| ITC DELTACOM INC Item 1A Risk Factors Our business and operations are subject to a number of risks and uncertainties, including the following: Our ability to comply with the financial covenants in our debt agreements depends primarily on our ability to generate substantial operating cash flow |
| Our ability to comply with the financial covenants under the agreements governing our outstanding secured indebtedness will depend primarily on our success in generating substantial operating cash flow |
| Under our debt agreements, we are subject to a maximum capital expenditures covenant, a senior debt ratio covenant, a total leverage ratio covenant, an interest coverage ratio covenant, a minimum unrestricted cash covenant and a minimum consolidated EBITDA covenant, as EBITDA is defined for purposes of the agreements |
| Industry conditions and financial, business and other factors, including those we identify as risk factors in this report, will affect our ability to generate the cash flows we need to meet those financial tests and ratios |
| Our failure to meet the tests or ratios could result in a default and acceleration of repayment of the indebtedness under our credit facilities |
| If the maturity of our indebtedness were accelerated, we may not have sufficient funds to pay such indebtedness |
| In such event, our lenders would be entitled to proceed against the collateral securing the indebtedness, which includes substantially all of our assets |
| Our substantial level of indebtedness could adversely affect our financial health and ability to compete |
| As of March 1, 2006, we had dlra326dtta3 million of total long-term indebtedness, net of unamortized discount, including current portion |
| Our substantial level of indebtedness could have important consequences |
| For example, it may: • increase our vulnerability to general adverse economic and industry conditions, including interest rate fluctuations, because a significant portion of our borrowings will continue to be at variable rates of interest; • require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; • limit our ability to borrow additional funds to alleviate liquidity constraints, as a result of financial and other restrictive covenants in our indebtedness; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; • place us at a competitive disadvantage relative to companies that have less indebtedness; and • limit our ability to refinance our principal secured indebtedness, which matures in the third quarter of 2009 |
| A total of dlra318dtta1 million of our secured indebtedness will be payable during the third quarter of 2009 |
| We will be required either to repay or refinance a total of dlra318dtta1 million principal amount of our outstanding secured indebtedness upon maturity during the third quarter of 2009 |
| If principal payments due at maturity cannot be refinanced or extended, our cash flow may not be sufficient to repay all such indebtedness at the relevant times |
| Failure either to repay or refinance such indebtedness would result in a default and entitle our lenders to proceed against our assets securing the indebtedness |
| 22 ______________________________________________________________________ [47]Table of Contents Affiliates of Welsh, Carson, Anderson & Stowe own securities representing a majority of our voting power, which gives them the ability to exercise significant or controlling influence over major corporate actions by us |
| The controlling affiliates of the investment funds that constitute Welsh, Carson, Anderson & Stowe, a private equity firm, have reported in SEC filings that such affiliates and the funds, as a group, beneficially own common stock and Series B preferred stock representing a majority of the voting power of our outstanding capital stock |
| Based on their existing capital stock ownership, the members of this group currently have the right to block actions involving our company or its assets that require stockholder approval |
| In addition, four of our ten directors are members of, or affiliated with members of, this group |
| The Welsh, Carson, Anderson & Stowe group may have interests with respect to our company that differ from those of our other stockholders as a result of significant investments by the group in other communications companies |
| The FCC may restrict our ability to provide local services and may increase the costs we incur to provide these services |
| In February 2005, the FCC released an order limiting the number and types of unbundled network elements that incumbent local exchange carriers must make available to us and other competitive communications companies |
| The FCC’s order also eliminated the requirement that incumbent carriers make available to us and other competitive carriers local switching services for residential and small business customers |
| If these incumbent carriers do not continue to cooperate in facilitating an orderly transition to the new rules, our business could be adversely affected |
| If prices of the network elements that we use to provide our services increase or if those network elements are eliminated as a result of the implementation of the February 2005 order or any future consideration of this issue by the FCC, our cost of providing local exchange service could increase and have a significant adverse impact on our operating results and cash flows |
| Because of the February 2005 order, incumbent local telephone companies no longer are required to provide local switching services, which means that we can no longer rely on the Unbundled Network Element-Platform, or UNE-P, to provide local services to customers |
| The FCC’s order also limits the availability to us of some incumbent carrier dedicated transport services between central offices and broadband local loops |
