RCN Corporation Q3 2008 Earnings Call Transcript

Nov. 4.08 | About: RCN Corp. (RCNI)

RCN Corporation (RCNI) Q3 2008 Earnings Call November 4, 2008 8:30 AM ET

Executives

Richard R. Ramlall - Senior Vice President - Programming, Strategic and External Affairs

Peter D. Aquino - President, Chief Executive Officer, Director

Michael T. Sicoli - Chief Financial Officer, Executive Vice President

Analysts

David Joyce - Miller Tabak & Co., LLC

Frank G. Louthan IV - Raymond James

David Kestenbaum - Morgan Joseph & Co., Inc.

Donna Jaegers - D.A. Davidson

[Mark Darusi] - Raymond James

[Andrew Morrey - Cowen Asset Management]

Tuna Amobi - Standard & Poor’s

Operator

Welcome to the RCN Corporation third quarter 2008 earnings report. At this time all participants are in a listen-only mode. Following management’s prepared remarks we’ll hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded Tuesday, November 4, 2008.

I would now like to turn the conference over to Mr. Richard Ramlall, Senior Vice President - Strategic and External Affairs and Programming.

Richard R. Ramlall

Welcome everyone and thank you for joining us today to discuss RCN’s third quarter 2008 results. Joining me on the line are Peter Aquino, President and Chief Executive Officer of RCN, and Mike Sicoli, our Chief Financial Officer. After management’s prepared remarks we’ll open up the line for Q&A.

Before we get started I want to point out that today’s conference call and webcast are being accompanied by a slide presentation that we invite you to join by accessing RCN’s website www.rcn.com clicking Investor Relations at the bottom of the home page and then in blue Learn More under Special Announcements.

We have recently relaunched www.rcn.com. The first time you visit our new site you’re prompted to choose a market such as Boston. We invite you to take a look around.

We’ve also posted a pdf document of the slides on our website so that you can download them for easier viewing, and if you haven’t done so already, you can access the results press release we provided today at the same site.

We will refer to GAAP and non-GAAP measures in today’s call and in the press release and webcast slides. Tables of reconciliation of income statement, balance sheet, operating metric measures and segment results are available on pages 8 through 10 of today’s press release and can also be found by clicking the Non-GAAP measures link in the Investor Relations area of our website.

Before we begin, I’d like to remind you that today’s release, conference call and presentation contain forward-looking statements regarding future events and the future performance of RCN that involve risks and uncertainties that could materially affect actual results. This information is qualified in its entirety by cautionary statements and risk factor disclosures contained in certain of RCN’s Securities and Exchange Commission filings. For a description of certain factors that could cause actual results to vary from current expectations and forward-looking statements, please refer to documents that RCN files with the SEC and that are available through www.rcn.com.

With that I’ll turn the call over to Pete Aquino.

Peter D. Aquino

RCN had another good quarter and reached some important milestones for the consolidated company and business units. As I walk through our accomplishments for the third quarter I will highlight the results for our key initiatives that position RCN for continued operational improvements as well as future growth opportunities.

RCN’s success thus far has been driven by a string of major investments, key dispositions and operational tactics. We have strengthened our capabilities in the Triple Play and have built confidence in the market place, and our potential as a leading regional CLEC.

Given our progress year-to-date we have tightened our guidance ranges and revised our outlook for 2008 that still remains very positive. So let’s get started and turn to slide 3 and go over the third quarter results.

As you can see from the results this quarter, consolidated revenue was $187 million. That’s up 20% year-over-year. Our consistent growth in revenue is primarily driven by management’s investment strategy to fuel areas of the business that are accelerating. These opportunities exist in all three segments: Resi, small/medium business and RCN Metro. With the capital program this year of $125 million we increased revenue while enhancing the overall customer experience. As our track record has shown we believe that this is the right formula for sustainable growth.

Pointing to an important milestone. For the first time in our history RCN reached $50 million EBITDA for the quarter. We’re up 34% from last year and achieved 27% EBITDA margin. Overall operating efficiency in our core business and integration success in our CLEC are key contributors to our consistent march towards 30%.

At RCN Metro enterprise and carrier customers are driving a lot of repeat business. This has driven the segment’s new growth to date. We have yet to maximize the potential revenue synergy inherent in Con Ed, NEON and the RCN networks. Even without this upside included, RCN Metro alone produced over 31% EBITDA margin inside of a year of the NEON acquisition.

