ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
Real Estate
As of December 31, 2009, we leased 104 facilities, including 90 technical and 14 non-technical facilities, which encompassed approximately 659,000 and 329,000 square feet, respectively, to support our operations. These leases are typically non-cancelable with terms ranging from one to 20 years. We also currently own seven technical facilities, which encompass approximately 58,700 square feet. Thirty-three of the leased facilities and three of the owned facilities are used by our RCN Metro segment in their operations. We lease our corporate office space in Herndon, VA.
We believe that our properties are generally in good operating condition and are suitable for our business operations.
We are party to various legal proceedings that arise in the normal course of business. In the present opinion of management, none of these proceedings, individually or in the aggregate, are likely to have a material adverse effect on our consolidated financial position or consolidated results of operations or cash flows. However, we cannot provide assurance that any adverse outcome would not be material to our consolidated financial position or consolidated results of operations or cash flows.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
RCN’s shares are traded on the NASDAQ under the symbol “RCNI”.
The tables below set forth, on a per share basis for the periods indicated, the closing high and low bid prices for RCN’s common stock as reported on the NASDAQ. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
On March 5, 2010, the last reported sale price of RCN’s common stock was $15.15 per share and the number of stockholders of record was six. This does not include those stockholders who hold shares in street name accounts.
Purchases of Equity Securities
(1)
Our repurchase plan was established in 2007 and authorizes the repurchase of up to $25 million of our shares of common stock. The repurchase plan does not have a specified expiration date.
(2)
The approximate dollar value of shares that may yet be repurchased under the program shown in the schedule above includes commissions paid.
Dividends
Between our emergence from bankruptcy on December 21, 2004 and June 10, 2007, we did not declare or pay a cash dividend on our common stock. Our debt agreements that existed during that time period did not permit such dividends to be declared or paid. On June 11, 2007, in connection with the refinancing of our senior debt, we paid a special cash dividend of $9.33 per share on all issued and outstanding RCN common stock as of June 4, 2007, totaling approximately $347 million. The total dividend paid in June 2007 excluded $4.5 million of dividends due upon vesting of unvested restricted stock issued to employees prior to the dividend record date, the majority of which has now been paid. The Company does not intend to pay additional dividends for the foreseeable future.
Description of RCN Corporation’s Equity Securities
As contemplated in RCN’s 2004 Plan of Reorganization, RCN issued Convertible Notes, which, pursuant to their terms, were convertible into approximately five million shares of RCN common stock, subject to certain limitations. All such Convertible Notes were repurchased by RCN in May 2007 as part of our recapitalization initiative. As part of the consideration for the purchase of such Convertible Notes, RCN issued to former holders of such Convertible Notes warrants to purchase 5,328,521 shares of RCN common stock at an exercise price of $25.16 per share (subject to adjustment). Following the adjustments caused by the special cash dividend (see Note 11 to the Consolidated Financial Statements), the warrants are currently exercisable for approximately 8,018,276 shares of common stock at an exercise price of $16.72. All of these warrants were outstanding as of December 31, 2009 and expire on June 21, 2012.
As of December 31, 2009, RCN has reserved for issuance under the RCN Stock Compensation Plan (the “Stock Plan”) 8,327,799 shares of our common stock, to be issued in connection with the exercise of equity compensation grants made to RCN’s directors, officers, and employees. The remaining information required by this item regarding securities authorized for issuance under equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Form 10-K.
RCN STOCK PERFORMANCE
The graph below compares the cumulative total shareholder return on Common Stock for the five years ended December 31, 2009, with the cumulative total return of the NASDAQ Composite and the NASDAQ Telecommunications Index over the same period. The graph assumes $100 was invested on December 21, 2004 in the Common Stock and $100 was invested on the same date in each of the NASDAQ Composite and the NASDAQ Telecommunications Index. Note that historic stock price performance is not necessarily indicative of future stock price performance.
The table below presents the selected financial data from the Company’s audited Consolidated Financial Statements for the years 2005 through 2009.
The information contained in the “Selected Financial Data” is not necessarily indicative of the results of operations to be expected for future years, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in Item 7, and the Consolidated Financial Statements and related notes thereto included in Item 8 of this Form 10-K.
(1)
The results of operations from NEON (see Item 7) are included in the above financial information from the date of acquisition (November 13, 2007) and all periods thereafter.
(2)
The results of operations from Consolidated Edison Communications Holding Company, Inc. (“CEC”) are included in the above financial information from the date of acquisition (March 17, 2006) and all periods thereafter.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read together with RCN’s Consolidated Financial Statements and related notes thereto beginning on page. Reference is made to “Cautionary Statements Regarding Forward-Looking Statements” on page 2 of this Annual Report on Form 10-K (the “Annual Report”), which describes important factors that could cause actual results to differ from expectations and non-historical information contained in this Annual Report.
Unless stated otherwise, as in the section titled “Discontinued Operations” under this Item 7, all of the information contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations relates to continuing operations. Therefore, the results of operations from our San Francisco and Los Angeles markets, as discussed below, are excluded for all periods covered by this Annual Report.
Overview
RCN is a competitive broadband services provider, delivering all-digital and high-definition video, high-speed internet and premium voice services to Residential and Small and Medium Business (“SMB”) customers under the brand names of RCN and RCN Business Services, respectively. In addition, through our RCN Metro Optical Networks business unit (“RCN Metro”), we deliver fiber-based high-capacity data transport services to large commercial customers, primarily large enterprises and carriers, targeting the metropolitan central business districts in our geographic markets. We construct and operate our own networks, and our primary service areas include: Washington, D.C., Philadelphia, Lehigh Valley (PA), New York City, Boston and Chicago.
Subsequent to the Company’s acquisition of NEON Communications Group, Inc. (“NEON”) in November 2007, management reorganized RCN’s business into two key segments: (i) Residential/SMB and (ii) RCN Metro. There is substantial managerial, network, operational support and product overlap between the Residential and SMB businesses and, as a result, we had historically reported these two businesses as one segment. RCN Metro, however, is managed separately from the other two business units, with separate network operations, engineering, and sales personnel, as well as separate systems, processes, products, customers and financial measures. Management of the Company’s two key businesses is unified only at the most senior executive levels of the Company. Therefore, beginning with the results of operations for 2008, the financial results of the RCN Metro business unit are reported as a separate segment in accordance with the requirements of FASB ASC Topic 280 and applicable SEC regulations. All prior period amounts in this Report have been restated to present the results as two separate reportable segments. For financial and other information about our segments, refer to Item 8, Note 15 to our Consolidated Financial Statements included in this Annual Report.
All of the Company’s operations are in the United States. Our Residential/SMB segment, which serves approximately 429,000 Residential and SMB customers generated approximately 75% of our consolidated revenues and the RCN Metro segment generated approximately 25% for 2009.
Basis of Reporting
Following is a discussion of the key factors that have affected the Company’s business over the last three fiscal years. This commentary should be read in conjunction with the Company’s Consolidated Financial Statements, Selected Financial Data and the remainder of this Form 10-K.
Key Transactions
In November 2007, we completed the acquisition of NEON, a network transport services provider to carrier and enterprise customers in the New England and mid-Atlantic regions. NEON had a fiber optic network that consisted of approximately 4,800 route miles, over 230,000 fiber miles, 22 co-location facilities, and more than 200 points of presence from Maine to Virginia. We paid a purchase price of $5.15 per share of NEON common stock, or total consideration of approximately $255 million. Including transaction costs, the total purchase price for NEON was approximately $260 million. We funded the transaction with a combination of proceeds from an additional $200 million term loan under our existing credit agreement, a draw of approximately $25 million under our existing $75 million line of credit and cash on hand.
In March 2007, we completed the sale of our San Francisco, California assets to an affiliate of Astound Broadband LLC, a subsidiary of Wave Broadband LLC (“Wave”). Separately, we decided to exit the Los Angeles, California market during 2007. Accordingly, the accompanying audited consolidated results of operations and statements of cash flows for all periods presented in this Annual Report include the results for these two markets as discontinued operations. There were no assets and liabilities related to these markets on the consolidated balance sheets at December 31, 2009 and 2008.
In 2007, we completed a recapitalization initiative in which we repaid all of our then outstanding debt, totaling approximately $199 million, and paid a special cash dividend of $9.33 per share, totaling approximately $347 million, utilizing the proceeds of a new $595 million revolving credit and term loan agreement.
Critical Accounting Policies and Estimates
The preparation of the Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting period. Management periodically assesses the accuracy of these estimates and assumptions. Actual results could differ from those estimates. Estimates are used when accounting for various items, including but not limited to allowances for doubtful accounts; investments; derivative financial instruments; asset impairments; certain acquisition-related liabilities; programming-related liabilities; revenue recognition; depreciation and amortization; income taxes; exit and restructuring costs; and legal and other contingencies. Estimates and assumptions are also used when determining the allocation of the purchase price in a business combination to the fair value of assets and liabilities and determining related useful lives.
Refer to Note 2 to our Consolidated Financial Statements for a more complete discussion of all of the Company’s significant accounting policies.
Results of Operations
The comparability of our results of operations for 2008 with earlier periods is significantly impacted by the acquisition of NEON in November 2007, the sale of our San Francisco, California assets in March 2007, and the subsequent exit of our operations in the Los Angeles, California market during 2007. The accompanying consolidated results of operations and statements of cash flows for all periods presented in this Annual Report include the results for the two California markets as discontinued operations. NEON results are included in our consolidated results subsequent to the closing date of November 13, 2007. To provide better comparisons of operating results in light of the NEON transaction, the discussion below provides certain pro forma amounts, in addition to actual results, when comparing 2008 to 2007. Pro forma basis means that the results are discussed as if NEON was owned throughout the periods presented including the impact of adjustments made to eliminate certain deferred revenue amortization and transaction related costs from historical NEON results.
The Consolidated Financial Statements include the accounts of RCN and its consolidated subsidiaries. All intercompany transactions and balances among consolidated entities have been eliminated.
The financial information presented in the table below comprises the audited consolidated financial information for 2009, 2008 and 2007.
Consolidated Operating Results
Consolidated Revenues
Consolidated revenue increased $24.5 million, or 3.3%, in 2009 compared to 2008, primarily due to higher transport revenues in the RCN Metro segment and a slight increase in the average number of customers from 2008 to 2009 in the Residential/SMB segment.
Consolidated revenue increased $103.1 million, or 16.2%, in 2008 compared to 2007, largely due to the acquisition of NEON. In 2007, the Company recorded a $4.4 million benefit related to a reciprocal compensation agreement. On a pro forma basis, and excluding the $4.4 million benefit, consolidated revenue increased $43.2 million, or 6.2%, in 2008 as compared to the same period in 2007, primarily due to an increase in the number of customers in the Residential/SMB segment and higher transport revenues in the RCN Metro segment.
Consolidated Direct Expenses
Consolidated direct expenses increased $11.0 million, or 4.2%, in 2009 compared to 2008. Direct expenses include net benefits from favorable settlements with voice and data network providers related to ordinary course network cost disputes totaling $4.0 million during 2009 and $1.9 million during 2008. Excluding these benefits, consolidated direct expenses increased $13.1 million, or 4.9%, in 2009 compared to 2008, primarily due to an increase in the average programming cost per subscriber in the Residential/SMB segment as well as added costs associated with the increase in revenue in the RCN Metro segment.
Consolidated direct expenses increased $39.4 million, or 17.6%, in 2008 compared to 2007, primarily due to the acquisition of NEON. On a pro forma basis, consolidated direct expenses increased $14.2 million, or 5.7%, in 2008 compared to 2007 as a result of an increase in the average programming cost per subscriber in the Residential/SMB segment and an increase in customers and revenue in the RCN Metro segment as well. Direct expenses also include net benefits from favorable settlements with voice and data network providers related to ordinary course network cost disputes totaling $1.9 million and $2.2 million in 2008 and 2007, respectively.
