RCN Corporation Q4 2007 Earnings Call Transcript

RCN Corporation (RCNI)

Q4 2007 Earnings Call

March 11, 2008 8:30 am ET

Executives

Richard Ramlall – Senior VP of Strategic and External Affairs

Peter D. Aquino – President, Chief Executive Officer & Director

Michael T. Sicoli – Chief Financial Officer & Executive Vice President

Analysts

Stefan Anninger – Bear Stearns

Ian Zaffino – Oppenhiemer

Lucas Binder – UBS

Colby Synesael – Merriman Curhan

Chris Roberts – Tejas Securities Group

David Joyce – Miller Tabak & Company

David Kestenbaum – Morgan Joseph

James Breen – Thomas Weisel

Presentation

Operator

Welcome to the RCN fourth quarter earnings conference call. At this time all participants are in a listen only mode. Following management’s prepared remarks we will hold a Q&A session. (Operators Instructions) As a reminder this conference is being recorded today, March 11, 208. I would now like to turn the conference over to Richard Ramlall, Senior VP of Strategic and External Affairs. Please go ahead sir.

Richard Ramlall

Welcome everyone and thank you for joining us today to discuss RCN’s fourth quarter 2007 results. Joining me on the line are Pete Aquino, President and Chief Executive Officer of RCN, Mike Sicoli, our Chief Financial Officer and Ben Preston, our General Counsel. 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 so we invite you to join by accessing RCN’s website at www.RCN.com, clicking on company and events calendar. We’ve also posted a PDF document of the slides on our website so you can download them for easier viewing. And, if you haven’t done so already you can access the results press release we’ve provided today at the same site.

We will refer to GAAP and non-GAAP measures in today’s calls and in the press release and webcast slides. A table of reconciliation of income statements, balance sheets and operating measures are available on pages 8 through 10 of today’s press release and can also be found on RCN’s website at www.RCN.com, clicking on company and investor relations.

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 future performance of RCN that involve risk 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 & Exchange Commission filings. For a description of center factors that could cause actual results to vary from current expectations and forward-looking statements please refer to documents that RCN filed with the SEC and that are available through RCN.com.

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

Peter D. Aquino

Good morning everyone. It’s been a really strong finish in 2007 meeting our increased guidance once again. We made a lot of progress in advancing our competitive position in the markets that we serve. Our momentum in delivering the triple play in high end telecom products and services, points us in a direction of another record breaking year for RCN in 2008. In this fourth quarter I’m happy to report once again that we grew [resi] customers. This is our seventh consecutive quarter which busts the trend relative to many other operators in the industry. This is a tribute to our growth strategy our highly skilled and dedicated employees and I’m very proud of the team. We are committed to being the premier alternative to incumbent cable, telco and satellite providers. Our aim is to provide our customers with the best that technology can offer and build value for our shareholders.

I will highlight our key accomplishments to date and describe our vision for growing our business in 08 and beyond. Mike will cover the financials and metrics for the fourth quarter calendar year 07 and then create a bridge to our 2008 financial guidance. After that we’ll take your questions.

So let’s get started and turn to Slide Three to discuss our revenue margin expansion track record. The first Slide shows our corporate and financial achievements during the past three years. Over this time management has increased revenues by 10% annual reaching $636 million and EBITDA increased even faster with 36% growth annually to $156 million. We have in essence transformed the company into a profitable and sustainable model and used M&A to concentrate in the North East and Mid Atlantic corridors and Chicago. These past three years have been action packed and we’ve completed four major deals. We sold Megacables and our West Coast assets and raised $350 million in cash. We returned $350 million of capital to our shareholders and took advantage of great market timing to relever our balance sheet. Then, we acquired Con Ed and NEON to jump start our [c.LINK] business. But, while we pursued M&A opportunities management also streamlined the business and we restarted our growth engines. We’ve become even more competitive now taking share business in commercial sectors to supplement our core residential growth. Our improving results are evidence to RCN succeeding as a competitive alternative to incumbent cable and telco operators.

Let’s turn to Slide Four to discuss our business unit approach and how we get to the next level. So, when you think of RCN think of the power of our vertical model. We have the unique ability to sell to all three customer groups, resi, small/medium business and large commercial customers. RCN is operating in five of the top 10 metropolitan markets in the country: Washington DC, New York City, Philadelphia, Boston and Chicago. Besides producing Super Bowl Champions, our big cities are great for telcom competition as well. Both consumers and businesses are demanding broadband alternatives in which we provide a superior choice.

Our customers who watch the Super Bowl in HD, had a great experience with RCN, assuming they were Giants fans. Our success as a provider is significant and highlights our ability to operate in high demand areas that clearly have room for multiple competitors. Our cities literally and figuratively go straight up and RCN is in a position to exploit this vertical model from a suburban neighborhood to a Trump Tower, from a small store front to a major financial institution; we cover all types of customers and we have the expertise to deliver. From a residential perspective the density of a metro market provides a wide candidate for RCN. We already know that our triple play compares favorably to traditional competitor products and our addressable market of 1.3 million homes provides a great target for us to pursue.

