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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| Quarterly Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period June 30, 2002.
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 (I.R.S. 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)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES |X| NO | |
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of June 30, 2002.
Common Stock 110,476,411
1
RCN CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Quarter Ended
and Six Months Ended June 30, 2002 and 2001
Condensed Consolidated Balance Sheets- June 30, 2002 and December 31,
2001
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2002 and 2001
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Item 6 - Exhibits and Reports on Form 8-K
SIGNATURE
2
This Quarterly Report on Form 10-Q is for the Quarter Ended June 30, 2002. This
Quarterly Report modifies and supersedes documents filed prior to this Quarterly
Report. The SEC allows us to incorporate by reference information that we file
with them, which means that we can disclose important information to you by
referring you directly to those documents. Information incorporated by reference
is considered to be part of this Quarterly Report. In this Quarterly Report,
"RCN", "we", "us" and "our" refer to RCN Corporation and its subsidiaries.
You should carefully review the information contained in this Quarterly Report
and in other reports or documents that we file from time to time with the SEC.
Some of the statements and information contained in this Form 10-Q discuss
future expectations, contain projections of results of operations or financial
condition or state other forward-looking information. Those statements and
information are subject to known and unknown risks, uncertainties and other
factors that could cause the actual results to differ materially from those
contemplated by the statements. The "forward-looking" information is based on
beliefs of management as well as assumptions made and information currently
available to us. In some cases, these so-called forward-looking statements can
be identified by words like "may," "will," "should," "expects," "plans,"
"anticipates," "believes," estimates," "predicts," "potential," or "continue" or
the negative of those words and other comparable words. These statements only
reflect our predictions. Actual events or results may differ substantially.
Important factors that could cause actual results to be materially different
from anticipated results and expectations expressed in any forward-looking
statements made by or on behalf of us include, but are not limited to, the
Company's failure to:
- achieve and sustain profitability based on the implementation of our
broadband network;
- obtain adequate financing;
- overcome significant operating losses;
- produce sufficient cash flow to fund our business and our
anticipated growth;
- attract and retain qualified management and other personnel;
- develop and implement effective business support systems for
provisioning orders and billing customers;
- obtain and maintain regulatory approvals;
- meet the terms and conditions of our franchise agreements and debt
agreements, including the indentures relating to our bonds and our
secured credit agreement;
- achieve adequate customer penetration of our services to offset the
fixed costs of our network;
- reduce our overhead costs;
- develop and successfully implement appropriate strategic alliances
or relationships;
- obtain equipment, materials, inventory at competitive prices;
- obtain video programming at competitive rates;
- complete acquisitions or divestitures;
- efficiently and effectively manage changes in technology, regulatory
or other developments in the industry, changes in the competitive
climate in which we operate, and relationships with franchising
authorities.
The Company undertakes no obligation to publicly update any forward-looking
statements whether as a result of new information, future events or otherwise.
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share and Per Share Data)
(Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------- ----------- ------------- ------------
Sales $ 127,989 $ 110,963 $ 252,524 $ 216,911
Costs and expenses, excluding non-cash
stock based compensation, depreciation
and amortization:
Direct expenses 51,436 52,783 102,274 105,944
Operating and selling, general
and administrative 98,320 119,796 199,201 256,917
Non-cash stock based compensation 11,826 16,433 14,402 30,759
Depreciation and amortization 87,605 83,949 163,502 175,625
Asset impairment and special charges 892,284 454,880 891,806 470,880
------------- ------------ ------------- ------------
Operating loss (1,013,482) (616,878) (1,118,661) (823,214)
Investment income 2,488 18,457 10,132 55,921
Interest expense (38,920) (50,675) (79,534) (104,240)
Other expense, net (2,734) (3,443) (1,822) (3,995)
------------- ------------ ------------- ------------
Loss before income taxes (1,052,648) (652,539) (1,189,885) (875,528)
Benefit from income taxes (130) (709) (880) (3,287)
------------- ------------ ------------- ------------
Loss before equity in unconsolidated
entities and minority interest (1,052,518) (651,830) (1,189,005) (872,241)
Equity in (loss) income of unconsolidated entities (35,030) 6,843 (23,916) (329)
Minority interest in loss of
consolidated entities 33,340 5,732 36,495 12,342
------------- ------------ ------------- ------------
Loss before extraordinary item (1,054,208) (639,255) (1,176,426) (860,228)
Extraordinary item, net of tax of $0 in
2002 and $0 in 2001 -- -- 13,073 --
------------- ------------ ------------- ------------
Net loss (1,054,208) (639,255) (1,163,353) (860,228)
Preferred dividend and accretion requirements 40,192 37,595 79,718 74,567
------------- ------------ ------------- ------------
Net loss to common shareholders $ (1,094,400) $ (676,850) $ (1,243,071) $ (934,795)
============= ============ ============= ============
Basic and Diluted loss per average common share:
Net loss before extraordinary item $ (10.46) $ (7.38) $ (12.17) $ (10.43)
Extraordinary item $ -- $ -- $ .13 $ --
Net loss to shareholders $ (10.46) $ (7.38) $ (12.04) $ (10.43)
============= ============ ============= ============
Weighted average shares outstanding 104,591,255 91,672,969 103,223,747 89,594,869
See accompanying notes to Condensed Consolidated Financial Statements.
4
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
June 30, December 31,
2002 2001
-------- ------------
ASSETS
Current assets:
Cash and temporary cash investments $ 99,509 $ 476,220
Short-term investments 315,912 362,271
Accounts receivable from related
parties 10,638 16,765
Accounts receivable, net of reserve
for doubtful accounts of $15,013
at June 30, 2002 and $17,392
at December 31, 2001 54,467 51,766
Unbilled revenues 1,230 2,090
Interest and dividends receivable 2,133 4,558
Prepayments and other 20,459 18,828
Restricted short-term investments 40,056 23,676
---------- ----------
Total current assets 544,404 956,174
Property, plant and equipment, net of
accumulated depreciation of $804,391
at June 30, 2002 and $643,754 at
December 31, 2001 1,369,633 2,320,198
Investments in joint ventures and equity
securities 213,707 229,294
Intangible assets, net of accumulated
amortization of $64,876 at June 30,
2002 and $64,692 at December 31, 2001 1,802 3,263
Goodwill, net of accumulated amortization
of $11,567 at June 30, 2002 and
$51,792 at December 31, 2001 6,220 45,147
Deferred charges and other assets 50,134 49,055
---------- ----------
Total assets $2,185,900 $3,603,131
========== ==========
5
LIABILITIES, REDEEMABLE PREFERRED AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of capital lease
obligations and long-term debt $ 33,184 $ 22,532
Accounts payable 23,218 34,718
Accounts payable to related parties 14,553 20,693
Advance billings and customer deposits 29,183 25,781
Accrued exit costs 36,662 39,271
Accrued expenses, interest, cost of sales,
employee compensation and other 170,696 214,435
----------- -----------
Total current liabilities 307,496 357,430
----------- -----------
Long-term debt 1,690,173 1,873,616
Other deferred credits 4,956 10,653
Minority interest 933 51,298
Commitments and contingencies
Redeemable preferred stock, Series A,
convertible, par value $1 per share;
708,000 shares authorized, and 312,887
and 302,217 shares issued and
outstanding at June 30, 2002 and December
31, 2001, respectively 304,958 293,951
Redeemable preferred stock, Series B, convertible, par
value $1 per share; 2,681,931 shares authorized, and
1,940,832 and 1,874,645 shares issued and outstanding
at June 30, 2002 and December 31,
2001, respectively 1,917,036 1,848,325
Common shareholders' equity:
Common stock, par value $1 per share, 300,000,000
shares authorized, 110,476,411 and 99,841,256
shares issued, respectively 110,476 99,841
Additional paid-in capital 1,433,292 1,416,529
Cumulative translation adjustments (5,134) (8,208)
Unearned compensation expense (8,301) (15,898)
Unrealized appreciation on investments 1,714 2,949
Treasury stock, 785,185 shares and 513,615
shares at cost at June 30, 2002 and
December 31, 2001, respectively (9,583) (8,309)
Accumulated deficit (3,562,116) (2,319,046)
----------- -----------
Total common shareholders' deficit (2,039,652) (832,142)
----------- -----------
Total liabilities, redeemable preferred stock and
common shareholders' deficit $ 2,185,900 $ 3,603,131
=========== ===========
See accompanying notes to Condensed Consolidated Financial Statements.
6
RCN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(Unaudited)
For the
Six Months Ended
June 30,
2002 2001
----------- ---------
Cash flows from operating activities
Net loss $(1,163,353) $(860,228)
Adjustments to reconcile net loss to net
cash used in operating activities:
Accretion of discounted debt 37,591 61,031
Amortization of financing costs 9,594 4,266
Non-cash stock based compensation expense 14,402 30,759
Gain on sale of property, plant
and equipment (465) --
Extraordinary item (13,073) --
Depreciation and amortization 163,502 175,625
Deferred income taxes, net (880) (3,287)
Provision for losses on accounts
Receivable 6,514 7,840
Write down on non-marketable investment 2,250 --
Equity in (income) loss of
unconsolidated entities 23,916 329
Minority interest (36,495) (12,342)
Impairments and special charges 891,806 470,880
----------- ---------
(64,691) (125,127)
Change in working capital (58,603) (207,410)
----------- ---------
Net cash used in operating activities (123,294) (332,537)
----------- ---------
Cash flows from investing activities
Additions to property, plant and equipment,
net of retirements and capitalized interest (78,712) (356,056)
Short-term investments, net 45,124 580,877
Investment in unconsolidated joint venture (7,500) (27,000)
Proceeds from sale of assets 4,048 --
Increase in restricted cash (16,380) --
Other -- (9)
----------- ---------
Net cash (used in) provided by
investing activities (53,420) 197,812
----------- ---------
7
Cash flows from financing activities
Repayments of long term debt (187,500) (794)
Payments of capital lease obligations (741) --
Payments made for debt financing costs (11,843) --
Contribution from minority interest 87 --
Proceeds from the issuance of common stock -- 50,000
Proceeds from the exercise of stock options -- 137
----------- ---------
Net cash (used in) provided by
financing activities (199,997) 49,343
----------- ---------
Net decrease in cash and temporary
cash investments (376,711) (85,382)
Cash and temporary cash investments at
beginning of period 476,220 356,377
----------- ---------
Cash and temporary cash investments at
end of period $ 99,509 $ 270,995
=========== =========
Supplemental disclosures of cash flow information Cash paid during the periods
for:
Interest (net of $8,040 and $7,774 capitalized
in 2002 and 2001, respectively) $ 41,943 $ 53,365
=========== =========
Supplemental Schedule of Non-Cash Investing Activities:
During the second quarter of 2002, The Company issued 7.5 million shares of the
Company's Common Stock, with a fair value of $11,625, to NSTAR Communications in
exchange for NSTAR Communication's 17.83% investment in RCN-Becocom.