Consolidated Selling, General and Administrative Expenses
Consolidated selling, general and administrative expenses (“SG&A”) decreased $14.2 million, or 4.8%, in 2009 compared to 2008. Excluding stock-based compensation, SG&A expense decreased $11.1 million, or 4.0%, in 2009 compared to 2008, primarily reflecting (i) the results of the investments made in 2008 and 2009 to improve the long-term productivity and effectiveness of field operations, and the marketing and sales functions in the Residential/SMB segment, which were partially offset by increases in property tax and collections expense and (ii) synergies associated with the integration of the NEON business acquired in November 2007 in the RCN Metro segment. In addition, SG&A expenses decreased by $2.2 million in 2009, as compared to 2008, due to the suspension of the Company’s matching contribution to the 401(k) plan in the beginning of the second quarter of 2009.
Consolidated SG&A increased $5.7 million, or 2.0%, in 2008 compared to 2007, primarily due to the acquisition of NEON partially offset by a decrease in stock-based compensation expense of $19.9 million. On a pro forma basis, and excluding stock-based compensation, SG&A increased by $1.2 million, or 0.4%, in 2008 compared to 2007, reflecting increases in bad debt expense, property taxes and legal costs, partially offset by a decline in certain general and administrative expenses, primarily due to the integration and synergies achieved through the NEON acquisition.
Segment Operating Results
To measure the performance of our operating segments, we use operating income before depreciation and amortization, stock-based compensation, exit costs and restructuring charges. This measure eliminates the significant level of non-cash depreciation and amortization expense that results from the capital-intensive nature of our businesses and from intangible assets recognized in business combinations, as well as non-cash stock-based compensation and other special items such as exit costs and other restructuring charges. We use this measure to evaluate our consolidated operating performance and the performance of our operating segments, and to allocate resources and capital. It is also a significant performance measure in our annual incentive compensation programs. We believe that this measure is useful to investors because it is one of the bases for comparing our operating performance with that of other companies in our industries, although our measure may not be directly comparable to similar measures used by other companies. Because we use this metric to measure our segment profit or loss, we reconcile it to operating income, the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP in the business segment footnote to our consolidated financial statements (see Note 15). You should not consider this measure a substitute for operating income (loss), net income (loss), net cash provided by operating activities or other measures of performance or liquidity we have reported in accordance with U.S. GAAP.
Residential/SMB Segment Operating Results
Reconciliation to Operating Loss
Residential/SMB Metrics
(1)
Revenue Generating Units (“RGUs”) are all video, high-speed data, and voice connections provided to residential households and SMB customers. Dial-up Internet and long distance voice services are not included. Additional telephone lines are each counted as an RGU, but additional room outlets for video service are not counted. For bulk arrangements in residential multiple dwelling units (“MDUs”), including dormitories, the number of RGUs is based on the number of video, high-speed data and voice connections provided and paid for in that MDU. Commercial structures such as hotels and offices are counted as one RGU regardless of how many units are in the structure. Delinquent accounts are generally disconnected and no longer counted as RGUs after a set period of time in accordance with our credit and disconnection policies. RGUs may include customers receiving some services for free or at a reduced rate in connection with promotional offers or bulk arrangements. RGUs provided free of charge under courtesy account arrangements are not counted, but additional services paid for are counted.
(2)
A “Customer” is a residential household or SMB that has at least one paid video, high-speed data or local voice connection. Customers with only dial-up Internet or long distance voice service are not included. For bulk arrangements in residential MDUs, including dormitories, each unit for which service is provided and separately paid for is counted as a Customer. Commercial structures such as hotels and offices are counted as one Customer regardless of how many units are in the structure. Delinquent accounts are generally disconnected and no longer counted as Customers after a set period of time in accordance with our credit and disconnection policies.
(3)
Average revenue per customer (“ARPC”) is total revenue for a given monthly period (excluding dial-up Internet, reciprocal compensation and commercial revenue) divided by the average number of Customers for the period. This definition of ARPC may not be similar to ARPC measures of other companies.
Residential/SMB Revenues
Residential/SMB revenue increased $6.1 million, or 1.1% in 2009 compared to 2008. The increase is primarily due to a slight increase in the average number of customers from 2008 to 2009. Total RGUs decreased by approximately 12,000, or 1.3%, from December 31, 2008 to December 31, 2009, driven primarily by voice penetration losses, consistent with trends for highly penetrated landline voice providers, partially offset by growth in data RGUs. Video RGUs decreased slightly from December 31, 2008 to December 31, 2009. ARPC was flat at $110 in both 2009 and 2008, as growth in average revenue per video RGU and increased high-speed data penetration was offset by declines in voice penetration and average revenue per data RGU. The increase in average revenue per video RGU was driven mainly by our annual video rate increase, which partially mitigates the impact of annual increases in programming costs, as well as increased penetration of our digital set-top, HD and DVR boxes. Our digital video penetration rate rose to 100% of video customers in the fourth quarter of 2009 from 87% in the fourth quarter of 2008, as we completed Project Analog Crush. The decrease in average revenue per data RGU was primarily due to a shift towards lower-speed data plans, a trend which has increased over the past year.
Residential/SMB revenue increased $21.7 million, or 4.0%, in 2008 compared to 2007. Excluding a $4.4 million benefit related to a reciprocal compensation agreement recognized in 2007, Residential/SMB revenue increased $26.1 million, or 4.8%, during 2008 as compared to 2007. The increase is primarily due to an increase in the average number of customers and ARPC. Customers increased by approximately 12,000, or 2.9%, from December 31, 2007 to December 31, 2008, primarily due to increased sales opportunities generated through investments in new and rebuilt homes, and increased focus on sales and marketing to SMB customers. Total RGUs grew by approximately 18,000, or 2.0%, from December 31, 2007 to December 31, 2008, driven primarily by overall customer increases, with data RGU growth outpacing video RGU growth. Voice RGUs declined consistent with industry trends. ARPC increased from $109 for 2007 to $110 for 2008 due primarily to growth in average revenue per video RGU and increased high-speed data penetration, partially offset by declines in average revenue per voice and data RGU. The increase in average revenue per video RGU was driven mainly by our annual video rate increase, as well as increased customer purchases of value added products and services such as our digital set-top, HD and DVR boxes, digital programming tier and premium channels. Our digital video penetration rate rose to 87% of video customers in the fourth quarter of 2008 from 69% in the fourth quarter of 2007. The decrease in average revenue per voice RGU was due to overall market pricing trends, where voice prices have consistently decreased over the past several years. The decrease in average revenue per data RGU was primarily due to an increase in the percentage of data RGUs representing lower-speed data plans, a trend which has increased since RCN introduced these plans in 2007.
Residential/SMB Direct Expenses
Direct expenses increased $6.9 million, or 3.5%, in 2009 compared to 2008. Direct expenses include a net benefit from favorable settlements with voice and data network providers on ordinary course network cost disputes totaling $4.0 million during 2009 and $1.9 million during 2008. Excluding these settlements, Residential/SMB direct expenses increased $9.0 million, or 4.5%, in 2009 compared to 2008. Increases in the average programming cost per subscriber resulted in an increase in video direct costs for 2009 totaling $12.5 million as compared to 2008. Voice and data network costs in 2009, excluding the impact of settlements with providers of our voice and data network services, decreased by $3.5 million, or 10.9%, primarily due to a reduction in voice RGUs and benefits achieved as a result of an ongoing network optimization initiative.
Direct expenses increased $9.3 million, or 4.9%, in 2008 compared to 2007 primarily due an increase in the average programming cost per subscriber and higher average video RGUs. Direct expenses for 2008 and 2007 include a net benefit of $1.9 million and $2.2 million, respectively, as a result of favorable settlements with our voice and data network providers. Direct expenses for 2007 also include a charge of approximately $1.5 million for franchise fees identified during an audit.
Residential/SMB Selling, General and Administrative Expenses
SG&A decreased by $13.4 million, or 5.8%, in 2009 as compared to 2008. Excluding stock-based compensation expense, SG&A decreased by $10.7 million, or 4.8%, in 2009 as compared to 2008, reflecting decreases in costs related to technical and network operations, sales, legal and litigation, billing, customer service and the suspension of the 401(k) match as discussed above, partially offset by slight increases in bad debt expense, collections costs and property taxes. The overall reduction in SG&A reflects the results of the investments made in 2008 and 2009 to improve the long-term productivity and effectiveness of field operations, and sales and marketing functions.
SG&A decreased by $15.4 million, or 6.2%, in 2008 as compared to 2007. Excluding stock-based compensation expense, SG&A increased $2.4 million, or 1.1%, in 2008 as compared to 2007. For 2008, the increase in SG&A expenses primarily reflects an increase in bad debt expense, legal costs and property taxes, partially offset by reductions in facilities, customer care and other general and administrative expenses.
RCN Metro Optical Networks Operating Results
Reconciliation to Operating Loss
RCN Metro Revenues
Revenue increased $18.4 million, or 10.7%, in 2009 as compared to 2008, primarily due to growth in transport services to our carrier and enterprise customers. RCN Metro had approximately 800 customers as of December 31, 2009. The top 20% of these customers had monthly revenue in excess of $10,000 per customer, generating approximately 90% of RCN Metro’s total revenue, and the top 3% of these customers had monthly revenue in excess of $100,000 per customer, representing multiple locations and services purchased per customer, and generated approximately 60% of RCN Metro’s total revenue. From a customer segment perspective, RCN Metro generates approximately 30% of its revenue each from telecommunications carriers, national wireless providers and financial services enterprise customers, and the remainder from other enterprise customers.
RCN Metro revenue increased $81.5 million, or 90.7%, in 2008 as compared to 2007, primarily due to the acquisition of NEON. On a pro forma basis, revenue increased $17.2 million, or 11.1%, in 2008 as compared to 2007, due primarily to growth in transport services to our carrier and enterprise customers.
While RCN Metro’s revenue is somewhat concentrated within certain industries and customers, we attempt to mitigate any potential risk by performing detailed credit analyses on new customers and by aggressively managing outstanding accounts receivable balances and customer payments. In addition, our core product set often supports mission critical customer applications (e.g., trading operations, voice/data traffic aggregation, core network connectivity, etc.), which positions us well relative to other suppliers.
RCN Metro Direct Expenses
Direct expenses increased $4.1 million, or 6.3%, in 2009 as compared to 2008, largely due to added costs associated with the increase in revenue, including co-location costs and leased circuits, partially offset by a reduction in building access fees.
Direct expenses increased $30.2 million, or 87.0%, in 2008 as compared to 2007, primarily due to the acquisition of NEON. On a pro forma basis, direct expenses increased $4.9 million, or 8.2%, for 2008, largely due to added costs associated with the increase in revenue, including leased circuits, building access, rights-of-way and co-location costs.
RCN Metro Selling, General and Administrative Expenses
SG&A decreased $0.7 million, or 1.2%, in 2009 as compared to 2008. Excluding stock-based compensation, SG&A decreased $0.3 million, or 0.6%, for 2009, primarily due to a reduction in network operations expenses, as well facilities, bad debt and legal expenses partially offset by increases in technical operations and property tax expenses. Excluding stock-based compensation, the decrease in overall SG&A expenses, despite a significant increase in revenue of $18.4 million during 2009, reflects the high operating leverage of our primarily on-net model, as well as synergies associated with NEON’s integration.
SG&A increased $21.1 million, or 53.3%, in 2008 as compared to 2007. On a pro forma basis and excluding stock-based compensation, SG&A decreased $1.3 million, or 2.2%, in 2008 as compared to 2007, primarily as a result of cost synergies realized through employee and other cost reductions enabled by the integration of NEON, partially offset by increases in sales and marketing expenses.
