Our segments are RLEC, CLEC, Internet Services, and Systems Integration. The measure of profitability that management uses to evaluate performance of our 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. Effective January 1, 2007, we reorganized our business segments in order to better align them with our management structure and organized our segments based on the similar nature of products and services, production processes and distribution methods. Based on that reorganization, the RLEC, CLEC and Internet Services business units and the cable television and video operations currently reported in the corporate and other segment will be combined into one reportable segment, “Wireline.” The Systems Integration and Corporate and Other units will continue as distinct, reportable business segments.
As of December 31, 2006, we served 129,848 RLEC access lines, 43,720 CLEC access lines, 31,724 digital subscriber line (“DSL”)/high-speed Internet subscribers, 5,337 dial-up internet access subscribers, 7,437 video subscribers and 951 web-hosting customers. For the year ended December 31, 2006, we generated revenue of $162.1 million, operating income of $22.5 million and a net income of $6.7 million.
Historically, we have derived a majority of our revenues from the regulated RLEC segment. The RLEC segment accounted for approximately 59% of total 2006 revenues and substantially all of our operating income. Our RLEC revenue is derived primarily from local telephone service, network access charges, enhanced telephone services, directory advertising, private line service and regional toll service. Our CLEC focuses primarily on businesses, and revenue is derived primarily from local telephone service, network access charges, enhanced telephone services, private line service and long distance service revenue. Our Internet Services
revenue is derived from broadband and dial-up Internet access services, web-hosting services and Voice over Internet Protocol (“VoIP”) service. Our Systems Integration revenue is derived from the sale of professional data and information technology services and equipment that support the design, implementation and maintenance of client-focused technology solutions including local and wide area networks. The following graphs represent fiscal year segment revenues and operating income.
Our company currently owns a one-third interest in EuroTel, LLC (“EuroTel”), a domestic corporate joint venture, which previously owned 100% of Pennecom BV (“PenneCom”), a Netherlands telecommunications holding company. Effective January 26, 2007, PenneCom has been dissolved and its existence terminated. We expect that EuroTel will be dissolved and liquidated prior to the end of the second quarter of 2007.
Our common stock is listed for quotation on the Global Market System of the National Association of Securities Dealers Automated Quotation System under the symbol “DECC.” Our internet address is www.decommunications.com. Electronic copies of the 2006 Annual Report on Form 10-K are available free of charge by visiting the “Investor Relations” section of www.decommunications.com. Electronic copies of quarterly reports on Form 10-Q and current reports on Form 8-K are also available at this internet address. These reports are posted as soon as reasonably practicable after they are electronically filed with the United States Securities and Exchange Commission (SEC).
Our principal offices are located at 124 E. Main Street, Ephrata, Pennsylvania 17522, and we can be reached by telephone by calling (717) 733-4101 or through our website at www.decommunications.com. The contents of this website are not part of this filing. We are a Pennsylvania corporation.
Recent Developments
Debt Refinancing
On September 19, 2006, we completed an amendment to our syndicated senior debt financing, consisting of a $25 million revolving line of credit, Term Loan A in the amount of $36.1 million, Term Loan B in the amount of $144.7 million, and $28.9 million of term indebtedness. The amendment reduced the interest rates on the indebtedness, provided greater flexibility in the financial covenants, extended the scheduled amortization of principal, eliminated the $10 million permanent reduction on the revolving line of credit previously scheduled for December 31, 2006 and eliminated the requirement to maintain interest rate protection with a weighted average life of at least two years on 50% of total variable rate indebtedness. We anticipate that the reduction in interest rates will result in an average annual cash savings of approximately $0.6 million assuming the margin added to the U.S. prime or LIBOR rates in effect prior to the amendment would have been in effect throughout the term of the credit facilities using the amended loan amortization schedules.
Discontinued Operations
On September 29, 2006, we completed the sale of assets of the commercial voice equipment and service operations of the Systems Integration segment (“Voice Systems Business”) to eCommunication Systems Corporation (“eComm”) under an Asset Purchase Agreement dated September 13, 2006. The Voice Systems Business generally consisted of our voice telephone equipment business, but does not include the professional data and information technology services, security, design and network monitoring operations of the Systems Integration segment. The Voice Systems Business represented a component of our Systems Integration segment and accordingly, the results of operations have been classified as a discontinued operation for all periods presented in the consolidated statements of operations.