Compared to our success in Lehigh Valley which is over 50% penetrated given our 42 years of superior service, our other systems are relatively young. Our penetration rates range from 25 to 32% with great upside potential. In addition, we often point out that there are over 400,000 homes that we can build for $500 a home or less and this year we will continue our construction program balanced with our accelerate digital CPE plan and I’ll discuss this in a minute. Regarding the launch of our emerging small and medium business group branded RCN business service, we’re just scratching the surface. Many MSOs are pointing to this addressable market as the pure land grab away from incumbent telcos and we agree. We estimate that there are 300,000 small and medium businesses that are within 50 feet of our network. There may not be another broadband company our size that can claim this reach. Our success in the [c.LINK] space with the new RCN metro assets is very promising for building shareholder value. The number of commercial buildings, carrier hotels and central offices that we pass is very impressive. We currently have over 1,200 on net buildings and nearly 6,000 fiber op miles that rival any regional [c.LINK] in our footprint. With our core resi business we now have over 11,000 fiber op miles.

With the combined assets of NEON, the MCI POSS and Con Ed, RCN metro now has access to 12 metropolitan markets from Richmond, Virginia to Portland, Maine and out to Chicago. In addition, I’m very pleased to announce that we’ve just completed construction of our latest metro ring in downtown Philadelphia. This expands our ability to sell now in the central business district. Overall, our [c.LINK] routes are yet another way to extend our resi and SMB reach. So, to give you an idea of what type of traffic metro carries, many of your wireless calls to the Northeast are originating and terminating on our network. In addition, our New York facility carries trades to and from exchanges and trading floors every business day. This speaks to the quality and reliability of our networks and we’re really proud of this.

At this point let’s turn to Slide Five. I’ll summarize our strong competitive position. First of all we have the best of cable TV, Internet and phone built into our triple play and if you took the Pespi challenge you couldn’t tell the difference between our HD or anybody else’s. We have 30 HD channels today on most of our systems and growing. We also offer thousands of hours of VOD content including free movies and recent releases. And in VOD we’re experiencing enormous growth and take rates, this is due in part to our digital set top push and today we’re at almost 70% digital penetration, one of the highest in the industry. A trend you’re probably aware of is that consumers are buying more and more HD TVs and they’re becoming very accustomed to recording their favorite chose on a DVR. Educated consumers are also aware of the national shift to a digital broadcast by February, 2009.

In addition, Internet applications requiring greater speed are on the rise and households are getting more comfortable with buying phones lines from providers other than the phone company, like RCN for example. We have 70% voice penetration which is also far above cable. All of these trends benefit RCN and work well into our long term strategy. Our high speed data service offers up to 20 Megabytes of speed and is already ahead of mass market applications. When he comes to overall prospects we’re shooting at a very large target. The majority of consumers are still subscribing to slower cable modem speeds, DSL and even dial up and technically prospects for RCN become even better with [inaudible] 3.O becomes even more mainstream. We too expect to reap the benefits of 3.O and still maintain our speed advantage over much of the competition given our smaller node sizes.

To give you an idea how we gain share in high speed data, according to a recent study in comScore, 45% of RCN high speed data gains came from DSL, 47% came from cable and 8% from dial up. This tells us that there’s still a tremendous opportunity to gain share from either cable or telco with satellite currently out of the game. When it comes to FiOS, it stands for find out it’s the same. Find out is the same as RCN. We match up very well on nearly all fronts the number of HD channels, 20 megabytes of speed and phone quality. Despite all the hype and lobbying efforts, it’s important to keep the overall impact on our business in perspective. Our portfolio of assets is well diversified with half of resi customers and MDUs. We currently overlap in about 15% of our marketable homes, primarily in single family homes in suburban Boston and Maryland and we’re now winning back some of the early adopters and plan to become even more competitive in the future. RCN is also diversified by having a strong tier two presence in Lehigh Valley where our reputation as the primer provider supported by consistent performance and customer surveys. In addition, our system in Chicago is also very advanced and executing well against cable, telco and satellite providers.

The next competitive advantage is our built in business and commercial diversity. I believe that RCN business services and RCN metro will be huge contributors as we leverage our shared infrastructure and when it comes to the vertical model, it clearly stems from being in the right location. You’ve all heard the real estate cliché location, location, location, location well, this certainly applies to us. It allows RCN to penetrate all customers groups from resi to large business. When it comes to our ability to compete in the big leagues regarding video of the future, we are again a first mover. So, let me explain. This past January, we launched project analog crush in Chicago. Through this initiative we are reclaiming one of the 430 Megahertz of analog spectrum from 72 channels. We are currently duplicating these in digital simulcast where we reuse this reclaimed spectrum for new HD and standard def channels. With up to 3 to 1 compression we estimate that we can add over 200 HD channels. Our spin to basic tier now called RCN signature went from 80 channels to 200. The analog crush line ups going to be really hard to match and regarding Hi Def, our Chicago team launched with 50 channels to start and our programming team here at corporate is looking for even more new content for them, not just adding east and west feeds. Those arcane jumps ahead have the cable industries debating whether it should use switch digital or reclaim only some spectrum to avoid CPE spend. This will limit their future HD potential, I believe. We have decided to take the leap and do it right. When we say all digital, we mean it. There will be no analog channels, period.

