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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 0-23253
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ITC/\DELTACOM, INC.
(Exact name of registrant as specified in its charter)
Delaware 58-2301135
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1791 O.G. Skinner Drive, West Point, Georgia 31833
(Address of principal executive offices)
(706) 385-8000
Registrant's telephone number, including area code
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Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant at March 22, 2002, based upon the last reported
sale price of the registrant's common stock on the Nasdaq National Market on
that date, was approximately $20.7 million.
The number of shares of the registrant's common stock outstanding on March
22, 2002 was 62,364,768.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business....................................................................... 1
Item 2. Properties..................................................................... 19
Item 3. Legal Proceedings.............................................................. 20
Item 4. Submission of Matters to a Vote of Security Holders............................ 21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......... 22
Item 6. Selected Financial Data........................................................ 23
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................... 48
Item 8. Financial Statements and Supplementary Data.................................... 48
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure..................................................................... 48
PART III
Item 10. Directors and Executive Officers of the Registrant............................. 48
Item 11. Executive Compensation......................................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and Management................. 58
Item 13. Certain Relationships and Related Transactions................................. 63
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................ 67
.
Index to Consolidated Financial Statements.................................................. F-1
i
This report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. When used in this report, the words "anticipate,"
"believe," "estimate," "expect," "intend," "plan" and similar words as they
relate to ITC/\DeltaCom, Inc. or our management are intended to identify some of
these forward-looking statements. All statements by ITC/\DeltaCom, Inc.
regarding our expected future financial position and operating results, our
business strategy, our financing plans, forecasted trends relating to the
markets in which we operate and similar matters are forward-looking statements.
We cannot assure you that our expectations expressed or implied in these
forward-looking statements will turn out to be correct. Our actual results could
be materially different from our expectations as a result of, among other
factors, the factors discussed under "Business-Regulation" and "-Risk
Factors."
Some of the information contained in this report concerning the markets and
industry in which we operate is derived from publicly available information and
from industry sources. Although we believe that this publicly available
information and the information provided by these industry sources is reliable,
we have not independently verified the accuracy of any of this information.
Unless we indicate otherwise, references in this report to "we," "us,"
"our" and "ITC/\DeltaCom" mean ITC/\DeltaCom, Inc. and its subsidiaries and
predecessors. Unless we indicate otherwise, we have rounded dollar amounts over
$1 million to one decimal place and dollar amounts less than $1 million to the
nearest thousand.
ii
PART I
Item 1. Business.
Overview
We provide voice and data telecommunications services to businesses in the
southern United States and regional telecommunications transmission services
over our network on a wholesale basis to other telecommunications companies. In
connection with these businesses, we own, operate or manage an extensive fiber
optic network in the southern United States.
We operate our business in three segments: retail services, broadband
transport services and e/\deltacom. Through our retail services operations, we
provide local telephone services, long distance telephone services, data
services, Internet services, customer premise equipment sale, installation and
maintenance services and related telecommunications services to customers served
by 35 branch offices in the southern United States. Through our broadband
transport services operations, we sell regional telecommunications transmission
capacity on a wholesale basis using our fiber optic network. Through our
e/\deltacom operations, which we commenced in March 2000, we provide customers
with colocation services, managed services and professional services primarily
through e/\deltacom's data center in Suwanee, Georgia.
In September 2001, we announced changes to our business plan as a result of
which:
. we have increased our focus on sales of our retail service offerings,
while planning to maintain our broadband transport services business
at current levels;
. we reduced planned capital expenditures by approximately $150 million
from $440 million through the end of 2003; and
. we reduced our workforce by approximately 20%, thereby reducing
annualized operating expenses by an estimated $22 million.
During 2001, our operational achievements included the following:
. we increased revenues from our local telephone services by 53% and
from our enhanced data services by 52%;
. we increased retail services access lines installed by 46% and
wholesale services access lines installed by 6.5%;
. we increased our total network mileage to approximately 9,980 route
miles;
. we pursued an enhanced data strategy with an introduction of a suite
of managed services, including Internet protocol, virtual private
network, firewall security, internal data services and a suite of
managed service offerings from e/\deltacom;
. we implemented new service level agreements under which e/\deltacom
undertakes to provide 100% Internet access and power availability; and
. we inaugurated a suite of e-billing solutions for retail services
customers.
1
We are incorporated in Delaware. Our principal executive offices are
located at 1791 O.G. Skinner Drive, West Point, Georgia 31833, and our telephone
number at that address is (706) 385-8000.
Services and Facilities
Services. We currently provide three basic services:
. integrated voice and data telecommunications services on a retail
basis, which we refer to as our "retail services ";
. regional telecommunications transmission services to other
telecommunications companies on a wholesale basis using our fiber
optic network and directory assistance services, which we refer to as
our "broadband transport services"; and
. colocation services, managed services and professional services
through our e/\deltacom division.
Retail Services. Our retail services involve the provision of voice and
data telecommunications services to end users and resellers. These retail
services include:
. local telephone services;
. long distance telephone services;
. toll-free calling, calling card and operator services;
. asynchronous transfer mode, frame relay and high-capacity broadband
private line services;
. primary rate interface connectivity and colocation services to
Internet service providers;
. enhanced services, including conference calling and fax broadcasting;
. consulting, integration, operation and proactive management of data
networks;
. in-depth network performance analysis and implementation and design
services for data network deployment;
. Internet and Web page hosting services; and
. customer premise equipment sales, installation and maintenance.
We intend to provide additional types of retail services to expand our
comprehensive bundle of value-added telecommunications services. Our
customer-focused software and network architecture permits us to present our
customers with one fully integrated monthly billing statement for the entire
package of retail services they purchase from us.
Local Telephone Services. We currently provide local telephone services by
using our network and facilities and by reselling the services of the former
monopoly local telephone companies, which we refer to as the "incumbent
carriers." Since our initial offering of local service in 1997, we have steadily
increased the percentage of services we provide over our network and facilities
compared to the services we provide by reselling the services of the incumbent
carriers. We offer local telephone services in all 35 markets in which we have a
branch office.
2
In connection with offering local telephone services, we have entered into
interconnection agreements with BellSouth Telecommunications, Inc., SBC
Communications Inc., Sprint Communications Company, L.P. and Verizon
Communications Inc. to resell the local telephone services of these incumbent
carriers and interconnect our network with the networks of these incumbent
carriers for the purpose of gaining immediate access to their unbundled network
elements. These interconnection agreements currently allow us to provide local
service on a resale basis or by purchasing the unbundled network elements
required to provide local service over our network and facilities. These
agreements allow us to enter new markets with reduced capital expenditures and
to offer local service to our customer base. The applicable state regulatory
authorities have either approved the terms of our interconnection agreements or
we expect that such approvals are imminent. Our interconnection agreements will
remain subject to review and modification by the applicable state regulatory
authorities. We believe, but cannot assure you, that these interconnection
agreements provide a foundation for us to provide local service on a reasonable
commercial basis. Factors that may adversely affect our ability to provide local
service on a reasonable commercial basis include unsettled legal and regulatory
issues, legal and regulatory developments and existing operational issues with
the incumbent carriers that are not resolved by the interconnection agreements.
BellSouth is the incumbent carrier in a majority of the markets in which we
offer local services. Our interconnection agreement with BellSouth, which we
entered into in March 1997 and that governed our ability to gain access to
BellSouth's unbundled network elements in all states where BellSouth is the
incumbent carrier, expired on July 1, 1999. We have entered into new
interconnection agreements with BellSouth in all nine BellSouth states. The
public utility commissions of Alabama, Florida, Georgia, North Carolina and
Tennessee have approved the new interconnection agreements applicable to those
states. Although the approval of the interconnection agreements applicable to
Kentucky, Louisiana, Mississippi and South Carolina remain pending before the
state public utility commissions of those states, we do not expect that approval
will be withheld.
Our strategy is to offer facilities-based local service in a majority of
our markets by colocating our equipment with that of the incumbent carriers with
which we have interconnection agreements. We began colocating our equipment in
some of BellSouth's central office locations during the first quarter of 1998.
As of December 31, 2001, we had completed physical colocation of 177 access
nodes and were offering our "Unity" service in all of the 35 markets in which we
have a branch office. The Unity service, which we market primarily to mid-sized
and major regional businesses, connects our customer's location to one of our
switches using a direct T-1 digital connection and provides the customer with
local and long distance calling capacity on any of the T-1's 24 available
channels.
In June 2000, we signed an agreement with BellSouth to offer a UNE-P, or
unbundled network element-platform, service in all of the BellSouth markets. To
provide the UNE-P service, we purchase all of the required facilities of
BellSouth at reduced prices. This allows us to convert existing resale customers
to facilities-based customers and to earn higher gross margins on the sale of
our services. Because of BellSouth operational delays, we did not begin to offer
this service to our customers until the fourth quarter of 2000. Through December
2001, we had installed over 36,500 UNE-P lines and expect to continue to convert
resale customers to this service during 2002. We expect that this conversion
will have a favorable impact on our gross margins.
Long Distance Telephone Services. We offer a wide range of retail long
distance telephone services, including traditional switched and dedicated long
distance, toll-free calling, international, calling card and operator services.
Data Services. We provide a variety of data services to our customers,
including point-to-point, asynchronous transfer mode, frame relay and Internet
protocol-based virtual private networking services. Our network equipment
enables customers to use a single network connection to communicate with
multiple connection sites throughout our fiber optic network. We will continue
to seek, through strategic business relationships with other providers, to
interconnect our fiber optic network with the fiber optic networks of those
other providers.
In the fourth quarter of 1999, we began offering our Integrated-T service,
which allows our customers to use a single digital T-1 transmission line for
both voice and data services, including frame relay, Internet access and private
line services. The Integrated-T service enables our customers to take advantage
of advanced features and lower costs offered by digital access and offers the
convenience of one service provider for voice and data services.
3
This product enables us to take advantage of our existing voice services and
network infrastructure by selling additional services, such as data services,
over the same transmission line.
In 2001, we inaugurated three new services intended to enhance our current
data offerings to mid-sized businesses and to take advantage of our existing
network infrastructure. These products include virtual private networking
services based on the Internet protocol, Internet security services, including
managed firewall services and our Intrusion Detection Service, and network
managed services. Our virtual private network offering provides our customers
with a dedicated line or secure dial-up access between multiple sites allowing
the same level of security, performance and availability as a private network.
