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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, 1999
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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: 0-11258
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MCI WORLDCOM, Inc.
(Exact name of registrant as specified in its charter)
-------------------------
Georgia 58-1521612
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
500 Clinton Center Drive, Clinton, Mississippi 39056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (601) 460-5600
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 outstanding shares of the registrant's Common Stock, par
value $.01 per share, was 1,892,230,287, net of treasury shares, on October 31,
1999.
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QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998....................... 3
Consolidated Statements of Operations for the
three and nine months ended September 30, 1999
and September 30, 1998.......................................... 4
Consolidated Statements of Cash Flows for the
nine months ended September 30, 1999 and
September 30, 1998.............................................. 5
Notes to Consolidated Financial Statements...................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................... 18
Item 3. Quantitative and Qualitative Disclosure About Market Risk....... 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 33
Item 2. Changes in Securities and Use of Proceeds....................... 33
Item 3. Defaults Upon Senior Securities................................. 33
Item 4. Submission of Matters to a Vote
of Securities Holders........................................... 33
Item 5. Other Information............................................... 33
Item 6. Exhibits and Reports on Form 8-K................................ 33
Signature.................................................................... 34
Exhibit Index................................................................ 35
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited. In Millions, Except Share Data)
September 30, December 31,
1999 1998
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 307 $ 1,710
Accounts receivable, net of allowance for bad debts of $1,102 in 1999 and $897 in 1998 5,240 5,226
Deferred tax asset 2,602 2,523
Other current assets 1,558 1,180
------- -------
Total current assets 9,707 10,639
------- -------
Property and equipment:
Transmission equipment 13,092 12,052
Communications equipment 5,905 5,256
Furniture, fixtures and other 6,582 5,986
Construction in progress 4,378 3,080
------- -------
29,957 26,374
Accumulated depreciation (4,056) (2,067)
------- -------
25,901 24,307
------- -------
Goodwill and other intangible assets, net 47,287 47,018
Other assets 4,067 4,437
------- -------
$86,962 $86,401
======= =======
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
Short-term debt and current maturities of long-term debt $ 3,679 $ 4,756
Accounts payable 2,258 1,737
Accrued line costs 3,982 3,903
Accrued interest 443 505
Other current liabilities 5,191 5,128
------- -------
Total current liabilities 15,553 16,029
------- -------
Long-term liabilities, less current portion:
Long-term debt 13,245 16,083
Deferred tax liability 4,107 2,960
Other liabilities 1,576 1,852
------- -------
Total long-term liabilities 18,928 20,895
------- -------
Commitments and contingencies
Minority interests 2,366 3,676
Company obligated mandatorily redeemable preferred securities of subsidiary trust holding
solely junior subordinated deferrable interest debentures of the Company and other
mandatorily redeemable preferred securities 798 798
Shareholders' investment:
Series B preferred stock, par value $.01 per share; authorized, issued and outstanding:
11,190,244 shares in 1999 and 11,643,002 shares in 1998 (liquidation preference of $1.00
per share plus unpaid dividends) - -
Preferred stock, par value $.01 per share; authorized: 34,905,008 shares in 1999 and
1998; none issued - -
Common stock, par value $.01 per share; authorized: 5,000,000,000 shares; issued
and outstanding: 1,880,219,054 shares in 1999 and 1,840,280,479 shares in 1998 19 18
Additional paid-in capital 51,294 49,544
Retained earnings (deficit) (1,811) (4,473)
Unrealized holding gain on marketable equity securities 357 122
Cumulative foreign currency translation adjustment (357) (23)
Treasury stock, at cost, 4,510,211 shares in 1999 and 1998 (185) (185)
------- -------
Total shareholders' investment 49,317 45,003
------- -------
$86,962 $86,401
======= =======
The accompanying notes are an integral part of these statements.
3
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited. In Millions, Except Per Share Data)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
1999 1998 1999 1998
-------- ------- -------- -------
Revenues $9,186 $ 3,758 $27,131 $ 8,661
------ ------- ------- -------
Operating expenses:
Line costs 3,887 1,792 11,940 4,141
Selling, general and administrative 2,040 902 6,530 1,904
Depreciation and amortization 1,057 469 3,200 1,099
In-process research and development and other charges - 3,227 - 3,725
------ ------- ------- -------
Total 6,984 6,390 21,670 10,869
------ ------- ------- -------
Operating income (loss) 2,202 (2,632) 5,461 (2,208)
Other income (expense):
Interest expense (214) (141) (710) (351)
Miscellaneous 28 14 44 36
------ ------- ------- -------
Income (loss) before income taxes, minority interests and extraordinary items 2,016 (2,759) 4,795 (2,523)
Provision for income taxes 797 174 1,992 462
------ ------- ------- -------
Income (loss) before minority interests and extraordinary items 1,219 (2,933) 2,803 (2,985)
Minority interests (112) (11) (92) (11)
------ ------- ------- -------
Income (loss) before extraordinary items 1,107 (2,944) 2,711 (2,996)
Extraordinary items (net of income taxes of $78 in 1998) - - - (129)
------ ------- ------- -------
Net income (loss) 1,107 (2,944) 2,711 (3,125)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities 16 3 48 3
Preferred dividend requirement - - - 13
------ ------- ------- -------
Net income (loss) applicable to common shareholders $1,091 $(2,947) $ 2,663 $(3,141)
====== ======= ======= =======
Earnings (loss) per common share:
Net income (loss) applicable to common shareholders before extraordinary items:
Basic $ 0.58 $ (2.44) $ 1.43 $ (2.77)
====== ======= ======= =======
Diluted $ 0.56 $ (2.44) $ 1.38 $ (2.77)
====== ======= ======= =======
Extraordinary items $ - $ - $ - $ (0.12)
====== ======= ======= =======
Net income (loss) applicable to common shareholders:
Basic $ 0.58 $ (2.44) $ 1.43 $ (2.89)
====== ======= ======= =======
Diluted $ 0.56 $ (2.44) $ 1.38 $ (2.89)
====== ======= ======= =======
The accompanying notes are an integral part of these statements.
