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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 June 30, 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 (I.R.S. Employer
incorporation or organization) Identification No.)
105 Carnegie Center
Princeton, New Jersey 08540
(Address of principal executive offices)
(Zip Code)
(609) 734-3700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock ($1.00 par value), as of June 30, 2003.
Common Stock 111,170,504
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 and Six Months Ended June 30, 2003 and 2002
Condensed Consolidated Balance Sheets at June 30, 2003 and
December 31, 2002
Condensed Consolidated Statements of Cash Flows
for the Three and Six Months Ended June 30, 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 4. Submission of Matters to a Vote of Security Holders
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)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Sales $ 121,648 $ 114,255 $ 246,108 $ 225,638
Costs and expenses, excluding non-cash stock based
compensation, depreciation and amortization
Direct expenses 44,499 46,526 86,651 93,217
Operating and selling, general and
administrative 71,115 92,311 155,504 188,403
Non-cash stock based compensation 2,798 11,825 4,847 14,402
Impairments and special charges, net 6,571 892,284 6,651 891,806
Depreciation and amortization 46,287 85,389 97,771 159,064
------------- ------------- ------------- -------------
Operating loss (49,622) (1,014,080) (105,316) (1,121,254)
Investment income 2,041 2,840 3,694 9,150
Interest expense 45,689 39,025 94,912 79,598
Gain on early extinguishment of debt -- -- -- 13,073
Other income (expense), net 2,384 (3,303) 8,533 (1,056)
------------- ------------- ------------- -------------
Loss from continuing operations before income taxes (90,886) (1,053,568) (188,001) (1,179,685)
Income tax provision (benefit) -- (130) 12 (880)
------------- ------------- ------------- -------------
Loss from continuing operations before equity
in unconsolidated entities and minority interest (90,886) (1,053,438) (188,013) (1,178,805)
Equity in income (loss) of unconsolidated entities 6,904 (35,030) 10,686 (23,916)
Minority interest in loss of consolidated entities -- 33,438 -- 36,650
------------- ------------- ------------- -------------
Net loss from continuing operations (83,982) (1,055,030) (177,327) (1,166,071)
Discontinued operations (see Note 5)
Income from discontinued operations, (including
net gain on disposal of $165,989) 532 819 169,216 2,717
Income tax provision 5 -- 726 --
------------- ------------- ------------- -------------
Gain from discontinued operations 527 819 168,490 2,717
Net loss (83,455) (1,054,211) (8,837) (1,163,354)
Preferred dividend and accretion requirements 42,978 40,193 85,241 79,718
------------- ------------- ------------- -------------
Net loss to common shareholders $ (126,433) $ (1,094,404) $ (94,078) $ (1,243,072)
============= ============= ============= =============
Basic and diluted loss per common share
Net loss from continuing operations $ (1.15) $ (10.47) $ (2.38) $ (12.07)
============= ============= ============= =============
Net income from discontinued operations 0.00 0.01 1.53 0.03
------------- ------------- ------------- -------------
Net loss to common shareholders $ (1.15) $ (10.46) $ (0.85) $ (12.04)
============= ============= ============= =============
Weighted average shares outstanding, basic
and diluted 110,564,300 104,591,255 110,366,753 103,223,747
============= ============= ============= =============
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)
June 30, December 31,
2003 2002
----------- -----------
ASSETS
Current Assets:
Cash and temporary cash investments $ 52,274 $ 49,365
Short-term investments 65,815 227,641
Accounts receivable from related parties 12,240 10,207
Accounts receivable, net of reserve for
doubtful accounts of $14,583 and $10,705 53,687 56,915
Unbilled revenues 500 770
Interest and dividends receivable 1,391 1,595
Prepayments and other current assets 36,730 17,835
Short-term restricted investments (Note 7) 139,753 34,920
Current assets of discontinued operations -- 3,971
----------- -----------
Total current assets 362,390 403,219
Property, plant and equipment, net of
accumulated depreciation of $903,101 and $809,000 1,168,682 1,234,939
Investments in joint ventures and equity securities 234,143 228,231
Intangible assets, net of accumulated
amortization of $18,156 and $64,912 1,612 1,741
Goodwill, net 6,130 6,130
Long-term restricted investments (Note 7) 100,000 --
Deferred charges and other assets 45,054 43,606
Noncurrent assets of discontinued operations -- 72,416
----------- -----------
Total assets $ 1,918,011 $ 1,990,282
=========== ===========
4
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Current maturities of long-term debt $ 41,891 $ 37,417
Accounts payable 19,844 28,016
Accounts payable to related parties 6,475 13,558
Advance billings and customer deposits 28,047 27,940
Accrued exit costs 29,357 30,667
Accrued expenses 146,537 176,866
Current liabilities of discontinued operations -- 3,852
----------- -----------
Total current liabilities 272,151 318,316
----------- -----------
Long-term debt 1,686,489 1,706,997
Other deferred credits 6,044 4,166
Minority interest -- 791
Commitments and contingencies
Redeemable preferred stock, Series A, convertible,
par value $1 per share; 708,000 shares authorized, 335,372
and 323,934 shares issued and outstanding, respectively 328,116 316,342
Redeemable preferred stock, Series B, convertible,
par value $1 per share; 2,681,931 shares
authorized, 2,080,297 and 2,009,335 shares issued and
outstanding, respectively 2,061,552 1,988,084
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, 111,853,391
and 110,795,577 shares issued and 111,170,504
and 110,112,690 shares outstanding, respectively 111,853 110,796
Class B Common stock, par value $1 per share,
400,000,000 shares authorized, none issued
and outstanding -- --
Additional paid-in-capital 1,458,224 1,451,744
Cumulative translation adjustments (11,907) (5,134)
Unearned compensation expense (2,844) (4,336)
Unrealized appreciation on investments 1,379 1,484
Treasury stock, 682,867 shares at cost (9,583) (9,583)
Accumulated deficit (3,983,463) (3,889,385)
----------- -----------
Total shareholders' deficit (2,436,341) (2,344,414)
----------- -----------
Total liabilities, redeemable preferred stock and
common shareholders' deficit $ 1,918,011 $ 1,990,282
=========== ===========
5
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
RCN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
For the For the
Six months ended Six months ended
June 30, 2003 June 30, 2002
----------------- ----------------
Cash flows from operating activities
Net loss $ (8,837) $(1,163,354)
--------- -----------
Income from discontinued operations 2,501 2,717
Net loss from continuing operations (11,338) (1,166,071)
Adjustments to reconcile net income (loss) from
continuing operations to net cash used in
operating activities:
Accretion of discounted debt 11,715 37,591
Amortization of financing costs 10,981 9,594
Non-cash stock based compensation expense 4,847 14,402
Gain on sale of assets (8,118) (465)
Gain on early extinguishment of debt -- (13,073)
Gain on sale of discontinued operation (165,989) --
Depreciation and amortization 97,771 159,060
Income taxes, net 12 --
Deferred income taxes, net -- (880)
Provision for losses on accounts receivable 10,380 6,514
Write down on non-marketable investment -- 2,250
Equity in (income) loss of unconsolidated entities (10,686) 23,916
Impairments and special charges 6,651 891,806
Minority interest -- (36,495)
--------- -----------
(53,774) (71,851)
Net change in working capital (66,461) (55,631)
--------- -----------
Net cash used in continuing operations (120,235) (127,482)
Cash provided by discontinued operations 4,622 4,187
--------- -----------
Net cash used in operating activities (115,613) (123,295)
--------- -----------
6
Cash flows from investing activities:
Additions to property, plant and equipment (36,367) (77,990)
Short-term investments 161,825 45,124
Investment in unconsolidated joint venture -- (7,500)
Proceeds from sale of assets 2,628 4,048
Proceeds from sale of discontinued operations 242,844 --
Discontinued operations (2,191) (722)
Increase in restricted cash -- (16,380)
Increase in investments restricted for debt service (221,344) --
--------- -----------
Net cash provided by (used in) investing activities 147,395 (53,420)
--------- -----------
Cash flows from financing activities:
Repayment of long-term debt (15,563) (187,500)
Repayment of capital lease obligations (1,427) (741)
Payments made for debt financing costs (11,883) (11,843)
Contribution from minority interest -- 87
--------- -----------
Net cash used in financing activities (28,873) (199,997)
--------- -----------
Net increase (decrease) in cash and temporary
cash investments 2,909 (376,712)
Cash and temporary cash investments at beginning of period 49,365 476,220
--------- -----------
Cash and temporary cash investments at end of period $ 52,274 $ 99,508
========= ===========
Supplemental disclosures of cash flow information
Cash paid during the periods for:
Interest (net of $681 and $8,040 capitalized as of
June 30, 2003 and 2002, respectively) $ 58,986 $ 41,943
========= ===========
Income taxes $ 56 $ --
========= ===========
The accompanying notes are an integral part of these Condensed Consolidated
Financial Statements.
