The following discussion and analysis should be read together with RCN's Consolidated Financial Statements and related notes thereto beginning on page F-1. Reference is made to "Cautionary Statement Regarding Forward Looking Statements" on page 3 of this Annual Report on Form 10-K (the "Annual Report"), which describes important factors that could cause actual results to differ from expectations and non-historical information contained in this Annual Report. Unless stated otherwise, as in the section titled "Discontinued Operations" under this Item 7, all of the information contained in Management's Discussion and Analysis of Financial Condition and Results of Operations relates to continuing operations. Therefore, the results of operations from our San Francisco and Los Angeles markets, as discussed below, are excluded for all periods covered by this Annual Report.
Overview
RCN is a competitive broadband services provider, delivering all-digital and high-definition video, high-speed internet and premium voice services primarily to Residential and Small and Medium Business ("SMB") customers under the brand names of RCN and RCN Business Services, respectively. In addition, through our RCN Metro Optical Networks business unit ("RCN Metro"), we deliver fiber-based high-capacity data transport services to large commercial customers, primarily large enterprises and carriers, targeting the metropolitan central business districts in our geographic markets. We construct, operate, and manage our own networks, and our primary service areas include: Washington, D.C., Philadelphia, Lehigh Valley (PA), New York City, Boston and Chicago.
Subsequent to the Company's acquisition of NEON Communications Group, Inc. ("NEON"), in November 2007, management reorganized RCN's business into two key segments: (i) Residential/SMB and (ii) RCN Metro. There is substantial managerial, network, operational support and product overlap between the Residential and SMB businesses and, as a result, we have historically reported these two businesses as one segment. RCN Metro, however, is managed separately from the other two business units, with separate network operations, engineering, and sales personnel, as well as separate systems, processes, products, customers and financial measures. Management of the Company's two key businesses is unified only at the most senior executive levels of the Company. Therefore, beginning with the results of operations for 2008, the financial results of the RCN Metro business unit are being reported as a separate segment in accordance with the requirements of SFAS 131, "Disclosures about segments of an enterprise and related information" and applicable SEC regulations. All prior period amounts in this Report have been restated to present the results as two separate reportable segments. For financial and other information about our segments, refer to Item 8, Note 15 to our Consolidated Financial Statements included in this Annual Report .
All of the Company's operations are in the United States. Our Residential/SMB segment, which serves approximately 428,000 Residential and SMB customers, generates approximately 77% of our consolidated revenues and the RCN Metro segment generates approximately 23%. During 2008, our operations generated consolidated revenues of approximately $739 million. Basis of reporting
Following is a discussion of the key factors that have affected the company's business over the last three fiscal years. This commentary should be read in conjunction with the company's Consolidated Financial Statements, Selected Financial Data and the remainder of this Form 10-K. Key Transactions
In November 2007, we completed the acquisition of NEON, a network transport services provider to carrier and enterprise customers in the New England and mid-Atlantic regions. NEON had a fiber optic network that consisted of approximately 4,800 route miles, over 230,000 fiber miles, 22 co-location facilities, and more than 200 points of presence from Maine to Virginia. We paid a purchase price of $5.15 per share of NEON common stock, or total consideration of approximately $255 million. Including transaction costs, the total purchase price for NEON was approximately $260 million. We funded the transaction with a combination of proceeds from an additional $200 million term loan under our existing credit agreement, a draw of approximately $25 million under our existing $75 million line of credit, and cash on hand.
In March 2007, we completed the sale of our San Francisco, California assets to an affiliate of Astound Broadband LLC, a subsidiary of Wave Broadband LLC ("Wave"). Separately, we decided to exit the Los Angeles, California market during 2007. Accordingly, the accompanying audited consolidated results of operations and statements of cash flows for all periods presented in this Annual Report include the results for these two markets as "discontinued operations". There were no assets and liabilities related to these markets on the consolidated balance sheets at December 31, 2008 and 2007.