4
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited. In Millions)
For the Nine Months
Ended September 30,
-------------------
1999 1998
------- -------
Cash flows from operating activities:
Net income (loss) $ 2,711 $(3,125)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Minority interests 92 11
Extraordinary items - 129
In-process research and development and other charges - 3,725
Depreciation and amortization 3,200 1,099
Provision for losses on accounts receivable 658 115
Provision for deferred income taxes 1,727 451
Change in assets and liabilities, net of effect of business combinations:
Accounts receivable (977) (753)
Other current assets (219) (139)
Accrued line costs (47) (397)
Accounts payable and other current liabilities 528 383
Other 104 (20)
------- -------
Net cash provided by operating activities 7,777 1,479
------- -------
Cash flows from investing activities:
Capital expenditures (5,839) (3,267)
Sale of short-term investments, net - 53
Acquisitions and related costs (769) (3,049)
Increase in intangible assets (528) (96)
Proceeds from sale of SHL 1,390 -
Proceeds from disposition of long-term assets 1,516 146
Increase in other assets (1,301) (270)
Decrease in other liabilities (265) (305)
------- -------
Net cash used in investing activities (5,796) (6,788)
------- -------
Cash flows from financing activities:
Net change in credit facility and commercial paper program (2,851) 835
Borrowings 1,000 6,100
Principal payments on debt (2,042) (1,102)
Common stock issuance 799 281
Distributions on subsidiary trust and other mandatorily redeemable preferred securities (48) (3)
Dividends paid on preferred stock - (13)
------- -------
Net cash provided by (used in) financing activities (3,142) 6,098
Effect of exchange rate changes on cash (242) -
------- -------
Net increase (decrease) in cash and cash equivalents (1,403) 789
Cash and cash equivalents at beginning of period 1,710 155
------- -------
Cash and cash equivalents at end of period $ 307 $ 944
======= =======
The accompanying notes are an integral part of these statements.
5
MCI WORLDCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(A) General
- -----------
References herein to the "Company" or "MCI WorldCom" refer to MCI WORLDCOM,
Inc., a Georgia corporation, and its subsidiaries, which prior to September 15,
1998, was named WorldCom, Inc. ("WorldCom").
The financial statements included herein, are unaudited and have been prepared
in accordance with generally accepted accounting principles for interim
financial reporting and Securities and Exchange Commission ("SEC") regulations.
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 financial statements reflect all adjustments (of a
normal and recurring nature) which are necessary to present fairly the financial
position, results of operations and cash flows for the interim periods. These
financial statements should be read in conjunction with the Annual Report of the
Company on Form 10-K for the year ended December 31, 1998 (the "Form 10-K") and
the Company's Current Report on Form 8-K dated November 5, 1999 (filed November
5, 1999). The results for the three and nine month periods ended September 30,
1999, are not necessarily indicative of the results that may be expected for the
year ending December 31, 1999.
(B) Business Combinations
- -------------------------
On September 14, 1998, the Company acquired MCI Communications Corporation
("MCI") for approximately $40 billion, pursuant to the merger (the "MCI Merger")
of MCI with and into a wholly owned subsidiary of the Company. Through the MCI
Merger, the Company acquired one of the world's largest and most advanced
digital networks, connecting local markets in the United States to more than 280
countries and locations worldwide.
