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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-22609
------------------------
QWEST COMMUNICATIONS INTERNATIONAL INC.
(EXACT NAME OF REGISTRANT SPECIFIED IN ITS CHARTER)
------------------------
DELAWARE 84-1339282
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
555 SEVENTEENTH STREET, SUITE 1000
DENVER, COLORDADO 80202
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(303) 291-1400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares of Common Stock, $.01 par value, outstanding (the only
class of common stock of the Company outstanding) was 103,320,766, as of
November 12, 1997.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
QUARTER ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Consolidated Balance Sheets of Qwest Communications International Inc. and
Subsidiaries as of September 30, 1997 (Unaudited) and December 31, 1996................................ 3
Consolidated Statements of Operations of Qwest Communications International
Inc. and Subsidiaries for the Periods Ended September 30, 1997 and 1996 (Unaudited).................... 5
Consolidated Statement of Stockholders' Equity of Qwest Communications
International Inc. and Subsidiaries for the Nine Months Ended September 30, 1997 (Unaudited)........... 6
Consolidated Statements of Cash Flows of Qwest Communications International
Inc. and Subsidiaries for the Nine Months Ended September 30, 1997 and 1996 (Unaudited)................ 7
Notes to Consolidated Financial Statements of Qwest Communications
International Inc. and Subsidiaries (Information as of September 30, 1997 and 1996 and
for the Three and Nine Months Ended September 30, 1997 and 1996 Is Unaudited).......................... 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations for the Three and Nine Months Ended September 30, 1997 and 1996............................. 19
Item 3. Quantitative and Qualitative Disclosures About Market Risks........................................ 30
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................................................ 31
Item 5. Other Information................................................................................ 31
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE...................................................................................................... 32
Part I. Financial Information
Item 1. Financial Statements
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
- - -------------------------------------------------------------------------------
1997 1996
---------- -----------
(unaudited)
ASSETS
- - ------
Current assets:
Cash and cash equivalents $186,731 $6,905
Accounts receivable, net 64,719 29,248
Costs and estimated earnings in excess of billings 164,986 4,989
Deferred income tax asset -- 6,301
Notes and other receivables 14,936 14,934
Other current assets 7,063 328
---------- -----------
Total current assets 438,435 62,705
---------- -----------
Property and equipment, net 444,816 186,535
Deferred income tax asset 8,902 --
Notes and other receivables 115 11,052
Intangible and other long-term assets, net 16,210 3,967
---------- -----------
Total assets $908,478 $264,259
========== ===========
See accompanying notes to consolidated financial statements.
3
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
- - --------------------------------------------------------------------------------
1997 1996
---------- -----------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
- - ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $178,676 $80,129
Deferred revenue 4,044 2,649
Billings in excess of costs and estimated earnings 12,440 5,034
Deferred income tax liability 6,432 --
Current portion of long-term debt 15,782 25,193
Advances from parent -- 19,138
---------- -----------
Total current liabilities 217,374 132,143
Long-term debt 268,946 109,268
Deferred income tax liability -- 1,708
Other liabilities 53,307 11,698
---------- -----------
Total liabilities 539,627 254,817
---------- -----------
Stockholders' equity:
Preferred Stock, $.01 par value. Authorized
25,000,000 shares. No shares issued and outstanding. -- --
Common Stock, $.01 par value. Authorized
400,000,000 shares. 103,320,766 shares and
86,500,000 shares issued and outstanding at
September 30, 1997 and December 31, 1996,
respectively. 1,033 865
Additional paid-in capital 412,005 55,027
Accumulated deficit (44,187) (46,450)
---------- -----------
Total stockholders' equity 368,851 9,442
---------- -----------
Commitments and contingencies
Total liabilities and stockholders' equity $908,478 $264,259
========== ===========
See accompanying notes to consolidated financial statements.
4
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIODS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
- - ---------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------- -------------- --------------
1997 1996 1997 1996
------------- -------------- -------------- --------------
Revenue:
Carrier services $ 14,098 $ 9,247 $ 39,062 $ 45,106
Commercial services 18,361 9,163 38,033 25,475
------------- -------------- -------------- --------------
32,459 18,410 77,095 70,581
Network construction services 156,496 25,923 413,226 59,255
------------- -------------- -------------- --------------
188,955 44,333 490,321 129,836
------------- -------------- -------------- --------------
Operating expenses:
Telecommunications services 26,417 14,398 65,310 62,399
Network construction services 106,160 15,717 282,472 37,661
Selling, general and administrative 27,316 9,656 59,987 34,230
Growth share plan 4,131 -- 69,320 --
Depreciation and amortization 5,071 3,991 13,114 11,890
------------- -------------- -------------- --------------
169,095 43,762 490,203 146,180
------------- -------------- -------------- --------------
Income (loss) from operations 19,860 571 118 (16,344)
Other income (expense):
Gain on sale of contract rights -- -- 9,296 --
Gain on sale of telecommunications
service agreements -- 6,126 -- 6,126
Interest expense, net (4,159) (1,944) (8,886) (5,004)
Interest income 3,926 728 5,912 1,898
Other income (expense), net 15 133 (1,986) 113
------------- -------------- -------------- --------------
Income (loss) before income tax
expense (benefit) 19,642 5,614 4,454 (13,211)
Income tax expense (benefit) 6,991 2,160 2,191 (4,310)
------------- -------------- -------------- --------------
Net income (loss) $ 12,651 $ 3,454 $ 2,263 $(8,901)
============= ============== ============== ==============
Net income (loss) per share $ 0.12 $ 0.04 $ 0.02 $ (0.10)
============= ============== ============== ==============
See accompanying notes to consolidated financial statements.
5
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
Common Stock
---------------------
Additional Total
Number of paid-in Accumulated stockholders'
shares Amount capital deficit equity
---------- ------- ------------ ----------- ------------
Balances, December 31, 1996 86,500,000 $865 $55,027 $(46,450) $ 9,442
Issuance of common stock, net (unaudited) 15,525,000 155 319,381 - 319,536
Issuance of common stock warrants (unaudited) - - 2,300 - 2,300
Issuance of common stock for growth shares (unaudited) 1,295,766 13 35,297 - 35,310
Net income (unaudited) - - - 2,263 2,263
---------- ------ --------- ----------- ---------
Balances, September 30, 1997 (unaudited) 103,320,766 $1,033 $412,005 $(44,187) $368,851
=========== ====== ========= =========== =========
See accompanying notes to consolidated financial statements.
6
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
- - --------------------------------------------------------------------------------
1997 1996
-------- --------
Cash flows from operating activities:
Net income (loss) $2,263 $(8,901)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Gain on sale of contract rights (9,296) --
Gain on sale of telecommunications service agreements -- (6,126)
Depreciation and amortization 13,114 11,890
Deferred income tax expense 2,123 4,173
Changes in operating assets and liabilities:
Receivables -accounts and notes, net (24,536) (23,200)
Costs and estimated earnings in excess of billings (159,997) 14,706
Accounts payable and accrued expenses 59,848 (3,412)
Payable to related parties, net -- (508)
Billings in excess of costs and estimated earnings 7,406 3,158
Accrued growth share plan expense and deferred
compensation 33,953 --
Other changes 15,050 (1,120)
-------- -------
Net cash used in operating activities (60,072) (9,340)
-------- -------
Cash flows from investing activities:
Proceeds from sale of telecommunications service
agreements -- 4,500
Proceeds from sale of contract rights 9,000 --
Expenditures for property and equipment (205,304) (48,853)
-------- -------
Net cash used in investing activities (196,304) (44,353)
-------- -------
7
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
- - --------------------------------------------------------------------------------
1997 1996
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 319,536 --
Proceeds from issuance of common stock warrants 2,300 --
Borrowings of long-term debt 328,000 51,000
Repayments of long-term debt (185,858) (14,689)
Debt issuance costs (8,638) (459)
Net (payments to) advances from Parent (19,138) 20,486
--------- ---------
Net cash provided by financing activities 436,202 56,338
--------- ---------
Net increase in cash and cash equivalents 179,826 2,645
Cash and cash equivalents, beginning of period 6,905 1,484
--------- ---------
Cash and cash equivalents, end of period $186,731 $ 4,129
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest, net $ 4,473 $ 4,786
========= =========
Cash paid for taxes, other than Parent $ 195 $ 132
========= =========
Supplemental disclosure of significant non-cash investing and
financing activities:
Capital lease obligation $ -- $ 720
========= =========
Accrued capital expenditures $ 57,903 $ --
========= =========
Issuance of common stock in settlement of a portion of accrued
Growth Share liability $ 35,310 $ --
========= =========
Capital expenditures financed with equipment credit facility $ 8,125 $ --
========= =========
See accompanying notes to consolidated financial statements.
