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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File No. 1-16805
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3498533
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
105 Carnegie Center, Princeton, New Jersey 08540
(Address of principal executive offices)(Zip Code)
Registrant's telephone number including area code: 609-734-3700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes | | No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. | |
Number of shares of the registrant's Stock ($1.00 par value) outstanding at
February 28, 2003: 109,666,640 Common Stock
Aggregate market value of registrant's voting and non-voting common stock held
by non-affiliates at June 28, 2002, the last business day of the registrant's
most recently completed second fiscal quarter, computed by reference to closing
price as reported by NASDAQ for Common Stock of $1.37 per share on June 28,
2002:
$79,987,592 Common Stock
Indicate by check mark whether the registrant is an accelerated filer as defined
by Rule 12b-2 of the 1934 Securities and Exchange Act:
|X| Yes | | No
Documents Incorporated by Reference
1. Proxy Statement to be filed in connection with the 2003 Annual Meeting of
Shareholders is incorporated by reference into Part III of this Form 10-K.
1
TABLE OF CONTENTS
PART I
Item 1 Business..........................................................................3
Item 2 Properties.......................................................................35
Item 3 Legal Proceedings................................................................37
Item 4 Submission of Matters to a Vote of Security Holders..............................37
PART II
Item 5 Market for the Registrant's Common Stock and Related Shareholder Matters.........39
Item 6 Selected Financial Data..........................................................39
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations....................................................................39
Item 7a Quantitative and Qualitative Disclosures about Market Risk.......................39
Item 8 Financial Statements and Supplementary Data......................................39
Item 9 Disagreements on Accounting and Financial Disclosure.............................39
PART III
Item 10 Directors and Executive Officers of the Registrant...............................39
Item 11 Executive Compensation...........................................................39
Item 12 Security Ownership of Certain Beneficial Owners and Management...................39
Item 13 Certain Relationships and Related Transactions...................................40
Item 14 Controls and Procedures..........................................................40
PART IV
Item 15 Exhibits, Financial Statement Schedules and Report on Form 8-K...................40
SIGNATURES...............................................................................45
CERTIFICATIONS...........................................................................47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....54
CONSOLIDATED STATEMENTS OF OPERATIONS....................................................74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...............................................81
2
PART I
This Annual Report on Form 10-K is for the year ended December 31, 2002. This
Annual Report modifies and supersedes documents filed prior to this Annual
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 Annual Report. RCN, we, us and our refer to RCN
Corporation and our subsidiaries.
You should carefully review the information contained in the Annual Report, but
should particularly consider any risk factors that we set forth in this Annual
Report and 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-K 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 and restructure our existing Credit
Facility;
- 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;
- 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.
Item 1. BUSINESS
Overview
The Company's primary business is delivering bundled communications services to
residential customers over a broadband network predominantly owned or leased by
the Company either directly or through joint ventures. Our network delivers
bundled communications services to consumers in some of the most densely
populated markets in the U.S. We are currently operating in Boston, including 18
surrounding communities, New York City, the Philadelphia suburbs, Chicago, San
Francisco, and several of its suburbs along with communities in Los Angeles. We
also serve the Lehigh Valley in Pennsylvania, communities in and around Carmel,
NY and we were the incumbent franchised cable operator in many communities in
central New Jersey until those operations were sold on February 19, 2003. In
addition, we also have a joint venture with Pepco Communications, Inc.,
Starpower, serving the Washington, D.C. metropolitan markets. We believe we are
the first company in many of our markets to offer one-stop
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shopping for phone, cable television and high-speed cable modem Internet
services to residential customers.
ResiLink(R) and Essentials(R) are the brand names of our two
families of bundled service offerings, offered for a flat monthly price to
residential customers of cable television, phone, and high-speed Internet.
In addition to our bundled package offerings, we sell cable
television, phone, and high-speed cable modem and dial-up Internet to
residential customers on an a-la-carte basis. We also provide communication
services to commercial customers.
We are working to leverage the capacity of our broadband network to
allow us to expand our offering of new services. In 2002, we launched RCN
MegaModem which provides 3 Mbps of speed for customers looking to download
movie videos, MP3 music files, and other Web-based forms of entertainment in as
little as half the time it would take with a standard 1.5 Mbps cable modem or
DSL connection. We believe MegaModem is the fastest Internet connection
available to residential customers in our markets. Also in 2002, we expanded
our launch of VOD in the Philadelphia market. We plan to launch Video-on-Demand
(VOD), Subscription Video-on-Demand (SVOD) and High Definition Television
(HDTV) in certain markets in 2003.
Our services are typically delivered over our own high-speed,
high-capacity, fiber-optic broadband network. In most markets our network can
reach an average of 150 homes per mile of network plant. The broadband network
is a fiber-optic platform that typically employs diverse backbone architecture
and localized fiber-optic nodes. This architecture allows us to bring our
state-of-the-art fiber optics within approximately 900 feet of our customers,
with fewer electronics and generally lower maintenance costs than existing
competitors' local networks. We have generally designed our broadband network in
certain markets to have sufficient capacity so we can add new communications
services more efficiently and effectively than the incumbents or other
competitors.
There can be no assurance that the Company will achieve or sustain
profitability, positive operating income or positive cash flows in the future as
we develop our business.
Historically we have reported the total number of service
connections purchased for high-speed Internet, cable television and phone rather
than the number of customers. For example, a single customer who purchases
high-speed Internet, cable television and a phone line is reported as three
connections. In addition, currently, phone connections only include access lines
and do not include long distance customer connections. See "Connections", below.
With the recent introduction of our new billing system, we are now also able to
quantify the number of customers we service. As of December 31, 2002, we had
approximately 1,143,283 total service connections including our Starpower joint
venture and excluding long distance. Of the these connections, approximately
846,000 connections are attributable to customers connected to our broadband
network, approximately 16,300 connections are attributable to resale telephony
customers served through other facilities and approximately 281,100 are
attributable to "dial-up" Internet customers.
We have undertaken major initiatives in our Information Technology
(IT) and Customer Care Departments. We have been and will continue devoting
resources toward the implementation of a new operational support system that
will allow us to more efficiently and effectively provision and manage the
delivery of our bundled services. The new operational support system has been
designed to help us provide superior customer service and simplified billing
choices. We believe that these and other initiatives will have a positive impact
in achieving our business goals.
Connections. The following table summarizes the development of our subscriber
base:
As of December 31,
RCN 2000 2001 2002
---- ---- ----
Phone 113,820 203,653 233,513
Cable television 245,260 371,063 388,209
Internet 38,063 100,336 143,529
------- ------- -------
Subtotal network connections 397,143 675,052 765,251
Resale 25,629 22,433 9,838
Dial-up N/A 200,349 147,388
------- ------- -------
Total service connections 422,772 897,834 922,477
Long distance connections N/A N/A 158,784
Marketable homes 924,609 1,218,045 1,228,812
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Homes passed 1,222,217 1,386,377 1,399,191
Starpower
Phone 5,668 16,909 24,590
Cable television 19,935 31,300 39,120
Internet 4,103 10,280 16,874
------- ------- -------
Subtotal network connections 29,706 58,489 80,584
Resale 18,913 11,499 6,465
Dial-up N/A 161,244 133,757
------- ------- -------
Total service connections 48,619 231,232 220,806
Long distance connections N/A N/A 23,870
Marketable homes 175,449 171,167 175,072
Homes passed 166,605 208,512 211,387
Combined
Phone 119,488 220,562 258,103
Cable television 265,195 402,363 427,329
Internet 42,166 110,616 160,403
------- ------- -------
Subtotal network connections 426,849 733,541 845,835
Resale 44,542 33,932 16,303
Dial-up N/A 361,593 281,145
------- ------- -------
Total service connections 471,391 1,129,066 1,143,283
Long distance connections N/A N/A 182,654
Marketable homes 1,100,058 1,389,212 1,403,884
Homes passed 1,388,822 1,594,889 1,610,578
"Resale" figures in the table above represent resold local phone
service provided to customers through third party facilities.
"Cable television" figures in the table above include at December
31, 2002 approximately 28,000 connections, which reside on the Company's 18 GHZ
wireless network (primarily in New York City and Chicago).
"Dial-up" figures in the table above primarily represent 56K dial-up
Internet access services. Dial-up figures not available prior to December 31,
2001.
"Long distance" connections in the table above are not available
prior to December 31, 2002.
In the Washington, D.C. area served by our Starpower joint venture,
subscribers are Starpower customers and are included in the combined connections
section of the table above. As of December 31, 2002, we own 50% of the Starpower
joint venture. (See Joint Ventures.)
We distinguish between homes passed and marketable homes because of
the steps required to prepare to sell and provide services to customers after
the network has been constructed in a particular building or neighborhood. We
report marketable homes, which represent that segment of homes passed to which
we have commenced selling our products.
Recent Developments
The Company entered into an amendment on March 7, 2003 to the Credit
Agreement dated June 3, 1999 (the "Fifth Amendment"). The Fifth Amendment
adjusts the operating and financial
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covenants to reflect the Company's business plan and modifies other restrictions
that existed under the previous agreement. The Fifth Amendment reduces the
amount available under the revolving loan facility, under which there are
currently no borrowings outstanding, to $15,000, and requires the Company to
maintain a cash collateral account of at least $100,000 for the benefit of the
lenders under its credit facility. These collateral amounts will be recorded as
restricted cash on the Company's balance sheet. The Fifth Amendment also calls
for half of the first $100,000 in proceeds from future asset sales, and 80% of
proceeds from assets sales in excess of $100,000 to be used to pay down the
Company's senior secured term loans. Additionally, the Company will increase
amortization payments under its term loans by an amount equal to 50% of interest
savings from new repurchases of senior notes, not to exceed $25,000. The Fifth
Amendment also enables the Company to incur up to $500,000 of new senior
indebtedness that may be secured by a second subordinated lien on RCN's assets.
Up to $125,000 of existing cash and the proceeds of new indebtedness may be used
to repurchase outstanding senior notes. Additionally, covenants are revised to
reflect RCN's current long-term business plan.
On February 19, 2003, the Company consummated a previously announced
$245,000 sale of its central New Jersey cable system assets to Patriot Media &
Communications CNJ, LLC ("Patriot"). The cash proceeds of the sale received by
RCN, after taking into account the amount paid by Patriot to acquire the
minority interest in the portion of the New Jersey cable systems that was not
owned by RCN and other closing adjustments, was approximately $239,500. The
Company realized a gain of approximately $155,000 to $180,000 on the
transaction. In accordance with the Credit Agreement, an amount equal to the net
cash proceeds of the sale of the central New Jersey cable system assets in
excess of $5,000 was deposited into a cash collateral account. Other than the
minimum $100,000 required to be maintained on deposit in the cash collateral
account under the Fifth Amendment, proceeds on deposit in the cash collateral
account may be used to repay loans outstanding under the Credit Agreement or to
purchase telecommunications assets if the Company does not have other available
cash on hand to fund such expenditures. In accordance with SFAS No. 144, the
results of operations for central New Jersey is reported as discontinued
operations.
On March 25, 2002, the Company entered into an amendment to its
Credit Agreement (the "Fourth Amendment") governing its Credit Facility with
JPMorgan Chase Bank (formerly known as The Chase Manhattan Bank) and other
lenders. The Fourth Amendment, among other things, required the reduction of the
Credit Facility of $187,500 on March 25, 2002. Application of $187,500 Credit
Facility payment to the December 31, 2001 cash balances would have reduced cash
and short-term investments from $838,491 to $651,991.
These events are described in the Liquidity and Capital Resources
section in the Management Discussion and Analysis and the Notes to the
Consolidated Financial Statements.
On March 13, 2003 we announced that our Vice Chairman and Chief
Financial Officer, Jeffrey White, will be leaving the company for personal
reasons. It is anticipated that Mr. White will be leaving during the second
quarter of 2003.
On March 28, 2003 Edward S. Harris resigned from the Board of
Directors of the Company.
History
Prior to September 30, 1997, we were operated as a wholly-owned
subsidiary of C-TEC Corporation, the predecessor to Commonwealth Telephone
Enterprises, Inc. On September 30, 1997, RCN was spun off to C-TEC Corporation
shareholders in a transaction in which each holder of record of C-TEC
Corporation common equity received one share of RCN Common Stock for every one
share of C-TEC owned.
Business Strategy
Our goal is to become the leading provider of bundled communications
services to residential customers in our target markets by pursuing the
following key strategies:
Exploit the "Last Mile" Bottleneck in Existing Local Networks: In
our target markets, we construct networks capable of providing multiple services
and we seek to be the preferred provider of advanced bundled communications
services to residential customers.
Leverage our Network and Customer Base: We are able to leverage our
network by delivering a broad range of communications products and by focusing
on high-density residential markets. Our high bandwidth capacity and home
density allows us to maximize the revenue potential per mile of constructed
network and the return on invested capital. We believe we can further exploit
our network capacity and customer base by exploring opportunities to deliver new
products and services in the future, including complementary commercial and
wholesale products and services.
Offer Bundled phone, cable television and Internet services with
Quality Customer Service: We offer our customers various single-source packages
of competitively priced Phone, cable television and Internet services, on a
bundled or a-la-carte basis. By selling multiple services, we improve our
operating economics and, by owning our own
6
network, we have better control over our customers' experience with us. We have
invested significant resources in an integrated provisioning and billing
system. We believe that the combination of bundled communications services on
our own network and quality customer care will be key drivers to effectively
compete in the residential market.
Construction of our Broadband Networks: Our broadband networks are
generally designed to meet the growing demand for high speed, high capacity,
phone, cable television and Internet services. We believe our networks also have
a significant amount of capacity which can be utilized at relatively low
incremental cost and which we believe will provide us the opportunity for
additional potential revenue sources. We believe that our high capacity networks
provide us with certain competitive advantages such as the ability to offer
bundled services and the opportunity to recover the cost of our network through
multiple revenue streams.
Network Development and Financing Plan
Our principal fixed costs in each market are incurred in connection
with the establishment of a video transmission and a telephone and data routing
facility. To make each market economically viable, it is then necessary to
construct infrastructure to connect subscribers to the transmission and routing
facility.
We intend to use our capital to fund the additional construction of
our networks in current markets, upgrade our legacy cable network, fund
operating losses and repay our debts. Capital expenditures will be incurred
principally to fund additional customer growth and system upgrades in our
current markets. Capital expenditures are subject to circumstances related to
construction, timing of receipt of regulatory approvals and opportunities to
accelerate the deployment of our networks change, among other things. We would
require a substantial amount of capital to expand the development of our network
and operations into new areas outside of our existing markets.
In order to facilitate growth beyond our current market footprint,
we would expect to supplement our future operating cash flow by continuing to
add customers, seek additional capital to increase our network coverage and pay
for other capital expenditures, working capital, debt service requirements and
anticipated further operating losses. We may seek sources of funding from vendor
financing, public offerings, sale of assets or private placements of equity
and/or debt securities, and bank loans.
The Company's debt and equity offerings have given the Company the
ability to implement the business plan. However, if additional opportunities
should present themselves, the Company may seek to secure additional financing
in the future. 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. In addition, proceeds from dispositions
of the Company's assets may not reflect the assets' intrinsic values. Further,
expenses may exceed the Company's estimates and the financing needed may be
higher than estimated.
Services
The Company's primary business is delivering bundled communications
services to residential customers over the Company's broadband network, which is
predominantly owned or leased by the Company, including through joint ventures,
to consumers in some of the most densely populated markets in the U.S. We are
currently operating in Boston, including 18 surrounding communities, New York
City, the Philadelphia suburbs, Chicago, San Francisco, and several of its
suburbs, and communities in Los Angeles. We also serve the Lehigh Valley in
Pennsylvania, communities in and around Carmel, NY and we were the incumbent
franchised cable operator in many communities in central New Jersey until these
operations were sold on February 19, 2003. In addition, we also have a joint
venture with Pepco Communications, Inc., Starpower, serving the Washington, D.C.
metropolitan markets. We believe we are the first company in many of our markets
to offer one-stop shopping for cable television, phone and high-speed cable
modem Internet services to residential customers.
ResiLink and Essentials are the brand names of our two families of bundled
service offerings, offered for a flat monthly price to residential customers of
cable television, phone, and high-speed Internet.
ResiLink packages have different combinations of core services and include
various phone features and premium channels. These bundles are designed to
appeal to customers seeking simplification and value. ResiLink is available in
five unique packages--Platinum, Gold, Silver, Bronze and Mercury. For the most
part, these packages are the same across all our markets.
The ResiLink Platinum package includes two phone lines with unlimited local and
regional calling, four premium phone features for both lines (Call Waiting,
Caller ID, 3-Way
7
Calling, Family Voicemail), full basic cable, two digital converter boxes with
an interactive programming guide and 45 channels of digital music, four movie
channel multiplexes (HBO, Cinemax, Starz!/Encore and Showtime/The Movie
Channel), additional channels of digital programming, 3.0 Mbps high-speed cable
modem service called MegaModem, which provides Internet access with four e-mail
addresses and 10 MB of storage.
The ResiLink Gold package includes one phone line with unlimited local and
regional calling, three premium phone features, full basic cable, a digital
converter box with an interactive programming guide and 45 channels of digital
music, HBO and Cinemax multiplexes, additional channels of digital programming
and 3.0 Mbps MegaModem Internet access with four e-mail addresses and 10 MB of
storage.
The ResiLink Silver package includes one phone line with unlimited local and
regional calling, a choice of two premium phone features, full basic cable, a
digital converter box with an interactive programming guide and 45 channels of
digital music and the HBO multiplex.
The ResiLink Bronze package includes one phone line with unlimited local and
regional calling, a choice of two premium phone features and high-speed cable
modem Internet access with four e-mail addresses and 10 MB of storage.
The ResiLink Mercury package includes full basic cable, a digital converter box
with an interactive programming guide and 45 channels of digital.
RCN Essentials packages offer various combinations of our core services, but do
not come prepackaged with phone features or premium channels. Essentials
customers are encouraged to design their own bundles by adding specific features
they value. The Essentials bundles are available in three different packages for
a flat monthly fee--Essentials CPI, (cable television, phone and Internet), CP,
(cable television and phone) and International. As with our ResiLink bundles,
the Essential bundles are generally the same across all markets.
The Essentials/CPI (cable television, phone and Internet) package includes one
phone line with unlimited local calling, full basic cable, a converter box, and
1.5 Mbps cable modem service with 4 e-mail address and 10MB of storage.
The Essentials/CP (cable television and phone) package includes one phone line
with unlimited local calling, full basic cable, and a converter box. In
addition, Essentials CP customers can choose from a selection of additional
services to complete their package.
The Essentials/International package includes one phone line with unlimited
local calling, Limited Tier cable, a converter box, and one of our International
Premium channels.
In addition to our bundled package offerings, we sell cable television, phone,
and high-speed cable modem and dial-up Internet to residential customers on an
a-la-carte basis. We also provide communication services to commercial
customers.
We are working to leverage the capacity of our broadband network to allow us to
expand our offering of new services. In 2002, we launched RCN MegaModem which
provides 3 Mbps of speed for customers looking to download movie videos, MP3
music files, and other Web-based forms of entertainment in as little as half the
time it would take with a standard 1.5 Mbps cable modem or DSL connection. We
believe MegaModem is the fastest Internet connection available to residential
customers in our markets. Also in 2002, we expanded our launch of VOD in the
Philadelphia market. We plan to launch Video-on-Demand (VOD), Subscription
Video-On-Demand (SVOD) and High Definition Television (HDTV) in certain markets
in 2003.
The following is a brief description of our current product offerings:
Phone: We offer a full range of local calling plans to meet the needs of
residential customers across our markets. The phone plans are competitive with
the incumbent and competitive local exchange carriers ("ILEC")("CLEC")
providers, and offer value for the customers' individual calling needs. Phone
calling plans generally include an unlimited local calling plan, an unlimited
local and regional plan and a phone bundle of local, regional and long distance
calling with features. RCN offers all of the most popular phone features at
competitive rates, including voicemail, Caller ID, Call Waiting, Call Forwarding
and 3-Way Calling. Bundled feature packages are available to offer additional
savings and we also offer maintenance protection plans which allow customers to
pay a monthly fee to eliminate potential future wire repair costs. Additionally,
we provide 911 access, operator services, and directory assistance services.
8
RCN's local voice products are featured in four of the ResiLink and all of the
Essentials packages, which increases overall penetration and revenue. Bundling
local voice products encourages customers to subscribe to RCN local voice
services, as savings increase when customers purchase additional services. As of
December 31, 2002, we had approximately 258,000, including approximately 25,000
Starpower, local facility based connections, with approximately 53% of the
connections from ResiLink products and 47% of the connections from a-la-carte
products.
Long Distance, Toll-Free, and Calling Card services are also offered and priced
competitively with inter-exchange carriers ("IXCs") across the country. We offer
plans with monthly fees, no monthly fees, specialized international plans and
bundle-of-minute plans that allow high volume users to pay a single rate per
month for high volume calling at one rate. Customers that subscribe to one of
RCN's Resilink or Essentials bundles are offered long distance services at
discounted rates.
Cable television: We offer a diverse line-up of high quality basic, premium and
pay-per-view video programming. Our basic video-programming package provides
extensive channel selection featuring all major cable and broadcast networks.
Our premium services include HBO, Cinemax, Showtime/The Movie Channel and
Starz!/Encore. Pay-per-View ("PPV") is available on our broadband network, using
technology which allows convenient instant ordering of the latest hit movies and
special events from the customer's remote. "Music Choice" offers 31-45 different
commercial-free music channels delivered to the customer's stereo in digital CD
quality sound. As of December 31, 2002, we had approximately 427,330 subscribers
for our cable television services including approximately 39,000 in our
Starpower joint venture.
As of December 31, 2002, a digital tier, (a package of digital video services),
is available in all markets except Chicago. Subscribers to our digital Cable TV
service receive a mix of additional cable television networks, multiplexed
premium channels from HBO, Showtime and STARZ, an interactive program guide and
"Music Choice" with 45 different commercial-free music channels delivered to the
customer's stereo in digital CD quality sound. There is also additional PPV
programming, such as more frequent showings of the most popular films to provide
near Video-on-Demand that customers can pay for on a per purchase basis.
Subscribers pay us on a monthly basis for cable services and can discontinue
service at any time. We have 92,207 digital subscribers that take the digital
tier.
We launched our Video-on-Demand ("VOD") service on December 7, 2001
to approximately 1,100 customers in three Philadelphia suburbs. In October 2002,
we expanded our VOD service to the entire Philadelphia system. In 2003, we
anticipate upgrading the Philadelphia market to SVOD and launching VOD and SVOD
in five additional markets. We plan to continue to build and expand our content
offering for these new services and launch additional communities and markets
throughout 2003.
Other video services launches scheduled for 2003 include High
Definition Television ("HDTV") a digital television service that displays sharp,
lifelike images that surpass regular analog television. We currently anticipate
launching HDTV in four of our markets in 2003 with expansion into other markets
throughout 2004.
We pay a monthly fee per subscriber per channel for cable network
programming. Programming costs are directly impacted by the number of
subscribers, the number of channels provided to subscribers and increases in
contract rates from programming suppliers. We attempt to secure long-term
programming contracts with volume and penetration discounts and/or marketing
support and other incentives from program suppliers. Our programming contracts
are subject to negotiated renewal. We are also members of the National Cable
Television Co-op, (NCTC), which provides us with volume discounts on many of our
programming services. We have experienced increases in the cost of our
programming year to year, and we anticipate that future contract renewals will
result in programming costs that are higher than our costs today, particularly
for sports programming. Retransmission consent impacts programming costs either
through cash for carriage arrangements or requirements to launch additional
networks in exchange for continued carriage of the local broadcast stations. In
addition, as our MSO and potentially DBS competitors merge, their negotiating
leverage and control of programming make it more difficult for us to obtain
programming or competitive programming rates and access to new program networks
owned by merged companies.
High-Speed Internet: RCN's traditional high speed Internet Service
lets the customer experience the vast resources of the Internet at speeds up to
1.5 Mbps. In 2002 we launched our new Megamodem cable modem services in four
markets which provides Internet speeds of up to 3.2 Mbps. Additional market
launches of the MegaModem offering are planned throughout 2003. RCN's high speed
Internet service is capable of delivering much greater bandwidth to the customer
than traditional dial-up service, utilizing our
9
broadband network. Our cable modem customers receive a reliable, always on
connection with the following standard features: four e-mail addresses,
web-mail, 10MB web space, and 24 X 7 technical support. Our network utilizes
industry standard two-way cable modems for approximately 97% of our cable modem
customers. As of December 31, 2002, we had approximately 160,400 high speed
Internet subscribers including approximately 16,900 in our Starpower joint
venture. During November 2003 RCN introduced a prototype of our new broadband
portal. Upon launch of the broadband portal in early 2003, our high speed
Internet customers will have access to robust, customizable, broadband content
that includes thousands of streaming media clips in many content genres (news,
sports, entertainment, finance) and games. In addition, the section entitled
"RCN Premium Services" will be a platform for delivery of additional pay-for-use
services. In December 2002, RCN launched two such pay-for-use services, a
music-on-demand service through an agreement with Listen.com and a parental
control service through an agreement with Net Nanny. We plan to launch
additional pay-per-use services in 2003.
Dial-up Internet: Customers can also connect to the Internet
primarily through RCN's 56K dial-up service. RCN's dial-up customers have the
advantage of connecting to the Internet through a network of our own points of
presence ("POPs") that are connected to our broadband network. In addition to
reliable Internet access, customers receive two mailboxes, web-mail, 10MB web
space and 24 X 7 technical support. In certain markets, RCN's dial-up service is
V.92 compatible allowing customers to receive an incoming call while remaining
connected to the Internet. Dial-up service can also be bundled with any of RCN's
on-net cable, phone and Internet offerings. As of December 31, 2002, we had
281,145 dial-up connections including approximately 133,800 in our Starpower
joint venture.
Commercial Services: We provide certain services in addition to our
residential communications services. We provide switch-based resale
long-distance services and local telephone services to customers on our
broadband network. We provide high-speed data services, T1, OC3, DS3, dial-up
Internet access and web-hosting as well as other services to certain commercial
accounts.
Strategic Relationships and Facilities Agreements
We have entered into certain joint ventures which allow us to
penetrate the telecommunications services market early and to reduce the cost of
entry into certain markets. We expect to continue to pursue potential
opportunities by entering into strategic alliances to facilitate network
expansion.
Joint Ventures
RCN is party to the RCN-Becocom 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 have
agreed to make capital contributions in accordance with their respective
membership interests. In addition, RCN has access to and use of NSTAR's large
broadband network, rights-of-way and construction expertise. Pursuant to an
exchange agreement between NSTAR Communications and RCN, NSTAR Securities has
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
Securities. As of December 31, 2001, NSTAR Securities had exchanged portions of
its interest for a total of 4,097,193 shares of RCN Common Stock. In April 2000,
NSTAR Securities 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 that exchange and to amend certain other agreements
governing the RCN-Becocom, LLC joint venture (the "Joint Venture"). 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. This exchange
gave NSTAR a total of 11,597,193 of the Company's common stock or 10.6% as of
December 31, 2002. Following this exchange, NSTAR Securities profit and loss
sharing ratio in the joint venture was reduced to zero and it retained its
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. Such investment percentage will
decrease to the extent NSTAR Securities disposes of any such RCN Common Stock.
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.
10
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 Preferred Equity interest of the Joint Venture, which
carries a cash coupon rate of 1.84% per month guaranteed by the Company and its
affiliate, RCN Telecom Services of Massachusetts, Inc. The maximum permitted
amount of such investment is $100,000. 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 December 31, 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 twelve months ended December 31, 2002, NSTAR's portion of the
loss in RCN-Becocom was $36,650.
RCN is party to a joint venture with Pepco Communications, Inc.
("Pepco"), a subsidiary of Pepco Holdings, Inc. ("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, under the brand name "Starpower." Through its subsidiaries,
Potomac is engaged in regulated utility operations and in diversified
competitive energy and telecommunications businesses. Each of RCN and Pepco owns
a 50% membership interest in Starpower. RCN provides certain services to the
joint venture pursuant to support services and Internet services agreements.
Pursuant to the joint venture agreements, both parties have agreed to make
capital contributions in accordance with their respective membership interests.
In addition, Starpower has access to and use of Potomac's large broadband
network, rights-of-way and construction expertise. Starpower is reflected in our
financial statements under the equity method of accounting.
Agreements with Significant Shareholders
On or about July 18, 2002, the Company entered a Master Computer
Services Agreement with I-Structure, LLC, a Delaware limited liability company
that is wholly-owned by Level 3 Communications, LLC. Pursuant to this
outsourcing agreement I-Structure will perform data center operations,
monitoring, administration and management services for the Company's open and
mid-frame systems in I-Structure data centers in Tempe, Arizona and Omaha,
Nebraska. The term of the agreement is four years. The Company's budgeted costs
for the I-Structure services for the current year is approximately $2,050 for
recurring charges paid monthly. The Company may, from time-to-time, incur
additional non-recurring costs for equipment purchases and configuration
services. The Company expects its recurring charges to increase to over $2,400
annually. Beginning in third year of the term, the Company will have the right
terminate with a one-time cancellation payment of approximately $1,500 which
decreases monthly to $60 at the beginning of the final month of the term.
On June 28, 2001, Red Basin, LLC, an entity formed by Walter Scott,
Jr. together with certain family members and trusts, purchased $50,000 worth of
common stock and warrants of RCN. Under the terms of the private placement, Red
Basin purchased approximately 7,661,000 shares of common stock and warrants to
acquire approximately 3,831,000 shares of common stock, for $50,000. The
purchase price of the common stock and accompanying warrants is approximately
$6.53 per share of common stock, which is based on the average of the closing
prices of RCN common stock for the 5 trading days ending on Friday, May 25,
2001. The warrants have a term of 4-1/2 years and an exercise price equal to
$12.928 per share. The private placement is subject to certain conditions,
including the purchase of $50,000 in debt securities and other customary
conditions. The Company used the proceeds to complete a tender offer of certain
Senior Notes in July 2001. Mr. Scott is a Vice-Chairman of the board of
directors of RCN and is Chairman of Level 3 Communications, Inc., one of RCN's
largest shareholders. Mr. Scott is also a consultant to the Board and management
in connection with various matters requested by the Board, including relating to
raising capital and construction issues. Pursuant to a stock purchase agreement,
Red Basin has certain other rights and obligations, including relating to
preemptive rights to purchase additional share of common equity, registration
rights, restrictions on transfer of shares, limitations on acquiring additional
shares, and other matters.
On February 28, 2000, Vulcan Ventures Inc. ("Vulcan"), the
investment organization of Paul G. Allen, made a $1,650,000 investment in our
company. The investment is in the form of mandatorily convertible cumulative
preferred stock (the "Series B Preferred Stock"), which will be converted into
Common Stock or Class B Stock no later than seven years after it is issued. We
have the option of redeeming at any time after August 28, 2003. Vulcan has
purchased 1,650,000 shares of the Series B Preferred Stock. The Series
11
B Preferred Stock has a liquidation preference of $1,000 per share and is
convertible at a price of $61.86 per share. All dividends will be paid in
additional shares of Series B Preferred Stock. At December 31, 2002 we had paid
cumulative dividends in the amount of approximately $359,355 in the form of
359,355 additional shares of Series B Preferred Stock. At December 31, 2002 the
number of shares that would be issued upon conversion of the Series B Preferred
Stock was 32,482,282. In connection with the investment, Vulcan appointed each
of William D. Savoy, President of Vulcan, and Edward S. Harris, an independent
Financial consultant and previously an Investment Analyst with Vulcan, to our
Board of Directors. The Series B Preferred Stock has a dividend rate of 7% per
annum. Vulcan Ventures is limited to a 15% vote, in most cases. Certain other
important terms of the Series B Preferred Stock can be found in the Certificate
of Designations relating to such Series B Preferred Stock. Pursuant to a stock
purchase agreement and voting agreement, Vulcan has certain additional rights
and obligations, including relating to preemptive rights to purchase additional
shares of common equity, registration rights, restrictions on transfer of
shares, limitations on acquiring additional shares, voting arrangements, and
other matters. Upon a Change of Control prior to the Series B Preferred Stock
being converted or redeemed or transferred, we are required to offer to
repurchase 50% of the Preferred Stock equal to: (a) if prior to July 1, 2003,
110% of the value of such Preferred Stock (plus accrued and unpaid dividends);
and (b) if on or after July 1, 2003, the Liquidation Preference (plus accrued
and unpaid dividends). We are not required to make any Change of Control payment
until we have repurchased all debt securities required to be repurchased upon
such Change of Control under our credit and financing agreements.
On April 7, 1999, Hicks, Muse, Tate & Furst, through Hicks Muse Fund
IV purchased 250,000 shares of Series A Preferred Stock, par value $1 per share,
(the "Series A Preferred Stock") for gross proceeds of $250,000. The Series A
Preferred Stock is convertible into common stock at any time and is subject to a
mandatory redemption on March 31, 2014 at $1.00 per share, plus accrued and
unpaid dividends, but may be called by the Company after four years. The Series
A Preferred Stock is cumulative and has an annual dividend rate of 7% payable
quarterly in cash or additional shares of Series A Preferred Stock and has a
conversion price of $38.97 per share. At December 31, 2002 we had paid
cumulative dividends in the amount of approximately $73,934 in the form of
73,934 additional shares of Series A Preferred Stock. At December 31, 2002 the
number of common shares that would be issued upon conversion of the Series A
Preferred Stock was 8,312,423. In connection with the investment, Hicks, Muse,
Tate & Furst has appointed Peter Brodsky to our Board of Directors. Certain
other important terms of the Series A Preferred Stock can be found in the
Certificate of Designations relating to such Series A Preferred Stock. Within 60
days of the Change of Control, we must offer to repurchase shares of Series A
Preferred Stock for a price equal to the Liquidation Preference plus accrued and
unpaid dividends. We are not required to make any Change of Control payment
until we have repurchased all debt securities required to be repurchased upon
such Change of Control under our credit and financing agreements.
On September 30, 1997, C-TEC Corporation spun-off to its
shareholders the stock of RCN and the stock of C-TEC Cable Systems of Michigan,
Inc., wholly owned subsidiaries of C-TEC Cable Systems, Inc., which is a wholly
owned subsidiary of the Level 3 Delaware Holdings ("Level 3"). In connection
with the restructuring and as a result of the conversion of certain shares of
C-TEC held by Level 3, Level 3 owns 24.29% of the outstanding shares of common
stock in RCN as of December 31, 2002. On December 3, 2001, we entered into an
agreement with C-TEC to provide them certain overhead services, i.e., legal and
tax services, for $100 per month. The Agreement was terminable at will by both
parties, and was terminated by C-TEC in December, 2002.
RCN-BecoCom, LLC and NSTAR Communications entered into a
Construction and Indefeasible Right to Use ("IRU") Agreement dated as of June
17, 1997 and amended June 19, 2002. Under the IRU, NSTAR Communications provides
construction and construction management services to RCN-BecoCom, LLC and access
to and use of portions of NSTAR's broadband network, rights of way and certain
equipment sites. The cost of such services provided to RCN-BecoCom, LLC by NSTAR
Communications are believed to be equivalent to those which would be obtained
from third party contractors.
In 1997, RCN entered into various agreements with Starpower under which RCN
provides support services and Internet support services, such as accounting,
customer service, billing, network management and other services to Starpower.
Under these agreements, Starpower reimburses the cost of providing these
services to RCN. In 1997, Starpower and Pepco entered into an agreement for the
lease of certain portions of Pepco's fiber system and under which Pepco provides
construction and construction management services to Starpower. The costs of
such services provided by RCN and Pepco to Starpower are believed to be
equivalent to those that would be obtained from third party contractors.
Other Investments
12
In January 1995, the Company purchased a 40% equity interest in
Megacable, S.A. de. C.V., the second largest cable television provider in
Mexico, from Mazon Corporativo, S.A. de. C.V. ("Mazon"). In July 1999 our
ownership interest in Megacable increased to approximately 48.96%. Megacable
owns 27 wireline cable systems in Mexico, principally on the Pacific and Gulf
coasts and including Guadalajara, the second largest city in Mexico; Hermosillo,
the largest city in the state of Sonora; and Veracruz, the largest city in the
state of Veracruz. At December 31, 2002, their wireline systems passed
approximately 1,876,000 homes and served approximately 462,500 video subscribers
and 103,000 high-speed Internet subscribers. Megacable had approximate revenues
of $142,488 and $130,600 for the years ended December 31, 2002 and 2001,
respectively.
Separately, RCN presently holds a 48.96% interest in Megacable
Comunicaciones de Mexico S.A. ("MCM"). MCM has a license from the Mexican
government to operate a broadband network in Mexico City, Monterrey and
Guadalajara. MCM has activated its network in Mexico City and is providing local
voice and high-speed data service in that city, principally to commercial
customers.
In 1999, the Company acquired a 47.5% stake in JuniorNet for
approximately $47,000 in cash. Concurrent with that transaction, JuniorNet
purchased the Company's Lancit Media subsidiary for approximately $25,000 in
cash. In 2000, the Company wrote down approximately $24,400, which represented
the Company's full investment in JuniorNet. During 2001, the Company made
secured loans to JuniorNet. Subsequently, the assets of JuniorNet were
foreclosed upon by the secured creditor group, including RCN. The secured
creditor group sold the assets and intellectual property relating to the on-line
business of JuniorNet to J2 Interactive, LLC ("J2") for cash proceeds and 30.6%
of J2's initial equity. The Company owns 23.5% of the equity in J2.
Additionally, in the foreclosure, RCN received 100% of the assets of JuniorNet's
subsidiary Lancit. Those assets were used to start RCN's wholly-owned
subsidiary, RCN Entertainment. RCN Entertainment produces children's/family
programming.
COMPETITION
We believe that among the existing competitors, the ILECs, incumbent
cable providers, CLECs and Direct Broadcast Satellite ("DBS") represent our
primary competitors in the delivery of "last mile" connections for voice, video
and Internet services.
Overview
We compete with a wide range of service providers for each of our
services. Virtually all markets for phone, cable television and Internet
services are extremely competitive, and we expect that competition will
intensify in the future. Our competitors are often larger, better-financed
incumbent local telephone carriers and cable companies with better access to
capital resources, and many have historically dominated their local telephone
and cable television markets. These incumbents presently have numerous
advantages as a result of their historic monopolistic control of their
respective markets, economies of scale and scope and control of limited conduit
and pole space. They also have well-established customer and vendor
relationships. Despite their strong brands, however, these providers continue to
receive low customer satisfaction ratings which creates opportunities for us.
In order to compete, we strive to provide competitively priced bundled services,
excellent technical performance and quality customer service.
We compete with the ILEC's for the provision of local telephone
services, as well as with alternative service providers including CLECs. Cable
operators are also entering the local exchange market in some locations. Other
sources of competitive local and long distance telephone services include
Commercial mobile radio services providers, including cellular carriers (such as
Verizon Wireless Services); personal communications services carriers such as
Sprint PCS; and enhanced specialized mobile radio services providers (such as
NexTel). Although consumers generally continue to subscribe to their landline
services, wireless/cellular growth is the bigger threat for long distance
services and increasing concern in the wireline local dial-tone market though
consumers continue to subscribe to landline service for Internet and other
reasons.
We expect to continue to face significant competition for long
distance telephone services from the incumbent providers including MCI/
WorldCom, AT&T, Verizon and Sprint which account for the majority of all U.S.
long distance revenue. The major long distance service providers benefit from
established market share, both in traditional direct-dial services as well as in
prepaid and dial around products, and from established trade names through
nationwide advertising. However, we regard our long-distance service as a
complementary service rather than a principal source of revenue. Certain
incumbents including MCI/WorldCom, AT&T, Verizon and Sprint, are able to offer
local services in major U.S. markets using their existing infrastructure in
combination with resale of ILEC service, lease of unbundled local loops or other
providers' services. A new threat comes from Verizon's entrance into the long
distance market. RCN markets in
13
competition with Verizon' long distance offering include New York,
Massachusetts, Pennsylvania and Virginia. Internet-based telephony, a potential
competitor for low cost telephone service, is also developing, but penetration
levels are not significant at this time.
