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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
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
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QWEST COMMUNICATIONS INTERNATIONAL INC.
(Exact name of registrant specified in its charter)
---------------
Delaware 84-1339282
-------- ----------
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
700 QWEST TOWER
555 SEVENTEENTH STREET
DENVER, COLORADO 80202
----------------------
(Address of principal executive offices)
(303) 992-1400
--------------
(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 approximately 352 million,
as of April 30, 1999.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
QUARTER ENDED MARCH 31, 1999
TABLE OF CONTENTS
Page
----
PART I. Financial Information
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 1999 and 1998 3
Condensed Consolidated Balance Sheets as of March 31, 1999
and December 31, 1998 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations for the Three Months Ended
March 31, 1999 and 1998 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
PART II. Other Information
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 6 Exhibits and Reports on Form 8-K 22
Signature Page 26
2
Part I. Financial Information
Item 1. Condensed Financial Statements
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Millions, Except Per Share Information)
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
----------------------
Revenue:
Communications services $737.2 $ 42.6
Construction services 141.2 134.5
------ ------
Total revenue 878.4 177.1
------ ------
Operating expenses:
Access and network operations 432.9 30.8
Construction services 76.8 97.4
Selling, general and administrative 213.3 44.4
Depreciation and amortization 95.9 8.0
------ ------
Total operating expenses 818.9 180.6
------ ------
Earnings (loss) from operations 59.5 (3.5)
Other (income) expense:
Interest expense, net 32.0 14.4
Other (income) expense, net 2.9 (8.1)
------ ------
Earnings (loss) before income taxes 24.6 (9.8)
Income tax expense (benefit) 19.8 (3.2)
------ ------
Net earnings (loss) $ 4.8 $ (6.6)
====== ======
Net earnings (loss) per share - basic $ 0.01 $(0.03)
====== ======
Net earnings (loss) per share - diluted $ 0.01 $(0.03)
====== ======
See accompanying notes to condensed consolidated financial statements.
3
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of March 31, 1999 and December 31, 1998
(In Millions)
(Unaudited)
1999 1998
-------- --------
ASSETS
Current assets:
Cash $ 119.0 $ 462.8
Trade accounts and notes receivable, net 656.6 628.1
Prepaid expenses and other 321.2 348.2
-------- --------
Total current assets 1,096.8 1,439.1
Property and equipment, net 2,827.1 2,655.4
Excess of cost over net assets acquired, net 3,394.9 3,402.0
Other, net 690.4 571.1
-------- --------
TOTAL ASSETS $8,009.2 $8,067.6
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 227.1 $ 205.1
Facility costs accrued and payable 235.3 300.2
Construction costs accrued and payable 147.1 145.9
Accrued expenses and other 395.8 586.3
-------- --------
Total current liabilities 1,005.3 1,237.5
Debt and capital lease obligations, net of current portion 2,319.9 2,307.1
Other long-term liabilities 283.1 284.8
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.01 par value; authorized 25.0 million
shares; no shares issued and outstanding - -
Common stock - $.01 par value; authorized 2,000 million shares;
issued and outstanding --
351 million shares at March 31, 1999;
347 million shares at December 31, 1998 3.5 3.5
Paid-in capital 5,210.5 5,108.4
Accumulated other comprehensive income 58.0 2.2
Accumulated deficit (871.1) (875.9)
-------- --------
Total stockholders' equity 4,400.9 4,238.2
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $8,009.2 $8,067.6
======== ========
See accompanying notes to condensed consolidated financial statements.
4
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Millions)
(Unaudited)
Three Months Ended
March 31,
-------------------------
1999 1998
------- -------
Net cash provided by (used in) operating activities $ (79.6) $ 53.5
------- -------
Cash flows from investing activities:
Acquisitions and other (15.3) 0.5
Expenditures for property and equipment (299.8) (142.1)
------- -------
Net cash used in investing activities (315.1) (141.6)
------- -------
Cash flows from financing activities:
Proceeds from long-term debt - 300.0
Repayments of long-term debt (1.8) (19.4)
Proceeds from employee stock transactions 58.0 1.8
Other (5.3) (0.9)
------- -------
Net cash provided by financing activities 50.9 281.5
------- -------
Net (decrease) increase in cash and cash equivalents (343.8) 193.4
Cash and cash equivalents, beginning of period 462.8 379.8
------- -------
Cash and cash equivalents, end of period $ 119.0 $ 573.2
======= =======
Supplemental disclosure of significant non-cash investing activities:
Unrealized gain on marketable equity securities, net of tax $ 57.2 $ -
======= =======
See accompanying notes to condensed consolidated financial statements.
5
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
(1) Business and Background
Qwest Communications International Inc. and subsidiaries ("Qwest" or the
"Company") is a leading Internet communications company engaged in two core
business segments: Communications Services and Construction Services.
Communications Services provides a full range of voice, data, video and
related services to business customers, governmental agencies and consumers.
In addition, it provides high-volume voice and conventional private line
services to other communications providers, Internet service providers
("ISPs") and other data service companies.
Construction Services constructs and installs fiber optic systems for
other communications providers, as well as for the Company's own use.
(2) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of management, the
condensed consolidated financial statements include all adjustments,
consisting of normal recurring items, necessary to fairly present the results
of operations, financial position and cash flows for the periods presented.
The results of operations for any interim period are not necessarily
indicative of results for the full year. These financial statements should
be read in conjunction with the audited financial statements included in the
Company's Annual Report on Form 10-K (as incorporated by reference from its
annual report to shareholders) for the year ended December 31, 1998. Certain
prior year balances have been reclassified to conform to the 1999
presentation.
(3) Comprehensive Income
The following table represents the calculation of comprehensive income
(loss) for the three months ended March 31, 1999 and 1998 (in millions):
Three Months Ended March 31,
----------------------------
1999 1998
------------ ------------
Net income (loss) $ 4.8 $ (6.6)
Other comprehensive income:
Net unrealized holding gains on securities 57.2 -
Foreign currency translation adjustments (1.4) -
------------ ------------
Total other comprehensive income 55.8 -
------------ ------------
Comprehensive income $ 60.6 $ (6.6)
============ ============
6
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
(4) KPNQwest Joint Venture
In April 1999, Qwest and KPN Telecom B. V. ("KPN") completed the
formation of a joint venture to create a pan-European IP-based fiber optic
network, linked to Qwest's network in North America, for data, video and
voice services.
Qwest and KPN each owns 50 percent of the venture. The venture is
governed by a six-person supervisory board, to which Qwest and KPN each has
named three members. KPN contributed two partially completed bi-directional,
self-healing fiber optic rings (EuroRingsTM 1 and 2) and certain
communications services contracts. Qwest and KPN have contributed
transatlantic capacity that connect EuroRingsTM with Qwest's network in
North America, as well as certain other assets. In April 1999, Qwest
contributed Xlink Internet Service Gmbh ("Xlink") and the operating
subsidiaries of EUnet International Limited ("EUnet"). The net book value of
total assets contributed by Qwest totaled approximately $300.0 million.
Qwest will deconsolidate EUnet and Xlink, and Qwest's interest in the joint
venture will be accounted for under the equity method.