As a result of the MCI Merger, each outstanding share of MCI common stock was
converted into the right to receive 1.2439 shares of MCI WorldCom common stock,
par value $.01 per share (the "MCI WorldCom Common Stock"), or approximately 755
million MCI WorldCom common shares in the aggregate, and each share of MCI Class
A common stock outstanding (all of which were held by British Telecommunications
plc ("BT")) was converted into the right to receive $51.00 in cash or
approximately $7 billion in the aggregate. The funds paid to BT were obtained
by the Company from (i) available cash as a result of the Company's $6.1 billion
public debt offering in August 1998; (ii) the sale of MCI's Internet backbone
facilities and wholesale and retail Internet business (the "iMCI Business") to
Cable and Wireless plc ("Cable & Wireless") for $1.75 billion in cash on
September 14, 1998; (iii) the sale of MCI's 24.9% equity stake in Concert
Communications Services ("Concert") to BT for $1 billion in cash on September
14, 1998; and (iv) availability under the Company's commercial paper program and
credit facilities.
Upon effectiveness of the MCI Merger, the then outstanding and unexercised
options exercisable for shares of MCI common stock were converted into options
exercisable for an aggregate of approximately 83 million shares of MCI WorldCom
Common Stock having the same terms and conditions as the MCI options, except
that the exercise price and the number of shares issuable upon exercise were
divided and multiplied, respectively, by 1.2439. The MCI Merger was accounted
for as a purchase; accordingly, operating results for MCI have been included
from the date of acquisition.
The purchase price in the MCI Merger was allocated based on estimated fair
values at the date of acquisition. This resulted in an excess of purchase price
over net assets acquired of which $3.1 billion was allocated to in-process
research and development ("IPR&D") and $1.7 billion to developed technology,
which is being depreciated over 10 years on a straight-line basis. The
remaining excess was allocated to goodwill and tradename, which are being
amortized over 40 years on a straight-line basis.
6
On August 4, 1998, MCI acquired a 51.79% voting interest and a 19.26% economic
interest in Embratel Participacoes S.A. ("Embratel"), Brazil's only facilities-
based national communications provider, for approximately R$2.65 billion (U.S.
$2.3 billion). The purchase price is being paid in local currency installments,
of which R$1.06 billion (U.S. $916 million) was paid on August 4, 1998, R$795
million (U.S. $442 million) was paid on August 4, 1999, and the remaining R$795
million (U.S. $414 million at September 30, 1999) will be paid August 4, 2000.
Embratel provides interstate long distance and international telecommunications
services in Brazil, as well as over 40 other communications services, including
leased high-speed data, satellite, Internet, frame relay and packet-switched
services. Operating results for Embratel are consolidated in the accompanying
consolidated financial statements and are included from the date of the MCI
Merger.
On January 31, 1998, MCI WorldCom acquired CompuServe Corporation
("CompuServe"), for approximately $1.3 billion, pursuant to the merger (the
"CompuServe Merger") of a wholly owned subsidiary of the Company with and into
CompuServe. Upon consummation of the CompuServe Merger, CompuServe became a
wholly owned subsidiary of MCI WorldCom.
As a result of the CompuServe Merger, each share of CompuServe common stock was
converted into the right to receive 0.40625 shares of MCI WorldCom Common Stock,
or approximately 37.6 million MCI WorldCom common shares in the aggregate.
Prior to the CompuServe Merger, CompuServe operated primarily through two
divisions: Interactive Services and Network Services. Interactive Services
offered worldwide online and Internet access services for consumers, while
Network Services provided worldwide network access, management and applications,
and Internet service to businesses. The CompuServe Merger was accounted for as
a purchase; accordingly, operating results for CompuServe have been included
from the date of acquisition.
On January 31, 1998, the Company also acquired ANS Communications, Inc. ("ANS")
from America Online, Inc. ("AOL"), for approximately $500 million, and has
entered into five year contracts with AOL under which MCI WorldCom and its
subsidiaries provide network services to AOL (collectively, the "AOL
Transaction"). As part of the AOL Transaction, AOL acquired CompuServe's
Interactive Services division and received a $175 million cash payment from MCI
WorldCom. MCI WorldCom retained the CompuServe Network Services division. ANS
provides Internet access to AOL and AOL's subscribers in the United States,
Canada, the United Kingdom, Sweden and Japan. The AOL Transaction was accounted
for as a purchase; accordingly, operating results for ANS have been included
from the date of acquisition.
The purchase price in the CompuServe Merger and AOL Transaction was allocated
based on estimated fair values at the date of acquisition. This resulted in an
excess of purchase price over net assets acquired of which $429 million was
allocated to IPR&D. The remaining excess was recorded as goodwill, which is
being amortized over 10 years on a straight-line basis.
On January 29, 1998, MCI WorldCom acquired Brooks Fiber Properties, Inc.
("BFP"), pursuant to the merger (the "BFP Merger") of a wholly owned subsidiary
of MCI WorldCom, with and into BFP. Upon consummation of the BFP Merger, BFP
became a wholly owned subsidiary of MCI WorldCom. BFP is a leading facilities-
based provider of competitive local telecommunications services, commonly
referred to as a competitive local exchange carrier ("CLEC"), in selected cities
within the United States. BFP acquires and constructs its own state-of-the-art
fiber optic networks and facilities and leases network capacity from others to
provide long distance carriers ("IXCs"), Internet service providers ("ISPs"),
wireless carriers and business, government and institutional end users with an
alternative to the incumbent local exchange carriers ("ILECs") for a broad array
of high quality voice, data, video transport and other telecommunications
services.