Looking back, we proactively invested in programs to build a brighter future for our company. We reinvested short-term gains in operating cash flow and invested in Analog Crush and in our CLEC. This was the right decision. It sets us up very well for positive free cash flow in the future and builds on our strong liquidity position.

Over the last few years management has transformed the new RCN into a more clustered yet better diversified portfolio of assets. We are building value while mitigating risks. Today our revenue mix has evolved to 77% from resi and SMB and 23% from our facilities based CLEC. Last year it was 87% and 13%. This shift of business is not only a diversification strategy but a pure vertical opportunity for us given our metro markets with 12,000 fiber route miles and our telecom expertise.

Our built-in acquired fiber footprint in the central business districts and surrounding suburbs are addressing many aspects of broadband demand in some of the best markets in the country.

Let’s turn to slide 4 for more details on resi and SMB. Revenue for the residential and SMB group is $144 million. This is up 6% over last year. EBITDA has reached $37 million or 26% margin. Customer growth also continued for the 10th consecutive quarter and is up 15,000 from last year reaching 428,000 customers. Our RGUs increased by 31,000 to achieve another record high of 915,000 connections. Other key metrics are also remaining strong.

RPU increased to $111 per month versus $109 last year and technically we divide total revenue by total customers versus the industry definition of RPU where most operators divide by total video subs. Using this definition RCN’s ARPC would be about $129 and this is important for comparison purposes.

In addition our bundle rate remains steady at 68% where we’re competing very well for growth in resi and SMB, and our general managers are doing a great job by focusing on tactics that drive share and customer satisfaction.

One of the boldest initiatives in progress since RCN virtually invented the Triple Play is our Project Analog Crush. By the end of this year we will significantly increase the amount of deployed digital set-top boxes in the field by about 30%. This is a massive undertaking. I’m very proud to say that teams really stepped up from corporate strategy right to the warehouse.

You may recall that Chicago is our first market to go all digital in January of this year. Boston was our second and began its digital resolution on the 4th of July. With the FCC set-top waiver extension granted, we accelerated New York, Washington, DC and the Philadelphia suburbs and launched them all this past October. This puts all of our metro markets on track with Lehigh Valley and Dec for early 2009.

Our experience with customer acceptance so far has been excellent. Customers realize that RCN is making major upgrades for their benefit. They’re getting more quality choices for the same basic rate. In some cases customers were rushing out and purchased new HDTVs to experience the flood of new standard and high definition channels. Since we started we accumulated 75 HD channels immediately and now are shooting for 100+. There’s a lot of good energy in the field as we roll through town-by-town.

Internally our product development and programming teams are now gearing up to deliver a very robust international tier that rivals the best offerings available including satellite. We are dedicating 150 linear channels and VOD capacity freed up by Analog Crush.

One unique characteristic of our big cities is that they’re multicultural and according to our analysis there’s significant demand for foreign films, language news and entertainment in our service area. The new platform will be called RCN Global Passport and be available by the end of this year.

In addition, the reclaimed analog spectrum we utilized to enhance our performance in high speed data service especially when the DOCSIS goes live next year. This enhancement will take us beyond our 20 megabits consumer products.

Finally, the net result of the all-digital push puts us way ahead of the cable industry on digital penetration. Today RCN’s already approaching 80% and this is a big plus for additional revenue streams as well as to provide service and subscriber management benefits for RCN.

Moving on the RCN business services. In addition to the Triple Play we now offer hosted VoIP and T1 services. In many cases multitenant buildings that we already entered with fiber are great prospects. We estimate that our network path has approximately 300,000 locations that we can address.

We’re also doing very well with our premier hotel lineup. For example, we’ve expanded our relationship with the Mandarin oriental hotel properties. We now serve the Mandarin Boston after great success with the Mandarin New York. In addition our work in New York City has also led us to educational housing services where we delivered a Triple Play to student dorms. Larger projects such as these really boost our success in RCN business services.

Beyond 2008 we intend to get back to our low-hanging fruit and cold pockets in and around our footprint. We also want to allocate incremental capital to accelerate our CLEC growth. However we do consider these capital investments more discretionary in nature and will keep our eye on the economy in 2009. The good news is that we can control the flow of incremental capital spending without slowing down our momentum.

In terms of current economic trends we’re holding up pretty well. We’ve seen a gradual increase in bad debt and nonpaying churn over the past year. But we’ve been able to continue to deliver positive customer, revenue and EBITDA growth despite that trend. The high end demographics in our markets combined with strong demand for broadband products and services appear to provide some relative support relative to others in the country. Obviously we’ll continue to monitor trends closely and manage our business and invest in key priorities.