(5) Construction Services
Costs and billings on uncompleted contracts included in the accompanying
condensed consolidated balance sheets were as follows (in millions):
March 31, December 31,
1999 1998
------------- ------------
Costs incurred on uncompleted contracts $ 975.4 $ 898.8
Estimated earnings 560.0 499.4
------------- ------------
1,535.4 1,398.2
Less: billings to date (1,350.7) (1,176.1)
------------- ------------
Costs and estimated earnings in excess of billings, net $ 184.7 $ 222.1
============= ============
The Company has entered into various agreements to provide indefeasible
rights of use of multiple fibers along the network. Such agreements include
contracts with three major customers for an aggregate purchase price of
approximately $1.0 billion. Construction Services revenue relating to the
contracts with these major customers was approximately $43.0 million and
$106.5 million for the three months ended March 31, 1999 and 1998,
respectively. Progress billings are made upon customers' acceptance of
performance milestones.
Although these construction 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.
7
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
(6) Debt and Capital Lease Obligations
Debt and capital lease obligations consisted of the following (in
millions):
March 31, December 31,
1999 1998
------------- --------------
Fixed rate debt at interest ranging
from 7.25% to 10 7/8% $ 2,293.5 $ 2,279.5
Capital lease and other obligations 28.6 30.4
------------- --------------
Total debt and capital lease obligations 2,322.1 $ 2,309.9
Less current portion (2.2) (2.8)
------------- --------------
Debt and capital lease obligations $ 2,319.9 $ 2,307.1
============= ==============
The current portion of long-term debt and capital lease obligations is
included in accrued expenses and other in the accompanying condensed
consolidated balance sheets.
In March 1999, the Company entered into a $1.0 billion credit agreement
with a syndicate of banks. This credit agreement provides for two five-year
revolving credit facilities for a total of $500.0 million and one 364-day
revolving credit facility in the amount of $500.0 million. The credit
facilities bear interest at either the bank base rate of interest or LIBOR
plus an applicable margin.
(7) Income Taxes
Total income tax expense (benefit) differed from the amounts computed by
applying the federal statutory income tax rate (35%) to earnings (loss)
before income tax expense (benefit) as a result of the following items:
Three Months Ended March 31,
-----------------------------
1999 1998
------------- --------------
Statutory income tax expense (benefit) 35.0% (35.0%)
Goodwill amortization 28.7% 3.5%
Foreign losses 12.5% --
Other, net 4.3% (1.2%)
------------- --------------
Total income tax expense (benefit) 80.5% (32.7%)
============= ==============
(8) Commitments and Contingencies
(a) Network Construction Project and Capital Requirements
In 1996, the Company commenced construction of its network. The Company
estimates the total cost to construct and activate the network and to
complete construction of the dark fiber sold to customers will be
approximately $2.3 billion. The Company projected its total remaining cost
as of March 31, 1999 for completing the construction of the network to be
approximately $0.3 billion.
(b) DSL Services Commitments
In January 1999, Qwest made a $15.0 million equity investment in high-
speed, digital subscriber line ("DSL") local networks through an agreement
with Covad Communications Group, Inc. ("Covad"), a packet-based Competitive
Local Exchange Carrier ("CLEC"). The Company has committed to purchase DSL
services for
8
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
approximately $20.0 million over a five-year term commencing on the date
that Covad's DSL services are commercially available in all 22 metropolitan
areas, which is expected to occur by the end of 1999.
In April 1999, Qwest made an additional equity investment, totaling
$15.0 million in cash, in DSL local networks through an agreement with
Rhythms NetConnections Inc. ("Rhythms"), a packet-based CLEC that provides
high-speed networking solutions for remote access to private networks and
the Internet. The Company has committed to place a minimum number of orders
for DSL service over a seven-year term commencing on the date that Rhythms
is operational in 29 metropolitan areas, which is expected to be in the
first quarter of 2000. In the event that the Company fails to meet the order
target, the Company is committed to pay Rhythms for the difference between
the order target and the number of actual orders placed.
(c) Network and Communications Capacity Exchanges
From time to time, the Company enters into agreements to acquire long-
term telecommunications capacity rights from unrelated third parties in
exchange for long-term telecommunications capacity rights along segments of
the network under construction. The exchange agreements provide for
liquidated damages to be levied against the Company in the event the Company
fails to deliver the telecommunications capacity, in accordance with the
agreed-upon timetables.
(d) Vendor Agreements
The Company has agreements with certain telecommunications inter-
exchange carriers and third party vendors that require the Company to
maintain minimum monthly and/or annual billings based on usage. The Company
has historically met all minimum billing requirements and believes the
minimum usage commitments will continue to be met.
(e) Japan-U.S. Cable Consortium Commitment
The Company is participating in a consortium of communications
companies that is building a submarine cable system connecting the United
States to Japan. In connection with this transaction, the Company is
committed to purchase approximately $56.0 million of fiber optic cable and
other network assets of the 13,125-route-mile, four-fiber pair cable system
to the Pacific Rim. The total remaining commitment through January 2001 was
approximately $49.0 million as of March 31, 1999.
(f) Legal Matters
The Company has been named as a defendant in various litigation
matters. Management intends to vigorously defend these outstanding claims.
The Company believes it has adequate accrued loss contingencies and that,
although the ultimate outcome of these claims cannot be ascertained at this
time, current pending or threatened litigation matters are not expected to
have a material adverse impact on the Company's results of operations or
financial position.
(9) Weighted Average Shares Outstanding
For the three months ended March 31, 1999, the weighted average number
of shares used for computing basic earnings per share was 349.1 million, and
the weighted average number of shares used for computing diluted earnings
per share was 368.6 million (including 19.5 million incremental common
shares attributable to dilutive securities related to warrants, options and
growth shares). The weighted average number of shares used for computing
basic and diluted loss per share for the three months ended March 31, 1998
was 206.7 million. Because the Company had a net loss in 1998, the effect
on loss per share of all options and warrants was anti-dilutive.
9
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
(10) Business Segment Information
The Company's two business segments are Communications Services and
Construction Services, each having a separate management team and
infrastructure, offering different products and services, and utilizing
different marketing strategies to target different types of customers.
Communications Services provides multimedia communications services to
retail and wholesale customers. Construction Services constructs and
installs fiber optic systems for other communications entities, as well as
for the Company's own use.
The Company evaluates the performance of its business segments based on
their respective earnings (loss) from operations, before interest and other
(income) expense and income taxes. The following table presents summarized
financial information related to the business segments for the three months
ended March 31, 1999 and 1998 (in millions):
Three Months Ended March 31,
-----------------------------
1999 1998
------------- --------------
Revenue:
Communication services $ 737.2 $ 42.6
Construction services 141.2 134.5
------------- --------------
Total revenue $ 878.4 $ 177.1
============= ==============
Earnings (loss) from operations:
Communications services $ 26.9 $ (26.1)
Construction services 45.1 27.0
Depreciation and amortization -
corporate (12.5) (4.4)
------------- --------------
Total earnings (loss) from operations 59.5 (3.5)
Unallocated other (income) expense:
Interest expense, net 32.0 14.4
Other (income) expense, net 2.9 (8.1)
------------- --------------
Earnings (loss) before income taxes $ 24.6 $ (9.8)
============= ==============
During the three months ended March 31, 1999, no single customer
accounted for 10% or more of the Company's total revenue. During the three
months ended March 31, 1998, Frontier and GTE accounted for 27% and 27%,
respectively, of the Company's total revenue and are included in the
Construction Services segment.
