<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition periods from to
Commission file number 0-22825
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3498533
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
105 Carnegie Center
Princeton, New Jersey 08540
(Address of principal executive offices)
(Zip Code)
(609) 734-3700
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of March 31, 1998.
Common Stock 28,900,359
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RCN CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page Number
-----------
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations-Quarters Ended
March 31, 1998 and 1997 3
Condensed Consolidated Balance Sheets-
March 31, 1998 and December 31, 1997 4
Condensed Consolidated Statements of
Cash Flows-Quarters Ended March 31,
1998 and 1997 5-6
Notes to Condensed Consolidated Financial
Statements 7-10
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial
Condition 11-17
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
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 18,131 12,191
Nonrecurring acquisition costs: In-process technology 18,293 -
Other nonrecurring charges - 10,000
--------------- ---------------
Operating (loss) (44,741) (18,038)
Interest income 12,815 5,153
Interest expense (22,735) (3,431)
Other (expense), net (899) (33)
--------------- ---------------
(Loss) before income taxes (55,560) (16,349)
(Benefit) for income taxes (11,682) (4,800)
--------------- ---------------
(Loss) before equity in unconsolidated
entities and minority interest (43,878) (11,549)
Equity in (loss) of unconsolidated entities (1,493) (805)
Minority interest in loss of
consolidated entities 3,586 910
--------------- ---------------
Net (loss) $ (41,785) $ (11,444)
=============== ===============
Basic and Diluted (loss) per average common share:
Net loss to shareholders $ (.74) $ (0.21)
=============== ===============
Weighted average shares outstanding 56,216,310 54,950,914
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
RCN CORPORATION
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 159,694 96,547
Deferred charges and other assets 46,689 41,038
-------------- --------------
Total assets $ 1,617,206 $ 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 405,155 321,766
Cumulative translation adjustments (3,055) (3,055)
Unrealized appreciation on investments 502 -
Treasury stock (255) -
Retained earnings (58,901) (17,116)
-------------- --------------
Total common shareholders' equity 401,257 356,584
-------------- --------------
Total liabilities and shareholders' equity $ 1,617,206 $ 1,150,992
============== ==============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
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.
<PAGE>
<PAGE>
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars, 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:
1998 1997
---- -----
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
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.
<PAGE>
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.
Quarter Ended March 31,
----------------------
1998 1997
---- ----
Net (loss) $ (41,785) $ (11,444)
Basic earnings per average common share:
Weighted average shares outstanding 56,216,310 54,950,914
Loss per average common share $ (.74) $ (.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 $ (.74) $ (.21)
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.
<PAGE>
8. In February 1998, the Company acquired Erols Internet, Inc. ("Erols"). The
total approximate consideration includes $36,000 in cash including out of pocket
costs of approximately $1,400 and the assumption and repayment of debt of
approximately $5,100 and RCN Common Stock with a fair value of approximately
$45,000 at the time of issuance. Additionally, the purchase price includes
approximately $11,000 representing the fair value of Erols stock options which
were converted to RCN stock options in connection with the acquisition. The
total purchase price of the acquisition was $92,000. The transaction was
accounted for by the purchase method of accounting.
RCN contributed to Starpower approximately 60% of the subscribers and related
unearned revenue acquired in the acquisition of Erols. RCN contributed to RCN-
BECOCOM approximately 1% of the subscribers and related unearned revenue
acquired in the acquisition of Erols.
Goodwill of approximately $35,000 was recorded in connection with the
acquisition of Erols and contribution to Starpower. Such goodwill includes the
value assigned to certain current products and technologies, primarily
residential dial-up and dedicated Internet access, and Internet advertising.
Such goodwill is being amortized over approximately four years.