Another good sign so far is that overall churn for the resi and SMB group was relatively flat at 3% despite an increase in nonpay churn. The third quarter tends to be seasonally high given move activity primarily in [MDUs] and dorms, and ultimately the stability of churn was a net contributor to another quarter of positive subscriber growth for RCN.

Finally, management continues to focus on areas where our back office infrastructure is catching up with our ambition of product innovation. We’ve made great progress on our [sierra] platform and initiatives that help us optimize the business.

One specific byproduct of our back office investment is our new ecommerce platform. In October we reinvented www.rcn.com and created a new and improved website for buying RCN services online. Potential customers can now shop, order and schedule an install all at their convenience.

We also expect to drive down costs by standardizing our products and leveraging our ecommerce platform for other channels including telesales and direct sales. Ultimately the team will be selling to new customers from the same dynamic catalog and the possibilities are endless as we reinvent the way the Triple Play’s promoted and sold at RCN. We think we’re just at the beginning of this and looking forward to develop its full potential in driving new revenue.

Let’s turn to slide 5 to review RCN Metro’s progress. RCN Metro continues to perform very well. We’re clearly making our mark as a preferred alternative in the Northeast and Mid-Atlantic corridors and Chicago. As you can see from the map, our fiber network includes Metro and intercity rings connecting many of the best markets on the East Coast. This is very attractive for redundancy and diversity for both carriers and enterprises.

Today RCN Metro serves five of the Top 10 markets in the country and we carry mission critical traffic for many of our customers including top tier wireless and financial services firms. We offer SONET, wavelength, Internet access, Metro Ethernet, and co-location services. The combination of carrier hotels, central offices, Internet POPs, and enterprise locations on our network provides a smaller alternative for CIOs who are looking for premier transport services.

RCN Metro revenues of $43 million were up 113% as reported and over 9% pro form including NEON. One key advantage for future growth is that we have significant capacity in our system. We have thousands of miles of available fiber as well as significant lightweight capacity that give us a lot of runway going forward.

With fiber in over 1,200 points of presence today we also have a lot of potential in connected buildings. The incremental construction costs that add new customers to a lit building tend to be very modest. In addition given our numerous fiber routes, we estimate that RCN Metro passes thousands of commercial buildings with its 6,500 route miles. This is a tremendous sales opportunity for our net business that drives EBITDA margin.

Regarding customer retention, despite the headlines in the financial sector exposure to specific failures within our customer accounts tends to be minimal. Overall about 25% of RCN Metro revenues are derived from the financial services vertical. However in down times there are also opportunities and we are aggressively pursuing new business as urgent integration requests have been driven by bank consolidators. With RCN Metro’s fiber density and speed-to-market, we’re in a great position to be a net beneficiary of this trend.

In terms of core investments we proactively upgraded all of our markets with Metro Ethernet infrastructure. This cap ex requirement is also behind us. In hindsight it was a great decision to invest in these upgrades to improve our product set going forward. We’re now seeing more requests for 10 gig E and above versus a year ago and we’re a great position to satisfy this demand.

Overall, the award-winning service provided by RCN Metro is one of the key attributes that attracts large commercial customers to our network. We believe that the state-of-the-art infrastructure that we already have in place along with our success based capital philosophy provides us with great momentum into 2009.

Let’s turn to slide 6 to review our 2008 initiatives and next steps. To summarize how far we came this year, let’s review some of our key objectives.

First, we’re running a portfolio of business units with many options for high return on investment projects to consider. We’ve been building homes in Chicago and [inaudible] value very consistently over the last several quarters and we’ll continue to extend these projects going forward. Our target opportunities in metro markets especially on addresses downtown are also in the play book.

Next, we remain committed to our investment strategy in RCN business services and RCN Metro. Both business segments present untapped opportunities for growth beyond business as usual. Opportunistic M&A may also play a role as credit markets improve in the future.

In the resi group, we’re full steam ahead in going all digital. We’re also investing in enhancing the customer experience such as in our new www.rcn.com, ecommerce and self help platforms.

Looking to margin expansion, on a consolidated basis EBITDA margin is up from 25.5% in the second quarter to 27% this quarter. 30% is within our reach and we will continue to find ways to not only cut costs from approved processes but also grow the top line.