Consolidated Depreciation and Amortization
Depreciation expense increased $8.1 million, or 4.5%, to $187.1 million in 2009 compared to 2008, due primarily to additional depreciation of approximately $19.1 million from assets placed into service since December 31, 2008 and adjustments of $1.6 million (discussed below), offset by a decline of approximately $13.2 million due to fixed assets that became fully depreciated since December 31, 2008.
Depreciation expense in 2009 includes impairment adjustments totaling $4.5 million related to equipment which has not been returned by former customers. Included in this impairment adjustment is $1.6 million that relates to periods prior to January 1, 2009. Management believes the impact of this error is immaterial to each of the applicable prior periods.
Depreciation expense increased $3.6 million, or 2.1%, to $179.0 million in 2008 compared to 2007, reflecting additional expense of approximately $19.5 million associated with NEON, and approximately $15.3 million from additional assets placed into service since December 31, 2007, offset by a decline of approximately $30.5 million due to fixed assets that became fully depreciated since December 31, 2007.
Amortization expense decreased $13.7 million, or 68.8%, to $6.2 million in 2009 as compared to 2008 primarily due to certain intangible assets becoming fully amortized as of December 31, 2008.
Amortization expense decreased $0.8 million, or 3.9%, to $19.9 million in 2008 compared to 2007. During 2008, the valuation of the tangible and intangible assets acquired in the NEON transaction was completed by management and the preliminary values assigned to customer relationships and internally developed software were reduced by $9.4 million and increased by $0.2 million, respectively. As a result, a cumulative reduction to amortization expense was recognized in 2008 totaling $1.0 million. Excluding this adjustment, amortization would have increased by $1.0 million due to the intangible assets acquired in the NEON acquisition.
Consolidated Exit Costs and Restructuring Charges
During 2009 and 2008, we recorded exit costs and restructuring charges of $0.6 million and $2.3 million, respectively, primarily from employee termination benefits. In 2008, the employee termination benefits were associated with a reduction in force and a voluntary separation program completed in connection with plans to reduce operating expenses.
Total exit costs and restructuring charges were $8.2 million in 2007, consisting primarily of exit costs, totaling $7.9 million as a result of our exiting or terminating property leases in Pennsylvania, New Jersey and New York, and restructuring charges totaling $3.4 million, which were primarily related to the outsourcing of our customer care operations. These charges were partially offset by a $3.1 million settlement for damages incurred relating to space that was exited in 2002, net of legal fees incurred. At the time the property was exited, the abandoned property, plant and equipment was recorded in exit costs and restructuring charges and, therefore, the portion of the settlement relating to these costs was recorded in exit costs and restructuring charges during 2007.
Consolidated Stock-Based Compensation
Total non-cash stock-based compensation expense recognized in 2009 was $10.2 million, a decrease of $3.1 million, or 23.3%, compared to 2008. The decrease in stock-based compensation expense was primarily due to the added expense recognized in 2008 as a result of the modification made in 2007 in connection with the payment of the special cash dividend. These reductions were partially offset by additional expense incurred related to restricted stock unit grants made during 2009.
Total non-cash stock-based compensation expense recognized in 2008 was $13.3 million, a decrease of $19.9 million, or 59.8%, compared to 2007. The decrease in stock-based compensation expense was primarily due to a reduction in the amount of expense recognized as a result of the modification made in 2007 in connection with the payment of the special cash dividend, as well as grants made in 2005, which became fully vested in mid 2008. These reductions were partially offset by additional expense incurred related to option and restricted stock unit grants made during 2008.
We expect to recognize approximately $10.4 million, $6.8 million and $2.7 million in compensation expense based on outstanding grants under the Stock Plan at December 31, 2009 in 2010, 2011 and 2012, respectively.
Consolidated Other Income (Expense) Items
Consolidated Investment Income
Investment income decreased $2.5 million, or 86.3%, to $0.4 million in 2009 compared to the same period in 2008. The decrease was due to lower yields from the Company’s short-term investments due to decreases in short-term market rates.
Investment income decreased $6.5 million, or 69.4%, to $2.9 million in 2008 compared to the same period in 2007. This decrease was primarily due to decreased yields from the Company’s short-term investments as well as a lower weighted average cash and short-term investment balance.
Consolidated Interest Expense
Interest expense decreased by $11.0 million, or 20.6%, to $42.3 million in 2009 compared to the same period in 2008. The decrease in interest expense was primarily due to the decrease in LIBOR.
Interest expense increased by $18.8 million, or 54.5%, to $53.3 million in 2008 compared to the same period in 2007. The increase in interest expense was primarily due to the increase in our weighted average debt balance, offset slightly by a reduction in our weighted average interest rate.
Outstanding debt at December 31, 2009 was $735.3 million compared to $742.6 million at December 31, 2008. The weighted average interest rate, including the effect of the swap agreements (discussed in Item 7A) was 5.2% and 6.6% in 2009 and 2008, respectively.
Consolidated Loss on the Early Extinguishment of Debt
In connection with the repayment of our Former First-Lien Credit Agreement (see Note 9 to our Consolidated Financial Statements) and successful tender offer and consent solicitation for our Second-Lien Convertible Notes, we recognized a loss on extinguishment of debt of $63.8 million during 2007, consisting of (i) the fair value of all new warrants issued, totaling $38.4 million, (ii) the cash paid in excess of par value ($133 per $1,000 principal amount), totaling $16.6 million, and (iii) the write-off of deferred financing costs and professional fees, totaling $8.8 million.
Consolidated Other Expense, Net
Other expense, net consisted mainly of translation gains and losses on a security deposit designated in a foreign currency in 2009 and penalties and late fees in 2007.
Consolidated Discontinued Operations
On March 13, 2007, we completed the sale of our San Francisco, California market for cash consideration of approximately $45 million and recorded an after-tax gain on this transaction of $15.9 million. During 2007, we also exited the Los Angeles, California market. The revenues and expenses from each of these properties, along with associated income taxes, have been removed from continuing operations and reclassified into a single line item on the Consolidated Statements of Operations as income from discontinued operations, net in each period presented.
Liquidity and Capital Resources
Subject to the risks outlined in our “Cautionary Statements Regarding Forward-Looking Statements,” we expect to fund our ongoing investing and mandatory financing activities, excluding the final maturity of our First-Lien Credit Facility in 2014, with cash on hand and cash flows from operating activities. If our operating performance differs significantly from our forecasts, we may be required to reduce our operating expenses and curtail capital spending, and we may not remain in compliance with our debt covenants.
Operating Activities
Net cash provided by operating activities was $152.9 million in 2009, which reflects an increase of $12.9 million over cash provided by operating activities in 2008. The increase reflects improved earnings from operations and lower interest payments, offset by changes in working capital, primarily driven by the timing of vendor payments.
During 2009 and 2008, we made cash payments for interest totaling $40.1 million and $51.2 million, respectively. The decrease in interest payments was due primarily to the decrease in LIBOR. We anticipate that our cash paid for interest will decrease slightly in the year ended December 31, 2010 due to a lower weighted average debt balance.
Investing Activities
Net cash used in investing activities was $75.7 million in 2009 which reflected a $62.9 million reduction compared to 2008. This reduction reflects a $37.8 million decrease in short-term investments compared to an increase of $7.1 million in 2008 and a $25.0 million decrease in additions to property, plant and equipment, partially offset by smaller decreases in restricted investments and proceeds from sale of property, plant and equipment as compared to 2008. The decrease in additions to property, plant and equipment in 2009, as compared to 2008, was primarily due to the completion of “Project Analog Crush” in each of our major metropolitan markets (excluding Lehigh Valley) in 2008. “Project Analog Crush” was completed in our Lehigh Valley market in 2009. Capital expenditures for 2010 are expected to be approximately $130 million, excluding business or customer acquisitions, which we expect to fund with cash flow from continuing operations as well as cash on hand. The decrease in short-term investments in 2009 totaling $37.8 million is due to the change in investment allocation from short-term investments to money market funds in anticipation of the Company’s transition to a new money management service provider.
Net cash used in investing activities was $138.7 million in 2008 reflecting $143.3 million in additions to property, plant and equipment and an increase in short-term investments totaling $7.1 million, partially offset by $2.5 million in proceeds from the sale of assets related to our discontinued California operations, $1.9 million in proceeds from sales of operating fixed assets, and a $7.4 million decrease in restricted investments.
Financing Activities
Net cash used in financing activities was $16.2 million in 2009, reflecting the purchase of common stock of $8.0 million (consisting of $7.3 million related to our stock repurchase program and $0.7 million of treasury shares resulting from the vesting of restricted shares), the repayment of long-term debt of $7.4 million, and dividend payments of $0.8 million. Net cash used in financing activities was $12.3 million in 2008, primarily reflecting the purchase of common stock of $8.7 million (consisting of $7.7 million related to our stock repurchase program and $1.0 million of treasury shares resulting from the vesting of restricted shares), the repayment of long-term debt of $7.3 million and dividend payments of $1.6 million, partially offset by $5.0 million in proceeds from a draw under our revolving credit facility.
Contractual Obligations and Commercial Commitments
The following table provides a summary of our contractual obligations and commercial commitments at December 31, 2009. Additional detail about these items is included in the Notes to our Consolidated Financial Statements.
(1)
In addition to scheduled mandatory repayments under the First-Lien Credit Agreement, the Company is also required to repay 50% of Excess Cash Flow (as defined in the First-Lien Credit Agreement) if the Company’s Total Leverage Ratio for the period is greater than 3:00:1. Pursuant to this Excess Cash Flow provision, the Company expects to repay $18.6 million on or before April 15, 2010, related to the year ended December 31, 2009.
(2)
Interest payments are based on interest rates in effect at December 31, 2009 and include payments on our interest rate swap agreements.
(3)
Net of contractual sublease income of $1.9 million in total through 2015.
(4)
Purchase obligations consist of agreements to purchase goods and services that are enforceable and legally binding on us and that specify all significant terms, including fixed or minimum quantities to be purchased, price provisions and timing. Our purchase obligations principally consist of contracts with telecommunications providers, and other contracts entered into in the normal course of business. Amounts reflected as liabilities in the consolidated balance sheet at December 31, 2009 are excluded from the table above.
(5)
A total of $30.5 million of our purchase obligations and operating lease obligations are collateralized via letters of credit at December 31, 2009.
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Description of Outstanding Debt
As of December 31, 2009, our total debt was approximately $735.3 million, including $2.8 million of capital leases. The following is a description of our debt and the significant terms contained in the related agreements.
First-Lien Credit Agreement
The Company’s credit agreement with Deutsche Bank, as Administrative Agent, and certain syndicated lenders (“First-Lien Credit Agreement”) provides for term loans to the Company in the aggregate principal amount of $720 million, and a $75 million revolving line of credit, all of which can be used as collateral for letters of credit. Approximately $40.1 million of the revolving line of credit is currently utilized for outstanding letters of credit relating to our surety bonds, real estate lease obligations, right-of-way obligations, and license and permit obligations. As of December 31, 2009, the Company had drawn an additional $30 million under the revolving line of credit and had $4.9 million of available borrowing capacity remaining. The obligations of the Company under the First-Lien Credit Agreement are guaranteed by all of its operating subsidiaries and are collateralized by substantially all of the Company’s assets.
The term loan bears interest at the Administrative Agent’s prime lending rate plus an applicable margin or at the Eurodollar rate plus an applicable margin, based on the type of borrowing elected by the Company. The effective rate on outstanding debt at December 31, 2009 and December 31, 2008 was 4.9% and 5.5%, respectively, including the effect of the interest rate swaps.
