<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-23253
ITC/\DELTACOM, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 58-2301135
- ------------------------------- --------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1241 O.G. Skinner Drive, West Point, GA 31833
- ---------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (706) 645-3880
-----------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ________
---------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at August 10, 1998
------------------------------
Common Stock at $.01 par value 25,622,256 Shares
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1998 AND DECEMBER 31, 1997
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $150,990,878 $ 94,373,610
Restricted assets 14,300,000 22,000,000
Accounts receivable:
Customer, net of allowance for uncollectible accounts of
$1,178,664 and $1,060,842 in 1998 and 1997, respectively 25,230,394 21,439,365
Affiliate 1,850,326 2,011,822
Inventory 1,732,688 1,018,212
Prepaid expenses 1,061,343 534,909
Federal income tax refunds receivable from ITC Holding 561,096 2,448,297
Deferred income taxes 1,052,393 589,799
------------ ------------
Total current assets 196,779,118 144,416,014
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, net 175,462,523 141,534,626
OTHER LONG-TERM ASSETS:
Intangible assets, net of accumulated amortization of
$4,865,129 and $3,634,152 in 1998 and 1997, respectively 64,163,899 61,347,786
Restricted assets 12,110,821 28,495,831
Other long-term assets 11,703,218 10,310,220
------------ ------------
Total assets $460,219,579 $386,104,477
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
2
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1998 AND DECEMBER 31, 1997
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable:
Trade $ 8,123,678 $ 7,714,878
Construction 3,061,238 6,770,923
Affiliate - 534,461
Accrued interest 5,978,448 1,867,208
Accrued compensation 1,216,751 1,875,663
Unearned revenue 6,107,002 4,778,819
Other accrued liabilities 7,123,600 3,516,510
Current portion of long-term debt and capital lease
obligations 1,381,450 912,037
------------ ------------
Total current liabilities 32,992,167 27,970,499
------------ ------------
LONG-TERM LIABILITIES:
Deferred income taxes 821,850 6,890,952
Long-term debt and capital lease obligations 292,218,868 202,977,499
------------ ------------
Total long-term liabilities 293,040,718 209,868,451
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; $7.40 liquidation preference;
5,000,000 shares authorized; 1,480,771 shares issued and
outstanding in 1998 and 1997, respectively 14,808 14,808
Common Stock, $.01 par value; 90,000,000 shares authorized;
25,584,637 and 24,817,556 shares issued and outstanding
in 1998 and 1997, respectively 255,846 248,176
Additional paid-in-capital 166,843,748 163,011,879
Accumulated deficit (32,927,708) (15,009,336)
------------ ------------
Total stockholders' equity 134,186,694 148,265,527
------------ ------------
Total liabilities and stockholders' equity $460,219,579 $386,104,477
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
3
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ----------------------------
1998 1997 1998 1997
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Operating revenues $40,851,776 $27,942,483 $ 77,546,278 $53,365,061
Cost of services 19,260,494 13,105,426 36,134,035 25,302,747
----------- ----------- ------------ -----------
Gross margin 21,591,282 14,837,057 41,412,243 28,062,314
----------- ----------- ------------ -----------
Operating expenses:
Selling, operations and administration 15,471,059 9,072,480 29,038,017 16,961,324
Depreciation and amortization 6,922,046 4,430,543 13,242,747 8,273,232
----------- ----------- ------------ -----------
Total operating expenses 22,393,105 13,503,023 42,280,764 25,234,556
----------- ----------- ------------ -----------
Operating income (loss) (801,823) 1,334,034 (868,521) 2,827,758
----------- ----------- ------------ -----------
Other income (expense):
Interest expense (7,939,478) (4,892,979) (15,437,900) (7,561,591)
Interest income 2,520,489 839,021 5,354,169 883,388
Other income (expense) 65,605 - (2,225,209) -
----------- ----------- ------------ -----------
Total other expense (5,353,384) (4,053,958) (12,308,940) (6,678,203)
----------- ----------- ------------ -----------
Loss before income taxes, preacquisition loss
and extraordinary item (6,155,207) (2,719,924) (13,177,461) (3,850,445)
Income tax benefit 1,307,692 741,338 3,695,259 1,005,809
----------- ----------- ------------ -----------
Loss before preacquisition loss and
extraordinary item (4,847,515) (1,978,586) (9,482,202) (2,844,636)
Preacquisition loss - - - 74,132
----------- ----------- ------------ -----------
Loss before extraordinary item (4,847,515) (1,978,586) (9,482,202) (2,770,504)
Extraordinary item -- loss on extinguishment
of debt (less related income tax benefit of
$2,133,154 and $311,057 in 1998 and
1997, respectively) - - (8,436,170) (507,515)
----------- ----------- ------------ -----------
Net loss $(4,847,515) $(1,978,586) $(17,918,372) $(3,278,019)
=========== =========== ============ ===========
Basic and diluted net loss per common share:
Before extraordinary loss $(0.19) $(0.10) $(0.37) $(0.15)
Extraordinary loss - - (0.34) (0.02)
----------- ----------- ------------ -----------
Net loss $(0.19) $(0.10) $(0.71) $(0.17)
=========== =========== ============ ===========
Basic weighted average common shares
outstanding 25,472,243 19,053,675 25,332,166 19,053,675
Diluted weighted average common shares
outstanding 25,472,243 19,101,926 25,332,166 19,101,926
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
4
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(17,918,372) $ (3,278,019)
------------ ------------
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 13,243,247 8,334,065
Amortization of bond issue costs 756,837 -
Deferred income taxes (6,531,696) 104,330
Preacquisition loss - (74,132)
Extraordinary item--loss on extinguishment of
debt 10,569,324 507,515
Other - 73,369
Changes in current operating assets and liabilities:
Accounts receivable, net (3,629,533) (3,055,995)
Inventory (714,476) (86,984)
Prepaid expenses (526,434) (101,682)
Income tax refunds receivable from ITC Holding 1,887,201 (663,200)
Accounts payable (471,363) (505,512)
Accrued interest 4,111,240 3,180,390
Unearned revenue 1,328,183 2,415,538
Accrued compensation and other accrued liabilities 2,747,572 2,563,342
Other, net - (3,246)
------------ ------------
Total adjustments 22,770,102 12,687,798
------------ ------------
Net cash provided by operating activities 4,851,730 9,409,779
------------ ------------
Cash flows from investing activities:
Capital expenditures (45,583,038) (14,069,380)
Change in accrued construction costs (3,709,685) 1,711,909
Change in restricted assets 24,085,010 -
Purchase of Gulf States FiberNet, net of cash received - 574,600
Other (385,070) -
------------ ------------
Net cash used in investing activities (25,592,783) (11,782,871)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of 8 7/8% Senior Notes,
net of issuance costs 155,170,450 -
Proceeds from issuance of 11% Senior Notes,
net of issuance costs - 194,250,000
Repayment of 11% Senior Notes (70,000,000) -
Premium paid on early retirement of 11% Senior Notes (7,700,000) -
Proceeds from issuance of other long-term debt - 41,095,061
Repayment of debt assumed in IT Group Communications
acquisition (760,339) -
Repayment of other long-term debt and
capital lease obligations (170,798) (41,746,920)
Proceeds from advance from ITC Holding - 8,243,990
Repayment of advance from ITC Holding - (48,329)
Proceeds from issuance of common stock
pursuant to options 974,379 -
Proceeds from issuance of common stock - 150,000
Capital contributions from ITC Holding, net - (624,465)
Other (155,371) 6,082
------------ ------------
Net cash provided by financing activities 77,358,321 201,325,419
------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
5
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Increase in cash and cash equivalents $ 56,617,268 $198,952,327
Cash and cash equivalents at beginning of period 94,373,610 1,301,415
------------ ------------
Cash and cash equivalents at end of period $150,990,878 $200,253,742
============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest $ 10,527,713 $ 1,034,980
============ ============
Cash refunds received for income taxes,
net of payments $ (1,674,000) $ (621,319)
============ ============
NONCASH TRANSACTIONS:
IT Group acquisition:
Note and capital lease obligation
and accrued liabilities assumed $ 1,174,739 $ -
============ ============
Equity portion $ 2,792,740 $ -
============ ============
Equity portion of acquisition of 64% interest
in Gulf States FiberNet and Georgia Fiber Assets $ - $ 17,896,665
============ ============
Assumption of long-term debt related to acquisition of
Georgia Fiber Assets $ - $ 9,964,091
============ ============
Offset of advances to ITC Holding as a reduction to related
advances from ITC Holding $ - $ 2,546,534
============ ============
Forgiveness of long-term advances by ITC Holding $ - $ 289,220
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
6
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION, NATURE OF BUSINESS, AND BASIS OF PRESENTATION
ORGANIZATION
ITC/\DeltaCom, Inc. ("ITC/\DeltaCom" or the "Company") was incorporated on
March 24, 1997 under the laws of the State of Delaware, as a wholly-owned
subsidiary of ITC Holding Company, Inc. ("ITC Holding"), to acquire and operate
the following wholly owned subsidiaries of ITC Holding: Interstate FiberNet,
Inc. (formerly ITC Transmission Systems, Inc.) ("FiberNet"), ITC Transmission
Systems II, Inc. ("Transmission II"), Gulf States Transmission Systems, Inc.