7
RCN CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED JUNE 30, 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 consolidated 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 consist 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 June 30, 2003 are not necessarily
indicative of operating results expected for the full year or future interim
periods. These unaudited condensed consolidated financial statements should be
read in conjunction with the audited financial statements and notes thereto
included in the Company's December 31, 2002 Annual Report on Form 10-K filed
with the SEC.
2. OPERATIONS AND LIQUIDITY
At June 30, 2003, the Company had approximately $118,089 in cash, temporary cash
and short-term investments and $239,753 in restricted cash. The Company believes
that current cash, including available restricted 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 into the first quarter of 2004. In order for the Company to meet its
liquidity needs through mid-2004 and beyond, 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, (vi) alter capital deployment plans, and
(vii) consummate additional asset sales. During the three months ended June 30,
2003, the Company entered into a $41,500 Senior Secured Credit Facility, and
during July 2003, entered into a definitive agreement to sell its Carmel, NY
cable system, and commenced a cash tender offer to purchase a portion of its
outstanding Senior Notes. (See Notes 7, Long-Term Debt and 12, Subsequent
Events, to the Unaudited Condensed Consolidated Financial Statements for
additional discussion relating to these actions.) The Company can offer no
assurances that it will be able to implement any additional actions on
acceptable terms.
If the Company were (i) unable to implement any additional actions as described
above, (ii) adversely impacted by any unforeseen business conditions and/or
(iii) unable to comply with the financial and negative covenants of the Credit
Agreement, the lenders under the Credit Facility would be entitled to declare
the outstanding borrowings under the Credit Facility immediately due and payable
and exercise any or all of their other rights and remedies. In addition, any
such acceleration of amounts due under the Credit Facility would, due to cross
default provisions in the indentures governing the Company's Senior Notes,
entitle holders of Senior Notes to declare the Senior Notes and any accrued and
unpaid interest thereon immediately due and payable. Any such acceleration or
other exercise of rights and remedies by lenders under the Credit Facility
and/or holders of Senior Notes would have a material adverse effect on the
Company. The Company does not have sufficient cash resources to repay our
outstanding indebtedness if it is declared immediately due and payable.
See Note 7, Long-Term Debt for further discussion relating to the Company's
long-term debt.
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
8
the assets useful life. The Company is primarily subject to asset retirement
obligations associated with its cable franchise agreements, which are subject to
the provisions of this statement. Cable franchise agreements frequently contain
clauses requiring that the Company remove its facilities from the public rights
of way upon the expiration or termination of the agreement, creating an asset
retirement obligation. Local governments may choose not to exercise these rights
as the facilities could be considered useful improvements. The Company has
concluded that the fair value of these obligations cannot be reasonably
estimated because neither the settlement date of the asset retirement obligation
nor the probability of enforcement of the remediation clauses are currently
determinable. The Company has insufficient historical data to reasonably
determine the probability of whether the remediation terms of the agreements
will be enforced and to what extent. In addition, the Company is unable to
estimate a potential range of settlement dates due to its intent and ability to
renew the franchise agreement after the initial franchise expiration. A
liability for the asset retirement obligation associated with the Company's
franchise agreement will be recorded if, and when, a reasonable estimate of fair
value can be determined. 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, Long-Term
Debt, for additional discussion regarding the Company's adoption of 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, Impairment Charges and Accrued Exit Costs, for
discussion regarding the Company's adoption of 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 Financial Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", which expands upon and
strengthens existing accounting guidance concerning when a company should
include in its financial statements the assets, liabilities and activities of
another entity. Prior to the issuance of FIN 46, a company generally included
another entity in its consolidated financial statements only if it controlled
the entity through voting interests. FIN 46 now requires a variable interest
entity, as defined in FIN 46, to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's 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 does not have any interest in any entity that require disclosure or
consolidation as a result of adopting the provisions of FIN 46. In May 2003, the
FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity". This statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. This statement
is effective for financial instruments entered into or modified after May 31,
2003 and otherwise is effective at the beginning of the first interim
9
period beginning after June 15, 2003. The Company is currently evaluating the
impact the adoption of SFAS No. 150 will have on its financial position, results
of operations and cash flows.
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.
Reciprocal compensation revenue 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 and regulatory rulings as well as the Company's inability to
accurately determine the amount of reciprocal compensation revenue to recognize
prior to the point in time such amounts were paid, principally due to the manner
in which the information was reported by the counterparty. Over the past year,
the FCC has ruled 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 first six months of 2003, the
Company recognized approximately $10,852 of incremental reciprocal compensation
revenue. Approximately $4,100 of this amount related to services rendered in
fiscal 2002.
5. DISCONTINUED OPERATIONS
a) During the first quarter of 2003, the Company closed the sale of 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 has been reimbursed for
certain post-signing expenditures related to upgrades to the central New Jersey
network being performed by the Company. The central New Jersey network services
approximately 80,000 customers. The transaction was structured as an asset
purchase, with the buyer assuming certain liabilities related to the business.
The Company recorded a gain of approximately $165,989 from sale of the assets of
the discontinued operations net of taxes, transaction fees and minority
interest. At June 30, 2003, approximately $16,511 of the cash proceeds from the
sale of assets are being held in an escrow account for potential losses for
which the purchaser of the central New Jersey cable system and its affiliates
may be entitled to indemnification under the terms of the agreement governing
the sale of the central New Jersey cable system. 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
were 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:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2003 2002 2003 2002
----- ------- ------ -------
Sales $ -- $13,732 $7,428 $26,886
Direct expenses -- 4,910 2,907 9,057
Operating and selling, general and
administrative, and depreciation
and amortization expense (282) 6,912 1,694 12,532
Income before tax 532 819 3,227 2,717
Income after tax $ 527 $ 819 $2,501 $ 2,717
The current and noncurrent assets and liabilities, at December 31, 2002, of the
central New Jersey operation were as follows:
10
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
Advance 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
(expense), net line item in the statement of operations.
6. IMPAIRMENT CHARGES AND ACCRUED EXIT COSTS
The total asset impairment and other charges are comprised of the following:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2003 2002 2003 2002
------ -------- ------ --------
Impairment of property, plant
and equipment $ -- $734,821 $ -- $734,821
Abandoned assets -- 52,071 -- 52,071
Construction materials -- 56,995 -- 61,322
Goodwill -- 38,927 -- 38,927
Franchises -- 1,379 -- 1,379
Exit costs for excess facilities - net 6,571 8,091 6,651 3,286
------ -------- ------ --------
Total impairment and other charges $6,571 $892,284 $6,651 $891,806
====== ======== ====== ========
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 reduce
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.
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 June 30, 2003 and 2002 the Company
recognized approximately $250 and $1,202, respectively, and during the six
months ended June 30, 2003 and 2002, the Company recognized approximately $250
and $3,251, respectively, in additional accrued costs and penalties
11
which are included in the operating and selling, general and administrative
expenses in the statement of operations. Additionally, during the six months
ended June 30, 2003 and 2002, the Company recognized approximately $2,252 and
$784, respectively, of recoveries resulting from settlements and changes in
estimates related to certain franchise obligations primarily as a result of
negotiations with franchise authorities.
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 six months ended June 30, 2003 and 2002, the Company recorded additional
accrued costs to exit excess facilities of approximately $6,590 and $14,197,
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 six months ended June 30, 2003 and 2002, the
Company recognized approximately $340 and $10,911, respectively, of recoveries
resulting from settlements and changes in estimates related to certain lease
obligations as a result of negotiations with landlords and/or better than
expected sublease rentals.
The total activity for the six months ended June 30, 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.