Our cable television service competes with DBS operators in all
markets and the existing franchised cable operator except in our Carmel, New
York system where we are currently the only franchised cable operator.
All of our video services face competition from alternative methods
of receiving and distributing television signals and from other sources of news,
information and entertainment. Other sources include off-air television
broadcast programming, newspapers, movie theaters, live sporting events,
interactive online computer services and home video products, including
videotape cassette recorders, DVD players, and, in the future, streaming
applications on PCs. Alternative video distribution technologies include
traditional cable networks, wireless local video distribution technologies, and
DBS, where signals are transmitted by satellite to receiving facilities located
on customer premises. DBS systems enable individual households to receive many
of the satellite-delivered program services formerly available only to cable
subscribers. The cable television Consumer Protection and Competition Act of
1992 (the "1992 Act") contains provisions, which the FCC has implemented with
regulations, to enhance the ability of cable competitors to purchase and make
available to DBS owners certain satellite-delivered cable programming at
competitive costs. We face additional competition from private satellite master
antenna television ("SMATV") systems that serve condominiums, apartment and
office complexes and private residential developments. The FCC and Congress have
adopted policies providing a more favorable operating environment for new and
existing technologies that compete, or may compete, with our various video
distribution systems. We expect that our video programming services will face
growing competition from current and new DBS service providers. We also compete
with wireless program distribution services such as Multi-Channel Multi-Point
Distribution Service (MMDS) which use low-power microwave frequencies to
transmit video programming over-the-air to subscribers. The major MMDS license
holders, however, are scaling back their deployments and those remaining in the
market continue to focus on the technology mainly as a platform for delivery of
high-speed Internet access service. In addition, certain local telephone
companies provide, or plan to provide, video services within and outside their
telephone service areas, through a variety of methods, including cable networks,
satellite program distribution and wireless transmission facilities.
The Internet access market is competitive and highly fragmented. We
expect that competition in this market will intensify, specifically among the
cable operators and the ILECs. Our current and prospective competitors include
established online service providers; local, regional and national Internet
Service Providers ("ISPs"); national and international telecommunications
companies including Regional Bell Operating Companies ("RBOCs") and affiliates
of incumbent cable providers. In the high-speed Internet access market, some
providers such as data local exchange carriers have exited the market as a
result of financial and operational distress. However, cable operators and other
providers continue to make significant progress penetrating this market.
Advances in communications technology as well as changes in the
marketplace and the regulatory and legislative environment are constantly
occurring. Therefore, we cannot predict the effect that ongoing or future
developments might have on the phone, cable television and Internet industries
or on our operations or financial condition.
Incumbent LECs
In each of our target markets for broadband networks, we face, and
expect to continue to face, significant competition from the ILECs. The ILECs
include Verizon in the northeast corridor, SBC in California and Chicago, both
of whom currently dominate their respective local telephone markets. We compete
with the ILECs in our markets for local exchange services on the basis of
product offerings, including the ability to offer bundled cable television,
phone and Internet service, reliability, state-of-the-art technology and
superior customer service, as well as price. We believe that our broadband
networks provide superior technology for delivering high-speed, high-capacity
phone, cable television and Internet services compared to the ILECs' primarily
copper wire based networks. However, the ILECs have long-standing relationships
with their customers. They have also begun to expand the amount of fiber
facilities in their networks, offer broadband digital transmission services and
retail Internet access, and are re-entering the long distance telephone service
market. During 2002 both Verizon and SBC began offering long distance and
launched bundled products including wireless, local and long distance services
at substantial discounts.
In light of the Telecommunications Act of 1996 (the "1996 Act"), and
ensuing federal and state regulatory initiatives, barriers to local exchange
competition are disappearing. The introduction of such competition, however,
also establishes the precedent for the RBOCs, such as Verizon, to provide
in-region interexchange long
14
distance services. The RBOCs are currently allowed to offer "incidental" long
distance service in-region and to offer out-of-region long distance service.
Because the RBOCs have gained approval to offer in-region long distance services
in certain markets, they will also be in a position to offer single source local
and long distance service similar to what we offer and what is proposed by the
largest long distance service providers: Verizon,AT&T, MCI WorldCom and Sprint.
We expect that the increased competition made possible by regulatory reform will
result in certain pricing and margin pressures in the local telephone services
business.
We provide a full range of local phone services, which compete with
ILECs in our service areas. We expect that competition for local telephone
services will be based primarily on quality, capacity and reliability of network
facilities, customer service, response to customer needs, service features and
price. We may also have a competitive advantage because we are able to deliver a
bundled phone, cable television and Internet service.
The 1996 Act permits the ILECs and others with which we compete to
provide a wide variety of video services directly to subscribers. Various LECs
currently are providing video services within and outside their telephone
service areas through a variety of distribution methods, including both the
deployment of broadband wire facilities or through partnerships with direct
broadcast satellite (DBS) providers. We cannot predict the likelihood of success
of video service ventures by LECs or the impact such competitive ventures may
have on us. Some LECs also offer Internet access services that compete with our
Internet services. We are unable to predict the likelihood of success of
competing video or cable service ventures by local telephone companies or other
businesses. Nor can we predict the impact these competitive ventures might have
on our business and operations.
Multi-channel Video Service Providers
Most of our cable television service businesses compete with
incumbent cable companies in their respective service areas. Specifically, we
compete for cable subscribers with the major wireline multi-system cable
operators, ("MSO") in our markets, such as AOL Time-Warner Cable in New York
City and Los Angeles, Comcast in Boston, Chicago, San Francisco, Los Angeles,
the Philadelphia suburbs and the greater Washington, D.C. area and Cox in
Virginia. We believe that our fiber-rich network architecture makes us better
equipped to provide high capacity communications services. AT&T Broadband and
Comcast effectively completed a merger late in 2002 making them the largest
national incumbent cable television provider. The impact of the their increased
economic base, subscriber scale, buying power and influence on market pricing
and content-ownership has yet to be measured in the markets in which RCN
competes. Our Lehigh Valley, Pennsylvania television system also competes with
an alternate service provider, Service Electric, which also holds franchises for
the relevant service area.
Direct Broadcast Satellite companies, DirecTV and DISH also compete
directly for cable subscribers in all of the markets RCN serves. Their fully
digital service, with a plethora of channels, personal video recorders and high
definition television makes them a strong competitor. It was once considered
that DBS providers would be limited in distribution in urban areas, yet they
have developed programming packages, especially DISH's ethnic content that
especially appeals to customers cities.
Cable television systems generally operate pursuant to franchises
granted on a non-exclusive basis, and the 1992 Act prohibits franchising
authorities from unreasonably denying requests for additional franchises and
permits franchising authorities to operate cable systems. Therefore,
well-financed businesses from outside the cable industry, such as the public
utilities that own certain of the conduits or poles, which carry cable
television facilities, may become competitors for franchises or providers of
competing services. Telephone companies or others may also enter the video
distribution market by becoming open video service operators pursuant to Section
653 of the Communications Act, as we have done in several markets. . No local
franchise is required for the provision of such service (see "Regulation of
Video Services" below). Certain of our competitors own or control content and
programming which could enhance their ability to compete with other providers in
the local service area. ILEC video, however, is a longer term threat as all the
RBOCs are currently focusing on gaining in-region long distance approval. We are
unable to predict the likelihood of success of competing video or cable service
ventures by local telephone companies or other businesses. Nor can we predict
the impact these competitive ventures might have on our business and operations.
CLECs and Other Competitors
We expect to continue to face competition from other potential
competitors in certain of our geographic markets. Other CLECs, such as
subsidiaries of AT&T and MCI WorldCom, compete for local telephone services,
although they have, to date, focused primarily on the market for commercial
customers rather than residential customers. In addition, potential competitors
include other smaller long distance carriers, cable
15
television companies, electric utilities, microwave carriers, wireless telephone
system operators and private networks built by large end-users.
Internet Services
With the recent consolidation or acquisition of many smaller ISPs,
and the failure of many Internet providers, the competition is becoming limited
to the larger national and regional providers of Internet access. While we do
not expect significant new entrants into the Internet access market in the near
future, new technologies are being introduced which will provide customers other
choices for Internet access. Our current and prospective competitors include
many large companies with substantially greater market presence and financial
and other resources. RCN competes directly or indirectly with:
- established online services, such as America Online, the
Microsoft Network and Earthlink;
- small local ISPs;
- the Internet services of national and international
telecommunications companies, such as AT&T and MCI
WorldCom;
- Internet access (including high-speed digital subscriber
line service) offered by RBOCs such as Verizon and SBC;
- high-speed services offered by incumbent cable
providers, such as Comcast, Time Warner's Roadrunner and
other regional cable providers offering high-speed
Internet access over cable modem;
- fixed wireless Internet access services offered by
telecommunications providers such as WorldCom and
smaller local ISPs using technologies such as WIFI; and
- mobile wireless Internet access services offered by
cellular providers such as AT&T Wireless.
We expect that competition could intensify with the availability of
wireless ISPs, both in the licensed and unlicensed spectrums. Diversified
competitors may bundle other services and products with Internet connectivity
services, potentially placing us at a competitive disadvantage.
Advances in communications technology as well as changes in the
marketplace and the regulatory and legislative environment are constantly
occurring. In addition, a continuing trend toward business combinations, such as
the acquisition of AT&T Broadband and Comcast, and alliances in the
telecommunications industry may also create significant new competitors.
REGULATION
Our telephone and video programming transmission services are
subject to federal, state and local government regulation. The 1996 Act
introduced widespread changes in the regulation of the communications industry,
including the local telephone, long distance telephone, data services, and
television entertainment segments. The 1996 Act was intended to promote
competition and decrease regulation of these segments of the industry. The law
delegates to both the FCC and the states broad regulatory and administrative
authority to implement the 1996 Act.
Telecommunications Act of 1996
The 1996 Act was intended to eliminate many of the pre-existing
legal barriers to competition in the telephone and video programming
communications businesses. The 1996 Act also preempts many of the non-federal
barriers to local telephone service competition that previously existed in state
and local laws and regulations and sets basic standards for relationships
between telecommunications providers.
The 1996 Act removes barriers to entry in the local exchange
telephone market by preempting state and local laws that restrict competition
and by requiring LECs to provide nondiscriminatory access and interconnection to
potential competitors, such as cable operators, wireless telecommunications
providers and long distance companies. In addition, the 1996 Act provides some
regulatory relief and pricing flexibility for the ILECs. The 1996 Act also has
allowed the RBOCs, once they met certain conditions, to enter the long distance
market within their own local service regions.
16
Regulations promulgated by the FCC under the 1996 Act require LECs
to provide interconnection, access to unbundled network elements and retail
services at wholesale rates to competitors. As a result of these changes,
companies such as ours are now able to interconnect with ILECs in order to
provide local exchange services. The FCC has revised these regulations several
times since 1996, and many of the FCC's decisions under the 1996 Act have been
subject to court appeals. The FCC began to re-examine its rules regarding access
to unbundled network elements in late 2001. It announced a portion of the review
in February, 2003 with a complete order expected in the first or second quarter
of 2003, and may reduce or modify the LECs' obligations to provide such access.
Because we are building our own networks rather than relying on the ILECs'
facilities, such changes may affect us less than they do some of our
competitors. However, we do require interconnection with the ILECs for a variety
of purposes, and regulatory actions have generally facilitated this
interconnection. Ongoing and future regulatory proceedings and court appeals may
create delay and uncertainty in effectuating the local competition provisions of
the 1996 Act.
We have entered into interconnection agreements with Verizon, SBC,
and other ILECs serving our target market areas. These agreements are usually
effective for terms of two or three years, after which we must renegotiate the
terms of interconnection. As a general matter, our agreements provide for
service to continue without interruption while a new agreement is negotiated.
Most of the agreements also provide for amendments in the event of changes in
the law, such as the regulatory and court decisions described above. We cannot
assure you, however, that we will be able to obtain or enforce future
interconnection agreements, or obtain renewal of existing agreements, on
acceptable terms.
While such interconnection agreements include key terms and prices
for interconnection, a significant joint implementation effort must be made with
the LEC in order to establish operationally efficient and reliable traffic
interchange arrangements. Like many other new entrants, we have experienced
recurrent problems in several markets in the provisioning and maintenance of
interconnection facilities and in the transfer of customers from the incumbent's
network to ours. The FCC and state regulators have taken steps to monitor ILEC
performance of their local competition obligations, and to impose penalties for
poor performance, but these measures are not always effective. Our market
success may be materially affected by ILEC provisioning difficulties.
The 1996 Act establishes certain conditions before RBOCs are allowed
to offer interLATA long distance service to customers within their local service
regions. These conditions include 14 "checklist" requirements designed to open
the RBOC networks to competitors. As of the end of 2002, Verizon and SBC had
received FCC approval to offer in-region long distance service in many, but not
all, of the markets that we serve. We expect these companies to seek approval to
provide this service in their remaining markets during 2003. When an RBOC is
authorized to provide in-region long distance service in its market area, the
RBOC may be able to offer "one-stop shopping" services that compete with our
service offerings. See "Business-Competition". In addition, the RBOC will lose
the incentive it now has to rapidly implement the interconnection provisions of
the 1996 Act in order to obtain in-region authority, although the RBOC will
remain subject to a legal obligation to comply with those provisions.
The 1996 Act also made far-reaching changes in the regulation of
video programming transmission services. These included changes applicable to
video operators, the elimination of restrictions on telephone company entry into
the video business, and the establishment of a new "open video system" ("OVS")
regulatory structure for telephone companies and others. Under the 1996 Act and
implementing rules adopted by the FCC, local telephone companies, including both
ILECs such as Verizon, and CLECs such as ourselves, may provide service as
traditional cable television operators subject to municipal cable television
franchises, or they may choose to provide their programming over open video
systems. Although OVS operators are not required to secure local franchises by
federal law, local franchising authorities may legally require such a franchise.
To date, however, none have done so. OVS operators must make available a portion
of their channel capacity for use by unaffiliated program distributors and must
satisfy certain other requirements, including providing capacity for public,
educational and government channels, and paying a gross receipts fee equal to
the franchise fee paid by the incumbent cable television operator. We are one of
the first CLECs to provide television programming over a broadband network under
the OVS regulations implemented by the FCC under the 1996 Act. As discussed
below, we are currently providing OVS service in the City of Boston and certain
suburbs of Boston, New York City, Washington, D.C. (through Starpower), and in a
limited number of smaller communities.
Although we initially intended to enter the market throughout our
proposed service territories as an OVS provider, we have found during the
negotiation process that many local jurisdictions prefer that we operate subject
to a traditional cable television franchise rather than as an OVS provider. We
consider providing our video service under franchise agreements rather than OVS
certification if the local authorities prefer franchise agreements and such
agreements can be obtained on acceptable terms and
17
conditions. We consider the relative benefits of OVS certification versus local
franchise agreements, including the possible imposition of build out
requirements, before making any decisions.
In those cases where cable franchise agreement could be reached with
such local governments on terms acceptable to us, we have entered a cable
franchise. We are currently providing franchised cable television service in
certain communities in the Boston area, as well as portions of Montgomery
County, Maryland and Falls Church, Virginia (through Starpower), and San
Francisco, California, as well as a number of other smaller markets, including
some in New York, New Jersey, Pennsylvania and Virginia (through Starpower),
among others. In Chicago, we entered the market acquiring the assets of 21st
Century Telecom, an existing cable television franchise holder in portions of
Chicago and nearby communities.
In order to develop our networks for both telecommunications and
video services, we must also obtain local franchises and/or other permits and
licenses, as well as building access agreements and rights to use underground
conduit and pole space, private easements and other rights-of-way and fiber
capacity from entities such as ILECs and other utilities, railroads, long
distance companies, state highway authorities, local governments and transit
authorities. We cannot assure that we will be able to maintain our existing
franchises, permits and rights or to obtain and maintain the other franchises,
permits, building access agreements and rights needed to implement our business
plan on acceptable terms. Although we do not believe that any of the existing
arrangements will be canceled without our consent or will not be renewed as
needed in the near future, certain cancellation or non-renewal of these
arrangements could materially adversely affect our business. In addition, our
failure to enter into and maintain any such required arrangements for a
particular network, including a network, which is already under development, may
affect our ability to acquire or develop that network.
Regulation of Voice Services
Our voice business is subject to regulation by the FCC at the
federal level for interstate telephone services (i.e., those that originate in
one state and terminate in a different state, including the use of our local
networks to originate or terminate such services). State regulatory commissions
have jurisdiction over intrastate communications (i.e., those that originate and
terminate in the same state).
State Regulation of Intrastate Local and Long Distance Telephone
Services. Our intrastate telephone services are regulated by the public service
commissions or comparable agencies of the various states in which we offer these
services. Our subsidiaries or affiliates have received authority to offer
intrastate telephone services, including local exchange service, in all of the
states in our target market areas. We also have authority to provide in-state
long distance services in all states except Alaska and Hawaii. To date, none of
our applications for state authorizations has been rejected.
FCC Regulation of Interstate and International Telephone Services.
We provide domestic interstate telephone services nationwide, and have been
authorized by the FCC to offer worldwide international services. Under recent
FCC decisions, the rates, terms, and conditions of these services are no longer
regulated, although we remain subject to the FCC's jurisdiction over complaints
regarding these services. We also must comply with various FCC rules regarding
disclosure of our rates, the contents and format of our bills, payment of
various regulatory fees and contributions, and the like.
Local Regulation of Telephone Services. Municipalities also regulate
limited aspects of our voice business by, for example, imposing various zoning
requirements. In some instances, they require telecommunications licenses,
franchise agreements and/or installation permits for access to local streets and
rights-of-way. In New York City, for example, we have obtained a telephone
franchise in order to provide voice services using our broadband network
facilities located in the streets of New York City.
Reciprocal Compensation Disputes. Our interconnection agreements
with Verizon and other ILECs entitle us to collect reciprocal compensation
payments from them for local telephone calls that terminate on our facilities.
We make similar payments for outbound local calls we deliver to the ILECs. Some
incumbent carriers have disputed whether their obligation to pay reciprocal
compensation to us (and to other competitive carriers under similar under
similar agreements) encompasses local telephone calls placed by the incumbent
carrier's customers to Internet service providers served by competing carriers.
They claim that this traffic is interstate in nature and therefore should be
exempt from compensation arrangements applicable to local, intrastate calls. We
have contended that the interconnection agreements provide no exception for
local calls to Internet service providers and reciprocal compensation is
therefore applicable.
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In February 1999, the Federal Communications Commission (FCC) ruled
that calls to Internet providers are jurisdictionally interstate. The FCC,
however, determined that this issue did not resolve the question of whether
reciprocal compensation is owed. The FCC noted a number of factors that would
allow the state commissions to leave their decisions requiring the payment of
compensation undisturbed. In March 2000, the FCC's ruling was vacated by the
United States Court of Appeals for the District of Columbia Circuit for lack of
reasoned decision making, and remanded to the FCC for further consideration.
On April 27, 2001, the FCC adopted a new ruling on compensation for
ISP-bound traffic. The FCC asserted exclusive jurisdiction over ISP-bound
traffic and established a new interim inter-carrier compensation regime for this
traffic with capped rates above a fixed traffic exchange ratio. Traffic in
excess of a ratio of 3:1 (terminating minutes to originating minutes) is
presumed to be ISP-bound traffic, and is to be compensated at rates that
decrease from $.0015 to $.0007, or the applicable state-approved rate if lower,
over two years. Traffic below the 3:1 threshold is to be compensated at the
rates in existing interconnection agreements. Traffic above the 3:1 ratio is
also subject to a growth ceiling using First Quarter 2001 traffic data as the
baseline. Traffic in excess of the growth ceiling is subject to "bill and keep,"
an arrangement in which the originating carrier pays nothing to the terminating
carrier to complete calls. In addition, when a competitive carrier begins to
provide service in a state it has not previously served, all traffic in excess
of the 3:1 ratio is subject to bill-and-keep arrangements. The rate caps imposed
by the FCC rules are, in most states, considerably lower than the rates that we
were collecting under existing interconnection agreements.
In May, 2002, the United States Court of Appeals for the District of
Columbia Circuit remanded the FCC's April 2001 decision for lack of an adequate
legal justification for the rules adopted, but did not vacate those rules. The
FCC has not yet taken any action in response to the Court's remand, so the April
2001 rules remain in effect.
Starpower currently has pending complaints against Verizon based on
its refusal to pay reciprocal compensation in the District of Columbia and
Virginia for periods prior to the effective date of the new FCC rules. With
respect to Virginia, the FCC ruled that one subsidiary of Verizon was liable for
reciprocal compensation payments under its interconnection agreement, but that
another subsidiary operating under a different agreement was not liable. The FCC
has not yet determined the amount of compensation payable under the first
agreement, and Starpower has appealed the adverse ruling on the second
agreement. In addition, Verizon has brought a complaint against Starpower to
recover reciprocal compensation payments it made for Maryland traffic for
periods prior to that effective date. At this time we are unable to provide any
assurance as to the outcome of these complaints.
Regulation of Video Services
Open Video Systems. At various times between February 1997 and
December 2002, our subsidiaries and affiliates have been certified by the FCC to
operate OVS networks in Northern New Jersey, Cook County, Illinois, as well as
other key metropolitan markets, such as New York City, Boston, Washington, D.C.,
Philadelphia, Los Angeles, and San Francisco, among others. Initiation of OVS
services is subject to completion of an open enrollment period that permits
unaffiliated video programmers to seek capacity on the systems. Negotiation of
certain agreements with local governments is also a prerequisite to initiating
service. The initial open enrollment period for Northern New Jersey, New York
City, Washington, D.C., and Philadelphia has been completed. The open enrollment
period has not yet begun for the remaining markets.
OVS networks are subject to a certain degree of local regulation for
use of local streets and rights-of-way, but not to the same extent as
traditional cable systems. The terms and conditions of our OVS agreements vary
from jurisdiction to jurisdiction. Generally, they contain provisions governing
gross receipts fees, term, public, educational and governmental channel
requirements, and other standard right-of-way management requirements. Gross
receipt fees for OVS operators such as the Company are required to mirror the
gross receipts fees paid by the incumbent cable operator, which fees are limited
by the Communications Act to a maximum of 5 percent of gross revenues derived
from cable operations.
In areas where we offer video programming services as an OVS
operator, we are required to make up to two-thirds of channel capacity on the
system available to Video Programming Providers ("VPPs"). The FCC's rules permit
us to retain up to one-third of the system capacity for our own (or our
affiliate's) use. Under the OVS regulations, during the initial open enrollment
period we must offer at least two-thirds of our capacity to unaffiliated
parties, if demand for such capacity exists during the open enrollment period.
Where we have conducted open enrollment periods for our operational
19
OVS systems, we have provided the required data to various potential VPPs, but
to date none have requested carriage on any of our systems.
In a decision released in January 1999, the U.S. Court of Appeals
for the Fifth Circuit approved some portions of the FCC's OVS rules but struck
down other portions. Although a number of the Court's rulings are favorable to
OVS operators, others could have an adverse impact on our OVS operations and
planning. The Court's most significant decision was to strike down the FCC's
rule terminating the right of a local authority to require a franchise of OVS
operators. The FCC's rules had set forth a relatively simple procedure at the
FCC for rapid certification of each OVS system on a regional basis and permitted
local authorities to regulate OVS only as to rights-of-way administration and in
other minor respects. One of the principal advantages of OVS as structured by
Congress and by the FCC was to eliminate the time, expense, and uncertainty
generally required to secure a local franchise. The Court's action allowing
local governments to require area-by-area franchising may significantly reduce
the advantage of OVS operation as compared with traditional franchising and
delay achieving agreements with local governments. To date, however, no local
franchising authority has insisted on franchising our OVS systems, although some
have considered doing so. In many instances, we, at the insistence of local
authorities, have negotiated a cable television franchise agreement in lieu of
an OVS agreement. In other instances we have agreed to provisions in OVS
right-of-way agreements which to some extent erode the differences between the
two modes of operation. Accordingly, while the ruling is disadvantageous to our
OVS operations, it has not significantly altered the way that we offer our video
services.
The FCC's rules require OVS operators to make their facilities
available to unaffiliated VPPs on a non-discriminatory basis, with certain
exceptions. One such exception is that a competing in-region cable operator is
not entitled to become a VPP on an OVS except in certain limited circumstances.
Notwithstanding this limitation, incumbent cable operators in our Boston, New
York and Washington, D.C. area markets have sought proprietary OVS system
information from us to analyze the possibility of becoming a VPP on our network.
Such requests were submitted by Time Warner Cable Co., which then operated
franchised cable systems in many suburban Boston communities included within our
Boston-area OVS certification, and operates the franchised cable system in a
portion of our New York City market within our OVS service area, and Media
General Cable, which then operated cable systems in a portion of Starpower's
Washington, D.C. OVS service area. We denied all of those requests based on our
belief that the cable companies are ineligible under the FCC's rules. Each of
Time Warner and Media General Cable subsequently filed separate complaints to
the FCC against RCN seeking FCC action imposing fines or canceling our OVS
authority. Media General Cable's systems were subsequently transferred to a new
operator, and Media General Cable has voluntarily withdrawn its complaints.
In the Time Warner proceedings, which are still pending, the FCC
adopted a standard under which eligibility to obtain the information sought by
the cable companies will be based on whether the in-region cable competitor is
franchised within the "technically integrated service area" of the OVS
certificate holder. RCN has submitted information to the FCC regarding our
Boston and New York OVS systems to enable the Commission to make a determination
as to whether Time Warner is eligible to receive confidential information under
this new standard. RCN has requested confidential treatment of such information.
The FCC has not yet ruled on that request. Subsequently, in February 2000, after
the sale of its Boston area cable operations to MediaOne, Time Warner renewed
its request for Boston area OVS data from RCN alleging that it was no longer an
in-region cable competitor. We again declined to provide such data based upon
Time Warner's affiliations and possible contractual arrangements with MediaOne.
Time Warner filed another petition to the FCC renewing its earlier allegations
that RCN was not adhering to certain of the OVS rules and was not operating a
truly "open" OVS system. Time Warner sought an order compelling us to provide
the OVS data to Time Warner, and for the imposition of forfeitures on RCN for
allegedly failing to comply with Commission orders. We opposed the petition and
the FCC has not yet acted on it.
We believe that we are operating in strict conformity with all
applicable provisions of the law and will continue to defend our OVS rollouts
against what we believe are anti-competitive requests for data or carriage by
competing with in-region cable operators. However, we cannot assure that the FCC
will resolve the pending Time Warner request for OVS data in our favor or that
other incumbents will not file similar requests in our other markets. If the FCC
were to grant such request and as a result we were obliged to share system data
with our local competitors, we would be forced to reassess the desirability of
continuing to operate in certain markets as an OVS operator as compared with
seeking a cable television franchise. We do not believe that converting our OVS
certifications under such circumstances would materially adversely affect our
video distribution activities, although it could potentially require us to agree
to a network build-out obligation in that market.
Wireless Video Services. Our 18 GHz wireless video services
primarily in New York City are distributed using microwave facilities. We cannot
assure you that we will be able to obtain or retain all necessary authorizations
needed to construct broadband
20
network facilities, to convert our wireless video subscribers to an broadband
network or to offer wireless video services under our own FCC licenses.
Cable television Systems. Our cable television systems, including
those systems where we have entered a cable television franchise with the local
government in lieu of an OVS agreement and those areas where we operate our
cable network cable systems, are subject to regulation under the 1992 Cable Act.
The 1992 Cable Act regulates rates for cable services in communities that are
not subject to "effective competition," certain programming requirements, and
broadcast signal carriage requirements that allow local commercial television
broadcast stations to require a cable system to carry the station. Local
commercial television broadcast stations may elect once every three years to
require a cable system to carry the station ("must-carry"), subject to certain
exceptions, or to withhold consent and negotiate the terms of carriage
("retransmission consent"). A cable system generally is required to devote up to
one-third of its activated channel capacity for the carriage of local commercial
television stations whether under the mandatory carriage or retransmission
consent requirements of the 1992 Cable Act. The Communications Act also permits
franchising authorities to require cable operators to set aside certain channels
for public, educational and governmental access programming. Cable systems with
36 or more channels must designate a portion of their channel capacity for
commercial leased access by third parties to provide programming that may
compete with services offered by the cable operator.
Local non-commercial television stations are also given mandatory
carriage rights. The FCC has issued rules establishing standards for digital
television ("DTV"). The FCC's rules require television stations to simulcast
their existing television signals ("NTSC") and DTV signals for a period of years
prior to the expected cutover to full digital broadcasting in 2006. During this
simulcast period, it is unclear whether must-carry rules will apply to DTV
signals. The FCC has undertaken a rulemaking proceeding seeking comment on the
carriage of broadcast DTV signals by cable and OVS operators during the
transitional period to full digital broadcasting. The FCC's proceeding addresses
the need for the digital systems to be compatible and changes to the mandatory
carriage rules, and explores the impact carriage of DTV signals may have on
other FCC rules. The cable industry has generally opposed many of the FCC's
proposals, on the grounds that they constitute excessively burdensome
obligations on the industry. Several of the largest MSOs, however, have agreed
to limited carriage of digital signals during the transition process.
Because a cable communications system uses local streets and
rights-of-way, such cable systems are generally also subject to state and local
regulation, typically imposed through the franchising process. The terms and
conditions of state or local government franchises vary materially from
jurisdiction to jurisdiction. Generally, they contain provisions governing cable
service rates, franchise fees, franchise term, system construction and
maintenance obligations, customer service standards, franchise renewal, sale or
transfer of the franchise, territory of the franchisee, and use and occupancy of
public streets, and types of cable services provided. Local franchising
authorities may award one or more franchises within their jurisdictions and
prohibit non-grandfathered cable systems from operating without a franchise. The
Communications Act also provides that, in granting or renewing franchises, local
authorities may establish requirements for cable-related facilities and
equipment, but not for video programming or information services other than in
broad categories. The Communications Act limits franchise fees to 5% of revenues
derived from cable operations and permits the cable operator to seek
modification of its franchise requirements through the franchise authority or by
judicial action if changed circumstances warrant.
The Company currently does not pay a 5% franchise fees on its cable
modem Internet access services on the basis that the FCC has determined that
such Internet services are not "cable services" as defined in the Communications
Act. The Company's position has been challenged by the City of Chicago, which
has brought suit against the Company, as well as AT&T Broadband, the incumbent
cable operator in the Company's franchise service area, and the other franchised
cable television operators in the City of Chicago (together the "Defendants").
The Defendants have sought to remove the action to federal court and to dismiss
it on the ground that cable modem service, as a matter of law, is not a cable
television service within the scope of the Franchise Agreement and cannot be
subject to the Agreement's franchise fee provision, which is, by its express
terms, is to be interpreted and applied in accordance with the federal
Communications Act. The City of Chicago has opposed these motions and both
matters is now before the Court. The Company will continue to vigorously defend
its position in this action but can provide no assurances that the Defendants
will prevail in this action. To the extent that the City of Chicago prevails, it
would mean that the Company would likely be required to pass through the
additional fees to its cable modem Internet service customers. However, because
any adverse result will affect all of the Company's competitors in the Chicago
market, we do not believe that an adverse ruling would materially adversely
affect the Company's ability to compete in the Chicago market. The Company also
notes that to the extent that this question is one of nationwide significance to
local franchising authorities and cable television franchisees, so that any
decision in the City of Chicago
21
case (or any other similar cases brought by local franchising authorities) is
likely to be appealed, and the ultimate result will likely determine whether the
Company's cable modem Internet service fees are required to be includes as cable
service revenues for purposes of franchise fee payments.
Our ability to provide franchised cable television services depends
largely on our ability to obtain and renew franchise agreements from local
government authorities on generally acceptable terms. We cannot assure that such
agreements will be reached in every instance, and the failure to do so in a
particular local jurisdiction could have a material effect on our ability to
enter or continue to operate in that local area. In Philadelphia, we experienced
significant delays in securing authorization from the city to provide cable or
OVS service on commercially reasonable terms. As a result, RCN has withdrawn
from such negotiations with the city and has no present plans to build out its
system in Philadelphia. We are, however, continuing to operate in certain of the
Philadelphia suburbs.
We currently have numerous franchise agreements relating to systems
where we have entered into cable franchises in lieu of OVS agreements, including
cable franchises in San Francisco, Chicago, and a number of surrounding
communities. We also have franchise agreements relating to cable network systems
in New York (outside New York City) and Pennsylvania. All of the cable
franchises typically contain many conditions, such as time limitations on
commencement and completion of construction, conditions of service, including
the number of channels, the provision of free service to schools and certain
other public institutions, liquidated damages and the maintenance of insurance
and indemnity bonds. These franchises provide for the payment of fees to the
issuing authorities and generally range from 3% to 5% of revenues.
In light of current economic conditions in the communications
industry and limitations on the Company's ability to raise capital, it is likely
that the Company will continue to substantially decrease the amount it is
spending on capital expenditures. The Company decreased capital expenditures in
2001 and 2002 and expects it to fall again 2003. As a result, it is probable
that the Company will not be able to meet all of the construction and system
build-out requirements contained in some of the cable franchises arrangements it
has entered into with certain local governments in lieu of OVS agreements. In
certain communities in the Boston area, South Florida, the Pacific Northwest,
the Chicago area, Northern New Jersey, and Eastern Pennsylvania, the Company has
agreed with the franchising authorities either to terminate the franchise
without penalty or prejudice to entering a new franchise in the future, or to
postpone indefinitely any build-out obligations. In Boston, the Company has
entered into an OVS agreement with the City and terminated its franchise. In
other cases, the Company is attempting to negotiate with franchising authorities
to extend or modify the terms of the applicable franchise to avoid any breaches
and related penalties, terminate the applicable franchise without penalty or
prejudice to entering a new franchise in the future, to convert the franchise to
an OVS agreement in order to relax build-out obligations, or to postpone
indefinitely any build-out obligations under the franchise. Although in many
cases the local government and franchising authorities have indicated that they
are willing to work with the Company to reach agreements as to such amendments
or modifications, the Company can make no assurances that it will be able to
reach a satisfactory resolution of these issues, or that the municipalities
involved will not seek to invoke the liquidated damages and other penalties to
which they may claim to be entitled pursuant to the franchise agreements.
Several jurisdictions have threatened to seek damages or other remedies for our
current or expected future non-compliance with construction and system build-out
requirements. The Town of Northbrook, Illinois, has brought legal action against
the Company for breach of the Company's franchise agreement commitments, and the
Town of Newtown Township, Pennsylvania has also threatened to assess penalties
against the Company. While the Company has raised both statutory and contractual
defenses to the Northbrook and Newtown Township claims, and believes that such
defenses are reasonable and justified, the law in this area is uncertain and the
Company can make no assurances that it will be successful in defending such
actions. If the Company does not prevail in our defense of these actions, it
could be subject to significant damages. If all of the franchising authorities
with which the Company has franchise arrangements were to make similar
challenges and prevail in such efforts, the Company could be subject to
aggregate penalties which could have a material adverse effect on its
operations.
Right-of-Way Access. As in the case of traditional franchised cable
systems, OVS operators must have access to public rights-of-way for a
substantial portion, if not all, of their distribution plant. In a number of
jurisdictions local authorities have attempted to impose rights-of-way fees on
us that we believe are in violation of federal law. A number of FCC and judicial
decisions have addressed the issues posed by the imposition of rights-of-way
fees on competitive LECs and on video distributors. To date the state of the law
is uncertain and may remain so for some time. The obligation to pay local
rights-of-way fees, which are excessive or discriminatory, could have adverse
effects on our business activities.
22
Pole and Conduit Attachments. Under the Pole Attachment Act, the FCC
is required to regulate the rates, terms and conditions imposed by utilities,
ILECs and CLECs for cable systems and telecommunications providers use of
utility pole and conduit space unless state authorities can demonstrate that
they adequately regulate pole attachment rates, terms and conditions. In the
absence of state regulation, the FCC administers pole attachment rates on a
formula basis. We are being subjected in some instances to pole attachment
practices and fees which we believe are in violation of applicable federal law.
We have attempted to resolve certain of these matters informally. In some cases,
utility companies have increased pole attachment fees for cable systems that
have installed fiber-optic cables and that are using these cables for the
distribution of non-video services. The 1996 amendments to the Pole Attachment
Act modified the prior pole attachment provisions by establishing a new formula
for setting rates for attachment of telecommunications wiring, and requires that
utilities provide cable systems and telecommunications carriers with
nondiscriminatory access to any pole, conduit or right-of-way, owned or
controlled by the utility if the facility is carrying wires already. The FCC
adopted regulations to govern the charges for pole attachments used by companies
providing telecommunications services, including cable operators. These
regulations became effective on February 8, 2001 and any increase in attachment
rates for telecommunications companies resulting from the FCC's new regulations
is being phased-in in equal annual increments over a period of five years
beginning on the effective date of the new FCC regulations. A number of
pole-owning utilities challenged the new rules, raising constitutional and other
issues. The FCC strongly asserted its jurisdiction to regulate pole attachment
fees, including those charged to companies providing broadband services. The
United States Supreme Court and Court of Appeals for the District of Columbia
Circuit both issued rulings in 2002 upholding aspects of the FCC's pole
attachment rules favorable to the Company. In a ruling of particular importance
to the Company, the Supreme Court held that broadband service providers that
provide co-mingled video, telecommunications, and Internet services over their
networks are entitled to the protections of the Pole Attachment Act. This ruling
ensures that we will have the benefit of the FCC's rate formula for our pole
attachments.
In the Boston area, pole attachment policies imposed by
Verizon-Massachusetts had substantially delayed the rollout of our services in
certain communities. Our Affiliate, RCN-Becocom, sought relief from the
Massachusetts Department of Telecommunications and Energy ("DTE") and from the
FCC, and in response, Verizon-Massachusetts and RCN-Becocom have developed,
under the auspices of the Massachusetts DTE, an experimental pole attachment
program which, if permanently implemented, could substantially accelerate access
to poles and reduce the cost of such access.
In the Philadelphia suburbs, RCN encountered delays and high costs
in gaining access to poles owned by PECO, an electric utility that owns the
majority of the poles in the suburban Philadelphia communities in which RCN is
currently operating its network. PECO has sought to impose significantly
increased pole attachment licensing fees on RCN and has also engaged in a number
of practices concerning the preparation of the poles which RCN believes are
contrary to the law. After trying to resolve these issues informally with PECO,
RCN has filed a formal pole attachment complaint against PECO and certain of its
affiliates at the FCC. In December 2002, the FCC Enforcement Bureau granted
RCN's complaint with respect to PECO's pole attachment fees, and ordered PECO to
reduce its fees and to reimburse to RCN the excessive fees paid from the date of
the complaint going forward. PECO has appealed the ruling. However, if upheld,
the ruling will result in a substantial reduction in the fees RCN must pay to
PECO. The Enforcement Bureau has not yet acted on the merits of RCN's complaint
with respect to "make ready" preparation of the poles.
Program Access. The 1992 Act, the 1996 Act and FCC regulations
preclude any cable operator or satellite video programmer affiliated with a
cable company, or with a common carrier providing video programming directly to
its subscribers, from favoring an affiliated company over competitors. In
certain circumstances, these programmers are required to sell their programming
to other multichannel video distributors. The provisions limit the ability of
program suppliers affiliated with cable companies or with common carriers
providing satellite delivered video programming directly to their subscribers to
offer exclusive programming arrangements to their affiliates. The FCC's Cable
Service Bureau, however, has ruled that, except in limited circumstances, these
statutory and regulatory limitations do not apply to programming which is
distributed other than by satellite. We have experienced difficulty in securing
access to certain local sports programming in the New York City and other local
markets, which we consider important to successful competition. We brought a
formal program access complaint against Cablevision Systems, Inc., over its
refusal to provide such programming to RCN. However, the Cable Services Bureau
found that programming distributed by fiber-optic cable was not covered by the
program access provisions of the Communications Act, and denied our complaint.
We sought review by the full Commission of this ruling. Absent reversal,
however, we do not have guaranteed access to non-satellite-delivered
programming. Although we typically have been able to negotiate viable agreements
to carry such programming, if we are denied access to certain non-satellite
delivered
23
programming, such denial has the potential to impair our ability to compete
effectively in those markets.
