEC. Upon retirement, employees are provided a monthly
pension based on length of service and compensation. C-TEC funds pension
costs to the extent necessary to meet the minimum funding requirements of
ERISA. Substantially, all employees of C-TEC's Pennsylvania cable television
operations (formerly Twin County Trans Video, Inc.) were covered by an
underfunded plan which was merged into C-TEC's overfunded plan on February 28,
1996.
The information that follows relates to the entire C-TEC
noncontributory defined benefit plan. The components of C-TEC's pension cost
are as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Benefits earned during the year (service cost)... $2,365 $1,656
Interest cost on projected benefit obligation.... 3,412 3,083
Actual return on plan assets..................... (3,880) (12,897)
Other components - net........................... (1,456) 8,482
------ -------
Net periodic pension cost........................ $441 $324
====== =======
</TABLE>
The following assumptions were used in the determination of the
consolidated projected benefit obligation and net periodic pension cost:
<TABLE>
<CAPTION>
December 31,
-------------------
1996 1995
---- ----
<S> <C> <C>
Discount rate.................................................... 7.5% 7.0%
Expected long-term rate of return on plan assets................. 8.0% 8.0%
Weighted average long-term rate of compensation increases........ 6.0% 6.0%
</TABLE>
The Company's allocable share of the consolidated net periodic
pension costs, based on the Company's proportionate share of consolidated
annualized salaries as of the valuation date, was approximately $158 and $251
for 1996 and 1995, respectively. These amounts are reflected in operating
expenses. As discussed below, no pension cost (credit) was recognized in 1997.
In connection with the restructuring, C-TEC completed a
comprehensive study of its employee benefit plans in 1996. As a result of
this study, effective December 31, 1996, in general, employees of the Company
no longer accrue benefits under the defined benefit pension plans and became
fully vested in their benefit accrued through that date. C-TEC notified
affected participants in December 1996. In December 1996, C-TEC allocated
pension plan assets of $6,984 and the related liabilities to a separate plan
for employees who no longer accrue benefits after lump sum distributions. The
allocation of assets and liabilities resulted in a curtailment/settlement gain
of $4,292. The Company's allocable share of this gain was $3,437. This gain
results primarily from the reduction of the related projected benefit
obligation. The curtailed plan has assets in excess of the projected benefit
obligation. Such excess amounts to $3,917 which, along with unrecognized
items of $1,148 results in prepaid pension cost of $2,769, which is included
in "Prepayments and other" in the accompanying 1997 and 1996 consolidated
balance sheets.
The following table sets forth the plans' funded status and
amounts recognized in C-TEC's balance sheet at December 31, 1996:
<TABLE>
<S> <C>
Plan assets at fair value......................................... $55,325
Actuarial present value of benefit obligations:
Accumulated benefit obligations:
Vested............................................................ 32,372
Nonvested......................................................... 1,704
-------
Total............................................................. 34,076
Effect of increases in compensation............................... 6,042
-------
Plan assets in excess of (less than) projected benefit obligation. 15,207
Unrecognized transition asset..................................... (3,463)
Unrecognized prior service cost................................... 2,438
Unrecognized net gain............................................. (11,215)
-------
Prepaid pension cost.............................................. $2,967
=======
</TABLE>
C-TEC's pension plan has assets in excess of the accumulated
benefit obligation. Plan assets include cash, equity, fixed income securities
and pooled funds under management by an insurance company. Plan assets include
common stock of C-TEC with a fair value of approximately $5,835 at December
31, 1996.
Prepaid pension cost is included in "Deferred Charges and Other
Assets" in the accompanying 1996 consolidated balance sheet. The prepaid
pension asset was transferred to CTE in connection with the Distribution in
1997.
C-TEC sponsors a 401(k) savings plan covering substantially all
employees of the Company who are not covered by collective bargaining
agreements. Contributions made by the Company to the 401(k) plan are based on
a specific percentage of employees contributions. Contributions charged to
expense were $354 and $268 in 1996 and 1995, respectively. Contributions
charged to expense in 1997 prior to the Distribution were $515.
In connection with the Distribution, RCN established a
qualified savings plan under Section 401(k) of the Code that will also qualify
as an ESOP under Sections 401(a) and 4975(e)(7) of the Code (the "ESOP").
Eligible active employees under the ESOP, employees of the Company Businesses
who make Section 401(k) contributions and certain other employees will be
allocated shares of Company Common Stock. Contributions charged to expense in
1997 were $306.
The Company provides certain postemployment benefits to former
or inactive employees of the Company who are not retirees. These benefits are
primarily short-term disability salary continuance. The Company accrues the
cost of postemployment benefits over employees' service lives. The Company
uses the services of an enrolled actuary to calculate the expense. Prior to
the Distribution, C-TEC allocated the cost of these benefits to the Company
based on the Company's proportionate share of consolidated annualized
salaries. The Company reimbursed C-TEC for its allocable share of the
consolidated postemployment benefit cost. The net periodic postemployment
benefit cost (credit) was approximately $458, $539 and ($106) in 1997, 1996
and 1995, respectively.
14. COMMITMENTS AND CONTINGENCIES
a. The Company had various purchase commitments at December
31, 1997 related to its 1998 construction budget.
b. Total rental expense, primarily for office space and pole
rentals, was $3,505, $3,632 and $2,846 for 1997, 1996 and 1995, respectively.
At December 31, 1997, rental commitments under noncancellable leases, excluding
annual pole rental commitments of approximately $794 that are expected to
continue indefinitely, are as follows:
<TABLE>
<CAPTION>
Aggregate
Year Amounts
- ---- -------
<S> <C>
1998.................................. $3,725
1999.................................. $3,314
2000.................................. $2,939
2001.................................. $2,826
2002.................................. $2,848
Thereafter............................ $8,501
</TABLE>
c. The Company has outstanding letters of credit aggregating
$3,060 at December 31, 1997.
d. The Company has entered into various noncancellable
contracts for network services. Future obligations under these agreements are
as follows:
<TABLE>
<CAPTION>
Network
Year Services
- ---- --------
<S> <C>
1998................................... $3,026
1999................................... $3,064
2000................................... $3,012
2001................................... $2,762
2002................................... $12
Thereafter............................. $14
</TABLE>
e. The Company is subject to the provisions of the Cable
Television Consumer Protection and Competition Act of 1992, as amended, and
the Telecommunications Act of 1996. The Company has either settled challenges
or accrued for anticipated exposures related to rate regulation. However,
there is no assurance that there will not be additional challenges to its
rates.
f. In the normal course of business, there are various legal
proceedings outstanding. In the opinion of management, these proceedings will
not have a material adverse effect on the financial position or results of
operations or liquidity of the Company.
g. The Company has agreed to indemnify Cable Michigan and CTE
and their respective subsidiaries against any and all liabilities which arise
primarily from or relate primarily to the management or conduct of the
business of the Company prior to the effective time of the Distribution. The
Company has also agreed to indemnify Cable Michigan and CTE and their
respective subsidiaries against 30% of any liability which arises from or
relates to the management or conduct prior to the effective time of the
Distribution of the businesses of C-TEC and its subsidiaries and which is not
a true CTE liability, a true Cable Michigan liability or a true Company
liability.
The Tax Sharing Agreement, by and among the Company, Cable
Michigan and CTE (the "Tax Sharing Agreement"), governs contingent tax
liabilities and benefits, tax contests and other tax matters with respect to
tax returns filed with respect to tax periods, in the case of the Company,
ending or deemed to end on or before the Distribution Date. Under the Tax
Sharing Agreement, Adjustments (as defined in the Tax Sharing Agreement) to
taxes that are clearly attributable to the Company Group, the Cable Michigan
Group, or the CTE Group will be borne solely by such group. Adjustments to
all other tax liabilities will be borne 50% by CTE, 30% by the Company and 20%
by Cable Michigan.
Notwithstanding the above, if as a result of the acquisition of
all or a portion of the Capital stock or assets of the Company, the
Distribution fails to qualify as a tax-free distribution under Section 355 of
the Code, then the Company will be liable for any and all increases in tax
attributable thereto.
h. Under the Starpower Amended and Restated Operating
Agreement, the Company is committed to make quarterly capital contributions
aggregating the following in the years ended December 31:
<TABLE>
<S> <C>
1998................................ $56,250
1999................................ $68,750
2000................................ $25,000
</TABLE>
i. If, within five years after the Distribution, the ESOP
portion of the 401(k) Plan does not hold shares representing at least 3% of
the number of shares of Company Common Stock outstanding immediately after the
Distribution as increased by the number of shares issuable to BECO pursuant to
the Exchange Agreement (collectively, "Outstanding Company Common Stock") with
a market value at such time of not less than $24,000, RCN will issue to the
ESOP, in exchange for a note from the ESOP (the "ESOP Note"), the amount of
Company Common Stock necessary to increase the ESOP's holdings of Company
Common Stock to that level, provided, however, that RCN is not obligated to
issue shares to the ESOP in excess of 5% of the number of shares of
Outstanding Company Common Stock.
15. AFFILIATE AND RELATED PARTY TRANSACTIONS
The Company had the following transactions with affiliates
during the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Corporate office costs allocated to affiliates............................ $12,091 $12,362 $10,009
Cable staff and customer service costs allocated to Cable Michigan........ 3,489 3,577 2,952
Interest income on affiliate notes........................................ 8,688 15,119 17,340
Interest expense on affiliate notes....................................... 537 354 279
Long-distance terminating access charge expense from CTE.................. 1,312 728 862
Royalty fees charged by CTE............................................... 669 859 533
Revenue from engineering services......................................... -- 296 2,169
Other affiliate revenues.................................................. 1,576 -- 6
Other affiliate expenses.................................................. 2,199 1,980 2,090
</TABLE>
At December 31, 1997 and 1996, the Company has accounts
receivable from related parties of $9,829 and $12,614, respectively, for these
transactions. At December 31, 1997 and 1996, the Company has accounts payable
to related parties of $3,748 and $4,880, respectively, for these transactions.
The Company had notes receivable of $7,914 in 1996 from
advances by the Company's corporate financial services company to CTE. The
Company also had notes receivable of $147,567 at December 31, 1996, from Cable
Michigan, Inc. primarily related to the acquisition of the Michigan cable
operations and subsequent operations. All intercompany notes receivable were
settled in connection with the Distribution.
The Company had notes payable of $11,854 in 1996 from excess
cash advanced by CTE to the Company's corporate financial services company for
investment. All intercompany notes payable were settled in connection with
the Distribution.
16. OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Certain financial instruments potentially subject the Company
to concentrations of credit risk. These financial instruments consist
primarily of trade receivables, cash and temporary cash investments, and
short-term investments.
The Company places its cash and temporary investments with high
credit quality financial institutions and limits the amount of credit exposure
to any one financial institution. The Company also periodically evaluates the
creditworthiness of the institutions with which it invests. The Company does,
however, maintain unsecured cash and temporary cash investment balances in
excess of federally insured limits.
The Company's trade receivables reflect a customer base
primarily centered in the Boston to Washington, D.C. corridor of the United
States. The Company routinely assesses the financial strength of its
customers. As a consequence, concentrations of credit risk are limited.
17. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
a. Cash and temporary cash investments
The carrying amount approximates fair value because of the
short maturity of these instruments.
b. Short-term investments
Short-term investments consist of commercial paper, corporate
debt securities, certificates of deposit and federal agency notes. Short-term
investments are carried at amortized cost which approximates fair value due to
the short period of time to maturity.
c. Long-term investments
Long-term investments consist of investments accounted for
under the equity method for which disclosure of fair value is not required.
The note and interest receivable are carried at cost plus accrued interest
which management believes approximates fair value.
d. Investments restricted for debt service
Investments restricted for debt service consists of an amount
placed in escrow from the proceeds of the 10% Senior Notes which, together
with the proceeds from the investment thereof, will be sufficient to pay
interest on the 10% Senior Notes for six scheduled interest payments.
Investments restricted for debt service are carried at amortized cost.
e. Long-term debt
The fair value of fixed rate long-term debt was estimated based
on the Company's current incremental borrowing rate for debt of the same
remaining maturities. The fair value of floating rate debt is considered to be
equal to the carrying value since the debt reprices at least every six months
and the Company believes that its credit risk has not changed from the time
the floating rate debt was borrowed and therefore, it would obtain similar
rates in the current market.
f. Letter of credit
The contract amount of letters of credit represents a
reasonable estimate of their value since such instruments reflect fair value
as a condition of their underlying purpose and are subject to fees
competitively determined in the marketplace.
The estimated carrying fair value of the Company's financial
instruments are as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
------------------------ --------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and temporary cash investments............ $222,910 $222,910 $61,843 $61,843
Short-term investments......................... $415,603 $415,603 $46,831 $46,831
Note and interest receivable................... $17,682 $17,682 $15,310 $15,310
Investments restricted for debt service........ $61,911 $61,911 -- --
Financial Liabilities:
Fixed rate long-term debt:
Senior Secured Notes......................... -- -- $131,250 $137,459
Senior Notes 10%............................. $225,000 $233,438 -- --
Senior Discount Notes 11.125%................ $358,103 $377,156 -- --
Floating rate long-term debt:..................
Revolving Credit Agreement................... $3,000 $3,000 -- --
Term Credit Agreement........................ $100,000 $100,000 -- --
Unrecognized financial instruments:............
Letters of credit............................ $3,060 $3,060 $3,060 $3,060
</TABLE>
18. QUARTERLY INFORMATION (Unaudited)
<TABLE>
<CAPTION>
1997 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- ---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales.................................................. $29,677 $31,029 $ 31,148 $35,443
Operating income (loss) before depreciation,
amortization and nonrecurring charges................. $4,153 $850 $ (4,332) ($8,341)
Operating (loss)....................................... $(18,037) $(12,416) $ (18,011) $(22,411)
Loss before extraordinary charge....................... N/A N/A N/A $(17,116)
Loss before extraordinary charge per average common
share................................................. N/A N/A N/A $ (0.31)
Common Stock
High................................................... N/A N/A $ 16.63 $ 21.63
Low.................................................... N/A N/A $ 12.44 $ 12.50
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
1996 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- ---- ----------- ----------- ----------- -----------
Sales.................................................... $24,165 $24,852 $ 26,746 $29,147
Operating income before depreciation and amortization.... $4,199 $7,777 $ 9,188 $4,639
Operating (loss)......................................... $(4,621) $(1,233) $ (19) $(7,205)
</TABLE>
19. SUBSEQUENT EVENTS
a. In February 1998, the Company completed an offering of 9.8%
Senior Discount Notes with an aggregate principal amount at maturity of
$567,000, due February 2008. The 9.8% Senior Discount Notes were issued at a
discount and generated gross proceeds to the Company of $350,587.
The 9.8% Senior Discount Notes are general senior obligations
of the Company, limited to $567,000 aggregate principal amount at maturity and
will mature on February 15, 2008. The 9.8% Senior Discount Notes were issued
at a discount to yield gross proceeds of $350,587. The 9.8% Senior Discount
Notes will not pay cash interest prior to February 15, 2003. The yield to
maturity of the 9.8% Senior Discount Notes, determined on a semi-annual bond
equivalent basis, will be 9.8% per annum.
The 9.8% Indenture contains certain covenants that, among other
things, limit the ability of the Company and its subsidiaries to incur
indebtedness, pay dividends, prepay subordinate indebtedness, repurchase
capital stock, engage in transactions with stockholders and affiliates, create
liens, sell assets and engage in mergers and consolidations.
The 9.8% Senior Discount Notes are redeemable, in whole or in
part, at any time on or after February 15, 2003 at the option of the Company.
The 9.8% Senior Discount Notes may be redeemed at redemption prices starting at
104.9% of the principal amount at maturity and declining to 100% of the
principal amount at maturity, plus any accrued and unpaid interest.
b. On January 21, 1998, RCN entered into the Agreement and
Plan of Merger (the "Erols Merger Agreement") among RCN, Erols Internet, Inc.
("Erols"), Erol Onaran, Gold & Appel Transfer, S.A., a British Virgin Islands
corporation ("Gold & Appel"), and ENET Holdings, Inc., a Delaware corporation
and a wholly owned subsidiary of RCN ("ENET"), to acquire all of the
outstanding shares of common stock of Erols. The merger was consummated on
February 20, 1998. Erols merged with and into ENET (the "Erols Merger"), with
ENET as the surviving corporation. The approximate total Erols Merger
consideration was $29,200 in cash, 1,730,648 shares of RCN common stock plus
the assumption and repayment of $5,800 of debt. Additionally, the Company is
converting approximately 999,000 Erols stock options to 699,104 RCN stock
options at an average exercise price of $3.424 per share. The transaction
was accounted for under the purchase method of accounting.
RCN expects to contribute to Starpower approximately 60% of the
subscribers acquired in the acquisition of Erols.
c. On January 21, 1998, RCN, UNET Holdings, Inc., a wholly
owned subsidiary of RCN, and Ultranet Communications, Inc. ("Ultranet")
entered into an Agreement and Plan of Merger (the "Ultranet Merger
Agreement"). The total consideration for the acquisition was $7,368 in cash,
890,384 shares of RCN common stock, and $3,000 in deferred compensation.
Additionally, the Company is converting 63,500 UltraNet stock options to
117,052 RCN stock options at an average exercise price of $1.825 per share and
making cash payments aggregating approximately $503 to certain other holders
of UltraNet stock options. The transaction was consummated on February 27,
1998. The transaction was accounted for under the purchase method of
accounting.
RCN expects to contribute to RCN-BECOCOM approximately 30% of
the subscribers acquired in the acquisition of Ultranet.
d. RCN paid $12,500 in cash in January 1998 as its initial
capital contribution to Starpower.
e. In January 1998, BECO notified RCN that it has elected to
exercise its option to the full extent permitted by the Exchange Agreement
(Note 7) with respect to 1997. RCN and BECO are presently in discussions with
respect to the calculation of the agreed upon value for the exercise of such
option.
f. On February 27, 1998, the Company entered into an Agreement
and Plan of Merger (the "Merger Agreement") with Lancit Media Entertainment,
Ltd. ("Lancit") and LME Acquisition Corporation ("MergerSub"), a wholly owned
subsidiary of RCN. Pursuant to the terms of the Merger Agreement, MergerSub
will be merged with and into Lancit (the "Merger") such that immediately
following the Merger, Lancit will be a wholly-owned subsidiary of RCN. The
consummation of the Merger is subject to customary conditions, including the
adoption and approval of the Merger and the Merger Agreement by the
stockholders of Lancit in accordance with the provisions of applicable law
and the filing and effectiveness of a registration statement of RCN. There is
no assurance that this transaction will be consummated.
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATION
(Dollars in Thousands, Except Per Share)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended
March 31,
-----------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
Sales........................................................................ $ 40,138 $ 29,677
Costs and expenses, excluding depreciation and amortization.................. 48,455 25,524
Depreciation and amortization................................................ 17,691 12,191
Nonrecurring acquisition costs: In-process technology........................ 44,700 --
Other nonrecurring charges................................................... -- 10,000
------------ ------------
Operating (loss)............................................................. (70,708) (18,038)
Interest income.............................................................. 12,815 5,153
Interest expense............................................................. (22,735) (3,431)
Other (expense), net......................................................... (899) (33)
------------ ------------
(Loss) before income taxes................................................... (81,527) (16,349)
(Benefit) for income taxes................................................... (11,682) (4,800)
------------ ------------
(Loss) before equity in unconsolidated entities and minority interest........ (69,845) (11,549)
Equity in (loss) of unconsolidated entities.................................. (1,493) (805)
Minority interest in loss of consolidated entities........................... 3,586 910
------------ ------------
Net (loss).................................................................. $ (67,752) $ (11,444)
============ ============
Basic and Diluted (loss) per average common share:
Net loss to shareholders.................................................... $ (1.21) $ (0.21)
============ ============
Weighted average shares outstanding......................................... 56,216,310 54,950,914
</TABLE>
See accompanying notes to Condensed Consolidated Financial
Statements.
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary cash investments.................................................. $511,762 $222,910
Short-term investments............................................................... 411,238 415,603
Accounts receivable from related parties............................................. 4,120 9,829
Accounts receivable, net of reserve for doubtful accounts of $3,427 at March 31,
1998 and $2,134 at December 31, 1997............................................... 24,567 19,510
Material and supply inventory, at average cost....................................... 2,613 2,745
Prepayments and other................................................................ 7,489 5,314
Deferred income taxes................................................................ 4,913 4,821
Investments restricted for debt service.............................................. 22,500 22,500
---------- ----------
Total current assets.................................................................. 989,202 703,232
Property, plant and equipment, net of accumulated depreciation of $119,039 at
March 31, 1998 and $107,419 at December 31, 1997..................................... 247,118 200,340
Investments restricted for debt service............................................... 41,119 39,411
Investments........................................................................... 133,384 70,424
Intangible assets, net................................................................ 120,720 96,547
Deferred charges and other assets..................................................... 46,689 41,038
---------- ----------
Total assets.......................................................................... $1,578,232 $1,150,992
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt................................................. $1,094 $ --
Accounts payable..................................................................... 36,872 24,835
Accounts payable to related parties.................................................. 867 3,748
Advance billings and customer deposits............................................... 18,999 7,318
Accrued taxes........................................................................ -- 488
Accrued interest..................................................................... 10,970 5,549
Accrued contract settlements......................................................... 3,029 3,126
Accrued cable programming expense.................................................... 3,908 3,498
Accrued expenses..................................................................... 30,767 21,143
---------- ----------
Total current liabilities............................................................. 106,506 69,705
Long-term debt........................................................................ 1,053,324 686,103
Deferred income taxes................................................................. 22,985 19,612
Other deferred credits................................................................ 9,358 2,596
Minority interest..................................................................... 23,776 16,392
Commitments and contingencies.........................................................