("GSTS"), Eastern Telecom, Inc. (d.b.a. InterQuest) ("InterQuest") and
ITC/\DeltaCom Communications, Inc. (formerly DeltaCom, Inc.) ("DeltaCom"). On
July 25, 1997, upon receipt of certain regulatory approvals and certain other
consents, ITC Holding completed the reorganization of such subsidiaries (the
"Reorganization"), as follows:
. InterQuest and Transmission II were merged with and into FiberNet.
. ITC Holding contributed to the Company all of the issued and outstanding
capital stock of FiberNet, DeltaCom and GSTS.
. The Company contributed to FiberNet all of the outstanding capital stock
of DeltaCom and GSTS.
GSTS held a 36% ownership in and was the managing partner of Gulf States
FiberNet ("Gulf States"), a Georgia general partnership. On March 27, 1997, ITC
Holding purchased the remaining 64% interest in Gulf States ("the Gulf States
Acquisition") and contributed this interest to GSTS as part of the
Reorganization. On December 29, 1997, GSTS was merged with and into FiberNet.
Effective October 20, 1997, as part of a further reorganization of ITC
Holding, ITC Holding transferred all of its assets, other than stock in the
Company, and all of its liabilities to another entity and then merged with and
into the Company. The Company was the surviving corporation in the Merger.
NATURE OF BUSINESS
The Company provides integrated voice and data telecommunications services
to mid-sized and major regional businesses in the southern United States
("Retail Services") and is a leading regional provider of wholesale long-haul
services to other telecommunications companies ("Carriers' Carrier Services").
Retail Services includes local exchange services, long distance services,
800/888 calling, calling card and operator services, Asynchronous Transfer Mode
("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 sale, installation and repair. In connection with these
businesses, the Company owns, operates and manages an extensive fiber optic
network in the southern United States.
BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are unaudited
and have been prepared by Company management in accordance with the rules and
regulations of the Securities and Exchange Commission (the "Commission"). In
the opinion of management, all adjustments considered necessary for the fair
presentation of the unaudited, consolidated financial statements have been
included, and the unaudited, consolidated financial statements present fairly
the financial position and results of operations for the interim periods
presented. These unaudited, consolidated financial statements should be read in
conjunction with the audited, consolidated financial statements and related
footnotes included in the Company's Annual Report on Form 10-K, as filed with
the Commission on March 30, 1998 (File No. 0-23252).
7
<PAGE>
The comparability of the three-month and six-month periods ended June 30,
1998 and June 30, 1997 has been affected by the Gulf States Acquisition and the
1998 Senior Notes Offering (as defined and further discussed in Notes 2 and 4,
below, respectively). The unaudited, consolidated financial statements for the
three and six months ended June 30, 1997 reflect the total revenues and expenses
from January 1, 1997, attributable to Gulf States FiberNet with the
preacquisition loss attributable to the previous owner deducted to determine
consolidated net loss.
Net Loss Per Share
The Company adopted Statement on Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share," effective December 31, 1997. Basic net loss per
common share is computed by dividing net loss by the weighted average number of
common shares outstanding during the period. Pursuant to the Commission Staff
Accounting Bulletin No. 98, for periods prior to the Company's initial public
offering, basic net loss per share is computed using the weighted average number
of shares of common stock outstanding during the period. Diluted net loss per
share is computed using the weighted average number of shares of common stock
outstanding during the period and, nominal issuances of common stock and common
stock equivalents, regardless of whether they are antidilutive. For the three
and six-month periods ended June 30, 1997, 48,251 stock options are included in
the computation of diluted net loss per share.
2. ACQUISITION OF MAJORITY INTEREST OF GULF STATES FIBERNET AND GEORGIA FIBER
ASSETS
On March 27, 1997, ITC Holding purchased the remaining 64% partnership
interest in Gulf States FiberNet and certain assets, including a significant
long-term customer contract (the "Georgia Fiber Assets"), for approximately $28
million, plus certain contingent consideration. The purchase price included
588,411 shares of ITC Holding's Series A Convertible Preferred Stock valued at
approximately $17.9 million and an unsecured purchase money note for
approximately $10 million. The purchase price was allocated as follows: $17
million to the 64% interest in Gulf States and $10.9 million to the Georgia
Fiber Assets. The note, bearing interest at 11%, was payable in ten semi-annual
principal payments of approximately $1 million plus accrued interest, beginning
September 30, 1997. The contingent consideration was due no later than April
30, 1998, at which time the Company was obligated to deliver additional
preferred stock equal to 35.7% of 64% multiplied by 6, multiplied by the amount,
if any, by which the earnings before interest, taxes, depreciation, and
amortization of Gulf States for the year ended December 31, 1997 exceeded
$11,265,696. In October 1997, ITC Holding issued 56,742 shares of its Series A
Convertible Preferred Stock in connection with this earn-out provision. The
645,153 shares of ITC Holding Series Preferred Stock issued in conjunction with
this acquisition were converted into 1,480,771 of the Company's Series A
Convertible Preferred Stock in conjunction with the merger. The Company
recorded goodwill totaling approximately $7.5 million in connection with this
acquisition. No further payments under the contingent consideration provision
were due.
Upon the closing of these acquisitions, ITC Holding contributed the
remaining 64% partnership interest in Gulf States FiberNet to GSTS and the
Georgia Fiber Assets to FiberNet. The Gulf States partnership has been
dissolved. The purchase money note was repaid in full in November 1997.
3. NONRECURRING CHARGES
On April 2, 1998, the Company redeemed $70 million principal amount of its 11%
Senior Notes due 2007 (the "11% Senior Notes"), at a redemption price of 111% of
the principal amount thereof, plus accrued and unpaid interest. Upon announcing
the redemption in March 1998, the Company accrued 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. Additionally, as a result
of the receipt by the Company of the proceeds from the 1998 Senior Note Offering
(as defined in Note 4, below), the Company's interest rate swap agreement no
longer may be accounted for as a hedge of an anticipated transaction, but rather
must be treated as a trading security. This change in classification required
the Company to record the payable related to the interest rate swap agreement on
the consolidated balance sheet at fair market value at the time of receipt of
the proceeds
8
<PAGE>
from the 1998 Senior Notes Offering. The loss, charged against earnings, was
approximately $2.5 million. The interest rate swap agreement was marked to
market at March 31, 1998 resulting in income of approximately $200,000 and will
continue to be marked to market on a monthly basis. For the three months ended
June 30, 1998, the Company recognized approximately $65,000 in income from the
mark-to-market of the interest rate swap.