Exit Costs
Franchise Facility Total
--------- ----------- --------
Balance, December 31, 2002 $ 15,595 $ 15,072 $ 30,667
Additional accrued costs 250 6,590 6,840
Recoveries (2,252) (340) (2,592)
Payments (270) (5,288) (5,558)
-------- -------- --------
Balance, June 30, 2003 $ 13,323 $ 16,034 $ 29,357
======== ======== ========
7. LONG-TERM DEBT
Long-term debt, including capital leases, outstanding at June 30, 2003 and
December 31, 2002 is as follows:
June 30, December 31,
2003 2002
---------- ------------
Term Loans $ 531,375 $ 546,938
Evergreen Facility 346 --
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 145,022 137,459
Senior Notes 10.125% due 2010 231,736 231,736
Capital Leases 12,002 24,187
---------- ----------
Total 1,728,380 1,744,414
Current maturities of long-term debt, including capital leases 41,891 37,417
---------- ----------
Total Long-Term Debt $1,686,489 $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
12
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"). Since that time, the
Credit Agreement, including amounts available under the Credit Facility, has
been amended, including 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 $7,062. The Fifth Amendment also reduces the
amount available under the Revolver to $15,000, under which there were no
borrowings outstanding at June 30, 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 June 30, 2003 the Company maintained cash
collateral relating to the Fifth Amendment, of approximately $208,000 (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. 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.
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 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 earnings before
interest, income taxes, depreciation and amortization ("EBITDA") was at least
$60,000 in the aggregate for the two most recent consecutive fiscal quarters. In
connection with the Fourth Amendment, each of the lenders party thereto also
agreed to waive any default or event of default under the Credit Agreement that
may have occurred prior to the date of the 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 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.
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 June 30, 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 June 30, 2003, there were $15,000 in letters of credit outstanding
under the Revolver, none of which were drawn down.
13
In accordance with the Fourth Amendment, the Company prepaid $62,500 of the Term
Loan A on March 25, 2002. At June 30, 2003, $159,375 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 six months ended June 30, 2003, the Company repaid
approximately $14,063 of the Term Loan A.
In accordance with the Fourth Amendment, the Company prepaid $125,000 of the
Term Loan B on March 25, 2002. At June 30, 2003, $372,000 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 six months ended June 30, 2003, the Company repaid
approximately $1,500 of the Term Loan B.
In June 2003, the Company entered into a $41,500 Commerical Term Loan and Credit
Agreement (the "Evergreen Facility") with Evergreen Investment Management
Company, LLC and certain of its affiliates ("Evergreen"). Evergreen's commitment
expires September 4, 2003. Any term loans made under the Evergreen Facility will
mature on June 30, 2008. The interest rate on the Evergreen loans is 12.5% per
annum; however, no cash interest is payable until April 1, 2006. The interest
rate is subject to upward adjustment in the event the Company incurs new
indebtedness within 90 days after closing at a higher rate. In the event the
Company or certain of its subsidiaries receive net proceeds in respect of
certain prepayment events such as asset sales or casualty events and such net
proceeds are not applied to the repayment of amounts outstanding under the
Senior Credit Facility, the Company must repay the Evergreen loans in an
aggregate amount equal to such net proceeds or use such proceeds to acquire
telecommunications assets, or for working capital. Following the termination of
the Senior Credit Facility, the Company must apply 50% of the net proceeds from
such assets sales or casualty events to repay the Evergreen loans and not to
reinvestment. The Company must apply 50% of excess cash flow for each fiscal
year commencing on the earlier of (i) the fiscal year ending December 31, 2007
or (ii) the fiscal year in which all amounts outstanding under the Senior Credit
Facility have been paid in full or the Senior Credit Facility does not prohibit
such payment to prepay the Evergreen loans, provided that any lender may waive
its right to receive the amount of such mandatory prepayment, and any amount
will be applied to the mandatory prepayment of other Evergreen loans on a pro
rata basis. Evergreen has a second priority lien on substantially all assets of
the Company. The Evergreen Facility contains affirmative covenants, negative
covenants and events of default substantially similar to those set forth in the
Credit Facility. Upon closing, the Company paid a 4% or $1,660 funding fee to
Evergreen. As of June 30, 2003, $41,500 was available to be drawn down from the
Evergreen Facility and approximately $346, relating to interest, was
outstanding.
In connection with the signing of the Evergreen Facility, the Company issued
warrants to Evergreen to purchase 4,150,000 shares of Common stock at an initial
exercise price of $1.25 per share. The warrants are exercisable any time
following three months from their issuance. The Company valued the warrant using
the Black-Scholes pricing model, applying an expected life of 5 years, a
weighted average risk-free rate of 3.5%, a volatility of 70% and a deemed value
of Common stock of $1.67 per share. The estimated value of the warrant, $4,026
was recorded as an other non-current asset to be amortized over the next 5
years.
Capital Leases
During the six months ended June 30, 2003, the Company completed a 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 (expense), net line item on the statement of operations.
Contractual maturities of long-term debt, including capital leases over the next
5 years are as follows:
Aggregate Amount
----------------
For the period July 1, 2003 through
December 31, 2003 $ 21,191
For the year ended December 31, 2004 46,722
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
14
During the quarter ended March 31, 2002, the Company completed various debt
repurchases for certain of its Senior Discount Notes. The Company retired
approximately $24,037 in face amount of debt with a book value of approximately
$22,142. The Company recognized an extraordinary gain of approximately $13,073
from the early retirement of debt in which approximately $722 of 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 SFAS No. 145 did not have a
material impact on the Company's financial statements, cash flows or results
from operations.
8. STOCK BASED COMPENSATION, 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 period of the option 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 from that date forward are now
accounted for under the recognition provisions of SFAS 123.
The tables below reflect the grants and compensation expense recorded for the
three and six months ended June 30, 2003 and 2002 for the Incentive Stock Option
("ISO") and the Outperform Stock Option ("OSO") plans.
Three Months Ending June 30, 2003 Three Months Ending June 30, 2002
------------------------------------------ ------------------------------------------
Unamortized Unamortized
compensation compensation
Granted Fair Value expense Granted Fair Value expense
------- ---------- ------------ ------- ---------- ------------
ISO 77,200 $72 $2,329 60,850 $118 $15,245
OSO -- $-- $7,614 10,000 $ 61 $44,966
Non-cash stock based compensation expense
Three Months Ending June 30, Six Months Ending June 30,
-------------------------------- ---------------------------------
2003 2002 2003 2002
------ ------ ------ -------
ISO $ 629 $3,460 $1,258 $ 7,066
OSO $1,197 $5,772 $2,522 $11,531
Incentive Stock Options
The unamortized compensation expense is recognized over the ISO's vesting
period, which is three years.
Outperform Stock Option Plan
The unamortized compensation expense is recognized over the OSO's vesting
period, which is five years.
Employee Stock Purchase Plan
The Company recorded $108 and $229 of non-cash compensation expense during the
three and six months ended June 30, 2003 respectively, and $263 and $512 of
non-cash compensation expense during the three and six months ended June 30,
2002, respectively, relating to purchases of stock by employees pursuant to its
employee stock program.
Restricted Stock
The Company recorded $871 and $2,328 of non-cash compensation expense during the
three months ended June 30, 2003 and 2002, respectively, and $837 and $(4,667)
for the six months ended June 30, 2003 and 2002, respectively, relating to
grants of restricted stock to employees pursuant to its restricted stock
program. During the three and six
15
months ended June 30, 2003, the Company cancelled approximately 41,300 and
35,200 grants of restricted stock, respectively, resulting in a reduction to
non-cash compensation expense for the three and six months ended June 30, 2003
by approximately $55 and $964, respectively. During the three and six months
ended June 30, 2002, the Company cancelled approximately 31,300 and 698,000,
grants of restricted stock, respectively, resulting in a reduction to non-cash
compensation expense for the three and six months ended June 30, 2002 by
approximately $164 and $11,360, respectively.
As of June 30, 2003, the Company had unearned compensation costs of $2,844
related to restricted stock which is being amortized to expense over the
restriction period.
Redeemable Preferred Stock
At June 30, 2003, the Company had paid cumulative dividends in the amount of
$85,372 in the form of additional Series A Preferred stock. At June 30, 2003,
the number of common shares that would be issued upon conversion of the Series A
Preferred stock was 8,663,953.
At June 30, 2003, the Company had paid cumulative dividends in the amount of
$430,297 in additional shares of Series B Preferred stock. At June 30, 2003, the
number of common shares that would be issued upon conversion of the Series B
Preferred stock was 33,687,823.
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 three and six months ended
June 30, 2003 and have a dilutive effect if the Company had income from
continuing operations is 42,495,025 and 42,503,775, respectively. The number of
shares of preferred stock and stock options which would have been assumed to be
converted in the three and six months ended June 30, 2002 and have a dilutive
effect if the Company had income from continuing operations is 38,329,909 and
38,664,608, respectively.
