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SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): March 8, 2000
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ITC/\DELTACOM, INC.
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(Exact name of registrant as specified in its charter)
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Delaware 0-23252 58-2301135
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(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
ITC/\DeltaCom, Inc.
1791 O.G. Skinner Drive
West Point, Georgia 31833
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(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (706) 385-8000
__________________________________________________________________________
(Former name or former address, if any changed since last report)
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Item 5. Other Events
ITC/\DeltaCom, Inc. files herewith its audited consolidated financial
statements as of December 31, 1999 and 1998 and for the three years ended
December 31, 1999 and its related Management's Discussion and Analysis of
Financial Condition and Results of Operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Current Report on Form 8-K contains forward-looking statements that
involve risks and uncertainties. In addition, members of ITC/\DeltaCom's
management from time to time, may make forward-looking statements concerning
ITC/\DeltaCom's business, operating results 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 in this Current Report on Form 8-K, as well as factors which may be
identified from time to time in ITC/\DeltaCom's other filings with the
Securities and Exchange Commission.
ITC/\DeltaCom has included data with respect to EBITDA, as adjusted, in the
following analysis because it is a measure commonly used in our industry.
EBITDA, as adjusted, represents earnings before extraordinary item, net
interest, other income (expense), income taxes, and depreciation and
amortization. EBITDA, as adjusted, 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 flow as a
measure of liquidity. EBITDA, as adjusted, is not necessarily comparable with
similarly titled measures for other companies.
Unless the context indicates otherwise, references in this Current Report
on Form 8-K to "ITC/\DeltaCom" and "we" 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.
OVERVIEW
We are a full service provider of integrated voice and data
telecommunications services on a retail basis to mid-size and major regional
businesses in the southern United States and a leading regional provider of
wholesale long-haul services to other telecommunications companies. In
connection with these businesses, we own, operate and manage an extensive fiber
optic network in the southern United States. We had revenues of $244.8 million,
$171.8 million and $114.6 million for the years ended December 31, 1999, 1998
and 1997, respectively.
We provide our wholesale long-haul services, which we refer to as our
"carriers' carrier services," to other telecommunications carriers, including,
among others, AT&T, Sprint, MCI WorldCom, Qwest, Cable & Wireless, and
Broadwing. During 1999, we extended our fiber network approximately 450 route
miles to approximately 8,250 route miles, consisting of approximately 4,550
owned miles and approximately 3,700 managed, monitored and marketed miles. Our
carriers' carrier services business generated revenues of $72.9 million, $51.9
million and $31.0 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
We are also a full service provider of integrated retail telecommunications
services, which we refer to as our "retail services," to mid-sized and major
regional businesses in the southern United States. We offer our retail services
in a bundled package tailored to the business customer's specific needs. These
retail services include:
. local exchange services;
. long distance services;
. calling card and operator services;
. Asynchronous Transfer Mode, or "ATM," frame relay and high capacity
broadband private line services;
. Internet, Intranet and Web page hosting services;
. primary rate interface connectivity and collocation services to
Internet service providers;
. customer premise equipment sale, installation and repair;
. enhanced services, including conference calling, fax broadcasting and
pre-paid calling cards;
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. consulting, integration, operation and proactive management of data
networks; and
. in-depth network performance analysis and implementation and design
services for data network deployment.
At December 31, 1999, we provided our retail services to approximately
12,375 business customers in 33 metropolitan areas and had sold approximately
128,200 access lines, of which approximately 101,500 had been installed. We
added eleven branch offices, three Nortel DMS-500 voice switches, three frame
relay switches and four ATM switches to our existing network during 1999. We
intend to provide the full range of our retail services in a total of
approximately 47 metropolitan areas throughout the southern United States by the
end of 2001. Our retail services business generated revenues of $172.0 million,
$119.9 million and $83.6 million for the years ended December 31, 1999, 1998 and
1997, respectively.
Company Background. We were 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. As discussed in Note
1 to our consolidated financial statements appearing elsewhere in this report,
this reorganization was accounted for in a manner similar to a pooling of
interests.
ITC Holding began to offer carriers' carrier services in late 1992 through
Interstate FiberNet, a partnership in which ITC Holding held a 49% interest. In
August 1994, ITC Holding acquired the remaining 51% interest in Interstate
FiberNet. Also in August 1994, ITC Holding formed a second partnership, Gulf
States FiberNet, to construct and operate a fiber optic route primarily from
Atlanta, Georgia to Shreveport, Louisiana with several supplemental spur routes.
In March 1997, ITC Holding acquired the remaining partnership interests in Gulf
States FiberNet and the Georgia Fiber Assets, which we refer to as the "Gulf
States Acquisition," which included one customer contract representing $3.5
million in annual revenues through August 2001, the expiration date of the
contract. InterQuest, which was merged into our subsidiary, Interstate FiberNet,
in July 1997, has provided operator and directory assistance services since
March 1992. Members of our management have been managing the businesses of both
Interstate FiberNet and Gulf States FiberNet since their inception.
In January 1996, as a result of the acquisition of DeltaCom, Inc., which we
refer to as the "DeltaCom Acquisition," we entered the retail long distance
business and acquired several fiber optic routes within Alabama that
complemented the existing networks operated by Interstate FiberNet and Gulf
States FiberNet. DeltaCom, a provider of telecommunications services since its
inception in 1982, provided long distance services to mid-sized and major
regional businesses in the southern United States.
Carriers' Carrier Services. We provide our carriers' carrier services using
our owned and managed fiber optic network. This network reaches over 100 points
of presence, or "POPs," in the following ten southern states:
. Alabama
. Arkansas
. Florida
. Georgia
. Louisiana
. Mississippi
. North Carolina
. South Carolina
. Tennessee
. Texas
Of our network's approximately 8,250 route miles, approximately 4,550 are
owned and operated by us and approximately 3,700 are owned and operated
principally by three public utilities, Duke Power Company, Florida Power & Light
Company and Entergy Technology Company, with which we have marketing and
management arrangements. Our arrangement with Entergy is exclusive. In
addition, we have 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 us to provide customers with access to POPs throughout those states.
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In addition, as part of our strategy, we intend to continue to evaluate the
potential expansion of our 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.
To the extent that we elect to expand our network through long-term operating
leases in lieu of construction, fiber swap transactions or long-term dark fiber
capital leases, we expect such leases to have a negative effect on EBITDA, as
adjusted; however, we expect that any expansion of our network through long-term
operating leases will provide opportunities to generate additional revenues,
which would partly offset any negative effects on EBITDA, as adjusted. We
expect to add approximately 1,000 to 1,500 owned and operated route miles to our
fiber network by the end of 2000 through a combination of construction and long-
term dark fiber leases on various routes.
We derive commission revenues from the marketing, sale and management of
capacity on the utility-owned portions of our network. Negligible incremental
costs are associated with these commissions, because we use the same marketing
and sales force in servicing the utility-owned portions of the network as we do
for the portions owned by us. Our commission revenues from these arrangements
amounted to approximately $8.4 million, $3.8 million and $1.5 million for the
years ended December 31, 1999, 1998 and 1997, respectively. We expect
commissions associated with the utility-owned portions of the network to
continue to increase in 2000.
We provide wholesale long-haul services to our carriers' carrier customers
on a "take or pay" long-term basis, on an individual circuit basis, or on a
month-to-month basis after the initial term of the "take or pay" or individual
circuit contract. As of December 31, 1999, we had remaining future long-term
contract commitments totaling approximately $114.2 million. These contracts
expire on various dates through 2008 and are expected to generate approximately
$103.3 million in revenues for us through 2004.
We have implemented electronic redundancy throughout our network, which
enables traffic to be rerouted to another fiber in the same sheath in the event
of a partial fiber cut or electronic failure. At December 31, 1999,
approximately 64% of our network was also protected by geographical diverse
routing, also called a self-healing ring, which is a network design that enables
traffic to be rerouted to an entirely different fiber optic cable, assuming
capacity is available, in the event of a total cable cut.
Retail Services. Our retail services involve the provision of voice, data
and video telecommunications services to end users or resellers. Our retail
services include the following:
Local Services. We currently provide local service by using our own
facilities and by reselling the services of incumbent local exchange carriers.
Over time, we expect to migrate a majority of the local service onto our own
facilities. At December 31, 1999, we offered local exchange services in 32 of
the 33 markets in which we provided our retail services. Local service revenue
comprised approximately 42% of all new retail services revenues purchased by
customers during 1999.
In connection with offering local exchange services, we have entered into
an interconnection agreement with BellSouth to (1) resell BellSouth's local
exchange services and (2) interconnect our network with BellSouth's network for
the purpose of gaining immediate access to all of BellSouth's unbundled network
elements. This agreement allows us to enter new markets with minimal capital
expenditures and to offer local exchange service to our current customer base.
The BellSouth interconnection agreement currently allows us to provide local
service on a resale basis or by purchasing all unbundled network elements
required to provide local service on a facilities basis, without using our
facilities. The terms of this interconnection agreement, including interim
pricing terms agreed to by us and BellSouth, have been approved by state
regulatory authorities in all states in which BellSouth operates, although they
remain subject to review and modification by such authorities. In addition, the
BellSouth interconnection agreement does not resolve all operational issues,
which BellSouth and we are continuing to negotiate to resolve. We believe that
this interconnection agreement provides a foundation for us to provide local
service on a reasonable commercial basis, but there can be no assurance in this
regard and important issues remain unsettled as a result of legal and regulatory
developments and related matters.
On July 1, 1999, our resale and interconnection agreement with BellSouth
expired. We are currently in arbitration with BellSouth, in all BellSouth
states except Kentucky, regarding some of the terms and conditions of the
interconnection agreement. As contemplated by the original interconnection
agreement, we will continue to
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exchange traffic under substantially the same terms on a month-to-month basis
until such time as renewal terms, conditions and prices are ordered by a state
commission or negotiated by us and BellSouth. The new terms, conditions and
prices would then be retroactive to July 1, 1999. To date, orders regarding the
terms and conditions of the interconnection agreement have been issued by
Florida and South Carolina in the arbitration proceedings and we anticipate the
remaining states will issue orders by the end of the second quarter of 2000.
Our strategy is ultimately to offer facilities-based local service in a
majority of our markets by collocating our equipment with that of BellSouth and
other incumbent local exchange carriers with which we have concluded
interconnection agreements. We began collocating our equipment in some of the
BellSouth central office locations during the first quarter of 1998. As of
December 31, 1999, we had completed physical collocation of switching equipment
in 125 BellSouth markets, and were offering our "Unity" product in 31 markets.
The Unity product, which we market primarily to mid-sized and major regional
businesses, utilizes a direct T-1 connection from the customer's location to one
of our switches and provides the customer with both local and long distance
calling on any of 24 available channels. We expect to add an additional 60 to
80 collocations during 2000, bringing our total collocations to 185 to 205.
Under the BellSouth interconnection agreement, we continued to bill
BellSouth during 1999 for reciprocal interconnection charges related to the
provision by us of facilities-based local exchange services. A significant
amount of such charges is attributable to call terminations by us to customers
that are Internet service providers, or ISPs. BellSouth has stated that it views
termination to such ISPs as not included under the reciprocal charge
arrangements set forth in the interconnection agreement, and has refused to pay
compensation for such terminations either to us or to other competitive local
exchange carriers, or CLECs, operating under similar interconnection agreements.
The Alabama Public Service Commission rendered a ruling in our favor in March
1999 and issued an order requiring BellSouth to pay all withheld reciprocal
compensation sums within 20 days. BellSouth appealed this order to the United
States District Court in Montgomery, Alabama. In August 1999, the United States
District Court entered a decision and ordered BellSouth to pay reciprocal
compensation for dial-up calls from BellSouth customers to ISPs served by us.
BellSouth filed an appeal of the United States District Court's decision to the
11th Circuit Court of the United States regarding this issue. The funds are
currently being held in escrow by the federal court pending outcome of
BellSouth's request for review of the public order. We have filed a similar
complaint before the South Carolina Public Utilities Commission and the Florida
Public Service Commission seeking a ruling requiring BellSouth to pay the
reciprocal compensation with respect to our South Carolina and Florida
operations. We are reviewing all potential remedies and claims in the remaining
jurisdictions.
We have continued to bill BellSouth the reciprocal compensation rate under
the interconnection agreement which expired July 1, 1999. We believe this rate
will be substantially reduced retroactively to July 1, 1999 pursuant to the
proceedings described above. Such a rate reduction would result in a substantial
reduction in the related accounts receivable billed and reserved subsequent to
July 1, 1999. For the years ended December 31, 1999 and 1998, these charges to
BellSouth amounted to approximately $23.4 million and $7.4 million,
respectively, inclusive of $15.7 million of charges from July 1, 1999 to
December 31, 1999. We recognized approximately $2.0 million and $756,000 of
these charges as operating revenue during the years ended December 31, 1999 and
1998, respectively, which represent amounts BellSouth had actually paid or
indicated it will pay. We reserved directly against the remaining $21.4 million
and $6.6 million of billings for the years ended December 31, 1999 and 1998,
respectively, inclusive of $14.6 million of billings for the period from July 1,
1999 to December 31, 1999. We believe our position with respect to the reserved
portion of the cumulative local interconnection billings is supported by the
terms of the BellSouth interconnection agreement, as do other CLECs who are
strongly contesting refusals by incumbent local exchange carriers, or ILECs, to
pay compensation in these circumstances, although, as discussed above, our
billed and reserved accounts receivable for the period from July 1, 1999 to
December 31, 1999 may be substantially reduced pending outcome of the terms of
the new interconnection agreement. As of December 31, 1999, we had reserved for
approximately $28.0 million of cumulative local interconnection billings.
Many regulatory authorities that have addressed the issue have ruled in
favor of CLECs, but the issue generally remains under appeal in those
circumstances. In Alabama, Florida, Georgia, North Carolina, Tennessee and
Kentucky, the state utility commissions have entered rulings favoring the
arguments of the CLECs. The issue in these states is under appeal by the ILECs.
The issue is still pending in Louisiana. Mississippi has issued an unfavorable
ruling against CLECs 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
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respect to payment of such charges by BellSouth in favor of us could have a
positive impact on both gross margin and EBITDA, as adjusted. Although
discussions and arbitration hearings have taken place between the parties since
expiration of the BellSouth interconnection agreement on July 1, 1999, 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 our favor under the current
interconnection agreement, there can be no assurance that any positive effect on
our financial position will continue beyond July 1, 1999. The South Carolina
Public Service Commission has ruled in favor of BellSouth regarding reciprocal
compensation on a going forward basis. We have appealed this decision.
We expect that as we increase our provision of local service on a
facilities basis rather than on a resale basis, we will (1) reduce our own
access costs when we sell our end users long distance services, and (2) realize
increased revenues from the originating and terminating switched access services
we provide to other carriers originating and/or terminating calls for our local
end user customers. Certain incumbent local exchange companies, including
BellSouth, have taken the position that when a carrier seeking to provide local
service obtains all necessary elements consisting of loops and switches, from
the incumbent local exchange carrier in a combined form, the incumbent local
exchange carrier retains the right to receive the access revenues associated
with service to the customers served on that basis. Further legal challenges are
likely and important issues related to this form of interconnection remain open,
including issues related to when a competitor can obtain network elements used
for, among other things, access purposes.
We anticipate that an increasing portion of our revenue will be derived
from local services, primarily those provided pursuant to the BellSouth
interconnection agreement and similar agreements we have with other local
exchange carriers, including GTE, Sprint and SBC Communications. We expect that
gross margin associated with our facilities-based local retail services will be
slightly better than gross margin associated with our long distance retail
services, but that in general, gross margin associated with our retail services
will be lower than that associated with our carriers' carrier services. There
can be no assurance that we will be able to enter into additional
interconnection agreements on terms acceptable to us or at all, or that the
incumbent local exchange carriers will provide the operational support required
for us to provide local services to end users.
Long Distance. We offer a full range of retail long distance services,
including traditional switched and dedicated long distance, toll-free calling,
international, calling card and operator services.
Data Services. We provide high quality data services to our customers
primarily using frame relay switches distributed throughout our network, which
enable customers to use a single network connection to communicate with multiple
sites throughout our fiber optic network. We currently provide ATM services on
a facilities-based and resale basis. We will continue to seek, through
strategic business relationships with other providers, to interconnect our fiber
optic network with the fiber optic networks of other companies. We anticipate
increased demand for data services in the future and expect that in the future a
larger percentage of our revenues will be derived from the sale of dedicated
data services.
During 1999, we increased our data and related service offerings with the
acquisition, by merger, of AvData Systems, Inc. New or expanded services
offerings resulting from the acquisition include consulting, integration,
operation and proactive management of data networks with 24 x 7 monitoring,
trouble shooting, problem resolution and comprehensive network performance
reporting for corporate networks. In addition, we added in-depth network
performance analysis, as well as design and implementation services for data
network deployment, to our product mix through our acquisition of AvData. This
acquisition has also strengthened and enhanced our data service offerings.
Internet Access, Intranet Services and Web Hosting. We provide dedicated,
frame relay Internet access and Internet and Intranet services, electronic mail,
e-commerce and Web hosting services. We expect that mid-sized and larger
businesses will require faster Internet access and larger bandwidth in the
future, and we intend to develop and offer products and services that will
respond to that demand using our network and services.
During 1999, we continued to expand our service offerings to the Internet
marketplace by increasing our existing service offerings to the ISP market
segment. We offer local service to ISPs via primary rate interface
connectivity, including the collocation of ISP terminal equipment such as
modems, routers and/or network servers.
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We increased our capital expenditures related to these services significantly
during 1999 and the second half of 1998 because we expect demand for these
services to continue to be strong, we plan to continue to allocate an increasing
amount of capital to these services during 2000.
Customer Premise Equipment Sale, Installation and Repair. We sell, install
and repair customer premise equipment such as telephones, office switchboard
systems and, to a lesser extent, private branch exchange, or PBX, for customers
in the following markets:
. Anniston, Birmingham, Dothan, Florence, Huntsville, Mobile and
Montgomery, Alabama;
. Atlanta and Columbus, Georgia;
. Jacksonville, Ocala and Pensacola, Florida;
. Baton Rouge, Louisiana;
. Greenwood, Hattiesburg, Jackson and Tupelo, Mississippi;
. Charlotte and Greensboro, North Carolina; and
. Charleston, Columbia and Greenville, South Carolina.
We intend to offer customer premise equipment sales, installation and
repair in additional markets in the future, with the goals of (1) enhancing and
supporting our sale of local and long distance services and (2) enhancing
customer retention. We plan to form relationships with local customer premise
equipment installation companies in all of our markets for the purpose of
selling and installing customer premise equipment not otherwise provided by us.
Although we expect that a majority of our revenue growth will come from our
retail services business, we do not expect our retail services to obtain a
significant share of the market for telecommunications services in the southern
United States. The customer contracts for our retail services generally provide
for payment in arrears based on minutes of use for switched services and payment
in advance for private line services. The contracts generally also provide that
the customer may terminate the affected services without penalty in the event of
certain outages in service and for certain other defined causes. The contracts
also typically provide that the customer must use at least a minimum dollar
amount of switched long distance services per month for the term of the
contract. During the past several years, market prices for many
telecommunications services segments have been declining, which we believe will
likely continue. In response to these and other competitive pressures, we have
modified some of our retail contracts to extend to selected customers lower
rates over longer terms as a means of maintaining and developing our customer
base. In the future, in response to competitive considerations, we may decide to
modify other retail customer contracts in a similar manner, emphasizing lower
pricing and longer commitment periods. A substantial portion of our total
revenues is from retail long distance services. Revenue per minute from these
services has been declining and we expect it to continue to decline.