There are also many operational benefits of going all digital for RCN including subscriber management, immediate feature provisions and reduced truck rolls. All of this fits very well into our plan to streamline transactions and improve the efficiency and the customer satisfaction. Our FCC set top wavier last summer really encouraged us to go all digital and we’re proud to lead the industry in this important initiative. We look forward to continue support as we accelerate analog crush into other markets.

Finally, our focus on the customer is relentless and we’re making the necessary investments to enhance our service levels even further. We invested in SalesForce.com and initiated customer relationship management tools. [Inaudible] parts of the program include customer rewards, post install phone surveys, contractor management reviews and new training programs. So, having the right tools to arm our employees is a top priority for us. We believe that great customer service is truly a differentiator in our business. We expect that these investments will pay off in customer loyalty and retention.

Let’s turn to Slide Six and discus our 2008 key initiatives. So, as we look ahead into 08 the transformational work is much behind us. RCN is entering a new phase. We’re in a great position to leverage our competitive advantage for growth and reach new financial and operational milestones. We will continue to evaluate accretive M&A opportunities and prioritize our projects in a such as way as to maximize our total return. Included in this balancing act will be consideration to buy back additional shares. We already purchased 4 million of the 25 million authorized in 07 and we also used our cash to help fund NEO. So having this kind of financial flexibility is a great advantage because it allows us to pursue high return on investment opportunities. It’s also important to note that we’re planning to invest in success based projects and broadband infrastructure. Not constricting the company but rather expanding our growth potential all at the same time generating positive free cash flow.

Our business unit approaches design to drive revenue growth and margin expansion with continued work towards our goal of exiting 08 near 30% EBITDA margins and are confident that now this is within our reach. So, in summary, our 2008 key initiatives include continuing to build new homes and focusing on underpenetrated areas, enhancing the customer experience with new systems and continuing focus by all employees, evaluating strategic M&A opportunities, aggressively pursuing analog crush and rolling it out in all digital platforms and all markets over the next two years. We’re also expecting incremental revenue from digital cable and BOD. In business services, we’re expecting to deliver strong double digit customer and revenue growth and beginning to offer customized board T1 solutions. Finally, in RCN metro we will be selling to enterprises and carriers now across all of our territories and are expecting double digit revenue growth. The synergies captured from Con Ed and NEON acquisitions are head of schedule, helping RCN metro to produce nearly 30% EBITDA margins already. In addition, increasing billing penetration and adding on net buildings will carry RCN metro fair beyond 2008.

So in summary, we intend to make smart investments and execute on our key initiatives through 08 to continue to build value for our shareholders.

At this point let me turn it over to Mike who will walk us through the financial results.

Michael T. Sicoli

As a reminder all historical information contained in today’s presentation excludes results from our previously held California properties as these results were reflected in discontinued operations in our financial statements. Also, our reported results include results from our two commercial acquisitions Con Ed Communications and NEON Communications only after their respective closing dates. Con Ed in March 2006 and NEON in November, 2007. Starting in 2008 we’ll begin reporting our results in two segments with our residential and small business units consisting of one segment and our carrier enterprise United, RCN Metro as the other segment. RCN Metro results will be presented on a pro forma basis as if NEON had been known by RCN for all of 2007. In addition, we’ve reclassified certain costs previously reported in SG&A in direct costs. These costs consist primarily of building access rights which are directly related to generating revenue similar to right of way fees and we’ve now classified them as direct costs. The reclass applied to all periods contained in today’s presentation as well as our reported results.

Let’s move to Slide Seven which highlights our key fourth quarter financial trends. Core residential revenue of $132 million grew 5% year-over-year comprised of video revenues of $68 million up 11% from last year due to 3,000 more video RGUs and a $6 increase in average revenue per video customer resulting from annual rent increases and higher penetration of enhanced services such as digital tier, HD DVRs and VOD. Cable modem revenues of $34 million up 9% from last year due mainly to an increase of 26,000 cable modem RGUs. And, voice revenues of $28 million down 5% from last year due mainly to a $2 decrease in average revenue per voice line. Voice RGUs grew slightly for the first time in several years as the planned attrition of our off net customer base is now largely complete. Going forward we expect voice RGUs to be relatively stable as gains in Lehigh Valley, Chicago and small business should offset continued resi landline penetration declines in our highly penetrated Northeast Metro markets. Commercial revenue of $33 million grew 55% from last year driven by a half quarter of NEON revenue or $10 million and organic growth of 8% from continued momentum in transport and other data products. Our year-over-year growth rate remains slightly lower than prior quarters due to the full quarter impact of the large customer contract renegotiation we talked about last quarter. But, for the full year we were up 10% and we expect to be back at those levels in 2008. NEON integration is going well so far and we’re on track to deliver our expected synergy target.