The following table is a reconciliation of the numerators and denominators of
the basic and diluted per share computations:
16
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net loss from continuing operations $ (83,982) $ (1,055,030) $ (177,327) $ (1,166,071)
Income from discontinued operations, net of tax 527 819 168,490 2,717
------------- ------------- ------------- -------------
Net loss (83,455) (1,054,211) (8,837) (1,163,354)
Preferred dividend and accretion requirements 42,978 40,193 85,241 79,718
Net loss to common shareholder $ (126,433) $ (1,094,404) $ (94,078) $ (1,243,072)
============= ============= ============= =============
Basic and diluted loss per average common share:
Weighted average shares outstanding 110,564,300 104,591,255 110,366,753 103,223,747
=========== =========== =========== ===========
Loss per average common share from
continuing operations $ (1.15) $ (10.47) $ (2.38) $ (12.07)
============= ============= ============= =============
Gain from discontinued operations 0.00 0.01 1.53 0.03
------------- ------------- ------------- -------------
Net loss to common shareholders $ (1.15) $ (10.46) $ (0.85) $ (12.04)
============= ============= ============= =============
10. COMPREHENSIVE INCOME
The Company primarily has two components of comprehensive income: cumulative
translation adjustments and unrealized appreciation (depreciation) on
investments. The following table reflects the components of comprehensive income
(loss) and its effect on net income (loss).
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- ----------- -------- -----------
Net loss $(83,455) $(1,054,211) $ (8,837) $(1,163,354)
Cumulative foreign currency translation
gain (loss) -- -- (6,773) 3,074
Unrealized appreciation (depreciation)
on investments 549 1,464 (105) (1,235)
-------- ----------- -------- -----------
Comprehensive loss $(82,906) $(1,052,747) $(15,715) $(1,161,515)
======== =========== ======== ===========
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.
12. SUBSEQUENT EVENTS
17
On July 8, 2003, the Company notified employees of its Springfield, MA call
center of its intention to consolidate call center operations effective
September 5, 2003. The Company will record a one-time charge, related to the
facility closure, of approximately $10,000, during the three months ended
September 30, 2003.
On July 10, 2003, the Company reached an agreement to sell its Carmel, NY cable
and voice system for approximately $120 million in cash. The purchase price is
subject to adjustments based on the number of video subscribers and certain
working capital items at closing. The transaction is structured as an asset
purchase, with the buyer assuming certain contractual liabilities related to the
business. The sale is not expected to close prior to the first quarter of 2004.
Approximately $66 million of the proceeds from the sale will be used as a
partial pay-down of the Company's senior secured bank facility.
On July 11, 2003, the Company commenced a cash tender offer to purchase up to
$290,000 aggregate principal amount of its outstanding Senior Notes with cash
not to exceed $92,500. The price will not be less than $320 nor more than $370
per $1,000 face amount, plus accrued and unpaid interest. The offer applies to
all series of the Company's senior notes. The offer will expire on August 15,
2003 unless otherwise extended or terminated by the Company.
WHERE YOU CAN FIND MORE INFORMATION
RCN Corporation and its consolidated subsidiaries, ("We, Our, Us") as a
reporting company, are subject to the informational requirements of the Exchange
Act and accordingly file our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, proxy statements and other information
with the SEC. You may read and copy any materials filed with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549.
Please call the SEC at (800) SEC-0330 for further information on the Public
Reference Room. As an electronic filer, our public filings are maintained on the
SEC's Internet site that contains reports, proxy and information statements, and
other information regarding issuers that file electronically with the SEC. The
address of that website is http://www.sec.gov. In addition, our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act may be accessed free of charge through our website as
soon as reasonably practicable after we have electronically filed such material
with, or furnished it to, the SEC. The address of that website is
http://www.rcn.com/investor/secfilings.php. Since 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 periods ended June 30, 2003, and with the
audited financial statements and notes included in our 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 the 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, our
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
18
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.
Except as discussed in Note 4, there has been no change to the our critical
accounting policies and use of estimates that are reported in the our 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 905,000 average connections
during the three months ended June 30, 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 two communities
the in Los Angeles area. We also serve the Lehigh Valley in Pennsylvania and
communities in and around Carmel, NY. We are also a party to the Starpower
Communications, LLC ("Starpower") joint venture with Pepco Communications, Inc.
("Pepco"), a subsidiary of Pepco Holdings, Inc. ("Potomac"). Starpower serves
the Washington, D.C. metropolitan market with approximately 210,000 total
service connections at June 30, 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
television and high definition television) 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(SM) and Essentials(SM) 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 MegaModemSM 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 MegaModemSM is the fastest Internet connection available to residential
customers in our markets. Also in 2002, we expanded our launch of
Video-on-Demand ("VOD") in the Philadelphia market. We continue to launch VOD,
Subscription VOD and high definition television in certain markets during 2003.
Our services are typically delivered over our predominantly 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 incumbent cable companies. 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.
19
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 (loss) 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. Our
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 generally accepted accounting principles
("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 our
statements of financial position, cash flows and results of operations are
presented under GAAP. The use of non-GAAP financial disclosures represents our
view of the total consolidated, operational results.
The following unaudited non-GAAP financial summary, highlights our results of
operations on a consolidated basis for the three and six months ended June 30,
2003, had the results of operations of the Starpower joint venture been
consolidated with ours for the same period:
20
Three Months Ended June 30, 2003 Six Months Ended June 30, 2003
----------------------------------------- -----------------------------------------
RCN RCN
Including Less RCN Including Less RCN
Starpower (2) Starpower (1) GAAP (2) Starpower (2) Starpower (1) GAAP (2)
------------- ------------- ---------- ------------- ------------- ----------
Total sales $ 142,123 $ 20,475 $ 121,648 $ 288,792 $ 42,684 $ 246,108
Total direct costs 50,279 5,780 44,499 98,130 11,479 86,651
--------- -------- --------- --------- -------- ---------
Margin 91,844 14,695 77,149 190,662 31,205 159,457
Total operating and
selling, general and
administrative costs 83,122 12,007 71,115 180,087 24,583 155,504
--------- -------- --------- --------- -------- ---------
Adjusted EBITDA (3) 8,722 2,688 6,034 10,575 6,622 3,953
Non-cash stock-based
compensation 2,816 18 2,798 4,865 18 4,847
Impairment and special
charges 6,571 -- 6,571 6,651 -- 6,651
Depreciation and
amortization 51,301 5,014 46,287 107,773 10,002 97,771
--------- -------- --------- --------- -------- ---------
Operating loss $ (51,966) $ (2,344) $ (49,622) $(108,714) $ (3,398) $(105,316)
========= ======== ========= ========= ======== =========
(1) We own 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 us.
(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, Discontinued Operations, to the Unaudited 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 we and our 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 95.5% of the our revenue for the six months ended June 30, 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 4.5% of revenue is mostly derived from
reciprocal compensation, which is the fee local exchange carriers pay to
terminate calls on each other's networks.
We have 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 and regulatory
rulings that affected our 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 FCC has ruled on various
tariff/interconnect rules that have now permitted us to accurately estimate the
amount of reciprocal compensation revenue to be earned for calls terminated on
our network in the period such services are rendered. Accordingly, during the
six months ended June 30, 2003, we recognized approximately $10,852 of
incremental reciprocal compensation revenue. Approximately $4,100 of this amount
related to services rendered in calendar 2002.
Our expenses primarily consist of direct expenses, operating and selling and
general and administrative expenses, stock-based compensation, depreciation and
amortization, and interest expense. Direct expenses primarily include cost
21
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 six months ended June 30, 2003, we have continued our initiative
begun 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 costs as a result of increased operational efficiencies
and the elimination of costs as a result of the reduction and elimination of
construction in new markets.
During the first six months of 2003, we continued our 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 six months ended June 30, 2003, there
were no write downs of excess construction material. We are aware that the
secondary market for construction materials is changing, which could negatively
affect our salvage value.
In 2003, we 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 exit costs accordingly. We recorded approximately $6,571 and
$6,551 in exit costs in the three and six months ended June 30, 2003,
respectively. (See Note 6, Impairment Charges and Accrued Exit Costs, 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, Long-Term Debt, to the Unaudited
Condensed Consolidated Financial Statements.) There has been no early debt
extinguishment in 2003.
RESULTS OF OPERATIONS
Three and six months ended June 30, 2003 compared to the three and six months
ended June 30, 2002.