The First-Lien Credit Agreement requires the Company to maintain a Secured Leverage Ratio not to exceed 4.00:1 through December 30, 2010. On December 31, 2010, the maximum permitted Secured Leverage Ratio declines to 3.50:1, then declines to 3.25:1 on December 31, 2011 and 3.00:1 on December 31, 2012 where it remains until maturity in May 2014. The First-Lien Credit Agreement also contains certain covenants that, among other things, limit the ability of the Company and its subsidiaries to incur indebtedness, create liens on their assets, make particular types of investments or other restricted payments, engage in transactions with affiliates, acquire assets, utilize proceeds from asset sales for purposes other than debt reduction (except for limited exceptions for reinvestment in the business), merge or consolidate or sell substantially all of the Company’s assets.
The Company is in compliance with all financial covenants under the First-Lien Credit Agreement as of the date of this filing.
Recently Issued Accounting Pronouncements
See Note 2, “Summary of Significant Accounting Policies,” to our Consolidated Financial Statements for a full description of recently issued accounting pronouncements including the date of adoption and effects on results of operations and financial condition.
Inflation
The Company’s results of operations and financial condition have not been significantly affected by inflation. The Company’s principal operating costs have not generally been subject to significant inflationary pressures.
Letters of Credit
The Company had outstanding letters of credit in an aggregate face amount of $40.1 million at December 31, 2009. These letters of credit utilize approximately 53% of the Company’s $75 million revolving line of credit as collateral.
Subsequent Event
On March 5, 2010, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with entities controlled by a private equity fund associated with ABRY Partners, LLC, pursuant to which to those entities agreed to acquire the Company for total consideration of approximately $1.2 billion, including the assumption of debt. The transaction is expected to be completed in the second half of 2010, subject to receipt of stockholder approval, regulatory approvals, including the receipt of required consents and approvals of the Federal Communications Commission, as well as satisfaction of other customary closing conditions. The transaction is not subject to any financing condition. Under the terms of the Merger Agreement, the Company may solicit proposals from third parties for 40 days through April 14, 2010.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 2009, we held $15.1 million of short-term investments and $71.8 million of cash and cash equivalents, primarily consisting of U.S. Treasury bills, government backed obligations, and money market deposits. Our primary interest rate risk on short-term investments and cash and cash equivalents results from changes in short-term (less than six months) interest rates. However, this risk is largely offset by the fact that interest on our bank credit facility borrowings is variable and is reset over periods of no more than six months unless agreed to by each lender.
During 2007, the Company entered into three interest rate swap agreements with an initial notional amount of $345 million to partially mitigate the variability of cash flows due to changes in the Eurodollar rate, specifically related to interest payments on its term loans under the First-Lien Credit Agreement. The interest rate swap agreements have a seven year term with an amortizing notional amount which adjusts down on the dates payments are due on the underlying term loans. Under the terms of the swap agreements, on specified dates, the Company makes payments calculated using a fixed rate of 5.319% and receives payments equal to 3-month LIBOR. These interest rate swap agreements qualify for hedge accounting because the swap terms match the critical terms of the hedged debt. The Company has assessed, on a quarterly basis, that the swap agreements are completely effective based on criteria listed in the authoritative guidance pertaining to cash flow derivative instruments that are interest rate swaps. Accordingly, these agreements had no net effect on the Company’s results of operations in 2009. At December 31, 2009 and 2008, the estimated fair values of these swap agreements were liabilities of $37.0 million and $54.5 million, respectively, and the notional amount was $335.3 million and $339.2 million, respectively. The Company uses derivative instruments as risk management tools and not for trading purposes.
At December 31, 2009, the interest rate for the term loans issued pursuant to our First-Lien Credit Agreement was LIBOR plus 2.25% (2.56% at December 31, 2009), and current borrowings totaled $702.5 million. The effective interest rate was 4.87%, including the effect of the interest rate swap agreements noted above. The interest rate for the revolving credit line under our First-Lien Credit Agreement was LIBOR plus 2.00% (2.31% at December 31, 2009), and current borrowings totaled $30.0 million. Assuming the current level of borrowings under the First-Lien Credit Agreement and the effect of the swap agreements, an increase in LIBOR of 100 basis points would result in an increase in annual interest expense of approximately $4.0 million.
See Note 2 to our Consolidated Financial Statements for discussions of our accounting policies for derivative financial instruments and counterparty credit risk.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
RCN’s Consolidated Financial Statements are filed under this Item, beginning on page of this Report.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
As of the end of the period covered by this Annual Report, an evaluation was carried out under the supervision and with the participation of RCN’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of RCN’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) and “internal control over financial reporting”.
The evaluation of RCN’s disclosure controls and procedures and internal control over financial reporting included a review of our objectives and processes, implementation by the Company and the effect on the information generated for use in this Annual Report. In the course of this evaluation and in accordance with Section 302 of the Sarbanes Oxley Act of 2002, we sought to identify material weaknesses in our controls, to determine whether we had identified any acts of fraud involving personnel who have a significant role in our internal control over financial reporting that would have a material effect on our Consolidated Financial Statements, and to confirm that any necessary corrective action, including process improvements, were being undertaken. Our evaluation of our disclosure controls and procedures is done quarterly and management reports the effectiveness of our controls and procedures in our periodic reports filed with the SEC. Our internal control over financial reporting is also evaluated on an ongoing basis by RCN’s internal auditors and by other personnel in RCN’s finance organization. The overall goals of these evaluation activities are to monitor our disclosure controls and procedures and internal control over financial reporting and to make modifications as necessary. We periodically evaluate our processes and procedures and make improvements as required.
Because of its inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management applies its judgment in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Disclosure Controls and Procedures
Disclosure controls and procedures are designed with the objective of ensuring that (i) information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures in place at the end of the period covered by this Annual Report pursuant to Rule 13a-15(b) of the Exchange Act. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that RCN’s disclosure controls and procedures (as defined in the Exchange Act Rule 13(a)-15(e)) were effective as of December 31, 2009.
Management’s Report on Internal Control over Financial Reporting
RCN’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of RCN management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2009.
The Company’s internal control over financial reporting as of December 31, 2009 has been audited by BDO Seidman, LLP, an independent registered public accounting firm, as stated in their report which appears below in this Item.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
RCN Corporation
Herndon, Virginia
We have audited RCN Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). RCN Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, RCN Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of RCN Corporation as of December 31, 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year ended December 31, 2009 and our report dated March 9, 2010 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Bethesda, Maryland
March 9, 2010
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Pursuant to General Instruction G(3) to Form 10-K, we intend to file an amendment to this Form 10-K containing the Part III information with the Securities and Exchange Commission within 120 days of the end of the Company’s year ended December 31, 2009.
Pursuant to General Instruction G(3) to Form 10-K, we intend to file an amendment to this Form 10-K containing the Part III information with the Securities and Exchange Commission within 120 days of the end of the Company’s year ended December 31, 2009.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Pursuant to General Instruction G(3) to Form 10-K, we intend to file an amendment to this Form 10-K containing the Part III information with the Securities and Exchange Commission within 120 days of the end of the Company’s year ended December 31, 2009.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Pursuant to General Instruction G(3) to Form 10-K, we intend to file an amendment to this Form 10-K containing the Part III information with the Securities and Exchange Commission within 120 days of the end of the Company’s year ended December 31, 2009.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Pursuant to General Instruction G(3) to Form 10-K, we intend to file an amendment to this Form 10-K containing the Part III information with the Securities and Exchange Commission within 120 days of the end of the Company’s year ended December 31, 2009.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as part of this Annual Report:
(1)
Financial Statements.
A listing of the financial statements, notes and reports of independent registered public accountants required by Item 8 begins on page of this annual report.
(2)
Financial Statement Schedules
See Schedule II-Valuation and Qualifying Accounts on page
(3)
The index to the Exhibits begins on page E-1 of this Annual Report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
S-1
EXHIBITS INDEX
(Exhibits are listed by numbers corresponding to the Exhibit Table of Item 601 in Regulation S-K).
E-1
E-2
E-3
E-4
*
Document attached.
**
Confidential treatment requested as to certain portions of the document, which portions have been omitted and filed separately with the Securities and Exchange Commission.
+
Management compensatory plan or arrangement.
E-5
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
The Board of Directors and Stockholders
RCN Corporation
Herndon, Virginia
We have audited the accompanying consolidated balance sheet of RCN Corporation and subsidiaries (the “Company”) as of December 31, 2009 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended. In connection with our audit of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. The financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RCN Corporation and subsidiaries at December 31, 2009, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), RCN Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 9, 2010 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Bethesda, Maryland
March 9, 2010
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of RCN Corporation
Herndon, Virginia
We have audited the accompanying consolidated balance sheet of RCN Corporation and subsidiaries (the “Company”) as of December 31, 2008 and the related statements of operations, stockholders’ equity, and cash flows for the years ended December 31, 2008 and 2007. In connection with our audit of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. The Company’s management is responsible for these financial statements and schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and financial schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinions.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of RCN Corporation and subsidiaries as of December 31, 2008 and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ Friedman LLP
East Hanover, New Jersey
February 24, 2009
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
RCN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Dollars in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
RCN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND DESCRIPTION OF BUSINESS
RCN Corporation (“RCN” or the “Company”) is a competitive broadband services provider, delivering all-digital and high-definition video, high-speed internet and premium voice services to Residential and Small and Medium Business (“SMB”) customers under the brand names of RCN and RCN Business Services, respectively. In addition, the Company’s RCN Metro Optical Networks business unit (“RCN Metro”) delivers fiber-based high-capacity data transport services to large commercial customers, primarily large enterprises and carriers, targeting the metropolitan central business districts in RCN’s geographic markets. The Company constructs and operates its own networks, and its primary service areas include: Washington, D.C., Philadelphia, Lehigh Valley (PA), New York City, Boston and Chicago.
The Company has two principal business segments (i) Residential/SMB and (ii) RCN Metro. For financial and other information about the Company’s segments, refer to Note 15.
In connection with the March 2007 sale of the San Francisco operations to Astound Broadband LLC, a subsidiary of Wave Broadband LLC (“Wave”), and the Company’s exit from the Los Angeles operations during 2007, the results for these businesses are presented in the consolidated statements of operations as discontinued operations. At December 31, 2009 and December 31, 2008, there were no current assets and current liabilities related to these discontinued operations in the consolidated balance sheets. See Note 3 for a complete discussion of all acquisitions and dispositions.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements of the Company have been prepared in accordance with rules and regulations of the Securities and Exchange Commission (“SEC”) for annual reports on Form 10-K. The consolidated financial statements include the accounts of RCN and its consolidated subsidiaries. All intercompany transactions and balances among consolidated entities have been eliminated.
Use of Estimates and Assumptions
The preparation of consolidated financial statements in accordance with Accounting Principles Generally Accepted in the United States (“U.S. GAAP”) requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Management periodically assesses the accuracy of these estimates and assumptions. Actual results could differ from those estimates. Estimates are used when accounting for various items, including but not limited to allowances for doubtful accounts; investments; derivative financial instruments; asset impairments; certain acquisition-related liabilities; programming-related liabilities; revenue recognition; depreciation and amortization; income taxes; exit and restructuring costs; and legal and other contingencies. Estimates and assumptions are also used when determining the allocation of the purchase price in a business combination to the fair value of assets and liabilities and determining related useful lives.
Revisions and Reclassifications
The Company has changed the classification of short-term securities totaling $30.1 million at December 31, 2008 from cash and cash equivalents to short-term investments to conform to the Company’s policy of classifying securities with original maturities of greater than three months at the time of purchase as short-term investments.
Certain other immaterial reclassifications have been made to prior period amounts in order to conform to the current year presentation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents consist of commercial paper, government-backed obligations, and money market funds.
