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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 1998
OR
[_] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ______ to ______
Commission File Number: 0-23252
ITC/\DELTACOM, INC.
(Exact name of registrant as specified in its charter)
Delaware 58-2301135
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ITC/\DeltaCom, Inc.
1241 O.G. Skinner Drive
West Point, Georgia 31833
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (706) 645-3880
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
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 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 voting stock held by non-affiliates of the
registrant, based upon the closing price of the registrant's common stock as of
March 15, 1999, is $409,071,581.50. */
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The number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date is:
Common Stock, par value $.01 per share, outstanding as of March 15, 1999:
51,553,197 shares
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the Part
of the Form 10-K into which the document is incorporated:
None.
*/ Solely for the purposes of this calculation, all directors and executive
- -
officers of the registrant and all stockholders beneficially owning more than 5%
of the registrant's common stock are considered to be affiliates.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business........................................... 3
Item 2. Properties......................................... 43
Item 3. Legal Proceedings.................................. 43
Item 4. Submission of Matters to a Vote of Security Holders 43
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters........................ 44
Item 6. Selected Financial Data............................ 45
Item 7. Management's Discussion and Analysis of Financial
Condition and Results Operations................... 47
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk........................................ 69
Item 8. Financial Statements and Supplementary Data........ 69
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................ 69
PART III
Item 10. Directors and Executive Officers of the Registrant. 70
Item 11. Executive Compensation............................. 73
Item 12. Security Ownership of Certain Beneficial Owners
and Management..................................... 82
Item 13. Certain Relationships and Related Transactions..... 85
PART IV Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K................................ 87
GLOSSARY.................................................................. 98
SIGNATURES................................................................ 102
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................ F-1
2
This Annual Report on Form 10-K contains certain forward-looking statements
that involve risks and uncertainties. In addition, members of ITC/\DeltaCom's
senior management may, from time to time, make certain forward-looking
statements concerning ITC/\DeltaCom's operations, performance and other
developments. ITC/\DeltaCom's actual results could differ materially from those
anticipated in such forward-looking statements as a result of various factors,
including those set forth under the caption "Business--Risk Factors" and
elsewhere in this Annual Report on Form 10-K, as well as factors which may be
identified from time to time in ITC/\DeltaCom's filings with the Securities and
Exchange Commission.
Unless the context suggests otherwise, references in this Annual Report on
Form 10-K to "we," "us", "our," and "ITC/\DeltaCom" mean ITC/\DeltaCom, Inc. and
its subsidiaries and predecessors. Unless otherwise indicated, dollar amounts
over $1 million have been rounded to one decimal place and dollar amounts less
than $1 million have been rounded to the nearest thousand. See the "Glossary"
appearing elsewhere herein for more detailed definitions of numerous terms used
in this Form 10-K.
PART I
ITEM 1. BUSINESS.
OVERVIEW
ITC/\DeltaCom provides integrated voice and data telecommunication services to
mid-sized and major regional businesses in the southern United States and is a
leading regional provider of wholesale long-haul services to other
telecommunications companies. In connection with these businesses, ITC/\DeltaCom
owns, operates and manages an extensive fiber optic network in the southern
United States. ITC/\DeltaCom had revenues of approximately $171.8 million for
the year ended December 31, 1998, which represents a 50% increase over revenues
of $114.6 million for the year ended December 31, 1997.
ITC/\DeltaCom provides integrated retail telecommunications services to mid-
sized and major regional businesses in the southern United States in a single
bundled package tailored to the business customer's specific needs. These
services include local exchange services, long distance services, 800/888
calling, calling card and operator services, Asynchronous Transfer Mode or ATM,
frame relay, high capacity broadband private line services, as well as Internet,
Intranet and Web page hosting and development services, and customer premise
equipment sales, installation and repair. ITC/\DeltaCom refers to these services
collectively as its Retail Services. As of December 31, 1998, ITC/\DeltaCom
provided Retail Services to approximately 10,700 business customers.
ITC/\DeltaCom currently offers Retail Services in 22 metropolitan areas
(including local exchange services in 20 markets) in Alabama, Arkansas, Florida,
Georgia, Louisiana, Mississippi, North Carolina and South Carolina.
ITC/\DeltaCom intends to provide a full range of Retail Services in a total of
approximately 42 metropolitan areas throughout the southern United States over
the next five years. For the year ended December 31, 1998, revenue from the
Retail Services was $119.9 million and EBITDA as a percentage of revenue or
EBITDA Margin for the Retail Services was (5)%.
ITC/\DeltaCom provides wholesale long-haul services to other
telecommunications carriers, including AT&T Corp., MCI WorldCom, Inc., Sprint
Corporation, Qwest Communications International Inc., Cable & Wireless
Communications, Inc., Allnet Communications, Inc. d/b/a Frontier Communications
Services and IXC Communications, Inc. ITC/\DeltaCom refers to these wholesale
long-haul services as its Carriers' Carrier Services. ITC/\DeltaCom's fiber
optic network reaches over 80 points of presence, or POPs, in ten southern
states, Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, North
Carolina, South Carolina, Tennessee and Texas. This network extends
approximately 7,800 route miles, of which approximately 4,150 miles are owned by
ITC/\DeltaCom. The remaining approximately 3,650 miles are owned and operated
principally by three public utilities, Duke Power Company, Florida Power & Light
Company and Entergy Technology Company, but are managed and marketed by
ITC/\DeltaCom. For the year ended December 31, 1998, revenue from the Carriers'
Carrier Services was $51.9 million and EBITDA Margin for the Carriers' Carrier
Services was 58%. As of
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December 31, 1998, ITC/\DeltaCom had remaining future long-term contract
commitments for Carriers' Carrier Services totaling approximately $139.7
million. These contracts expire on various dates through 2008 and are expected
to generate approximately $122.4 million in revenues to ITC/\DeltaCom through
2003, of which approximately $34.2 million are expected to be realized in 1999.
In connection with offering local exchange services, ITC/\DeltaCom has entered
into an interconnection agreement with BellSouth Telecommunications, Inc. to (1)
resell BellSouth's local exchange services and (2) interconnect ITC/\DeltaCom's
network with BellSouth's network for the purpose of immediately gaining access
to all of BellSouth's unbundled network elements. ITC/\DeltaCom has also entered
into similar interconnection agreements with GTE Corporation for its Alabama
market and with Sprint Corporation for Sprint's Florida markets. ITC/\DeltaCom
intends to complete interconnection agreements with GTE Corporation, SBC
Communications, Inc. and Sprint Corporation for certain other markets that it
serves or intends to serve. These agreements allow ITC/\DeltaCom to enter new
markets with minimal capital expenditures and to offer local exchange services
to its current customer base.
ITC/\DeltaCom was incorporated in Delaware. ITC/\DeltaCom's principal
executive offices are located at 1241 O.G. Skinner Drive, West Point, Georgia
31833, and its telephone number is (706) 645-3880.
HISTORY OF ITC/\DELTACOM
ITC/\DeltaCom was incorporated in March 1997 as a wholly owned subsidiary of
ITC Holding Company, Inc., to acquire and operate ITC Holding's Retail Services
and Carriers' Carrier Services businesses. ITC/\DeltaCom acquired such
businesses on July 25, 1997 in the Reorganization described below.
Background. ITC Holding began providing operator and directory assistance
services in March 1992 through its subsidiary, Eastern Telecom, Inc., which did
business as InterQuest. Carriers' Carrier Services have been offered since April
1992 through Interstate FiberNet, a partnership originally formed by ITC Holding
(with a 49% interest) and SCANA Communications, Inc. (with a 51% interest). In
August 1994, ITC Holding acquired SCANA's interest in Interstate FiberNet
through ITC Transmission Systems II, Inc., a wholly owned subsidiary of ITC
Holding. Also in August 1994, ITC Holding and SCANA formed a second partnership,
Gulf States FiberNet, to construct and operate a fiber optic route primarily
between Atlanta, Georgia and Shreveport, Louisiana with several supplemental
spur routes. In a transaction consummated in March 1997 (the "Gulf States
Acquisition"), ITC Holding acquired SCANA's 64% partnership interest in Gulf
States FiberNet and certain fiber and fiber-related assets, including a
significant customer contract for network services in Georgia (the "Georgia
Fiber Assets"). Following the Gulf States Acquisition, ITC Holding contributed
the remaining 64% interest in Gulf States FiberNet to Gulf States Transmission
Systems, Inc., a wholly owned subsidiary of ITC Holding, and the Georgia Fiber
Assets to ITC Transmission Systems, Inc., a wholly owned subsidiary of ITC
Holding. Several current members of ITC/\DeltaCom's management have been
managing the businesses of both Interstate FiberNet and Gulf States FiberNet
since their inception.
In January 1996, through its acquisition (the "DeltaCom Acquisition") of
ITC/\DeltaCom Communications Inc., formerly DeltaCom, Inc., ("DeltaCom"), ITC
Holding entered the retail long distance business and acquired several fiber
optic routes within the state of Alabama that complemented the existing networks
operated by Interstate FiberNet, including a fiber optic route from Atlanta,
Georgia to Columbus, Georgia, and Gulf States FiberNet. DeltaCom, a provider of
telecommunications services since its inception in 1982, provides integrated
telecommunications services to mid-sized and major regional businesses primarily
in the southern United States. In July 1996,
4
DeltaCom purchased substantially all of the assets of Viper Computer Systems,
Inc. ("ViperNet"), which provides Internet access, Intranet services, Web-
hosting and Web page development services to business customers.
To finance the DeltaCom Acquisition and to refinance existing DeltaCom debt,
ITC Holding incurred approximately $74.0 million of indebtedness, which was
pushed down to ITC/\DeltaCom (the "DeltaCom Indebtedness"). The aggregate
consideration paid by ITC Holding in the Gulf States Acquisition was
approximately $27.9 million, of which $10.0 million consisted of an unsecured
note (the "SCANA Note") which was repaid in November 1997, and $17.9 million
consisted of ITC Holding preferred stock. In connection with the Gulf States
Acquisition, Gulf States Transmission borrowed $41.6 million under a bridge
credit facility with NationsBank, N.A., to refinance a project loan incurred by
Gulf States FiberNet, which was repaid with proceeds from ITC/\DeltaCom's 1997
Notes Offering, as defined below, on July 25, 1997.
1997 Notes Offering; Redemption. On June 3, 1997, ITC/\DeltaCom completed the
sale (the "1997 Notes Offering") of $200.0 million principal amount of its 11%
Senior Notes due 2007 (the "1997 Notes"). The net proceeds from the sale of
the 1997 Notes, other than the portion of such proceeds invested in U.S.
government securities pledged to secure and fund the first six scheduled
interest payments on the 1997 Notes, were released to ITC/\DeltaCom upon
consummation of the Reorganization described below. On April 2, 1998
ITC/\DeltaCom used approximately $77.7 million of the net proceeds of the
initial public offering, as discussed below, to redeem $70.0 million principal
amount of the 1997 Notes at a redemption price of 111% of such principal amount,
plus accrued and unpaid interest to April 2, 1998. ITC/\DeltaCom recorded a pre-
tax extraordinary loss of approximately $10.6 million (approximately $8.4
million after tax), consisting of a $7.7 million premium and a $2.9 million
write off of debt issue costs related to the early redemption of this debt.