As a result of the BFP Merger, each share of BFP common stock was converted into
the right to receive 1.85 shares of MCI WorldCom Common Stock or approximately
72.6 million MCI WorldCom common shares in the aggregate. The BFP Merger was
accounted for as a pooling-of-interests; and accordingly, the Company's
financial statements for periods prior to the BFP Merger have been restated to
include the results of BFP for all periods presented.
7
Upon effectiveness of the BFP Merger, the then outstanding and unexercised
options and warrants exercisable for shares of BFP common stock were converted
into options and warrants, respectively, exercisable for shares of MCI WorldCom
Common Stock having the same terms and conditions as the BFP options and
warrants, except that the exercise price and the number of shares issuable upon
exercise were divided and multiplied, respectively, by 1.85.
The following unaudited pro forma combined results of operations for the Company
for the nine months ended September 30, 1998, assumes that the MCI Merger was
completed on January 1, 1998 (in millions, except per share data):
Revenues $22,950
Loss before extraordinary items (2,985)
Net loss (3,114)
Loss per common share:
Loss before extraordinary items $ (1.68)
Net loss $ (1.75)
These pro forma amounts represent the historical operating results of MCI
combined with those of the Company with appropriate adjustments which give
effect to an IPR&D charge of $3.1 billion in 1998, depreciation, amortization,
interest and the common shares issued. These pro forma amounts do not include
amounts with respect to the CompuServe Merger, AOL Transaction or Embratel prior
to their respective business combination dates because they are individually,
and in the aggregate, not material to MCI WorldCom. These pro forma amounts are
not necessarily indicative of operating results which would have occurred if MCI
had been operated by current management during the periods presented because
these amounts do not reflect cost savings related to full network optimization
and the redundant effect on operating, selling, general and administrative
expenses.
(C) Earnings Per Share
- ----------------------
The following is a reconciliation of the numerators and the denominators of the
basic and diluted per share computations for the three and nine months ended
September 30, 1999 and 1998 (in millions, except per share data):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ -------------
Basic
- -----
Income (loss) before extraordinary items $1,107 $(2,944) $2,711 $(2,996)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities 16 3 48 3
Preferred dividend requirement - - - 13
------ ------- ------ -------
Net income (loss) applicable to common shareholders
before extraordinary items $1,091 $(2,947) $2,663 $(3,012)
====== ======= ====== =======
Weighted average shares outstanding 1,874 1,209 1,861 1,088
====== ======= ====== =======
Basic earnings (loss) per share before extraordinary items $ 0.58 $ (2.44) $ 1.43 $ (2.77)
====== ======= ====== =======
Diluted
- -------
Net income (loss) applicable to common shareholders
before extraordinary items $1,091 $(2,947) $2,663 $(3,012)
====== ======= ====== =======
Weighted average shares outstanding 1,874 1,209 1,861 1,088
Common stock equivalents 63 - 71 -
Common stock issuable upon conversion of preferred stock 1 - 1 -
------ ------- ------ -------
Diluted shares outstanding 1,938 1,209 1,933 1,088
====== ======= ====== =======
Diluted earnings (loss) per share before extraordinary items $ 0.56 $ (2.44) $ 1.38 $ (2.77)
====== ======= ====== =======
8
(D) Supplemental Disclosure of Cash Flow Information
- ----------------------------------------------------
Interest paid by the Company during the nine months ended September 30, 1999 and
1998, amounted to $853 million and $423 million, respectively. Income taxes paid
during the nine months ended September 30, 1999 and 1998, were $56 million and
$24 million, respectively. Additionally, Embratel paid interest and income taxes
of approximately $33 million and $19 million, respectively, for the nine months
ended September 30, 1999. In conjunction with business combinations during the
nine months ended September 30, 1999 and 1998, assumed assets and liabilities
were as follows (in millions):
1999 1998
----------- ------------
Fair value of assets acquired $ 611 $ 21,590
Excess of cost over net tangible 2,324 36,866
assets acquired
Liabilities assumed (1,938) (22,147)
Common stock issued (228) (33,260)
------- --------
Net cash paid $ 769 $ 3,049
======= ========
Acquisition and related costs for the nine months ended September 30, 1999
reflect additional costs related to the acquisitions that occurred in 1998 and
smaller acquisitions completed during 1999.