Short-term Investments
The Company’s entire portfolio of short-term investments is currently classified as “available for sale” in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 320 Investments - Debt and Equity Securities and is stated at fair value as determined by quoted market values. Investments having maturities of more than three months but not more than one year at the time of purchase are considered short-term and are classified as current assets. The Company’s short-term investments consist of the following:
Concentration and Monitoring of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, restricted investments, accounts receivable, interest rate swap agreements, and undrawn revolving line of credit commitments.
The Company invests its cash and cash equivalents and short-term investments in accordance with the terms and conditions of its First-Lien Credit Agreement, which seeks to ensure both liquidity and safety of principal. The Company’s policy limits investments to instruments issued by the U.S. government and commercial institutions with strong investment grade credit ratings, and places restrictions on the length of maturity. The Company monitors the third-party depository institutions that hold its cash and cash equivalents, and short-term investments. As of December 31, 2009 and 2008, the Company held no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or non-government guaranteed mortgage backed securities.
The Company’s restricted investments are either held in escrow or in deposit accounts with institutions having strong investment grade credit ratings.
The Company’s trade receivables reflect a diverse customer base. Up front credit evaluation and account monitoring procedures are used to minimize the risk of loss. As a result, concentrations of credit risk are limited. The Company believes that its allowances for doubtful accounts are adequate to cover these risks.
The Company has potential exposure to credit losses in the event of nonperformance by the counterparties to its revolving line of credit specifically related to undrawn commitments, including amounts utilized as collateral for letters of credit, and interest rate swap agreements. The Company anticipates however, that the counterparties will be able to fully satisfy their obligations under these agreements, given that they are very large, highly rated financial institutions who are also key lenders under the Company’s First Lien Credit Agreement.
Accounts Receivable
The Company carries the accounts receivable at cost less an allowance for doubtful accounts. Allowances for doubtful accounts are recorded as a selling, general and administrative expense. The Company evaluates the adequacy of the allowance for doubtful accounts at least quarterly and computes the allowance for doubtful accounts by applying an increasing percentage to accounts in past due categories. This percentage is based on the history of actual write-offs. The Company also performs a subjective review of specific large accounts to determine if an additional reserve is necessary. The formula for calculating the allowance closely parallels the Company’s history of actual write-offs net of recoveries.
Long-Term Restricted Investments
The Company has cash balances held as collateral related to various insurance policies (mainly general, auto liability, and workers compensation), and surety bonds primarily for franchise and permit obligations. These investments are restricted and unavailable for use by the Company.
Property, Plant and Equipment
Additions to property, plant and equipment are stated at cost or fair value, if acquired through an acquisition. Costs associated with new customer installations and the additions of network equipment necessary to provide advanced services are capitalized. Costs capitalized as part of initial customer installations include material, labor, and certain indirect costs. Indirect costs pertain to the Company’s personnel that assist in connecting the new service and primarily consist of employee benefits and payroll taxes, and direct variable costs associated with the capitalizable activities such as installation and construction, vehicle costs, and the cost of dispatch personnel. The costs of disconnecting service at a customer’s dwelling or reconnecting service to a previously installed dwelling are charged to expense in the period incurred. Costs for repairs and maintenance are charged to expense as incurred, while plant and equipment replacement and betterments, including replacement of cable drops from the pole to the dwelling, are capitalized.
Depreciation is recorded using the straight-line method over the estimated useful lives of the various classes of depreciable property. Leasehold improvements are amortized over the lesser of the life of the lease or the asset’s estimated useful life. Equipment held under capital leases is stated at the lower of the fair value of the asset or the net present value of the minimum lease payments at the inception of the lease. For assets held under capital leases, depreciation is recorded using the straight-line method over the shorter of the estimated useful lives of the leased assets or the related lease term. The significant components of property, plant and equipment as well as average estimated lives are as follows:
Depreciation expense was $187.1 million, $179.0 million, and $175.4 million for 2009, 2008 and 2007 respectively.
Depreciation expense in 2009 includes impairment adjustments totaling $4.5 million related to equipment which has not been returned by former customers. Included in this impairment adjustment is $1.6 million that relates to periods prior to January 1, 2009. Management believes the impact of this error is immaterial to each of the applicable prior periods.
The Company accounts for its long-lived assets in accordance with FASB ASC Topic 360 Property, Plant and Equipment which requires that long-lived assets be evaluated whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed. Such indicators include significant technological changes, adverse changes in relationships with local franchise authorities, adverse changes in market conditions and/or poor operating results. The carrying value of a long-lived asset group is considered impaired when the projected undiscounted future cash flows is less than its carrying value, and the amount of impairment loss recognized is the difference between the estimated fair value and the carrying value of the asset or asset group. Fair market value is determined primarily using the projected future cash flows discounted at a rate commensurate with the risk involved. Significant judgments in this area involve determining whether a triggering event has occurred, determining the future cash flows for the assets involved and selecting the appropriate discount rate to be applied in determining estimated fair value. In 2009, 2008 and 2007, there were no significant long-lived asset impairment charges.
Goodwill and Other Intangible Assets
Goodwill
Goodwill represents the excess of the acquisition cost of an acquired entity over the fair value of the identifiable net assets acquired. In accordance with the provisions of FASB ASC Topic 350 Intangibles - Goodwill and Other (“ASC Topic 350”), goodwill is not amortized but is tested for impairment on an annual basis or between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Goodwill at December 31, 2009 and 2008 totaled $15.5 million. The Company conducted an annual impairment test of its goodwill during the fourth quarter of 2009. The Company used an income-based approach and discounted the cash flows attributable to the RCN Metro reporting unit to estimate its fair value. Several estimates were incorporated into this analysis, including projected net monthly installed revenue, related operating and capital spending projections, cost of capital and estimated terminal value. In addition, comparative market multiples were used to corroborate discounted cash flow results. The impairment test indicated that the goodwill was not impaired. To evaluate the sensitivity of the estimated fair value calculation of the Company’s RCN Metro reporting unit on the annual impairment calculation for goodwill, the Company applied hypothetical 10%, 20% and 30% decreases to the estimated fair value of the reporting unit. These hypothetical decreases of 10%, 20% and 30% would have no impact on the goodwill impairment analysis.
Indefinite-Lived Intangibles
In accordance with the provisions of FASB ASC Topic 350, indefinite-lived intangible assets are tested for impairment on an annual basis or between annual tests if events occur or circumstances change that would indicate that the assets might be impaired. The Company’s indefinite-lived intangible assets consist of certain franchise rights associated with the Residential/SMB segment as well as certain rights-of-way acquired in the NEON transaction. The Company conducted an annual impairment test of its indefinite-lived assets during the fourth quarter of 2009 at the units of accounting level. The units of accounting were determined under the provisions of FASB ASC Topic 350 to be the Company’s franchise rights in the Pennsylvania market and certain rights-of-way acquired in the NEON transaction. The Company used an income-based approach and discounted the cash flows attributable to the applicable franchise rights to estimate their fair value. Several estimates and assumptions were incorporated into this analysis including existing customers, expected penetration level of marketable homes within the franchised areas, expected average revenue per customer, projected operating expenses, contributory asset charges, applicable cost of capital, estimated terminal value and present value of tax benefits. The fair value of the rights-of-way was estimated using a replacement cost approach using internal personnel involved in the original construction and attainment of the rights-of-way. The impairment tests performed indicated that the franchise rights and rights-of-way were not impaired. While management believes the estimates used in the impairment tests of goodwill and the indefinite-lived intangibles are reasonable, actual results may differ significantly from these assumptions, which could materially affect the valuation. To evaluate the sensitivity of the fair value calculations of the Company’s identifiable indefinite-lived intangibles, the Company applied hypothetical 10%, 20% and 30% decreases to the estimated fair value of each of the Company’s identifiable indefinite-lived intangibles. These hypothetical 10%, 20% and 30% decreases in estimated fair value would not have resulted in any impairment of the franchise rights, but would have resulted in impairment charges of approximately $3.0 million, $7.0 million, and $10.0 million, respectively, for the rights-of-way.
Other Intangibles
The costs of other intangible assets, including trademarks, trade names, customer relationships and software, are amortized over their estimated useful lives. Amortizable intangible assets are tested for impairment based on undiscounted cash flows in accordance with FASB ASC Topic 350 and, if impaired, are written down to fair value based on discounted cash flows. See Note 6 for the ranges of useful lives of the amortizable intangible assets.
Asset Retirement Obligations
FASB ASC Topic 410 Asset Retirement and Environmental (“ASC Topic 410”) addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FASB ASC Topic 410 requires recognition of a liability for an asset retirement obligation in the period in which it is incurred at its estimated fair value. Certain of the Company’s franchise and lease agreements contain provisions that require the Company to restore facilities or remove property in the event that the franchise or lease agreement is not renewed. The Company expects to continually renew its franchise agreements and therefore, cannot estimate any liabilities associated with such agreements. A remote possibility exists that franchise agreements could terminate unexpectedly, which could result in the Company incurring significant expense in complying with the restoration or removal provisions. There are no significant asset retirement-related liabilities recorded in the Company’s consolidated financial statements.
Legal Contingencies
The Company is subject to legal, regulatory and other proceedings and claims that arise in the ordinary course of business and, in certain cases, those that the Company assumes from an acquired entity in a business combination. An estimated liability for those proceedings and claims arising in the ordinary course of business is recorded based upon the probable and reasonably estimable criteria contained in FASB ASC Topic 450 Contingencies. The Company reviews outstanding claims with internal and external counsel to assess the probability and the estimates of loss as new information becomes available, and adjusts its liabilities as appropriate.
Revenue Recognition
Revenues are principally derived from fees associated with the Company’s video, telephone, high-speed data and transport services and are recognized as earned when the services are rendered, evidence of an arrangement exists, the fee is fixed and determinable and collection is probable. Payments received in advance are deferred and recognized as revenue when the service is provided. Installation fees charged to the Company’s residential and small business customers are less than related direct selling costs and therefore, are recognized in the period the service is provided. Installation fees charged to larger commercial customers are generally recognized over the contract life which is not materially different than the service life. Reciprocal compensation revenue, the fees that local exchange carriers pay to terminate calls on each other’s networks, is based upon calls terminated on the Company’s network at contractual rates. Under the terms of applicable franchise agreements, the Company is generally required to pay an amount based on gross video revenues to the local franchising authority. These fees are normally passed through to the Company’s cable subscribers and accordingly, the fees are classified as revenue with the corresponding cost included in direct expenses. Certain other taxes imposed on revenue producing transactions, such as Universal Service Fund fees are also presented as revenue and expense.
Sales of Multiple Products or Services
When the Company enters into sales contracts for the sale of multiple products or services, then the Company evaluates whether it has fair value evidence for each deliverable in the transaction. If the Company has fair value evidence for each deliverable of the transaction, then it accounts for each deliverable in the transaction separately, based on the relevant revenue recognition accounting policies. For example, the Company sells video, high-speed data and voice services to subscribers in a bundled package at a rate lower than if the subscriber purchases each product on an individual basis. Subscription revenues received from such subscribers are allocated to each product in a pro-rata manner based on the fair value of each of the respective services.
Direct Expenses
Direct expenses consist primarily of video programming costs, leased telecommunications services, voice termination costs, franchise and regulatory fees, pole rental and right-of-way fees, co-location costs, building access costs and revenue share payments.