The managed firewall service and our Intrusion Detection Service provide our
customers security for Internet connections and reduce our customer's capital
expenditures and personnel costs necessary to achieve this level of security.
Our network management services allow our customers to outsource all of their
frame relay network management to us. We intend to provide those customers with
complementary services that will range from reactive monitoring to proactive
vendor management.
Internet Access and Web Development. We provide dedicated Internet access,
electronic mail and Web hosting services. We expect that mid-sized and larger
businesses will require faster Internet access and larger bandwidth in the
future, and we intend to offer products that will meet that demand.
Local Telecommunications Services for Internet Service Providers. We
provide local wholesale telecommunications services to Internet service
providers. These services include primary rate interface connectivity between
our network and the network of the Internet service provider and equipment
colocation services that permit the Internet service provider to colocate its
modems, routers or network servers with our switching facilities.
Customer Premise Equipment. We sell, install and perform on-site
maintenance of equipment, such as telephones, office switchboard systems and, to
a lesser extent, private branch exchanges, for customers in the following
markets:
. Anniston, Birmingham, Dothan, Florence, Huntsville, Mobile and
Montgomery, Alabama;
. Albany, Atlanta, Augusta, Columbus and Macon, Georgia;
. Pensacola, Florida;
. Baton Rouge and New Orleans, Louisiana;
. Biloxi, Greenwood, Gulfport, Hattiesburg, Jackson and Tupelo,
Mississippi;
. Charlotte, North Carolina;
. Charleston, Columbia and Greenville, South Carolina; and
. Nashville, Tennessee.
We intend to offer these customer premise equipment sales, installation and
maintenance services in additional markets in the future, with the goals of
augmenting and supporting our sale of local and long distance services and
enhancing customer retention.
Broadband Transport Services. Our broadband transport services customers
include telecommunications carriers and non-facilities based carriers that have
switches but do not own transmission facilities, such as fiber optic cables.
These customers use our broadband transport services to transport their
customers' traffic between local access and transport areas, which are
geographic areas composed of contiguous local exchanges. Calls transmitted over
a long-haul circuit for a customer are generally routed by the customer through
a switch to a receiving terminal
4
in our network. We transmit the signals over a long-haul circuit to the terminal
where the signals are to exit our network. Our customer then routes the signals
through another switch and to the call recipient through a local carrier. We
offer our broadband transport services in varying degrees of speed and size.
Some of our services are used by our customers for very high capacity inter-city
connectivity and specialized high-speed data networking. We connect our network
to our customer's facilities either by local carrier or by a direct connection.
We typically bill our broadband transport services customers a fixed monthly
rate depending on the capacity and length of the circuit, regardless of the
amount that the circuit is actually used by the customer. We also offer
directory assistance services through our broadband transport services
business.
e/\deltacom. We established e/\deltacom in 2000. Our e/\deltacom business
provides colocation services, managed services and professional services,
primarily through its data center near Atlanta, Georgia.
Colocation Services. Our colocation services allow businesses to have a Web
presence without incurring significant capital expenditures, increasing traffic
on their corporate network or burdening their information technology staff. We
offer Web server hosting, security, software updates, monitoring and hardware
solutions. Our colocation services include Internet connectivity with varying
speeds of bandwidth, primary and secondary domain name services support, timely
reporting of system performance and continuous monitoring by our network
operations staff.
Managed Services. The four basic managed services we offer encompass
enhanced monitoring, managed security services, storage management services and
hardware management services. Our enhanced monitoring services consist of
extended monitoring to include not only port level monitoring, but also server
monitoring and detailed reporting. Our managed security services involve
firewall deployment, virtual private networks, vulnerability assessments,
content and virus scanning and authentication systems. e/\deltacom's storage
management services include the assessment and implementation of storage
solutions, which offer customers multiple technology and hardware choices. Our
hardware management services offer the customer e/\deltacom's ability to provide
hardware maintenance for servers from numerous vendors.
Professional services. Our professional services provide our customers with
a single source for the design and implementation of an e-business solution from
the needs assessment phase to the design, implementation and support phases.
These professional services include project management and methodology,
consulting, system design, implementation and deployment services, and
maintenance and support services.
During 2001, our e/\deltacom segment continued to experience an increase in
negative EBITDA, as adjusted, in operating losses and in negative cash flows
from operations. EBITDA, as adjusted, represents earnings before extraordinary
item, preacquisition loss, net interest, other income and other expenses,
income taxes and depreciation and amortization. Based on current market
conditions, we do not expect that this segment will generate positive EBITDA, as
adjusted, or positive cash flows from operations in the near term. As a result
of our need for improved liquidity and our strategic focus on our retail
services, we continue to evaluate alternatives for this segment, including the
elimination of additional operating expenses.
Facilities. As of December 31, 2001, we owned or managed approximately
9,980 route miles of a fiber optic network which covered portions of ten states
in the southern United States. As of the same date, our network extended to
approximately 175 points of presence, which are the locations along our network
where we are able to deliver telecommunications traffic to, and receive
telecommunications traffic from, other carriers for further transmission or
ultimate delivery to an end-user. These points of presence are located in most
major population centers in the areas covered by our fiber optic network and in
a significant number of smaller cities where our only competitor is the
incumbent carrier.
As of December 31, 2001, we owned approximately 6,180 route miles of our
fiber optic network, which we have built or acquired since 1992, either directly
or through indefeasible rights of use arrangements. In addition, we have
strategic relationships principally with three public utilities, Duke Power
Company, Florida Power & Light Company and Entergy Technology Company, pursuant
to which we market, sell and manage capacity on approximately 3,800 route miles
of network owned and operated by these three utilities. In addition, we are able
to purchase network capacity to some cities not covered by our owned and managed
network in North Carolina and South Carolina under a buy-sell agreement with CFN
FiberNet, LLC, which manages fiber optic facilities in those two states and in
one
5
additional state. This agreement enables the parties to buy and sell capacity on
each other's networks at pre-established prices, which are generally more
favorable than the prices for such capacity available in the open market. Under
this agreement, neither party is responsible for network maintenance charges
relating to the other party's network.
As a result of the changes to our business plan that we announced in
September 2001, we do not expect to spend a significant amount on capital
expenditures for our broadband transport business. We expect little, if any,
expansion of our network route mileage during 2002 and anticipate that any
capital expenditures associated with our network will be applied to maintain the
existing capabilities of the network.
We have implemented electronic redundancy, which enables traffic to be
rerouted to another fiber in the same fiber sheath in the event of a partial
fiber cut or electronic failure, over a portion of our network. At December 31,
2001, over 70% of our network traffic was also protected by geographical diverse
routing, a network design also called a "self healing ring," which enables
traffic to be rerouted in the event of a total cable cut to an entirely
different fiber optic cable, assuming capacity is available.
We purchase much of our network equipment, including switches, optical
transport products and access nodes, from Nortel Networks Inc. Under the
purchase agreement we entered into in November 2000, we have committed to
purchase up to $250 million of products and services from Nortel Networks from
November 1999 through December 2002. As of December 31, 2001, we had purchased
$113.1 million of such products and services. For additional information about
our agreement with Nortel Networks, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
A key component of our network is our switches, which are the primary
electronic components that connect customers to our network and transmit voice
and data communications over our network. Our primary switching facilities for
voice and data communications consist of Nortel DMS-500 switches in the
following locations:
. Anniston, Birmingham and Montgomery, Alabama;
. Jacksonville, Ocala and West Palm Beach, Florida;
. Atlanta, Georgia;
. Gulfport, Mississippi;
. Greensboro, North Carolina;
. Columbia, South Carolina;
. Nashville, Tennessee; and
. Houston, Texas.
The Nortel DMS-500 switches are capable of handling both local and long distance
voice and data traffic.
We expect to continue to evaluate our network and assess the need for
additional switching capacity. We also have colocated 177 Nortel access nodes in
various markets in the southern United States. These access nodes enable us to
perform remote local and long distance switching in additional markets where we
do not have switches by using our Nortel DMS-500 switches as hosts to the access
nodes we locate in remote markets. The Nortel access nodes are connected to our
Nortel DMS-500 switching platform using our fiber optic network wherever
possible. This networking design, together with our interconnection agreements
with incumbent carriers such as BellSouth, has
6
enabled us to be a facilities-based provider of local and long distance
telephone services in all of our markets.
We are a member of the Associated Communications Companies of America, an
eight-member trade association that negotiates with carriers for wholesale
telecommunications services for its members. The collective buying power of its
members enables the association to negotiate as if it were one of the larger
long distance providers in the United States.
In November 2000, we opened and commenced operations in an initial portion
of e/\deltacom's data center in Suwanee, Georgia. We completed the remainder of
the facility in 2001. The data center, which serves as e/\deltacom's
headquarters, is a centralized facility that provides advanced Web server
hosting, server colocation and other services. Our e/\deltacom management team
manages the implementation and integration of e/\deltacom's services from this
facility. The data center floor space contains open racks, enclosed cabinets,
caged areas and suites or fully enclosed vaults. The center is connected through
multiple and diverse connections to our fiber optic network. Site access is
controlled by security officers, video surveillance and enhanced security
procedures, and the center is protected by advanced fire protection devices.
Temperature, humidity and dust are carefully maintained to promote uninterrupted
server operation. The data center also has redundant power supply systems to
provide a constant source of power in the event of a component failure.
Sales and Marketing
Retail Services. We focus our retail sales efforts on small, mid-sized and
major regional businesses in the southern United States. We market our retail
services through a sales force composed of direct sales personnel, technical
consultants and technicians. We believe that high-quality employee training is a
prerequisite for superior customer service and, as a result, require each member
of our retail sales force to complete our intensive training program. Our
marketing strategy is built upon the belief that customers prefer to hold one
company accountable for all of their telecommunications services. Each branch
office provides technical assistance for its voice, data, Internet and customer
premise equipment as required. Our customers are assured that they will have a
single point of contact, 24 hours a day, seven days a week, to support all of
the services they receive from us.