In 2007, we completed a recapitalization initiative in which we repaid all of our then outstanding debt, totaling approximately $199 million, and paid a special cash dividend of $9.33 per share, totaling approximately $347 million, utilizing the proceeds of a new $595 million revolving credit and term loan agreement.
In March 2006, we acquired the stock of Consolidated Edison Communications Holding Company, Inc. ("CEC"), the telecommunications subsidiary of Consolidated Edison, Inc. CEC, a competitive local exchange carrier, offers a comprehensive suite of broadband-based communications products and services, including business continuity and disaster recovery to commercial customers in the greater New York metropolitan area. Total cash paid for the acquisition, including transaction costs and post-closing adjustments, was approximately $41.4 million. In March 2006, we sold our 48.93% interest in both Megacable, a cable television and high-speed data services provider in certain portions of Mexico, and MCM, a provider of local voice and high-speed data services in Mexico City (collectively, "Megacable"), for net after-tax proceeds of $300 million. Critical Accounting Policies and Estimates The preparation of the Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States ("GAAP") requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Management uses historical experience and all available information to make these judgments and estimates. These estimates and assumptions affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ. Despite these inherent limitations, management believes that Management's Discussion and Analysis and the accompanying Consolidated Financial Statements and footnotes provide a meaningful and fair perspective of our financial condition and operating results for the current period. Estimates are used when accounting for various items, including allowances for doubtful accounts; investments; asset impairments; programming related liabilities; revenue recognition; depreciation and amortization; income taxes; exit and restructuring costs; and legal and other contingencies. Estimates and assumptions are also used when determining the allocation of the purchase price in a business combination to the fair value of the assets and liabilities and determining related useful lives. Refer to Note 2 to our Consolidated Financial Statements for a more complete discussion of all of the Company's significant accounting policies. Results of Operations
The comparability of our results of operations for the year ended December 31, 2008 with earlier periods is significantly impacted by the acquisition of NEON in November 2007, the sale of our San Francisco, California assets in March 2007, and the subsequent exit of our operations in the Los Angeles, California market during 2007. The accompanying consolidated results of operations and statements of cash flows for all periods presented in this Annual Report include the results for the two California markets as "discontinued operations" and the assets and liabilities related to these markets were classified as held for sale on the consolidated balance sheets. NEON results are included in our consolidated results subsequent to the closing date of November 13, 2007. To provide better comparisons of operating results in light of the NEON transaction, the discussion below provides certain pro forma amounts, in addition to actual results, when comparing the year ended December 31, 2008 to the year ended December 31, 2007. Pro forma basis means that the results are discussed as if NEON was owned throughout the periods presented including the impact of adjustments made to eliminate certain deferred revenue amortization and transaction related costs from historical NEON results. The Consolidated Financial Statements include the accounts of RCN and its consolidated subsidiaries. All intercompany transactions and balances among consolidated entities have been eliminated.
The financial information presented in the table below comprises the audited consolidated financial information for the years ended December 31, 2008, 2007, and 2006.

                        RCN CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
            (dollars in thousands, except share and per share data)

                                                          Year Ended December 31,
                                                    2008            2007           2006

Revenues                                          $ 739,243      $  636,097      $ 585,476
Costs and expenses:
Direct expenses                                     264,219         224,770        201,370
Selling, general and administrative (including
stock-based compensation of $13,335, $33,206,
and $18,162)                                        294,100         288,426        276,471
Exit costs and restructuring charges, net of
recoveries                                            2,314           8,194          6,702
Depreciation and amortization                       198,734         195,239        192,964


Operating loss                                      (20,124 )       (80,532 )      (92,031 )
Investment income                                     2,880           9,424          5,983
Interest expense                                    (53,301 )       (34,510 )      (24,659 )
Gain on sale of investment in unconsolidated
entity                                                    -               -        125,370
Loss on sale of assets                                 (181 )          (827 )       (2,119 )
Loss on the early extinguishment of debt                  -         (63,795 )      (19,287 )
Other (expense) income, net                               -            (451 )           35


Loss from continuing operations before income
taxes                                               (70,726 )      (170,691 )       (6,708 )
Income tax (benefit) expense                              -          (1,049 )        7,612