See accompanying notes to Condensed Consolidated Financial Statements
8
RCN CORPORATION AND SUBSIDIARIES
FORM 10Q
QUARTER ENDED JUNE 30, 2002
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars, Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of RCN Corporation
and its wholly owned subsidiaries, (the "Company") have been prepared in
conformity with accounting principles generally accepted in the United States
and the rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and footnote disclosures normally included in
the Company's annual financial statements have been condensed or omitted as
permitted by the Securities and Exchange Commission.
The accompanying condensed consolidated financial statements are unaudited. In
the opinion of management, such statements include all adjustments necessary to
present fairly the financial position, results of operations and cash flows for
the periods presented. These condensed consolidated financial statements should
be read in conjunction with the audited financial statements and notes thereto,
and the Risk Factors included in the Company's December 31, 2001 Annual Report
on Form 10-K filed with the Securities and Exchange Commission. The results of
operations for the Quarter Ended and Six Months Ended June 30, 2002 are not
necessarily indicative of operating results for the full year.
For a more complete discussion of the Company's accounting policies, use of
estimates, and certain other information, refer to the financial statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2001.
Certain reclassifications have been made to the prior year condensed
consolidated financial statements to conform to those classifications used in
2002.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for
Obligations Associated with the Retirement of Long-Lived Assets". SFAS No. 143
requires retirement obligations to be recognized when they are incurred and
displayed as liabilities, with a corresponding amount capitalized as part of the
related long-lived asset. The capitalized element is required to be expensed
using a systematic and rational method over its useful-life. SFAS 143 will be
adopted by the Company commencing January 1, 2003 and is not expected to have a
significant impact on the Company's financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission on FASB Statements 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
Under certain provisions of SFAS No. 145, gains and losses related to the
extinguishment of debt should no longer be segregated on the income statement as
extraordinary items net of the effects of income taxes. Instead, those gains and
losses should be included as a component of income before income taxes. The
provisions of SFAS No. 145 are effective for fiscal years beginning after May
15, 2002 with early adoption encouraged. Any gain or loss on the extinguishment
of debt that was classified as an extraordinary item should be reclassified upon
9
adoption. Had the Company adopted SFAS No. 145 in the fiscal year 2002, the
extraordinary gain on early retirement of debt of $13,073 would have been
reflected in loss before income taxes. There would be no resulting change in the
reported net loss.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
when the liability is incurred rather than when a company commits to such an
activity and also establishes fair value as the objective for initial
measurement of the liability. SFAS No. 146 will be adopted by the Company for
exit or disposal activities that are initiated after December 31, 2002. The
Company is still in the process of evaluating the impact of adopting SFAS No.
146 on the consolidated financial statements.
3. ASSET IMPAIRMENT AND SPECIAL CHARGES
During the second quarter of 2002, as a response to the severe slowdown in the
telecommunications industry and the economy, the limited available capital in
the telecommunications industry, and following the completion of the Amendment
to the Company's Credit Agreement with JPMorgan Chase dated March 25, 2002, the
Company revised its growth plan. The revised plan meets the terms and conditions
as outlined in the Amendment, which permits the Company to lower its growth
trajectory. Under the revised plan, the Company has substantially curtailed
future capital spending and network geographic expansion in all existing
markets, focuses on the continuation of customer acquisition growth, and has
reduced operating expenses. During the second quarter of 2002, the Company also
performed a comprehensive review of its network capacity and current network
utilization levels for the purpose of identifying underutilized network-related
assets and assets not in use. The review consisted of a detailed assessment of
the current network infrastructure, ongoing network optimization activities,
usage projections based on target future customer levels, and available capital
resources for completion of construction in progress and future expansion. As a
result of all of the foregoing, the Company recognized an asset impairment of
approximately $884,193 during the second quarter of 2002. In addition, the
Company recognized approximately $8,091 of special charges net of recoveries for
exiting excess real estate facilities during the second quarter of 2002, as a
result of the curtailing of construction and expansion, and the consolidation of
certain operating activities.
The total asset impairment and special charges for the quarter ended June 30,
2002 is comprised of the following:
Quarter Ended
June 30, 2002
-------------
Impairment of property plant, and equipment $734,821
Abandoned assets 52,071
Construction materials 56,995
Goodwill 38,927
Franchises 1,379
--------
Total asset impairment 884,193
Exit costs for excess facilities 8,091
--------
Total asset impairment and
special charges $892,284
========
10
The second quarter review compared the net book values of each reporting unit
with undiscounted future cash flow projections based on the Company's current
operating plan. The results indicated that certain assets and capitalized costs
associated with the building and constructing the Company's network in all of
the Company's overbuild reporting units were not recoverable. To determine the
impairment loss of those assets to be held and used, the Company performed a
fair value test, using the "best-estimate" approach on the primary asset group
of each reporting unit by comparing the carrying value to the present value of
estimated future cash flows for the remaining useful life of the asset group.
The amount by which the carrying value of the assets exceeded the present value
of estimated cash flows was approximately $734,821. The impairment loss affected
all of the Company's overbuild reporting units and none of the Company's
incumbent reporting units.
The impairment loss on the Company's assets was measured in accordance with SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS
No. 144 provides guidance on the recognition of impairment losses on long-lived
assets to be held and used or to be disposed of, and also broadens the
definition of what constitutes a discontinued operation and how the results of a
discontinued operation are to be measured and presented. On January 1, 2002, the
Company adopted the guidance of SFAS No. 144.
Based on the Company's revised business plan, certain construction projects in
progress were stopped and other previous planned expansion projects were
abandoned. This stoppage is deemed to be other than temporary. In addition,
certain capitalized costs and assets related to the subscribers gaining access
to the Company's network were stranded based on the cost of retrieving the
assets. The Company also abandoned certain corporate assets including leasehold
improvements in certain facilities that were exited. The costs related to these
stranded assets were approximately $52,071.
Construction material levels were also assessed based on the revised business
plan and stoppage of certain construction projects. The assessment process
resulted in the identification of excess construction material that cannot be
used for alternative purposes and which is either to be returned to vendors, or
resold to a secondary market. The carrying values of the construction materials
that were identified that will be used in operations were written down to market
value, which was lower than carrying value. The carrying values of the
identified excess construction materials that will be sold were written down to
the anticipated recovery rate or salvage value. The total amount of charges to
dispose of inventory determined to be in excess was approximately $56,995.
In conjunction with the asset impairment review and test, the Company also
performed a test to identify any potential impairment on the carrying value of
goodwill on each identified reporting unit of the Company. The results of the
test indicated that the carrying amount of goodwill on certain reporting units
was impaired. During the second quarter 2002, the Company measured the
impairment loss by the amount the carrying value exceeded the implied fair value
of the goodwill on the reporting unit. This amount was approximately $38,927.
The fair value of the reporting units was estimated using the expected present
value of future cash flows. This measurement is in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets". This pronouncement changes the
11
accounting for goodwill and intangible assets with indefinite lives from an
amortized method to an impairment approach. On January 1, 2002, the Company
adopted the provisions of SFAS No. 142. Our transitional impairment test,
measured as of January 1, 2002, did not result in an impairment loss.
As a result of the change in expansion plans, management has been in contact
with the relevant franchising authorities to inform them of the Company's
decision to stop construction and expansion. Based on the revised business plan
and the curtailing of expansion, the Company wrote off the value of certain
franchise licenses of approximately $1,379. A review to evaluate the effects, if
any, was conducted on the Company's obligations under the associated franchise
agreements. The estimated costs associated to exit certain franchises were
approximately $1,200 and were included in the Operating, selling, and G&A
expense line, and approximately $62 was paid during the second quarter 2002.
Over the past year, a detailed review of facility requirements against lease
obligations has been continuously conducted to identify excess space. Along with
the stoppage of certain construction projects and expansion, the Company has
also consolidated certain operating activities, which resulted in exiting excess
facilities. Costs to exit excess real estate facilities net of recoveries were
approximately $8,091 and of which approximately $2,204 was paid in the second
quarter 2002.
The total activity for the six months ended June 30, 2002 for accrued exit costs
representing estimated damages, costs and penalties relating to franchises and
real estate facilities is presented below. Recoveries are recorded when sublease
agreements are executed at more favorable rates than originally anticipated.
Franchise Exit Total
Costs and Facility Accrued
Penalties Exit Costs Exit Costs
--------- ---------- ----------
Balance at December 31, 2001 $ 15,710 $ 23,561 $ 39,271
Six months ended June 30, 2002:
Additional accrued costs 3,251 14,197 17,448
Recoveries (784) (10,911) (11,695)
Payments (386) (7,976) (8,362)
-------- -------- --------
Balance at June 30, 2002 $ 17,791 $ 18,871 $ 36,662
======== ======== ========
The Company also recognized an asset impairment during the second quarter of
2001. Beginning in the fourth quarter of 2000, in light of the declining
economic environment, the Company began planning to modify its growth trajectory
in light of the available capital and anticipated availability of capital. The
Company also began planning to undertake certain initiatives to effect
operational efficiencies and reduce costs.
Accordingly, during the second quarter of 2001, management revised its strategic
and fundamental plans in order to achieve these objectives. Based on these
revisions to its plans, management took actions during the second quarter of
2001 to realign resources to focus on core opportunities and product offerings.
The Company also shifted focus from beginning construction in new markets to
completing additional construction activities in its existing markets so that
the Company could achieve higher growth with lower incremental capital spending.
Specifically, expansion to new markets was curtailed and expansion plans for
existing markets over the subsequent 24 to 36 months were curtailed in some
12
markets, delayed in some markets and shifted in other markets as deemed
appropriate.
As a result, during the second quarter 2001, the Company assessed the
recoverability of its investment in each market, which lead to the recognition
of an impairment to goodwill and the recording of special charges aggregating
approximately $471,000. The special charge of $471,000 included the impairment
of identifiable intangible and goodwill assets in the amount of $256,000, and
the impairment of property and equipment in the amount of $114,000. In addition,
charges to dispose of excess construction materials were approximately $70,000
and estimated costs to exit excess facilities were approximately $31,000.
4. GOODWILL AND INTANGIBLE ASSETS
The Company has $6,220 of unamortized goodwill and $1,802 of unamortized
identifiable intangible assets at June 30, 2002. In addition, there is
approximately $59,000 of remaining goodwill embedded in the carrying amount of
the Company's investment in Megacable. On January 1, 2002, the Company adopted
the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets". This
pronouncement changes the accounting for goodwill and intangible assets with
indefinite lives from an amortized method to an impairment approach.
Accordingly, the Company no longer records amortization relating to its existing
goodwill and embedded goodwill. The Company has identified and established 11
reporting units which correspond to the geographical markets in which the
Company operates.