Our sales personnel make direct calls to prospective and existing business
customers, conduct analyses of business customers' usage histories and service
needs, and demonstrate how our service package will improve a customer's
communications capabilities and costs. Sales personnel locate potential business
customers by several methods, including customer referrals, market research,
telemarketing, and networking alliances, such as endorsement agreements with
trade associations and local chambers of commerce. Our sales personnel work
closely with our network engineers and information systems consultants to design
new service products and applications. Our branch offices also are primarily
responsible for coordinating service and customer premise equipment installation
activities. Technicians survey customers' premises to assess power and space
requirements, and coordinate delivery, installation and testing of equipment.
Our retail services contracts generally provide for payment in arrears
based on minutes of use for long distance services and in advance for local
telephone and data services. The agreements also generally provide that the
customer may terminate the affected service without a charge for early
termination in the event of substantial and prolonged outages arising from
causes within our control and for other specified causes. Generally, the
agreements provide that the customer must utilize at least a minimum amount,
measured by dollars or minutes of use, of switched long distance services per
month for the term of the agreement.
We also market our retail services through public relations,
advertisements, event sponsorships, trade journals, direct mail and trade
forums. Because we seek to distinguish our retail services largely based on the
convenience of our integrated bundle of these services and the benefits of our
comprehensive and individualized customer support, we continue to believe that
advertising and public relations will play a significant role in our retail
services marketing strategy.
7
Broadband Transport Services. We provide long distance voice and data
transmission services through long distance circuit contracts with other long
distance carriers, including WorldCom, Inc., Sprint, Qwest Communications
International Inc. and Cable & Wireless plc. As of December 31, 2001, we had
remaining future long-term contract commitments for broadband transport services
totaling approximately $69.2 million. These contracts expire on various dates
through 2008 and are expected to generate approximately $66.7 million in
revenues for us through 2006. We also provide our long-haul transmission
services to customers after contract expiration on a month-to-month basis. Our
long-haul contracts provide for fixed monthly payments, which are generally made
in advance. Although sales volumes from particular customers vary from year to
year, we have historically experienced success in retaining customers and
renewing long-haul circuit contracts.
e/\deltacom. e/\deltacom provides colocation services, managed services and
professional services from our data center in Suwanee, Georgia to business
customers primarily located in the Atlanta, Georgia area. e/\deltacom's sales
personnel make direct calls to prospective and existing business customers, work
closely with our engineering staff to design specific solutions for each
customer and seek to market e/\deltacom's services along with our bundle of
retail service offerings.
e/\deltacom markets its brand and services through advertising and public
relations campaigns, event sponsorships, trade journals and trade forums.
Competition
The telecommunications industry is highly competitive. We compete primarily
on the basis of price, availability, transmission quality, reliability, customer
service and variety of product offerings. Our ability to compete effectively
depends on our ability to maintain high-quality services at prices generally
equal to or below those charged by our competitors. In particular, price
competition in the retail services and broadband transport services markets
generally has been intense and is expected to increase. Our competitors include,
among others, AT&T Corp., Sprint and WorldCom for long distance telephone
services and BellSouth for local telephone services. These companies, among
others, have substantially greater financial, personnel, technical, marketing
and other resources, larger numbers of established customers and more prominent
name recognition than ITC/\DeltaCom. These companies also operate more extensive
transmission networks than we do. In addition, companies such as Broadwing Inc.
and Qwest have constructed or are constructing nationwide fiber optic systems,
including routes through portions of the southern United States in which we
operate our fiber optic network. We also increasingly face competition in the
long distance market from local carriers, resellers, cable companies and
satellite carriers, and may compete with electric utilities. We also may
increasingly face competition from businesses offering long distance data and
voice services over the Internet. These businesses could enjoy a significant
cost advantage because, at this time, they generally do not pay carrier access
charges or universal service fees.
Our principal competitor for local services is the incumbent carrier in the
particular market, including BellSouth in a large majority of our market areas.
Incumbent carriers enjoy substantial competitive advantages arising from their
historical monopoly position in the local telephone market, including
pre-existing customer relationships with all or virtually all end-users.
Further, we are highly dependent on incumbent carriers for local network
facilities and wholesale services required in order for us to assemble our own
local retail services. We also face competition from local carriers other than
incumbent carriers, which we refer to as "competitive carriers," some of which
already have established local operations in some of our current and target
markets. In addition, incumbent carriers are expected to compete in each other's
markets in some cases. Wireless telecommunications providers may develop into
effective substitutes for wireline local telephone service, which would further
increase competition.
Local and long distance marketing is converging, as other carriers offer
integrated retail services. For example, many competitive carriers also offer
long distance service to their customers and large long distance carriers, such
as AT&T, Sprint and WorldCom, have begun to offer local services in some
markets. We also compete with numerous direct marketers, telemarketers and
equipment vendors and installers with respect to portions of our business.
8
Regional Bell operating companies, such as BellSouth, are allowed to
provide outside their home regions "interLATA" long distance services, which are
long distance services that originate and terminate in different local access
and transport areas, as well as interLATA mobile services within their regions.
Under the Telecommunications Act of 1996, the regional Bell operating companies
are allowed to provide interLATA long distance services within their regions
after meeting requirements intended to foster opportunities for local telephone
competition. These companies already have extensive fiber optic cable, switching
and other network facilities in their respective regions that they can use to
provide long distance services. BellSouth and other regional Bell operating
companies are taking significant steps toward obtaining approval to provide
in-region long distance service. As of March 20, 2002, the FCC had approved
applications of Verizon Communications to provide in-region long distance
service in Connecticut, Massachusetts, New York, Pennsylvania and Rhode Island,
and of SBC Communications to provide in-region long distance service in
Arkansas, Texas, Kansas, Missouri and Oklahoma. Verizon Communications has an
additional application pending in Vermont, and BellSouth has filed for approval
to enter the long distance market in Georgia and Louisiana. If the FCC permits
BellSouth to provide long distance service in those or other states before
meeting our local interconnection needs, BellSouth would be able to duplicate
our integrated local and long distance services and could have a significant
competitive advantage in marketing those services to its existing local
customers.
A continuing trend toward consolidation, mergers, acquisitions and
strategic alliances in the telecommunications industry also could increase the
level of competition faced by our broadband transport customers or us. SBC
Communications acquired Ameritech Corporation in October 1999, GTE Corporation
and Bell Atlantic Corporation merged to form Verizon Communications in June
2000, Qwest acquired US WEST, Inc. in June 2000, Time Warner, Inc. merged with
America Online, Inc. to form AOL Time Warner Inc. in January 2001, and AT&T
entered into an agreement to merge its AT&T Broadband unit with Comcast
Corporation in December 2001. In addition, SBC Communications and Williams
Communications, a long distance services provider, entered into a strategic
alliance in 2000 pursuant to which the two companies have agreed to supply
services to each other. The telecommunications market is very dynamic, and we
believe additional competitive changes are likely in the future.
Regulation
Overview. Our services are subject to federal, state and local regulation.
Through our wholly-owned subsidiaries, we hold numerous federal and state
regulatory authorizations. The FCC exercises jurisdiction over
telecommunications common carriers to the extent they provide, originate or
terminate interstate or international communications. The FCC also establishes
rules and has other authority over some issues related to local telephone
competition. State regulatory commissions retain jurisdiction over
telecommunications carriers to the extent they provide, originate or terminate
intrastate communications. Local governments may require us to obtain licenses,
permits or franchises in order to use the public rights-of-way necessary to
install and operate our networks.
Federal Regulation. We are categorized as a non-dominant carrier by the FCC
and, as a result, are subject to relatively limited regulation of our interstate
and international services. Some general policies and rules of the FCC apply to
us, and we are subject to some FCC reporting requirements, but the FCC does not
review our billing rates. We possess the operating authority required by the FCC
to conduct our long distance business as it is currently conducted. As a
non-dominant carrier, we may install and operate additional facilities for the
transmission of domestic interstate communications without prior FCC
authorization, except to the extent that radio licenses are required.
The FCC required non-dominant long distance companies, including us, to
detariff interstate long distance domestic and international services in 2001.
In 2001 the FCC also permitted competitive local carriers, including us, to
choose either to detariff the interstate access services that we sell to long
distance companies that originate or terminate traffic from or to our local
customers, or to maintain tariffs but comply with rate caps. Tariffs set forth
the rates, terms and conditions for service and must be updated or amended when
rates are adjusted or products are added or removed. Before detariffing, we
filed tariffs with the FCC to govern our relationship with most of our long
distance customers and with long distance companies that originated or
terminated traffic from or to our local customers. The detariffing process
required us, among other things, to post these tariffs on our Website instead of
to
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file them at the FCC. Because detariffing precludes us from filing our tariffs
at the FCC, we are no longer subject to the "filed rate doctrine," under which
the tariff controls all contractual disputes between a carrier and its
customers. The detariffing process effectively required us to enter into
individual contracts with each of our customers and notify them of the change.
This process increases our costs of doing business. Detariffing may expose us to
legal liabilities and costs if we can no longer rely on the filed rate doctrine
to settle contract disputes with our customers.
The FCC's role with respect to local telephone competition arises
principally from the Telecommunications Act of 1996. The Telecommunications Act
preempts state and local laws to the extent that they prevent competitive entry
into the provision of any telecommunications service. Subject to this
limitation, however, the state and local governments retain telecommunications
regulatory authority. The Telecommunications Act imposes a variety of new duties
on local carriers, including competitive carriers such as ITC/\DeltaCom, in
order to promote competition in local telephone services. These duties include
requirements to:
. complete calls originated by customers of competing carriers on a
reciprocal basis;
. permit the resale of services;
. permit users to retain their telephone numbers when changing carriers;
and
. provide competing carriers access to poles, ducts, conduits and
rights-of-way at regulated prices.
Incumbent carriers also are subject to additional duties. These duties
include obligations to:
. interconnect their networks with networks or facilities of
competitors;
. offer colocation of competitors' equipment at their premises;
. make available elements of their networks, including network
facilities, features and capabilities, on non-discriminatory,
cost-based terms; and
. offer wholesale versions of their retail services for resale at
discounted rates.