| Although the FCC’s order permits carriers to enter into commercial agreements for network elements and provides for a transition period to the new rules, BellSouth and the other incumbent carriers in our markets have not made, and are not expected to make, network elements available to us at the same rates they have in the past |
| The FCC also has proposed new rules that would change the existing cost-based method of pricing the services that we obtain from the incumbent local telephone companies |
| If adopted, the proposed rules would enable the incumbent local telephone companies to initiate proceedings before state public utility commissions to seek increased rates for unbundled network elements |
| If some elements in particular markets or on particular transport routes in those markets cease to be available to us at the existing cost-based rates, we could experience an increase in our cost of providing local exchange services, which would negatively affect our operating results and cash flows |
| We are subject to a significant number of legal proceedings that could result in our payment of substantial monetary damages and could adversely affect our ability to provide services |
| To maintain our fiber optic network, we have obtained easements, rights-of-way, franchises and licenses from various third parties, including actual and potential competitors, local governments, private landowners and others |
| Third parties have initiated legal proceedings in a number of states challenging some of our significant licenses to use the rights-of-way of others, including our licenses to use the rights-of-way of Mississippi Power Company, Gulf Power Company, Georgia Power Company, Kansas City Southern Railroad and Illinois Central Railroad |
| The pending proceedings affect approximately 1cmam600 route miles of our network as of December 31, 2005 and, if resolved in a manner adverse to us, could affect additional portions of our network |
| We cannot predict whether additional portions of our network will become subject to similar legal proceedings in the future |
| If some of these or similar future challenges are 23 ______________________________________________________________________ [48]Table of Contents successful, or if we are otherwise unsuccessful in maintaining or renewing our rights to use our network easements, rights-of-way, franchises and licenses, we may be compelled to abandon significant portions of our network, which would require us to incur additional expenditures, and to pay substantial monetary damages |
| Our integrated communications services business is subject to significant competitive pressures that could restrict our ability to achieve or sustain operating profitability |
| Our industry is highly competitive, and the level of competition, particularly with respect to pricing, is increasing |
| As a result of competitive pressures, we may not be able to achieve or sustain operating profitability, adequate market share or significant revenue growth in any of our markets |
| The prices we charge for our retail local, long distance and data services have declined significantly in recent years |
| BellSouth, which has recently agreed to be acquired by AT&T, and the other incumbent local telephone companies in our markets offer substantially the same services we offer, in some cases at lower prices |
| These companies have substantially greater infrastructures, financial, personnel, technical, marketing and other resources, larger numbers of established customers and more prominent name recognition than we do |
| These advantages may increase as a result of pending and contemplated consolidations in our industry |
| We expect to continue to face significant pricing and product competition from BellSouth and the other large, established telephone companies that currently are the dominant providers of telecommunications services in our markets |
| We also will continue to face significant competitive product and pricing pressures from other types of communications businesses, including cable companies providing broadband Internet access and other integrated services providers, and from other companies like us that attempt to compete in the local services market |
| We may be required to reduce further some or all of the prices we charge for our retail local, long distance and data services for the following reasons, which could adversely affect our ability to generate positive cash flows from operations: • BellSouth, our principal competitor in many of the markets we serve, has been authorized to offer in-region long distance services throughout its nine-state region, which will allow it to offer the same bundle of local, long distance and data services that we offer; • the recent acquisition of AT&T by SBC Communications and the recent acquisition of MCI by Verizon Communications have increased substantially the market power of these incumbent carriers, particularly in the market for business customers in which we compete, and these mergers may accelerate other pending or future consolidations among our competitors; • if completed, AT&T’s recent agreement to acquire BellSouth will further increase the market power of our principal competitor in many of the markets we serve; • cable companies and providers of alternative forms of communication that rely on Voice over Internet Protocol or similar applications are increasingly attracting customers, and are expected to expand their target customer base from primarily residential customers to the small and medium-sized businesses we serve; and • recent regulatory decisions have decreased regulatory oversight of incumbent local telephone companies, which may increase the benefits that these companies could experience from their long-standing customer relationships, greater financial and technical resources, and ability to subsidize local services with revenue from unrelated businesses |
| The foregoing competitive pressures have contributed to a significant increase in our customer attrition over the past two years |