Preferred stock....................................................................... -- --
Common shareholders' equity:
Common stock......................................................................... 57,811 54,989
Additional paid-in capital........................................................... 392,148 321,766
Cumulative translation adjustments................................................... (3,055) (3,055)
Unrealized appreciation on investments............................................... 502 --
Treasury stock....................................................................... (255) --
Retained earnings.................................................................... (84,868) (17,116)
---------- ----------
Total common shareholders' equity..................................................... 362,283 356,584
---------- ----------
Total liabilities and shareholders' equity............................................ $1,578,232 $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>
Quarter Ended March 31,
-----------------------
1998 1997
---- ----
<S> <C> <C>
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES........................ $8,277 $(1,107)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant & equipment.................................. (28,064) (7,459)
Investment in unconsolidated joint venture................................ (12,500) --
Purchase of short-term investments........................................ (77,614) --
Sales and maturities of short-term investments............................ 82,014 33,925
Acquisitions.............................................................. (40,717) (30,079)
Other..................................................................... 602 (1,142)
-------- -------
Net cash used in investing activities................................... (76,279) (4,755)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt................................................ 350,588 --
Redemption of long-term debt.............................................. (122) --
Purchase of treasury stock................................................ (255) --
Payments made for debt financing costs.................................... (5,652) --
Contribution from minority interest partner............................... 11,025 --
Proceeds from the exercise of stock options............................... 1,270 --
Transfer to CTE........................................................... -- (16,418)
Change in affiliate notes................................................. -- 567
-------- -------
Net cash provided by (used in) financing activities....................... 356,854 (15,851)
-------- -------
Net increase (decrease) in cash and temporary cash investments............ 288,852 (21,713)
Cash and temporary cash investments at beginning of year.................. 222,910 61,843
-------- -------
Cash and temporary cash investments at March 31........................... $511,762 $40,130
======== =======
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of amounts capitalized)................................... $16,711 $7,363
======== =======
Income taxes............................................................ $75 $25
======== =======
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Supplemental Schedule of Non-Cash Investing and Financing
Activities
On February 20, 1998, the Merger with Erols was consummated.
The transaction was accounted for under the purchase method of accounting.
A summary of the transaction is as follows:
<TABLE>
<S> <C>
Cash paid............................................ $35,931
Fair value of RCN stock issued....................... 44,672
Liabilities assumed.................................. 58,664
Deferred tax liability incurred...................... 14,626
Acquisition cost--In-process technology.............. (31,600)
--------
Fair value of assets acquired........................ $122,293
========
</TABLE>
On February 27, 1998, the Merger with Ultranet was consummated.
The transaction was accounted for under the purchase method of accounting.
A summary of the transaction is as follows:
<TABLE>
<S> <C>
Cash paid............................................ $7,608
Fair value of RCN stock issued....................... 26,155
Liabilities assumed.................................. 5,688
Deferred tax liability incurred...................... 683
Acquisition cost--In-process technology.............. (13,100)
-------
Fair value of assets acquired........................ $27,034
=======
</TABLE>
The company transferred approximately 60% of the subscribers
acquired in the Merger with Erols, and related unearned revenue to the
Starpower joint venture. The value of the subscriber contribution was
preliminary estimated to be $51,937 and the related unearned revenue was
preliminary estimated to be $25,523.
See accompanying notes to Condensed Consolidated Financial Statements.
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
1. The Condensed Consolidated Financial Statements included
herein have been prepared by the Company, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed
or omitted pursuant to such rules and regulations. However, in the opinion of
the Management of the Company, the Condensed Consolidated Financial Statements
include all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the financial information. The Condensed
Consolidated Financial Statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K for
the year ended December 31, 1997.
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"). In connection with the Distribution, C-TEC changed its name to
Commonwealth Telephone Enterprises, Inc. ("CTE").
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 March 31, 1998 and 1997, the Company recorded equity in the
earnings of Megacable which consists of its proportionate share of income and
amortization of excess cost over equity in net assets of $709 and $712,
respectively.
Summarized information for the financial position and results
of operations of Megacable, as of and for the three months ended March 31,
1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Assets.................................... $76,449 $70,575
Liabilities............................... 6,150 7,185
Shareholders' equity...................... 70,299 63,390
Sales..................................... 9,219 6,764
Cost and expenses......................... 6,085 4,530
Foreign currency transaction losses....... 104 --
Net income................................ $2,638 $2,144
</TABLE>
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 losses of $(41), for the three month period ended March 31, 1998.
4. During the first quarter of 1998, approximately 1,180,000
options were granted, approximately 227,000 were exercised yielding cash
proceeds of $1,270 and approximately 48,000 options were canceled. At March 31,
1998, there are approximately 8,012,000 options outstanding at exercise prices
ranging from $1.30 to $25.75 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 allege 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. At this writing, the Court has not scheduled oral argument on the
Motion.
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 first quarter of 1998 and
have a dilutive effect if the Company had income from continuing operations is
4,041,754.
For periods prior to October 1, 1997, during which the Company
was a wholly-owned subsidiary of C-TEC, earnings per share was calculated by
dividing net (loss) income by the number of average common shares of C-TEC
outstanding, based upon a distribution ratio of one share of Company common
equity for each share of C-TEC common equity owned.
<TABLE>
<CAPTION>
Quarter Ended March 31,
---------------------------------
1998 1997
<S> <C> <C>
Net (loss).................................................................. $ (67,752) $ (11,444)
Basic earnings per average common share:
Weighted average shares outstanding........................................ 56,216,310 54,950,914
Loss per average common share.............................................. $ (1.21) $ (.21)
Diluted earnings per average common share:
Weighted average shares outstanding........................................ 56,216,310 54,950,914
Dilutive shares resulting from stock options............................... -- --
-------------- -------------
Weighted average shares and common stock equivalents outstanding........... 56,216,310 54,950,914
============== =============
Loss per average common share.............................................. $ (1.21) $ (.21)
</TABLE>
7. In August 1997, RCN and Potomac Electric Power Company
("PEPCO"), through wholly-owned subsidiaries, entered into a letter of intent
to form a joint venture to own and operate a communications network to provide
voice, video, data and other communications services to residential and
commercial customers in the Greater Washington, D.C., Virginia and Maryland
area. The venture in the form of an unregulated entity with a perpetual term,
was formed pursuant to a joint venture agreement providing for the
organization and operation of Starpower Communications, LLC ("Starpower").
RCN owns 50% of the equity interest in Starpower and PEPCO owns
the remaining 50% interest.
RCN paid $12,500 in cash in January 1998 as its initial capital
contribution to Starpower.
8. On January 21, 1998, RCN entered into the Agreement and Plan
of Merger (the "Erols Merger Agreement") among RCN, Erols Internet, Inc.
("Erols"), Erol Onaran, Gold & Appel Transfer, S.A., a British Virgin Islands
corporation ("Gold & Appel"), and ENET Holdings, Inc., a Delaware corporation
and a wholly-owned subsidiary of RCN ("ENET"), to acquire all of the
outstanding shares of common stock of Erols. The merger was consummated on
February 20, 1998. Erols merged with and into ENET (the "Erols Merger"), with
ENET as the surviving corporation. The approximate total Erols Merger
consideration was $29,200 in cash, 1,730,648 shares of RCN Common Stock plus
the assumption and repayment of $5,800 of debt. Additionally, the Company is
converting approximately 999,000 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 at least
$31,600 will be allocated to in-process technology, which the Company recorded
as a charge in the first quarter of 1998.
RCN expects to contribute to Starpower approximately 60% of the
subscribers acquired in the acquisition of Erols.
9. On January 21, 1998, RCN, UNET Holdings, Inc., a
wholly-owned subsidiary of RCN, and Ultranet Communications, Inc. ("Ultranet")
entered into an Agreement and Plan of Merger (the "Ultranet Merger
Agreement"). The total consideration for the acquisition was $7,368 in cash,
890,384 shares of RCN Common Stock, and $3,000 in deferred compensation.
Additionally, the Company is converting 63,500 of Ultranet stock options to
117,052 of RCN stock options at an average exercise price of $1.825 per share
and making 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
at least $13,100 will be allocated to in-process technology, which the Company
recorded as a charge in the first quarter of 1998.
RCN expects to contribute to RCN-BECOCOM approximately 30% of
the subscribers acquired in the acquisition of Ultranet.
10. In January 1998, Boston Edison Company ("BECO") notified
RCN that it has elected to exercise its option to the full extent permitted by
the Exchange Agreement with respect to 1997. RCN and BECO are presently in
discussions with respect to the calculation of the agreed upon value for the
exercise of such option.
11. On February 27, 1998, the Company entered into an Agreement
and Plan of Merger (the "Merger Agreement") with Lancit Media Entertainment,
Ltd. ("Lancit") and LME Acquisition Corporation ("Merger Sub"), a wholly-owned
subsidiary of RCN. Pursuant to the terms of the Merger Agreement, Merger Sub
will be merged with and into Lancit (the "Merger") such that immediately
following the Merger, Lancit will be a wholly-owned subsidiary of RCN. The
consummation of the Merger is subject to customary conditions, including the
adoption and approval of the Merger and the Merger Agreement by the
stockholders of Lancit in accordance with the provisions of applicable law and
the filing and effectiveness of a registration statement of RCN. There is no
assurance that this transaction will be consummated.
12. In February 1998, the Company completed an offering of 9.8%
Senior Discount Notes with an aggregate principal amount at maturity of
$567,000, due February 2008. The 9.8% Senior Discount Notes were issued at a
discount and generated gross proceeds to the Company of $350,588. The 9.8%
Senior Discount Notes are general senior obligations of the Company. The 9.8%
Senior Discount Notes will not pay cash interest prior to February 15, 2003.
The yield to maturity of the 9.8% Senior Discount Notes, determined on a
semi-annual bond equivalent basis, will be 9.8% per annum. The 9.8% Indenture
contains certain covenants that, among other things, limit the ability to the
Company and its subsidiaries to incur indebtedness, pay dividends, prepay
subordinate indebtedness, repurchase capital stock, engage in transactions
with stockholders and affiliates, create liens, sell assets and engage in
mergers and consolidations. The 9.8% Senior Discount Notes are redeemable, in
whole or in part, at any time on or after February 15, 2003 at the option of
the Company. The 9.8% Senior Discount Notes may be redeemed at redemption
prices starting at 104.9% of the principal amount at maturity and declining to
100% of the principal amount at maturity, plus any accrued and unpaid interest.
13. 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 to the single source network,
including customers which were served by the Company's previously separate
lines of business, for which profitability was separately measurable and
monitored. 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; because management believes
that any allocation of the expenses incurred on a single network to multiple
revenue streams would be impractical and arbitrary, 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 Company's historical general purpose financial statements.
