Quarterly Report

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2009

or

o		Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 1-16805

Registrant’s telephone number, including area code: (703) 434-8200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

o Large accelerated filer		þ Accelerated filer		o Non-accelerated filer		o Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes o No þ

Indicate by check mark whether the registrant has filed all documents and reports to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes þ No o

The number of shares of the Registrant’s common stock, par value of $0.01 per share, outstanding at October 30, 2009 was approximately 35,731,837.

 

 

RCN CORPORATION AND SUBSIDIARIES

FORM 10-Q

Table of Contents

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008			4
Condensed Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008			5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008			6
Notes to Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			30
Item 4. Controls and Procedures			31
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 1A. Risk Factors			31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 5. Other Information			31
Item 6. Exhibits			33
SIGNATURES			34
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Cautionary Statements Regarding Forward-Looking Statements

Certain of the statements contained in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the current views of RCN Corporation (“RCN” or the “Company”) with respect to current events and financial performance. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “could,” “should,” and “continue” or similar words. These forward-looking statements may also use different phrases. From time to time, RCN also provides forward-looking statements in other materials RCN releases to the public or files with the Securities and Exchange Commission (“SEC”), as well as oral forward-looking statements. You should consult any further disclosures on related subjects in RCN’s Annual Reports on Form 10-K, Quarterly Reports of Form 10-Q and Current Reports on Form 8-K filed with the SEC.

Such forward-looking statements are and will be subject to many risks, uncertainties and factors, which may cause RCN’s actual results to be materially different from such forward-looking statements. Factors that could cause RCN’s actual results to differ materially from these forward-looking statements include, but are not limited to, the following:

•

our ability to operate in compliance with the terms of our financing facilities (particularly the financial covenants);

•

our ability to maintain adequate liquidity and produce sufficient cash flow to fund our capital expenditures and debt service;

•

our ability to attract and retain qualified management and other personnel;

•

our ability to maintain current price levels;

•

our ability to acquire new customers and retain existing customers;

•

changes in the competitive environment in which we operate, including the emergence of new competitors;

•

changes in government and regulatory policies;

•

deterioration in and uncertainty relating to economic conditions generally and, in particular, affecting the markets in which we operate;

•

pricing and availability of equipment and programming;

•

our ability to obtain regulatory approvals and our ability to meet the requirements in our license agreements;

•

our ability to complete acquisitions or divestitures and to integrate any business or operation acquired;

•

our ability to enter into strategic alliances or other business relationships;

•

our ability to overcome significant operating losses;

•

our ability to expand our operating margins;

•

our ability to develop products and services and to penetrate existing and new markets;

•

technological developments and changes in the industry; and

•

the risks discussed in Part 1, Item 1A “Business-Risk Factors” in our Annual Report for the 2008 fiscal year, filed on February 24, 2009, or our “Annual Report”.

Statements in this report and the exhibits to this report should be evaluated in light of these important factors. RCN is not obligated to, and undertakes no obligation to, publicly update any forward-looking statement due to actual results, changes in assumptions, new information or future events.

PART I — FINANCIAL INFORMATION

The accompanying notes are an integral part of these condensed consolidated financial statements.

RCN CORPORATION

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 operating expenses. Certain other taxes imposed on revenue producing transactions, such as Universal Service Fund fees are also presented as revenue and expense.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to 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 September 30, 2009, 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, as well as 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 financial institutions who are also key lenders under the Company’s First-Lien Credit Agreement.

Recently Issued Accounting Pronouncements

Accounting Standards Codification

In the second quarter of 2009, the Financial Accounting Standards Board (“FASB”) established the FASB Accounting Standards Codification ^TM (Codification) as the single source of authoritative US GAAP. The Codification was not intended to modify or alter prior authoritative guidance and only affected how specific references to US GAAP literature are disclosed in the notes to the condensed consolidated financial statements.

Fair Value Measurements

In the second quarter of 2009, the Company adopted a new accounting standard included in FASB Accounting Standards Codification (“ASC”) Topic 820 Fair Value Measurements and Disclosure (“ASC Topic 820”) that provides guidance on how to determine the fair value of assets and liabilities in the current economic environment and reemphasizes that the objective of a fair value measurement remains the determination of an exit price. If the Company were to conclude that there has been a significant decrease in the volume and level of activity of the asset or liability in relation to normal market activities, quoted market values may not be representative of fair value and we may conclude that a change in valuation technique or the use of multiple valuation techniques may be appropriate. The adoption did not have a material impact on our condensed consolidated financial statements.

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05 Measuring Liabilities at Fair Value to provide guidance on measuring 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. This ASU is effective for the interim period beginning October 1, 2009. The adoption of this ASU is not anticipated to have a material impact on the Company’s consolidated financial statements.