The Telecommunications Industry
The telecommunications industry is comprised of companies involved in the transmission of voice, data and video communications over various media and through various technologies from the point of origination to the point of termination. In recent years the industry has undergone significant change due to competition, the construction of additional infrastructure and the introduction of new technologies, which has resulted in increased demand for telecommunications services. The Telecommunications Act of 1996 (“TA-96”) and its subsequent interpretation and implementation by the Federal Communications Commission (“FCC”) has had a far reaching impact on telecommunications companies, regulators and customers.
There are two predominant types of local wireline telephone service providers in the telecommunications industry: Incumbent Local Exchange Carriers (“ILEC”) and Competitive Local Exchange Carriers (“CLEC”).
Within the ILEC sector, generally there are Rural Local Exchange Carriers (“RLEC”), which operate primarily in rural areas, RLEC aggregators, which operate multiple RLEC properties throughout the United States, and Regional Bell Operating Companies (“RBOC”).
The passage of TA-96, with its stated goal of encouraging the rapid deployment of new telecommunications technologies and promoting competition to ensure lower prices and higher quality services for U.S. telecommunications customers, substantially changed the telecommunications industry. TA-96 permitted CLECs to compete with ILECs on more favorable terms and conditions. As a result, ILEC and CLEC operators increasingly seek to differentiate themselves by bundling their communications service offerings and providing high quality customer service. Both ILEC and CLEC operators face other competitive methods of delivering communications services including wireless telephones, cable service, satellite transmission and VoIP service.
Despite competition introduced into the telecommunications industry as a result of the passage of TA-96, many large RLECs continue to grow portions of their business by capitalizing on their extensive networks, favorable demographic trends and the increasing demand for communications services, including new service offerings such as broadband and enhanced telephone services. There are also a number of RLECs that operate in rural areas where competition from CLECs generally has been minimal due to regulatory factors, including exemptions from rules applicable to the RBOCs that require competitive access as mandated by TA-96, and the unfavorable economics of constructing and operating competitive systems in rural areas. Additionally, there has been consolidation among RLECs, which has created economies of scale and the ability to cross-sell new services across a larger customer base. Nationally, there are a large number of RLECs similar to ours that operate in sparsely populated rural areas where competition from CLECs generally has been minimal due to these same economic and competitive conditions. Most of these RLECs have fewer than 50,000 access lines.
Business Strategy
Our primary business objective is to be a leading, regional integrated communications service provider (“ICP”). To achieve this objective, we will continue to pursue the following goals:
•
We will 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 in the RLEC and CLEC areas to broadband connections. New broadband customers will also be aggressively pursued. Targeting customers with a broadband connection to their home and/or business is vital for the future delivery of Internet Protocol (“IP”) services. •
We will implement 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 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 applications. •
We will continue to operate under a disciplined strategy to increase our market share in our edge-out markets, primarily to business customers, by offering competitive communication service packages. We will continue to leverage our modern network infrastructure, established reputation, extensive local knowledge and significant operating experience to attempt to gain new customers and increase our market share in our edge-out 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 will pursue the goal of Delivering Excellence for our customers by providing reliable, responsive, state-of-the-art broadband communications services, including voice, high-speed data and, in certain of our RLEC and CLEC markets, video. We will assess and tailor the bundling of services to best serve our customers and endeavor to achieve a competitive advantage in our local markets. We have direct
experience with video deployments on two technology platforms—hybrid fiber coaxial in the State College CLEC market and ADSL2+ over the RLEC copper system in Union County, Pennsylvania. The deployment of video in our other RLECs remains under review and evaluation. •
We will endeavor to be a single-source provider of voice and data communications services to our business customers. 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 and information technology needs. We are creating a more direct link between our RLEC, CLEC and Internet customer base and the Systems Integration business through joint sales proposals, sales incentive plans, and needs-based proposals that combine Systems Integration and RLEC, CLEC or Internet services for a custom and differentiated offering including professional information technology services, network security services and network monitoring and response. •
We will continue to make our commitment to customer service a top priority. Our Network Operations Center (“NOC”) provides monitoring, repair and emergency services 24 hours a day, 7 days a week and 365 days a year, which strengthens our relationships with our customers and enhances our competitive position. In an effort to enhance the customers’ experience when they call in service issues, we integrated a case management system into the NOC. The system has given us the ability to better manage and prioritize service calls resulting in greater ability to manage the customer’s request. To further enable this capability, several automated tests were developed and implemented that allow us to analyze every issue that is called in, determine the location of the issue and identify the appropriate technical group to resolve the issue. 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. •
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. Using softswitch technology currently being implemented, a unified communications portfolio of integrated application services (e.g., email, voicemail, instant messaging and video conferencing) will provide customers with more flexible communication alternatives. Operations
RLEC Operations
Our RLEC segment has provided telecommunications services to the RLEC territories since the early 1900s and was one of the first to deploy a 100% digitally switched network. Today, we market our RLEC services, including local telephone, network access, long distance, data and enhanced telephone services, as D&E Communications, in three distinct service territories. Our RLEC strategy is to sell additional communications services, including broadband and enhanced telephone services, and to manage expenses through improved operating efficiencies.