9. In February 1998, the Company acquired UltraNet Communications, Inc.
("UltraNet"). The total approximate consideration includes $7,700 in cash
including cash payments aggregating approximately $503 to certain holders of
UltraNet stock options and RCN Common Stock with a fair value of approximately
$26,200 at the time of issuance. Additionally, the purchase price includes
approximately $1,900 representing the fair value of UltraNet stock options which
were converted to RCN stock options in connection with the acquisition. The
total purchase price of the acquisition was 35,800. The transaction was
accounted for by the purchase method of accounting.
RCN contributed to RCN-BECOCOM approximately 30% of the subscribers acquired in
the acquisition of UltraNet.
Goodwill of approximately $31,100 was recorded in connection with the
acquisition of Ultranet and contribution to RCN-BECOCOM. Such goodwill includes
the value assigned to certain current products and technologies, primarily
residential dial-up and high speed Internet access. Such goodwill is being
amortized over approximately four years.
In connection with the acquisitions of Erols and UltraNet, RCN has allocated
$13,228 for Erols and $5,065 for UltraNet to in-process research and development
("IPR&D"). Specifically, four projects were identified which qualified as IPR&D
by definition of not having achieved technological feasibility and representing
technology which at the point of acquisition offered no alternative use than the
defined project. The fair value of the IPR&D projects associated with these
acquisitions is based upon a discounted cash flow analysis modified to represent
only that portion of the project associated with completed research and
developments efforts at the date of acquisition. The IPR&D valuation charge was
measured by the stage of completion method. The expected completion percentages
are estimated based on the latest available financial information at the date of
acquisition and were established on a project by project basis primarily
calculated by dividing the costs incurred to date by the total expected R&D
expenses specific to the project. The Company's management is primarily
responsible for estimating the fair value of the purchased IPR&D. The
significant assumptions utilized by management were as follows:
Cash flow projections, utilizing risk adjusted discount rates of between 35% and
40% for Erols projects, commenced in 1998, and were expected to grow
significantly in 1999 and 2000. Cash flow projections, utilizing risk adjusted
discount rates of between 30% and 33% for UltraNet projects, were expected to
commence in 1999, growing significantly in 2000 and 2001. The IPR&D projections
are founded on significant assumptions with regard to timing of market entrance,
levels of penetration, and costs of provisioning.
RCN is constructing new telecommunications networks. The margins on products
expected to result from acquired in-process technologies in some cases represent
higher margins than RCN's margins on existing products primarily due to the
efficiencies in delivering multiple products, including bundled-service
offerings, over a single state of the art high capacity fiber optic network.
For both the Erols and the UltraNet acquisitions, RCN identified the R&D
development projects to include -
-Cable Modem Internet access for subscribers, consisting of projects to
develop the hardware, systems and software to permit subscribers to be offered
high-speed Internet access through direct cable connection. The remaining
development effort is concerned with technical standards for this service and
with the design and integration of this product into RCN's cable and fiber
optic network. RCN management estimated that this project for both
acquisitions was approximately 70% complete and that each had approximately
$250 of direct development expense remaining to be spent in 1998 and 1999,
with planned revenues from this service expected to begin thereafter.
-Internet Telephony, representing projects to develop the potential for dial-
up telephone service through the Internet. This service area presented
significant technical challenges as well as political, commercial and market
challenges to be faced before service could be offered to subscribers. Since
at the acquisition date neither hardware nor systems have been acquired or
developed in support of this new product, a high degree of development
activity remains. RCN management estimated that this project for both
acquisitions was only approximately 20% complete and that the remaining
development cost at the date of acquisition was approximately $1,000 in 1998,
$2,000 in 1999 and $5,000 in 2000 with revenues from this service expected to
begin thereafter.
-E-Commerce Systems, consisted of the companies' efforts to develop a
suitable system that would permit subscribers to conduct commercial activities
over the Internet. Following evaluation of commercially-available packages,
none were capable of meeting subscriber needs and development of the suitable
system was undertaken. RCN management estimated that the project for both
acquisitions was approximately 90% complete and that each had about $25 of
development expense remaining to be spent in 1998 with revenues from this
service expected to begin thereafter.