Reorganization. On July 25, 1997, ITC Holding contributed to ITC/\DeltaCom in
a series of transactions the businesses of Interstate FiberNet, Gulf States
FiberNet, DeltaCom and InterQuest. In connection with such transactions,
approximately $31.0 million of the $74.0 million of the DeltaCom Indebtedness
was forgiven by ITC Holding and contributed to ITC/\DeltaCom as additional
equity. Following the Reorganization, ITC/\DeltaCom repaid the remaining $43.0
million of the DeltaCom Indebtedness, accrued interest on all $74.0 million of
such indebtedness and the $41.6 million of indebtedness outstanding under the
bridge facility and accrued interest thereon with a portion of the net proceeds
from the 1997 Notes Offering. On October 20, 1997, as part of a reorganization
of the ITC Holding group of companies, ITC Holding transferred all of its assets
(other than its stock in ITC/\DeltaCom) and all of its liabilities to another
entity (which is now called ITC Holding Company, Inc.) and then merged with and
into ITC/\DeltaCom, which was the surviving corporation in the merger. On
December 31, 1997, Gulf States Transmission merged with and into Interstate
FiberNet, Inc., a wholly owned subsidiary of ITC/\DeltaCom. The foregoing
transactions are collectively referred to herein as the "Reorganization."
Initial Public Offering. On October 29, 1997, ITC/\DeltaCom completed an
initial public offering of its common stock, par value $.01 per share, in which
it issued 11,500,000 shares at a price of $8.25 per share.
March 1998 Notes Offering; Modification of Credit Facility. On March 3, 1998,
ITC/\DeltaCom completed the sale (the "March 1998 Notes Offering") at a price of
99.9% of $160.0 million principal amount of its 8-7/8% Senior Notes due 2008
(the "March 1998 Notes"). Additionally, ITC/\DeltaCom modified its secured
revolving credit facility (the "Credit Facility") to, among other things,
reduce available borrowings from $100.0 million to $50.0 million.
Two-For-One Stock Split. On July 29, 1998, ITC/\DeltaCom announced a two-for-
one stock split of its common stock to be effected in the form of a stock
dividend. The record date for the stock split was August 18, 1998 and the
payment date was September 4, 1998. The common stock began trading giving
effect to the stock split on September 8, 1998. All references to number of
shares,
5
except shares authorized, and to per share information in this Form 10-K have
been adjusted to reflect the stock split on a retroactive basis.
November 1998 Notes Offering; Modification of Credit Facility. On November 5,
1998, ITC/\DeltaCom completed the sale (the "November 1998 Notes Offering") of
$125.0 million principal amount of 9-3/4% Senior Notes due 2008 (the "November
1998 Notes"), yielding net proceeds of approximately $121 million (the November
1998 Notes, the March 1998 Notes and the 1997 Notes are collectively referred to
herein as the "Notes"). Additionally, ITC/\DeltaCom modified its Credit Facility
to, among other things, permit the issuance of and payment on the November 1998
Notes, and to maintain the lenders' commitment under the facility at $50.0
million.
INDUSTRY OVERVIEW
The long distance and local telecommunications markets are currently
undergoing substantial changes, including fundamental changes resulting from the
February 8, 1996 enactment of the Telecommunications Act of 1996 (the
"Telecommunications Act"), and ITC/\DeltaCom believes that it is well
positioned to take advantage of these developments.
Long Distance Services. Until 1984, AT&T largely monopolized local and long
distance telephone services in the United States. Technological developments
gradually enabled others to compete with AT&T in the long distance market. In
1984, largely as the result of a court decree, AT&T was required to divest its
local telephone systems but was permitted to retain its long distance
operations. Since 1984, competition in the long distance market has increased,
service levels have improved, product offerings have increased and prices for
long distance services have generally declined, all of which has resulted in
increased consumer demand and significant market growth for long distance
services. The increase in competition among long distance providers has also
resulted in a growing trend toward industry consolidation.
Local Services. The market for local exchange services consists of a number
of distinct service components. These service components are defined by specific
regulatory tariff classifications including:
. local network services, which generally include basic dial tone, enhanced
calling features and data services (dedicated point-to-point and frame relay
service)
. network access services, which consist of access provided by local exchange
carriers to long distance network carriers
. short-haul long distance network services, which include intraLATA long
distance calls and
. other varied services, including the publication of "white page" and "yellow
page" telephone directories.
Industry sources have estimated that the 1997 aggregate revenues for all local
exchange carriers approximated $104 billion. Until recently, there was
virtually no competition in the local exchange markets, particularly for local
network and network access services.
Since 1984, several factors have served to promote competition in the local
exchange market, including:
. rapidly growing customer demand for an alternative to the local exchange
carrier monopoly, spurred partly by the development of competitive activities
in the long distance market
. advances in the technology for transmission of data and video, which require
significant capacity and reliability levels
. the development of fiber optics and digital electronic technology, which
reduced network construction costs while increasing transmission speeds,
capacity and reliability as compared to copper-based networks
. the significant access charges interexchange carriers are required to pay to
local exchange carriers to access the local exchange carriers' networks, and
6
. a willingness on the part of legislators to enact and regulators to enforce
legislation and regulations permitting and promoting competition in the local
exchange market.
In particular, the Telecommunications Act requires all local exchange carriers
to "unbundle" their local network offerings and allow other providers of
telecommunications services to interconnect with their facilities and equipment.
Most significantly, the incumbent local exchange carriers will be required to
complete local calls originated by ITC/\DeltaCom's customers and switched by
ITC/\DeltaCom and to deliver inbound local calls to ITC/\DeltaCom for
termination to its customers, assuring customers of unimpaired local calling
ability. ITC/\DeltaCom expects to obtain access to incumbent carrier local
"loop" facilities (the transmission lines connecting customers' premises to the
public telephone network) on an unbundled basis at reasonable rates. In
addition, local exchange carriers are obligated to provide local number
portability and dialing parity upon request and make their local services
available for resale by competitors. Local exchange carriers also are required
to allow competitors non-discriminatory access to local exchange carrier pole
attachments, conduit space and other rights-of-way. Moreover, states may not
erect "barriers to entry" of local competition, although they may regulate such
competition.
ITC/\DeltaCom believes that, as a result of continued regulatory and
technological changes and competitive trends, competitive local
telecommunications companies have substantial opportunities for growth.
BUSINESS STRATEGY
ITC/\DeltaCom's objectives are to maintain its position as a leading provider
of Carriers' Carrier Services and to become a leading provider of Retail
Services in the southern United States. ITC/\DeltaCom intends to increase its
market share in existing markets and expand into new markets.
The principal elements of ITC/\DeltaCom's business strategy are to:
. Provide Integrated Telecommunications Services to Its Existing Base of Mid-
sized and Major Regional Business Customers.
By providing additional telecommunications services such as local telephone
service to its existing, well-established base of long distance customers,
ITC/\DeltaCom expects to be able to increase revenues at relatively low
incremental cost. ITC/\DeltaCom believes that bundling a variety of
telecommunications services and presenting customers with one fully integrated
monthly billing statement for all of those services will allow it to penetrate
its target markets rapidly and build customer loyalty. ITC/\DeltaCom believes
that there is substantial demand in its target markets among mid-sized and major
regional business customers for an integrated package of telecommunications
services that meets all of their telecommunications needs.
ITC/\DeltaCom provides local exchange services by reselling the services of
incumbent local exchange carriers and, in some of its markets, by using its own
local switching facilities. Over time, ITC/\DeltaCom expects to provide local
exchange services by primarily using its own switching facilities and its
existing fiber optic network, supplemented by unbundled facilities of incumbent
local exchange carriers or other competitive local exchange carriers. To access
the unbundled network elements of incumbent local exchange carriers,
ITC/\DeltaCom collocates its access nodes in the incumbent local exchange
carrier's central office. These access nodes operate in conjunction with our
Nortel DMS-500 switches to provide facilities-based local services. As of
December 31, 1998, ITC/\DeltaCom had collocated 30 such access nodes. Because
access nodes are less expensive to purchase and install than Nortel DMS-500
switches and can be installed more quickly than Nortel DMS-500 switches,
ITC/\DeltaCom believes that it will be able to enter new markets at less expense
than many of its competitors. At present, ITC/\DeltaCom does not expect to
construct intra-city local loop facilities.
7
. Leverage Its Extensive Fiber Optic Network.
ITC/\DeltaCom intends to leverage its extensive fiber optic network, which
currently reaches over 80 POPs, by (1) continuing to provide switched and
transport services to other communications carriers throughout its region to
enable such carriers to diversify their routes and expand their networks;
(2) targeting customers that need to transmit large amounts of data within
ITC/\DeltaCom's service region, such as banks and local and state governments;
and (3) offering local exchange services to its business customers as part of
its integrated package of telecommunications services.
. Focus on the Southern United States.
ITC/\DeltaCom intends to continue to focus on the southern United States in
order to leverage its extensive telecommunications network in the region.
ITC/\DeltaCom believes that its regional focus will enable it to take advantage
of economies of scale in management, network operations and sales and marketing.
The regional concentration of ITC/\DeltaCom's network also provides an
opportunity for improved margins because a high portion of ITC/\DeltaCom's
customers' telecommunications traffic originates and terminates within the
region. ITC/\DeltaCom also believes that its regional focus will enable it to
build on its long-standing customer and business relationships in the region.
. Build Market Share Through Personalized Customer Service.
ITC/\DeltaCom believes that the key to revenue growth in its target markets is
capturing and retaining customers by emphasizing marketing, sales and customer
service. Management believes that customers prefer one company to be accountable
for their telecommunications services, and that a consultative, face-to-face
sales and service strategy is the most effective method of acquiring and
maintaining a high quality customer base. ITC/\DeltaCom seeks to obtain long-
term commitments from its business customers by responding rapidly and
creatively to their telecommunications needs.
ITC/\DeltaCom currently operates 23 branch offices in 22 markets in Alabama,
Arkansas, Florida, Georgia, Louisiana, Missis
sippi, North Carolina and South
Carolina. Each branch office is staffed by personnel capable of marketing all of
ITC/\DeltaCom's products and providing comprehensive support to ITC/\DeltaCom's
customers. As part of its strategy to continue to grow its retail services
business, ITC/\DeltaCom plans to open branch offices in Texas by the end of 1999
and increase its provision of local exchange services to Internet service
providers ("ISPs"). In the future, ITC/\DeltaCom expects to expand significantly
its direct sales force and open branch offices in additional major and secondary
population centers in the southern United States.
. Expand Its Fiber Optic Network and Switching Facilities.
ITC/\DeltaCom expects to expand its fiber optic telecommunications network and
switching facilities to include additional markets within the southern United
States. ITC/\DeltaCom currently owns and operates approximately 4,150 route
miles of fiber optic network extending from Florida to Texas and expects to add
an additional approximately 700 owned and operated route miles by the end of
1999.