(11) Subsequent Events
In May 1999, Qwest's stockholders approved an increase in the number of
authorized common shares from 600 million to 2 billion.
In April 1999, BellSouth Corporation (together with its subsidiaries,
"BellSouth") and Qwest announced a strategic relationship whereby BellSouth
will invest approximately $3.5 billion for an approximately 10 percent
equity stake in Qwest. Qwest will issue approximately 20.35 million shares
to BellSouth in exchange for approximately $1.9 billion in cash. Qwest's
principal stockholder, Anschutz Company, will sell approximately 16.65
million shares to BellSouth for approximately $1.6 billion. The investment
is conditioned on the termination of the Hart-Scott-Rodino Antitrust Act
waiting period. At the same time, a BellSouth affiliate and Qwest entered
into a commercial arrangement for provisioning of a full range of
integrated digital data, image and voice communications services for
customers. These services will include Qwest's portfolio of data
networking, Internet and voice services and BellSouth's local networking
services. Once BellSouth is allowed to enter the long distance market, the
companies will jointly develop and deliver a comprehensive set of end-to-
end, high-speed data, image and voice communications services to business
customers, with an emphasis on broadband and Internet-based data services.
10
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
In April 1999, Qwest announced that its board of directors approved a
two-for-one stock split in the form of a stock dividend for stockholders of
record as of the close of business on May 3, 1999. The new shares will be
distributed on May 24, 1999. The effect of this stock split is not
reflected in the accompanying condensed consolidated financial statements.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information Regarding Forward-Looking Statements
This report contains or incorporates by reference "forward-looking
statements" as that term is used in federal securities laws about Qwest's
financial condition, results of operations and business. These statements
include, among others:
. statements concerning the benefits that Qwest expects will result from
its business activities and certain transactions Qwest has completed,
such as increased revenues, decreased expenses and avoided expenses
and expenditures,
. Qwest's plans to complete its communications network, and
. other statements of Qwest's expectations, beliefs, future plans and
strategies, anticipated developments and other matters that are not
historical facts.
These statements may be made expressly in this document, or may be
incorporated by reference to other documents Qwest has filed with the Securities
and Exchange Commission ("SEC"). You can find many of these statements by
looking for words such as "believes," "expects," "anticipates," "estimates," or
similar expressions used in this report or incorporated by reference in this
report.
These forward-looking statements are subject to numerous assumptions, risks
and uncertainties that may cause Qwest's actual results to be materially
different from any future results expressed or implied by Qwest in those
statements. The risks and uncertainties include those risks, uncertainties and
risk factors identified, among other places, under "Risk Factors" in Qwest's
registration statement on Form S-4, SEC file number 333-72929, beginning on page
12.
The most important factors that could prevent Qwest from achieving its
stated goals include, but are not limited to, the following:
. Qwest's failure to construct its communications network on schedule and
on budget;
. operating and financial risks related to managing rapid growth,
integrating acquired businesses and sustaining operating cash flow to
meet Qwest's debt service requirements, make capital expenditures and
fund operations;
. potential fluctuation in quarterly results;
. volatility of stock price;
. intense competition in the communications services market;
. dependence on new product development;
. Qwest's ability to achieve year 2000 compliance;
. rapid and significant changes in technology and markets;
. adverse changes in the regulatory or legislative environment affecting
Qwest's business; and
. failure to maintain necessary rights of way.
Because the statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the forward-
looking statements. Qwest cautions you not to place undue reliance on the
statements, which speak only as of the date of this report or, in the case of
documents incorporated by reference, the date of the document.
The cautionary statements contained or referred to in this section should be
considered in connection with any subsequent written or oral forward-looking
statements that Qwest or persons acting on its behalf may issue. Qwest
undertakes no obligation to review or confirm analysts' expectations or
estimates or to release publicly any revisions to any forward-looking statements
to reflect events or circumstances after the date of this report or to reflect
the occurrence of unanticipated events.
12
Overview
Qwest Communications International Inc. ("Qwest" or the "Company") is a
leading Internet communications company engaged in two core businesses:
Communications Services and Construction Services.
Communications Services includes Internet and Multimedia Services, Business
Services, Consumer Services and Wholesale Services. Internet and Multimedia
Services provides Internet Protocol ("IP") - enabled services such as Internet
access, web hosting, co-location and remote access. Internet and Multimedia
Services are being developed according to market demand in partnership with
leading information technology companies, including the following:
. Microsoft Corporation for business applications and service;
. Netscape Communications Corporation for one-stop access for an
array of communications services accessed over the Internet; and
. Covad Communications Group, Inc. ("Covad") and Rhythms NetConnections
Inc. ("Rhythms") for digital subscriber line ("DSL") technology for high-
speed local network connectivity.
Business Services and Consumer Services provide a full range of voice, data,
video and related services to business customers, governmental agencies and
consumers. Wholesale Services provides high-volume voice and conventional
private line services to other communications providers, as well as to Internet
service providers ("ISPs"), and other data service companies.
Construction Services constructs and installs fiber optic systems for other
communications providers, as well as for the Company's own use. The Company
began operations in 1988 constructing fiber optic conduit systems primarily for
major long distance carriers in exchange for cash and capacity rights. The
Company entered into major construction contracts for the sale of dark fiber to
Frontier, MCI WorldCom and GTE whereby the Company has agreed to install and
provide dark fiber to each along portions of the Company's network. In addition
to these contracts, the Company has signed agreements with other communications
providers and government agencies for the sale of dark fiber along the Company's
network. Revenue from Construction Services generally is recognized under the
percentage of completion method as performance milestones relating to the
contract are satisfactorily completed.
Central to Qwest's strategy is the Qwest Macro Capacity(SM) Fiber Network, a
high-capacity IP-based fiber optic network designed to allow customers to
seamlessly exchange multimedia content -- images, data and voice. The
technologically advanced network will reach approximately 18,800 route miles,
with the initial 18,500-route-mile network scheduled for completion in mid-1999,
and a 300-route-mile segment scheduled for completion by the end of 1999. The
network employs a self-healing SONET ring architecture. It is equipped with
advanced fiber and state-of-the-art transmission electronics. Qwest's network
architecture supports IP, Asynchronous Transfer Mode ("ATM") and frame relay
services, as well as circuit switched services.
In 1998, Qwest became the first network service provider to complete a
transcontinental IP-based fiber optic network when it activated its network from
Los Angeles to San Francisco to New York. The Company also activated the
nation's first OC-48 native IP network along certain routes of the Company's
network. Along this OC-48 network, the Company will offer high-speed dedicated
Internet access, web hosting, IP-based virtual private network services and
expanded availability of voice over IP long distance services. Additionally,
the Company's European joint venture, KPN Qwest, will provide a pan-European IP-
based fiber optic network. The services offered will allow customers in Europe
to broadcast video, data and voice globally. (See further discussion of the KPN
joint venture below.)
The Company is also expanding its network to carry international data and
voice traffic to Mexico, Europe and the Far East. The 1,400-route mile Mexico
network is substantially complete. The network expansion into Europe includes
capacity on undersea submarine systems. The transatlantic capacity includes up
to four STM-1s (the European equivalent to SONET OC-3) from New York City to
London and other European destinations. The Company is also participating in a
consortium of communications companies that is building a submarine cable system
connecting the United States to Japan. Scheduled for completion by the second
quarter of 2000, the 13,125-mile four-fiber pair cable will ultimately be
capable of transmitting information at the rate of 640 gigabits per second.