8
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(INFORMATION AS OF SEPTEMBER 30, 1997, AND FOR THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED)
- - --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) GENERAL AND BUSINESS
Qwest Communications International Inc. (the Company) was wholly-owned
by Anschutz Company (the Parent) until June 27, 1997, when the Company
issued common stock in an initial public offering (as described in note
(12) Securities Offering). Subsequent to the initial public offering
and the issuance of additional common shares in settlement of certain
Growth Shares (as described in note (11) Growth Share Plan), the Parent
owns approximately 83.7% of the outstanding common stock of the
Company. The Company is the ultimate holding company for the operations
of Qwest Communications Corporation and subsidiaries (Qwest).
The accompanying consolidated financial statements include the accounts
of the Company and all majority-owned subsidiaries. Intercompany
balances and transactions have been eliminated in consolidation.
(b) NET INCOME (LOSS) PER SHARE
Net income (loss) per share for the three and nine months ended
September 30, 1997 and 1996 was computed by dividing net income (loss)
by the weighted average number of common shares outstanding during such
periods. Common stock equivalent shares from options, warrants and
common stock issuable for Growth Shares (as described in note (11)
Growth Share Plan) are included in the computation when their effects
are dilutive except that pursuant to Securities and Exchange Commission
Staff Accounting Bulletin Number 83, Earnings Per Share Computations in
an Initial Public Offering, 1,658,000 common shares issuable for Growth
Shares granted during the 12-month period prior to the Company's
initial public offering at prices below the anticipated public offering
price were included in the calculation as if they were outstanding for
all periods presented, up to the close of the initial public offering.
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128).
SFAS 128 requires
9
the presentation of basic earnings per share (EPS) and, for companies
with potentially dilutive securities, such as convertible debt, options
and warrants, diluted EPS. SFAS 128 is effective for annual and interim
periods ending after December 15, 1997. The Company does not believe
that the adoption of SFAS 128 will significantly affect the calculation
of the Company's net income (loss) per common share.
(c) MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of 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.
The accompanying unaudited, interim consolidated financial statements
as of September 30, 1997, and for the three and nine months ended
September 30, 1997 and 1996 are prepared in accordance with generally
accepted accounting principles for interim financial information and
with the instructions of Form 10-Q, Article 10 of Regulation S-X. In
the opinion of management, these statements reflect all adjustments
(consisting of normal recurring accruals) necessary for a fair
presentation of the results of such periods. The results of operations
for any interim period are not necessarily indicative of results for
the full year. Such financial statements should be read in conjunction
with the audited consolidated balance sheets of the Company as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholder's equity and cash flows for each of the years
in the three-year period ended December 31, 1996, included in the
registration statement (no. 333-25391) on Form S-1 filed by the Company
(as described in note (12) Securities Offering). The information
contained in these unaudited interim consolidated financial statements
as of December 31, 1996 has been derived from those statements.
(d) INCOME TAXES
The Company is included in the consolidated income tax return of the
Parent, and a tax-sharing agreement provides for allocation of tax
liabilities and benefits to the Company, in general, as though it filed
a separate return.
(2) GAIN ON SALE OF CONTRACT RIGHTS
On March 10, 1997, the Company entered into an agreement with an unrelated
third party to terminate certain equipment purchase and telecommunications
capacity rights and options of the Company exercisable against the third
party for $9.0 million. In 1997, the Company received the $9.0 million in
cash.
10
(3) GAIN ON SALE OF TELECOMMUNICATIONS SERVICE AGREEMENTS
On July 1, 1996, the Company sold its right, title and interest in certain
telecommunications service agreements to an unrelated third party (the
Buyer) for $5.5 million. During the transition of service agreements to the
Buyer, the Company has incurred certain facilities costs on behalf of the
Buyer, which are reimbursable to the Company. As of September 30, 1997 and
December 31, 1996, net amounts of approximately $3.5 million and $2.0
million, respectively, were due to the Company for such costs. On March 31,
1997, the arrangement relating to transition services expired and has not
yet been renegotiated. A dispute has arisen with respect to reimbursement
of these costs and, as a result, the Company made a provision of $2.0
million in the three months ended March 31, 1997. Negotiations with the
Buyer are continuing. The Company believes that the receivable balance as
of September 30, 1997 is collectible.
(4) NETWORK CONSTRUCTION SERVICES REVENUE AND EXPENSES
Costs and billings on uncompleted contracts included in the accompanying
consolidated financial statements are as follows (in thousands):
September 30, December 31,
1997 1996
------------- ------------
(unaudited)
Costs incurred on uncompleted contracts $359,338 $ 82,840
Estimated earnings 185,032 48,853
-------- --------
544,370 131,693
Less: billings to date 391,824 131,738
-------- --------
$152,546 $ (45)
======== ========
Included in the accompanying balance sheet
accounts under the following captions:
Costs and estimated earnings in excess
of billings $164,986 $4,989
Billings in excess of costs and estimated
earnings (12,440) (5,034)
-------- --------
$152,546 $ (45)
======== ========
Revenue the Company expects to realize for
work to be performed on the above
uncompleted contracts $577,886 $328,688
======== ========
The Company has entered into agreements with unrelated third parties
whereby the Company will provide indefeasible rights of use in multiple
fibers along a coast-to-coast fiber optic telecommunications network (the
Network) for a purchase price of approximately $1.1 billion. Earnings
relating to these contracts are estimated using
11
allocations of the total cost of constructing the Network (as described in
note (10) Commitments and Contingencies).
(5) PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
September 30, December 31,
1997 1996
------------------- -----------------
(unaudited)
Land $ 558 $ 506
Facility and leasehold improvements 12,761 7,951
Communications and construction equipment 74,751 52,076
Fiber and conduit systems 92,924 42,446
Office equipment and furniture 8,324 6,360
Network construction and other assets held
under capital leases 3,071 3,197
Work in progress 288,710 99,915
-------- --------
481,099 212,451
Less accumulated depreciation and amortization (36,283) (25,916)
-------- --------
Property and equipment, net $444,816 $186,535
======== ========
(6) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consists of the following (in
thousands):
September 30, December 31,
1997 1996
------------------- -----------------
(unaudited)
Accounts payable $ 40,163 $ 44,766
Construction accounting accrual 66,976 18,071
Capacity service obligation 8,971 3,658
Property, sales and other taxes 28,551 3,793
Accrued interest 14,594 707
Other 19,421 9,134
-------- --------
Accounts payable and accrued expenses $178,676 $ 80,129
======== ========
12
(7) OTHER LIABILITIES
Other liabilities consists of the following (in thousands):
September 30, December 31,
1997 1996
(unaudited)
------------------- -----------------
Right-of-way obligation $ 31,295 $ 1,297
Growth share accrual 13,996 9,291
Other 8,016 1,110
-------- --------
Other liabilities $ 53,307 $ 11,698
======== ========
(8) LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
September 30, December 31,
1997 1996
------------------- -----------------
(unaudited)
Senior notes-Series B $250,000 $ --
Revolving credit facility 10,000 60,000
Customer contract credit facility 15,000 25,918
Equipment credit facility 8,125 --
Network credit facility -- 27,077
Equipment loans -- 9,820
Term notes -- 9,416
Capital lease obligations 1,423 2,010
Other 180 220
-------- --------
Total debt 284,728 134,461
Less current portion (15,782) (25,193)
-------- --------
Long-term debt $268,946 $109,268
======== ========
In August 1997, the Company completed an exchange of notes (the Exchange
Notes), registered under the Securities Act of 1933 (the Act), for all of
the originally issued 10 7/8% Senior Notes due 2007 (the Senior Notes). The
Exchange Notes are identical in all material respects to the originally
issued Senior Notes. The Company received no proceeds from and recognized
no profit on the exchange transaction, and no change in the financial
condition of the Company occurred as a result of the exchange transaction.