4. OFFERING OF 8 7/8% SENIOR NOTES
On March 2, 1998, the Company issued $160 million principal amount of 8
7/8% Senior Notes due 2008 (the "8 7/8% Senior Notes"), at a price of 99.9% (the
"1998 Senior Notes Offering"), yielding net proceeds of approximately $155
million. The Company is using these proceeds (i) to replace portions of the
proceeds from the Company's initial public offering in October 1997, which the
Company used in April 1998 to redeem $70 million of its 11% Senior Notes at a
redemption price of 111% (as discussed in Note 3, above), (ii) to fund continued
market and fiber optic expansion and (iii) to replace funds that would have
otherwise been available under the Company's secured credit facility, which has
been modified to, among other things, reduce available borrowings thereunder
from $100 million to $50 million.
5. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long term debt and capital lease obligations at June 30, 1998 and December
31, 1997 consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---------- -------------
<S> <C> <C>
11% Senior Notes $130,000 $200,000
8 7/8% Senior Notes 159,845 -
Capital lease obligations at varying interest rates,
maturing through June 2006 3,115 3,249
Other 640 640
-------- --------
Total long-term debt and capital leases 293,600 203,889
Less current maturities (1,381) (912)
-------- --------
Total $292,219 $202,977
======== ========
</TABLE>
In connection with the 1998 Senior Notes Offering, the Company modified its
Credit Agreement to reduce the available credit to $50 million and to amend
and/or delete various covenants.
6. COMMITMENTS AND CONTINGENCIES
At June 30, 1998, the Company had entered into agreements with vendors to
purchase approximately $33.4 million of equipment related to the improvement and
installation of switches, other network expansion efforts and certain services.
7. ACQUISITION OF IT GROUP
On May 20, 1998, the Company completed its acquisition of certain assets
and liabilities of PSP Marketing Group, Inc., d/b/a IT Group Communications
Company ("IT Group Communications"), a Jackson, Mississippi-based long distance
carrier. The Company issued 88,553 shares of common stock and assumed
liabilities of approximately $1.2 million to consummate the transaction.
9
<PAGE>
8. SUBSEQUENT EVENTS
On July 29, 1998, the Company announced that its Board of Directors had
declared a two-for-one stock split to be effected in the form of a stock
dividend (the "Stock Split"). The record date for the Stock Split is August 18,
1998 and the payment date is September 4, 1998. The Common Stock will begin
trading giving effect to the Stock Split on September 8, 1998. If the stock
split had been effected on January 1, 1997, net loss per common share for the
three months ended June 30, 1998 and 1997 would have been $(0.10) and $(0.05),
respectively and $(0.35) and $(0.09) for the six months ended June 30, 1998 and
1997, respectively.
10
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This quarterly report on Form 10-Q contains certain forward-looking
statements that involve risks and uncertainties. In addition, members of the
Company's senior management may, from time to time, make certain forward-looking
statements concerning the Company's operations, performance and other
developments. The Company's actual results could differ materially from those
anticipated in such forward-looking statements as a result of various factors.
The following analysis should be read in conjunction with the Annual Report of
Form 10-K and financial statements and the notes thereto appearing elsewhere in
this report. The Company has included EBITDA data in the following analysis
because it is a measure commonly used in the Company's industry. EBITDA
represents earnings before extraordinary item, net interest, other income
(expense), preacquisition loss, equity in losses of unconsolidated subsidiary,
income taxes, depreciation and amortization. EBITDA is not a measure of
financial performance under generally accepted accounting principles and should
not be considered an alternative to net income as a measure of performance or to
cash flows as a measure of liquidity. EBITDA is not necessarily comparable with
similarly titled measures for other companies.
See the notes to the unaudited, consolidated financial statements appearing
elsewhere in this report for definitions of certain terms used in the following
analysis.
OVERVIEW
The Company provides integrated voice and data telecommunications services
to mid-size 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, the Company
owns, operates and manages an extensive fiber optic network in the southern
United States. The Company had revenues of $40.9 million and $27.9 million for
the three months ended June 30, 1998 and 1997, respectively, and $77.5 million
and $53.4 million for the six months ended June 30, 1998 and 1997, respectively.
The Company provides wholesale long-haul services (the "Carriers' Carrier
Services") to other telecommunications carriers, including AT&T, MCI, Sprint,
WorldCom, Cable & Wireless, LCI, Frontier and IXC. The Company's Carriers'
Carrier Services business generated revenues of $12.3 million and $7.6 million
for the three months ended June 30, 1998 and 1997, respectively, and $23.4
million and $13.4 million for the six months ended June 30, 1998 and 1997,
respectively.
The Company also provides integrated retail telecommunications services to
mid-sized and major regional businesses in a bundled package tailored to the
business customer's specific needs. These services (the "Retail Services")
include local exchange services, long distance services, 800/888 calling,
calling card and operator services, Asynchronous Transfer Mode ("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 sale, installation and repair. As of June 30, 1998, the Company
provided Retail Services to over 9,600 business customers in 19 metropolitan
areas and had sold approximately 23,200 access lines, of which approximately
17,800 had been installed. As part of its strategy to continue to grow its
Retail Services business, the Company plans to open branch offices in Texas and
expand its Internet Service Provider ("ISP") local telecommunications services.
The Company intends to provide a full range of Retail Services in a total of
approximately 40 metropolitan areas throughout the southern United States over
the next five years. The Company's Retail Services business generated revenue
of $28.6 million and $20.4 million for the three months ended June 30, 1998 and
1997, respectively, and $54.2 million and $39.9 million for the six months ended
June 30, 1998 and 1997, respectively.
The Company's fiber optic network reaches over 60 points of presence
("POPs") in ten southern states (Alabama, Arkansas, Florida, Georgia, Louisiana,
Mississippi, North Carolina, South Carolina, Tennessee and Texas) and extends
approximately 7,000 route miles, of which approximately 3,800 miles
11
<PAGE>
are Company-owned and approximately 3,200 miles are owned and operated
principally by three public utilities (Duke Power Company, Florida Power & Light
Company and Entergy Technology Company) and managed and marketed by the Company.
The Company expects to add approximately 1,200 owned and operated route miles to
its fiber network by the end of the second quarter of 1999 through a combination
of construction and long-term dark fiber leases. The Company's network includes
three Nortel DMS-500 and one Nortel DMS-250 voice switches, ten Cascade 9000
frame relay switches and four ATM switches.
During the three months ended June 30, 1998, the Company's operational
highlights included the following: (i) installation of four additional access
nodes, raising the total number of operational BellSouth collocations to eight,
(ii) expansion of its network infrastructure with the installation of its Ocala,
Florida, DMS500 switch and added two ATM switches and three frame relay switches
to its existing network, (iii) completion of the acquisition of certain assets
of IT Group Communications by issuing 88,553 shares of common stock and assuming
liabilities of approximately $1.2 million, and (iv) opening of a new branch
office in Anniston, Alabama, bringing the total number of markets served to 19
with 20 branch office locations.
In July, the Company also announced two new growth initiatives. First, the
Company plans to expand its existing fiber optic network and retail services
market presence in Texas. The new expansion is expected to include Austin and
San Antonio, extending the current network westward from Dallas and Houston.
This network addition is expected to include two DMS500 voice switches and
additional ATM and frame relay switches. The Company intends to expand its
market plan to include branch offices in Dallas, Houston, San Antonio, and
Austin by year-end 1999. The Company expects to make capital expenditures of
approximately $40.0 million associated with this expansion, most of which are
expected to be incurred in 1999.