Net loss from continuing operations                 (70,726 )      (169,642 )      (14,320 )
Income from discontinued operations, net of
tax                                                       -           1,684          2,464
Gain on sale of discontinued operations, net
of tax                                                    -          15,921              -


Net loss                                          $ (70,726 )    $ (152,037 )    $ (11,856 )

Consolidated Operating Results
Consolidated Revenues
Consolidated revenue increased $103.1 million, or 16.2%, for the year ended December 31, 2008 compared to the year ended December 31, 2007 largely due to the acquisition of NEON. In 2007, the Company recorded a $4.4 million benefit related to a reciprocal compensation agreement. On a pro forma basis, and excluding the $4.4 million benefit, consolidated revenue increased $43.2 million, or 6.2%, for the year ended December 31, 2008, as compared to the same period in 2007, primarily due to an increase in the number of customers in the Residential/SMB segment and higher transport revenues in the RCN Metro segment.
Consolidated revenue increased $50.6 million, or 8.6% for the year ended December 31, 2007 compared to the year ended December 31, 2006 primarily due to an increase in APRC and average number of customers, as well as the acquisitions of CEC in March 2006 and NEON in November 2007. Consolidated Direct Expenses
Consolidated direct expenses increased $39.4 million, or 17.6% for the year ended December 31, 2008 compared to the same period in 2007 primarily due to the acquisition of NEON. On a pro forma basis, consolidated direct expenses increased $14.2 million, or 5.7%, for the year ended December 31, 2008 compared to the same period in 2007, as a result of an increase in customers and revenue for both the Residential/SMB and RCN Metro segments, as well as an increase in the average programming cost per subscriber in the Residential/SMB segment. Consolidated direct expenses increased $23.4 million, or 11.6%, for the year ended December 31, 2007 compared to the year ended December 31, 2006. The increase was primarily due to the incremental expenses associated with NEON and CEC of approximately $11.5 million as well as an increase in programming costs of approximately $8.0 million. The increase in direct expenses was also attributable to the impact of vendor settlements with providers of our voice and data network services which totaled $2.2 million and $6.8 million for the years ended December 31, 2007 and 2006, respectively. Higher franchise fees, which includes the impact of $1.5 million incurred in 2007 as a result of an audit of prior years, also contributed to the increase in direct expenses.

Consolidated Selling, General and Administrative Expenses Consolidated selling, general and administrative expenses ("SG&A") increased $5.7 million, or 2.0%, for the year ended December 31, 2008 compared to the same period in 2007, primarily due to the acquisition of NEON, partially offset by a decrease in stock-based compensation expense of $19.9 million. On a pro forma basis, and excluding stock-based compensation, SG&A increased by $1.2 million, or 0.4%, for the year ended December 31, 2008 compared to the same period in 2007, reflecting increases in bad debt expense, property taxes and legal costs, partially offset by a decline in certain general and administrative expenses, primarily due to the integration and synergies achieved through the NEON acquisition.
Consolidated SG&A increased $12.0 million, or 4.3%, for the year ended December 31, 2007 compared to the year ended December 31, 2006. The increase was primarily due to an increase in stock-based compensation of $15.0 million and the acquisitions of NEON and CEC. Excluding the impact of stock-based compensation and the acquisitions of NEON and CEC, SG&A decreased approximately $10.3 million for the year ended December 31, 2007, reflecting a decrease in general and administrative expenses offset by increases in sales and marketing expenses. Also included in SG&A is $1.1 million of termination pay related to the retirement of the Executive Chairman of the RCN Board of Directors in December 2007.
Segment Operating Results
To measure the performance of our operating segments, we use operating income before depreciation and amortization, stock-based compensation, exit costs and restructuring charges. This measure eliminates the significant level of non-cash depreciation and amortization expense that results from the capital-intensive nature of our businesses and from intangible assets recognized in business combinations, as well as non-cash stock-based compensation and other special items such as exit costs and other restructuring charges. We use this measure to evaluate our consolidated operating performance and the performance of our operating segments, and to allocate resources and capital. It is also a significant performance measure in our annual incentive compensation programs. We believe that this measure is useful to investors because it is one of the bases for comparing our operating performance with that of other companies in our industries, although our measure may not be directly comparable to similar measures used by other companies. Because we use this metric to measure our segment profit or loss, we reconcile it to operating income, the most directly comparable financial measure calculated and presented in accordance with GAAP, in the business segment Note 15 to our Consolidated Financial Statements. You should not consider this measure a substitute for operating income (loss), net income (loss), net cash provided by operating activities, or other measures of performance or liquidity we have reported in accordance with GAAP. Residential / SMB Segment Operating Results