The Company manages operations and evaluates operating
financial performance on a pro forma total RCN basis, which reflects the
consolidation of all domestic joint ventures, including those not consolidated
under generally accepted accounting principles. The same net loss results on
both a historical and pro forma total RCN basis since the outside ownership of
the joint venture, which is consolidated only in the pro forma total RCN
information, is reflected as minority interest in the pro forma total RCN
information. Such results are as follows:
<TABLE>
<CAPTION>
Pro Forma
Total RCN Quarter
Ended March 31,
----------------------------
1998 1997
------------ -----------
<S> <C> <C>
Sales:
Voice........................................................................... $ 3,515 $ 431
Video........................................................................... 26,707 24,596
Data............................................................................ 5,732 4
Commercial & other.............................................................. 7,065 4,646
---------- --------
Total......................................................................... 43,019 29,677
Cost and expenses, excluding depreciation and amortization:
Direct expenses............................................................. 18,837 11,287
Operating, selling, general and administrative.............................. 33,815 14,237
---------- --------
EBITDA before nonrecurring charges........................................... (9,633) 4,153
Depreciation and amortization................................................... 17,691 12,191
Nonrecurring charge............................................................. -- 10,000
Nonrecurring acquisition costs:
In-process technology......................................................... 44,700 --
---------- --------
Operating (loss)................................................................. (72,024) (18,038)
Interest income................................................................. 13,046 5,153
Interest expense................................................................ (22,735) (3,431)
Other (expense)................................................................. (1,381) (33)
---------- --------
(Loss) before income taxes....................................................... (83,094) (16,349)
(Benefit) for income taxes...................................................... (11,682) (4,800)
---------- --------
(Loss) before equity in unconsolidated entities and minority interest........... (71,412) (11,549)
Equity in loss of unconsolidated entities....................................... (709) (805)
Minority interest in loss of consolidated entities.............................. 4,369 910
---------- --------
Net (loss)...................................................................... $ (67,752) $(11,444)
========== ========
BALANCE SHEET DATA (AT MARCH 31):
Cash, temporary cash investments and short-term investments..................... $ 942,304 $ 53,137
Property, plant and equipment................................................... $ 373,587 $227,635
Accumulated depreciation........................................................ 119,040 89,948
---------- --------
Net property, plant and equipment............................................... $ 254,547 $137,687
Long-term debt.................................................................. $1,054,418 $131,250
</TABLE>
14. In June 1997, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standard No. 130--"Reporting
Comprehensive Income" ("SFAS 130"). This statement, which establishes
standards for reporting and disclosure of comprehensive income, is effective
for interim and annual periods beginning after December 15, 1997. The Company
does not currently have any material items subject to disclosure pursuant to
SFAS 130.
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors
Erols Internet, Inc.
We have audited the accompanying balance sheets of Erols
Internet, Inc. as of December 31, 1996 and 1997, and the related statements of
operations, stockholders' deficit, and cash flows for the period from August
1, 1995 (inception) to December 31, 1995 and for the years ended December 31,
1996 and 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Erols
Internet, Inc. at December 31, 1996 and 1997, and the results of its
operations and its cash flows for the period from August 1, 1995 (inception)
to December 31, 1995 and years ended December 31, 1996 and 1997, in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Vienna, Virginia
January 15, 1998, except for Note 10,
as to which the date is February 20, 1998
EROLS INTERNET, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1997
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................................... $ 2,540,857 $ 103,718
Accounts receivable, less allowance of $42,000 and $161,000 at December 31,
1996 and 1997, respectively...................................................... 233,508 544,051
Restricted cash.................................................................... -- 150,000
Note receivable from related parties............................................... 350,000 370,572
Prepaid expenses and other current assets.......................................... 21,815 19,953
----------- -----------
Total current assets................................................................ 3,146,180 1,188,294
Property and equipment, net......................................................... 10,499,332 17,840,969
Restricted cash..................................................................... 850,166 743,353
Deposits............................................................................ 63,321 395,711
----------- -----------
Total assets........................................................................ $14,558,999 $20,168,327
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable................................................................... $ 9,973,259 $ 8,651,104
Accrued expenses................................................................... 586,874 1,404,170
Current portion of unearned revenues............................................... 12,916,864 25,582,996
Notes payable...................................................................... 700,000 700,000
Current portion of capital lease obligations....................................... 613,506 1,466,701
Current portion of deferred gain................................................... 42,444 66,079
----------- -----------
Total current liabilities........................................................... 24,832,947 37,871,050
----------- -----------
Long-term portion of unearned revenues.............................................. 3,440,928 8,906,491
Note payable to stockholder......................................................... -- 5,000,000
Long-term portion of capital lease obligations...................................... 994,343 1,852,026
Long-term portion of deferred gain.................................................. 60,722 66,580
Deferred rent....................................................................... 120,611 134,376
Commitments......................................................................... -- --
Stockholders' deficit:
Preferred Stock, $.001 par value; 10,000,000 shares authorized..................... -- --
Common Stock, $.001 par value; 50,000,000 shares authorized; 5,586,492 and
5,836,779 shares issued and outstanding at December 31, 1996 and 1997,
respectively..................................................................... 5,586 5,837
Additional paid-in capital......................................................... 3,127,239 4,066,088
Deferred stock compensation........................................................ (364,250) (202,361)
Accumulated deficit................................................................ (17,659,127) (37,531,760)
----------- -----------
Total stockholders' deficit......................................................... (14,890,552) (33,662,196)
=========== ===========
Total liabilities and stockholders' deficit......................................... $14,558,999 $20,168,327
=========== ===========
</TABLE>
EROLS INTERNET, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from Year ended December 31,
August 1, 1995 ------------------------------
(inception) to
December 31, 1995 1996 1997
----------------- ------------------------------
<S> <C> <C> <C>
Net revenues:
Dial access revenues...................... $125,752 $10,948,863 $33,588,925
Other revenues............................ -- -- 2,939,215
----------- ------------ ------------
Total net revenues......................... 125,752 10,948,863 36,528,140
----------- ------------ ------------
Costs and expenses:
Cost of dial access revenues.............. 63,030 6,002,155 13,338,452
Cost of other revenues.................... -- -- 1,198,837
Operations and customer support........... 125,095 6,227,011 9,930,114
Sales and marketing....................... 188,314 9,475,585 19,777,437
General and administrative................ 90,880 2,092,421 5,584,224
Depreciation and amortization............. 16,741 2,013,967 6,360,573
----------- ------------ ------------
Total costs and expenses................... 484,060 25,811,139 56,189,637
Loss from operations....................... (358,308) (14,862,276) (19,661,497)
Other income (expense):
Other expense, net........................ (658,421) (1,628,201) (49,157)
Interest expense, net..................... (1,545) (150,376) (161,979)
----------- ------------ ------------
Net loss................................... $(1,018,274) $(16,640,853) $(19,872,633)
=========== ============ ============
</TABLE>
EROLS INTERNET, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Additional Deferred Total
Common Stock Paid-in Stock Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Deficit
--------- --------- ----------- ------------ -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance at August 1, 1995....... -- $ -- $ -- $ -- $ -- $ --
Net loss....................... -- -- -- -- (1,018,274) (1,018,274)
--------- ------ ---------- --------- ------------ ------------
Balance at December 31, 1995.... -- -- -- -- (1,018,274) (1,018,274)
Contribution of divisional
equity to Erols Internet,
Inc. (Note 1).......... 424 -- 1,000 -- -- 1,000
Recapitalization of
Erols Internet, Inc.
(Note 1):
Retirement of
Common Stock of
Erols Computer, Inc....... (424) -- (1,000) -- -- (1,000)
Issuance of Common Stock of
Erols Internet, Inc........ 4,272,023 4,272 5,803 -- -- 10,075
Issuance of Common Stock....... 1,314,469 1,314 2,757,186 -- -- 2,758,500
Compensatory stock options..... -- -- 364,250 (364,250) -- --
Net loss....................... -- -- -- -- (16,640,853) (16,640,853)
--------- ------ ---------- --------- ------------ ------------
Balance at December 31, 1996.... 5,586,492 5,586 3,127,239 (364,250) (17,659,127) (14,890,552)
Issuance of Common Stock....... 250,287 251 938,849 -- -- 939,100
Compensatory stock options..... -- -- -- 161,889 -- 161,889
Net loss....................... -- -- -- -- (19,872,633) (19,872,633)
--------- ------ ---------- --------- ------------ ------------
Balance at December 31, 1997.... 5,836,779 $5,837 $4,066,088 $(202,361) $(37,531,760) $(33,662,196)
=== ===== ========= ====== ========== ========= ============ ============
</TABLE>
EROLS INTERNET, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
August 1, 1995
(inception) to Year ended December 31,
December 31, --------------------------------
1995 1996 1997
------------------ -------------- --------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................................... $(1,018,274) $(16,640,853) $(19,872,633)
Adjustments to reconcile net loss to net cash (used in) provided
by operating activities:
Depreciation and amortization.................................. 16,741 2,013,967 6,360,573
Allowance for doubtful accounts................................ -- 42,000 119,000
Gain related to sale-leaseback transactions.................... (42,444)
Stock and stock option compensation expense.................... -- -- 161,889
Changes in operating assets and liabilities:
Accounts receivable.......................................... (14,764) (260,744) (450,115)
Prepaid expenses and other current assets.................... -- (21,815) 1,862
Restricted cash.............................................. -- (850,166) (43,187)
Deposits..................................................... -- (63,321) (332,390)
Accounts payable............................................. 92,400 9,880,859 (1,322,155)
Accrued expenses............................................. 29,241 557,633 817,296
Unearned revenues............................................ 743,496 15,614,296 18,131,695
Deferred rent................................................ 68,105 52,506 13,765
----------- ------------ ------------
Net cash (used in) provided by operating activities............... (83,055) 10,324,362 3,543,156
INVESTING ACTIVITIES
Purchases of property and equipment............................... (416,945) (10,174,143) (11,350,440)
Proceeds from disposal of property and equipment.................. -- -- 12,172
Advance under note receivable from related parties................ -- (350,000) --
----------- ------------ ------------
Net cash used in investing activities............................. (416,945) (10,524,143) (11,338,268)
FINANCING ACTIVITIES
Proceeds from notes payable to bank............................... 500,000 700,000 600,000
Proceeds from notes payable to related party...................... -- -- 5,000,000
Payments of notes payable to bank................................. -- (500,000) (600,000)
Payments on obligations under capital leases...................... -- (227,937) (581,127)
Net proceeds from issuance of Common Stock........................ -- 2,768,575 939,100
----------- ------------ ------------
Net cash provided by financing activities......................... 500,000 2,740,638 5,357,973
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents.............. -- 2,540,857 (2,437,139)
Cash and cash equivalents at beginning of period.................. -- -- 2,540,857
----------- ------------ ------------
Cash and cash equivalents at end of period........................ $ -- $ 2,540,857 $ 103,718
=========== ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid..................................................... $ 1,545 $ 159,196 $ 281,085
=========== ============ ============
</TABLE>
EROLS INTERNET, INC.
NOTES TO FINANCIAL STATEMENTS
1. Organization
Erols Internet, Inc. (the "Company") began operations on August
1, 1995 as a division of OEO, Inc., which changed its name to Erols Internet,
Inc. on December 2, 1996. The Company is an Internet service provider ("ISP"),
offering a combination of low priced, high quality Internet access in targeted
markets located throughout the corridor stretching from Massachusetts to
Virginia.
From its inception on August 1, 1995 through December 2, 1996,
the Company operated as a division of OEO, Inc., a company that had two
divisions consisting of the Company's ISP operations and a computer,
television and video cassette recorder repair division. On December 2, 1996,
OEO, Inc. reincorporated in the State of Delaware and changed its name to
Erols Internet, Inc. Shortly thereafter, on December 28, 1996, the assets and
liabilities of the computer, television and video cassette recorder repair
division were spun-off to a newly formed Virginia corporation named Erol's
Computer & TV/VCR, Inc.
The financial statements of Erols Internet, Inc. as of and for
the five month period ended December 31, 1995 have been prepared on the basis
that Erols Internet, Inc. operated as a division of OEO, Inc. and accordingly,
there are no equity accounts such as common stock or paid in capital related
to the Internet division. The financial statements of Erols Internet, Inc. as
of December 31, 1996 have been prepared on the basis that Erols Internet, Inc.
operated as a separately incorporated company and accordingly, reflect the
shares of Common Stock issued to the former stockholder of OEO, Inc. as a
result of the reincorporation and recapitalization of Erols Internet, Inc.
