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| DECC > SEC Filings for DECC > Form 10-Q on 11-Aug-2008 | All Recent SEC Filings |
11-Aug-2008
Quarterly Report
Forward-Looking Statements
This quarterly report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements provide our current
expectations or forecasts of future events. You can identify these statements by
the fact that they do not relate strictly to historical or current facts. These
statements may relate to our financial condition, results of operations, plans,
objectives, future performance and business. Often these statements include
words such as "believes," "expects," "anticipates," "estimates," "intends,"
"strategy," "plans," or similar words or expressions. In particular, statements,
express or implied, concerning future operating results, the ability to generate
income or cash flows, or our capital resources or financing plans are
forward-looking statements. These forward-looking statements involve certain
risks and uncertainties. Our actual performance or achievements may differ
materially from those contemplated by these forward-looking statements. These
forward-looking statements involve certain risks and uncertainties, including,
but not limited to:
changes in the competitive and technological environment in which we operate;
our ability to fund necessary investment in plant and equipment;
our current level of debt financing;
our ability to further penetrate our markets and the related cost of that effort;
economic conditions;
government and regulatory policies at both the federal and state levels; and
reductions in rates or call volume that generate network access revenues.
You should understand that various factors, in addition to those discussed elsewhere in this document, could affect our future results and could cause results to differ materially from those expressed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. All subsequent written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements contained or referred to in this report. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.
Overview
This Overview is intended to provide a context for the following Management's Discussion and Analysis of Financial Condition and Results of Operations. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements, including the notes thereto, included in this quarterly report on Form 10-Q, as well as our audited consolidated financial statements for the year ended December 31, 2007, as filed on
Item 2. Management's Discussion and Analysis of
Form 10-K with the Securities and Exchange Commission ("SEC"). We have attempted to identify the most important matters on which our management focuses in evaluating our financial condition and operating performance and the short-term and long-term opportunities, challenges and risks (including material trends and uncertainties) which we face. We also discuss the actions we are taking to address these opportunities, challenges and risks. The Overview is not intended as a summary of, or a substitute for review of, Management's Discussion and Analysis of Financial Condition and Results of Operations.
Business Segments
Our business segments are Wireline, Systems Integration and Corporate and Other. The measure of profitability that management uses to evaluate performance of its business segments is operating income (loss) because individual segments are not charged an allocation for such items as interest and income taxes that are reported below operating income on the statement of operations.
Our Wireline segment includes three rural local exchange carriers ("RLEC"), providing services in parts of Berks, Lancaster, Union and smaller portions of five other adjacent counties in Pennsylvania, and a competitive local exchange carrier ("CLEC"), providing services in the Lancaster, Reading, Harrisburg, State College, Pottstown, Williamsport and Altoona, Pennsylvania metropolitan areas. We offer our Wireline customers a comprehensive package of communications services, including local telephone service, enhanced telephone services, network access services, long-distance toll services, dedicated data circuits, and communication services, such as broadband and dial-up Internet access services, business continuity services, co-location facilities, web-hosting services, directory and other revenue sources such as video and VoIP services.
Our Systems Integration segment provides business customers with professional data and information technology services, network design, monitoring, security assessments and penetration tests. We offer customers our Managed Services products, which are internal monitoring (within the customer's enterprise), external monitoring (devices outside the customer's enterprise) and comprehensive security assessments and management. Our complement of Managed Services fills the needs of our customers by allowing them to improve reliability, provide higher levels of service and save money through efficient device management and planning.
As of June 30, 2008, we served 122,461 RLEC access lines, 46,462 CLEC access lines, 39,888 digital subscriber lines ("DSL")/high-speed Internet subscribers, 2,683 dial-up Internet access subscribers, 7,425 video subscribers and 1,002 web-hosting customers resulting in total customer connections of 219,921. For the quarter ended June 30, 2008, we generated total consolidated revenues of $37,549, a consolidated operating loss of $18,089 and a consolidated net loss of $11,942. The operating and net losses were primarily a result of a non-cash intangible asset impairment described below.