                                                          Residential/SMB
                                                  For the year ended December 31,
                                                           Fav(unfav)                       Fav(unfav)
                              2008           2007             Var%             2006            Var %
Revenue:

Video                       $ 294,650      $ 271,330               8.6 %     $ 250,655              8.2 %
Data                          142,704        133,406               7.0 %       121,407              9.9 %
Voice                         114,386        117,477              (2.6 %)      126,990             (7.5 %)
Recip Comp/Other               16,191         24,050             (32.7 %)       26,108             (7.9 %)

Total Revenue                 567,931        546,263               4.0 %       525,160              4.0 %

Direct expenses               199,367        190,093               4.9 %       177,844              6.9 %
Selling, general and
administrative
(excluding stock-based
compensation)                 223,143        220,700               1.1 %       227,614             (3.0 %)


Operating income before
depreciation and
amortization,
stock-based
compensation, exit costs
and restructuring
charges                     $ 145,421      $ 135,470               7.3 %     $ 119,702             13.2 %

Reconciliation to Operating Loss

                                                    2008           2007           2006

Operating income before depreciation and
amortization, stock-based compensation, exit
costs and restructuring charges                   $ 145,421      $ 135,470      $ 119,702
Less: Stock-based compensation                       10,364         28,205         16,452
Less: Depreciation and amortization                 167,355        183,038        187,025
Less: Exit costs and restructuring charges            1,602          8,089          6,449

Operating loss                                    $ (33,900 )    $ (83,862 )    $ (90,224 )

Residential / SMB Revenues
Residential/SMB revenue increased $21.7 million, or 4.0%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. Excluding a $4.4 million benefit related to a reciprocal compensation agreement recognized in 2007, Residential/SMB revenue increased $26.1 million, or 4.8%, during the year ended December 31, 2008 as compared to the same period in 2007. The increase is primarily due to an increase in the average number of customers and average revenue per customer ("ARPC"). Customers increased by approximately 12,000, or 2.9%, from December 31, 2007 to December 31, 2008 primarily due to increased sales opportunities generated through investments in new and rebuilt homes, and increased focus on sales and marketing to SMB customers. Total revenue generating units ("RGUs") grew by approximately 18,000, or 2.0%, from December 31, 2007 to December 31, 2008, driven primarily by overall customer increases, with data RGU growth outpacing video RGU growth. Voice RGUs declined consistent with industry trends. ARPC increased from $109 for the year ended December 31, 2007 to $110 for the year ended December 31, 2008, due primarily to growth in average revenue per video RGU and increased high-speed data penetration, partially offset by declines in average revenue per voice and data RGU. The increase in average revenue per video RGU was driven mainly by our annual video rate increase, which partially mitigates the impact of annual increases in programming costs, as well as increased customer purchases of value added products and services such as our digital set-top, high-definition ("HD") and digital video recorder ("DVR") boxes, digital programming tier and premium channels. Our digital video penetration rate rose to 87% of video customers in the fourth quarter of 2008 from 69% in the fourth quarter of 2007, as we neared the completion of Project Analog Crush. The decrease in average revenue per voice RGU was due to overall market pricing trends, where voice prices have consistently decreased over the past several years. The decrease in average revenue per data RGU was primarily due to an increase in the percentage of data RGUs representing lower-speed data plans, a trend which has increased since RCN introduced these plans last year.