Collectively, these requirements recognize that local telephone service
competition is dependent upon cost-based and non-discriminatory interconnection
with and use of incumbent carrier networks and facilities. Failure to achieve
such arrangements could have a material adverse impact on our ability to provide
competitive local telephone services. Under the Telecommunications Act,
incumbent carriers are required to negotiate in good faith with carriers
requesting any or all of the foregoing arrangements. In addition, in August
1996, the FCC released the "interconnection decision" implementing the
interconnection portions of the Telecommunications Act. The FCC subsequently
adopted further specific rules to implement these requirements. The
interconnection decision has been the subject of significant legal dispute. In
January 1999, the U.S. Supreme Court rejected most of the challenges to the
interconnection decision and affirmed the authority of the FCC to establish
rules governing interconnection. The Supreme Court required the FCC to revise
its method for determining which network elements incumbent carriers must
provide to competitive carriers. The FCC's actions in response to the decision
of the Supreme Court resulted in changes to the number and type of network
elements available to competitive carriers. Additional disputes regarding the
interconnection decision and other related FCC actions are pending, and we
believe additional disputes are likely. Currently, the FCC is considering
changes to the rule on compensation for services provided by one carrier to
another and on the provision of unbundled network elements by incumbent
carriers. Any changes to these rules could have a significant impact on the
industry and on us.
We cannot assure you that FCC rules, together with rules adopted by state
public utility commissions, will be implemented in a manner that will permit
local telephone competition to develop to a substantial extent and without
significant delays. For example, many new carriers, including ITC/\DeltaCom,
have experienced problems with
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respect to the operations support systems used by new carriers to order and
receive network elements and wholesale services from the incumbent carriers.
These systems are necessary for new carriers like us to provide local service to
customers on a timely and competitive basis. In September 1999, the FCC adopted
revised rules defining the circumstances under which incumbent carriers must
make network elements available to competitors. In a number of ways, these rules
are more favorable to competitors than prior rules, but the FCC's pricing
methodology for network elements included in these rules are being challenged in
the Supreme Court. In other ways, these rules are less favorable to competitors
than the prior rules. The revised rules restrict in some respects the
availability of some network elements and limit in some respects the services
that competitors can provide over those elements. Additionally, the FCC
currently is considering whether incumbent carriers should have to make
available to competitors network elements used to provide broadband services.
The FCC also is considering removing certain network elements from the list of
network elements incumbent carriers are required to make available to
competitors. Legislation has been proposed in Congress and passed in the House
of Representatives that would further restrict competitive carriers' access to
incumbent local carriers' network elements. Any restriction on, or contraction
of, the availability of network elements could have a material adverse effect on
us.
Among other interconnection agreements, we entered into an interconnection
agreement with BellSouth in 1997 that enabled us to provide local service in all
nine BellSouth states on either a resale basis or by purchasing all unbundled
network elements required to provide local service on a facilities basis,
without using facilities we own. The initial term of the interconnection
agreement expired in 1999, but we have replaced the agreement in each of the
nine BellSouth states. The public utility commissions of Alabama, Florida,
Georgia, North Carolina and Tennessee have approved the new interconnection
agreements applicable to those states. Although the approval of the
interconnection agreements applicable to Kentucky, Louisiana, Mississippi and
South Carolina remain pending before the public utility commissions of those
states, we do not expect that approval will be withheld. The expired 1997
interconnection agreement did not resolve, and the new BellSouth interconnection
agreements to which we are a party do not resolve, all operational issues,
including those relating to the colocation of our equipment with that of
BellSouth. We expect, but cannot assure you, that each new BellSouth
interconnection agreement to which we are a party will provide a foundation for
us to provide local service in the nine BellSouth states on a reasonable
commercial basis.
In July 2001, the FCC adopted revised rules affecting its equipment
colocation requirements, which initially were adopted by the FCC in 1999 but
then sent back to the FCC for reconsideration by a reviewing court. In a number
of ways, the FCC's revised rules are favorable to competing carriers such as
ITC/\DeltaCom. In other ways, however, these rules may prevent competing
carriers from colocating their equipment in a manner that best suits their
business needs. We expect that the interconnection agreements we enter into with
BellSouth and with other carriers will be subject to the FCC's revised
colocation rules, but we cannot assure you that these rules will not change or
otherwise accrue to the advantage of incumbent carriers.
The Telecommunications Act eliminated previous prohibitions on the
provision of interLATA long distance services by the regional Bell operating
companies and GTE Corporation, which is now part of Verizon Communications. The
regional Bell operating companies are permitted to provide interLATA long
distance service outside those states in which they provide local service, or
"out-of-region long distance service," upon receipt of any necessary state and
federal regulatory approvals that are otherwise applicable to the provision of
intrastate and interstate long distance service. Under the Telecommunications
Act, the regional Bell operating companies will be allowed to provide long
distance service within the regions in which they also provide local service, or
"in-region long distance service," on a state-by-state basis upon specific
approval of the FCC and satisfaction of other conditions, including a checklist
of interconnection requirements intended to open local telephone markets to
competition.
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In the future, an important element of providing competitive local services
may be the ability to offer customers high-speed broadband local connections. As
noted above, the FCC currently is considering whether to expand or restrict the
unbundled network elements that incumbent carriers must make available to
competitors to enable them to provide broadband services to customers using
incumbent carrier networks. The FCC also is considering what regulatory
treatment, if any, should be accorded to digital subscriber line services
provided by telecommunications companies and to cable modem services, which are
used by cable companies to deploy high-speed Internet access services. The FCC
has sought comment on a number of other regulatory proposals that could affect
the speed and manner in which high-speed broadband local services are deployed
by our competitors. Congress also is considering legislation that would
deregulate some aspects of the incumbent local carriers' broadband services and
would reduce the extent to which those carriers must provide access to their
networks to competitive local carriers for the provision of broadband services.
Several cable companies already are offering broadband Internet access over
their network facilities, and incumbent carriers and competitive carriers also
offer such service through digital subscriber line technology. If we are unable
to meet the future demands of our customers for broadband local access on a
timely basis at competitive rates, we may be at a significant competitive
disadvantage.
The FCC regulates the interstate access rates charged by incumbent carriers
for the origination and termination of interstate long distance traffic. These
access rates make up a significant portion of the cost of providing long
distance service. The FCC is in the process of implementing access policy
changes that over time are expected to reduce access rates and the cost of
providing long distance service, especially to business customers. In 2001, the
FCC continued its efforts to lower access charges. Further FCC action in this
area is expected. The full impact of the FCC's decisions will not be known until
its decisions are implemented over the next several years, at which time they
could have an adverse impact on our business.
In April 2001, the FCC issued a ruling changing the compensation mechanism
for traffic exchanged between telecommunications carriers that is destined for
Internet service providers. In doing so, the FCC prescribed a new rate structure
for this traffic and prescribed gradually reduced caps for its compensation.
ITC/\DeltaCom may, in the course of its business, exchange the traffic of
Internet service providers with other carriers. The FCC's ruling in connection
with such traffic affected a large number of carriers, including ITC/\DeltaCom,
and further developments in this area could have a significant impact on the
industry and on us.
The FCC has granted incumbent carriers some flexibility in pricing their
interstate special and switched access services. Under this pricing scheme,
local carriers may establish pricing zones based on access traffic density and
charge different prices for access provided in each zone. The FCC recently
granted incumbent carriers additional pricing flexibility as local competition
develops in their markets. We cannot assure you that this pricing flexibility
will not place us at a competitive disadvantage, either as a purchaser of access
for our long distance operations or as a vendor of access to other carriers or
end-user customers.
In a related proceeding, the FCC has adopted changes to the methodology by
which access has been used in part to subsidize universal telephone service and
other public policy goals. Telecommunications providers like us now pay a fee
calculated as a percentage of revenues to support these goals. Some states are
also implementing universal service funds. The effects of these decisions are
uncertain and subject to change.
In addition, the FCC continues to consider related questions regarding the
applicability of access charges and universal service fees to Internet service
providers. Currently, Internet service providers are not subject to these
expenses, and a federal court of appeals has upheld the FCC's decision not to
impose such fees. However, the incumbent carriers and other parties argue that
this exemption unfairly benefits Internet service providers, particularly when
they provide data, voice or other services in direct competition with
conventional telecommunications services. The FCC recently initiated a
proceeding to examine this issue. We are not in a position to determine how
these issues regarding access charges and universal service fees will be
resolved or whether such resolution will be harmful to our competitive position
or our results of operations.
The FCC imposes prior approval requirements on transfers of control and
assignments of radio licenses and operating authorizations. The FCC has the
authority generally to condition, modify, cancel, terminate or revoke
12
licenses and operating authority for failure to comply with federal laws and the
rules, regulations and policies of the FCC. Fines or other penalties also may be
imposed for such violations. We cannot assure you that the FCC or third parties
will not raise issues with regard to our compliance with applicable laws and
regulations.
As a general matter, we cannot provide assurance regarding how quickly or
how adequately we will be able to take advantage of the opportunities created by
the Telecommunications Act. We could be materially adversely affected if a court
decision reversing some of the FCC's rules or problems in the related
arbitration and negotiation process increase our costs of using incumbent
carrier network elements or services, or if such actions otherwise delay or
impede the development of local telephone competition.
State Regulation. We are subject to various state laws and regulations.
Most state public utility commissions require providers such as ITC/\DeltaCom to
obtain authority from the commission before initiating service in that state. In
most states, including Alabama, Georgia and Florida, we also are required to
file tariffs or price lists setting forth the terms, conditions and prices for
services that are classified as intrastate and to update or amend our tariffs
when we adjust our rates or add new products. We also are subject to various
reporting and record-keeping requirements. In addition, some states are ordering
the detariffing of services, which may impede our reliance on the filed rate
doctrine and increase our costs of doing business.
Many states also require prior approval for transfers of control of
certified carriers, corporate reorganizations, acquisitions of
telecommunications operations, assignment of carrier assets, carrier stock
offerings and incurrence by carriers of significant debt obligations.
Certificates of authority can generally be conditioned, modified, canceled,
terminated or revoked by state regulatory authorities for failure to comply with
state law or the rules, regulations and policies of state regulatory
authorities. Fines or other penalties also may be imposed for such violations.