-High-speed shared office Internet access, representing a blending of fiber
optic and Internet networking technologies, was under development as a package
to be offered to commercial clients. While the technical challenges were still
being addressed at the acquisition date, there was no certainty that this
system would result in a competitive product offering in the market. The
management of RCN estimated that the project for both acquisitions was
approximately 75% complete and that each had less that $25 of development
expense remaining to be spent in 1998 with revenues from this service expected
to begin thereafter.
Relative to the qualifiation of these projects as IPR&D projects under the
meaning within Statement of Financial Accounting Standards No. 2 ("SFAS 2"),
each represented at the date of acquisition a development project associated
with new and uncertain technology that was incomplete and had not reached
technical feasibility. Further, the technology under development in each of
these areas was not seen to present opportunities for alternative future use
should the comtemplated development project fail to achieve completion. In each
of the above projects, the uncertainty associated with each, in the absence of a
successful product introduction, may result in the possible abandonment of the
project and the loss of both invested development funds and the profit
contributions that such projects were expected to bring to the business as a
whole.
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
<PAGE>
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. In June 1997 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 131 - "Disclosure about Segments
of an Enterprise and Related Information" ("SFAS 131"). This statement, which
establishes standards for the reporting of information about operating segments
and requires the reporting of selected information about operating segments in
interim and year end financial statements, is effective for fiscal years
beginning after December 15, 1997. The Company's operations involve developing
an advanced fiber network to provide a bundled service package of voice, video
and data services to new customers in high density markets and migrating as many
customers as is economically justified which were served by the Company's
previously separate lines of business, for which profitability was separately
measurable and monitored, to the single source network. While the Company's
chief decision makers monitor the revenue streams of the various products,
operations are managed and financial performance is evaluated based upon the
delivery of multiple services to customers over a single network. This allows
the Company to leverage its network costs to maximum profitability. It is
management's belief that the Company operates as one reportable operating
segment which contains many shared expenses generated by the Company's various
revenue streams and that any segment allocation of shared expenses incurred on a
single network to multiple revenue streams would be impractical and arbitrary;
furthermore, the Company currently does not make such allocations internally.
The Company's chief decision makers do, however, monitor financial performance
in a way which is different from that depicted in the historical general purpose
financial statements in that such measurement includes the consolidation of all
joint ventures, including Starpower which is not consolidated under generally
accepted accounting principles. Such information, however, does not represent a
separate segment under generally accepted accounting principles and therefore it
is not separately disclosed.
<PAGE>
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.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(Thousands of Dollars, Except Per Share Amounts)
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this Quarterly
Report is forward-looking, such as information relating to the effects of future
regulations and competition, expected capital expenditures, capital
contributions to joint ventures by joint venture partners, and expected trends
in operating losses and cash flows associated with investments in new markets.
Such forward-looking information involves important risks and uncertainties that
could significantly affect expected results in the future differently from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. These risks and uncertainties include, but are not limited to,
uncertainties relating to economic conditions, acquisitions and divestitures,
government and regulatory policies, the pricing and availability of equipment,
materials, inventories and programming, technological developments and changes
in the competitive environment in which the Company operates.
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the year ended
December 31, 1997 included in the Company's Form 10-K together with any
amendment thereto.
The negative operating cash flow from the Company's advanced fiber optic network
business has resulted primarily from expenditures associated with the
development of the Company's operational infrastructure and marketing expenses.