Sales:
Total sales increased $7,393 or 6.5% to $121,648 for the three months ended June
30, 2003 from $114,255 for the three months ended June 30, 2002. Total sales
increased $20,470 or 9.1% to $246,108 for the six months ended June 30, 2003
from $225,638 for the six months ended June 30, 2002.
Sales by service offerings, which reflect certain internal allocations made for
bundled product sales, are as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------- ----------------------------------------------
Increase (Decrease) Increase (Decrease)
------------------- --------------------
2003 2002 $ % 2003 2002 $ %
-------- -------- -------- ------ -------- -------- -------- ------
Voice $ 37,516 $ 32,594 $ 4,922 15.1% $ 75,437 $ 68,135 $ 7,302 10.7%
Video 55,773 49,580 6,193 12.5% 109,091 96,482 12,609 13.1%
Data - high speed 18,670 14,583 4,087 28.0% 37,216 30,297 6,919 22.8%
Data - dial up 4,196 6,839 (2,643) -38.6% 9,916 14,026 (4,110) -29.3%
Reciprocal compensation 3,265 5,679 (2,414) -42.5% 10,852 9,776 1,076 11.0%
Other 2,228 4,980 (2,752) -55.3% 3,596 6,922 (3,326) -48.0%
-------- -------- ------- ----- -------- -------- -------- -----
Total $121,648 $114,255 $ 7,393 6.5% $246,108 $225,638 $ 20,470 9.1%
======== ======== ======= ===== ======== ======== ======== =====
22
About 48.4% 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 0.6% to 900,631 at June 30, 2003 from 895,540 at
June 30, 2002. Average connections by service offering are as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------- --------------------------------------------
Increase (Decrease) Increase (Decrease)
------------------- -------------------
2003 2002 # % 2003 2002 # %
------- ------- ------- ------ ------- ------- -------- ------
Voice 241,398 220,987 20,411 9.2% 238,769 215,799 22,970 10.6%
Video 389,783 385,891 3,892 1.0% 389,060 381,688 7,372 1.9%
Data - high speed 161,730 120,255 41,475 34.5% 156,995 115,102 41,893 36.4%
Data - dial up 107,720 168,407 (60,687) -36.0% 124,870 176,665 (51,795) -29.3%
------- ------- ------- ----- ------- ------- ------- -----
Total 900,631 895,540 5,091 0.6% 909,694 889,254 20,440 2.3%
======= ======= ======= ===== ======= ======= ======= =====
The change in average connections resulted in the following volume related
revenue variances for the three months ended June 30, 2003 for each service
offerings:
Voice $ 3,010
Video 500
Data - high speed 5,030
Data - dial up (2,464)
-------
Total connections volume variance $ 6,076
=======
Another 51.6% 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 June 30, Six Months Ended June 30,
----------------------------------------- -----------------------------------------
Increase (Decrease) Increase (Decrease)
------------------- -------------------
2003 2002 $ % 2003 2002 $ %
------ ------ ------- ----- ------ ------ ------- -----
Voice $51.80 $49.16 $ 2.64 5.4% $52.66 $52.62 $ 0.03 0.1%
Video $47.70 $42.83 $ 4.87 11.4% $46.73 $42.13 $ 4.60 10.9%
Data - high speed $38.48 $40.42 $(1.95) -4.8% $39.51 $43.87 $(4.36) -9.9%
Data - dial up $12.98 $13.54 $(0.55) -4.1% $13.24 $13.23 $ 0.00 0.0%
The decrease in average monthly revenue per connection for data - high speed
relates primarily to increased promotional campaigns during the three months
ended June 30, 2003.
The change in average monthly revenues per connection resulted in the following
revenue variances for the three months ended June 30, 2003 for each service
offerings:
23
Voice $ 1,912
Video 5,693
Data - high speed (943)
Data - dial up (179)
-------
Total rate volume variance $ 6,483
=======
For the three month period ending June 30, 2003, reciprocal compensation
decreased 42.5% and for the six month period ending June 30, 2003 reciprocal
compensation increased 11.0%, 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 of which approximately $4,100
related to services provided in 2002.
Other sales decreased $2,752 or 55.3% to $2,228 for the three months ended June
30, 2003 from $4,980 for the quarter ended June 30, 2002. For the six months
ended June 30, 2003 other sales decreased $3,326, or 48.0% to $3,596 from $6,922
for the six months ended June 30, 2002. The decrease was due primarily to lower
television production revenues.
Costs and Expenses, Excluding Stock-Based Compensation, Depreciation and
Amortization:
Direct expenses are comprised of the costs of providing services. Following is a
table of direct costs by service type for the three and six months ended June
30, 2003 as compared to the same periods of 2002:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------- --------------------------------------------
Increase (Decrease) Increase (Decrease)
------------------- --------------------
2003 2002 $ % 2003 2002 $ %
------- ------- ------- ------- ------- ------- ------- -------
Voice $10,710 $12,329 $(1,619) -13.1% $20,345 $25,701 $(5,356) -20.8%
Video 29,610 27,508 2,102 7.6% 58,472 53,327 5,145 9.6%
Data 3,670 5,417 (1,747) -32.3% 7,179 11,655 (4,476) -38.4%
Other 509 1,272 (763) -60.0% 655 2,534 (1,879) -74.2%
------- ------- ------- ------- ------- ------- ------- -------
Total Direct Costs $44,499 $46,526 $(2,027) -4.4% $86,651 $93,217 $(6,566) -7.0%
======= ======= ======= ======= ======= ======= ======= =======
The decrease in direct expenses, for both periods, 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.
Operating and selling and general and administrative costs decreased $21,196 or
23.0% to $71,115 for the three months ended June 30, 2003 from $92,311 for the
three months ended June 30, 2002. For the six months ended June 30, 2003,
operating, selling and general and administrative costs decreased $32,899 or
17.5% to $155,504 from $188,403 for the six months ended June 30, 2002.
Components of operating, selling and general and administrative costs are as
follows:
24
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------------------- ------------------------------------------------
Increase (Decrease) Increase (Decrease)
-------------------- --------------------
2003 2002 $ % 2003 2002 $ %
------- -------- -------- ------ -------- --------- -------- ------
Customer service $25,913 $ 29,883 $ (3,970) -13.3% $ 52,107 $ 59,284 $ (7,177) -12.1%
Network operations
and construction 10,515 12,550 (2,035) -16.2% 21,355 26,454 (5,099) -19.3%
Marketing
and advertising 6,169 6,062 107 1.8% 9,973 10,711 (738) -6.9%
Sales 8,445 7,970 475 6.0% 16,472 16,899 (427) -2.5%
Operating, general
and administration 20,073 35,846 (15,773) -44.0% 55,597 75,055 (19,458) -25.9%
------- -------- -------- ------ -------- --------- -------- ------
$71,115 $ 92,311 $(21,196) -23.0% $155,504 $ 188,403 $(32,899) -17.5%
======= ======== ======== ====== ======== ========= ======== ======
Customer service costs decreased for both the three and six months ended June
30, 2003 over the comparable 2002 periods. This decrease was due to reduction in
staff and temporary labor costs of approximately $3,636 and $5,399 respectively.
Other decreases for the six months ended June 30, 2002 of approximately $1,328
were due to lower costs for facilities and related operating expenses such as
utilities and telephone.
Network operations and construction costs decreased for both the three and six
months ended June 30, 2003 over the same comparable 2002 periods. This decrease
was primarily due to reductions in staff labor costs of approximately $1,997 and
$5,261, respectively.
Marketing and advertising costs increased $107 for the three months ended June
30, 2003 compared to the three months ended June 30, 2002 and decreased $738 for
the six months ended June 30, 2003 compared to the six months ended June 30,
2002. Decreases of approximately $162 and $302, respectively were due to reduced
staff labor costs and was offset by an increase of approximately $217 relating
to higher advertising agency fees during the three months ended June 30, 2003.
An additional reduction of approximately $479 for the six months ending June 30,
2003 was due to lower advertising agency fees.
Selling expenses increased $475 for the three months ended June 30, 2003
compared to the three months ended June 30, 2002 and decreased $427 for the six
months ended June 30, 2003 compared to the six months ended June 30, 2002.
Increases of approximately $909 and $427, respectively, were due to increased
sales headcount. These increases were offset by a reduction of outside
telemarketing costs of approximately $388 and $809, respectively.