Operating Expenses. Our principal operating expenses consist of cost of
services, selling, operations and administration expenses, and depreciation and
amortization.
Cost of Services. Cost of services related to our retail services consists
primarily of access charges and local facility charges paid to local exchange
carriers, as well as wholesale carrier origination, termination and
interexchange facility charges paid to other interexchange carriers. Cost of
services related to our carriers' carrier services are substantially all fixed
costs attributable to:
. the leasing of dark fiber under long-term operating leases;
. the leasing of capacity outside our owned or managed network, referred
to as "off-net capacity," to meet customer requirements; and
. network costs associated with the provision of signaling system 7, or
"SS7," services.
We purchase off-net capacity to provide our carriers' carrier services in
cases where we plan to construct our own network to replace the off-net portion
of particular fiber routes. Although we are substantially able to meet the
requirements of our customers on our network, we purchase off-net capacity to
fill customers' requirements that cannot be met on our network.
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Selling, operations and administration. Selling, operations and
administration expenses consist of expenses of selling and marketing, field
personnel engaged in direct network maintenance and monitoring, customer service
and corporate administration.
Depreciation and amortization. Depreciation and amortization include
depreciation of our telecommunications network and equipment and amortization of
goodwill and other intangible assets related to acquisitions, primarily the
DeltaCom Acquisition and the AvData Acquisition.
As we continue to expand into new geographic markets, add new branch
offices and facilities, and enlarge our current product offerings, cost of
services and selling, operations and administration expenses are expected to
increase substantially. Therefore, we expect to incur increasing operating
losses over the next few years. Although we anticipate that we will generate
positive cash flow from operations, we expect that such cash flows will be more
than offset by capital expenditures during the next several years as we
implement our business plan. We expect that our gross margins from our bundle of
telecommunications services will continue to be adversely affected by our local
service product, because the gross margin on the resale of local services
through incumbent local exchange carrier facilities will be lower than the gross
margin on our existing businesses. As we increasingly use incumbent local
exchange carrier unbundled network elements instead of resold services, we
expect gross margin on local service to improve. Such improvement is expected to
result from reduced access charges and from efficiencies realized through
increased reliance on the owned portion of our network. Competitive market
pressures to reduce prices for our retail services, as discussed above, however,
could offset improved margins that may result from a shift away from resold
local exchange services.
Recent Developments
In July 1999, we completed our acquisition, by merger, of AvData, a
privately owned data network management solutions provider in Atlanta, Georgia.
We issued 983,511 shares of our common stock related to this merger, of which
171,898 shares are being held in a two-year escrow account to protect against
certain contingencies. We expect to issue an additional 123,757 shares in March
2000 under earn-out provisions in the merger agreement. We believe that this
acquisition has strengthened and enhanced our data service offerings by
expanding our current base of data products to include consulting, integration,
operation and proactive management of data networks, in-depth network
performance analysis, as well as design and implementation services for data
network deployment.
In July 1999, we announced that we would introduce an advanced Internet
protocol, or "IP," network in the Southeast beginning in the fall. This network
became operational in October 1999. Through October 1999, we had installed 12
Cisco GSR routers and 14 Cisco 7513 edge routers at strategic points on this IP
network. The addition of this network is expected to enhance our data product
offerings and allow us to better serve the expanding demand for enhanced IP-
based data and Internet services.
In August 1999, we completed our acquisition of certain assets of
Scientific Telecommunications, Inc., or "SciTel," a privately owned
telecommunications equipment provider headquartered in Greenwood, Mississippi.
We issued 83,117 shares of our common stock to complete the transaction. This
acquisition expanded our physical presence in Mississippi to include the
Hattiesburg, Tupelo and Greenwood markets.
On February 28, 2000, we announced the creation of a new business to be
operated as e/\DeltaCom. e/\DeltaCom will enable us to extend and enhance our
current data and Internet access products, offering customers collocation and
Web server hosting services integral to operating business-critical applications
over the Internet. In addition to the collocation and Web server hosting
services, e/\DeltaCom will provide a wide range of optional configurations and
services, including cabinet, caged and suite space, metered power, network
management, firewall management, disaster recovery, and circuits from customer
premises to our network. We expect e/\DeltaCom to generate increased Internet
access traffic resulting from the connection of e/\DeltaCom's customers to our
existing IP backbone.
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Other Information About Our Business
The following table presents as of recent dates information about our operations
and business.
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Statistical Data*
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December 31, September 30, June 30, March 31, December 31,
1999 1999 1999 1999 1998
---- ---- ---- ---- ----
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Cumulative markets 33 30 26 23 22
Business customer served -
retail services** 12,375 11,900 11,250 11,000 10,500
Route miles 8,250 8,250 8,100 7,800 7,800
Collocations 125 70 36 30 30
Voice switches 10 9 8 7 7
ATM switches 10 10 10 7 6
Frame relay switches 17 17 19 15 14
Number of employees 1,640 1,570 1,330 1,170 1,125
Lines sold cumulative 128,200 91,800 74,400 60,000 42,000
Lines installed cumulative 101,500 76,000 56,000 45,300 32,200
Lines installed/Lines sold percentage 79% 83% 75% 76% 77%
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*Data rounded except as to markets, collocations and switches
**Reflects the combination of certain customers' multiple accounts into a
single customer profile.
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RESULTS OF OPERATIONS
The following tables present for the years ended December 31, 1999, 1998
and 1997 for our carriers' carrier services and our retail services businesses
selected statement of operations data as a percentage of our revenue:
Results of Operations
(In thousands)
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Carriers' Carrier Services
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Year Ended December 31,
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1999 % 1998 % 1997 %
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Revenues $72,853 100% $51,902 100% $31,024 100%
Cost of services 10,771 15 7,642 15 3,908 13
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Gross margin 62,082 85 44,260 85 27,116 87
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Selling, operations and
administration 24,151 33 14,411 28 8,401 27
Depreciation and amortization 28,857 40 19,136 37 12,077 39
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Total operating expenses 53,008 73 33,547 65 20,478 66
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Operating income $ 9,074 12 $10,713 20 $ 6,638 21
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EBITDA, as adjusted $37,931 52 $29,849 57 $18,715 60
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Retail Services
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Year Ended December 31,
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1999 % 1998 % 1997 %
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Revenues $171,991 100% $119,936 100% $83,566 100%
Cost of services 107,950 63 75,337 63 50,642 61
-------- -------- -------
Gross margin 64,041 37 44,599 37 32,924 39
-------- -------- -------
Selling, operations and
administration 72,703 42 50,490 42 29,854 36
Depreciation and amortization 24,871 14 11,669 10 6,255 7
-------- -------- -------
Total operating expenses 97,574 56 62,159 52 36,109 43
-------- -------- -------
Operating loss $(33,533) (19) $(17,560) (15) $(3,185) (4)
======== ======== =======
EBITDA, as adjusted $ (8,662) (5) $ (5,891) (5) $ 3,070 4
======== ======== =======
</TABLE>
Year Ended December 31, 1999 Compared with Year Ended December 31, 1998
Revenues
Total revenue increased $73.0 million (42.5%), from $171.8 million for the
year ended December 31, 1998 to $244.8 million for the year ended December 31,
1999.
Revenues from our retail services increased $52.1 million (43.5%), from
$119.9 million for the year ended December 31, 1998 to $172.0 million for the
year ended December 31, 1999. The increase in our retail services revenue was
primarily attributable to:
. continued geographic expansion, including the opening of eleven branch
sales offices;
. maturation of existing sales offices;
. continued increase in the number of business customers, from
approximately 10,500 as of December 31, 1998 to approximately 12,375
as of December 31, 1999;
. an increase in product diversity, including an increase in revenues
from our local exchange services, local ISP telecommunications
services and data related services;
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. the inclusion of revenue from the operations of AvData and SciTel
since our acquisition of those companies on July 8, 1999 and August
16, 1999, respectively;
. continued growth in local lines in service, from approximately 32,200
as of December 31, 1998 to approximately 101,500 as of December 31,
1999;
. continued growth in long distance minutes of use, partially offset by
a decrease in long distance rates; and
. continued stability in the rate of revenue loss from lost customers
from period to period.
Revenues from our carriers' carrier services increased $21.0 million
(40.5%), from $51.9 million for the year ended December 31, 1998 to $72.9
million for the year ended December 31, 1999. The increase in revenue from our
carriers' carrier services was primarily attributable to:
. an increase in our customer base resulting from the continued
increasing demand for bandwidth, partially offset by pricing pressures
on some of our network routes;
. expansion of our fiber optic network, from approximately 7,800 route
miles as of December 31, 1998 to approximately 8,250 route miles as of
December 31, 1999; and
. continued growth in commissions derived from our managed, monitored,
and marketed portion of our network.
We expect to experience continued revenue growth in both our retail
services and our carrier's carrier services into 2000. This growth is expected
to be driven primarily by (1) increased demand for our diverse retail product
mix, especially our local and data products, (2) increased minutes of use,
partially offset by declining rates, and (3) increased demand for bandwidth,
including our new wholesale IP backbone product, partially offset by declining
rates.
No single retail services or carriers' carrier services customer
represented over 10% of our total revenues for the year ended December 31, 1999.
Cost of Services
Total cost of services increased $35.7 million, from $83.0 million for the
year ended December 31, 1998 to $118.7 million for the year ended December 31,
1999.
Cost of services for our retail services increased $32.6 million, from
$75.3 million for the year ended December 31, 1998 to $107.9 million for the
year ended December 31, 1999. Cost of services as a percentage of revenue for
our retail services remained constant at 63% from 1998 to 1999. The increase in
cost of services in absolute dollars for our retail services was primarily
attributable to an increase in our network and other usage based provider costs
associated with our product and customer growth. We expect to experience
improvements in the cost of services as a percentage of revenues as we continue
to move local and long distance services to our own facilities and as we receive
reductions in our off-network costs. We expect that such improvements will
continue to be partially offset by costs related to our advanced IP and other
network initiatives.
Cost of services for our carriers' carrier services increased $3.1 million,
from $7.7 million for the year ended December 31, 1998 to $10.8 million for the
year ended December 31, 1999. Cost of services as a percentage of revenue for
our carriers' carrier services remained constant at 15% from 1998 to 1999. The
increase in absolute dollars was primarily attributable to an increase in our
network costs resulting from the expansion of our fiber network. We believe the
pricing pressures we have experienced will be partially offset in the future by
an increasing demand for bandwidth, which will facilitate continued revenue
growth.
Selling, Operations and Administration Expense
Total selling, operations and administration expense increased $32.0
million, from $64.9 million (38% as a percentage of revenue) for the year ended
December 31, 1998 to $96.9 million (40% as a percentage of revenue) for the year
ended December 31, 1999.
10
<PAGE>
Selling, operations and administration expense attributable to our retail
services increased $22.2 million, from $50.5 million (42% as a percentage of
revenue) for the year ended December 31, 1998 to $72.7 million (42% as a
percentage of revenue) for the year ended December 31, 1999. The increase in
selling, operations and administration expense in absolute dollars for our
retail services was primarily attributable to:
. an increase in the number of employees, primarily employees dedicated
to sales, customer support and provisioning;
. our continued geographic expansion including opening eleven branch
sales offices; and
. expansion of our product lines, especially local and data services.
Selling, operations and administration expense attributable to our
carriers' carrier services increased $9.8 million, from $14.4 million (28% as a
percentage of revenue) for the year ended December 31, 1998 to $24.2 million
(33% as a percentage of revenue) for the year ended December 31, 1999. The
increase in selling, operations, and administration expense for our carrier's
carrier services was primarily due to additions of personnel resulting from the
geographic expansion of our network, the infrastructure required to support the
IP backbone and an increase in information systems, research and development,
marketing and accounting costs.
Depreciation and Amortization
Total depreciation and amortization increased $22.9 million, from $30.9
million for the year ended December 31, 1998 to $53.8 million for the year ended
December 31, 1999. Our retail services accounted for $13.2 million of the
increase, which was primarily related to installation of new central office
equipment and other telecommunications equipment. Our carriers' carrier
services accounted for $9.7 million of the increase, which was primarily
attributable to network expansion. We expect depreciation and amortization to
continue to increase during 2000 as we add new switches and network facilities
and expand into new markets.
Interest Expense
Total interest expense increased $13.4 million, from $31.9 million for the
year ended December 31, 1998 to $45.3 million for the year ended December 31,
1999. The increase in interest expense in 1999 was primarily attributable to a
full year's interest on our 8 7/8% Senior Notes issued in March 1998, which we
refer to as the "March 1998 Notes," our 9-3/4% Senior Notes issued in November
1998, which we refer to as the "November 1998 Notes," and our 4 1/2% Convertible
Subordinated Notes due 2006, which we refer to as the "1999 Convertible
Subordinated Notes." We expect interest expense to continue to increase during
2000 as a result of incurring interest for a full year on the outstanding notes.
Interest Income
Total interest income increased $4.4 million, from $9.8 million for the
year ended December 31, 1998 to $14.2 million for the year ended December 31,
1999 as a result of the temporary investment of available cash balances.
Other Income (Expense)
In March 1998, we reclassified our interest rate swap agreement from a
hedge of an anticipated transaction to a trading security resulting in a non-
cash charge against earnings of approximately $2.5 million. This change in
classification required us to record the interest rate swap agreement on the
consolidated balance sheet at fair market value at the time of receipt of the
proceeds from the offering of the March 1998 Notes. The interest rate swap
agreement is marked to market on a monthly basis. For the year ended December
31, 1999 and 1998, we recognized income (expense) from the mark-to-market of the
interest rate swap of approximately $1.6 million and $(2.4) million,
respectively.
11
<PAGE>
EBITDA, as adjusted
EBITDA, as adjusted, increased $5.3 million, from $24.0 million for the
year ended December 31, 1998 to $29.3 million for the year ended December 31,
1999.
EBITDA, as adjusted, attributable to our retail services for the year ended
December 31, 1999 was $(8.7) million, a decrease of $2.8 million, compared to
$(5.9) million for the year ended December 31, 1998. EBITDA, as adjusted,
attributable to our retail services remained constant at (5)% of revenues for
the years ended December 31, 1998 and 1999. The decrease in EBITDA, as
adjusted, in absolute dollars for our retail services was primarily attributable
to increases in:
. network costs associated with increased customer usage;
. costs associated with the expansion of new sales offices; and
. employment of additional personnel to support growth and expansion of
this segment.
EBITDA, as adjusted, attributable to our carriers' carrier services for the
year ended December 31, 1999 was $37.9 million, an increase of $8.0 million,
compared to $29.9 million for the year ended December 31, 1998. The increase in
EBITDA, as adjusted, for our carriers' carrier segment was primarily
attributable to the increased demand for bandwidth, partially offset by rate
adjustments for customers to current market rates and the cost of additional
support personnel.
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Revenues
Total revenue increased $57.2 million (49.9%), from $114.6 million for the
year ended December 31, 1997 to $171.8 million for the year ended December 31,
1998. Revenues from our retail services increased $36.3 million (43.4%), from
$83.6 million for the year ended December 31, 1997 to $119.9 million for the
year ended December 31, 1998. The increase in our retail services revenue was
primarily attributable to:
. continued geographic expansion, including the opening of seven new
branch sales offices;
. the maturation of existing sales offices;
. continued product expansion as local exchange services and data
services increased as a percentage of our total retail services
revenue;
. an increase in the customer base from approximately 7,700 to
approximately 10,500;
. an increase in long distance minutes of use; and
. continued stability from period to period in the rate of revenue loss
from lost customers.
The majority of our retail services revenue growth during 1998 was a result
of our execution of our business plan through internal expansion efforts. We
completed the acquisition of IT Group Communications, a Jackson, Mississippi-
based long distance carrier, in 1998.
Revenues from our carriers' carrier services increased $20.9 million
(67.4%), from $31.0 million for the year ended December 31, 1997 to $51.9
million for the year ended December 31, 1998. The increase in revenue for our
carriers' carrier services was primarily attributable to continued:
. increases in the existing customer base as a result of increasing
demand for bandwidth;
. expansion of owned and operated routes; and
. growth in commissions derived from our managed, monitored, and
marketed routes.
No single retail services or carriers' carrier services customer
represented over 10% of our total revenues for the year ended December 31, 1998.
12
<PAGE>
Cost of Services
Total cost of services increased $28.4 million, from $54.6 million for the
year ended December 31, 1997 to $83.0 million for the year ended December 31,
1998. Cost of services for our retail services operations increased $24.7
million, from $50.6 million for the year ended December 31, 1997 to $75.3
million for the year ended December 31, 1998. Cost of services as a percentage
of revenue for our retail services operations increased from 61% in the year
ended December 31, 1997 to 63% in the year ended December 31, 1998. The increase
in cost of services as a percentage of revenue for our retail services was
primarily attributable to:
. a significant increase in the local service offering in 1998, mostly
on a resale basis, which has a lower gross margin than our other
services; and
. trunking and routing inefficiencies as we installed four new Nortel
DMS-500 switches and other telecommunications facilities in new
markets.
Cost of services for our carriers' carrier services operations increased
$3.7 million, from $3.9 million for the year ended December 31, 1997 to $7.6
million for the year ended December 31, 1998. Cost of services as a percentage
of revenue from our carriers' carrier services operations increased from 13% in
the year ended December 31, 1997 to 15% in the year ended December 31, 1998. The
increase in the cost of services as a percentage of revenue from our carriers'
carrier services was primarily attributable to:
. acceptance of fibers under a long term dark fiber operating lease for
a route from Dallas to Longview, Texas in April 1998; and
. pricing pressures as a result of new competitors entering our markets.
Selling, Operations and Administration Expense
Total selling, operations and administration expense increased $26.6
million, from $38.3 million (33% as a percentage of revenue) for the year ended
December 31, 1997 to $64.9 million (38% as a percentage of revenue) for the year
ended December 31, 1998.
Selling, operations and administration expense attributable to our retail
services increased $20.6 million, from $29.9 million (36% as a percentage of
revenue) for the year ended December 31, 1997 to $50.5 million (42% as a
percentage of revenue) for the year ended December 31, 1998. The increase in
selling, operations and administration expense as a percentage of revenue from
our retail services was primarily attributable to:
. an increase in the number of employees, primarily sales, information
system and provisioning personnel;
. continued geographic expansion including opening seven new branch
offices;
. expansion of existing service offerings, primarily local services; and
. external costs associated with our Year 2000 readiness program, which
amounted to approximately $1.1 million for the year ended December 31,
1998, compared to no such external costs in the year ended December
31, 1997.
Selling, operations and administration expense attributable to our
carriers' carrier services increased $6.0 million, from $8.4 million (27% as a
percentage of revenue) for the year ended December 31, 1997 to $14.4 million
(28% as a percentage of revenue) for the year ended December 31, 1998. The
increase in selling, operations, and administration expense for our carrier's
carrier services resulted from the increased cost of personnel necessitated by
geographic and service capability expansion of our network.