We cannot assure you that public utility commissions or third parties will not
raise issues with regard to our compliance with applicable laws or regulations.
We have authority to offer intrastate long distance services in all 50 U.S.
states and the District of Columbia. We have obtained authority to provide long
distance service in states outside of our current and target markets to enhance
our ability to attract business customers with offices, or whose employees
travel, outside of our markets.
We provide local services in our region by reselling the retail local
services of the incumbent carrier in a given territory and, in some established
markets, using incumbent network elements and our own local switching
facilities. We possess authority to provide local telephone services in Alabama,
Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina,
South Carolina, Tennessee and Texas.
Many issues remain open regarding how new local telephone carriers will be
regulated at the state level. For example, although the Telecommunications Act
preempts the ability of states to forbid local service competition, the
Telecommunications Act preserves the ability of states to impose reasonable
terms and conditions of service and other regulatory requirements. These
statutes and related issues arising from the Telecommunications Act will be
refined through rules and policy decisions made by public utility commissions as
they address local service competition issues.
We also will be affected by state public utility commission decisions
related to the incumbent carriers despite recent U.S. Supreme Court decisions
upholding the FCC's rule-making power under the Telecommunications Act. For
example, public utility commissions have responsibility under the
Telecommunications Act to oversee relationships between incumbent carriers and
their new competitors with respect to such competitors' use of the incumbent
carriers' network elements and wholesale local services. Public utility
commissions arbitrate interconnection agreements between the incumbent carriers
and competitive carriers such as us when necessary. Important issues regarding
the scope of the authority of public utility commissions in this area and the
extent to which the commissions will adopt policies that promote local telephone
service competition remain unresolved. We believe it is too early to evaluate
how these matters will be resolved or their impact on our ability to pursue our
business plan.
13
States also regulate the intrastate carrier access services of the
incumbent carriers. We are required to pay access charges to the incumbent
carriers when they originate or terminate our intrastate long distance traffic.
We could be materially adversely affected by high access charges, particularly
to the extent that the incumbent carriers do not incur the same level of costs
with respect to their own intrastate long distance services. States also will be
developing intrastate universal service charges parallel to the interstate
charges created by the FCC. For example, incumbent carriers such as BellSouth
advocate the formation of state-level funds that would be supported by
potentially large payments by businesses such as ITC/\DeltaCom based on their
total intrastate revenues. Another issue is the use by some incumbent carriers,
with the approval of the relevant public utility commissions, of extended local
area calling that converts otherwise competitive intrastate toll service to
local service. States also are or will be addressing various intraLATA dialing
parity issues that may affect competition. Our business could be materially
adversely affected by these or other developments.
We also will be affected by how states regulate the retail prices of the
incumbent carriers with which we compete. We believe that, as the degree of
intrastate competition increases, the states will offer the incumbent carriers
increasing pricing flexibility. This flexibility may present the incumbent
carriers with an opportunity to subsidize services that compete with our
services with revenues generated from non-competitive services, thereby allowing
incumbent carriers to offer competitive services at prices lower than most or
all of their competitors. In addition, BellSouth has obtained authority to
create affiliates that would operate on a much less regulated basis and,
therefore, could provide significant competition even if the traditional
BellSouth local business does not receive more pricing flexibility. Kentucky has
placed limitations on such affiliates, while Tennessee has refused such
affiliate applications of BellSouth. We cannot predict the extent to which these
developments may affect our business.
Local Government Authorizations and Related Rights-of-Way. We are required
to obtain street use and construction permits and licenses or franchises to
install and expand our fiber optic network using municipal rights-of-way. In
some municipalities where we have installed network equipment, we are required
to pay license or franchise fees based on a percentage of gross revenues or a
per linear foot basis. We cannot assure you that, following the expiration of
existing franchises, fees will remain at their current levels. In many markets,
the incumbent carriers do not pay these franchise fees or they pay fees that are
substantially less than those required to be paid by us, although the
Telecommunications Act requires that, in the future, such fees be applied in a
competitively neutral manner. To the extent that competitors do not pay the same
level of fees as we do, we could be at a competitive disadvantage. Termination
of the existing franchise or license agreements before their expiration dates,
or a failure to renew the franchise or license agreements, and a requirement
that we remove the corresponding portion of our facilities or abandon the
corresponding portion of our network could have a material adverse effect on us.
In addition, we would be adversely affected if we are unable to obtain
additional authorizations for any new network construction on reasonable terms.
Further, unresolved issues exist regarding the ability of new local service
providers to gain access to commercial office buildings to serve tenants.
Employees
As of December 31, 2001, we had more than 1,900 full-time employees, none
of whom was represented by a union or covered by a collective bargaining
agreement. We believe that our relationship with our employees is good. In
connection with the construction and maintenance of our fiber optic network and
the conduct of our other business operations, we use third-party contractors,
some of whose employees may be represented by unions or covered by collective
bargaining agreements.
Risk Factors
Our business is subject to a number of risks, including the following:
14
In order to continue as a going concern, we will need to achieve a significant
improvement in our liquidity position by August 2002.
Our independent public accountants have stated in their report on our 2002
audited consolidated financial statements included elsewhere in this report that
our recurring losses from operations and negative cash flows from operations and
limited access to additional capital raise substantial doubt about our ability
to continue as a going concern. We must achieve a significant improvement in our
liquidity position by August 2002 to conduct our business and to continue to
service our indebtedness. For information about our current liquidity position,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity."
We have significant indebtedness and may be unable to continue to service that
indebtedness.
We had indebtedness of $723.9 million as of December 31, 2001, and our
earnings were insufficient to cover our fixed charges by $215.6 million for the
year ended December 31, 2001. To continue to service our current indebtedness,
we will need to raise significant additional funds to supplement our operating
cash flows. Our ability to raise additional funds will be subject to prevailing
economic conditions and to financial, business and other factors. If we do not
obtain additional funds, we will not be able to continue to meet our current
debt service obligations. For information about our current liquidity position,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity."
Unless our liquidity position improves significantly, we will not be able to
make additional capital expenditures to support our growth.
We have historically made significant capital expenditures to expand our
network, operations and services according to our business plan. During 2001, we
made capital expenditures of approximately $162 million. Because of our current
need for additional funds, we expect to use little, if any, capital to expand
our network, operations and services in 2002, but instead expect to apply any
capital expenditures associated with our network to maintain the network's
existing capabilities. To conserve cash while we seek to complete a potential
restructuring to alleviate the significant constraints on our liquidity, we plan
to further reduce our capital expenditures. Such a reduction could have a
material negative effect on our expected revenue growth. As a result, we do not
expect that any growth in revenues or operations we are able to achieve in 2002
will be as significant as the growth we have achieved in previous years.
Agreements governing our current indebtedness contain restrictive covenants that
place limits on our business activities.
We are subject to restrictions under the indentures pursuant to which we
issued our publicly traded senior notes, under our $160 million senior secured
credit facility and under our $40 million capital lease facility. These
restrictions affect and, in some cases, significantly limit or prohibit, among
other things, our ability to incur additional indebtedness, create liens, make
investments, issue stock and sell assets. Our senior note indentures restrict
our ability to incur indebtedness, other than indebtedness to finance the
acquisition of equipment, inventory or network assets and other specified
indebtednes. Our senior secured credit facility and our $40 million capital
lease facility also contain restrictions on our ability to incur indebtedness.
In order to incur additional indebtedness under the foregoing agreements, we
must meet minimum specified leverage and interest coverage ratios based on our
operating cash flow. As of February 28, 2002, we had not met, and we do not
expect that we will be able to meet in the foreseeable future, the measurement
criteria under these ratios that would allow us to incur additional
indebtedness. These agreements may also limit our flexibility to plan for, or
react to, changes in our business, place us at a competitive disadvantage
relative to our competitors who have less debt, make us more vulnerable to a
downturn in our business or the economy generally, and require us to use a
substantial portion of our cash flow from operations to pay principal and
interest on our debt, rather than for working capital and capital expenditures.
15
We are dependent upon rights-of-way and other third-party agreements to maintain
our fiber optic network.
To maintain our fiber optic network, we have obtained easements,
rights-of-way, franchises and licenses from various private parties, including
actual and potential competitors, local governments, private landowners and
others. We cannot assure you that we will continue to use or have access to all
of our existing easements, rights-of-way, franchises and licenses or that we
will be able to renew or replace them after they expire. Third parties have
challenged some of our licenses to use the rights-of-way of others, including
our licenses to use the rights-of-way of Mississippi Power Company, Florida
Power Company, Gulf Power Company and Georgia Power Company. If these or similar
future challenges are successful, or if we otherwise are unsuccessful in
maintaining or renewing our rights to use our network easements, rights-of-way,
franchises and licenses, we may be forced to abandon a significant portion of
our network and possibly pay monetary damages. For information on legal
proceedings related to some of our rights-of-way, see "Legal Proceedings."
Our business is subject to significant competitive pressures.
Our industry is highly competitive, and the level of competition,
particularly with respect to pricing, is increasing. For example, the prices we
charge for our retail local, long distance and data services and for our
broadband transport services have declined significantly in recent years. Some
or all of these prices may continue to decline, which will adversely affect our
gross margins as a percentage of revenues. If the FCC authorizes BellSouth to
provide in-region long distance services in one or more of our markets, we may
be required to reduce our prices for the local, long distance or data services
we provide in the affected markets.
In addition, many of our existing and potential competitors, such as
BellSouth, AT&T and WorldCom, have financial, technical and other resources and
customer bases and name recognition far greater than our own. We expect to
continue to face significant pricing and product competition from BellSouth and
the other large, established telephone companies which currently are the
dominant providers of telecommunications services in our markets. We also will
face significant competitive product and pricing pressures from other companies
like us that attempt to compete in the local services market. As a result of
these factors, we cannot assure you that we will be able to achieve operating
profitability, adequate market share or continued significant revenue growth in
any of our markets.
The local and long distance industries are subject to significant government
regulation, and the regulations may change.