The second growth initiative is the expansion of an important local product
focused on the Internet Service Provider (ISP) market segment. The Company is
offering local service to ISPs via PRI (Primary Rate Interface) connectivity,
including the collocation of the ISPs' terminal equipment such as modems,
routers, and/or network servers. This service offering will continue to be
phased in during the remainder of 1998 through 1999 at selected switch locations
as physical space, power, switch capacity and personnel levels are increased for
this purpose. The Company expects to make capital expenditures of approximately
$18.0 million associated with this expansion, most of which are expected to be
incurred during the remainder of 1998 and throughout 1999.
Due to the estimated time required for completion of the facilities
necessary for the roll-out of these two initiatives, the Company does not expect
these initiatives to have a positive impact on revenues, EBITDA, and EBITDA as a
percentage of revenue before at least 2000 for the ISP initiative and 2001 for
the Texas initiative.
QUARTERLY STATISTICAL HIGHLIGHTS*
<TABLE>
<CAPTION>
June 30, March 31, December 31,
1998 1998 1997
--------- ---------- -------------
<S> <C> <C> <C>
STATISTICAL DATA:
Cumulative markets 19 16 15
Business customers served -
Retail Services 9,600 8,100 7,700
Route miles 7,000 6,800 6,300
Collocations 8 4 0
Voice switches 4 3 2
ATM switches 4 2 0
Frame relay switches 10 7 6
Number of employees 870 740 650
Lines sold cumulative 23,200 16,000 8,700
Lines installed cumulative 17,800 10,800 3,450
Lines installed/Lines sold percentage 77% 67% 40%
*Data rounded except as to markets, collocations and switches.
</TABLE>
12
<PAGE>
Pursuant to its interconnection agreement (the "Interconnection Agreement")
with BellSouth Telecommunications, Inc. ("BellSouth"), the Company continued to
bill BellSouth for reciprocal interconnection charges related to the provision
by the Company of facilities-based local exchange services during the second
quarter of 1998. The majority of such charges are attributable to call
terminations by the Company to customers that are Internet service providers.
BellSouth has stated that it views termination to such Internet service
providers as not included under the reciprocal charge arrangements set forth in
the Interconnection Agreement, and is expected to refuse to pay compensation for
such terminations either to the Company or to other competitive local exchange
carriers ("CLECs") operating under similar interconnection agreements. The
Alabama PUC, in response to a request from the Company, has scheduled a hearing
for September 3, 1998 at which the issue to be reviewed is the failure by
BellSouth to pay the disputed charges. This same issue is a matter of dispute
between incumbent local exchange carriers ("ILECs") and CLECs across the
country. In view of BellSouth's stated position that such charges with respect
to ISPs are excluded from the reciprocal charge arrangements set forth in the
Interconnection Agreement, and the fact that the ultimate outcome of this
controversy before the state regulatory authorities and in the courts is
uncertain, the Company does not record any revenue for these charges until
received and reserves directly against the amounts billed to BellSouth. For the
three and six months ended June 30, 1998, such charges to BellSouth amounted to
approximately $1.74 million and $2.52 million, respectively. During July, the
Company received notice and subsequent payment from BellSouth of an amount equal
to approximately 10% of the total cumulative local interconnection billings of
approximately $2.52 million. The 10% payment reflects BellSouth's estimate of
the local minutes terminated to the Company exclusive of any minutes related to
traffic terminated to an Internet service provider. Accordingly, the Company
recognized approximately $252,000 in operating revenues during the second
quarter of 1998 and continued to reserve against the remaining $2.3 million of
cumulative local interconnection billings. The Company believes its position
with respect to the remaining $2.3 million of billings is supported by the terms
of the Interconnection Agreement, as do other CLECs who are strongly contesting
ILEC refusals to pay compensation in these circumstances. Many regulatory
authorities that have addressed the issue have ruled in favor of CLECs, but the
issue generally remains under appeal in those circumstances. Most of the state
regulatory authorities in the Company's markets have not yet formally ruled on
this issue. Although the provision of facilities-based local services involves
high fixed costs, associated variable costs are generally low. Consequently, a
resolution of the controversy with respect to payment of such charges by
BellSouth in favor of the Company could have a positive impact on both gross
margin and EBITDA for the remainder of 1998. Assuming current levels of such
local minutes continue or increase, the Company expects such charges to
BellSouth to be at least $2 million during each of the third and fourth quarters
of 1998. The Company has filed a formal complaint with the Public Service
Commission of Alabama demanding payment of these monies from BellSouth under its
interconnection agreement and is reviewing all potential remedies and claims in
remaining jurisdictions. The Interconnection Agreement expires, however, on
July 1, 1999, and by its terms, provides that the parties are to begin to
negotiate renewal terms by July 1, 1998. Although very preliminary discussions
have taken place between the parties, there can be no assurance that the
Interconnection Agreement will be renewed on the same terms with respect to the
disputed charges, or at all. Therefore, even if the controversy regarding such
charges is resolved in favor of the Company under the current Interconnection
Agreement, there can be no assurance that any positive effect on the Company's
financial position will continue beyond July 1, 1999.
HISTORICAL RESULTS OF OPERATIONS
The following tables set forth certain historical data for the three
and six month periods ended June 30, 1998 and the three and six month periods
ended June 30, 1997 for the Carriers' Carrier Services business and the Retail
Services business.
The comparability of the historical financial data set forth below for
the three and six months ended June 30, 1998 and 1997 has been affected by the
Gulf States Acquisition completed on March 27, 1997. Due to the Gulf States
Acquisition, the results of operations for the three and six months ended June
30, 1997 reflect the total revenues and expenses from January 1, 1997
attributable to Gulf States
13
<PAGE>
FiberNet with the preacquisition loss attributable to the previous owner from
January 1, 1997 through March 27, 1997, deducted to determine the Company's
consolidated net loss.
<TABLE>
<CAPTION>
CARRIERS' CARRIER SERVICES
-------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1998 % 1997 % 1998 % 1997 %
------------- --------- ------------ ---- ------------ ----- ----------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $12,258,236 100% $ 7,560,592 100% $23,370,176 100% $13,444,647 100%
Cost of services 1,823,291 15% 870,663 12% 3,034,692 13% 1,774,736 13%
----------- ---- ----------- --- ----------- ---- ----------- ---
Gross margin 10,434,945 85% 6,689,929 88% 20,335,484 87% 11,669,911 87%
----------- ---- ----------- --- ----------- ---- ----------- ---
Operating expenses:
Selling, operations
and administration 3,557,601 29% 2,066,449 27% 7,069,917 30% 3,790,864 28%
Depreciation and
amortization 4,604,619 38% 2,959,950 39% 8,711,136 37% 5,315,500 40%
----------- ---- ----------- --- ----------- ---- ----------- ---
Total operating expenses 8,162,220 67% 5,026,399 66% 15,781,053 67% 9,106,364 68%
----------- ---- ----------- --- ----------- ---- ----------- ---
Operating income $ 2,272,725 18% $ 1,663,530 22% $ 4,554,431 20% $ 2,563,547 19%
=========== ==== =========== === =========== ==== =========== ===
</TABLE>
<TABLE>
<CAPTION>
RETAIL SERVICES
------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1998 % 1997 % 1998 % 1997 %
----------- ---- ----------- --- ----------- ---- ----------- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $28,593,540 100% $20,381,891 100% $54,176,102 100% $39,920,414 100%
Cost of services 17,437,203 61% 12,234,763 60% 33,099,343 61% 23,528,011 59%
----------- ---- ----------- --- ----------- ---- ----------- ---
Gross margin 11,156,337 39% 8,147,128 40% 21,076,759 39% 16,392,403 41%
----------- ---- ----------- --- ----------- ---- ----------- ---
Operating expenses:
Selling, operations
and administration 11,913,458 42% 7,006,031 34% 21,968,100 41% 13,170,460 33%
Depreciation and
amortization 2,297,003 8% 1,470,593 7% 4,490,763 8% 2,957,732 7%
----------- ---- ----------- --- ----------- ---- ----------- ---
Total operating
expenses 14,210,461 50% 8,476,624 41% 26,458,863 49% 16,128,192 40%
----------- ---- ----------- --- ----------- ---- ----------- ---
Operating income(loss) $(3,054,124) (11)% $ (329,496) (1)% $(5,382,104) (10)% $ 264,211 1%
=========== ==== =========== === =========== ==== =========== ===
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1997
Revenues
Total revenue increased $13.0 million (46.6%), from $27.9 million for
the three months ended June 30, 1997, to $40.9 million for the three months
ended June 30, 1998. Revenues from Retail Services increased $8.2 million
(40.2%) , from $20.4 million for the three months ended June 30, 1997 to $28.6
million for the three months ended June 30, 1998. This increase in Retail
Services revenue was attributable to an increase in business customers from
approximately 6,600 as of June 30, 1997 to over 9,600 as of June 30, 1998,
continued geographic and product expansion, growth in local lines in service,
14
<PAGE>
growth in long distance minutes of use and stability in the rate of revenue loss
from lost customers from period to period. Additionally, revenues attributable
to the IT Group Communications assets amounted to approximately $500,000 during
the three months ended June 30, 1998. Revenues from Carriers' Carrier Services
increased $4.7 million (61.8%), from $7.6 million for the three months ended
June 30, 1997 to $12.3 million for the three months ended June 30, 1998. This
increase was attributable to increasing demand for bandwidth and continued
expansion of the owned and operated portion of the Company's fiber optic
network.