Relationship With BellSouth. In April 1999, BellSouth Corporation (together
with its subsidiaries, "BellSouth") and Qwest announced a strategic relationship
whereby BellSouth will invest approximately $3.5 billion for an approximately 10
percent equity stake in Qwest. Qwest will issue approximately 20.35 million
shares to BellSouth in exchange for approximately $1.9 billion in cash. Qwest's
principal stockholder, Anschutz Company, will sell approximately 16.65 million
of existing shares to BellSouth for approximately $1.6 billion. The investment
is conditioned on the termination of the Hart-Scott-Rodino Antitrust Act waiting
period. At the same time, a BellSouth affiliate and Qwest entered into a
13
commercial arrangement for provisioning of a full range of integrated digital
data, image and voice communications services for customers. These services
will include Qwest's portfolio of data networking, Internet and voice services
and BellSouth's local networking services. Once BellSouth is allowed to enter
the long distance market, the companies will jointly develop and deliver a
comprehensive set of end-to-end, high-speed data, image and voice communications
services to business customers, with an emphasis on broadband and Internet-based
data services.
Investment in Covad. In January 1999, Qwest made its first equity
investment, totaling $15.0 million in cash, in high-speed, DSL local networks
through an agreement with Covad, a packet-based Competitive Local Exchange
Carrier ("CLEC"). Under this agreement, the Company expects to have access to 22
metropolitan areas by the end of 1999, while enhancing its ability to provide
its customers with high-speed DSL connectivity to its network. The Company has
committed to purchase DSL services for approximately $20.0 million over a five-
year term commencing on the date that Covad's DSL services are commercially
available in all 22 metropolitan areas.
Investment in Rhythms. In April 1999, Qwest made an additional equity
investment, totaling $15.0 million in cash, in DSL local networks through an
agreement with Rhythms, a packet-based CLEC that provides high-speed networking
solutions for remote access to private networks and the Internet. Under this
agreement, the Company expects to have access to 29 metropolitan areas (10 of
which are in addition to the areas covered by the agreement with Covad) by the
first quarter of 2000, while further enhancing its ability to provide its
customers with high-speed DSL connectivity to its network. The Company has
committed to place a minimum number of orders for DSL service over a seven-year
term commencing on the date that Rhythms is operational in 29 metropolitan
areas. In the event that the Company fails to meet the order target, the Company
is committed to pay Rhythms for the difference between the order target and the
number of actual orders placed.
KPNQwest Joint Venture. In April 1999, the Company and KPN Telecom B.V.
("KPN") formed a joint venture to create a pan-European IP-based fiber optic
network, linked to the Company's network in North America, for data, video and
voice services.
The venture initially will offer managed broadband services, IP transit,
Internet connectivity and value-added IP services, including consulting,
hosting, and the broadcasting of live events over the Internet. The venture also
plans to selectively sell dark fiber along its network. Customers of the
venture will include Internet service and content providers, multinational firms
in Europe and North America, as well as telecommunications carriers, operators
and others who want to purchase wholesale or retail network capacity, fiber or
services.
Qwest and KPN each own 50 percent of the venture. The venture is governed by
a six-person supervisory board, to which Qwest and KPN have each named three
members. KPN contributed two partially completed bi-directional, self-healing
fiber optic rings (EuroRingsTM 1 and 2) and certain communications services
contracts. Qwest and KPN have contributed transatlantic capacity that connect
EuroRingsTM with Qwest's network in North America, as well as certain other
assets. In April 1999, Qwest contributed Xlink Internet Service Gmbh ("Xlink")
and the operating subsidiaries of EUnet International Limited ("EUnet"). The
net book value of total assets contributed by Qwest totaled approximately $300.0
million. Qwest will deconsolidate EUnet and Xlink, and Qwest's interest in the
joint venture will be accounted for under the equity method.
Results of Operations
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998
The Company reported net earnings of $4.8 million in the first quarter of
1999, compared to a net loss of $(6.6) million in the same quarter of the prior
year. The Company's results of operations include the acquisitions of the
following: Phoenix Network, Inc. from March 1998; EUnet International Limited
from April 1998; and LCI International, Inc. from June 1998. After giving pro
forma effect to these acquisitions and the acquisition of Icon CMT Corp.
("Icon") as if such acquisitions had occurred on January 1, 1998, and excluding
the effects of merger related costs and non-recurring charges, the Company's
reported net loss in the first quarter of 1998 would have been $(20.5) million,
compared to net earnings of $4.8 million in the first quarter of 1999.
14
Revenue. Components of revenue for the first quarter of 1999 and 1998 were
as follows (in millions):
Three Months Ended March 31,
-----------------------------
1999 1998 Increase
------------- -------------- --------------
Communications services $ 737.2 $ 42.6 $ 694.6
Construction services 141.2 134.5 6.7
------------- -------------- --------------
Total revenue $ 878.4 $ 177.1 $ 701.3
============= ============== ==============
During the first quarter of 1999, as compared to the same quarter of the
prior year, Communications Services revenue increased due to the addition of
revenue from the acquisitions discussed above, and due to growth in all aspects
of Communications Services. Construction Services revenue increased during the
first quarter of 1999, as compared to the same quarter of the prior year,
primarily as a result of additional dark fiber sales to other carriers and the
further completion of construction of the Company's nationwide network. As the
completion of the Company's network occurs during the remainder of 1999, the
Company expects that revenue from Construction Services will be less significant
to the Company's operations.
Operating Expenses. Components of operating expenses for the first quarter
of 1999 and 1998 were as follows (in millions):
Three Months Ended March 31,
----------------------------- Increase
1999 1998 (Decrease)
------------- -------------- --------------
Access and network operations $ 432.9 $ 30.8 $ 402.1
Construction services 76.8 97.4 (20.6)
Selling, general and administrative 213.3 44.4 $ 168.9
Depreciation and amortization 95.9 8.0 87.9
------------- -------------- --------------
Total operating expenses $ 818.9 $ 180.6 $ 638.3
============= ============== ==============
Expenses for access and network operations primarily consist of the cost of
operating the Company's network, Local Exchange Carrier ("LEC") access charges
and the cost of leased capacity. The increase in access and network operations
for the first quarter of 1999 over the same quarter of the prior year was
primarily attributable to growth in revenue from acquisitions, as well as
internally generated growth in Communications Services revenue. Expressed as a
percentage of communications services revenue, access and network operations
expenses decreased from 72% in the first quarter of 1998 to 59% in the first
quarter of 1999. As the network is completed and activated, the Company will be
able to serve more customer needs over its own network, thereby reducing such
costs as a percentage of revenue.
Expenses for Construction Services consist primarily of costs of sale on
network construction contracts, including conduit, fiber, cable, construction
crews and rights of way. Costs attributable to the construction of the network
for the Company's own use are capitalized. Expenses for construction services
expressed as a percentage of construction revenue decreased from 72% for the
first quarter of 1998 to 54% for the first quarter of 1999 reflecting the impact
of higher margin network construction contracts.
