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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
OR
[ ] Transition Report pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the Transition Periods from ______ to ______.
Commission File Number: 001-16805
RCN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3498533
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
105 Carnegie Center
Princeton, New Jersey 08540
(Address of principal executive offices)
(Zip Code)
(609) 734-3700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the 7registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of March 31, 2003.
Common Stock 110,948,391
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
RCN CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2003 and 2002
Condensed Consolidated Balance Sheets at March 31, 2003 and December
31, 2002
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2003 and 2002
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars In Thousands, Except Share and Per Share Data)
(Unaudited)
For the Three Months Ended
March 31,
------------------------------
2003 2002
------------- -------------
Sales $ 124,458 $ 111,381
Costs and expenses, excluding non-cash
stock based compensation, depreciation
and amortization:
Direct expenses 42,152 46,690
Operating and selling, general
and administrative 84,390 96,093
Non-cash stock based compensation 2,049 2,576
Impairments and special charges 80 (478)
Depreciation and amortization 51,484 73,675
------------- -------------
Operating loss (55,697) (107,175)
Investment income 1,653 7,644
Interest expense (49,222) (40,573)
Gain on early extinguishment of debt -- 13,073
Other income, net 6,179 912
------------- -------------
Loss from continuing operations
before income taxes (97,087) (126,119)
Income tax provision (benefit) 12 (750)
------------- -------------
Loss from continuing operations before equity
in unconsolidated entities and minority interest (97,099) (125,369)
Equity in income of unconsolidated entities 3,781 11,114
Minority interest in loss of consolidated
entities -- 3,212
------------- -------------
Net loss from continuing operations (93,318) (111,043)
Discontinued operations (see Note 5)
Income from discontinued operations,
(including gain on disposal of $165,865) 168,695 1,898
Income tax provision 761 --
------------- -------------
Gain from discontinued operations 167,934 1,898
Net income (loss) 74,616 (109,145)
Preferred dividend and accretion requirements 42,263 39,526
------------- -------------
Net income (loss) to common shareholders $ 32,353 $ (148,671)
============= =============
Basic and Diluted loss per common share:
Net loss from continuing operations $ (1.23) $ (1.48)
Net income from discontinued operations 1.52 0.02
------------- -------------
Net income (loss) to common shareholders $ 0.29 $ (1.46)
============= =============
Weighted average shares outstanding 110,165,770 101,826,546
============= =============
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
3
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands, Except Share and Per Share Data)
(Unaudited)
March 31, December 31,
2003 2002
---------- ------------
ASSETS
Current assets:
Cash and temporary cash investments $ 205,309 $ 49,365
Short-term investments -- 227,641
Accounts receivable from related parties 16,051 10,207
Accounts receivable, net of reserve for
doubtful accounts of $10,274 and $10,705 61,754 56,915
Unbilled revenues 667 770
Interest and dividends receivable 1,288 1,595
Prepayments and other current assets 36,760 17,835
Short-term restricted investments (Note 2) 136,051 34,920
Current assets of discontinued operations -- 3,971
---------- ----------
Total current assets 457,880 403,219
Property, plant and equipment, net of
accumulated depreciation of $857,000
and $809,000 1,195,766 1,234,939
Investments in joint ventures and equity
securities 227,239 228,231
Intangible assets, net of accumulated
amortization of $64,977 and $64,912 1,916 1,741
Goodwill 6,130 6,130
Long-term restricted investments (Note 2) 100,000 --
Deferred charges and other assets 43,584 43,606
Noncurrent assets of discontinued operations -- 72,416
---------- ----------
Total assets $2,032,515 $1,990,282
========== ==========
4
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt $ 39,539 $ 37,417
Accounts payable 24,334 28,016
Accounts payable to related parties 14,584 13,558
Advance billings and customer deposits 25,716 27,940
Accrued exit costs 28,188 30,667
Accrued expenses 170,928 176,866
Current liabilities of discontinued operations -- 3,852
----------- -----------
Total current liabilities 303,289 318,316
----------- -----------
Long-term debt 1,692,980 1,706,997
Other deferred credits 6,848 4,166
Minority interest -- 791
Commitments and contingencies
Redeemable preferred stock, Series A, convertible, par value $1 per share;
708,000 shares authorized, 329,306 and 323,934 shares issued and
outstanding, respectively 322,179 316,342
Redeemable preferred stock, Series B, convertible,
par value $1 per share; 2,681,931 shares
authorized, 2,044,099 and 2,009,335 shares
issued and outstanding, respectively 2,024,511 1,988,084
Common shareholders' deficit:
Preferred stock, par value $1 per share,
21,610,069 authorized, none issued and outstanding -- --
Class A Common stock, par value $1 per share,
500,000,000 shares authorized, 110,948,391 and
110,795,577 shares issued and 110,265,524 and
110,112,690 shares outstanding,
respectively 110,948 110,796
Class B Common stock, par value $ per share,
400,000,000 shares authorized, none issued and
outstanding -- --
Additional paid-in capital 1,451,902 1,451,744
Cumulative translation adjustments (11,907) (5,134)
Unearned compensation expense (2,450) (4,336)
Unrealized appreciation on investments 830 1,484
Treasury stock, 682,867 shares at cost (9,583) (9,583)
Accumulated deficit (3,857,032) (3,889,385)
----------- -----------
Total common shareholders' deficit (2,317,292) (2,344,414)
----------- -----------
Total liabilities, redeemable preferred stock
and common shareholders' deficit $ 2,032,515 $ 1,990,282
=========== ===========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
5
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars In Thousands)
(Unaudited)
For the Three Months Ended
March 31,
2003 2002
--------- ---------
Cash flows from operating activities
Net income (loss) $ 74,616 $(109,145)
Income from discontinued operations 2,830 1,898
--------- ---------
Net income (loss) from continuing operations 71,786 (111,043)
Adjustment to reconcile net income (loss) from continuing
Operations to net cash used in operating activities:
Accretion of discounted debt 7,563 18,562
Amortization of financing costs 8,954 7,415
Non-cash stock based compensation expense 2,049 2,576
Gain on sale of assets (8,118) (516)
Gain on early extinguishment of debt - (13,073)
Gain on sale of discontinued operation (165,134) -
Depreciation and amortization 51,484 73,675
Income taxes, net 12 (750)
Provision for losses on accounts receivable 3,774 2,754
Equity in income of unconsolidated entities (3,781) (11,114)
Impairments and special charges 80 (478)
Minority interest - 3,212
--------- ---------
(31,331) (28,780)
Net change in working capital (23,097) (61,095)
--------- ---------
Net cash used in continuing operations (54,428) (89,875)
Cash provided by discontinued operations 3,158 4,146
--------- ---------
Net cash used in operating activities (51,270) (85,729)
--------- ---------
Cash flows from investing activities:
Additions to property, plant and equipment (21,551) (41,516)
Short-term investments 227,641 (37,433)
Investment in unconsolidated joint venture - (6,000)
Proceeds from sale of assets 2,628 2,302
Proceeds from sale of discontinued operations 242,844 -
Discontinued operations (2,191) 25
Increase in investments restricted for debt service (219,538) -
Other (3,813) 1,585
--------- ---------
Net cash provided by (used in) investing activities 226,020 (81,037)
--------- ---------
Cash flows from financing activities:
Repayment of long term debt (7,781) (187,500)
Repayment of capital leases (1,427) (549)
Payments made for debt financing costs (9,598) (10,315)
Proceeds from the exercise of stock options - 9
--------- ---------
Net cash used in financing activities (18,806) (198,355)
--------- ---------
Net increase (decrease) in cash and temporary cash investments 155,944 (365,121)
Cash and temporary cash investments at beginning of quarter 49,365 476,220
--------- ---------
Cash and temporary cash investments at end of quarter $ 205,309 $ 111,099
========= =========
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of $430, and $6,275 capitalized
as of March 31, 2003 and 2002, respectively) $ 23,529 $ 25,268
========= =========
Income taxes $ - $ -
========= =========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements
6
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTER ENDED MARCH 31, 2003
(Dollars In Thousands, Except Share and Per Share Data)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of RCN
Corporation and its wholly owned subsidiaries, ("RCN" or the "Company") have
been prepared in accordance with requirements of the Securities and Exchange
Commission ("SEC") for Form 10-Q and Article 10 of Regulation S-X. Accordingly,
certain information and footnote disclosures required by generally accepted
accounting principles for complete financial statements have been condensed or
omitted.