We operate in rural and suburban territories totaling 802 square miles, averaging 162 access lines per square mile as of December 31, 2006. Access lines represent revenue producing voice grade equivalent lines connected to the public switch providing dial tone to the customer. As of December 31, 2006, the RLEC served 129,848 access lines. Approximately 71% of these access lines served residential customers.
We offer our customers a broad array of enhanced telephone services, including call waiting, call transferring and forwarding, automatic callback, call trace, call-blocking, conference calling, voice mail, teleconferencing, DID (direct inward dial), caller name and number identification, distinctive ringing and simultaneous ringing (in limited areas).
We also offer network access services that provide other telecommunications carriers, such as local exchange carriers, long distance carriers and wireless companies access, to our local network facilities for the
completion of their calls. Payment for providing these services comes either directly from our customers or from other telecommunications carriers that utilize our networks. Additional interstate access revenues are received from settlement pools administered by the National Exchange Carrier Association, Inc. (“NECA”). In addition, we offer private-line service and long-distance telephone service to our RLEC customers and directory advertising to give customers business service information in addition to telephone number data.
Historically, we have derived a majority of our revenues from the regulated RLEC segment. The RLEC segment accounted for approximately 59% of total 2006 operating revenues and substantially all of our operating income. Our RLEC revenue is derived primarily from network access charges, local telephone service, enhanced telephone services, directory advertising, private line service and regional toll service. Network access revenue consists of charges paid by wireless companies for access to our network and by long distance companies for access to our network in connection with the completion of long distance telephone calls. Local telephone service revenue consists of charges for local telephone services, including monthly charges for basic local service. Enhanced telephone services revenue is derived from providing special calling features. Regional long distance revenue is derived from providing regional long distance services to our RLEC customers.
Our total RLEC lines decreased by 2.2% in 2004, 3.5% in 2005 and 3.6% in 2006, as a result of various factors that reflect industry trends, including the use of wireless service in place of second lines and, in some cases, primary lines, the move to VoIP service and the use of alternative telecommunication services. The following table reflects RLEC access line trends over the past three years:
| At Or For The Years Ended December 31, |
|||||||||
| 2006 | 2005 | 2004 | |||||||
| ACCESS LINES: |
|||||||||
| Residential |
92,400 | 97,100 | 101,366 | ||||||
| Business |
37,448 | 37,598 | 38,241 | ||||||
| Total RLEC |
129,848 | 134,698 | 139,607 | ||||||
| PERCENT OF TOTAL: |
|||||||||
| Residential |
71.2 | % | 72.1 | % | 72.6 | % | |||
| Business |
28.8 | % | 27.9 | % | 27.4 | % | |||
| PERCENTAGE CHANGE: |
|||||||||
| Residential |
(4.8 | )% | (4.2 | )% | (3.5 | )% | |||
| Business |
(0.4 | )% | (1.7 | )% | 1.4 | % | |||
| Total RLEC |
(3.6 | )% | (3.5 | )% | (2.2 | )% | |||
CLEC Operations
Our CLEC began operations in 1998 and offers services similar to the RLEC, but primarily targets small and medium-sized business customers within the edge-out markets. We also provide services to residential customers in certain markets, where economically prudent, as part of bundled services with video, high-speed data or long distance. By concentrating the CLEC strategy on markets surrounding the RLEC territories, we are able to leverage our existing human resources including technical and engineering professionals, significant back office infrastructure and network assets. As a result, three of the CLEC markets are within 10 miles, three are within 50 miles, and one is within 100 miles of one or more of the RLEC territories.
We provide our CLEC customers with broadband services, local calling, customized extended local calling, long distance and enhanced telephone services. In addition, we have developed a broadband fiber and coaxial cable network in our State College market to offer bundled services, including cable television, to business and multi-dwelling unit residential customers. We plan to continue to focus primarily on business customers, leverage our existing facilities and construct new facilities when and where it is economically prudent.