We are required to obtain authorizations from the FCC and state public
utility commissions to offer some of our telecommunications services. We are
also required to file tariffs for many of our services and to comply with local
license, franchise or permit requirements relating to installation and operation
of our network. Any of the following events related to the manner in which our
business is regulated could have a material adverse effect on our business,
results of operations and financial condition:
. our failure to maintain proper federal and state tariffs;
. our failure to maintain proper state certifications;
. our failure to comply with federal, state or local laws and
regulations;
. our failure to obtain and maintain required licenses, franchises and
permits;
. the imposition of burdensome license, franchise or permit
requirements to operate in public rights-of-way; and
. the occurrence of burdensome or adverse regulatory requirements or
developments.
Although the local telephone services market was opened to competition
through the passage of the Telecommunications Act in 1996, the FCC and the
states are still implementing many of the rules and policies necessary for local
telephone competition and addressing other related consumer issues. As a result,
we believe that we may see increased state regulation of competitive carriers.
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We depend on access service from incumbent carriers to provide long distance
services, and we could be adversely affected if we do not benefit from reduced
access charges at least as much as our competitors.
We continue to depend on other telecommunications companies to originate
and terminate a significant portion of the long distance traffic initiated by
our customers. We could be adversely affected if we do not experience access
cost reductions proportionally equivalent to those of our competitors.
Historically, charges for access service have made up a significant percentage
of the overall cost of providing long distance service. In 1998, the FCC
implemented changes to its interstate access rules that, among other things,
have reduced per-minute access charges and substituted new per-line flat rate
monthly charges. The FCC also approved reductions in overall access rates, and
established new rules to recover subsidies to support universal service and
other public policies. Additional access charge adjustments were implemented in
July 2000, and others are expected in the future. The impact of these changes on
our competitors or us is not yet clear. New Internet-based competitors generally
are exempt from these charges, which could give them a significant cost
advantage in this area.
If we are unable to interconnect with BellSouth and other incumbent carriers on
acceptable terms, our ability to offer local telephone services will be
adversely affected.
Our March 1997 interconnection agreement with BellSouth, which expired on
July 1, 1999, was our most significant interconnection agreement and enabled us
to provide local telephone services in all nine states in which BellSouth
operates. Although we eventually reached new terms with BellSouth for all nine
BellSouth states, it took a significant amount of resources and time to reach
those terms, and the new terms applicable to four of the nine states remain
subject to approval by the public utility commissions in those states. We cannot
assure you that these agreements will be approved or that, in the future, we
will be able to enter into new interconnection agreements with BellSouth or
other carriers on favorable terms, in a timely manner, or at all. If we are
unable to enter into or maintain favorable interconnection agreements in our
markets, our ability to provide local services on a competitive and profitable
basis may be materially adversely affected. Any successful effort by the
incumbent carriers to deny or substantially limit our access to their network
elements or wholesale services also would have a material adverse effect on our
ability to provide local telephone services.
Under the Telecommunications Act, BellSouth and the other regional Bell
operating companies are not permitted to provide in-region long distance service
to customers in their primary markets until there is adequate competition in the
local services industry. This provides some incentive to these carriers to
provide access to their facilities to competitive new entrants such as
ITC/\DeltaCom. We cannot assure you, however, that once BellSouth or other
regional Bell operating companies are permitted to offer in-region long distance
service, they will continue to be willing to enter into interconnection
agreements with us that will enable us to provide local services on competitive
and profitable terms.
Our inability to maintain our network infrastructure, portions of which we do
not own, could adversely affect our business, results of operations and
financial condition.
We have effectively extended our network with minimal capital expenditures
by entering into marketing and management agreements with three public utility
companies to sell long-haul private line services on the fiber optic networks
owned by these companies. Under these agreements, we generally earn a commission
based upon a percentage of the gross revenues generated by the sale of capacity
on the utility's networks. One of these agreements, under which we continue to
operate, expired in January 2002 and the other two agreements will expire in
March 2003 and October 2004, respectively. We expect to replace the expired
agreement with a new agreement, the term of which we expect will commence
effective as of February 2002 and expire in February 2004, although we cannot
assure you that the terms of the new agreement will be on the same or
substantially similar terms as the expired agreement. We also purchase network
capacity from CFN FiberNet, a manager of fiber optic facilities, in North
Carolina and South Carolina under a buy-sell agreement expiring in February
2004. Cancellation or non-renewal of any of the foregoing agreements, or any
future failure by us to acquire and maintain similar network agreements in these
or other markets as necessary, could materially adversely affect our business,
results of
17
operations and financial condition. In addition, two of our three agreements
with the public utility companies are nonexclusive, and any reduction in the
amount of capacity that is made available to us could adversely affect us.
Our business also could be materially adversely affected by a cable cut or
equipment failure along our fiber optic network. A significant portion of our
fiber optic network is not protected by electronic redundancy or geographical
diverse routing. Our lack of these protections would not enable us to reroute
traffic to another fiber in the same fiber sheath in the event of a partial
fiber cut or electronics failure or to an entirely different fiber optic route,
assuming capacity is available, in the event of a total cable cut.
We depend on a few large customers for a significant percentage of our revenues
and cannot assure you that we will be able to retain those customers.
The table below sets forth, for 2001 and 2000, the approximate percentages
of our total revenues generated by our five largest retail services customers
and our two largest broadband transport services customers:
Year Ended Year Ended
December 31, 2001 December 31, 2000
----------------- -----------------
Five largest retail services customers.. 6.3% 7.5%
Two largest broadband transport
services customers.................... 10.2% 11.5%
We cannot assure you that we will be able to retain our customers or that
we will not be required to lower our prices in an effort to maintain customers.
For both retail services and broadband transport services, our customers,
including some large customers, generally have concurrent arrangements with more
than one service provider. This enables our customers to reduce their use of our
services and switch to other providers without incurring significant expense.
Our agreements with our retail customers generally provide that the customer may
terminate service without incurring a discontinuation charge for termination of
the agreement before its expiration in the event of specified types of outages
in service and for other defined causes. As of December 31, 2001, our broadband
transport services business had remaining future long-term contract commitments
totaling approximately $69.2 million. Some of those contractual commitments
provide that, if the customer is offered lower pricing with respect to any
circuit by another carrier, the customer's commitment to us will be reduced to
the extent we do not match the price for that circuit and the customer purchases
that circuit from the other carrier.
We depend on sophisticated billing, customer service and information systems.
We depend on sophisticated information and processing systems to grow,
monitor costs, bill customers, provision customer orders and achieve operating
efficiencies. As we increase our provision of dial tone and other services, our
need for enhanced billing and information systems will also increase. Our
inability to identify adequately all of our information and processing needs, to
process the information adequately or accurately or to upgrade our systems as
necessary could have a material adverse effect on our results of operations and
financial condition.
We are subject to risks associated with rapid changes in technology.
The telecommunications industry is subject to rapid and significant changes
in technology. We may be required to select one emerging technology over
another, but it will be impossible to predict with any certainty, at the time we
are required to make our investment, which technology will prove to be the most
economic, efficient or capable of attracting customer usage. Unexpected
developments, or our failure to adapt to them, could have a material adverse
effect on our business, results of operations and financial condition.
18
Our success depends on our ability to attract and retain key personnel.
Our business is currently managed by a small number of key management and
operating personnel, including our executive officers. We do not maintain "key
man" insurance on these employees. In addition, we have relied on awards of
stock options as a significant component of the compensation we offer to our
current and potential key employees. Because of the downward trend in the market
price of our common stock since 2000, our stock option program may not provide
an adequate incentive to current or potential key employees to become or remain
employed by us. The loss of the services of our key personnel, or our inability
to attract, recruit and retain sufficient or additional qualified personnel,
could have a material adverse effect on our business, results of operations and
financial condition.
Our operating results could vary significantly from period to period.
Our revenues and operating results could vary significantly from period to
period for many reasons, including:
. significant expenses associated with the operation, maintenance or
future expansion of our network or services;
. competition and regulatory developments;
. changes in market growth rates for our products and services;
. availability or announcement of alternative technologies; and
. general economic conditions.
These factors and any resulting fluctuations in our operating results will
make period-to-period comparisons of our financial condition less meaningful and
could have a material adverse effect on our business, results of operations and
financial condition.
Item 2. Properties.
We own our corporate headquarters in West Point, Georgia and the
e/\deltacom data center in Suwanee, Georgia.
We own switch sites in Anniston, Birmingham and Montgomery, Alabama and
Nashville, Tennessee and lease space for a network operations center in Arab,
Alabama. We also lease space for our switch sites in the following locations:
. Jacksonville, Ocala and West Palm Beach, Florida;
. Atlanta, Georgia;
. Gulfport, Mississippi;
. Greensboro, North Carolina;
. Columbia, South Carolina; and
. Houston, Texas.
The leases for these switch sites expire on various dates from 2002 to 2014.
19
We have constructed and own a multi-service facility in Anniston, Alabama,
which functions as a centralized switching control center for our network and as
an operator services center. In addition, we lease space to operate a customer
network operations center in Atlanta, Georgia. The lease for this space is
renewable on an annual basis.
We operate branch offices in the following locations:
. Anniston, Birmingham, Dothan, Florence, Huntsville, Mobile and
Montgomery, Alabama;
. Daytona, Ft. Lauderdale, Jacksonville, Ocala, Orlando, Pensacola,
Tallahassee and Tampa, Florida;
. Albany, Atlanta (two offices), Augusta, Columbus and Macon, Georgia;
. Baton Rouge and New Orleans, Louisiana;
. Biloxi, Hattiesburg and Jackson, Mississippi;
. Charlotte, Greensboro and Raleigh, North Carolina;
. Charleston, Columbia and Greenville, South Carolina; and
. Chattanooga, Knoxville and Nashville, Tennessee.
The leases for these branch offices expire on various dates from 2002 through
2006. We also lease office space for various administrative functions, including
accounting, legal, sales and human resources, in Huntsville, Alabama, and own an
administrative office in Arab, Alabama.
As part of our fiber optic network and switched service system, we own or
lease rights-of-way, land, office space and towers throughout the southern
United States.
See "Business-Services and Facilities-Facilities" for additional
information about our facilities.
Item 3. Legal Proceedings.
General. We are a party to legal proceedings in the ordinary course of our
business, including disputes with contractors or vendors, which we believe are
not material to our business. We also are a party to regulatory proceedings
affecting the segments of the communications industry in which we operate.