Item 2. Management's Discussion and Analysis of
Business Strategy
Our primary business objective is to be a leading, regional broadband integrated communications service provider ("ICP"). To achieve this objective:
We are continuing to pursue the goal of capturing as many broadband connections to customers' homes and businesses as possible. While we intend to continue to serve our dial-up Internet access customer base, our focus will be to migrate these customers to broadband connections. New broadband customers are being aggressively pursued. Targeting customers with a broadband connection to their home and/or business is vital for the delivery of Internet Protocol ("IP") and web-based application services. We have implemented an IP core network, along with a softswitch platform, to more efficiently support and expand our voice and data delivery. In conjunction with this network implementation, we will continue to build out our fiber-to-the-node ("FTTN") infrastructure to support the future deployment of advanced broadband IP communication services. With the establishment of an IP core network as part of our circuit switch to IP switch network migration, we expect to meet the demands of our residential and business customers for increased bandwidth and new IP-based multimedia applications. Furthermore, our Haywire computer support services which allow us to handle new computer set-up, installation, troubleshooting and preventive maintenance services for our customers, is another example of our commitment to our broadband business. Through our Internet service provider, we also offer our customers the convenience of using a web portal (www.dejazzd.net) that showcases content and technologies like news, weather, shopping, music and more.
We are continuing to operate under a disciplined strategy, with the goal to increase our market share in our CLEC markets, primarily to business customers, by offering competitive communication service packages. We will continue to leverage our state-of-the-art network infrastructure, established reputation, extensive local knowledge and significant operating experience to attempt to gain new customers and increase our market share in our CLEC markets. Our focus will be on acquiring customers that can be served on our own network facilities and moving existing customers from leased facilities to our own network.
We believe that the convergence and complexity of voice communications and data network technologies has increased the need for businesses to seek a single provider for all of their communications, information technology, business continuity and co-location needs. We have created a more direct link between our Wireline customer base and the Systems Integration business through joint sales proposals, sales incentive plans and needs-based proposals that combine Wireline and Systems Integration services for a custom and differentiated offering, including professional information technology services, network security services and network monitoring and response.
We will offer a broad array of advanced communication services that will enable new modes of communication to become a part of the daily home or business experience. Utilizing softswitch technology, we will deliver advanced applications such as unified communications and integrated application services (e.g., email, voicemail, instant messaging and video conferencing), which will provide customers with more flexible communication alternatives. We have direct experience with video deployments on two technology platforms - hybrid fiber coaxial in the State College market and ADSL2+ over the copper network in Union County, Pennsylvania. The deployment of video in other markets remains under review and evaluation.
Item 2. Management's Discussion and Analysis of
Business Risks
Business risks affecting our Company include increased competition, the complex and uncertain regulatory environment in the telecommunications industry and our debt financing. Our Annual Report on Form 10-K for the year ended December 31, 2007 contains a more extensive discussion of risk factors affecting our business.
Increased competition
We have faced, and expect to continue to face, increased competition as a result of a convergence of technologies and a pro-competitive regulatory environment, which has eroded barriers to entry into our Wireline business segment.
Convergence of technologies
One of the critical drivers in the communications industry today is the convergence of voice and data communication technologies into various IP based platforms, all of which have the potential to provide VoIP, broadband services and IP video over telephone companies' copper and fiber networks, cable companies' coaxial and fiber networks, wireless telephone companies' wireless networks and satellite companies' satellite networks. Although each of the networks has relative strengths and weaknesses, they are all effectively in competition for the customers' communications needs. These developments mean that we are competing for our existing customer base in our Wireline markets with cable TV companies, wireless telephone companies, satellite communications providers and VoIP providers. The decreases in the number of access lines in our RLEC territories reflect such increased competition, in addition to the elimination of lines by our customers as they shift to DSL for high-speed Internet access.
We have competitive strengths and weaknesses in the competition for the customer's communications dollar. Cable TV companies are now delivering VoIP services with systems fully capable of providing IP telephony services. We are now offering video over a portion of our fiber-copper network in the area of Lewisburg, Pennsylvania in competition with the video services offered by incumbent cable companies.
The competitive threat posed by the convergence of technologies makes our commitment to customer service even more critical to the protection of our competitive position. We are a local company with local connections that can give individual, personalized service. We are also flexible enough to be able to provide an individual response to customers' needs. We feel that this responsiveness will be critical to our ability to successfully convince both our business and residential customers to see us as their "preferred provider" of integrated communications services, particularly in light of the substantially greater resources of many of our competitors.
Item 2. Management's Discussion and Analysis of
In order to remain competitive and provide the broadband services required for high-speed data and video, we must continue to invest substantial amounts of capital in our infrastructure. We have installed significant amounts of fiber in our system. We have installed "gigabit" networks, and believe that we have the expertise to lead the way to providing ubiquitous broadband access in our markets. We have completed 99% of our requirements under Act 183 of the Pennsylvania Public Utility Code to provide broadband availability in 100% of our RLEC system by December 31, 2008. In keeping with the foregoing, our 2008 capital budget is approximately $25,000. However, our ability to invest in infrastructure may be limited by our indebtedness of $189,665 as of June 30, 2008 and the covenants contained in the Company's credit facility.