ITC/\DeltaCom also markets and manages capacity on approximately 3,650
additional network route miles through its strategic relationships principally
with public utilities. In addition, ITC/\DeltaCom has a buy-sell agreement with
Carolinas Fibernet, LLC, which manages fiber optic facilities in North Carolina
and South Carolina. This agreement enables the parties to buy and sell capacity
on each other's networks and allows ITC/\DeltaCom to provide customers with
access to POPs throughout those states.
8
ITC/\DeltaCom believes that, by continuing to combine its owned network with
the networks of public utilities and by adding switching facilities throughout
its network, it will be able to achieve capital efficiencies and rapidly expand
its network in a cost-effective manner.
. Benefit from the Experience of its Proven Management Team.
ITC/\DeltaCom's management team consists of experienced telecommunications
managers who in the past have successfully implemented a customer-focused long
distance telecommunications strategy in the southern United States. Members of
the team include Andrew Walker, Chief Executive Officer, Foster McDonald,
President, and Douglas Shumate, Chief Financial Officer.
SERVICES AND FACILITIES
Services. ITC/\DeltaCom currently provides two basic services: (1) Retail
Services and (2) Carriers' Carrier Services.
Retail Services. Retail Services involve the provision of voice, data or
video telecommunications services to end users or resellers. Retail Services
include:
. basic long distance services (switched, dedicated, and calling card)
. dedicated Internet access
. Intranet services
. Web page hosting and development
. data network solutions (frame relay, ATM, point-to-point)
. local exchange services and
. the sale, installation and repair of customer premise equipment.
ITC/\DeltaCom intends to provide additional types of Retail Services in the
future and expand the markets in which it offers local services as part of a
bundled "one-stop" integrated telecommunications service which will offer
customers a wide range of switch-based value-added services. ITC/\DeltaCom's
customer-focused software and network architecture permits ITC/\DeltaCom to
present its customers with one fully integrated monthly billing statement for
the entire package of Retail Services.
Set forth below are brief descriptions of ITC/\DeltaCom's Retail Services:
Local Services. ITC/\DeltaCom currently provides local exchange services by
(1) reselling the services of incumbent local exchange carriers and (2) using
its own local switching facilities. Over time, ITC/\DeltaCom expects to
provide local services primarily using ITC/\DeltaCom's own switching
facilities and existing regional fiber optic network, supplemented by
unbundled facilities of incumbent local exchange carriers or other competitive
local exchange carriers. ITC/\DeltaCom offers local exchange services in 20 of
the 22 markets in which it currently provides Retail Services and expects to
offer local services in a total of 30 markets by the end of 1999.
Long Distance. ITC/\DeltaCom offers a full range of retail long distance
services, including traditional switched and dedicated long distance, 800/888
calling, international, calling card and operator services.
Data Services. ITC/\DeltaCom provides high quality data services to its
customers primarily using frame relay switches distributed strategically
throughout ITC/\DeltaCom's network, which enables customers to use a single
network connection to communicate with multiple sites throughout
ITC/\DeltaCom's fiber optic network. ITC/\DeltaCom provides ATM services both
on a resale basis and by using its own network, providing data services to
customers that need to transmit large amounts of data within ITC/\DeltaCom's
service region, such as banks and local
9
and state governments. ITC/\DeltaCom will continue to seek, through strategic
business relationships with other providers, to interconnect its fiber optic
network with the fiber optic networks of other companies. ITC/\DeltaCom
anticipates increased demand for data services in the future, and expects that
in the future a larger percentage of its revenues will be derived from the
sale of dedicated data services.
Internet Access, Intranet Services and Web Development. Since its
acquisition in 1996 of substantially all of the assets of ViperNet, an
Internet access provider and Web page developer for business customers,
ITC/\DeltaCom has provided dedicated (frame relay) Internet access and
Intranet services, electronic mail, Web page design and Web hosting services.
ITC/\DeltaCom expects that mid-sized and larger businesses will require faster
Internet access and larger bandwidth in the future, and intends to offer
products that will meet that demand.
ISP Local Telecommunications Services. ITC/\DeltaCom provides local
wholesale telecommunications services to ISPs such as primary rate interface
connectivity between ITC/\DeltaCom's network and the network of the ISP and
equipment collocation services whereby the ISP can collocate its modems,
routers and/or network servers with ITC/\DeltaCom's switching facilities.
Customer Premise Equipment. ITC/\DeltaCom sells, installs and repairs
customer premise equipment such as telephones, office switchboard systems and,
to a lesser extent, private branch exchanges, or PBX, for customers in the
Huntsville, Mobile, Birmingham, Dothan, Florence, Anniston and Montgomery,
Alabama; Atlanta and Columbus, Georgia; Baton Rouge, Louisiana; Charlotte,
North Carolina; Pensacola, Florida; and Greenville and Columbia, South
Carolina markets. ITC/\DeltaCom intends to offer customer premise equipment
sales, installation and repair in additional markets in the future, with the
goals of (1) enhancing and supporting ITC/\DeltaCom's sale of local and long
distance services and (2) enhancing customer retention.
Carriers' Carrier Services. ITC/\DeltaCom's Carriers' Carrier Services are
used by customers, such as major telecommunications carriers and non-facilities
based carriers that have switches but do not own transmission facilities, to
transport their already-switched traffic between LATAs. Calls being transmitted
over a long-haul circuit for a customer are generally routed by the customer
through a switch to a receiving terminal in ITC/\DeltaCom's network.
ITC/\DeltaCom transmits the signals over a long-haul circuit to the terminal
where the signals are to exit ITC/\DeltaCom's network. The signals are then
routed by the customer through another switch and to the call recipient through
a local exchange carrier. ITC/\DeltaCom provides DS-1, DS-3 and OC-N services.
OC-N services are used by ITC/\DeltaCom's customers for very high capacity
inter-city connectivity and specialized high speed data networking. The
interface between ITC/\DeltaCom's network and the customer's facilities is by
either local exchange carrier or a direct connection between ITC/\DeltaCom's
network and the facilities of the customer. ITC/\DeltaCom typically bills the
customers a fixed monthly rate depending on the capacity and length of the
circuit, regardless of the amount the circuit is actually used.
Facilities. ITC/\DeltaCom owns or manages approximately 7,800 route miles of a
high quality fiber optic network which covers portions of ten states in the
southern United States and extends to over 80 POPs. These POPs are located in
almost all major population centers in the areas covered by the fiber optic
network and in a significant number of smaller cities where ITC/\DeltaCom's only
competitor is the incumbent local exchange carrier.
ITC/\DeltaCom owns approximately 4,150 route miles of its fiber optic network,
which ITC/\DeltaCom has built or acquired since 1992. In addition, ITC/\DeltaCom
has strategic relationships principally with three public utilities, Duke Power
Company, Florida Power & Light Company and Entergy Technology Company, pursuant
to which ITC/\DeltaCom markets, sells and manages capacity on approximately
3,650 route miles of network owned and operated by the utilities.
10
In addition, ITC/\DeltaCom is able to purchase network capacity to certain
cities not covered by ITC/\DeltaCom's owned and managed network in North
Carolina and South Carolina pursuant to a buy-sell agreement with Carolinas
Fibernet, LLC, which manages fiber optic facilities in North Carolina and South
Carolina. This agreement enables the parties to buy and sell capacity on each
other's networks at pre-established prices, which are generally favorable to 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.
ITC/\DeltaCom expects to add approximately 700 owned and operated route miles
to its fiber network by the end of 1999 through a combination of construction
and long-term dark fiber leases. In addition, as part of its strategy,
ITC/\DeltaCom intends to continue to evaluate the potential expansion of its
network through a combination of new construction, long-term dark fiber leases
and fiber swap transactions, depending on the extent of capital required over
the economic life of the fiber assets to be deployed.
ITC/\DeltaCom's decision to further expand its fiber optic network will be
based on various factors, including:
. the number of its customers in a market
. the anticipated operating cost savings associated with such construction,
and
. any strategic relationships with owners of existing infrastructure (e.g.,
utilities and cable operators).
Through its strategic relationships with public utility companies, ITC/\DeltaCom
believes that it will be able to achieve capital efficiencies in constructing
and expanding its fiber optic network in a rapid and cost-effective manner.
ITC/\DeltaCom also believes that its fiber optic network, in combination with
its personalized approach to customer service, will create an attractive
customer-focused platform for the provision of local, long distance and enhanced
services.
ITC/\DeltaCom has implemented electronic redundancy throughout its network,
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. Approximately 51% of
ITC/\DeltaCom's owned and operated fiber optic network is also protected by
geographically diverse routing, a network design (also called a "self healing
ring") which enables traffic to be rerouted to an entirely different fiber
optic cable (assuming capacity is available) in the event of a total cable cut.
ITC/\DeltaCom is continuing to increase the geographic diversity of its fiber
optic network, and expects to have approximately 64% of its network protected in
this manner by the end of 1999.
ITC/\DeltaCom's switching facilities currently consist of a Nortel DMS-250
switch in Arab, Alabama and Nortel DMS-500 switches in the following locations:
. Anniston and Birmingham, Alabama
. Ocala, Florida
. Atlanta, Georgia
. Gulfport, Mississippi
. Columbia, South Carolina
The Nortel DMS-500 switches are capable of handling both local and long distance
traffic while the Nortel DMS-250 switch is capable on handling long distance
only.
These installations enable ITC/\DeltaCom to market its Retail Services,
including local services, on a switch-based facilities basis in, among other
markets:
. Huntsville, Birmingham, Montgomery, and Mobile, Alabama
. Jacksonville, Ocala and Orlando, Florida
. Atlanta, Georgia
11
. Gulfport, Mississippi
. Greenville, Columbia and Charleston, South Carolina
. Charlotte, North Carolina.
ITC/\DeltaCom expects to place a Nortel DMS-500 switch into service in
Greensboro, North Carolina by the end of the first quarter of 1999 and one into
service in Montgomery, Alabama by the end of 1999.
ITC/\DeltaCom intends to place additional switches strategically along its
fiber optic network over the next five years. ITC/\DeltaCom also intends to
deploy a significant number of Nortel Access Nodes in the majority of the
markets, which ITC/\DeltaCom intends to serve. The additional switches and nodes
will allow ITC/\DeltaCom to perform local and long distance switching in its
markets on a host/remote type relationship to the applicable Nortel DMS-500
switch. The Nortel Access Nodes will be connected to ITC/\DeltaCom's Nortel DMS-
500 switching platform, utilizing ITC/\DeltaCom's fiber optic network wherever
possible. This networking design, together with the BellSouth interconnection
agreement, will enable ITC/\DeltaCom to be a facilities-based provider of local
and long distance services in all of the markets that it intends to enter.
ITC/\DeltaCom is a member of the Associated Communications Companies of
America (the "ACCA"), a 9-member trade association that negotiates with carriers
for wholesale telecommunications services for its members. The collective buying
power of its members enables the ACCA to negotiate as if it were one of the
larger long distance providers in the United States.
ITC/\DeltaCom's data network currently consists of fourteen Ascend 9000 frame
relay switches located in:
. Atlanta (two switches) and West Point, Georgia
. Birmingham (two switches), Montgomery, Mobile, Anniston (two switches) and
Arab, Alabama
. Ocala, Florida
. Gulfport and Jackson, Mississippi
. Columbia, South Carolina.