Our CLEC revenue is derived primarily from local telephone service, long distance service, network access charges, enhanced telephone services and dedicated data circuits. Local telephone service revenue consists of charges for local telephone services, including monthly charges for basic local service. Long distance revenue consists of charges for both national and regional long distance services, a portion of which is provided on a resale basis. Network access revenue consists of charges paid by long distance companies and other telecommunications carrier customers for access to our network in connection with the completion of long distance telephone calls. Dedicated circuit revenue consists of charges for T-1, DS-3 and other high capacity broadband circuits. Enhanced telephone services revenue is derived from providing special calling features, such as caller ID, call waiting and a telemarketer call-blocking service.
The number of access lines served by our CLECs has increased from 38,461 access lines as of December 31, 2004, to 40,796 access lines as of December 31, 2005 and 43,720 as of December 31, 2006. We believe that market demand for an alternative communications provider, combined with our sales efforts and quality reputation, will contribute to continued growth. As of December 31, 2006, approximately 30% of access lines were “On-Net,” defined as served entirely on our own facilities. Approximately 62% were “On-Switch,” or served through a combination of our facilities and leased facilities, and 8% were served completely on lines of another provider, known as “Resale.” At December 31, 2005, approximately 26% of access lines were “On-Net,” approximately 64% were “On-Switch” and 10% were “Resale” lines. We provide residential service in our markets but we concentrate our expansion of service to business customers. To help improve profitability, we focus our sales efforts in areas where we can provide service “On-Net” and capital spending is targeted for places where “Resale” and “On-Switch” customers can be converted to “On-Net.” The following table reflects our CLEC access line growth over the past three years:
| At Or For The Years Ended December 31, |
|||||||||
| 2006 | 2005 | 2004 | |||||||
| ACCESS LINES: |
|||||||||
| Residential |
3,536 | 3,727 | 4,298 | ||||||
| Business |
40,184 | 37,069 | 34,163 | ||||||
| Total CLEC |
43,720 | 40,796 | 38,461 | ||||||
| PERCENT OF TOTAL: |
|||||||||
| Residential |
8.1 | % | 9.1 | % | 11.2 | % | |||
| Business |
91.9 | % | 90.9 | % | 88.8 | % | |||
| PERCENTAGE GROWTH: |
|||||||||
| Residential |
(5.1 | )% | (13.3 | )% | (13.0 | )% | |||
| Business |
8.4 | % | 8.5 | % | 13.1 | % | |||
| Total CLEC |
7.2 | % | 6.1 | % | 9.5 | % | |||
| Percent On-Net or On-Switch |
92.0 | % | 90.0 | % | 89.0 | % | |||
Internet Service Operations
As part of the strategy to provide a range of data services to customers, we began offering DSL service in the second half of 1999 and began bundling DSL and Internet access services to RLEC and CLEC customers when we launched our Internet service provider, D&E Jazzd, in the fourth quarter of 2000. We began offering VoIP services in May 2005 in our CLEC territory. Our Internet services revenue is derived from dial-up and broadband services and web-hosting services. Internet services are offered to residential and business customers in a geographic region that includes and surrounds the RLEC and CLEC operations. This service is offered entirely on our own facilities in our RLEC territories and primarily on our own facilities in our CLEC markets. Our objective has been to migrate our dial-up Internet customers to our broadband service with DSL. In 2006, 11% of our new DSL subscribers upgraded to our broadband service from our previous dial-up service. The fact that we have succeeded in adding Internet service customers at a substantial rate over the past three years
demonstrates that our customers value broadband Internet services. We believe the opportunity to provide such services is an important component of our business plan. The following table reflects subscriber growth over the past three years:
| At Or For The Years Ended December 31, |
||||||||||
| 2006 | 2005 | 2004 | ||||||||
| DSL/High-Speed Internet * |
31,724 | 22,504 | 13,595 | |||||||
| Dial-up |
5,337 | 7,959 | 11,535 | |||||||
| Total Subscribers |
37,061 | 30,463 | 25,130 | |||||||
| Web-Hosting Customers |
951 | 952 | 909 | |||||||
| PERCENT OF TOTAL: |
||||||||||
| DSL/High-Speed Internet |
85.6 | % | 73.9 | % | 54.1 | % | ||||
| Dial-up |
14.4 | % | 26.1 | % | | | | | | ||