Total revenue of $168 million increased 12% from last year and 8% from last quarter due in part to the $10 million in NEON revenue I highlighted earlier. Excluding NEON total revenue grew 5% from last year and 1% from last quarter. Fourth quarter EBITDA was $41 million representing a 26% year-over-year increase and an 8% sequential increase. These figures include approximately $3 million from NEON and $1 million in severance payments related to the contract expiration of our former executive chairman. Excluding these items fourth quarter EBTIDA was $39 million up 20% from last year and 2% from last quarter. Our fourth quarter EBTIDA margin of 24% was up nearly 300 basis points from last year demonstrating our continued ability to grow margins. As Pete mentioned we’re focused on continuing our margin expansion progress and reaching our goal of 30% margin in the key areas of targeted improvement remains field ops, customer care and sales and marketing.

Moving to Slide Eight, let’s review our full year financial trends. Core residential revenue of $519 million grew 5% year-over-year driven by 9% growth in video revenue, 10% growth in data revenue and offset by an 8% decline in voice revenue. Commercial revenue of $101 million grew 40% year-over-year driven in part by the CEC acquisition in March, 2006 and the NEON acquisition in November, 2007 as well organic growth of 10%. Total revenue of $636 million increased 9% year-over-year driven in part by the CEC and NEON acquisitions as well as 5% total organic growth. Full year EBITDA was $156 million representing a 24% year-over-year increase. Excluding NEON and the severance I highlighted above. 2007 EBITDA was $154 million near the upper end of our 2007 guidance range of $150 to $155 million and representing a 22% year-over-year increase. Full year EBTIDA margin of nearly 25% was up by more than 300 basis points from last year.

Moving to page nine you’ll see that year-over-year we grew customers and RGUs by 10,000 and 30,000 respectively. As Pete mentioned, we’ve grown customers and RGUs for every quarter for the past seven quarters and our bundle rates remain very strong. 68% of our customers take in at least two products. [RPIC] grew $2 year-over-year due primarily to increases in average revenue per video customer and our $109 level remains among the highest in the industry. On the bottom right you’ll see that we made significant progress increasing our digital video penetration growing from 55% at the end of 2006 to 69% at the end of 2007 laying the ground work for the all digital push that Pete mentioned earlier.

Turning to page 10 we’ve broken out our cap ex in two different ways. First, we’ve categorized our spending over the past three years into two buckets: growth and maintenance and support. Growth includes resi and commercial footprint expansion as well as CPE and installation related costs. Maintenance and support includes infrastructure spending primarily on the resi side to augment capacity where needed and replace depreciated assets as well as support spending to upgrade or replace back office systems, vehicles and facilities. As you can see, the majority of our spending is growth related with most of these projects driven by discreet business cases requiring a minimum 30% ROR. The second break out is 2007 spending by category comprised of $18 million for residential growth which consists primarily of the 60,000 plus homes we built or rebuilt during 2007, $54 million for residential customer premise equipment and installation driven by the significant increase in digital penetration I highlighted earlier as well as increasing penetration of HD DVR boxes which rose from 18% at year end 2006 to 26% at year end 2007. $18 million for commercial growth consisting of primarily new laterals, customer electronics and installation labor for enterprise and carrier customers including approximately $1 million related to NEON in the November/December time frame. Also, just to clarify, spending related to small business growth is included in the resi figures I just mentioned. Next, we have $22 million for residential infrastructure which includes capacity augments, product upgrades and the replacement of end of life assets and for 2007 also included $9 million related to long term IRU renewals and $7 million for support infrastructure which includes systems, vehicles and facilities.

While certain portions of this spending simply represent the cost of doing business, some of the money spent here has a direct impact on improving revenue and cash flow growth. For example, in 2007 our key support investments included ecommerce, work force automation and data warehouse. We also kicked off our customer relationship management or CRM project at the very end of the year. These projects will run indefinitely as they’ve become core parts of our business with quarterly releases that deliver incremental functionality that help us increase sales, lower costs or both. This is not an area RCN invested much in historically but we believe its key to our future success not only to help achieve our 30% margin goal but also to provide a superior customer experience versus incumbent providers which is an area where we feel we can build a competitive advantage given the incumbent’s history of poor customer service.