Certain important provisions of the Cable Act of 1992 that restrict
exclusivity in the distribution of certain video programming were scheduled to
lapse in 2002 but were extended by the FCC for an additional five years. The
extension of these rules ensures that we will continue to have access to
important satellite delivered programming until at least 2007.
The term of our existing franchises presently varies up to the year
2015. To date, all of our cable franchises that have reached their expiration
date have been renewed or extended, generally at or before their stated
expirations and on acceptable terms. Numerous cable franchises are due for
renewal within the next three years. We cannot assure that we will be able to
renew these or our other franchises on acceptable terms.
Cable television systems are also subject to certain service quality
standards and other obligations imposed by the FCC and, where effective
competition has not been demonstrated to exist, had been subject to rate
regulation by the FCC as well. All of our cable franchises that have been
entered in lieu of an OVS agreement are subject to effective competition, since
in each case there has been an existing incumbent cable operator already serving
the area. These systems are therefore exempt from many FCC cable television
regulations, including rate regulation. Our cable network television system in
the Lehigh Valley area of Pennsylvania has been operating in a competitive cable
environment for almost 30 years, with approximately 80% of the homes passed
having access to an alternate cable operator, Service Electric cable television.
As a result, our Lehigh Valley cable system is also exempt from many FCC cable
television regulations, including rate regulation. Our other cable network
television systems in New York State had been subject to FCC rate regulation. As
required by the 1996 Act, however, all cable programming services except limited
basic service rate regulation were deregulated on March 31, 1999. There has been
discussion in Congress about possible legislation to reimpose cable rate
regulation. We cannot assure you that legislation will not be adopted. We
anticipate that the remaining provisions of the 1992 Act that do not relate to
rate regulation, including provisions relating to retransmission consent and
customer service standards, will remain in place and may reduce the future
operating margins of our cable network cable television businesses as video
programming competition develops in our cable television service markets.
In addition to the FCC regulations previously discussed, there are
other FCC cable regulations covering areas such as:
- equal employment opportunity;
- syndicated program exclusivity;
- network program non-duplication;
- registration of cable systems;
- maintenance of various records and public inspection
files;
- microwave frequency usage;
- lockbox availability;
- sponsorship identification;
- antenna structure notification;
- tower marking and lighting;
- carriage of local sports broadcast programming;
- application of rules governing political broadcasts;
- limitations on advertising contained in non-broadcast
children's programming;
- consumer protection and customer service;
- ownership and access to cable home wiring and home run
wiring in multiple dwelling units;
- indecent programming;
24
- programmer access to cable systems;
- programming agreements;
- technical standards; and
- consumer electronics equipment compatibility and closed
captioning.
The FCC has the authority to enforce its regulations by imposing
substantial fines, issuing cease and desist orders and/or imposing other
administrative sanctions, such as revoking FCC licenses needed to operate
certain transmission facilities often used in connection with cable operations.
We have had difficulty gaining access to the video distribution
wiring in certain multiple dwelling units ("MDUs") in the City of Boston. In
some buildings the management will not permit us to install our own distribution
wiring and Cablevision has not been willing to permit us to use the existing
wiring on some equitable basis when we wish to initiate service to an individual
unit previously served by Cablevision. We have encountered similar problems in
New York City and Washington, D.C., where we also provide service as an OVS
operator and it is unsettled whether we have the protection of the mandatory
access laws that entitle franchised cable television operators to gain entry to
MDU buildings. We sought a ruling from the FCC that existing FCC inside wiring
rules require Cablevision to cooperate with us in Boston to make such wiring
available to us. By Order released on January 29, 2003, the FCC granted our
request, ruling that where cable wiring is located behind sheet rock walls or
ceilings, the designated point at which we are allowed to access the wires must
be demarcated at a physically accessible location that does not require us to
disturb the sheet rock. The order will apply to all of our markets, not just
Boston. In the same order, the FCC also clarified and upheld other aspects of
its existing rules providing for access to cable inside wiring. Although aspects
of the FCC order are likely to be appealed, the order may ease at least some of
the difficulty we have experienced in gaining access to the video distribution
wiring in certain MDUs, thereby making it easier for us to provide service to
customers in those buildings. The order also clarifies that the FCC's rules
apply to both OVS operators and franchised cable television providers.
We also sometimes are precluded from serving an MDU, because the MDU
owner has entered into an exclusive agreement with another provider. In some
instances, these exclusive agreements are perpetual. The FCC, in its January 29,
2003 order, declined to ban such exclusive and perpetual contracts for the
provision of video service in MDUs.
Other bills and administrative proposals pertaining to cable
television have previously been introduced in Congress or considered by other
governmental bodies over the past several years. There will likely be
legislative proposals in the future by Congress and other governmental bodies
relating to the regulation of communications services.
Cable television systems are subject to federal compulsory copyright
licensing covering the retransmission of television and radio broadcast signals.
In exchange for filing certain reports and contributing a percentage of their
basic revenues to a federal copyright royalty pool, cable operators can obtain
blanket licenses to retransmit the copyrighted material on broadcast signals.
Numerous jurisdictions have imposed or attempted to impose so-called "open
access" requirements in connection with the grant or transfer of a cable
franchise and many more are considering doing so. As used in this context, "open
access" refers to the requirement that a broadband operator permit unaffiliated
entities to provide Internet services over the cable television operator's
broadband facilities. We believe our business interests may be served by such
open access but we are opposed to further regulations or government intervention
in regard to such matters.
Responding to pressure principally from direct broadcast satellite
("DBS") companies, Congress passed the Satellite Home Viewer Improvement Act in
late fall of 1999. The principal purpose of this legislation, known as "SHVIA"
was to amend the copyright law to permit the DBS companies to carry more local
broadcast programming in their programming packages (so-called
"local-into-local"). At the same time the legislation directed the FCC to
develop new regulations concerning retransmission consent and mandatory access.
The retransmission consent provision of SHVIA covers all multiple video program
distributors ("MVPDs") as well as DBS providers. The Commission has adopted
retransmission consent rules as required by SHVIA. These new regulations
establish an obligation on the part of broadcasters to bargain in good faith and
define good faith by reference to certain prohibited bargaining tactics or
positions. The regulations also bar exclusive retransmission agreements but do
permit broadcasters to enter into varying terms with MVPDs carrying their signal
based on normal competitive criteria. To the extent that we will need to
negotiate such retransmission consent agreements in the future these regulations
should help to strengthen our negotiating position.
25
Other Regulatory Issues
Data Services. The data services business, including Internet
access, is largely unregulated at this time apart from federal, state and local
laws and regulations applicable to businesses in general. However, we cannot
assure you that this business will not become subject to regulatory restraints.
Some federal, state, local and foreign governmental organizations are
considering a number of legislative and regulatory proposals with respect to
Internet user privacy, infringement, pricing, quality of products and services
and intellectual property ownership. We are also unsure how existing laws will
be applied to the Internet in areas such as property ownership, copyright,
trademark, trade secret, obscenity and defamation. Additionally, some
jurisdictions have sought to impose taxes and other burdens on providers of data
services, and to regulate content provided via the Internet and other
information services. We expect that proposals of this nature will continue to
be debated in Congress and state legislatures in the future. In addition, the
FCC is now considering a proposal to impose obligations on some or all providers
of Internet access services to contribute to the cost of federal universal
service programs, which could increase the cost of Internet access. The adoption
of new laws or the modification of existing laws to the Internet may decrease
the growth in the use of the Internet, which could in turn have a material
adverse effect on our Internet business.
We have summarized present and proposed federal, state, and local
regulations and legislation affecting the telephone, video programming and data
service industries. However, other existing federal regulations, copyright
licensing, and, in many jurisdictions, state and local franchise requirements,
are currently the subject of judicial proceedings, legislative hearings and
administrative proposals that could change, in varying degrees, the operations
of communications companies. The ultimate outcome of these proceedings, and the
ultimate impact of the 1996 Act or any final regulations adopted thereunder on
us or our businesses cannot be determined at this time.
Employees
As of December 31, 2002, we had approximately 3,623 employees
including 95 in our discontinued operations. This includes approximately 114
part-time employees, of which none were in the discontinued operation. In
addition, our joint venture, Starpower, had full time employees of
approximately 231 and 2 part time employees as of December 31, 2002.
During 2002, the company was the subject of two union campaigns
involving warehouse and technician employees in our Manhattan and Boston
markets. In Manhattan, the union withdrew its representation petition involving
the representation of 170 employees prior to a vote. The 185 employees in the
Boston campaign voted not to affiliate with the bargaining representative.
Risk Factors
The risks and uncertainties described below are not the only ones
facing our company. Additional risks and uncertainties not presently known to us
or that we currently believe to be immaterial may also adversely affect our
business. If any of the following risks actually occur, our business, financial
condition and operating results could be materially adversely affected.
- - During Our Limited Operating History, We Have Incurred Negative Cash Flow
And Operating Losses.
In connection with the operation of our business,
including the build-out of our network, we have incurred significant
operating and net losses and negative cash flows and we expect to
continue to experience losses for the foreseeable future. We may not
be able to achieve or sustain operating profitability in the future.
Whether we continue to have negative cash flow in the future will be
affected by a variety of factors including:
- The rate at which we add new customers;
- the time and expense required to acquire new customers
and for constructing our broadband network as we
planned;
- our ability and the expense to lower the cost to serve
our customers;
26
- our success in marketing services;
- the intensity of competition; and
- the availability of additional capital to pursue our
business plans.
We had operating losses from continuing operations after
depreciation and amortization and nonrecurring charges of
$1,432,009, $1,175,380, and $891,466 for the years ended December
31, 2002, 2001, and 2000, respectively. We cannot assure you that we
will achieve or sustain profitability or positive cash flows from
operating activities in the future. Continued operating losses could
limit our ability to obtain the cash needed to execute our business
plan, make interest and principal payments on our debt, comply with
financial covenants under our credit agreement or fund other
business needs.
- - Our Substantial Indebtedness Limits Our Business Flexibility.
We have indebtedness that is substantial in relation to
our stockholders' equity and cash flow. Part of this indebtedness
arises from the $750,000 senior secured Credit Facility, as amended
on March 7, 2003, that we have with JPMorgan Chase Bank and other
lenders. The Credit Facility is comprised of a $15,000 seven-year
revolving Credit Facility, a $187,500 seven-year multi-draw term
loan facility and a $375,000 eight-year term loan facility. All
three facilities are governed by a single credit agreement dated as
of June 3, 1999, and as amended.
As of December 31, 2002, we had an aggregate of
approximately $1,744,414 of indebtedness outstanding, including
indebtedness arising under the JPMorgan Chase Bank Credit Facility.
As a result of our substantial indebtedness, fixed
charges are expected to exceed earnings for the foreseeable future,
and our operating cash flow may not be sufficient to pay principal
and interest on our various debt securities. To the extent we are
able to reduce our outstanding indebtedness, our leverage may also
have the following consequences:
- limit our ability to obtain necessary financing in the
future for working capital, capital expenditures, debt
service requirements or other purposes;
- require that a substantial portion of our cash flows
from operations be dedicated to paying principal and
interest on our indebtedness and therefore not be
available for other purposes;
- limit our flexibility in planning for, or reacting to,
changes in our business;
- limit our ability to pay dividends;
- place us at a competitive disadvantage as compared with
our competitors who do not have as much debt; and
- render us more vulnerable in the event of a downturn in
our business or industry or the economy generally.
Our outstanding debt securities and our credit agreement
with JPMorgan Chase Bank and other lenders contain customary
covenants limiting our flexibility, including covenants limiting our
ability to incur additional debt, make liens, make investments,
consolidate, merge or acquire other businesses, sell assets, pay
dividends and other distributions, make capital expenditures and
enter into transactions with affiliates and requiring that we meet
certain financial ratios and tests.
- - We Are Limited In Our Ability To Borrow Under Our Existing Credit Facility
And May Have Limited Access To Other Sources Of Capital.
On March 7, 2003, we entered into an Amendment to our
Credit Agreement governing our Credit Facility with JPMorgan Chase
Bank and other lenders ("the Fifth Amendment"). The Fifth Amendment
enables us to incur up to $500,000 of additional senior secured
debt, adjusts the operating and financial covenants to
27
reflect the Company's business plan and modifies other restrictions
that existed under the previous agreement. The Fifth Amendment also
reduces the amount available under the revolving loan facility,
under which there are currently has no borrowings outstanding, to
$15,000, and requires us to maintain additional cash collateral of
at least $100,000 for the benefit of the lenders under its credit
facility which will be recorded as restricted cash on our balance
sheet. The Fifth Amendment also calls for half of the first $100,000
in proceeds from future asset sales, and 80% of proceeds from assets
sales in excess of $100,000, to be used to pay down our senior
secured term loans. Additionally, we will increase amortization
payments under its term loans by an amount equal to 50% of interest
savings from new repurchases of senior notes, not to exceed $25,000.
The Fifth Amendment enables us to incur up to $500,000 of new senior
indebtedness that may be secured by a second subordinated lien on
RCN's assets and we may use up to $125,000 of existing cash, and the
proceeds of new indebtedness, to repurchase outstanding senior
notes. Additionally, covenants are revised to reflect RCN's current
long-term business plan. However, the Company may be unable to
secure lenders for the $500,000 additional senior secured debt or
secure such debt with terms and conditions which are acceptable to
the Company.
The Company may experience difficulty raising capital from
other sources in the future, as both the equity and debt capital
markets continue to experience periods of significant volatility,
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. Our public
equity and debt securities are trading at or near all time lows,
which together with our substantial leverage, means we may have
limited access to certain of our historic sources of capital.
In order to meet its long-term liquidity needs, the Company
anticipates it will have to do one or a combination of the
following: (i) outperform its business plan, (ii) improve
operational efficiencies,(iii) raise additional capital through
issuance of equity or debt securities, (iv) further amend its Credit
Facility, (v) restructure its balance sheet, and (vi) consummate
additional asset sales. The Company cannot assure you that it will
be able to implement any of the foregoing on acceptable terms.
- - We may in the future seek to raise funds through equity offerings, which
would have dilutive effect on our common stock.
In the future we may determine to raise capital through
offerings of additional equity securities, which could have a
dilutive effect on the percentage ownership of our shareholders. In
addition, such equity securities may have rights, preferences and
privileges senior to those of our current shareholders.
- - As A Result Of Limitations On Our Ability To Raise Capital, We Will Likely
Decrease The Amount We Are Spending On Capital Expenditures, Which Could
Result In Our Failure To Meet Build-out And Construction Obligations Under
Some Of Our Franchise Agreements And Limit Our Ability To Increase Our
Subscriber Numbers In The Short Term And Adversely Affect Our Revenues.
In light of current economic conditions in the
communications industry and limitations on our ability to access new
sources of capital, it is likely that we will decrease the amount we
are spending on capital expenditures. We decreased capital
expenditures from continuing operations from $1,242,865 in 2000 to
$493,215 in 2001 and $141,758 in 2002. As a result, it is probable
that we will not be able to meet all of the construction and system
build-out requirements contained in some of the cable franchises
arrangements it has entered into with certain local governments. In
such cases, the Company is attempting to negotiate with franchising
authorities to extend or modify the terms of the applicable
franchise to avoid any breaches and related penalties, terminate the
applicable franchise without penalty or prejudice to entering a new
franchise in the future or to postpone indefinitely any build-out
obligations under the franchise. We can make no assurances that we
will be able to reach a satisfactory resolution of these issues, or
that the municipalities involved will not seek to invoke the
liquidated damages and other penalties to which they may claim to be
entitled pursuant to the franchise agreements. Several jurisdictions
have threatened to seek damages or other remedies for our current or
expected future non-compliance with construction and system
build-out requirements. The Town of Northbrook, Illinois, has
brought legal action against us for breach of our franchise
agreement commitments, and the Town of Newtown Township,
Pennsylvania has also threatened to assess penalties
28
against us. We can make no assurances that we will be successful in
defending such actions. If we do not prevail in our defense of these
actions, we could be subject to significant damages. If all of the
franchising authorities with which we have franchise arrangements
were to make similar challenges and prevail in such efforts, we
could be subject to aggregate penalties, which could have a material
adverse effect on our operations. In addition, our failure to build
out under our franchises will severely limit the number of new
marketable homes passed by our network and, accordingly, limit the
growth in potential subscribers. As a result, we will have to focus
on marketing, or often re-marketing, to prospective customers in our
network footprint. We expect this could limit our ability to
increase our subscriber numbers in the short-term at historical
rates, and lead to a decrease in the rate of our revenue growth in
the future.
- - If We Are Unable To Comply With The Restrictions And Covenants In Our
Amended Credit Agreement, There Would Be A Default Under The Terms Of The
Credit Agreement, Which Could Result In An Acceleration Of Payment Of
Funds That We Have Borrowed.
Our credit agreement with JPMorgan Chase Bank requires
us, and certain subsidiaries, to maintain specified financial ratios
and satisfy financial tests. Our ability to meet these financial
ratios and tests may be affected by events beyond our control. As a
result, we can make no assurances that we will be able to meet such
tests. In the event that we unable to satisfy or comply with any of
the financial tests or other covenants of our credit agreement and
we are unable to obtain modifications or a waiver with respect
thereto, the lenders under the credit agreement would be entitled to
declare the outstanding borrowings thereunder immediately due and
payable and exercise all or any of their other rights and remedies.
We can make no assurances regarding our ability to obtain any such
modification or waiver or the additional costs in the form of fees
or interest expense for any such modification or waiver. In
addition, any acceleration of amounts due under the credit agreement
would, due to cross default provisions in the indentures governing
our Senior Notes, entitle holders of Senior Notes to declare the
Senior Notes and any accrued and 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. We do not
have sufficient cash resources to repay our outstanding indebtedness
if it is declared immediately due and payable.
- - If We Fail To Maintain Our Listing On The Nasdaq Market, We Could Be
Delisted And There May Not Be A Liquid Market For Our Common Stock.
On September 25, 2002, the Nasdaq Market notified us,
among other things, that our average closing price over the previous
30 trading days was than less than $1. Under the Nasdaq Small Cap
Market's rules, the Nasdaq had granted us through March 24, 2003 to
bring the bid price for our shares to $1 or more for a consecutive
10-day trading period and otherwise comply with the Nasdaq Small Cap
Market's rules. The Company did not meet the $1 closing bid price
for 10 consecutive days, however, the Company was notified on March
25, 2003 that it qualified for an additional 180 day listing
extension because the Company maintained a common stock market
capitalization of at least $50 million dollars. The market cap was
approximately $89 million on March 24, 2003. The Company has 180
days meet the listing criteria referenced above.
- - We May Encounter Difficulties In Competing In The Highly Competitive
Telecommunications Industry.
In each of the markets where we offer our services, we
face significant competition from larger, better-financed telephone
carriers, cable companies and Internet service providers. Virtually
all markets for voice, video and data services are extremely
competitive, and we expect that competition will intensify in the
future. Our principal competitors include:
- traditional telephone companies, including Verizon,
AT&T, Sprint, and WorldCom, some of which are
constructing extensive broadband networks and expanding
into data services. For example, during 2002 both
Verizon and SBC began offering long distance and
launched bundled products including wireless, local and
long distance services at substantial discounts;
- cable television service operators such as AOL Time
Warner, some of which offer telephone and data services
through cable networks using fiber-optic networks and
high-speed modems;
29
- established online services, such as AOL Time Warner's
America Online and Internet services of other
telecommunications companies; ILEC's, for the provision
of local telephone services, such as Verizon and SBC;
- during 2002, AT&T Broadband and Comcast effectively
completed a merger positioning them as the largest
national incumbent cable TV provider. The impact of the
their increased economic base, subscriber scale, buying
power and influence on market pricing and content has
yet to be determined in the five markets in which RCN
competes;
- commercial mobile radio service providers, including
cellular carriers, personal communications services
carriers and enhanced specialized mobile radio services
providers;
- alliances and combinations of telephone companies, cable
service providers and Internet companies; and
- developing technologies such as Internet-based telephony
and satellite communications services.
It may be difficult to gain customers from the incumbent
providers which have historically dominated their markets. To
compete against these established companies, we expect to have to
offer both competitive products and superior service to our
customers, and we may not be able to do so on profitable terms.
Other new technologies may become competitive with
services that we offer. Advances in communications technology as
well as changes in the marketplace and the regulatory and
legislative environment are constantly occurring. New products and
technologies may reduce the prices for services or they may be
superior to, and render obsolete, the products and services we offer
and the technologies we use. If we do not replace or upgrade
technology and equipment that becomes obsolete, we will be unable to
compete effectively because we will not be able to meet the needs or
expectations of our customers. It may be very expensive to upgrade
products and technology in order to continue to compete effectively.
As a result, the most significant competitors in the future may be
new entrants to the market, which would not be burdened by an
installed base of older equipment. We may not be able to
successfully anticipate and respond to various competitive factors
affecting the industry, including regulatory changes that may affect
our competitors and us differently, new technologies and services
that may be introduced, changes in consumer preferences, demographic
trends and discount pricing strategies by competitors.
Increased competition could lead to price reductions,
fewer large-volume sales, under-utilization of resources, reduced
operating margins and loss of market share. Many of our competitors
have, and some potential competitors are likely to enjoy,
substantial competitive advantages, including the following:
- greater name recognition;
- greater financial, technical, marketing and other
resources;
- a larger installed base of customers;
- well-established relationships with current and
potential customers;
- a greater international presence; and
- a greater local presence.
In addition, a continuing trend toward business
combinations and alliances in the telecommunications industry may
also create significant new competitors. We cannot predict the
extent to which competition from such developing and future
technologies or from such future competitors will impact our
operations.
30
- - Our Business Is Subject To Extensive Regulation And Our Business Plan
Depends Upon Continued Application Of Regulations That Have Been
Challenged In The Past.
The telecommunications industry is subject to extensive
regulation. Cable television providers must typically receive
authority from local governmental jurisdictions to operate their
networks within the jurisdictions rights-of-way. These
authorizations typically in the form of a franchise, impose certain
restrictions on the operators' ability to, among other things, raise
rates. Also, franchises generally expire and are subject to periodic
renewals. We cannot predict whether any of the franchises under
which we operate will be renewed upon their expiration, or will be
renewed with other restrictions on our ability to operate our
business. Local telephone providers must typically receive authority
from state public utility commissions to operate within the states.
These authorizations, generally in the form of a certificate of
public convenience and necessity, contain certain prohibitions and
restrictions on our ability to operate our business. We cannot
predict whether there may be a change in the regulatory schemes
under which we operate, or whether such change could negatively
impact our business or its operations.
Our ability to provide telephone and video programming
transmission services was made possible by important changes in
government regulations which have been subsequently challenged and
may be subject to change in the future. These regulations often have
a direct or indirect impact on the costs of operating our networks,
and therefore the profitability of our services. In addition, we
will continue to be subject to other regulations at the federal,
state and local levels, all of which may change in the future. The
costs of complying with these regulations, delays or failures to
receive required regulatory authorizations, changes in existing
regulations or the enactment of new, adverse regulatory requirements
may have a material adverse effect upon our ability to obtain or
retain authorizations and on our business. We cannot assure you that
we will be able to obtain all of the authorizations we need to
construct broadband network facilities or to retain the
authorizations we have already acquired. In addition, we cannot
predict whether any additional regulations will be adopted that will
result in reductions in the revenues we receive.
Regulations promulgated by the FCC under the 1996 Act
require LECs to provide interconnection, access to unbundled network
elements ("UNE") and retail services at wholesale rates to
competitors. The FCC began to re-examine its rules regarding access
to UNE in late 2001. On December 23, 2002, SBC filed the request
with the FCC to increase UNE rates more than 230%. While we cannot
predict the outcome of the FCC examination, a significant increase
in the wholesale rates we pay for UNE could negatively impact our
ability to provide competitively-priced retail services in the
markets in which we use UNE, Chicago and portions of Lehigh Valley,
and any other markets in which we may in the future use such
services.
- - Our Business Is Dependent Upon Acceptance Of Fiber Optic Technology As The
Platform Of Choice.
The telecommunications industry has been and will
continue to be subject to rapid and significant changes in
technology. The effect of technological changes on our business
cannot be predicted, and we cannot assure you that the fiber optic
technology that we use will not be supplanted by new or different
technologies.
- - We Are Dependent On Our Strategic Relationships And Joint Ventures.
We have entered into certain strategic alliances and
relationships, which allowed us to enter into the market for
telecommunications services earlier than if we had made the attempt
independently. As our network is further developed, we will be
dependent on some of these arrangements to provide a full range of
telecommunications service offerings. Our key strategic
relationships include:
- our joint venture with NSTAR Communications under which
we have access to its extensive fiber optic network in
the greater Boston area;
- our joint venture with Pepco Communications to develop
and operate an advanced fiber optic network in the
Washington, D.C. market;
Our joint venture agreements with NSTAR Communications
and Pepco Communications contain provisions for the management,
governance and ownership of the RCN-Becocom and Starpower joint
ventures, respectively. Certain matters require the approval of our
joint venture partner, including some matters beyond our control,
such as a change of control. In addition, although certain covenants
contained in our indentures apply to the joint venture companies
that we have formed with our joint venture partners, neither the
joint venture companies nor our joint venture partners are parties
to these indentures and are not bound to comply with the indentures.
A disagreement with our joint venture partners over certain business
actions, including actions related to compliance with these
indentures, could impede our ability to conduct our business. It may
also trigger deadlock provisions in the joint venture agreements,
which could force us to sell
31
our interest in the relevant joint venture or buy out the interest
of the other joint venturer.
In addition, any disruption of our relationships or
arrangements with incumbent local phone companies, such as Verizon,
could have a material adverse effect on our company. We cannot
assure you that we will successfully negotiate agreements with the
incumbent local phone company in new markets or renew existing
agreements. Our failure to negotiate or renew required
interconnection and resale agreements could have a material adverse
effect on our business.
- - We May Not Be Able To Procure Programming Services From The Third Parties
We Depend On.
Our cable television service is dependent upon our
management's ability to procure programming that is attractive to
our customers at reasonable commercial rates. We are dependent upon
third parties for the development and delivery of programming
services. These programming suppliers include cable MSO's, broadcast
network cross-owned cable networks, and independent companies. They
charge us for the right to distribute the channels to our customers.
The costs to us for programming services are determined through
negotiations with these programming suppliers and are primarily
based on size. Cable operators with the largest subscriber bases
receive the lowest license fees. With the goal of achieving scale,
RCN is a member of the National Cable Television Cooperative. The
combined size of the group of small operators is used to manage
programming to the lowest level. Even with the advantage of scale,
programming license fees are escalating at an average rate of 8%
annually. These increases are passed on to the customer base through
annual rate increases.
There are several other factors that hamper our ability
to control programming costs: Retransmission Consent,
cross-ownership of cable and broadcast networks, and MSO ownership
of cable networks. The Cable Act of 1992 gave broadcasters the right
to grant permission to cable operators for carriage of their local
broadcast stations in exchange for value. This has translated into
broadcast cross-owned cable networks demanding cash for carriage or
the launch of new program networks inhibiting our ability to choose
what networks to launch based on their appeal to our customer base.
Additionally, many networks are owned by competing cable MSO's, like
AOL Time Warner and Comcast. Although program access rules require
these content owners to offer satellite delivered networks to
multi-channel video providers, RCN is not able, in some cases, to
provide its customers with added value services like the network's
programming in high definition or on demand replays. Management
believes that the availability of sufficient programming and added
value features delivered on a timely basis will be important to our
future success. We cannot assure you that we will have access to
programming services or that management can secure rights to such
programming on commercially acceptable terms.
- - Our Management May Have Conflicts Of Interest With Other Companies.
Based upon a review of documents filed with the SEC, we
believe that Level 3 beneficially owned approximately 24.29% of our
common stock and Vulcan Ventures Incorporated beneficially owned, on
an as converted basis, approximately 24.00% of our common stock, in
each case as of December 31, 2002. This may tend to deter
non-negotiated tender offers or other efforts to obtain control of
our company and thereby deprive stockholders of opportunities to
sell shares at prices higher than the prevailing market price.
Moreover, a disposition by either Level 3 or Vulcan Ventures of a
significant portion of our common stock, or the perception that such
a disposition may occur, could affect the trading price of our
common stock and the control of our company. Level 3 beneficially
owns our common stock by virtue of its indirect ownership of 100% of
the capital stock of Level 3 Telecom Holdings, Inc. ("LTH"). As of
February 28, 2003, Level 3 Delaware Holdings, Inc. ("LDH") owned
26,640,970 shares of RCN common stock. LDH is a wholly-owned
subsidiary of LTH. Walter Scott, Jr., Richard R. Jaros, David C.
McCourt, James Q. Crowe and Michael B. Yanney are executive officers
or directors of RCN and Level 3. Messrs. McCourt, Scott and Crowe
also serve on our board's executive committee, and Mr. Yanney serves
on our compensation committee.
As a result of the September 30, 1997 spin-off of our
shares to holders of common equity of Commonwealth Telephone
Enterprises, Inc. ("CTE"), relationships exist that may lead to
conflicts of interest. In addition, a number of our named executive
officers are also directors and/or executive officers of CTE. Our
success may be affected by the degree to which our officers and
directors are involved in our business and the abilities of
officers, directors and employees to
32
manage both our Company and CTE. We will deal with potential
conflicts of interest on a case-by-case basis taking into
consideration relevant factors including the requirements of the
United States Securities and Exchange Commission, The Nasdaq Market
and prevailing corporate practices.
In February 1999, we announced that we have entered into
joint construction agreements with Level 3. We also previously
announced that we entered into an agreement with Level 3 to provide
us with cross-country capacity to allow our customers to connect to
major Internet connection points in the United States. Although
these arrangements are designed to reflect similar arrangements
entered into by parties negotiating at arm's length, we cannot
assure you that we would not be able to obtain better terms from an
unrelated third party.
As of December 31, 2002, Vulcan Ventures owns of record
3,470,100 shares of our common stock and is deemed beneficially to
own 35,952,382 shares of our common stock by virtue of its ownership
of record of 1,974,795 shares of our preferred stock which is
convertible into an aggregate of 32,482,282 shares of our common
stock. Paul G. Allen is the sole stockholder of the common stock of
Vulcan Ventures and may be deemed to be the beneficial owner of our
shares of common stock that are beneficially owned by Vulcan
Ventures. Vulcan Ventures has designated William D. Savoy to serve
as directors on our board of directors, and Mr. Savoy has been
appointed to serve on our executive committee.
- We rely on our senior management and highly skilled employees.
Our business depends on the efforts, abilities and
expertise of our executive officers, other senior management and
technically skilled employees. We cannot assure you that we will be
able to retain the services of any of the key executives. In
addition, our future operating results will substantially depend
upon our ability to attract and retain highly qualified management,
financial, technical and administrative personnel. Competition for
services of these types of employees is vigorous. We cannot assure
you that we will be able to attract and retain these types of
employees. If we are unable to continue to attract and retain
members of our senior management team as well as additional skilled
employees, our competitive position could be materially adversely
affected.
- - Some Provisions Of The Agreements Governing Our Indebtedness And Certain
Provisions Of Our Certificate Of Incorporation And Some Provisions Of Our
Preferred Stock Could Delay Or Prevent Transactions Involving A Change Of
Control.
Provisions of the agreements governing our outstanding
indebtedness, which either require such indebtedness to be repaid or
give the holder the option to require repayment, could have the
effect of delaying or preventing transactions involving a change of
control of the Company, including transactions in which stockholders
might otherwise receive a substantial premium for their shares over
then current market prices, and may limit the ability of
stockholders of the Company to approve transactions that they may
deem to be in their best interest.
Our certificate of incorporation contains provisions
which may have the effect, alone or in combination with each other
or with the existence of authorized but unissued common stock and
preferred stock, of preventing or making more difficult a hostile
takeover and making it more difficult to remove our incumbent board
of directors and our officers, including:
- provisions eliminating the ability of stockholders to
take action by written consent;
- provisions limiting the ability of stockholders to call
special meetings; and
- provisions creating a classified board and prohibiting
cumulative voting.
We have adopted a stockholder rights plan and declared a
dividend distribution of one right for each outstanding share of
Class A common stock and one right for each outstanding share of
Class B common stock to stockholders of record as of December 17,
2001. Each right entitles the holder to purchase one unit consisting
of one one-thousandth of a share of our Series C Junior
Participating Preferred Stock for $30 per unit. Under certain
circumstances, if a person or group acquires 15% or more of our
outstanding common stock, holders of the rights (other than the
person or group triggering their exercise) will be able to purchase,
in exchange for the $30 exercise price, shares of our common stock
or of any company into which we are merged having a value of $60.
The rights expire on December 5, 2011 unless extended by our board
of directors. Because the rights
33
may substantially dilute the stock ownership of a person or group
attempting to take us over without the approval of our board of
directors, our rights plan could make it more difficult for a third
party to acquire us (or a significant percentage of our outstanding
capital stock) without first negotiating with our board of directors
regarding such acquisition.
Further, we are subject to the anti-takeover provisions
of Section 203 of the Delaware General Corporation Law, which will
prohibit us from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date
of the transaction in which the person became an interested
stockholder, even if such combination is favored by a majority of
stockholders, unless the business combination is approved in a
prescribed manner. The application of Section 203 also could have
the effect of delaying or preventing a change of control or
management.
Additionally, certain provisions in our Preferred Stock
provide that we must make certain payments, or offer to make certain
payments, upon a change of control (see Agreements with Significant
Shareholders).
- - There Are Limitations On Our Ability To Utilize Tax Loss Carryforwards.
We have generated, and may continue to generate, certain
net operating losses (commonly referred to as "NOLs" for federal
income tax purposes) that generally may be carried forward to offset
taxable income realized in future years. However, if an ownership
change (as defined in Section 382 of the Internal Revenue Code of
1986, as amended) occurs with respect to our equity interests, our
ability to utilize NOLs generated before the date of the ownership
change (and certain built-in losses (if any) that exist as of the
date of the ownership change) generally would be limited to specific
annual amounts.
Generally an ownership change occurs if certain persons or
groups increase their aggregate ownership of a corporation's equity
interests by more than 50 percentage points in any three-year
period. We believe that we did undergo an ownership change in the
year 2000, and may undergo additional ownership changes in the
future.
- - The outbreak and escalation of hostilities in the Middle East or elsewhere
and terrorist attacks in the United States may have a material adverse effect
on our business, results of operations and financial condition.
The United States military action in Iraq and the advent
of hostilities between the United States and any foreign power or
territory, including, without limitation, an armed conflict with
North Korea, and any terrorist attacks in the United States may have
a material adverse effect on our business, results of operations or
financial condition.
- - There are risks of network failure and disruption.
Network disruptions could adversely affect our operating
results. For example, many of our agreements with commercial
customers, many of our franchises to provide cable television
services, and many of our certificates to provide local telephone
service contain provisions requiring us to rebate or credit
customers for service interruptions. Further, we would expect
repeated service interruptions to result in customers disconnecting
from our service.
- - There are risks in regards to our current vendor platform.
The Company is concerned that as technology to deliver
voice over Internet Protocol ("IP") develops and products are
deployed in commercial launches, the market for switched voice
solutions that the Company currently deploys will diminish. The
Company believes that this could result in a decline in residential
subscriber unit ("RSU") technology product improvements, upward
price pressure due to limited production or even a stop in
production altogether. While the Company believes that the new voice
over IP technology has the potential to replace the current RSU
technology and to potentially reduce the cost per incremental line
without abandoning the current switching infrastructure, we can
provide no assurances that these IP solutions will be as effective
as expected.
WHERE YOU CAN FIND MORE INFORMATION
We, as a reporting company, are subject to the informational requirements
of the Exchange Act and accordingly file our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements
and other information with the SEC. You may read and copy any materials filed
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, D.C. 20549. Please call the SEC at (800) SEC-0330 for further
information on the Public Reference Room. As an electronic filer, our public
filings are maintained on the SEC's Internet site that contains reports, proxy
and information statements, and other information regarding issuers that file
electronically with the SEC. The address of that website is http://www.sec.gov.
In addition, our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act may be accessed free of
charge through our website as soon as reasonably practicable after we have
electronically filed such material with, or furnished it to, the SEC. The
address of that website is http://www.rcn.com/investor/secfilings.php. Since
November 15, 2002, all reports pursuant to the Exchange Act that we have filed
with, or furnished to, the SEC have been timely posted on our website.
34
ITEM 2. PROPERTIES
Overview of Our Network
Our broadband network is generally designed to support Phone, cable
television and Internet services via a fiber-rich network architecture. Our
multi-service network is presently operating in Boston, New York City, Lehigh
Valley, PA, Washington, D.C., San Francisco, Queens, Chicago, Los Angeles and
Philadelphia. The broadband network typically consists of fiber-optic transport
facilities; local and long distance telephone capability; video head-ends;
voice, video and data transmission and distribution equipment; Internet routing
and WAN equipment and the associated network wiring and network termination
equipment. The Company's telephone switching network typically utilizes either
the Lucent 5ESS-2000 or the Nortel DMS-100 switching platforms as the local
switching element, and the network is generally designed to provide local
telephony service.
The networks' common backbone signal transport medium for both
digital signals (phone, video and Internet) and analog signals (video) is
normally broadband cable, either RCN-owned, or leased from other providers.
Generally, the digital broadband backbone transport network utilizes a
Synchronous Optical Network ("SONET") self-healing ring architecture and other
technologically advanced transport methods to provide high-speed, redundant
connections for the delivery of our voice, video and data services. Facility
connections from the backbone network to individual buildings or residential and
commercial service areas are typically provided via our own broadband
facilities.
Presently, we own and operate nine local telephony switches, one
long distance switch, and eleven video head-ends within the existing operational
markets. As of December 31, 2002, including our Starpower joint venture, RCN has
passed 1,610,578 homes with its broadband network. As of December 31, 2002,
approximately 30% of our homes passed were comprised of multiple dwellings with
12 or more units.
The majority of our network is built using fiber-optic cable as the
predominant transport medium. Broadband systems are suitable for transmission of
phone, cable television and Internet information, or a combination of these
types of signals. The main benefits resulting from the deployment of fiber-optic
cable in the network, in place of traditional coaxial cable or copper wire, are
greater network capacity, increased functionality, smaller size service areas
and decreased requirements for periodic amplification of the signal. These
factors contribute to lower maintenance costs, and increase the variety and
quality of the service offerings. Newly constructed fiber-based networks provide
a superior platform for delivering phone, cable television and high-speed,
high-capacity Internet services, when compared to traditional legacy systems
relying more heavily on copper wire or coaxial cable.
Our network is inherently designed and built to provide the
increased capacity necessary for the transport and delivery of today's high
bandwidth data and video transmission requirements. The fiber optic cable used
typically contains up to 864 individual strands of optical fiber. Each strand of
fiber is capable of providing a large number of high-bandwidth
telecommunications channels that can each be used to reliably transport a high
volume of voice, video and data signals. Although the LECs commonly use copper
wire in their networks, they are currently deploying fiber cable to upgrade
portions of their copper based network, particularly in areas we serve. We
expect that continued developments and enhancements in communications equipment
will increase the capacity of each optical fiber, thereby providing even more
capacity at relatively low incremental cost.
As the Company's network is further developed, we may rely on
certain strategic alliances and other arrangements to provide a full range of
telecommunication service offerings. These relationships include our joint
venture with NSTAR Communications, Inc. in Boston, and the Starpower joint
venture in Washington, D.C. A portion of our business relies on these
arrangements to interconnect our network with the serving LECs and other
carriers. Any disruption of these arrangements and relationships could have a
material adverse effect on the Company.
Phone Plant & Equipment
Voice Networks: Our voice network is capable of supporting both
switched and non-switched (private line) services. In metropolitan areas,
individual buildings are connected to the network backbone via fiber extensions
that are generally terminated on high-speed transport equipment, which provides
redundant and fail-safe interconnection between the building and the RCN central
switch location. In limited situations where fiber extensions are not yet
available, interim facility connections can be provided by leasing special
access facilities through an arrangement, primarily with MCI WorldCom, the ILEC
or other service providers. As our network expands to reach more areas within a
target market, subscribers served by these temporary connections are migrated to
our broadband network. Within large MDU buildings in metropolitan areas,
generally a voice
35
service hub is established by installing Integrated Digital Loop Carrier
("IDLC") equipment, which acts as the point of interface between the backbone
facility and the intra-building wiring. Each IDLC is installed with a standby
power system and is capable of serving up to 2,048 lines. Our voice offerings
include a full suite of features and services including custom calling and
custom local access signaling services ("CLASS") features. The network is built
with excess capability to meet the anticipated requirements of future subscriber
demand.