The Senior Notes and the Exchange Notes are referred to, collectively,
hereinafter as the "Series B Senior Notes."
The Company had a $100.0 million three-year revolving credit facility. In
October 1997, the Company paid the outstanding balance and terminated this
credit facility.
13
In February 1997, the Company entered into a one year $50.0 million line of
credit from a commercial bank. No amounts were ever drawn under this credit
line, and the Company canceled the facility in July 1997.
In October 1997, the Company issued $555,890,000 in principal amount at
maturity of Senior Discount Notes, due 2007 (the Discount Notes),
generating net proceeds of approximately $342.6 million, after deducting
offering costs which are included in intangible and other long-term assets.
Such net proceeds will be used to fund capital expenditures for continuing
construction and activation of the Network and to fund further growth in
the business. The Discount Notes will accrete at a rate of 9.47% per annum,
compounded semi-annually, to an aggregate principal amount of $555,890,000
by October 15, 2002. The principal amount of the Discount Notes is due and
payable in full on October 15, 2007. The Discount Notes are redeemable at
the Company's option, in whole or in part, at any time on or after October
15, 2002, at specified redemption prices. In addition, prior to October 15,
2000, the Company may use the net cash proceeds from certain equity
transactions to redeem up to 35% of the Discount Notes at specified
redemption prices. Cash interest on the Discount Notes will not accrue
until October 15, 2002, and thereafter will accrue at a rate of 9.47% per
annum, and will be payable semi-annually in arrears commencing on April 15,
2003 and thereafter on April 15 and October 15 (each an interest payment
date) of each year. The Company has the option of commencing the accrual of
cash interest on an interest payment date on or after October 15, 2000, in
which case the outstanding principal amount at maturity of the Discount
Notes will, on such interest payment date, be reduced to the then accreted
value, and cash interest will be payable on each interest payment date
thereafter.
In connection with the sale of the Discount Notes, the Company agreed to
make an offer to exchange new notes, registered under the Act and with
terms identical in all material respects to the Discount Notes, for the
Discount Notes or, alternatively, to file a shelf registration statement
under the Act with respect to the Discount Notes. If the registration
statement for the exchange offer or the shelf registration statement, as
applicable, are not filed or declared effective within specified time
periods or, after being declared effective, cease to be effective or usable
for resale of the Discount Notes during specified time periods (each a
Registration Default), additional cash interest will accrue at a rate per
annum equal to 0.50% of the principal amount at maturity of the Discount
Notes during the 90-day period immediately following the occurrence of a
Registration Default and increasing in increments of 0.25% per annum of the
principal amount at maturity of the Discount Notes up to a maximum of 2.0%
per annum, at the end of each subsequent 90-day period until the
Registration Default is cured.
The terms of certain loan agreements described above limit the Company's
ability to pay dividends and restrict certain assets of the Company's
subsidiaries.
14
(9) ADVANCES FROM PARENT
Advances from Parent at December 31, 1996, which were non-interest
bearing, included costs charged to the Company by the Parent and advances
received from the Parent to fund operations, net of repayments. In May
1997, all outstanding advances from Parent, totaling approximately $28.0
million, were repaid.
(10) COMMITMENTS AND CONTINGENCIES
(a) NETWORK CONSTRUCTION PROJECT
In 1996, the Company commenced construction of the Network, which is
scheduled for completion in the second quarter of 1999. The Company
projects its total remaining cost at September 30, 1997 for completing
the construction of the Network will be approximately $1.2 billion.
This amount includes the Company's remaining commitment through
December 31, 1998 to purchase a minimum quantity of materials for
approximately $200.5 million as of September 30, 1997, subject to
quality and performance expectations. The Company has the option to
extend the materials purchase agreement through December 31, 1999 and
may assign some or all of its remaining purchase commitment to a third
party or cancel the agreement by paying the seller an amount equal to
7% of any remaining commitment. The Company has contracted to provide a
portion of the fibers in the Network to third parties (see note (4)
Network Construction Services Revenue and Expenses).
Although these agreements provide for certain penalties if the Company
does not complete construction within the time frames specified within
the agreements, management does not anticipate that the Company will
incur any substantial penalties under these provisions.
(b) EASEMENT AGREEMENTS
In February 1997, the Company entered into a right-of-way agreement
with an unrelated third party which provides for advance payment of
$1.9 million for the initial five-year period of the agreement and $1.9
million in advance of each subsequent five-year period during the
remainder of the 25-year term of the agreement. The present value of
this obligation is included in other non-current liabilities as of
September 30, 1997.
In July 1997, the Company entered into a 25-year right-of-way agreement
with an unrelated third party that allows the Company to construct and
operate a fiber optic network for approximately 850 route miles along
such right-of-way. The agreement provides for annual payments of
approximately $2,500 per route mile. The present value of this
obligation is included in other non-current liabilities as of September
30, 1997.
15
In October 1997, the Company entered into a perpetual right-of-way
agreement with an unrelated third party that allows the Company to
install conduit in up to approximately 300 route miles along such
right-of-way. The agreement provides for a total payment in advance of
approximately $4.9 million, which was paid by the Company in October
1997.
In October 1997, the Company entered into a 25-year right-of-way
agreement with an unrelated third party that allows the Company to
construct and operate a fiber optic network over up to approximately
370 route miles along such right-of-way. The agreement provides for
advance annual payments of approximately $4,500 per route mile.
(11) GROWTH SHARE PLAN
The Company has a Growth Share Plan for certain of its employees and
directors. A "Growth Share" is a unit of value based on the increase in
value of the Company over a specified measuring period. Upon completion of
the common stock offering in June 1997 (as described in note (12)
Securities Offering), certain Growth Shares vested in full. The Company
has estimated an increase in value of the Growth Shares during 1997 and
has recorded approximately $69.3 million of additional compensation
expense in the nine months ended September 30, 1997. In July 1997, the
Company issued 1,295,766 common shares, net of amounts relating to tax
withholdings of approximately $21.9 million, in settlement of a portion of
the accrued liability related to Growth Shares. Compensation relating to
certain non-vested Growth Shares will be amortized as expense over the
remaining approximately four-year vesting period.
(12) SECURITIES OFFERING
On May 23, 1997, the Board of Directors approved a change in the Company's
capital stock to authorize 400 million shares of $.01 par value Common
Stock (of which 10 million shares are reserved for issuance under the
Equity Incentive Plan (as described in note (13) Equity Incentive Plan), 2
million shares are reserved for issuance under the Growth Share Plan, and
4.3 million shares are reserved for issuance upon exercise of warrants, as
described below), and 25 million shares of $.01 par value Preferred Stock.