Operating, general and administrative expenses decreased for both the three and
six months ended June 30, 2003 over the comparable periods in 2002. The major
component was the result of staff reductions and personnel related costs of
approximately $8,629 and $11,036, respectively. Additional decreases of
approximately $1,562 and $3,436, respectively, resulted from the implementation
of computer systems for automated billing and data processing and related
reductions in maintenance costs. Other decreases of approximately $1,723 and
$2,566 respectively were due to lower costs for facilities and facilities
operating expenses such as utilities and telephone. Decreases of approximately
$3,622 and $3,091 respectively were due to lower than expected costs to exit
municipal franchise agreements. A decrease of approximately $6,200 for the three
and six months ended June 30, 2003 was due to a non-recurring decrease in
compensation plan expense resulting from a plan amendment. These decreases were
partially offset by an increase in bad debt expense of approximately $3,021 and
$4,041 principally due to an increase of the reserve on dial up receivables and
higher legal fees of approximately $1,177 and $1,728 respectively, principally
due to the sale of our central New Jersey assets and additional debt issuance
activities.
Non-cash Stock-Based Compensation:
The non-cash stock-based compensation decreased $9,027 for the three months
ended June 30, 2003 compared to the three months ended June 30, 2002 and
decreased $9,555 for the six months ended June 30, 2003 compared to the six
months ended June 30, 2002. The decrease was due to the reduced fair value of
stock options and restricted stock granted in 2003 and the forfeiture of 41,300
and 35,200 grants of restricted stock during the three and six months ended June
30, 2003 versus the forfeiture of 31,288 and 697,835 grants of restricted stock
during the three and six months ended June 30, 2002.
25
Depreciation and Amortization:
Depreciation and amortization expense decreased $39,102 or 45.8% to $46,287 for
the three months ended June 30, 2003 from $85,389 for the three months ended
June 30, 2002. For the six months ended June 30, 2003 depreciation and
amortization decreased $61,293 or 38.5% to $97,771 from $159,064 for the six
months ended June 30, 2002. The decreases are due to the disposition and
impairment in the value of network construction materials, equipment and
leasehold improvements as we curtailed our network expansion plans to preserve
capital. We ceased depreciating the assets of the central New Jersey system when
we entered into an agreement to sell that system in August 2002. (See Note 5,
Discontinued Operations, to the Unaudited Condensed Consolidated Financial
Statements.)
The table below details the changes in the investment income, interest expense,
gain on early extinguishment of debt and other income (expense) net accounts.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------- ------------------------------------------------
Increase (Decrease) Increase (Decrease)
-------------------- --------------------
2003 2002 $ % 2003 2002 $ %
------- ------- -------- ------- -------- -------- -------- -------
Investment income $ 2,041 $ 2,840 $ (799) -28.1% $ 3,694 $ 9,150 $ (5,456) -59.6%
Interest expense $45,689 $39,025 $ 6,664 17.1% $ 94,912 $ 79,598 $ 15,314 19.2%
Gain on early
extinguishment of debt $ -- $ -- $ -- n/a $ -- $ 13,073 $(13,073) -100.0%
Other income (expense), net $ 2,384 $(3,303) $ 5,687 -172.2% $ 8,533 $ (1,056) $ 9,589 -908.0%
Investment Income:
The decrease in investment income for both periods presented was a result of
lower interest rates and a decrease in average cash, temporary cash investments,
short-term investments and restricted investments at June 30, 2003 compared to
June 30, 2002. Cash, temporary cash investments, short-term investments, and
restricted investments were $357,842 at June 30, 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, compared to $455,477 at June 30, 2002.
Interest Expense:
The increase in interest expense for both periods presented is primarily due to
less interest being capitalized associated with capital expenditures during the
current periods coupled with debt issuance costs and commitment fees incurred to
secure the Fifth Amendment to our Credit Agreement. (See Note 7, Long-Term Debt,
to the Unaudited Condensed Consolidated Financial Statements.) These increases
were partly offset by the debt extinguishment during the first quarter of 2002.
On July 2, 2003, we announced an investigation into inconsistencies in the terms
of the indenture governing our 11% Senior Discount Notes due 2008 ("the 11%
Notes"), which resulted in an additional $7,976 interest payment made on the 11%
Notes on July 1, 2003. Approximately $3,533 of interest expense has been
recorded in the three months ending June 30, 2003 with the remaining $4,443
amortized over the remaining life of the notes.
Gain on Early Extinguishment of Debt:
A gain of $13,073 for the six months ended June 30, 2002 resulted from us
repurchasing certain of our long-term debt. We 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 has been repurchased in 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, Long-Term Debt, to the
Unaudited Condensed Consolidated Financial Statements.)
Other income (expense), net:
Other income (expense), net increased $5,687 or 172.2% to $2,384 for the three
months ended June 30, 2003 from $(3,303) for the three months ended June 30,
2002. The increase was principally due to write-offs of certain 2002 assets of
RCN Entertainment of $2,862 and receipt of $915 insurance reimbursement in 2003.
Other income (expense), net increased $9,589 or 908.0% to $8,533 for the six
months ended June 30, 2003 from $(1,056) for the six months
26
ended June 30, 2002. The increase resulted primarily from a gain of
approximately $7,235 recorded from the buyout of a capital lease.
Income Tax:
Our effective income tax rate was a provision of 0.01% on losses from continuing
operations for the three and six months ended June 30, 2003 as a result of
estimated alternate minimum state tax rate requirements. For the three and six
months ended June 30, 2002, the effective rate was a benefit of 0.50% of net
losses for the period. A tax provision of approximately $726 from the sale of
discontinued operations has been recorded as a reduction to the gain realized
upon the sale. The tax effect of our cumulative losses has exceeded the tax
effect of accelerated deductions, primarily depreciation, which we have 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 (Loss) of Unconsolidated Entities:
Equity in income of unconsolidated entities increased $41,935 or 119.7% to
income of $6,905 for the three months ended June 30, 2003 from a loss of $35,030
for the three months ended June 31, 2002. Equity in income of unconsolidated
entities increased $34,602 or 144.7% to income of $10,686 for the six months
ended June 30, 2003 from a loss of $23,916 for the six months ended June 31,
2002. The components of income or (loss) are shown in the table below.
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------------------- ------------------------------------------------
Increase (Decrease) Increase (Decrease)
-------------------- --------------------
2003 2002 ($) (%) 2003 2002 ($) (%)
-------- --------- ------- -------- --------- --------- --------- ------
Megacable $ 8,497 $ 1,545 $ 6,952 450.0% $ 12,836 $ 13,237 $ (401) -3.0%
Starpower (1,592) (36,568) 34,976 95.6% (2,150) (37,126) 34,976 94.2%
J2 Interactive -- (7) 7 100.0% -- (27) 27 100.0%
------- -------- ------- ------- -------- -------- -------- -----
Total equity in
income (loss) of
unconsolidated entities $ 6,905 $(35,030) $41,935 119.7% $ 10,686 $(23,916) $ 34,602 144.7%
======= ======== ======= ======= ======== ======== ======== =====
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 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 December 31, 2002
was 100%. As a result, no minority interest was recorded for the three and six
months ended June 30, 2003. Minority interest in loss of consolidated entities
decreased $33,438 and $36,650 or 100.0% in the three and six months ended June
30, 2003, respectively.
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 $16,511, net of purchase price adjustments of approximately $(510),
that remain 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 $165,989 net of taxes. In addition, we
recorded net income of $2,830 from operations 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
27
cash collateral account under the Fifth Amendment, (see Liquidity and Capital
Resources for discussion regarding the Fifth Amendment) proceeds on deposit in
the cash collateral account may be used (i) to repay any loans outstanding
under the Credit Agreement or (ii) to purchase telecommunications assets and/or
for working capital 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.
LIQUIDITY AND CAPITAL RESOURCES
Our cash, temporary cash investments, and short-term investments decreased to
$118,089 at June 30, 2003 from $277,006 at December 31, 2002. The change
resulted primarily from $120,2354 used in operating activities, $28,873 used in
financing activities and $147,395 provided by investing activities.
Net cash of $120,235 used in operating activities consisted of approximately
$25,738 in net losses from continuing operations before preferred dividends and
accretion adjusted for non-cash items which included $97,771 in depreciation and
amortization, $11,714 in accretion of discounted debt, and $10,380 in provision
for losses on accounts receivable. The provision for losses on accounts
receivable is principally due to increasing the reserve on dial-up receivables.
In addition, $66,461 was used in working capital consisting mostly of decreases
in accounts payable, related party payables, and accrued expenses of $49,765 as
well as increases in accounts receivable and related party receivables of
$8,214.