ITC/\DeltaCom's data network connects with BellSouth's and other carriers' frame
relay networks to provide nationwide connectivity for ITC/\DeltaCom's customers.
ITC/\DeltaCom's Ascend frame relay switches have the capability to provide ATM
connectivity, and ITC/\DeltaCom has one ATM connection to the Internet.
ITC/\DeltaCom intends to strategically locate additional frame relay and ATM
switch sites over the next five years. These frame relay and ATM switches will
be collocated with ITC/\DeltaCom's Nortel DMS-500 switches at strategic network
facility locations where possible, and will create a data backbone which will
support ITC/\DeltaCom's data services.
SALES AND MARKETING
Retail Services. ITC/\DeltaCom focuses its sales efforts on mid-sized and
major regional businesses in the southern United States. ITC/\DeltaCom believes
that it can effectively compete for business customers based upon service,
product diversity, price and reliability. ITC/\DeltaCom's sales force, composed
of direct sales personnel, technical consultants and technicians, markets
ITC/\DeltaCom's telecommunications services. ITC/\DeltaCom's management believes
that high quality employee training is a prerequisite for superior customer
service, and as a result each member of ITC/\DeltaCom's sales force is required
to complete ITC/\DeltaCom's intensive training program. ITC/\DeltaCom's
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. Customers are assured a single point of contact,
24 hours a day, seven days a week.
12
Approximately 160 direct sales personnel conducted marketing of
ITC/\DeltaCom's Retail Services to mid-sized and major regional businesses as of
December 31, 1998. Such personnel are located in 23 branch offices in 22 markets
in the southern United States. ITC/\DeltaCom significantly expanded its sales
force in 1998 and expects to continue to expand its direct sales force and open
branch offices in additional major and secondary population centers in the
southern United States during 1999. ITC/\DeltaCom's sales personnel make direct
calls to prospective and existing business customers, conduct analyses of
business customers' usage histories and service needs, and demonstrate how
ITC/\DeltaCom's service package will improve a customer's communications
capabilities and costs. Sales personnel locate potential business customers by
several methods, including customer referral, market research, telemarketing and
other networking alliances such as endorsement agreements with trade
associations and local chambers of commerce. ITC/\DeltaCom's sales personnel
work closely with ITC/\DeltaCom's network engineers and information systems
consultants to design new service products and applications. ITC/\DeltaCom's
branch offices are also 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.
A primary element of ITC/\DeltaCom's Retail Services marketing strategy is to
enter into contracts with its customers. Those agreements generally provide for
payment in arrears based on minutes of use for switched services and in advance
for private line services. The agreements generally also provide that the
customer may terminate the affected service without penalty in the event of
substantial and prolonged outages arising from causes within ITC/\DeltaCom's
control, and for certain other defined causes. Generally, the agreements provide
that the customer must utilize at least a minimum dollar amount (measured by
dollars or minutes of use) of switched long distance services per month for the
term of the agreement.
In addition, ITC/\DeltaCom markets its business communication services through
advertisements, event sponsorships, trade journals, direct mail and trade
forums. Because ITC/\DeltaCom intends to distinguish its retail products largely
on the convenience of its single communications bundle and the benefits of
ITC/\DeltaCom's comprehensive, individualized and innovative customer support,
ITC/\DeltaCom believes that advertising will play a larger role in its marketing
strategy than it has in the past.
Carriers' Carrier Services. ITC/\DeltaCom has long-haul circuit contracts with
major long distance carriers, including AT&T, MCI WorldCom, Sprint, Qwest, Cable
& Wireless, Frontier and IXC. As of December 31, 1998, ITC/\DeltaCom had
remaining future long term contract commitments totaling approximately $139.7
million. These contracts expire on various dates through 2008 and are expected
to generate approximately $122.4 million in revenues to ITC/\DeltaCom through
2003, of which $34.2 million are expected to be realized in 1999. ITC/\DeltaCom
also provides long-haul transmission to customers after contract expiration on a
month-to-month basis. ITC/\DeltaCom's long-haul contracts provide for fixed
monthly payments, generally in advance. Although sales volumes from particular
customers vary from year to year, ITC/\DeltaCom has historically enjoyed high
customer retention and circuit renewal rates.
ITC/\DeltaCom believes that it can continue to compete effectively in the
wholesale, carrier-to-carrier market on the basis of price, reliability, state-
of-the-art technology, route diversity, ease of ordering and customer service.
ITC/\DeltaCom believes that demand for its Carriers' Carrier Services will
increase as the incumbent local exchange carriers begin competing in the long
distance market.
COMPETITION
The telecommunications industry is highly competitive. ITC/\DeltaCom competes
primarily on the basis of price, availability, transmission quality,
reliability, customer service and variety of product offerings. The ability of
ITC/\DeltaCom to compete effectively will depend on its ability to
13
maintain high quality services at prices generally equal to or below those
charged by its competitors. In particular, price competition in the retail and
carrier's carrier long distance markets has generally been intense and is
expected to increase. ITC/\DeltaCom's competitors include AT&T, Sprint and MCI
WorldCom on an interexchange basis and BellSouth on an intraLATA basis. 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 and utilize
more extensive transmission networks than ITC/\DeltaCom. In addition, IXC, Qwest
and Williams Communications are constructing nationwide fiber optic systems,
including routes through portions of the southern United States. ITC/\DeltaCom
will also increasingly face competition in the long distance market from local
exchange carriers, switchless resellers, and satellite carriers and may
eventually compete with public utilities and cable companies. ITC/\DeltaCom also
may increasingly face competition from firms offering long distance data and
voice services over the Internet. Such firms could enjoy a significant cost
advantage because at this time they do not pay carrier access charges or
universal service fees.
ITC/\DeltaCom's principal competitor for local exchange services will be the
incumbent local exchange carrier in the particular market, including BellSouth
in virtually all of ITC/\DeltaCom's initial market areas. The incumbent local
exchange carriers will enjoy substantial competitive advantages arising from
their historical monopoly position in the local telephone market, including
their preexisting customer relationship with all or virtually all end users.
Furthermore, ITC/\DeltaCom will be highly dependent on the competing incumbent
local exchange carrier ("ILEC") for local network facilities and wholesale
services required in order for ITC/\DeltaCom to assemble its own local retail
products. ITC/\DeltaCom will also face competition from competitive local
exchange carriers ("CLEC"), some of whom have already established local
operations in ITC/\DeltaCom's target markets. In addition, incumbent local
exchange carriers are expected to compete in each other's markets in some cases.
BellSouth has plans to provide local services within its geographic region in
competition with independent telephone companies. Wireless telecommunications
providers may develop into effective substitutes for wireline local telephone
service. See "Risk Factors--If We Are Unable To Interconnect With BellSouth
and Incumbent Local Exchange Carriers on Acceptable Terms, Our Ability To Offer
Local Telephone Services Will Be Adversely Affected."
Local and long distance marketing is converging as other carriers besides
ITC/\DeltaCom offer integrated retail product lines. For example, large long
distance carriers such as AT&T, Sprint and MCI WorldCom have begun to offer
local services in certain markets and CLEC's typically offer long distance
services to their customers. ITC/\DeltaCom also competes with numerous direct
marketers and telemarketers and equipment vendors and installers with respect to
certain portions of its business.
Similarly, Regional Bell Operating Companies ("RBOCs") such as BellSouth are
now allowed to provide interLATA long distance services outside their home
regions, as well as interLATA mobile services within their regions. Under the
Telecommunications Act, the RBOCs will be allowed to provide interLATA long
distance services within their regions after meeting certain requirements
intended to foster opportunities for local telephone competition. The RBOCs
already have extensive fiber optic cable, switching, and other network
facilities in their respective regions that can be used for their long distance
services. BellSouth and other RBOCs are already beginning to take steps toward
obtaining approval to provide in-region long distance services. The Federal
Communications Communication (the "FCC") forced the withdrawal of the first RBOC
request for in-region long distance authority, and has rejected several other
applications, including applications by BellSouth to provide interLATA service
in South Carolina and Louisiana. However, additional interLATA applications are
expected to be filed in 1999. There can be no assurance that such approvals
will be delayed until local competition is established.
A continuing trend toward consolidation, mergers, acquisitions and strategic
alliances in the telecommunications industry could also increase the level of
competition faced by ITC/\DeltaCom or ITC/\DeltaCom's carrier customers. For
example, WorldCom acquired MCI in September 1998 and
14
AT&T acquired Tele-Communications, Inc. in March 1999. Merger plans have been
announced by SBC and Ameritech as well as Bell Atlantic and GTE. AT&T also
announced plans to enter into a joint venture with British Telecommunications
plc to combine the international assets and operations of each company,
including their existing international networks. In addition, SBC has announced
a strategic alliance with Williams Communications Group Inc., a long distance
company, pursuant to which the two companies would supply services to each
other. The telecommunications market is very dynamic, and additional competitive
changes are likely in the future.
REGULATION
Overview. ITC/\DeltaCom's services are subject to federal, state and local
regulation. ITC/\DeltaCom, through its wholly owned subsidiaries, holds various
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 certain 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 ITC/\DeltaCom to obtain
licenses, permits or franchises in order to use the public rights of way
necessary to install and operate its networks.
Federal Regulation. ITC/\DeltaCom is categorized as a non-dominant carrier by
the FCC, and as a result is subject to relatively limited regulation of its
interstate and international services. Certain general policies and rules apply,
as well as certain reporting requirements, but ITC/\DeltaCom's rates are not
reviewed. ITC/\DeltaCom has all the operating authority required by the FCC to
conduct its long distance business. As a non-dominant carrier, ITC/\DeltaCom 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's role with respect to local telephone competition arises principally
from the Telecommunications Act, which became effective February 8, 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 exchange carriers, including non-incumbent local
exchange carriers such as ITC/\DeltaCom, in order to promote competition in
local exchange and access services. These duties include requirements to:
. complete calls originated by competing carriers on a reciprocal basis
. permit resale of services
. permit users to retain their telephone numbers when changing carriers
. provide competing carriers access to poles, ducts, conduits and rights-of-
way at regulated prices
Incumbent local exchange carriers are also subject to additional requirements.
These duties include obligations of the incumbent local exchange carriers to:
. interconnect their networks with competitors
. offer collocation of competitors' equipment at their premises
. make available elements of their networks (including network facilities,
and capabilities) on non-discriminatory, cost-based terms
. offer wholesale versions of their retail services for resale at discounted
rates
Collectively, these requirements recognize that local exchange competition is
dependent upon cost-based and non-discriminatory interconnection with and use of
incumbent local exchange carrier networks. Failure to achieve such
interconnection arrangements could have an adverse impact on the ability of
ITC/\DeltaCom or other entities to provide competitive local exchange services.
15
Under the Telecommunications Act, incumbent local exchange carriers are required
to negotiate in good faith with carriers requesting any or all of the above
arrangements. In addition, in August 1996, the FCC released a decision (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
challenges to the Interconnection Decision and affirmed the authority of the FCC
to establish rules governing interconnection. ITC/\DeltaCom believes that
additional disputes regarding the Interconnection Decision and other related FCC
actions are likely.