In the opinion of the management, the unaudited condensed consolidated financial
statements include all adjustments, which consists of normal recurring
adjustments, necessary to present fairly the consolidated financial position,
results of operations and cash flows of the Company for the periods presented.
The results of operations for the period ended March 31, 2003 are not
necessarily indicative of operating results expected for the full year or future
interim periods. These condensed consolidated financial statements should be
read in conjunction with the audited financial statements and notes thereto, and
the Risk Factors included in the Company's December 31, 2002 Annual Report on
Form 10-K filed with the SEC.
2. OPERATIONS AND LIQUIDITY
At March 31, 2003, the Company had approximately $205,309 in cash, temporary
cash and short-term investments and $236,051 in restricted cash. The Company
believes that current available cash, cash equivalents, short-term investments
and proceeds from revenues will be sufficient to meet its anticipated cash needs
for working capital, capital expenditures and other activities for at least
through mid-2004. In order for the Company to meet its long-term liquidity
needs, the Company will have to do one of, 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 the Credit Facility, (v) restructure the balance sheet, and (vi)
consummate additional asset sales. The Company cannot assure that it will be
able to implement any of the foregoing on acceptable terms.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" in the quarterly report in which
these consolidated financial statements are included for more information about
the risks associated with our current financial condition.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for
Obligations Associated with the Retirement of Long-Lived Assets." SFAS No. 143
is effective for fiscal years beginning after June 15, 2002, and 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 the assets useful-life. The Company adopted
7
SFAS No. 143 on January 1, 2003 and the adoption of this statement did not have
a material impact on the Company's financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission on FASB Statements No.
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. The Company adopted
SFAS No. 145 on January 1, 2003. Accordingly in the condensed consolidated
statements of operations for the period ended March 31, 2002, the extraordinary
gains on early retirement of debt has been reclassified. See Note 7 on Long-term
debt for discussion on SFAS No. 145. The adoption of this statement did not have
a material impact on the Company's financial position or results of operations.
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 rather than when a company commits
to such an activity. It also establishes fair value as the objective for initial
measurement of the liability. The Company adopted the provisions of SFAS No. 146
on January 1, 2003. See Note 6 on Accrued Exit Costs for discussion on the
impact of adopting SFAS No. 146.
In November 2002, the FASB issued Financial Interpretation No. 45 ("FIN 45"),
"Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." 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 requires a guarantor 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 adoption of the recognition and initial measurement requirements
of FIN 45 did not have a material impact on the financial position, cash flows
or results of operations of the Company.
In January 2003, the FASB issued 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 financial position, results of
operations and cash flows particularly as it relates to the Company's interest
in Starpower and Megacable.
8
4. CHANGE IN ESTIMATE FOR RECIPROCAL COMPENSATION REVENUE
The Company recognizes revenue when evidence of an arrangement exists, services
are rendered, the selling price is determinable and collectibility is reasonably
assured.
As it pertains to reciprocal compensation revenue, which is the fee local
exchange carriers pay to terminate calls on each other's networks, the Company
has historically recognized such revenue as it was realized. This was due to the
uncertainty of various legal regulatory rulings that affected the Company's
ability to accurately determine the amount of reciprocal compensation revenue to
recognize prior to the point in time such amounts were paid. Over the past year,
the system limitations have been resolved and the FCC has concluded on various
tariff/interconnect rules that have now permitted the Company to accurately
estimate the amount of reciprocal compensation revenue to be earned for calls
terminated on the Company's network in the period such services are rendered.
Accordingly, during the quarter ended March 31, 2003, the Company recognized
approximately $7,100 of incremental reciprocal compensation revenue as a result
of this change in estimate. Approximately $4,100 of this amount related to
services rendered in calendar 2002.
5. DISCONTINUED OPERATIONS
a) 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 net cash proceeds of approximately $242,844 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. The Company recorded a gain of approximately $165,134 from sale of the
assets of the discontinued operations net of taxes, transaction fees and
minority interest. At March 31, 2003, approximately $18,407 of the cash proceeds
from the sale of assets are being held in an escrow account for purchase price
adjustments that were determinable at the closing date. This amount is included
in Prepayments and other current assets on the balance sheet and is expected to
be released to the Company by February 19, 2004.
In accordance with SFAS No. 144, the results of operations for central New
Jersey are reported as discontinued operations and depreciation and amortization
was no longer recognized on assets to be sold since the date of the agreement.
The following are the summarized results of the central New Jersey operations:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
------- -------
Sales $ 7,480 $13,154
Direct expenses 2,663 4,148
Operating and selling, general and
Administrative, and depreciation
and amortization expense 2,019 4,788
Income before tax 2,860 1,898
Income after tax $ 2,830 $ 1,898
9
The current and noncurrent assets and liabilities of the central New Jersey
operation to be sold at December 31, 2002 were as follows:
DECEMBER 31,
------------
2002
-------
Current assets:
Accounts receivable from related parties $ 154
Accounts receivable, net of reserve 3,817
-------
Current assets of discontinued operations $ 3,971
=======
Noncurrent assets:
Property, plant and equipment, net $72,304
Intangible assets, net 22
Goodwill 90
-------
Noncurrent assets of discontinued operations $72,416
=======
Current liabilities:
Advanced billings and customer deposits $ 3,852
-------
Current liabilities of discontinued operations $ 3,852
=======
b) In the first quarter of 2002, the Company completed the sale of a portion of
its business customer base that was not served by its 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. The gain is included in the Other income
line item.
6. SPECIAL CHARGES AND ACCRUED EXIT COSTS
The total asset impairment and special charges are comprised of the following:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
------- -------
Construction materials $ - $ 4,327
Exit costs for excess facilities-net 80 (4,805)
------- -------
Total impairments and special charges $ 80 ($ 478)
======= =======
Due to the continued severe slowdown in the telecommunications industry, the
economy, and continued limited availability of capital, the Company revised its
growth plan during 2002. Under the revised plan, the Company decided to
substantially curtail future capital spending and network geographic expansion
in all existing markets, focus on customer growth in existing markets and
reducing operating expenses. As part of the revised growth plan, 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 cannot be used for alternative use and which is
either to be returned to vendors, or resold to a secondary market. During the
three months ended March 31, 2002, a charge in the amount of approximately
$4,327 was recognized to write down excess construction materials to their net
realizable value.