Net cash of $147,395 provided by investing activities resulted from proceeds for
the sale of discontinued operations of $242,844 and decreases of short term
investments of $161,825 and reclassification of $221,344 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 $36,367 for continuing operations and $2,191 for
discontinued operations.
Cash used in financing activities of $28,873 consisted primarily of $15,563 in
debt repayment under our Term Loans, $1,427 in capital lease principal and
buyout payments and $11,883 of payments made for debt financing costs made
primarily to secure the Fifth Amendment to our Credit Agreement. (See Note 7,
Long-Term Debt, to the Unaudited Condensed Consolidated Financial Statements.)
We have historically met our liquidity requirements through cash and short-term
investments 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 June 30, 2003, we had
approximately $118,089 in cash, temporary cash and short-term investments and
$239,753 in restricted cash. We believe 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 into the first quarter of 2004. In order for
us to meet our liquidity needs, we will have to do one of, or a combination of,
the following: (i) outperform our 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. During the three months ended
June 30, 2003, we entered into a $41,500 Senior Secured Credit Facility, and in
July 2003, entered into a definitive agreement to sell our Carmel, NY cable
system, and commenced a cash tender offer to purchase a portion of our
outstanding Senior Notes. (See Notes 7, Long-Term Debt, and 12, Subsequent
Events, to the Unaudited Condensed Consolidated Financial Statements for
additional discussion relating to these actions.)
We can offer no assurances that we will be able to implement any additional
actions on acceptable terms. If we were (i) unable to implement any additional
actions as described above, (ii) adversely impacted by any unforeseen business
conditions and/or (iii) unable to comply with the financial and negative
covenants of the Credit Agreement, the lenders under the Credit Facility would
be entitled to declare the outstanding borrowings under the Credit Facility
immediately due and payable and exercise any or all 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 our
Senior Notes, entitle holders of the Senior Notes to declare the Senior Notes
and any accrued and unpaid interest thereon immediately due and payable. Any
such acceleration or other exercise of rights and remedies by lenders under the
Credit Facility and/or holders of the Senior Notes would have a material adverse
effect us. We do not have sufficient cash resources to repay our outstanding
indebtedness if it is declared immediately due and payable.
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
28
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 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 assurances 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 $16,511
that remains in escrow. We realized a net gain of approximately $165,989 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, to purchase telecommunications
assets, or working capital, 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 our 2002 Annual Report on
the Form 10-K filed with the SEC.
In June 1999, we and certain of our 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.
We entered into an amendment to the Credit Agreement dated March 7, 2003 (the
"Fifth Amendment"). The Fifth Amendment enables us to incur additional senior
secured debt, adjusts the operating and financial covenants to better reflect
our business plan and modifies certain other restrictions. In connection with
the Fifth Amendment, we paid certain lenders fees of approximately $7,062. The
Fifth Amendment also reduces the amount available under the Revolver to $15,000,
under which there were no borrowings outstanding at June 30, 2003, and requires
us to maintain a cash collateral account of at least $100,000 for the benefit of
the lenders under its credit facility. At June 30, 2003, we maintained cash
collateral relating to the Fifth Amendment, of approximately $208,000 (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 our
senior secured term loans. Additionally, we will increase amortization payments
under our 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 us to incur up to $500,000 of new senior indebtedness that may be
secured by a second subordinated lien on our 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, we will not be able to borrow
money that may otherwise have previously been available to it under the
Revolver. 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.
At June 30, 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 June 30, 2003, there were $15,000 in
letters of credit outstanding under the Revolver. At June 30, 2003, we also had
letters of credit outside the Revolver of $23,005 collateralized by restricted
cash in escrow accounts. As of June 30, 2003, a total of $531,375 was
outstanding under Terms loans A and B.
29
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 our assets
and our subsidiaries.
Our ability to maintain our liquidity and maintain compliance with the 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 or modify the new covenants. We can make no
assurances that our business will generate sufficient cash flow from operations
or that existing available cash or future financings will be available to us in
an amount sufficient to enable us to pay our indebtedness or to fund our other
liquidity needs.
In June 2003, we entered into a $41,500 Commercial Term Loan and Credit
Agreement (the "Evergreen Facility") with Evergreen Investment Management
Company, LLC and certain of its affiliates ("Evergreen"). Evergreen's commitment
expires September 4, 2003. Any term loans made under the Evergreen Facility will
mature on June 30, 2008. The interest rate on the Evergreen loans is 12.5% per
annum; however, no cash interest is payable until April 1, 2006. The interest
rate is subject to upward adjustment in the event we incur new indebtedness
within 90 days after closing at a higher rate. In the event we or certain of our
subsidiaries receive net proceeds in respect of certain prepayment events such
as asset sales or casualty events and such net proceeds are not applied to the
repayment of amounts outstanding under the Senior Credit Facility we must repay
the Evergreen loans in an aggregate amount equal to such net proceeds or use
such proceeds to acquire telecommunications assets, including working capital.
Following the termination of the Senior Credit Facility, we must apply 50% of
the net proceeds from such assets sales or casualty events to repay the
Evergreen loans and not to reinvestment. We must apply 50% of excess cash flow
for each fiscal year commencing on the earlier of (i) the fiscal year ending
December 31, 2007 or (ii) the fiscal year in which all amounts outstanding under
the Senior Credit Facility have been paid in full or the Senior Credit Facility
does not prohibit such payment to prepay the Evergreen loans, provided that any
lender may waive its right to receive the amount of such mandatory prepayment,
and any amount will be applied to the mandatory prepayment of other Evergreen
loans on a pro rata basis. Evergreen will have a second priority lien on
substantially all of our assets. Upon closing, we paid a 4% or $1,660 funding
fee to Evergreen. As of June 30, 2003, the $41,500 was available to be drawn
down from the Evergreen Facility and approximately $346, relating to interest,
was outstanding.
In connection with the signing of the Evergreen Facility with Evergreen, we
issued warrants to Evergreen to purchase 4,150,000 shares of Common stock at an
initial exercise price of $1.25 per share. The warrants are exercisable any time
following three months from their issuance. We valued the warrants using the
Black-Scholes pricing model, applying an expected life of 5 years, a weighted
average risk-free rate of 3.5%, a volatility of 70% and a deemed value of Common
stock of $1.67 per share. The estimated value of the warrant, $4,026 was
recorded as an other non-current asset to be amortized over the next 5 years.
We may be required to seek additional modifications to the Credit Agreement or
new modification to the Evergreen Facility in order to satisfy or comply with
the financial and negative covenants of the Credit Agreement, as amended by the
Amendment and the Evergreen Facility. 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 the
Evergreen Facility and are unable to obtain additional modifications or a waiver
with respect thereto, the lenders under the Credit Facility and the Evergreen
Facility would be entitled to declare the outstanding borrowings under the
Credit Facility and the Evergreen Facility immediately due and payable and
exercise any or all of their other rights and remedies. In addition, any such
acceleration of amounts due under the Credit Facility and the Evergreen Facility
would, due to cross default provisions in the indentures governing our Senior
Notes, entitle holders of Senior Notes to declare the Senior Notes and any
accrued and unpaid interest thereon immediately due and payable. Any such
acceleration or other exercise of rights and remedies by lenders under the
Credit Facility and the Evergreen Facility and/or holders of the Senior Notes
would 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.
30
Since the spin-off of RCN from C-TEC Corporation, we have completed debt
offerings generating gross proceeds of $1,491,500 and common and preferred
equity offerings generating gross proceeds of $2,316,000.
We have indebtedness that is substantial in relation to the shareholders'
deficit and cash flow. At June 30, 2003, we had an aggregate of approximately
$1,728,380 of indebtedness outstanding including capital lease obligations. We
also have cash, cash equivalents and short-term investments aggregating
approximately $118,089. We had the following contractual obligations as of June
30, 2003:
Payments Due by Period
---------------------------------------------------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 Year Years Years Years
- ----------------------------------- ---------- --------- -------- ---------- --------
Senior Notes $1,184,657 $ -- $ -- $ 952,921 $231,736
Term Loans 531,721 40,500 127,875 363,346 --
Capital Leases 12,002 1,708 3,075 1,228 5,991
Operating Lease Commitments 270,521 29,880 24,778 24,364 191,499
---------- ------- -------- ---------- --------
Total Contractual Cash Obligations $1,998,901 $72,088 $155,728 $1,341,859 $429,226
========== ======= ======== ========== ========
At June 30, 2003, we had the following other commercial commitments:
Amount of Commitment Expiration Per Period
---------------------------------------------------
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 23,005 21,605 1,400 -- --
------- ------- ------ ------ ------
Total Other Commercial
Commitments $38,005 $36,605 $1,400 $ -- $ --
------- ------- ------ ------ ------
As a result of our substantial indebtedness, our fixed charges are expected to
exceed our earnings for the foreseeable future. Our leveraged nature could limit
our ability to effect future financing or may otherwise restrict our business
activities.