As discussed we made some investments in op ex and cap ex to protect our future and long-term success. We believe our enhanced capabilities will pay great dividends in generating sustainable positive free cash flow in ’09 and beyond.

In considerations in the future we’ll also include share repurchases. Today we have $19 million available under our program and we still intend to use part of this program as our balanced approach in the future.

At this point let me turn it over to Mike to go through the financials in some more details.

Michael T. Sicoli

As a reminder, our 2007 reported results exclude NEON results prior to the acquisition date of November 13. Both RCN consolidated and RCN Metro results are presented in our materials today on an as-recorded basis but we’ll also discuss the pro forma impact as if NEON had been owned by RCN for all of 2007 excluding deal-related costs and some deferred revenue amortization that did not carry over post close.

Let’s move to slide 7 which highlights our consolidated results. On an as-reported basis compared to last year revenue of $187 million grew 20%. EBITDA of $50 million grew 34% and EBITDA margin of 27% grew by nearly 300 basis points. On a pro forma basis compared to last year revenue was up 7%, EBITDA was up 17% and EBITDA margin grew by over 200 basis points. Sequentially revenue grew by 1%, EBITDA grew by 7%, and EBITDA margin grew by over 100 basis points.

On the bottom right is our EBITDA mix. As we have highlighted all year this chart demonstrates our balanced portfolio both from a geographic and customer segment standpoint. Each of these areas has unique growth and profitability characteristics but they’re all served by a common foundation, our fiber rich broadband network which enables us to compete successfully for high end customers of all types across our entire footprint.

Before we move to our segment results I want to highlight that our consolidated results include corporate SG&A costs of approximately $7 million in third quarter 2008 and $6 million each in second quarter 2008 and third quarter 2007. During third quarter 2008 the resi/SMB segment received approximately 77% of these costs, down from 87% last year due to the increase in size of RCN Metro primarily from the acquisition of NEON.

Moving to slide 8, resi/SMB revenue of $144 million grew 6% year-over-year due mainly to the increase in total customers in RGUs with some contribution from higher average revenue per customer as well.

Within our total resi/SMB revenue video revenues of $75 million were up 11% from last year due to an increase of approximately 9,000 video RGUs plus a $5 increase in average revenue per video unit resulting from rate increases implemented during the third quarter as well as higher penetration of set-top boxes including HDDVRs.

Cable modem revenues of $36 million were up 8% from last year due primarily to an increase of 22,000 cable modem RGUs. Voice revenues of $29 million were down 3% from last year as voice RGUs were flat and average revenue per voice line decreased by 3%.

Resi/SMB EBITDA of $37 million was up 12% year-over-year driven by the revenue growth I just discussed as well as higher EBITDA margins which grew by over 100 basis points. Margin expansion resulted primarily from improvements in SG&A as a percent of revenue as total SG&A excluding stock-based comp increase by only $800,000 on revenue growth of over $8 million. This small net increase was a function of numerous cost reductions including field ops and marketing offset by increases in bad debt, property taxes and utilities costs.

Clearly our key margin expansion initiatives which include Analog Crush, product level profitability, efficiency improvements in field ops, care, sales and marketing and continued control over corporate costs are producing results and remain critical to reaching our goal of 30% consolidated EBITDA margin. And remember, our objective here is not only to cut costs. We’re also investing to create a superior customer experience. When the job gets done right the first time, we can reduce our costs while also growing revenue.

Moving to cap ex, resi/SMB cap ex of $27 million was down $3 million from last year and up $2 million from last quarter. The year-over-year decline was due mainly to last year’s renewal of two long-term IRU agreements which totaled $9 million. Excluding those items, cap ex was up $6 million year-over-year driven by higher CPE and installation spending due to the acceleration of Analog Crush. This also drove the sequential increase.

Moving to slide 9, RCN Metro revenue of $43 million grew 113% from last year as reported and 9% on a pro forma basis driven by continued robust growth in transport related products resulting from higher demand for bandwidth as well as vendor and route diversity from both carrier and enterprise customers.

The quality of RCN Metro’s revenue mix and customer base remains strong with approximately 90% of revenue coming from customers with monthly revenue in excess of $10,000 and approximately 60% of revenue coming from customers with monthly revenue in excess of $100,000. From a customer segment perspective, RCN Metro continues to generate approximately 1/3 of its revenue from telecommunications carriers, ¼ each from national wireless providers and financial services customers, and the remainder from other 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 all new customers and by aggressively managing outstanding accounts receivable balances and customer payments.