On May 23, 1997, the Board of Directors declared a stock dividend to the
existing stockholder of 86,490,000 shares of Common Stock, which was paid
immediately prior to the effectiveness of the registration statement on
June 23, 1997. This dividend is accounted for as a stock split. All shares
and per share information included in the accompanying interim
consolidated financial statements have been adjusted to give retroactive
effect to the change in capitalization. The Company completed the initial
public offering of 15,525,000 shares of Common Stock on June 27, 1997,
raising net proceeds of approximately $319.5 million.
Effective May 23, 1997, the Company sold to an affiliate of the Parent for
$2.3 million in cash, a warrant to acquire 4.3 million shares of Common
Stock at an exercise price of
16
$28.00 per share, exercisable on May 23, 2000. The warrant is not
transferable. Stock issued upon exercise of the warrant will be subject to
restrictions on sale or transfer for two years after exercise.
(13) EQUITY INCENTIVE PLAN
Effective June 23, 1997, the Company adopted the Qwest Communications
International Inc. Equity Incentive Plan (the Equity Incentive Plan). This
plan permits the grant of non-qualified stock options, incentive stock
options, stock appreciation rights, restricted stock, stock units and
other stock grants to key employees of the Company and affiliated
companies and key consultants to the Company and affiliated companies who
are responsible for the Company's growth and profitability. A maximum of
10 million shares of Common Stock may be subject to awards under the
Equity Incentive Plan.
The Company's Compensation Committee (the Committee) determines the
exercise price for each option; however, stock options must have an
exercise price that is at least equal to the fair market value of the
Common Stock on the date the stock option is granted, subject to certain
restrictions.
All awards granted under the Equity Incentive Plan will immediately vest
upon any change in control of the Company, as defined, unless provided
otherwise by the Committee at the time of grant. All outstanding options
will automatically terminate upon the occurrence of certain merger and
reorganization transactions and appropriate notice by the Company to all
option holders, as defined.
For the nine months ended September 30, 1997, the Company has granted
options to purchase a total of 5,800,500 shares of Common Stock of the
Company. The options are exercisable over five years from the date of
grant and have a weighted average exercise price of approximately $29.00
per share.
As permitted by Statement of Financial Accounting Standards No. 123,
Accounting for Stock Based Compensation, the Company accounts for the
Equity Incentive Plan in accordance with Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. No compensation
expense has been recognized for grants under the Equity Incentive Plan.
(14) MEXICO FIBER PURCHASE AGREEMENT
In July 1997, the Company entered into an agreement with an unrelated
third party whereby the Company will receive (i) four dark fibers along a
2,270 kilometer route to be constructed in Mexico (the Mexico Network) by
the third party, and (ii) certain construction inventory and value-added
tax refunds, totaling approximately $2.9 million. In exchange for these
assets, the third party will receive the stock of the Company's
subsidiary, SP Servicios de Mexico S. A. de C. V. (SPS), and approximately
$6.7 million in cash. Upon completion of the Mexico Network and the
extension of the Qwest Network
17
to the Mexican border, the Qwest Network will be linked to Mexico City,
Mexico. Completion of the Mexican network is scheduled for late 1998.
(15) SIGNIFICANT CUSTOMERS
During the nine months ended September 30, 1997 and the year ended
December 31, 1996, two or more customers, in aggregate, have accounted for
10% or more of the Company's total revenues in one or more periods, as
follows:
Customer Customer Customer
A B C
-----------------------------------
1996 27.8% 26.3% -
1997 6.3% 33.4% 36.9%
(16) ACQUISITION
In October 1997, Qwest and an unrelated third party consummated an
agreement whereby Qwest acquired from the third party all of the issued
and outstanding shares of capital stock of the third party's then wholly
owned internet service provider (the ISP), and the capital stock of the
ISP issued at the closing of the acquisition, for $20.0 million in cash.
The acquisition will be accounted for using the purchase method of
accounting. The purchase price will be allocated to the assets and
liabilities acquired based upon the estimated fair values of such assets
and liabilities.
18
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
The following discussion and analysis should be read in conjunction with
(i) the Company's accompanying unaudited interim financial statements and the
notes thereto, and (ii) the financial statements, and related notes thereto, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the registration statement (File No. 333-25391) on Form
S-1 (Form S-1) filed by the Company.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of federal securities laws, including statements about the
Company's plans to complete the Qwest Network (defined below), expectations as
to funding its capital requirements, anticipated expansion of Carrier Services
(defined below) and Commercial Services (defined below), regulatory and pricing
trend projections, and other statements of expectations, beliefs, future plans
and strategies, anticipated developments, and other matters that are not
historical facts. Management cautions the reader that these forward-looking
statements are subject to risks and uncertainties that could cause actual events
or results to differ materially from those expressed or implied by the
statements. Important factors that could prevent the Company from achieving its
stated goals include, but are not limited to failure by the Company (i) to
manage effectively, cost efficiently and on a timely basis the construction of
the route segments, (ii) to enter into additional customer contracts to sell
dark fiber or provide high-volume capacity and otherwise expand its
telecommunications customer base, (iii) to obtain and maintain all necessary
rights-of-way. For additional information, see "Risk Factors" included in the
Company's filings with the SEC.
OVERVIEW
The Company is a facilities-based provider of communications services to
interexchange carriers and other communications entities (Carrier Services) and
to businesses and consumers (Commercial Services), and it constructs and
installs fiber optic communications systems for interexchange carriers and other
communications entities, as well as for its own use (Network Construction
Services).
The Company is expanding its existing long distance network into an
approximately 16,000 route-mile, coast-to-coast, technologically advanced fiber
optic telecommunications network (the Qwest Network), which includes the
recently announced 3,000 route-mile extensions in the Southeastern states,
California and Texas. The Company will employ, throughout substantially all of
the Qwest Network, a self-healing SONET four-fiber ring architecture equipped
with the most advanced commercially available fiber and transmission electronics
manufactured by Lucent Technologies and Northern Telecom Inc. (Nortel),
respectively. The Qwest Network's advanced fiber and transmission electronics
are expected to provide the Company with lower installation, operating and
maintenance costs than older fiber systems generally in commercial use today.
In addition, the Company has entered into construction contracts for the sale of
dark fiber along the route of the Qwest Network, which will reduce the Company's
net cost per fiber mile with respect to
19
the fiber it retains for its own use. As a result of these cost advantages, the
Company believes it will be well positioned to capture market share and take
advantage of the rapidly growing demand for data transmission, multimedia and
long haul voice capacity. The Company derives its revenue from Carrier Services,
Commercial Services and Network Construction Services.
In October 1997, Qwest and NEWSUPERNET (NSN) consummated an agreement
whereby Qwest acquired from NSN all of the issued and outstanding shares of
capital stock of NSN's then wholly-owned internet service provider, SuperNet,
Inc. (SNI), and the capital stock of SNI issued at the closing of the
acquisition, for $20.0 million in cash. The acquisition will be accounted for
using the purchase method of accounting. The purchase price will be allocated to
the assets and liabilities acquired based upon the estimated fair values of such
assets and liabilities.
Carrier Services. Carrier Services provide high-volume and conventional
dedicated line services over the Company's owned capacity and switched services
over owned and leased capacity to interexchange carriers and other
telecommunications providers. The Company is currently focusing on expanding
Carrier Services to increase its revenue stream and reduce per unit costs,
targeting short-term capacity sales on a segment-by-segment basis as the Qwest
Network is deployed and activated, and is increasingly seeking longer-term,
high-volume capacity agreements from major carriers. In addition to traditional
telecommunications carriers, the Company is marketing to internet service
providers and other data service companies. Revenue from Carrier Services has
been derived from high-volume capacity services, dedicated line services and
switched services. The Company provides high-volume transmission capacity
services through service agreements for terms of one year or longer. Dedicated
line services are generally offered under service agreements for an initial term
of one year. High-volume capacity service agreements and dedicated line service
agreements generally provide for "take or pay" monthly payments at fixed rates
based on the capacity and length of circuit used. Customers are typically billed
on a monthly basis and also may incur an installation charge or certain
ancillary charges for equipment. After contract expiration, the contracts may be
renewed or the services may be provided on a month-to-month basis. Switched
services agreements are generally offered on a month-to-month basis, and the
service is billed on a minutes-of-use basis. Revenue from carrier customers that
is billed on a minutes-of-use basis has the potential to fluctuate significantly
based on changes in usage that are highly dependent on differences between the
prices charged by the Company and its competitors. The Company, however, has not
experienced significant fluctuations to date. For the three and nine months
ended September 30, 1997, the Company's five largest carrier customers accounted
for approximately 44.4% and 41.3% of Carrier Services revenue, respectively.