Depreciation and Amortization
Total depreciation and amortization increased $12.6 million, from $18.3
million for the year ended December 31, 1997 to $30.9 million for the year ended
December 31, 1998. Our retail services accounted for $5.4 million of the
increase, which was primarily attributable to installation of new
telecommunications equipment. Our carriers' carrier services accounted for $7.1
million of the increase, which was primarily attributable to network expansion.
13
<PAGE>
Interest Expense
Total interest expense increased $10.5 million, from $21.4 million for the
year ended December 31, 1997 to $31.9 million for the year ended December 31,
1998. The increase in interest expense in 1998 was due to interest expense
incurred on the March 1998 Notes, the November 1998 Notes and five additional
months interest on our 11% Senior Notes due 2007 issued in June 1997, which we
refer to as the "1997 Notes."
Interest Income
Interest income increased $5.5 million, from $4.3 million for the year
ended December 31, 1997 to $9.8 million for the year ended December 31, 1998 as
a result of short-term investment of proceeds from the March 1998 Notes and the
November 1998 Notes.
Other Expense
In March 1998, we changed the accounting for our interest rate swap
agreement from a hedge of an anticipated transaction to a trading security,
resulting in a non-cash charge against earnings of approximately $2.5 million.
This change in classification required us to record the interest rate swap
agreement on the consolidated balance sheet at fair market value at the time of
receipt of the proceeds from the sale of the March 1998 Notes. The interest rate
swap agreement is marked to market on a monthly basis. For the year ended
December 31, 1998, we recognized expense of approximately $2.4 million from the
mark to market of the interest rate swap.
Income Taxes
For the year ended December 31, 1997, we included the taxable income of ITC
Holding, our former parent, through the date of our merger with ITC Holding, in
our consolidated tax return. As a result of tax sharing arrangements with ITC
Holding, we received benefits for certain of our net operating losses. The
benefit received, as a percentage of taxable income, was 24% for the year ended
December 31, 1997. During 1998, we recorded a $3.9 million receivable related
from the carry back of our 1998 net operating loss. The benefit received, as a
percentage of taxable income, was 20% for the year ended December 31, 1998.
Extraordinary Loss
We recorded a pre-tax loss of $10.6 million, or $8.4 million after tax,
related to the redemption on April 2, 1998 of $70 million principal amount of
the 1997 Notes. The extraordinary loss consisted of a $7.7 million redemption
premium and a $2.9 million write-off of related debt issuance costs.
EBITDA, as adjusted
EBITDA, as adjusted, increased $2.2 million, from $21.8 million for the
year ended December 31, 1997 to $24.0 million for the year ended December 31,
1998. EBITDA, as adjusted, attributable to our retail services for the year
ended December 31, 1998 was $(5.9) million, a decrease of $9.0 million, compared
to $3.1 million for the year ended December 31, 1997. EBITDA, as adjusted,
attributable to our retail services decreased from 4% of revenues for the year
ended December 31, 1997 to (5)% of revenues for the year ended December 31,
1998. EBITDA, as adjusted, attributable to our carriers' carrier services for
the year ended December 31, 1998 was $29.9 million, an increase of $11.2
million, compared to $18.7 million for the year ended December 31, 1997.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
We (used) generated net cash from operating activities of $(5.3) million,
$9.5 million, and $6.3 million for the years ended December 31, 1999, 1998 and
1997, respectively. Changes in working capital were $(6.4) million in the year
ended December 31, 1999, $6.7 million in the year ended December 31, 1998 and
$(5.0) million in the year ended December 31, 1997.
. The change in the year ended December 31, 1999 was primarily due to an
increase in accounts receivable and other current assets, partially
offset by an increase in accounts payable, unearned revenue and
accrued compensation and other accrued liabilities.
. The change in the year ended December 31, 1998 was primarily due to an
increase in accounts payable, interest and other accruals and unearned
revenue, partially offset by increases in accounts receivable.
. The change in the year ended December 31, 1997 was primarily due to
increases in unearned revenue and accrued liabilities, offset by
increases in accounts receivable. Of this increase in accounts
receivable and unearned revenue, $2.3 million and $1.3 million,
respectively, resulted from the Gulf States Acquisition, with the
remaining increase in accounts receivable attributable to increased
earned and unearned revenue in our carriers' carrier services and our
retail services.
Cash used for investing activities was $150.0 million, $118.2 million, and
$93.9 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
. The cash used in the year ended December 31, 1999 was primarily for
the funding of capital expenditures.
. The cash used in the year ended December 31, 1998 was primarily for
the funding of capital expenditures.
. The cash used in the year ended December 31, 1997 was primarily for
the purchase of restricted investments held by a trustee to fund the
first six interest payments on the 1997 Notes, as required by the
indenture for the 1997 Notes, and to fund capital expenditures.
We made capital expenditures of $165.5 million, $147.8 million, and $43.9
million for the years ended December 31, 1999, 1998 and 1997, respectively.
. Of the $165.5 million of capital expenditures for the year ended
December 31, 1999, $66.8 million related to our carriers' carrier
services and $98.7 million related to our retail services.
. Of the $147.8 million of capital expenditures for the year ended
December 31, 1998, $80.4 million related to our carriers' carrier
services and $67.4 million related to our retail services.
. Of the $43.9 million of capital expenditures for the year ended
December 31, 1997, $27.5 million related to our carriers' carrier
services and $16.4 million related to our retail services.
Cash provided by financing activities was $219.6 million, $198.4 million,
and $180.6 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
. Net cash provided by financing activities for the year ended December
31, 1999 consisted primarily of net proceeds of $97 million from the
sale of the 1999 Convertible Subordinated Notes, $120.9 million from
the sale of common stock in a public offering, $2.7 million from
exercise of common stock options, and net repayment of other long-term
debt and capital leases of $1.1 million.
. Net cash provided by financing activities for the year ended December
31, 1998 consisted primarily of net proceeds of $155.2 million from
the sale of the March 1998 Notes, $121.4 million from the sale of the
November 1998 Notes, and $1.3 million from exercise of common stock
options, less $70 million paid in redemption of some of the 1997
Notes, a $7.7 million premium paid in connection with the partial
redemption of the 1997 Notes, and net repayment of other long-term
debt and capital leases of $1.6 million.
. Net cash provided by financing activities for the year ended December
31, 1997 consisted primarily of net proceeds of $192.1 million from
the sale of the 1997 Notes and $87.6 million from our initial public
offering of common stock, less $43.2 million of repayment of advances
from ITC Holding, net repayments of other long-term debt and capital
leases of $52.6 million and $3.3 million of other cash used in
financing activities.
15
<PAGE>
ITC Holding partially financed the DeltaCom Acquisition and the Gulf States
Acquisition with debt, which consisted of the following:
. a $74.0 million term loan under a bank facility incurred in connection
with the DeltaCom Acquisition and pushed down to us, which we refer to
as "the DeltaCom Indebtedness";
. a $41.6 million bridge facility incurred in connection with the Gulf
States Acquisition, which required the refinancing of Gulf States
FiberNet's existing project facility; and
. a $10.0 million unsecured note issued in connection with the Gulf
States Acquisition and assumed by a subsidiary of ours, which was
repaid in full in November 1997 with a portion of the net proceeds
from our initial public offering.
On July 25, 1997, approximately $62.7 million of the $192.1 million of net
proceeds from the sale of the 1997 Notes was used to purchase U.S. government
securities, which are held by the 1997 Notes trustee in a pledged account to
fund the first six scheduled interest payments on the 1997 Notes. The balance of
the net proceeds from the 1997 Notes offering, approximately $129.4 million, was
released to us. A portion of the released proceeds was applied on July 25, 1997
as follows: (1) to repay approximately $57.8 million of indebtedness to ITC
Holding, including approximately $9.5 million of accrued interest associated
with the DeltaCom Acquisition and advances used by us for capital expenditures;
and (2) to repay approximately $41.6 million of indebtedness incurred under the
bridge facility, referred to above, together with approximately $200,000 of
accrued interest. In connection with our reorganization, $31.0 million of the
DeltaCom Indebtedness was forgiven by ITC Holding and contributed to us as
additional equity.
In September 1997, Interstate FiberNet, Inc., a wholly-owned subsidiary of
ours, entered into a five-year $100 million term and revolving credit facility
to be used for working capital and other corporate purposes, including
refinancing existing indebtedness, capital expenditures and permitted
acquisitions. In February 1998, we amended the credit facility to provide, among
other things, for a $50 million revolving credit facility. We further amended
this facility in November 1998 and May 1999. No funds were ever dispersed under
this facility. We recorded a loss of approximately $2.5 million due to the
reclassification of our interest rate swap agreement in connection with this
facility from a hedge of an anticipated transaction to a trading security, as a
result of our sale of the March 1998 Notes. See Note 5 to our consolidated
financial statements appearing elsewhere in this report for further discussion
of this interest rate swap agreement. The credit facility contains restrictions
on Interstate FiberNet and its subsidiaries and requires Interstate FiberNet to
comply with financial tests and to maintain financial ratios. The credit
facility is guaranteed by us and ITC/\DeltaCom Communications, Inc. and is
secured by a first priority lien on all current and future assets of Interstate
FiberNet and its subsidiaries and a first priority pledge of the stock of
Interstate FiberNet and its subsidiaries.
On October 29, 1997, we completed our initial public offering in which we
issued 5,750,000 shares of common stock at a price of $16.50 per share. After
giving effect to the two-for-one stock split we completed in the third quarter
of 1998, the initial public offering would have been 11,500,000 shares at a per
share price of $8.25.
On March 3, 1998, we issued $160 million principal amount of the March 1998
Notes at a price of 99.9%, yielding net proceeds of approximately $155 million.
We are using the proceeds (1) to replace portions of the proceeds from our
initial public offering in October 1997, which we used in April 1998 to redeem
$70 million principal amount of the 1997 Notes, (2) to fund continued market and
fiber optic expansion and (3) to replace funds that would have otherwise been
available under our credit facility, which was modified to, among other things,
reduce available borrowings thereunder from $100 million to $50 million.
On April 2, 1998, we redeemed $70 million principal amount of the 1997
Notes, with proceeds remaining from the initial public offering, at a redemption
price of 111% of such principal amount, plus accrued and unpaid interest. We
recorded an extraordinary loss of approximately $10.6 million related to the
redemption of this debt. In connection with the redemption, the trustee for the
1997 Notes released to us approximately $18.0 million held by the trustee as
security for the payment of remaining interest through June 1, 2000 on the 1997
Notes which we redeemed.
On May 20, 1998, we completed our acquisition of certain assets and
liabilities of IT Group Communications. We issued 177,106 shares of common
stock and assumed liabilities of approximately $1.2 million to consummate
16
<PAGE>
the transaction. We acquired approximately 900 customers, predominately located
in Mississippi, and an important network point of presence in Jackson,
Mississippi.
On November 5, 1998, we issued, in a private offering, $125 million
principal amount of the November 1998 Notes, yielding net proceeds of
approximately $122 million. We intend to continue to use the net proceeds from
this issuance to fund market expansion, the on-going development and
construction of our fiber optic network, product development and general
corporate purposes.
In April 1999, we filed a registration statement with the Securities and
Exchange Commission for the issuance from time to time of up to $300 million in
equity securities, including common stock, preferred stock, shares of preferred
stock represented by depositary shares, warrants exercisable for common stock,
preferred stock or depositary shares, subscription rights evidencing the right
to purchase any of these securities and stock purchase contracts to purchase
common stock or preferred stock and stock purchase units. The common stock we
issued and sold in May 1999, as described below, was registered pursuant to this
registration statement.
In May 1999, we completed an underwritten public offering and sale of
6,037,500 shares of our common stock, yielding net proceeds to us of
approximately $120.9 million. We intend to continue to use the net proceeds
from this offering (1) to fund an accelerated market expansion of our
telecommunications business, including expansion of our fiber optic network,
expansion of our local ISP telecommunications services and the opening of new
sales offices, and (2) for additional working capital and other general
corporate purposes.
In May 1999, we completed a private offering and sale of $100 million
aggregate principal amount of the 1999 Convertible Subordinated Notes. The 1999
Convertible Subordinated Notes bear interest at an annual rate of 4 1/2%
payable each May 15 and November 15, beginning November 15, 1999. These notes
are unsecured general obligations of ours and are convertible into common stock
at any time after August 10, 1999, at a conversion price of $26.67 per share,
subject to adjustment in certain events. We may redeem these notes or make the
notes nonconvertible under specified circumstances before May 17, 2002. We
intend to continue to use the net proceeds from this issuance (1) to fund an
accelerated expansion of our fiber optic network and (2) to purchase switching
equipment, inventory, and other electronics and network assets related (a) to
our fiber optic network and (b) to our provision of primary rate interface
connectivity to ISPs.
At December 31, 1999, we had entered into agreements with vendors to
purchase approximately $52 million of equipment and services, and, for the year
ended December 31, 1999, had made capital expenditures of $165.5 million. We
currently estimate that our aggregate capital requirements for our existing
lines of business will range from $235 million to $245 million in 2000,
inclusive of the $52 million in commitments as of December 31, 1999. We expect
to make substantial capital expenditures thereafter. We intend to make capital
expenditures in 2000 primarily for the following:
. accelerated expansion of our fiber optic network in Texas, including
Austin and San Antonio, and in Tennessee, including Memphis,
Nashville, Chattanooga and Knoxville;
. continued acquisition and installation of switches and related
equipment related to our facilities-based local telephone service
offering;
. continued addition of switching capacity, electrical equipment and
additional collocation space in connection with the expansion of our
ISP local telecommunications services;
. market expansion; and
. infrastructure enhancements, principally for information systems.
In February 2000, we received a commitment from Morgan Stanley Senior
Funding, Inc., Bank of America Securities and Goldman Sachs Credit Partners L.P.
to fully underwrite a $160 million senior secured credit facility. This credit
facility will be subject to customary conditions for a transaction of its type,
including without limitation, completion of definitive documentation and
finalization of all terms and conditions. We expect this credit facility to be
syndicated and fully funded by March 31, 2000, completely drawn at closing and
not subject to financial maintenance covenants.
In March 2000, we expect to enter a new business we have launched, to be
operated as e/\DeltaCom, to extend and enhance our data and Internet access
products by offering customers collocation and Web server hosting
17
<PAGE>
services integral to operating business-critical applications over the Internet.
We expect to invest approximately $250 million of capital to cover capital
expenditures and working capital requirements during the first three years of
operations of this business, including approximately $65 million during 2000. We
expect the revenues from the business of e/\DeltaCom to be insignificant in
2000, while resulting in negative cash flow from operations of approximately $15
million. We will use some of the proceeds expected to be available under our new
$160 million senior secured credit facility to fund the operations of this new
business.
The actual amount and timing of our capital requirements may differ
materially from the foregoing estimate as a result of regulatory, technological
and competitive developments, including market developments and new
opportunities, or in the event we decide to make acquisitions or enter into
joint ventures and strategic alliances in our industry.
We may require additional capital to fund our growth, as well as to fund
continued operating losses and working capital. We believe that cash on hand,
cash flow from operations and anticipated borrowings under the $160 million
senior secured credit facility will provide sufficient funds to enable us to
expand our business as currently planned through the second quarter of 2001,
after which we may need to seek additional financing to fund capital
expenditures and working capital. We will review all of our alternatives for
obtaining additional equity investments. If these or other sources of funds are
unavailable, we may not have a ready source of liquidity. In the event that our
plans or assumptions change or prove to be inaccurate, the foregoing sources of
funds may prove to be insufficient to fund our currently planned growth and
operations. In addition, if we make acquisitions, we 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 we will be able to generate
sufficient cash flow from operations or that additional financing arrangements
will be available, or if available, that they can be concluded on terms
acceptable to us. Inability to generate or obtain sufficient funds would result
in delay or abandonment of some or all of our development and expansion plans,
which could have a material adverse effect on us.
Although our liquidity has improved, our level of indebtedness and debt
service obligations significantly increased as a result of our issuances of the
1997 Notes, the March 1998 Notes, the November 1998 Notes and the 1999
Convertible Subordinated Notes and will increase as a result of our anticipated
borrowings under our planned $160 million senior secured credit facility. The
successful implementation of our strategy, including expansion of our network
and obtaining and retaining a significant number of customers, and significant
and sustained growth in our cash flow are necessary for us to be able to meet
our debt service requirements. There can be no assurance that we will
successfully implement our strategy or that we will be able to generate
sufficient cash flow from operating activities to improve our earnings before
fixed charges, or 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.
Year 2000
We developed and implemented a comprehensive Year 2000 plan to guide us
through the evaluation, testing, remediation and implementation of all facets of
the Year 2000 transition, including among other things, the monitoring of any
potential adverse impact arising from services and equipment provided to us, by
our vendors within the telecommunications industry. In the hours after the Year
2000 date change, our network operations and information technology teams
validated and monitored our network elements, software and hardware operations,
and the business operation processes. To our knowledge, we experienced no
networking problems arising from the transition of our network into the year
2000. However, we may not have identified and remediated all significant Year
2000 problems. Further remediation efforts may involve significant time and
expense, and unremediated problems may have a material adverse effect on our
business.
18
<PAGE>
We sell our products and service to companies in a variety of industries,
each of which may be experiencing different Year 2000 issues. Customer
difficulties with Year 2000 issues might require us to devote additional
resources to resolve underlying problems.
Although we have not been made a party to any litigation or arbitration
proceeding to date involving our products or services and related to Year 2000
compliance issues, we may in the future be required to defend our products or
services in such proceedings, or to negotiate resolutions of claims based on
Year 2000 issues. The costs of defending and resolving Year 2000-related
disputes regardless of the merits of such disputes, and any liability for Year
2000-related damages, including consequential damages, would negatively affect
our business, results of operations, financial condition and liquidity, perhaps
materially.
We have incurred internal labor as well as consulting and other expenses
necessary to prepare our systems for the transition into the year 2000. Through
the end of 1999, we incurred approximately $2.1 million in external costs for
our Year 2000 program, inclusive of $1.0 million of costs incurred during the
year ended December 31, 1999. These costs have been expensed as incurred.
EFFECTS OF NEW ACCOUNTING STANDARDS
Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, provides guidance on accounting for the
costs of computer software developed or obtained for internal use. We adopted
Statement of Position 98-1 effective January 1, 1999, 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 was originally effective for fiscal years
beginning after June 15, 1999. SFAS No. 133 cannot be applied retroactively.
SFAS No. 133 must be applied to (1) derivative instruments and (2) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997. In June 1999, the FASB
issued SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133, which
amends SFAS No. 133 to be effective for all fiscal years beginning after June
15, 2000 or January 1, 2001 for companies with calendar-year fiscal years. We
expect to implement SFAS No. 137 for the fiscal year beginning January 1, 2001,
and do not expect the adoption of SFAS No. 137 will have a material effect on
our consolidated financial statements.
INFLATION
We do not believe that inflation has had a significant impact on our
consolidated operations in any of the three years ended December 31, 1999.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk related to our interest rate swap
agreement and our borrowings under our credit facility. There were no
borrowings outstanding under our credit facility as of December 31, 1999. In
addition, we are exposed to fair value risk related to our fixed-rate, long-term
debt. Our market risk sensitive instruments do not subject us to material
market risk exposures. See Note 5 to our consolidated financial statements
appearing elsewhere in this report for additional information.
19
<PAGE>
Item 7. Financial Statements and Exhibits
(c) Exhibits
23 - Consent of Arthur Andersen LLP
27 - Financial Data Schedule
99.1 - Audited Consolidated Financial Statements of
ITC/\DeltaCom, Inc. as of December 31, 1999 and 1998 and for
the three years ended December 31, 1999
99.2 - Certain Terms of Proposed Credit Facility
SIGNATURE
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.