Pro-competitive regulatory environment
It is basic policy of the Federal Communications Commission ("FCC") and the Pennsylvania Public Utility Commission ("PA PUC") to encourage competition in the communications industry. Federal and state regulatory trends toward a more competitive marketplace through reduced competitive entry standards are likely to have negative effects on our business and our ability to compete. The introduction of new competitors could have a negative effect on our RLEC markets, yet at the same time present operating benefits to our CLEC business.
Legislation enacted in Pennsylvania in the fourth quarter of 2004 provides a continuing limited suspension from certain interconnection requirements of the Telecommunications Act of 1996 to our Buffalo Valley RLEC through December 31, 2008. Competitors currently have the opportunity to seek the removal of our rural exemption applicable to our other two RLECs in order to have access to our customers by entering our territory and using our facilities through interconnection agreements to provide local services.
The PA PUC granted CORE Communications, Inc. ("CORE") a certificate to provide telecommunications services in the entire rural telephone company territory of Pennsylvania and the Commonwealth Court has affirmed the PA PUC's decision to grant CORE a CLEC certificate. CORE requested interconnection agreements with other RLECs, including our RLECs. The request was contested and referred to arbitration by the PA PUC. A hearing was held before a PA PUC Administrative Law Judge in March 2008 in order to allow the parties to submit testimony in regard to issues involving interconnection agreements between CORE and other RLECs, including our RLECs. Legal briefs and final offers by both sides were filed by April 30, 2008. CORE is unable to operate in our RLEC markets until the PA PUC resolves our interconnection agreement arbitration proceeding and we enter into a PA PUC approved interconnection agreement with them.
Comcast Business Communications ("Comcast") filed an application with the PA PUC on January 31, 2008 for certification to be a facilities-based CLEC in our Conestoga RLEC territory in areas where they currently have facilities to provide cable TV services. Comcast also requested to negotiate an interconnection agreement with our Conestoga RLEC. The negotiation process between Comcast and our Conestoga RLEC is now in progress.
Item 2. Management's Discussion and Analysis of
In our competitive markets, the incumbent carrier, Verizon, enjoys certain business advantages, including its size, financial resources, brand recognition and network connection to virtually all of our customers and potential customers in those areas. Similarly, in areas where we do or may provide video services, the incumbent cable operators enjoy certain business advantages, including their size, financial resources, brand recognition and ownership of or superior access to programming.
Complex and uncertain regulatory environment
The United States communications industry is subject to federal, state and local regulations that are continually evolving. As new communications laws and regulations are issued, we may be required to modify our business plans or operations, and we may not be able to do so in a cost-effective manner.
Prices for our RLECs' interstate services, consisting primarily of subscriber line charges and access charges for interstate and international toll calls, are regulated by the FCC based on the "average schedule" formulas proposed by the National Exchange Carrier Association, Inc. ("NECA"). If the FCC would disallow RLECs from receiving compensation for interstate services based on the NECA average schedule formulas, our RLECs could experience a change in revenues. Changes in the average schedule formula amounts developed by NECA and implemented annually in July will impact our RLECs' future revenues. The average schedule settlement formulas, which were effective July 1, 2006 and July 1, 2007, included a two-year transition period for implementing the new calculations. We estimate that the total combined effect of the July 2006 and July 2007 changes in NECA average schedule settlement formulas on consolidated network access revenues, based on 2007 access lines and minutes of use, will be a reduction of approximately $450 during the remaining six months of 2008, and further reductions of approximately $700 during fiscal year 2009 and $100 during fiscal year 2010. NECA implemented new average schedule formulas that became effective July 1, 2008. We estimate that the July 2008 changes to these formulas, based on current access lines and minutes of use, will reduce annual consolidated network access revenues by approximately $100.
The FCC is reviewing potential modifications to the current systems of interstate network access rates that telecommunication companies charge each other for network access. The FCC is considering comments from the public on the Missoula Plan, a proposal that was developed by industry representatives. The Missoula Plan, if adopted, would have a significant impact on the intercarrier compensation revenues and the federal Universal Service Fund ("USF") funding that our RLECs receive, as well as the intercarrier compensation expense that they incur. The FCC has also received other proposals to reform intercarrier compensation.