In addition, the Company initiated discussions with the respective franchising
authorities to inform them of the Company's decision to stop or delay
construction. During the three months ended March 31, 2003 and 2002, the Company
recognized approximately $0 and $2,049 in additional accrued costs and
10
penalties which are included in the Operating and selling, general and
administrative expenses in the statement of operations.
A detailed review of facility requirements against lease obligations has been
continuously conducted by the Company to identify excess space. Along with the
revised expansion plans, the Company has also consolidated certain operating
activities, which has resulted in the Company exiting excess facilities. During
the three months ended March 31, 2003 and 2002, the Company recorded additional
accrued costs to exit excess facilities of approximately $370 and $0,
respectively. In accordance with the provisions of SFAS No. 146, the exit costs
accrued in 2003 were made at the cease-use date and include estimated sublease
rentals. Additionally, during the three months ended March 31, 2003 and 2002,
the Company recognized approximately $290 and $4,805, respectively, of
recoveries resulting from settlements and changes in estimates related to
certain lease obligations.
The total activity for the three months ended March 31, 2003 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, 2002 $ 15,595 $ 15,072 $ 30,667
Additional accrued costs -- 370 370
Recoveries -- (290) (290)
Payments -- (2,559) (2,559)
----------- -------- --------
Balance at March 31, 2003 $ 15,595 $ 12,593 $ 28,188
=========== ======== ========
7. LONG-TERM DEBT
Long-term debt including capital leases outstanding at March 31, 2003 and
December 31, 2002 is as follows:
MARCH 31, DECEMBER 31,
---------- ------------
2003 2002
---------- ----------
Term Loans $ 539,156 $ 546,938
Senior Notes 10% due 2007 161,116 161,116
Senior Discount Notes 11.125% due 2007 320,497 320,497
Senior Discount Notes 9.8% due 2008 326,286 322,481
Senior Discount Notes 11% due 2008 141,240 137,459
Senior Notes 10.125% due 2010 231,735 231,735
Capital Leases 12,489 24,188
---------- ----------
Total 1,732,519 1,744,414
Current maturities of long-term debt 39,539 37,417
---------- ----------
Total Long-Term Debt $1,692,980 $1,706,997
========== ==========
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").
11
The Company entered into an amendment to the Credit Agreement dated March 7,
2003 (the "Fifth Amendment"). The Fifth Amendment enables the Company to incur
additional senior secured debt, adjusts the operating and financial covenants to
better reflect the Company's business plan and modifies certain other
restrictions. In connection with the Fifth Amendment, the Company paid certain
lenders fees of approximately $9,644. The Fifth Amendment also reduces the
amount available under the Revolver to $15,000, under which there were no
borrowings outstanding at March 31, 2003, 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. At March 31, 2003 the Company maintained cash
collateral of approximately $236,051 (of which $100,000 has been classified as
long-term). 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 the company'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.
On March 25, 2002, the Company entered into an amendment to the Credit Agreement
(the "Fourth Amendment"). The Fourth Amendment amended certain financial
covenants, 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 approximately $12,900, repaid $187,500 of outstanding
term loans under the Credit Facility and permanently reduced the amount
available under the Revolver 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 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 300 basis
points per annum minimum. As 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 100 basis points; 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.
12
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 Company 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 March 31, 2003 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 March 31, 2003 there were $15,000 in letters of credit outstanding
under the Revolver, none of which were drawn down.
In accordance with the 2002 Amendment, the Company prepaid $62,500 of the Term
Loan A on March 25, 2002. At March 31, 2003, $166,406 of the Term Loan A was
outstanding. Amortization of the Term Loan A commenced in September 2002 with
amounts being 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. For the period ended March 31, 2003, the Company repaid
approximately $7,031 of the Term Loan A.
In accordance with the 2002 Amendment, the Company prepaid $125,000 of the Term
Loan B on March 25, 2002. At March 31, 2003, $372,750 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. For the period ended March 31, 2003, the Company repaid approximately
$750 of the Term Loan B.
Capital Leases and Long Term Debt
During the three months ended March 31, 2003, the Company completed buyout of
certain of its capital lease obligations of approximately $12,655. The Company
recognized a gain of approximately $7,235 from the buyout net of asset costs of
$4,420 and payment of approximately $1,000. The gain is included in the Other
income, net line item on the statements of operations.
Contractual maturities of long-term debt, including capital leases over the next
5 years are as follows:
AGGREGATE AMOUNT
----------------
For the period April 1, 2003 through
December 31, 2003 $ 29,414
For the year ended December 31, 2004 46,765
For the year ended December 31, 2005 65,418
For the year ended December 31, 2006 222,156
For the year ended December 31 ,2007 663,380
During the quarter ended March 31, 2002, the Company completed two debt
repurchases for certain of its Senior Discount Notes. The Company retired
13
approximately $24,037 in face amount of debt with a book value of approximately
$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 approximately $7,875 were
issued. In addition, the Company incurred fees of approximately $180 and wrote
off debt issuance costs of approximately $292. The Company adopted SFAS No. 145
on January 1, 2003, accordingly in the condensed consolidated statements of
operations for the period ended March 31, 2002, the extraordinary gains on early
retirement of debt of $13,073 have been reclassified and are included in the
results from continuing operations. The adoption of this statement did not have
a material impact on the Company's financial statements, cash flows or results
from operations.
8. STOCK BASED COMPENSATION AND REDEEMABLE PREFERRED STOCK
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". 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.
Incentive Stock Options
The Company granted 34,000 and 38,250 Incentive Stock Options ("ISO's") with a
fair value under SFAS No. 123 of approximately $16 and $78 to employees during
the quarter ended March 31, 2003 and 2002, respectively.
Non-cash stock based compensation expense under SFAS No. 123 related to ISO's
recognized during the quarter ended March 31, 2003 and 2002 was approximately
$629 and $3,607, respectively. As of March 31, 2003, the Company had not
reflected approximately $2,918 of unamortized compensation expense in its
financial statements for options granted as of March 31, 2003. The unamortized
compensation expense is recognized over the ISO's vesting period, which is three
years.
Outperform Stock Option Plan
The Company granted Outperform Stock Options ("OSO's") during the quarter ended
March 31, 2003 of 750,000 including a 250,000 grant to a non-employee director.
The fair value of all OSO's granted in three months ended March 31, 2003 under
SFAS No. 123 was approximately $423. There were 53,000 OSO's granted during the
quarter ended March 31, 2002 with a fair value under SFAS No. 123 of
approximately $608.
Non-cash stock based compensation expense related to OSO's recognized during the
quarter ended March 31, 2003 was approximately $1,326 including the entire value
of the 250,000 OSO's granted to a non-employee director. Non-cash stock based
compensation expense for the quarter ended March 31, 2002 was approximately
$5,759.
As of March 31, 2003, the Company had not reflected $8,810 of unamortized
compensation expense in its financial statements for options granted as of March
31, 2003. The unamortized compensation expense is recognized over the OSO's
vesting period, which is five years.