Commercial Services. Commercial Services provide long distance voice, data
and video services to businesses and consumers. The Company plans to build on
its Carrier Services experience to expand its presence in the Commercial
Services market by developing its distinctive "ride the light" brand identity
and aggressively marketing its existing and planned voice, data and other
transmission products and services. The Company plans to build direct end user
relationships by developing strong distribution channels, providing competitive
pricing and superior network quality and offering enhanced, market-driven
services to businesses and consumers. Revenue from Commercial Services is
recognized primarily on a minutes-of-use basis. Commercial Services has
generated revenue using three primary sales channels: direct mail, agent and
telemarketing. The Commercial Services market is highly competitive and
generally subject to significant customer attrition. The Company's attrition
rates vary by product line and sales channel, and the Company typically has
experienced an average monthly attrition rate ranging from 4% to 9%. The average
20
attrition rates for the three and nine months ended September 30, 1997 have been
consistent with historical rates. In September 1997, the Company entered into an
arrangement with a third party under which they will jointly define and test new
broadband business multimedia services. The Company has also entered into
marketing agreements in September 1997 with two additional third parties. Under
one of these agreements, the third party, a marketing company that wholesales
and retails telecommunications products on a national basis, will be an
authorized sales representative of Qwest, marketing the Company's long-distance
products through affinity groups. Under the second of these agreements, the
Company will offer its One Plus and Calling Card services (with competitive
international pricing for both) to utilities across the nation along with other
services provided by the third party under its Simple Choice/SM/ brand name.
Network Construction Services. Network Construction Services consist
of the construction and installation of fiber optic communication systems for
interexchange carriers and other telecommunications providers, as well as for
the Company's own use. Revenue from Network Construction Services generally is
recognized under the percentage of completion method as performance milestones
relating to the contracts are completed. Losses, if any, on uncompleted
contracts are expensed in the period in which they are identified, and any
revisions to estimated profits on a contract are recognized in the period in
which they become known.
In 1996, the Company entered into construction contracts for the sale of
dark fiber to Frontier Communications International, Inc. (Frontier) and
WorldCom, Inc. (WorldCom) whereby the Company has agreed to install and provide
dark fiber to each along portions of the Qwest Network. The Company also
entered into two construction contracts in 1997 with GTE Intelligent Network
Services Incorporated (GTE) for the sale of dark fiber along segments of the
route of the Qwest Network. After completion of the Qwest Network, the Company
expects that revenues from Network Construction Services will be less
significant to the Company's operations.
As previously disclosed, the Company is expanding its network into Mexico.
Upon completion of the Qwest Network to the Mexican border, the Qwest Network
will be linked to Mexico City, Mexico. Completion of the Mexican network is
scheduled for late 1998.
Pricing. The Company believes that prices in the telecommunication
services industry will continue to decline as a result of reforms prompted by
the Telecommunications Act of 1996 and reform of the rules governing access
charges and international settlement rates. The Company also believes that the
effect of such decreases in prices on total revenue will be partially offset by
increased demand for telecommunications services, and that the low cost per unit
base of the Qwest Network will give it a competitive advantage relative to its
competitors.
Operating Expenses. The Company's principal operating expenses consist of
expenses for network construction incurred by Network Construction Services,
expenses for telecommunications services, selling, general and administrative
expenses (SG&A), and depreciation and amortization. Expenses for Network
Construction Services consist primarily of costs to construct the Qwest Network,
including conduit, fiber cable, construction crews and rights-of-way. Costs
attributable to the construction of the Qwest Network for the Company's own use
are capitalized.
Expenses for telecommunications services primarily consist of the cost
of leased capacity, Local Exchange Carrier (LEC) access charges, engineering and
other operating costs. Since the Company currently provides dedicated line
services primarily over its owned network, the cost of
21
providing these services generally does not include the cost of leased capacity
or LEC access charges. Expenses for switched services, however, include these
costs. The Company leases capacity from other carriers to extend its switched
services for originating and terminating traffic beyond its own network
boundaries. LEC access charges, which are variable, represent a significant
portion of the total cost for switched services. Due in part to these costs,
revenue from switched services has lower gross margins than revenue from
dedicated line services. When the Qwest Network is completed and activated, the
Company will be able to serve more customer needs over its own capacity on the
Qwest Network. Furthermore, with additional switched traffic on the Qwest
Network, the Company believes it will realize economies of scale and thereby
lower its telecommunications costs as a percentage of revenue.
SG&A includes the cost of salaries, benefits, occupancy costs, commissions,
sales and marketing expenses and administrative expenses. Commercial Services
sales and marketing expenses are incurred primarily through the use of its
agent, telemarketing and direct mail sales channels. The Company expects that
increased SG&A will be necessary to realize the anticipated growth in revenue
for Carrier Services and Commercial Services as the Company develops the Qwest
Network. The Company is in the process of opening commercial sales offices in
selected major geographic markets to implement the Company's strategy, as
segments of the Qwest Network become operational. In addition, SG&A expenses
will increase as the Company continues to recruit experienced telecommunications
industry personnel to implement the Company's strategy.
The Company has a Growth Share Plan for certain of its employees and
directors. Growth Share Plan expense, included in operating expenses, reflects
the Company's estimate of compensation expense with respect to the Growth Shares
issued to participants. A "Growth Share" is a unit of value based on the
increase in value of the Company over a specified measuring period. Growth
Shares granted under the Plan generally vest at the rate of 20% for each full
year of service completed after the grant date subject to risk of forfeiture.
Participants receive their vested portion of the increase in value of the Growth
Shares upon a triggering event, as defined, which includes the end of a growth
share performance cycle. Upon completion of the common stock offering in June
1997, certain Growth Shares vested in full, which resulted in substantial
compensation expense under the Growth Share Plan in the second quarter of 1997,
and the issuance in July 1997 of 1,295,766 shares of Common Stock, which were
net of amounts related to tax withholdings, in settlement of the accrued
liability related to these Growth Shares. Effective with the initial public
offering, all holders of Growth Shares not vested by virtue of the initial
public offering have been granted nonqualified stock options under the Company's
Equity Incentive Plan, and the value of these Growth Shares has been capped
based upon the initial public offering price of $22.00 per share. Compensation
expense relating to these non-vested Growth Shares will be recognized over the
remaining approximately four-year vesting period and is estimated to be up to
approximately $27.7 million in total. The Company does not anticipate any
future grants under the Growth Share Plan.