Generally, in new and rebuilt residential situations, we provide a
fiber-rich architecture capable of delivering voice services to the residential
or commercial subscriber. Fiber optic backbone facilities using SONET transport
electronics typically provide interconnection from the RCN local telephony
switch to the telephony distribution electronics. The telephony distribution
electronics support up to 2,048 lines and serve as the interconnection point
between the telephone switch and the local distribution fiber. Broadband
facilities are utilized to transport the telephony signals to a residential
service area node, a point typically within 900 feet from the furthest
subscriber. The residential service node encompasses on average approximately
150 homes. The distribution facilities between the node and the subscriber are
typically coaxial cable. Our voice network provides primary line service with
full interconnection to the local emergency 911 centers. Our voice service is
fully networked powered with reserve batteries to provide backup power in the
event of a commercial power failure.
Cable television Plant & Equipment
Broadband Video Networks: There are presently eleven video head-end
locations within our broadband networks (i.e., Manhattan, Boston, Lehigh Valley,
Carmel, N.Y., Washington, D.C., Philadelphia, Queens, Chicago, Los Angeles and
San Francisco). The video head-ends typically consist of optical transmitters,
optical receivers, satellite receivers, signal processors, modulators, encoding
equipment, digital video transport equipment, network status monitoring and
other ancillary equipment. From the head-end, the video signals are transported
to secondary hub sites in either digital or analog signal format. Once the
signal is received at the secondary hub site, the signal is conditioned,
processed and interconnected to the local broadband transport facilities for
distribution to the video subscribers. Typically, the video signals are
distributed to individual fiber nodes or receivers via the broadband cable used
to deliver the voice and data service. The local distribution fiber cable
terminates in a broadband receiver within an individual building or video
service area. From the fiber node, coaxial cable and related distribution
equipment is used to distribute the video signals to the customer premises. The
bandwidth of the video distribution is generally 750-860 MHz, which is capable
of supporting between 90 and 110 analog video channels and a substantial number
of digital video channels. The new distribution plant is specifically designed
to be predominantly fiber-based, which increases the capacity, reliability and
the quality of the services delivered as compared to traditional cable
television distribution architectures. We have deployed VOD in our Philadelphia
market and expect to deploy VOD in other markets in 2003.
Wireless Video
We also own and operate a "wireless video" television system (which
was formerly operated as Liberty Cable Television of New York and acquired by
RCN in 1996) using point-to-point 18 GHz microwave technology. We are utilizing
this system in New York City as an alternate platform for delivering television
programming to buildings that are not yet connected to the broadband network. We
expect that the majority of the buildings currently served by the wireless
service will ultimately be connected to the network to the extent that
connection is economically feasible.
Internet Plant & Equipment
Our primary Internet product is a high-speed cable modem connection
over our broadband network. The RCN cable modem product offers speeds up to 3.2
megabits per second to the individual cable modem user. Future developments will
further increase the speed of the cable modem service. RCN also provides
Internet access via dial-up modems. This product is available in all of our
service areas as well as other locations surrounding our major markets.
Our Internet network consists of all the networking and computer
equipment required to provide full and complete ISP services to our both our
cable modem and dialup customers. These Internet services include unlimited
access to the World-Wide Web, personal email addresses, access to USEnet News
services, personal web pages and file transfer capability. Additionally, RCN
Internet users are able to access other popular Internet-based services such as
Instant Messaging, on-line electronic gaming and Chat facilities. The underlying
RCN network is comprised of a state-of-the-art TCP/IP network including core,
border and edge routers, servers, switches, and the necessary high-speed
transport and interconnection network. We have also designed and deployed a long
haul, high-bandwidth broadband transport facility that interconnects Boston, New
York,
36
Philadelphia and Washington, D.C. This facility is used to provide high-speed
connectivity between each of our points of presence along the Northeast
Corridor. It is through this network, plus additional high-speed connections to
peering partners, that we can offer RCN customers uncompromising access to the
Internet.
We rely on a combination of copyright, trademark and trade secret
laws and contractual restrictions to establish and protect our proprietary
technology. However, there can be no assurance that our technology will not be
misappropriated or that equivalent or superior technologies will not be
developed. In addition, there can be no assurance that third parties will not
assert that our services or our users' content infringe their proprietary
rights. The Company has obtained authorization, typically in the form of a
license, to distribute third-party software incorporated in the RCN access
software product for Windows 3.1, Windows 95, Windows NT and Macintosh
platforms. The Company plans to maintain or negotiate renewals of existing
software licenses and authorizations. We may desire or need to license other
applications in the future.
Real Estate
As of December 31, 2002, we leased approximately 146 facilities
including 108 technical and 38 non-technical facilities, which encompass
1,036,506 and 1,520,261 square feet, respectively, to support our operations
under various non-cancelable leases with terms ranging from 1 to 19 years. Of
the 146 facilities that we lease, we are actively seeking to sublease or buyout
the leases of 32 facilities including 15 technical and 17 non-technical
facilities, which contain 242,058 and 461,228 square feet, respectively. We also
currently own 8 technical facilities, which encompass 150,286 square feet. Of
the 8 facilities that we own, we are looking to sell 3 facilities, which contain
81,420 square feet.
During 2002, due to reduced growth plans, we have terminated and
subleased 45 facilities, including 28 technical and 17 non-technical, which
encompass 175,603 and 663,347 square feet, respectively. In addition, we also
sold 5 facilities, including 2 technical and 3 non-technical facilities
consisting of 80,000 and 97,938 square feet, respectively. We believe our leased
and owned facilities are in good condition.
ITEM 3. LEGAL PROCEEDINGS
We have filed suit in the U.S. Court of Appeals for the D.C. Circuit
seeking the Court's review of a decision of the FCC which requires us, where we
operate as an OVS provider, to share certain OVS system and corporate data with
in-region cable competitors if such competitors are not franchised within our
technically integrated service area. We believe the FCC's decision, as well as
two related decisions of the Cable Services Bureau, are contrary to law,
arbitrary and capricious. The FCC has asked the Court to hold the case in
abeyance pending its resolution of a petition for reconsideration filed by
AOL/Time Warner. We have not opposed this request and the Court has granted the
Motion. See "Regulatory."
A suit has been commenced against RCN Corporation in the Delaware
Court of Chancery by Edward T. Joyce, as representative of the former
stockholders and warrant holders of 21st Century Telecom Group, Inc. ("21st
Century"). Mr. Joyce is a former member of the Board of Directors of 21st
Century. RCN acquired the stock of 21st Century pursuant to an Agreement and
Plan of Merger that closed in April, 2000 (the "Merger Agreement"). Pursuant to
the Merger Agreement, RCN held back 10% of its common stock consideration (the
"10% Holdback") for a period of one year to allow for any indemnity claims. The
Merger Agreement stated that the 10% Holdback would be based upon RCN's stock
price at the time the Merger Agreement was executed. The suit seeks reformation
of the Merger Agreement to reflect what Plaintiffs allege was actually
negotiated and agreed to -- that the 10% Holdback would be based upon RCN's
stock price as of the end of the one year holdback period. Because RCN's stock
had fallen in value during this period, if Plaintiffs prevail RCN would have to
distribute approximately 5 million additional shares in consideration of the
Merger Agreement. RCN has filed a Motion to Dismiss this matter.
In the normal course of business, there are various legal
proceedings outstanding. In the opinion of management, these proceedings will
not have a material adverse effect on the results of operations or financial
condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the
Registrant during the fourth quarter of the Registrant's 2002 fiscal year.
EXECUTIVE AND ACCOUNTING OFFICERS OF THE REGISTRANT
37
Pursuant to General Instruction G(3) of Form 10-K, the following list is
included as an un-numbered Item in Part I of this Report in lieu of being
included in the definitive proxy statement relating to the Registrant's Annual
Meeting of Shareholders to be filed by Registrant with the Commission pursuant
to Section 14(A) of the Securities Exchange Act of 1934 (the "1934 Act").
Executive and Accounting Officers of the Registrant
David C. McCourt, 46 has been Chairman and Chief Executive Officer
of the Company as well as a Director since September 1997. In
addition, he is a Director and Chairman of Commonwealth Telephone
Enterprises, Inc. ("CTE"), positions he has held since October 1993.
Mr. McCourt served as a Director and Chairman and Chief Executive
Officer of Cable Michigan from September 1997 to November 1998. Mr.
McCourt was Chief Executive Officer of CTE from October 1993 to
November 1998. Mr. McCourt is also a Director of Level 3
Communications, Inc., formerly known as Peter Kiewit Sons', Inc. and
Cable Satellite Public Affairs Network ("C-SPAN"). Mr. McCourt has
also been President and Chief Executive Officer, and remains a
Director of Level 3 Telecom Holdings, Inc. formerly Kiewit Telecom
Holdings, Inc. He was also Chairman and Chief Executive Officer as
well as a Director of Mercom, S.A. de C.V. from October 1993 to
November 1998. He was a Director of MFS Communications Company, Inc.
("MFS/Worldcom") from July 1990 to December 1996. Mr. McCourt was a
Director of WorldCom from December 1996 to March 1998.
Michael A. Adams, 45 was named Chief Strategy Officer in September
2002. He has served as Chief Network Officer from June 2002 to
September 2002. Mr. Adams has also served as President, Wholesale
and New Product Development Group from January 2001 to June 2002.
Prior to that he served as President and Chief Operating Officer of
the Company, from October 1999 to January 2001. Previously, he was
President of the Technology and Network Development Group from
September 1997 to October 1999. Prior to that he served as Vice
President of Technology with C-TEC Corporation from November 1993 to
September 1997. Mr. Adams is also a Director of the Company and CTE.
Jeffrey M. White, 46 was appointed the Company's Vice Chairman and
Chief Financial Officer in June 2002. He was named President,
Customer & Field Operations of the Company in January 2001. Prior to
joining the Company, Mr. White served as Chief Financial Officer of
Telecom New Zealand, from 1993 to 1999. He held several management
and executive officer positions in Finance, Corporate Strategy and
Investments and Acquisitions with Ameritech from 1983 to 1993. Mr.
White announced his resignation from the Company effective in the
quarter ending June 30, 2003.
Timothy J. Stoklosa, 42 has been Executive Vice President of the
Company since May 2002. Mr. Stoklosa also served as Chief Financial
Officer of the Company from January 2000 to May 2002. Previously, he
was Senior Vice President and Treasurer of the Company, September
1997 from September 1997 to January 2000. Prior to that he served as
Executive Vice President and Chief Financial Officer and was a
Director of Mercom, Inc. from 1997 to 1998. Prior to that, Mr.
Stoklosa was Treasurer of CTE from 1994 to 1997. Mr. Stoklosa is
also a Director of CTE.
Terry Wingfield, 50, has been General Counsel and Secretary of RCN
Corporation since November 2002. He was Senior Vice President and
General Counsel of Velocita Corp. from October 2000 until November
2002. On May 30, 2002, Velocita Corp. filed for voluntary bankruptcy
protection under Chapter 11 of the U.S. Bankruptcy Code. He was
Executive Vice President for Sales and Marketing for ICG
Communications, Inc. from August 2000 to October 2000 and Executive
Vice President for Corporate Development for ICG Communications,
Inc. from March 2000 to August 2000. On November 14, 2000, ICG
Communications, Inc. filed for voluntary bankruptcy protection under
Chapter 11 of the U.S. Bankruptcy Code. Prior to that he was Senior
Vice President of Telephony Ventures for AT&T Broadband and Internet
Services from June 1999 to March 2000. From August 1998 to March
2000, he was the Legal and Government Affairs Vice President for
AT&T's Local Services Division. Prior thereto, Mr. Wingfield was
Vice President and General Counsel of the Teleport Communications
Group from March 1996 until it was merged into AT&T in August 1999.
Mary West Young, 47 was named Senior Vice President-Finance and
Controller of the Company in June 2001. Prior to joining the
Company, Ms. Young served as Vice President-Finance for De Lage
Landen Financial Services, Inc., formerly Tokai Financial Services,
Inc. since 1999, and as Vice President and Corporate Controller from
1998 to 1999. Ms. Young was Director-International Finance and
Controller of Verizon Communications International, Inc., formerly
Bell Atlantic International, Inc. from 1995 until 1998. She also
held several management positions in Treasury and Accounting with
Verizon from 1984 to 1992.
P.K. Ramani, 46, was named Senior Vice President - Operations
Support of the company in June 2002. Mr. Ramani also served as the
Senior Vice President of Customer Care from June 1999 to May 2002.
Prior to joining RCN, Mr. Ramani served as Group Vice President of
Customer Operations at Primestar, Inc. from 1998 to 1999 and also
served as Vice President of Business Integration from 1997 to 1998.
38
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters
The Company's Common Stock is traded on the NASDAQ stock exchange.
There were approximately 3,425 holders of Registrant's Common Stock
on February 28, 2003. The Company maintains a no cash dividend
policy. The Company does not intend to alter this policy in the
foreseeable future. Other information required under Item 5 of Part
II is set forth in Note 18 to the consolidated financial statements
included in Part IV Item 15(a)(1) of this Form 10-K.
Item 6. Selected Financial Data
Information required under Item 6 of Part II is set forth in Part IV
Item 15(a)(1) of this Form 10-K.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information required under Item 7 of Part II is set forth in Part IV
Item 15(a)(1) of this Form 10-K.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.
Information required under Item 7 of Part II is set forth in Part IV
Item 15(a)(1) of this Form 10-K.
Item 8. Financial Statements and Supplementary Data.
The consolidated financial statements and supplementary data
required under Item 8 of Part II are set forth in Part IV Item
15(a)(1) of this Form 10-K.
Item 9. Disagreements on Accounting and Financial Disclosure.
During the two years preceding December 31, 2002, there has been
neither a change of accountants of the Registrant nor any
disagreement on any matter of accounting principles, practices or
financial statement disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required under Item 10 of Part III with respect to
the Directors of Registrant is set forth in the definitive proxy
statement relating to Registrant's Annual Meeting of Shareholders to
be filed by the Registrant with the Commission pursuant to Section
14(a) of the 1934 Act and is hereby specifically incorporated herein
by reference thereto.
The information required under Item 10 of Part III with respect to
the executive officers of the Registrant is set forth at the end of
Part I hereof.
Item 11. Executive Compensation
The information required under Item 11 of Part III is set forth in
the definitive Proxy Statement relating to Registrant's Annual
Meeting of Shareholders to be filed by the Registrant with the
Commission pursuant to Section 14(a) of the 1934 Act, and is hereby
specifically incorporated herein by reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required under Item 12 of Part III is included in
the definitive Proxy Statement relating to Registrant's Annual
Meeting of Shareholders to be filed by Registrant with the
Commission pursuant to Section 14(a) of the 1934 Act, and is hereby
specifically incorporated herein by reference thereto.
39
Item 13. Certain Relationships and Related Transactions
The information required under Item 13 of Part III is included in
the definitive Proxy Statement relating to Registrant's Annual
Meeting of Shareholders to be filed by Registrant with the
Commission pursuant to Section 14 (a) of the 1934 Act, and is hereby
specifically incorporated herein by reference thereto.
Item 14. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Within the 90 day period prior to the filing of this Annual Report on Form
10-K, the Company, under the supervision, and with the participation of
its management, including its principal executive officer and principal
financial officer, performed an evaluation of the Company's disclosure
controls and procedures, as contemplated by Securities Exchange Act Rule
13a-15. Based on that evaluation, the Company's principal executive
officer and principal financial officer concluded that such disclosure
controls and procedures are effective to ensure that material information
relating to the Company, including its consolidated subsidiaries, is made
known to them, particularly during the period for which the periodic
reports are being prepared.
(b) Changes in Internal Controls
No significant changes were made in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to
the date of the evaluation performed pursuant to Securities Exchange Act
Rule 13a-15 referred above.
PART IV
Item 15. Exhibits, Financial Statement Schedules and Report on Form 8-K.
On October 18, 2002 RCN filed a Current Report on Form 8-K making
available various slides in connection with the Company's
presentation at the Undiscovered Stocks Conference on October 17,
2002.
On November 5, 2002 RCN filed a Current Report on Form 8-K making
available various slides in connection with RCN's presentation at
its 3rd Quarter Results Conference Call. The report also included
the RCN 3rd Quarter Earnings Release.
Item 15 (a)(1) Financial Statements:
Consolidated Statements of Operations for the Years Ended December
31, 2002, 2001 and 2000.
Consolidated Balance Sheets - December 31, 2002 and 2001.
Consolidated Statements of Cash Flows for Years Ended December 31,
2002, 2001 and 2000.
Consolidated Statements of Changes in Common Shareholders'
Equity/(Deficit) for Years Ended December 31, 2002, 2001 and 2000.
Notes to Consolidated Financial Statements
Report of Independent Accountants
Item 15 (a)(2) Financial Statement Schedules:
Description
Condensed Financial Information of Registrant for the Year Ended
December 31, 2002. (Schedule I)
Valuation and Qualifying Accounts and Reserves for the Years Ended
December 31, 2002, 2001 and 2000 (Schedule II)
All other financial statement schedules not listed have been omitted
since the required information is included in the consolidated
financial statements or the notes thereto, or are not applicable or
required.
40
Item 15 (a)(3) Exhibits:
Exhibits marked with an asterisk are filed herewith and are listed
in the index to exhibits of this Form 10-K. The remainder of the
exhibits have been filed with the Commission and are incorporated
herein by reference.
(2) Plan of acquisition, reorganization, arrangement and Report on Form 8-K
2.1 Form of Distribution Agreement among C-TEC Corporation, Cable
Michigan, Inc. and the Registrant incorporated by reference to
Exhibit 2.1 to the Company's Amendment No. 2 to Form 10/A filed
September 5, 1997. (Commission File No. 0-22825.)
2.2 Asset Purchase Agreement among RCN Telecom Services, Inc., RCN and
Patriot Media & Communications CNJ, LLC (incorporated by reference
to Exhibit 10.1 to RCN's current report on Form 8-K (filed on August
29, 2002) (Commission File No. 0-22825.)
(3) Articles of Incorporation and By-laws
3.1 Form of Amended and Restated Articles of Incorporation of the
Registrant are incorporated herein by reference to Exhibit 3.1 to the
Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
3.2 Certificate of Amendment to the amended and restated Articles of
Incorporation Certificate of Amendment to the amended and restated of the
Registrant are incorporated herein by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1 filed on August 11, 1998.
(Commission File No. 333-61223.)
3.3 Certificate of Amendment to the amended and restated Certificate of
Incorporation of the Registrant (incorporated by reference herein to
Exhibit 3.01 to RCN's Current Report on Form 8-K dated May 22, 2001)
(Commission File No. 0-22825.)
3.4 Certificate of Designations, Preferences and Rights of Series A 7%
Senior Convertible Preferred Stock dated April 7, 1999 (incorporated
herein by reference to Exhibit 3.1 to RCN's Registration Statement on Form
S-3 (filed February 1, 1999) (Commission File No. 333-71525) ("1999 Form
S-3")
3.5 Certificate of Designations, Preferences, and Rights of Series B 7%
Senior Convertible Preferred Stock (incorporated by reference to Exhibit A
of Exhibit 10.01 to RCN's current report on Form 8-K (filed October
1,1999) (Commission File No. 0-22825.)
3.6 Form of Amended and Restated Bylaws of the Registrant are incorporated
herein by reference to Exhibit 3.2 to the Company's Amendment No. 2 to
Form 10/A filed September 5, 1997 (Commission File No. 0-22825.)
3.7 Amended and Restated ByLaws of the Registrant, as adopted by RCN's
Board of Directors on December 4, 2001 are incorporated herein by
reference to Exhibit 3.7 to the Company's annual report on Form 10-K filed
March 29, 2002 (Commission File No. 1-16805.)
(4) Instruments defining the rights of security holders, including indentures
4.1 Credit Agreement dated as of June 3, 1999 among RCN, the borrowers
named therein, the lenders party thereto, The JPMorgan Chase Bank, as
Agent, Chase Securities Inc., as Lead Arranger and Book Manager, and
Deutsche Bank A.G., Merrill Lynch Capital Corp. and Morgan Stanley Senior
Funding, as Documentation Agents (incorporated herein by reference to
Exhibit 10.01 to RCN's Current Report on Form 8-K dated August 17, 1999
(filed August 17, 1999) (Commission File No. 000-22825.)
4.2 Form of Indenture between RCN, as Issuer, and The JPMorgan Chase Bank,
as Trustee, with respect to the 10 1/8% Senior Notes due 2010
(incorporated herein by reference to Exhibit 4.11 to RCN's 1999 Form S-3)
(Commission File No. 333-71525.)
4.3 Indenture dated June 24, 1998 between RCN, as Issuer, and The JPMorgan
Chase Bank, as Trustee, with respect to the 11% Senior Discount Notes due
2008 (incorporated herein by reference to Exhibit 4.8 to RCN's
Registration Statement on Form S-1 (filed June 1, 1998) (Commission File
No. 333-55673) ("1998 Form S-1")
4.4 Form of 11% Senior Discount Note due 2008 (included in Exhibit 4.3)
(incorporated herein by reference to Exhibit 4.9 to RCN's 1998 Form S-1.)
(Commission File No. 333-55673.)
41
4.5 Indenture dated as of February 6, 1998 between RCN, as Issuer, and The
JPMorgan Chase Bank, as Trustee, with respect to the 9.80% Senior Discount
Notes due 2008 (incorporated herein by reference to Exhibit 4.1 to RCN's
Registration Statement on Form S-4 (filed March 23, 1998) (Commission File
No. 333-48487) ("1998 Form S-4")
4.6 Form of the 9.80% Senior Discount Notes due 2008, Series B (included
in Exhibit 4.5) (incorporated herein by reference to Exhibit 4.2 to RCN's
1998 Form S-4.) (Commission File No. 333-48487.)
4.7 Indenture dated as of October 17, 1997 between RCN, as Issuer, and The
JPMorgan Chase Bank, as Trustee, with respect to the 10% Senior Notes due
2007 (incorporated herein by reference to Exhibit 4.1 to RCN's
Registration Statement on Form S-4 (filed November 26, 1997) (Commission
File No. 333-41081) ("1997 Form S-4")
4.8 Form of the 10% Senior Exchange Notes due 2007 (included in Exhibit
4.7) (incorporated herein by reference to Exhibit 4.2 to RCN's 1997 Form
S-4.) (Commission File No. 333-41081.)
4.9 Indenture dated as of October 17, 1997 between RCN, as Issuer, and The
JPMorgan Chase Bank, as Trustee, with respect to the 11 1/8% Senior
Discount Notes due 2007 (incorporated herein by reference to Exhibit 4.3
to RCN's 1997 Form S-4.) (Commission File No. 333-41081.)
4.10 Form of the 11 1/8% Senior Discount Exchange Notes due 2007 (included
in Exhibit 4.9) (incorporated herein by reference to Exhibit 4.4 to RCN's
1997 Form S-4.) (Commission File No. 333-41081.)
4.11 Escrow Agreement dated as of October 17, 1997 among The JPMorgan
Chase Bank, as escrow agent, The JPMorgan Chase Bank, as Trustee under the
Indenture (as defined therein), and RCN (incorporated herein by reference
to Exhibit 4.6 to RCN's 1997 Form S-4.) (Commission File No. 333-41081.)
4.12 First Amendment, dated as of December 3, 1999, to the Credit
Agreement, dated as of June 3, 1999 among RCN, the borrowers named
therein, the lenders party thereto, The JPMorgan Chase Bank, as Agent,
Chase Securities Inc., as Lead Arranger and Book Manager, and Deutsche
Bank A.G., Merrill Lynch Capital Corp. and Morgan Stanley Senior Funding,
as Documentation Agents (incorporated herein by reference to Exhibit 10.01
to RCN's Current Report on Form 8-K dated August 17, 1999 (filed August
17, 1999) (Commission File No. 000-22825.)
4.13 Indenture, dated as of December 22, 1999, between RCN, as Issuer, and
The JPMorgan Chase Bank, as Trustee, with respect to the 10 1/8% Senior
Discount Notes due 2010. (incorporated herein by reference to Exhibit 4.11
to RCN's Registration Statement on Form S-3/A (filed October 6,
1999)(Commission File No. 333-71525) ("1999 Form S-3/A")
4.14 Form of the 10 1/8% Senior Discount Notes due 2010 (included in
Exhibit 4.11 (incorporated herein by reference to exhibit 4.11 to RCN's
1999 Form S-3/A.
4.15 Stock Purchase Agreement dated as of October 1, 1999 between Vulcan
Ventures Incorporated (incorporated by reference to RCN's Form 8-K dated
October 1, 1999, (Commission file No. 0-22825.)
4.16 Voting Agreement dated as of October 1, 1999 among RCN, Vulcan
Ventures Incorporated and Level 3 Telecom Holdings, Inc. (incorporated by
reference to RCN's Form 8-K dated October 1, 1999, (Commission File No.
0-22825.)
4.17 Second Amendment, dated as of June 28, 2000, to the Credit Agreement,
dated as of June 3, 1999 among RCN, the borrowers named therein, the
lenders party thereto, the JPMorgan Chase Bank, as Agent, Chase
Securities, Inc., as Load Arranger and Book Manager, and Deutsche Bank
A.G., Merrill Lynch Capital Corp. and Morgan Stanley Senior Funding, as
Documentation Agents (incorporated herein by reference to Exhibit 4.0 to
RCN's Form 10-Q for the second quarter ended June 30, 2000) (Commission
File No. 0-22825.)
4.18 Third Amendment, dated as of May 31, 2001, to the Credit Agreement,
dated as of June 3, 1999, as amended among RCN, the borrowers named
therein, the lenders party thereto and the JPMorgan Chase Bank, as
Administrative Agent and Collateral Agent (incorporated herein by
reference to Exhibit 4.1 to RCN's Form 10-Q for the second quarter ended
June 30, 2001) (Commission File No. 0-22825.)
4.19 Stock Purchase Agreement, dated as of May 28, 2001, between RCN and
Red Basin, LLC (incorporated herein by reference to Exhibit 4.01 to RCN's
Current Report on Form 8-K dated May 29, 2001) (Commission File No.
0-22825.)
42
4.20 Instrument of Resignation, Appointment and Acceptance, dated as of
August 9, 2001, among RCN, The JPMorgan Chase Bank, as Resigning Trustee,
and HSBC Bank, USA as Successor Trustee with respect to the Indenture
dated October 17, 1997 with respect to the 10% Senior Notes due 2007.
(Incorporated herein by reference to Exhibit XX to the Company's annual
report on Form 10-K filed March 29, 2002) (Commission File No. 1-6805.)
4.21 Instrument of Resignation, Appointment and Acceptance, dated as of
August 9, 2001, among RCN, The JPMorgan Chase Bank, as Resigning Trustee,
and HSBC Bank, USA as Successor Trustee with respect to the Indenture
dated October 17, 1997 with respect to the 11 1/8% Senior Discount Notes
due 2007. (Incorporated herein by reference to Exhibit XX to the Company's
annual report on Form 10-K filed March 29, 2002) (Commission File No.
1-6805.)
4.22 Instrument of Resignation, Appointment and Acceptance, dated as of
August 9, 2001, among RCN, The JPMorgan Chase Bank, as Resigning Trustee,
and HSBC Bank, USA as Successor Trustee with respect to the Indenture
dated February 6, 1998 with respect to the 9.8% Senior Discount Notes due
2008. (Incorporated herein by reference to Exhibit XX to the Company's
annual report on Form 10-K filed March 29, 2002) (Commission File No.
1-6805.)
4.23 Instrument of Resignation, Appointment and Acceptance, dated as of
August 9, 2001, among RCN, The JPMorgan Chase Bank, as Resigning Trustee,
and HSBC Bank, USA as Successor Trustee with respect to the Indenture
dated June 24, 1998 with respect to the 11% Senior Discount Notes due
2008. (Incorporated herein by reference to Exhibit XX to the Company's
annual report on Form 10-K filed March 29, 2002) (Commission File No.
1-6805.)
4.24 Instrument of Resignation, Appointment and Acceptance, dated as of
August 9, 2001, among RCN, The JPMorgan Chase Bank, as Resigning Trustee,
and HSBC Bank, USA as Successor Trustee with respect to the Indenture
dated December 22, 1999 with respect to the 10 1/8% Senior Discount Notes
due 2010. (Incorporated herein by reference to Exhibit XX to the Company's
annual report on Form 10-K filed March 29, 2002) (Commission File No.
1-6805.)
4.25 Rights Agreement, dated as of December 5, 2001, between RCN and HSBC
Bank USA, as Rights Agent, which includes the form of Rights Certificates
(incorporated herein by reference to Exhibit 4 to RCN's Current Report on
Form 8-K dated December 5, 2001) (Commission File No. 0-22825.)
4.26 Fourth Amendment, dated as of March 25, 2002, to the Credit
Agreement, dated as of June 3, 1999, as amended, among RCN, the borrowers
named therein, the lenders party thereto and the JPMorgan Chase Bank, as
Administrative Agent and Collateral Agent (incorporated by reference to
Exhibit 4.1 to RCN's Form 8-K dated March 26, 2002) (Commission File No.
1-6805.)
4.26 Fifth Amendment, dated as of March 7, 2003, to the Credit Agreement,
dated as of June 3, 1999, as amended, among RCN, the borrowers named
therein, the lenders party thereto and the JPMorgan Chase Bank, as
Administrative Agent and Collateral Agent (incorporated by reference to
Exhibit 4.1 to RCN's Form 8-K dated March 11, 2003) (Commission File No.
1-6805.)
(10) Material Contracts
10.1 Tax Sharing Agreement by and among C-TEC Corporation, Cable Michigan,
Inc. and the Registrant is incorporated herein by reference to Exhibit
10.1 to the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
10.2 Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan
Fiber Systems/McCourt, Inc. and RCN Telecom Services of Massachusetts,
Inc. is incorporated herein by reference to Exhibit 10.2 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
10.3 Dark Fiber IRU Agreement dated as of May 8, 1997 among Metropolitan
Fiber Systems of New York, Inc. and RCN Telecom Services of New York, Inc.
is incorporated herein by reference to Exhibit 10.3 to the Company's
Amendment No. 2 to Form 10/A filed September 5, 1997 (Commission File No.
0-22825.)
43
10.4 Joint Venture Agreement dated as of December 23, 1996 between RCN
Telecom Services, Inc. and Boston Energy Technology Group, Inc. is
incorporated herein reference by Exhibit 10.7 to the Company's Amendment
No. 2 to Form 10/A filed September 5, 1997 (Commission File No. 0-22825.)
10.5 Amended and Restated Operating Agreement of RCN-Becocom, LLC dated as
of June 17, 1997 is incorporated herein by reference to Exhibit 10.8 to
the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
10.6 Management Agreement dated as of June 17, 1997 among RCN Operating
Services, Inc. and RCN-Becocom, Inc. is incorporated herein by reference
to Exhibit 10.9 to the Company's Amendment No.2 to Form 10/A filed
September 5, 1997 (Commission File No. 0-22825.)
10.7 Construction and Indefeasible Right of Use Agreement dated as of June
17, 1997 between RCN-Becocom, Inc. and RCN-Becocom, LLC is incorporated
herein by reference to Exhibit 10.10 to the Company's Amendment No. 2 to
Form 10/A filed September 5, 1997 (Commission File No. 0-22825.)
10.8 License Agreement dated as of June 17, 1997 between Boston Edison
Company and RCN-Becocom, Inc. is incorporated herein by reference to
Exhibit 10.11 to the Company's Amendment No. 2 to Form 10/A filed
September 5, 1997 (Commission File No. 0-22825.)
10.9 Joint Investment and Non-Competition Agreement dated as of June 17,
1997 among RCN Telecom Services of Massachusetts, Inc., RCN-Becocom, Inc.
and RCN-BecoCom, LLC is incorporated herein by reference to Exhibit 10.12
to the Company's Amendment No. 2 to Form 10/A filed September 5, 1997
(Commission File No. 0-22825.)
10.10 Amended and restated Operating Agreement of Starpower
Communications, L.L.C. by and between Pepco Communications, L.L.C. and RCN
Telecom Services of Washington, D.C. Inc. dated October 28, 1997 is
incorporated herein by reference to Exhibit 10.13 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 (Commission File
No. 0-22825.)
10.11 Employment Agreement dated as of January 8, 2001, by and between RCN
and Jeffrey M. White, President, Customer & Field Operations for RCN.
10.12 1997 Stock Plan for Non-Employee Directors is incorporated herein by
reference to Exhibit 99 to the Company's Form 10-Q for the First Quarter
ended March 31, 2000. (Commission File No. 0-22825.)
10.13 1997 Amendments to 1997 Stock Plan for Non-Employee Directors are
incorporated herein by reference to the Company's Def 14A dated May 17,
2001. (Commission File No. 0-22825.)
10.14 2000 Employee Stock Purchase Plan is incorporated herein by
reference to Exhibit 99 to the Company's Form 10-Q for the Second Quarter
ended June 30, 2000. (Commission File No. 0-22825.)
10.15 Executive Stock Purchase Plan is incorporated herein by reference to
Exhibit 99 to the Company's Form 10-Q for the Third Quarter ended
September 30, 2000. (Commission File No. 0-22825.)
10.16 1997 Equity Incentive Plan is incorporated herein by reference to
Exhibit 99.2 to the Company's Form 10-Q for the Third Quarter ended
September 30, 1999. (Commission File No. 0-22825.)
10.17 Amendments to 1997 Equity Incentive Plan are incorporated herein by
reference to the Company's Def 14A dated May 16, 2000. (Commission File
No. 0-22825.)
10.18* 2001 Chairman's Performance and Retention Bonus Plan.
21* Subsidiaries of Registrant
23.1* Consent of PricewaterhouseCoopers LLP with respect to RCN Corporation
24* Power of Attorney
99.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Item 15.(b) Reports on Form 8-K
On October 18, 2002 RCN filed a Current Report on Form 8-K making
available various slides in connection with the Company's presentation at
the Undiscovered Stocks Conference on October 17, 2002.
On November 5, 2002 RCN filed a Current Report on Form 8-K making
available various slides in connection with RCN's presentation at its 3rd
Quarter Results Conference Call. The report also included the RCN 3rd
Quarter Earnings Release.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2003 RCN Corporation
By: /s/ David C. McCourt
-------------------------
David C. McCourt
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
PRINCIPAL EXECUTIVE AND
ACCOUNTING OFFICERS:
/s/ David C. McCourt Chairman and Chief March 31, 2003
- -------------------------- Executive Officer
David C. McCourt
/s/ Jeffrey M. White Vice Chairman March 31, 2003
- -------------------------- and Chief Financial Officer
Jeffrey M. White
/s/ Mary West Young Senior Vice President, Finance March 31, 2003
- -------------------------- and Controller
Mary West Young
DIRECTORS:
/s/ David C. McCourt March 31, 2003
- --------------------------
David C. McCourt
/s/ James Q. Crowe March 31, 2003
- --------------------------
James Q. Crowe
/s/ Walter E. Scott, Jr. March 31, 2003
- --------------------------
Walter E. Scott, Jr.
/s/ Richard R. Jaros March 31, 2003
- --------------------------
Richard R. Jaros
/s/ Thomas May March 31, 2003
- --------------------------
Thomas May
/s/ Alfred Fasola March 31, 2003
- --------------------------
45
Alfred Fasola
/s/ Thomas P. O'Neill, III March 31, 2003
- --------------------------
Thomas P. O'Neill, III
/s/ Eugene Roth March 31, 2003
- --------------------------
Eugene Roth
/s/ Michael B. Yanney March 31, 2003
- --------------------------
Michael B. Yanney
/s/ Michael A. Adams March 31, 2003
- --------------------------
Michael A. Adams
/s/ Timothy J. Stoklosa March 31, 2003
- --------------------------
Timothy J. Stoklosa
- --------------------------
Edward S. Harris
/s/ Peter S. Brodsky March 31, 2003
- --------------------------
Peter S. Brodsky
/s/ William D. Savoy March 31, 2003
- --------------------------
William D. Savoy
46
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Section 302 Certification
I, David C. McCourt, certify that:
1. I have reviewed this annual report on Form 10-K of RCN Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
7. A signed original of this written statement required by Section 906 has
been provided to RCN Corporation and will be retained by RCN Corporation
and furnished to the Securities and Exchange Commission or its staff upon
request.
Date: March 31, 2003 /s/ DAVID C. MCCOURT
--------------------------
Name: David C. McCourt
Title: Chief Executive Officer
47
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Section 302 Certification
I, Jeffrey M. White, certify that:
1. I have reviewed this annual report on Form 10-K of RCN Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions)and have identified for the registrant's auditors any
material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
7. A signed original of this written statement required by Section 906 has
been provided to RCN Corporation and will be retained by RCN Corporation
and furnished to the Securities and Exchange Commission or its staff upon
request.
Date: March 28, 2003 /s/ JEFFREY M. WHITE
--------------------------
Name: Jeffrey M. White
Title: Vice Chairman and Chief
Financial Officer
48
SCHEDULE I
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
(THOUSANDS OF DOLLARS)
For the Years Ended December 31,
-----------------------------------------------
2002 2001 2000
------------- ------------ ------------
Sales $ -- $ -- $ --
Other income (expense) (14,778) 367 (24,531)
Costs and expenses (36,666) (62,086) (438)
------------- ------------ ------------
Operating loss (51,444) (61,719) (24,969)
Interest income 9 9 2,356
Depreciation and Amortization -- (300) --
Interest expense (190,185) (238,952) (238,491)
------------- ------------ ------------
Loss before income taxes (241,620) (300,962) (261,104)
(Benefit)/ Provision for income taxes (63,547) 70,554 (96,048)
Equity in loss of consolidated entities (1,656,379) (397,877) (603,658)
------------- ------------ ------------
Loss before extraordinary item (1,834,452) (769,393) (768,714)
Extraordinary item, net of tax of $0 426,263 84,604 --
------------- ------------ ------------
Net loss (1,408,189) (684,789) (768,714)
Preferred stock dividend and accretion requirements 162,150 151,663 122,752
------------- ------------ ------------
Net loss to common shareholders $ (1,570,339) $ (836,452) $ (891,466)
============= ============ ============
Basic and Diluted Loss per average common share:
Net loss before extraordinary item $ (18.79) $ (9.79) $ (10.59)
Extraordinary item $ 4.01 $ (0.90) $ --
Net loss to common shareholders $ (14.78) $ (8.89) $ (10.59)
Weighted average common shares outstanding 106,211,979 94,117,391 84,200,329
49
SCHEDULE I
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(THOUSANDS OF DOLLARS)
December 31,
---------------------------
2002 2001
----------- -----------
ASSETS
Current assets
Cash and temporary cash investments $ 1,047 $ 1,026
Accounts receivable from affiliates 175,415 147,548
Prepayments & other 6 3
Deferred tax asset 26 53
Other assets 141,267 50,456
----------- -----------
Total current assets 317,761 199,086
Investments in subsidiaries 2,208,709 3,707,686
Unamortized debt issuance cost 34,773 45,407
Deferred charges and other assets 164,448 152,269
----------- -----------
Total assets $ 2,725,691 $ 4,104,448
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities
Accounts payable to affiliates 1,020,568 354,256
Accrued interest 26,369 23,959
Current maturities of long-term debt 35,813 20,750
----------- -----------
Total current liabilities 1,082,750 398,965
Long-term debt 1,684,413 2,460,864
Preferred stock 2,304,426 2,142,276
Shareholders' Deficit
Common stock 110,796 99,841
Accumulated deficit (3,889,389) (2,369,502)
Additional paid in capital 1,451,744 1,404,419
Cumulative translation adjustment (5,134) (8,208)
Unearned compensation expense (4,336) (15,898)
Treasury stock (9,583) (8,309)
----------- -----------
Total common shareholders' deficit (2,345,898) (897,657)
Total liabilities and shareholders' deficit $ 2,725,691 $ 4,104,448
=========== ===========
50
SCHEDULE I
RCN CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
For the Years Ended December 31,
------------------------------------------
2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,408,189) $ (684,789) $ (768,714)
Realized gain on disposal of subsidiaries 37,721 (8,180) --
Deferred income taxes and investment tax credits (12,903) (69,259) (55,630)
Working capital 549,846 (226,205) 571,174
Equity in loss of consolidated entity 1,678,449 320,444 587,675
Equity in loss of unconsolidated entity (75) (7,171) 15,985
Write-down of equity investment -- 24,418
Extraordinary item - debt prepayment gain (426,263) (83,604) --
Non-cash accretion of discounted senior notes 88,625 112,500 112,997
Amortization of financing costs 22,925 8,478 8,713
Other -- 2,258 (646)
----------- ----------- -----------
Net cash (used in) provided by operating activities 530,136 (635,528) 495,972
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions -- (316,074)
Investments in consolidated entity (301,482)
Dividend from consolidated entity 207,404
Other 381,637 (1,823,908)
----------- ----------- -----------
Net cash (used in) provided by investing activities (94,078) 381,637 (2,139,982)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of common stock -- 50,000 --
Proceeds from the issuance of preferred stock -- 1,614,423
Issuance of long-term debt -- 250,000 --
Interest paid on senior notes -- 23,111
Financing costs (12,291) (2,838)
Proceeds from the exercise of stock options 4 38 6,635
Purchase of treasury stock -- (200)
Payment of long-term debt (423,750) (45,945) --
----------- ----------- -----------
Net cash (used in) provided by financing activities (436,037) 254,093 1,641,131
----------- ----------- -----------
Net increase/(decrease) in cash and temporary cash investments 21 202 (2,879)
Beginning cash & temporary cash investments 1,026 824 3,703
----------- ----------- -----------
Ending cash & temporary cash investments $ 1,047 $ 1,026 $ 824
=========== =========== ===========
51
RCN CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. All required disclosures associated with the Condensed Financial
Information of RCN Corporation for the year ended December 31, 2002 are
included in the footnotes to the consolidated financial statements.