By: /s/ Douglas A. Shumate
------------------------------
Douglas A. Shumate, Senior Vice
President and Chief Financial
Officer
Date: March 8, 2000
20
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated February 11, 2000 on the financial statements of
ITC/\DeltaCom, Inc. and Subsidiaries, included in this Form 8-K into
ITC/\DeltaCom, Inc.'s previously filed Registration Statement on Form S-8, File
No. 333-85627.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
March 6, 2000
<PAGE>
Exhibit 99.1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants............................ F-2
Consolidated Balance Sheets - December 31, 1999 and 1998............ F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1999, 1998 and 1997.................................. F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997.................................. F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997.................................. F-7
Notes to Consolidated Financial Statements.......................... F-9
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To ITC/\DeltaCom, Inc.:
We have audited the accompanying consolidated balance sheets of ITC/\DELTACOM,
INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1999 and 1998,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements (pages F3-F28) referred to above
present fairly, in all material respects, the consolidated financial position of
ITC/\DeltaCom, Inc. and subsidiaries as of December 31, 1999 and 1998 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
February 11, 2000
F-2
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31,
---------------------------------
1999 1998
------------ ------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................................... $ 248,431 $ 184,167
Restricted assets................................................... 6,741 14,300
Accounts receivable:
Customer, net of allowance for uncollectible accounts of
$1,524 and $1,260 in 1999 and 1998, respectively................. 47,377 34,219
Affiliates (Note 10)............................................. 4,047 3,307
Inventory........................................................... 5,074 1,635
Prepaid expenses.................................................... 6,011 591
Federal income tax receivables (Note 6)............................. 0 3,939
------------ ------------
Total current assets............................................. 317,681 242,158
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, net (Notes 2 and 3)................... 382,867 262,050
------------ ------------
OTHER LONG-TERM ASSETS:
Intangible assets, net (Notes 2 and 4).............................. 91,762 63,160
Restricted assets................................................... 0 5,735
Other assets........................................................ 15,288 14,414
------------ ------------
Total other long-term assets..................................... 107,050 83,309
------------ ------------
Total assets..................................................... $ 807,598 $ 587,517
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31,
----------------------
1999 1998
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable:
Trade........................................................................... $ 22,343 $ 12,810
Construction.................................................................... 8,516 7,233
Accrued interest................................................................. 8,281 8,049
Accrued compensation............................................................. 4,444 2,998
Unearned revenue................................................................. 14,625 11,457
Other accrued liabilities........................................................ 13,808 8,418
Current portion of long-term debt and capital lease obligations (Note 5)......... 751 1,075
--------- ---------
Total current liabilities..................................................... 72,768 52,040
--------- ---------
LONG-TERM LIABILITIES:
Deferred income taxes (Note 6)................................................... 512 418
Long-term debt and capital lease obligations (Note 5)............................ 516,156 416,859
--------- ---------
Total long-term liabilities................................................... 516,668 417,277
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 5 and 8)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; $7.40 liquidation preference; 5,000,000
shares authorized; 1,480,771 shares issued and outstanding in
1999 and 1998................................................................... 15 15
Common stock, $.01 par value; 90,000,000 shares authorized; 59,556,775 and
51,339,838 shares issued and outstanding in 1999 and 1998, respectively......... 595 513
Additional paid-in capital....................................................... 321,882 167,023
Accumulated deficit.............................................................. (104,330) (49,351)
--------- ---------
Total stockholders' equity.................................................... 218,162 118,200
--------- ---------
Total liabilities and stockholders' equity.................................... $ 807,598 $ 587,517
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-4
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING REVENUES................................................... $ 244,844 $ 171,838 $ 114,590
COST OF SERVICES..................................................... 118,721 82,979 54,550
----------- ----------- -----------
GROSS MARGIN......................................................... 126,123 88,859 60,040
----------- ----------- -----------
OPERATING EXPENSES:
Selling, operations, and administration............................ 96,854 64,901 38,255
Depreciation and amortization...................................... 53,810 30,887 18,332
----------- ----------- -----------
Total operating expenses........................................ 150,664 95,788 56,587
----------- ----------- -----------
OPERATING (LOSS) INCOME.............................................. (24,541) (6,929) 3,453
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense................................................... (45,293) (31,930) (21,367)
Interest income.................................................... 14,195 9,753 4,251
Other income (expense)............................................. 754 (3,254) 0
----------- ----------- -----------
Total other expense, net...................................... (30,344) (25,431) (17,116)
----------- ----------- -----------
LOSS BEFORE INCOME TAXES,
PREACQUISITION LOSS
AND EXTRAORDINARY ITEM.............................................. (54,885) (32,360) (13,663)
INCOME TAX EXPENSE (BENEFIT)......................................... 94 (6,454) (3,324)
----------- ----------- -----------
LOSS BEFORE PREACQUISITION
LOSS AND EXTRAORDINARY ITEM......................................... (54,979) (25,906) (10,339)
PREACQUISITION LOSS (Note 1)......................................... 0 0 74
----------- ----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM....................................... (54,979) (25,906) (10,265)
EXTRAORDINARY ITEM-- LOSS ON EARLY
EXTINGUISHMENT OF DEBT (LESS
RELATED INCOME TAX BENEFIT OF $2,133 and
$311 in 1998 and 1997, respectively)........................... 0 (8,436) (508)
----------- ----------- -----------
NET LOSS............................................................ $ (54,979) $ (34,342) $ (10,773)
=========== =========== ===========
BASIC AND DILUTED NET LOSS
PER COMMON SHARE:
Before extraordinary loss.......................................... $ (0.98) $ (0.51) $ (0.26)
Extraordinary loss................................................. (0.00) (0.16) (0.01)
----------- ----------- -----------
Net loss........................................................... $ (0.98) $ (0.67) $ (0.27)
=========== =========== ===========
Basic and diluted weighted average common shares
outstanding...................................................... 56,370,269 50,972,361 40,249,816
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Contributions Accumulated
------------------ ----------------
Shares Amount Shares Amount Paid-in Capital Receivable Deficit
------- -------- ------- -------- --------------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996.... 0 $ 0 30,000,000 $ 300 $ 23,343 $ (150) $ (4,236)
Initial capitalization of
ITC/\DeltaCom ............... 0 0 0 0 0 150 0
Capital contributions from
ITC Holding, net............. 0 0 0 0 52,070 0 0
Issuance of stock in
connection with merger
with ITC Holding............. 1,480,771 15 8,107,350 81 (96) 0 0
Sale of common stock, net of
offering expenses............ 0 0 11,500,000 115 87,385 0 0
Issuance of common stock
options...................... 0 0 0 0 580 0 0
Deferred compensation......... 0 0 0 0 (555) 0 0
Exercise of common stock
options...................... 0 0 27,762 0 37 0 0
Net loss...................... 0 0 0 0 0 0 (10,773)
--------- -------- ----------- -------- ---------- ------- ---------
BALANCE, December 31, 1997.... 1,480,771 15 49,635,112 496 162,764 0 (15,009)
Issuance of common stock for
IT Group acquisition......... 0 0 177,106 2 2,791 0 0
Deferred compensation......... 0 0 0 0 144 0 0
Exercise of common stock
options...................... 0 0 1,527,620 15 1,324 0 0
Net loss...................... 0 0 0 0 0 0 (34,342)
--------- -------- ----------- -------- ---------- ------- ---------
BALANCE, December 31, 1998.... 1,480,771 15 51,339,838 513 167,023 0 (49,351)
Sale of common stock, net of
offering expenses............ 0 0 6,037,500 60 120,869 0 0
Issuance of common stock for
AvData acquisition........... 0 0 983,511 10 29,180 0 0
Issuance of common stock for
SciTel acquisition........... 0 0 83,117 1 1,999 0 0
Retirement of common shares... 0 0 (3,473) 0 (55) 0 0
Deferred compensation......... 0 0 0 0 145 0 0
Exercise of common stock
options...................... 0 0 1,116,282 11 2,721 0 0
Net loss...................... 0 0 0 0 0 0 (54,979)
--------- -------- ----------- ------- ---------- ------- ---------
BALANCE, December 31, 1999.... 1,480,771 $ 15 59,556,775 $ 595 $321,882 $ 0 $(104,330)
========= ======== =========== ======= ========== ======= =========
<CAPTION>
Total
Stockholders
Equity
------
<S> <C>
BALANCE, December 31, 1996.... $ 19,257
Initial capitalization of
ITC/\DeltaCom ............... 150
Capital contributions from
ITC Holding, net............. 52,070
Issuance of stock in
connection with merger
with ITC Holding............. 0
Sale of common stock, net of
offering expenses............ 87,500
Issuance of common stock
options...................... 580
Deferred compensation......... (555)
Exercise of common stock
options...................... 37
Net loss...................... (10,773)
----------
BALANCE, December 31, 1997.... 148,266
Issuance of common stock for
IT Group acquisition......... 2,793
Deferred compensation......... 144
Exercise of common stock
options...................... 1,339
Net loss...................... (34,342)
----------
BALANCE, December 31, 1998.... 118,200
Sale of common stock, net of
offering expenses............ 120,929
Issuance of common stock for
AvData acquisition........... 29,190
Issuance of common stock for
SciTel acquisition........... 2,000
Retirement of common shares... (55)
Deferred compensation......... 145
Exercise of common stock
options...................... 2,732
Net loss...................... (54,979)
----------
BALANCE, December 31, 1999.... $218,162
==========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1999 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $ (54,979) $ (34,342) $(10,773)
--------- --------- --------
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities
(excluding the effects of acquisitions):
Depreciation and amortization............................ 53,810 30,887 18,332
Amortization of debt issuance costs...................... 2,112 1,622 721
Deferred income taxes.................................... 94 (5,883) 2,056
Extraordinary item--loss on early extinguishment
of debt................................................ 0 10,569 819
Other.................................................... 0 0 187
Changes in current operating assets and
liabilities:
Accounts receivable, net........................... (12,725) (14,075) (9,028)
Other current assets............................... (3,322) (2,164) 336
Accounts payable................................... 6,968 4,215 552
Accrued interest................................... 232 6,182 (4,054)
Unearned revenue................................... 985 6,678 4,016
Accrued compensation and other accrued
liabilities....................................... 1,491 5,823 3,138
--------- --------- --------
Total adjustments..................................... 49,645 43,854 17,075
--------- --------- --------
Net cash (used in) provided by operating activities... (5,334) 9,512 6,302
--------- --------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Capital expenditures...................................... (166,823) (148,304) (48,692)
Change in accounts payable-construction................... 1,283 462 4,818
Purchase of Gulf States FiberNet, net of cash
received (Note 11)....................................... 0 0 575
Purchase of AvData Systems, Inc., net of cash received
(Note 11)................................................ 2,881 0 0
Release (purchase) of restricted assets, net.............. 13,294 30,461 (50,496)
Other..................................................... (630) (785) (59)
--------- --------- --------
Net cash used in investing activities................. (149,995) (118,166) (93,854)
--------- --------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-7
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from issuance of 4 1/2% Convertible Subordinated
Notes, net of issuance costs................................ $ 96,954 $ 0 $ 0
Proceeds from issuance of 9 3/4% Senior Notes, net of
issuance costs.............................................. 0 121,397 0
Proceeds from issuance of 8 7/8 % Senior Notes, net of
issuance costs.............................................. 0 155,170 0
Proceeds from issuance of 11% Senior Notes, net of
issuance costs.............................................. 0 0 192,113
Repayment of 11% Senior Notes.................................. 0 (70,000) 0
Premium paid on early retirement of 11% Senior Notes........... 0 (7,700) 0
Proceeds from other long-term debt............................. 0 0 41,290
Payment of commitment fee...................................... 0 0 (2,719)
Repayment of other long-term debt and capital lease
obligations................................................. (1,102) (1,597) (93,894)
Repayment of advance from ITC Holding.......................... 0 0 (43,228)
Capital contributions from ITC Holding, net.................... 0 0 (624)
Proceeds from issuance of common stock, net of
offering expenses........................................... 120,929 0 87,650
Proceeds from exercise of common stock options................. 2,732 1,339 0
Retirement of common shares.................................... (55) 0 0
Other.......................................................... 135 (162) 37
--------- --------- ---------
Net cash provided by financing activities................... 219,593 198,447 180,625
--------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS....................... 64,264 89,793 93,073
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR.............................................. 184,167 94,374 1,301
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END
OF YEAR........................................................ $248,431 $184,167 $ 94,374
========= ========= =========
SUPPLEMENTAL CASH FLOW
DISCLOSURES:
Cash paid for interest......................................... $ 43,973 $ 25,477 $ 24,391
========= ========= =========
Cash paid (refunds received) for income taxes, net............. $ (3,949) $ (1,604) $ (6,287)
========= ========= =========
NONCASH TRANSACTIONS:
Note payable and capital lease obligation assumed in
AvData acquisition.......................................... $ 63 $ 0 $ 0
========= ========= =========
Issuance of common stock in connection with acquisition of
AvData...................................................... $ 29,190 $ 0 $ 0
========= ========= =========
Issuance of common stock in connection with acquisition of
SciTel...................................................... $ 2,000 $ 0 $ 0
========= ========= =========
Note payable and capital lease obligation assumed in
IT Group acquisition........................................ $ 0 $ 974 $ 0
========= ========= =========
Issuance of common stock in connection with acquisition
of IT Group................................................. $ 0 $ 2,793 $ 0
========= ========= =========
Equity portion of acquisition of 64% interest in
Gulf States FiberNet and Georgia Fiber Assets............... $ 0 $ 0 $ 21,695
========= ========= =========
Assumption of long-term debt related to
acquisition of Georgia Fiber Assets......................... $ 0 $ 0 $ 9,963
========= ========= =========
Forgiveness of long-term advances by ITC Holding............... $ 0 $ 0 $ 31,000
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-8
<PAGE>
ITC/\DELTACOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization, Basis of Presentation, and Nature of Business
Organization
Interstate FiberNet, Inc. (formerly ITC Transmission Systems, Inc.)
("FiberNet"), ITC Transmission Systems II, Inc. ("Transmission II"), Gulf States
Transmission Systems, Inc. ("GSTS"), and Eastern Telecom, Inc., d.b.a.
InterQuest ("InterQuest") (collectively, the "Fiber Companies"), as well as
ITC/\DeltaCom Communications, Inc. (formerly DeltaCom, Inc.), were wholly owned
subsidiaries of ITC Holding Company, Inc. ("ITC Holding"). ITC/\DeltaCom, Inc.
(the "Company") was incorporated on March 24, 1997 under the laws of the State
of Delaware, as a wholly owned subsidiary of ITC Holding, to acquire and operate
the Fiber Companies and ITC/\DeltaCom Communications, Inc. Upon receipt of
certain regulatory approvals and certain other consents on July 25, 1997, ITC
Holding completed the reorganization of such subsidiaries (the "Reorganization")
as follows:
a. InterQuest and Transmission II were merged with and into FiberNet.
b. ITC Holding contributed all of the outstanding capital stock of
FiberNet, ITC/\DeltaCom Communications, Inc. and GSTS to the
Company.
c. The Company contributed all of the outstanding capital stock of
ITC/\DeltaCom Communications, Inc. and GSTS to FiberNet.
At December 31, 1996, FiberNet and Transmission II together held 100% of
the ownership interests in Interstate FiberNet ("Interstate"), a Georgia general
partnership. Effective with the Reorganization, Interstate was absorbed by law
into FiberNet. GSTS held a 36% ownership interest 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 (Note 11) and contributed this interest to GSTS upon the Reorganization.
On December 29, 1997, GSTS 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 its stock in the
Company, and all of its liabilities to another entity and then merged with and
into the Company (the "Merger"). The Company was the surviving corporation in
the Merger.
Basis of Accounting and Financial Statement Presentation
The accompanying consolidated financial statements are prepared on the
accrual basis of accounting. The consolidated financial statements reflect the
Reorganization and the Merger in a manner similar to a pooling of interests and
include the accounts of the Company and its wholly owned subsidiaries. All
material intercompany accounts and transactions have been eliminated in
consolidation.
Prior to 1997, GSTS accounted for its 36% investment in Gulf States using
the equity method. To reflect the acquisition of the remaining 64% of Gulf
States, the revenues and expenses of Gulf States have been included in the
accompanying consolidated statement of operations for the year ended December
31, 1997, with the preacquisition loss attributable to the previous owner
deducted to determine the consolidated net loss of the Company.
Nature of Business
The Company operates in two business segments. ITC/\DeltaCom
Communications, Inc. is an integrated telecommunications service provider
operating primarily in the southern United States.
F-9
<PAGE>
ITC/\DeltaCom Communications, Inc. is engaged in the retail sale of local
exchange telephone services; long-distance telephone services such as
traditional switched and dedicated long-distance; toll-free calling; calling
card and operator services; ATM and frame relay; high-capacity broadband private
line services, as well as Intranet, Internet, and Web page hosting; and customer
premise equipment sale, installation and repair. ITC/\DeltaCom Communications,
Inc. primarily serves mid-sized and major regional businesses in the southern
United States (the "Retail Services").
The Fiber Companies are engaged in the sale of long-haul private-line
services on a wholesale basis to other telecommunications companies using their
owned and managed fiber optic network which extends throughout ten southern
states (Arkansas, Texas, Tennessee, Mississippi, Louisiana, Alabama, Georgia,
North Carolina, South Carolina, and Florida) (the "Carriers' Carrier Services").
The Company has experienced operating losses as a result of efforts to
build its network infrastructure and internal staffing, develop its systems, and
expand into new markets. Assuming financing is available, the Company expects to
continue to focus on increasing its customer base and expanding its network
operations. Accordingly, the Company expects that its cost of services, selling,
operations, and administration expenses and capital expenditures will continue
to increase significantly, all of which will have a negative impact on short-
term operating results. In addition, the Company may change its pricing policies
to respond to a changing competitive environment. FiberNet has obtained a five-
year, secured credit facility with Bank of America, N.A. (formerly NationsBank
of Texas, N.A.) (Note 5), and the Company has issued senior notes and equity
(Notes 5 and 7). In the opinion of management, the Company's current cash
position and available line of credit will be sufficient to meet the capital and
operating needs of the Company through at least 2000. However, there can be no
assurance that growth in the Company's revenue or customer base will continue or
that the Company will be able to achieve or sustain profitability and/or
positive cash flow.
Sources of Supplies
The Company voluntarily uses a single vendor for transmission equipment
used in its network. However, if this vendor were unable to meet the Company's
needs, management believes that other sources for this equipment exist on
commensurate terms and that operating results would not be adversely affected.
Credit Risk and Significant Customers
The Company's accounts receivable subject the Company to credit risk, as
collateral is generally not required. The Company's risk of loss is limited due
to advance billings to certain customers for services and the ability to
terminate access on delinquent accounts. The large number of customers
comprising the customer base mitigates the concentration of credit risk. In
1999, 1998 and 1997, no customer represented more than 10% of the Company's
consolidated operating revenues.
Regulation
The Company is subject to certain regulations and requirements of the
Federal Communications Commission and various state public service commissions.
Reclassifications
Certain reclassifications have been made to amounts previously reported to
conform to the current year presentation.