There can be no assurance that the FCC's 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 respect to the operational support
systems used by new carriers to order and receive network elements and wholesale
services from the incumbent local exchange carriers. These systems are necessary
for new carriers like ITC/\DeltaCom to provide local service to customers on a
timely and competitive basis. The FCC has created a task force to examine
problems that have slowed the development of local telephone competition but as
yet has taken no enforcement actions. The FCC also will be reconsidering the
circumstances in which it is necessary for new carriers to use particular
network elements of the incumbent exchange carriers. Any restriction on the
availability of network elements could have a materially adverse effect on
ITC/\DeltaCom.
ITC/\DeltaCom has entered into an interconnection agreement with BellSouth.
This interconnection agreement currently allows ITC/\DeltaCom to provide local
service on either a resale basis or by purchasing all unbundled network elements
required to provide local service on a facilities basis, without using Company-
owned facilities. ITC/\DeltaCom and BellSouth have agreed on interim pricing
terms for such resale and purchase of unbundled network elements. The terms of
the interconnection agreement were approved by the public utilities commissions
(the "PUCs") regulating ITC/\DeltaCom's markets. The BellSouth interconnection
agreement however does not resolve all operational issues, particularly those
relating to the collocation of ITC/\DeltaCom's equipment with that of BellSouth.
ITC/\DeltaCom and BellSouth are continuing to negotiate to resolve such issues.
ITC/\DeltaCom expects that the BellSouth interconnection agreement will provide
a foundation for it to provide local service on a reasonable commercial basis,
but there can be no assurance in this regard and important issues remain
unsettled. See "Risk Factors--If We Are Unable To Interconnect With BellSouth
and Incumbent Local Exchange Carriers on Acceptable Terms, Our Ability To Offer
Local Telephone Services Will Be Adversely Affected."
ITC/\DeltaCom has negotiated similar interconnection agreements with other
incumbent local exchange carriers, including interconnection agreements with GTE
and Sprint for Alabama and Florida, respectively. However, other carriers who
have preceded ITC/\DeltaCom in the negotiation process with certain of these
incumbent local exchange carriers have expressed dissatisfaction with some of
the terms of their agreements, or with the operational support systems by which
they obtain the interconnection they require to provide local services to end
users.
The Telecommunications Act also eliminates previous prohibitions on the
provision of interLATA long distance services by the RBOCs and GTE. The RBOCs
are permitted to provide interLATA long distance service outside those states in
which they provide local exchange service ("out-of-region long distance
service") upon receipt of any necessary state and/or federal regulatory
approvals that are otherwise applicable to the provision of intrastate and/or
interstate long distance service. Under the Telecommunications Act, the RBOCs
will be allowed to provide long distance service within the regions in which
they also provide local exchange service ("in-region 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. As of the date hereof, the FCC has
not found that any RBOC has met these interconnection requirements. If the FCC
does permit BellSouth to provide long distance service in its local service
regions before
16
meeting ITC/\DeltaCom's 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.
The Telecommunications Act also imposes other restrictions on the RBOCs in
connection with their entry into the interLATA long distance services market.
Among other things, for the first three years (unless extended by the FCC) the
RBOCs must pursue such activities only through separate subsidiaries with
separate books and records, financing, management and employees. In addition,
affiliate transactions with these subsidiaries must be conducted on a non-
discriminatory basis.
In the future, an important element of providing competitive services may
be the ability to offer customers high-speed broadband local connections. The
FCC is considering a proposal that would allow incumbent local exchange carriers
to offer these and other services through separate affiliates, in which case
their network elements for providing these services would not need to be made
available to us or other competitors. AT&T has announced that it is entering
into arrangements with cable companies for the exclusive use of their local
networks for broadband telecommunications and several cable companies are
offering broadband Internet access over their network facilities. If
ITC/\DeltaCom is unable to meet future demands of its customers for broadband
local access on a timely basis at competitive rates, ITC/\DeltaCom may be at a
significant competitive disadvantage.
The FCC also regulates the interstate access rates charged by incumbent local
exchange 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 overtime are expected to reduce access rates, and
hence the cost of providing long distance service, especially to business
customers. However, further FCC action in this area is necessary and the full
impact of the FCC's decisions will not be known until those decisions are
implemented over the next several years.
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 ITC/\DeltaCom now
pay a fee calculated as a percentage of their revenues to support these goals.
Certain individual states are also implementing universal service funds. The
full implications of these decision also remain uncertain and subject to change.
In addition, the FCC continues to consider related questions regarding the
applicability of access charge and universal service fees to ISPs. Currently
ISPs are not subject to these expenses and the U.S. Court of Appeals for the
Eighth Circuit (the "Eighth Circuit") has upheld the FCC's decision not to
impose such fees. However, the incumbent local exchange carriers and other
parties argue that this exemption unfairly advantages ISPs, particularly when
they provide data, voice or other services in direct competition with
conventional telecommunications ITC/\DeltaCom is not in a position to determine
how these access and universal service matters will be resolved in the future,
and whether or not such resolution will be harmful to its competitive position.
The FCC also 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 licenses
and operating authority for failure to comply with federal laws and/or the
rules, regulations and policies of the FCC. Fines or other penalties also may be
imposed for such violations. There can be no assurance that the FCC or third
parties will not raise issues with regard to ITC/\DeltaCom's compliance with
applicable laws and regulations.
As a general matter, no assurance is possible regarding how quickly or how
adequately ITC/\DeltaCom will be able to take advantage of the opportunities
created by the Telecommunications Act. ITC/\DeltaCom could be adversely affected
if the court decision reversing some of the new FCC rules, or problems in the
related arbitration and negotiation process, result in
17
increasing the cost of using incumbent local exchange carrier network elements
or services, or if such actions otherwise result in delays in the implementation
of the Telecommunications Act or impediments to the development of local
telephone competition.
The FCC has granted incumbent local exchange carriers certain flexibility in
pricing their interstate special and switched access services. Under this
pricing scheme, local exchange carriers may establish pricing zones based on
access traffic density and charge different prices for access provided in each
zone. ITC/\DeltaCom anticipates that the FCC will grant incumbent local exchange
carriers increasing pricing flexibility as the number of interconnection
agreements and competitors increases. In a pending rulemaking proceeding
scheduled for completion soon, the FCC is expected to announce new and more
specific policies regarding the conditions and timing under which incumbent
local exchange carriers will be eligible for such increased pricing flexibility.
There can be no assurance that such pricing flexibility will not place
ITC/\DeltaCom at a competitive disadvantage, either as a purchaser of access for
its long distance operations, or as a vendor of access to other carriers or end
user customers.
State Regulation. ITC/\DeltaCom is also subject to various state laws and
regulations. Most PUCs require providers such as ITC/\DeltaCom to obtain
authority from the commission prior to the initiation of service. In most
states, including Alabama, Georgia and Florida, ITC/\DeltaCom also is required
to file tariffs setting forth the terms, conditions and prices for services that
are classified as intrastate. ITC/\DeltaCom also is required to update or amend
its tariffs when it adjusts its rates or adds new products, and is subject to
various reporting and record-keeping requirements.
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 and/or the rules,
regulations and policies of state regulatory authorities. Fines or other
penalties also may be imposed for such violations. There can be no assurance
that PUCs or third parties will not raise issues with regard to ITC/\DeltaCom's
compliance with applicable laws or regulations.
ITC/\DeltaCom has all necessary authority to offer intrastate long distance
services in Alabama, Arkansas, California, Colorado, Connecticut, Delaware,
District of Columbia, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota,
Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New
Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon,
Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas,
Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.
ITC/\DeltaCom is authorized to provide intrastate long distance service in the
state of Arizona while a certificate in that state is pending. An application
for authority to provide intrastate long distance is pending in Hawaii. An
application will be filed, in the near future, in Alaska. ITC/\DeltaCom seeks
authority to provide long distance service in states outside of its target
markets to enhance its ability to attract business customers with offices, or
whose employees travel, outside of ITC/\DeltaCom's target markets.
ITC/\DeltaCom now provides local exchange services in its region by reselling
the retail local services of the incumbent local exchange carrier in a given
territory and, in some established markets, using its own local switching
facilities. ITC/\DeltaCom has obtained competitive local exchange carrier
certification in Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi,
North Carolina, South Carolina, Tennessee and Texas. An application for such
authority is pending in Arkansas.
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. However,
these
18
statutes and related questions arising from the Telecommunications Act will be
elaborated further through rules and policy decisions made by PUCs in the
process of addressing local service competition issues.
ITC/\DeltaCom also will be affected by state PUC decisions related to the
incumbent local exchange carriers despite the recent U.S. Supreme Court
decisions upholding the FCC's rule making power under the Telecommunications
Act. For example, PUCs have responsibility under the Telecommunications Act to
oversee relationships between incumbent local exchange carriers and their new
competitors with respect to such competitors' use of the incumbent local
exchange carriers' network elements and wholesale local services. PUCs arbitrate
interconnection agreements between the incumbent local exchange carriers and new
competitors such as ITC/\DeltaCom when necessary. Important issues remain open
regarding both the scope of PUC authority in this area and the extent to which
PUCs will adopt policies that promote local exchange competition. It is too
early to evaluate how these matters will be resolved, or their impact on the
ability of ITC/\DeltaCom to pursue its business plan.
States also regulate the intrastate carrier access services of the incumbent
local exchange carriers. ITC/\DeltaCom is required to pay such access charges to
originate and terminate its intrastate long distance traffic. ITC/\DeltaCom
could be adversely affected by high access charges, particularly to the extent
that the incumbent local exchange carriers do not incur the same level of costs
with respect to their own intrastate long distance services. In a related
development, states also will be developing intrastate universal service charges
parallel to the interstate charges created by the FCC. For example, incumbent
local exchange carriers such as BellSouth advocate the formation of state-level
funds that would be supported by potentially large payments by firms such as
ITC/\DeltaCom based on their total intrastate revenues. Another issue is use by
certain incumbent local exchange carriers, with the approval of PUCs, 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. ITC/\DeltaCom's
business could be adversely affected by these or other developments.
ITC/\DeltaCom also will be affected by how states regulate the retail prices
of the incumbent local exchange carriers with which it competes. ITC/\DeltaCom
believes that, as the degree of intrastate competition increases, the states
will offer the incumbent local exchange carriers increasing pricing flexibility.
This flexibility may present the incumbent local exchange carriers with an
opportunity to subsidize services that compete with ITC/\DeltaCom's services
with revenues generated from non-competitive services, thereby allowing
incumbent local exchange carriers to offer competitive services at lower prices
than they otherwise could. In a related development, BellSouth is seeking
authority to create "CLEC" affiliates that would operate on a much less
regulated basis and therefore could provide significant competition in the
business market whether or not the traditional BellSouth local business receives
more pricing flexibility. Currently, only Kentucky and Tennessee have placed
limitations on such CLEC affiliates. ITC/\DeltaCom cannot predict the extent to
which these developments may occur or their impact on ITC/\DeltaCom's business.