14
Employee Stock Purchase Plan
The Company recorded $128 and $204 of non-cash compensation expense during the
quarter ended March 31, 2003 and 2002, respectively, relating to purchases of
stock by employees pursuant to its employee stock program.
Restricted Stock
The Company recorded $930 and $4,366 of non-cash compensation expense during the
quarter ended March 31, 2003 and 2002, respectively, relating to grants of
restricted stock to employees pursuant to its restricted stock program. During
the quarter ended March 31, 2003 and 2002, the Company cancelled 35,200 and
687,753 grants of restricted stock, respectively, resulting in a reduction to
non-cash compensation expenses for the quarter ended March 31, 2003 and 2002 by
approximately $964 and $11,360, respectively.
As of March 31, 2003, the Company had unearned compensation costs of $2,450
related to restricted stock which is being amortized to expense over the
restriction period.
Redeemable Preferred Stock
At March 31, 2003 the Company paid cumulative dividends in the amount of $79,604
in the form of additional Series A Preferred Stock. At March 31, 2003 the number
of common shares that would be issued upon conversion of the Series A Preferred
Stock was 8,457,890.
At March 31, 2003 the Company paid cumulative dividends in the amount of
$394,518 in additional shares of Series B Preferred Stock. At March 31, 2003 the
number of common shares that would be issued upon conversion of the Series B
Preferred Stock was 33,050,722.
9. LOSSES 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 before giving effect to gains
from the sale of the discontinued 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 during the period ending March 31, 2003
and 2002 and have a dilutive effect if the Company had income from continuing
operations are 41,508,612 and 35,445,598, respectively.
15
The following table is a reconciliation of the numerators and denominators of
the basic and diluted per share computations:
THREE MONTHS ENDED
------------------
MARCH 31,
---------
2003 2002
------------- -------------
Net loss from continuing operations $ (93,318) $ (111,043)
Income from discontinued operations
net of tax (2003 includes a gain on sale of $165134) 167,934 1,898
------------- -------------
Net income (loss) to common shareholder 74,616 (109,145)
Preferred dividend and accretion requirements (42,263) (39,526)
------------- -------------
Net income (loss) to common shareholder $ 32,353 $ (148,671)
============= =============
Basic and diluted loss per average common share:
Weighted average shares outstanding 110,165,770 101,826,546
============= =============
Loss per average common share from
Continuing operations $ (1.23) $ (1.48)
Gains from discontinued operations 1.52 .02
------------- -------------
Net income (loss) to common shareholders $ 0.29 $ (1.46)
============= =============
10. 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 gain (loss) adjustment
was $(6,773) and $3,074 for the three months ended March 31, 2003 and 2002,
respectively; the unrealized depreciation on investments was $654 and $2,699 for
the three months ended March 31, 2003 and 2002, respectively. Comprehensive
income (loss) for the three month period ended March 31, 2003 and 2002 was
$67,189 and $(108,770), respectively.
11. SEGMENT REPORTING
Management believes that the Company operates as one reportable operating
segment, which contains many shared expenses generated by the Company's various
revenue streams. 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.
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
16
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
March 31, 2003, all reports pursuant to the Exchange Act that we have filed
with, or furnished to, the SEC have been timely posted on our website.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of our financial condition and results of operations
should be read in conjunction with the unaudited condensed consolidated
financial statements and notes for the three months ended March 31, 2003, and
with the audited financial statements and notes included in the Company's
December 31, 2002 Annual Report on the Form 10-K filed with the Securities and
Exchange Commission.
You should carefully review the information contained in the 2002 Annual Report
on the Form 10-K and particularly consider the "Risk Factors" and "Critical
Accounting Policies" that we set forth in 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 these documents 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.
17
Except as discussed in Note 4, there has been no change to the Company's
critical accounting policies and use of estimates that are reported in the
Company's December 31, 2002 Annual Report on the Form 10-K.
INTRODUCTION
We are 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 917,000 average connections
during the three months ended March 31, 2003. We provide services 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 are also a party to the Starpower joint venture
with Pepco Communications, Inc. ("Pepco"), a subsidiary of Pepco Holdings, Inc.
("Potomac"), Starpower, serving the Washington, D.C. metropolitan market with
approximately 238,073 total service connections at March 31, 2003. We were the
incumbent franchised cable operator in many communities in central New Jersey
until these operations were sold on February 19, 2003.
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. We do not 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 we continue to increase the number of customers on
our network and increase the number of services per customer while lowering the
costs associated with the new subscribers and reducing the costs of providing
services by capturing economies of scale.
GENERAL
Our primary business is delivering bundled communications services, including
local and long distance telephone, video programming (including digital cable
TV) and data services (including cable modem, high speed Internet access and
dial-up Internet) to residential customers over our predominantly owned network.
We currently serve consumers in some of the most densely populated markets in
the U.S.
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 continue to launch Video-on-Demand (VOD), Subscription
Video-on-Demand (SVOD) and High Definition Television in certain markets in
2003.
18
Our services are typically delivered over our primarily owned high-speed,
high-capacity, fiber-optic network. Our network is a hybrid broadband
fiber-optic platform. This architecture allows us to bring our state-of-the-art
broadband network within approximately 900 feet of our 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 two strategic markets.
We are a party to the RCN-Becocom, LLC joint venture with NSTAR Communications,
Inc. ("NSTAR Communications"), a subsidiary of NSTAR, regarding construction of
our broadband network and operation of our telecommunications 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 RCN's stock, the Company had a profit(loss) sharing ratio
of 100% and an investment percentage of 70.24% in the RCN-Becocom joint venture.
The investment percentage represents the amount of any additional capital
investment in the venture that RCN has the right to invest. Results of
operations of RCN-Becocom are consolidated in our financial statements.
We are also a party to the Starpower 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. Through its subsidiaries, Potomac is engaged in regulated utility
operations and in diversified competitive energy and telecommunications
businesses. RCN and Pepco each own a 50% membership interest in Starpower. The
Starpower joint venture is accounted for in our financial statements under the
equity method of accounting and our pro-rata portion of Starpower's operating
results is included in the Equity in income of unconsolidated entities line in
our condensed consolidated statements of operations.
SEGMENT REPORTING
We believe that we operate as one reportable operating segment, which contains
many shared expenses generated by the 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 results of
operations of Starpower, which is not consolidated under GAAP. Such information,
however, does not represent a separate segment under GAAP and therefore it is
not separately disclosed.
For the purposes of measuring the financial and operational performance of the
Company, we consolidate the results of operations of all joint ventures
including Starpower, the results of which are not consolidated when the
Company's statements of financial position, cash flows and results of operations
are presented under generally accepted accounting principles
19
("GAAP"). The use of non-GAAP financial disclosures represents our view of the
total Company's consolidated operational results.