The changes in the carrying amount of goodwill for the six months ended June 30,
2002, are as follows:
Accumulated Carrying
Goodwill Amortization Value
-------- ------------ -----
Balance as of January 1, 2002 $ 96,939 $ 51,792 $ 45,147
Impairment losses (80,146) (41,219) (38,927)
-------- -------- --------
Balance as of June 30, 2002 $ 16,793 $ 10,573 $ 6,220
======== ======== ========
During the second quarter 2002, the Company performed a test and identified that
the carrying value of goodwill on certain identified reporting units of the
Company was impaired. Also during the second quarter 2002, the Company measured
the impairment loss by the amount the carrying value exceeded the implied fair
value of the goodwill on the reporting units. This amount of the impairment loss
was $38,927. The fair value of the reporting units was estimated using the
expected present value of future cash flows. This measurement is in accordance
with SFAS No. 142. The impairment amount is included in the line item Asset
impairment and special charges and is discussed further in Note 3. The Company
also assessed for impairment, the value of goodwill imbedded in the carrying
amount of the Company's investment in Megacable, in accordance with the
Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock". The results indicated that there was no impairment
on the embedded goodwill.
The estimated annual amortization of goodwill no longer recorded in accordance
with the adoption of SFAS No. 142 prior to the impairment would have been
approximately $12,000. The estimated amortization for the period July 1, 2002
through December 31, 2002 of goodwill no longer recorded after the impairment is
approximately $840. The estimated annual amortization of goodwill embedded in
13
the carrying value of the investment in Megacable would have been approximately
$7,300.
The following table provides comparative earnings and earnings per share had the
non-amortization provisions of SFAS No. 142 been adopted for the previous
periods presented:
Quarter Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------- ------------ ------------- ------------
Loss before extraordinary items $ (1,094,400) $ (676,850) $ (1,256,144) $ (934,795)
Extraordinary item -- -- 13,073 --
------------- ------------ ------------- ------------
Adjusted net loss to common
shareholders $ (1,094,400) $ (676,850) $ (1,243,071) $ (934,795)
Goodwill amortization, net of tax -- 15,620 -- 42,383
Amortization of goodwill embedded in
the carrying value of the investment
in Megacable -- 1,833 -- 3,666
------------- ------------ ------------- ------------
Adjusted net loss to common
shareholders $ (1,094,400) $ (659,397) $ (1,243,071) $ (888,746)
============= ============ ============= ============
Basic and diluted loss per common share:
Weighted average shares outstanding 104,591,255 91,672,969 103,223,747 89,594,869
Loss from continuing operations $ (10.46) $ (7.38) $ (12.17) $ (10.43)
Extraordinary item -- -- .13 --
------------- ------------ ------------- ------------
Reported net loss (10.46) (7.38) (12.04) (10.43)
Goodwill amortization -- .17 -- .47
Amortization of embedded goodwill -- .02 -- .04
------------- ------------ ------------- ------------
Adjusted net loss per common share $ (10.46) $ (7.19) $ (12.04) $ (9.92)
============= ============ ============= ============
The following are identifiable intangible assets that have finite lives and are
subject to amortization:
June 30, December 31,
2002 2001
-------- -----------
Franchise and subscriber lists $ 65,284 $ 66,561
Non-compete agreements 100 100
Building access rights 98 98
Other intangible assets 1,196 1,196
-------- --------
Total intangible assets 66,678 67,955
Less accumulated amortization (64,876) (64,692)
-------- --------
Intangible assets, net $ 1,802 $ 3,263
======== ========
The total amortization expense for six months ended June 30, 2002 was $186. The
estimated aggregate amortization expense for the next five succeeding fiscal
years is:
For the period July 1, 2002 through
December 31, 2002 $ 81
For the year ended December 31, 2003 $274
For the year ended December 31, 2004 $211
For the year ended December 31, 2005 $219
For the year ended December 31, 2006 $225
14
The Company had no identifiable intangible assets with indefinite lives that are
not subject to amortization at June 30, 2002 and December 31, 2001.
5. ASSET SALE
In 2002, the Company completed the sale of a portion of our business customer
base that was not served by our broadband network, for cash proceeds of
approximately $3,000. The sale includes approximately 12,000 service connections
of which 9,000 are Verizon commercial resale voice lines and the balance is
digital subscriber lines. Based on certain contingencies as outlined in the sale
agreement, the final result of the sale has not been determined. The Company
expects to realize an immaterial gain on the transaction.
6. JOINT VENTURE
In December 1996, the Company became party to the RCN-Becocom joint venture (the
"Joint Venture") with NSTAR Communications, Inc. ("NSTAR Communications"), a
subsidiary of NSTAR, regarding construction of our broadband network and
operation of our telecommunications business in the Boston metropolitan area.
NSTAR is a holding company that, through its subsidiaries, provides regulated
electric and gas utility services in the Boston area. Pursuant to the joint
venture agreements, both parties agreed to make capital contributions in
accordance with their respective membership interests. In addition, RCN gained
access to and use of NSTAR's large broadband network, rights-of-way and
construction services. Pursuant to an exchange agreement between NSTAR
Communications and RCN, NSTAR Communications retained the right, from time to
time, to convert portions of its ownership interest in RCN-Becocom into shares
of the Company's Common Stock, based on an appraised value of such interest.
Shares issued upon such exchanges are issued to NSTAR. As of December 31, 2001,
NSTAR Communications had exchanged portions of its interest for a total of
4,097,193 shares of RCN Common Stock. Following such exchanges, NSTAR retained a
17.83% profit and loss sharing ratio in the joint venture, and an investment
percentage interest of 36.53%.
In April 2000, NSTAR Communications gave notice of its intent to convert its
remaining ownership interest into shares of the Company's Common Stock. In
October 2000, the Company and NSTAR Communications reached an agreement in
principle regarding settlement of the final valuation of this exchange and to
amend certain other agreements governing the Joint Venture. These discussions
continued and in June 2002, NSTAR Communications received 7.5 million shares of
the Company's Common Stock for their investment of $152,145 in RCN-Becocom, LLC,
which had been contributed as capital by RCN-Becocom in response to capital
calls. Following this exchange, NSTAR Securities profit and loss sharing ratio
in the joint venture was reduced to zero and it retained their investment
percentage and the right to invest in future capital calls as if it owned a
29.76% interest. Any future capital contributions made by NSTAR for operating
and liquidity requirements would require an adjustment to the sharing ratio and
investment percentage accordingly. In connection with the exchange, NSTAR on
behalf of itself and controlled affiliates, agreed to certain "standstill"
restrictions for the period of one year from June 19, 2002, including refraining
from further acquisitions of the Company's Common Stock beyond 10.75% in
aggregate of the total number of voting shares and refraining from activities
designed to solicit proxies or otherwise influence shareholders or management of
RCN.
Under the amended agreements governing the Joint Venture, future investments by
NSTAR Communications are not convertible into the Company's Common Stock. NSTAR
Communications is permitted to invest in response to capital calls, based on its
investment percentage, at its option, in Joint Venture equity, or in a Class B
15
Preferred Equity interest of the Joint Venture, which carries a cash coupon rate
of 1.84% per month guaranteed by the Company and RCN Telecom Services of
Massachusetts, Inc. The maximum permitted amount of such investment is $100
million. Such coupon includes amortization of principal over a fifteen-year
term. The security is callable by RCN after eight years following issuance at a
redemption price equal to the net present value of the payments over the life of
the security discounted on a monthly basis using an annual discount rate of 12%.
There was no Class B Preferred Equity interest outstanding at June 30, 2002 or
December 31, 2001.
The financial results of RCN-Becocom are consolidated in our financial
statements. NSTAR's portion of the operating loss in RCN-Becocom is reported in
the line item, Minority interest in the loss of consolidated entities. For the
quarter and the six months ended June 30, 2002, NSTAR's portion of the loss in
RCN-Becocom was $33,439 and $36,651, respectively.
In June 2002, NSTAR Communications received 7.5 million shares of the Company's
Common Stock with a market value of $11,625, in exchange for NSTAR
Communications investment, which had a carrying value of approximately $13,781.
7. LONG-TERM DEBT
In June 1999, the Company and certain of its subsidiaries together, (the
"Borrowers") entered into a $1,000,000 Senior Secured Credit Facility (the
"Credit Facility"). The collateralized facilities were comprised of a $250,000
seven-year revolving Credit Facility (the "Revolver"), a $250,000 seven-year
multi-draw term loan facility (the "Term Loan A") and a $500,000 eight-year term
loan facility (the "Term Loan B"). All three facilities are governed by a single
credit agreement (as amended, the "Credit Agreement").
The Company entered into an Amendment to the Credit Agreement dated March 25,
2002 (the "Amendment"). This Amendment amends certain financial covenants and
certain other negative covenants, and adds certain covenants to reflect the
Company's current business plan and amends certain other terms of the Credit
Agreement, including increases to the interest rate margins and commitment fee
payable thereunder. The Company can make no assurances that it would have been
able to satisfy and comply with the covenants under the Credit Agreement if it
had not negotiated and entered into the Amendment, which could have resulted in
an event of default under the Credit Agreement. In connection with the
Amendment, the Company agreed to pay to certain lenders and third parties an
aggregate fee of approximately $14,400 of which approximately $11,843 was paid
through June 30, 2002, to repay $187,500 of outstanding term loans under the
Credit Facility, and to permanently reduce the amount available under the
revolving loan from $250,000 to $187,500. The Company has also agreed that it
may not draw down additional amounts under the revolving loan until the later of
the date on which the Company delivers to the lenders financial statements for
the period ending March 31, 2004, and the date on which the Company delivers to
the lenders a certificate with calculations demonstrating that the Company's
EBITDA was at least $60,000 in the aggregate for the two most recent consecutive
fiscal quarters. In connection with the Amendment, each of the lenders party
thereto also agreed to waive any default or event of default under the Credit
Agreement that may have occurred prior to the date of the Amendment.
As adjusted by the Amendment, the interest rate on the Credit Facility is, at
the election of the Borrowers, based on either a LIBOR or an alternate base rate
option. For the Revolver or Term Loan A borrowing, the interest rate will be
16
LIBOR plus a spread of up to 350 basis points or the base rate plus a spread of
250 basis points, depending upon whether the Company's earnings before interest,
income taxes, depreciation and amortization, non-cash stock based compensation,
and asset impairment and special charges ("EBITDA") has become positive and
thereafter upon the ratio of debt to EBITDA. In the case of the Revolver the
Company will pay a fee of 150 basis points on the unused commitment. For all
Term Loan B borrowings the interest includes a spread that is fixed at 400 basis
points over the LIBOR or 300 basis points over the alternate base rate. In
addition, the LIBOR rate is subject to a 3.00% per annum minimum.