Cost of Services
Total cost of services increased $6.2 million, from $13.1 million for
the three months ended June 30, 1997 to $19.3 million for the three months ended
June 30, 1998. Cost of services for Retail Services increased $5.2 million,
from $12.2 million for the three months ended June 30, 1997 to $17.4 million for
the three months ended June 30, 1998. Cost of services as a percentage of
revenue for Retail Services totaled 61% for the three months ended June 30,
1998, compared to 60% for the three months ended June 30, 1997. Cost of
services for Retail Services increased primarily because of continued expansion
of local exchange services, which have a lower margin, and costs associated with
the geographic expansion of facilities for the provision of such services. Cost
of services attributable to Carriers' Carrier Services increased $0.9 million,
from $0.9 million for the three months ended June 30, 1997 to $1.8 million for
the three months ended June 30, 1998. Cost of services as a percentage of
revenue for Carriers' Carrier Services increased to 15% for the three months
ended June 30, 1998 from 12% for the three months ended June 30, 1997. The
increase in cost of services as a percentage of revenue for the Carriers'
Carrier Services was attributable mainly to the Company's acceptance of fibers
under a long-term dark fiber lease for a route from Dallas to Longview, Texas.
The Company expects this negative effect to be offset as new customers are added
on this route and certain off-net leases on this route expire or are terminated.
Selling, Operations and Administration Expense
Total selling, operations and administration expense increased $6.4
million, from $9.1 million (32.6% as a percentage of revenue) for the three
months ended June 30, 1997 to $15.5 million (37.9% as a percentage of revenue)
for the three months ended June 30, 1998. Selling, operations and
administration expense attributable to Retail Services increased $4.9 million,
from $7.0 million (34% as a percentage of revenue) for the three months ended
June 30, 1997 to $11.9 million (42% as a percentage of revenue) for the three
months ended June 30, 1998. This increase resulted from employment of
additional sales, information services and provisioning personnel to support the
Company's continued geographical market and product expansion. Selling,
operations and administration expense attributable to Carriers' Carrier Services
increased $1.5 million, from $2.1 million (27% as a percentage of revenue) for
the three months ended June 30, 1997 to $3.6 million (29% as a percentage of
revenue) for the three months ended June 30, 1998. This increase in selling,
operations and administration expense resulted from additions to personnel as
the Company expanded its existing fiber optic network. The Company expects
selling, operations and administration expense to continue to increase as a
percentage of revenue through the end of 1999 as new offices are opened and the
Company continues to expand its products, markets and fiber optic network and
adds personnel.
Depreciation and Amortization
Total depreciation and amortization expense increased $2.5 million,
from $4.4 million for the three months ended June 30, 1997 to $6.9 million for
the three months ended June 30, 1998. Retail Services accounted for $800,000 of
the increase, which was primarily related to installation of new equipment.
Carriers' Carrier Services operations accounted for $1.7 million of the
increase, which was primarily due to the continued expansion of the fiber optic
network operations. The Company expects depreciation and amortization to
continue to increase during the remainder of 1998 and through 1999 as the
Company adds new facilities to its existing network and expands into new
markets.
15
<PAGE>
Interest Expense
Total interest expense increased $3.0 million, from $4.9 million for
the three months ended June 30, 1997 to $7.9 million for the three months ended
June 30, 1998. The $3.0 million increase in interest expense is attributable to
the interest payments on the 11% Senior Notes and the 8 7/8% Senior Notes.
Interest Income
Total interest and other income increased $1.7 million, from $0.8
million for the three months ended June 30, 1997 to $2.5 million for the three
months ended June 30, 1998 as a result of the investment of excess cash
balances.
Other Income (Expense)
In March 1998, the Company changed the accounting for its interest
rate swap agreement from a hedge of an anticipated transaction to a trading
security resulting in a loss charged against earnings of approximately $2.5
million. This change in classification required the Company to record the
payable related to the interest rate swap agreement on the consolidated balance
sheet at fair market value at the time of receipt of the proceeds from the 1998
Senior Notes Offering. The interest rate swap agreement was marked to market at
March 31, 1998 resulting in income of approximately $200,000 and will continue
to be marked to market on a monthly basis. For the three months ended June 30,
1998, the Company recognized approximately $65,000 in income from the mark-to-
market of the interest rate swap.
EBITDA
EBITDA increased $300,000, from $5.8 million for the three months
ended June 30, 1997 to $6.1 million for the three months ended June 30, 1998.
EBITDA attributable to Carriers' Carrier Services increased $2.3 million for the
three months ended June 30, 1998 compared to the three months ended June 30,
1997. EBITDA attributable to Retail Services was $(0.8) million for the three
months ended June 30, 1998 compared to $1.1 million for the three months ended
June 30, 1997. EBITDA attributable to Retail Services decreased from 5.6% of
revenues for the three months ended June 30, 1997 to (2.6)% for the three months
ended June 30, 1998, primarily due to increased costs associated with the
expansion of new sales offices and the employment of additional support
personnel to position this segment for growth and expansion. The Company expects
a continued decrease in EBITDA for the Retail Services business through the
remainder of 1998 and 1999 as the Company continues to position itself for
future operations by expanding its products and markets.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997
Revenues
Total revenue increased $24.1 million (45.1%), from $53.4 million for
the six months ended June 30, 1997 to $77.5 million for the six months ended
June 30, 1998. Revenues from Retail Services increased $14.3 million (35.8%),
from $39.9 million for the six months ended June 30, 1997 to $54.2 million for
the six months ended June 30, 1998. This increase was attributable to an
increase in business customers from approximately 6,600 as of June 30, 1997 to
over 9,600 as of June 30, 1998, continued geographic and product expansion,
growth in local lines in service, growth in long distance minutes of use and
stability in the rate of revenue loss from lost customers from period to period.
Additionally, revenues attributable to the IT Group Communications assets
amounted to approximately $500,000 during the six months ended June 30, 1998.
Revenues from Carriers' Carrier Services increased $10.0 million (74.6%), from
$13.4 million for the six months ended June 30, 1997 to $23.4 million for the
six months ended June 30, 1998. This increase was attributable to increasing
demand for bandwidth and continued owned and operated route expansions.