Additionally, the statements of operations for the period from August 1, 1995
(inception) to December 31, 1995 and for the period from January 1, 1996 to
December 28, 1996 have been prepared from the historical books and records of
the Internet division and include all amounts directly attributable and
identifiable to the Internet business as well as indirect expenses, such as
physical operating costs and management salaries. The physical operating
costs and management salaries were charged based on square feet and hours
attributable to the Internet business, respectively.
The Company has experienced operating losses since its
inception as a result of efforts to build its network infrastructure, increase
internal staffing, develop its systems and expand into new markets. The
Company expects to continue to focus on increasing its subscriber base and
geographic coverage. Accordingly, the Company expects its cost and operating
expenses and capital expenditures to continue to increase significantly, all
of which will have a negative impact on short-term operating results. The
online services and Internet markets are highly competitive. The Company
believes that existing competitors, Internet-based services, Internet service
providers, Internet directory services and telecommunication companies are
likely to enhance their service offerings resulting in greater competition for
the Company. The competitive conditions could have the following effects:
require additional pricing programs, increase spending on marketing, limit the
Company's ability to expand its subscriber base and result in increase
attrition in the existing subscriber base. There can be no assurance that
growth in the Company's revenues or subscriber base will continue or that the
Company will be able to achieve or sustain profitability or positive cash flow.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company
considers all highly liquid investments with a maturity of three months or
less at the time of purchase to be cash equivalents. On December 31, 1997, the
Company had purchased $5,125,000 of U.S. Government securities under
agreements to resell on January 1, 1998. Due to the short-term nature of the
agreements, the Company did not take possession of the securities which were
held by the Company's asset managers. The market value of the securities
approximated the carrying amount at December 31, 1997.
Restricted Cash
Certain capital lease agreements generally require the Company
to maintain restricted cash deposit accounts with a bank which amounted to
$850,166 and $893,353 as of December 31, 1996 and 1997, respectively.
Impairment of Long-Lived Assets
At each balance sheet date, management determines whether any
property and equipment or any other assets have been impaired based on the
criteria established in Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed of." The Company made no adjustments to the
carrying values of the assets during the period from August 1, 1995
(inception) to December 31, 1995 and during the years ended December 31, 1996
and 1997.
Stock Compensation
The Company accounts for its stock-based compensation in
accordance with APB No. 25 "Accounting for Stock Issued to Employees" ("APB
25") using the intrinsic value method. The Company has made pro forma
disclosures required by SFAS No. 123 "Accounting for Stock Based Compensation"
("SFAS 123") using the fair value method.
Revenue Recognition
The Company recognizes Internet access revenue when the
services are provided. During the period from August 1, 1995 (inception) to
December 31, 1995 and the years ended December 31, 1996 and 1997, the Company
offered one, two and three year contracts for Internet access that are
generally paid for in advance by customers. The Company has deferred
recognizing revenue on these advance payments and amortizes the amounts to
revenue on a straight-line basis as the services are provided.
The Company allows for cancellations of up to thirty days after
service is initiated for a full refund. Any cancellations in the period
subsequent to the first thirty days of service are refunded on a pro-rata
schedule. The Company reviews its history of cancellations periodically and,
when appropriate, records a reserve for estimated amount of returns.
The Company recognizes web page hosting revenues when the
services are rendered. During the year ended 1997, the Company offered
monthly and one year contracts to host customers' web pages. The revenues
related to these contracts were recognized on the straight line basis over the
term of the contract. Revenues from internet classes and product sales are
recognized as the service is performed or product shipped.
Costs of Revenues
Cost of dial access revenues primarily consists of
telecommunication expenses inherent in the network infrastructure. Cost of
dial access revenues also includes fees paid for lease of the Company's
backbone, as well as license fees for Web browser software based on a per
user charge, other license fees paid to third-party software vendors, product
costs, and contractor fees for distribution of software to new subscribers.
Advertising Costs
All advertising and promotion costs are expensed as incurred.
During the period from August 1, 1995 (inception) to December 31, 1995 and for
the years ended December 31, 1996 and 1997, the Company expensed $121,451,
$6,530,877 and $12,267,445, respectively, as advertising costs.
Income Taxes
Prior to December 28, 1996, the Internet Business operated as a
division of OEO, Inc. and accordingly, a consolidated tax return for OEO, Inc.
was filed. Since OEO, Inc. generated consolidated net losses for the period
from August 1, 1995 to December 28, 1996, no provision for income taxes would
have been recorded for the consolidated company and, as such, no additional
disclosure has been made as to the Internet division's portion of the net
losses for tax purposes. In connection with the reincorporation of OEO, Inc.
and the spin-off of Erol's Computer & TV/VCR, Inc., the provision for income
taxes and the resulting deferred tax asset (see Note 8) for the Company using
the liability method was calculated for the period December 2, 1996 through
December 31, 1996. There was no provision for income taxes required for this
period.
Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash, restricted cash and
accounts receivable. The cash and restricted cash are held by a high credit
quality financial institution. For accounts receivable, the Company performs
ongoing credit evaluations of its customers' financial condition and generally
does not require collateral. The Company maintains reserves for credit
losses, and such losses have been within management's expectations. The
concentration of credit risk is mitigated by the large customer base. The
carrying amount of the receivables approximates their fair value.
Sources of Supplies
The Company relies on local telephone companies and other
companies to provide data communications. Although management feels
alternative telecommunications facilities could be found in a timely manner,
any disruption of these services could have an adverse effect on operating
results. Although the Company attempts to maintain multiple vendors for each
required product, its modems, terminal servers, and high-performance routers,
which are important components of its network, are currently acquired from two
sources. In addition, some of the Company's suppliers have limited resources
and production capacity. If the suppliers are unable to meet the Company's
needs as it builds out its network infrastructure, then delays and increased
costs in the expansion of the Company's network infrastructure could result,
which would affect operating results adversely.
Recent Pronouncements
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Comprehensive Income", which is required to be adopted for the year ended
December 31, 1998. SFAS 130 requires that an enterprise (a) classify items of
other comprehensive income by their nature in the financial statements and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the Statements of
Stockholders' Deficit. The Company will be required to restate earlier
periods provided for comparative purposes. The disclosure for comprehensive
income is not expected to be material.
3. Property and Equipment
Property and equipment, including leasehold improvements, are
stated at cost. Depreciation is calculated using the straight-line method
over estimated useful lives ranging between three and seven years. Leasehold
improvements are amortized over the lesser of the related lease term or the
useful life.
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1997
----------- -----------
<S> <C> <C>
Computer equipment.......................... $11,570,218 $24,517,954
Furniture, fixtures, and office equipment... 721,218 1,378,768
Leasehold improvements...................... 238,604 335,528
----------- -----------
12,530,040 26,232,250
Less accumulated depreciation............... 2,030,708 8,391,281
----------- -----------
$10,499,332 $17,840,969
=========== ===========
</TABLE>
4. Notes Payable
Pursuant to a promissory note agreement dated December 20,
1995, the Company owed $500,000 to a financial institution as of December 31,
1995. The loan bore interest at an annual rate of 1.5% plus prime rate (10%
at December 31, 1995). Prior to the repayment of the loan balance, the loan
was collateralized by certain assets of the Company and was guaranteed by an
officer and stockholder of the Company. During 1996, the Company repaid the
balance of the note plus unpaid interest totaling $16,131.
As of December 31, 1996 and 1997, the Company had a short-term
line of credit arrangement with a bank which allowed for aggregate borrowings
up to $700,000. As of December 31, 1996 and 1997, $700,000 was outstanding
under this arrangement. The line of credit bears interest at the bank prime
rate plus 1 1/2 % per annum (10% as of December 31, 1997). As of December
31, 1996 and 1997, the Company has accrued $2,051 and $7,158, respectively, of
interest related to this line of credit. The note is due on September 25,
1998. The line of credit is personally guaranteed by an officer and
stockholder of the Company. See Note 6.
During December 1997, the Company entered into a subordinated
revolving line of credit agreement, with a maximum borrowing amount of
$5,000,000, and a $5,000,000 subordinated note payable agreement with a
stockholder. The Company received the proceeds from the $5,000,000 note
payable in December 1997 and utilized the proceeds to repay certain accounts
payable. The subordinated revolving line of credit and note payable bear
interest at a fluctuating rate equal to the greater of 11% per annum or 4 1/2
per annum over the prime rate. The subordinated revolving line of credit
agreement provides for an unused facility fee equal to 1/2% of the difference
between the average daily balance outstanding and the $5,000,000 maximum
borrowing amount, payable quarterly. The revolving line of credit and the
note payable are secured by certain assets of the Company. The balance of the
note payable, as well as any outstanding borrowings under the line of credit
facility, are due upon the acquisition of more than 50% of the Company's
outstanding Common Stock or the sale in an underwritten public offering of debt
or equity securities issued by the Company.
5. Commitments
Operating Leases
The Company leases office space and various office and computer
equipment under non-cancelable operating lease agreements. The leases
generally provide for renewal terms and the Company is required to pay a
portion of the common areas' expenses including maintenance, real estate taxes
and other expenses. Rent expense for the period from August 1, 1995
(inception) to December 31, 1995 and for the years ended December 31, 1996 and
1997, was $12,601, $843,615 and $2,236,183, respectively. The Company is also
required to pay additional rent based on certain percentages of revenues
recorded by the various stores (kiosks) when the revenues exceed certain
predetermined amounts. The Company has not incurred any significant
additional rent charges to date.
As of December 31, 1997, payments due under non-cancelable
operating leases are as follows:
<TABLE>
<S> <C>
1998............................... $1,301,609
1999............................... 914,082
2000............................... 578,203
2001............................... 461,561
2002............................... 314,831
----------
$3,570,286
==========
</TABLE>
Capital Leases
The Company leases certain office and computer equipment as a
result of sales-leaseback agreements, which will be accounted for as capital
leases. The Company recorded approximately $192,000 of deferred gain related to
the difference between the sale price of the equipment and present value of
the minimum lease payments. The Company will amortize the deferred gain to
other income over the lease term. Computer equipment held under capital
leases at December 31, 1996 and 1997 amounted to $1,956,407 and $4,320,349,
respectively. Accumulated amortization related to this equipment amounted to
$480,384 and $1,329,551 at December 31, 1996 and 1997, respectively.
Amortization related to capital leased equipment is included in depreciation
and amortization expense. The non-cash portion of these transactions has been
excluded from the Statements of Cash Flows.
As of December 31, 1997, future minimum lease payments under
the capital leases are as follows:
<TABLE>
<S> <C>
1998............................................... $1,805,933
1999............................................... 1,487,236
2000............................................... 536,826
----------
3,829,995
Less interest...................................... (511,268)
----------
Present value of net minimum payments.............. 3,318,727
Less current portion............................... 1,466,701
----------
$1,852,026
==========
</TABLE>
Letters of Credit
During 1996 and 1997, in connection with capital lease
agreements, the Company obtained several letters of credit with a financial
institution in the amounts of the lease obligations. As collateral for these
letters of credit, the financial institution required that the Company invest
certain amounts in certificate of deposits at the financial institution. The
total amount of cash restricted in connection with these letters of credit is
approximately $905,000 and $837,000 at December 31, 1996 and 1997,
respectively. The certificates of deposit bear interest at a rate of 4.7%,
mature in one year and are renewable at the option of the financial
institution. The letters of credit expire in 1998 and will be automatically
renewed, subject to certain withdrawal privileges by the Company, by the
financial institution for an additional one year period for each year under
which the capital lease obligations are outstanding.