The Credit Agreement contains covenants customary for facilities of this nature,
including financial covenants and covenants limiting debt, liens, investments,
consolidation, mergers, acquisitions, asset sales, sale and leaseback
transactions, payments of dividends and other distributions, making of capital
expenditures and transactions with affiliates. The Borrowers must apply 50% of
excess cash flow for each fiscal year commencing with the fiscal year ending on
December 31, 2003 and certain cash proceeds realized from certain asset sales,
certain payments under insurance policies and certain incurrences of additional
debt to repay the Credit Facility.
The Credit Facility is collateralized by substantially all of the assets of the
Company and its subsidiaries.
In accordance with the Credit Agreement, the Company prepaid $62,500 of the Term
Loan A on March 25, 2002. At June 30, 2002, $187,500 of the Term Loan A was
outstanding. Amortization of the Term Loan A starts on September 3, 2002 and
will be repaid in quarterly installments based on percentage increments of the
Term Loan A that start at 3.75% per quarter on September 3, 2002 and increase in
steps to a maximum of 10% per quarter on September 3, 2005 through to maturity
at June 3, 2006.
In accordance with the Credit Agreement, the Company prepaid $125,000 of the
Term Loan B on March 25, 2002. At June 30, 2002, $375,000 of the Term Loan B was
outstanding. Amortization of the Term Loan B starts on September 3, 2002 with
quarterly installments of $750 per quarter until September 3, 2006 when the
quarterly installments increase to $90,750 per quarter through to maturity at
June 3, 2007.
During the first quarter ended March 31, 2002, the Company completed two debt
repurchases for certain of its Senior and Senior Discount Notes. The Company
retired approximately $24,037 in face amount of debt with a book value of
$22,142. The Company recognized an extraordinary gain of approximately $13,073
from the early retirement of debt in which approximately $722 in cash was paid
and approximately 2,589,237 shares of common stock with a value of $7,875 were
issued. In addition, the Company incurred fees of $180 and wrote off debt
issuance costs of $292. There were no debt repurchases during the second quarter
ending June 30, 2002.
Long-term debt outstanding at June 30, 2002 and December 31, 2001 is as follows:
June 30, December 31,
2002 2001
---------- ----------
Term Loans $ 562,500 $ 750,000
Senior Notes 10% due 2007 161,116 161,116
Senior Discount Notes 11.125% due 2007 310,646 316,351
Senior Discount Notes 9.8% due 2008 307,435 293,073
Senior Discount Notes 11% due 2008 130,291 123,499
17
Senior Notes 10.125% due 2010 231,736 231,736
Capital Leases 19,633 20,373
---------- ----------
Total 1,723,357 1,896,148
Due within one year 33,184 22,532
---------- ----------
Total Long-Term Debt $1,690,173 $1,873,616
========== ==========
Contractual maturities of long-term debt over the next 5 years are as follows:
Aggregate Amounts
For the period July 1, 2002 through
December 31, 2002 $ 16,707
For the year ended December 31, 2003 $ 38,466
For the year ended December 31, 2004 $ 46,471
For the year ended December 31, 2005 $ 64,813
For the year ended December 31, 2006 $221,468
8. STOCK OPTIONS
Incentive Stock Options
The Company granted 60,850 and 441,000 Incentive Stock Options ("ISO's")with a
fair value under SFAS No. 123 of approximately $118 and $486 to employees during
the quarter ended June 30, 2002 and 2001, respectively.
Non-cash stock based compensation expense under SFAS No. 123 related to ISO's
recognized during the quarter ended June 30, 2002 and 2001 was approximately
$3,460 and $3,543, respectively. Non-cash stock based compensation expense under
SFAS No. 123 related to ISO's recognized during the six months ended June 30,
2002 and 2001 was approximately $7,066 and $6,844, respectively. As of June 30,
2002, the Company had not reflected $15,245 of unamortized compensation expense
in its financial statements for options granted as of June 30, 2002. The
unamortized compensation expense is recognized over the ISO's vesting period,
which is approximately three years.
Outperform Stock Option Plan
The Company granted 10,000 and 500,000 Outperform Stock Options ("OSO's") to
employees during the quarter ended June 30, 2002 and 2001, respectively, with a
fair value under SFAS No. 123 of $61 and $3,602, respectively. The terms and
conditions of the OSO's granted in 2002 and 2001 were generally the same except
that the initial strike price is the market price on the date of grant.
Non-cash stock based compensation expense related to OSO's recognized during the
quarter ended June 30, 2002 and 2001 was approximately $5,772 and $6,842,
respectively. Non-cash stock based compensation expense related to OSO's
recognized during the six months ended June 30, 2002 and 2001 was approximately
$11,531 and $13,507, respectively. As of June 30, 2002, the Company had not
reflected $44,966 of unamortized compensation expense in its financial
statements for options granted as of June 30, 2002. The unamortized compensation
expense is recognized over the OSO's vesting period, which is approximately five
years.
Restricted Stock
18
The Company recorded $2,328 and $5,794 of non-cash compensation expense during
the quarter ended June 30, 2002 and 2001, respectively, and $(4,667) and $9,743
for the six months ended June 30, 2002 and 2001, respectively, relating to
grants of restricted stock to employees pursuant to its restricted stock
program. During the quarter and six months ended June 30, 2002, the Company
cancelled 31,288 and 697,835, respectively, grants of restricted stock,
resulting in a $164 and $11,360 reduction to non-cash compensation expense for
the quarter and six months ended June 30, 2002.
As of June 30, 2002, the Company had unearned compensation costs of $8,301 which
is being amortized to expense over the restriction period.
Preferred Stock
At June 30, 2002 the Company paid cumulative dividends in the amount of $62,887
in the form of additional Series A Preferred Stock. At June 30, 2002 the number
of common shares that would be issued upon conversion of the Series A Preferred
Stock was 8,022,755.
At June 30, 2002 the Company paid cumulative dividends in the amount of $290,832
in additional shares of Series B Preferred Stock. At June 30, 2002 the number of
common shares that would be issued upon conversion of the Series B Preferred
Stock was 31,303,734.
9. EARNINGS PER SHARE
Basic loss per share is computed based on net loss after preferred stock
dividend and accretion requirements divided by the weighted average number of
shares of common stock outstanding during the period.
Diluted loss per share is computed based on net loss after preferred stock
dividend and accretion requirements 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 preferred stock and 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 shares of preferred stock and stock options
which would have been assumed to be converted in the quarter and six months
ended June 30, 2002 and have a dilutive effect if the Company had income from
continuing operations is 38,329,909 and 38,664,608, respectively. The number of
shares of preferred stock and stock options which would have been assumed
converted in the quarter and six months ended June 30, 2001 and have a dilutive
effect if the Company had income from continuing operations is 36,018,210 and
36,717,302, respectively.
Quarter Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
------------- ------------ ------------- ------------
Net (loss) $ (1,054,208) $ (639,255) $ (1,163,353) $ (860,228)
Preferred stock dividend and accretion
requirements 40,192 37,595 79,718 74,567
------------- ------------ ------------- ------------
Net loss to common shareholders $ (1,094,400) $ (676,850) $ (1,243,071) $ (934,795)
Basic loss per average common share:
Weighted average shares outstanding 104,591,255 91,672,969 103,223,747 89,594,869
Loss per average common share before
extraordinary item $ (10.46) $ (7.38) $ (12.17) $ (10.43)
Extraordinary item -- -- $ .13 --
Net loss to common shareholders $ (10.46) $ (7.38) $ (12.04) $ (10.43)
Diluted loss per average common share:
Weighted average shares outstanding 104,591,255 91,672,969 103,223,747 89,594,869
Dilutive shares -- -- -- --
------------- ------------ ------------- ------------
Weighted average shares and common stock
equivalents outstanding 104,591,255 91,672,969 103,223,747 89,594,869
============= ============ ============= ============
Loss per average common share $ (10.46) $ (7.38) $ (12.04) $ (10.43)
19
10. COMPREHENSIVE INCOME
The Company primarily has two components of comprehensive income, cumulative
translation adjustments and unrealized appreciation/depreciation on investments.
The amount of total comprehensive loss for the quarter ended June 30, 2002 and
2001 was $(1,052,744) and $(644,573), respectively. The amount of total
comprehensive loss for the six months ended June 30, 2002 and 2001 was
$(1,161,514) and $(863,107), respectively.
11. SEGMENT REPORTING
Management believes that the Company operates as one reportable operating
segment, which contains many shared expenses generated by the Company's various
revenue streams. Any segment allocation of these shared expenses that were
incurred on a single network to multiple revenue streams would be impractical
and arbitrary. In addition, 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.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Thousands of Dollars, Except Per Share Data)
The following discussion should be read in conjunction with the RCN
Corporation's ("RCN" or the "Company") condensed consolidated financial
statements and notes for the periods ended June 30, 2002, and with the audited
financial statements and notes included in the Company's December 31, 2001
Annual Report on the Form 10-K filed with the Securities and Exchange
Commission.
INTRODUCTION
RCN Corporation is a leading facilities-based competitive provider of bundled
phone, cable television and high-speed Internet services to the most densely
populated markets in the U.S. We have more than one million customer connections
and provide service in the Boston, New York, Philadelphia, Chicago, Los Angeles,
San Francisco and Washington DC metropolitan markets.
We have experienced significant growth over the past years through acquisitions
and building and developing our own network. We believe we are the first company
in many of our markets to offer one-stop shopping for video, phone and Internet
services to residential customers. The costs associated with the growth of our
network and our operational infrastructure, expanding the level of service
provided to our customers, and sales and marketing expenses are the primary
reasons for the past operating losses. The Company does anticipate income from
operations in the foreseeable future as we continue our efforts to optimize our
network infrastructure, increase operating efficiencies, and reduce operating
costs. Certain of our operating markets are currently achieving positive
operating results before the recognition of non-cash expenses primarily relating
to the previous network development and non-cash stock based compensation. We
also expect to continue to grow and achieve positive operating margins (revenues
less direct costs). This will be accomplished as the Company continues to
increase the number of customers on our network, increase the number of services
per customer while lowering the costs associated with the new subscribers and
reducing the costs of providing services by capturing economies of scale.
GENERAL
Our primary business is delivering bundled communications services, including
local and long distance telephone, video programming (including digital cable
TV) and data services (including cable modem high speed internet access and dial
up Internet) to residential customers over our predominately owned network. We
currently serve customers in 7 of the 10 most densely populated areas of the
country. These markets include Boston and 18 surrounding communities, New York
City, including Queens, the Philadelphia suburbs, Washington D.C. and certain
suburbs, Chicago, San Francisco and certain suburbs, and certain communities in
Los Angeles. We also serve the Lehigh Valley in Pennsylvania, and we are the
incumbent franchised cable operator in many communities in central New Jersey
and in Carmel, New York.