In addition the nature of our core product set; high bandwidth, high availability, low latency redundant transport; often supports mission critical applications for our customers such as trading operations, traffic aggregation and core network connectivity which positions us to maintain and grow our customer and revenue base even in a challenging economic environment.

RCN Metro EBITDA of $14 million grew 180% from last year as reported and 34% on a pro forma basis. The pro forma growth was driven by continued realization of NEON synergies and the strong operating leverage associated with our on net business model. These factors led to an EBITDA margin of 31% which grew by approximately 600 basis points from last year and 400 basis points from last quarter.

RCN Metro cap ex of $6 million was up $2 million year-over-year as reported and down $1 million from last year on a pro forma basis and also sequentially. Substantially all of our spending remains success based including new laterals, customer electronics and installation labor, and infrastructure to support new customer demand such as our recent long-haul optical layer upgrade and MPLS core upgrade projects.

Moving to slide 10, on a year-to-date basis free cash flow was flat compared to last year with significant increases in unleveraged free cash flow offset by higher interest expense due to last year’s dividend recap and NEON acquisition and by higher working capital outflows due to increases in CPE inventory in anticipation of Analog Crush acceleration, payments related to NEON severance and pre-closed liabilities, and a benefit last year related to a real estate settlement. Our cash position remains sound at $59 million.

We didn’t repurchase any shares during the quarter given the state of the financial system and capital markets but we do expect to resume repurchase activity in the future subject to financial system stability and our ability to maintain sufficient liquidity. We have approximately $19 million remaining under our $25 million repurchase authorization.

As you might expect, we’ve recently taken a closer look at our counterparty credit risks with a particular emphasis on cash and short-term investments as well as revolving line of credit commitments. With respect to our cash and short-term investments we invest in accordance with the terms of our credit agreement which seeks to ensure both liquidity and safety of principal. We hold no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or non-government guaranteed mortgage backed securities. In addition we monitor our third party depository institutions closely.

We like many have some potential exposure in the event of nonperformance by the counterparties to our revolving line of credit, specifically related to undrawn commitments including amounts utilized as collateral for layers of credit. We currently anticipate that these counterparties will be able to fully satisfy their obligations given that they are very large global highly rated financial institutions who are also key lenders under our credit facility.

As Pete mentioned we’re also monitoring overall economic trends. With regard to the year-over-year increase in resi/SMB bad debt, the impact is limited rising from 2% to 3% of revenue and with expanded overall margins despite the increase.

We also implemented tighter upfront credit screening and backend collections procedures during the third quarter which we expect will mitigate any further increases.

In terms of additional impacts, we haven’t seen much thus far. We’re fortunate that the products we sell across all segments tend to be high priority items for our customers and that the geographic markets we serve have fared better than most. Clearly we’ll keep a close eye on the impact of the economy as we move ahead balancing near-term liquidity with our desire to continue investing prudently in the growth of each of our business units and to preserve flexibility for potential strategic investment opportunities.

Our debt balance stood at $739 million at quarter end representing a trailing 12-month leverage ratio of 4 times on a gross basis, down nearly half a turn from year end and 3.7 times on a net basis.

Looking at our debt maturity profile, we’re in a good position with nominal mandatory principal payments required prior to 2014. There is an excess cash flow sweep in our credit facility so to the extent we generate free cash flow in the future roughly half of it would go towards debt pay-down. In addition, we have a secured leverage covenant in our credit facility of 4.5 times at year end 2008 dropping to 4 times at year end 2009 and then down gradually to 3 times at year end 2012 where it will remain until maturity. As you can see based on our third quarter performance, we’re already below our required levels for 2008 on a trailing 12-month basis and we’re already below our required 2009 levels on an annualized basis.

Moving to slide 11, we’ve narrowed our 2008 outlook for both revenue and EBITDA while maintaining our previous outlook for 2008 cap ex. To summarize, the updated numbers are as follows: Revenue range of $738 million to $742 million, slightly higher than the previous range; EBITDA range of $191 million to $195 million in the middle of the previous range; and cap ex of approximately $125 million, unchanged from our previous estimate.

That concludes our prepared remarks. I’ll now turn the call back to the operator to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from David Joyce - Miller Tabak & Co., LLC.

David Joyce - Miller Tabak & Co., LLC

Given that you’re cognizant about the regulatory environment, with the FCC looking into the cable industry channel changes in the digital conversion process, could you give some color on your experience in Chicago as you’ve migrated customers? Was there any short-term initial churn for example if people were confused or upset by channel changes?