Selling, general and administrative ("SG&A") expense includes the cost of
salaries, benefits, occupancy costs, commissions, sales and marketing expenses
and administrative expenses. The increase in SG&A in the first quarter of 1999
as compared to the same quarter of the prior year, was due primarily to the
following: additional expenses related to acquired entities; increased sales
and marketing efforts; additional bad debt expense related to the increase in
Communications Services revenues; increased payroll-related costs from the
recruiting and hiring of additional sales and administrative personnel;
increased commissions expense related to the growth in Communications Services
revenue; and additional building rent expense related to increased space
obtained in response to the Company's infrastructure growth. During the first
quarter of 1999, as compared to the same quarter of the prior year, the number
of employees increased, due to acquisitions and the expansion of the sales and
customer support infrastructure, from approximately 2,000 employees at March 31,
1998 to approximately 9,200 employees at March 31, 1999. Expressed as a
percentage of total revenue, SG&A decreased from 25% in the first quarter of
1998 to 24% in the first quarter of 1999. SG&A is expected to increase as the
Company continues to intensify brand advertising, as services are expanded and
as segments of the Company's network become operational.
15
The Company's depreciation and amortization expense increased due primarily
to activating segments of the Company's network, purchases of assets to
accommodate the Company's growth and depreciation and amortization of assets and
goodwill related to the Company's acquisitions. The Company expects that
depreciation expense will continue to increase in subsequent periods as the
Company continues to activate additional segments of its network.
Through the use of third-party appraisal consultants, the Company assessed
and allocated values to in-process R&D projects related to the acquisition of
LCI in June 1998. The values assigned to these assets were determined by
identifying significant research projects for which technological feasibility
had not been established. These assets consisted of a significant number of R&D
projects grouped into three categories: (1) network systems automation tools;
(2) advanced data services, including frame relay and Internet Protocol
technologies; and (3) new operational systems and tools. Taken together, these
projects, if successful, will enable the Company to provide advanced voice and
data services as well as sophisticated network management and administration
functions. The Company believes development efforts through March 31, 1999 have
proceeded according to expectations.
Remaining R&D efforts for these projects include various phases of
technology design, development and testing. Anticipated completion dates for the
remaining projects in progress will occur in phases through 1999, at which point
the Company expects to begin generating the economic benefits from the
technologies. Costs incurred in connection with these R&D efforts are expensed
as incurred.
The Company expects to continue its support of these efforts and the Company
believes it has a reasonable chance of successfully completing the R&D programs.
However, risk is associated with the completion of the projects, and the Company
cannot assure that the projects will meet with either technological or
commercial success.
If none of these projects is successfully developed, the sales and
profitability of the Company may be adversely affected in future periods. The
failure of any particular individual in-process project would not materially
impact the Company's financial condition or results of operations. Operating
results are subject to uncertain market events and risks, which are beyond the
Company's control, such as trends in technology, government regulations, market
size and growth, and product introduction or other actions by competitors.
16
Other Expense (Income). Components of other expense (income) for the first
quarter of 1999 and 1998, were as follows (in millions):
Three Months Ended March 31,
-----------------------------
1999 1998 Increase
------------- -------------- --------------
Interest expense, net $ 32.0 $ 14.4 $ 11.0
Other expense (income), net 2.9 (8.1) 17.6
------------- -------------- --------------
Total other expense (income) $ 34.9 $ 6.3 $ 28.6
============= ============== ==============
The increase in interest expense, net during the first quarter of 1999, as
compared to the same quarter of the prior year, resulted from an increase in
long-term indebtedness, (see "Liquidity and Capital Resources" below), partially
offset by an increase in capitalized interest resulting from construction of the
Company's network. As the network is completed, interest expense will increase
as the amount of capitalized interest decreases. Other income, net, decreased
due primarily to decreases in interest income, which resulted from lower average
cash balances.
Income Taxes.The Company's effective tax rate for the first quarter of 1999
differed from the statutory income tax rate primarily as a result of the non-
deductibility of acquisition-related goodwill and foreign losses. The effective
tax rate for the first quarter of 1998 differed from the statutory rate
primarily as a result of the non-deductibility of acquisition-related goodwill.
Liquidity and Capital Resources
During the first quarter of 1999, cash used in operations was $79.6 million;
cash used in investing activities was $315.1 million, including $299.8 million
of capital expenditures; and cash provided by financing activities, consisting
primarily of employee stock transactions, was $50.9 million.
The Company estimates the total cost to construct and activate its network
and complete construction of dark fiber sold to third parties will be
approximately $2.3 billion, of which the Company had already expended
approximately $2.0 billion as of March 31, 1999.
The Company is participating in a consortium of communications companies
that is building a submarine cable system connecting the United States to Japan.
In connection with this transaction, the Company is committed to purchase
approximately $56.0 million of fiber optic cable and other network assets of the
13,125-route-mile, four-fiber pair cable system to the Pacific Rim. The total
remaining commitment through January 2001 was approximately $49.0 million as of
March 31, 1999.
The Company has obtained the funds available to complete these build-outs
from construction contracts for sales of dark fiber and from various debt and
equity financings. The Company believes that its available cash and cash
equivalent balances at March 31, 1999, cash flow from operations, cash flow from
the investment by BellSouth and its credit agreement (described below) will
satisfy its currently anticipated cash requirements for at least the next 12
months. The Company anticipates capital expenditures during the remainder of
1999 to support its growth in Communications Services and to complete
construction and activate additional capacity along the Company's network to be
approximately $1.1 billion to $1.2 billion.
In April 1999, the Company entered into a $1.0 billion credit agreement with
a syndicate of banks. This credit agreement provides for two five-year
revolving credit facilities for a total of $500.0 million and one 364-day
revolving credit facility in the amount of $500.0 million. The credit
facilities bear interest at either the bank base rate of interest or LIBOR plus
an applicable margin.
Year 2000
Many existing computer systems, including hardware and software, use only
the last two digits to identify a year. Consequently, as the year 2000
approaches, such systems will not recognize the difference in a year that begins
with "20" rather than "19". As a result of the date change in the year 2000, if
any of the Company's computer systems use only two
17
digits to define the year, these defective systems may cause disruptions in its
network operations through which the Company provides communications services to
its customers and in its internal operations. Additionally, the Company is
dependent upon outside sources to provide communications services to its
customers and to bill its customers for such services. The greatest risk to the
Company's ability to provide communications services is the failure of third-
party service providers to be year 2000 compliant, especially those third-party
service providers that provide local access and certain of the billing systems
upon which the provision of long distance telecommunications service relies.
The Company has established a year 2000 compliance group. The objective of
the year 2000 compliance group is to minimize disruptions as a result of the
date change in the year 2000. The compliance group has developed a five-step
plan to identify and repair year 2000 affected systems: (i) identify potentially
date-sensitive systems, including third-party products; (ii) assess such systems
for year 2000 compliance; (iii) modify, upgrade or replace non-compliant
systems; (iv) test the corrected systems; and (v) deploy the corrected systems.
The year 2000 compliance group has focused mainly on the Company's domestic
operations and, to a lesser extent, on its international operations.
In addition to reviewing its own systems, the year 2000 compliance group is
submitting requests to third-party service providers to obtain information as to
their compliance efforts.
Inventory, assessment and remediation of mission critical software
applications is substantially complete. Testing and deployment of corrected
software systems is scheduled for completion by June 30, 1999.
Inventory and assessment of mission critical hardware systems, including
network computing and network systems engineering, is substantially complete.
Testing and deployment of upgrades necessary to complete remediation of mission
critical systems is expected to be complete by May 31, 1999. Inventory and
assessment of corporate facilities is scheduled for completion by May 31, 1999,
with necessary upgrades and contingency plans in place by June 30, 1999.