ResiLink(sm) is the brand name of our family of bundled service offerings that
enables residential customers to enjoy pre-packaged bundles of Phone, Cable TV
and high-speed Internet for a flat monthly price. These packages have different
combinations of our core services and include various phone features and premium
channels. In addition, we offer RCN Essentials(SM), which is designed to appeal
to
21
customers seeking simplification and value. These packages offer consumers a
core set of communications and entertainment services that include cable TV and
phone and lets customers build their own bundle through the purchase of
additional voice, video and data products.
In addition to ResiLink, we sell Phone, Cable TV, High-Speed cable modem and
dial-up Internet to residential customers on an a-la-carte basis, and we provide
communication services to commercial customers. We are working to leverage the
excess capacity of our broadband network to allow us to expand our offering of
new services.
Our services are typically delivered over our predominately owned high-speed,
high-capacity, fiber-optic network. Our network is a broadband fiber-optic
platform that typically employs diverse backbone architecture and localized
fiber-optic nodes. This architecture allows the Company to bring its
state-of-the-art broadband within approximately 900 feet of its customers, with
fewer electronics and lower maintenance costs than existing competitors' local
networks. We have generally designed our broadband network to have sufficient
capacity so that we believe we have the capability of adding new communications
services more efficiently and effectively than the incumbents or other
competitors.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements of the Company and its wholly-owned
subsidiaries and joint ventures are prepared in conformity with accounting
principles generally accepted in the United States. Generally accepted
accounting principles require management to make estimates and assumptions that
affect the amounts reported in the financial statements and notes. When sources
of information regarding the carrying values of assets and liabilities are not
readily apparent, the Company bases its estimates on historical experience and
on various other assumptions that are believed to be reasonable for making
judgments. The Company evaluates all of its estimates on an on-going basis.
Actual results could differ from those estimates.
The significant accounting policies of the Company are described in the notes to
the consolidated financial statements included in the Company's December 31,
2001 Annual Report on the form 10-K filed with the Securities and Exchange
Commission.
The critical accounting practices that contain management judgement and
estimates used in the preparation of our condensed consolidated financial
statements include the economic useful lives of the property, plant and
equipment, estimated losses from the inability of our customers to make required
payments, estimated costs to settle any disputes or claims, including legal
fees, and cash flow valuation assumptions in performing asset impairment tests
of long-lived assets.
JOINT VENTURES
To increase our market entry and gain access to rights of way, we formed key
alliances in strategic markets.
The Company is party to the RCN-Becocom, LLC joint venture with NSTAR
Communications, Inc. ("NSTAR Communications"), a subsidiary of NSTAR, regarding
construction of our broadband network and operation of our telecommunications
22
business in the Boston metropolitan area. NSTAR is a holding company that,
through its subsidiaries, provides regulated electric and gas utility services
in the Boston area. At June 30, 2002, following NSTAR's exchanges of their joint
venture ownership interest for the Company's stock (see note 3 of the notes to
condensed consolidated financial statements for the quarter ended June 30,
2002), the Company had a sharing ratio of 100% and an investment percentage of
70.24% in the RCN-Becocom joint venture. The investment percentage represents
the percent of each capital call that RCN has the right to invest. RCN-Becocom
is consolidated in our financial statements.
The Company is party to the Starpower joint venture with Pepco Communications,
Inc. ("Pepco"), a subsidiary of Potomac Electric Power Company ("Potomac"),
regarding construction of our broadband network and operation of our
telecommunications business in the Washington, D.C. metropolitan area, including
parts of Virginia and Maryland. Through its subsidiaries, Potomac is engaged in
regulated utility operations and in diversified competitive energy and
telecommunications businesses. The Company and Pepco each own a 50% membership
interest in Starpower. Starpower is reflected in our financial statements under
the equity method of accounting.
USE OF PRO-FORMA DISCLOSURES
The Company's management measures financial and operational performance, which
includes the consolidation of all joint ventures including Starpower, which is
not consolidated under generally accepted accounting principles ("GAAP"). The
use of pro-forma financial disclosures represents management's view of the total
RCN consolidated operation.
The following financial highlights for the six months ended June 30, 2002
reflect the consolidation of Starpower:
Financial Highlights Consolidated
(dollars in thousands) RCN Corporation Starpower** Pro-Forma
---------------------- --------------- ----------- -------------
Total sales $ 252,524 $41,477 $ 294,001
Total direct costs $ 102,274 $10,227 $ 112,501
Margin $ 150,250 $31,250 $ 181,500
Total operating,
selling and general
and administrative costs $ 199,201 $22,937 $ 222,138
Adjusted EBITDA* $ (48,951) $ 8,313 $ (40,638)
* Adjusted EBITDA - Non GAAP measure calculated as net loss before interest,
tax, depreciation and amortization, stock based compensation, extraordinary
gains and special charges. Other companies may calculate and define EBITDA
differently than RCN.
** Net of related party transactions with RCN Consolidated
23
SEGMENT REPORTING
Management believes that the Company operates as one reportable operating
segment, which contains many shared expenses generated by the Company's various
revenue streams. Any segment allocation of these shared expenses that were
incurred on a single network to multiple revenue streams would be impractical
and arbitrary. In addition, 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.
OVERVIEW
Approximately 92% of the Company's revenue for the six months ended June 30,
2002 is attributable to monthly telephone line service charges, local toll,
special features and long-distance telephone service fees, monthly subscription
fees for basic, premium, and pay-per-view cable television services, and
Internet access fees through high-speed cable modems, dial up telephone modems,
web hosting and dedicated access. The remaining 8% of revenue is derived from
reciprocal compensation which is the fee local exchange carriers pay to
terminate calls on each other's networks, and the Company's long distance
wholesale operation. Because of the uncertainty of various regulatory rulings
that affect the collectibility of reciprocal compensation, the Company
recognizes this revenue as cash is received. We have generated increased
revenues over the past quarters and years, primarily through internal growth of
our broadband network, internal customer growth, and revenues from new services
per customer.
Our expenses primarily consist of direct expenses, operating, selling and
general and administrative expenses, stock-based compensation, depreciation and
amortization, and interest expense. Direct expenses primarily include cost of
providing services such as cable programming, franchise costs and network access
fees. Operating, selling and general and administrative expenses primarily
include customer service costs, advertising, sales, marketing, order processing,
telecommunications network maintenance and repair ("technical expenses"),
general and administrative expenses, installation and provisioning expenses, and
other corporate overhead.
The Company has had a history of net losses as we built and expanded our
network. As we continue to optimize our network infrastructure, increase
operating efficiencies and expand our marketing and sales initiatives, we
anticipate continuing losses in the foreseeable future. For the six months ended
June 30, 2002, our operating, and selling and general administrative expenses
decreased $57,716 or 22.5% to $199,201 from $256,917 for the six months ended
June 30, 2001.
As a response to the severe slowdown in the telecommunications industry and
economy, the limited available capital resources for our industry, and following
the completion of the Amendment to the Company's Credit Agreement with JPMorgan
Chase dated March 25, 2002, we revised our growth plan accordingly during the
second quarter 2002. The revised growth plan also meets the terms and conditions
as outlined in the Amendment, which permits the Company to lower its growth
trajectory. Under the revised plan, the Company has substantially curtailed
future capital spending and network geographic expansion in all existing
markets, focuses on the
24
continuation of customer acquisition growth, and has reduced operating expenses.
During the second quarter 2002, we also performed a comprehensive review of our
network capacity and current network utilization levels for the purpose of
identifying underutilized network-related assets and assets not in use. The
review consisted of a detailed assessment of the current network infrastructure,
ongoing network optimization activities, usage projections based on target
future customer levels, and available capital resources for completion of
construction in progress and future expansion. As a result, the Company
recognized an asset impairment of approximately $884,193 during the second
quarter of 2002. In addition, the Company recognized approximately $8,091 of
special charges, net of recoveries for exiting excess facilities, during the
second quarter of 2002 as a result of the curtailing of construction and
expansion, and the consolidation of certain operating activities. The Company
can make no assurances that future impairments on our long-lived assets will not
be realized.
The total asset impairment and special charges for the quarter ended June 30,
2002 is as follows:
Quarter Ended
June 30, 2002
-------------
Impairment on property plant, and equipment $734,821
Abandoned assets 52,071
Construction materials 56,995
Goodwill 38,927
Franchises 1,379
--------
Total asset impairment 884,193
Exit costs for excess facilities 8,091
--------
Total asset impairment and
special charges $892,284
========
When we developed our network, we built our network capacity to meet
expectations regarding rapid expansion of demand, including in connection with
anticipated growth of new technology that would demand higher levels of capacity
to service customers in the future. In accordance with our revised plan, we have
substantially curtailed future capital spending and network geographic
expansion. The second quarter review compared the net book value of each
reporting unit with undiscounted future cash flow projections based on the
Company's current operating plan. The results indicated that certain assets and
capitalized costs associated with the building and constructing our network in
all of our overbuild reporting units were not recoverable. To determine the
impairment loss of those assets to be held and used, the Company performed a
fair value test, using the "best-estimate" approach on the primary asset group
of each reporting unit by comparing the carrying value to the present value of
estimated future cash flows for the remaining useful life of the asset group.
The amount by which the carrying value of the assets exceeded the present value
of estimated cash flows was approximately $734,821. The impairment loss affected
all of our overbuild reporting units and none of our incumbent reporting units.
Based on our revised business plan, certain construction projects in progress
were stopped and other previous planned expansion projects were abandoned. This
stoppage is deemed to be other than temporary. In addition, certain capitalized
25
costs and assets related to the subscriber gaining access to the Company's
network were stranded based on the cost of retrieving the assets. The Company
also abandoned certain corporate assets including leasehold improvements in
certain facilities that were exited. The cost related to these stranded assets
was approximately $52,071.
Construction material levels were also assessed based on the revised business
plan and stoppage of certain construction projects. The assessment process
resulted in the identification of excess construction material that cannot be
used for alternative use and which is either to be returned to vendors, or
resold to a secondary market. The carrying values of the construction materials
that were identified that will be used in operations were written down to market
value, which was lower than carrying value. The carrying values of the
identified excess construction materials that will be sold were written down to
the anticipated recovery rate or salvage value. The total amount of charges to
dispose of inventory determined to be in excess was approximately $56,995.
In conjunction with the asset impairment test and review, the Company also
performed a test to identify any potential impairment on the carrying value of
goodwill on each identified reporting unit of the Company. The results of the
test indicated that the carrying amount of goodwill on certain reporting units
was impaired. During the second quarter 2002, the Company measured the
impairment loss by the amount the carrying value exceeded the implied fair value
of the goodwill on the reporting unit. During the second quarter 2002, a
goodwill impairment loss of $38,927 was recognized in the Company's reporting
units. The fair value of the reporting units was estimated using the expected
present value of future cash flows.
As a result of the change in expansion plans, management has been in contact
with the relevant franchising authorities to inform them of the Company's
decision to stop construction and expansion. Based on the revised business plan
and the curtailing of expansion, the Company wrote off the value of certain
franchise licenses of approximately $1,379.