(E) Comprehensive Income
- ------------------------
The following table reflects the calculation of comprehensive income (loss) for
MCI WorldCom for the three and nine months ended September 30, 1999 and 1998 (in
millions):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- ------------- --------------
Net income (loss) applicable to common shareholders $1,091 $(2,947) $2,663 $(3,141)
Other comprehensive income (loss):
Foreign currency translation gains/losses (29) 24 (334) 15
Unrealized holding gains (losses):
Unrealized holding gains (losses) during the period (79) (22) 458 (39)
Reclassification adjustment for (gains) losses included
in net income (loss) (66) 49 (81) 36
------ ------- ------ -------
Other comprehensive income (loss) before tax (174) 51 43 12
Income tax (expense) benefit 55 (10) (142) 1
------ ------- ------ -------
Other comprehensive income (loss) $ (119) $ 41 $ (99) $ 13
------ ------- ------ -------
Comprehensive income (loss) applicable to common
shareholders $ 972 $(2,906) $2,564 $(3,128)
====== ======= ====== =======
(F) Segment Information
- -----------------------
Based on its organizational structure, the Company operates in five reportable
segments: MCI WorldCom Communications, MCI WorldCom International Operations,
Embratel, Operations and technology and Other. The Company's reportable
segments represent business units that primarily offer similar products and
services; however, the business units are managed separately due to the
geographic dispersion of their operations. MCI WorldCom Communications provides
voice, data and other types of domestic communications services including
Internet services. MCI WorldCom International Operations provides voice, data,
Internet and other similar types of communications services to customers
primarily in Europe. Embratel provides communications services in Brazil.
Operations and technology includes network operations, information services,
engineering and technology, and customer service. Other includes primarily the
operations of MCI Systemhouse Corp. and SHL Systemhouse Co., former wholly owned
subsidiaries of the Company (collectively, "SHL"), and other non-communications
services.
9
In April 1999, the Company completed the previously announced sale of SHL to
Electronic Data Systems Corporation ("EDS").
The Company's chief operating decision maker utilizes revenue information in
assessing performance and making overall operating decisions and resource
allocations. Communications services are generally provided utilizing the
Company's fiber optic networks, which do not make a distinction between the
types of services. As a result, the Company does not allocate line costs or
assets by segment. Profit and loss information is reported only on a
consolidated basis to the chief operating decision maker and the Company's board
of directors.
Information about the Company's segments for the three and nine months ended
September 30, 1999 and 1998, is as follows (in millions):
Revenues From External Customers
---------------------------------------------------------
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------------- ---------------------------
1999 1998 1999 1998
------------- ------------- -------------- -----------
MCI WorldCom Communications $8,068 $3,201 $23,340 $7,522
MCI WorldCom International Operations 464 302 1,241 802
Operations and technology - - - -
Other (10) 81 513 163
Corporate - - - -
------ ------ ------- ------
Total before Embratel $8,522 $3,584 $25,094 $8,487
Embratel 689 174 2,091 174
Elimination of intersegment revenues (25) - (54) -
------ ------ ------- ------
Total $9,186 $3,758 $27,131 $8,661
====== ====== ======= ======
The following is a reconciliation of the segment information to income (loss)
before income taxes, minority interests and extraordinary items for the three
and nine months ended September 30, 1999 and 1998 (in millions):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Revenues $9,186 $ 3,758 $27,131 $ 8,661
Operating expenses 6,984 6,390 21,670 10,869
------ ------- ------- -------
Operating income (loss) 2,202 (2,632) 5,461 (2,208)
Other income (expense):
Interest expense (214) (141) (710) (351)
Miscellaneous 28 14 44 36
------ ------- ------- -------
Income (loss) before income taxes, minority interests
and extraordinary items $2,016 $(2,759) $ 4,795 $(2,523)
====== ======= ======= =======
(G) Debt
- --------
On August 5, 1999, MCI WorldCom extended its existing $7 billion 364-Day
Revolving Credit and Term Loan Agreement for a successive 364-day term pursuant
to an Amended and Restated 364-Day Revolving Credit and Term Loan Agreement
("Facility C Loans"). The Facility C Loans together with the $3.75 billion
Amended and Restated Facility A Revolving Credit Agreement dated August 6, 1998
("Facility A Loans"), provide MCI WorldCom with aggregate credit facilities of
$10.75 billion (the "Credit Facilities"). The Credit Facilities provide
liquidity support for the Company's commercial paper program and are available
for other general corporate purposes. The Facility A Loans mature on June 30,
2002. The Facility C Loans have a 364-day term, which may be extended for a
second successive 364-day term thereafter to the extent of the committed amounts
from those lenders consenting thereto, with a requirement that lenders holding
at least 51% of the committed amounts consent.