Other-Than-Temporary Impairments

In the second quarter of 2009, the Company adopted a new accounting standard included in FASB 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 our condensed consolidated financial statements.

Interim Disclosures about Fair Value of Financial Instruments

In the second quarter of 2009, the Company adopted a new accounting standard included in FASB ASC Topic 825 Financial Instruments that requires disclosures about the fair value of financial instruments in interim financial statements as well as in annual financial statements; it also requires those disclosures in all interim financial statements. Reporting entities are required to disclose the fair value of all financial instruments for which it is practicable to estimate that value, the method and significant assumptions used to estimate the fair value and a discussion of changes in methods and significant assumptions during the period. The adoption did not have a material impact on our condensed consolidated financial statements.

Subsequent Events

In the second quarter of 2009, the Company adopted a new accounting standard included in FASB ASC Topic 855 Subsequent Events that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. This new accounting standard provides guidance on the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The implementation of this standard did not have a material impact on our condensed consolidated financial statements. The Company evaluated subsequent events through November 3, 2009, the date the accompanying financial statements were issued.

Multiple-Deliverable Arrangements

In October 2009, the FASB issued ASU 2009-13 Multiple-Deliverable Arrangements which amends FASB ASC Topic 605 Revenue Recognition to provide another alternative for determining the selling price of deliverables, allowing entities to allocate revenue in multiple deliverable arrangements based on their relative selling prices. 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.

During the three and nine months ended September 30, 2009, the Company recorded exit costs and restructuring charges of $0.3 million and $0.6 million, respectively, consisting primarily of employee termination benefits. During the three and nine months ended September 30, 2008, the Company recorded exit costs and restructuring charges of $0.8 million and $1.4 million, respectively, primarily from employee termination benefits during the three months ended September 30, 2008 as well as revisions to the amount of estimated cash flows from certain leased properties.

The following table presents the activity in the lease fair value and exit cost liability accounts for the nine months ended September 30, 2009 (dollars in thousands):

The current portion of these liabilities is included in “accrued expenses and other liabilities” 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 option 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 September 30, 2009 were as follows (dollars in thousands):

For the interest rate swap agreements, fair value is calculated using standard industry models used to calculate the fair value of the various financial instruments based on significant observable market inputs such as swap rates, interest rates, and implied volatilities obtained from the counterparties to the swap agreements.

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 $666.4 million as of September 30, 2009.

The carrying values of accounts receivable, accounts payable and accrued liabilities are reasonable estimates of their fair values due to the short maturity of these financial instruments.

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 its estimated useful life. Depreciation expense was $47.9 million and $144.0 million for the three and nine months ended September 30, 2009, respectively and $44.9 million and $133.7 million for the three and nine months ended September 30, 2008, respectively. Depreciation expense in the three and nine months ending September 30, 2009 includes impairment adjustments totaling $0.6 million and $3.7 million, respectively, related to equipment which has not been returned by former customers. Included in the $3.7 million impairment adjustment recorded in the nine months ending September 30, 2009, is $1.6 million that relates to periods prior to January 1, 2009. Management believes the impact of this adjustment is immaterial to each of the applicable prior periods.

Amortization expense was $1.5 million and $4.7 million for the three and nine months ended September 30, 2009, respectively and $4.6 million and $15.0 million for the three and nine months ended September 30, 2008, respectively.

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 $41.6 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 September 30, 2009, the Company had drawn an additional $30 million under the revolving line of credit and had $3.4 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 secured 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 September 30, 2009 and September 30, 2008 was 4.9% and 6.8%, respectively, including the effect of the interest rate swaps discussed in Note 9.

The First-Lien Credit Agreement requires the Company to maintain a Secured Leverage Ratio not to exceed 4.50:1 through December 30, 2009. On December 31, 2009, the maximum permitted Secured Leverage Ratio declines to 4.00:1, then declines to 3.50:1 on December 31, 2010, 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 covenants under the First-Lien Credit Agreement as of the date of this filing.

NOTE 9. 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 for the three and nine months ended September 30, 2009. The Company uses derivative instruments as risk management tools and not for trading purposes. As of September 30, 2009, the notional amount of these swaps was $336.2 million.

The following table summarizes the Company’s outstanding liability derivative instruments and their effect on the condensed consolidated balance sheet at September 30, 2009 (dollars in thousands):

The effects of liability derivative instruments on our condensed consolidated statement of operations and other comprehensive income (loss) (“OCI”) for the three months ending September 30, 2009 are as follows (dollars in thousands):

The effects of liability derivative instruments on our condensed consolidated statement of operations and other comprehensive income (loss) for the nine months ending September 30, 2009 are as follows (dollars in thousands):

NOTE 10. 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. For the three and nine months ended September 30, 2009 and 2008, because the Company incurred a loss, 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 at September 30, 2009 and 2008 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 and Dividends

At September 30, 2009, 5.3 million warrants to purchase 1.50478 shares of common stock (an aggregate of 8,018,276 shares) at a price per share of $16.72 are outstanding. These warrants expire on September 21, 2012.