Proceedings Affecting Rights-of-Way. Third parties have challenged some of
our licenses to use the rights-of-way of others, including our licenses to use
the rights-of-way of Mississippi Power Company, Gulf Power Company, Georgia
Power Company and others.
A portion of our network runs through fiber optic cables owned by the
Mississippi Power Company over its rights-of-way located in Jasper County,
Mississippi. A proceeding involving Mississippi Power and several landowners who
have granted Mississippi Power rights-of-way in Jasper County resulted in a
January 1999 order of the Mississippi Supreme Court holding that Mississippi
Power could not permit third parties to use its rights-of-way at issue for any
purpose other than in connection with providing electricity to customers of
Mississippi Power. We became a party to the proceeding after the January 1999
order. The Circuit Court of the First Judicial District of Jasper County,
Mississippi has directed us not to use that portion of our fiber optic network
located on Mississippi Power's rights-of-way in Jasper County, except in an
emergency, pending the outcome of the trial. We have rerouted all of the
circuits on the affected portion of our network so that we may continue to
provide services to our customers along the affected route. If the courts
ultimately agree with the landowners that the existing easements do not permit
our use, we believe our potential liability for damages may be limited to the
value of a permanent easement for that
20
use. We cannot assure you in this respect, however, since the landowners are
seeking damages equal to the profits or gross revenues received by us from our
use of Mississippi Power's rights-of-way in Jasper County and punitive damages
for our use of the route.
We initiated a civil suit in August 2001 in the U.S. District Court for the
Southern District of Mississippi, Southern Division, in which we seek a
declaratory judgment confirming our continued use of cables in Mississippi Power
Company's rights-of-way on 37 parcels of land or, alternatively, condemnation of
the right to use the cables upon payment of just compensation to the landowners.
Some of the defendants have filed a counterclaim against Mississippi Power and
us seeking a constructive trust upon the revenues earned on those rights-of-way,
together with compensatory and punitive damages. Although we have resolved the
issue of our use of the rights-of-way with some of the defendants, we cannot
assure you that we will be successful in this proceeding. This civil suit has
been consolidated with another pending civil suit in the U.S. District Court for
the Southern District of Mississippi initiated by landowners claiming to
represent a class of landowners and seeking compensatory and punitive damages
against Mississippi Power arising from Mississippi Power's allowance of third
parties to use its rights-of-way for telecommunications purposes.
We use the rights-of-way of Gulf Power Company in Florida for a portion of
our network. In the fourth quarter of 2000, Gulf Power was sued in the Circuit
Court of Gadsden County, Florida, by two landowners that claim to represent a
class of all landowners over whose property Gulf Power has facilities that are
used by third parties. The landowners have alleged that Gulf Power does not have
the authority to permit us or other carriers to transmit telecommunications
services over the rights-of-way. We were made a party to this litigation in
August 2001. In March 2002, the court dismissed this matter without prejudice on
the basis that, among other things, there was no additional burden on the
property as a result of third-party use of the rights-of-way for
telecommunications purposes and that the easements were broad enough in scope to
permit such third-party use. However, the court also is permitting the
plaintiffs to amend their complaint to allege additional facts to support their
contention that there is an additional burden on the property because of the
maintenance requirements of the fiber routes and the placement of buildings and
other physical telecommunications equipment on the rights-of-way.
We use rights-of-way of Georgia Power Company in Georgia for a portion of
our network. In July 2001, a suit filed in the Superior Court of Decatur County,
Georgia, by a group seeking compensatory and punitive damages and claiming to
represent a class of landowners alleged that Georgia Power and the other
entities do not have the right to grant third parties the use of the
rights-of-way for the transmission of telecommunications services of such third
parties. We were made a party to the suit in January 2002.
In August 2001, we filed suit in the Superior Court of Troup County,
Georgia, against Southern Telecom, Inc., Alabama Power Company, Georgia Power
Company, Mississippi Power Company, Gulf Power Company and related entities from
which we have obtained use of rights-of-way for our fiber optic
telecommunications network. We seek a declaratory judgment that the defendants
are legally required to use their best efforts to defend against any claims that
we do not have the right to use the rights-of-way granted to these entities and
to defend, indemnify and hold us harmless against all such claims. In December
2001, we filed for summary judgment, but the court has not ruled on this action.
The defendants have filed a counterclaim requesting, among other items, that we
reimburse them for the cost of perfecting the applicable rights-of-way.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to our security holders in the fourth
quarter of 2001.
21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Our common stock is traded on the Nasdaq National Market under the symbol
"ITCD." The following table sets forth for the last two years the high and low
sales prices per share of the common stock as reported by the Nasdaq National
Market:
2000 High Low
- ---- ------- -------
First Quarter........ $43.500 $24.750
Second Quarter....... 35.625 16.312
Third Quarter........ 23.250 8.375
Fourth Quarter....... 12.500 4.375
2001 High Low
- ---- ------- ------
First Quarter........ $11.438 $4.750
Second Quarter....... 6.700 2.910
Third Quarter........ 4.500 1.060
Fourth Quarter....... 1.330 0.510
On March 22, 2002, there were approximately 920 holders of record of our
common stock.
We have never declared or paid any cash dividends on our capital stock and
do not anticipate paying cash dividends on our common stock in the foreseeable
future. It is the current policy of our board of directors to retain earnings,
if any, to finance our business. The indentures under which we have issued our
publicly traded senior notes, the agreement for our $160 million senior secured
credit facility and the agreement for our $40 million capital lease facility
contain restrictions on our ability to pay cash dividends. We must satisfy debt
incurrence and other financial tests to pay cash dividends under these
agreements.
22
Item 6. Selected Financial Data.
The following table sets forth selected financial and operating data for
ITC/\DeltaCom. The selected historical statement of operations data for each of
the years ended December 31, 2001, 2000, 1999, 1998 and 1997 and the selected
historical balance sheet data for the years then ended have been derived from
the consolidated financial statements that have been audited by Arthur Andersen
LLP, independent public accountants.
2001 2000 1999 1998 1997(a)(b)
----------- ----------- ----------- ----------- -----------
Income Statement Data:
Operating revenues .................................. $ 415,339 $ 363,648 $ 244,844 $ 171,838 $ 114,590
----------- ----------- ----------- ----------- -----------
Expenses:
Cost of services .................................. 186,121 155,000 118,721 82,979 54,550
Inventory write-down .............................. 1,663 0 0 0 0
Selling, operations and administration ............ 188,712 151,050 96,854 64,901 38,255
Depreciation and amortization ..................... 118,938 86,519 53,810 30,887 18,332
Special charges (c) ............................... 74,437 0 0 0 0
----------- ----------- ----------- ----------- -----------
Total expenses .................................. 569,871 392,569 269,385 178,767 111,137
----------- ----------- ----------- ----------- -----------
Operating (loss) income ............................. (154,532) (28,921) (24,541) (6,929) 3,453
Interest expense .................................... (58,833) (55,482) (45,293) (31,930) (21,367)
Interest and other income (expense), net ............ 1,434 14,337 14,949 6,499 4,251
----------- ----------- ----------- ----------- -----------
Loss before income taxes, preacquisition loss and
extraordinary item ................................. (211,931) (70,066) (54,885) (32,360) (13,663)
Income tax expense (benefit) ........................ 0 (512) 94 (6,454) (3,324)
Preacquisition loss ................................. 0 0 0 0 74
Extraordinary item (net of tax) ..................... 0 (1,321) 0 (8,436) (508)
----------- ----------- ----------- ----------- -----------
Net loss ............................................ (211,931) (70,875) (54,979) (34,342) (10,773)
Preferred stock dividends and accretion ............. (3,713) 0 0 0 0
----------- ----------- ----------- ----------- -----------
Net loss applicable to common stockholders ...... $ (215,644) $ (70,875) $ (54,979) $ (34,342) $ (10,773)
=========== =========== =========== =========== ===========
Basic and diluted net loss per common share:(d)
Before extraordinary loss ......................... $ (3.46) $ (1.14) $ (0.98) $ (0.51) $ (0.26)
Extraordinary loss ................................ 0.00 (0.02) 0.00 (0.16) (0.01)
----------- ----------- ----------- ----------- -----------
Net loss applicable to common stockholders ...... $ (3.46) $ (1.16) $ (0.98) $ (0.67) $ (0.27)
=========== =========== =========== =========== ===========
Basic and diluted weighted average common shares
outstanding (d) ................................... 62,292,085 60,928,387 56,370,269 50,972,361 40,249,816
Balance Sheet Data:
Working (deficit) capital ........................... $ (6,741) $ 85,094 $ 244,913 $ 190,118 $ 116,446
Total assets ........................................ 878,332 1,048,526 807,598 587,517 386,104
Long-term debt and capital lease
obligations, including current portions ........... 723,874 713,869 516,907 417,934 203,889
Stockholders' (deficit) equity ...................... (21,930) 181,053 218,162 118,200 148,266
Other Financial Data:
Capital expenditures ................................ 161,965 309,831 165,540 147,842 43,874
Cash flows (used in) provided by operating activities (10,524) 45,931 (5,334) 9,512 6,302
Cash flows used in investing activities ............. 154,798 305,208 149,995 118,166 93,854
Cash flows provided by financing activities ......... 65,225 151,986 219,593 198,447 180,625
EBITDA, as adjusted(e) .............................. (35,594) 57,598 29,269 23,958 21,785
Ratio of earnings to fixed charges(f) ............... -- -- -- -- --
- ----------
(a) On March 27, 1997, ITC/\DeltaCom purchased fiber and fiber-related assets,
including a significant customer contract for network services in Georgia,
from SCANA Corporation. The results of operations for these assets are
included in our consolidated statements of operations beginning March 27,
1997.
(b) On March 27, 1997, ITC/\DeltaCom purchased the remaining 64% partnership
interest in Gulf States FiberNet that it did not already own from SCANA
Corporation. Gulf States FiberNet's revenues and expenses have been
included in the consolidated statement of operations data effective January
1, 1997, with the preacquisition loss attributable to the previous owner
deducted to determine the consolidated net loss for the year ended December
31, 1997.