10
Additionally, effective as of the end of such 364-day term, the Company may
elect to convert up to $4 billion of the principal debt outstanding under the
Facility C Loans from revolving loans to term loans with a maturity date no
later than one year after the conversion. The Credit Facilities bear interest
payable in varying periods, depending on the interest period, not to exceed six
months, or with respect to any Eurodollar Rate borrowing, 12 months if available
to all lenders, at rates selected by the Company under the terms of the Credit
Facilities, including a Base Rate or Eurodollar Rate, plus the applicable
margin. The applicable margin for the Eurodollar Rate borrowing varies from
0.35% to 0.75% as to Facility A Loans and from 0.225% to 0.45% as to Facility C
Loans, in each case based upon the better of certain debt ratings. The Credit
Facilities are unsecured but include a negative pledge of the assets of the
Company and its subsidiaries (subject to certain exceptions). The Credit
Facilities require compliance with a financial covenant based on the ratio of
total debt to total capitalization, calculated on a consolidated basis. The
Credit Facilities require compliance with certain operating covenants which
limit, among other things, the incurrence of additional indebtedness by the
Company and its subsidiaries, sales of assets and mergers and dissolutions, and
which covenants do not restrict distributions to shareholders, provided the
Company is not in default under the Credit Facilities. At September 30, 1999,
the Company was in compliance with these covenants. The Facility A Loans and the
Facility C Loans are subject to annual commitment fees not to exceed 0.25% and
0.15%, respectively, of any unborrowed portion of the facilities.
Additionally, in August 1999, the Company completed the private placement
offering of $1.0 billion principal amount of floating rate notes due August 2000
(the "Floating Rate Notes"). Interest on the Floating Rate Notes is payable
quarterly, equal to the London Interbank Offered Rate for the three-month U.S.
dollar deposits plus 0.18%. The net proceeds of the offering were used to pay
down debt under the Company's Credit Facilities and commercial paper program and
for general corporate purposes.
In January 1999, the Company and one of its wholly owned subsidiaries redeemed
all of its outstanding 9.375% Senior Notes due January 15, 2004 (the "Senior
Notes"). Holders of the Senior Notes received 103.52% of the principal amount
plus accrued and unpaid interest to January 15, 1999, of $46.875 per $1,000
aggregate principal amount of such Senior Notes. The total redemption cost of
$743 million was obtained from available liquidity under the Company's Credit
Facilities and commercial paper program. The Company recorded a $28 million
charge related to the redemption.
In March 1999, $300 million and $200 million of MCI senior notes, with interest
rates of 6.25% and 6.37%, respectively, matured. The funds utilized to repay
the maturing MCI senior notes were obtained from available liquidity under the
Company's Credit Facilities and commercial paper program.
The following table sets forth the outstanding debt of the Company as of
September 30, 1999 (in millions):
Excluding
Embratel Embratel Consolidated
-------------- ------------- --------------
Commercial paper and Credit Facilities $ 1,735 $ - $ 1,735
Floating rate notes due 2000 1,000 - 1,000
6.13% - 6.95% Notes Due 2001 - 2028 6,100 - 6,100
7.55% - 7.75% Notes Due 2004 - 2027 2,000 - 2,000
8.88% Senior Notes Due 2006 672 - 672
7.13% - 8.25% MCI Senior Debentures Due 2023 - 2027 1,439 - 1,439
6.13% - 7.50% MCI Senior Notes Due 2000 - 2012 2,145 - 2,145
Note payable due 2000 - 414 414
Capital lease obligations (maturing through 2002) 503 - 503
Other debt (maturing through 2008) 295 621 916
------- ------ -------
$15,889 $1,035 $16,924
Less: Short-term debt and current maturities of long-term debt (3,124) (555) (3,679)
------- ------ -------
$12,765 $ 480 $13,245
======= ====== =======
11
(H) Contingencies
- ------------------
The Company is involved in legal and regulatory proceedings generally incidental
to its business and has included loss contingencies in other current liabilities
and other liabilities for certain of these matters. In some instances, rulings
by federal and some state regulatory authorities may result in increased
operating costs to the Company. Except as described herein, and while the
results of these various legal and regulatory matters contain an element of
uncertainty, based on information currently available, MCI WorldCom believes
that the probable outcome of these matters should not have a material adverse
effect on the Company's consolidated results of operations or financial
position.
General. MCI WorldCom is subject to varying degrees of federal, state, local
and international regulation. In the United States, the Company's subsidiaries
are most heavily regulated by the states, especially for the provision of local
exchange services. The Company must be certified separately in each state to
offer local exchange and intrastate long distance services. No state, however,
subjects MCI WorldCom to price cap or rate of return regulation, nor is the
Company currently required to obtain Federal Communications Commission ("FCC")
authorization for installation or operation of its network facilities used for
domestic services, other than licenses for specific terrestrial microwave and
satellite earth station facilities that utilize radio frequency spectrum. FCC
approval is required, however, for the installation and operation of its
international facilities and services. MCI WorldCom is subject to varying
degrees of regulation in the foreign jurisdictions in which it conducts business
including authorization for the installation and operation of network
facilities. Although the trend in federal, state and international regulation
appears to favor increased competition, no assurance can be given that changes
in current or future regulations adopted by the FCC, state or foreign regulators
or legislative initiatives in the United States or abroad would not have a
material adverse effect on MCI WorldCom.