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
June 30, 2003 we had paid cumulative dividends in the amount of $515,669 in the
form of additional Series A and B Preferred stock. At June 30, 2003, the number
of common shares that would be issued upon conversion of the Series A and B
Preferred stock was 42,351,776.
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.
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."
31
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. We adopted
SFAS No. 143 on January 1, 2003 and the adoption of this statement did not have
a material impact on our 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, Long-Term
Debt for discussion regarding our adoption of SFAS No. 145.) The adoption of
this statement did not have a material impact on our 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. We adopted the provisions of SFAS No. 146 on
January 1, 2003. (See Note 6, Impairment Charges and Accrued Exit Costs, for
discussion regarding our adoption of 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 our financial position, cash flows
or results of operations.
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 entity's activities or entitled to receive a majority of the
entity's residual returns or both. FIN 46 also requires disclosures about
variable interest entities that we are 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. We do not have any interest in any entity that requires
disclosure or consolidation as a result of adopting the provisions of FIN 46.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with both liabilities and equity. This statement is
effective for financial instruments entered into or modified after May 31, 2003
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. We are currently evaluating the impact the
adoption of SFAS No. 150 will have on our financial position, results of
operations and cash flows.
RECENT EVENTS AND OTHER MATTERS
On July 10, 2003, we reached an agreement to sell our Carmel, NY cable and voice
system for approximately $120 million in cash. The purchase price is subject to
adjustments based on the number of video subscribers and certain working capital
items at closing. The transaction is structured as an asset purchase, with the
buyer assuming certain contractual liabilities related to the business. The sale
is not expected to close prior to the first quarter of 2004. Approximately $66
million of the proceeds from the sale will be used as a partial pay-down of our
senior secured bank facility.
32
On July 11, 2003, we commenced a cash tender offer to purchase up to $290,000
aggregate principal amount of our outstanding Senior Notes with cash not to
exceed $92,500. The price will not be less than $320 nor more than $370 per
$1,000 face amount, plus accrued and unpaid interest. The offer applies to all
series of our senior notes. The offer will expire on August 15, 2003 unless
otherwise extended or terminated by us.
The Audit Committee consists of the following four (4) directors who are not our
employees: Alfred Fasola, Chairman, Thomas P. O'Neill, III, Richard R. Jaros and
Thomas J. May. Mr. May is Chairman and Chief Executive Officer of NSTAR and its
wholly owned subsidiary, NSTAR Communications, Inc. We pay NSTAR Communications
for network construction in its Boston area market. NSTAR Communications is a
party to a joint venture with RCN Telecom Services, Inc., our subsidiary. Our
Board of Directors has determined that Mr. May's membership on the Audit
Committee is in our best interests and the best interests of our shareholders,
despite his relationship with us for the following reasons:
Mr. May is a Certified Public Accountant and has extensive background in
accounting, including previously as Chief Financial Officer of Boston Edison, a
predecessor of NSTAR. He has been an actively involved member of the Audit
Committee for four years and regularly provides needed insight and diligence. As
Chief Executive Officer of NSTAR Communications, Mr. May brings financial
sophistication and knowledge regarding financial controls. Mr. May also has a
good understanding of our business through his relationship with us, thereby
enhancing the Committee's ability to provide financial oversight to us.
33
Item 3. Quantitative & Qualitative Disclosures About Market Risk.
We have 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. We currently have no items that relate
to "trading portfolios". Under the "other than trading portfolios" we do 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 our 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. We
believe 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, our internal investment policies have set
maturity limits, concentration limits, and credit quality limits to minimize
risk and promote liquidity. We 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 our "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.
(a) Disclosure Controls and Procedures
We have performed an evaluation, under the supervision and with the
participation of management, including the Chief Executive and Principal
Financial officers, of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a - 15(e) and 15d - 15(e) under the Securities
and Exchange Act of 1934) as of the end of the period covered by this report.
Based on this evaluation, the Chief Executive Officer and Principal Financial
Officer have concluded that, as of the end of such period, our disclosure
controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, information required to be disclosed by us in the
reports that we file or submit under the Exchange Act.
(b) Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting
(as such term is defined in Rules 13a - 15(f) and 15d - 15(f) under the Exchange
Act) during the fiscal quarter to which this report relates that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
34
Part II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders was held on June 6, 2003. Matters submitted
to and approved by Shareholders included:
1. The election of Class III Directors to serve a term of three years:
Nominee For Withheld
----------------- ----------- ---------
David C. McCourt 98,627,813 3,385,681
James Q. Crowe 100,819,469 1,194,025
Eugene Roth 100,048,480 1,965,014
William D. Savoy 100,847,776 1,165,718
Walter Scott, Jr. 100,813,412 1,200,082
2. To ratify the appointment of PricewaterhouseCoopers LLP as independent
public accountants of the Company for the fiscal year ending December 31,
2003.
For Against Abstain
----------------- ----------- ---------
101,241,716 288,267 483,511
3. To approve a proposal to increase the number of shares of Common Stock
that the Company has the authority to issue under the 1997 Stock Plan for
Non-Employee Directors from 600,000 shares to 1,000,000 shares.
For Against Abstain
----------------- ----------- ---------
93,574,956 7,842,432 596,106
4. To approve a proposal to amend the Amended and Restated Certificate of
Incorporation of the Company (as amended) to effect a reverse stock split
of the Company's Common Stock.
For Against Abstain
----------------- ----------- ---------
99,015,022 2,417,219 581,253
5. To approve a proposal to amend the Amended And Restated Certificate of
Incorporation of the Company (as amended) to increase the number of shares
of Common Stock that the Company has the authority to issue from
300,000,000 shares to 500,000,000 shares.
For Against Abstain
----------------- ----------- ---------
98,192,979 3,199,434 621,081
Item 6. Exhibits and Reports on Form 8-K
(a.) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Principal Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b.) Reports on Form 8-K
On May 14, 2003, the Company announced its financial results for the
quarter ended March 31, 2003. The contents of that press release are
described in Exhibit 99.2 to the Form 8-K and incorporated herein by
reference.
35
On June 6, 2003, the Company held its annual shareholder meeting. The
contents of the meeting presentation are described in Exhibit 99.2 to the
Form 8-K and incorporated herein by reference.
On June 9, 2003, the Company announced that it had entered into a
commercial term loan and credit agreement dated June 6, 2003. The
agreement and warrants, and a press release with respect thereto were
filed with an 8-K as Exhibits 4.1 through 4.9 and Exhibit 99.1 and are
incorporated herein by reference.
On July 2, 2003, the Company announced it was investigating
inconsistencies in the terms of the indenture governing its 11% Senior
Discount Notes due 2008 ("the 11% Notes"), which it has uncovered in
connection with an approximately $8 million interest payment made on the
11% Notes on July 1, 2003. The press release with respect thereto was
filed with an 8-K as Exhibit 99.1 and is incorporated herein by reference.
On July 10, 2003, the Company announced that it intended to commence on
July 11, 2003 a cash tender offer to purchase up to approximately $290,000
aggregate principal amount of its outstanding Senior Notes with cash not
to exceed $92,500. Additionally, on July 10, RCN Telecom Services, Inc., a
wholly owned subsidiary of RCN Corporation, reached a definitive agreement
to sell its cable system located in Carmel, New York, to Susquehanna Cable
Co. for approximately $120 million in cash subject to certain purchase
price adjustments. The agreement and press release with respect thereto
were will with an 8-K as Exhibits 10.1 and 99.1 and are incorporated
herein by reference.
On August 8, 2003, the Company announced it had extended its tender offer
for up to between approximately $250,000 and $290,000 aggregate principal
amount of its outstanding Senior Notes without distinguishing between the
issues, from 11:59 p.m. New York City time on August 7, 2003 to 5:00 p.m.
New York City time, on August 15, 2003. The press release with respect
thereto was filed with an 8-K as Exhibit 99.1 and is incorporated herein
by reference.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RCN Corporation
Date: August 12, 2003
/s/ TIMOTHY J. STOKLOSA
----------------------------
Timothy J. Stoklosa
Executive Vice President
37