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 2.4 million shares, of which 84,229 shares were purchased at a weighted average price of $6.94 totaling $0.6 million in the third quarter of 2009 and 1,148,605 shares at a weighted average price of $4.95 totaling $5.7 million during the nine months ended September 30, 2009. All of these shares were retired. As of September 30, 2009, approximately $7.9 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 September 30, 2009, there were 1,248,621 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 (dollars in thousands):

As of September 30, 2009, total unamortized stock-based compensation expense related to stock options, restricted stock, and restricted stock units totaled $23.3 million. The unamortized expense of $23.3 million will be recognized through the third quarter of 2012. The Company expects to recognize approximately $3.4 million for the remainder of 2009 as well as $10.3 million, $6.8 million and $2.8 million in compensation expense in the years ended December 31, 2010, 2011 and 2012, respectively, based on outstanding grants under the Stock Plan as of September 30, 2009.

There were no stock options exercised during the three and nine months ended September 30, 2009. The following table summarizes additional information regarding outstanding and exercisable options at September 30, 2009:

During the three and nine months ended September 30, 2009, the Company recorded compensation expense related to stock option grants totaling $0.3 million and $2.3 million, respectively. During the three and nine months ended September 30, 2008, the Company recorded compensation expense related to stock option grants totaling $1.2 million and $7.5 million, respectively. Unamortized stock-based compensation expense for stock option awards at September 30, 2009 totaled $3.1 million and will be amortized through the third quarter of 2012.

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 covering 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 for 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.

Restricted Stock Awards

The following table summarizes the Company’s RSA activity during the nine months ended September 30, 2009 and 2008:

During the three and nine months ended September 30, 2009, the Company recorded compensation expense related to RSA grants totaling $0.5 million and $1.6 million, respectively. During the three and nine months ended September 30, 2008, the Company recorded compensation expense related to RSA grants totaling $0.7 million and $2.2 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 September 30, 2009 for RSA grants totaled $0.8 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.

On February 12, 2009, the Compensation Committee of the Board of Directors of the Company (“Compensation Committee”) approved a grant of restricted stock units to each director with such grant to be effective on March 2, 2009. On April 6, 2009, the Compensation Committee also made an additional grant to an incoming board member and to the Vice Chairman. The restricted stock units vested in June, 2009, on the date of the Company’s Annual Meeting of Stockholders.

During the three months ended September 30, 2009, the Compensation Committee approved a grant of 1,828,558 RSU’s to management and employees which vest over a three-year period. Certain RSUs granted to employees were performance-based and vest subject to meeting performance goals established by the Board of Directors. During this period the Compensation Committee also approved a grant of 80,265 restricted stock units to the Board of Directors scheduled to vest September 1, 2010.

The following table summarizes the Company’s RSU activity during the nine months ended September 30, 2009 and 2008:

During the three and nine months ended September 30, 2009, the Company recorded compensation expense related to RSU grants totaling $1.3 million and $2.7 million, respectively. During the three and nine months ended September 30, 2008, the Company recorded compensation expense related to RSU grants totaling $0.7 million and $1.8 million, respectively. Unamortized stock-based compensation expense for RSU grants at September 30, 2009 totaled $19.4 million and will be amortized through the third quarter of 2012.

NOTE 11. INCOME TAXES

For the three months and nine months ended September 30, 2009, the Company’s provision for income taxes was $0 and $0.8 million, respectively, all of which is attributable to changes in the deferred tax liability provided for the Company’s indefinite-lived intangibles due to revised effective tax rates. As of September 30, 2009 and December 31, 2008, the Company’s net deferred tax liability was $36.9 million and $36.2 million, respectively. The net deferred tax liability is included in “other long-term liabilities” on the balance sheet.

The Company’s domestic effective income tax rate for the interim periods presented is based on management’s estimate of the Company’s effective tax rate for the applicable year and differs from the federal statutory income tax rate primarily due to nondeductible permanent differences, foreign taxes, state income taxes and changes in the valuation allowance for deferred income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The reversal of the valuation allowance that existed at the fresh start date, which would have benefited earnings, is instead recorded as a reduction of intangibles. Once intangibles are reduced to zero, any remaining realization of pre-fresh start net deferred tax assets will be recorded as an increase to additional paid in capital. This treatment does not result in any change in liabilities to taxing authorities or in cash flows.

With exceptions, periods ending after December 31, 2005 are subject to U.S., state and local income tax.