The following unaudited non-GAAP financial summary, highlights the Company's
results of operations on a consolidated basis for the three months ended March
31, 2003, had the results of operations of the Starpower joint venture been
consolidated with that of the Company for the same period:
RCN
Including Less (1)
Starpower (2) Starpower RCN (2) GAAP
---------------------------------------
Total sales $ 146,667 $ 22,209 $ 124,458
Total direct costs 47,852 5,700 42,152
-----------------------------------
Margin 98,815 16,509 82,306
Total operating and selling,
general and administrative
costs 96,964 12,574 84,390
-----------------------------------
Adjusted EBITDA (3) 1,851 3,935 (2,084)
Non-cash stock-based
compensation 2,049 -- 2,049
Impairment and special 80 - 80
charges
Depreciation and amortization 56,465 4,981 51,484
-----------------------------------
Operating loss $ (56,743) $ (1,046) $ (55,697)
===================================
(1) The Company owns 50% of Starpower, a joint venture in the Washington, D.C.
market which is accounted for as an equity investment in our condensed
consolidated financial statements. Results of operations of Starpower have been
presented here net of related party transactions with the company.
(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 5 of the Condensed Consolidated Financial Statements.)
(3) Adjusted EBITDA - Non GAAP measure calculated as net income (loss) before
interest, tax, depreciation and amortization, stock based compensation,
extraordinary gains and special charges that the Company and its chief
decision-makers use to measure performance and liquidity. Adjusted EBITDA is a
meaningful indicator of profitability for capital-intensive businesses, and is a
key valuation metric in the investment community. Other companies may calculate
and define EBITDA differently than RCN.
OVERVIEW OF OPERATIONS
Approximately 94% of the Company's revenue for the three months ended March 31,
2003 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 6% of revenue is mostly derived
from reciprocal compensation which is the fee local exchange carriers pay to
terminate calls on each other's networks.
The Company has historically recognized reciprocal compensation revenue, which
is the fee local exchange carriers pay to terminate calls on each other's
networks, as it was realized. This was due to the uncertainty of various legal
regulatory rulings that affected the Company's ability to accurately determine
the amount of reciprocal compensation revenue to recognize prior to the point in
time such amounts were
20
paid. Over the past year, the system limitations have been resolved and the FCC
has concluded on various tariff/interconnect rules that have now permitted the
Company to accurately estimate the amount of reciprocal compensation revenue to
be earned for calls terminated on the Company's network in the period such
services are rendered. Accordingly, during the quarter ended March 31, 2003, the
Company recognized approximately $7,100 of incremental reciprocal compensation
revenue as a result of this change in estimate. Approximately $4,100 of this
amount related to services rendered in calendar 2002.
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.
During the three months ended March 31, 2003, the Company has continued its
initiative set out in 2002 to reduce costs, increase operational efficiencies,
and realign resources to focus on core opportunities and product offerings. The
most significant decrease in operating, selling, general and administrative
expenses was due to reduced labor cost as a result of increased operational
efficiencies and the elimination of costs associated with the reduction and
elimination of construction in new markets.
During the first quarter 2003, the Company continued its review of expansion
plans in existing markets to achieve higher growth with lower incremental
capital spending. Capitalized construction material levels also continued to be
assessed based on the build-out requirements of our expansion plans. The
assessment process includes the identification of excess construction material
that cannot be used for alternative use and which is either to be returned to
vendors, or resold to a secondary market. During the three months ended March
31, 2003, there were no charges to write down excess construction material. The
Company is aware that the secondary market for construction materials is
changing, which could effect our salvage value.
In 2003, the Company will continue to conduct detailed reviews of facility
requirements against lease obligations to identify excess space. We are
continuing the process of consolidating space and exiting or subleasing excess
facilities and will recognize exist costs accordingly. The Company recorded
approximately $80 in net exit costs in the three months ended March 31, 2003.
(See Note 6 to the Unaudited Condensed Consolidated Financial Statements.)
Prior to the adoption of SFAS No. 145, we historically recorded gains upon the
early retirement of debt as an extraordinary item. In the first quarter of 2002
we recorded an extraordinary gain of $13,073 from the early retirement of debt
in which approximately $722 of cash was used. In accordance with SFAS No. 145
this gain has been reclassified. (See Note 7 to the Unaudited Condensed
Consolidated Financial Statements.) There was no early debt extinguishment in
the first quarter of 2003.
RESULTS OF OPERATIONS
Sales:
Total sales increased $13,077, or 11.7%, from $111,381 for the three months
ended March 31, 2002 to $124,458 for the three months ended March 31, 2003.
21
Sales by service offerings, which reflect certain internal allocations made for
bundled product sales, are as follows:
Three Months Ended March 31,
Increase (Decrease)
-------------------
2003 2002 ($) (%)
-----------------------------------------
Voice $ 37,921 $ 35,541 $ 2,380 6.7%
Video 53,318 46,902 6,416 13.7%
Data - high speed 11,959 7,055 4,904 69.5%
Data - Dial up 12,308 15,846 (3,538) -22.3%
Reciprocal Compensation 7,587 4,097 3,490 85.2%
Other 1,365 1,940 (575) -29.6%
----------------------------------------
Total sales $124,458 $111,381 $ 13,077 11.7%
========================================
About 40% of the increase in sales by service offering, excluding reciprocal
compensation and other, was the result of a higher number of average
connections, which increased 4.2% from 880,309 at March 31, 2002 to 917,000 at
March 31, 2003. Excluding the Starpower joint venture, average connections by
service offering are as follows:
Three Months Ended March 31, Increase (Decrease)
2003 2002 (#) (%)
------------------------------------------------------
Voice 235,558 208,907 26,651 12.8%
Video 387,689 375,878 11,811 3.1%
Data - Cable modem 150,121 107,111 43,010 40.2%
Data - Dial up 143,632 188,413 (44,781) -23.8%
----------------------------------------------------
Total connections 917,000 880,309 36,691 4.2%
====================================================
The change in average connections resulted in the following volume related
revenue variances for the three months ended March 31, 2003 for each service
offerings:
Voice $ 4,600
Video 1,500
Data - Cable modem 2,800
Data - Dial up (3,800)
---------
Total connections volume variance $ 5,100
=========
In addition, another 40% of the increase in sales by service offering, excluding
reciprocal compensation and other, was the result of higher average monthly
revenue per connection by service offering as follows:
Three Months Ended March 31, Increase (Decrease)
2003 2002 ($) (%)
-----------------------------------------------------
Voice $53.66 $56.71 $(3.05) (5.4)%
Video $45.84 $41.59 $ 4.25 10.2 %
Data - Cable modem $26.55 $21.96 $ 4.59 20.9 %
Data - Dial up $28.56 $28.03 $ 0.53 1.9 %
22
The change in average monthly revenues per connection resulted in the following
revenue variances for the three months ended March 31, 2003 for each service
offerings:
Voice $ (2,100)
Video 4,900
Data - Cable modem 2,100
Data - Dial up 200
--------
Total connections volume variance $ 5,100
========
For the three-month period ended ending March 31, 2003, reciprocal compensation
increased 85.2% due to a change in estimate related to these revenues. Due to
the uncertainty of various regulatory rulings that had affected the
collectibility of reciprocal compensation, we had recognized this revenue as it
was realized in periods prior to 2003. In 2003, based on regulatory changes and
our experience of realizing reciprocal compensation revenues, we changed our
estimate of reciprocal compensation revenues in the period reported. This change
resulted in our recording approximately $7,100 in additional reciprocal
compensation for the quarter ended March 31, 2003.
Other sales decreased $575 or (29.6)% from $1,940 for the three months ended
March 31, 2002 to $1,365 for the quarter ended March 31, 2003. The decrease was
due primarily to lower television production revenues and was partially offset
by an increase in cable advertising sales.