The Company expects it will continue to experience negative operating cash flow
and operating and net losses while it continues to invest in its networks and
until such time as revenue growth is sufficient to fund operating expenses. The
Company expects to achieve positive operating margins over time by (i)
increasing the number of customers it serves, (ii) increasing the number of
connections per customer by cross marketing its services and promoting bundled
service options and therefore increasing the revenue per customer, (iii)
lowering the costs associated with new subscriber additions and (iv) reducing
the cost of providing services by capturing economies of scale. The Company
expects its operating revenues will increase in 1998 through internal growth of
its current advanced fiber optic networks; however, the Company also expects
negative operating cash flow will increase for some period of time as the
Company initiates network development in Washington, D.C. and expands its
current networks. When the Company makes its initial investment in a new market,
the operating losses typically increase as the network and sales force are
expanded to facilitate growth. The Company's ability to generate positive cash
flow in the future will depend on the extent of capital expenditures in current
and additional markets, the ability of the joint ventures to generate revenues
and cash flow, competition in the Company's markets and any potential adverse
regulatory developments. The Company will be dependent on various financing
sources to fund its growth as well as continued losses from operations. There
can be no assurance that such funding will be available, or available on terms
acceptable to the Company. See " -Liquidity and Capital Resources."
Prior to September 30, 1997, the Company was operated as part of C-TEC
Corporation ("C-TEC"). The historical financial information presented herein
reflects periods during which the Company did not operate as an independent
company and accordingly, certain assumptions were made in preparing such
financial information. Such information, therefore, may not necessarily reflect
the results of operations or the financial condition of the Company which would
have resulted had the Company been an independent, public company during the
reporting periods, and are not necessarily indicative of the Company's future
operating results or financial condition.
<PAGE>
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
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.
<PAGE>
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 $10,461, or 35.3% to $40,138 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 180.7% to
approximately 660,000 at March 31, 1998 from approximately 235,000 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 $3,079 to $3,510 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 was
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 $2,852 to $2,856 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, including connections of the Starpower joint
venture.
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
Enterprises, Inc. (formerly C-TEC Corporation). CTSI is a CLEC which operates in
areas adjacent to the traditional service area of Commonwealth Telephone Company
(also a wholly owned subsidiary of Commonwealth Telephone Enterprises, Inc.).
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.
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 $6,570, or 58.2% to $17,857 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
<PAGE>
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 $16,361, or
114.9% to $30,598 for the quarter ended March 31, 1998 from $14,237 for the
quarter ended March 31, 1997. Advertising costs increased approximately $5,200
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 $3,500, or 165.7% 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. Technicial expense increased approximately
$3,000, or 67.8%, 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 $3,000, or 107.5%, 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
telelphony services.
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 $18,131 for the three month period ending
March 31, 1998 and $12,191 for the three month period ending March 31, 1997. The
increase of $5,940, or 48.7% 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 at March 31, 1998 and
1997 was $366,157 and $227,635, respectively. Additionally, intangible assets
resulting 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 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 was
$220,205 and $150,272 at March 31, 1998 and 1997, respectively. The increase
primarily resulted from the acquisition of Erols and UltraNet in March 1998.
Acquisition costs - In-process technology was $18,293 for the quarter ended
March 31, 1998. In the allocation of purchase price associated with the
acquisition of Erols and UltraNet, $13,228 and $5,065 respectively, was
determined to represent acquired in-process research & development ("IPR&D").
Specifically, four projects were identified which qualified as IPR&D by
definition of not having achieved technological feasibility and representing
technology which at the point of acquisition offered no alternative use than the
defined project. The fair value of the IPR&D projects associated with these
acquisitions is based upon a discounted cash flow analysis modified to represent
only that portion of the project associated with completed research and
development efforts at the date of acquisition. For both the Erols and the
UltraNet acquisitions, RCN identified the R&D development projects to include-
-Cable Modem Internet access for subscribers, consisting of projects to
develop the hardware, systems and software to permit subscribers to be offered
high-speed Internet access through direct cable connection. The remaining
development effort is concerned with technical standards for this service and
with the design and integration of this product into RCN's cable and fiber
optic network. RCN management estimated that this project for both
acquisitions was approximately 70% complete and that each had approximately
$250 of direct development expense remaining to be spent in 1998 and 1999,
with planned revenues from this service expected to begin thereafter.