The Company's overall efforts to integrate the operations of recently
acquired businesses and various other factors, including the compliance efforts
of third parties, over which the Company has no control, may affect these target
dates.
The Company will develop contingency plans as needed. The contingency plans
are expected to be completed by June 1999 and tested through the third quarter
of 1999.
During the first quarter of 1999, the Company incurred approximately $3.5
million for year 2000 compliance costs, included in SG&A expense. The Company
expects to incur approximately $7.0 million to $12.0 million in additional SG&A
expense during the remainder of 1999 to implement its year 2000 plan. The
Company currently estimates capital expenditures for new systems to replace non-
year 2000 compliant systems will total approximately $20.0 million (having
incurred approximately $4.5 million through March 31, 1999).
Euro Conversion
On January 1, 1999, 11 of the 15 member countries of the European Union (the
"Participating Countries") established fixed conversion rates between their
existing sovereign currencies and established the euro as their common legal
currency. Revenues and operating income of the Company's operations in
Participating Countries are less than 5% of the Company's consolidated results.
The Company intends to address operational and information systems issues
related to the euro conversion. The Company does not expect the euro conversion
to have a material adverse impact on the Company's operations or financial
condition.
Regulatory Matters--Recent Developments
Access Charge Reform. Qwest's costs of providing long distance services
could be affected by changes in the "access charges" imposed by local exchange
carriers on long distance carriers to originate and terminate calls over local
networks. Changes in the interstate access charge structure could also affect
the costs of providing long distance "phone-to-phone" voice services using IP
technology. Traditionally, providers of long distance voice services over the
Internet and companies that use IP technology to provide long distance services
have been exempt from access charges.
18
One major local exchange carrier recently demanded, however, that carriers
providing long distance voice services using IP technology must pay access
charges. In late 1998, US West asked the FCC to consider using its accelerated
complaint procedures to determine whether Qwest's long distance phone-to-phone
voice services using IP technology is subject to the payment of access charges.
Qwest vigorously objected to the FCC's consideration of this issue in an
accelerated fashion. The FCC subsequently decided not to entertain US West's
complaint using the FCC's accelerated complaint procedures. US West was given
the option however, of re-filing its complaint using the FCC's normal complaint
procedures. In April 1999, US West filed a Petition for Expedited Declaratory
Ruling seeking resolution of whether a long distance carrier is required to pay
access charges when that carrier holds itself out as a provider of voice
telephony; does not require the customer to use customer premises equipment
different from the customer premises equipment necessary to place an ordinary
touch-tone call; allows the customer to call telephone numbers assigned in
accordance with the North American Numbering Plan; and transmits customer
information, without net change in form or content, using a packet switching
protocol solely within the carrier's own network. As of mid-April 1999, the FCC
has not sought comment on US West's Petition, and has not conclusively
determined whether local exchange carriers may impose access charges on carriers
providing long distance phone-to-phone voice services using IP technology. It is
not clear whether or when a decision will be made.
In the past, the FCC has suggested that access charges might appropriately
be imposed on long distance phone-to-phone voice services under certain
circumstances. If the FCC allows local exchange carriers to levy access charges
on carriers providing long distance phone-to-phone voice services using Internet
protocol technology, Qwest's costs to provide such services could increase.
Supreme Court Decision on FCC Rules Implementing the Telecommunications Act
of 1996. On January 25, 1999, the U.S. Supreme Court issued a decision that
upheld many of the rules the FCC had created to implement the portions of the
1996 Act that are designed to bring competition to local exchange markets. In
the decision, the Supreme Court upheld the FCC's authority to implement the
Telecommunications Act of 1996 through rules binding on the states. The Supreme
Court also upheld the FCC's regulations regarding state review of
interconnection agreements, the granting of certain exemptions to rural
incumbent local exchange carriers, and dialing parity. "Dialing parity" means
that consumers can use non-incumbent carriers by dialing as they normally do,
rather than having to dial extra access codes. The Supreme Court also upheld
the FCC's rulings:
. that competitors need not own facilities in order to purchase network
elements from incumbent local exchange carriers;
. that incumbent local exchange carriers may not separate combinations of
network elements before providing them to nondominant carriers unless
requested to do so by a nondominant carrier;
. that network elements include the features, functions, and capabilities
provided by means of network equipment; and
. that non-incumbent carriers may adopt particular provisions of another
carrier's interconnection agreement without adopting the entire
agreement.
The Supreme Court sent back to the FCC, however, the issue of what network
elements local exchange carriers must make available to non-incumbent carriers.
In April 1999, the FCC released proposed rules on this subject. The FCC is
expected to complete this proceeding later in 1999. In addition, a federal
court will now need to decide whether the method adopted by the FCC in 1996 for
establishing prices for network elements purchased from the incumbent local
exchange carriers and for interconnection with the incumbent local exchange
carriers' networks is permissible. Qwest is unable to predict what actions the
FCC or a federal court will take on these and other issues related to the
Supreme Court's decision.
The Supreme Court's decision is likely to have an impact on other matters as
well, including interconnection agreements between non-incumbent carriers and
incumbent local exchange carriers, the rules the states have adopted concerning
local exchange competition, and the original local exchange carriers'
applications for long distance authority. Qwest is unable to predict, however,
how the decision will impact those matters or how the decision will affect
competition.
Truth-in-billing. In April 1999, the FCC adopted guidelines governing the
format and content of telephone bills. These guidelines, which are intended to
become effective in the spring of 1999, will require carriers to (1) clearly
identify the service provider responsible for each charge on the bill; (2)
clarify when customers may withhold payment to dispute a charge without risking
the loss of their basic local service; (3) identify on the bill the carrier to
whom a customer should
19
direct his or her complaint about a particular charge; and (4) adopt uniform
descriptions for line item charges related to federal regulatory action. The
adoption of these new rules will impact the way Qwest presents its bills to
customers.
1+ Dialing Parity. In many states, consumers wishing to use carriers other
than the incumbent local exchange carrier for long distance services within the
incumbent local exchange carrier's area have had to dial special access codes to
do so. The need to dial extra digits in these states has put Qwest and other
carriers at a competitive disadvantage compared with incumbent local exchange
carriers whose customers can make these calls simply by dialing "1" plus the
desired number. If a non-incumbent carrier's customer attempts to make one of
these calls by simply dialing "1" plus the desired number, the call will
automatically be routed to the incumbent local exchange carrier in those states
that have not required 1+ dialing parity. The Supreme Court's January 25, 1999
decision which is discussed above upholds the FCC's rule requiring that
incumbent local exchange carriers make it possible for consumers to make these
long distance calls on a 1+ basis, using Qwest or any other carrier the consumer
desires. Regulatory commissions in a number of states also have issued
decisions imposing similar requirements. Dialing parity is scheduled to be
implemented in all states by the late summer of 1999. Qwest expects to benefit
from the implementation of this 1+ calling capability.
20
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company has $162.5 million of 10 7/8% Senior Notes, due 2007, $555.9
million of 9.47% Senior Discount Notes, due 2007, $450.5 million of 8.29% Senior
Discount Notes, due 2008, $750.0 million of 7.50% Senior Notes, due 2008, $350.0
million of 7.25% Notes Due 2007 and $300.0 million of 7.25% Senior Notes, due
2008.