| We expect that these pressures will continue to affect adversely our ability to maintain existing customers and win new customers |
| 24 ______________________________________________________________________ [49]Table of Contents Our wholesale services, including our broadband transport services, continue to be adversely affected by pricing pressure, network overcapacity, service cancellations and other factors |
| We have continued to experience adverse trends relating to our wholesale service offerings, including our broadband transport services, that have resulted primarily from a reduction in rates charged to our customers due to overcapacity in the broadband services business and from service cancellations by some customers, including customers of our local interconnection business |
| Pending or contemplated consolidations in our industry also may continue to affect adversely our wholesale services by improving the resources of the consolidating companies and reducing their demand for our services as those companies upgrade their own networks and consolidate their voice and data traffic on those networks |
| We expect that these factors will result in continued declines in revenues and cash flows from our wholesale service offerings |
| Such declines will have a disproportionately adverse effect on our operating results, because of the higher gross margins associated with our wholesale services |
| Our operating performance will suffer if we are not offered competitive rates for the access services we need to provide our long distance services |
| We depend on other communications companies to originate and terminate a significant portion of the long distance traffic initiated by our customers |
| Our operating performance will suffer if we are not offered these access services at rates that are substantially equivalent to the costs of, and rates charged to, our competitors and permit profitable pricing of our long distance services |
| The charges for access services historically have made up a significant percentage of our overall cost of providing long distance service |
| Some of our Internet-based competitors generally have been exempt from these and other regulatory charges, which could give them a significant cost advantage in this area |
| The FCC currently is considering what charges, if any, should be assessed on long distance services provided over the Internet |
| Our inability to maintain our network infrastructure, portions of which we do not own, could adversely affect our operating results |
| We have effectively extended our network with minimal capital expenditures by entering into marketing and management agreements with public utility companies to sell long-haul private line services on the fiber optic networks owned by these companies |
| Under these agreements, we generally earn a commission based upon a percentage of the gross revenues generated by the sale of capacity on the utility’s networks |
| Any cancellation or non-renewal of any of these agreements, any adverse legal ruling with respect to our rights under any of these agreements, or any future failure by us to acquire and maintain similar network agreements in these or other markets as necessary could materially adversely affect our operations |
| In addition, some of our agreements with the public utility companies are nonexclusive, and our business would suffer from any reduction in the amount of capacity they make available to us |
| Our ability to provide service also could be materially adversely affected by a cable cut, switch failure or other equipment failure along our fiber optic network or along any other fiber optic network on which we lease transmission capacity |
| A significant portion of our fiber optic network is not protected by electronic redundancy or geographical diverse routing |
| Lack of these safeguards could result in our inability to reroute traffic to another fiber in the same fiber sheath in the event of a partial fiber cut or electronics failure or to an entirely different fiber optic route, assuming capacity is available, in the event of a total cable cut or if we fail to maintain our rights-of-way on some routes |
| If we are unable to interconnect with BellSouth and other incumbent carriers on acceptable terms, our ability to offer competitively-priced local telephone services will be adversely affected |
| To provide local telephone services, we must interconnect with and resell the services of the incumbent carriers to supplement our own network facilities |
| Our interconnection agreements with BellSouth expired in June 2003 |
| Although we have adopted the agreements between BellSouth and another provider in three states, and have entered into our own agreement with BellSouth in a fourth state, we are arbitrating the rates and terms of new agreements with BellSouth in five of the nine BellSouth states |
| We may not be able to enter into new 25 ______________________________________________________________________ [50]Table of Contents interconnection agreements with BellSouth or other carriers on favorable terms, in a timely manner, or at all |
| Further, federal regulators have adopted substantial modifications to the requirements that obligate BellSouth and other former monopoly local telephone companies to provide to us at cost-based rates the elements of their telephone networks that enable us to offer many of our services at competitive rates |
| If we are unable to enter into or maintain favorable interconnection agreements in our markets, our ability to provide local services on a competitive and profitable basis may be materially adversely affected |
| Any successful effort by the incumbent carriers to deny or substantially limit our access to their network elements or wholesale services also would harm our ability to provide local telephone services |
| We may not be able to retain the few large customers on which we depend for a significant percentage of our revenues |