Moving to Slide 11, 2007 free cash flow was negative $8 million down year-over-year due mainly to higher interest expense from the dividend recap this past summer plus the acquisition of NEON as we chose to invest our year-over-year EBITDA increase in additional growth cap ex which I highlighted earlier. As we have articulated previously, we set our capital plan and capital structure in 2007 to position us for positive free cash flow in 2008 and as Pete mentioned we believe we are on track to deliver that. Our cash position remains strong at $68 million down $57 million from year end due primarily from the free cash use plus the NEON acquisitions as our proceeds from assets sales effectively offset the net impact of the dividend recap. We chose to use more cash than originally planned to finance NEON because it enabled us to complete the entire financing within our existing first lien credit facilities thereby providing us with the highest flexibility at the lowest cost. We also repurchased approximately $4 million of RCN common stock during 2007 pursuant to the $25 million repurchase authorization we announced last summer. As Pete mentioned, we’ll continue to evaluate share repurchases as we move ahead. In comparison to other potential organic and/or strategic investments and in balance with our liquidity and credit profile objectives. Our debt balance stood at $745 million at year end representing a trailing 12 month leverage ratio of approximately 4.4 times on gross basis and 4.0 times on a net basis. Based on our 2008 EBITDA guidance which I’ll discuss further in a moment, we expect to be under 4 times on a gross basis by year end.

Even with our increase in leverage during 2007 we believe our balance sheet gives us sufficient flexibility to support future organic and strategic growth opportunities. Before getting into 2008 guidance I want to take you through our 2007 pro forma consolidated results on page 12 so you have a basis of comparison. In the first column you’ll see NEON’s pro form full year 2007 results. Revenue of $74 million excluding approximately $2 million in deferred revenue that will not be recognized going forward due to purchase price accounting, EBTIDA of $18 million excluding approximately $5.4 million of deal related costs and stock-based comp and cap ex of $15 million. In the second column you’ll see stand alone 2007 RCN results excluding NEON results recorded during the second half of the fourth quarter. The third column is simply a sum of the first two columns resulting in pro form 2007 consolidated RCN revenue of $700 million, EBITDA of $171 million and cap ex of $133 million.

Carrying this column over to Slide 13 we then adjust these pro forma results for certain previously reported non-recurring items noted at the bottom of the slide to establish a 2007 base line which shows our revenue of $696 million, EBTIDA of $166 million and cap ex of $124 million. Our 2008 outlook consists of a revenue range of $730 to $740 million representing a 5 to 6% growth rate versus the 07 baseline, an EBTIDA range of $190 to $200 million representing a 15 to 20% growth rate versus the 07 baseline and within those numbers we expect that RCN Metro will represent approximately 23 to 24% of consolidated 2008 revenue with an EBITDA margin of approximately 30% on a fully allocated basis. And finally, we have a cap ex range of $110 to $120 million reflecting a slight decrease versus the 07 baseline. We expect a similar amount of activity in 2008 but at a lower cost primarily as a result of pricing discounts negotiated with our key equipment vendors and to a lesser extent due to expected NEON synergies.

That concludes our prepared remarks. I’ll now turn the call back over to the operator to start Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) One moment for your first question. Your first question comes from the line of Stefan Anninger with Bear Stearns. Please go ahead with your question.

Stefan Anninger – Bear Stearns

I was just wondering if you could update us on the build out in Lehigh Valley, what you’re expecting in terms of additional homes passed in 2008 and any update on the cost per homes passed that you’re seeing right now? Then, also if you could update us a little bit on the I think you called it digital crush but what’s happening in Chicago right now, what you’re seeing in terms of the transition process of going all digital and any disruption of service for customers, etcetera?

Peter D. Aquino

Let me start and I’ll hand it over to Mike if there’s other details on the Lehigh Valley. But, in particular, Lehigh Valley is very mature so our build out is going outside so we’re going to new franchises in Lehigh Valley and that’s been a great opportunity for us. So, the maturity of the market is such that the reputation we carry will basically push us to extended areas. Our plan in Lehigh Valley has always been aggressive. The last two years we even dedicated quite a bit of our capital in category one to the Valley growth and we’re going to continue to do that. I don’t think we specifically gave guidance to the Valley homes passed targets but I assure you we’re focused on the Valley. Regarding analog crush in Chicago, it has been a really good new story, I think the fact of the matter is that most of the consumers are expecting an all digital world. There’s a lot of talk in the marketplace about whether it’s U-verse out in Chicago or Comcast that’s a form of analog crush where they reclaim I think maybe 20 channels or so, maybe 30 versus our 70 plus. So, there’s been a lot of education out there and I think consumers expected it and all of the reports we’re hearing including the real testimonies are very positive. The idea of launching with 50 HD channels in Chicago is creating a lot of excitement and the lessons we’ve learned even in launching crush is to really educate the market in front of the launch. We spent months ahead of January talking to our customers about how it’s going to roll out, what the advantages will be and again, Comcast went probably several months ahead of us and already educated the market regarding additional set top requirements and such. So, it’s been nothing but good news so far and I’m really, really excited to continue the program throughout the rest of the company.