Employment Agreements
During 1996 and 1997, the Company executed employment
agreements with certain key executives under which the Company is required to
pay the following base salaries annually over the next two years:
<TABLE>
<S> <C>
1998............................... $840,000
1999............................... 225,000
----------
$1,065,000
==========
</TABLE>
Other Commitments
Effective January 31, 1997, the Company entered into an ISP
License Agreement with a vendor. The Company agreed to license a minimum of
1,000,000 software mailbox products in exchange for $3,000,000, which is to be
paid in quarterly installments over the next three years. After exceeding the
1,000,000 software mail box products, the Company may license additional
mailbox products for a fee of $3.00 per mailbox.
6. Related Party Transactions
Since inception, the Company has shared common facilities and
operating costs such as executive management salaries, accounting, supplies,
marketing, etc., with Erol's Computer & TV/VCR, Inc. (the "Affiliated Company")
which shares common ownership with the Company. During the period from August
1, 1995 (inception) to December 31, 1995 and the years ended December 31, 1996
and 1997, $11,530, $721,557 and $0 were charged to operations related to
shared facilities and operating costs, respectively.
The Company executed a promissory note agreement with an
Individual (the "Individual"), an officer and stockholder of the Company, and
the Affiliated Company, whereby the Company agreed to loan $350,000 to the
Individual and the Affiliated Company. The note bears annual interest at a
rate equivalent to the federal rate, defined by the Internal Revenue Code.
The balance of the note plus compounded interest will become due to the
Company three weeks after the date on which the short-term line of credit
arrangement expires and the Individual has been released as a guarantor of the
line of credit arrangement with the bank.
Since inception in August 1995 through December 31, 1996, Erols
Internet paid certain expenses related to the Affiliated Company on behalf of
the Affiliated Company. These expenses amounted to $658,422 and $1,645,511
during the period from August 1, 1995 (inception) to December 31, 1995 and
during the year ended December 31, 1996, respectively. Since there is no
intention to repay these amounts to the Company, the Company has written off
the receivable and has included the amount in other expense in the Statements
of Operations.
Effective January 1, 1997, the Company entered into a five year
management agreement with Erol's Computer & VCR (the "Affiliated Company").
Pursuant to this agreement, the Company will provide office space, general and
administrative services, sales services and print advertising services to the
Affiliated Company in exchange for a management fee. The management fee is
based on actual direct labor charges to the Affiliated Company and an
allocation of facilities costs based on square feet used by the Affiliated
Company. During the year ended December 31, 1997, the management fee amounted
to $58,784. The $58,784 is included in accounts receivable as of December 31,
1997. During December 1997, the parties agreed to terminate the agreement
effective December 31, 1997.
The Company purchased computer equipment for resale and
internal use from the Affiliated Company. During the year ended December 31,
1997, purchases amounted to $532,714.
7. Stockholders' Deficit
Equity transactions
During 1995, the Company operated as a division of OEO, Inc.
and accordingly, had no Common Stock outstanding. During 1996, as a part of
the reorganization, the sole common stockholder was issued 4,272,023 shares of
voting Common Stock, par value $0.001 in Erols Internet, Inc.
In December 1996, the Company completed a private placement to
raise total proceeds of approximately $3,000,000 from an outside investor (the
"Minority Stockholder"). The Company sold 1,314,469 shares of voting Common
Stock at $2.29 per share.
In May 1997, the Company completed a private placement to raise
total proceeds of approximately $500,000 from the Minority Stockholder. The
Company sold 131,447 shares of voting Common Stock at $3.80 per share.
In September 1997, the Company completed a private placement to
raise total proceeds of approximately $500,000 from the Minority Stockholder.
The Company sold 114,600 shares of voting Common Stock at $4.36 per share.
On December 4, 1997, the Board of Directors and stockholders of
the Company approved a 1 for 2.3583672 reverse stock split of the Company's
$0.001 par value voting Common Stock, which became effective on December 5,
1997. In addition, the Company eliminated the authorized non-voting Common
Stock. All references in the accompanying financial statements to the number
of shares of Common Stock and per-share amounts have been restated to reflect
these transactions.
Stock Option Plan
During 1996, the Company adopted a stock option plan (the
"Option Plan") which permits the Company to grant up to 657,234 voting Common
Stock options to employees, board members and others who contribute materially
to the success of the Company. During 1997, the Company increased the number
of options available for grant under the plan to 826,843. Stock options are
generally granted at prices which the Company's Board of Directors believes
approximates the fair market value of its Common Stock at the date of grant.
Individual grants generally become exercisable ratably over a period of three
years from the date of hire. The contractual term of the options is ten years
from the date of grant.
In December 1996, the Company issued 328,617 options to a
certain officer at an exercise price of $1.18 which was considered to be below
fair market value at the time of the option grant. Accordingly, the Company
recorded deferred stock compensation of $364,250 which will be amortized to
expense over the vesting period of three years beginning in January 1997, of
which $161,889 was recognized as expense during 1997.
Common stock option activity was as follows:
<TABLE>
Year ended December 31,
1996 1997
---------------------------------- ---------------------------------
Weighted Weighted-
Number of Average Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year...... - $ - 455,823 $1.49
Options granted....................... 455,823 1.49 675,611 3.04
Options exercised..................... - - (4,240) 3.32
Options canceled or expired........... - - (75,333) 2.29
------- --------- --------- -----
Outstanding at end of year............ 455,823 $ 1.49 1,051,861 $2.42
======= ========= ========= =====
Exercisable at year-end............... - $ - 264,278 $1.91
======= ========= ========= =====
</TABLE>
As of December 31, 1997, there were 95,119 options available
for future grants under the Option Plan.
The following table summarizes information about fixed-price
stock options outstanding at December 31, 1997:
<TABLE>
Options Outstanding Options Exercisable
--------------------------------------------------- -----------------------------
Number Average Weighted- Number Weighted-
Outstanding at Remaining Average Exercisable Average
December 31, Contractual Exercise at December Exercise
Range of Exercise Prices 1997 Life Price 31, 1997 Price
- ------------------------ ------------------ ---------------- ------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Less than $2.30............. 784,238 9.0 $1.82 253,332 $1.81
$2.30 - $4.75............... 267,623 9.0 4.18 10,946 4.17
--------- ----- ------- -----
$1.18 - $4.55............... 1,051,861 2.42 264,278 1.91
========= ===== ======= =====
</TABLE>
Had compensation expense related to the stock option plan been
determined based on the fair value at the grant date for options granted
during the period from August 1, 1995 to December 31, 1995 and for the years
ended December 31, 1996 and 1997 consistent with the provisions of SFAS 123,
the Company's net loss would have been as follows:
<TABLE>
Period from
August 1, 1995
to December 31, Years Ended December 31,
1995 1996 1997
--------------- ------------- -------------
<S> <C> <C> <C>
Net loss--pro forma.. $(1,018,274) $(16,690,399) $(20,086,156)
=========== ============ ============
</TABLE>
The effect of applying SFAS 123 on 1995, 1996 and 1997 pro
forma net loss as stated above is not necessarily representative of the
effects on reported net loss for future years due to, among other things, the
vesting period of the stock options and the fair value of additional stock
options in future years.
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing fair value model with the
following weighted-average assumptions used for grants in 1996 and 1997:
dividend yield of 0%, expected volatility of 70%; risk-free interest rate of
6.5%; and expected terms from 3 to 4 years. The weighted average fair values
of the options granted in 1996 and 1997 with a stock price equal to the
exercise price is $1.31 and $1.79, respectively. The weighted average fair
value of the options granted in 1996 with a stock price greater than the
exercise price in 1996 is $0.38.
Reserve for Issuance
As of December 31, 1997, the Company had reserved 11,151,220,
respectively, shares of non-voting common stock, preferred stock and voting
Common Stock options.
8. Income Taxes
Net deferred income tax assets are as follows:
<TABLE>
<CAPTION>
December 31,
------------------------------------
1996 1997
------------ ------------
<S> <C> <C>
Unearned revenue $ 1,307,553 $ 7,766,210
Operating loss carryforwards 1,913,864 2,793,213
Provision for bad debts 15,960 61,305
Accrued vacation -- 50,005
Deferred rent -- 51,009
Stock options -- 61,452
Depreciation (228,000) (267,131)
----------- -----------
Deferred tax assets 3,009,377 10,516,063
Valuation allowance (3,009,377) (10,516,063)
----------- -----------
Net deferred tax assets $ -- $ --
=========== ===========
</TABLE>
At December 31, 1997, the Company has net operating loss
carryforwards amounting to approximately $7,358,305. Operating loss
carryforwards expire in 2010 and 2011.
9. Contingencies
On September 1, 1997, a motion for judgment was filed against
the Company in Virginia state court by the Company's former Vice President,
Marketing. The motion for judgment alleges breach of contract and wrongful
termination and seeks punitive and compensatory damages of approximately
$1,000,000. Additionally, the Company's former Vice President, Marketing
seeks to exercise certain stock options. Discovery has just been initiated
and, therefore, it is premature to reach an opinion on liability or the extent
of exposure. However, the Company believes that it has a meritorious defense
and is conducting a vigorous defense. The Company doesn't believe that the
conclusion of this matter will materially affect the Company's financial
position or results of operations.
10. Subsequent Event
On January 21, 1998, the Company entered into an Agreement and
Plan of Merger with RCN Corporation ("RCN"). In the transaction, RCN will
issue common stock and replacement stock options valued at $48,500,000 and pay
$35,000,000 in cash, including the assumption and repayment of the $5,700,000
note payable, in exchange for all of the outstanding equity securities of
Erols Internet, Inc. The Agreement and Plan of Merger was closed on February
20, 1998.
In conjunction with the merger agreement with RCN, certain
outstanding options held by two employees of the Company became fully vested.
Additionally, all outstanding options held by non-employees will fully vest
and be repurchased by the Company at a price equal to the difference between
$14 and the option exercise price multiplied by the number of outstanding
options.
================================================================================
No person has been authorized to give any information or make any
representations, other than those contained in this Prospectus, in connection
with the offering made hereby, and, if given or made, such information or
representation must not be relied upon as having been authorized by the Company,
or any other person. Neither the delivery of this Prospectus nor any sale made
hereunder shall, under any circumstances create any implication that there has
been no change in the affairs of the Company since the date hereof. This
Prospectus does not constitute an offer to sell or a solicitation of an offer to
buy any securities offered hereby by anyone in any jurisdiction in which such
offer or solicitation is not authorized or in which the person making such offer
or solicitation is not qualified to do so or to any person to whom it is
unlawful to make such offer or solicitation.
TABLE OF CONTENTS
Page
----
Summary................................... 1
Risk Factors.............................. 11
Use of Proceeds........................... 25
Capitalization............................ 26
Unaudited Pro Forma Consolidated Financial
Statements.......................... 27
Selected Historical Consolidated Financial
Data................................ 32
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.......................... 34
Business.................................. 48
Management................................ 77
Security Ownership of Management,
Principal Stockholders and Selling
Stockholders........................ 85
Description of Certain Indebtedness....... 88
Description of the Notes.................. 92
Certain U.S. Federal Income Tax
Consequences........................ 119
Underwriting.............................. 122
Legal Matters............................. 123
Experts................................... 123
Additional Information.................... 123
Index to Financial Statements............. F-i
================================================================================
[LOGO]
$250,000,000 Gross Proceeds
% Senior Discount Notes
Due 2008
RCN Corporation
----------
PROSPECTUS
----------
Merrill Lynch & Co.