2. Certain obligations of RCN Corporation's subsidiaries are guaranteed by
RCN Corporation including amounts drawn under the Company's Credit
Agreement, letters of credit and some lease commitments. In November 2002,
the FASB issued Interpretation Number 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). This interpretation clarifies that a
guarantor is required to recognize a liability for the fair value of the
obligation undertaken in issuing the guarantee. The Condensed Financial
Information of RCN Corporation for the year ended and as of December 31,
2002 contain no provision for the recognition of the fair value of any
subsidiary guarantees. The initial recognition and initial measurement
requirements of FIN 45 are effective prospectively for guarantees issued
or modified after December 31, 2002.
52
SCHEDULE II
RCN CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(THOUSANDS OF DOLLARS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
---------- ------------ ---------- ---------- ----------
ADDITION
--------------------------
BALANCE AT CHARGED CHARGED BALANCE AT
BEGINNING OF TO COSTS TO OTHER END OF
DESCRIPTION PERIOD AND EXPENSE ACCOUNTS DEDUCTIONS PERIOD
- ----------- ------------ ------------ ---------- ---------- ----------
ALLOWANCE FOR DOUBTFUL ACCOUNTS-
DEDUCTED FROM ACCOUNTS RECEIVABLE
IN THE CONSOLIDATED BALANCE SHEETS
2002 $ 17,081 $ 12,700 $ 397 $ 19,473 $ 10,705
2001 $ 4,000 $ 14,249 $ (191) $ 977 $ 17,081
2000 $ 12,160 $ 10,834 $ 367 $ 19,361 $ 4,000
ALLOWANCE FOR DEFERRED TAX ASSETS-
DEDUCTED FROM DEFERRED TAX ASSETS
IN THE CONSOLIDATED BALANCE SHEETS
2002 $ 773,864 $ 955,844 $ - $ 424,074 $1,305,634
2001 $ 587,645 $ 239,896 $ (1,358) $ 52,319 $ 773,864
2000 $ 235,375 $ 355,775 $ - $ 3,505 $ 587,645
RCN CORPORATION
SELECTED FINANCIAL DATA
Thousands of Dollars Except Per Share Amounts
For the Years Ended December 31,
2002 2001 2000
----------- ----------- -----------
Sales $ 457,351 $ 405,571 $ 285,612
Loss from continuing operations before
extraordinary item $(1,594,159) $(1,327,043) $ (897,378)
Basic and diluted loss from continuing
operations per average common share
before extraordinary charge $ (15.00) $ (14.09) $ (10.99)
Total assets $ 1,990,282 $ 3,603,131 $ 4,775,552
Long-term debt, net of current maturities $ 1,706,997 $ 1,873,616 $ 2,257,357
Redeemable preferred stock $ 2,304,426 $ 2,142,276 $ 1,990,613
Preferred stock dividend and accretion
requirements $ 162,150 $ 151,663 122,752
53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(Dollars in thousands, except per share data)
The following discussion should be read in conjunction with RCN Corporation's
("RCN" or the "Company") audited consolidated financial statements and notes for
the years ended December 31, 2002, 2001, and 2000. Prior years have been revised
for discontinued operations:
INTRODUCTION
RCN Corporation is a leading facilities-based competitive provider of bundled
phone, cable television and high-speed Internet services to some of the most
densely populated markets in the U.S. We had approximately 922,477 total service
connections as of December 31, 2002 and provide service in Boston, including 18
surrounding communities, New York City, the Philadelphia suburbs, Chicago, San
Francisco and several of its suburbs, along with a few communities in Los
Angeles. We also serve the Lehigh Valley in Pennsylvania and
communities in and around Carmel, NY. We also have joint venture with Pepco
Communications, Inc., Starpower, serving the Washington, D.C. metropolitan
market with approximately 220,800 total service connections at December 31,
2002.
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 positive cash flow from operations in the
foreseeable future as we continue our efforts to optimize our network
infrastructure, increase operating efficiencies, and reduce operating costs. We
expect to accomplish this 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.
HISTORY
Prior to September 30, 1997, we were operated as a wholly owned subsidiary of
C-TEC Corporation ("C-TEC"). On September 30, 1997, RCN was spun off to C-TEC
shareholders in a transaction in which each holder of record of C-TEC common
equity received one share of RCN Common Stock for every one share of C-TEC
owned.
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 predominantly owned network. We
currently serve consumers in some of the most densely populated markets in the
U.S. These markets include Boston and 18 surrounding communities, New York City,
including Queens, the Philadelphia suburbs, Chicago, San Francisco and several
of its suburbs, and certain communities in Los Angeles. We also serve the Lehigh
Valley in Pennsylvania, communities in and around Carmel, NY and we were are the
incumbent franchised cable operator in many communities in central New Jersey
until these operations were sold on February 19, 2003. In addition, we also
have a joint venture with Pepco Communications, Inc., Starpower, serving the
Washington, D.C. metropolitan markets.
ResiLink and Essentials are the brand names of our two families of bundled
service offerings, offered for a flat monthly price to residential customers of
cable television, phone, and high-speed Internet.
In addition to our bundled package offerings, we sell cable television, phone
and high-speed cable modem and dial-up Internet to residential customers on an
a-la-carte basis. We also provide communication services to commercial
customers.
We are working to leverage the capacity of our broadband network to allow us to
expand our offering of new services. In 2002, we launched RCN MegaModem which
provides 3 Mbps of speed for customers looking to download movie videos, MP3
music files, and other Web-based forms of entertainment in as little as half
the time it would take with a standard 1.5 Mbps cable modem or DSL connection.
We believe MegaModem is the fastest Internet connection available to
residential customers in our markets. Also in 2002, we expanded our launch of
VOD in the Philadelphia market. We plan to launch Video-on-Demand (VOD),
Subscription Video-On-Demand (SVOD) and High Definition Television (HDTV in
certain markets in 2003.
54
Our services are typically delivered over our primarily 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 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.
JOINT VENTURES
To increase our market entry and gain access to Right of Ways, 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 broad band 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. At December 31, 2002, following NSTAR's exchanges of their
joint venture ownership interest for the Company's stock (see Note 11 of the
notes to consolidated financial statements for the year ended December 31,
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 Pepco Holdings, Inc. ("Potomac"),
regarding construction of our broad band 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 and our pro-rata portion of Starpower's
operating results are recorded on the equity in the loss of unconsolidated
entities line of our consolidated statements of operations.
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 year ended December 31, 2002 reflect
the consolidation of Starpower:
RCN (2)
Less (1) Corporation
Pro Forma (2) Starpower "GAAP"
------------- --------- ------
Total sales $ 542,037 $ 84,686 $ 457,351
Total direct costs $ 195,635 $ 20,159 $ 175,476
Margin $ 346,402 $ 64,527 $ 281,875
Total operating, selling and general
and administrative costs $ 429,602 $ 50,303 $ 379,299
Adjusted EBITDA (3) ($ 83,200) $ 14,224 ($ 97,424)
Non-cash stock-based compensation 37,721 -- 37,721
Depreciation and amortization 300,266 21,091 279,175
Asset impairment and special
charges, net 895,043 -- 895,043
Operating loss from continuing
operations $(1,316,230) $ (6,867) $(1,309,363)
55
(1) RCN owns 50% of Starpower, a joint venture in the Washington, D.C. market
which is accounted for as an equity investment in our consolidated financial
statements. Starpower is presented here net of related party transactions with
RCN Consolidated.
(2) Excludes results of central New Jersey operations which was sold February
19, 2003 and is included as a discontinued operation for GAAP purposes. (See
Note 6 of the Consolidated Financial Statements.)
(3) Adjusted EBITDA - Non GAAP measure calculated as net loss before interest,
tax, depreciation and amortization, stock based compensation, extraordinary
gains and special charges that the Company uses to measure performance and
liquidity. Other companies may calculate and define EBITDA differently than RCN.
Our critical accounting policies are as follows:
Revenue Recognition. Revenues are recognized and earned when evidence of an
arrangement exists, services are rendered, the selling price is determinable and
collectibility is reasonably assured. The Company recognizes local telephone
service revenue as earned when services are provided. The charges to the
customer and amount recognized as revenue for local telephone charges are based
on tariffed rates. We recognize long distance telephone service revenue based
upon minutes of traffic processed in accordance with tariffed rates or contract
fees. Other telephone services are recognized as revenue when the services are
provided to the customer in accordance with contract terms. Reciprocal
compensation, which is the fee local exchange carriers pay to terminate calls on
each other's networks, is recognized as revenue as it is realized. Revenues from
cable programming services are recognized and earned in the month the service is
provided to the customers. Cable installation revenue is recognized in the
period the installation services are provided to the extent of direct selling
costs. Any remaining amount is deferred and recognized over the estimated
average period that customers are expected to remain connected to our network
system. Internet access service revenues are recorded as earned based on
contracted fees.
Leases. Leases of the Company's assets including integral equipment and property
that contains a provision for the transfer of title are accounted for as a sales
or a direct finance lease. All other leased asset agreements, whereby the
Company is the lessor, are accounted for as operating leases, whereby the leased
assets remain on the Company's balance sheet and depreciated. Scheduled lease
payments are recognized as revenue when earned. Leasing transactions that the
Company enters as a lessee that bears all substantial risks and rewards from the
use of the leased item are accounted for as a capital lease. Capitalized leased
assets and the corresponding lease obligations are recorded on the Company's
balance sheet. All other lease agreements are accounted for as an operating
lease. Operating lease payments are expensed as incurred.
Reserve for Bad Debts. Bad debt expense and reserve is based on historical
trends and analysis. The Company's policy to reserve against potential bad debts
is based on the aging of the individual receivables. The practice to write-off
the individual receivables is performed after all resources to collect the funds
have been exhausted. Actual bad debt expense may differ from the amounts
reserved.
Property, Plant and Equipment and Depreciation. Property, plant and equipment is
recorded at cost. Costs to build and construct our network are capitalized which
includes all direct labor and materials, and certain indirect costs.
Expenditures for repairs and maintenance are charged to expense as incurred,
while equipment replacement and betterments are capitalized. Depreciation is
provided on the straight-line method based on the useful lives of the various
classes of depreciable property. The average estimated lives of depreciable
property, plant and equipment are:
Telecommunications network 5-22.5 years
Computer equipment 3-5 years
Building and leasehold improvements 5-30 years
Furniture, fixtures, and vehicles 3-10 years
Other 5-10 years
The carrying values of long-lived assets, which include construction material,
property, plant and equipment, goodwill, and other intangible assets, are
evaluated for impairment whenever events or changes in circumstances indicate
the carrying amount may not be recoverable. An impairment would be determined
based on a comparison of future undiscounted cash flows to the underlying
assets. If required, adjustments would be measured based on discounted cash
flows.
Stock Based Compensation. The Company has adopted and applies the recognition of
stock based compensation expense under the provisions of SFAS No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"). Under SFAS No. 123,
the fair value of an option or
56
other stock based compensation (as computed in accordance with accepted option
valuation models) on the date of grant is amortized over the vesting periods of
the options. The incentive stock options and the non-qualifying stock options
vest over a three year period and have a five year life. The outperformed stock
options vest over a five-year period and have a 10-year life. The restricted
stock options vest over three years and have a five year life and are subject to
transfer restrictions and are all or partially forfeited if a grantee terminates
employment with the Company. The compensation expense is applied to all stock
awards granted in the year 2000, the year of adoption, and is not applied to
awards granted in previous years unless those awards are modified or settled in
cash. The expense recognition of the value of the instruments is recorded in the
Consolidated Statement of Operations on the line "Non-cash stock based
compensation". This expense differs from other compensation expenses in that
these charges may be settled in cash, but generally are settled through issuance
of common stock.
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. We do not allocate shared expenses incurred on a single network
to our multiple revenue streams as any such allocation would be costly,
impractical and arbitrary. The Company's chief decision-makers do, however,
monitor operating results in a way different from that depicted in the
historical general purpose financial statements. These measurements include the
consolidation of discontinued operations and joint ventures, including Central
New Jersey and Starpower, which are not consolidated under generally accepted
accounting principles and are presented on a pro-forma basis herein. Such
information, however, does not represent a separate segment under generally
accepted accounting principles and therefore it is not separately disclosed.
OVERVIEW OF OPERATIONS
Approximately 93% of the Company's revenue for the year ended December 31, 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 7% of revenue is primarily 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 it is realized. We have generated increased revenues
in each of the past three 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.
We have a history of net losses as we built and expanded our network. When we
make an investment in a new market, the operating losses typically increase as
the network and sales force are expanded to facilitate growth. The primary
reason for anticipated net losses include the continuing investment to increase
the number of customers on our network, the cost of serving customers,
depreciation and amortization expenses associated with our capital expenditures
related to the past construction and development of our network, and interest on
the long-term debt.
In 2001, the Company modified its growth trajectory based on the anticipated
lack of available capital and revised its strategic and fundamental plans to
undertake certain initiatives to effect operational efficiencies and reduce
costs. The Company shifted focus from beginning construction in new markets to
completing additional construction activities in its existing markets.
Specifically, expansion to new markets was curtailed and expansion plans for
existing markets over the subsequent 24 to 36 months were curtailed or delayed.
As a result of these activities, the Company recorded $470,880 of asset
impairments and special charges, the primary components of which were $255,791
related to goodwill and $183,857 of tangible assets. The intangible and tangible
asset impairments largely affected the certain assets acquired from our Chicago
acquisitions and certain Internet operations.
57
In 2002, as a response to the severe slowdown in the telecommunications
industry, the economy, and continued limited available capital in the
telecommunications industry; the Company revised its growth plan again during
the second quarter 2002 following the completion of the Amendment to the
Company's Credit Agreement with JPMorgan Chase dated March 25, 2002. Under the
revised plan, the Company has substantially curtailed future capital spending
and network geographic expansion in all existing markets, has focused on the
continuation of customer acquisition growth, and has reduced operating expenses.
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. As a result of all of the
foregoing, the Company recognized $895,043 of asset impairment and special
charges, the primary components of which were $848,949 of tangible assets and
$38,927 of goodwill. The asset impairment and special charges affected all of
the Company's overbuild reporting units and none of the Company's incumbent
reporting units.
During the third quarter of 2002, the Company entered into an agreement to sell
its central New Jersey cable system assets and customers serviced by this
network. On February 19, 2003, the Company consummated the $245,000 sale of
central New Jersey cable system assets to Patriot Media & Communications CNJ,
LLC ("Patriot"). The cash proceeds of the sale received by RCN, net of amounts
paid to the minority interest and other closing adjustments, was approximately
$239,500. The Company will record a gain of approximately $155,000 to $180,000
on the transaction. In accordance with the Credit Agreement, as amended on March
7, 2003, an amount equal to the net cash proceeds of the sale of the central New
Jersey cable system assets in excess of $5,000 was deposited into a cash
collateral account. The proceeds on deposit in the cash collateral account may
be used by the Company to repay loans outstanding under the Credit Agreement or
to purchase telecommunications assets if the Company does not have other
available cash on hand to fund such expenditures. As a result of the sale and in
accordance with generally accepted accounting principles, the central New Jersey
operation is a discontinued operation and financial information regarding
continuing operations presented herein excludes central New Jersey operations
except where otherwise noted.
The Company has reduced its workforce by 1,012 employees in 2002 and 2,372
employees in 2001. The total headcount at December 31, 2002 was 3,623 which
includes discontinued operations. This excludes our Starpower joint venture. For
the year ended December 31, 2002, our operating, selling and general
administrative expenses decreased $76,136 or 16.7% to $379,299 from $455,435 for
the year ended December 31, 2002.
During the year, we retired approximately $24,037 in face amount of debt with a
book value of $22,142. We recognized a $13,073 gain from the early retirement of
debt in which approximately $722 in cash was used. The total debt outstanding at
the end of the year was $1,744,414.
In 2002, the Company sold one of its real properties in Pennsylvania to
Commonwealth Telephone Company. Proceeds from the sale were $1,974, and a gain
of $719 was recorded.
In 2002, the Company completed the sale of a portion of our business customer
base that was not served by our broadband network. The sale was based on certain
contingencies outlined in the sales agreement. After such contingencies, cash
proceeds of the sale were $2,169, which includes approximately 10,350 service
connections of which 7,750 are incumbent commercial resale voice lines and the
balance is digital subscriber lines. The Company realized a gain of $1,147 on
the transaction.
During the year ended December 31, 2001, the Company completed the sale of one
of its New Jersey real properties for approximately $40,000 resulting in a gain
of approximately $9,500. The property sits on 134 acres and is zoned for
1,520,000 square feet of office space. Pursuant to the sale of the land, the
Company entered into a 99-year ground lease on the property giving the Company
the right to develop 402,904 square feet of office space. Subsequent to the
Company entering into the ground lease and prior to the year ending December 31,
2001, the Company sold the development rights for approximately $14,000,
resulting in a gain of approximately $3,500. The gains are included in the other
income/expense line item.
RESULTS OF OPERATIONS
The following dollar amounts discussed in this section are in thousands.
Statistics and other disclosed non-dollar amounts are in whole numbers.
58
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001:
Sales:
Total sales increased $51,780, or 12.8%, to $457,351 for the year ended December
31, 2002 compared to $405,571 for the year ended December 31, 2001. The overall
increase was a result of higher network connections which increased 6.8% from
853,467 at December 31, 2001 to 911,690 at December 31, 2002.
Sales by service offerings, which reflect certain internal allocations made for
bundled product sales, are as follows:
Year ended December 31,
2002 2001 Change
Voice $136,832 $112,076 $ 24,756
Video 197,416 161,905 35,511
Data - Cable modem 52,295 29,444 22,851
Data - Dial up 25,666 41,904 (16,238)
Data - Other 12,160 24,415 (12,255)
Other 32,982 35,827 (2,845)
-------- -------- --------
$457,351 $405,571 $ 51,780
======== ======== ========
The increase in sales by service offering was primarily due to an increase in
average connections. Excluding the Starpower joint ventures, average connections
by service offering are as follows:
Year ended December 31,
2002 2001 Change % Change
------- ------- ------- --------
Voice 235,143 201,502 33,641 16.7%
Video 385,791 349,517 36,274 10.4%
Data - Cable modem 125,366 77,021 48,345 62.8%
Data - Dial up 165,390 225,427 (60,037) (26.6)%
------- ------- ------- -------
911,690 853,467 58,223 6.8%
======= ======= ======= =======
The increase in average voice connections resulted in additional voice sales for
the year ended December 31, 2002 of $19,576. The increase in average video
connection resulted in additional video sales for the year ended December 31,
2002 of $18,562. The increase in average cable modem connections resulted in
additional data sales for the year ended December 31, 2002 of $20,171. The
decrease in average dial up connections resulted in lower data sales for the
year ended December 31, 2002 of $9,317.
Average monthly revenue per connection by service offering is as follows:
Year ended December 31,
2002 2001 Change % Change
-------- -------- -------- --------
Voice $ 48.49 $ 46.35 $ 2.14 4.6%
Video $ 42.64 $ 38.60 $ 4.04 10.5%
Data - Cable modem $ 34.76 $ 31.86 $ 2.90 9.1%
Data - Dial up $ 12.93 $ 15.49 $ (2.56) (16.5)%
The increase in average monthly voice revenue per connection resulted in $5,180
of additional voice sales for the year ended December 31, 2002. The increase in
average monthly video revenue per connection resulted in $16,949 of additional
video sales for the year ended December 31, 2002. The increase in average
monthly cable modem revenue per connection resulted in $2,680 of higher cable
modem sales for the year ended December 31, 2002. The decrease in average
monthly dial up revenue per connection resulted in $6,921 of lower dial up sales
for the year ended December 31, 2002.
The decrease in data-other sales was due to the sale or disconnection of
approximately 3,600 resold high-speed connections not served by our broadband
network.
59
Other sales including reciprocal compensation decreased $2,845 or 7.9% to
$32,982 for the year ended December 31, 2002 from $35,827 for the year ended
December 31, 2001. The decrease was due primarily to recognition of installation
revenues and lower reciprocal compensation revenues which were offset, in part,
by increases in RCN Entertainment and cable advertising sales.
Costs and Expenses, Excluding Stock-Based Compensation, Depreciation and
Amortization:
Direct expenses, consisting of costs of providing services, decreased $13,301,
or 7.0% to $175,476 for the year ended December 31, 2002 from $188,777 for the
year ended December 31, 2001. Following is a table of direct expenses by type of
service:
Year ended December 31,
2002 2001 Change
--------- --------- ---------
Voice $ 38,129 $ 50,646 $ (12,517)
Video 107,689 86,459 21,230
Data 19,960 40,336 (20,376)
Other 9,698 11,336 (1,638)
--------- --------- ---------
$ 175,476 $ 188,777 $ (13,301)
========= ========= =========
The decrease in direct expenses was principally the result of initiatives to
further optimize our network and lower operating costs. While we achieved lower
cost per connection, some of the internally generated savings were absorbed by
higher franchise and programming fees. The Company also sold digital subscriber
lines not served by our broad band network, which accounts to the significant
reduction in direct data costs.
Operating, selling and general and administrative costs decreased $76,136, or
16.7% to $379,299 for the year ended December 31, 2002 from $455,435 for the
year ended December 31, 2001, reflecting efforts to affect operating
efficiencies. Components of Operating, selling, general and administrative costs
are as follows:
2002 2001* Change
--------- --------- ---------
Customer Services $ 53,994 $ 53,996 $ (2)
Network operations and construction 50,771 53,746 (2,975)
Sales and marketing 43,390 68,930 (25,540)
Advertising 12,772 9,011 3,761
Operating, general and administrative 218,372 269,752 (51,380)
--------- --------- ---------
$ 379,299 $ 455,435 $ (76,136)
========= ========= =========
*2001 operating expenses have been reclassified to be consistent with
management's 2002 classification. The management discussion and analysis of 2001
results does not include this reclassification.
Customer service and order processing costs decreased $2 for the year ended
December 31, 2002 compared to the year ended December 31, 2001. Decreases in
costs due primarily to lower wages were mostly offset by increases in benefits,
insurance and rents.
Network operations and construction costs decreased for year ended December 31,
2002 compared to the same period in 2001. The decreases for the year were
primarily due to lower rental costs relating to the network. In addition, the
Company had lower repairs and maintenance costs relating to the network, which
also contributed to the decrease in costs from the same period in 2001.
Sales and marketing costs decreased for the twelve months ended December 31,
2002 compared to the same period in 2001 primarily as a result of the
improvements in efficiencies and sales distribution management. The Company's
sales and marketing efforts are now more focused on direct mail and
telemarketing versus direct sales, resulting in lower overall cost per acquired
connection than in 2001.
Advertising costs increased in 2002 as compared to 2001 primarily due to higher
direct mail and newspaper advertising costs relating to campaigns introducing
several new service combination offerings in 2002 such as Essentials.
Advertising also includes costs for the preparation of the launch of our new
broad band Internet service, Mega Modem, in early 2003.
Overall general and administrative expenses decreased for year ended December
31, 2002 compared to the same period in 2001 by $51,380 primarily due to staff
reductions and personnel related costs, and a decrease in legal expense. For the
year, staff reductions and personnel related costs decreased approximately
$16,630. Legal expense decreased
60
approximately $26,560, representing a reduction in litigation and legal costs
for franchise related exit costs. For the year ended December 31, 2002, as
compared to 2001, building facility costs decreased approximately $14,840
including decreases in rent of approximately $11,590 and building repairs and
maintenance costs of approximately $2,110 resulting from the Company's efforts
to reduce excess space and consolidate operations. Decreases in expenses were
partially offset by higher computer system and maintenance contract costs
associated with the new customer care and billing system of approximately $4,410
and higher professional fees related to regulatory compliance and accounting
costs of approximately $890.
Non-cash Stock-Based Compensation:
Non-cash stock-based compensation decreased $25,234 or 40.1% for the year ended
December 31, 2002 as compared to 2001, due to the cancellation of restricted
stock grants in 2002 as a result of a reduction in the Company's work force. The
Company cancelled 1,097,303 restricted stock grants in the twelve months ended
December 30, 2002.
Depreciation and Amortization:
For the year ended December 31, 2002, depreciation and amortization expense
decreased $33,640 or 10.8%, to $279,175 from $312,815 for the year ended
December 31, 2001. Most of the variance is due to the Company's adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets." Goodwill amortization in year ended December 31, 2001 was
$56,322. There was no goodwill amortization expense in 2002.
Asset Impairment and Special Charges:
Asset impairment and special charges for the twelve months ended December 31,
2002 were $895,043. In response to the severe slowdown in the telecommunications
industry and the economy, and continued limited available capital in the
telecommunications industry, we revised our growth plan following the completion
of the Amendment to the Company's Credit Agreement with JPMorgan Chase dated
March 25, 2002. Under the revised plan, we substantially curtailed future
capital spending and network geographic expansion in all existing markets,
focused on the continuation of customer acquisition growth, and reduced
operating expenses. We also performed a comprehensive review of 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 the foregoing, we recognized asset
impairment charges during 2002 of $889,255. In addition, we recognized $5,788 of
special charges net of recoveries for exiting excess real estate facilities in
2002, as a result of the curtailing of construction and expansion, and the
consolidation of certain operating activities.
Asset impairment and special charges for the year ended December 31, 2001 were
$470,880. 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
beginning construction in new markets to its existing markets where the Company
could achieve higher growth with lower incremental capital spending.
Specifically, expansion to new markets was curtailed and expansion plans for
existing markets were reassessed resulting in certain projects being curtailed,
delayed of funding shifted to other markets as deemed appropriate.
As a result, during 2001, the Company assessed the recoverability of its
investment in each market, which led to the recognition of impairment to
goodwill and the recording of special charges aggregating approximately
$470,880. These special charges comprised the impairment of identifiable
intangible and goodwill assets of approximately $256,000, and the impairment of
property and equipment of approximately $114,000. In addition, charges
61
to dispose of excess construction materials were approximately $69,800 and
estimated costs to exit excess facilities were approximately $31,000.
Investment Income:
For the year ended December 31, 2002, investment income decreased $69,138 or
81.8%, to $15,349 from $84,487 for the year ended December 31, 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
during 2002 as compared to the twelve months ended December 30, 2001. Cash,
temporary cash investments, short-term investments, and restricted investments
were $311,926 at December 31, 2002 compared to $862,167 at December 31, 2001.
The decrease in average cash was attributable to long-term debt repayments,
capital expenditures, and working capital requirements.
Interest Expense:
Interest expense decreased for the year ended December 31, 2002 compared to the
same period in 2001 primarily due to lower interest accretion on discount notes
and the extinguishment of debt. For the twelve months ended December 31, 2002,
interest expense decreased $29,089 or 14.8% to $167,644 from $196,733 in 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 September
1998, respectively, and the debt extinguishment during 2001 and 2002. The total
debt of the Company decreased $151,734 or 8.0% from $1,896,148 at December 31,
2001 to $1,744,414 at December 31, 2002.
Income Tax:
The Company's effective income tax rate was a benefit of 0.07% and 0.32%,
respectively, for the years ended December 31, 2002 and December 31, 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.
Equity in Loss of Unconsolidated Entities:
For the year ended December 31, 2002, equity in loss of unconsolidated entities
decreased $7,868 to a loss of $9,317 from a loss of $17,185 for the year ended
December 31, 2001. The loss from unconsolidated entities, represents the
Company's investments in Starpower, Mega Cable, MCM Holding, and J2 Interactive.
Losses in 2002 also include an impairment in our investment in Starpower in the
amount of $32,274.
The Company has imbedded goodwill in the investment in Mega Cable, which is no
longer amortized in accordance with SFAS No. 142 beginning in 2002. The
estimated amortization of goodwill in Mega Cable was approximately $7,200 in
2001.
Minority Interest in Loss of Consolidated Entities:
For the year ended December 31, 2002, minority interest in loss of consolidated
entities increased $14,319 to $36,650 from $22,331 at December 31, 2001. The
minority interest primarily represents the interest of NSTAR Communications,
Inc. in the loss of RCN-Becocom. Losses for year ended December 31, 2002 are
primarily due to asset impairment and special charges related to RCN-Becocom.
Discontinued Operations:
The income from discontinued operations represents the net operating results of
the central New Jersey cable system operations. (See note 6 to the consolidated
financial statements.) In accordance with generally accepted accounting
principles, no depreciation or amortization is recorded for assets held for
sale. Therefore, the Company stopped recording depreciation on assets sold as a
part of its central New Jersey operation as of August 27, 2002.
Extraordinary Item:
Extraordinary item decreased to $13,073 for the year ended December 31, 2002
from $484,011 for the same period in 2001. During the twelve months ended
December 31, 2002, the Company retired $24,037 in face value of debt with a book
value of $22,142 for $722 in cash, 2,589,237 shares of common stock with a value
of $7,875, fees of $180 and write-off of debt issuance costs of $292. During
2001, the Company retired approximately $816,000 of face amount debt with a book
value of $740,940 which generated an extraordinary gain of $484,011.
62
For the foregoing reasons we incurred net losses after preferred stock
dividends and accretion requirements of $1,570,339, $836,452 and $891,466 for
the years ended December 31, 2002, 2001 and 2000 respectively. Losses per
average common share including extraordinary items and discontinued operations
were $(14.78), $(8.89) and $(10.59) for the years ended December 31, 2002, 2001
and 2000, respectively.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000:
Sales:
Total sales increased $119,959, or 42.0%, to $405,571 for the year ended
December 31, 2001 compared to $285,612 for the year ended December 31, 2000. The
increase was a result of higher network connections, which increased 33.3% from
576,738 at December 31, 2000 to 768,916 at December 31, 2001.
Phone sales increased $44,704, or 66.4%, to $112,076 for the year ended December
31, 2001 from $67,372 for the year ended December 31, 2000. Approximately
$38,444 of the increase in phone sales is attributable to higher average
connections. Average network phone connections increased approximately 82.6% to
approximately 173,996 for the year ended December 31, 2001 from approximately
95,277 for the year ended December 31, 2000. Average resale phone connections
were approximately 26,932 and 32,681 at December 31, 2001 and 2000 respectively.
The increase in phone sales was also partially attributable to higher average
revenue per connection of 5.9%.
Cable television sales increased $52,709, or 48.3% to $161,905 for the year
ended December 31, 2001 from $109,196 for the year ended December 31, 2000. The
increase was primarily due to additional average network cable television
connections of 82,793 or 23.9% to approximately 429,851 for the year ended
December 31, 2001 from approximately 347,058 for the year ended December 31,
2000. Overall higher service connections contributed approximately $30,956 to
the increase in cable television sales and higher average revenue per connection
of 9.1% principally contributed the remainder.
Internet sales increased $21,254, or 28.5% to $95,763 for the year ended
December 31, 2001 from $74,509 for the year ended December 31, 2000. The
increase was primarily due to approximately 55,193 additional average Internet
connections that grew to 82,779 for the year ended December 31, 2001 as compared
to the year ended December 31, 2000.
For the year ended December 31, 2001, the Company had approximately 229,427
average dial-up Internet connections as compared to approximately 287,261 for
the year ended December 31, 2000.
Other sales increased $1,292 or 3.7% to $35,827 for the year ended December 31,
2001 from $34,535 for the year ended December 31, 2000. The increase was due
primarily to higher reciprocal compensation.
Costs and Expenses, Excluding Stock-Based Compensation, Depreciation and
Amortization:
Direct expenses, comprising of costs of providing services, increased $27,225,
or 16.9% to $188,777 for the year ended December 31, 2001 from $161,552 for the
year ended December 31, 2000. The increase was principally the result of higher
sales, increased costs of cable television services due to higher franchise fees
and programming rates, and partially offset by a higher margin on Internet sales
due to network optimization.
Operating, selling and general and administrative costs decreased $13,002, or
2.8% to $455,435 for the year ended December 31, 2001 from $468,437 for the year
ended December 31, 2000.
The following expenses are included in the Operating, selling and general and
administrative costs:
Customer services and order processing costs decreased approximately $14,400, or
16.7% to approximately $71,900 for the year ended December 31, 2001 from
approximately $86,300 for the year ended December 31, 2000. The decrease is
primarily internal and external staff and personnel related reductions of
approximately $8,900. The remainder of the decrease was attributable to rental
and telephone expenses of approximately $5,500.
Technical expense, including installation and provisioning, increased
approximately $3,482, or 3.7% to approximately $96,959 for the year ended
December 31, 2001 from approximately $93,477 for to the year ended December 31,
2000. The increase was primarily for rental and utility expense for material
storage and hub sites, which increased approximately $12,900. This expense was
offset by a decrease of approximately $7,500 due to engineering and construction
headcount and contract labor reductions. The remaining
63
$800 decrease was principally due to lower repair and maintenance costs relating
to the network and the fleet.
Advertising costs decreased approximately $28,000, or 80% to approximately
$7,050 for the year ended December 31, 2001 from $34,986 for the year ended
December 31, 2000. The decrease is primarily related to a shift in the Company's
advertising philosophy away from mass media branding to a more stratified
customer targeted campaign. In addition, some of the decreases were due to the
reduction of network expansion resulting in the reduction of the need for
advertising in newly entered markets.
Sales and marketing costs decreased approximately $4,400, or 5.8% to $71,513 for
the year ended December 31, 2001 from $75,956 for the year ended December 31,
2000. A decrease of approximately $3,000 resulted principally from reductions in
staff as a result of the reduction of network expansion and network operations
and related commissions and benefits. The remaining decrease is primarily
attributable to reductions in recruiting expenses of approximately $1,800.
General and administrative expenses increased approximately $30,300, or 17.1% to
approximately $208,045 for the year ended December 31, 2001 from $177,712 for
the year ended December 31, 2000. Information technology expenses increased
approximately $9,844 to approximately $38,000 for the year ended December 31,
2001 from approximately $27,300 for the year ended December 31, 2000. The
Company developed an information technology system, which provides a
sophisticated customer care infrastructure as well as other administrative
support systems. The expense increases represent primarily staff additions to
both support this effort and maintain the systems as well as maintenance
contracts costs offset by a reduction in consulting expenses.
As a result of the Company's decision to stop or delay construction in certain
markets and the related reduction in head count, recruiting, training, employee
relations and outside labor expenses decreased in the year 2001 approximately
$12,300. As a result of increased sales, the bad debt expense increased
approximately $3,700 in the year 2001 as compared to 2000. Building rent,
utilities, and repair and maintenance expenses increased approximately $10,000
for the year ended December 31, 2001 as compared to the same period in 2000.
Franchise costs in the amount of $15,700 were accrued, primarily representing
costs related to the Company's decision to stop or delay construction in certain
markets. Additional franchise costs of $500 were paid as of December 31, 2001.
Costs related to workforce reductions of approximately $7,700 have been expensed
and paid in 2001.
Goodwill Write-Down and Special Charges:
Special charges aggregated approximately $471,000. Components of the special
charges are as follows: Estimated costs to exit excess facilities were
approximately $31,000 of which $7,600 were paid as of December 31, 2001. Charges
to write down construction material determined to be excessive relative to
currently planned construction activities were $70,000 and are included in the
line item Goodwill write-down and special charges as opposed to the line item
Costs and expenses. Costs related to property and equipment in abandoned markets
aggregated $75,000. Impairments of tangible, identifiable intangible and
goodwill assets from prior acquisitions, measured as the amount by which the
carrying value exceeded the present value of estimated future cash flows, was
$295,000.
Stock Based Compensation:
During the fourth quarter of 2001, the Company completed a stock option exchange
offer. Under the offer, all options with a strike price below $16.00 were
eligible to be exchanged in the ratio of 3 new options for 4 old options.
Options with a strike price of $16.00 and above were eligible to be exchanged in
the ratio of 1 new option for 2 old options. Approximately 6,150,000 new stock
options were issued as a result of the exchange program and approximately
9,750,000 stock options were cancelled. Approximately 1,622,000 new out
performance options ("OSOs") were issued as a result of the exchange program and
approximately 3,163,000 OSOs were cancelled. The strike price of the new options
are $1.95 and the new stock options will vest monthly at a rate of 1/36 each
month over a three year period and the term of the new options will be five
years. The OSOs will vest monthly at a rate of 1/60 each month over a five year
period and the term of the new OSOs will be ten years. Generally accepted
accounting principles requires the non-vested exchanged options to be expensed
over the vesting period of the new options. Additional non-cash stock based
compensation will be recorded in the future as a result of the program. For the
year ended December 31, 2001, the Stock Based Compensation was $62,955 compared
to $41,237 for the year ended December 31, 2000.
Depreciation and Amortization:
64
Depreciation and amortization was $312,815 for the year ended December 31, 2001
and $279,817 for the year ended December 31, 2000. The increase of $32,998 was
the result of a higher depreciable basis of property, plant, and equipment
resulting primarily from expansion of the Company's broadband network and
amortization of intangible assets arising primarily from the acquisition of 21st
Century in April of 2000.
Investment Income:
Investment income was $84,487 and $141,563 for the year ended December 31, 2001
and 2000, respectively. The decrease of $57,076, or 40.3%, was a result of the
decrease in average cash, temporary cash investments and short-term investments
as compared to the same period in 2000. Cash, temporary cash investments and
short-term investments were $838,491 at December 31, 2001 and $1,728,392 at
December 31, 2000. The decrease in average cash was primarily attributable to
capital expenditures, inventory increases and working capital requirements.
Interest Expense:
For the year ended December 31, 2001, interest expense was $196,733 as compared
to $223,383 for the year ended December 31, 2000. This decrease was primarily
due to the extinguishment of debt resulting in lower cash interest and accretion
in discount notes (see Note 14 of the Consolidated Financial Statements) and
higher capitalized interest aggregating approximately $17,673).
Other Income and Expense:
For the year ended December 31, 2001, the Company completed the sale of one of
its New Jersey properties for approximately $40,000 and the related development
rights for $14,000, resulting in a gain of approximately $9,500 and $3,500,
respectively. There was no tax effect on the gain. Overall, other income was
$13,239 and $1,847 in the years ended December 31, 2001 and 2000, respectively.