Stefan Anninger – Bear Stearns

Just one additional follow up on the digital transition if I could. Has the set top box walk out begun? So, are you removing all the analog boxes from existing analog homes, is that right?

Peter D. Aquino

We already did that Stefan. In the case of RCN, we don’t have many analog boxes at all. A few years ago we started with digital simulcast so we went straight to digital from a simulcast perspective a couple of years ago. So, our systems are really quite ahead regarding digital penetration that’s why we’re already at 70%. Our general managers kind of felt that pain almost two years ago and we’re all digital.

Michael T. Sicoli

Just to follow up on your question about the homes numbers, within the 60,000 approximately 20,000 each were in Lehigh and Chicago and then about 10,000 each in New York and Boston.

Operator

Your next question comes from Ian Zaffino with Oppenheimer. Please state your question.

Ian Zaffino – Oppenhiemer

Just a really quick question, you’ve alluded to all the data gains you are making and most of it was from DSL, what’s driving that? Is that because Verizon is out there stirring the pot trying to get people over to FiOS so the customers are taking a fresh look at their options? Or, is there another reason I’m not thinking of?

Peter D. Aquino

I always knew that the addressable market for us was huge, I mean DSL penetration out in the market place and slow cable modem speeds is there. It’s there for us to go after. It’s been forever there, including dial up which is amazing there’s still a lot of customers still using dial up. So, our target is the existing base and so the approach we’ve had for years here has been really look at the addressable market and when we have launched with up to 20 megabytes, the customers that know RCN know that we just blow those speeds away. So, you’re kind of at the forefront of the applications, really. I mean, in the past email was really was the only thing they were ever using but now as you think about movies, and videos and Utube and all the downloads that are going on, folks are looking at RCN for that type of application. So, that’s the awareness there.

Michael T. Sicoli

I am sure that the increased marketing spend and the focus on higher bandwidth products has made a difference in the minds of the consumer but I do agree with Pete that I think it has more to do with applications and the customer experience and basically DSL is the new dial up. DSL just doesn’t get it done for the average broadband consumer today and that’s why we think it’s such a great opportunity for us.

Operator

Your next question is from Lucas Binder with UBS.

Lucas Binder – UBS

I just had a couple of quick questions, when you look at this guidance that you guys are providing, 5% growth in revenues, 15 to 20% growth in EBIDTA can you maybe talk a little bit about what the drivers are especially for where you’re going to see the margin expansion and the [c.LINK] business and I guess why you feel that 5% growth on the top line on a pro forma basis, where that’s going to be driven from?

Michael T. Sicoli

I started on the top line which is that from an RCN Metro perspective we expect continued double digit growth rates. Pro forma, RCN Metro as well as NEON were 10 to 11% growth in 07 year-over-year and we would expect it to be at a similar level in 08. On the residential side we grew about 5% year-over-year and if you do the math about 5% year-over-year on that part of the business still gets you in that 5 to 6% range. We just feel that the overwhelming majority of our revenue is on the resi/small business side versus the [c.LINK]. The revenue growth comes from obviously addition [RPOO] from rate increases and higher take rates on the digital services as well as hopefully additional customers from the new builds that we’ve been doing over the past couple of years. On the margins side obviously revenue growth had something to do with that on a fixed cost base but on top of that it’s really the areas of efficiency that we’ve talked about before so we know that we are inefficient in field operations, as an example. We know that our repeat truck rolls, our on-time percentages, our job completion rates are all below industry standard and fixing those areas are completely within our control it’s a matter of process and tools as Pete and I were mentioning and we’re making the necessary investments there. Customer care is another area and a) from an efficiency standpoint putting the tolls in our employees hands so that they can process transactions efficiently and that we can close out customer issues first time but also from an ecommerce perspective enabling customers to buy over the web in a non-commissioned way and frankly in a way that they would expect to do business with broadband company in 2008. Then there’s several other areas of just normal course cost containment and from an overhead perspective that we’ve done a really good job on the past couple of years and there’s still a little bit of room left there as well.

Operator

Your next question comes from Colby Synesael with Merriman.

Colby Synesael – Merriman Curhan

Just a few of them, one I think you mentioned that Verizon you see them in about 15% overlap with your markets. If you looked out maybe a year from now what do you think that number is and maybe you can correlate that back to some of the press releases they’ve already put out in terms of where they’re going. Two, the Metro business obviously has a large exposure to the financial services market. I’m just wondering if you’re seeing any slowdown in terms of demand as it relates to the macroeconomic down turn we’re all seeing. And then three, you mentioned that you’re seeing your channel lineup expand with digital specifically in Chicago going to, I think you mentioned, 200 channels. What’s the costs associated with bringing those new channels online?