Peter D. Aquino

Our experience in Chicago really gave us the confidence to do all of the other markets this year besides having the set-top waiver. Our experience has been that customers really saw this as an upgrade.

What we did in the basic tier where some of the conversation’s happening is we went from 80 channels to 200, so we gave the customer more channels with the set-top box if they didn’t already have it; we did not charge them for the additional set-top box so it wasn’t a financial burden; and we didn’t raise the rate. So the overall experience really came across as an upgrade and that’s been our strategy, and it’s really rolled out quite well in Boston the same exact way.

We stepped back probably three months and wrote letters. We had a lot of events that prepped the market, and then we had these town events basically where we make it easy for customers to get a set-top box if they don’t already have them. If it’s an MDU, we set up in the lobby and really promote the activity. So we did as much as we could to really educate and bring benefit to the customer without raising their basic rate.

Richard R. Ramlall

You’re probably referring to what’s been reported in the letter of inquiry that’s being released by the FCC. It appears that what they’re focused on is something that most of the other cable companies have done that aren’t and didn’t. As you’ll recall with our Analog Crush, we actually made the move completely over to digital in the markets where we introduced Analog Crush.

Most of the other MSOs actually kept an analog tier in addition to introducing digital. So the question for them and it seems what the FCC’s hearing is that there’s a requirement in those cases that you continue to down convert to those subscribers, and the question is what did the MSOs to those subscribers. In our case it’s really different because again we made a switch entirely over to digital.

David Joyce - Miller Tabak & Co., LLC

With the 7% or 8% digital penetration right now, are Chicago and Boston both at a 100%?

Peter D. Aquino

Chicago is nearly there and Boston’s about done in another couple weeks.

David Joyce - Miller Tabak & Co., LLC

On RCN Metro, granted there are some fears in the financial sector and that’s only one quarter of your customer base there, can you give us some color on the different segments? As that number of customers or is that revenue contribution?

Michael T. Sicoli

It was revenue contribution. The customer metrics really aren’t as relevant for this business because the revenue base is so dominated by the top 20 to 30 customers and those customers remain stable obviously from period to period. So the 25% is a revenue number.

It’s important to note though that even within that 25% it’s a pretty big mix of types of customers. There are exchanges, there are commercial banks, there are investment banks, there are hedge funds, there are information service providers, there’s a whole ecosystem there and the thing that really bodes well for us is that the primary application that we support in the financial services sector is trading. So despite what’s been happening to overall market values with volatility where it is and trading volumes where they are, people are not skimping on the spend as it relates to core trading operation.

We also were fortunate in that we didn’t have much exposure to the institutions that had the most trouble so we have fared quite well so far and think we’re well positioned to do well even into the future.

Operator

Our next question comes from Frank G. Louthan IV - Raymond James.

Frank G. Louthan IV - Raymond James

On the Metro side can you give us an idea of how that’s trending? Are you seeing any customers delaying installations or the sales cycle lengthening in any way? Can you give us an outlook there? Are you hiring more folks? Of the growth that you’ve seen, how much of that is coming from say the New York City market versus your other markets outside of the Con Ed properties or is that fairly evenly distributed?

Michael T. Sicoli

In terms of the trends the pipeline is still good. I would say we’re not seeing a material increase in lead times but clearly it’s something that we’re watching and that others have talked about. But we’re not seeing it so far.

In terms of where the revenue growth’s been coming from it’s still pretty balanced to be honest with you. Obviously prior to Con Ed we were heavily concentrated in Newark metro. With the addition of Con Ed, they really had a good mix throughout New England and even into the Mid-Atlantic.

The revenue growth has really been consistent I think across those two footprints. We are generating some additional growth in Chicago and in Philadelphia. They’ve done some recent investments there but those are still relatively small numbers. We would expect them to contribute a lot more in ’09 and beyond. But it’s almost Greenfield opportunity in Chicago and Philly today so we’re excited about that.

In terms of the hiring, we are absolutely hiring more sales folks in particular and don’t expect to stop that any time soon because the opportunities for us are still there.

Operator

Our next question comes from David Kestenbaum - Morgan Joseph & Co., Inc.

David Kestenbaum - Morgan Joseph & Co., Inc.

Can you just talk about your 30% EBITDA margin goal? It seems like it maybe got delayed slightly but can you talk about the time when you think you can achieve that and maybe some of the issues that forced it to take longer than you may have one time expected?