The federal USF program is under legislative and industry scrutiny as a result of the growth in the fund and changes within the telecommunications industry. The primary change is the increase in the number of eligible telecommunications carriers ("ETCs") receiving compensation from the USF. There are several FCC proceedings underway that are likely to change the way the universal service programs are funded and the way universal service funds are distributed. The Federal/State Joint Board on Universal Service ("Joint Board") released a recommended decision to the FCC to impose an interim cap on the amount of high-cost support that competitive ETCs ("CETCs") receive. On May 1, 2008, the FCC adopted an interim cap on payments to CETCs. The FCC capped total annual support for CETCs at the level they were eligible to receive in each state during March 2008, on an annualized basis. The
Item 2. Management's Discussion and Analysis of
Joint Board also issued a subsequent recommended decision to the FCC to establish a provider of last resort fund, a mobility fund and a broadband fund. Each fund would have a separate distribution and allocation mechanism. We cannot estimate at this time what impact the Joint Board's recommended changes would have on our RLECs. Finally, the FCC is considering proposals regarding the USF contribution methodology, which would change the type of service providers required to contribute to the fund and the basis on which they would contribute. Until the FCC adopts a specific contribution methodology we cannot estimate the impact a change in carrier contributions would have on our companies.
The PA PUC has a proceeding open to consider changes in intrastate switched access rates and the Pennsylvania Universal Service Fund ("PA USF"), along with the potential impact on local service rates, for rural local exchange carriers in Pennsylvania. The PA PUC granted a further stay of this proceeding on April 9, 2008, but voted to open the proceeding for the limited purpose of re-examining whether the current residential local service rate cap of eighteen dollars for RLECs is appropriate, and whether the PA USF can be utilized by the RLECs for revenue support if their annual state regulatory price-cap guideline ("Chapter 30") rate increases result in rates that exceed the cap. Until the PA PUC adopts specific proposals, it is impossible to predict how much the proposed changes will affect our business and whether they will be favorable or unfavorable.
Our RLECs filed for changes in local and intrastate access rates to be effective July 1, 2006, in accordance with our Chapter 30 plan. The PA PUC identified a minor change to our filing, but allowed the new rates to go into effect on July 1, 2006 as modified for the change. Verizon, however, filed comments against our increase in intrastate access rates and requested that the PA PUC investigate our ability to increase access rates. On July 11, 2007, the PA PUC rescinded its June 2006 order allowing the increase in our access rates. We filed a request for reconsideration and clarification of the order on a number of issues and proposed an increase in local service rates for one of our RLECs retroactive to November 15, 2006. From November 9, 2006 through July 31, 2007, we continued to bill carriers at the July 1, 2006 rates. However, we recorded a reserve against amounts that were collected from carriers related to the rate increases that were challenged by Verizon.
On November 29, 2007, the PA PUC granted our request to increase local rates retroactive to November 15, 2006 but denied our request to collect the amounts in excess of the existing caps for residential and business single party services from the PA USF. On December 17, 2007, the Office of Consumer Advocate ("OCA") filed a petition for reconsideration, claiming the PA PUC erred in its ruling that rates could be increased above the existing residential caps established by the PA PUC. We filed in support of the petition while Verizon filed opposition to the petition. The PA PUC granted the petition for review. On April 9, 2008, the PA PUC issued an Opinion and Order which denied the OCA's petition and ordered our RLECs to issue refunds, as required by the July 11, 2007 Order, within 30 days from the date of entry of the Opinion and Order. We promptly issued refunds of $1,020 in April 2008. On May 9, 2008, we filed an appeal in Commonwealth Court, seeking to overturn the PA PUC's decisions denying our requests to increase rates or, in the alternative, increase our compensation from the PA USF instead of increasing residential rates above the cap. On May 23, 2008, the OCA filed a cross appeal in Commonwealth Court, agreeing with our position that we should receive compensation from the PA USF instead of increasing residential local rates above the residential rate cap. We expect the case will be heard later this year but cannot predict what the outcome of this appeal will be.
Item 2. Management's Discussion and Analysis of
Debt financing
We had indebtedness of $189,665, including current maturities and a capital lease obligation of $1,415, at June 30, 2008. Our indebtedness could restrict our operations because:
We will use a substantial portion of our cash flow from operations to pay principal and interest on our indebtedness, which will reduce the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes;
Certain covenants in our loan agreement limit the amount of capital investment; and
The level of indebtedness will make us more vulnerable to economic or industry downturns, and our debt service obligations increase our vulnerability to competitive pressures.
The non-cash intangible asset impairment incurred in the second quarter of 2008 did not have a material effect on the results of the financial covenant calculations required by our credit facilities.
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