-Internet Telephony, representing projects to develop the potential for dial-
up telephone service through the Internet. This service area presented
significant technical challenges as well as political, commercial and market
challenges to be faced before service could be offered to subscribers. Since
at the acquisition date neither hardware nor systems have been acquired or
developed in support of this new product, a high degree of development
activity remains. RCN management estimated that this project for both
acquisitions was only approximately 20% complete and that the remaining
development cost at the date of acquisition was approximately $1,000 in 1998,
$2,000 in 1999 and $5,000 in 2000 with revenues from this service expected to
begin thereafter.
-E-Commerce Systems, consisted of the companies' efforts to develop a
suitable system that would permit subscribers to conduct commercial activities
over the Internet. Following evaluation of commercially-available packages,
none were capable of meeting subscriber needs and development of the suitable
system was undertaken. RCN management estimated that the project for both
acquisitions was approximately 90% complete and that each had about $25 of
development expense remaining to be spent in 1998 with revenues from this
service expected to begin thereafter.
-High-speed shared office Internet access, representing a blending of fiber
optic and Internet networking technologies, was under development as a package
to be offered to commercial clients. While the technical challenges were still
being addressed at the acquisition date, there was no certainty that this
system would result in a competitive product offering in the market. The
management of RCN estimated that the project for both acquisitions was
approximately 75% complete and that each had less that $25 of development
expense remaining to be spent in 1998 with revenues from this service expected
to begin thereafter.
Relative to the qualifiation of these projects as IPR&D projects under the
meaning within Statement of Financial Accounting Standards No. 2 ("SFAS 2"),
each represented at the date of acquisition a development project associated
with new and uncertain technology that was incomplete and had not reached
technical feasibility. Further, the technology under development in each of
these areas was not seen to present opportunities for alternative future use
should the comtemplated development project fail to achieve completion. In each
of the above projects, the uncertainty associated with each, in the absence of a
successful product introduction, may result in the possible abandonment of the
project and the loss of both invested development funds and the profit
contributions that such projects were expected to bring to the business as a
whole.
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
<PAGE>
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.
Interest income was $12,815 and $5,153 for the three month periods ended March
31, 1998 and 1997, respectively. The increase of $7,662, or 148.7%, 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 were approximately $923,000 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.
Other expense was $899 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.
The Company's effective income tax rate was a benefit of 21.9% and 29.6% 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.
For the first quarter of 1998 minority interest of $3,586 primarily represents
the 49% interest of Boston Edison Company ("BECO") in the loss of RCN-BECOCOM of
$3,645. 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 the loss of unconsolidated entities primarily represents the Company's
share of the losses and amortization of excess cost over net assets of Megacable
of $709 and $712 for the three months ended March 31, 1998 and 1997,
respectively. 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.
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. To build out these areas on an efficient basis, the
Company undertakes a subscriber-driven capital expenditure strategy whereby it
(i) closely monitors development of its subscriber base in order to tailor
network development in each target market, and (ii) seeks to establish a
customer base in advance of or concurrently with its network deployment. For
example, the Company offers resale telephone services on an interim basis to
customers located near its advanced fiber optic networks. Depending upon factors
such as subscriber density, proximity to the advanced fiber optic network and
development costs and the degree of success achieved in its initial markets, the
Company will determine whether extending its advanced fiber optic network to
additional high density target markets can be achieved on an attractive economic
basis. In addition to its own capital requirements, the Company's joint venture
partners are each expected to make capital contributions to the joint ventures
in connection with development of the Boston and Washington, D.C. markets
through 2000.