In implementing the Telecommunications Act of 1996 (the "Telecom Act"), the FCC
established nationwide rules designed to encourage new entrants to participate
in the local services markets through interconnection with the ILECs, resale of
ILECs' retail services and use of individual and combinations of unbundled
network elements. Appeals of the FCC order adopting those rules were
consolidated before the United States Court of Appeals for the Eighth Circuit
(the "Eighth Circuit"). Thereafter, the Eighth Circuit held that constitutional
challenges to various practices implementing cost provisions of the Telecom Act
that were ordered by certain Public Utility Commissions ("PUCs") were premature;
it vacated, however, significant portions of the FCC's nationwide pricing rules
and an FCC rule requiring that unbundled network elements be provided on a
combined basis. The United States Supreme Court (the "Supreme Court") reviewed
the decision of the Eighth Circuit and on January 25, 1999, reversed the Eighth
Circuit in part and reinstated, with one exception, all of the FCC local
competition rules. The Court vacated and remanded to the FCC for
reconsideration the rule determining which unbundled network elements must be
provided by ILECs to new entrants. On September 15, 1999, the FCC announced its
intention to promulgate a new unbundling rule that will require two additional
network elements, as well as most of the previously identified elements, to be
made available to new entrants. The Eighth Circuit is now considering the
ILECs' challenges to the substance of pricing rules which it previously had
found to be premature.
Access charges, both interstate and intrastate, are a principal component of MCI
WorldCom's telecommunications expense. Regulators have historically permitted
access charges to be set at levels that are well above ILECs' costs. As a
result, access charges have been a source of universal service subsidies that
enable local exchange rates to be set at levels that are affordable. MCI
WorldCom has actively participated in a variety of state and federal regulatory
proceedings with the goal of bringing access charges to cost-based levels and to
fund universal service using explicit subsidies funded in a competitively-
neutral manner.
On May 21, 1999, the United States Court of Appeals for the District of Columbia
Circuit remanded to the FCC its recent decision to adjust its price cap
regulation of ILECs to require access charges to fall 6.5% per year adjusted for
inflation. On June 22, 1999, that Court stayed the effect of its decision
pending a further order by the FCC justifying or modifying its decision in
response to the Court's opinion. On November 4, 1999, the FCC's decision
allowing price-cap regulated ILECs to offer customer specific pricing in
contract tariffs took effect. Price-cap regulated ILECs can now offer access
arrangements with contract-type pricing in competition with long distance
carriers who have previously been able to offer contract-type pricing for access
arrangements. As ILECs experience increasing competition in the local services
market, the FCC will grant increased pricing flexibility and relax
12
tariffing requirements for access services. The FCC is also conducting a
proceeding to consider additional pricing flexibility for a wider range of
access services.
On May 27, 1999, the FCC amended its prior universal service decisions in two
significant respects. First, the FCC raised the funding level for universal
service support to schools and libraries to $2.25 billion per year, the current
maximum that FCC rules allow. This brings the total amount of federal universal
service funds collected from telecommunications carriers to slightly less than
$4.0 billion in the current year. Second, the FCC modified its approach to
subsidizing non-rural high cost areas by rejecting its prior approach of sizing
the subsidy based on forward-looking cost models, and instead adopted a more
complex approach that the FCC said it hoped would produce a small high cost
fund. On November 2, 1999, the FCC released a further universal service order,
which provides for federal support for non-rural high cost areas. On July 30,
1999, the United States Court of Appeals for the Fifth Circuit issued a decision
reversing and vacating in part portions of a May 1997 FCC universal service
decision. Among other things, the Court held that the FCC may collect universal
service subsidies from interstate carriers based only on interstate revenues,
and that the FCC could not force the ILECs to recover their universal service
contributions through interstate access charges. On November 1, 1999, the FCC
implemented the Court's decision. ILEC interstate access charges decreased by
approximately $400 million, and direct universal service assessments on
interstate carriers such as MCI WorldCom increased by $700 million.
In August 1998, in response to petitions filed by several ILECs under the guise
of Section 706 of the Telecom Act, the FCC issued its Advanced Services Order.
This order clarifies that the interconnection, unbundling, and resale
requirements of Section 251(c) of the Telecom Act, and the interLATA
restrictions of Section 271 of this Act, apply fully to so-called "advanced
telecommunications services," such as Digital Subscriber Line ("DSL"). US West
Communications Group appealed this order to the United States Court of Appeals
for the District of Columbia Circuit. At the request of the FCC, the court has
remanded the case for further administrative proceedings. In a companion notice
to the original order, the FCC sought comment on how to implement Section 706 of
the Telecom Act, which directs the FCC to (1) encourage the deployment of
advanced telecommunications capability to Americans on a reasonable and timely
basis, and (2) complete an inquiry concerning the availability of such services
no later than February 8, 1999. The Commission's rulemaking notice included a
proposal that, if adopted, would allow the ILECs the option of providing
advanced services via a separate subsidiary free from the unbundling and resale
obligations of Section 251(c), as well as other dominant carrier regulatory
requirements.
In early February 1999, the FCC issued its report to Congress, concluding that
the deployment of advanced services is proceeding at a reasonable and timely
pace. The FCC has not yet issued its Section 706 rulemaking order.