Costs and Expenses, Excluding Stock-Based Compensation, Depreciation and
Amortization:
Direct expenses, comprising of costs of providing services, decreased $4,538 or
9.7% from $46,690 for the three month period ended March 31, 2002 to $42,152 for
the three month period ended March 31, 2003. The decrease in direct expenses was
due primarily to lower voice and data network operating costs resulting from
network optimization and were partially offset by higher video costs resulting
from increases in video connections, franchise fees and increases in basic and
premium programming rates. Following is a table of direct costs by service type
for the three months ended March 31, 2003:
Three months ended March 31,
Increase (Decrease)
2003 2002 ($) (%)
------------------------------------------
Voice $ 9,635 $ 14,438 $ (4,803) -33.3%
Video 28,862 25,818 3,044 11.8%
Data 3,509 6,238 (2,729) -43.7%
Other 146 196 (50) -25.5%
-----------------------------------------
$ 42,152 $ 46,690 $ (4,538) -9.7%
=========================================
Operating, selling and general and administrative costs decreased $11,703 or
12.2% from $96,093 for the three months ended March 31, 2002 to $84,390 for the
three months ended March 31, 2003. Components of Operating, selling and general
and administrative costs are as follows:
23
For the three months ended March 31,
Increase (Decrease)
2003 2002 ($) (%)
------------------------------------------------------
Customer Services $ 26,195 $ 29,400 $ (3,205) -10.9%
Network operations and construction 10,840 13,904 (3,064) -22.0%
Marketing and advertising 3,804 4,649 (845) -18.2%
Sales 8,026 8,929 (903) -10.1%
Operating, general and administrative 35,525 39,211 (3,686) -9.4%
---------------------------------------------------
$ 84,390 $ 96,093 $(11,703) -12.2%
===================================================
Customer service costs decreased due to reduction in staff and temporary labor
costs of approximately $1,650 and $1,203, respectively. Other decreases of
approximately $350 were due to lower costs for facilities operating expenses
such as utilities and telephone.
Network operations and construction costs decreased approximately $3,064 due to
lower engineering and construction salaries and related benefits and taxes of
approximately $4,250. Additional reductions resulted from lower facilities costs
for rent, utilities and phone of approximately $1,120 and right-of-way use fees
of approximately $600. These reductions were offset by lower absorption of
network construction labor into capital projects of approximately $2,850 as we
continue to slow network expansion.
Marketing and advertising costs decreased $845 including advertising reductions
of approximately $640 resulting from lower agency fees, direct mail printing and
postage costs along with an increase in vendor co-op credits. An additional
reduction of $234 was due to lower marketing research costs.
Selling expenses decreased $903 from $8,929 for the three months ended March 31,
2002 to $8,026 for the same period in 2003. Decreases of approximately $620 were
due to reduced sales headcount. An additional reduction of outside telemarketing
labor of $355 also contributed to the decline is selling expenses.
The Operating, general and administrative expenses decreased $3,686 primarily as
the result of staff reductions and personnel related costs of approximately
$5,500. Additional decreases of approximately $1,560 resulted from the
implementation of computer systems for automated billing and data processing and
related reductions in maintenance costs. These decreases were partially offset
by increased property and franchise taxes of approximately $2,180 and an
increase in allowances for uncollectable receivables of approximately $1,020.
Non-cash Stock-Based Compensation:
The Non-cash stock-based compensation decreased $527 or 20.5%, from $2,576 for
the three months ended March 31, 2002 to $2,049 for the three months ended March
31, 2003. The decrease was due to the reduced fair value of stock options and
restricted stock granted in 2003 and the forfeiture of 35,200 grants of
restricted stock during the current quarter versus the forfeiture of 687,753
grants of restricted stock during the quarter ending March 31, 2002.
24
Depreciation and Amortization:
Depreciation and amortization expense decreased $22,191 or 30.1% from $73,675
for the three months ended March 31, 2002 to $51,484 for the three months ended
March 31, 2003. The decrease is due to the disposition and impairment in the
value of network construction materials, equipment and leasehold improvements as
we curtail our network expansion plans to preserve capital. Additional
reductions resulted from the sale of our central New Jersey system assets which
was completed in February 2003. In accordance with accounting rules, we ceased
depreciating the assets of the central New Jersey system when we entered into an
agreement to sell in August 2002. (See Note 5 to the Unaudited Condensed
Consolidated Financial Statements.)
Investment Income:
Investment income decreased $5,991 or 78.4% from $7,644 for the three months
ended March 31, 2002 to $1,653 for the three months ended March 31, 2003. The
decrease was a result of lower interest rates and a decrease in average cash,
temporary cash investments, short-term investments and restricted investments at
March 31, 2003 compared to March 31, 2002. Cash, temporary cash investments,
short-term investments, and restricted investments were $531,530 at March 31,
2002 compared to $441,360 at March 31, 2003 of which $224,437 was received in
cash proceeds from the sale of the central New Jersey assets between February
19, 2003 and March 4, 2003.
Interest Expense:
Interest expense increased $8,649 or 21.3% from $40,573 for the three months
ended March 31, 2002 to $49,222 for the three months ended March 31, 2003. The
increase resulted primarily from less interest having been capitalized during
the current period coupled with debt issuance costs and commitment fees incurred
to secure the Fifth Amendment to our Credit Agreement. (See Note 7 to the
Unaudited Condensed Consolidated Financial Statements.) These increases were
partly offset by lower accretion on the 11.125%, 9.8% and 11.0% senior discount
notes issued in October 1997, February 1998 and June 1998, respectively, and the
debt extinguishment from the tender offers in the first quarter of 2002.
Gain on Early Extinguishment of Debt:
A gain of $13,073 for the three months ended March 31, 2002 resulted from the
Company repurchasing certain of its long-term debt. The Company retired
approximately $24,037 in face value of debt with a book value of approximately
$22,142 for approximately $722 in cash and approximately 2,589,237 shares of
common stock with a value of $7,875, plus fees of $180 and the write-off of debt
issuance costs of $292. No debt was repurchased in the quarter ended March 31,
2003. The 2002 gain was recorded as an extraordinary gain, however, with the
adoption of SFAS No. 145 in 2003, the gain was reclassified to an ordinary gain
and is now reflected in loss from continuing operations before income taxes.
(See Note 7 to the Unaudited Condensed Consolidated Financial Statements.)
Other income, net:
Other income increased $5,267 or 577.5% from $912 for the three months ended
March 31, 2002 to $6,179 for the three months ended March 31, 2003. The increase
resulted primarily from a gain of approximately $7,235 recorded from the buyout
a capital lease.
25
Income Tax:
The Company's effective income tax rate was a provision of 0.01% on losses from
continuing operations for the quarter ended March 31, 2003 as a result of
estimated alternate minimum state tax rate requirements. For the quarter ended
March 31, 2002, the effective rate was a benefit of 0.50% of net losses for the
period. A tax provision of approximately $761 from the sale of discontinued
operations has been recorded as a reduction to the gain realized upon the sale.