Local Government Authorizations and Related Rights of Way. ITC/\DeltaCom is
required to obtain street use and construction permits and licenses and/or
franchises to install and expand its fiber optic networks using municipal rights
of way. In some municipalities where ITC/\DeltaCom has installed or anticipates
constructing networks, it will be required to pay license or franchise fees
based on a percentage of gross revenues or on a per linear foot basis. There can
be no assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, the incumbent local exchange
carriers do not pay such franchise fees or pay fees that are substantially less
than those required to be paid by ITC/\DeltaCom, although the Telecommunications
Act requires that in the future such fees be applied in a competitively neutral
manner. To the extent that, notwithstanding the Telecommunications Act,
competitors do not pay the same level of fees as ITC/\DeltaCom, ITC/\DeltaCom
could be at a competitive disadvantage. Termination of the existing franchise or
license agreements prior to their expiration dates or a failure to renew the
franchise or license agreements and a requirement that ITC/\DeltaCom remove
19
its facilities or abandon its network in place could have a material adverse
effect on ITC/\DeltaCom. In addition, ITC/\DeltaCom would be adversely affected
if it is unable to obtain additional authorization for new construction on
reasonable terms. Furthermore, open issues exist regarding the ability of new
local service providers to gain access to commercial office buildings to serve
tenants.
General. The telecommunications market is in a period of substantial change
and uncertainty. As the Telecommunications Act and related FCC and state actions
are implemented, new issues are likely to arise that can affect ITC/\DeltaCom
and its business plan. No assurance can be given that future regulatory
developments will not have a materially adverse impact on ITC/\DeltaCom.
DESCRIPTION OF SIGNIFICANT INDEBTEDNESS
Credit Facility
ITC/\DeltaCom's wholly owned subsidiary, Interstate FiberNet, Inc. (the
"Borrower"), has a credit agreement with NationsBank and certain other lenders
(the "Credit Agreement"), which provides for a $50.0 million revolving Credit
Facility to be used for working capital and other purposes, including capital
expenditures and permitted acquisitions. To date, no amounts have been borrowed
under the Credit Facility.
Set forth below is a summary of the material provisions of the Credit
Facility. The following summary does not purport to be complete and is subject
to, and is qualified in its entirety by reference to, the Credit Agreement.
Certain capitalized terms used in this description of the Credit Facility are
defined at the end of this section while the remaining undefined capitalized
terms are defined in the Credit Agreement.
Amounts drawn under the Credit Facility will bear interest, at the Borrower's
option, at either the Base Rate or the LIBOR Rate, plus an Applicable Margin.
The Applicable Margin will be an annual rate which will fluctuate based on the
Borrower's Total Leverage Ratio and which will be between 0% and 1.125% for Base
Rate borrowings and between 1.0% and 2.125% for LIBOR Rate borrowings.
The Credit Agreement requires the Borrower to repay indebtedness outstanding
under the Credit Facility with the net cash proceeds from certain sales of
assets by ITC/\DeltaCom, the Borrower or the Borrower's subsidiaries other than
in the ordinary course of business and from certain public or private issuances
of equity securities or debt securities by ITC/\DeltaCom, the Borrower or the
Borrower's subsidiaries. In addition, the amount of credit available to the
Borrower under the Credit Agreement would be permanently reduced in the amount
and manner required by the Credit Agreement.
The Borrower's obligations under the Credit Facility are guaranteed by
ITC/\DeltaCom and the Borrower's subsidiaries and are secured by a first
priority lien on all current and future assets and properties of the Borrower
and its subsidiaries, except for certain contract rights and interests in real
estate, and by a first priority pledge of the stock of the Borrower and its
subsidiaries.
The Credit Agreement contains negative covenants limiting the ability of the
Borrower, the Borrower's current and future subsidiaries and ITC/\DeltaCom to
incur debt, create liens, pay dividends, make distributions or stock
repurchases, make investments or capital expenditures, change their name, issue
capital stock, engage in transactions with affiliates, sell assets, engage in
mergers and acquisitions and assume or make guaranties. In addition, the Credit
Agreement contains affirmative covenants, including covenants requiring
engagement primarily in the business of telecommunications and activities
related thereto, compliance with applicable laws, maintenance of corporate
existence, licenses, properties and insurance, payment of taxes and performance
of other material obligations and the delivery of financial and other
information.
20
The Credit Agreement restricts the Borrower from declaring and paying
dividends or other distributions to ITC/\DeltaCom. However, the Borrower is
permitted to pay dividends to ITC/\DeltaCom to pay scheduled cash interest due
and payable on:
. the 1997 Notes, beginning after the sixth scheduled interest payment
. the March 1998 Notes
. the November 1998 Notes
unless at the time of such dividend an event of default (other than an event of
default resulting solely from the breach of a representation or warranty) under
the Credit Agreement exists or would be caused by such dividend; provided that,
with respect to any event of default (other than a payment default, a bankruptcy
event with respect to ITC/\DeltaCom, the Borrower or (with respect to the March
1998 Notes and the November 1998 Notes) any Significant Subsidiary of
ITC/\DeltaCom, or an event in which any portion of the assets of the Borrower
and its subsidiaries that has generated more than 5% of the Operating Cash Flow
for the most recently completed twelve-month period shall not be operating for a
period in excess of 30 days), the Borrower will not be prohibited for more than
180 consecutive days from paying dividends to ITC/\DeltaCom to pay scheduled
cash interest due and payable on the Notes.
The Credit Agreement also requires the Borrower to comply with certain
financial tests and to maintain certain financial ratios on a consolidated
basis. The Borrower must maintain:
(1) a Total Leverage Ratio no greater than 9.5 to 1.0 through June 30, 1999,
8.75 to 1.0 from July 1, 1999 to June 30, 2000, 7.5 to 1.0 from July 1,
2000 to June 30, 2001, 6.0 to 1.0 from July 1, 2001 to June 30, 2002 and
4.5 to 1.0 from July 1, 2002 and thereafter, provided that compliance
with this ratio is not required until such time, if any, as the Borrower
obtains an extension of credit under the Credit Agreement;
(2) a Senior Leverage Ratio no greater than 2.75 to 1.0 through June 30, 2000
and 2.25 to 1.0 from July 1, 2000 and thereafter, provided that
compliance with this ratio is not required until such time, if any, as
the Borrower obtains an extension of credit under the Credit Agreement;
(3) an Interest Coverage Ratio no less than 1.50 to 1.0 (or, in the event
ITC/\DeltaCom does not redeem 35% of the 1997 Notes within 60 days
after the closing date of the Credit Agreement, 1.75 to 1.0) through June
30, 2000 and 1.75 to 1.0 from July 1, 2000 and thereafter, provided that
compliance with this ratio is not required until such time, if any, as
the Borrower obtains an extension of credit under the Credit Agreement;
and
(4) capital expenditures made by ITC/\DeltaCom, the Borrower and its
subsidiaries no greater than $150,000,000 for fiscal year 1998,
$130,000,000 for fiscal year 1999, $90,000,000 for fiscal year 2000,
$60,000,000 for fiscal year 2001 and for each fiscal year thereafter;
provided, that (A) to the extent that less than such amount is used by
ITC/\DeltaCom, the Borrower and its subsidiaries for any fiscal year, the
limitation on capital expenditures for succeeding fiscal years may be increased
by the amount of such unused amount and (B) the Borrower may add 50% of the net
proceeds from any issuance of equity by ITC/\DeltaCom, the Borrower, or any of
its subsidiaries plus additional $50,000,000 in the aggregate to the maximum
amounts set forth above, provided that at the time the Borrower elects to
increase the maximum amount by any portion of the foregoing, there exists no
default or event of default.
Failure to satisfy any of the financial covenants constitutes an event of
default under the Credit Facility, notwithstanding the ability of the Borrower
to meet its debt service obligations. The Credit Agreement also includes other
customary events of default, including, without limitation, a cross-default to
other indebtedness, material undischarged judgments, bankruptcy and a change of
control.
21
As used in this section:
"Annualized Operating Cash Flow" means Operating Cash Flow for the six-month
period most recently ended, multiplied by two.
"Interest Coverage Ratio" means, for ITC/\DeltaCom on a consolidated basis
for any period, the ratio of Annualized Operating Cash Flow to the aggregate
amount of interest due and payable by ITC/\DeltaCom, the Borrower and the
Borrower's subsidiaries with respect to Total Debt during such period net of
interest on the 1997 Notes funded by pledged securities and Permitted
Subordinated Debt, interest income for such period, interest actually paid-in-
kind, any one-time facility fees paid in connection with the Credit Facility and
in connection with any pre-existing debt of ITC/\DeltaCom, the Borrower or the
Borrower's subsidiaries, up to $9.5 million of accrued interest paid by the
Borrower to ITC Holding prior to September 17, 1997, one-time prepayment
penalties incurred as a result of the extinguishment on the closing date of the
Credit Agreement of interest rate protection agreements of the Borrower in an
amount not in excess of $2,800,000 and any interest expense associated
exclusively with the mark to market on such closing date of interest rate
protection agreements of the Borrower in an amount not in excess of $2,800,000.
"Operating Cash Flow" for any period means the consolidated net income
(loss) of ITC/\DeltaCom, the Borrower and the Borrower's subsidiaries for such
period plus the following amounts for such period, to the extent included in the
determination of such income (loss): depreciation expense, amortization expense
and other non-cash charges reducing income, net interest expense, and income tax
expense.
"Permitted Subordinated Debt" means all debt of the Borrower pursuant to
subordinated notes between the Borrower and ITC/\DeltaCom containing certain
specified terms and conditions and otherwise acceptable to the administrative
agent and a majority of the lenders.
"Senior Leverage Ratio" means the ratio of Senior Debt (Total Debt minus the
aggregate outstanding principal amount, and accrued and unpaid interest, on the
Notes plus all permitted subordinated debt) to Annualized Operating Cash Flow.
"Total Debt" means the aggregate indebtedness of ITC/\DeltaCom for borrowed
money on a consolidated basis.
"Total Leverage Ratio" means at any date, for ITC/\DeltaCom on a consolidated
basis, the ratio of Total Debt (net of cash balances in excess of $5,000,000
plus the balance of pledged securities securing the 1997 Notes plus all
Permitted Subordinated Debt) on such date to Annualized Operating Cash Flow.
1997 Notes
On June 3, 1997, ITC/\DeltaCom completed the sale of $200.0 million principal
amount of its 1997 Notes. Interest on the 1997 Notes is payable semiannually in
cash, on each June 1 and December 1.
The 1997 Notes are unsubordinated indebtedness of ITC/\DeltaCom, ranking pari
passu in right of payment with all of our existing and future unsubordinated
indebtedness, including the March 1998 Notes and the November 1998 Notes. At
December 31, 1998, approximately $20.0 million of the net proceeds from the sale
of the 1997 Notes were being held in a pledged account as security for and to
fund the balance of the first six interest payments on the 1997 Notes.
22
The 1997 Notes will mature on June 1, 2007. The 1997 Notes are redeemable at
our option, in whole or in part, at any time on or after June 1, 2002, initially
at 105.5% of their principal amount, declining ratably to 100% of their
principal amount, plus accrued interest, on or after June 1, 2004.