<PAGE>
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
approximately $61,000 of restricted cash to be used to fund the Escrow Account
to pay interest on the 10% Senior Notes for three years. In February 1998, the
Company raised $350,588 in gross proceeds from an offering of $567,000 principal
amount at maturity of 9.8% Senior Discount Notes, due in 2008. The Company
expects to have sufficient liquidity to meet its capital requirements through
mid-2000. The Company will continue to require additional capital for planned
increases in network coverage and other capital expenditures, working capital,
debt service requirements, and anticipated further operating losses. The actual
timing and amount of capital required to roll out the Company's network and to
fund operating losses may vary materially from the Company's estimates and
additional funds will be required in the event of significant departures from
the current business plan, unforeseen delays, cost overruns, engineering design
changes and other technological risks or other unanticipated expenses. Due to
its subscriber driven investment strategy, should the Company encounter a
successful rollout in its initial markets, the Company may accelerate the
expansion and extend the reach of its network. Conversely, should the Company be
less successful than anticipated the operating losses associated with the
installed network may be higher than anticipated. The Company presently intends
to judge the success of its initial rollout in deciding whether to undertake
additional capital expenditures to rollout the network to additional areas.
Since the Company anticipates that, if it is successful, it will continue to
extend its network coverage into additional areas within the Boston-Washington,
D.C. corridor, it expects to continue to experience losses and negative cash
flow on an aggregate basis for an extended period of time.
The Company's current joint venture agreements reduce the amount of expenditures
required by RCN to develop the network due both to access to the joint venture
partners' existing facilities and to the anticipated joint venture partners'
equity contributions. However, the joint venture arrangements will also reduce
the potential cash flows to be realized from operation of the networks in the
markets in which the joint ventures operate and restrict the Company's access to
cash flow generated by the joint ventures (which will be paid in the form of
dividends). The Company may enter into additional joint ventures in the future
as the Company begins to develop new markets.
Sources of funding for the Company's further financing requirements may include
vendor financing, public offering or private placements of equity and/or debt
securities, and bank loans. There can be no assurance that additional financing
will be available to the Company or, if available, that it can be obtained on a
timely basis and on acceptable terms. Failure to obtain such financing could
result in the delay or curtailment of the Company's development and expansion
plans and expenditures. Any of these events could impair the Company's ability
to meet its debt service requirements and could have a material adverse effect
on its business.
RCN Cable and certain of its subsidiaries have in place secured credit
facilities comprised of a five-year revolving credit facilities 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.
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 $1,054,000 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
<PAGE>
telecommunications services to new markets. The leveraged nature of the Company
could limit its ability to effect future financing or may otherwise restrict the
Company's business activities.
The extent of the Company's leverage may have the following consequences: (i)
limit the ability of the Company to obtain necessary financing in the future for
working capital, capital expenditures, debt service requirements or other
purposes; (ii) require that a substantial portion of the Company's cash flows
from operations be dedicated to the payment of principal and interest on its
indebtedness and therefore not be available for other purposes; (iii) limit the
Company's flexibility in planning for, or reacting to, changes in its business;
(iv) place the Company at a competitive disadvantage as compared with less
leveraged competitors; and (v) render the Company more vulnerable in the event
of a downturn in its business.
For the 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 purchases 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
acquisition 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 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.
<PAGE>
Part II - OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
(27) Financial Data Schedule
(b.) Reports on Form 8-K
On March 6, 1998 the company filed an 8-K. On January 21,
1998, RCN entered into the Agreement and Plan of Merger (the "Erols Merger
Agreement") among RCN, 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 May 8, 1998 the Company filed an 8K to file the required financial statements
and the pro forma financial statements related to the Erols acquisition.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: April 16, 1999
/s/ Bruce C. Godfrey
------------------------------
Bruce C. Godfrey
Executive Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS AS OF AND IN THE THREE MONTHS ENDED MARCH 31, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 511,762
<SECURITIES> 411,238
<RECEIVABLES> 22,241
<ALLOWANCES> 3,427
<INVENTORY> 2,613
<CURRENT-ASSETS> 989,202
<PP&E> 366,157
<DEPRECIATION> 119,039
<TOTAL-ASSETS> 1,617,206
<CURRENT-LIABILITIES> 106,506
<BONDS> 1,053,324
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<COMMON> 57,811
<OTHER-SE> 343,446
<TOTAL-LIABILITY-AND-EQUITY> 1,617,206
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