2. Summary of Significant Accounting Policies
Accounting Estimates
F-10
<PAGE>
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all short-term highly liquid investments with an
original maturity date of three months or less to be cash equivalents.
Inventory
Inventory consists primarily of customer premise equipment held for resale
and is valued at the lower of cost or market, using the first-in, first-out
method.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation of
property, plant and equipment is provided using the composite or straight-line
method over the following estimated useful lives:
<TABLE>
<CAPTION>
Years
---------------
<S> <C>
Buildings and towers............................... 30
Furniture, fixtures and office equipment........... 3 to 15
Vehicles........................................... 5
Telecommunications equipment....................... 5 to 20
</TABLE>
Intangible Assets
Intangible assets include the excess of the purchase price of acquisitions
over the fair value of identifiable net assets acquired as well as various other
acquired intangibles. Intangible assets are amortized over the following
estimated useful lives:
<TABLE>
<CAPTION>
Years
---------------
<S> <C>
Goodwill 20 to 40
Trademark.......................................... 40
Customer base...................................... 5 to 12
Noncompete agreements.............................. 2 to 3
</TABLE>
Restricted Assets
Restricted assets include investments in U.S. government treasury notes
that are classified as held-to-maturity and are reported at amortized costs.
These investments represent a portion of the proceeds from the Company's senior
notes offering in 1997 (Note 5) that are held by a trustee as security for and
to fund the first six interest payments on these notes.
Other Long-Term Assets
Other long-term assets primarily include debt issuance costs that are
amortized using the effective interest rate method over the life of the related
debt.
Long-Lived Assets
The Company reviews its long-lived assets, such as property, plant and
equipment and intangible assets, for impairment at each balance sheet date or
whenever events or changes in circumstances indicate that the carrying amount of
an asset should be assessed. Management evaluates the intangible assets related
F-11
<PAGE>
to each acquisition individually to determine whether impairment has occurred.
Management believes its long-lived assets in the accompanying balance sheet are
appropriately valued.
Unearned Revenue
Unearned revenue represents the liability for advance billings to customers
for use of the Company's fiber-optic network. Customers are billed in advance
for fixed monthly charges.
Unbilled Revenue
ITC/\DeltaCom Communications, Inc. records unbilled revenue for long-
distance services provided to customers but not yet billed. Approximately $7.3
million and $4.9 million in unbilled revenue are included in accounts receivable
in the accompanying consolidated balance sheets at December 31, 1999 and 1998,
respectively.
Income Taxes
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred taxes are determined based on the
difference between the financial and tax bases of assets and liabilities using
enacted tax rates in effect in the years in which the differences are expected
to reverse.
The Internal Revenue Code and applicable state statutes provide that the
income and expenses of a partnership are not separately taxable to the
partnership but rather accrue directly to the partners. Accordingly, the
accompanying financial statements include provisions for federal and state
income taxes related to partnership interests in Interstate and Gulf States held
by FiberNet, Transmission II, and GSTS prior to the Reorganization.
The Company was included in the consolidated federal income tax return of
ITC Holding through 1996. Under a tax-sharing arrangement with ITC Holding,
prior to the Merger the Company was paid for the utilization of net operating
losses included in the consolidated tax return, even if such losses could not
have been used if the Company were to have filed on a separate return basis. As
a result of the Merger (Note 1), ITC Holding's consolidated results of
operations through October 20, 1997 were included in the Company's 1997
consolidated federal income tax return. The Company and its subsidiaries file
separate state income tax returns.
Revenue Recognition
Revenues are recognized as services are provided and consist primarily of
charges for use of telecommunications services and for use of the Company's
fiber-optic network.
Fair Value of Financial Instruments
The carrying values of the Company's financial instruments approximate
their fair values as of December 31, 1999 and 1998, except for the Company's 11%
Senior Notes due 2007, 8 7/8% Senior Notes due 2008, 9 3/4 Senior Notes due 2008
and 4 1/2% Convertible Subordinated Notes due 2006 (Note 5). Based on their
quoted market prices, such notes have fair values at December 31, 1999 and 1998
as follows (in thousands):
F-12
<PAGE>
<TABLE>
<CAPTION>
1999 1998
---- ----
Instrument Fair Value Carrying Value Fair Value Carrying Value
---------- ---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
11% Senior Notes $137,150 $130,000 $142,025 $130,000
8 7/8% Senior Notes 153,200 160,000 156,000 160,000
9 3/4% Senior Notes 125,938 125,000 129,375 125,000
4 1/2% Convertible
Subordinated Notes 119,230 100,000 0 0
-------- -------- -------- --------
$535,518 $515,000 $427,400 $415,000
======== ======== ======== ========
</TABLE>
Advertising Costs
The Company expenses all advertising costs as incurred.
3. Property, Plant and Equipment
Balances of major classes of property, plant and equipment and the related
accumulated depreciation as of December 31, 1999 and 1998 are as follows (in
thousands):
<TABLE>
<CAPTION>
1999 1998
------------------- ------------------
<S> <C> <C>
Land................................................................ $ 889 $ 527
Buildings and towers................................................ 28,493 17,327
Furniture, fixtures and office equipment............................ 27,220 16,621
Vehicles............................................................ 4,097 2,367
Assets under capital lease.......................................... 3,470 3,470
Telecommunications equipment........................................ 392,301 246,631
--------- --------
456,470 286,943
Less accumulated depreciation....................................... (103,857) (53,930)
--------- --------
Net property, plant and equipment in service........................ 352,613 233,013
Assets under construction........................................... 30,254 29,037
--------- --------
Property, plant and equipment, net.................................. $ 382,867 $262,050
========= ========
</TABLE>
4. Intangible Assets
Intangible assets and the related accumulated amortization as of December
31, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
------------------- -------------------
<S> <C> <C>
Goodwill............................................................ $ 87,403 $58,994
Customer base....................................................... 12,839 9,570
Noncompete agreements............................................... 727 427
Trademark........................................................... 40 40
Other............................................................... 432 432
-------- -------
101,441 69,463
Less accumulated amortization....................................... (9,679) (6,303)
-------- -------
Intangible assets, net.............................................. $ 91,762 $63,160
======== =======
</TABLE>
See Note 11 for discussion of intangible assets recorded in 1999 related to
acquisitions of AvData Systems, Inc. and Scientific Telecommunications, Inc. and
for a discussion of intangible assets recorded in 1998 related to the
acquisition of PSP Marketing Group, Inc. d/b/a IT Group Communications.
F-13
<PAGE>
5. Financing Obligations
Long-Term Debt
Long-term debt at December 31, 1999 and 1998 consist of the following (in
thousands):
<TABLE>
<CAPTION>
1999 1998
--------- ----------
<S> <C> <C>
11% Senior Notes due 2007.......................................................... $130,000 $130,000
8 7/8% Senior Notes due 2008, net of unamortized discount of $131 and $147 in
1999 and 1998, respectively....................................................... 159,869 159,853
9 3/4% Senior Notes due 2008....................................................... 125,000 125,000
4 1/2% Convertible Subordinated Notes due 2006.................................... 100,000 0
Other.............................................................................. 0 438
-------- --------
514,869 415,291
Less current maturities............................................................ 0 (438)
-------- --------
Long-term debt, net of current portion............................................. $514,869 $414,853
======== ========
Maturities of long-term debt at December 31, 1999 are as follows (in thousands):
2000............................................................................... $ 0
2001............................................................................... 0
2002............................................................................... 0
2003............................................................................... 0
2004............................................................................... 0
Thereafter......................................................................... 515,000
--------
$515,000
========
</TABLE>
Lease Obligations
The Company has entered into various operating and capital leases for
facilities and equipment used in its operations. Aggregate future minimum rental
commitments under noncancelable operating leases with original or remaining
periods in excess of one year and maturities of capital lease obligations as of
December 31, 1999 are as follows (in thousands):
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
------------- -----------
<S> <C> <C>
2000...................................................................... $10,422 $ 956
2001...................................................................... 9,843 369
2002...................................................................... 8,732 318
2003...................................................................... 7,747 316
2004...................................................................... 7,470 316
Thereafter................................................................ 13,491 368
------- ------
$57,705 2,643
=======
Less amounts representing interest............................................. (605)
------
Present value of net minimum lease payments.................................... 2,038
Less current portion........................................................... (751)
------
Obligations under capital leases, net of current portion....................... $1,287
======
</TABLE>
Rental expense charged to operations for the years ended December 31, 1999,
1998, and 1997 was $10.0 million, $7.4 million, and $6.2 million, respectively.
Notes Offerings
On June 3, 1997, the Company completed the issuance of $200 million
principal amount of 11% Senior Notes due 2007 (the ''1997 Notes''). Interest is
payable semiannually on June 1 and December 1. On March 3, 1998, the Company
completed the issuance of $160 million principal amount of 8 7/8% Senior Notes
due 2008 at a price of 99.9% (the "March 1998 Notes") for an effective yield of
8.88%. Interest is payable semiannually on March 1 and September 1. On November
5, 1998, the Company completed the
F-14
<PAGE>
issuance of $125 million principal amount of 9 3/4% Senior Notes due 2008 (the
"November 1998 Notes"). Interest is payable semiannually on May 15 and November
15. On May 12, 1999, the Company completed the issuance of $100 million
principal amount of 4 1/2% Convertible Subordinated Notes due 2006 (the "1999
Notes"). Interest is payable semiannually on May 15 and November 15.
Proceeds from the 1997 Notes were held by the trustee until all regulatory
approvals related to the Reorganization described in Note 1 were received. Upon
their release, a portion of the proceeds was used to repay approximately $48
million of the Company's advances from ITC Holding and approximately $41.6
million under the GSTS Bridge Facility discussed below, as well as accrued
interest. At December 31, 1999, approximately $6.7 million of such proceeds are
held by the trustee as security for, and to fund, the next payment on these
notes due on June 1, 2000.
On April 2, 1998, the Company used proceeds from its initial public
offering of common stock to redeem $70 million principal amount of its 1997
Notes at a redemption price of 111% of the principal amount thereof, plus
accrued and unpaid interest. In conjunction with this redemption, the Company
recorded a pre-tax extraordinary loss of $10.6 million (approximately $8.4
million after tax), consisting of a $7.7 million redemption premium and a $2.9
million write off of debt issuance costs.
The 1997 Notes, the March 1998 Notes, and the November 1998 Notes
(collectively the "Senior Notes") are general, unsubordinated and unsecured
senior obligations of the Company. The Company's subsidiaries have no obligation
to pay amounts due on the Senior Notes and do not guarantee the Senior Notes.
Therefore, the Senior Notes are effectively subordinated to all liabilities of
ITC/\DeltaCom's subsidiaries, including trade payables. Any rights of the
Company and its creditors, including holders of the Senior Notes, to participate
in the assets of any subsidiary of the Company upon any liquidation or
reorganization of any such subsidiaries will be subject to the prior claims of
that subsidiary's creditors. The Senior Notes are subject to certain covenants
that, among other things, restrict the ability of ITC/\DeltaCom and its
subsidiaries to incur additional indebtedness, pay dividends or make
distributions.
The 1999 Notes are unsecured general obligations of the Company, and are
convertible into common stock any time after August 10, 1999, at a conversion
price of $26.67 per share, subject to adjustment in certain events.
ITC/\DeltaCom may redeem the notes or make the notes nonconvertible under
certain circumstances before May 17, 2002.
GSTS Bridge Facility
In connection with the acquisition of the remaining 64% interest in Gulf
States in March 1997 (Note 11), GSTS refinanced Gulf States' outstanding
indebtedness of approximately $41.6 million with a bridge facility (the "GSTS
Bridge Facility"). In connection with the refinancing, GSTS wrote off $819,000
($508,000 net of tax benefits) in unamortized debt issuance costs, which is
reflected in the accompanying statement of operations as an extraordinary loss
on early extinguishment of debt. The GSTS Bridge Facility, which bore interest
at LIBOR plus 2.25%, matured on the date the proceeds from the Company's
offering of the 1997 Notes were released (July 25, 1997).
GSTS did not retire a forward starting interest rate swap agreement (the
"Swap"), which swapped the variable interest rate with a fixed rate of 8.25%,
held by Gulf States in connection with this refinancing. At December 31, 1999,
the Swap had a notional amount of approximately $23.8 million. At December 31,
1999, the Company would be required to pay approximately $751,000 to terminate
the Swap. The Company made payments totaling approximately $851,000, $898,000
and $990,000 during 1999, 1998 and 1997, respectively, in connection with the
Swap, which are included in other income (expense) in the accompanying
consolidated statements of operations. While borrowings were outstanding under
the GSTS Bridge Facility, the Swap was accounted for as a hedge. The Company
planned to continue accounting for this agreement as a hedge of an anticipated
transaction, in connection with planned borrowings under the Credit Agreement,
as defined below. The interest rate swap agreement expires in December 2002.
F-15
<PAGE>
Upon receipt of the proceeds from the March 1998 Notes, the Company ceased
accounting for the Swap as a hedge of an anticipated transaction and began
accounting for the Swap as a trading security. The Swap is marked to market at
each balance sheet date and the related gain (loss) is included in other income
(expense). For the year ended December 31, 1999, the Company recorded
approximately $754,000 in other income related to the Swap agreement. For the
year ended December 31, 1998, the Company recorded approximately $3.3 million in
other expense related to the Swap.
Credit Agreement
On September 17, 1997, FiberNet entered into a credit agreement with Bank
of America, N.A., as administrative lender, and certain other lenders (the
''Credit Agreement''). The Credit Agreement originally provided for a term and
revolving credit facility of up to $100 million to be used for working capital
and other purposes, including refinancing existing indebtedness, capital
expenditures, and permitted acquisitions. The Credit Agreement matures on
September 15, 2002 and included a $50 million multidraw term loan facility and a
$50 million revolving credit facility allowing for amounts to be drawn under the
term loan facility until September 15, 1999. All $50 million of the term loan
facility was required to be utilized before any amount over $10 million could be
drawn down under the revolving credit facility. Amounts drawn under the Credit
Agreement will bear interest, at FiberNet's option, at either the Base Rate or
LIBOR, plus an applicable margin.
In connection with the 1999 Notes offering, the Company amended its secured
revolving credit facility with Bank of America, N.A., to permit (1) the merger
with AvData Systems, Inc. (see Note 11), (2) the issuance of the common stock in
the May 1999 common stock offering (see Note 7) and (3) the issuance of and
payment of interest on the 1999 Notes, the redemption of the 1999 Notes and the
issuance of common stock upon conversion of the 1999 Notes.
Borrowings under the Credit Agreement are guaranteed by the Company and are
secured by a first priority lien on substantially all current and future assets
and properties of FiberNet and its subsidiaries and a first priority pledge of
the stock of FiberNet and its subsidiaries. No amounts were outstanding under
the Credit Agreement at December 31, 1999 or 1998. The Credit Agreement contains
covenants limiting the Company's ability to incur debt or make guaranties,
create liens, pay dividends, make distributions or stock repurchases, make
investments or capital expenditures, issue capital stock, engage in transactions
with affiliates, sell assets, and engage in mergers and acquisitions. The Credit
Agreement also requires the Company to comply with certain financial tests and
to maintain certain financial ratios on a consolidated basis.
6. Income Taxes
Details of the income tax expense (benefit) for the years ended December
31, 1999, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------- ------- -------
<S> <C> <C> <C>
Current:
Federal............................... $ - $(3,277) $(6,141)
State................................. - 573 12
-------- ------- -------
Total current...................... - (2,704) (6,129)
-------- ------- -------
Deferred:
Federal............................... (20,125) (6,871) 2,679
State................................. (2,273) (1,194) (264)
Increase in valuation allowance.......... 22,492 4,315 390
-------- ------- -------
Total deferred..................... 94 (3,750) 2,805
-------- ------- -------
Total expense (benefit)............ $ 94 $(6,454) $(3,324)
======== ======= =======
</TABLE>
The tax effects of temporary differences between the carrying amounts of
assets and liabilities in the consolidated financial statements and their
respective tax bases, which give rise to deferred tax assets and liabilities, as
of December 31, 1999 and 1998 are as follows (in thousands):
F-16
<PAGE>
<TABLE>
<CAPTION>
1999 1998
---------- ---------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............................... $ 50,002 $ 20,302
Alternative minimum tax credit carryforward.................... 350 350
Interest rate swap............................................. 608 895
Other.......................................................... 1,461 1,132
-------- --------
52,421 22,679
-------- --------
Deferred tax liabilities:
Property....................................................... (21,420) (14,253)
Other.......................................................... (326) (149)
-------- --------
(21,746) (14,402)
-------- --------
Net deferred tax assets........................................... 30,675 8,277
Valuation allowance............................................... (31,187) (8,695)
-------- --------
Net deferred tax liabilities...................................... $ (512) $ (418)
======== ========
</TABLE>
During 1998, the Company recorded a receivable for federal income taxes of
approximately $3.9 million in connection with the carry back of a portion of its
1998 federal net operating loss. At December 31, 1999, the Company had federal
and state net operating loss carryforwards of approximately $128.0 million and
$167.8 million, respectively. The carryforwards expire primarily in 2018 and
2019. As the Company is unable to conclude that it is more likely than not that
it will be able to realize the benefit of its deferred tax assets, it has
provided a 100% valuation allowance against the net amount of such assets at
December 31, 1999. In addition to the $4.3 million increase in the 1998
valuation allowance recorded within the income tax provision, approximately $1.9
million of the 1998 valuation allowance increase was allocated to the
extraordinary item (Note 5). Also, the Company realized the benefit of non-
qualified stock compensation expense for tax purposes in excess of stock
compensation expense for book purposes of approximately $2.7 million and $2.1
million for the years ended December 31, 1999 and 1998, respectively. This
amount has been credited directly against additional paid-in capital, net of a
full valuation allowance. The net deferred tax liabilities at December 31, 1999
of $512,000 represent certain net state deferred tax liabilities.
Section 382 of the Internal Revenue Code of 1986, as amended, limits the
utilization of net operating loss carryforwards when there are changes in
ownership greater than 50%, as defined. If such a change occurs, the timing of
the Company's utilization of its U.S. net operating loss carryforwards could be
affected.
A reconciliation of the federal statutory income tax rate to the effective
income tax rate for the periods presented is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Federal statutory rate......................................... (34)% (34)% (34)%
State income taxes, net of federal benefit..................... (4) (2) (3)
Permanent differences.......................................... (3) 3 6
Increase in valuation allowance................................ 41 13 3
Other.......................................................... 0 0 4
---- ---- ----
Effective income tax rate...................................... 0% (20)% (24)%
==== ==== ====
</TABLE>
F-17
<PAGE>
7. Equity Interests
Merger With ITC Holding
In connection with the Merger (Note 1), holders of ITC Holding's common
stock and convertible preferred stock received 4.59045 shares of the Company's
common stock and Series A convertible preferred stock. Fractional shares were
paid in cash.
Initial Public Offering
During October 1997, the Company completed the sale of 11,500,000 shares of
its common stock to the public at an offering price of $8.25 a share. The
proceeds of the offering, net of offering expenses, were $87.7 million.
Stock Split
On July 29, 1998, the Company announced a two-for-one stock split of its
common stock to be effected in the form of a stock dividend (the "Stock Split").
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, except shares
authorized, and to per share information in the consolidated financial
statements have been adjusted to reflect the Stock Split on a retroactive basis.