The indenture pursuant to which the 1997 Notes were issued (the "1997 Note
Indenture") contains certain covenants that affect, and in certain cases
significantly limit or prohibit, among other things, ITC/\DeltaCom's ability to
incur indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, make investments, engage in transactions with stockholders and
affiliates, create liens, sell assets and engage in mergers and consolidations.
If ITC/\DeltaCom fails to comply with these covenants, ITC/\DeltaCom's
obligation to repay the 1997 Notes may be accelerated. However, these
limitations are subject to a number of important qualifications and exceptions.
In particular, while the 1997 Note Indenture restricts ITC/\DeltaCom's ability
to incur additional indebtedness by requiring compliance with specified leverage
ratios, it permits ITC/\ DeltaCom and its subsidiaries to incur an unlimited
amount of additional indebtedness to finance the acquisition of equipment,
inventory and network assets and up to $100.0 million of additional
indebtedness.
Upon a "Change of Control" of ITC/\DeltaCom (as defined in the 1997 Note
Indenture), ITC/\ DeltaCom will be required to make an offer to purchase the
1997 Notes at a purchase price equal to 101% of their principal amount, plus
accrued interest.
March 1998 Notes
On March 3, 1998, ITC/\DeltaCom completed the sale of $160.0 million principal
amount of its March 1998 Notes. Interest on the March 1998 Notes is payable
semiannually in cash, on each March 1 and September 1.
The March 1998 Notes are unsubordinated indebtedness of ITC/\DeltaCom, ranking
pari passu in right of payment with all of our existing and future
unsubordinated indebtedness, including the 1997 Notes and the November 1998
Notes.
The March 1998 Notes will mature on March 1, 2008. The March 1998 Notes are
redeemable at ITC/\DeltaCom's option, in whole or in part, at any time on or
after March 1, 2003, initially at 104.4375% of their principal amount, declining
ratably to 100% of their principal amount, plus accrued interest, on or after
March 1, 2006.
The indenture pursuant to which the March 1998 Notes were issued (the "March
1998 Note Indenture") contains certain covenants that affect, and in certain
cases significantly limit or prohibit, among other things, our ability to incur
indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, make investments, engage in transactions with stockholders and
affiliates, create liens, sell assets and engage in mergers and consolidations.
If we fail to comply with these covenants, our obligation to repay the March
1998 Notes may be accelerated. However, these limitations are subject to a
number of important qualifications and exceptions. In particular, while the
March 1998 Note Indenture restricts our ability to incur additional indebtedness
by requiring compliance with specified leverage ratios, it permits us and our
subsidiaries to incur an unlimited amount of additional indebtedness to finance
the acquisition of equipment, inventory and network assets and up to $150.0
million of additional indebtedness.
Upon a "Change of Control" of ITC/\DeltaCom (as defined in the March 1998
Note Indenture), ITC/\DeltaCom will be required to make an offer to purchase the
March 1998 Notes at a purchase price equal to 101% of their principal amount,
plus accrued interest.
23
November 1998 Notes
On November 5, 1998, ITC/\DeltaCom completed the sale of $125.0 million
principal amount of its November 1998 Notes. Interest on the November 1998
Notes is payable semiannually in cash, on each May 15 and November 15.
The November 1998 Notes are unsubordinated indebtedness of ITC/\DeltaCom,
ranking pari passu in right of payment with all of our existing and future
unsubordinated indebtedness, including the 1997 Notes and the March 1998 Notes.
The November 1998 Notes will mature on November 15, 2008. The November 1998
Notes are redeemable at ITC/\DeltaCom's option, in whole or in part, at any time
on or after November 15, 2003, initially at 104.875% of their principal amount,
declining ratably to 100% of their principal amount, plus accrued interest, on
or after November 15, 2006.
The indenture pursuant to which the November 1998 Notes were issued (the
"November 1998 Note Indenture") contains certain covenants that affect, and in
certain cases significantly limit or prohibit, among other things, our ability
to incur indebtedness, pay dividends, prepay subordinated indebtedness,
repurchase capital stock, make investments, engage in transactions with
stockholders and affiliates, create liens, sell assets and engage in mergers and
consolidations. If ITC/\DeltaCom fails to comply with these covenants,
ITC/\DeltaCom's obligation to repay the November 1998 Notes may be accelerated.
However, these limitations are subject to a number of important qualifications
and exceptions. In particular, while the November 1998 Note Indenture restricts
our ability to incur additional indebtedness by requiring compliance with
specified leverage ratios, it permits us and our subsidiaries to incur an
unlimited amount of additional indebtedness to finance the acquisition of
equipment, inventory and network assets and up to $150.0 million of additional
indebtedness.
Upon a "Change of Control" of ITC/\DeltaCom (as defined in the November 1998
Note Indenture), ITC/\DeltaCom will be required to make an offer to purchase the
November 1998 Notes at a purchase price equal to 101% of their principal amount,
plus accrued interest.
24
EMPLOYEES
As of December 31, 1998, ITC/\DeltaCom had over 1,100 full-time employees,
none of whom was represented by a union or covered by a collective bargaining
agreement. ITC/\DeltaCom believes that its relationship with its employees is
good. In connection with the construction and maintenance of its fiber optic
network and the conduct of its other business operations, ITC/\DeltaCom uses
third party contractors, some of whose employees may be represented by unions or
covered by collective bargaining agreements.
EXECUTIVE OFFICERS
The following is a list of the executive officers of ITC/\DeltaCom, together
with biographical summaries of their experience. The ages of persons set forth
below are as of December 31, 1998.
NAME AGE POSITION(S) WITH COMPANY
Campbell B. Lanier, III 48 Chairman, Director
Andrew M. Walker 57 Chief Executive Officer, Director
Foster O. McDonald 36 President
Douglas A. Shumate 33 Senior Vice President,
Chief Financial Officer
Steven D. Moses 49 Senior Vice President-
Network Services
J. Thomas Mullis 55 Senior Vice President-
General Counsel, Secretary
Roger F. Woodward 46 Senior Vice President, Sales,
Marketing and Customer Support
Sara L. Plunkett 49 Vice President-Finance, Treasurer
Campbell B. Lanier, III has been Chairman of ITC/\DeltaCom since March 1997.
Mr. Lanier also is the Chairman of the Board and Chief Executive Officer of ITC
Holding and has served as a director of ITC Holding since its inception in 1985
through a predecessor company. In addition, Mr. Lanier serves as a director of
Innotrac Corporation ("Innotrac") (a provider of marketing support services),
KNOLOGY Holdings, Inc. ("KNOLOGY") (a broadband telecommunications services
company) (formerly known as CyberNet Holding, Inc.), MindSpring Enterprises,
Inc. ("MindSpring") (a company that provides Internet services), Vista Eyecare,
Inc. (formerly known as National Vision Associates, Ltd.) (a full service
optical retailer) and K&G Men's Centers (a discount retailer of men's clothing),
Vice Chairman of the Board of AvData Systems, Inc. ("AvData") (a company
providing data communications networks) and Chairman of the Board of Powertel,
Inc. (formerly InterCel, Inc.) ("Powertel") (a wireless telecommunications
services company). He has served as a Managing Director of South Atlantic
Private Equity Fund IV, Limited Partnership since 1997.
Andrew M. Walker has been Chief Executive Officer of ITC/\DeltaCom since March
1997and Vice Chairman of the Board of Directors of ITC/\DeltaCom since April
1998. He served as President and Chief Executive Officer of the managing partner
of each of Interstate FiberNet and Gulf States FiberNet from November 1994 until
March 1997. Mr. Walker has served as a director of KNOLOGY since July 1996, and
he served as Chief Executive Officer and President of KNOLOGY from July 1996 to
February 1997. Mr. Walker worked for MCI from 1990 to 1994 as Vice President
Carrier Services. From 1986 to 1990, Mr. Walker served as a Division President
for Telecom*USA, Inc. Prior to 1986, Mr. Walker held different positions with
the Christian Broadcasting Network, M/A-Com and Comsat Laboratories.
25
Foster O. McDonald has been President of ITC/\DeltaCom since March 1997. He
served as President of DeltaCom from January 1991 until March 1997. From
February 1996 until March 1997, Mr. McDonald also served as Chief Executive
Officer of DeltaCom. From May 1984 through December 1990, Mr. McDonald served as
Vice President and General Manager of DeltaCom. He also serves as a director of
Brindlee Mountain Telephone Company.
Douglas A. Shumate has been Senior Vice President and Chief Financial Officer
of ITC/\ DeltaCom since March 1997. He served as Chief Financial Officer of the
Managing Partners of each of Interstate FiberNet and Gulf States FiberNet from
January 1995 until March 1997. From May 1991 to January 1995, he served as Vice
President-Finance and Chief Financial Officer of Interstate Telephone Company
("Interstate Telephone"), a local telephone service provider and wholly owned
subsidiary of ITC Holding. From December 1986 through April 1991, Mr. Shumate
was employed as a C.P.A. at Arthur Andersen LLP.
Steven D. Moses has been Senior Vice President-Network Services of
ITC/\DeltaCom since March 1997. He served as Vice President of Interstate
FiberNet from January 1992 until April 1995 and Chief Operating Officer of
Interstate FiberNet from April 1995 until March 1997. From May 1991 to January
1992, Mr. Moses served as Director-Special Projects of Interstate Telephone and
Valley Telephone Company (a local telephone service provider and a wholly owned
subsidiary of ITC Holding).
J. Thomas Mullis has been Senior Vice President, General Counsel and Secretary
of ITC/\ DeltaCom since March 1997. Mr. Mullis served as General Counsel and
Secretary of DeltaCom from May 1985 to March 1997 and as Executive Vice
President of DeltaCom from January 1994 to November 1996. From November 1996 to
March 1997, he also served as Senior Vice President of DeltaCom. From January
1990 to December 1993, Mr. Mullis served as President, General Counsel and
Secretary of both Southern Interexchange Services, Inc. (a switched services
carrier) and Southern Interexchange Facilities, Inc. (a private line carriers'
carrier).
Roger F. Woodward has been Senior Vice President-Sales, Marketing and Customer
Support of ITC/\DeltaCom since March 1997. Mr. Woodward served as Senior Vice
President-Sales of DeltaCom from October 1996 until March 1997. From March 1990
until July 1996, Mr. Woodward served in a variety of positions, including
Regional Sales Director and Vice President-Sales, with Allnet Communications,
Inc., which was acquired by Frontier in August 1995.
Sara L. Plunkett has been Vice President-Finance and Treasurer for
ITC/\DeltaCom since March 1997. She served as Vice President-Finance of DeltaCom
from October 1996 until March 1997. From May 1989 through October 1996, she
served as Chief Financial Officer of DeltaCom.
26
RISK FACTORS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, set forth below are cautionary statements
identifying important factors that could cause our actual results to differ
materially from those projected in any of our forward-looking statements made by
or on behalf of us, whether oral or written. These forward-looking statements
can be identified by use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. We wish to ensure that any
forward-looking statements are accompanied by meaningful cautionary statements
in order to maximize to the fullest extent possible the protections of the safe
harbor established in the Private Securities Litigation Reform Act of 1995.
Accordingly, any such statements are qualified in their entirety by reference
to, and are accompanied by, the following important factors, among others, that
could cause our actual results to differ materially from those projected in our
forward-looking statements.