Programming costs consist of the fees paid to suppliers of video content, which is generally obtained through multiyear agreements and contains rates that are typically based on the number of authorized subscribers that receive the programming content. At times, as these contracts expire, programming content continues to be provided based on interim arrangements while the parties negotiate new contractual terms, sometimes with effective dates that affect prior periods. While actual payments are generally made under the prior contract terms during the negotiation period, the amount of programming expenses recorded during the negotiation period is based on management’s estimates of the expected contractual terms to be ultimately negotiated. Programming costs are paid each month based on calculations performed by the Company and are subject to periodic audits performed by the programmers. Certain programming contracts contain launch incentives paid by the programmers. The Company records the launch incentives on a straight-line basis over the life of the programming agreement as a reduction of programming expense. The deferred amount of launch incentives is included in other long-term liabilities.
The Company accrues for the expected costs of leased telecommunications and voice termination services provided by third party telecommunications providers in the period the services are rendered. Invoices received from the third party telecommunications providers are often disputed due to billing discrepancies. The Company accrues for all disputed invoiced amounts that are considered probable and estimable as contingent liabilities. Disputes that are resolved in the Company’s favor are recorded as a reduction in direct expenses in the period the dispute is settled. Because the time required to resolve these disputes is often more than one quarter, any benefits associated with the favorable resolution of such disputes are often realized in periods subsequent to the accrual of the disputed invoice.
All other direct costs are expensed as incurred.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include customer service, sales, marketing, billing, network maintenance and repair, installation and provisioning, bad debt, rent and other overhead costs. All personnel costs, including stock-based compensation but excluding certain retention and severance benefits accounted for in accordance with FASB ASC Topic 420 Exit or Disposal Cost Obligations (“ASC Topic 420”), are included in selling, general and administrative expense.
Non-Cash Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with FASB ASC Topic 718 Compensation - Stock Compensation (“ASC Topic 718”), which requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions) and recognize that cost over the period during which an employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service.
Exit and Restructuring Costs
Exit and restructuring costs are recorded in accordance with FASB ASC Topic 420. The Company continuously monitors its organizational structure and associated operating expenses. Depending upon events and circumstances, actions may be taken periodically to restructure the business. Restructuring activities may include terminating employees, abandoning excess office space and incurring other exit costs. Any resulting exit and restructuring costs depend on estimates made by management based on its knowledge of the cost to terminate existing commitments and estimates of termination benefits. These estimates could differ from actual results. The Company monitors the initial estimates periodically and records an adjustment for any significant changes in estimates.
The Company has exited numerous facilities, in whole or in part, over the last three years. FASB ASC Topic 420 requires the Company to offset the present value of the remaining lease payments for the exited property against estimated sublease rental income. Sublease assumptions frequently change based on market conditions, which require the Company to adjust the projected cash flows related to exited properties. Changes in assumptions are recognized in income when made. When the Company terminates or buys out of a lease agreement, the payment is charged against the liability and/or the remaining liability is reversed into income. The Company amortizes the liability for these facilities as an offset to rent expense, which is included in selling, general and administrative expense, over the remaining term of the lease.
Upon its emergence from bankruptcy, the Company recorded a liability in “fresh start accounting” in accordance with the American Institute of Certified Public Accountants (“AICPA”) statement of position No. 90-7 “Financial Reporting By Entities in Reorganization Under the Bankruptcy Code” for the excess of cost over fair value on all of its leased facilities. The liability for these facilities is amortized as an offset to rent expense over the remaining term of the lease. When the Company exits a facility and accrues an exit cost liability, it reverses the remaining “fresh start” reserve established for that property into exit costs and restructuring charges. Similarly, when the Company renegotiates a lease on one of these properties the reserve is reversed into exit costs and restructuring charges as the amended lease is assumed to reflect market rates and terms.
Debt Issuance Costs
Debt financing costs are capitalized and amortized to interest expense over the term of the underlying obligations using the straight-line method which approximates the effective interest method.
Income Taxes
Income taxes are accounted for under the provisions of FASB ASC Topic 740 Income Taxes (“ASC Topic 740”). Accordingly, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The measurement of net deferred tax assets is reduced by the amount of any tax benefit that, based on available evidence, is not expected to be realized, and a corresponding valuation allowance is established. The determination of the required valuation allowance against net deferred tax assets was made without taking into account the deferred tax liabilities created from the book and tax differences on indefinite-lived assets.
When the Company has claimed tax benefits that may be challenged by a tax authority, these uncertain tax positions are accounted for under FASB ASC Topic 740. Under this accounting guidance, tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. A liability for unrecognized tax benefits is recorded for any tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards. As of December 31, 2009 and 2008, the Company has not recorded any liability for unrecognized tax benefits.
Derivative Instruments and Hedging Activities
In accordance with FASB ASC Topic 815 Derivatives and Hedging (“ASC Topic 815”), all derivatives are recorded in the balance sheet as either an asset or liability and are measured at fair value with the changes in fair value recognized currently in earnings unless specific hedge accounting criteria are met. In May 2007, the Company entered into three interest rate swap agreements with a notional amount of $345 million to partially mitigate the variability of cash flows in interest payments due to changes in the LIBOR interest rate on its First-Lien Credit Agreement. The Company designated the swap agreements as an accounting hedge under FASB ASC Topic 815. These interest rate swap agreements qualify for hedge accounting because the swap terms match the critical terms of the hedged debt. Accordingly, gains and losses on derivatives designated as cash flow hedges, to the extent they are effective, are recorded in accumulated other comprehensive income (loss) and subsequently reclassified to interest expense during the same period in which the hedged item affects earnings.
Accumulated Other Comprehensive Income (Loss)
The Company has three primary components of other comprehensive income (loss): fair value of interest rate swaps, foreign currency translation losses, and unrealized appreciation (depreciation) on investments. The following table reflects the components of accumulated other comprehensive loss:
Recently Issued Accounting Pronouncements
In July 2009, the FASB“s Accounting Standards Codification™ (“Codification”) became the single source of authoritative U.S. GAAP (other than rules and interpretive releases of the SEC). The Codification is topically based with topics organized by ASC number and updated Accounting Standards Updates (“ASU”). ASUs replace accounting guidance that was historically issued as Statements of Financial Accounting Standards (“SFAS”), FASB Interpretations (“FIN”), FASB Staff Positions (“FSP”), Emerging Issue Task Force (“EITF”) Abstracts and other types of accounting standards. The Codification became effective September 30, 2009 for the Company, and disclosures within this Annual Report on Form 10-K have been updated to reflect the change.
In January 2010, the FASB issued ASU 2010-6, Fair Value Measurements and Disclosures, that amends existing disclosure requirements under ASC Topic 820 by adding required disclosures about items transferring into and out of levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchase, sales, issuances, and settlements relative to level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. This ASU is effective for annual and interim reporting periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity between purchases, sales, issuances, and settlements on a gross basis. That requirement is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. This pronouncement is related to disclosure only and it is not anticipated to have a material impact on the Company’s consolidated financial statements.
In October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements which amends the criteria for when to evaluate individual delivered items in a multiple deliverable arrangement and how to allocate the consideration received. This ASU is effective for fiscal years beginning on or after June 15, 2010, which is January 1, 2011 for the Company. This ASU is effective prospectively for revenue arrangements entered into or materially modified after January 1, 2011. The Company is currently evaluating the impact that this new accounting guidance will have on its consolidated financial statements.
In August 2009, the FASB issued ASU 2009-05 Measuring Liabilities at Fair Value to clarify how entities should estimate the fair value of liabilities under ASC Topic 820. This ASU clarifies the fair value measurements for a liability in an active market and the valuation techniques in the absence of a Level 1 measurement. The Company has adopted this guidance in its consolidated financial statements for the year ended December 31, 2009. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In May 2009, the FASB issued guidance now included in ASC Topic 855 Subsequent Events. This guidance establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before the consolidated financial statements are issued or are available to be issued. Among other items, the guidance requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. In February 2010, the FASB amended its guidance on subsequent events to remove the requirement for SEC filers (as defined in ASU 2010-09) to disclose the date through which an entity has evaluated subsequent events. The Company has adopted this guidance in its consolidated financial statements for the year ended December 31, 2009.
In April 2009, the FASB issued guidance now included in ASC Topic 825 Financial Instruments. The guidance requires that the fair value disclosures required for financial instruments be included in interim financial statements. In addition, the guidance requires public companies to disclose the method and significant assumptions used to estimate the fair value of those financial instruments and to discuss any changes of method or assumptions, if any, during the reporting period. The guidance was effective for the Company’s year ended December 31, 2009. This pronouncement is related to disclosure only and did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued guidance now included in ASC Topic 320 Investments - Debt and Equity Securities that modifies the requirements for recognizing other-than-temporarily impaired debt securities and revises the existing impairment model for such securities by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporarily impaired. The adoption did not have a material impact on the Company’s consolidated financial statements.
NOTE 3. ACQUISITIONS AND DISPOSITIONS
NEON Communications Group, Inc.
On November 13, 2007 (the “Closing Date”), the Company completed the acquisition of NEON Communications Group, Inc. (“NEON”). The cash purchase price paid was $5.15 per share, resulting in total cash consideration of approximately $255 million. Including transaction costs, the total purchase price for NEON was approximately $260 million.
The acquisition of NEON was accounted for under the purchase method of accounting, with the Company as the acquirer in accordance with FASB ASC Topic 805 Business Combinations. The results of operations from NEON are included in the accompanying consolidated financial statements from the Closing Date through December 31, 2009. The following table summarizes, on an unaudited, pro forma basis, the estimated combined results of operations of the Company for 2007 as though the acquisition of NEON was completed at the beginning of 2007. These pro forma statements have been prepared for comparative purposes only and are not intended to be indicative of what the Company’s results would have been had the acquisition occurred at the beginning of the period presented or the results which may occur in the future.
*
from continuing operations
(1)
Includes non-recurring charges incurred by NEON (primarily deal-related costs), and stock-based compensation expense totaling $5.4 million during 2007.
San Francisco and Los Angeles Operations
In March 2007, the Company completed the sale of its San Francisco operations for $45 million in cash and recorded an after-tax gain on this transaction of $15.9 million. In addition, during 2007, the Company completely exited its operations in the Los Angeles, California market and sold the building and certain other assets for net total proceeds of approximately $3.9 million and recorded a de minimis after-tax gain on this transaction. The results of operations of its California assets are shown as discontinued operations in the consolidated statements of operations and include operating revenues totaling $6.8 million for 2007.
NOTE 4. EXIT COSTS AND RESTRUCTURING CHARGES
Total exit costs and restructuring charges were comprised of the following:
During 2009, the Company recorded exit costs and restructuring charges of $0.6 million, consisting primarily of employee termination benefits. The Company recorded total exit costs and restructuring charges of $2.3 million during 2008, primarily consisting of employee termination benefits associated with a reduction in force and a voluntary separation program in connection with plans to reduce operating expenses. The majority of these benefits were paid out by the date of this filing.
Total exit costs and restructuring charges were $8.2 million in 2007, consisting primarily of exit costs totaling $7.9 million as a result of exiting or terminating property leases in Pennsylvania, New Jersey and New York and restructuring charges totaling $3.4 million, which were primarily related to the outsourcing of the Company’s customer care operations. These charges were partially offset by a $3.1 million settlement for damages incurred relating to space that was exited in 2002 and are net of legal fees incurred. At the time the property was exited, the abandoned property, plant and equipment was recorded in exit costs and restructuring charges and therefore, the portion of the settlement relating to these costs was recorded in exit costs and restructuring charges during 2007.
The following table presents the activity in the lease fair value and exit cost liability accounts for 2008 and 2009:
The current portion of these liabilities is included in accrued exit costs on the balance sheet and the long-term portion is included in other long-term liabilities.