Income Tax:
The Company's effective income tax rate was a benefit of 0.32% and 0.65% for the
year ended December 31, 2001 and December 31, 2000, respectively. 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. For additional
analysis of the changes in income taxes, see the reconciliation of the effective
income tax rate in Note 16 to the consolidated financial statements.
Equity in the Loss of Unconsolidated Entities:
For the year ended December 31, 2001, equity in the loss of unconsolidated
entities primarily represents the Company's net share of the income or loss and
amortization of excess cost over net assets, included income from Megacable of
$1,282 and JuniorNet of $7,171, and losses from Starpower of $25,602 and J2
Interactive of $36. For the year ended December 31, 2000, equity in the loss of
unconsolidated entities included income from Megacable of $1,695, and a loss
from Starpower of $20,208 and JuniorNet of $15,984. Results for 2000 also
include an impairment in our investment in JuniorNet in the amount of $24,418.
During 2001, the Company made secured loans to JuniorNet. Subsequently, the
assets of JuniorNet were foreclosed upon by the secured creditor group,
including RCN. In the foreclosure, RCN received 100% of the assets of
JuniorNet's subsidiary Lancit. Those assets were used to start RCN's
wholly-owned subsidiary, RCN Entertainment. The liabilities assumed by RCN
Entertainment exceeded the assets, resulting in an expense of $606, which is in
the line item Other income/(expense). RCN Entertainment produces
children's/family television programming.
Minority Interest:
For the year ended December 31, 2001 and 2000 minority interest of $22,331 and
$24,845, respectively, primarily represents the interest of NSTAR
Communications, Inc. in the loss of RCN-Becocom.
Extraordinary Item - Prepayment of Debt:
65
For the year ended December 31, 2001, the Company completed several debt tender
offers to purchase certain of its long-term debt. As a result, the Company
recognized an extraordinary gain of approximately $484,011 on the debt
extinguishment. The Company purchased a total of $740,940 of certain outstanding
long-term debt for $226,995 in cash and $5,850 in common stock, plus fees of
$14,428 and the write-off of debt issuance costs of $9,656.
RELATED PARTY TRANSACTIONS
The Company had the following material transactions with related parties during
the year. We believe all transactions were designed to reflect arrangements
that would have been agreed upon by parties negotiating at arm's length:
The Company has an existing relationship with Commonwealth Telephone
Enterprises, Inc. ("CTE"). Our Chairman and Chief Executive Officer is also the
Chairman of CTE. Eight of our Directors also serve on the board of directors of
CTE. Prior to September 30, 1997, RCN was a wholly owned subsidiary of CTE
(formerly C-TEC Corporation). On September 30, 1997 C-TEC distributed the shares
of RCN to its shareholders. The Company agreed to provide or cause to be
provided certain specified services (management services) to CTE for a
transitional period after the distribution. The total fee for 2002 and 2001 was
approximately $1,200 each year. The agreement was terminated by CTE in December
2002. This transaction was not the result of an arm's length negotiations as the
Company and CTE have certain common officers and directors.
Starpower joint venture - Based on the joint venture approved service agreement,
we allocate certain identified expenses incurred by the Company to the Starpower
joint venture. These expenses include network cost allocations, customer call
center costs, and general administrative costs. These identifiable costs totaled
approximately $17,782 for the year ended December 31, 2002. Based on the
Company's interest in the Starpower joint venture, 50% of these costs are
recognized by the Company on the `Equity in (loss) of unconsolidated entities'
line in the Consolidated Statements of Operations. The cost allocated to
Starpower for the years ended December 31, 2001 was $19,594.
In 2002, the Company paid NSTAR Communications approximately $7,333, primarily
for network construction and separately paid NSTAR approximately $3,297 for
utility services. For the years ended December 31, 2001 the total costs paid to
NSTAR were approximately $64,400. Construction costs are capitalized and are
recorded as Property, plant, and equipment on the Company's Balance Sheets. A
Director of the Company is also the Chairman and Chief Executive Officer of BECO
and NSTAR Communications. NSTAR owns 10.6% of the Company's common stock as to
December 31, 2002.
In 2002, the Company paid Sordoni Skanska, a subsidiary of Skanska USA, as
project manager, approximately $594 to oversee network construction and for
related labor costs in several of the Company's markets. The Company reimburses
Sordoni Skanska for staff and administrative services, project management fees,
and invoices from sub contractors. The Company also paid Barney Skanska
approximately $1,088 for construction services relating to certain of the
Company's hub sites. For the years ended December 31, 2001 and 2000 the total
costs paid were approximately $65,500 and $52,600, respectively. Construction
costs are capitalized and are recorded as Property, plant, and equipment on the
Company's balance sheets. A former Director of the Company was the President of
Skanska USA.
In 2002, the Company paid Level 3 Communications approximately $2,088 for
network construction and approximately $2,305 for circuit costs. For the year
ended December 31, 2001 the total costs paid were approximately $13,400. Level 3
owns 24.29% of the outstanding common stock in RCN as of December 31, 2002. In
addition, the Company's Chairman and Chief Executive Officer is also a Director
of Level 3.
In July 2002, the Company entered into a four year data center outsourcing
contract with (i)Structure, Inc., a subsidiary of Level 3 Communications. The
(i)Structure data center will primarily host the Company's billing systems and
financial support applications. The base service fee is approximately $150 per
month.
The Company provided CTE local and long distance services of approximately
$3,509 during 2002. Commonwealth Telephone Company and CTSI, Inc. a subsidiary
of CTE, provided the Company with local and long distance services of
approximately $198. For the year ended December 31, 2001 total costs paid to CTE
and its subsidiaries were approximately $702.
In December 2002, the Company sold a parcel of real estate in Dallas,
Pennsylvania to Commonwealth Telephone Company for proceeds of $1,974. The sale
price was based on independent appraisals. As part of the sale contract, the
Company will pay no rent or operating costs from the date of sale until it exits
the facility in 2003.
66
In 2002, the Company paid the Hanify and King law firm approximately $287 for
legal services. In 2001 fees totaled $182. The Company's Chairman and Chief
Executive Officer and Director has a family member who is a partner with Hanify
and King.
In 2002, the Company paid $225 to Liberty Mutual Insurance Company to lease
office space for operations in our Boston market. Lease payments were $196 in
2001. Thomas J. May, a Director of the Company, is also a Director of Liberty
Mutual Insurance Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents, and short-term investments decreased to
$277,006 at December 31, 2002 from $838,491 at December 31, 2001. The decrease
resulted primarily from $202,814 used in operating activities, $218,275 used in
financing activities and $141,758 used by investing activities for additions to
property, plant, equipment and construction materials.
Net cash of $202,814 used in operating activities consisted primarily of
$1,418,936 in net losses from continuing operations before preferred dividends
and accretion adjusted for non-cash items which included $895,043 of goodwill
write-down and special charges and $279,175 in depreciation and amortization. In
addition, $76,659 was used in working capital consisting mostly of decreases in
accounts payable and accrued expenses of $52,074 as well as increases in
accounts receivable and unbilled revenues of $22,439. These working capital cash
uses were partially offset by decreases in receivables from related parties of
$6,491.
Net cash of $5,766 used by investing activities resulted from additions to
property, plant, equipment and construction materials of $141,758. These uses
were partly offset by net increases in short term investments of $133,165.
Cash used in financing activities of $218,275 consisted primarily of repayment
of long-term debt and debt financing costs of $203,062 and $12,219,
respectively.
The Company has historically met its liquidity requirements through cash on
hand, amounts available under its Credit Facility and issuances of high-yield
debt securities in the capital markets and convertible preferred stock and
common stock to strategic investors. At December 31, 2002, the Company had
approximately $277,006 in cash and short-term investments. The Company believes
that current available cash and proceeds from revenues will be sufficient to
meet its anticipated cash needs for working capital, capital expenditure and
other activities for at least through mid-2004. However, in order to meet its
long-term liquidity needs, the Company anticipates it will have to do one or a
combination of the following: (i) outperform its business plan, (ii) improve its
operational efficiencies, (iii) raise additional capital through issuance of
equity or debt securities, (iv) further amend its Credit Facility, (v)
restructure its balance sheet, and (vi) consummate additional asset sales. The
Company cannot assure you that it will be able to implement any of the foregoing
on acceptable terms.
The Company expects to supplement its available cash and operating cash flow by
continuing to seek to raise capital to pay for capital expenditures, working
capital, debt service requirements, anticipated future operating losses and
acquisitions. The Company may experience difficulty raising capital in the
future, however, as both the equity and debt capital markets continue to
experience periods of significant volatility, 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 remains
restricted while financing costs continue to increase. Capital markets remain
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.
The Company has used and continues to use capital raised from debt and equity
offerings to implement its business plan. However, the Company may seek
additional financing, but there can be no assurance that it will be able to
obtain additional financing. 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, reducing debt or raising
sufficient debt or equity capital on terms that it will consider acceptable. In
addition, proceeds from dispositions of the Company's assets may not be
sufficient to support operations or debt service.
On February 19, 2003, the Company consummated a previously announced $245,000
sale of its central New Jersey cable system assets to Patriot Media &
Communications CNJ, LLC ("Patriot"). The cash proceeds of the sale received by
RCN, after taking into account the amount paid by Patriot to acquire the
67
minority interest in the portion of the New Jersey cable systems that was not
owned by RCN and other closing adjustments, was approximately $239,500. The
Company realized a gain of approximately $155,000 to $180,000 on the
transaction. In accordance with the Credit Agreement, an amount equal to the net
cash proceeds of the sale of the central New Jersey cable system assets in
excess of $5,000 was deposited into a cash collateral account. Other than the
minimum $100,000 required to be maintained on deposit in the cash collateral
account under the Fifth Amendment, proceeds on deposit in the cash collateral
account may be used to repay loans outstanding under the Credit Agreement or to
purchase telecommunications assets if the Company does not have other available
cash on hand to fund such expenditures. In accordance with SFAS No. 144, the
results of operations for central New Jersey is reported as discontinued
operations.
Changes in the cable television, Internet and voice services markets may also
affect the Company's ability to execute its business plan and achieve its
revenue growth and spending objectives. Changes that may impact our business
include regulatory, competitive and technological factors discussed in more
detail in the preceding business and risk factors sections of this report.
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") with the JPMorgan Chase Bank (formerly known as The Chase
Manhattan Bank) and certain other lenders. 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 dated as of June 3, 1999 (as amended,
the "Credit Agreement"). Since such time, the Credit Agreement, including the
amounts available under the Credit Facility, has been amended as described
below.
The Company most recently amended the Credit Agreement in a Fifth Amendment
dated March 7, 2003 (the "Fifth Amendment"). The Fifth Amendment amends certain
financial covenants and certain other negative covenants to reflect the
Company's current business plan and amends certain other terms of the Credit
Agreement, including increases to the margins payable thereunder if the
aggregate amount of outstanding loans exceeds certain thresholds on July 1,
2004. In connection with the Fifth Amendment, the Company has agreed to pay to
certain lenders an aggregate fee of approximately $5,000 and to permanently
reduce the amount available under the Revolver from $187,500 to $15,000. The
Fifth Amendment permits the Company to incur up to $500,000 of additional
indebtedness that may be secured by a junior lien on the Company's assets and
permits the Company to use up to $125 million of existing cash and proceeds of
this new indebtedness to repurchase its outstanding Senior Notes and Senior
Discount Notes. The Company also agreed to repay outstanding term loans with 50%
of the first $100,000 of net proceeds received from asset sales, 80% of net
proceeds received from asset sales in excess of $100,000 and 50% of cash
interest savings realized by the Company from repurchases of its outstanding
senior notes. Further, the Company agreed to maintain a cash collateral account
for the benefit of the lenders under the Credit Agreement that will have at
least $100,000 on deposit at all times. As a result of the Fifth Amendment, the
Company will not be able to borrow money that may otherwise have previously been
available to it under the Revolver, and the Company can make no assurances that
it will be able to raise any of the $500,000 of additional indebtedness now
permitted under the terms of the Amendment. In addition, the requirement that
the Company maintain a minimum balance of $100,000 in the cash collateral
account significantly reduces the amount of cash available to the Company to
invest in its business and execute its current business plan. The Company also
entered into four previous amendments to the Credit Agreement, as described
below.
At December 31, 2002 there were no outstanding loans under the Revolver. In
accordance with the Amendment, the Revolver can also be utilized for letters of
credit up to a maximum of $15,000. At December 31, 2002, there were $15,000 in
letters of credit outstanding under the Revolver. At December 31, 2002 the
Company also had letters of credit outside the Revolver of $25,005 and $9,915 in
escrow accounts collateralized by restricted cash. As of December 31, 2002, a
total of $546,938 was outstanding under Terms loans A and B.
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.
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. The Company's ability to maintain its liquidity and
maintain compliance with its amended covenants under the Credit Agreement is
dependent upon its ability to achieve the covenants in the recently amended
Credit Agreement. The Company can make no assurances that it will be able to
achieve the new covenants in the long-term. The Company can make no assurances
that its business will generate sufficient cash flow from
68
operations or that existing available cash or future borrowings will be
available to it under the Credit Facility in an amount sufficient to enable it
to pay its indebtedness or to fund its other liquidity needs.
If the Company were adversely impacted by unforeseen business conditions, it may
be required to seek additional modifications to the Credit Agreement in order to
satisfy or comply with the financial and negative covenants of the Credit
Agreement, as amended by the Amendment. In addition to the potential uncertainty
of the Company's ability to obtain additional modifications, if necessary, the
Company may incur additional costs in the form of fees or interest expense for
any such modifications. 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
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.
A fourth Amendment to the Credit Agreement is dated March 25, 2002 (the "Fourth
Amendment"). This Fourth Amendment amended certain financial covenants and
certain other negative covenants to reflect the Company's business plan at that
time and amended certain other terms of the Credit Agreement, including
increases to the margins and commitment fee payable thereunder. In connection
with the Fourth Amendment, the Company agreed to pay to certain lenders an
aggregate fee of approximately $12,900, 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 also agreed that
it would not draw down additional amounts under the Revolver 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 Fourth 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 an amendment to the Credit Agreement dated May 31,
2001. This amendment permits the Company 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.
The Company entered into an amendment to the Credit Agreement dated December 3,
2000 which, among other things, amended certain financial covenants.
The Company first amended the Credit Agreement on June 28, 2000. That amendment,
among other things, amended certain financial covenants and gave the Company the
ability to request from the JPMorgan Chase Bank up to $500,000 of incremental
term loans. To the extent that JPMorgan Chase is unable to arrange commitments
to the Company for the amount requested, then the Company has the right to
arrange the shortfall in incremental loans from other banks or financial
institutions.
The Company made tender offers to purchase certain of its Senior Notes which it
purchased in 2001 and 2002. The Company recognized extraordinary gains of
$13,073 and $484,011 on debt extinguishment in the years ended December 31, 2002
and 2001, respectively. During 2002, the Company completed two debt repurchases
for certain of its 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 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.
During 2001, the Company completed several debt tender offers to purchase
certain of its Senior and Senior Discount Notes. The Company retired
approximately $816,000 in face amount of debt with a book value of $740,940. The
Company recognized an extraordinary gain of approximately $484,011 from the
early retirement of debt in which approximately
69
$226,995 in cash was paid and 1,988,966 of shares of common stock with a value
of $5,850 were issued. In addition, the Company incurred fees of $14,428 and
wrote off debt issuance costs of $9,656. The Company also saved approximately
$20,000 in interest payments in 2002 related to the debt buybacks.
During the quarter ended June 30, 2001, the Company completed a private
placement of $50,000 of approximately 7.66 million shares of common stock and
warrants to purchase approximately 3.83 million shares of common stock with Red
Basin, LLC. Red Basin is an entity formed by Walter Scott, Jr., a Director of
the Company, together with certain family members and trusts. The Company used
the proceeds to complete portions of the tender offer mentioned above
During the year 2001, the Company completed the sale of one of its New Jersey
real properties for approximately $40,000 resulting in a gain of approximately
$9,500. In connection with the sale of the land, the Company entered into a
99-year ground lease on the property, which gave the Company the right to
develop office space. In December 2001, the Company sold the development rights
for approximately $14,000 resulting in a gain of approximately $3,500.
The Company is aware that the various issuances of Senior Notes and Senior
Discount Notes continue to trade at significant discounts to their respective
face or accreted amounts. In accordance with the amendment, and 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 for cash or 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.
Since the spin-off of RCN from C-TEC Corporation, the Company completed debt
offerings generating gross proceeds of $1,450,000 and common and preferred
equity offerings generating gross proceeds of $2,316,000.
The Company has indebtedness that is substantial in relation to its
shareholders' equity and cash flow. At December 31, 2002 the Company had an
aggregate of approximately $1,744,414 of indebtedness outstanding including
capital lease obligations. The Company also has cash, temporary cash investments
and short-term investments aggregating approximately $277,006. Applying the
effect of additional restricted cash per the terms of the Fifth Amendment to the
Credit Agreement would reduce cash and short-term investments from $227,006 to
$127,006 as of December 31, 2002. The Company had the following contractual
obligations at December 31, 2002:
Payments Due by Period (in thousands)
---------------------------------------------------------------------------
Less than 1-3 4 - 5 After 5
Contractual Obligations Total 1 year years years years
---------- ---------- ---------- ---------- ----------
Senior Notes $1,173,288 481,613 691,675
Term Loans $ 546,938 35,813 109,125 402,000 --
Capital Leases $ 24,188 1,604 4,507 3,730 14,347
Operating Leases $ 295,443 30,868 52,069 57,711 154,795
---------- ------ ------- ------- -------
Total Contractual Cash Obligations $2,039,857 68,285 165,701 945,054 860,817
At December 31, 2002, the Company had the following other commercial
commitments:
Amount of Commitment Expiration Per Period (in thousands)
---------------------------------------------------------
Total
Amounts Less than 1-3 4 - 5 Over 5
Other Commercial Commitments Committed 1 year years years years
---------- ---------- ---------- ---------- ----------
Letters of Credit - Collateralized
by Revolver 15,000 15,000
Letters of Credit - Collateralized
by Restricted Cash 25,005 23,255 1,750
Total Other Commercial Commitments $ 40,005 $ 38,255 $ 1,750
70
As a result of the substantial indebtedness of the Company, the Company's fixed
charges are expected to exceed its earnings for the foreseeable future. The
leveraged nature of the Company could limit its ability to effect future
financing or may otherwise restrict the Company's business activities.
The extent of the Company's leverage may have the following consequences: (i)
limit the ability of the Company to obtain necessary financing in the future for
working capital, capital expenditures, debt service requirements or other
purposes; (ii) require that a substantial portion of the Company's cash flows
from operations be dedicated to the payment of principal and interest on its
indebtedness and therefore not be available for other purposes; (iii) limit the
Company's flexibility in planning for, or reacting to, changes in its business;
(iv) place the Company at a competitive disadvantage as compared with less
leveraged competitors; and (v) render the Company more vulnerable in the event
of a downturn in its business.
The Company has two tranches of redeemable preferred stock, Series A and Series
B. At December 31, 2002 the Company had paid cumulative dividends in the amount
of $433,288 in the form of additional Series A and B Preferred Stock. At
December 31, 2002 the number of common shares that would be issued upon
conversion of the Series A and B Preferred Stock was 40,794,705.
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.
CAPITAL EXPENDITURES
The Company's capital expenditures for 2002 are primarily to increase the number
of connections in our current markets and complete the development of our
information technology systems.
We completed major initiatives in our Information Technology ("IT") and Customer
Care Departments. Our IT department devoted significant resources toward the
implementation of a new operational support system that allows us to more
efficiently and effectively provision and administrate the delivery of our
bundled services. The new operational support system is designed to help us
provide superior customer service and simplified billing choices. We believe
these and other initiatives will have a positive impact in achieving our revenue
goals.
Capital expenditures excluding those for discontinued operations were $141,758,
$493,215 and $1,242,865 for the years ended December 31, 2002, 2001 and 2000,
respectively. The majority of these capital expenditures related to the growth
in new markets prior to the change in expansion plans and the upgrade to our
cable network.
NEW ACCOUNTING STANDARDS
In August 2001, FASB issued SFAS No. 143, "Accounting for Obligations Associated
with the Retirement of Long-Lived Assets"("SFAS No. 143"). 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. Any gain or loss on the extinguishment of debt that was classified as
an extraordinary item will be reclassified upon adoption. Had the Company
adopted SFAS No. 145 in the fiscal year 2002, the extraordinary gains on early
retirement of debt of $13,073 in 2002 and $484,011 in 2001 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 SFAS 146
requires that a liability for costs associated with an exit or disposal activity
be recognized when the liability is incurred
71
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.
In November 2002, the FASB issued Interpretation Number 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). This interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
requirements of FIN 45 are effective prospectively for guarantees issued or
modified after December 31, 2002. The Company is currently assessing, but at
this point does not believe the adoption of the recognition and initial
measurement requirements of FIN 45 will have a material impact on the financial
position, cash flows or results of operations of the Company.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which expands upon and strengthens
existing accounting guidance concerning when a company should include in its
financial statements the assets, liabilities and activities of another entity.
Prior to the issuance of FIN 46, a company generally included another entity in
its consolidated financial statements only if it controlled the entity through
voting interests. FIN 46 now requires a variable interest entity, as defined in
FIN 46, to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entities activities or entitled
to receive a majority of the entities residual returns or both. FIN 46 also
requires disclosures about variable interest entities that the Company is not
required to consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to older entities in the first
fiscal year or interim period beginning after June 15, 2003. The Company is
currently evaluating the impact the adoption of FIN 46 will have on the Company
s financial position, results of operations and cash flows particularly as it
relates to the Company's interest in Starpower and Megacable.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
You should carefully review the information contained in the Annual Report, but
should particularly consider any risk factors that we set forth in this Annual
Report and other reports or documents that we file from time to time with the
SEC. Some of the statements made by us in this Form 10-K discuss future
expectations, contain projections of results of operations or financial
condition or state other forward-looking information. Those statements 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 various factors and
was derived using numerous assumptions. 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 its
advanced 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
regulatory approvals; Meet the requirements contained in our franchise
agreements and debt agreements; Achieve adequate customer penetration of
our services to offset the fixed 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.
These risks should be read in conjunction with those set forth herein under
"Risk Factors" on pages 24 to 30 and with the summary under the caption "Risk
Factors" in the Company's Registration Statement on Form S-3 filed with the
Securities and Exchange
72
Commission on June 2, 2000. Statements in this Form 10-K should be evaluated in
light of these important factors.
Item 7a. 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.
73
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
For the Years Ended December 31,
2002 2001 2000
------------- ------------- -------------
Sales $ 457,351 $ 405,571 $ 285,612
Costs and expenses, excluding non-cash stock-based
compensation, depreciation and amortization:
Direct expenses 175,476 188,777 161,552
Operating and selling, general & administrative 379,299 455,435 468,347
Non-cash stock-based compensation 37,721 62,955 41,237
Depreciation and amortization 279,175 312,815 279,817
Asset impairment and special charges, net 895,043 470,880 --
------------- ------------- -------------
Operating loss (1,309,363) (1,085,291) (665,431)
Investment income 15,349 84,487 141,563
Interest expense (167,644) (196,733) (223,383)
Other income, net 1,322 13,239 1,847
------------- ------------- -------------
Loss from continuing operations before income taxes, equity
in unconsolidated entities and minority interest (1,460,336) (1,184,298) (745,404)
Benefit from income taxes (994) (3,772) (4,848)
------------- ------------- -------------
Loss from continuing operations before equity in
unconsolidated entities and minority interest (1,459,342) (1,180,526) (740,556)
Equity in loss of unconsolidated entities (9,317) (17,185) (58,915)
Minority interest in loss of consolidated entities 36,650 22,331 24,845
------------- ------------- -------------
Net loss from continuing operations (1,432,009) (1,175,380) (774,626)
Income from discontinued operations,
net of tax of $187, $90 and $70 10,747 6,580 5,912
Extraordinary item, net of tax of $0 13,073 484,011 --
------------- ------------- -------------
Net loss (1,408,189) (684,789) (768,714)
Preferred dividend and accretion requirements 162,150 151,663 122,752
------------- ------------- -------------
Net loss to common shareholders $ (1,570,339) $ (836,452) $ (891,466)
============= ============= =============
Basic and diluted loss per average common share:
Net loss from continuing operations $ (15.00) $ (14.10) $ (10.66)
Net income from discontinued operations $ .10 $ .07 $ .07
Extraordinary item $ .12 $ 5.14 $ --
Net loss to common shareholders $ (14 .78) $ (8.89) $ (10.59)
Weighted average shares outstanding 106,211,979 94,117,391 84,200,329
The accompanying notes are an integral part of these Consolidated Financial
Statements.
74
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
December 31,
2002 2001
----------- -----------
ASSETS
Current assets
Cash and temporary cash investments $ 49,365 $ 476,220
Short-term investments 227,641 362,271
Accounts receivable from related parties 10,207 16,698
Accounts receivable, net of reserve for doubtful accounts
of $10,705 and $17,081, respectively 56,915 46,145
Unbilled revenues 770 2,052
Interest and dividends receivable 1,595 4,558
Prepayments and other 17,835 18,828
Restricted short-term investments 34,920 23,676
Current assets of discontinued operations 3,971 5,726
----------- -----------
Total current assets 403,219 956,174
----------- -----------
Property, plant and equipment, net of accumulated depreciation
of $809,000 and $567,681, respectively 1,234,939 2,250,218
Investments in joint ventures and equity securities 228,231 229,294
Intangible assets, net of accumulated amortization of
$64,912 and $64,496, respectively 1,741 3,231
Goodwill 6,130 45,057
Deferred charges and other assets 43,606 49,055
Noncurrent assets of discontinued operations 72,416 70,102
----------- -----------
Total assets $ 1,990,282 $ 3,603,131
=========== ===========
LIABILITIES REDEEMABLE PREFERRED AND SHAREHOLDERS' DEFICIT
Current liabilities
Current maturities of capital lease obligations $ 1,604 $ 1,782
Current maturities of long-term debt 35,813 20,750
Accounts payable 28,016 34,718
Accounts payable to related parties 13,558 20,693
Advance billings and customer deposits 27,940 21,895
Accrued expenses 71,163 106,047
Accrued interest 26,422 17,811
Accrued cost of sales 47,179 57,544
Accrued exit costs 30,667 39,271
Accrued employee compensation and related expenses 32,084 32,747
Deferred income taxes 18 344
Current liabilities of discontinued operations 3,852 3,886
----------- -----------
Total current liabilities 318,316 357,488
----------- -----------
Long-term debt 1,706,997 1,873,616
Other deferred credits 4,166 10,595
Minority interest 791 51,298
Commitments and contingencies
Preferred stock, Series A, convertible, par value $1
per share, 708,000 shares authorized, and 323,934
and 302,217 shares issued and outstanding, respectively 316,342 293,951
Preferred stock, Series B, convertible, par value $1
per share, 2,681,931 shares authorized, and 2,009,355
and 1,874,645 issued and outstanding, respectively 1,988,084 1,848,325
Common shareholders' deficit:
Common stock, par value $1 per share, 500,000,000 shares
authorized, 110,795,577 and 99,841,256 shares issued,
respectively 110,796 99,841
Additional paid-in capital 1,451,744 1,416,529
Accumulated deficit (3,889,385) (2,319,046)
Unearned compensation expense (4,336) (15,898)
Cumulative translation adjustments (5,134) (8,208)
Unrealized appreciation on investments 1,484 2,949
Treasury stock, 682,867 and 513,615 shares at cost,
respectively (9,583) (8,309)
----------- -----------
Total common shareholders' deficit (2,344,414) (832,142)
----------- -----------
Total liabilities, redeemable preferred stock and
common shareholders' deficit $ 1,990,282 $ 3,603,131
=========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
75
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
For the Years Ended December 31,
2002 2001 2000
----------- ----------- -----------
Cash flows from operating activities
Net loss $(1,408,189) $ (684,789) $ (768,714)
Income from discontinued operations (10,747) (6,580) (5,912)
----------- ----------- -----------
Net loss from continuing operations (1,418,936) (691,369) (774,626)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Accretion of discounted debt 69,656 112,500 112,997
Amortization of financing costs 15,295 8,266 8,713
Non-cash stock based compensation expense 37,721 62,955 41,237
Gain on sale of assets 3,089 (12,912) --
Loss on assumption of subsidiary -- (606) --
Extraordinary item (13,073) (484,011) --
Depreciation and amortization 279,175 312,815 279,817
Deferred income taxes, net (807) (338) (782)
Provision for losses on accounts receivable 12,700 14,249 10,834
Equity in loss of unconsolidated entities 9,317 17,185 58,915
Goodwill write-down and special charges 895,043 470,880 --
Minority interest (36,650) (22,331) (24,845)
Write down of cost based investment 2,246 -- --
Net change in certain assets and liabilities,
net of business acquisitions:
Accounts receivable and unbilled revenues (22,439) (4,967) (29,504)
Accounts payable (9,146) (162,720) 78,342
Accrued expenses (42,928) 4,933 109,670
Accounts receivable from related parties 6,491 20,262 (29,350)
Accounts payable to related parties (8,639) (69,107) 53,991
Unearned revenue,advanced billing and customer de (3,209) 2,902 7,761
Other 3,211 4,837 (23,791)
----------- ---------- ----------
Net cash used in continuing operations (221,883) (416,577) (120,621)
Cash provided by discontinued operations 19,069 13,801 11,797
----------- ----------- -----------
Net cash used in operating activities (202,814) (402,776) (108,824)
Cash flows from investing activities:
Additions to property, plant and equipment (111,105) (482,041) (1,092,908)
Additions to construction material (30,653) (11,174) (149,957)
Short-term investments, net 133,165 1,004,568 49,784
Investment and advance to unconsolidated entity -- -- (12,000)
Acquisitions -- -- (316,074)
Investment in unconsolidated joint venture (7,500) (50,500) (64,647)
Purchase of preferred stock -- -- (750)
Proceeds from sale of assets 22,872 54,294 --
Increase in restricted cash (11,244) (23,676) --
Discontinued operations (1,301) (20,424) (37,602)
Other -- 283 225
----------- ----------- -----------
Net cash provided by (used in) investing activities (5,766) 471,330 (1,623,929)
Cash flows from financing activities:
Repayment of long term debt (203,062) (246,366) (3,435)
Repayment of capital leases (2,634) (2,482) (988)
Long-term borrowings -- 250,000 --
Purchase of treasury stock -- -- (200)
Proceeds from the issuance of stock -- 50,000 1,614,423
Payments made for debt financing costs (12,219) -- (2,823)
Contribution from minority interest partner -- -- 61,005
Contribution to minority interest partner (364) -- --
Proceeds from the exercise of stock options 4 137 6,625
Decrease related to investments
restricted for debt service -- -- 23,111
----------- ----------- -----------
Net cash (used in) provided by financing activities (218,275) 51,289 1,697,718
Net increase in cash and temporary cash investments (426,855) 119,843 (35,035)
Cash and temporary cash investments at beginning of year 476,220 356,377 391,412
----------- ----------- -----------
Cash and temporary cash investments at end of year $ 49,365 $ 476,220 $ 356,377
=========== =========== ===========
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of $9,132, $32,765, and $15,092 capitalized
in 2002, 2001 and 2000, respectively) $ 78,102 $ 87,992 $ 87,543
----------- ----------- -----------
Income taxes $ 1,416 $ -- $ 228
=========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements
76
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
Supplemental Schedule of Non-Cash Investing and Financing Activities:
During the years ended December 31, 2002 and 2001, the Company entered into
capital lease obligations of $3,823 and $18,601, respectively.
Preferred stock dividends in the form of additional shares of redeemable
preferred stock aggregated $156,427, $145,941 and $117,867 in 2002, 2001 and
2000, respectively.
Non-cash accretion of preferred stock was $5,723, $5,722 and $4,885 in 2002,
2001 and 2000, respectively.
During 2002, the Company issued 7.5 million shares of the Company's Common
Stock, with a fair value of $11,625, to NSTAR in exchange for NSTAR's 17.83%
investment in RCN-Becocom.
During 2002, the Company issued 2,589,237 shares of the Company's Common Stock,
with a fair value of $7,875 to retire long-term debt with a face value of
$24,037.
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.
Following this exchange, NSTAR Securities profit and loss sharing ratio in the
joint venture was reduced to zero. NSTAR had previously exchanged a portion of
its ownership interest in RCN-Becocom for 2,989,654 shares of the Company's
Common Stock, with a fair value of approximately $127,150 in February 2000.
During 2001, the Company issued 1,988,966 shares of common stock with a total
value of $5,850 to retire long-term debt with a face value of $15,000.
In 2001, the Company assumed assets and liabilities that related to the
foreclosure of its investment in JuniorNet. The Company assumed $606 more in
liabilities than assets.
During the 2002 and 2001, the Company issued 25,862 and 51,014 shares of
treasury stock, respectively. 2002 treasury stock was issued in lieu of vendor
cash payments with a fair value of $76 and 2001 issuances were to the RCN 401(k)
savings plan valued at $1,282 and related to late deposits.
Based on certain future contingencies in the original purchase agreement of 21st
Century, the Company issued additional stock in the amount of $7,229 during the
year ended 2001.
In April 2000, the Company completed the acquisition of 21st Century Telecom
Group, Inc. The transaction was accounted for as a purchase.
A summary of the transaction is as follows:
Fair value of assets acquired $ 556,361
Less:
Fair value of the Company's stock issued 208,510
Fair value of stock options exchanged 2,489
Liabilities assumed 35,755
Cash acquired 15,065
-----------
Net cash paid $ 294,542
===========
77
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY/(DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
Additional
Common Paid Accumulated
Stock in Capital Deficit
---------- ----------- ------------
Balance, December 31, 1999 $ 77,724 $ 923,340 $ (591,128)
Net loss to common shareholders (891,466)
Stock plan transactions 1,141 71,769
Recognition of unearned compensation
Conversion of joint venture ownership interest 2,990 124,159
Common stock and stock options issued
in connection with acquisitions 5,249 205,750
Purchase of treasury stock
Unrealized appreciation on investments
Cumulative translation adjustment
---------- ----------- ------------
Balance, December 31, 2000 $ 87,104 $ 1,325,018 $ (1,482,594)
Net loss to common shareholders (836,452)
Stock plan transactions 2,343 49,730
Common stock offering 7,661 42,339
Stock issued to retire long-term debt 1,989 3,861
Recognition of unearned compensation
Common stock in connection with acquisitions 744 (3,649)
Treasury stock issuance (770)
Unrealized depreciation on investments
Cumulative translation adjustment
---------- ----------- ------------
Balance, December 31, 2001 $ 99,841 $ 1,416,529 $ (2,319,046)
Net loss to common shareholders (1,570,339)
Stock plan transactions 865 34,669
Conversion of joint venture ownership interest 7,500 4,125
Stock issued to retire long-term debt 2,590 5,285
Recognition of unearned compensation
Purchase of treasury stock
Treasury stock issuance (8,864)
Unrealized depreciation on investments
Cumulative translation adjustment
---------- ----------- ------------
Balance, December 31, 2002 $ 110,796 $ 1,451,744 $ (3,889,385)
========== =========== ============
The accompanying notes are an integral part of these Consolidated Financial
Statements
78
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY/(DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
Unrealized
Unearned Cumulative Appreciation/ Total Common
Treasury Compensation Translation Depreciation Shareholders'
Stock Expense Adjustment on Investments Equity(Deficit)
----------- ------------ ------------ -------------- ---------------
Balance, December 31, 1999 $ (9,391) $ -- $ (2,014) $ (6,228) $ 392,303
Net loss to common shareholders (891,466)
Stock plan transactions (37,941) 34,969
Recognition of unearned compensation 12,052 12,052
Conversion of joint venture ownership interest 127,149
Common stock and stock options issued in connection
with acquisitions 210,999
Purchase of treasury stock (200) (200)
Unrealized appreciation on investments 14,353 14,353
Cumulative translation adjustment (4,681) (4,681)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2000 $ (9,591) $ (25,889) $ (6,695) $ 8,125 $ (104,522)
Net loss to common shareholders (836,452)
Stock plan transactions (9,559) 42,514
Common stock offering 50,000
Stock issued to retire long-term debt 5,850
Recognition of unearned compensation 19,550 19,550
Common stock issued in connection
with acquisitions (2,905)
Treasury stock issuance 1,282 512
Unrealized depreciation on investments (5,176) (5,176)
Cumulative translation adjustment (1,513) (1,513)
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2001 $ (8,309) $ (15,898) $ (8,208) $ 2,949 $ (832,142)
----------- ----------- ----------- ----------- -----------
Net loss to common shareholders (1,570,339)
Stock plan transactions (909) 34,625
Conversion of joint venture ownership interest 11,625
Stock issued to retire long-term debt 7,875
Recognition of unearned compensation 12,471 12,471
Cancellation of restricted stock grants (1,831) (1,831)
Treasury stock issuance 557 (8,307)
Unrealized depreciation on investments (1,465) (1,465)
Cumulative translation adjustment 3,074 3,074
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2002 $ (9,583) $ (4,336) $ (5,134) $ 1,484 $(2,344,414)
=========== =========== =========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial
Statements
79
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY/(DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
Common Treasury Shares
Shares Issued Stock Outstanding
------------- ------------ ------------
Balance, December 31, 1999 77,724,070 (562,000) 77,162,070
Stock plan transactions 1,141,405 1,141,405
Conversion of joint venture ownership interest 2,989,654 2,989,654
Common stock issued in connection with
acquisitions 5,249,100 5,249,100
Purchase of treasury stock (2,629) (2,629)
------------ ------------ ------------
Balance, December 31, 2000 87,104,229 (564,629) 86,539,600
Common stock offering 7,661,000 7,661,000
Stock issued to retire long-term debt 1,988,966 1,988,966
Stock plan transactions 2,343,215 2,343,215
Common stock issued in connection with
acquisitions 743,846 743,846
Treasury stock issuance 51,014 51,014
------------ ------------ ------------
Balance, December 31, 2001 99,841,256 (513,615) 99,327,641
Stock issued to retire long-term debt 2,589,237 2,589,237
Stock plan transactions 865,084 865,084
Conversion of joint venture ownership interest 7,500,000 7,500,000
Cancellation of restricted stock grants (195,114) (195,114)
Treasury stock issued 25,862 25,862
------------ ------------ ------------
Balance, December 31, 2002 110,795,577 (682,867) 110,112,710
============ ============ ============
The accompanying notes are an integral part of these Consolidated Financial
Statements
80
RCN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
1. BACKGROUND AND BASIS OF PRESENTATION
The Company's primary business is delivering bundled communications services to
residential customers over the Company's broadband network, predominantly owned
by the Company. We are currently operating in Boston, including 18 surrounding
communities, New York City, the Philadelphia suburbs, Chicago, San Francisco,
and several of its suburbs, along with a few communities in Los Angeles. We also
serve the Lehigh Valley in Pennsylvania and communities in and around Carmel,
New York. We were the incumbent franchised cable operator in many communities in
central New Jersey, until the sale of the central New Jersey assets in February
2003. (See Note 6 regarding discontinued operations.) In addition, we also have
a joint venture with Pepco Communications, Inc., Starpower, serving the
Washington, D.C. metropolitan markets. We believe we are the first company in
many of our markets to offer one-stop shopping for phone, cable television and
high-speed cable modem Internet services to residential customers.
ResiLink(SM) and Essentials(SM) are the brand names of our various bundled
service alternatives that enables residential customers to enjoy various,
pre-packaged bundles which may include phone, cable television and high-speed
Internet for a flat monthly price. The bundles are designed to appeal to
consumers seeking simplification and value. In addition to ResiLink and
Essentials, we sell phone, cable television, 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 also 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 own high-speed, high-capacity,
fiber-optic broadband network. The broadband network is a fiber-optic platform
that typically employs diverse backbone architecture and localized fiber-optic
nodes. This architecture allows us to bring our state-of-the-art fiber-optics
within approximately 900 feet of our customers, with fewer electronics and lower
maintenance costs than existing competitors' local networks. We have generally
designed our broadband network, in certain markets, 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.