Donaldson, Lufkin & Jenrette
Securities Corporation
NationsBanc Montgomery
Securities LLC
Salomon Smith Barney
June , 1998
================================================================================
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses payable
by the Company in connection with the sale of the securities being registered
hereby. All amounts are estimates except the Registration Fee.
Amount to be Paid
-----------------
Registration fee...................... $ 73,750.00
NASD fee.............................. $ 25,500.00
Printing.............................. $ *
Legal fees and expenses............... $ *
Accounting fees and expenses.......... $ *
Miscellaneous......................... $ *
-------------
TOTAL............................. $ *
=============
- ----------
* To be filed by amendment.
Item 14. Indemnification of Directors and Officers
Reference is made to Section 102(b)(7) of the Delaware General
Corporation Law (the "DGCL"), which enables a corporation in its original
certificate of incorporation or an amendment thereto to eliminate or limit the
personal liability of a director for violations of the director's fiduciary
duty, except (i) for any breach of the director's duty of loyalty to the
corporation or it stockholders, (ii) for acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of law, (iii)
pursuant to Section 174 of the DGCL (providing for liability of directors for
the unlawful payment of dividends or unlawful stock purchases or redemptions)
or (iv) for any transaction from which a director derived an improper personal
benefit.
Section 145 of the DGCL empowers the Company to indemnify,
subject to the standards set forth therein, any person in connection with any
action, suit or proceeding brought before or threatened by reason of the fact
that the person was a director, officer, employee or agent of such company, or
is or was serving as such with respect to another entity at the request of
such company. The DGCL also provides that the Company may purchase insurance
on behalf of any such director, officer, employee or agent.
The Company's Amended and Restated Articles of Incorporation
provides in effect for the elimination of the personal liability of RCN
directors for breaches of fiduciary duty and for the indemnification by the
Company of each director and officer of the Company, in each case, to the
fullest extent permitted by applicable law.
Item 15. Recent Sales of Unregistered Securities
1. Issuance of Notes. On October 10, 1997, RCN issued
$225,000,000 aggregate principal amount of 10% Senior Notes due 2007 and
$601,045,000 aggregate principal amount at maturity of 11 1/8% Senior
Discount Notes due 2007. On February 6, 1998, RCN issued $567,000,000
aggregate principal amount at maturity of 9.80% Senior Discount Notes due
2008. The underwriters for each of the issuances were Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Salomon Brothers Inc and NationsBanc Montgomery
Securities LLC. The notes were sold under Rule 144A under the Securities Act
to qualified institutional buyers.
<TABLE>
Principal
Amount at Offering Underwriting
Title of Notes Maturity Price Commission
-------------- -------- ----- ----------
<S> <C> <C> <C>
10% Senior Notes due 2007.......................... $225,000,000 $225,000,000 $6,750,000
11 1/8% Senior Discount Notes due 2007............. $601,045,000 $350,000,524 $12,250,018
9.80% Senior Discount Notes due 2008............... $567,000,000 $350,587,440 $5,732,370
</TABLE>
2. Issuance of Common Stock. On February 20, 1998, RCN issued
1,730,648 shares of RCN Common Stock in connection the merger of Erols
Internet, Inc. with and into a wholly owned subsidiary of RCN. On February 27,
1998, RCN issued 890,384 shares of RCN Common Stock in connection with the
merger of UltraNet Communications, Inc. with and into a wholly owned
subsidiary of RCN. Both of these issuances were made pursuant to the exemption
from registration under Section 4(2) of the Securities Act.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Document
<S> <C>
1.1* Form of Underwriting Agreement
2.1 Form of Distribution Agreement among C-TEC Corporation, Cable Michigan, Inc. and RCN
Corporation (incorporated by reference to Exhibit 2.1 to Amendment No. 2 to the Company's
Information Statement on Form 10/A ("Form 10A") filed on September 5, 1997)
2.2 Agreement and Plan of Merger dated as of January 21, 1998 among Erols Internet, Inc., Erol
Onaran, Gold & Appel Transfer, S.A., RCN Corporation and ENET Holding, Inc. (incorporated
by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K ("Form 8-K") filed on
March 6, 1998)
2.3 Amendment No. 1 to Agreement and Plan of Merger dated as of January 21, 1998 among Erols
Internet, Inc., Erol Onaran, Gold & Appel Transfer, S.A., RCN Corporation and ENET Holding,
Inc. (incorporated by reference to Exhibit 2.2 to the Company's Form 8-K)
3.1 Amended and Restated Articles of Incorporation of the Company (incorporated by reference to
Exhibit 3.1 to Amendment No. 1 to the Company's Form 10A)
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Form 10A)
4.1 Indenture dated as of February 6, 1998 between the Company, as Issuer, and The Chase Manhattan
Bank, as Trustee, with respect to the 9.80% Senior Discount Notes due 2008 (incorporated by
reference to Exhibit 4.1 to the Company's Registration Statement on Form S-4 ("1998 Form S-4")
filed on March 23, 1998)
4.2 Form of the 9.80% Senior Discount Notes due 2008, Series B (included in Exhibit 4.1)
(incorporated by reference to Exhibit 4.2 to the Company's 1998 Form S-4)
4.3 Indenture dated as of October 17, 1997 between the Company, as Issuer, and The Chase Manhattan
Bank, as Trustee, with respect to the 10% Senior Notes due 2007 (incorporated by reference to
Exhibit 4.1 to the Company's Registration Statement on Form S-4 ("Form S-4") filed on November
26, 1997)
4.4 Form of the 10% Senior Exchange Notes due 2007 (included in Exhibit 4.4) (incorporated by
reference to Exhibit 4.2 to the Company's Form S-4)
4.5 Indenture dated as of October 17, 1997 between the Company, as Issuer, and The Chase Manhattan
Bank, as Trustee, with respect to the 11 1/8% Senior Discount Notes due 2007 (incorporated by
reference to Exhibit 4.3 to the Company's Form S-4)
4.6 Form of the 11 1/8% Senior Discount Exchange Notes due 2007 (included in Exhibit 4.6)
(incorporated by reference to Exhibit 4.4 to the Company's Form S-4)
4.7 Escrow Agreement dated as of October 17, 1997 among The Chase Manhattan Bank, as escrow
agent, The Chase Manhattan Bank, as Trustee under the Indenture (as defined therein), and the
Company (incorporated by reference to Exhibit 4.6 to the Company's Form S-4)
4.8* Indenture dated as of , 1998 between the Company, as Issuer, and The Chase Manhattan
Bank, as Trustee, with respect to the % Senior Discount Notes due 2008
4.9* Form of the % Senior Discount Notes due 2008 (included as an exhibit to 4.8)
5.1* Opinion re legality
10.1 Tax Sharing Agreement by and among C-TEC Corporation, Cable Michigan, Inc. and the Registrant
(incorporated by reference to Exhibit 10.1 to the Company's Form 10A)
10.2 Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan Fiber Systems/McCourt,
Inc. and RCN Telecom Services of Massachusetts, Inc. (incorporated by reference to Exhibit 10.2
to the Company's Form 10A)
10.3 Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan Fiber Systems of New
York, Inc. and RCN Telecom Services of New York, Inc. (incorporated by reference to Exhibit 10.3
to the Company's Form 10A)
10.4 Telephone Service to Reseller Agreement for Boston among Metropolitan Fiber Systems/McCourt,
Inc. and RCN Telecom Services of Massachusetts, Inc. (incorporated by reference to Exhibit 10.4
to the Company's Form 10A)
10.5 Telephone Service to Reseller Agreement for New York among Metropolitan Fiber Systems of New
York, Inc. and RCN Telecom Services of New York, Inc. (incorporated by reference to Exhibit 10.5
to the Company's Form 10A)
10.6 OVS Agreement dated May 8, 1997 between RCN Telecom Services, Inc. and MFS
Communication Company, Inc. (incorporated by reference to Exhibit 10.6 of the Company's Form
10A)
10.7 Joint Venture Agreement dated as of December 23, 1996 between RCN Telecom Services, Inc. and
Boston Energy Technology Group, Inc. (incorporated by reference to Exhibit 10.7 to the
Company's Form 10A)
10.8 Amended and Restated Operating Agreement of RCN-BECOCOM, LLC dated as of June 17, 1997
(incorporated by reference to Exhibit 10.8 to the Company's Form 10A)
10.9 Management Agreement dated as of June 17, 1997 among RCN Operating Services, Inc. and
BECOCOM, Inc. (incorporated by reference to Exhibit 10.9 to the Company's Form 10A)
10.10 Construction and Indefeasible Right of Use Agreement dated as of June 17, 1997 between
BECOCOM, Inc. and RCN-BECOCOM, LLC (incorporated by reference to Exhibit 10.10 to the
Company's Form 10A)
10.11 License Agreement dated as of June 17, 1997 between Boston Edison Company and BECOCOM,
Inc. (incorporated by reference to Exhibit 10.11 to the Company's Form 10A)
10.12 Joint Investment and Non-Competition Agreement dated as of June 17, 1997 among RCN Telecom
Services of Massachusetts, Inc., BECOCOM, Inc. and RCN-BECOCOM, LLC (incorporated by
reference to Exhibit 10.12 to the Company's Form 10A)
10.13 Credit Agreement dated as of July 1, 1997 among C-TEC Cable Systems, Inc., ComVideo Systems,
Inc., C-TEC Cable Systems of New York, Inc. and First Union National Bank, as agent**
(incorporated by reference to Exhibit 4.1 to the Company's Information Statement on Form 10
("Form 10") filed on July 9, 1997)
10.14 Amended and Restated Operating Agreement of Starpower Communications, LLC dated as of
December 18, 1997 by and between Pepco Communications, L.L.C. and RCN Telecom Services
of Washington, D.C., Inc. (incorporated by reference to Exhibit 10.M to RCN's Annual Report on
Form 10-K filed on March 31, 1998 ("10-K"))
11.1 Statement regarding Computation of Per Share Earnings (included in the Notes to the Consolidated
Financial Statements)
21.1 Subsidiaries (incorporated by reference to Exhibit 21 to the Company's 10-K)
23.1 Consent of Coopers & Lybrand L.L.P. with respect to RCN Corporation
23.2 Consent of Ernst & Young LLP, Independent Auditors, with respect to Erols Internet, Inc.
24.1 Power of Attorney (included on the signature page of the Registration Statement)
99.1 Financial Statement Schedule -- Schedule I: Condensed Financial Information of RCN for the Year
Ended December 31, 1997 (incorporated by reference to Item 14(a)(2) to RCN's 10-K)
99.2 Financial Statement Schedule -- Schedule II: Valuation and Qualifying Accounts and Reserves for
the Years Ended December 31, 1997, 1996 and 1995 (incorporated by reference to Item 14(a)(2)
to RCN's 10-K)
</TABLE>
- ----------
* To be filed by amendment.
**Exhibits and schedules which have not been filed with Exhibit 10.13 will be
provided to the Commission by the Registrant upon request.