NOTE 5. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES
In accordance with the authoritative guidance for fair value measurements and the fair value election for financial assets and financial liabilities, a fair value measurement is determined based on the assumptions that a market participant would use in pricing an asset or liability. A three-tiered hierarchy was established that draws a distinction between market participant assumptions based on (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than quoted prices in active markets that are observable either directly or indirectly (Level 2) and (iii) unobservable inputs that require the Company to use present value and other valuation techniques in the determination of fair value (Level 3). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measure. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.
The Company’s financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 were as follows:
For the interest rate swap agreements, fair value is calculated using standard industry models based on significant observable market inputs such as swap rates, interest rates, and implied volatilities obtained from the counterparties to the swap agreements. The Company performs an independent evaluation to validate the reasonableness of the fair value obtained.
Pursuant to the authoritative guidance which requires fair value disclosures for financial instruments that are not currently reflected on the balance sheet at fair value, the Company’s term loan borrowings under the First-Lien Credit Agreement have a fair value of $654.2 million as of December 31, 2009, as determined based on the bid and ask quotes for the related debt.
The carrying values of accounts receivable, accounts payable and accrued liabilities are reasonable estimates of their fair values due to their short maturity.
NOTE 6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
Activity related to the Company’s amortizable intangible assets, net was as follows:
Amortization expense was $6.2 million, $19.9 million, and $20.7 million for 2009, 2008 and 2007, respectively. During 2008, management completed the valuation of the tangible and intangible assets acquired in the NEON transaction in November 2007 (see Note 3) and as a result, the fair values initially assigned to the intangible assets were adjusted. Specifically, adjustments to increase the value assigned to internally developed software of $0.2 million and reduce the value assigned to customer relationships by $9.4 million were recorded. As a result of these adjustments, a cumulative reduction to amortization expense was recognized in 2008 totaling $1.0 million.
Expected amortization expense of finite-lived intangible assets over each of the next five years is as follows:
NOTE 7. DEFERRED CHARGES AND OTHER ASSETS
Deferred charges and other assets consisted of the following:
NOTE 8. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following:
NOTE 9. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt consisted of the following:
At December 31, 2009, contractual annual maturities of long-term debt and capital lease obligations over the next five years are as follows (dollars in thousands):
The following is a description of the Company’s debt and the significant terms contained in the related agreements.
First-Lien Credit Agreement
The Company’s credit agreement with Deutsche Bank, as Administrative Agent, and certain syndicated lenders (“First-Lien Credit Agreement”) provides for term loans to the Company in the aggregate principal amount of $720 million, and a $75 million revolving line of credit, all of which can be used as collateral for letters of credit. Approximately $40.1 million of the revolving line of credit is currently utilized for outstanding letters of credit relating to the Company’s surety bonds, real estate lease obligations, right-of-way obligations, and license and permit obligations. As of December 31, 2009, the Company had drawn an additional $30 million under the revolving line of credit and had $4.9 million of available borrowing capacity remaining. The obligations of the Company under the First-Lien Credit Agreement are guaranteed by all of its operating subsidiaries and are collateralized by substantially all of the Company’s assets.
The term loan bears interest at the Administrative Agent’s prime lending rate plus an applicable margin or at the Eurodollar rate plus an applicable margin, based on the type of borrowing elected by the Company. The effective rate on outstanding debt at December 31, 2009 and December 31, 2008 was 4.9% and 5.5%, respectively, including the effect of the interest rate swaps discussed in Note 10.
The First-Lien Credit Agreement requires the Company to maintain a Secured Leverage Ratio not to exceed 4.00:1 through December 30, 2010. On December 31, 2010, the maximum permitted Secured Leverage Ratio declines to 3.50:1, then declines to 3.00:1 on December 31, 2012 where it remains until maturity in May 2014. The First-Lien Credit Agreement also contains certain covenants that, among other things, limit the ability of the Company and its subsidiaries to incur indebtedness, create liens on their assets, make particular types of investments or other restricted payments, engage in transactions with affiliates, acquire assets, utilize proceeds from asset sales for purposes other than debt reduction (except for limited exceptions for reinvestment in the business), merge or consolidate or sell substantially all of the Company’s assets.
The Company is in compliance with all financial covenants under the First-Lien Credit Agreement as of the date of this filing.
NOTE 10. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
During May 2007, the Company entered into three interest rate swap agreements with an initial notional amount of $345 million to partially mitigate the variability of cash flows due to changes in the Eurodollar rate, specifically related to interest payments on its term loans under the First-Lien Credit Agreement. The interest rate swap agreements have a seven year term with an amortizing notional amount which adjusts down on the dates payments are due on the underlying term loans. Under the terms of the swap agreements, on specified dates, the Company makes payments calculated using a fixed rate of 5.319% and receives payments equal to 3-month LIBOR.
These interest rate swap agreements qualify for hedge accounting because the swap terms match the critical terms of the hedged debt. The Company has assessed, on a quarterly basis that the swap agreements are completely effective based on criteria listed in the authoritative guidance pertaining to cash flow derivative instruments that are interest rate swaps. Accordingly, these agreements had no net effect on the Company’s results of operations in 2009, 2008 and 2007. The Company uses derivative instruments as risk management tools and not for trading purposes. As of December 31, 2009 and 2008, the estimated fair values of these swap agreements were liabilities of $37.0 million and $54.5 million, respectively, and the notional amount was $335.3 million and $339.2 million, respectively.
The following table summarizes the Company’s outstanding liability derivative instruments and their effect on the consolidated balance sheet at December 31, 2009 (dollars in thousands):
The effects of liability derivative instruments on the Company’s consolidated statement of operations and other comprehensive income (loss) (“OCI”) for the year ending December 31, 2009 are as follows (dollars in thousands):
NOTE 11. STOCKHOLDERS’ EQUITY AND STOCK PLANS
Income (Loss) Per Share
Basic earnings per share (“EPS”) is computed by dividing the income available to common stockholders by the average weighted number of shares of common stock outstanding during the period.
The computation of weighted average shares outstanding for the dilutive EPS calculation includes the number of additional shares of common stock that would be outstanding if all dilutive potential common stock equivalents would have been issued. The Company incurred losses in 2009, 2008 and 2007 and accordingly, all potential common stock equivalents would have been anti-dilutive so the average weighted common shares for the basic EPS computation is equal to the weighted average common shares used for the diluted EPS computation.
The following table shows the securities outstanding that could potentially dilute basic EPS in the future and the number of shares of common stock represented by, or underlying, such securities.
Common Stock, Warrants and Dividends
As contemplated in RCN’s Plan of Reorganization, RCN issued Convertible Notes, which, pursuant to their terms, were convertible into approximately five million shares of RCN common stock, subject to certain limitations. All such Convertible Notes were repurchased by RCN in May 2007. As part of the consideration for the purchase of such Convertible Notes, RCN issued to former holders of such Convertible Notes warrants to purchase 5,328,521 shares of RCN common stock at an exercise price of $25.16 per share (subject to adjustment). Following the adjustments caused by the special cash dividend (discussed below), the warrants are currently exercisable for approximately 8,018,276 shares of common stock at an exercise price of $16.72. All of these warrants were outstanding as of December 31, 2009 and expire on June 21, 2012.
Also in May 2007, the Company declared a dividend of $9.33 per share of outstanding common stock (the “special dividend”), pursuant to which approximately $347.3 million was paid in June 2007, excluding an additional amount of $4.5 million in dividends to be paid upon vesting of employee restricted stock granted prior to the dividend date. As of December 31, 2009, approximately $0.5 million remains to be paid upon vesting of the employee restricted stock. Pursuant to the warrant agreement, the adjustment to the price of the common stock due to the dividend resulted in an adjustment to both the exercise price of the warrants and the number of shares of common stock for which the warrants are exercisable. Immediately prior to the dividend “ex” date, the warrants were exercisable for one share of common stock at a price of $25.16 per share.
Stock Repurchase Program
During 2007, the Company’s Board of Directors authorized the repurchase of up to $25 million of the Company’s common stock. To date, the Company has repurchased approximately 2.6 million shares, of which 1,330,217 shares were repurchased in 2009 at a weighted average price of $5.49 totaling $7.3 million. In 2008 the company repurchased 1,035,800 shares at an average price of $7.46 totaling $7.7 million. All of these shares were retired. As of December 31, 2009, approximately $6.3 million remains authorized for repurchases under the stock repurchase program.
Stock-Based Compensation
RCN’s 2005 Stock Compensation Plan (the “Stock Plan”) currently allows for the issuance of up to 8,327,799 shares of the Company’s stock in the form of stock options, restricted stock and restricted stock units to RCN’s directors, officers and employees. As of December 31, 2009, there were approximately 1.3 million shares available for grant under the Stock Plan.
The Company recognizes compensation expense for stock-based compensation issued to or purchased by employees, net of estimated forfeitures, using a fair value method. When estimating forfeitures, the Company considers voluntary termination behavior as well as actual option forfeitures. Any adjustments to the forfeiture rate result in a cumulative adjustment in compensation cost in the period the estimate is revised. Compensation expense is recorded for performance-based stock options, restricted stock awards (“RSAs”), and restricted stock units (“RSUs”) based on the Company’s projected performance relative to the performance goals established by the Board of Directors.
Compensation expense recognized related to RSAs, RSUs and stock option awards are summarized in the table below:
As of December 31, 2009, total unamortized stock-based compensation expense related to stock options, restricted stock, and restricted stock units totaled $20.0 million. The unamortized expense of $20.0 million will be recognized through the third quarter of 2012. The Company expects to recognize approximately $10.5 million, $6.8 million and $2.7 million in compensation expense in 2010, 2011 and 2012, respectively, based on outstanding grants under the Stock Plan as of December 31, 2009.
Stock Options
Stock options may be granted as either non-qualified stock options or incentive stock options. Substantially all of the options become exercisable in three equal installments (generally annual vesting over a three-year period), and generally expire seven years from the grant date. Certain executives have been awarded stock options which are performance-based and vest over a three-year period subject to meeting performance goals established by the Board of Directors.
The following table summarizes the Company’s option activity during 2009, 2008 and 2007:
The intrinsic value in the awards outstanding was $3.4 million at December 31, 2009. There was no intrinsic value in the awards exercisable at December 31, 2009. During 2008 and 2007, the total intrinsic value of stock options exercised was $0.04 million and $2.1 million, respectively and cash received from the stock options exercised was $0.4 million and $5.8 million, respectively. There were no stock options exercised in 2009.
In connection with the special cash dividend declared in May 2007 of $9.33 per share, the Compensation Committee of the Board of Directors approved antidilution adjustments to outstanding stock option awards pursuant to the equity-based compensation plans to take into account the payment of the special cash dividend. Outstanding stock option awards were adjusted on June 12, 2007 (the ex-dividend date) by reducing the exercise price and increasing the number of shares issuable upon the exercise of each option, in accordance with safe harbor provisions of Section 409A of the Internal Revenue Code, such that the aggregate difference between the market price and exercise price multiplied by the number of shares issuable upon exercise was substantially the same immediately before and after the payment of the special cash dividend. The antidilution modification made with respect to such options resulted in a decrease in the weighted average exercise price from $23.69 to $15.58 and an increase in the aggregate number of shares issuable upon exercise of such options by 1,327,799. Since the Stock Plan permits, but does not require, antidilution modifications, FASB ASC Topic 718 requires a comparison of the fair value of each award immediately prior to and after the date of modification, assuming the value immediately prior to modification contains no antidilution protection, and the value immediately after modification contains full antidilution protection. This comparison resulted in an aggregate difference of $14.2 million despite the fact that the aggregate difference between the market price and exercise price multiplied by the number of shares issuable upon exercise was substantially the same immediately before and after the modification. As of December 31, 2009, all of the additional expense as a result of the modification has been recognized.