We expect to continue to have operating losses and negative cash flow after
capital expenditures which may result in our failure to meet our working capital
and debt service requirements
As we have implemented our business strategy to expand our telecommunications
service offerings, expand our fiber optic network and enter new markets, we have
experienced operating losses and negative cash flow after capital expenditures.
We expect this will continue during the next several years as we continue to
expand our business and make substantial capital expenditures. If we cannot
achieve or sustain operating profitability and positive net cash flow, we may
not be able to obtain the funds necessary to continue our operations or to repay
amounts due on our outstanding indebtedness. We cannot assure you that we will
achieve or sustain profitability or positive net cash flow in the future. See
"--We May Not Have, or Be Able to Obtain, the Significant Amounts of Capital
That We Need to Expand Our Network, Operations and Services as Planned."
We may not have, or be able to obtain, the significant amounts of capital that
we need to expand our network, operations and services as planned
We need significant capital to expand our network, operations and services in
accordance with our business plans. We have continued to accelerate expansion of
our fiber optic network and our Retail Services segment for which we have made
significant capital expenditures. During 1998, we made capital expenditures of
approximately $148 million on a consolidated basis. We currently estimate that
our capital expenditures will total approximately $125 million in 1999. In
addition, we expect to make substantial capital expenditures after 1999 and are
in the process of evaluating those requirements. If our estimates are inaccurate
and/or we do not have access to the capital that we require, we will need to
change our business plans. This could have a material adverse effect on our
business, financial condition and results of operations.
Our planned capital expenditures primarily will be for:
. continued development and construction of our fiber optic network, including
transmission equipment;
. continued addition of facilities-based local telephone service to our bundle
of integrated telecommunications services, including acquisition and
installation of switches and related equipment;
. the addition of switching capacity, electrical equipment and additional
collocation space in connection with the expansion of our provision of local
telecommunications services to ISPs;
27
. market expansion; and
. infrastructure enhancements, principally for information systems.
We expect to have sufficient funds to enable us to expand our business as
currently planned through the second quarter of 2001. We believe that these
funds will be provided by:
. cash on hand, which amounted to approximately $184.2 million at December 31,
1998;
. cash flow from operations; and
. borrowings available under our $50.0 million Credit Facility with NationsBank.
However, we cannot assure you that our capital resources will permit us to fund
the planned expansion of our network, operations and services.
If our current sources of funds are unavailable to fund our business plans, we
may need to seek additional funds. These additional funds may come from public
and private equity and debt financings, but we cannot assure you that we will be
able to obtain any additional funds on a timely basis, on terms that are
acceptable to us or at all. Our inability to obtain the capital that we need to
implement our current business plans could have a material adverse effect on our
business, financial condition and results of operations. See "--Description of
Significant Indebtedness."
After the second quarter of 2001, or sooner if our estimates are not accurate
for any reason, we may need to seek additional financing:
. to fund capital expenditures;
. for working capital;
. to fund new business activities related to our current and planned businesses;
and
. to acquire, or enter into joint ventures and strategic alliances with, other
businesses.
These additional funds may come from public and private equity and debt
financings, or from borrowing from one or more lenders. We cannot assure you
that we will be able to obtain any additional funds on a timely basis, on terms
that are acceptable to us, or at all. If we cannot generate or obtain these
additional funds, we may have to delay or abandon some or all of our future
plans or expenditures. This could have a material adverse effect on our
business, financial condition and results of operations.
Our estimate of future capital requirements is a "forward-looking statement"
within the meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The actual amount and timing of our future
capital requirements may differ substantially from our estimate due to factors
such as:
. regulatory, technological, or competitive developments;
. unforeseen delays;
. cost overruns;
. changes in demand for our services; and
. new market developments and opportunities.
28
We have significant debt and we may be unable to service that debt
We have significant debt. Set forth below are some of our recent results on a
consolidated basis, adjusted to reflect our issuance of the November 1998 Notes
as if it had occurred on the date, or at the beginning of the periods, shown.
Year ended Year ended
------------------------------------ ---------------------------------------
At December 31, 1998 December 31, 1997 December 31, 1998
- ---------------------------------- ------------------------------------ ---------------------------------------
Indebtedness of $417.9 Earnings insufficient to cover Earnings insufficient to cover fixed
million fixed charges by $13.7 million charges by $32.4 million
Stockholders' equity of EBITDA, as adjusted, less capital EBITDA, as adjusted, less capital
$118.2 million expenditures and interest expense expenditures and interest expense
of negative $43.5 million of negative $156.7 million
See "Item 6. Selected Financial Data."
We cannot assure you that we will be able to improve our earnings before fixed
charges or that we will be able to meet our debt service obligations. We will be
in default under the terms of our debt obligations if:
. we are unable to generate sufficient cash flow or otherwise obtain funds
necessary to make required payments or
. we otherwise fail to comply with the various covenants in our debt
obligations. A default would permit the holders of the indebtedness to
accelerate its maturity.
This, in turn, could cause defaults under our other indebtedness and would
have a material adverse effect on our business, financial condition and results
of operations. See "--Description of Significant Indebtedness."
Even if we are able to meet our debt service obligations, the amount of debt
we have could adversely affect us in a number of ways, including by:
. limiting our ability to obtain any necessary financing in the future for
working capital, capital expenditures, debt service requirements or other
purposes;
. limiting our flexibility in planning for, or reacting to, changes in our
business;
. placing us at a competitive disadvantage relative to our competitors who have
lower levels of debt;
. making us more vulnerable to a downturn in our business or the economy
generally; and
. requiring us to use a substantial portion of our cash flow from operations to
pay principal and interest on our debt, instead of contributing those funds to
other purposes, such as working capital and capital expenditures.
To be able to meet our debt service requirements we must successfully
implement our business strategy. Therefore, we will need to:
. expand our network;
29
. obtain and retain a significant number of customers; and
. experience significant and sustained growth in our cash flow.
We cannot assure you that we will successfully implement our business strategy
or that we will be able to generate sufficient cash flow from operating
activities to meet our debt service obligations and working capital
requirements. Our ability to meet our obligations will be dependent upon our
future performance, which will be subject to prevailing economic conditions and
to financial, business and other factors.
If the implementation of our business strategy is delayed or unsuccessful, or
if we do not generate sufficient cash flow to meet our debt service and working
capital requirements, we may need to seek additional financing. If we are unable
to obtain such financing on terms that are acceptable to us, we could be forced
to dispose of assets to make up for any shortfall in the payments due on our
indebtedness under circumstances that might not be favorable to realizing the
highest price for those assets. A substantial portion of our assets consist of
intangible assets, the value of which will depend upon a variety of factors,
including without limitation the success of our business. As a result, we cannot
assure you that our assets could be sold quickly enough, or for amounts
sufficient, to meet our obligations.
Our current indebtedness contains restrictive covenants
We are subject to restrictions under:
. the indenture pursuant to which our $125.0 million principal amount of 9-3/4%
Senior Notes due November 15, 2008 were issued;
. the indenture pursuant to which our $160.0 million principal amount of 8-7/8%
Senior Notes due March 1, 2008 were issued;
. the indenture pursuant to which our $200.0 million principal amount of 11%
Senior Notes due June 1, 2007 were issued; and
. the Credit Facility.
These restrictions affect, and in certain cases significantly limit or
prohibit, among other things, our ability and the ability of our subsidiaries
to:
. incur additional indebtedness;
. create liens;
. make investments;
. issue stock; and
. sell assets.
The November 1998 Note Indenture, the March 1998 Note Indenture and the 1997
Note Indenture (collectively, the "Indentures") restrict our ability to incur
indebtedness, other than indebtedness to finance the acquisition of equipment,
inventory or network assets, by requiring compliance with specified leverage
ratios. In addition, if and when we borrow funds under the Credit Facility, the
Credit Facility will require us to maintain certain financial ratios. We cannot
assure you that we will be able to maintain the required ratios following such
borrowing. In addition, these restrictive covenants may adversely affect our
ability to finance our future operations or capital
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needs, or to engage in other business activities that may be in our interest.
See "--Description of Significant Indebtedness."
We may not be able to manage our growth successfully
The expansion and development of our business will depend upon, among other
things, our ability to:
. successfully implement our sales and marketing strategy;
. evaluate markets;
. design fiber routes;
. secure financing;
. install facilities;
. acquire rights of way;
. obtain any required government authorizations;
. interconnect to, and collocate with, facilities owned by incumbent local
exchange carriers; and
. obtain appropriately priced unbundled network elements and wholesale services
from the incumbent local exchange carriers.
These all must be accomplished in a timely manner, at reasonable cost and on
satisfactory terms and conditions. Our rapid growth, particularly in the
provision of Retail Services, has placed, and the growth we anticipate in our
other services may in the future also place, a significant strain on our
administrative, operational and financial resources. Our ability to continue to
manage our growth successfully will require us to:
. enhance our operational, management, financial and information systems and
controls; and
. hire and retain qualified sales, marketing, administrative, operating and
technical personnel.
We cannot assure you that we will be able to do so. In addition, as we
increase our service offerings and expand our targeted markets, there will be
additional demands on customer support, sales and marketing, administrative
resources and network infrastructure. These demands will be intensified if we
continue to accelerate our expansion plans. Our inability to manage our growth
effectively could have a material adverse effect on our business, results of
operations and financial condition.
Development and expansion of our business, including through acquisitions, is
subject to regulatory and market risks
The successful implementation of our business strategy to provide an
integrated bundle of telecommunications services and expand our operations will
be subject to a variety of risks, including:
. competition and pricing;
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. the availability of capital on favorable terms;
. regulatory uncertainties;
. operating and technical problems;
. the need to establish and maintain interconnection and collocation
arrangements with incumbent local exchange carriers in our target markets; and
. the potential difficulties of offering local exchange services.
In addition, the expansion of our business may involve acquisitions of other
telecommunications businesses and assets that, if made, could divert our
resources and management time and could require integration with our existing
operations. We cannot assure you that any acquisitions could be successfully
integrated into our operations or that any acquired business will perform as
expected. Our failure to implement our expansion and growth strategy
successfully would have a material adverse effect on our business, results of
operations and financial condition.
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, prices for long distance
services and for data transmission services have declined substantially in
recent years. These prices are expected to continue to decline, which will
adversely affect our gross margins as a percentage of revenues. In addition,
many of our existing and potential competitors have financial, technical and
other resources and customer bases and name recognition far greater than our
own. We cannot assure you that we will be able to achieve or maintain adequate
market share or revenues, or compete effectively in any of our markets.
. We face intense competition from incumbent local exchange carriers,
especially Bellsouth
Local telephone and intraLATA long distance services substantially similar to
those that we offer are also offered by the incumbent local exchange carriers
serving the markets that we serve or plan to serve. BellSouth is the incumbent
local exchange carrier and a particularly strong competitor in most of these
markets. BellSouth and other incumbent local exchange carriers already have
relationships with every customer. These carriers may be able to subsidize
services of the type we offer from service revenues not subject to effective
competition, which could result in even more intense price competition.
. Other competitors and technologies in our industries may further increase
competition
Providers of long distance services and Carriers' Carrier Services. We