Michael T. Sicoli

I’ll try to remember them in order. The Verizon question was the first one in terms of the footprint. I don’t think we expect them to roll out any additional territories in Boston where we provide service in 2008. We know they’re working on a franchise in New York that has been immanent for years I think at this point so at some point we would expect that to happen as well as in Washington DC, I think they’ve recently got the process started there.

Colby Synesael – Merriman Curhan

Is there a way to correlate that back to what that is in terms of a percentage of your coverage?

Michael T. Sicoli

You know, we haven’t historically provided the details of the number of customers in homes by market just for competitive reasons but I think the easiest way to think about it is in New York and in DC it’s primarily a MDU play for us and already non-exclusive MDUs. So, it’s something we’ve talked about before which is that Verizon has many hurdles to overcome there first to get the franchises and then there’s a building access issue to overcome and then there’s a cost effective solution issue in terms of retrofitting the existing MDUs. And even when they overcome all of those hurtles which we expect them to do at some point, they’d have to chose to be a third entrant in a building to be a material threat to us and our footprint and we just don’t think that’s realistic.

Peter D. Aquino

Colby, I would just add part of what Mike just said in terms of New York City and Washington DC, the reason why it’s difficult is that those negotiations, as Mike said have been going on for some time. We’re not in those negotiations but quite frankly, what we’ve seen in the past is Verizon typically does not want to provide service to all of the areas which is a concern to the local franchise authorities. So, until those discussions get to some conclusion it’s difficult to tell just what the areas they’re going to be able to cover. Those franchise authorities generally want them to cover all areas. Typically, as you know, Verizon tries not to do that.

Michael T. Sicoli

I think the second question was around the financial services sector and whether we’re seeing an impact of that in our business. I think the types of products that these companies buy from us are not typically impacted by the problems that they seem to be having. They’re still processing lots of trades, they still need very robust telco solutions. And remember also, in many cases, we’re a redundant or alternative provider and we’re the only ones in those alternative rights of way. So, we’re not seeing a huge impact there, at least not today. Then, you’re last question was around the cost of the incremental channels that we’re offering. The beauty of that is the way that we’ve been able to structure deals with the program providers is that it really isn’t a material incremental cost to provide the 200 channels versus the 80, the way we’ve got the new lineups set up. Also, on the HD side, again most of those fees that are not an incremental cost. You have something like Discovery HD which is legitimately incremental content so stuff like that costs money but the HD feed of a linear channel is not an extra cost, it’s just a better product. So, I think you’re going to see HD become to standard def digital what digital was to analog at some point in the not too distant future. So, that’s what we’re positioning ourselves for.

Operator

Your next question is from Chris Roberts with Tejas Securities Group.

Chris Roberts – Tejas Securities Group

I want to talk a little bit about gross margin. Mike mentioned that you allocate or moved a few items from SG&A to direct costs being building access rights and I calculate the gross margin at 63.4% which is down a bit from the 65 to 66% during the last four or five quarters. Mike, can you give an idea of how much of that decline was due to this reallocation to direct costs?

Michael T. Sicoli

About $4 million that moved from SG&A to direct costs. So, I think you’re calculating the margin correct, it’s probably about a point of margin. But, although of the numbers that you see in the results today have been adjusted even historically. So, if you’re comparing to numbers that you calculated previously off of what we reported previously you may see that decline but, if you recalculate it based on what we just provided it should be a consistent basis. And we did indicate in the 10K by the way in MD&A what the exact dollar amounts were for 05, 06 and 07.

Chris Roberts – Tejas Securities Group

Switching to another question, I know during the first quarter most of the industry [in ex] annual price increases, can you give some color as to what extent or impact that might be and what its been so far in the first quarter?

Michael T. Sicoli

Sure, I think overall for RCN it might be slightly less than you’ve seen from us in previous years primarily because we elected not to take a rate increase in Lehigh Valley. The gross margin profile of that business was very strong and from a competitive perspective there we felt like it was a real opportunity for us to make even more progress so we did not take a rate increase in Lehigh Valley, we did take a rate increase in the rest of our footprint in the order of what we typically do which is the neighborhood of 5%.

Operator

Your next question comes from David Joyce with Miller Tabak and company.

David Joyce – Miller Tabak & Company

Looking at guidance I know you’ve talked a little bit about the revenue side of it, are you seeing further discounting either from bundled promotions that you have to offer or is there something else in the voice [RPOO] that’s causing that to come down competitively? Secondly, on the cap ex side, it looks like that the cap ex spending is coming down now, you’ve fully upgraded. How would you break out cap ex plans for commercial versus residential?