Residential / SMB Metrics4    December 31, 2008       December 31, 2007       December 31, 2006

Video RGUs 1                             366,000                 358,000                 355,000
Data RGUs 1                              302,000                 285,000                 259,000
Voice RGUs 1                             244,000                 250,000                 249,000
Total RGUs 1                             911,000                 893,000                 863,000

Customers 2                              428,000                 416,000                 406,000
ARPC 3                       $               110     $               109     $               107

(1) RGUs are all video, high-speed data, and voice connections provided to residential households and SMB customers. Dial-up
Internet and
long distance
voice
services are
not included.
Additional
telephone
lines are
each counted
as an RGU,
but
additional
room outlets
for video
service are
not counted.
For bulk
arrangements
in
residential
multiple
dwelling
units
("MDUs"),
including
dormitories,
the number of
RGUs is based
on the number
of video,
high-speed
data and
voice
connections
provided and
paid for in
that MDU.
Commercial
structures
such as
hotels and
offices are
counted as
one RGU
regardless of
how many
units are in
the
structure.
Delinquent
accounts are
generally
disconnected
and no longer
counted as
RGUs after a
set period of
time in
accordance
with our
credit and
disconnection
policies.
RGUs may
include
customers
receiving
some services
for free or
at a reduced
rate in
connection
with
promotional
offers or
bulk
arrangements.
RGUs provided
free of
charge under
courtesy
account
arrangements
are not
counted, but
additional
services paid
for are
counted.

(2) A "Customer" is a residential household or SMB that has at least one paid video, high-speed data or local voice connection. Customers with only dial-up Internet or long distance voice service are not included. For bulk arrangements in residential MDUs, including dormitories, each unit or outlet for which service is provided and separately paid for is counted as a Customer. Commercial structures such as hotels and offices are counted as one Customer regardless of how many units are in the structure. Delinquent accounts are generally disconnected and no longer counted as Customers after a set period of time in accordance with our credit and disconnection policies.

(3) ARPC is total revenue for a given monthly period (excluding Dial-up Internet, reciprocal compensation and certain commercial revenue) divided by the average number of Customers for the period. This definition of ARPC may not be similar to ARPC measures of other companies.

(4) In connection with our transition to segment reporting, effective January 1, 2008, we have reclassified certain customers, RGUs and revenue related to our RCN Metro business unit, such that they are no longer included in our reported Residential and SMB metrics. The impact on customers and RGUs is de minimis, and the impact on ARPC would be to reduce historical reported amounts by approximately $1. Therefore, this change will only be reflected for periods after January 1, 2008, and historical results will remain as previously presented.

Residential/SMB revenue increased $21.1 million, or 4.0% for the year ended December 31, 2007 compared to the year ended December 31, 2006 primarily due to an increase in the number of customers as well as higher ARPC. Excluding a $4.4 million benefit related to a reciprocal compensation agreement recognized in 2007, revenue increased $16.7 million, or 3.2%, during the year ended December 31, 2007 as compared to the same period in 2006. Total customers increased by approximately 10,000 in 2007, or 2.5%, driven primarily by investments in new and rebuilt homes, as well as improved sales and marketing execution. ARPC increased $2, from $107 for the year ended December 31, 2006 to $109 for the year ended December 31, 2007, driven primarily by video price increases and higher cable modem penetration, partially offset by continued declines in voice penetration and average revenue per voice RGU, as customers have continued to migrate to lower priced voice plans or alternative solutions such as wireless.
Residential / SMB Direct Expenses
Direct expenses increased $9.3 million, or 4.9%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. Direct expenses for the year ended December 31, 2008 and 2007, include a net benefit of $1.9 million and $2.2 million, respectively, as a result of favorable settlements with our voice and data network providers. Direct expenses for the year ended December 31, 2007 also include a charge of approximately $1.5 million in franchise fees identified during an audit. During the year ended December 31, 2008 and 2007, direct expenses include a net benefit in programming expense of $1.4 million and $1.4 million, respectively, due to more favorable claims experience with programming audits. On a pro forma basis and excluding these benefits, consolidated direct expenses increased $10.5 million, or 5.4%, for the year . . .