Peter D. Aquino

First of all, I think we’re on track for our 30%. We took a little bit of a step back with Analog Crush because we had an opportunity in front of us in the summer with the set-top waivers. So investing in Crush was an investment in op ex and cap ex. It kind of slowed us down a little bit but we’ve always been targeting fourth quarter and first quarter as the range where we would see 30%. We thought the investment in Crush was really strategic for us. That caused a little bit of a delay but that’s about it.

For the most part we’re well on track and we really like the progress we have in the process improvements in place. If you check out www.rcn.com, the amount of time and money in effort by the time to really put that together really sets us up well for next year too. Things like that were very strategic.

But 30% is a milestone for us. We’re up from 25.5% last quarter to 27%. We’ve got one quarter to go here to really knock on the door so if it’s a little delayed, it’s probably a quarter or so but it’s not a big delay.

David Kestenbaum - Morgan Joseph & Co., Inc.

On the M&A side can you refresh my memory? Are you going to be looking more on the Metro side or residential opportunities?

Peter D. Aquino

I think it’s both. Certainly right now CLEC is a little bit more actionable and it’s been for us. Con-Ed and NEON were two back-to-back opportunistic deals for us. The cable side’s a little bit tougher. It’s more clustered by big cable and further away from our footprint. We’re committed to being in the Northeast corridor and Mid-Atlantic so we’re being very choosy there. But M&A tends to be opportunistic in nature and when the credit markets get back in shape, we’ll be a player.

Operator

Our next question comes from Donna Jaegers - D.A. Davidson.

Donna Jaegers - D.A. Davidson

Can you talk a little bit more on the RCN Metro about pricing trends; what you’re seeing there as far as competitive climate?

Michael T. Sicoli

Really there’s no substantial change today versus earlier this year. I think overall over the past couple of years we’ve seen pricing firm up as consolidation has occurred and as folks have been more reluctant to sell [dark] fiber. We’re not seeing a material change. Again though, remember we are only in the high end transport business so there’s no phone, no low-end broadband where I think you are seeing some pricing competition. But that’s not the space that we’re in.

Donna Jaegers - D.A. Davidson

In the financial sector do you deal at all with the AMEX Exchange?

Michael T. Sicoli

We’re not really in a position to talk about specific customers but I’d say it’s fair to say that we have a player with just about every exchange that’s in our footprint.

Operator

Our next question comes from [Mark Darusi] - Raymond James.

[Mark Darusi] - Raymond James

I have a follow up on the discussion about your international programming package. I think it’s called Global Passport or something like that. Is that just one large generic offering or are you tailoring or segmenting those 150 linear channels to maybe different ethnicities or different geographic focuses? Could you speak about the programming expense for that type of content vis-à-vis your more traditional lineup? I’m trying to understand the margin differential if you would.

Richard R. Ramlall

Relative to your two questions, the first is exactly how you described it in your [inaudible] comment, which is it’s broken up by segments, ethnic genres if you will. For example, there will be a number of South Asian channels, a number of Greek channels, Hispanic channels, etc.

And the second is, the way the cost model works for the international tier is basically, I can’t obviously go into specifics because of confidentialities, but basically the rate that’s set and we priced our rates above that cost. To the extent we have customers from there we pay a rate for that and then we basically price it above what that rate is.

Michael T. Sicoli

The other thing that I would point out as it relates to the cost is that not surprisingly the cost of these channels and of this content is much lower than regular domestic content and we’re in a really good position as well by our metro market footprint. We really can provide targeted access to folks with the international content.

Richard R. Ramlall

This is an area that Pete has focused quite a lot of attention over the last year or so as we’ve been looking at this and waiting for Analog Crush to come to give us the capacity to be able to offer this. As Mike said, with our markets that we have we’re actually having a lot of international operators actually approach us for bandwidth because they look our markets, they see what’s out there, and they’re I hate to use the word beating a path to our door but it actually is pretty much that way.

Peter D. Aquino

It’s been one of the benefits of releasing the spectrum because the real estate we now have available for not only international but other programming content that the programmers have. That has been really great for negotiations because we actually have the space to carry them and it provides consumer choice, it gets them new content out there, and we can differentiate ourselves. So we really want to take advantage of this new spectrum.

Operator

Our next question comes from [Andrew Morrey - Cowen Asset Management].

[Andrew Morrey - Cowen Asset Management]

The expenses for Analog Crush, are those in selling expense?