Over the past year, a detailed review of facility requirements against lease
obligations has been continuously conducted to identify excess space. Along with
the stoppage of certain construction projects and expansion, the Company has
also consolidated certain operating activities, which resulted in exiting excess
facilities. Costs to exit excess facilities in the amount of $8,091 were accrued
in the second quarter 2002. This amount represents future lease obligations less
estimates of net sublease income at prevailing market rates.
RESULTS OF OPERATIONS
Quarter and Six Months Ended June 30, 2002 Compared to Quarter and Six Months
Ended June 30, 2001
For the second quarter ended June 30, 2002 and 2001, net loss before
extraordinary item was $1,054,208 and $639,255, respectively, or $(10.46) and
$(7.38) per average common share. For the six months ended June 30, 2002 and
2001, net loss before extraordinary item was $1,176,426 and $860,228
respectively, or $(12.17) and $(10.43) per average common share.
Sales:
Total sales increased $17,026 or 15.3%, to $127,989 for the quarter ended June
30, 2002 from $110,963 for the quarter ended June 30, 2001. Total sales
26
increased $35,613 or 16.4% to $252,524 for the six months ended June 30, 2002
from $216,911 for the six months ended June 30, 2001.
Sales by service offerings are as follows:
Quarter Ended June 30, Six Months Ended June 30,
------------------------------- ------------------------------
2002 2001 Change 2002 2001 Change
-------- -------- --------- -------- -------- --------
Voice $ 32,594 $ 27,670 $ 4,924 $ 65,503 $ 51,332 $ 14,171
Video 61,563 50,433 11,130 120,129 97,402 22,727
Data:
Dial up 6,839 16,717 (9,878) 14,026 36,244 (22,218)
Cable modem 15,868 7,583 8,285 32,726 12,908 19,818
Other 11,125 8,560 2,565 20,140 19,025 1,115
-------- -------- --------- -------- -------- --------
$127,989 $110,963 $ 17,026 $252,524 $216,911 $ 35,613
======== ======== ========= ======== ======== ========
The increase in voice sales was primarily due to an increase in average voice
connections. For the quarter ended June 30, 2002, average voice connections
increased 34,614, or 17.4%, to 233,894 from 199,279 for the quarter ended June
30, 2001. For the six months ended June 30, 2002, average voice connections
increased 41,715, or 22.0%, to 231,426 from 189,711 for the six months ended
June 30, 2001. The increase in average voice connections resulted in additional
voice sales for the quarter and the six months ended June 30, 2002 of $4,824 and
$11,807, respectively.
In addition to the increase in average voice connections, average monthly
revenue per voice connection increased by $.17 to $46.45 for the quarter ended
June 30, 2002 from $46.28 for the quarter ended June 30, 2001. For the six
months ended June 30, 2002 average monthly revenue per voice connection
increased $2.07 to $47.17 from $45.10 for the six months ended June 30, 2001.
The increase in average monthly revenue per connection resulted in $100 and
$2,364, of additional voice sales for the quarter and six months ended June 30,
2002, respectively.
The increase in video sales was primarily due to higher average video
connections. For the quarter ended June 30, 2002, average video connections
increased 39,624, or 9.2%, to 468,386 from 428,762 for the quarter ended June
30, 2001. For the six months ended June 30, 2002, average video connections
increased 43,722, or 10.4%, to 464,739 from 421,017 for the six months ended
June 30, 2001. The increase in average voice connections resulted in additional
video sales for the quarter and six months ended June 30, 2002 of $5,208 and
$11,302, respectively.
In addition to the increase in average video connections, average monthly
revenue per video connection increased $4.60, or 11.7%, to $43.81 for the
quarter ended June 30, 2002 from $39.21 for the quarter ended June 30, 2001. For
the six months ended June 30, 2002, average monthly revenue per video connection
increased $4.52, or 11.7%, to $43.08 from $38.56 for the six months ended June
30, 2001. The increase in average monthly revenue per connection resulted in
$5,922 and $11,425, respectively, of additional video sales for the quarter and
six months ended June 30, 2002.
The decrease in data sales compared to the same period in 2001 was primarily due
to a decrease in average dial-up Internet connections, partially offset by an
increase in average high-speed cable modem connections. Average dial-up Internet
27
connections decreased 63,866, or 27.5%, to 168,407 for the quarter ended June
30, 2002 from 232,273 for the quarter ended June 30, 2001. For the six months
ended June 30, 2002, the average dial-up Internet connections decreased 62,773,
or 26.2%, to 176,715 from 239,488 for the six months ended June 30, 2001. The
decrease in average dial-up Internet connections was the primary factor in
$9,878 and $22,218 less data sales for the quarter and six months ended June 30,
2002, respectively.
The decrease in dial-up Internet connections was partially offset by an increase
in average high-speed cable modem connections for the quarter and six months
ended June 30, 2002. Average high-speed cable modem connections increased
52,538, or 66.3%, to 131,816 for the quarter ended June 30, 2002 from 79,278 for
the quarter ended June 30, 2001. For the six months ended June 30, 2002, average
high-speed cable modem connections increased 53,435, or 73.6%, to 126,079 from
72,644 for the six months ended June 30, 2001. The increase in average
high-speed cable modem connections was the primary factor in $8,285 and $19,818
additional data sales for the quarter and six months ended June 30, 2002,
respectively.
Other sales increased in the quarter and six months ended June 30, 2002,
compared to the same period in 2001 primarily due to higher reciprocal
compensation in 2002.
Costs and Expenses, Excluding Stock-Based Compensation, Depreciation and
Amortization:
Direct expenses, comprised of costs of providing services, decreased for the
quarter and six months ended June 30, 2002 compared to the same period in 2001.
For the quarter ended June 30, 2002, direct expenses decreased $1,347, or 2.6%,
to $51,436 from $52,783 for the quarter ended June 30, 2001. For the six months
ended June 30, 2002, Direct expenses decreased $3,670, or 3.5%, to $102,274 from
$105,944 for the six months ended June 30, 2001. The decrease in Direct expenses
was principally the result of lower cost per connection, which was offset by
higher average connections and lower margin on video sales due to higher
franchise fees and programming rates. The Company also recognized a higher
margin on Internet sales due to network optimization.
For the quarter and six months ended June 30, 2002, Operating, selling and
general and administrative costs decreased 17.9% and 22.5%, respectively,
compared to the same period in 2001. Components of Operating, selling and
general and administrative costs are as follows:
Quarter Ended June 30, Six Months Ended June 30,
-------------------------------- -------------------------------
2002 2001 Change 2002 2001 Change
-------- -------- --------- -------- -------- --------
Customer service $ 15,101 $ 16,082 $ (981) $ 29,419 $ 33,832 $ (4,413)
Network operations
and construction 13,754 14,407 (653) 28,916 30,457 (1,541)
Sales and marketing 11,246 20,112 (8,866) 22,967 42,268 (19,301)
Advertising costs 3,602 2,317 1,285 6,256 6,484 (228)
Operating, general and
administrative 54,617 66,878 (12,261) 111,643 143,876 (32,233)
-------- --------- --------- -------- --------- --------
$ 98,320 $ 119,796 $ (21,476) $199,201 $ 256,917 $(57,716)
======== ========= ========= ======== ========= ========
Customer service costs decreased for the quarter and six months ended June 30,
2002 compared to the same period in 2001. The major components of the decrease
are lower staff and personnel related reductions of approximately $2,054 and
28
$5,015,respectively, which was partially offset by higher outside labor costs of
$1,183 and $4,016, respectively. For the quarter ended June 30, 2002,
maintenance contract costs of approximately $108 were reduced. For the six
months ended June 30, 2002 lower telephone costs of approximately $1,648,
attributable to reduced rates from telephone service providers also contributed
to the decrease in costs.
Network operations and construction costs decreased for the quarter and six
months ended June 30, 2002 compared to the same period in 2001. For the quarter
and six months ended June 30, 2002, lower repair and maintenance costs relating
to the network and the fleet, and rental costs relating to the network of
approximately $1,388 and $1,453, respectively, contributed to the decrease
in costs.
Sales and marketing costs decreased for the quarter and six months ended June
30, 2002 compared to the same period in 2001 primarily due to reductions in
staff as a result of the reduction of network expansion and network operations,
and related commissions and benefits of approximately $6,026 and $12,234,
respectively. The Company's sales and marketing efforts are now focused on
higher mix of direct mail and telemarketing relative to direct sales, resulting
in lower overall cost per acquired connection. For the quarter and six months
ended June 30, 2002, lower sales and promotional discounts of approximately
$2,840 and $7,067, respectively, also contributed to the decrease in costs.
Advertising costs increased for the quarter ended June 30, 2002 compared to the
same period in 2001 primarily due to higher direct mail advertising costs of
approximately $688 relating to an advertising campaign introducing several new
service combination offering. Advertising costs decreased for the six months
ended June 30, 2002 compared to the same period in 2001 primarily from lower
radio advertising partially offset by higher direct mail advertising. The
decrease in radio advertising of $2,461 for the six months ended June 30, 2002
is primarily related to a shift in the Company's advertising philosophy away
from mass media branding to a more stratified customer targeted campaign. This
targeted approach is being executed through direct mail advertising, which
increased by approximately $2,071 for the six months ended June 30, 2002 as
compared to the same period in 2001. Higher newspaper advertising costs related
to the new service combination offerings of approximately $597 and $162,
respectively, also contributed to the increase in costs for the quarter and six
months ended June 30, 2002.
Operating, general and administrative expenses decreased for the quarter and six
months ended June 30, 2002 compared to the same period in 2001 primarily due to
staff reductions and personnel related costs, and a decrease in legal expense.
For the quarter and six months ended June 30, 2002, staff reductions and
personnel related costs decreased approximately $1,349 and $9,265, respectively.
Legal expense decreased approximately $14,655 and $18,854, respectively,
primarily representing a reduction in litigation and legal costs for franchise
related exit costs. For the quarter and six months ended June 30, 2002, compared
to the same periods in 2001, building rent decreased approximately $3,376 and
$6,921, primarily as a result of the Company's efforts to reduce excess space
and consolidate operations. For the quarter and six months ended June 30, 2002,
the decrease in expenses was partially offset by higher computer system and
maintenance contract costs associated with the new customer care and billing
system of approximately $4,765 and $2,808. For the quarter ended June 30, 2002,
29
compared to the quarter ended June 30, 2001, bad debt expense increased
approximately $2,352, primarily as the result of a detailed review of old
customer balances and billed but not collected revenue. Included in
the second quarter 2002 bad debt expense, the Company reserved 100% of the meet
point receivable from WorldCom Inc., which was approximately $485.