NOTE 12. COMMITMENTS AND CONTINGENCIES

Rent Expense

Total rental expense (net of sublease income of $0.4 million for the three months ended September 30, 2009 and 2008) primarily for facilities, was $4.1 million for the three months ended September 30, 2009 and 2008. Total rental expense (net of sublease income of $1.1 million and $1.3 million for the nine months ended September 30, 2009 and 2008, respectively) primarily for facilities, was $12.6 million for the nine months ended September 30, 2009 and 2008.

Letters of Credit

The Company had outstanding letters of credit in an aggregate face amount of $41.6 million as of September 30, 2009. These letters of credit utilize 55% of the Company’s $75 million revolving line of credit as collateral.

Guarantees

The Company is a guarantor on three leases for buildings that were used in the former San Francisco, California operations totaling $11.5 million at September 30, 2009.

Self Insurance

The Company is self-insured on its largest employee medical plan, which covers approximately 56% of its employees, and for its casualty insurance coverage (subject to certain limitations). The liabilities are established on an actuarial basis, with the advice of consulting actuaries, and totaled $4.7 million and $5.3 million at September 30, 2009 and December 31, 2008, respectively. The liability is included in “accrued expenses and other liabilities” on the condensed consolidated balance sheets.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto for the three and nine months ended September 30, 2009 contained in this Quarterly Report on Form 10-Q (the “Report”), and with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008 (the “Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on February 24, 2009.

Overview

RCN is a competitive broadband services provider, delivering all-digital and high-definition video, high-speed internet and premium voice services primarily 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, operate, and manage our own networks, and our primary service areas include: Washington, D.C., Philadelphia, Lehigh Valley (PA), New York City, Boston and Chicago.

Our RCN and RCN Business Services network passes approximately 1.4 million marketable homes and businesses, and we currently have licenses to provide video services to over 5 million licensed homes and businesses in our footprint. We serve approximately 430,000 residential and SMB customers.

RCN Metro also has numerous points of presence in other key cities from Richmond, Virginia to Portland, Maine. RCN Metro currently enters approximately 1,400 locations through our own diverse fiber facilities, providing connectivity to private networks, as well as telecommunications carrier meet points, and local exchange central offices owned and operated by other carriers. Our RCN Metro fiber routes now exceed 7,500 route miles, with hundreds of additional commercial buildings on or near our network. We also have over 300,000 fiber strand miles, which highlights the fact that many of our metro and intercity rings are fiber-rich.

The Company has two principal business segments (i) Residential/SMB and (ii) RCN Metro. For financial and other information about our segments, refer to Item 1, Note 13 to our condensed consolidated financial statements included in this Report and the discussion below. All of the Company’s operations are in the United States. Our Residential/SMB segment generated approximately 75% of our consolidated revenues and the RCN Metro segment generated approximately 25% for the nine months ended September 30, 2009.

The condensed consolidated financial statements include the accounts of RCN and its consolidated subsidiaries. All intercompany transactions and balances among consolidated entities have been eliminated.

Consolidated Operating Results

Consolidated Revenues

Consolidated revenue increased $4.9 million, or 2.6%, and $22.3 million, or 4.0%, for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008, primarily due to higher transport revenues in the RCN Metro segment.

Consolidated Direct Expenses

Consolidated direct expenses increased $2.1 million, or 3.2%, and $7.7 million, or 3.9%, for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008. Direct expenses include net benefits from favorable settlements with voice and data network providers on ordinary course network cost disputes totaling $2.2 million and $2.9 million (of which $1.8 million relates to one specific claim) during the three and nine months ended September 30, 2009 and $1.4 million during the nine months ended September 30, 2008. There were no settlements in the three months ended September 30, 2008. Excluding these benefits, consolidated direct expenses increased $4.3 million, or 6.6%, and $9.2 million, or 4.6%, for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 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 Selling, General and Administrative Expenses

Consolidated selling, general and administrative expenses (“SG&A”) decreased $3.8 million, or 5.0%, and $13.5 million, or 6.1%, for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008. Excluding stock-based compensation, SG&A expense decreased $3.2 million, or 4.5% and $8.6 million, or 4.1% for the three and nine months ended September 30, 2009 compared to the same periods in 2008, primarily reflecting (i) the results of the investments made in 2008 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 customer service costs and (ii) reflecting 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 $1.5 million in the nine months ended September 30, 2009 as compared to the same period in 2008 due to the suspension of the Company’s matching contribution to the Company’s 401(k) plan in the beginning of the second quarter of 2009.

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 generally accepted accounting principles in the United States (“US GAAP”) in the business segment footnote to our condensed consolidated financial statements (see Note 13). 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 US GAAP.

Residential / SMB Segment Operating Results