22
RESULTS OF OPERATIONS
The table set forth below summarizes the Company's revenue by source,
operating expenses, other income (expense), and other financial and operating
data (amounts in thousands, except per share information, minutes of use, route
miles and switch information):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------------------
1997 1996 1997 1996
----------------- ---------------- ----------------- -----------------
Revenue:
Carrier services................... $ 14,098 $ 9,247 $ 39,062 $ 45,106
Commercial services................ 18,361 9,163 38,033 25,475
------------- ------------- ------------- ------------
32,459 18,410 77,095 70,581
Network construction services...... 156,496 25,923 413,226 59,255
------------- ------------- ------------- ------------
Total revenue.................. 188,955 44,333 490,321 129,836
Operating Expenses:
Telecommunications services........ 26,417 14,398 65,310 62,399
Network construction services...... 106,160 15,717 282,472 37,661
Selling, general and
administrative................. 27,316 9,656 59,987 34,230
Growth share plan.................. 4,131 - 69,320 -
Depreciation and amortization...... 5,071 3,991 13,114 11,890
------------- ------------- ------------- ------------
Total operating expenses...... 169,095 43,762 490,203 146,180
Income (loss) from operations........... 19,860 571 118 (16,344)
Other income (expense):
Gain on sale of contract rights.... - - 9,296 -
Gain on sale of telecommunications
service agreements............. - 6,126 - 6,126
Interest and other (expense)
income, net.................... (218) (1,083) (4,960) (2,993)
------------- ------------- ------------- ------------
Income (loss) before income tax
expense (benefit).......... 19,642 5,614 4,454 (13,211)
Income tax expense (benefit)....... 6,991 2,160 2,191 (4,310)
------------- ------------- ------------- ------------
Net income (loss).............. $ 12,651 $ 3,454 $ 2,263 $ (8,901)
============= ============= ============= ============
Net income (loss) per share.... $ 0.12 $ 0.04 $ 0.02 $ (0.10)
============= ============= ============= ============
Weighted average common shares
outstanding........................ 105,812 88,158 93,945 88,158
============= ============= ============= ============
OTHER FINANCIAL AND OPERATING DATA:
EBITDA (1)......................... $ 24,946 $ 4,695 $ 11,246 $ (2,742)
============= ============= ============= ============
EBITDA, adjusted for growth
share plan expense (1)...... $ 29,077 $ 4,695 $ 80,566 $ (2,742)
============= ============= ============= ============
Capital expenditures, including
non-cash items.............. $ 271,332 $ 49,573
============= ============
Minutes of use..................... 199,000,000 107,000,000 433,000,000 275,000,000
============= ============= ============= ============
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------ ------------
Route miles of conduit installed........................................ 7,900 3,650
Route miles of dark fiber installed (excluding lit fiber)............... 2,800 1,800
Route miles of lit fiber installed...................................... 2,800 900
Switches................................................................ 5 5
23
(1) EBITDA represents net income (loss) before interest, income tax expense
(benefit), depreciation and amortization, a non-recurring expense of $1.6
million in the nine months ended September 30, 1996 to restructure its
operations (including the direct sales group), the gain on sale of
telecommunications agreements of $6.1 million (which is non-recurring) in the
nine months ended September 30, 1997, and the gain on sale of contract rights of
approximately $9.3 million (which is non-recurring) in the nine months ended
September 30, 1997, respectively. EBITDA includes earnings from the construction
contracts for the sale of dark fiber that the Company will use to provide cash
for construction costs of the Qwest Network. EBITDA does not represent cash flow
for the periods presented and should not be considered as an alternative to net
earnings (loss) as an indicator of the Company's operating performance or as an
alternative to cash flows as a source of liquidity and may not be comparable
with EBITDA as defined by other companies. The Company believes that EBITDA is
commonly used by financial analysts and others in the telecommunications
industry. EBITDA adjusted for Growth Share Plan expense represents EBITDA (as
defined above), excluding the effect of Growth Share Plan expense.
- - --------------------------------------------------------------------------------
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 1996
The Company reported net income of $12.7 million and $2.3 million in the
three and nine months ended September 30, 1997, respectively, compared to net
income of $3.5 million and a net loss of $8.9 million in the same periods of the
prior year. Excluding the effect of the compensation expense relating to the
Growth Share Plan, net of income tax, the Company's reported net income would
have been approximately $15.3 million and $46.6 million for the three and nine
months ended September 30, 1997, respectively.
Revenue. Total revenue increased $144.6 million, or 326%, and $360.5
million, or 278%, during the three and nine months ended September 30, 1997,
respectively, as compared to the corresponding periods in 1996. Revenue from
Network Construction Services increased $130.6 million, or 504%, and $354.0
million, or 597%, during the three and nine months ended September 30, 1997,
respectively, as compared to the corresponding periods in 1996. The increases
were due primarily to network construction revenue from dark fiber sales to
WorldCom, GTE and Frontier. Carrier Services revenue increased $4.9 million, or
52%, and decreased $6.0 million, or 13%, for the three and nine months ended
September 30, 1997, respectively, compared with the corresponding periods in
1996. The increase in the three months ended September 30, 1997, as compared to
the corresponding period in the prior year resulted from the growth in on-net
dedicated line services on lit portions of the Network. The decrease in revenue
in the nine months ended September 30, 1997, as compared to the corresponding
period in the prior year, was primarily due to the Company's sale of its resale
dedicated line services on leased capacity on July 1, 1996. The sold business
generated revenue of $18.8 million for the nine months ended September 30, 1996.
Exclusive of this revenue, Carrier Services revenue increased $12.8 million, or
48%, during the nine months ended September 30, 1997, as compared to the
corresponding period of 1996. This increase in Carrier Services revenue was due
primarily to increases in revenue from carrier switched services and carrier
dedicated line services provided on the Qwest Network. Commercial Services
revenue increased $9.2 million, or 100%, and $12.6 million, or 49%, for the
three and nine months ended September 30, 1997, respectively, as compared to the
corresponding periods in 1996. The increase was due primarily to growth in
switched services provided to small- and medium-sized businesses and to
consumers as a result of continued expansion of the Company's direct mail, agent
and telemarketing sales channels.
Operating Expenses. Total operating expenses increased $125.3 million, or
286%, and $344.0 million, or 235%, during the three and nine months ended
September 30, 1997, respectively, over the same periods in 1996, due primarily
to increases in telecommunications services, network construction services,
SG&A, Growth Share Plan and depreciation and amortization expense.
24
Expenses for telecommunications services increased $12.0 million, or
83%, and $2.9 million, or 5%, for the three and nine months ended September 30,
1997, respectively, compared to the corresponding periods in the prior year.
The growth in telecommunications services expenses was primarily attributable to
the continued growth in switched services and network engineering and
operations, partially offset by the reduction in expenses resulting from the
sale on July 1, 1996 of the Company's resale dedicated line services on leased
capacity. Expenses for Network Construction Services increased $90.4 million,
or 575%, and $244.8 million, or 650%, in the three and nine months ended
September 30, 1997, respectively, compared to the corresponding periods in 1996,
due to costs of construction contracts relating to increased dark fiber sales
revenue.
SG&A increased $17.7 million, or 183%, and $25.8 million, or 75%, in
the three and nine months ended September 30, 1997, respectively, compared to
the corresponding periods of 1996. The increase was due primarily to increases
in expenses related to the following: the Company's direct mail sales program,
the development of the Company's new brand identity, administrative and
information services support of the Company's growth, and recruiting and hiring
additional personnel. The Company anticipates that as it deploys the Qwest
Network, expands its Carrier Services and Commercial Services, and initiates its
direct sales operations, SG&A will continue to increase.
The Company has estimated an increase in the value of Growth Shares,
primarily triggered by the June 1997 initial public offering, and has recorded
approximately $4.1 million and $69.3 million of additional compensation expense
in the three and nine months ended September 30, 1997, respectively. No expense
was recognized in the three and nine months ended September 30, 1996, as there
were no compensatory elements in those periods. The Company anticipates total
additional expense of up to approximately $27.7 million through the year 2002 in
connection with this plan.
The Company's depreciation and amortization expense increased $1.1
million, or 27%, and $1.2 million, or 10%, during the three and nine months
ended September 30, 1997, respectively, from the corresponding periods in 1996.