The accompanying consolidated financial statements of the Company and its wholly
owned subsidiaries have been prepared in conformity with accounting principles
generally accepted in the United States. The consolidated financial statements
include the accounts of all wholly-owned subsidiaries. All intercompany
transactions and balances have been eliminated. The RCN-Becocom joint venture
which the Company controls is consolidated. The Company had an 82.17% interest
in the RCN-Becocom joint venture until the exchange of NSTAR Communication's
remaining 17.83% investment in the RCN-Becocom joint venture on June 19, 2002.
Thereafter, the Company had a 100% interest in the RCN-Becocom joint venture.
The Starpower joint venture and the investment in Megacable are accounted for
under the equity method.
Financial information in 2001 and 2000 has been revised to report income from
discontinued operations separately.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates -
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
When sources of information regarding the carrying values of assets and
liabilities, and reported amounts of revenue and expenses 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
judgements. The Company evaluates all of its estimates on an on-going basis.
Actual results could differ from those estimates.
Risks and Uncertainties -
Our future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cause actual results to
vary materially from historical results include, but are not limited to,
dependence upon acceptance of broadband technology as the platform of choice,
difficulties that may be encountered in
81
competing in the highly competitive telecommunications industry, dependence on
our strategic relationships and joint ventures, our limitations of our business
flexibility due to our substantial indebtedness, the competitive market from the
incumbent providers which are already established and have historically
dominated their markets, our ability to meet our long term liquidity needs and
our ability to utilize our existing cash resources.
Cash and Temporary Cash Investments -
The Company considers all highly liquid investments with original maturities of
three months or less to be temporary cash investments. The temporary cash
investments are carried at cost, which approximates market value. The Company
maintains cash balances at financial institutions, which at times exceed the
$100,000 FDIC limit.
Short-Term Investments and Investments Restricted for Debt Service -
The Company records its investments in fixed maturities and equity securities
which are classified as available for sale at fair value and reports the change
in the unrealized appreciation and depreciation as a separate component of
shareholders' equity. The amortized cost of fixed maturity investments
classified as available for sale is adjusted for amortization of premiums and
accretion of discounts. That amortization or accretion is included in net
investment income.
Short-term investments consist of commercial paper, U.S. Treasury Notes,
asset-backed securities, corporate debt securities, certificates of deposit and
federal agency notes. The short-term investments are carried at market value.
Property, Plant and Equipment and Depreciation -
Property, plant and equipment is recorded at cost of acquisition or
construction, including all direct and certain indirect costs. These costs
include related payroll, employee benefits, and interest from borrowed funds
used in the development and construction of the network. Expenditures for
repairs and maintenance are charged to expense as incurred, while equipment
replacement and betterments are capitalized. Depreciation is provided on the
straight-line method based on the useful lives of the various classes of
depreciable property. The costs and related depreciation for assets no longer in
service are eliminated from the account. Gain or loss is recognized on
retirements and dispositions. The average estimated lives of depreciable
property, plant and equipment are:
Lives
-----
Telecommunications Network 5-22.5 years
Computer Equipment 3-5 years
Buildings and leasehold improvements 5-30 years
Furniture, fixtures and vehicles 3-10 years
Other 5-10 years
Qualified internally developed software costs for internal use are capitalized
subsequent to both the preliminary project stage and when management has
committed to funding. The external direct costs of software, materials and
services, and payroll and employee related expenses directly associated with the
project are capitalized. Upon completion of the projects, the total costs are
amortized over their estimated useful lives of three years.
Goodwill and Other Intangible Assets -
The Company adopted Statement of Financial Accounting Standards ("SFAS")No. 142,
"Goodwill and Other Intangible Assets" on January 1, 2002. 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 reported goodwill and the
goodwill embedded in the carrying amount of the Company's investment in
Megacable.
SFAS No. 142 requires that goodwill and intangible assets be tested annually for
impairment using a two-step process. The first step is to identify a potential
impairment and, in transition, this step must be measured as of the beginning of
the fiscal year. The second step of the goodwill impairment test measures the
amount of the impairment loss (measured as of the beginning of the year of
adoption), if any, and must be completed by the end of the Company's fiscal
year. The Company's transitional impairment test, measured as of January 1,
2002, did not result in an impairment loss.
82
However, as described in Note 5, an impairment of our goodwill was recorded in
the second quarter of 2002.
Goodwill and other intangible assets are valued at cost. Prior to the adoption
of SFAS No. 142, goodwill was amortized on a straight-line basis over a three to
nine year period and the embedded goodwill in the carrying amount of the
Company's investment in Megacable was amortized on a straight-line basis over a
fifteen-year period. Identifiable intangible assets are amortized on a
straight-line basis over the expected period of the benefit ranging from 1 to 15
years. The average estimated lives of intangible assets are:
Lives
-----
Franchises and subscriber lists 3-15 years
Acquired current products/technologies 4 years
Non-compete agreements 5-8 years
Building access rights 5-14 years
Other intangible assets 1-10 years
Impairment of Long-Lived Assets -
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 provides new 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.
The carrying values of long-lived assets, which include construction materials,
property, plant and equipment, and identifiable intangible assets, are evaluated
for impairment whenever events or changes in circumstances indicate the carrying
amount may not be recoverable. An impairment would be determined based on a
comparison of future undiscounted cash flows to the underlying assets. If
required, adjustments would be measured based on discounted cash flows.
Fair Values of Financial Instruments -
The carrying amounts reported in the balance sheet for cash and temporary cash
investments, short-term investments, and restricted short-term investments are
carried at market value. Long-term investments consist of investments accounted
for under the equity method for which disclosure of fair value is not required.
The carrying amounts reported in the balance sheet for interest receivable,
accounts receivable, and receivables from related parties approximate those
assets fair values. The carrying amounts reported for long-term debt are at face
value. The fair value of the Senior and Senior Discount Notes is estimated based
on the current market price and the term debt is estimated based on the
Company's current incremental borrowing rate for debt of the same remaining
maturities.
Revenue Recognition -
Revenues are recognized and earned when evidence of an arrangement exists,
services are rendered, the selling price is determinable and collectibility is
reasonably assured. The Company recognizes local telephone service revenue as
earned when services are provided. The amount recognized as revenue for local
telephone charges are based on tariffed rates. We recognize long distance
telephone service revenue based upon minutes of traffic processed in accordance
with tariffed rates or contract fees. Other telephone services are recognized as
revenue when the services are provided to the customer in accordance with
contract terms. Reciprocal compensation, which is the fee local exchange
carriers pay to terminate calls on each other's networks, is recognized as
revenue as it is realized. Revenues from cable programming services are
recognized and earned in the month the service is provided to the customers.
Cable installation revenue is recognized in the period the installation services
are provided to the extent of direct selling costs. Any remaining amount is
deferred and recognized over the estimated average period that customers are
expected to remain connected to our network system. Internet access service
revenues are recorded as earned based on contracted fees. Unbilled revenues
represents telephony, cable and data revenues earned but not billed at the end
of the reporting period. Advanced billings represent monthly recurring charges
collected prior to the rendering of services.
Leases -
83
The Company has not entered into any lease transactions, as lessor, which
qualify for sale or direct finance treatment. The Company has agreements with
customers and other telecommunications carriers that grant and convey to the
user the right of access to, and use of, fiber optic cables and equipment. The
terms of these agreements range from five to thirty years. Fees received for the
use and access to cables and equipment are amortized on a straight-line basis
over the life of the agreement.
Leasing transactions that the Company enters as a lessee that bears all
substantial risks and rewards from the use of the leased item are accounted for
as a capital lease. Capitalized leased assets and the corresponding lease
obligations are recorded on the Company's balance sheet. All other lease
agreements are accounted for as an operating lease. Operating lease payments are
expensed as incurred.
Advertising Expense -
Advertising costs are expensed as incurred. Advertising expense charged to
operations was $12,772, $9,011 and $34,819 in 2002, 2001 and 2000, respectively.
Debt Issuance Costs -
Costs associated with the Company's debt and material changes to the original
debt are capitalized. Debt issuance costs are amortized over the life of the
note. Amortization expense related to debt issuance costs charged to operations
were $15,295, $8,266,and $8,713 in 2002, 2001, and 2000, respectively. Included
in the $15,295 amount for 2002, was $5,583 to expense debt issuance costs
associated with $187,500 in repayments on the Company's Credit Agreement, and
$1,219 in debt issuance fees for Amendment No. 4 to the Company's Credit
Agreement. In addition, $292 and $9,656 were expensed in connection with the
extinguishment of debt in 2002 and 2001, respectively.
Stock-Based Compensation -
The Company has followed the recognition provisions of SFAS No. 123 -
"Accounting for Stock-Based Compensation" since January 1, 2000. Under SFAS No.
123, the fair value of an option on the date of the grant, is amortized over the
vesting periods of the options in accordance with Financial Accounting Standards
Board ("FASB") Interpretation No. 28 "Accounting For Stock Appreciation Rights
and Other Variable Stock Option or Award Plans". The recognition provisions of
SFAS No. 123 are applied prospectively to all stock awards granted subsequent to
January 1, 2000 and to prior awards accounted for in accordance with Accounting
Principles Board Opinion ("APB") No. 25- "Accounting for Stock Issued to
Employees" that were significantly modified after adoption.
Pro-forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if the Company had accounted for its stock
options under the fair value method of SFAS 123 for periods prior to January 1,
2000.
For purposes of pro-forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's
pro-forma net loss and loss per share were as follows:
2002* 2001 2000
----------- ----------- -----------
Net loss - as reported $(1,570,339) $ (836,452) $ (891,466)
Add: Stock-based employee compensation expense
included in reported net loss, net of related
tax effects 37,721 62,955 41,237
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (37,721) (88,415) (71,961)
Net loss - pro-forma $(1,570,339) $ (861,912) $ (922,190)
Basic and diluted loss per share - as reported $ (14.78) $ (8.89) $ (10.59)
Basic and diluted loss per share - pro-forma $ (14.78) $ (9.16) $ (10.96)
* As a result of the completion of the Company's Option Exchange Program in the
quarter ended December 31, 2001, all of the Company's options are from that date
forward now accounted for under the recognition provisions of SFAS 123.
84
Income Taxes -
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates in effect for the year in which
those temporary differences are expected to be recovered or settled. The
measurement of net deferred tax assets is reduced by the amount of any tax
benefit that, based on available evidence, are not expected to be realized, and
a corresponding valuation allowance is established.
Foreign Currency Translation -
At December 31, 2002 the Company has a 48.96% interest in Megacable. Megacable's
functional currency is the Mexican Peso. For purposes of determining the
Company's equity in the earnings of Megacable, the Company translates the
revenues and expenses of Megacable into U.S. dollars at the average exchange
rates during the period reported. The assets and liabilities are translated into
U.S. dollars at the exchange rate as of the balance sheet date. The foreign
currency translation gains or losses are recorded on the balance sheet as a
separate component of shareholders' equity.
Comprehensive Income -
The Company primarily has two components of comprehensive income, cumulative
translation adjustments and unrealized appreciation (depreciation) on
investments. The cumulative foreign currency translation adjustment was $3,074,
for 2002, $(1,513) for 2001, and ($4,681) for 2000; the unrealized appreciation
(depreciation) on investments was $(1,465) for 2002, $(5,176) for 2001, and
$14,353 for 2000. The amount of other comprehensive loss for the years ended
December 31, 2002, 2001, and 2000 was ($1,406,580), ($691,477), and ($759,042),
respectively.
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. The Company does not allocate shared expenses incurred on a
single network to our multiple revenue streams as any such allocation would be
costly, impractical and arbitrary. The Company's chief decision-makers do,
however, monitor operating results in a way different from that depicted in the
historical general purpose financial statements. These measurements include the
consolidation of Starpower, which is not consolidated under generally accepted
accounting principles. Such information, however, does not meet the criteria for
segment reporting under generally accepted accounting principles and therefore
it is not separately disclosed.
New Accounting Standards -
In August 2001, FASB issued SFAS No. 143, "Accounting for Obligations Associated
with the Retirement of Long-Lived Assets"("SFAS No. 143"). 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. Any gain or loss on the extinguishment of debt that was classified as
an extraordinary item will be reclassified upon adoption. Had the Company
adopted SFAS No. 145 in the fiscal year 2002, the extraordinary gains on early
retirement of debt of $13,073 in 2002 and $484,011 in 2001 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
85
associated with exit or disposal activities. 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. It
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.
In November 2002, the FASB issued Interpretation Number 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). This interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
requirements of FIN 45 are effective prospectively for guarantees issued or
modified after December 31, 2002. The Company is currently assessing, but at
this point does not believe the adoption of the recognition and initial
measurement requirements of FIN 45 will have a material impact on the financial
position, cash flows or results of operations of the Company.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which expands upon and strengthens
existing accounting guidance concerning when a company should include in its
financial statements the assets, liabilities and activities of another entity.
Prior to the issuance of FIN 46, a company generally included another entity in
its consolidated financial statements only if it controlled the entity through
voting interests. FIN 46 now requires a variable interest entity, as defined in
FIN 46, to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entities activities or entitled
to receive a majority of the entities residual returns or both. FIN 46 also
requires disclosures about variable interest entities that the Company is not
required to consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to older entities in the first
fiscal year or interim period beginning after June 15, 2003. The Company is
currently evaluating the impact the adoption of FIN 46 will have on the Company
s financial position, results of operations and cash flows particularly as it
relates to the Company's interest in Starpower and Megacable.
3. LOSS 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 years ended December 31,
2002, 2001, and 2000 and have a dilutive effect if the Company had income from
continuing operations is 48,454,397, 43,099,484 and 38,269,575, respectively.
The following table is a reconciliation of the numerators and denominators of
the basic and diluted per share computations:
Years Ended December 31,
2002 2001 2000
------------- ------------- -------------
Loss from continuing operations $ (1,432,009) $ (1,175,380) $ (774,626)
Net income from discontinued operations 10,747 6,580 5,912
------------- ------------- -------------
Loss before extraordinary item (1,421,261) (1,168,800) (768,714)
Extraordinary item 13,073 484,011 --
Preferred stock dividend and accretion
requirements (162,150) (151,663) (122,752)
------------- ------------- -------------
Net loss to common shareholder $ (1,570,339) $ (836,452) $ (891,466)
============= ============= =============
Basic loss per average common share:
Weighted average shares outstanding 106,211,979 94,117,391 84,200,329
Loss per average common share from
continuing operations $ (15.00) $ (14.10) $ (10.66)
86
Earnings per average common share
from discontinued operations $ .10 $ .07 $ .07
------------- ------------- -------------
Loss before extraordinary item $ (14.90) $ (14.03) $ (10.59)
Extraordinary Item $ .12 $ 5.14 $ --
------------- ------------- -------------
Net loss to common shareholders $ (14.78) $ (8.89) $ (10.59)
Diluted loss per average common share:
Weighted average shares outstanding 106,211,979 94,117,391 84,200,329
4. BUSINESS COMBINATIONS
The company entered into the following business combinations and were all
accounted for by the purchase method of accounting.
During 2000, the Company acquired certain assets of two companies in Chicago, IL
for approximately $21,550 in cash. The excess of the book value of assets
acquired was recorded as goodwill and was being amortized over approximately
four years.
In April 2000, the Company acquired 21st Century Telecom Group, Inc. in Chicago,
IL for approximately $294,500 in cash and shares of common stock with a fair
value at the time of issuance of approximately $211,000. Additionally, the
purchase price includes approximately $2,500 representing the fair value of
stock options, which were converted to the Company's stock options in connection
with the acquisition. Goodwill of approximately $303,599 was recorded in
connection with this acquisition. Based on certain future contingencies in the
original agreement, the Company issued additional stock in the amount of $7,229
during the year ended December 31, 2001. This amount contributed to the
recognition of additional goodwill.
In 2001, the Company completed an assessment of the recoverability of its
investment in each market based on the expected future net cash flows. This
assessment indicated that certain assets from the Chicago acquisitions were
impaired. The company impaired the balance of goodwill, which was approximately
$222,166 (see Note 5).
5. ASSET IMPAIRMENT AND SPECIAL CHARGES
The total asset impairment and special charges are comprised of the following:
Twelve Months Ended December 31,
2002 2001
-------- --------
Impairment of property plant, and equipment $735,556 $114,018
Abandoned assets 52,071 --
Construction materials 61,322 69,839
Goodwill 38,927 255,791
Franchises 1,379 279
-------- --------
Total asset impairment 889,255 439,927
Exit costs for excess facilities 5,788 30,953
-------- --------
Total asset impairment and special charges $895,043 $470,880
======== ========
2001 Asset Impairment and Special Charges
In 2001, the Company modified its growth trajectory based on the anticipated
lack of available capital and revised its strategic and fundamental plans to
undertake certain initiatives to effect operational efficiencies and reduce
costs. The Company shifted focus from beginning construction in new markets to
completing additional construction activities in its existing markets.
Specifically, expansion to new markets was curtailed and expansion plans for
existing markets over the subsequent 24 to 36 months were curtailed or delayed.
To determine the impairment of tangible and intangible assets, including
goodwill, the Company assessed the recoverability of its investment in each
market based on expected undiscounted future net cash flows in the second
quarter of 2001. This assessment indicated that certain assets acquired in
business combinations, primarily with respect to the Chicago acquisitions and
certain Internet operations, were impaired. Accordingly, based on discounted
future net cash flows, the Company wrote-down $255,791 of goodwill, $279 of
franchise licenses and $114,018 of property, plant and equipment.
87
Construction material levels were assessed based on the build-out requirements
of our revised plan. The assessment process resulted in the identification of
excess construction material that could not be used for alternative use and
which is either to be returned to vendors, or resold to a secondary market. A
charge in the amount of $69,839 was recognized to write-down excess construction
materials to their net realizable value.
Costs to exit excess facilities in the amount of $30,953 was determined by
performing a detailed review of facility requirements against lease obligations
in an effort to identify excess space. The Company is in the process of
consolidating space and exiting or subleasing excess facilities. Exit costs were
determined based on existing contractual terms reduced by estimates of sublease
income at prevailing market rates.
Franchise exit costs in the amount of $15,710 were accrued primarily
representing costs related to the Company's decision to stop or delay
construction in certain markets all of which are included in Operating, selling,
general & administrative expenses.
Finally, costs related to workforce reductions of approximately $7,700 have been
paid.
2002 Asset Impairment and Special Charges
As a response to the severe slowdown in the telecommunications industry, the
economy, and continued limited available capital in the telecommunications
industry; the Company revised its growth plan again during the second quarter
2002 following the completion of the Amendment to the Company's Credit Agreement
with JPMorgan Chase dated March 25, 2002. Under the revised plan, the Company
has substantially curtailed future capital spending and network geographic
expansion in all existing markets, has focused on the continuation of customer
acquisition growth, and has reduced operating expenses. 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 asset impairment charges
during 2002 of approximately $889,255. In addition, the Company recognized
approximately $5,788 of special charges, net of recoveries, for exiting excess
real estate facilities as a result of the curtailing of construction and
expansion, and the consolidation of certain operating activities.
In accordance with SFAS 144, the 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 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 $735,556. The impairment
loss affected all of the Company's overbuild reporting units and none of the
Company's incumbent reporting units.
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. As a result,
certain subscriber related assets 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 $52,071. Following the assessment of the asset
impairment, the Company reviewed the useful life estimates of its long-lived
assets and prospectively shortened the useful life of our subscriber related
equipment from 10 years to 5 years in the fourth quarter of 2002. This had an
incremental impact on quarterly depreciation expense in the amount of
approximately $2,000.
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 construction materials determined to be in excess was $61,322.
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
88
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 $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.
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 expensed 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 less recoveries associated to exit certain
franchises for the twelve months ended December 31, 2002 were $1,544 and were
included in the Operating, selling, general & administrative expense line and
$1,659 of accrued franchise exit costs were paid during 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. The estimated costs less recoveries, to exit excess real estate
facilities for the year ended December 31, 2002 were $5,788.
Costs related to workforce reductions of $3,696 were incurred in 2002.
The total activity for the years ended December 31, 2002 and 2001 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 or franchise issues are resolved for lower expense than
anticipated.
Franchise Exit Total
Costs and Facility Accrued
Penalties Exit Costs Exit Costs
-------------- ---------- ----------
Balance at December 31, 2000 $ -- $ -- $ --
Accrued costs 15,710 30,953 46,663
Recoveries -- -- --
Payments -- (7,392) (7,392)
----------- --------- ---------
Balance at December 31, 2001 15,710 23,561 39,271
Additional accrued costs 8,362 21,355 29,717
Recoveries (6,818) (15,567) (22,204)
Payments (1,659) (14,277) (16,117)
----------- --------- ---------
Balance at December 31, 2002 $ 15,595 $ 15,072 $ 30,667
=========== ========= =========
6. DISCONTINUED OPERATIONS
During the third quarter 2002, the Company entered into a definitive agreement
to sell its central New Jersey cable system assets and customers serviced by
this network for an a net cash proceeds approximately $239,500 after transaction
fees and amounts paid to acquire minority interests. In addition, the Company
will be reimbursed for certain post-signing expenditures related to ongoing
upgrades to the central New Jersey network being performed by the Company. The
central New Jersey network services approximately 80,000 customers. The
transaction, which was completed on February 19, 2003, was structured as an
asset purchase, with the buyer assuming certain liabilities related to the
business. . In accordance with SFAS No. 144, the results of operations for
central New Jersey are reported as discontinued operations and depreciation and
amortization were no longer recognized on assets to be sold after August 27,
2002.
The following are the summarized results of the central New Jersey operations:
For the twelve months ended
December 31,
89
2002 2001 2000
------- ------- -------
(in thousands)
Sales $54,178 $50,400 $47,838
Direct expenses $18,817 $16,355 $15,121
Operating and selling, general and
administrative, and depreciation
and amortization expense $23,507 $26,952 $26,130
Income before tax $10,934 $ 6,670 $ 5,982
Income after tax $10,747 $ 6,580 $ 5,912
The current and noncurrent assets and liabilities of the central New Jersey
operation to be sold are as follows:
As of December 31,
2002 2001
------- -------
(in thousands)
Current assets:
Accounts receivable from related parties $ 154 $ 67
Accounts receivable, net of reserve $ 3,817 $ 5,659
------- -------
Current assets of discontinued operations $ 3,971 $ 5,726
======= =======
Noncurrent assets:
Property, plant and equipment, net $72,304 $69,980
Intangible assets, net 22 32
Goodwill 90 90
------- -------
Noncurrent assets of discontinued operations $72,416 $70,102
======= =======
Current liabilities:
Advanced billings and customer deposits $ 3,852 $ 3,886
------- -------
Current liabilities of discontinued operations $ 3,852 $ 3,886
======= =======
7. ASSET SALES
In 2002, the Company sold one of its real properties in Pennsylvania to
Commonwealth Telephone Company, a related party through common ownership.
Proceeds from the sale were $1,974, and a gain of $719 was recorded.
In 2002, the Company completed the sale of a portion of our business customer
base that was not served by our broadband network. The sale was based on certain
contingencies outlined in the sales agreement. After such contingencies, cash
proceeds of the sale were $2,169. The Company realized a gain of $1,147 on the
transaction.
During 2001, the Company completed the sale of one of its New Jersey real
properties for approximately $40,000 resulting in a gain of approximately
$9,500. Pursuant to the sale of the land, the Company entered into a 99-year
ground lease on the property giving the Company the right to develop office
space. Subsequent to the Company entering into the ground lease, the Company
sold the development rights for approximately $14,000, resulting in a gain of
approximately $3,500.
The gains are included in the other income/expense line item.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated carrying fair value of the Company's financial instruments at
December 31, 2002 and 2001 are as follows:
90
2002 2001
------------------------ ------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- ---------- ---------- ----------
Financial Assets:
Cash and temporary cash
investments $ 49,365 $ 49,365 $ 476,220 $ 476,220
Short-term investments $ 227,641 $ 227,641 $ 362,271 $ 362,271
Restricted short-term investments $ 34,920 $ 34,920 $ 23,676 $ 23,676
Financial Liabilities:
Fixed rate long-term debt:
Senior Notes 10.125% $ 231,735 $ 47,506 $ 231,735 $ 88,060
Senior Notes 10% $ 161,116 $ 34,640 $ 161,116 $ 61,224
Senior Discount Notes 11.125% $ 320,497 $ 68,907 $ 316,351 $ 91,742
Senior Discount Notes 9.8% $ 322,481 $ 58,047 $ 293,074 $ 84,991
Senior Discount Notes 11.0% $ 137,459 $ 28,179 $ 123,499 $ 35,815
Floating rate long-term debt:
Term Loan B (Note 14) $ 373,500 $ 214,128 $ 500,000 $ 350,000
Term Loan A (Note 14) $ 173,438 $ 99,432 $ 250,000 $ 175,000
Unrecognized financial instruments:
Letters of credit $ 40,005 $ 40,005 $ 38,676 $ 38,676
9. SHORT-TERM INVESTMENTS
Short-term investments, stated at market, include the following at December 31,
2002 and 2001:
2002 2001
-------- --------
Federal Agency notes $ -- $ 74,895
Commercial Paper -- 844
Corporate debt securities 40,151 106,326
Certificates of deposit -- 9,000
U.S. Treasury notes 2,104 65,394
Asset backed securities 60,341 105,812
Government Agencies 91,285 --
Municipal/Provincial Bonds 33,760 --
-------- --------
Total $227,641 $362,271
======== ========
At December 31, 2002, short-term investments with a market value of $149,446
have contractual maturities of one to five years. All remaining short-term
investments have contractual maturities less than one year.
10. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at December 31,
2002 2001
----------- -----------
Telecommunications plant $ 1,447,542 $ 1,760,609
Computer equipment 199,867 203,378
Buildings, leasehold improvements and land 154,327 202,892
Furniture, fixtures and vehicles 118,414 145,367
Construction materials 35,301 123,581
Construction in process 87,123 378,740
Other 1,365 3,332
----------- -----------
Total property, plant and equipment 2,043,939 2,817,899
Less accumulated depreciation (809,000) (567,681)
----------- -----------
Property, plant and equipment, net $ 1,234,939 $ 2,250,218
=========== ===========
Depreciation expense was $278,698, 241,334 and 165,311 for the years ended
December 31, 2002, 2001, and 2000, respectively.
11. INVESTMENTS AND JOINT VENTURES
Investments at December 31,2002 and 2001 are as follows:
2002 2001
-------- --------
Starpower Communications, LLC $111,692 $144,047
Megacable 116,539 82,975
Other -- 2,272
-------- --------
Total Investments $228,231 $229,294
======== ========
91
At December 31, 2002 and 2001, the Company has a 50% interest in Starpower, and
a 48.96% interest in Megacable. The Company accounts for these investments on
the equity method.
a. RCN-BECOCOM
RCN is party to the RCN-Becocom joint venture with NSTAR Communications, Inc.
("NSTAR") regarding construction of our broadband network and operation of our
telecommunications business in the Boston metropolitan area. Pursuant to the
joint venture agreements, both parties have agreed to make capital contributions
in accordance with their respective membership interests. Pursuant to an
exchange agreement between NSTAR and RCN, NSTAR has the right 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. Through December 31,
2001, NSTAR had exchanged portions of its interest for a total of 4,097,193
shares of RCN Common Stock. In June 2002, NSTAR received 7.5 million shares of
the Company's Common Stock with a market value of $11,625, in exchange for
NSTAR's remaining 17.83% sharing ratio, which had a carrying value of
approximately $13,781. This exchange gave NSTAR a total of 11,597,193 of the
Company's common stock or 10.6% as of December 31, 2002. Following this
exchange, NSTAR's profit and loss sharing ratio in the joint venture was reduced
to zero and it retained its investment percentage and the right to invest in
future capital calls as if it owned a 29.76% interest. Such investment
percentage will decrease to the extent NSTAR disposes of any such RCN Common
Stock. 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,
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 are not convertible into the Company's Common Stock. NSTAR 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 Preferred Equity interest of
the Joint Venture.
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.
b. Starpower
The Company is party to a joint venture with Pepco Communications, Inc.
("Pepco"), a subsidiary of Pepco Holdings, Inc., 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,
under the brand name "Starpower." Both the Company and Pepco each own a 50%
membership interest in Starpower. The Company provides certain services to the
joint venture pursuant to support services and Internet services agreements.
Pursuant to the joint venture agreements, both parties have agreed to make
capital contributions in accordance with their respective membership interests.
In addition, Starpower has access to and use of Potomac's large broadband
network, rights-of-way and construction expertise. Starpower's losses are
reflected in our financial statements under the equity method of accounting and
are reported on the line item Equity in loss of unconsolidated entities.
The Company recorded its proportionate share of losses in Starpower of $7,581,
$25,602, and $20,208 in 2002, 2001 and 2000, respectively.
Summary financial information for Starpower for the years ended December 31,
2002, 2001 and 2000 is presented in the following table. The amounts shown
represent Starpower's operating results and financial position based on
generally accepted accounting principles:
As of December 31,
2002 2001
-------- --------
Current assets $ 24,900 $ 30,800
Non-current assets 314,700 323,700
Current liabilities 50,000 65,600
Non-current liabilities 1,700 800
Members' equity 287,900 288,100
92
For the years ended December 31,
2002 2001 2000
-------- -------- --------
Sales $ 85,200 $ 82,200 $ 73,500
Gross profit 64,500 54,500 51,300
Net loss (15,200) (51,200) (40,400)
In accordance with APB No. 18 "The Equity Method of Accounting for Investments
in Common Stock", the Company considered their ability to recover the carrying
amount of their investment in Starpower and determined that the loss in the
value of the investment was other than temporary due to weaker than projected
performance and decreased valuations in the overall telecommunication industry.
As a result, the Company recorded an impairment in their investment in Starpower
in the amount of $32,274 in the second quarter of 2002. The amount of the
impairment was calculated based upon the Company's comparison of the estimated
fair value of their investment in Starpower with the carrying amount of the
investment. The impairment on the Starpower investment is reflected in the line
item, equity in the loss of unconsolidated entities.
c. Megacable
The Company has an investment in Megacable, S.A. de C.V. and Megacable
Comunicaciones de Mexico S.A. ("Megacable"), a cable television provider in
Mexico. At December 31, 2002, the basis of the Company's investment in Megacable
exceeded its underlying equity in the net assets of Megacable by $59,268. In
conjunction with the adoption of SFAS No. 142, the Company no longer records
amortization relating to the goodwill embedded in their investment in Megacable
but assesses whether such embedded goodwill is impaired on an annual basis. The
embedded goodwill in Megacable was not deemed impaired in 2002. The Company
recorded its proportionate share of gains and amortization of excess cost over
net assets (for 2001 and 2000) of $30,490, $1,282, and $1,695 in 2002, 2001 and
2000, respectively.
d. JuniorNet
In 2000, the Company wrote down $24,418 which represented the Company's 47.5%
ownership investment in JuniorNet. During 2001, the Company made secured loans
to JuniorNet. Subsequently, in 2001, the assets of JuniorNet were foreclosed
upon by the secured creditor group, including RCN. The secured creditor group
sold the assets to J2 Interactive, LLC ("J2") in Charlestown, MA for cash
proceeds that basically covered the transaction cost and 30.6% of J2's initial
equity. The Company owns 23.5% of the equity in J2. Additionally, in the
foreclosure of JuniorNet's assets by the secured creditor group, RCN received
100% of the assets of the former JuniorNet's wholly-owned subsidiary, Lancit.
Those assets were used to start RCN's wholly-owned subsidiary, RCN
Entertainment. The liabilities assumed by RCN Entertainment related to the
JuniorNet foreclosure, which exceeded the assets, resulted in an expense of
$606, which is in the 2001 other income/(expense) line item. RCN Entertainment
produces children's/family programming.
The Company recorded its proportionate share of income in JuniorNet and J2 of
$48 and $7,134 in 2002 and 2001, respectively, and its proportionate share of
losses in JuniorNet of $15,985 in 2000.
e. Intertainer
Included in the assets of 21st Century Telecom Group, Inc., acquired by the
Company was a 1.4% interest in Intertainer, Inc. ("Intertainer"). Intertainer
provides interactive programming services.
In 2002, the Company wrote-off its investment in Intertainer in the amount of
$2,246. The investment had been accounted for under the cost method and the
write-off was due to financial difficulties experienced by Intertainer.
12. GOODWILL AND INTANGIBLE ASSETS
The Company has $6,130 of goodwill and $1,741 of unamortized identifiable
intangible assets at December 31, 2002. On January 1, 2002, the Company adopted
the provisions of SFAS No. 142. Accordingly, the Company no longer records
amortization relating to its existing goodwill and embedded goodwill. The
Company has identified and established nine reporting units corresponding to the
geographical markets in which the Company operates.
The changes in the carrying amount of goodwill for the twelve months ended
December 31, 2002, are as follows:
Goodwill
--------
93
Balance as of January 1, 2002 $ 45,147
Goodwill of discontinued operations (see Note 6) (90)
--------
Adjusted balance as of January 1, 2002 $ 45,057
Impairment losses (see Note 5) (38,927)
--------
Balance as of December 31, 2002 $ 6,130
========
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:
Twelve Months Ended
December 31,
-----------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Reported net loss available to common
Stockholders before extraordinary items $ (1,583,412) $ (1,320,463) $ (891,466)
Add back:
Goodwill amortization, net of tax -- 56,322 92,346
Amortization of goodwill embedded in
the carrying value of the investment
in Mega Cable -- 7,332 7,332
------------- ------------- -------------
Adjusted net available to common
Stockholders before extraordinary items $ (1,583,412) $ (1,256,809) $ (791,788)
============= ============= =============
Reported net loss available to
common stockholders $ (1,570,339) $ (836,452) $ (891,466)
Add back:
Goodwill amortization, net of tax -- 56,322 92,346
Amortization of goodwill embedded in
the carrying value of the investment
in Mega Cable -- 7,332 7,332
------------- ------------- -------------
Adjusted net loss to common shareholders $ (1,570,339) $ (772,798) $ (791,788)
============= ============= =============
Basic and diluted loss per common share:
Reported net loss available to common
Stockholders before extraordinary items $ (14.90) (14.03) (10.59)
Reported extraordinary item .12 5.14 --
Reported net loss per common share (14.78) (8.89) (10.59)
Adjusted net available to common
Stockholders before extraordinary items $ (14.90) (13.35) (9.40)
Adjusted net loss per common share (14.78) (8.21) (9.40)
The following are identifiable intangible assets that have finite lives and are
subject to amortization:
For the years ended December 31,
2002 2001
-------- --------
Franchise and subscriber lists $ 66,088 $ 66,333
Non-compete agreements 100 100
Building access rights 98 98
Other intangible assets 367 1,196
-------- --------
Total intangible assets 66,653 67,727
Less accumulated amortization (64,912) (64,496)
-------- --------
Intangible assets, net $ 1,741 $ 3,231
======== ========
The total amortization expense for twelve months ended December 31, 2002, 2001
and 2000 was $477, $71,481 and $114,506, respectively. The estimated aggregate
amortization expense for the next five succeeding fiscal years is:
For the year ended December 31, 2003 $ 253
For the year ended December 31, 2004 $ 235
For the year ended December 31, 2005 $ 252
For the year ended December 31, 2006 $ 267
94
For the year ended December 31, 2007 $ 260
The Company had no identifiable intangible assets with indefinite lives that are
not subject to amortization at December 31, 2002 and 2001.
13. DEFERRED CHARGES AND OTHER ASSETS
Deferred charges and other assets consist of the following at December 31,
2002 2001
---------- ----------
Debt issuance costs, net $ 34,775 $ 37,990
Security deposits 2,421 2,244
Other 6,410 8,821
---------- ----------
Total $ 43,606 $ 49,055
========== ==========
14. DEBT
Long-term debt outstanding at December 31, 2002 and 2001 is as follows:
2002 2001
---------- ----------
Term Loans $ 546,938 $ 750,000
Senior Notes 10% due 2007 161,116 161,116
Senior Discount Notes 11.125% due 2007 320,497 316,351
Senior Discount Notes 9.8% due 2008 322,481 293,074
Senior Discount Notes 11% due 2008 137,459 123,499
Senior Notes 10.125% due 2010 231,735 231,735
Capital Leases 24,188 20,373
---------- ----------
Total 1,744,414 1,896,148
Due within one year 37,417 22,532
---------- ----------
Total Long-Term Debt $1,706,997 $1,873,616
========== ==========
Term Loans
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 are 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").
On March 25, 2002, the Company entered into an Amendment to the Credit Agreement
(the "Fourth Amendment"). The Fourth Amendment amends certain financial
covenants and certain other negative covenants and amends certain other terms of
the Credit Agreement, including increases to the margins and commitment fee
payable thereunder. In connection with the Fourth Amendment, the Company paid
certain lenders a fee of $12,900, repaid $187,500 of outstanding term loans
under the Credit Facility and permanently reduced the amount available under the
revolving loan from $250,000 to $187,500. The Company also agreed that it may
not draw down additional amounts under the revolving loan until the later of
March 31, 2004 or the date on which the Company delivers to the lenders a
certificate with calculations demonstrating that the Company's EBITDA, as
defined, was at least $60,000 in the aggregate for the two most recent
consecutive fiscal quarters. In connection with the Fourth 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
Fourth Amendment.
As adjusted by the Fourth 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 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 ("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
accrued including a 350 basis points fee on up to $15,000 available for Letters
of credits. 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. As
95
adjusted by the Fifth Amendment, on July 1, 2004, if the aggregate amount of
outstanding Loans exceeds $415,875 (i.e., $75,000 less than the currently
scheduled amount), the Applicable Spread with respect to all Loans shall be
increased by 1.00%; provided, that such increase shall be eliminated if the
aggregate amount of outstanding Loans is equal to or less than $390,937 on or
before December 31, 2004.
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.
At December 31, 2002 the Company was in compliance with the covenants and there
were no outstanding loans under the Revolver. In addition to being used to fund
working capital needs, general corporate purposes and to finance
telecommunications assets, the Revolver can also be utilized for letters of
credit. As of December 31, 2002 there were $15,000 in letters of credit
outstanding under the Revolver, none of which were drawn down against.
In accordance with the 2002 Amendment, the Company prepaid $62,500 of the Term
Loan A on March 25, 2002. At December 31, 2002, $173,438 of the Term Loan A was
outstanding. Amortization of the Term Loan A commenced in September 2002 and
will be repaid in quarterly installments based on percentage increments of the
Term Loan A that start at 3.75% per quarter in September 2002 and increase in
steps to a maximum of 10% per quarter in September 2005 through to maturity in
June 2006.
In accordance with the 2002 Amendment, the Company prepaid $125,000 of the Term
Loan B on March 25, 2002. At December 31, 2002, $373,500 of the Term Loan B was
outstanding. Amortization of the Term Loan B commenced in September 2002 with
quarterly installments of $750 per quarter until September 2006 when the
quarterly installments increase to $90,750 per quarter through to maturity in
June 2007.
The Company has entered into an amendment to the Credit Agreement dated March 7,
2003 (the "Fifth Amendment"). The Fifth Amendment enables the Company to incur
up to $500,000 of additional senior secured debt, adjusts the operating and
financial covenants to better reflect the Company's business plan and modifies
other restrictions. The Fifth Amendment also reduces the amount available under
the revolving loan facility, under which there are currently no borrowings
outstanding, to $15,000, and requires the Company to maintain a cash collateral
account of at least $100,000 for the benefit of the lenders under its credit
facility. The Fifth Amendment also calls for half of the first $100,000 in
proceeds from future asset sales, and 80% of proceeds from assets sales in
excess of $100,000, to be used to pay down the Company's senior secured term
loans. Additionally, the Company will increase amortization payments under its
term loans by an amount equal to 50% of interest savings from new repurchases of
senior notes, not to exceed $25,000. The Fifth Amendment also enables the
Company to incur up to $500,000 of new senior indebtedness that may be secured
by a second subordinated lien on RCN's assets. Up to $125,000 of existing cash
and the proceeds of new indebtedness may be used to repurchase outstanding
senior notes. As a result of the Fifth Amendment, the Company will not be able
to borrow money that may otherwise have previously been available to it under
the Revolver.
Notes
The 10% Senior Notes were issued under an indenture dated October 17, 1997 and
are general senior obligations of the Company which mature on October 15, 2007.
Interest on the 10% Senior Notes is payable in cash semi-annually in arrears on
each April 15 and October 15.