23
(c) In 2001, ITC/\DeltaCom recorded nonrecurring special charges consisting of
a write-down of impaired property and equipment of $23.0 million and a
write-down of goodwill and other intangible assets of $51.4 million. See
Note 9 to our consolidated financial statements included elsewhere in this
report.
(d) On September 4, 1998, ITC/\DeltaCom effected a two-for-one stock split of
its common stock in the form of a stock dividend. All references to number
of shares, except shares authorized, and to per share information in the
foregoing table have been adjusted to reflect the stock
split on a retroactive basis.
(e) EBITDA, as adjusted, represents earnings before extraordinary item,
preacquisition loss, net interest, other income and other expenses, income
taxes and depreciation and amortization. EBITDA, as adjusted, is provided
because it is a measure commonly used in our industry. EBITDA, as adjusted,
is not a measurement of financial performance under accounting principles
generally accepted in the United States and should not be considered an
alternative to net income as a measure of performance or to cash flow as a
measure of liquidity. EBITDA, as adjusted, is not necessarily comparable to
similarly titled measures for other companies.
(f) Earnings consist of income before income taxes, plus fixed charges. Fixed
charges consist of interest charges and amortization of debt issuance costs
and the portion of rent expense under operating leases representing
interest, estimated to be one-third of such expense. Earnings were
insufficient to cover fixed charges for the years ended December 31, 2001,
2000, 1999, 1998 and 1997 by $215.6 million, $70.1 million, $54.9 million,
$32.4 million and $13.7 million, respectively.
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The words "anticipate," "believe," "estimate," "expect,"
"intend," "plan" and similar words as they relate to ITC/\DeltaCom, Inc. or our
management are intended to identify some of these forward-looking statements.
All statements by us regarding our expected future financial position and
operating results, our business strategy, our financing plans, forecasted trends
relating to the markets in which we operate and similar matters are
forward-looking statements. We cannot assure you that our expectations expressed
or implied in these forward-looking statements will turn out to be correct. Our
actual results could be materially different from our expectations as a result
of, among other factors, the factors discussed in this report under
"Business-Regulation" and "-Risk Factors."
We have included data with respect to EBITDA, as adjusted, in the following
analysis because it is a measure commonly used in our industry. EBITDA, as
adjusted, represents earnings before extraordinary item, preacquisition loss,
net interest, other income and other expenses, income taxes and depreciation and
amortization. EBITDA, as adjusted, is not a measure of financial performance
under accounting principles generally accepted in the United States and should
not be considered an alternative to net income as a measure of performance or to
cash flow as a measure of liquidity. EBITDA, as adjusted, is not necessarily
comparable to similarly titled measures for other companies.
Overview
We provide voice and data telecommunications services on a retail basis to
businesses in the southern United States. Through our broadband transport
business, we also provide regional telecommunications transmission services to
other telecommunications companies on a wholesale basis using our network. In
connection with these businesses, we own, operate or manage an extensive fiber
optic network in the southern United States. Through our e/\deltacom business,
we provide customers with colocation services, managed services and professional
services primarily through e/\deltacom's data center in Suwanee, Georgia.
We provide our retail services individually or in a bundled package
tailored to the business customer's specific needs. We derive our retail
services revenues from the following four sources:
. sales of integrated telecommunications services, including local
exchange, long distance, enhanced data and Internet services, to
end-user customers;
. sales of local dial-up services to Internet service providers for use
in their provision of services to their customers;
. sales of nonrecurring equipment and professional services to end-user
customers; and
. sales of wholesale long distance services for resale by other
telecommunications carriers.
At December 31, 2001, we provided our retail services to approximately
15,400 customers, which were served by 35 branch offices, and had sold
approximately 297,600 access lines, of which approximately 278,650 had been
installed. The following table presents, for the periods indicated, selected
operating data, in thousands, for our retail services segment.
Year Ended December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Operating revenues ...................... $305,074 $269,947 $171,991
EBITDA, as adjusted ..................... (14,969) 29,354 (8,662)
Operating loss .......................... (75,445) (15,810) (33,533)
25
Year Ended December 31,
-------------------------------
2001 2000 1999
------- ------- -------
Pro forma EBITDA, as adjusted ........... $18,577 $13,254 $(8,662)
Pro forma EBITDA, as adjusted, for our retail services excludes $1.5
million of revenues for 2001 and $16.1 million of revenues for 2000 related to
prior-period interconnection agreement settlements. Pro forma EBITDA, as
adjusted, for our retail services for 2001 also excludes a $1.7 million
write-down of inventory, $4.0 million of restructuring expenses included in
selling, operations and administration expenses and $29.4 million of special
charges related to the write-down of impaired assets. See the discussion below
for more information about these expenses and charges.
Our broadband transport services include the provision to other
telecommunications companies of regional telecommunications transmission
services on a wholesale basis using our network, as well as the provision of
directory assistance services. In 2001, we extended our fiber network by
approximately 340 route miles to approximately 9,980 route miles. We own,
through construction, indefeasible rights of use agreements or long-term capital
leases, the network fiber and related electronic components for approximately
6,180 of our total network route miles and we manage and market under our own
name the network fiber and related switching capacity for the remaining 3,800
route miles under long-term agreements with the owners of those networks. The
following table presents, for the periods indicated, selected operating data, in
thousands, for our broadband transport services segment.
Year Ended December 31,
-------------------------------
2001 2000 1999
------- ------- -------
Operating revenues ..................... $95,034 $83,336 $72,853
EBITDA, as adjusted .................... 49,797 40,963 37,931
Operating income ....................... 706 3,033 9,074
Pro forma EBITDA, as adjusted .......... $49,972 $40,963 $37,931
Pro forma EBITDA, as adjusted, for our broadband transport services for
2001 excludes $120,000 of restructuring expenses included in selling, operations
and administration expenses and $55,000 of special charges related to the
write-down of impaired assets. See the discussion below for more information
about these expenses and charges.
Through our e/\deltacom business, we provide secure space for servers and
other computer equipment, Internet connections, managed services and
professional services integral to operating important business applications over
the Internet. e/\deltacom began generating revenue in May 2000. The following
table presents, for the periods indicated, selected operating data, in
thousands, for our e/\deltacom services segment.
Year Ended December 31,
-------------------------------
2001 2000 1999
-------- -------- -------
Operating revenues ..................... $ 15,231 $ 10,365 --
EBITDA, as adjusted .................... (70,422) (12,719) --
Operating loss ......................... (79,711) (16,062) --
Pro forma EBITDA, as adjusted .......... $(23,280) $(12,719) --
Pro forma EBITDA, as adjusted, for our e/\deltacom segment for 2001
excludes $2.1 million of restructuring expenses included in selling, operations
and administration expenses and $45.0 million of special charges related to the
write-down of impaired assets. See the discussion below for more information
about these expenses and charges.
During 2001, our e/\deltacom segment continued to experience an increase in
negative EBITDA, as adjusted, in operating losses and in negative cash flows
from operations. Based on current market conditions, we do not expect that this
segment will generate positive EBITDA, as adjusted, or positive cash flows from
operations in the near
26
term. As a result of our need for improved liquidity and our strategic focus on
our retail services, we continue to evaluate alternatives for this segment,
including the elimination of additional operating expenses.
In September 2001, we announced changes to our business plan and other
actions intended to reduce our operating expenses through a 20% reduction of our
workforce by approximately 430 employees and to reduce our non-personnel
operating expenses and our planned capital expenditures. As a result of this
restructuring, in September and December 2001 we recorded $4.8 million and
$251,000, respectively, in restructuring costs, which are included as components
of selling, operations and administration expenses. The restructuring charges
include our estimate of employee severance and related costs for employees
terminated as a result of the revised business plan. The restructuring charges
also include estimates of office space lease commitments where we closed
offices, net of any estimated sublease rentals, and other exit costs. In
connection with the restructuring, we closed an administrative office in Arab,
Alabama, retail services offices in Atlanta, Georgia and Greenwood and Tupelo,
Mississippi, and an e/\deltacom office in Nashville, Tennessee. We terminated
some employees in each department and did not specifically identify the
termination of an entire function or department. We have estimated that,
compared to our operating cost rates in the middle of the third quarter of 2001,
our operating costs have been reduced by approximately $21 million on an
annualized basis as a result of this restructuring.
In September 2001, we also recorded impairment charges in accordance with
Statement of Financial Accounting Standards No. 121 related to the net book
value of property and equipment removed from service less expected salvage
totaling $1.8 million, $21.2 million of impaired assets relating to the
e/\deltacom data center, and intangible assets consisting of goodwill and
customer lists related to the e/\deltacom and retail services segments totaling
$51.4 million. The impairment of property and equipment, except for the property
and equipment of e/\deltacom, relates to assets that we no longer plan to use as
a result of our restructuring. Based on market conditions and operating results
of e/\deltacom, we tested our e/\deltacom assets for impairment. We determined
that an impairment existed and wrote the related assets down to estimated fair
value. In the third quarter of 2001, we expensed goodwill of $23.9 million
related to e/\deltacom and $21.2 million of e/\deltacom property and equipment.
We determined fair value based on estimates of market values for comparable
properties.
Based on the expected operating results of our AvData Systems, Inc. network
solutions business, which we acquired in 1999, and the expected operating
results from customers acquired in our 1998 acquisition of IT Group
Communications, we tested the related assets for impairment. We determined that
an impairment existed and, in the third quarter of 2001, expensed $24.4 million
of goodwill and $1.6 million of customer base assets related to the AvData
Systems network solutions business and $1.6 million of customer base assets
related to former IT Group Communications customers.
In September 2001, we also recorded a total of $2.9 million of other
special charges, including a $1.7 million write-down of our retail services
inventory of telephone systems and related equipment as a result of a decline in
demand for those systems. These charges are included as a component of cost of
services. We also recorded additional bad debt expense of $1.2 million, which is
included in selling, operations and administration expenses. Of this amount,
$809,000 was associated with disputed access charge revenues billed to
interexchange carriers by our retail services segment and $392,000 was
associated with a discontinued service in our e/\deltacom business. We believe
that we may be able to recover at least part of the disputed access charge
revenues through our continued negotiations with the interexchange carriers.
As part of our revised business plan and restructured operations, we expect
to focus our operations primarily on offerings