(b) Financial Statement Schedules
Description
Condensed Financial Information of RCN for the Year Ended December 31, 1997
(Schedule I) (incorporated by reference to Item 14(a)(2) to RCN's 10-K)
Valuation and Qualifying Accounts and Reserves for the Years Ended December
31, 997, 1996 and 1995 (Schedule II) (incorporated by reference to Item
14(a)(2) to RCN's 10-K)
Item 17. Undertakings
(a) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this registration statement as of the time it was declared
effective.
(2) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the registrants pursuant to the foregoing provisions, or otherwise,
the registrants have been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrants will, unless
in the opinion of their counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York,
New York, on this 1st day of June, 1998.
RCN CORPORATION
By: /s/ Bruce C. Godfrey
---------------------------------
Bruce C. Godfrey
Executive Vice President and Chief
Financial Officer
The registrant and each person whose signature appears below
constitutes and appoints Michael J. Mahoney and Bruce Godfrey his true and
lawful attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign and file any and all amendments (including post-effective
amendments) to this registration statement and any supplemental registration
statement filed pursuant to rule 462(b) under the Securities Act of 1933, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them full power and authority to do and perform each and
every act and thing requisite or necessary to be done in and about the premises,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them, or their or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, the
registration statement has been signed below by the following persons in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ David C. McCourt Director, Chairman and Chief June 1, 1998
- ----------------------------- Executive Officer
David C. McCourt
/s/ Michael J. Mahoney Director, President and Chief June 1, 1998
- ----------------------------- Operating Officer
Michael J. Mahoney
/s/ Bruce C. Godfrey Director, Executive Vice President June 1, 1998
- ----------------------------- and Chief Financial Officer
Bruce C. Godfrey
/s/ Dennis Spina Director, Vice Chairman and June 1, 1998
- ----------------------------- President Internet Services
Dennis Spina
/s/ Alfred Fasola Director June 1, 1998
- -----------------------------
Alfred Fasola
/s/ Stuart E. Graham Director June 1, 1998
- -----------------------------
Stuart E. Graham
/s/ Richard R. Jaros Director June 1, 1998
- -----------------------------
Richard R. Jaros
/s/ Thomas May Director June 1, 1998
- -----------------------------
Thomas May
/s/ Thomas P. O'Neill, III Director June 1, 1998
- -----------------------------
Thomas P. O'Neill, III
/s/ Eugene Roth Director June 1, 1998
- -----------------------------
Eugene Roth
/s/ Walter Scott, Jr. Director June 1, 1998
- -----------------------------
Walter Scott, Jr.
/s/ Michael B. Yanney Director June 1, 1998
- -----------------------------
Michael B. Yanney
/s/ Ralph Hromisin Vice President and Chief June 1, 1998
- ----------------------------- Accounting Officer
Ralph Hromisin
EXHIBIT INDEX
Exhibit
No. Description Page
--- ----------- ----
1.1* Form of Underwriting Agreement
2.1 Form of Distribution Agreement among C-TEC Corporation,
Cable Michigan, Inc. and RCN Corporation (incorporated
by reference to Exhibit 2.1 to Amendment No. 2 to the
Company's Information Statement on Form 10/A ("Form
10A") filed on September 5, 1997)
2.2 Agreement and Plan of Merger dated as of January 21,
1998 among Erols Internet, Inc., Erol Onaran, Gold &
Appel Transfer, S.A., RCN Corporation and ENET Holding,
Inc. (incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K ("Form 8-K") filed
on March 6, 1998)
2.3 Amendment No. 1 to Agreement and Plan of Merger dated as
of January 21, 1998 among Erols Internet, Inc., Erol
Onaran, Gold & Appel Transfer, S.A., RCN Corporation and
ENET Holding, Inc. (incorporated by reference to Exhibit
2.2 to the Company's Form 8-K)
3.1 Amended and Restated Articles of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 to
Amendment No. 1 to the Company's Form 10A)
3.2 By-laws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Form 10A)
4.1 Indenture dated as of February 6, 1998 between the
Company, as Issuer, and The Chase Manhattan Bank, as
Trustee, with respect to the 9.80% Senior Discount Notes
due 2008 (incorporated by reference to Exhibit 4.1 to
the Company's Registration Statement on Form S-4 ("1998
Form S-4") filed on March 23, 1998)
4.2 Form of the 9.80% Senior Discount Notes due 2008, Series
B (included in Exhibit 4.1) (incorporated by reference
to Exhibit 4.2 to the Company's 1998 Form S-4)
4.3 Indenture dated as of October 17, 1997 between the
Company, as Issuer, and The Chase Manhattan Bank, as
Trustee, with respect to the 10% Senior Notes due 2007
(incorporated by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-4 ("Form
S-4") filed on November 26, 1997)
4.4 Form of the 10% Senior Exchange Notes due 2007 (included
in Exhibit 4.4) (incorporated by reference to Exhibit
4.2 to the Company's Form S-4)
4.5 Indenture dated as of October 17, 1997 between the
Company, as Issuer, and The Chase Manhattan Bank, as
Trustee, with respect to the 11 1/8% Senior Discount
Notes due 2007 (incorporated by reference to Exhibit 4.3
to the Company's Form S-4)
4.6 Form of the 11 1/8% Senior Discount Exchange Notes due
2007 (included in Exhibit 4.6) (incorporated by
reference to Exhibit 4.4 to the Company's Form S-4)
4.7 Escrow Agreement dated as of October 17, 1997 among The
Chase Manhattan Bank, as escrow agent, The Chase
Manhattan Bank, as Trustee under the Indenture (as
defined therein), and the Company (incorporated by
reference to Exhibit 4.6 to the Company's Form S-4)
4.8* Indenture dated as of , 1998 between the Company, as
Issuer, and The Chase Manhattan Bank, as Trustee, with
respect to the % Senior Discount Notes due 2008
4.9* Form of the % Senior Discount Notes due 2008 (included
as an exhibit to 4.8)
5.1* Opinion re legality
10.1 Tax Sharing Agreement by and among C-TEC Corporation,
Cable Michigan, Inc. and the Registrant (incorporated by
reference to Exhibit 10.1 to the Company's Form 10A)
10.2 Dark Fiber IRU Agreement dated as of May 8, 1997 among
Metropolitan Fiber Systems/McCourt, Inc. and RCN Telecom
Services of Massachusetts, Inc. (incorporated by
reference to Exhibit 10.2 to the Company's Form 10A)
10.3 Dark Fiber IRU Agreement dated as of May 8, 1997 among
Metropolitan Fiber Systems of New York, Inc. and RCN
Telecom Services of New York, Inc. (incorporated by
reference to Exhibit 10.3 to the Company's Form 10A)
10.4 Telephone Service to Reseller Agreement for Boston among
Metropolitan Fiber Systems/McCourt, Inc. and RCN Telecom
Services of Massachusetts, Inc. (incorporated by
reference to Exhibit 10.4 to the Company's Form 10A)
10.5 Telephone Service to Reseller Agreement for New York
among Metropolitan Fiber Systems of New York, Inc. and
RCN Telecom Services of New York, Inc. (incorporated by
reference to Exhibit 10.5 to the Company's Form 10A)
10.6 OVS Agreement dated May 8, 1997 between RCN Telecom
Services, Inc. and MFS Communication Company, Inc.
(incorporated by reference to Exhibit 10.6 of the
Company's Form 10A)
10.7 Joint Venture Agreement dated as of December 23, 1996
between RCN Telecom Services, Inc. and Boston Energy
Technology Group, Inc. (incorporated by reference to
Exhibit 10.7 to the Company's Form 10A)
10.8 Amended and Restated Operating Agreement of RCN-BECOCOM,
LLC dated as of June 17, 1997 (incorporated by reference
to Exhibit 10.8 to the Company's Form 10A)
10.9 Management Agreement dated as of June 17, 1997 among RCN
Operating Services, Inc. and BECOCOM, Inc. (incorporated
by reference to Exhibit 10.9 to the Company's Form 10A)
10.10 Construction and Indefeasible Right of Use Agreement
dated as of June 17, 1997 between BECOCOM, Inc. and
RCN-BECOCOM, LLC (incorporated by reference to Exhibit
10.10 to the Company's Form 10A)
10.11 License Agreement dated as of June 17, 1997 between
Boston Edison Company and BECOCOM, Inc. (incorporated by
reference to Exhibit 10.11 to the Company's Form 10A)
10.12 Joint Investment and Non-Competition Agreement dated as
of June 17, 1997 among RCN Telecom Services of
Massachusetts, Inc., BECOCOM, Inc. and RCN-BECOCOM, LLC
(incorporated by reference to Exhibit 10.12 to the
Company's Form 10A)
10.13 Credit Agreement dated as of July 1, 1997 among C-TEC
Cable Systems, Inc., ComVideo Systems, Inc., C-TEC Cable
Systems of New York, Inc. and First Union National Bank,
as agent** (incorporated by reference to Exhibit 4.1 to
the Company's Information Statement on Form 10 ("Form
10") filed on July 9, 1997)
10.14 Amended and Restated Operating Agreement of Starpower
Communications, LLC dated as of December 18, 1997 by and
between Pepco Communications, L.L.C. and RCN Telecom
Services of Washington, D.C., Inc. (incorporated by
reference to Exhibit 10.M to RCN's Annual Report on Form
10-K filed on March 31, 1998 ("10-K"))
11.1 Statement regarding Computation of Per Share Earnings
(included in the Notes to the Consolidated Financial
Statements)
21.1 Subsidiaries (incorporated by reference to Exhibit 21 to
the Company's 10-K)
23.1 Consent of Coopers & Lybrand L.L.P. with respect to RCN Corporation
23.2 Consent of Ernst & Young LLP, Independent Auditors, with
respect to Erols Internet, Inc.
24.1 Power of Attorney (included on the signature page of the
Registration Statement)
99.1 Financial Statement Schedule -- Schedule I: Condensed
Financial Information of RCN for the Year Ended December
31, 1997 (incorporated by reference to Item 14(a)(2) to
RCN's 10-K)
99.2 Financial Statement Schedule -- Schedule II: Valuation
and Qualifying Accounts and Reserves for the Years Ended
December 31, 1997, 1996 and 1995 (incorporated by
reference to Item 14(a)(2) to RCN's 10-K)
- ----------
* To be filed by amendment.
**Exhibits and schedules which have not been filed with Exhibit 10.13 will be
provided to the Commission by the Registrant upon request.
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Registration Statement of RCN
Corporation on Form S-1 and the related prospectus of RCN Corporation for the
registration of Senior Discount Notes due 2008, of our report dated March 13,
1998, except Note 2 as to which the date is May 20, 1998, on our audits of the
consolidated financial statements of RCN Corporation as of December 31, 1997
and 1996 and for the years ended December 31, 1997, 1996 and 1995. We also
consent to the reference to our Firm under the caption "Experts".
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
May 29, 1998
Consent of Ernst & Young LLP, Independent Auditors
We consent to the reference to our firm under the caption "Experts" and
to the use of our report dated January 15, 1998, except for Note 10, as to which
the date is February 20, 1998, in the Registration Statement to be filed
on or about May 28, 1998 and related Prospectus of RCN Corporation for the
registration % Senior Discount Notes due 2008.
/s/ Ernst & Young LLP
Vienna, Virginia
May 28, 1998