This increase resulted primarily from activating the Denver to Sacramento
segment of the Qwest Network in late July 1997, purchases of additional
equipment used in constructing the Qwest Network and purchases of other fixed
assets to accommodate the Company's growth. The Company expects that
depreciation and amortization expense will continue to increase in subsequent
periods as the Company continues to activate additional segments of the Qwest
Network and amortizes the goodwill acquired with the SNI purchase (discussed
above).
Interest and Other Income (Expense). Pursuant to a capacity sale in
1993, the Company obtained certain rights of first refusal to re-acquire network
communications equipment and terminal locations including leasehold improvements
should the purchaser, under that agreement, sell the network. In the first
quarter of 1997, the Company sold certain of these rights to the purchaser in
return for $9.0 million in cash and the right to re-acquire certain terminal
facilities.
As previously discussed, the Company sold a portion of its dedicated
line services on leased capacity in July 1996. During the transition of the
service agreements to the buyer, the Company incurred certain facilities costs
on behalf of the buyer, which were to be reimbursed to the Company. A dispute
arose with respect to the reimbursement of such costs and, as a result, the
Company made a provision of approximately $2.0 million in the first quarter of
1997.
25
During the three and nine months ended September 30, 1997 the Company's net
interest and other expenses decreased $.9 million and increased $2.0 million,
respectively, as compared to the corresponding periods of 1996. Interest
expense, net, increased $2.2 million, or 114%, and $3.9 million, or 78%, during
the three and nine months ended September 30, 1997, respectively, as compared to
the corresponding periods of 1996. These increases were due primarily to
interest expense related to the issuance of $250.0 million in principal amount
of 10 7/8% Senior Notes, due 2007 (the Senior Notes) on March 31, 1997,
partially offset by additional capitalized interest resulting from construction
of the Qwest Network. Interest income increased by $3.2 million, or 439%, and
$4.0 million, or 211%, during the three and nine months ended September 30,
1997, respectively, attributable to the increase in cash equivalent balances,
which resulted from the issuance of the Senior Notes and the initial public
offering. During the nine months ended September 30, 1997, the Company's other
expense, net, increased $2.1 million, as compared to the corresponding period of
1996 due primarily to the provision for transition service costs described in
the previous paragraph. The Company expects interest expense to grow in future
periods due to the issuance in October 1997 of its 9.47% Senior Discount Notes
(discussed below).
Income Taxes. The Company is included in the consolidated federal income
tax return of Anschutz Company (the Parent), and a tax sharing agreement
provides for allocation of tax liabilities and benefits to the Company, in
general, as though it filed a separate tax return. The Company's effective tax
rate nine months ended September 30, 1997 was higher than the statutory federal
rate as a result of permanent differences between book and tax expense relating
to the Growth Share Plan. The Company's effective tax rate in the three months
ended September 30, 1997 and in the three and nine months ended September 30,
1996 approximated the statutory federal rate.
Net Income (Loss). The Company realized net income of $12.7 million and
$2.3 million in the three and nine months ended September 30, 1997,
respectively, compared to net income of $3.5 million and a net loss of $8.9
million in the corresponding periods of 1996 as a result of the factors
discussed above.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1997, the Company has funded
capital expenditures and long-term debt repayments primarily through the net
proceeds from the debt and equity offerings. The Company intends to finance its
operations in the future through internally generated and external funds without
relying on cash advances, contributions or guarantees from the Parent.
The Company's operations generated insufficient cash flows during the nine
months ended September 30, 1997 to enable it to meet its capital expenditures,
debt service and other cash needs. Total cash expended during this period to
fund capital expenditures, repayments of long-term debt to third parties and net
repayments of advances from the Parent was approximately $205.3 million, $185.9
million and $19.1 million, respectively. Total cash used in operations was
approximately $60.1 million during the same period. During the first nine
months of 1997, total cash provided by loans secured by collateral owned by its
parent or an affiliate was approximately $78.0 million. As of September 30,
1997, the Company had positive working capital of approximately $221.1 million.
As of December 31, 1996, the Company had a working capital deficit of
approximately $69.4 million.
26
In March 1997, the Company issued $250.0 million in principal amount of its
10 7/8% Senior Notes due 2007 (the Senior Notes), the net proceeds
(approximately $242.0 million) of which were used to repay certain long-term
debt and to fund a portion of capital expenditures required to construct
segments of the Qwest Network. Issuance costs totaling approximately $8.0
million are being amortized to interest expense over the term of the Senior
Notes. Interest on the Senior Notes is payable semi-annually on April 1 and
October 1 of each year, commencing on October 1, 1997, and the principal amount
of the Senior Notes is due and payable in full on April 1, 2007. The Indenture
for the Senior Notes (the Indenture) contains certain covenants that, among
other things, limit the ability of the Company and certain of its subsidiaries
(the Restricted Subsidiaries) to incur additional indebtedness and issue
preferred stock, pay dividends or make other distributions, repurchase capital
stock or subordinated indebtedness, create certain liens, enter into certain
transactions with affiliates, sell assets of the Company or its Restricted
Subsidiaries, issue or sell capital stock of the Company's Restricted
Subsidiaries or enter into certain mergers and consolidations. In addition,
under certain limited circumstances, the Company will be required to offer to
purchase the Senior Notes at a price equal to 100% of the principal amount
thereof plus accrued and unpaid interest to the date of purchase with the excess
proceeds of certain asset sales. In the event of a Change of Control (as
defined in the Indenture), holders of the Senior Notes will have the right to
require the Company to purchase all of their Senior Notes at a price equal to
101% of the aggregate principal amount thereof plus accrued and unpaid interest.
In May 1997, the Company and an unrelated third party supplier (the
Supplier) entered into a $90.0 million credit agreement (the Equipment Credit
Facility) to finance the transmission electronics equipment to be purchased from
the Supplier under a procurement agreement. Under the Equipment Credit
Facility, the Company may borrow funds as it purchases the equipment to fund up
to 75% of the purchase price of such equipment and related engineering and
installation services provided by the Supplier, with the purchased equipment and
related items serving as collateral for the loans. Principal amounts
outstanding under the Equipment Credit Facility will be payable in quarterly
installments commencing on June 30, 2000, with repayment in full due and payable
on March 31, 2004. Borrowings will bear interest at the Company's option at
either: (i) a floating base rate announced by a designated reference bank plus
an applicable margin; or (ii) LIBOR plus an applicable margin. As of September
30, 1997, approximately $8.1 million was outstanding under the Equipment Credit
Facility.
In June 1997, the Company received approximately $319.5 million in net
proceeds from the sale of 15,525,000 shares of Common Stock in its Initial
Public Offering.
In August 1997, the Company completed a registered exchange of new Senior
Notes (with terms identical in all material respects to the originally issued
Senior Notes) for all of the originally issued Senior Notes. The Company
received no proceeds from and recognized no profit on the exchange transaction,
and no change in the financial condition of the Company occurred as a result of
the exchange transaction.
In October 1997, the Company issued $555,890,000 in principal amount at
maturity of Senior Discount Notes, due 2007 (the Discount Notes), generating net
proceeds of approximately $342.6 million, after deducting offering costs which
are included in intangible and other long-term assets, such net proceeds will be
used to fund capital expenditures for continuing construction and activation of
the Network and to fund further growth in the business. The Discount Notes will
accrete at a rate of 9.47% per annum, compounded semi-annually, to an aggregate
principal amount of $555,890,000
27
by October 15, 2002. The principal amount of the Discount Notes is due and
payable in full on October 15, 2007. The Discount Notes are redeemable at the
Company's option, in whole or in part, at any time on or after October 15, 2002,
at specified redemption prices. In addition, prior to October 15, 2000, the
Company may use the net cash proceeds from certain specified equity transactions
to redeem up to 35% of the Discount Notes at specified redemption prices. Cash
interest on the Discount Notes will not accrue until October 15, 2002, and
thereafter will accrue at a rate of 9.47% per annum, and will be payable semi-
annually in arrears commencing on April 15, 2003 and thereafter on April 15 and
October 15 (each an interest payment date) of each year. The Company has the
option of commencing the accrual of cash interest on an interest payment date on
or after October 15, 2000, in which case the outstanding principal amount at
maturity of the Discount Notes will, on such interest payment date, be reduced
to the then accreted value, and cash interest will be payable on each interest
payment date thereafter. The indenture for the Discount Notes contains certain
covenants that are substantially identical to the Senior Notes described below.