Stock Option Exchange Program
On June 2, 2009, RCN obtained stockholder approval for a stock option exchange program (“the Program”) that permitted all of the current employees of RCN, except for the chief executive officer, to exchange outstanding options issued under the Stock Plan for a lesser number of new options with lower exercise prices. Under the Program, the exchange ratios were designed to result in a fair value of the replacement options to be granted to be approximately equal to the fair value of the options that were surrendered. The Program started on July 16, 2009 and ended on August 12, 2009.
Pursuant to the Program, RCN accepted for cancellation options to purchase 1,179,651 shares of the Company’s common stock in exchange for new options to purchase 383,975 shares of the Company’s common stock. The per share exercise price of the new options is $9.05, which was the closing price of RCN’s common stock as quoted on the NASDAQ Global Select Market on August 12, 2009. These new options have a three-year vesting period with one-third of the new options vesting on each anniversary of the grant date. Each of the new options has an expiration date that is seven years from the exchange date. All new options will be subject to the terms and conditions of the Stock Plan.
In accordance with the authoritative guidance for stock compensation awards classified as equity, the exchange of options is characterized as a modification. Any difference between the fair value of the new options over the fair value of the exchanged options results in additional non-cash compensation expense. No incremental stock option expense was recognized in connection with the exchange because the fair value of the new options, as determined based on the Lattice option pricing model, was equal to or lower than the fair value of the exchanged options.
The following table summarizes additional information regarding outstanding and exercisable options as of December 31, 2009:
During 2009, 2008, and 2007, the Company recorded compensation expense related to stock option grants totaling $2.9 million, $8.0 million, and $23.1 million, respectively. Unamortized stock-based compensation expense for stock option awards at December 31, 2009 totaled $2.6 million and will be amortized through the third quarter of 2012.
The Company values its stock options using both the Black Scholes and Lattice Model valuation methods. Expected volatility is based on the historical volatility of the price of RCN and several similarly sized cable and telecommunications companies over the past seven years. The Company uses historical information to estimate award exercises and forfeitures within the valuation model. The expected term of awards is derived from an analysis of the historical average holding periods and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
The following table summarizes the weighted average valuation assumptions used in the Black Scholes valuation of the 2008 awards:
The weighted average fair value of options granted in 2008, valued using the Black Scholes method, was $4.95.
There were no awards granted in 2009 or 2007 that were valued using the Black Scholes valuation method.
The following table summarizes the weighted average valuation assumptions used in the Lattice valuation of the 2009, 2008 and 2007 awards:
The weighted average fair value of options granted in 2009, 2008 and 2007, valued using the Lattice method, was $3.45, $4.53 and $5.87, respectively.
Restricted Stock Awards
Prior to 2008, the Company issued stock-based compensation to employees in the form of RSAs. RSA awards entitle employees or directors to receive at the end of each vesting period (generally annual vesting over a three-year period) one share of common stock for each RSA granted, conditioned on continued employment or service as a director throughout each annual vesting period. The fair value of each RSA granted is equal to the market price of the Company’s stock at the date of grant.
The following table summarizes the Company’s RSA activity during 2009, 2008 and 2007:
During 2009, 2008 and 2007, the Company recorded compensation expense related to RSA grants totaling $2.1 million, $2.8 million and $10.1 million, respectively. Compensation expense recorded for performance-based restricted stock is based on the Company’s projected performance relative to the Board-established performance goals. Unamortized stock-based compensation expense at December 31, 2009 for RSA grants totaled $0.3 million and will be amortized through the first quarter of 2010.
Restricted Stock Units
Beginning in 2008, the Company issued stock-based compensation to employees in the form of RSUs, which are grants of a contractual right to receive future value delivered in the form of RCN common stock.
During 2009, the Compensation Committee approved grants of 1,828,558 RSUs to management and employees which vest over a three-year period. During this period the Compensation Committee also approved grants of 195,954 restricted stock units to the Board of Directors which generally vest over a one-year period.
The following table summarizes the Company’s RSU activity in 2009 and 2008:
Compensation expense for RSUs is recognized for the awards that are expected to vest. The expense is based on the fair value of the awards on the date of grant recognized on a straight-line basis over the requisite service period, which is generally a three-year period for employees and one-year period for the Board of Directors. Compensation expense recorded for performance-based RSUs is based on the Company’s projected performance relative to the Board-established performance goals. Certain RSUs granted to employees were performance-based and vest subject to meeting performance goals established by the Board of Directors. In 2009 and 2008, the Company recorded compensation expense related to RSU grants totaling $5.2 million and $2.5 million, respectively. At December 31, 2009, there was $17.1 million of unamortized stock-based compensation expense related to nonvested RSUs which will be amortized through the third quarter of 2012.
NOTE 12. INCOME TAXES
The provision (benefit) for income taxes on income from continuing operations consisted of the following:
The Company’s 2009 provision for income taxes was $1.1 million, $0.8 million of which is attributable to changes in the deferred tax liability provided for the Company’s indefinite-lived intangibles. The Company’s 2007 provision for income taxes was a benefit of $1.0 million, all of which is attributable to changes in the deferred tax liability provided for the Company’s indefinite-lived intangibles.
Deferred income taxes reflect temporary differences in the recognition of revenue and expense for tax reporting and financial statement purposes. Temporary differences that gave rise to a significant portion of deferred tax assets and liabilities were as follows:
The provision (benefit) for income taxes on continuing operations varies from the amounts computed by applying the U.S. federal statutory tax rate as a result of the following differences:
During 2009, the Company generated federal net operating losses (“NOLs”) of approximately $2.8 million resulting in a deferred tax asset of approximately $1.0 million. During 2008, the Company generated federal NOLs of approximately $64.2 million resulting in a deferred tax asset of approximately $22.3 million. As of December 31, 2009, the Company has federal NOL carryforwards of approximately $1.5 billion. The federal NOLs will expire between 2022 and 2029. Use of the NOLs acquired from NEON and generated prior to the Company’s emergence from bankruptcy are limited under the ownership change rules in the U.S. Internal Revenue Code (“IRC”). These limitations have been applied in determining the federal NOL and the related expiration periods detailed above. The utilization of the expected tax benefit from property and equipment depreciation could also be impacted by the ownership change rules of the IRC. In the table above, the change in the state valuation allowance for 2009 is included in State income taxes, net of federal income tax provision. For 2007 and 2008, the change in the state valuation allowance is included in valuation allowance.
The Company’s ability to use the NOLs can be negatively impacted if there is a future “ownership change” as defined in Section 382 of the IRC. In general, this would occur if certain ownership changes related to the Company’s stock that are held by five percent or greater stockholders, exceeds 50 percent measured over a rolling three year period. In the event an “ownership change” were to occur, the Company’s ability to utilize the NOLs could be significantly limited and could cause the Company to be a federal income tax cash payer much sooner than currently anticipated.
The net change in the valuation allowance for deferred tax assets during 2009 was an increase of $7.9 million and during 2008 was an increase of $38.9 million. The valuation allowance is primarily related to deferred tax assets due to the uncertainty of realizing the full benefit of the NOL carryforwards. In evaluating the amount of the valuation allowance needed, the Company considers the prior operating results and future plans and expectations. The utilization period of the NOL carryforwards and the turnaround period of other temporary differences are also considered. The determination of the required valuation allowance against net deferred tax assets was made without taking into account the deferred tax liabilities created from the book and tax differences on indefinite-lived assets.
The Company adopted the provisions of FASB ASC 740-10 on January 1, 2007 which did not have a material effect on the Company’s consolidated financial position or results of operations. The statute of limitations for the Company’s U.S. federal income tax returns and certain state income tax returns, including, among others, California, Illinois, New York and Virginia, remain open for tax years 2006 and after.
NOTE 13. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan that covers substantially all of its employees. Participants in the savings plan may elect to contribute, on a pretax basis, a certain percentage of their salary to the plan. Through March 2009, the Company matched a certain percentage of each participant’s contributions in accordance with the provisions of the 401(k) plan. The expense under the 401(k) plan related to the Company’s matching contribution was $0.5 million, $2.7 million and $2.6 million for 2009, 2008 and 2007, respectively. The Company suspended the matching contribution to the Company’s 401(k) plan in the beginning of March 2009.
NOTE 14. COMMITMENTS AND CONTINGENCIES
Rent Expense
Total rental expense (net of sublease income of $1.5 million, $1.8 million and $1.2 million for 2009, 2008 and 2007, respectively) primarily for facilities was $16.7 million, $16.9 million and $15.1 million for 2009, 2008 and 2007, respectively.
At December 31, 2009, approximate future minimum payments under non-cancelable real estate leases, net of contractual sublease income of $1.9 million in total through 2015, are as follows:
Letters of Credit
The Company had outstanding letters of credit in an aggregate face amount of $40.1 million at December 31, 2009. These letters of credit utilize approximately 53% of the Company’s $75 million revolving line of credit as collateral.
Guarantees
The Company is a guarantor on four leases for buildings that were used in the former San Francisco, California operations totaling $10.9 million at December 31, 2009.
Self Insurance
The Company is self-insured on its largest employee medical plan, which covers approximately 57% of its employees, and for its casualty insurance coverage (subject to certain limitations). The liabilities are established on an actuarial basis and totaled $4.9 million and $5.3 million at December 31, 2009 and 2008, respectively. The liability is included in accrued expenses and other liabilities on the consolidated balance sheets.
Litigation
The Company is party to various legal proceedings that arise in the normal course of business. In the present opinion of management, none of these proceedings, individually or in the aggregate, are likely to have a material adverse effect on the consolidated financial position or consolidated results of operations or cash flows of the Company. However, management cannot provide assurance that any adverse outcome would not be material to the Company’s consolidated financial position or consolidated results of operations or cash flows.
NOTE 15. FINANCIAL DATA BY BUSINESS SEGMENT
The Company’s reportable segments consist of (i) the Residential / SMB business units, and (ii) the RCN Metro business unit. In evaluating the profitability of these segments, the components of net income (loss) below operating income (loss) before depreciation and amortization, stock-based compensation and any exit costs or restructuring charges are not separately evaluated by the Company’s management. Assets are not allocated to segments for management reporting. Financial data by business segment is as follows:
(1)
All revenues reported for the individual segments are from external customers.
(2)
Operating expenses include stock-based compensation expense.
NOTE 16. SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
The table below summarizes the Company’s cash payments for interest and income taxes for 2009, 2008 and 2007:
In May 2007, the Company issued 5,328,521 warrants to purchase shares of common stock with an exercise price equal to $25.16 (subject to adjustment) to the former holders of its Convertible Notes. Following the adjustments caused by the special cash dividend, the warrants are currently exercisable for approximately 1.50478 shares of common stock (8,018,276 total shares) at a price per share of $16.72 (see Note 11).
NOTE 17. SELECTED FINANCIAL DATA (Unaudited)
Quarterly results of operations for 2009 and 2008 are as follows:
(1)
As a result of rounding, the total of the four quarters’ earnings per share does not equal the earnings per share for the year.
(2)
In the second quarter of 2009, the Company recorded an impairment adjustment totaling $4.5 million related to equipment which has not been returned by former customers. Included in this impairment adjustment is $1.6 million that relates to periods prior to January 1, 2009.
NOTE 18. SUBSEQUENT EVENT
On March 5, 2010, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with entities controlled by a private equity fund associated with ABRY Partners, LLC, pursuant to which to those entities agreed to acquire the Company for total consideration of approximately $1.2 billion, including the assumption of debt. The transaction is expected to be completed in the second half of 2010, subject to receipt of stockholder approval, regulatory approvals, including the receipt of required consents and approvals of the Federal Communications Commission, as well as satisfaction of other customary closing conditions. The transaction is not subject to any financing condition. Under the terms of the Merger Agreement, the Company may solicit proposals from third parties for 40 days through April 14, 2010.
RCN CORPORATION AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007