| We may not be able to retain our large customers, or we may be required to lower our prices significantly to retain them |
| Our ability to retain these customers may be adversely affected by pending or contemplated consolidations in our industry, adverse changes in our financial condition, increased competition, customer service issues and other events that may occur |
| The table below sets forth the approximate percentages of our total consolidated revenues generated in 2003, 2004 and 2005 by our five largest integrated communications services customers and our three largest wholesale services customers: Year Ended December 31, 2003 2004 2005 Five largest integrated communications services customers 5dtta5 % 4dtta4 % 4dtta2 % Three largest wholesale services customers 6dtta1 % 4dtta9 % 6dtta9 % If we were to lose any of these customers or were compelled to lower our prices to retain these customers, our operating revenues and business could be adversely affected |
| The local and long distance industries are subject to significant government regulation, which may change in a manner that is harmful to our business |
| We are required to comply with telecommunications regulations implemented by federal, state and local governments |
| We are required to obtain authorizations from the FCC and state public utility commissions to offer some of our communications services, to file tariffs for many of our services and to comply with local license, franchise or permit requirements relating to installation and operation of our network |
| Many of these regulations continue to change |
| Any of the following events related to the manner in which our business is regulated could limit the types of services we provide or the terms on which we provide these services: • our failure to maintain proper federal and state tariffs; • our failure to maintain proper state certifications; • our failure to comply with federal, state or local laws and regulations; • our failure to obtain and maintain required licenses, franchises and permits; • the imposition of burdensome license, franchise or permit requirements to operate in public rights-of-way; and • the occurrence of burdensome or adverse regulatory requirements or developments |
| Our failure to maintain adequate billing, customer service and information systems could limit our ability to increase our services |
| Our inability to identify adequately all of our information and processing needs, to process the information adequately or accurately, to upgrade our systems as necessary, or to integrate our systems with the systems of businesses we acquire could have a material adverse effect on our operating results |
| We depend on sophisticated 26 ______________________________________________________________________ [51]Table of Contents information and processing systems to grow, monitor costs, bill customers, provision customer orders and achieve operating efficiencies |
| As we increase our provision of dial tone and other services, our need for enhanced billing and information systems also will increase |
| We also depend on operations support systems and other new carriers to order and receive network elements and wholesale services from the incumbent carriers |
| These systems are necessary for carriers like us to provide local service to customers on a timely and competitive basis |
| FCC rules, together with rules adopted by state public utility commissions, may not be implemented in a manner that will permit us effectively to order, receive and provision network elements and other facilities necessary for us to provide many of our services |
| We are subject to risks associated with rapid changes in technology |
| Our business could suffer from unexpected developments in technology, or from our failure to adapt to these changes |
| The communications industry is subject to rapid and significant changes in technology, and we may be required to select one emerging technology over another |
| We will be unable to predict with any certainty, at the time we are required to make our investments, whether the technology we have chosen will prove to be the most economic, efficient or capable of attracting customer usage |
| If we choose the wrong technology, or if our competitors develop or select a superior technology, we could lose our existing customers and be unable to attract new customers, which would harm our business and operations |
| Our success depends on our ability to attract and retain key personnel |
| The loss of the services of our key personnel, or our inability to attract, recruit and retain sufficient or additional qualified personnel, could hurt our business |
| Our business is currently managed by a small number of key management and operating personnel, including our executive officers |
| Many members of our senior management team have extensive experience in the telecommunications industry |
| We do not maintain “key man” insurance on these employees |
| Because of current market conditions for our industry, our stock incentive program may not provide an adequate incentive to current or potential key employees to become or remain employed by us |
| Our network or other ground facilities could be damaged by natural catastrophes or terrorism |
| A major earthquake, tornado, hurricane, fire, terrorist attack on the United States, or other catastrophic event could damage our network, network operations center, central offices or corporate headquarters |
| Such an event could interrupt our service and harm our business in the affected areas |
| We do not have replacement or redundant facilities that we can use to provide alternative means of service to all customers or under every circumstance in the event of a catastrophic event |
| Any damage to our network could result in degradation of our service for some customers and could result in complete loss of service in affected areas |