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 Income of Unconsolidated Entities:
Equity in income of unconsolidated entities decreased $7,333 or 66.0% from
income of $11,114 for the three months ended March 31, 2002 to income of $3,781
for the three months ended March 31, 2003. The income of $3,781 for the three
months ended March 31, 2003 included income from Megacable of $4,339 and a loss
from Starpower of $558. Income of $11,114 in 2002 is comprised of the Company's
net share of the income from Megacable of $11,692, and losses from Starpower of
$558 and J2 Interactive of $20. The Company has imbedded goodwill in the
investment in Megacable which is no longer amortized in accordance with SFAS No.
142.
Minority Interest in Loss of Consolidated Entities:
Minority interest in loss of consolidated entities decreased $3,212 or 100.0% in
the three months ended March 31, 2003 as compared to the three months ended
March 31, 2002. Minority interest primarily represents the interest of NSTAR
Communications, Inc. in the results of RCN-Becocom. As discussed earlier,
following NSTAR's exchange of their joint venture ownership interest for RCN's
stock, our profit (loss) sharing ratio in the RCN-Becocom joint venture as of
March 31, 2003 was 100%. As a result, no minority interest was recorded for the
three months ended March 31, 2003.
Discontinued Operations:
On February 19, 2003, we completed the previously announced sale of our central
New Jersey cable system assets to Patriot Media & Communications CNJ, LLC
("Patriot"). The cash proceeds of the sale received by us were $242,844
including $18,407 net of purchase price adjustments of approximately $1,593 that
remains in escrow. After taking into account the net assets of the system,
transaction fees and amounts paid to acquire the minority interest, we recorded
a gain on the sale of approximately $165,134 net of taxes. In addition we
recorded net income of $2,830 from operation of the system from January 1, 2003
to February 19, 2003. 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 we do 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 cable system have been
reported as discontinued operations.
For the foregoing reasons, we recognized net income of $32,353 for the three
months ended March 31, 2003 or income of $0.29 per share.
26
LIQUIDITY AND CAPITAL RESOURCES
Our cash, temporary cash investments, and short-term investments decreased to
$205,309 at March 31, 2003 from $277,006 at December 31, 2002. The change
resulted primarily from $51,270 used in operating activities, $18,806 used in
financing activities and $226,020 provided by investing activities due mostly to
proceeds of the sale of our Central New Jersey unit which were partly offset by
additions to property, plant, equipment and construction materials.
Net cash of $ 51,270 used in operating activities consisted of approximately
$55,697 in net losses from continuing operations before preferred dividends and
accretion adjusted for non-cash items which included $8,954 for amortization of
debt financing costs and $51,484 in depreciation and amortization. In addition,
$23,097 was used in working capital consisting mostly of decreases in accounts
payable and accrued expenses of $10,786 as well as increases in accounts
receivable and related party receivables of $10,683.
Net cash of $226,020 provided by investing activities resulted from proceeds for
the sale of discontinued operations of $242,844 and decreases of short term
investments of $227,641 and reclassification of $219,538 to restricted cash
which includes $242,844 from the sale of discontinued operations in accordance
with the Credit Agreement which requires an amount equal to the net cash
proceeds of the sale in excess of $5,000 be deposited into a cash collateral
account. These increases were offset by additions to property, plant,
equipment and construction materials of $21,551 for continuing operations and
$2,191 for discontinued operations.
Cash used in financing activities of $18,806 consisted primarily of $7,781 in
debt repayment under our Term Loans, $1,427 in capital lease principal and
buyout payments and $9,598 of payments made for debt financing costs made
primarily to secure the Fifth Amendment to our Credit Agreement. (See Note 7 to
the Unaudited Condensed Consolidated Financial Statements.)
We have historically met our liquidity requirements through cash on hand,
amounts available under our Credit Facility, issuances of high-yield debt
securities in the capital markets and convertible preferred stock and common
stock to strategic investors. At March 31, 2003, we had approximately $205,309
in cash, temporary cash and short-term investments and $236,051 in restricted
cash. We believe that current available cash, cash equivalents, short-term
investments and proceeds from revenues will be sufficient to meet our
anticipated cash needs for working capital, capital expenditure and other
activities for at least through mid-2004. However, in order to meet our
long-term liquidity needs, we anticipate we will have to do by one of, or a
combination of, the following: (i) outperform our business plan, (ii) improve
our operational efficiencies, (iii) raise additional capital through issuance of
equity or debt securities, (iv) further amend our Credit Facility, (v)
restructure our balance sheet, and (vi) consummate additional asset sales. We
cannot assure that we will be able to implement any of the foregoing on
acceptable terms.
We expect to supplement our 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. We
may experience difficulty in raising capital 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. Further, the ability of telecommunications companies to
access those markets as well as their ability
27
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.
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.
We have used and continue to use capital raised from debt and equity offerings
to implement our business plan. However, we may seek additional financing, but
there can be no assurance that we will be able to obtain additional financing.
In addition to raising capital through the debt and equity markets, we may sell
or dispose of existing businesses or investments to fund portions of our
business plan. We may not be successful in producing sufficient cash flow,
reducing debt or raising sufficient debt or equity capital on terms that we may
consider acceptable. In addition, proceeds from dispositions of our assets may
not be sufficient to support operations or debt service.
On February 19, 2003, we consummated a previously announced sale of our central
New Jersey cable system assets to Patriot Media & Communications CNJ, LLC
("Patriot"). The cash proceeds of the sale received by us, after taking into
account the amount paid by Patriot to acquire the minority interest in the
portion of central New Jersey cable systems that was not owned by us and other
closing adjustments, was approximately $242,844 including approximately $18,407
that remains in escrow. We realized a net gain of approximately $165,134 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 we do 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 cable system have been reported as
discontinued operations.
Changes in the cable television, Internet and voice services markets may also
affect our ability to execute our business plan and achieve our 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 the Company's 2002 Annual
Report on the Form 10-K filed with the SEC.
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 entered into an amendment to the Credit Agreement dated March 7,
2003 (the "Fifth Amendment"). The Fifth Amendment enables the Company to incur
additional senior secured debt, adjusts the operating and financial covenants to
better reflect the Company's business plan and modifies certain other
restrictions. In connection with the Fifth Amendment, the Company paid certain
lenders fees of approximately $9,644. The Fifth Amendment also reduces the
28
amount available under the Revolver to $15,000, under which there were no
borrowings outstanding at March 31, 2003, 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. At March 31, 2003 the Company maintained cash
collateral of approximately $236,051 (of which $100,000 has been classified as
long-term). 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 the company'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.
At March 31, 2003 there were no loans outstanding 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 March 31, 2003, there were $15,000 in
letters of credit outstanding under the Revolver. At March 31, 2003 we also had
letters of credit outside the Revolver of $0 and $25,005 in escrow accounts
collateralized by restricted cash. As of March 31, 2003, a total of $539,156 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.
We can make no assurances that we would have been able to satisfy and comply
with the covenants under the Credit Agreement if we had not negotiated and
entered into the Amendment, which could have resulted in an event of default
under the Credit Agreement. Our ability to maintain our liquidity and maintain
compliance with the amended covenants under the Credit Agreement is dependent
upon our ability to achieve the covenants in the recently amended Credit
Agreement. We can make no assurances that we will be able to achieve the new
covenants in the long-term. We can make no assurances that our business will
generate sufficient cash flow from operations or that existing available cash or
future borrowings will be available to us under the Credit Facility in an amount
sufficient to enable us to pay our indebtedness or to fund our other liquidity
needs.