In connection with the sale of the Discount Notes, the Company agreed to
make an offer to exchange new notes, registered under the Securities Act of 1933
(the Act) and with terms identical in all material respects to the Discount
Notes (the New Notes), for the Discount Notes or, alternatively, to file a shelf
registration statement under the Act with respect to the Discount Notes. If the
registration statement for the exchange offer or the shelf registration
statement, as applicable, are not filed or declared effective within specified
time periods or, after being declared effective, cease to be effective or usable
for resale of the Discount Notes during specified time periods (each a
Registration Default), additional cash interest will accrue at a rate per annum
equal to 0.50% of the principal amount at maturity of the Discount Notes during
the 90-day period immediately following the occurrence of a Registration Default
and increasing in increments of 0.25% per annum of the principal amount at
maturity of the Discount Notes up to a maximum of 2.0% per annum, at the end of
each subsequent 90-day period until the Registration Default is cured.
In February 1997, the Company entered into a one-year $50.0 million line of
credit from a commercial bank. No amounts were ever drawn under this credit
line, and the facility was canceled by the Company in July 1997.
The Company had a $100.0 million three-year revolving credit facility that
converts to a two-year term loan maturing on April 2, 2001. In October 1997,
the Company repaid the outstanding balance and terminated this credit facility.
The Company is considering obtaining a new bank credit facility of equal or
lesser amount.
In May 1997, the Company's board of directors approved a change in the
Company's capital stock to authorize 400 million shares of $.01 par value Common
Stock (of which 10 million shares were reserved for issuance under the equity
incentive plan, 2 million shares were reserved for issuance under the Growth
Share Plan, and 4.3 million shares were reserved for issuance upon exercise of
warrants), and 25 million shares of $.01 par value Preferred Stock. In May 1997,
the Company declared a stock dividend to the existing stockholder of 86,490,000
shares of Common Stock, which was paid immediately prior to the effectiveness of
the registration statement on June 23, 1997. In June 1997, the Company
completed an initial public offering of 15,525,000 shares of its Common Stock.
Effective May 23, 1997, the Company sold to an affiliate of the Parent for
$2.3 million in cash, a warrant to acquire 4.3 million shares of Common Stock at
an exercise price of $28.00 per
28
share, exercisable on May 23, 2000. The warrant is not transferable. Stock
issued upon exercise of the warrant will be subject to restrictions on sale or
transfer for two years after exercise.
The Company estimates the total cost to construct and activate the
Qwest Network and complete construction relating to the dark fiber sold to
Frontier, WorldCom and GTE will be approximately $1.9 billion. Total
anticipated costs include approximately $640.0 million already expended by the
Company as of September 30, 1997. The Company anticipates remaining total cash
outlays for these purposes of approximately $170.0 million in 1997, $850.0
million in 1998 and $240.0 million in 1999. Estimated total expenditures in
1997 and 1998 include the Company's commitment to purchase a minimum quantity of
fiber for approximately $399.0 million (subject to quality and performance
specifications), of which approximately $198.5 million had been expended as of
September 30, 1997. Estimated total expenditures for 1997, 1998 and 1999
together also include approximately $139.0 million for the purchase of
electronic equipment. In addition, the Company anticipates approximately $97.0
million of aggregate capital expenditures in 1997 and 1998 to support growth in
Carrier Services and Commercial Services.
As of September 30, 1997, the Company has obtained the following sources of
funds: (i) approximately $1.1 billion under the Frontier, WorldCom and GTE
contracts and additional smaller construction contracts for sales of dark fiber,
of which approximately $351.0 million had already been paid and $770.0 million
remained to be paid at September 30, 1997; (ii) $90.0 million of vendor
financing; (iii) approximately $117.8 million of net proceeds from the sale of
the Senior Notes remaining after repayment of certain existing debt; and (iv)
approximately $319.5 million of net proceeds from the initial public offering,
of which approximately $164.3 million has been used as of September 30, 1997 for
construction of the Network. The Company believes that its available cash and
cash equivalent balances at September 30, 1997, the net proceeds from issuance
of the Discount Notes in October and cash flow from operations will satisfy its
currently anticipated cash requirements at least through the second quarter of
1998.
With the completion of the 16,000 route-mile network, the Company will
provide telecommunications services nationally to its customers primarily over
its own facilities, using leased facilities in those portions of the country not
covered by the Qwest Network. Qwest is evaluating the economics of extending
its core network versus continuing to lease network capacity. In this regard,
the Company is considering extensions in the Pacific Northwest, and the Company
is in negotiations to connect the route between Boston and New York City. Also,
the Company continues to evaluate opportunities to acquire or invest in
complementary, attractively valued businesses, facilities, contract positions
and hardware to improve its ability to offer new products and services to
customers, to compete more effectively and to facilitate further growth of its
business.
29
Item 3. Quantitative and Qualitative Disclosures About Market Risks
Not applicable.
30
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales of Unregistered Securities
No equity securities of the registrant were sold by the
registrant during the period covered by this report that were not
registered under the Securities Act of 1933. As described in
Part I of this report, in July 1997, the Company issued 1,295,766
shares of its Common Stock (par value $.01 per share) in
settlement of accrued liability related to "Growth Shares"
outstanding under its Growth Share Plan (a noncontributory,
nondiscretionary employee benefit plan); such issuances of Common
Stock did not require registration under policies and analyses
contained in applicable SEC releases relating to employee benefit
plans.
(d) Use of Proceeds
The registrant completed its initial public offering of
15,525,000 shares of its Common Stock (par value $.01 per share)
on June 27, 1997 pursuant to a registration statement (File No.
333-25391) declared effective on June 23, 1997. The underwriters
for the offering were Salomon Brothers Inc., Donaldson, Lufkin &
Jenrette Securities Corporation, Goldman, Sachs & Co. and Merrill
Lynch & Co. The initial public offering price was $22.00 per
share, with an aggregate offering price of $341,550,000
(including overallotment option shares) and net proceeds to the
Company of approximately $319.5 million, after deducting
underwriting discount of approximately $20.5 million and $1.5
million for expenses in connection with the issuance and
distribution of the Common Stock. Through September 30, 1997,
the Company has used approximately $164.3 million of such net
proceeds from its initial public offering for construction of its
fiber optic telecommunications network with the remaining net
proceeds temporarily invested in certain short-term investment
grade securities, such as money market funds, government
securities and commercial paper.
Item 5. Other Information
Annual Meeting Information
In order to be considered for inclusion in the Company's proxy
statement and form of proxy relating to the Company's annual
meeting of shareholders following the end of the Company's 1997
fiscal year, proposals by individual shareholders must be
received by the Company no later than December 31, 1997. The
Company expects to hold its first annual meeting of shareholders
in early May 1998, and the Company will notify the shareholders
appropriately of the details related to the meeting.
31
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.
Qwest Communications International Inc.,
a Delaware corporation
November 14, 1997 By: /s/ ROBERT S. WOODRUFF
--------------------------
Robert S. Woodruff
Executive Vice President - Finance
and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
32
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3. Bylaws (as amended)
11. Statements re computation of per share income (loss)
27. Financial data schedule
(b) Reports on Form 8-K
None