Non-cash Stock-Based Compensation:
Non-cash stock-based compensation decreased for the quarter and six months ended
June 30, 2002 compared to the same periods in 2001, due to the cancellation of
restricted stock grants in 2002 as a result of a reduction in the Company's work
force. For the quarter ended June 30, 2002, non-cash stock-based compensation
decreased by approximately $4,607, or 28.0%, to $11,826 from $16,433 for the
quarter ended June 30, 2001. For the six months ended June 30, 2002, non-cash
stock based compensation decreased $16,357 or 53.2%, to $14,402 from $30,759 for
the six months ended June 30, 2001. The Company cancelled restricted stock
grants of 10,082 and 697,835 grants, for the quarter and six months ended June
30, 2002, respectively.
Depreciation and Amortization:
For the quarter ended June 30, 2002, depreciation and amortization expense
increased $3,656 or 4.4%, to $87,605 from $83,949 for the quarter ended June 30,
2001. This increase was largely the result of additional capital expenditures
related to customer acquisition cost, which was partially offset by the decrease
in amortization of goodwill. For the six months ended June 30, 2002,
depreciation and amortization decreased $12,123 or 6.9% to $163,502 from
$175,625 for the six months ended June 30, 2001. The decrease in 2002 was the
result of goodwill no longer amortized. For the quarter and six months ended
June 30, 2001, goodwill amortization was $15,620 and $42,383, respectively.
There was no goodwill amortization expense in 2002 due to the Company's adoption
of Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets". This pronouncement changes the accounting for goodwill and
intangible assets with indefinite lives from an amortized method to an
impairment approach. See note 2 to the Condensed Consolidated Financial
Statements for the quarter ended June 30, 2002.
Asset Impairment and Special Charges:
As described and discussed in detail in the Overview section, the total Asset
impairment and special charges for the second quarter ended June 30, 2002 was
approximately $892,284.
The Asset impairment and special charges for the quarter ended June 30, 2001 was
approximately $454,880. This impairment primarily consisted of goodwill
recognized from prior business combinations. Beginning in the fourth quarter of
2000, in light of the declining economic environment, the Company began planning
to modify its growth trajectory in light of the available capital and
anticipated availability of capital. The Company also began planning to
undertake certain initiatives to effect operational efficiencies and reduce
cost.
Accordingly, during the second quarter of 2001, management concluded its
planning and revised its strategic and fundamental plans in order to achieve
these objectives. Based on these revisions to its plans, management took actions
during the second quarter of 2001 to realign resources to focus on core
opportunities and product offerings. The Company also shifted focus from
30
beginning construction in new markets to its existing markets where the Company
could based on higher growth with lower incremental capital spending.
Specifically, expansion to new markets was curtailed and expansion plans for
existing markets over the subsequent 24 to 36 months were curtailed in some
markets, delayed in some markets and shifted in other markets as deemed
appropriate.
As a result, during the six months ended June 30, 2001, the Company assessed the
recoverability of its investment in each market, which lead to the recognition
of an impairment to goodwill and the recording of special charges aggregating
approximately $471,000. The special charge of $471,000 comprised the impairment
of identifiable intangible and goodwill assets in the amount of $256,000, and
the impairment of property and equipment in the amount of $114,000. In addition,
charges to dispose of excess construction materials were approximately $70,000
and estimated costs to exit excess facilities were approximately $31,000.
Investment Income:
For the quarter ended June 30, 2002, Investment income decreased approximately
$15,969 or 86.5%, to $2,488 from $18,457 for the quarter ended June 30, 2001.
For the six months ended June 30, 2002, Investment income decreased $45,789 or
81.9% to $10,132 from $55,921 for the six months ended June 30, 2001. The
decrease was a result of lower interest rates and a decrease in average cash,
temporary cash investments, short-term investments and restricted investments at
June 30, 2002 compared to June 30, 2001. Cash, temporary cash investments,
short-term investments, and restricted investments were $455,477 at June 30,
2002 compared to $1,059,927 at June 30, 2001. The decrease in average cash was
primarily attributable to long-term debt repayments, capital expenditures, and
working capital requirements.
Interest Expense:
Interest expense decreased for the quarter and six months ended June 30, 2002
compared to the same period in 2001 primarily due to lower interest accretion on
discount notes and the extinguishment of debt. For the quarter ended June 30,
2002, interest expense decreased $11,755 or 23.2%, to $38,920 from $50,675 for
the quarter ended June 30, 2001. For the six months ended June 30, 2002,
Interest expense decreased $24,706 or 23.7% to $79,534 from $104,240 for the six
months ended June 30, 2001. The decrease resulted primarily from lower accretion
on the 11.125%, 9.8% and 11.0% senior discount notes issued in October 1997,
February 1998 and June 1998, respectively, and the debt extinguishment from the
tender offers during the second half of 2001 and quarter ended March 31, 2002.
The total debt of the Company decreased $598,250 or 25.8% from $2,321,607 at
June 30, 2001 to $1,723,357 at June 30, 2002.
Income Tax:
The Company's effective income tax rate was a benefit of 0.01% and 0.07%,
respectively, for the quarter and six months ended June 30, 2002 as compared to
0.1% and 0.4%, respectively, for the same period in 2001. The tax effect of the
Company's cumulative losses has exceeded the tax effect of accelerated
deductions, primarily depreciation, which the Company has taken for federal
income tax purposes. As a result, generally accepted accounting principles do
not permit the recognition of such excess losses in the financial statements.
This accounting treatment does not impact cash flows for taxes or the amounts or
expiration periods of actual net operating loss carryovers.
31
Equity in Income (Loss) of Unconsolidated Entities:
For the second quarter ended June 30, 2002, Equity in (loss) income of
unconsolidated entities decreased $41,873 to a loss of $35,030 from a gain of
$6,843 for the quarter ended June 30, 2001. For the six months ended June 30,
2002, Equity in (loss) income of unconsolidated entities decreased $23,587 to a
loss of $23,916 from a loss of $329 for the six months ended June 30, 2001. The
loss and or income from unconsolidated entities, primarily represents the
Company's investments in Starpower, Megacable, and J2 Interactive. The losses
for the quarter and six months ended June 30, 2002, includes the Company's
portion of our identified asset impairment on Starpower.
The Company has imbedded goodwill in the investment in Megacable, which is no
longer amortized in accordance with SFAS No. 142. The estimated amortization of
goodwill in Megacable was approximately $1,800 per quarter.
Minority Interest in Loss of Consolidated Entities:
For the quarter ended June 30, 2002, Minority interest in loss of consolidated
entities decreased $27,608 to $33,340 from $5,732 for the quarter ended June 30,
2001. For the six months ended June 30, 2002, Minority interest in loss of
consolidated entities decreased $24,153 to $36,495 from $12,342 for the six
months ended June 30, 2001. The minority interest primarily represents the
interest of NSTAR Communications, Inc. in the loss of RCN-Becocom. The loss for
the quarter and six months ended June 30, 2002 is primarily due to the asset
impairment and special charges related to RCN-Becocom.
Extraordinary Item:
Extraordinary item increased to $13,073 for the six months ended June 30, 2002
from none for the same period in 2001. During the six months ended June 30,
2002, the Company retired approximately $24,037 in face value of debt with a
book value of approximately $22,142 for approximately $722 in cash and
approximately 2,589,237 shares of common stock with a value of $7,875, plus fees
of $180 and the write-off of debt issuance costs of $292.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents, and short-term investments decreased
$423,070 to $415,421 at June 30, 2002 from $838,491 at December 31, 2001. The
decrease resulted primarily from $123,294 used in operating activities, $98,544
used in investing activities, $199,997 used in financing activities, and the
change in unrealized appreciation in short-term investments of $1,235.
Net cash of $123,294 used in operating activities consisted primarily of $64,690
net loss adjusted for non-cash items and $58,604 used in working capital and
other activities. Net cash used in working capital and other activities resulted
in decreases in accounts payable and accrued expenses of $61,167, a net decrease
in accounts receivable and receivable from related parties of approximately
$2,563.
Net cash of $98,544 used in investing activities resulted primarily from
additions to property, plant and equipment, and construction materials of
$78,712, investment and advances in unconsolidated joint ventures of $7,500, and
an increase to restricted cash of $16,380. This cash used was offset by the
proceeds from the sale of assets of $4,048. The increase to property, plant, and
32
equipment was primarily due to the Company's expansion of its network in its
current markets.
Cash used in financing activities of $199,997 consisted primarily of the
repayment of long-term borrowings of $187,500, payments made for debt financing
costs of $11,843, and repayment of capital leases of $741. The cash used in
financing activities was partially offset by contributions from a minority
interest party of $87.
The Company has indebtedness that is substantial in relation to its
shareholders' equity, its assets and cash flow. At June 30, 2002 the Company had
an aggregate of approximately $1,723,357 of indebtedness outstanding. The
Company also has cash, temporary cash investments and short-term investments
aggregating approximately $415,421.
Long-term debt outstanding at June 30, 2002 and December 31, 2001 is as follows:
June 30, December 31,
2002 2001
---------- ------------
Term Loans $ 562,500 $ 750,000
Senior Notes 10% due 2007 161,116 161,116
Senior Discount Notes 11.125% due 2007 310,646 316,351
Senior Discount Notes 9.8% due 2008 307,435 293,073
Senior Discount Notes 11% due 2008 130,291 123,499
Senior Notes 10.125% due 2010 231,736 231,736
Capital Leases 19,633 20,373
---------- ----------
Total 1,723,357 1,896,148
Due within one year 33,184 22,532
---------- ----------
Total Long-Term Debt $1,690,173 $1,873,616
========== ==========
Contractual maturities of long-term debt over the next 5 years are as follows:
Aggregate Amounts
For the period July 1, 2002 thru
December 31, 2002 $ 16,707
For the year ended December 31, 2003 $ 38,466
For the year ended December 31, 2004 $ 46,471
For the year ended December 31, 2005 $ 64,813
For the year ended December 31, 2006 $221,468
As a result of the substantial indebtedness of the Company, the Company's fixed
charges, which includes interest, amortization of debt, and capital
expenditures, are expected to exceed its earnings for the foreseeable future.
The leveraged nature of the Company could limit its ability to effect future
financing or may otherwise restrict the Company's business activities.
The Company entered into an Amendment to the Credit Agreement dated March 25,
2002 (the "Amendment"). This Amendment amends certain financial covenants and
certain other negative covenants to reflect the Company's current business plan
and amends certain other terms and adds certain covenants of the Credit
Agreement, including increases to the margins and commitment fee payable
thereunder. In connection with the Amendment, the Company agreed to pay to
certain lenders an aggregate fee of approximately $14,400 of which approximately
33
$11,843 has been paid through June 30, 2002, to repay $187,500 of outstanding
term loans under the Credit Facility, and to permanently reduce the amount
available under the revolving loan from $250,000 to $187,500. The Company has
also agreed that it may not draw down additional amounts under the revolving
loan until the later of the date on which the Company delivers to the lenders
financial statements for the period ending March 31, 2004 and the date on which
the Company delivers to the lenders a certificate with calculations
demonstrating that the Company's EBITDA was at least $60,000 in the aggregate
for the two most recent consecutive fiscal quarters. Together, these provisions
place substantial limitations on the Company's ability to borrow money under the
Revolver, and there can be no assurance that the Company will be able to satisfy
these conditions or be able to draw under the Revolver. In connection with the
Amendment, each of the lenders party thereto also agreed to waive any default or
event of default under the Credit Agreement that may have occurred prior to the
date of the Amendment. The Company also entered into three previous amendments
to the credit agreement, as described further below.