If we were adversely impacted by unforeseen business conditions, we 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 our ability to obtain additional modifications, if necessary, we may incur
additional costs in the form of fees or interest expense for any such
modifications. In the event that we fail to satisfy or comply with any of the
financial or negative covenants of the amended Credit Agreement and are 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
29
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
us. We do not have sufficient cash resources to repay our outstanding
indebtedness if it is declared immediately due and payable.
We are 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,
we may from time to time acquire certain of these outstanding debt securities
for cash or in exchange for shares of 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.
We have indebtedness that is substantial in relation to the shareholders' equity
and cash flow. At March 31, 2003 we had an aggregate of approximately $1,732,519
of indebtedness outstanding including capital lease obligations. We also have
cash, cash equivalents and short-term investments aggregating approximately
$205,309. We had the following contractual obligations at our latest fiscal year
end dated March 31, 2003 are as follows:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-------------------------------------
LESS THAN 1-3 4 - 5 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS YEARS
- ----------------------- ---------- ---------- ---------- ---------- ----------
Senior Notes $1,184,657 $ - $ $ 807,899 376,758
Term Loans 539,156 38,156 118,500 382,500 -
Capital Leases 12,489 1,383 3,077 1,576 6,453
Operating Leases 295,443 30,868 52,069 57,711 154,795
---------- ---------- ---------- ---------- ----------
Total Contractual Cash Obligations $2,031,745 70,407 173,646 $1,249,686 538,006
At March 31, 2003, we 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 21,810 20,410 1,400
---------- ---------- ---------- ---------- ----------
Total Other Commercial Commitments $ 36,810 $ 35,410 $ 1,400 $ - $ -
========== ========== ========== ========== ==========
As a result of our substantial indebtedness, our fixed charges are expected to
exceed our 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.
30
The extent of our leverage may have the following consequences: (i) limit our
ability 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 our cash flows from operations be dedicated to the
payment of principal and interest on our indebtedness and therefore not be
available for other purposes; (iii) limit our flexibility in planning for, or
reacting to, changes in our business; (iv) place us at a competitive
disadvantage as compared with less leveraged competitors; and (v) render us more
vulnerable in the event of a downturn in our business.
We have two tranches of redeemable preferred stock, Series A and Series B. At
March 31, 2003 we had paid cumulative dividends in the amount of $474,122 in the
form of additional Series A and B Preferred Stock. At March 31, 2003 the number
of common shares that would be issued upon conversion of the Series A and B
Preferred Stock was 41,508,612.
We have an investment portfolio. The objective of our "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.
NEW ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for
Obligations Associated with the Retirement of Long-Lived Assets." SFAS No. 143
is effective for fiscal years beginning after June 15, 2002, and 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 the assets useful-life. The Company adopted
SFAS No. 143 on January 1, 2003 and the adoption of this statement did not have
a material impact on the Company's financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission on FASB Statements No.
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. The Company adopted
SFAS No. 145 on January 1, 2003. Accordingly in the condensed consolidated
statements of operations for the period ended March 31, 2002, the extraordinary
gains on early retirement of debt has been reclassified. See Note 7 on Long-term
debt for discussion on SFAS No. 145. The adoption of this statement did not have
a material impact on the Company's financial position or results of operations.
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 rather than when a company commits
to such an activity. It also establishes fair value as the objective for initial
measurement of the liability. The Company adopted the provisions of SFAS No. 146
on January 1, 2003. See Note 6 on Accrued Exit Costs for discussion on the
impact of adopting SFAS No. 146.
31
In November 2002, the FASB issued Financial Interpretation No. 45 ("FIN 45"),
"Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." 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 requires a guarantor 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 adoption of the recognition and initial measurement requirements
of FIN 45 did not have a material impact on the financial position, cash flows
or results of operations of the Company.
In January 2003, the FASB issued 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 financial position, results of
operations and cash flows particularly as it relates to the Company's interest
in Starpower and Megacable.
32
Item 3. Quantitative & Qualitative Disclosures About Market Risk.
The Company has adopted Item 305 of Regulation S-K "Quantitative & qualitative
disclosures about market risk" which is effective in financial statements for
fiscal years ending after June 15, 1998. The Company currently has no items that
relate to "trading portfolios". Under the "other than trading portfolios" the
Company does have four short-term investment portfolios categorized as available
for sale securities that are stated at cost, which approximates market, and
which are re-evaluated at each balance sheet date and one portfolio that is
categorized as held to maturity which is an escrow account against a defined
number of future interest payments related to the Company's (10% Senior Discount
Notes). These portfolios consist of Federal Agency notes, Commercial Paper,
Corporate Debt Securities, Certificates of Deposit, U.S. Treasury notes, and
Asset Backed Securities. The Company believes there is limited exposure to
market risk due primarily to the small amount of market sensitive investments
that have the potential to create material market risk. Furthermore, the
Company's internal investment policies have set maturity limits, concentration
limits, and credit quality limits to minimize risk and promote liquidity. The
Company did not include trade accounts payable and trade accounts receivable in
the "other than trading portfolio" because their carrying amounts approximate
fair value.
The objective of the company's "other than trading portfolio" is to invest in
high quality securities and seeks to preserve principal, meet liquidity needs,
and deliver a suitable return in relationship to these guidelines.
Item 4. Controls and Procedures.
Within 90 days prior to the filing of this report, we preformed an evaluation,
under the supervision and with the participation of management, including the
Chief Executive and Chief Financial officers of our disclosure controls and
procedures (as defined in Rules 13a-14 15d-14 under the Securities and Exchange
Act of 1934). Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in period filings with the Securities and Exchange Commission.
There were no significant changes in our internal controls or in other factors
that could significantly affect these internal controls subsequent to the date
of our most recent evaluation.
33
Part II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
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.
(b.) Reports on Form 8-K
On March 13, 2003, the Company announced its financial results for the
quarter and year ended December 31, 2002 and the departure of our Chief
Financial Officer, Jeff White. The contents of that press release are
described in Exhibit 99.2 to the Form 8-K and incorporated herein by
reference.
On March 11, 2003, the Company announced that it had entered into an
amendment to its senior secured credit facility (the "Fifth Amendment")
dated March 7, 2003. The amendment and a press release dated March 10, 2003
with respect thereto were filed with an 8-K as Exhibits 4.1 and 99.1 and
are incorporated herein by reference.
On February 20, 2003, the company announced that it had completed its sale
of its central New Jersey cable systems to Patriot Media and Communications
CNJ, LLC. The contents of that press release were filed with a Form 8-K and
incorporated herein by reference.
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: May 14, 2003
/s/ TIMOTHY J. STOKLOSA
----------------------------
Timothy J. Stoklosa
Executive Vice President
35
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Section 302 Certification
I, David C. McCourt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of RCN Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly 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
quarterly 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: May 14, 2003 /s/ DAVID C. MCCOURT
-------------------------------
Name: David C. McCourt
Title: Chief Executive Officer
36
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Section 302 Certification
I, Timothy J. Stoklosa, certify that:
1. I have reviewed this quarterly report on Form 10-Q of RCN Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly 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
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
quarterly 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: May 14, 2003 /s/ TIMOTHY J. STOKLOSA
---------------------------------
Name: Timothy J. Stoklosa
Title: Executive Vice President
37