The Company's long-term debt obligations are principally fixed interest rate
and non-trading in nature, and as a result, the Company is less sensitive to
market rate fluctuations. The Company currently does not use derivative
financial instruments to manage its interest rate risk and has no cash flow
exposure due to general interest rate changes for its fixed interest rate long-
term debt. The following table provides information about the Company's market
risk exposure associated with changing interest rates on its fixed rate debt and
capital lease and other obligations (dollars in millions):
Expected Maturity
---------------------------------------------------------------------
1999 2000 2001 2002 2003 Thereafter Total
-------- -------- -------- -------- -------- -------------- ---------
Long-term fixed rate debt $ - $ - $ - $ - $ - $ 2,568.9 $ 2,568.9
Capital lease and other obligations $ 1.0 $ 2.1 $ 2.2 $ 2.6 $ 3.2 $ 17.5 $ 28.6
Average interest rate 8.1% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
Collectively, the fixed rate debt, capital lease and other obligations, with
a carrying value of $2,322.1 million, had an estimated fair value of $2,394.5
million at March 31, 1999, based on current interest rates offered for debt of
similar terms and maturity.
The Company's European-country operations were not material to the Company's
consolidated financial position as of March 31, 1999, and results of operations
or cash flows for the three months ended March 31, 1999. In addition, foreign
currency transaction gains and losses were not material to the Company's results
of operations for the three months ended March 31, 1999, and the Company does
not expect to be subject to material foreign currency exchange rate risk from
the effects of exchange rate movements of foreign currencies on the costs or
cash flows the Company would receive from its share of the KPNQwest Joint
Venture. To date, the Company has not entered into any significant foreign
currency forward exchange contracts or other derivative financial instruments to
hedge the effects of adverse fluctuations in foreign currency exchange rates.
21
Part II
Item 1. Legal Proceedings
On April 3, 1998, in an action captioned Lionel Phillips v. LCI
International Inc. and H. Brian Thompson, the plaintiffs filed a putative class
action complaint in the United States District Court for the Eastern District of
Virginia against LCI and H. Brian Thompson, the Chairman and Chief Executive
Officer of LCI. The plaintiffs brought the action purportedly on behalf of
stockholders of LCI who sold LCI Common Stock between February 17, 1998 and
March 9, 1998. The plaintiffs alleged, among other things, that the defendants
violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder
by making materially false and misleading statements that LCI was not for sale
at a time when negotiations between Qwest and LCI regarding a potential merger
were allegedly ongoing. The plaintiffs sought, among other things, to have the
Court declare the suit a proper class action and award damages, together with
costs and disbursements. On June 25, 1998, defendants moved to dismiss the
complaint on the grounds that it failed to state a claim against defendants. By
Order dated July 20, 1998, the Court granted defendants' motion to dismiss the
complaint but granted the plaintiffs leave to amend the complaint within fifteen
days. On August 4, 1998, the plaintiffs filed an amended complaint and Qwest
again moved to dismiss the lawsuit. On September 30, 1998, the Court granted
the defendant's motion to dismiss the complaint. On October 20, 1998, the
plaintiffs appealed the Court's decision and the appeal is still pending.
On September 15, 1998, in an action captioned Aaron Parnes v. Scott A.
Baxter, Wayne B. Weisman, Richard M. Brown, Scott Harmolin, Samuel A. Plum, Icon
CMT Corp. and Qwest Communications International Inc., the plaintiff filed a
putative class action complaint in the Court of Chancery of the State of
Delaware in and for New Castle County (the "Court") against Icon, its directors
and Qwest. In the suit, the plaintiff alleged that consummation of the Icon
merger will subject the Icon stockholders to the control of Mr. Anschutz, who
will continue to be the principal stockholder of Qwest after the consummation of
the merger. The plaintiff further alleged that the Icon merger constitutes a
change in control of Icon and imposes heightened fiduciary duties on the members
of the Icon board of directors to maximize stockholder value. The plaintiff
also alleged that the members of the Icon board of directors violated their
fiduciary duties by failing to auction Icon or to undertake an active "market
check" for other potential bidders. The plaintiff seeks, among other things, to
have the Court declare the suit a proper class action, enjoin the Icon merger
and require the members of the Icon board of directors to auction Icon and/or
conduct a "market check," and to award monetary damages, together with costs and
disbursements. The defendants consider the action to be without merit and
intend to vigorously defend the action. The defendants have filed answers
denying the allegations of the complaint.
Qwest also has been named as a defendant in various other litigation
matters. Management intends to vigorously defend these outstanding claims. Qwest
believes it has adequate accrued loss contingencies and that, although the
ultimate outcome of these claims cannot be ascertained at this time, current
pending or threatened litigation matters are not expected to have a material
adverse impact on Qwest's results of operations or financial position.
Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds
Qwest has used approximately $274.6 million of the $319.5 million net
proceeds from its initial public offering on Form S-1 as declared effective
on June 23, 1997 (File No. 333-25391) for construction of its fiber optic
communications network and to redeem a total of $87.5 million in principal
amount of its 10 7/8% Notes due 2007. The remaining net proceeds are
temporarily invested in certain short-term investment grade securities.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description
-------------- ------------------------------------------------------
3.1** Amended and Restated Certificate of Incorporation of
Qwest.
3.2***** Certificate of Amendment of Amended and Restated
Certificate of Incorporation of Qwest (incorporated by
reference to the exhibit of the same number to Qwest's
Registration Statement on Form S-3
22
(File No. 333-58617) filed July 7, 1998).
3.3 Certificate of Amendment to the Amended and Restated
Certificate of Incorporation, as amended.
3.4 Amended and Restated Bylaws (incorporated by reference
to Qwest's Annual Report on Form 10-K for the year
ended December 31, 1998).
4.1(a)*** Indenture dated as of October 15, 1997 with Bankers
Trust Company (including form of Qwest's 9.47% Senior
Discount Notes due 2007 and 9.47% Series B Senior
Discount Notes due 2007 as an exhibit thereto).
4.1(b)**** Indenture dated as of August 28, 1997 with Bankers
Trust Company (including form of Qwest's 10 7/8%
Series B Senior Notes due 2007 as an exhibit thereto).
4.1 (c)**** Indenture dated as of January 29, 1998 with Bankers
Trust Company (including form of Qwest's 8.29% Senior
Discount Notes due 2008 and 8.29% Series B Senior
Discount Notes due 2008 as an exhibit thereto).
4.1(d) Indenture dated as of November 4, 1998 with Bankers
Trust Company (including form of Qwest's 7.50% Senior
Discount Notes due 2008 and 7.50% Series B Senior
Discount Notes due 2008 as an exhibit thereto)
(incorporated by reference to Qwest's Registration
Statement on Form S-4 (File No. 333-71603) filed
February 2, 1999).
4.1(e) Indenture dated as of November 27, 1998 with Bankers
Trust Company (including form of Qwest's 7.25% Senior
Discount Notes due 2008 and 7.25% Series B Senior
Discount Notes due 2008 as an exhibit thereto)
(incorporated by reference to Qwest's Registration
Statement on Form S-4 (File No. 333-71603) filed
February 2, 1999).
4.2(b) Registration Agreement dated November 27, 1998 with
Salomon Brothers Inc relating to Qwest's 7.25% Senior
Discount Notes due 2008 (incorporated by reference to
Qwest's Registration Statement on Form S-4 (File No.