16
<PAGE>
Cost of Services
Total cost of services increased $10.8 million, from $25.3 for the six
months ended June 30, 1997 to $36.1 million for the six months ended June 30,
1998. Cost of services for Retail Services increased $9.6 million, from $23.5
million for the six months ended June 30, 1997 to $33.1 million for the six
months ended June 30, 1998. Cost of services as a percentage of revenue for
Retail Services increased slightly to 61% for the six months ended June 30, 1998
from 59% for the six months ended June 30, 1997. Cost of services for Retail
Services increased because of continued expansion of local exchange services,
which have a lower margin, and costs associated with the geographic expansion of
facilities for the provision of such services. Cost of services attributable to
Carriers' Carrier Services increased $1.2 million, from $1.8 million for the six
months ended June 30, 1997 to $3.0 million for the six months ended June 30,
1998. The increase in cost of services for the Carriers' Carrier Services was
primarily attributable to costs associated with the expansion of the existing
network from 6,300 owned and operated and managed, monitored and marketed route
miles to approximately 7,000 owned and operated and managed, monitored and
marketed route miles. Cost of services as a percentage of revenue for Carriers'
Carrier Services remained unchanged at 13% for the six months ended June 30,
1998 and June 30, 1997.
Selling, Operations and Administration Expense
Total selling, operations and administration expense increased $12.0
million, from $17.0 million (31.8% as a percentage of revenue) for the six
months ended June 30, 1997 to $29.0 million (37.4% as a percentage of revenue)
for the six months ended June 30, 1998. Selling, operations and administration
expense attributable to Retail Services increased $8.8 million, from $13.2
million for the six months ended June 30, 1997 to $22.0 million for the six
months ended June 30, 1998, which represented an increase from 33% to 41% as a
percentage of revenue. This increase resulted from employment of additional
sales, information services and provisioning personnel to support the Company's
continued geographical market and product expansion. Selling, operations and
administration expense attributable to Carriers' Carrier Services increased $3.3
million, from $3.8 million for the six months ended June 30, 1997 to $7.1
million for the six months ended June 30, 1998, representing an increase from
28% to 30% as a percentage of revenue. The increase in selling, operations and
administration expenses for the Carriers' Carrier Services was due to the hiring
of additional personnel to facilitate the Company's expansion of its existing
fiber optic network. The Company expects selling, operations and administration
expense to continue to increase as a percentage of revenue through the end of
1999 as new offices are opened and the Company continues to expand its products,
markets and fiber optic network and adds new personnel.
Depreciation and Amortization
Total depreciation and amortization expense increased $4.9 million,
from $8.3 million for the six months ended June 30, 1997 to $13.2 million for
the six months ended June 30, 1998. Retail Services accounted for $1.5 million
of the increase, which was primarily related to installation of new telephony
and office equipment. Carriers' Carrier Services accounted for $3.4 million of
the increase, which was primarily due to the continued expansion of the fiber
optic network operations. The Company expects depreciation and amortization
expense to continue to increase through the remainder of 1998 and through 1999
as new facilities are added and the fiber optic network is expanded.
Interest Expense
Total interest expense increased $7.8 million, from $7.6 million for
the six months ended June 30, 1997 to $15.4 million for the six months ended
June 30, 1998. The $7.8 million increase was attributable to interest payments
on the 11% Senior Notes and the 8 7/8% Senior Notes.
17
<PAGE>
Interest Income
Total interest and other income increased $4.5 million, from $0.9
million for the six months ended June 30, 1997 to $5.4 million for the six
months ended June 30, 1998 as a result of the investment of excess cash
balances.
Other Income (Expense)
In March 1998, the Company changed the accounting for its interest
rate swap agreement from a hedge of an anticipated transaction to a trading
security resulting in a loss charged against earnings of approximately $2.5
million. This change in classification required the Company to record the
payable related to the interest rate swap agreement on the consolidated balance
sheet at fair market value at the time of receipt of the proceeds from the 1998
Senior Notes Offering. The interest rate swap agreement was marked to market at
June 30, 1998 resulting in income of approximately $265,000 for the six month
period ending June 30, 1998, and will continue to be marked to market on a
monthly basis.
Extraordinary Loss
The Company incurred a pre-tax extraordinary loss of $10.6 million
($8.4 million after tax) related to the redemption of $70 million of the 11%
Senior Notes consisting of $7.7 million redemption premium and a $2.9 million
write-off of related debt-issuance costs during the six months ended June 30,
1998.
EBITDA
EBITDA increased $1.3 million, from $11.1 million for the six months
ended June 30, 1997 to $12.4 million for the six months ended June 30, 1998.
EBITDA attributable to Carriers' Carrier Services increased $5.4 million for the
six months ended June 30, 1998 compared to six months ended June 30, 1997.
EBITDA attributable to Retail Services decreased from 8.0% of revenues for the
six months ended June 30, 1997 to (1.6)% of revenues for the six months ended
June 30, 1998, primarily due to increased costs associated with the expansion of
new sales offices and the employment of additional support personnel to position
this segment for growth and expansion. The Company expects that EBITDA for
Retail Services will continue to decline through the remainder of 1998 and 1999
as the Company opens additional sales offices, expands its product offerings and
continues its geographic expansion of its fiber optic network.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated net cash from operating activities of $4.9
million and $9.4 million for the six months ended June 30, 1998 and 1997,
respectively. The components of cash flows from operations (consisting of net
loss adjusted for depreciation, amortization, deferred income taxes, equity in
losses of investee, preacquisition loss, extraordinary item-loss on
extinguishment of debt and other) totaled $.1 million for the six months ended
June 30, 1998, compared to $5.7 million for the six months ended June 30, 1997.
Changes in working capital provided $4.7 million for the six months ended June
30, 1998, resulting primarily from increases in accrued interest, unearned
revenue, other accrued liabilities and a decrease in income tax refund
receivable offset by increases in accounts receivable, inventory and prepaid
expenses and a decrease in accounts payable. Changes in working capital provided
$3.7 million for the six months ended June 30, 1997, primarily due to increases
in unearned revenue, accrued liabilities and income tax refunds receivable,
offset by increases in accounts receivable.
Cash used for investing activities was $25.6 million and $11.8 million
for the six months ended June 30, 1998 and 1997, respectively. The Company made
capital expenditures of $49.3 million and $12.4 million for the six months ended
June 30, 1998 and 1997, respectively. Of the $49.3 million of capital
expenditures for the six months ended June 30, 1998, $19.7 million related to
Carriers' Carrier Services and $29.6 million related to Retail Services. The
significant increase in cash used in investing activities between the six months
ended June 30, 1998 and 1997 is attributable to the Company's execution of its
business plan as it expands its existing network and facilities. The Company
expects its cash flows used
18
<PAGE>
in investing activities to continue to increase as the Company goes forward with
its business plan and implements its new initiatives.
Cash provided by financing activities was $77.4 million and $201.3
million for the six months ended June 30, 1998 and 1997, respectively. Cash
provided by financing activities for the six months ended June 30, 1998
consisted primarily of net proceeds of $155.2 million from the sale of the 8
7/8% Senior Notes, less $70.0 million repayment of principal on the 11% Senior
Notes and $7.7 million premium payment on the early extinguishment of debt, net
repayments of other long term debt, proceeds from the issuance of common stock
pursuant to option exercise and other financing activities of $0.1 million.
Cash provided by financing activities for the six months ended June 30, 1997
consisted primarily of net proceeds of $194.3 million from the sale of the 11%
Senior Notes, $8.2 million of advances received from ITC Holding, less $0.7
million return of capital to ITC Holding and $0.5 million of other cash used in
financing activities.