Registration Statement
In April 1999, the Company filed a registration statement with the
Securities and Exchange Commission for the issuance from time to time of up to
$300 million in equity securities, including common stock, preferred stock,
shares of preferred stock represented by depositary shares, warrants exercisable
for common stock, preferred stock or depositary shares, subscription rights
evidencing the right to purchase any of these securities and stock purchase
contracts to purchase common stock or preferred stock and stock purchase units.
Common Stock Offering
In May 1999, the Company completed an underwritten public offering and sale
of 6,037,500 shares of its common stock to the public, yielding net proceeds to
the Company of approximately $120.9 million.
Employee Stock Option Plan
Upon the Reorganization, all employees of the Company became eligible to
receive stock options under the Company's 1997 Stock Option Plan, as amended
(the "Stock Option Plan"), which was adopted by the Company and approved by ITC
Holding on March 24, 1997.
The Stock Option Plan provides for the grant of options that are intended
to qualify as "incentive stock options" under Section 422 of the Code to
employees of the Company, its subsidiaries, and ITC Holding, as well as the
grant of non-qualifying options to any other individual whose participation in
the Stock Option Plan is determined to be in the best interests of the Company.
The Stock Option Plan authorizes the issuance of up to 4,815,000 shares of the
Company's common stock pursuant to options granted under the Stock Option Plan
(subject to antidilution adjustments in the event of a stock split,
recapitalization, or similar transaction). On May 13, 1999, the Company's
stockholders approved an increase in the number of options authorized to be
granted under the 1997 Stock Option Plan from 4,815,000 to 7,815,000. The
maximum number of shares subject to options that can be awarded under the Stock
Option Plan to any person is 1,605,000 shares. The compensation committee of the
Company's board of directors will administer the Stock Option Plan and will
grant options to purchase common stock.
F-18
<PAGE>
The option exercise price for incentive stock options granted under the
Stock Option Plan may not be less than 100% of the fair market value of the
common stock on the date of grant of the option (or 110% in the case of an
incentive stock option granted to an optionee beneficially owning more than 10%
of the outstanding common stock). The option exercise price for non-incentive
stock options granted under the Stock Option Plan may not be less than the par
value of the common stock on the date of grant of the option. The maximum option
term is 10 years (or five years in the case of an incentive stock option granted
to an optionee beneficially owning more than 10% of the outstanding common
stock). There is also a $100,000 limit on the value of common stock (determined
at the time of grant) covered by incentive stock options that become exercisable
by an optionee in any year. Options granted will become exercisable with respect
to 50% of the shares subject to the options on the second anniversary of the
date of grant and with respect to 25% of the shares subject to the options on
each of the third and fourth anniversaries of the date of grant.
The Company's board of directors may amend or terminate the Stock Option
Plan with respect to shares of common stock as to which options have not been
granted.
On March 24, 1997 and July 29, 1997, the Company granted options to
purchase 2,532,690 shares and 337,866 shares, respectively, of common stock
under the Stock Option Plan. All options were granted at a price at least equal
to the estimated fair value of the common stock on the date of grant ($2.25) as
determined by the Company's board of directors based on equity transactions and
other analyses. Options to purchase an additional 96,502 shares of common stock
at $2.25 per share were granted on October 1, 1997. At December 31, 1999 and
1998, unamortized compensation expense of $266,000 and $410,000, respectively,
is recorded as an offset to equity in the accompanying balance sheet related to
the options granted October 1, 1997, since the price of the options was below
fair market value. Compensation expense is recognized over the vesting period.
Following the Company's initial public offering, options to purchase an
additional 123,830 shares of common stock at $8.63 per share were granted on
October 28, 1997. The $8.63 per share represents the closing sale price of the
Company's stock on the date of grant.
Director Stock Option Plan
On March 24, 1997, the Company adopted and its stockholders approved the
Director Stock Option Plan (the "Director Plan"). The Director Plan provides for
the "formula" grant of options that are not intended to qualify as "incentive
stock options" under Section 422 of the Code to directors of the Company who are
not officers or employees of the Company or ITC Holding, (each an "Eligible
Director"). The Director Plan authorizes the issuance of up to 481,500 shares of
common stock pursuant to options granted under the Director Plan (subject to
antidilution adjustments in the event of a stock split, recapitalization, or
similar transaction). The option exercise price for options granted under the
Director Plan will be at least 100% of the fair market value of the shares of
common stock on the date of grant of the option. Under the Director Plan, each
Eligible Director will be granted an option to purchase 32,100 shares of common
stock upon such person's initial election or appointment to serve as director.
Options granted will become exercisable with respect to 50% of the shares
subject to the options on the second anniversary of the date of grant and with
respect to 25% of the shares subject to the options on each of the third and
fourth anniversaries of the date of grant. The options will expire ten years and
30 days after the date of grant.
On March 24, 1997, the Company granted options to purchase 32,100 shares of
its common stock to each of its six non-employee directors. All options were
granted at a price equal to the estimated fair value of the common stock on the
date of grant ($2.25) as determined by the Company's board of directors based on
equity transactions and other analyses.
ITC Holding Stock Option Plan
Prior to the Merger, ITC Holding sponsored a stock option plan which
provided for the granting of stock options to substantially all employees of ITC
Holding and its wholly owned and majority owned subsidiaries, including the
Company. Options were generally granted at a price (established by ITC
F-19
<PAGE>
Holding's board of directors based on equity transactions and other analyses)
equal to at least 100% of the fair market value of ITC Holding's common stock on
the option grant date. Options granted generally became exercisable 40% after
two years and 20% per annum for the next three years and remained exercisable
for ten years after the option grant date. At December 31, 1996, employees of
the Company held outstanding options for a total of 314,768 of ITC Holding's
shares at option prices ranging from $7.60 to $30.50 per share. In connection
with the Merger and the related spin-off of ITC Holding's other subsidiaries,
stock options outstanding under ITC Holding's stock option plan were adjusted.
Each ITC Holding option holder received an option in the spin-off entity and
4.59045 options in the Company (the "Replacement Options"). All Replacement
Options were at exercise prices that preserved the economic benefit of the ITC
Holding options at the spin-off and merger date. As a result, options for
7,080,176 shares of the Company's Common Stock were issued under the Stock
Option Plan at exercise prices ranging from $0.16 per share to $4.44 per share.
Statement of Financial Accounting Standards (SFAS) No. 123
The Company accounts for its stock based compensation plans under
Accounting Principles Board Opinion No. 25, under which no compensation cost is
recognized for options granted with an exercise price equal to the fair market
value of the Company's common stock at the grant date. The Company has computed,
for pro forma disclosure purposes, the value of all options for shares of common
stock granted to employees of the Company using the Black-Scholes option pricing
model and the following weighted average assumptions:
1999 1998 1997
---- ---- ----
Risk-free interest rate....... 5.79% 5.26% 6.00%
Expected dividend yield....... 0% 0% 0%
Expected lives................ Seven years Ten years Ten years
Expected volatility........... 79.17% 77.45% 60%
The weighted average fair value of options and Replacement Options granted
to employees of the Company in 1999, 1998 and 1997 was $19.19, $13.48 and $7.34
per share, respectively. The total value of options and Replacement Options for
common stock granted to employees of the Company during 1999, 1998 and 1997 was
computed as approximately $35.4 million, $16.2 million and $14.2 million
(including approximately $7.7 million related to the Replacement Options in
1997), respectively, which would be amortized on a pro forma basis over the
four-year vesting period of the options (five-year vesting period as to the
Replacement Options). If the Company had accounted for these plans in accordance
with SFAS No. 123, Accounting for Stock Based Compensation, the Company's net
loss for the years ended December 31, 1999, 1998 and 1997 would have increased
as follows:
Net loss (in thousands) 1999 1998 1997
- ----------------------- ---- ---- ----
As Reported $(54,979) $(34,342) $(10,773)
Pro Forma $(69,301) $(41,159) $(20,415)
Basic and diluted net loss per share
- ------------------------------------
As Reported $ (0.98) $ (0.67) $ (0.27)
Pro Forma $ (1.23) $ (0.81) $ (0.54)
A summary of the status of the Company's portion of ITC Holding's
stock option plan through the date of the Merger is as follows:
Weighted Average
Exercise Price
Shares Per Option
------ ----------
Outstanding at December 31, 1996 314,768 $22.17
Granted 43,840 31.75
Exercised (6,500) 9.49
Forfeited (18,178) 25.81
-------
Outstanding at October 20, 1997 333,930 23.48
=======
F-20
<PAGE>
A summary of the status of the Company's stock option plans at December 31,
1999 and changes during the period from inception on March 24, 1997 through
December 31, 1999 are as follows:
Weighted Average
Exercise Price
Shares Per Option
------ ----------
Assumed in the Merger 7,080,176 $ 2.18
Granted 3,283,284 2.47
Exercised (27,762) 1.35
Forfeited (75,476) 2.41
----------
Outstanding at December 31, 1997 10,260,222 2.33
Granted 1,282,954 16.46
Exercised (1,573,528) 1.11
Forfeited (427,994) 5.84
----------
Outstanding at December 31, 1998 9,541,654 4.28
Granted 2,014,750 25.42
Exercised (1,116,282) 2.45
Forfeited (565,109) 13.33
----------
Outstanding at December 31, 1999 9,875,013 8.28
==========
The following table sets forth the exercise price range, number of shares,
weighted average exercise price, and remaining contractual lives by groups of
similar price and grant date:
<TABLE>
<CAPTION>
Weighted
Average Weighted Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise as of Contractual Exercise As of Exercise
Prices Dec. 31, 1999 Life Price Dec. 31, 1999 Price
------ ------------- ---- ----- ------------- -----
<S> <C> <C> <C> <C> <C>
$0.00 - $2.94 4,632,538 5.7 $ 1.89 3,101,554 $ 1.72
$2.94 - $5.88 2,305,669 6.7 3.55 989,960 3.42
$5.88 - $8.81 61,537 7.8 8.63 23,404 8.63
$8.81 - $11.75 210,420 8.1 9.78 0 0.00
$11.75 - $14.69 343,183 8.3 14.15 1,741 12.66
$14.69 - $17.63 320,810 9.1 15.77 0 0.00
$17.63 - $20.56 211,932 8.8 18.00 0 0.00
$20.56 - $23.50 260,081 8.4 22.79 9,926 21.09
$23.50 - $26.44 430,195 9.8 24.17 6,524 23.91
$26.44 - $29.38 1,098,648 9.5 29.31 0 0.00
</TABLE>
At December 31, 1999, 4,133,109 options for the Company's stock with a
weighted average price of $2.25 per share were exercisable by employees of the
Company. At December 31, 1998, 2,565,963 options for the Company's stock with a
weighted average exercise price of $1.69 per share were exercisable by employees
of the Company. At December 31, 1997, 3,159,134 options for the Company's stock
with a weighted average exercise price of $1.50 per share were exercisable by
employees of the Company.
8. Commitments and Contingencies
Purchase Commitments
At December 31, 1999 the Company had entered into agreements with vendors
to purchase approximately $52 million of equipment related to the improvement
and installation of switches, other network expansion efforts and certain
services, the majority of which is expected to be purchased in 2000.
F-21
<PAGE>
Legal Proceedings
In the normal course of business, the Company is subject to various
litigation; however, in management's opinion and the opinion of counsel, there
are no legal proceedings pending against the Company that would have a material
adverse effect on the financial position, results of operations, or liquidity of
the Company.
Reciprocal Interconnection Charges
In connection with offering local exchange services, the Company entered
into a resale and interconnection agreement (the "Interconnection Agreement")
with BellSouth Corporation ("BellSouth") effective July 1, 1997. On July 1,
1999, the Company's Interconnection Agreement with BellSouth expired. The
Company is currently in arbitration with BellSouth, in all BellSouth states
except Kentucky, regarding certain terms and conditions of the Interconnection
Agreement. As contemplated by the original Interconnection Agreement, the
parties will continue to exchange traffic under substantially the same terms on
a month-to-month basis until such time as renewal terms, conditions and prices
are ordered by a state commission or negotiated by the parties. The new terms,
conditions and prices would then be retroactive to July 1, 1999. To date, orders
regarding the terms and conditions of the Interconnection Agreement have been
issued by Florida and South Carolina in the arbitration proceedings, and the
Company anticipates the remaining states' orders to be issued by the end of the
second quarter of 2000. The Company is reviewing all potential remedies and
claims in remaining jurisdictions.
Pursuant to the Interconnection Agreement, the Company continued to bill
BellSouth during 1999 for reciprocal interconnection charges related to the
provision of facilities-based local exchange services. A significant amount of
these charges is attributable to call terminations by the Company to customers
that are Internet service providers, "ISPs". BellSouth has stated that it views
termination to ISPs as not included under the reciprocal charge arrangements set
forth in the Interconnection Agreement, and has refused to pay compensation for
such terminations either to the Company or to other competitive local exchange
carriers, or CLECs, operating under similar interconnection agreements. The
Alabama Public Service Commission rendered a ruling in favor of ITC/\DeltaCom in
March 1999 and issued an order requiring BellSouth to pay all withheld
reciprocal compensation sums within 20 days. BellSouth appealed this ruling to
the United States District Court in Montgomery, Alabama. In August 1999, the
United States District Court entered a decision and ordered BellSouth to pay
reciprocal compensation for dial-up calls from BellSouth customers to ISPs
served by the Company. BellSouth filed an appeal of the United States District
Court's decision to the 11/th/ Circuit Court of the United States regarding this
issue. The funds are currently being held in escrow by the federal court
pending outcome of BellSouth's request for review of the order by the United
States District Court. The Company has filed a similar complaint before the
South Carolina Public Utilities Commission and the Florida Public Service
Commission seeking a ruling requiring BellSouth to pay the reciprocal
compensation with respect to South Carolina and Florida operations.
The Company has continued to bill BellSouth the reciprocal compensation
rate under the Interconnection Agreement which expired July 1, 1999, which rate
the Company believes will be substantially reduced retroactively to July 1, 1999
pursuant to the proceedings described above. Such a rate reduction would result
in a substantial reduction in the related accounts receivable billed and
reserved subsequent to July 1, 1999. For the years ended December 31, 1999 and
1998, these charges to BellSouth amounted to approximately $23.4 and $7.4
million, respectively, inclusive of $15.7 million of charges from July 1, 1999
to December 31, 1999. The Company recognized approximately $2.0 million and
$756,000 of these charges as operating revenue during the years ended December
31, 1999 and 1998, respectively, which represent amounts BellSouth had actually
paid or indicated it will pay. The Company reserved directly against the
remaining $21.4 million and $6.6 million of billings for the years ended
December 31,
F-22
<PAGE>
1999 and 1998, respectively, inclusive of $14.6 million of billings for the
period from July 1, 1999 to December 31, 1999. As of December 31, 1999, the
Company had reserved for approximately $28.0 million of cumulative local
interconnection billings.
9. Employee Benefit Plans
Employees of the Fiber Companies participated in ITC Holding's 401(k)
defined contribution plan until the Merger. This plan covered all employees of
the participating entities who had one year of service and were at least 18
years of age. ITC Holding contributed a discretionary amount of the employees'
earnings based on the plan's earnings. No discretionary contributions were made
for 1997. In addition, the Fiber Companies offer a partial matching of employee
contributions at a rate of 1/2% for each 1% of the employee earnings contributed
to a maximum match of 4% of employee earnings. Total matching contributions made
to the plan and charged to expense for the year ended December 31, 1997 were
$84,000.
Employees of ITC/\DeltaCom Communications, Inc. participated in a
separately administered 401(k) defined contribution plan. The plan covered
substantially all ITC/\DeltaCom Communications, Inc. employees with at least one
year of service. Participants may elect to defer 15% of compensation up to a
maximum amount determined annually pursuant to Internal Revenue Service
regulations. ITC/\DeltaCom Communications, Inc. has elected to provide matching
employer contributions equal to the lesser of 3% of compensation or the maximum
amount annually for each participant. ITC/\DeltaCom Communications, Inc.'s
policy is to fund contributions as earned. Company contributions made to the
plan and charged to expense for the year ended December 31, 1997 were $199,000.
Following the Merger, ITC Holding's 401(k) defined contribution plan became
the Company's plan. Effective January 1, 1998, the ITC/\DeltaCom Communications,
Inc. 401(k) plan was merged into the Company's plan. The Company offers matching
of employee contributions at a rate of 100% of up to the first 2% of employee
contributions and 50% of up to the next 4% of employee contributions. Total
matching contributions made to the Company's plan and charged to expense by the
Company for the years ended December 31, 1999 and 1998 were $946,000 and
$542,000, respectively. No discretionary contributions were made for 1999 and
1998.
10. Related Party Transactions
Certain affiliates provide the Company with various services and/or receive
services provided by the Company. These entities include ITC Holding; Interstate
Telephone Company, Valley Telephone Company and Globe Telecommunications, Inc.,
which provide local and long-distance telephone services; InterCall, Inc.
("InterCall"), which provides conference calling services; Powertel, Inc.,
formerly InterCel, Inc., which provides cellular services; KNOLOGY Holdings,
Inc., which provides local and long distance services; MindSpring Enterprises,
Inc., which is a provider of Internet access; and ITC Service Company, which
provides transportation services. In management's opinion, the Company's
transactions with these affiliated entities are generally representative of
arm's-length transactions.
For the years ended December 31, 1999, 1998 and 1997, the Company received
services from these affiliated entities in the amounts of $877,000, $854,000 and
$206,000, respectively, which are reflected in selling, operations, and
administration expenses in the accompanying consolidated statements of
operations. In addition, in 1999, 1998 and 1997, the Company received services
from these affiliated entities in the amount of $610,000, $457,000 and $238,000,
respectively, which are reflected in cost of services in the accompanying
consolidated statements of operations.
The Fiber Companies provide operator and directory assistance services and
lease capacity on certain of their fiber routes to affiliated entities.
ITC/\DeltaCom Communications, Inc. provides long-distance and related services
to ITC Holding and all of its wholly owned and majority-owned subsidiaries.
ITC/\DeltaCom Communications, Inc. also acts as an agent for InterCall and
Mindspring in contracting
F-23
<PAGE>
with major interexchange carriers to provide origination and termination
services. Under these agreements, ITC/\DeltaCom Communications, Inc. contracts
with the interexchange carrier and rebills the appropriate access charges plus a
margin to InterCall and Mindspring, such that only the margin impacts the
Company's consolidated revenues. Total affiliated revenues included in the
accompanying consolidated statements of operations for the years ended December
31, 1999, 1998 and 1997 were $15.7 million, $13.4 million and $7.3 million,
respectively.
ITC/\DeltaCom Communications, Inc. had a contract with a former stockholder
to provide management services to the Company in 1997 for $300,000 annually. In
addition, ITC/\DeltaCom Communications, Inc. leases real properties from a
former stockholder and entities controlled by the former stockholder. Total
rental expense related to these leases was approximately $176,000, $164,000 and
$174,000 in 1999, 1998 and 1997, respectively. ITC/\DeltaCom Communications,
Inc. is obligated to pay rentals to the former stockholder totaling
approximately $169,000 annually from 2000 through April 2005 under leases which
are cancelable by either of the parties with 24 months' notice.
In July 1999, the Company completed the acquisition, by merger, of AvData
Systems, Inc., an affiliated entity (Note 11). Prior to the acquisition, some
of the directors and officers of the Company were stockholders of AvData.