In accordance with the Amendment, the Company prepaid $62,500 of the Term Loan A
on March 25, 2002. At June 30, 2002, $187,500 of the Term Loan A was
outstanding. Amortization of the Term Loan A starts on September 3, 2002 and
will be repaid in quarterly installments based on percentage increments of the
Term Loan A that start at 3.75% per quarter on September 3, 2002 and increase in
steps to a maximum of 10% per quarter on September 3, 2005 through to maturity
at June 3, 2006.
In accordance with the Amendment, the Company prepaid $125,000 of the Term Loan
B on March 25, 2002. At June 30, 2002, $375,000 of the Term Loan B was
outstanding. Amortization of the Term Loan B starts on September 3, 2002 with
quarterly installments of $750 per quarter until September 3, 2006 when the
quarterly installments increase to $90,750 per quarter through to maturity at
June 3, 2007.
The Revolver can also be utilized for letters of credit up to a maximum of
$15,000. At June 30, 2002 there were $15,000 in letters of credit outstanding
under the Revolver. At June 30, 2002 the Company also had letters of credit
outside the Revolver along with restricted cash of approximately $40,056, which
were collateralized by cash.
In accordance with the Amendment, the Company is permitted to contribute the
assets of the West Coast operations to a joint venture. Entering into a joint
venture is an alternative to the Company to leverage our assets, improve revenue
growth, and reduce the amount of expenditures required by the Company to develop
and maintain our network.
The Credit Agreement contains conditions precedent to borrowing, events of
default (including change of control) and covenants customary for facilities of
this nature. The Credit Facility is secured by substantially all of the assets
of the Company and its subsidiaries.
In the event that the Company fails to satisfy or comply with any of the
financial or negative covenants of the amended Credit Agreement and is unable to
obtain additional modifications or a waiver with respect thereto, the lenders
under the Credit Facility would be entitled to declare the outstanding
borrowings under the Credit Facility immediately due and payable and exercise
all or any of their other rights and remedies. In addition, any such
acceleration of amounts due under the Credit Facility would, due to cross
default provisions in the indentures governing the Company's Senior Notes,
entitle holders of Senior Notes to declare the Senior Notes and any accrued and
34
unpaid interest thereon immediately due and payable. Any such acceleration or
other exercise of rights and remedies by lenders under the Credit Facility
and/or holders of Senior Notes would likely have a material adverse effect on
the Company. The Company does not have sufficient cash resources to repay its
outstanding indebtedness if it is declared immediately due and payable.
The Company is permitted to make purchases of indebtedness of the Company solely
with equity proceeds of, or solely in exchange for, Common Stock of the Company
or Non-Cash Pay Preferred stock (as defined therein) of the Company provided
that, among other things, the amount of such purchases made with equity proceeds
does not exceed $300,000 in the aggregate. In June, 2001 the Company completed
an equity offering of 7,661,074 shares of common stock in exchange for $50,000
in proceeds.
During the first quarter ended March 31, 2002, the Company completed various
debt repurchases for certain of its Senior and Senior Discount Notes. The
Company retired approximately $24,037 in face amount of debt with a book value
of $22,142. The Company recognized an extraordinary gain of approximately
$13,073 from the early retirement of debt in which approximately $722 in cash
was paid and approximately 2,589,237 shares of common stock with a value of
$7,875 were issued to retire the debt. In addition, the Company incurred fees of
$180 and wrote off debt issuance costs of $292. There were no debt repurchases
during the second quarter ended June 30, 2002.
The Company is aware that the various issuances of Senior Notes and Senior
Discount Notes continue to trade at discounts to their respective face or
accreted amounts. In order to continue to reduce future cash interest payments,
as well as future amounts due at maturity, the Company may from time to time
acquire certain of these outstanding debt securities in exchange for shares of
RCN common stock pursuant to the exemption provided by Section 3(a)(9) of the
Securities Act of 1933, as amended, in open market or privately negotiated
transactions. We will evaluate any such transactions in light of then existing
market conditions. The amounts involved in any such transactions, individually
or in the aggregate, may be material.
The Company has two tranches of redeemable preferred stock, Series A and Series
B. At June 30, 2002 the Company had paid cumulative dividends in the amount of
$62,887 in the form of additional Series A Preferred Stock. At June 30, 2002 the
number of common shares that would be issued upon conversion of the Series A
Preferred Stock was 8,022,755. At June 30, 2002 the Company had paid cumulative
dividends in the amount of $290,832 in the form of additional shares of Series B
Preferred Stock. At June 30, 2002 the number of common shares that would be
issued upon conversion of the Series B Preferred Stock was 31,303,734. The
Series A Preferred Stock issued on April 7, 1999 is subject to a mandatory
redemption on March 31, 2014. The Series B Preferred Stock issued on February
28, 2000 is mandatorily convertible into the Company's Common Stock no later
than February 28, 2007.
The Company has an investment portfolio. The objective of the Company's "other
than trading portfolio" is to invest in high-quality securities, to preserve
principal, meet liquidity needs, and deliver a suitable return in relationship
to these guidelines.
The Company's successful debt and equity offerings have given the Company the
ability to partially implement the business plan. However, the Company may be
required to secure additional financing in the future. The Company can make no
assurances that we will have sufficient funds to meet or refinance our debt when
it becomes due.
35
The Company currently expects to fund expenditures for capital requirements as
well as liquidity needs for operations from a combination of available cash
balances, proceeds from revenues and financing arrangements. However, expenses
may exceed the Company's estimates and the financing needed may be higher than
estimated. At June 30, 2002, the Company had approximately $415,421 in cash and
short-term investments.
The Company may experience difficulty raising capital in the future, as both the
equity and debt capital markets have recently been difficult to access on
reasonable terms, particularly for securities issued by telecommunications and
technology companies. The ability of telecommunications companies to access
those markets as well as their ability to obtain financing provided by bank
lenders and equipment suppliers has become more restricted and financing costs
have increased. During some recent periods, the capital markets have been
largely unavailable to new issues of securities by telecommunications companies.
The Company's public equity and debt securities are trading at or near all time
lows, which together with its substantial leverage, means it may have limited
access to certain of its historic sources of capital.
In addition to raising capital through the debt and equity markets, the Company
may sell or dispose of existing businesses or investments to fund portions of
the business plan. The Company may not be successful in producing sufficient
cash flow, raising sufficient debt or equity capital on terms that it will
consider acceptable. The Company can make no assurances that we will have
sufficient funds to meet or refinance our debt when it becomes due.
Item 3. Quantitative & qualitative disclosures about market risk.
The Company has adopted Item 305 of Regulation S-K "Quantitative & qualitative
disclosures about market risk" which is effective in financial statements for
fiscal years ending after June 15, 1998. The Company currently has no items that
relate to "trading portfolios". Under the "other than trading portfolios" the
Company does have four short-term investment portfolios categorized as available
for sale securities that are stated at cost, which approximates market, and
which are re-evaluated at each balance sheet date and one portfolio that is
categorized as held to maturity which is an escrow account against a defined
number of future interest payments related to the Company's (10% Senior Discount
Notes). These portfolios consist of Federal Agency notes, Commercial Paper,
Corporate Debt Securities, Certificates of Deposit, U.S. Treasury notes, and
Asset Backed Securities. The Company believes there is limited exposure to
market risk due primarily to the small amount of market sensitive investments
that have the potential to create material market risk. Furthermore, the
Company's internal investment policies have set maturity limits, concentration
limits, and credit quality limits to minimize risk and promote liquidity. The
Company did not include trade accounts payable and trade accounts receivable in
the "other than trading portfolio" because their carrying amounts approximate
fair value.
The objective of the company's "other than trading portfolio" is to invest in
high quality securities and seeks to preserve principal, meet liquidity needs,
and deliver a suitable return in relationship to these guidelines.
36
Part II - OTHER INFORMATION
Item 4 - Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders was held on May 16, 2002. Matters submitted
to and approved by Shareholders included:
1. The election of Class II Directors to serve a term of three years:
Nominee For Withheld
- ------- --- --------
Alfred S. Fasola 101,539,918 2,008,013
Edward S. Harris 102,546,024 1,001,907
Richard R. Jaros 102,513,881 1,034,050
Timothy J. Stoklosa 102,482,610 1,065,321
Michael B. Yanney 102,515,064 1,032,867
Additional Directors whose term of office as a Director continued after the
meeting included:
David C. McCourt Michael A. Adams
James Q. Crowe Peter S. Brodsky
Eugene Roth Stuart E. Graham
William D. Savoy Thomas J. May
Walter Scott, Jr. Thomas P. O'Neill, III
2. The ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the fiscal year ending December 31, 2002.
For Against Abstain
- --- ------- -------
103,051,525 214,347 282,059
3. The approval of a proposal to amend the Amended and Restated Certificate of
Incorporation of the Company to increase the number of shares of Common Stock.
For Against Abstain
- --- ------- -------
101,390,856 1,983,436 173,639
4. The approval of a proposal to amend the Amended and Restated Certificate of
Incorporation of the Company to effect a reverse stock split.
For Against Abstain
- --- ------- -------
100,951,870 2,372,524 223,537
37
Item 6 - Exhibits and Reports on Form 8-K
(a.) Exhibits
(4.1) Consulting Agreement, effective as of September 20, 2001
between RCN and Walter Scott, Jr.
(4.2) Amendment No. 1 made as of July 2, 2002 to the Consulting
Agreement dated as of September 20, 2001, between RCN and Walter
Scott, Jr.
(4.3) Outperformance Option Agreement under the RCN Corporation 1997
Equity Incentive Plan, made as of September 20, 2001, between RCN and
Walter Scott, Jr.
(4.4) Amendment No. 1 made as of April 16, 2002 to the Outperformance
Option Agreement dated as of September 20, 2001, between RCN and
Walter Scott, Jr.
(99.1) Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(99.2) Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b.) Reports on Form 8-K
On May 7, 2002, RCN filed a Current Report on Form 8-K including the RCN
Corporation 1st Quarter Earnings Release.
On June 21, 2002, RCN filed a Current Report on Form 8-K announcing that RCN
Corporation ("RCN") and NSTAR Communications, Inc. completed an exchange of
NSTAR's investment in a joint venture for RCN Common Stock.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: August 14, 2002
/s/ Jeffrey M. White
----------------------------
Vice Chairman and
Chief Financial Officer
38