The 10% Senior Notes are redeemable, in whole or in part, at the option of the
Company. The 10% Senior Notes have redemption prices starting at 105% of the
principal amount and declining to 100% of the principal amount, plus any accrued
interest.
The 11.125% Senior Discount Notes were issued under an indenture dated October
17, 1997 and are general senior obligations of the Company, limited to $601,045
aggregate principal amount at maturity and will mature on October 15, 2007. The
11.125% Senior Discount Notes did not bear cash interest prior to October 15,
2002.
The 11.125% Senior Discount Notes are redeemable, in whole or in part, at the
option of the Company and have redemption prices starting at 105.562% of the
principal amount at
96
maturity and declining to 100% of the principal amount at maturity, plus any
accrued interest.
The 9.8% Senior Discount Notes are general senior obligations of the Company,
limited to $567,000 aggregate principal amount at maturity on February 15, 2008.
The 9.8% Senior Discount Notes will not bear cash interest prior to February 15,
2003.
The 9.8% Senior Discount Notes are redeemable, in whole or in part, at any time
on or after February 15, 2003 at the option of the Company and have redemption
prices starting at 104.9% of the principal amount at maturity and declining to
100% of the principal amount at maturity, plus any accrued interest.
The 11% Senior Discount Notes are general senior obligations of the Company,
limited to $256,755 aggregate principal amount at maturity on July 1, 2008. The
11% Senior Discount Notes will not bear cash interest prior to January 1, 2003.
The 11% Senior Discount Notes are redeemable, in whole or in part, at any time
on or after July 1, 2003 and have redemption prices starting at 105.5% of the
principal amount at maturity and declining to 100% of the principal amount at
maturity, plus any accrued interest.
The 10.125% Senior Notes are general senior obligations of the Company which
mature in January 2009. Interest on the 10.125% Senior Notes is payable in cash
semi-annually in arrears on each July 15 and January 15.
The 10.125% Senior Notes are redeemable, in whole or in part, at any time on or
after January 15, 2005 at the option of the Company and have redemption prices
starting at 105% of the principal amount and declining to 100% of the principal
amount, plus any accrued interest.
All of the Notes discussed above contain certain covenants that, among other
things, limit the ability of the Company and its subsidiaries to incur
indebtedness, prepay subordinated indebtedness, repurchase capital stock, engage
in transactions with stockholders and affiliates, create liens, sell assets and
engage in mergers and consolidations. The Notes contain cross default provisions
entitling holders to declare the Notes and any accrued and unpaid interest
thereon immediately due and payable. At December 31, 2002 the Company was
restricted from making any dividend payments under the terms of the Notes.
Contractual maturities of long-term debt over the next 5 years are as follows:
Year Ending December 31, Aggregate Amounts
2003 $ 37,417
2004 $ 47,444
2005 $ 66,187
2006 $ 223,022
2007 $ 664,321
In July 1999, the Company entered into $250,000 of two-year interest rate
protection agreements with various counter-parties. These agreements convert
$250,000 of the Company's floating rate debt under the Chase Facility to a fixed
rate of approximately 6.08%. For the years ended December 31, 2001 and 2000, the
Company's reported interest expense was approximately $1,364 higher in 2001 and
($1,032) lower in 2000 due to these agreements. There was no affect on interest
expense in 2002 as the interest rate agreement expired in 2001.
15. EXTRAORDINARY ITEMS
During the quarter ended March 31, 2002, the Company completed two debt
repurchases for certain of its 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 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.
During 2001, the Company completed several debt tender offers to purchase
certain of its Senior and Senior Discount Notes. The Company retired
approximately $816,000 in face amount of debt with a book value of $740,940. The
Company recognized an extraordinary gain of approximately $484,011 from the
early retirement of debt in which approximately $226,995 in cash was paid and
1,988,966 of shares of common stock with a value of $5,850 were issued. In
addition, the Company incurred fees of $14,428 and wrote off debt issuance costs
of $9,656.
16. INCOME TAXES
97
The (benefit) for income taxes is reflected in the Consolidated Statements of
Operations as follows:
2002 2001 2000
------- ------- -------
Current:
Federal $ (4) $ -- $ (14)
State 403 1,237 73
------- ------- -------
Total Current 399 1,237 59
------- ------- -------
Deferred:
Federal (880) (4,480) (3,282)
State (326) (439) (1,555)
------- ------- -------
Total Deferred (1,206) (4,919) (4,837)
------- ------- -------
(Benefit) for income taxes:
Before extraordinary item (807) (3,682) (4,778)
------- ------- -------
Total benefit for income taxes $ (807) $(3,682) $(4,778)
======= ======= =======
Temporary differences that give rise to a significant portion of deferred tax
assets and liabilities at December 31,2002 and 2001 are as follows:
2002 2001
----------- -----------
Net operating loss carryforwards $ 887,812 $ 675,990
Employee benefit plans 39,698 32,134
Reserve for bad debt 3,613 6,227
Start-up costs -- 3,413
Stock Based Compensation 33,733 20,194
Investment in unconsolidated entity 88,786 (19)
Accruals for nonrecurring charges and
Contract settlements 15,902 9,986
Deferred revenue -- 482
Intangibles 21,136 16,330
Property, plant and equipment 210,335 2,347
Other,net 4,601 6,436
----------- -----------
Total deferred tax assets 1,305,616 773,520
----------- -----------
Subtotal 1,305,616 773,520
Valuation allowance (1,305,634) (773,864)
----------- -----------
Total deferred taxes $ (18) $ (344)
=========== ===========
During 2002 the Company generated federal net operating losses in the amount of
$775,150 resulting in a deferred tax asset totaling $ 271,302. In the year ended
December 31, 2001 the Company generated federal net operating losses of
approximately $42,500 resulting in a deferred tax asset of approximately
$14,900. In the opinion of management, the Company is not certain of the
realization of all of its deferred tax assets. Thus, a valuation allowance has
been provided against the net federal deferred tax asset. A valuation allowance
has also been provided, as in past years, against the state net operating
losses, which, in the opinion of management, are also uncertain as to their
realization.
The net change in the valuation allowance for deferred tax assets during 2002
and 2001 was an increase of $531,770 and $186,219, respectively.
Net operating losses will expire as follows:
Federal State
2007-2012 $ 26,261 $1,891,214
2017-2021 2,070,554 618,804
---------- ----------
Total $2,096,815 $2,510,018
========== ==========
The company expects these operating losses to be available in the future to
reduce its federal and state income tax liability. However, certain changes in
stock ownership of the Company as defined under Section 382 of the Internal
Revenue Code of 1986, as amended, can result in limitations on the amount of net
operating loss carryovers that can be utilized each year for federal income tax
purposes and under state tax laws.
98
Consequently, utilization of the above net operating losses may be limited. To
the extent that net operating losses, when realized, relate to stock option
deductions, the resulting benefits will be credited to stockholders' equity.
The (benefit) for income tax is different from the amounts computed by applying
the U.S. statutory federal tax rate of 35%. The differences are as follows:
For the Years Ended
December 31,
2002 2001 2000
----------- ----------- -----------
(Loss) before (benefit) for
income taxes $(1,408,996) $ (688,471) $ (773,492)
=========== =========== ===========
Federal income tax benefit at statutory rate $ (493,148) $ (240,965) $ (270,722)
State income taxes net of federal
income tax benefit (48) 519 (963)
Federal valuation allowance 471,413 126,010 255,201
Amortization of goodwill 11,624 118,500 13,039
Estimated nondeductible expenses (880) (3,000) (3,000)
Adjustment to prior year accrual (446) (3,398) 383
Capitalize Interest 10,976 -- --
Other, net (298) (1,348) 1,284
----------- ----------- -----------
Total (benefit) for income taxes $ (807) $ (3,682) $ (4,778)
=========== =========== ===========
17. Stockholders' Equity and Stock Plans
In May 2002, the shareholders approved an amendment to the Company's Amended and
Restated Certificate of Incorporation (as amended), to increase the number of
authorized shares of capital stock from 725,000,000, of which 25,000,000 shares
are Preferred Stock and 400,000 are Non-Voting Class B Common Stock, to
925,000,000, including the same 25,000,000 shares of Preferred Stock and 400,000
of Non-Voting Class B Common Stock, and to increase the shares of Common Stock
from 300,000,000 to 500,000,000.
Therefore, the Company now has authorized 500,000,000 shares of $1 par value
common stock and 400,000,000 shares of $1 par value Class B nonvoting common
stock. The Company also has authorized 25,000,000 shares of $1 par value
preferred stock.
In May 2002, the shareholders approved an amendment to the Company's Amended and
Restated Certificate of Incorporation (as amended), to effect a reverse stock
split of its Common Stock. The effective date of the reverse stock split shall
be any date selected by the Board of Directors on or prior to the Company's next
annual meeting of shareholders. Alternatively, the Board may, at its sole
discretion, determine that the reverse stock split is not in the best interests
of the Company and its shareholders and not effect the reverse stock split.
In December of 2001, the Company adopted a stockholder rights plan. Under the
plan, each stockholder of record on December 17, 2001 will receive a
distribution of one Right for each share of Common Stock of the Company. The
Rights will become exercisable only if a person acquires, or announces a tender
offer that would result in ownership of 15% or more of the Company's Voting
Common Stock. The Company may redeem the Rights for $0.001 per Right, subject to
adjustment, at any time before the acquisition by a person or group of 15% or
more of the Company's ordinary shares. The Rights will expire on December 5,
2011.
Non-Cash Stock-Based Compensation
Non-cash stock-based compensation was recognized in connection with the
following plans in the following amounts during the years ended:
2002 2001 2000
-------- ------- -------
Incentive Stock Options $ 8,418 $14,459 $10,308
Incentive Stock Options (exchange-related) 5,619 1,216 --
Outperform Stock Options 16,048 25,254 17,910
Outperform Stock Options(exchange-related) 7,033 1,265 --
Restricted Stock (452) 19,551 12,052
Executive Stock Purchase Plan 1,055 1,210 967
-------- ------- -------
$ 37,721 $62,955 $41,237
======== ======= =======
Option Exchange Program
99
During the quarter ended December 31, 2001, the Company completed a stock option
exchange offer. Under the offer, all options with a strike price below $16.00
were eligible to be exchanged in the ratio of 3 new options for 4 old options
and options with a strike price of $16.00 and above were eligible to be
exchanged in the ratio of 1 new option for 2 old options. Approximately
6,150,000 new stock options were issued as a result of the exchange program and
approximately 9,750,000 stock options were cancelled. Approximately 1,622,000
new Outperformed Stock Options ("OSO's") were issued as a result of the exchange
program and approximately 3,163,000 OSO's were cancelled. The strike price of
the new options is $1.95 and the new stock options will vest monthly over a
three-year period and the term of the new options will be five years. The OSO's
will vest monthly over a five-year period and the term of the new OSO's will be
ten years. Although the options were exchanged, generally accepted accounting
principles requires additional non-cash stock based compensation be recorded as
a result of the program.
Stock Options
The 1997 RCN Corporation Stock Option Plan ("the 1997 Plan") contemplates the
issuance of incentive stock options, as well as stock options that are not
designated as incentive stock options, performance-based stock options, stock
appreciation rights, performance share units, restricted stock, phantom stock
units and other stock-based awards (collectively, "Awards"). Up to 30,000,000
shares of Common Stock, plus 3,040,100 shares of Common Stock issuable in
connection with the Distribution related option adjustments, may be issued
pursuant to the Plan.
Unless earlier terminated by the Company Board, the 1997 Plan will expire on the
tenth anniversary of the Distribution.
The RCN Corporation 1997 Stock Plan for Non-Employee Directors contemplates the
issuance of 600,000 options to purchase shares of common stock for directors of
the Company who are not employees of the Company or its affiliates. This plan
requires the exercise price for these options to be equal to the fair market
value of the Company's stock on the date of grant, the term is ten years from
the date of grant, and the options became exercisable immediately.
As a result of the option exchange program, approximately 6,150,000 new
Incentive Stock Options ("ISO's") were granted and approximately 9,750,000
pre-existing stock options were cancelled. The incremental fair value of the
options as a result of the exchange under SFAS No. 123 was $10,115. For the
years ended December 31, 2002 and 2001 the Company recognized non-cash stock
based compensation expense of $5,619 and $1,216 respectively, related to the
exchange program for the ISO's. Under SFAS No. 123, the unamortized non-cash
stock based compensation costs related to the cancelled options is recognized
based on the service period associated with the new terms of the new options.
Excluding the options granted as a result of the option exchange program, the
Company granted approximately 288,000, 2,019,000 and 5,322,000 ISO's to
employees and non-employee directors during the years ended December 31, 2002,
2001 and 2000, respectively, with a fair value under SFAS No. 123 of $400,
$5,193, and $27,845 respectively. The fair value of stock options recognized
during the years ended December 31, 2002, 2001 and 2000 were $8,418, $14,459 and
$10,308, respectively.
Under the option exchange program, all options granted prior to January 1, 2000,
and prior to the adoption of SFAS No. 123, were also eligible to be exchanged.
In accordance with SFAS No. 123, the eligibility of the options to be exchanged
that previously were accounted for under APB No. 25 automatically changes the
accounting for the compensatory options to fall under SFAS No. 123. As a result,
the fair value of the options under APB No. 25 that were not exchanged as part
of the program were expensed in the period in which the exchange took place. The
total non-cash stock based compensation expense related to the non-exchanged APB
No. 25 options in the amount of $341 was recognized in its entirety in the year
ended December 31, 2001 and is included in the $14,459 amount mentioned above.
As of December 31, 2002, the Company had not reflected $3,533 of unamortized
compensation expense in its financial statements for previously granted stock
options.
The weighted-average fair value of ISOs granted during 2002, 2001 and 2000 was
$1.39, $2.57 and $5.23, respectively.
The fair value for these options was estimated at the date of grant using a
Black Scholes option pricing model with weighted average assumptions for
dividend yield of 0% for 2002, 2001 and 2000; expected volatility of for 2002
and 2001 of 97.5% and 86.4% for 2000; a risk-free interest rate of 3.93% for
2002 and 2001 and 5.06% for 2000; and expected lives of 3 years for 2002, 2001
and 2000.
Information relating to Incentive stock options and Non-qualified stock options
are as follows:
Weighted
Average
Number of Exercise
Shares Price
---------- --------
100
Outstanding December 31, 1999 9,584,872 $ 22.34
Granted 5,322,034 $ 23.09
Exercised 567,034 $ 11.66
Cancelled 1,354,762 $ 28.94
----------
Outstanding December 31, 2000 12,985,110 $ 22.40
Granted 8,168,950 $ 2.93
Exercised 37,893 $ 3.59
Cancelled 12,630,309 $ 21.08
----------
Outstanding December 31, 2001 8,485,858 $ 5.21
Granted 288,100 $ 1.28
Exercised 4,338 $ 1.95
Cancelled 1,538,971 $ 7.77
----------
Outstanding December 31, 2002 7,230,649 $ 4.51
==========
Shares exercisable December 31, 2002 3,636,090 $ 6.68
The following table summarizes stock options outstanding and exercisable at
December 31, 2002:
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------- ----------------------------
Weighted Average
Range of Exercise Remaining Weighted Average Weighted Average
Prices Shares Contractual Life Exercise Price Shares Exercise Price
------ ------ ---------------- ---------------- ------ ----------------
.40 - 2.01 5,345,975 3.9 $ 1.91 2,075,882 $ 1.95
2.02 - 5.57 649,641 2.9 $ 4.19 365,372 $ 3.95
6.77 - 15.36 826,551 2.9 $ 8.12 822,694 $ 8.11
15.37 - 30.74 248,914 2.0 $ 23.75 213,491 $ 23.88
30.75 - 44.99 83,551 1.7 $ 41.62 82,634 $ 41.75
45.00 - 48.50 76,017 1.5 $ 47.26 76,017 $ 47.26
--------- --- ---------
Total 7,230,649 3.6 3,636,090
Outperform Stock Option Plan
In June 2000, the Company adopted an OSO program pursuant to the Company's 1997
Equity Incentive Plan. The OSO program was designed so that the Company's
stockholders would receive a market return on their investment before OSO
holders receive any return on their options. Participants in the OSO program
do not realize any value from awards unless the common stock price outperforms
the S&P 500 Index. When the stock price gain is greater than the corresponding
gain on the S&P 500 Index, the value received for awards under the OSO program
is based on a formula involving a multiplier related to the level by which the
common stock outperforms the S&P 500 Index. To the extent that the Company's
common stock outperforms the S&P 500 Index, the value of the OSO's to a holder
may exceed the value of other stock options.
OSO grants are only made to participants who are employees of the Company as of
the grant date. Each award vests over five years and has a ten-year life.
As a result of the option exchange program, approximately 1,622,000 new OSO's
were granted and approximately 3,163,000 pre-existing stock options were
cancelled. The incremental fair value of the options as a result of the exchange
under SFAS No. 123 was $16,614. For the years ended December 31, 2002 and 2001
the Company recognized non-cash stock based compensation expense of $7,033 and
$1,265, respectively, related to the exchange program for the OSO's. The
unamortized non-cash stock based compensation costs related to the cancelled
options is recognized based on the service period associated with the new terms
of the new options.
Excluding the options granted as a result of the option exchange program, the
Company granted approximately 563,000, 587,000 and 3,000,000 OSO's to employees
during the three years ended December 31, 2002 with a fair value of $2,785,
$6,194, and $51,630, respectively. During the years ended December 31, 2002,
2001 and 2000 the fair value recognized for OSO's granted to employees, in
addition to the exchange, were $16,048, $25,254 and $17,910, respectively. As of
December 31, 2002, the Company had not reflected $9,713 of unamortized
compensation expense in its financial statements for previously granted OSOs.
The weighted-average fair value of OSOs granted during 2002, 2001 and 2000 was
$4.95, $10.33 and $14.25, respectively.
101
The fair value for these options was estimated at the date of grant using a
Black Scholes option pricing model with weighted average assumptions for
dividend yield of 0% for 2002, 2001 and 2000; expected volatility of 97.5% for
2002 and 2001 and 86.4% for 2000; risk-free interest rates of 3.93% for 2002 and
2001 and 5.06% for 2000; and expected lives of 5 years for 2002 and 3 years for
2001 and 2000.
Information relating to outperform stock options is as follows:
Weighted
Average
Number of Exercise
Shares Price
--------- ---------
Outstanding December 31, 1999
Granted 3,000,000 $38.12
Exercised -- $ --
Cancelled -- $ --
=========
Outstanding December 31, 2000 3,000,000 $38.12
Granted 2,209,375 $ 2.57
Exercised -- $ --
Cancelled 3,162,500 $36.52
=========
Outstanding December 31, 2001 2,046,875 $ 2.23
Granted 563,000 $ 1.97
Exercised -- $ --
Cancelled -- $ --
=========
Outstanding December 31, 2002 2,609,875 $ 2.17
Shares exercisable December 31, 2002 965,438 $ 2.07
The following table summarizes stock options outstanding and exercisable at
December 31, 2002:
Stock Options Outstanding
--------------------------------------------------
Weighted Average
Range of Exercise Remaining Weighted Average
Prices Shares Contractual Life Exercise Price
----------------- --------- ---------------- ----------------
.40 - 2.01 2,174,875 8.8 $ 1.95
2.02 - 15.36 435,000 8.4 $ 3.31
---------- ----- ----------
Total 2,609,875 8.8 $ 2.17
Restricted Stock
In 2002 and 2001, the Company issued 775,212 and 2,275,779 shares of restricted
stock with a fair value of $863 and $9,560, respectively. During the performance
period the grantee may vote the shares, but the shares are subject to transfer
restrictions and are all or partially forfeited if a grantee terminates
employment with the Company. The restricted stock granted in 2002 and 2001 vests
over two years. The restricted stock is considered issued and outstanding.
Including the effect of forfeitures, the Company recorded ($452), $19,551 and
$12,052 of non-cash compensation expense for the three years ended December 31,
2002 relating to its restricted stock program.
As of December 31, 2002 and 2001, the Company had unearned compensation costs of
$4,336 and $15,898, respectively, which is being amortized to expense over the
restriction period.
Preferred Stock
In April 1999, Hicks Muse Fund IV purchased 250,000 shares of Series A Preferred
Stock, par value $1 per share, for gross proceeds of $250,000. The Series A
Preferred Stock is convertible into common stock at any time and is subject to a
mandatory redemption on March 31, 2014 at $1.00 per share, plus accrued and
unpaid dividends, but may be called by the Company after four years. The Series
A Preferred Stock is cumulative and has an annual dividend rate of 7% payable
quarterly in cash or additional shares of Series A Preferred Stock and has a
conversion price of $38.97 per share. At December 31, 2002 the Company has paid
cumulative dividends in the amount of $73,934 in the form of additional Series A
Preferred Stock. At December 31, 2002 the number of common shares that would be
102
issued upon conversion of the Series A Preferred Stock was 8,312,423. In
connection with the investment, the holder appointed a director to our Board.
In February 2000, Vulcan Ventures Incorporated ("Vulcan"), purchased $1,650,000
of mandatorily convertible cumulative Series B preferred stock (the "Series B
Preferred Stock"), which will be converted into Common Stock or Class B Stock no
later than seven years after it is issued. The Company has the option of
redeeming at any time after August 28, 2003. The Series B Preferred Stock has a
liquidation preference of $1,000 per share and is convertible at a price of
$61.86 per share. All dividends will be paid in additional shares of Preferred
Stock. At December 31, 2002 the Company has paid cumulative dividends in the
amount of $359,355 in the form of additional shares of Series B Preferred Stock.
At December 31, 2002 the number of shares that would be issued upon conversion
of the Series B Preferred Stock was 32,482,282. In connection with the
investment Vulcan appointed two directors to our Board. The Preferred Stock has
a dividend rate of 7% per annum. The investment is limited to a 15% vote, in
most cases.
In accordance with the Stock Purchase agreement between the Company and Vulcan,
in the event of a change of control, Vulcan may, at its election (i) continue to
hold the Preferred Stock, (ii) convert the Preferred Stock into Common Stock and
receive, in addition, an amount of cash equal to the value on an as-converted
basis of the additional Preferred Stock dividends it would have received on the
Preferred Stock if it had remained outstanding through the Non-Call Period, or
(iii) redeem the Preferred Stock (or, if the change of control occurs on or
after February 15, 2003, 50% of the Preferred Stock) for a cash price equal to
110% of the value of the Preferred Stock on an as-converted basis, provided that
if the change of control occurs after the end of the Non-Call Period, the
redemption price will be 100% of the liquidation preference.
Equity Offerings
On June 28, 2001, Red Basin, LLC, an entity formed by a director together with
certain family members and trusts, purchased approximately 7,661,000 shares of
common stock and warrants to acquire approximately 3,831,000 shares of common
stock, for $50,000. The purchase price of the common stock and accompanying
warrants is approximately $6.53 per share of common stock. The warrants have a
term of 4-1/2 years and an exercise price equal to $12.928 per share. Pursuant
to a stockholder's agreement, Red Basin has certain other rights and
obligations, including preemptive rights to purchase additional share of common
equity, registration rights, restrictions on transfer of shares, limitations on
acquiring additional shares, and other matters.
Executive Stock Purchase Plan
The Company has an Executive Stock Purchase Plan ("ESPP"), under which
participants may defer, on a tax-free basis, up to 20% of their annual salary
plus bonus. The deferred funds are used to purchase shares of RCN Common Stock.
Share units corresponding to the shares purchased credited to participants'
accounts, and held for the benefit of the participant until the earlier of the
end of the deferral period (no less than 3 years) or termination of employment.
The Company issues a matching share unit for each share unit credited to a
participant's account. The share units do not give such participant any rights
as a shareholder. The matching share units vest three years from the deferral
and are subject to forfeiture as provided in the ESPP.
The number of shares, which may be distributed under the RCN ESPP as matching
shares, or in payment of share units, is 500,000. At December 31, 2002, there
were 772,887 RCN ESPP shares arising from participants' contributions and
875,028 matching shares. At December 31, 2001, there were 304,494 RCN ESPP
shares arising from participants' contributions and 304,450 matching shares. The
Company recognizes the cost of the matching shares over the vesting period. At
December 31, 2002, deferred compensation cost relating to matching shares was
$703. Expense recognized in 2002, 2001 and 2000 was $1,055, $1,210 and $967,
respectively. Matching shares are included in weighted average shares
outstanding for purposes of computing earnings per share.
18. PENSIONS AND EMPLOYEE BENEFITS
In 1997, RCN established a 401(k) savings plan that also qualifies as an ESOP
(the "ESOP"). Contributions charged to expense in 2002, 2001, and 2000 for these
plans were $3,825, $4,824, and $3,591, respectively. The Company issued 51,014
shares of treasury stock to the RCN 401(k) savings plan related to late deposits
in 2001.
In order to meet the requirements of the Private Letter Ruling received at the
time of the tax-free distribution of RCN stock with respect to its spin-off from
CTE, Inc., the Company had a contingent obligation to fund the ESOP portion of
its 401(k) plan with shares of Company Common Stock by September 30, 2002 up to
3% of the total number of shares of Company Common Stock outstanding at
September 30, 1997 as increased by the number of shares issuable to NSTAR
Securities pursuant to the Exchange Agreement
103
(collectively, "Outstanding Company Common Stock") with a market value at such
time of not less than $24,000, the Company will issue to the ESOP, in exchange
for a note from the ESOP (the "ESOP Note"), the amount of Company Common Stock
necessary to increase the ESOP's holdings of Company Common Stock to that level,
provided, however, that the Company is not obligated to issue shares to the ESOP
in excess of 5% of the total number of shares of Outstanding Company Common
Stock.
During the second quarter of 2001, the Company received a supplemental IRS
Letter Ruling modifying the Company's contingent funding obligation to 3% of the
Company's outstanding shares immediately after the spin-off, or approximately
1.64 million shares of Common Stock, to the ESOP portion of the 401(k) plan,
regardless of the value of the shares in the ESOP.
During the third quarter of 2002, the Company received a second supplemental IRS
Letter Ruling indicating diversification of assets within the ESOP initiated by
employees as well as disposition of assets held by the ESOP in connection with
the termination of employment, will not have an adverse impact on rulings
previously issued.
As of September 30 2002, the ESOP owned Company Common Stock exceeding the
requirements of the Private Letter Ruling and its supplemental rulings.
In addition, the Company has two additional 401(k) savings plans as the result
of the 21st Century acquisition. Both plans are employee contribution plans with
no employer matching contribution. The Company plans to merge these plans into
the existing RCN 401(k) savings plan.
The Company provides certain post-employment benefits to former or inactive
employees of the Company who are not retirees. These benefits are primarily
short-term disability salary continuance. The Company accrues the cost of
post-employment benefits over employees' service lives. The Company uses the
services of an enrolled actuary to calculate the expense. The net periodic
post-employment benefit cost was approximately $1,304, $644, and $987 in 2002,
2001, and 2000, respectively.
19. COMMITMENTS AND CONTINGENCIES
a. The Company had various purchase commitments at December 31, 2002 related to
its 2003 construction budget.
b. Total rental expense, primarily for office space and equipment, was $29,275,
$42,680 and $32,166 for 2002, 2001 and 2000, respectively. At December 31, 2002,
rental commitments under non-cancellable leases, excluding annual pole rental
commitments of approximately $2,917 that are expected to continue indefinitely,
are as follows:
Year Aggregate Amounts
---- -----------------
2003 $ 30,868
2004 $ 28,025
2005 $ 24,044
2006 $ 26,439
2007 $ 31,272
Thereafter $154,795
c. The Company has outstanding letters of credit aggregating $40,005 at December
31, 2002 of which $25,005 is collateralized by cash.
d. The Company expects that it will not be able to meet all of the construction
and system build-out requirements contained in some of the cable franchise
agreements it has entered into with certain local governments. The Company is
attempting to negotiate with franchising authorities to extend, modify,
terminate or postpone the terms of the applicable franchise to avoid any
breaches and related penalties. The Company can make no assurances that it will
be able to reach a satisfactory resolution of these issues, or that the
municipalities involved will not seek to invoke the liquidated damages and other
penalties to which they may claim to be entitled pursuant to the franchise
agreements. Several jurisdictions have threatened or have brought legal action
to seek damages or other remedies for our current or expected future
non-compliance with construction and system build-out requirements. While the
Company will raise both statutory and contractual defenses to such claims, and
believes that its defenses are reasonable and justified, the law in this area is
uncertain and the Company can make no assurances that it will be successful in
defending such actions. If the Company does not prevail in our defense of these
actions, it could be subject to significant damages. If all of the franchising
authorities with which the Company has franchise arrangements were to make
similar challenges and prevail in such efforts, the Company could be subject to
aggregate penalties which could have a material adverse effect on its
operations.
104
e. The Company currently does not pay a 5% franchise fees on its cable modem
Internet access services on the basis that the FCC has determined that such
Internet services are not "cable services" as defined in the Communications Act.
The Company's position has been challenged by the City of Chicago, which has
brought suit against the Company and other franchised cable television operators
in the City of Chicago. The defendants have sought to remove the action to
federal court and to dismiss it on the ground that cable modem service is not a
cable television service. The City of Chicago has opposed these motions and both
matters are now before the Court. The Company will continue to vigorously defend
its position in this action but can provide no assurances that it will prevail
in this action. To the extent that the City of Chicago prevails, it would mean
that the Company would likely be required to pass through the additional fees to
its cable modem Internet service customers.
f. A suit has been commenced against RCN Corporation in the Delaware Court of
Chancery by Edward T. Joyce, as representative of the former stockholders and
warrant holders of 21st Century Telecom Group, Inc. ("21st Century"). Mr. Joyce
is a former member of the Board of Directors of 21st Century. RCN acquired the
stock of 21st Century pursuant to an Agreement and Plan of Merger that closed in
April, 2000 (the "Merger Agreement"). Pursuant to the Merger Agreement, RCN held
back 10% of its common stock consideration (the "10% Holdback") for a period of
one year to allow for any indemnity claims. The Merger Agreement stated that the
10% Holdback would be based upon RCN's stock price at the time the Merger
Agreement was executed. The suit seeks reformation of the Merger Agreement to
reflect what Plaintiffs allege was actually negotiated and agreed to -- that the
10% Holdback would be based upon RCN's stock price as of the end of the one year
holdback period. Because RCN's stock had fallen in value during this period, if
Plaintiffs prevail RCN would have to distribute approximately 5 million
additional shares in consideration of the Merger Agreement. RCN has filed a
motion to dismiss this matter.
g. With respect to its tax free spin-off in September 1997 from C-TEC
Corporation, the Company has agreed to indemnify Cable Michigan and CTE and
their respective subsidiaries against any and all liabilities which arise
primarily from or relate primarily to the management or conduct of the business
of the Company prior to the effective time of the Distribution. The Company has
also agreed to indemnify Cable Michigan and CTE and their respective
subsidiaries against 30% of any liability which arises from or relates to the
management or conduct prior to the effective time of the Distribution of the
businesses of C-TEC and its subsidiaries and which is not a true CTE liability,
a true Cable Michigan liability or a true Company liability. The Tax Sharing
Agreement, by and among the Company, Cable Michigan and CTE (the "Tax Sharing
Agreement"), governs contingent tax liabilities and benefits, tax contests and
other tax matters with respect to tax returns filed with respect to tax periods,
in the case of the Company, ending or deemed to end on or before the
Distribution Date. Under the Tax Sharing Agreement, Adjustments (as defined in
the Tax Sharing Agreement) to taxes that are clearly attributable to the Company
Group, the Cable Michigan Group, or the CTE Group will be borne solely by such
group. Adjustments to all other tax liabilities will be borne 50% by CTE, 30% by
the Company and 20% by Cable Michigan.
Notwithstanding the above, if as a result of the acquisition of all or a portion
of the capital stock or assets of the Company or as a result of any other action
taken by the Company, the distribution fails to qualify as a tax-free
distribution under Section 355 of the Code, then the Company will be liable for
any and all increases in tax attributable thereto.
In addition to the above, in the normal course of business, the Company becomes
party to various legal proceedings of which there are several pending. In the
opinion of management, these proceedings will not have a material adverse effect
on the financial position or results of operations or liquidity of the Company.
20. RELATED PARTY TRANSACTIONS
The Company had the following transactions with related parties during the years
ended December 31, 2002, 2001 and 2000:
2002 2001 2000
------- -------- -------
Corporate office costs allocated
to related parties $ 1,200 $ 1,200 $ 1,996
Terminating revenues from related party 3,677 7,846 7,066
Expenses allocated to unconsolidated
joint venture partner 17,782 19,594 21,776
Related party expenses for network construction 6,796 202,683 83,675
Related party expenses for utility service 3,297 2,467 2,392
105
At December 31, 2002 and 2001, the Company has accounts receivable from related
parties of $10,207 and $16,698, respectively, for these transactions. At
December 31, 2002 and 2001, the Company has accounts payable to related parties
of $13,558 and $20,693, respectively.
The Company has an existing relationship with Commonwealth Telephone
Enterprises, Inc. ("CTE"). Our Chairman and Chief Executive Officer is also the
Chairman of CTE. Eight of our Directors also serve on the board of directors of
CTE. Prior to September 30, 1997, RCN was a wholly owned subsidiary of CTE
(formerly C-TEC Corporation). On September 30, 1997, C-TEC distributed the
shares of RCN to its shareholders. The Company agreed to provide or cause to be
provided certain specified services (management services) to CTE for a
transitional period after the distribution. The agreement was terminated by CTE
in December 2002. The total fee for 2002 was approximately $1,200. Fees received
from C-TEC and its subsidiaries in 2001 and 2000 were approximately $1,200 and
$2,000, respectively.
In 2002, the Company paid NSTAR Communications and NSTAR approximately $7,333,
primarily for network construction and related support and separately paid NSTAR
approximately $3,297 for utility service. Total fees paid to NSTAR in 2001 and
2000 were approximately $64,400 and $36,700, respectively. Construction costs
are capitalized and are recorded as Property, plant, and equipment on the
Company's Balance Sheets. A Director of the Company is also the Chairman and
Chief Executive Officer of BECO and NSTAR Communications.
In 2002, the Company paid Sordoni Skanska, a subsidiary of Skanska USA, as
project manager, approximately $594 to oversee network construction and for
related labor costs in several of the Company's markets. The Company reimburses
Sordoni Skanska for staff and administrative services, project management fees,
and invoices from sub contractors. Fees paid during 2001 were approximately
$54,200. The Company also paid Barney Skanska approximately $1,088 and $11,300
for construction services relating to certain of the Company's hub sites in 2002
and 2001, respectively. Fees paid in 2000 to Sordoni Skanska and Mr. Skanska
were approximately $52,600. Construction costs are capitalized and are recorded
as Property, plant, and equipment on the Company's Balance Sheets. A former
Director of the Company was the President of Skanska USA.
In 2002, the Company paid Level 3 Communications approximately $2,088 for
network construction and approximately $2,305 for circuit costs. Approximate
total payments to Level 3 in 2001 and 2000 were $13,400 and $4,600,
respectively. Level 3 owns 24.29% of the outstanding shares of common stock in
RCN as of December 31, 2002. In addition, the Company's Chairman and Chief
Executive Officer and director is also a director of Level 3.
In July 2002, the Company entered into a four year data center outsourcing
contract with (i)Structure, Inc., a subsidiary of Level 3 Communications. The
(i)Structure data center will primarily host the Company's billing systems and
financial support applications. The base service fee is approximately $150 per
month.
The Company provided CTE local and long distance services of approximately
$3,509 during 2002. Commonwealth Telephone Company and CTSI, Inc. a subsidiary
of CTE, provided the Company with local and long distance services of
approximately $198. For the years ended December 31, 2001 and 2000 total costs
paid to CTE and its subsidiaries were $702 and $1,100, respectively.
In 2002, the Company paid the Hanify and King law firm approximately $287 for
legal services. In 2001, $182 in fees were paid to the firm. The Company's
Chairman and Chief Executive Officer and Director has a family member who is a
partner with Hanify and King.
In 2002, the Company paid $225 to Liberty Mutual Insurance Company to lease
office space for operations in our Boston market. Lease payments in 2001 were
$196. Thomas J. May, a Director of the Company is also a Director of Liberty
Mutual Insurance Company.
21. OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Certain financial instruments potentially subject the Company to concentrations
of credit risk. These financial instruments consist primarily of trade
receivables, cash and temporary cash investments, and short-term investments.
The Company places its cash, temporary cash investments and short-term
investments with high credit quality financial institutions and limits the
amount of credit exposure to any one financial institution. The Company also
periodically evaluates the creditworthiness of the institutions with which it
invests. The Company does, however, maintain invested balances in excess of
federally insured limits.
106
The Company's trade receivables reflect a customer base primarily centered in
the Boston to Washington, D.C. corridor of the United States. The Company
routinely assesses the financial strength of its customers. As a consequence,
concentrations of credit risk are limited.
107
SUPPLEMENTARY DATA - QUARTERLY INFORMATION (Unaudited)
Dollars in thousands except per share amounts
2002 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ----------- ----------- ----------- -----------
Sales $ 111,381 $ 114,256 $ 114,494 $ 117,220
Operating (loss) before non-cash stock
based compensation, depreciation and
amortization and goodwill write-down and
special charges $ (31,416) $ (25,898) $ (20,572) $ (19,538)
Net loss from continuing operations before
extraordinary item $(163,661) $(1,095,219) $(171,530) $(163,749)
Loss before discontinued operations
extraordinary item per average share $ (1.61) $ (10.47) $ (1.56) $ (1.49)
Net loss available to common shareholders $(148,671) $(1,094,400) $(169,154) $(158,114)
COMMON STOCK
High $ 3.14 $ 1.95 $ 1.56 $ 0.90
Low $ 1.20 $ 1.11 $ 0.51 $ 0.48
2001 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ----------- ----------- ----------- -----------
Sales $ 93,916 $ 98,259 $ 103,702 $ 109,694
Operating (loss) before non-cash stock
based compensation, depreciation and
amortization and goodwill write-down and
special charges $ (88,519) $ (65,875) $ (44,034) $ (40,213)
Net loss from continuing operations before
extraordinary item $(259,984) $ (679,268) $(187,858) $(199,933)
Loss before discontinued operations
extraordinary item per average share $ (2.97) $ (7.41) $ (1.93) $ (2.04)
Net income (loss) available to common
shareholders $(257,945) $ (676,850) $(111,640) $ 209,983
COMMON STOCK
High $ 14.06 $ 7.00 $ 5.75 $ 4.43
Low $ 5.13 $ 2.94 $ 1.95 $ 2.45
108
REPORT OF MANAGEMENT
The integrity and objectivity of the financial information presented in these
financial statements is the responsibility of the management of RCN Corporation.
The financial statements report on management's accountability for Company
operations and assets. To this end, management maintains a system of internal
controls and procedures designed to provide reasonable assurance that the
Company's assets are protected and that all transactions are accounted for in
conformity with accounting principles generally accepted in the United States.
The system includes documented policies and guidelines, augmented by a
comprehensive program of internal and independent audits conducted to monitor
overall accuracy of financial information and compliance with established
procedures.
PricewaterhouseCoopers LLP, independent accountants, conduct a review of
internal accounting controls to the extent required by generally accepted
auditing standards and perform such tests and procedures as they deem necessary
to arrive at an opinion on the fairness of the financial statements presented
herein.
The Board of Directors meets its responsibility for the Company's financial
statements through its Audit Committee which is comprised exclusively of
directors who are not officers or employees of the Company. The Audit Committee
recommends to the Board of Directors the independent auditors for election by
the shareholders. The Committee also meets periodically with management and the
independent and internal auditors to review accounting, auditing, internal
accounting controls and financial reporting matters. As a matter of policy, the
internal auditors and the independent auditors periodically meet alone with, and
have access to, the Audit Committee.
/s/ Jeffrey M. White
- -----------------------
Jeffrey M. White
Vice Chairman and Chief Financial Officer
109
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of
RCN Corporation
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 40 present fairly, in all material
respects, the financial position of RCN Corporation and its Subsidiaries at
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedules listed
in the index appearing under Item 15 (a)(2) on page 40 present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedules are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," and Statement of Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" on January 1, 2002.
/s/ PricewaterhouseCoopers LLP
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PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 12, 2003
110