11. Acquisitions
Acquisition of Gulf States
On March 27, 1997, ITC Holding purchased the remaining 64% interest in Gulf
States not previously owned, along with certain other fiber and fiber-related
assets, including a significant long-term customer contract (the "Georgia Fiber
Assets") for $27.9 million, plus contingent consideration valued at $3.7
million. 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 $10.0 million. The initial purchase price was
allocated: $17.0 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 six, 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 exceed $11.3 million. In October 1997, ITC Holding issued 56,742 shares of
its Series A convertible preferred stock in connection with this earn-out
provision. In connection with the Merger, these shares were converted into
130,236 shares of the Company's Series A convertible preferred stock valued at
$3.7 million. No further contingent consideration is due.
The purchase price was allocated to the underlying assets purchased and
liabilities assumed based on their estimated fair values at date of acquisition.
The following table summarizes the net assets purchased in connection with the
acquisition of the Georgia Fiber Assets and the remaining 64% Gulf States
partnership interest (in thousands):
<TABLE>
<CAPTION>
64% Gulf States
Georgia Fiber Assets Partnership Interest
-------------------- ---------------------
<S> <C> <C>
Property, plant, and equipment......................... $10,950 $ 42,312
Other assets........................................... 0 940
Working capital deficit................................ 0 (6,682)
Noncurrent liabilities................................. 0 (23,400)
Intangible assets...................................... 0 7,538
------- --------
Purchase price......................................... $10,950 $ 20,708
======= ========
</TABLE>
Upon the closing of these acquisitions, ITC Holding contributed the 64%
ownership interest in Gulf States to GSTS and the Georgia Fiber Assets to
FiberNet. The Gulf States partnership has been dissolved. The note was repaid in
full in November 1997.
F-24
<PAGE>
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 ("IT
Group"), a Jackson, Mississippi-based long distance carrier. The Company issued
177,106 shares of common stock valued at $2.8 million, assumed liabilities of
$1.2 million and paid $397,000 in cash to consummate the transaction.
The following table summarizes the net assets purchased in connection with
the acquisition of certain assets and liabilities of IT Group and the amount
attributable to cost in excess of net assets acquired (in thousands):
Property, plant and equipment........................ $ 316
Other assets......................................... 325
Working capital...................................... (201)
Noncurrent liabilities............................... (974)
Intangible assets.................................... 3,724
------
Purchase price....................................... $3,190
======
Acquisition of AvData Systems, Inc.
In July 1999, the Company completed its acquisition, by merger, of AvData
Systems, Inc. ("AvData"), a privately owned data network management solutions
provider in Atlanta, Georgia. Related to this merger, the Company issued
983,511 shares of common stock (including 171,898 shares which are being held in
a two-year escrow account to protect against certain contingencies) and 39,915
options for shares of common stock valued at $29.2 million. The Company expects
to issue an additional 123,757 shares of common stock and 6,163 options for
shares of common stock in March 2000 valued at $4.3 million, under earn-out
provisions based on certain performance objectives met as of December 31, 1999.
This contingent consideration has been reflected in the accompanying
consolidated balance sheet as of December 31, 1999 as an increase in intangible
assets and other accrued liabilities.
Acquisition of Scientific Telecommunications, Inc.
In August 1999, the Company completed its acquisition of certain assets of
Scientific Telecommunications, Inc. ("SciTel"), a privately owned
telecommunications equipment provider headquartered in Greenwood, Mississippi.
The Company issued 83,117 shares of common stock to consummate the transaction
valued at $2.0 million and paid $300,000 in cash in connection with the
transaction. This acquisition expanded the Company's physical presence in
Mississippi to include the Hattiesburg, Tupelo and Greenwood markets.
The purchase price of AvData and SciTel was allocated to the underlying
assets purchased and liabilities assumed based on their estimated fair values at
the dates of acquisition. The following table summarizes the net assets
purchased in connection with these acquisitions during 1999 and the amount
attributable to costs in excess of net assets acquired (in thousands):
AvData SciTel
------ ------
Property, plant, and equipment......................... $ 4,446 $ 107
Working capital........................................ (148) 498
Noncurrent liabilities................................. (63) 0
Intangible assets...................................... 29,240 1,695
------- ------
Purchase price......................................... $33,475 $2,300
======= ======
Pro forma results
F-25
<PAGE>
The following pro forma information has been prepared assuming the
acquisition of AvData occurred on January 1, 1998. Pro forma results for 1998
reflecting the acquisition of the IT Group and pro forma results for 1998 and
1999 reflecting the acquisition of SciTel are not presented as they are not
material. This information includes pro forma adjustments related to the
amortization of intangible assets resulting from the excess of the purchase
price over the fair value of the net assets acquired. The pro forma information
is presented for information purposes only and may not be indicative of the
results of operations as they would have been had this acquisition occurred on
January 1, 1998, nor is the information necessarily indicative of the results of
operations which may occur in the future.
1999 1998
------- --------
(In thousands, except share data)
Operating revenues................... $253,596 $202,021
Net loss ............................ (57,975) (33,867)
Net loss per share................... (1.03) (0.65)
F-26
<PAGE>
12. Segment Reporting
As discussed in Note 1, the Company operates in the Retail Services and
Carriers' Carrier Segments. The Company also has a corporate segment, which has
no operations. Identifiable assets of the corporate segment include $72.5
million of cash and cash equivalents, $0.2 million of other current assets and
$13.7 million of other non-current assets. The accounting policies of the
business segments are the same as those described in the summary of significant
accounting policies (Note 2). Summarized financial data by business segment as
of and for the years ended December 31, 1999, 1998 and 1997 are as follows (in
thousands):
<TABLE>
<CAPTION>
1999
---------------------------------------------
Carriers'
Carrier Retail Corporate
Segment Segment Segment Consolidated
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
Revenues........................................................ $ 72,853 $171,991 $ 0 $244,844
Gross margin.................................................... 62,082 64,041 0 126,123
Selling, operations, and administration expense ............... 24,151 72,703 0 96,854
Depreciation and amortization................................... 28,857 24,871 82 53,810
Other income (expense), net ................................... 14,949
Interest expense................................................ (45,293)
--------
Loss before income taxes........................................ $(54,885)
========
Identifiable assets............................................. $386,821 $334,368 $86,409 $807,598
======== ======== ======= ========
Capital expenditures, net ..................................... $ 66,806 $ 98,734 $ 0 $165,540
======== ======== ======= ========
<CAPTION>
1998
---------------------------------------------
Carriers'
Carrier Retail Corporate
Segment Segment Segment Consolidated
--------- --------- --------- ------------
<S> <C> <C> <C> <C>
Revenues........................................................ $ 51,902 $119,936 $ 0 $171,838
Gross margin.................................................... 44,260 44,599 0 88,859
Selling, operations, and administration expense ............... 14,411 50,490 0 64,901
Depreciation and amortization................................... 19,136 11,669 82 30,887
Other income (expense), net ................................... 6,499
Interest expense................................................ (31,930)
--------
Loss before income taxes, preacquisition loss
and extraordinary item....................................... $(32,360)
========
Identifiable assets............................................. $381,244 $189,788 $16,485 $587,517
======== ======== ======= ========
Capital expenditures, net ..................................... $ 67,467 $ 80,375 $ 0 $147,842
======== ======== ======= ========
<CAPTION>
1997
---------------------------------------------
Carriers'
Carrier Retail Corporate
Segment Segment Segment Consolidated
--------- --------- --------- ------------
<S> <C> <C> <C> <C>
Revenues........................................................ $ 31,024 $ 83,566 $ 0 $114,590
Gross margin.................................................... 27,116 32,924 0 60,040
Selling, operations, and administration expense................. 8,401 29,854 0 38,255
Depreciation and amortization................................... 12,077 6,255 0 18,332
Other income (expense), net..................................... 4,251
Interest expense................................................ (21,367)
--------
Loss before income taxes, preacquisition loss
and extraordinary item......................................... $(13,663)
========
Identifiable assets............................................. $192,820 $106,221 $87,063 $386,104
======== ======== ======= ========
Capital expenditures, net....................................... $ 27,464 $ 16,410 $ 0 $ 43,874
======== ======== ======= ========
</TABLE>
F-27
<PAGE>
13. Quarterly Financial Data (Unaudited)
The following table has been prepared from the financial records of the
Company, without audit, and reflects all adjustments that are, in the opinion of
management, necessary for a fair presentation of the results of operations for
the interim periods presented (in thousands, except per share amounts). The sum
of the per share amounts do not equal the annual amounts because of the changes
in the weighted-average number of shares outstanding during the year.
<TABLE>
<CAPTION>
1999 1/st/ Qtr 2/nd/ Qtr 3/rd/ Qtr 4/th/ Qtr Total
- ---- --------- --------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
Revenues.............................. $ 53,034 $ 57,376 $ 65,811 $ 68,623 $244,844
Gross margin.......................... 26,273 29,117 34,269 36,464 126,123
Net loss.............................. (13,012) (12,936) (13,528) (15,503) (54,979)
Basic and diluted net
loss per share...................... (0.25) (0.23) (0.23) (0.26) (0.98)
<CAPTION>
1998 1/st/ Qtr 2/nd/ Qtr 3/rd/ Qtr 4/th/ Qtr Total
- ---- ---------- --------- --------- --------- -------
<S> <C> <C> <C> <C> <C>
Revenues.............................. $ 36,694 $ 40,852 $ 45,676 $ 48,616 $171,838
Gross margin.......................... 19,821 21,591 23,191 24,256 88,859
Net loss before extraordinary item.... (4,635) (4,848) (6,816) (9,607) (25,906)
Basic and diluted net loss per share
before extraordinary item........... (0.09) (0.10) (0.13) (0.19) (0.51)
Net loss.............................. (13,071) (4,848) (6,816) (9,607) (34,342)
Basic and diluted net
loss per share...................... (0.26) (0.10) (0.13) (0.19) (0.67)
</TABLE>
14. Subsequent Events (Unaudited)
The Company expects to close Senior Secured Credit Facilities totaling $160
million by March 31, 2000, including a $100 million Tranche 1 Term Loan B
facility to be used to finance working capital, capital expenditures, and other
general corporate purposes, and a $60 million Tranche 2 Term Loan B facility to
be used to finance the purchase of telecommunications equipment. The $100
million Tranche 1 Term Loan B facility will be secured by all the Company's
assets, except for the telecommunications equipment purchased with proceeds from
the Tranche 2 Term Loan B facility. These credit facilities will be senior to
the $415 million principal amount of outstanding senior notes and $100 million
principal amount of convertible subordinated notes. Final maturity of the
facilities is expected to be 7 1/2 years after closing. The Company expects
these credit facilities to replace the credit facility entered into in September
1997 with Bank of America, N.A. (Note 5).
In March 2000, the Company expects to enter a new business it has launched,
to be operated as e/\DeltaCom, to extend and enhance the Company's data and
Internet access products by offering customers collocation and Web server
hosting services integral to operating business-critical applications over the
Internet.
F-28
<PAGE>
EXHIBIT 99.2
I. The Parties
-----------
Borrower: Interstate FiberNet, Inc., a Delaware corporation
(a wholly owned subsidiary of ITC/\DeltaCom, Inc.)
Joint Lead Arranger and
Joint Book-Runner: Morgan Stanley Senior Funding, Inc. ("MSSF")
Joint Lead Arranger and
Joint Book-Runner: Bank of America ("BofA") or one of its affiliates.
Administrative Agent: MSSF
Syndication Agent: BofA or one of its affiliates
Documentation Agent: Goldman Sachs Credit Partners L.P. ("GSCP") or one
of its affiliates.
Lenders: MSSF, BofA, GSCP and a syndicate of financial
institutions and institutional lenders lead
arranged by MSSF and BofA with the consent of the
Borrower (which consent cannot be unreasonably
withheld).
Guarantors: All obligations under the Senior Bank Financing
shall be unconditionally guaranteed by the Parent
and each of the Parent's direct and indirect
wholly-owned subsidiaries (other than the Borrower
and any entity that is a controlled foreign
corporation ("CFC") under Section 957 of the
Internal Revenue Code (the Parent and all of such
subsidiaries being, collectively, the
"Guarantors")), subject to customary exceptions
and exclusions and release mechanics for
transactions of this type.
II. Description of Credit Facilities Comprising the Senior Bank Financing
---------------------------------------------------------------------
Tranche 1 Term B Facility: $100 million Tranche 1 Term B Facility.
Maturity and Amortization: The final maturity of the Tranche 1 Term B
Facility shall be the date which occurs 7 and 1/2
years after the Closing Date. The loans under the
Tranche 1 Term B Facility (the "Tranche 1 Loans")
shall amortize in quarterly amounts to be mutually
agreed upon (with the final such installment
payable on the 90/th/month anniversary of the
Closing Date); provided, however, that (i) if the
Borrower's convertible debt securities due in May
2006 are not converted or refinanced in full on
terms and conditions reasonably satisfactory to
the Lenders on or prior to April 15, 2006, the
1
<PAGE>
Tranche 1 Loans shall be due and payable in full
on April 15, 2006 and (ii) if the Borrower's
senior subordinated notes due in May 2007 are not
refinanced in full on terms and conditions
reasonably satisfactory to the Lenders on or prior
to April 15, 2007, the Tranche 1 Loans shall be
due and payable in full on April 15, 2007.
Tranche 2 Term B
Loan Facility: $60 million Tranche 2 Term B Facility.
Maturity and Amortization: The final maturity of the Tranche 2 Term B
Facility shall be the date which occurs 7 and 1/2
years after the Closing Date. The loans under
Tranche 2 Term B Facility (the "Tranche 2 Loans";
together with the Tranche 1 Loans, the "Term B
Loans") shall amortize in quarterly amounts to be
mutually agreed upon (with the final such
installment payable on the 90th month anniversary
of the Closing Date); provided, however, that (i)
if the Borrower's convertible debt securities due
in May 2006 are not converted or refinanced in
full on terms and conditions reasonably
satisfactory to the Lenders on or prior to April
15, 2006, the Tranche 1 Loans shall be due and
payable in full on April 15, 2006 and (ii) if the
Borrower's senior subordinated notes due in May
2007 are not refinanced in full on terms and
conditions reasonably satisfactory to the Lenders
on or prior to April 15, 2007, the Tranche 2 Loans
shall be due and payable in full on April 15,
2007.
Use of Proceeds: The Tranche 1 Loans shall be utilized (x) to
finance working capital, capital expenditures
(including the build-out of the collocation and
data services businesses) and other general
corporate purposes, (y) to finance, in part, the
Transaction and (z) to pay fees and expenses
incurred in connection with the Transaction. The
Tranche 2 Loans shall be utilized solely to
finance the purchase of equipment.
Availability: Term B Loans may only be borrowed on the Closing
Date. No amount of Term B Loans once repaid may be
reborrowed. The proceeds from the Tranche 2 Loans
shall be deposited into an escrow account on terms
and conditions mutually agreed by the Borrower and
the Lenders and shall be released from escrow from
time to time to finance the purchase of equipment.
III. Terms Applicable to the Entire Senior Bank Financing
----------------------------------------------------
Closing Date On or before March 31, 2000.
2
<PAGE>
Security: The Borrower and each of the Guarantors shall
grant the Administrative Agent and the Lenders a
valid and perfected first priority (subject to
certain exceptions to be set forth in the loan
documentation) lien and security interest in all
of the following:
(a) All shares of capital stock (or other
ownership interests in) and intercompany
debt held and/or owned by the Borrower
and each present and future subsidiary
of the Borrower or such Guarantor,
limited, in the case of each CFC, to 66%
of the voting stock of such entity.
(b) All present and future property and
assets, real and personal, of the
Borrower or such Guarantor, including,
but not limited to, machinery and
equipment, inventory and other goods,
accounts receivable, owned real estate,
leaseholds, fixtures, bank accounts,
general intangibles, license rights,
patents, trademarks, tradenames,
copyrights, chattel paper, insurance
proceeds, contract rights, hedge
agreements, documents, instruments,
indemnification rights, tax refunds and
cash.
(c) All proceeds and products of the
property and assets described in clauses
(a) and (b) above.
At the reasonable request of the Borrower made
prior to the Closing Date, assets will be excluded
from the collateral in circumstances where the
Joint Lead Arrangers and the Borrower determine
that the economic detriment to the Borrower of
taking security interests in such assets would be
excessive in view of the related benefits to be
received by the Lenders.
The Tranche 2 Loans shall be secured solely by the
equipment purchased with the proceeds of the
Tranche 2 Loans until such time as the relevant
restrictions contained in the public debt
indentures of the Parent or any other agreements
now or hereafter in effect are no longer
applicable and thereafter shall be secured by all
of the assets of the Borrower and the Guarantors
(provided that any indenture or other agreement
entered into after the date of the Commitment
Letter shall not be more restrictive in respect of
liens securing the Credit Facilities than the
least restrictive indenture or other agreement in
effect on the date of the Commitment Letter). The
Tranche 1 Loans shall be secured by all of the
other assets of the Borrower and the Guarantors.
3
<PAGE>
Interest Rates: At the option of the Borrower, Loans may be
maintained from time to time as (x) Base Rate
Loans which shall bear interest at the Applicable
Margin in excess of the Base Rate in effect from
time to time or (y) Eurodollar Loans which shall
bear interest at the Applicable Margin in excess
of the Eurodollar Rate (adjusted for maximum
reserves) as determined by the Administrative
Agent for the respective interest period.
"Base Rate" shall mean the higher of (x) 1/2 of 1%
in excess of the federal funds rate and (y) the
rate that the Administrative Agent announces from
time to time as its prime or base commercial
lending rate, as in effect from time to time.
The "Applicable Margin" means at any time (i) for
Eurodollar Loans, TBD% per annum and (ii) for Base
Rate Loans, TBD% per annum.
During the continuance of any default under the
loan documentation, the Applicable Margin on all
obligations owing under the loan documentation
shall increase by 2% per annum.
Interest periods of 1, 2, 3 and 6 months shall be
available in the case of Eurodollar Loans.
Interest in respect of Base Rate Loans shall be
payable quarterly in arrears on the last business
day of each quarter. Interest in respect of
Eurodollar Loans shall be payable in arrears at
the end of the applicable interest period and
every three months in the case of interest periods
in excess of three months. Interest will also be
payable at the time of repayment of any Loans, and
at maturity. All interest and commitment fee and
other fee calculations shall be based on a 360-day
year, provided that interest calculated by
reference to the Base Rate shall be based on a
365/366-day year.
Joint Lead Arrangers
and Administrative
Agent Fees: MSSF, BofA and the Administrative Agent shall
receive such fees as have been separately agreed
upon with the Borrower.
Voluntary Prepayment: The Borrower may, upon at least one business day's
notice in the case of Base Rate Loans and three
business days' notice in the case of Eurodollar
Loans, prepay, in full or in part, the Senior Bank
Financing without premium or penalty (except as
set forth below); provided, however, that each
partial prepayment shall be in an amount of
$5,000,000 or an integral multiple of $1,000,000
in excess thereof; provided further that any such
prepayment of
4
<PAGE>
Eurodollar Loans shall be made together with
reimbursement for any funding losses of the
Lenders resulting therefrom. Any voluntary
prepayment of the Term B Loans (u) during the
first year following the Closing Date, shall be
made at 103% of the principal amount so prepaid,
(v) during the first six months of the second year
following the Closing Date, shall be made at 102%
of the principal amount so prepaid, (w) during the
second six months of the second year following the
Closing Date, shall be made at 101.5% of the
principal amount so prepaid, (x) during the first
six months of the third year following the Closing
Date, shall be made at 101% of the principal
amount so prepaid, and (y) during the second six
months of the third year following the Closing
Date, shall be made at 100.5% of the principal
amount so prepaid and (z) thereafter shall be made
at 100% of the principal amount so prepaid.