The Company used the net proceeds from the sale of the 8-7/8% Senior
Notes (i) to replace portions of the proceeds from the Company's initial public
offering in October 1997 which the Company used in April 1998 to redeem $70
million principal amount of its 11% Senior Notes, at a redemption price of 111%,
(ii) to fund continued market and fiber optic network expansion, and (iii) to
replace funds that would have otherwise been available under the Company's
secured credit facility, which has been modified to, among other things, reduce
available borrowings thereunder from $100 million to $50 million.
On May 20, 1998, the Company completed its acquisition of certain
assets and liabilities of IT Group Communications, a Jackson, Mississippi-based
long distance carrier. The Company issued 88,553 shares of common stock and
assumed liabilities of approximately $1.2 million to consummate the transaction.
The Company acquired approximately 900 customers, predominately located in
Mississippi, and an important network point of presence in Jackson, Mississippi.
At June 30, 1998, the Company had entered into agreements with vendors
to purchase approximately $33.4 million of equipment and services, and for the
six months ended June 30, 1998, had made capital expenditures of $49.3 million.
The Company currently estimates that its capital expenditures will total
approximately $215.0 million in 1998 and 1999, of which a total of approximately
$115.0 million is expected to be incurred in 1998 (inclusive of the $33.4
million in commitments as of June 30, 1998) and approximately $100.0 million is
expected to be incurred in 1999. The Company expects to make substantial
expenditures thereafter. Capital expenditures will be primarily for the
following: (i) continued development and construction of its fiber optic
network (including transmission equipment); (ii) continued addition of
facilities-based local telephone service to its bundle of integrated
telecommunications services, including acquisition and installation of switches
and related equipment; (iii) the addition of switching capacity, electrical
equipment and additional collocation space in connection with the expansion of
the Company's ISP local telecommunications services; (iv) market expansion; and
(v) infrastructure enhancements, principally for information systems. The
actual amount and timing of the Company's capital requirements may differ
materially from the foregoing estimate as a result of regulatory, technological
and competitive developments (including market developments and new
opportunities) in the Company's industry.
The Company may require additional capital to fund its growth, as well
as to fund continued operating losses and working capital. The Company believes
that cash on hand, cash flow from operations and available borrowings under the
Company's secured revolving credit facility (the "Credit Facility"), will
provide sufficient funds to enable the Company to expand its business as
currently planned through 2000, after which the Company will need to seek
additional financing to fund capital expenditures and working capital. Because
the Credit Facility will mature in 2003, the Company may not have a ready source
of liquidity after the maturity of the Credit Facility in 2003. In the event
that the Company's plans or assumptions change or prove to be inaccurate, the
foregoing sources of funds may prove to be insufficient to fund the Company's
currently planned growth and operations. In addition, if the Company
successfully completes any acquisitions, the Company may be required to seek
additional capital sooner than currently anticipated. Additional sources may
include equity and debt financing and other financing agreements, such as vendor
financing. There can be no assurance that the Company will be able to generate
sufficient cash flow from operations or that additional financing arrangements
will be available, or if available, that
19
<PAGE>
they can be concluded on terms acceptable to the Company. Inability to generate
or obtain sufficient funds would result in delay or abandonment of some or all
of the Company's development and expansion plans, which could have a material
adverse effect on the Company.
Although the Company's liquidity has improved, the Company's level of
indebtedness and debt service obligations significantly increased as a result of
the Company's issuance of the 11% Senior Notes and the 8-7/8% Senior Notes. The
successful implementation of the Company's strategy, including expansion of its
network and obtaining and retaining a significant number of customers, and
significant and sustained growth in the Company's cash flow are necessary for
the Company to be able to meet its debt service requirements. There can be no
assurance that the Company will successfully implement its strategy or that the
Company will be able to generate sufficient cash flow from operating activities
to improve its earnings before fixed charges, or to meet its debt service
obligations and working capital requirements. The ability of the Company to meet
its obligations will be dependent upon the future performance of the Company,
which will be subject to prevailing economic conditions and to financial,
business and other factors.
The Year 2000 Issue. The Year 2000 issue is the result of computer
programs using two digits rather than four to define the applicable year.
Because of this programming convention, software, hardware or firmware may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in system failures, miscalculations or errors causing disruptions
of operations or other business problems, including, among others, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company's Program. The Company has undertaken a comprehensive program
---------------------
to address the Year 2000 issue with respect to the following: (i) the Company's
information technology and operating systems (including network switching,
customer service, call detail and billing systems), (ii) the Company's non-
information technology systems (such as buildings, plant, equipment and other
infrastructure systems that may contain embedded microcontroller technology);
(iii) the systems of its major vendors, third party network service providers
and other material service providers (insofar as they relate to the Company's
business); and (iv) the Company's major Carrier's Carrier and Retail Services
customers. As explained below, the program involves (i) a wide-ranging
assessment of the Year 2000 problems that may affect the Company, (ii) the
development of remedies to address the problems discovered in the assessment
phase, (iii) testing of the remedies, and (iv) the preparation of contingency
plans to deal with worst case scenarios.
Assessment Phase. As part of the assessment phase of this program, the
----------------
Company has identified substantially all of the major components of the systems
described above. In order to determine the extent to which such systems are
vulnerable to the Year 2000 issue, the Company evaluated its internally
developed software applications. In addition, the Company sent letters
to substantially all of its significant hardware, software and other equipment
vendors, third party network service providers, other material service providers
and material customers, requesting detailed, written information related to Year
2000 compliance. The Company has not yet sent such inquiries to the electric
utilities or insurance companies that provide services to the Company, but
intends to do so during the third quarter of 1998.
To date, the Company has received and analyzed responses from a substantial
majority of its major vendors and service providers (other than the major
third party network service providers, from which responses are expected). The
Company has also received responses from approximately one fifth of its
customers to which inquiries were sent, which includes its major Carrier's
Carrier and Retail Services customers. Based upon the responses received to
date, and assuming contradictory responses are not received in the future from
the third parties who have been solicited, the Company believes that its Nortel
and Ascend system switches either already are Year 2000 compliant or will be by
end of 1998, as are the computer operating systems dedicated to the Company's
customer service, call detail records and billing systems. The Company is in the
process of investigating, and intends to closely monitor, the Year 2000
readiness of the three public utilities that own and operate approximately
3,200 miles of the Company's approximately 7,000-mile fiber optic network.
One of these utilities has indicated that it intends to be Year 2000 compliant
by year-end, one has stated that it is addressing the issue and one has not yet
responded. The Company has been informed by the financial institutions that
provide services to the Company that they each have undertaken Year 2000
programs and expect to be Year 2000 compliant. The Company's two largest
Carrier's Carrier customers, which together represented approximately 11.0% of
the Company's consolidated revenues for the six months ended June 30, 1998, have
responded that they are on target to be compliant by the end of 1998 in one
case, and the second
20
<PAGE>
quarter of 1999 in the, and intends to closely monitor, other. Of the Company's
five largest Retail Services customers, which represented an aggregate of
approximately 11.4% of the Company's consolidated revenues for the six months
ended June 30, 1998, four have either informed the Company or made public
disclosures to the effect that they have undertaken Year 2000 compliance
programs. In addition, the Company has begun to follow up with respect to those
entities that have not yet responded to the Company's Year 2000 inquiries.
Remediation and Testing Phase. Based upon the results to date of the
-----------------------------
Company's assessment efforts, the Company has begun its remediation and testing
phase. The activities conducted during this phase are intended to affirmatively
address potential Year 2000 problems in the Company-developed computer software
in its information technology and non-information technology systems and then
demonstrate that this software will be made Year 2000 compliant on a timely
basis. In this phase, the Company first evaluates a program application and, if
a potential Year 2000 problem is identified, steps are taken to remediate the
problem and the application is then individually tested to confirm that the
remediating changes are effective and have not adversely affected the
of that application. Similar remediation and testing are being undertaken
functionality with respect to the hardware and other equipment that runs or is
run by the software. After the individual applications and system components
have been remediated and tested, integrated testing will be conducted
to demonstrate functional integrated systems operation. The Company intends to
complete this phase by the second quarter of 1999. After the Company completes
its internal, integrated systems testing, it intends to conduct laboratory-
simulated integrated systems testing in an effort to demonstrate Year 2000
compliance of the Company's systems as they interface with external systems and
equipment of major vendors, third party network providers, other material
service providers and customers.