Michael T. Sicoli

It’s actually more just pure G&A. You’ve got customer notifications, you have extra staff on hand in the call centers, you have truck rolls and mailing costs associated with getting the set-top boxes in customers’ homes. So not so much on the sales side.

[Andrew Morrey - Cowen Asset Management]

But in that SG&A line?

Michael T. Sicoli

Yes.

[Andrew Morrey - Cowen Asset Management]

I missed the first part of the call so I apologize if it’s repetitive, but direct expenses, can you talk about the driver there because it looked like especially good leverage this quarter?

Michael T. Sicoli

First of all, the direct costs will fluctuate from quarter-to-quarter because that’s where the large spend is with programmers and with telecom network providers in particular.

To the extent that settlements come in or disputes get resolved, sometimes those can result in larger than average swings. In this quarter in particular, when you look at it relative to last year that activity was actually relatively consistent so what you saw really was just our voice and data, this is just on the residential side by the way, network costs are relatively flat to even slightly down and the programming cost is the big driver on the video side.

So the video direct cost is the same. It’s always biased upwards in the sort of 5% to 10% range, sometimes even higher. That’s a function of primarily programming cost increases as well as obviously the franchise fees that increase as your ARPU increases. That’s again very consistent with what you would see from other operators.

On the RCN Metro side you would see more operating leverage there as the sell-in of more and more on that business should contribute to a higher margin over time.

[Andrew Morrey - Cowen Asset Management]

Do you see D&A continuing to trend down as a percent? You’re just under $200 million in D&A but your cap ex is only going to be $125 million going forward.

Michael T. Sicoli

Two things there. The answer is yes and the reason it’s yes is primarily because of the impact of fresh start accounting when the company emerged from bankruptcy back in 2004. The valuation that was done on the asset base at that time resulted in a fairly high allocation to PP&E which then resulted in a high amount of depreciation. That’ll run its course here over the next two or three years and then it’ll be more of a normal “relationship” between cap ex and depreciation.

Operator

Our next question comes from Tuna Amobi - Standard & Poor’s.

Tuna Amobi - Standard & Poor’s

My first question is on the phone. It seems like you guys have hung in there with the circuit switch platform which generally has been contracting in the industry. What plans do you have to perhaps migrate those customers that you have out there now to kind of a VoIP digital platform, because clearly I think that’s been a drag on your RG growth now for a couple quarters?

Michael T. Sicoli

First of all, it’s been fairly stable for us now for well over a year. Prior to that the RGUs were coming down fairly significantly year-over-year because we had an off net customer base on the phone side that we divested basically through attrition. So what you’ve seen over the past year is more a tale of the different pieces of our footprint. Within the dense metro market areas we are losing phone penetration primarily to wireless substitution but within Lehigh Valley and within our small and medium business footprint we’re actually growing from RGUs. Those two have sort of offset each other to the point where the RGU numbers have been fairly stable.

Tuna Amobi - Standard & Poor’s

So you’re going to stay with circuits switch platform?

Michael T. Sicoli

I was getting to that. The first thing I just wanted to level set on the actual trends in the RGUs. The second point as it relates to technology is that in all of the areas that we have constructed within the past couple of years we do have a VoIP last mile architecture similar to other cable companies. In Chicago, certain areas of Pennsylvania, certain areas of Massachusetts is already VoIP last mile and we are actually in the process right now of our next generation network planning such that within the next couple of years you could expect us to be moving to an all IP architecture for phone and really the whole platform.

Tuna Amobi - Standard & Poor’s

Switching gears, in terms of counterparty exposure I presume that you had perhaps minimal risk to Lehman Brothers? Is that a fair statement?

Michael T. Sicoli

That’s correct.

Tuna Amobi - Standard & Poor’s

I’m trying to reconcile your headline number of customers and RG and net adds to the number that you actually break out in the table. Is the difference on that primarily or entirely due to digital video subscribers? You are highlighting 15,000 customers net adds and 31,000 RGUs and then you’re showing 4,000 and 6,000 respectively in terms of the actual numbers.

Michael T. Sicoli

Yes. The numbers we were talking about were year-over-year so the 4,000 and the 6,000 would be sequential.

Operator

There are no further questions at this time. Mr. Aquino, please proceed with your presentation or any closing remarks.

Peter D. Aquino

I want to thank you for your attention today. It’s been a very busy day for all of us with Election Day. If you have any questions, get back to Richard or myself or Mike. Thank you for your time.

Operator

Ladies and Gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect at this time.

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