333-71603) filed February 2, 1999).
4.3 Indenture dated as of June 23, 1997 between LCI
International, Inc., and First Trust National
Association, as trustee, Providing for the Issuance of
Senior Debt Securities, including Resolutions of the
Pricing Committee of the Board of Directors
establishing the terms of the 7.25% Senior Notes due
June 15, 2007 (incorporated by reference to exhibit
4(c) in LCI's Current Report on Form 8-K dated June
23, 1997).
4.4 Credit Agreement, dated as of March 31, 1999, among
Qwest Communications International Inc., as Borrower,
NationsBank, N.A., as Administrative Agent, and the
Lenders party thereto.
10.1** Growth Share Plan, as amended, effective October 1,
1996.*
10.2** Equity Incentive Plan.*
10.3 Qwest Communications International Inc. Employee Stock
Purchase Plan (incorporated by reference to Qwest's
Preliminary Proxy Statement for the Annual Meeting of
Stockholders, filed February 26, 1999).*
10.4 Qwest Communications International Inc. Deferred
Compensation Plan (incorporated by reference to
Qwest's Annual Report on Form 10-K for the year ended
December 31, 1998).*
10.5**** Equity Compensation Plan for Non-Employee Directors.*
10.6 Qwest Communications International Inc. 401-K Plan
(incorporated by reference to Qwest's Annual Report on
Form 10-K for the year ended
23
December 31, 1998).*
10.7** Employment Agreement dated December 21, 1996 with
Joseph P. Nacchio.*
10.8**** Growth Share Plan Agreement with Joseph P. Nacchio,
effective January 1, 1997, and Amendment thereto.*
10.9**** Non-Qualified Stock Option Agreement with Joseph P.
Nacchio, effective June 23, 1997.*
10.11** Promissory Note dated November 20, 1996 and Severance
Agreement dated December 1, 1996 with Robert S.
Woodruff.*
10.12**** Employment Agreement dated March 7, 1997 with Stephen
M. Jacobsen.*
10.13**** Employment Agreement dated September 19, 1997 with
Larry Seese.*
10.15**** Employment Agreement dated October 8, 1997 with Lewis
O. Wilks.*
10.16**+ IRU Agreement dated as of October 18, 1996 with
Frontier Communications International Inc.
10.17**+ IRU Agreement dated as of February 26, 1996 with
WorldCom Network Services, Inc.
10.18**+ IRU Agreement dated as of May 2, 1997 with GTE.
10.19 LCI International, Inc. 1992 Stock Option Plan
(incorporated by reference to LCI's Registration
Statement No. 33-60558).*
10.20 LiTel Communications, Inc. 1993 Stock Option Plan
(incorporated by reference to LCI's Registration
Statement No. 33-60558).*
10.21 LCI International, Inc. 1994/1995 Stock Option Plan
(incorporated by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1993).*
10.22 LCI International, Inc. 1995/1996 Stock Option
(incorporated by reference to LCI's Proxy Statement
for the 1995 Annual Meeting of Shareowners).*
10.23 LCI International Management Services, Inc.
Supplemental Executive Retirement Plan (incorporated
by reference to LCI's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1995).*
10.24 1997/1998 LCI International, Inc. Stock Option Plan
(incorporated by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1996).*
10.25(a) 1995 Stock Option Plan of Icon CMT Corp. (incorporated
by reference to Icon CMT Corp.'s Registration
Statement on Form S-1/A, No. 333-38339).*
10.25(b) Amendment to Amended and Restated 1995 Stock Option
Plan of Icon CMT Corp. (incorporated by reference to
Qwest's Annual Report on Form 10-K for the year ended
December 31, 1998).*
10.26 U.S. Long Distance Corp. 1990 Employee Stock Option
Plan (incorporated by reference to Qwest's Annual
Report on Form 10-K for the year ended December 31,
1998).*
10.27+ Contractor Agreement dated January 18, 1993 by and
between LCI International Telecom Corp. and American
Communications Network, Inc. (incorporated by
reference to LCI's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995).
10.28 Participation Agreement dated as of November 1996
among LCI International, Inc., as the Construction
Agent and as the Lessee, First Security Bank, National
Association, as the Owner Trustee under the Stuart
Park Trust the various banks and lending institutions
which are parties thereto from time to time as the
Holders, the various banks and lending institutions
which are parties thereto from time to time as the
Lenders and NationsBank of Texas, N.A., as the Agent
for the Lenders (incorporated by reference to LCI's
Annual Report on Form 10-K for the year ended December
31, 1996).
10.29 Agency Agreement between LCI International, Inc., as
the Construction Agent and First Security Bank,
National Association, as the Owner Trustee under the
Stuart Park Trust as the Lessor dated as of November
15, 1996
24
(incorporated by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1996).
10.30 Deed of Lease Agreement dated as of November 15, 1996
between First Security Bank, National Association as
the Owner Trustee under the Stuart Park Trust, as
Lessor and LCI International, Inc. as Lessee
(incorporated by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1996).
10.31 Common Stock Purchase Agreement dated as of December
14, 1998 with Microsoft Corporation (incorporated by
reference to Qwest's Current Report on Form 8-K filed
December 16, 1998).
10.32 Registration Rights Agreement dated December 14, 1998
with Microsoft Corporation (incorporated by reference
to Qwest's Current Report on Form 8-K filed December
16, 1998).
10.33 Registration Rights Agreement dated as of April 18,
1999 with Anschutz Company and Anschutz Family
Investment Company LLC (incorporated by reference to
Qwest's Current Report on Form 8-K/A filed April 28,
1999).
10.34 Common Stock Purchase Agreement dated as of April 19,
1999 with BellSouth Enterprises, Inc. (incorporated
by reference to Qwest's Current Report on Form 8-K/A
filed April 28, 1999).
10.35 Registration Rights Agreement dated as of April 19,
1999 with BellSouth Enterprises, Inc. (incorporated
by reference to Qwest's Current Report on Form 8-K/A
filed April 28, 1999).
21.1 Subsidiaries of the Registrant
27 Financial Data Schedule
* Indicates executive compensation plans and arrangements.
** Incorporated by reference in Form S-1 as declared effective
on June 23, 1997 (File No. 333-25391).
*** Incorporated by reference to exhibit 4.1 in Form S-4 as
declared effective on January 5, 1998 (File No. 333-42847).
**** Incorporated by reference in Qwest's Form 10-K for the year
ended December 31, 1997.
***** Incorporated by reference to the exhibit of the same number
to Qwest's Registration Statement on Form S-3 (File No. 333-
58617) filed July 7, 1998.
+ Portions have been omitted pursuant to a request for
confidential treatment.
(b) Reports on Form 8-K:
During the quarter ended March 31, 1999, Qwest filed the following
Current Reports on Form 8-K:
(1) On January 14, 1999, Qwest filed a Current Report on Form 8-K
announcing the consummation of the merger with Icon CMT Corp. ("Icon"). As
of December 31, 1998, the effective date of the merger, each outstanding
share of common stock of Icon was converted into the right to receive
0.3200 shares of Qwest's common stock and cash in lieu of fractional
shares, in accordance with the terms of the merger agreement.
25
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
By: /s/ Robert S. Woodruff
-------------------------------------
ROBERT S. WOODRUFF
Executive Vice President--Finance
And Chief Financial Officer
(Principal Financial and Accounting Officer)
May 12, 1999
26