Contingency Plans. The Company has begun to develop contingency plans to
-----------------
handle its most reasonably likely worst case Year 2000 scenarios, which have not
yet been identified fully. The Company intends to complete its determination of
worst case scenarios after it has received and analyzed responses to
substantially all of the inquiries it has made. Following that phase, the
Company intends to develop a timetable for completing its contingency plans.
Costs Related to the Year 2000 Issue. To date, the Company has incurred
------------------------------------
approximately $450,000 in costs for its Year 2000 program. The Company
currently estimates that it will incur additional expenses which are not
expected to exceed approximately $1.5 million to complete its Year 2000
compliance work, of which approximately $920,000 are expected to be incurred
during 1998 and approximately $600,000 are expected to be incurred during 1999.
These costs, which may vary from the estimates, have been, and will continue to
be, expensed as incurred.
Risks Related to the Year 2000 Issue. Although the Company's Year 2000
------------------------------------
efforts are intended to minimize the adverse effects of the Year 2000 issue on
the Company's business and operations, the actual effects of the issue cannot be
known until the Year 2000. Failure by the Company and/or its major vendors,
third party network service providers, and other material service providers and
customers to adequately address their respective Year 2000 issues in a timely
manner (insofar as they relate to the Company's business) could have a material
adverse effect on the Company's business, results of operations, and financial
condition.
Effects on Accounting Standards
SFAS No. 130, Reporting Comprehensive Income, issued by the Financial
Accounting Standards Board, establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. The Company
adopted SFAS No. 130, effective January 1, 1998, with no material impact on the
consolidated financial statements.
21
<PAGE>
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for the way that public business enterprises
report information about operating segments, in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. SFAS No. 131 also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The Company adopted SFAS No. 131,
effective January 1, 1998, with no material impact on the consolidated financial
statements.
SFAS No. 133, Accounting for Derivative Instruments and for Hedging
Activities, establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. A company may also implement SFAS No. 133 as of the beginning of
any fiscal quarter after June 15, 1998. SFAS No. 133 cannot be applied
retroactively. SFAS No. 133 must be applied to (i) derivative instruments and
(ii) certain derivative instruments embedded in hybrid contracts that were
issued, acquired, or substantively modified after December 31, 1997. The
Company expects to implement SFAS No. 133 for the fiscal year beginning January
1, 2000, and does not expect the adoption of SFAS No. 133 will have a material
affect on its consolidated financial statements.
INFLATION
The Company does not believe that inflation has had a significant impact on
the Company's consolidated operations.
22
<PAGE>
P A R T II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company completed its initial public offering (the "Equity Offering")
of its common stock, $.01 par value (the "Common Stock"), on October 29, 1997.
The registration statement relating to the Equity Offering (File No. 333-31361)
was declared effective by the SEC on October 22, 1997. The managing
underwriters of the Equity Offering were Morgan Stanley & Co. and Wheat, First
Securities, Inc. The number of shares of Common Stock registered and sold in
the Equity Offering was 5,750,000 and the aggregate price of the Equity Offering
amount registered and sold was $94,875,000. All shares were sold by the
Company. Net proceeds from the Equity Offering were approximately $87.5
million.
On April 2, 1998, the Company redeemed $70 million principal amount of its
11% Senior Notes, at a redemption price of 111% plus accrued and unpaid
interest. As required by the terms of the indenture pursuant to which the 11%
Senior Notes were issued, the redemption price was paid with a portion of the
remaining net proceeds from the Equity Offering. The net proceeds from the
Equity Offering not used for the redemption (approximately $10 million) were
temporarily invested in short-term, interest bearing, investment grade
securities.
During the period from April 1, 1998 to June 30, 1998, the Company issued
88,553 shares of its Common Stock in connection with its acquisition of certain
assets of IT Group Communications, a Jackson, Mississippi-based long distance
carrier.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on June 4, 1998.
All of the proposals presented for stockholder consideration at the Annual
Meeting were approved. The following is a tabulation of the voting on each
proposal presented at the Annual Meeting and a listing of the directors whose
term of office as a director continued after the meeting. Each share of Common
Stock voted on the proposals set forth below had one vote per share.
Proposal 1 --- Election of Directors
<TABLE>
<CAPTION>
Term Expires Votes For Votes Against
------------ ---------- -------------
<S> <C> <C> <C>
Elected Director
Donald W. Burton 2001 21,145,824 5,500
Malcolm C. Davenport, V 2001 21,145,824 5,500
William T. Parr 2001 21,145,824 5,500
Continuing Directors
Campbell B. Lanier, III 2000
Andrew M. Walker 2000
Robert A. Dolson 1999
O. Gene Gabbard 1999
William H. Scott 1999
William B. Timmerman 2000
</TABLE>
23
<PAGE>
Proposal 2 --- Ratification of the Appointment of the Company's Independent
Public Accountants
<TABLE>
<S> <C>
Votes For 21,142,599
Votes Against 2,200
Votes Withheld 6,575
Broker Non-Votes
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ITC/\DELTACOM, INC.
------------------
(Registrant)
Date: August 14, 1998 By: /s/ Foster O. McDonald
----------------------
Foster O. McDonald
President
Date: August 14, 1998 By: /s/ Douglas A. Shumate
----------------------
Douglas A. Shumate
Senior Vice President and
Chief Financial Officer
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE UNAUDITED BALANCE SHEET OF ITC/\DELTACOM, INC. AS OF JUNE 30, 1998 AND
THE RELATED UNAUDITED, CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND
SIX MONTHS ENDED JUNE 30, 1998. THIS INFORMATION IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> APR-01-1998 JAN-01-1998
<PERIOD-END> JUN-30-1998 JUN-30-1998
<CASH> 150,990,878 150,990,878
<SECURITIES> 0 0
<RECEIVABLES> 28,259,384 28,259,384
<ALLOWANCES> 1,178,664 1,178,664
<INVENTORY> 1,732,688 1,732,688
<CURRENT-ASSETS> 196,779,118 196,779,118
<PP&E> 213,258,891 213,258,891
<DEPRECIATION> 37,796,368 37,796,368
<TOTAL-ASSETS> 460,219,579 460,219,579
<CURRENT-LIABILITIES> 32,992,167 32,992,167
<BONDS> 292,218,868 292,218,868
0 0
14,808 14,808
<COMMON> 255,846 255,846
<OTHER-SE> 133,916,040 133,916,040
<TOTAL-LIABILITY-AND-EQUITY> 460,219,579 460,219,579
<SALES> 40,851,776 77,546,278
<TOTAL-REVENUES> 40,851,776 77,546,278
<CGS> 19,260,494 36,134,035
<TOTAL-COSTS> 41,653,599 78,414,799
<OTHER-EXPENSES> 0 2,225,209
<LOSS-PROVISION> 219,992 419,237
<INTEREST-EXPENSE> 7,939,478 15,437,900
<INCOME-PRETAX> (6,155,207) (13,177,461)
<INCOME-TAX> (1,307,692) (3,695,259)
<INCOME-CONTINUING> (4,847,515) (9,482,202)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 (8,436,170)
<CHANGES> 0 0
<NET-INCOME> (4,847,515) (17,918,372)
<EPS-PRIMARY> (.19) (.71)
<EPS-DILUTED> (.19) (.71)
</TABLE>