Mandatory Prepayment
and Commitment
Reduction: All net cash proceeds (a) from sales of property
and assets of the Borrower and its subsidiaries
(excluding (i) sales of inventory in the ordinary
course of business, (ii) sales of obsolete
equipment up to an aggregate amount equal to $50
million and (iii) other exceptions to be agreed
upon and subject to a 360-day reinvestment
provision to be negotiated), and (b) of
Extraordinary Receipts * (to be defined in the
loan documentation and to exclude cash receipts in
the ordinary course of business, and subject to a
360-day reinvestment provision to be negotiated),
and, on and after a date to be mutually agreed, a
percentage to be mutually agreed of Excess Cash
Flow (to be defined in the loan documentation) of
the Borrower and its subsidiaries shall be applied
to prepay ratably the principal repayment
installments of each of the Credit Facilities on a
pro rata basis.
Documentation: The commitment of MSSF and BofA will be subject to
the negotiation, execution and delivery of
definitive financing agreements (and related
security documentation, guaranties, etc.)
consistent with the terms of this letter, in each
case prepared by counsel to MSSF.
_________________________
* This would include items such as tax refunds, indemnity payments, pension
reversions and certain insurance proceeds that are probably not covered as
"asset sale" proceeds.
5
<PAGE>
Conditions Precedent
to Initial Extension
of Credit: Those customarily found in credit agreements for
similar secured financings and others appropriate
in the reasonable judgment of MSSF and BofA for
the Transaction, including, without limitation,
the following:
(a) The final terms and conditions of the
Transaction, including, without limitation,
all legal and tax aspects thereof, shall be
(i) as described in the Commitment Letter and
otherwise consistent with the description
thereof received in writing as part of the
Pre-Commitment Information and (ii) to the
extent any material terms of the Transaction
are not so described or differ from such
description, otherwise reasonably
satisfactory to the Lenders.
(b) All documentation relating to the Senior Bank
Financing, including a credit agreement
incorporating substantially the terms and
conditions outlined herein, and the other
parts of the Transaction shall be in form and
substance reasonably satisfactory to the
Lenders.
(c) The Lenders shall be satisfied with the
corporate and legal structure and the terms
and conditions of the capitalization of the
Borrower and each of the Guarantors,
including, without limitation, the charter
and bylaws of the Borrower and each such
Guarantor and each agreement or instrument
relating thereto.
(d) All capital stock of the Borrower shall be
owned by the Parent and all capital stock of
the Borrower's subsidiaries shall be owned by
the Borrower or one or more of the Borrower's
subsidiaries, in each case free and clear of
any lien, charge or encumbrance, other than
the liens and security interests created
under the loan documentation; the Lenders
shall have a valid and perfected first
priority (subject to certain exceptions to be
set forth in the loan documentation) lien and
security interest in such capital stock and
in the other collateral referred to under the
section "Security" above; all filings,
recordations and searches necessary or
desirable in connection with such liens and
security interests shall have been duly made
(subject to certain exceptions to be set
forth in the loan documentation); and all
filing and recording fees and taxes shall
have been duly paid.
6
<PAGE>
(e) There shall have occurred no material adverse
change in the business, condition (financial
or otherwise), operations, performance,
properties or prospects of the Parent and its
subsidiaries, taken as a whole.
(f) There shall exist no action, suit,
investigation, litigation or proceeding
pending or threatened in any court or before
any arbitrator or governmental or regulatory
agency or authority that (i) could reasonably
be expected to (A) have a material adverse
effect on the business, condition (financial
or otherwise), operations, performance,
properties or prospects of the Borrower and
its subsidiaries, taken as a whole, (B)
materially adversely affect the ability of
the Borrower or any Guarantor to perform its
obligations under the loan documentation or
(C) materially adversely affect the rights
and remedies of the Administrative Agent and
the Lenders under the loan documentation or
(ii) could reasonably be expected to have a
material adverse effect on the Transaction or
the Senior Bank Financing (collectively, a
"Material Adverse Effect").
(g) All governmental and third party consents and
approvals necessary in connection with the
Transaction and the Senior Bank Financing
shall have been obtained (without the
imposition of any conditions that are not
reasonably acceptable to the Lenders) and
shall remain in effect (other than any
consents and approvals the absence of which,
either individually or in the aggregate,
would not have a Material Adverse Effect);
all applicable waiting periods shall have
expired without any material adverse action
being taken by any competent authority; and
no law or regulation shall be applicable in
the reasonable judgment of the Lenders that
restrains, prevents or imposes materially
adverse conditions upon the Transaction or
the Senior Bank Financing.
(h) All Pre-Commitment Information shall be true
and correct in all material aspects; and no
additional information shall have come to the
attention of the Administrative Agent or the
Lenders that could reasonably be expected to
have a Material Adverse Effect.
(i) All loans made by the Lenders to the Borrower
or any of its affiliates shall be in full
compliance with the Federal Reserve's Margin
Regulations.
7
<PAGE>
(j) The Borrower and each Guarantor shall have delivered
certificates, in form and substance reasonably
satisfactory to the Lenders, attesting to the Solvency
(as hereinafter defined) of the Borrower and such
Guarantor, as the case may be, in each case
individually and together with its subsidiaries, taken
as a whole, immediately before and immediately after
giving effect to the Transaction, from their respective
chief financial officers. As used herein, the term
"Solvency" of any person means (i) the fair value of
the property of such person exceeds its total
liabilities (including, without limitation, contingent
liabilities), (ii) the present fair saleable value of
the assets of such person is not less than the amount
that will be required to pay its probable liability on
its debts as they become absolute and matured, (iii)
such person does not intend to, and does not believe
that it will, incur debts or liabilities beyond its
ability to pay as such debts and liabilities mature and
(iv) such person is not engaged, and is not about to
engage, in business or a transaction for which its
property would constitute an unreasonably small
capital.
(k) The Lenders shall be reasonably satisfied with the
nature and amount of any existing and potential
environmental concerns associated with the facilities
of the Borrower and its subsidiaries and with the
Borrower's plans with respect thereto.
(l) The Lenders shall be satisfied that (i) the Borrower
and its subsidiaries will be able to meet their
respective obligations under all employee and retiree
welfare plans, (ii) the employee benefit plans of the
Borrower and its ERISA affiliates are, in all material
respects, funded in accordance with the minimum
statutory requirements, (iii) no "reportable event" (as
defined in ERISA, but excluding events for which
reporting has been waived) has occurred as to any such
employee benefit plan and (iv) no termination of, or
withdrawal from, any such employee benefit plan has
occurred or is contemplated that could reasonably be
expected to result in a material liability.
(m) The Lenders shall be satisfied with the amount, types
and terms and conditions of all insurance maintained by
the Borrower and its subsidiaries, and the Lenders
shall have received endorsements naming the
Administrative Agent, on behalf of the Lenders, as an
additional insured under all insurance policies to be
maintained with respect to the
8
<PAGE>
properties of the Borrower and its subsidiaries forming
part of the Lenders' collateral described under the
section "Security" above.
(n) The Lenders shall have completed a due diligence
investigation of the Borrower and its subsidiaries in
scope, and with results, satisfactory to the Lenders
and shall have been given such access to the
management, records, books of account, contracts and
properties of the Borrower and its subsidiaries and
shall have received such financial, business and other
information regarding each of the foregoing persons as
they shall have requested, including, without
limitation, information as to possible contingent
liabilities, tax matters, collective bargaining
agreements and other arrangements with employees,
annual financial statements dated December 31, 1998,
interim financial statements dated the end of the most
recent fiscal quarter for which financial statements
are available (or, in the event the Lenders' due
diligence review reveals material changes since such
financial statements, as of a later date within 45 days
of the Closing Date), pro forma consolidated financial
statements as to the Borrower and its subsidiaries, and
forecasts prepared by management of the Borrower, in a
form satisfactory to the Lenders, of balance sheets,
income statements and cash flow statements on a monthly
basis for the first year following the Closing Date and
on an annual basis for each year thereafter during the
term of the Senior Bank Financing.
(o) The Lenders shall have received (i) satisfactory
opinions of counsel for the Borrower and the Guarantors
and of local counsel for the Lenders as to the
transactions contemplated hereby (including, without
limitation, compliance with all applicable securities
laws) and (ii) such corporate resolutions, certificates
and other documents as the Lenders shall reasonably
request.
(p) There shall exist no default under any of the loan
documentation, and the representations and warranties
of the Borrower, each of the Guarantors and each of
their respective subsidiaries therein shall be true and
correct immediately prior to, and after giving effect
to, the initial extension of credit under the loan
documentation.
(q) All accrued fees and expenses of the Administrative
Agent, the Joint Lead Arrangers and the Lenders
(including the
9
<PAGE>
fees and expenses of counsel for the Joint Lead
Arrangers and local counsel for the Lenders) shall
have been paid.
(r) The Joint Lead Arrangers and the Administrative
Agent shall be satisfied that all appropriate
offering documentation shall have been delivered
to the Lenders on terms and conditions
satisfactory to the Joint Lead Arrangers, the
Administrative Agent and the Lenders.
Representations and
Warranties: Those customarily found in credit agreements for
similar secured financings and others appropriate in
the reasonable judgment of MSSF and BofA for the
Transaction, including, without limitation, absence of
any material adverse change in the business, condition
(financial or otherwise), operations, performance,
properties or prospects of the Borrower and its
subsidiaries, taken as a whole.
Covenants: Those affirmative, negative and financial covenants
(applicable to the Parent and its subsidiaries)
customarily found in credit agreements for similar
secured financings and others appropriate in the
reasonable judgment of MSSF and BofA for the
Transaction, including, without limitation, the
following:
(a) Affirmative Covenants - (i) Compliance with laws
---------------------
and regulations (including, without limitation,
ERISA and environmental laws); (ii) payment of
taxes and other obligations; (iii) maintenance of
appropriate and adequate insurance; (iv)
preservation of corporate existence, rights
(charter and statutory), franchises, permits,
licenses and approvals; (v) preparation of
environmental reports; (vi) visitation and
inspection rights; (vii) keeping of proper books
in accordance with generally accepted accounting
principles; (viii) maintenance of properties; (ix)
performance of leases, related documents and other
material agreements; (x) conducting transactions
with affiliates on terms equivalent to those
obtainable on an arm's-length basis; (xi) further
assurances as to perfection and priority of
security interests (subject to the exceptions set
forth above under "Security"); (xii) grant of
security on additional property and assets upon
the occurrence of an Event of Default; and (xiii)
customary financial and other reporting
requirements (including, without limitation,
audited annual financial statements and monthly
and quarterly unaudited financial statements, in
each case prepared on a consolidated and a
consolidating basis, notices of defaults,
compliance certificates, annual business
10
<PAGE>
plans and forecasts, reports to shareholders and
other creditors and other business and financial
information as any Lender shall reasonably
request); in each of the foregoing cases, with
such exceptions as may be agreed upon in the loan
documentation.
(b) Negative Covenants - Restrictions on (i) liens
------------------
(other than (x) liens securing the Senior Bank
Financing and (y) liens securing up to $200
million of debt under an additional facility (the
"Additional Facility") to the extent that (1) such
debt is permitted pursuant to clause (ii)(v)
below, (2) no Default has occurred and is
continuing or would result from the issuance of
such debt, (3) such debt matures at least three
months after the Credit Facilities, (4) the
average life of the Additional Facility is longer
that the average life of the Credit Facilities and
(5) the interest rate in respect of the Additional
Facility is no greater than 0.50% per annum above
the interest rate applicable to the Credit
Facilities); (ii) debt, guaranties or other
contingent obligations (including, without
limitation, the subordination of all intercompany
indebtedness on terms satisfactory to the Lenders)
(other than (v) debt permitted pursuant to the
incurrence test referred to under Financial
Covenants below, (w) capitalized leases in an
amount not to exceed $50 million, (x) other junior
debt in an amount not to exceed $50 million so
long as the maturity of such debt is at least
three months following the final maturity of the
Credit Facilities and the other terms and
conditions of such debt is reasonably satisfactory
to the Required Lenders, (y) other debt of the
Parent so long as (1) a sufficient amount of cash
to pay interest on the Credit Facilities for the
next succeeding 24 months (in the reasonable
judgment of the Administrative Agent) is deposited
into escrow on terms and conditions that are
mutually acceptable to the Administrative Agent
and the Borrower, (2) the maturity of such debt is
at least three months after the maturity of the
Credit Facilities, (3) the Administrative Agent
and the Required Lenders are reasonably satisfied
that the Parent and its subsidiaries shall be in
compliance with the provisions of the loan
documentation for the period from the end of the
escrow arrangements through the final maturity of
the Credit Facilities and (4) the unsecured debt
rating of the Parent shall not be downgraded by
any rating agency by more than one level as a
result of the issuance of such debt and (z) other
exceptions to be agreed upon); (iii) mergers and
consolidations; (iv) sales, transfers and other
11
<PAGE>
dispositions of assets (other than sales of
inventory in the ordinary course of business); (v)
loans, acquisitions, joint ventures and other
investments (other than (x) stock for stock
transactions and (y) other acquisitions, joint
ventures and investments in an aggregate amount
not to exceed $150 million plus 50% of the net
cash proceed from any issuance of equity after the
date of the Commitment Letter); (vi) dividends and
other distributions to stockholders; (vii)
creating new subsidiaries; (viii) becoming a
general partner in any partnership; (ix)
repurchasing shares of capital stock; (x)
prepaying, redeeming or repurchasing debt; (xi)
granting negative pledges other than to the
Administrative Agent and the Lenders; (xii)
changing the nature of its business; (xiii)
amending organizational documents in any manner
that could reasonably be expected to have a
Material Adverse Effect, or amending or otherwise
modifying any debt for borrowed money, any related
document or any other material agreement in any
manner that could reasonably be expected to have a
Material Adverse Effect; and (xiv) changing
accounting policies or reporting practices; in
each of the foregoing cases, with such exceptions
as may be agreed upon in the loan documentation.
(c) Financial Covenants - There will be a incurrence
-------------------
test based on a minimum interest coverage of at
least 1.25:1. The incurrence test will be
calculated on a consolidated basis and EBITDA
shall be calculated as the product of two times
EBITDA for the two most recently ended fiscal
quarters.
The affirmative and negative covenants summarized above
shall be modified to be more similar to those contained
in an indenture relating to high yield securities
issued by a corporation similar to the Borrower.
Events of Default: Those customarily found in credit agreements for
similar secured financings and others appropriate in
the reasonable judgment of MSSF and BofA for the
Transaction, including, without limitation, (a) failure
to pay principal when due, or to pay interest or other
amounts within three business days after the same
becomes due, under the loan documentation; (b) any
representation or warranty proving to have been
materially incorrect when made or confirmed; (c)
failure to perform or observe covenants set forth in
the loan documentation within a specified period of
time, where customary and appropriate, after notice or
knowledge of such
12
<PAGE>
failure; (d) cross-defaults to other indebtedness in an
amount to be agreed in the loan documentation; (e)
bankruptcy and insolvency defaults (with grace period
for involuntary proceedings); (f) monetary judgment
defaults in an amount to be agreed in the loan
documentation and nonmonetary judgment defaults that
could reasonably be expected to have a Material Adverse
Effect; (g) impairment of loan documentation or
security; (h) change of ownership or operating control;
and (i) standard ERISA defaults.
Expenses: The Borrower shall pay all of the Administrative
Agent's, the Joint Lead Arrangers' due diligence,
syndication (including printing, distribution and bank
meetings), transportation, computer, duplication,
appraisal, audit, insurance, consultant, search, filing
and recording fees and all other out-of-pocket expenses
reasonably incurred by the Administrative Agent or the
Joint Lead Arrangers (including the reasonable fees and
expenses of counsel for the Joint Lead Arrangers),
whether or not any of the transactions contemplated
hereby are consummated, as well as all expenses of the
Administrative Agent in connection with the
administration of the loan documentation. The Borrower
shall also pay the reasonable expenses of the
Administrative Agent, the Joint Lead Arrangers and the
Lenders in connection with the enforcement of any of
the loan documentation.
Indemnity: The Borrower will indemnify and hold harmless the
Administrative Agent, the Joint Lead Arrangers, each
Lender and each of their affiliates and their officers,
directors, employees, agents and advisors from claims
and losses relating to the Transaction or the Senior
Bank Financing.
Required Lenders: Lenders holding loans and commitments representing more
than 50% of the aggregate amount of loans and
commitments under the Senior Bank Financing.
Waivers &
Amendments: Amendments and waivers of the provisions of the loan
agreement and other definitive credit documentation
will require the approval of the Required Lenders,
except that the consent of all affected Lenders be
required with respect to (i) increases in commitment
amounts, (ii) reductions of principal, interest, or
fees, (iii) extensions of scheduled maturities or times
for payment, and (iv) releases of all or substantially
all of the collateral or any material guarantee.
Assignments and
13
<PAGE>
Participations: Assignments may be non-pro rata and must be to Eligible
Assignees (as defined in the definitive loan
documentation) and, in each case other than an
assignment to a Lender or an assignment of the entirety
of a Lender's interest in the Senior Bank Financing, in
a minimum amount to be agreed (such amount to be
reduced proportionately with reductions in the Senior
Bank Financing). Each assignment shall be made with the
consent of the Borrower (which consent cannot be
unreasonably withheld) so long as no Event of Default
has occurred and is continuing. Each Lender will also
have the right, without consent of the Borrower or the
Administrative Agent, to assign (i) as security all or
part of its rights under the loan documentation to any
Federal Reserve Bank and (ii) all or part of its rights
or obligations under the loan documentation to any of
its affiliates. No participation shall include voting
rights, other than for reductions or postponements of
amounts payable or releases of all or substantially all
of the collateral.
Taxes: All payments to be free and clear of any present or
future taxes, withholdings or other deductions
whatsoever (other than income taxes in the jurisdiction
of the Lender's applicable lending office). The Lenders
will use reasonable efforts (consistent with their
respective internal policies and legal and regulatory
restrictions and so long as such efforts would not
otherwise be disadvantageous to such Lenders) to
minimize to the extent possible any applicable taxes
and the Borrower will indemnify the Lenders and the
Administrative Agent for such taxes paid by the Lenders
or the Administrative Agent. If a Lender makes a
request under this provision for indemnification, the
Borrower shall have the right to replace such Lender
under terms and conditions to be set forth in the loan
documentation.
Miscellaneous: Standard yield protection (including compliance with
risk-based capital guidelines, increased costs,
payments free and clear of withholding taxes and
interest period breakage indemnities), eurodollar
illegality and similar provisions, defaulting lender
provisions, waiver of jury trial, submission to
jurisdiction and Year 2000 compliance provisions.
Governing Law: New York.
Counsel for MSSF: Shearman & Sterling.
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE CONSOLIDATED BALANCE SHEETS OF ITC /\ DELTACOM, INC. AS OF DECEMBER 31,
1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 1999. THIS INFORMATION, IN THOUSANDS, IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
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0
15
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</TABLE>