Michael T. Sicoli

Sure. I think on the [RPOO] point first, obviously the competitive environment is very dynamic but we haven’t seen major price discounting. I think the larger players understand that that is not the way to play the game and we don’t expect that to sort of happen but in terms of the specific products, video [RPOO] has still come up nicely both from rate increases as well as the higher penetration of digital services which I would expect to continue. I think all of us from a video provider perspective have the same programming rate increases each year so all of us are raising prices on the video product and we’ve seen Verizon, Comcast, Satellite, we’ve seen everybody doing it so it’s not something we would expect to stop going forward. Data pricing is pretty simple and voice pricing has continued to creep down a little bit. We’re in the mid 30s though now so I don’t know that it’s going to come down that much more. I think it could approach $30 over the next couple of years but compared to the $55 that it was two or three years ago now down to the mid $30s I don’t think you see that same kind of downward pressure from here. But, I do think it will probably still continue to creep down a little bit just because of the effects of landline substitution and additional bundling from the other providers.

In terms of cap ex I think you saw $18 million is what we did in 07, that was just on the RCN side, NEON did itself another $15. One of that is an overlap from this year that they were owned by RCN but call it in the neighborhood of $30 that was spent pro forma for our RCN Metro unit. We would expect that number to be a little bit less in 08 but somewhere in that $25 to $30 million range as we move forward.

Operator

(Operator Instructions) Your next question comes from David Kestenbaum with Morgan Joseph.

David Kestenbaum – Morgan Joseph

Can you give us a little color as to where you are in the whole process of integrating NEON? I know you said it’s going well. Then, considering that you’re getting very little value in the market for your whole Metro business, would you consider splitting that off to increase shareholder value? Then finally, I know in the past we’ve talked about potentially hitting the 30% margin during at least one quarter this year. Is that a possibility? I know you’re guiding lower for the year but, will we see a 30% margin in 08?

Peter D. Aquino

Sure, I’ll take the integration of NEON first. The fact of the matter is the New York and New England teams really had a lot in common in the first place and the networks basically met in many hotels. So, the integration technically was very quick. The teams speak the same language, they have a very strong DNA from the telco side and the [c.LINK] side so it was a real lift for us to put both of those teams together, it’s a real all star team now. So, the integration from my perspective is going fast and the fact of the matter is we’re approaching 30% margin where both of those companies stand alone where nowhere near that number. So, I really like what we see so far. Splitting it off, I mean that’s something we could always consider in the future but right now we’re not planning to do that. What we’re doing is a segment reporting the [c.LINK] so you can see the results of it clearly. That’s the most important thing we can do. I believe in the past there was kind of buried inside of the core business but now we’re going to split that out, you’ll see the value of our [c.LINK] and we’re very excited about that, there’s no doubt about it.

Regarding 30% EBITDA margins, we’ve been very methodical and we’ve also by starting the growth engines we invested in the company both in cap ex and op ex really to get to this point. So, 30% was really within our grasp for some time but we didn’t want to slow the company down so we downsized. So, 30% by the end of this year exiting fourth quarter is definitely within our grasp. Mike do you want to add anything to that?

Michael T. Sicoli

No, I think its been our internal goal here for a couple of years now to exit 08 at that level and it remains our internal goal to do that. Obviously, there’s a lot of factors involved from getting from 24 to 30% in a 12 month period so all of these initiatives that we’ve laid out have to produce. And to the extent that they do we have confidence that that will occur.

Operator

Your next question comes from James Breen from Thomas Weisel.

James Breen – Thomas Weisel

A couple of comments on the color on the enterprise side, can you talk about if you’re seeing any lengthening of the sales process there just as a result of the economy? Secondly, on the balance sheet again with the capital markets, at least the high yield markets seem to be pretty close right now, do you face any restrictions on the debt side in terms of refinancing near term? Thanks.

Michael T. Sicoli

Sure. On the [c.Link] sales side, knock on wood, no real issues to report at this point. I think the products that we sell as I mentioned before, are not products that are slowing down as a result of the economic condition and our share levels on a relative basis are so low that we still have so much opportunity to take a relatively small share of a very big pie that I’m not sure how much impact it would really be unless the downturn was severe. In terms of the balance sheet side we’ve got a great credit facility right now. We did it back in June. So, it’s got LIBOR plus 225 on the term loan, LIBOR plus 200 on the revolver, it’s got an [inaudible] covenant package. We did add a secured leverage covenant when we did the NEON financing. But, we feel comfortable with the levels that that 5.5 at year end 07 and steps down to 3 times over the next few years, kind of ratably year by year. So, we feel comfortable with that level. So, there’s really no need to refinance anything, that’s kind of what I alluded to in terms of we ended up using a little bit more of our cash to finance the NEON transaction to make sure that we could finance the entirety of that transaction within our first lien credit facility because it was so favorable to us.

Operator

There are no further questions at this time. I would like to turn the call back over to Peter Aquino.

Peter D. Aquino

Thank you for joining us today. We look forward to the first quarter, that update will be in May. So, we’ll take the one-on-ones after this. Again, thank you for joining the call and we look forward to 2008.

Operator

Ladies and gentlemen that concludes your conference call today. We thank you for your participation and ask that you please disconnect.

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