In February 1999, the FCC adopted new rules expanding the rights of CLECs to
collocate equipment within ILEC-owned facilities. In that same order, the FCC
sought public comments on its tentative conclusion that loop spectrum standards
should be set in a competitively neutral process. The FCC also tentatively
concluded that ILECs should be required to share primary telephone lines with
CLECs, and sought comments on various technical, operational, pricing, and other
issues. As of November 5, 1999, the FCC has not yet issued a decision in this
proceeding. The ILECs have appealed the February 1999 collocation order to the
United States Court of Appeals for the District of Columbia Circuit.
On February 26, 1999, the FCC issued a Declaratory Ruling and Notice of Proposed
Rulemaking regarding the regulatory treatment of calls to ISPs. Prior to the
FCC's order, approximately thirty PUCs issued orders unanimously finding that
carriers, including MCI WorldCom, are entitled to collect reciprocal
compensation for completing calls to ISPs under the terms of their
interconnection agreements with ILECs. Many of these PUC decisions have been
appealed by the ILECs and, since the FCC's order, many have filed new cases at
the PUCs or in court. Moreover, MCI WorldCom has appealed the FCC's order to
the Court of Appeals for the District of Columbia Circuit. Oral argument in
that appeal is set for November 22, 1999. MCI WorldCom cannot predict either
the outcome of these appeals and the FCC's rulemaking proceeding or whether or
not the result(s) will have a material adverse impact upon its consolidated
financial position or results of operations.
Several bills have been introduced during the 106th Congress that would exclude
the transmission of data services or high-speed Internet access from the Telecom
Act's bar on the transmission of in-region interLATA services by the Bell
Operating Companies ("BOCs"). These bills also would make it more difficult for
competitors to resell the
13
high-speed Internet access services of the ILECs or to lease some of the network
components used for the provision of such services.
In 1996 and in 1997, the FCC issued decisions that would require non-dominant
telecommunications carriers to eliminate interstate service tariffs, except in
limited circumstances. MCI WorldCom has challenged this decision in the U.S.
Court of Appeals for the District of Columbia Circuit, and has successfully
obtained a stay of the FCC's decision. MCI WorldCom's appeal has been held in
abeyance pending FCC action with respect to petitions for reconsideration. The
FCC recently issued an order addressing those petitions for reconsideration,
briefing of the appeal is ongoing, and oral argument has been scheduled for
March 14, 2000. MCI WorldCom cannot predict the ultimate outcome of its appeal.
Should the FCC prevail, MCI WorldCom could no longer rely on its federal tariff
to limit liability or to establish its interstate rates for customers. Under
the FCC's decision, MCI WorldCom would need to develop a means to contract
individually with its millions of customers in order to establish lawfully
enforceable rates.
In 1997 and 1998, the FCC rejected five applications filed by BOCs to provide
in-region long distance service in competition with long distance carriers.
Pursuant to the Telecom Act, BOCs must file, in each state in their service
area, an application conforming to the requirements of Section 271 of the
Telecom Act if they wish to offer in-region long distance service. Among other
things, the applications must demonstrate that the BOC has met a 14-point
competitive checklist to open its local network to competition and demonstrate
that the application is in the public interest. SBC Corporation in Texas
announced its intention to file an application in 1999. Bell Atlantic
Corporation in New York filed its application with the FCC on October 19, 1999.
Bell Atlantic's is the first application to have been subjected to rigorous
operational testing of readiness to meet the Section 271 requirements. On
November 1, 1999, the Department of Justice filed its evaluation of the
application, noting several issues that indicate that Bell Atlantic has not met
the checklist requirements. The FCC must reach its decision on applications
within 90 days from the date they are filed.
International. In February 1997, the United States entered into a World Trade
Organization Agreement (the "WTO Agreement") that is designed to have the effect
of liberalizing the provision of switched voice telephone and other
telecommunications services in scores of foreign countries over the next several
years. The WTO Agreement became effective in February 1998. In light of the
United States commitments to the WTO Agreement, the FCC implemented new rules in
February 1998 that liberalize existing policies regarding (1) the services that
may be provided by foreign affiliated United States international common
carriers, including carriers controlled or more than 25 percent owned by foreign
carriers that have market power in their home markets, and (2) the provision of
alternative traffic routing. The new rules make it much easier for foreign
affiliated carriers to enter the United States market for the provision of
international services.
In August 1997, the FCC adopted mandatory settlement rate benchmarks. These
benchmarks are intended to reduce the rates that United States carriers pay
foreign carriers to terminate traffic in their home countries. The FCC will
also prohibit a United States carrier affiliated with a foreign carrier from
providing facilities-based service to the foreign carrier's home market until
and unless the foreign carrier has implemented a settlement rate at or below the
benchmark. The FCC also adopted new rules that will liberalize the provision of
switched services over private lines to World Trade Organization member
countries. These rules allow such services on routes where 50% or more of
United States billed traffic is being terminated in the foreign country at or
below the applicable settlement rate benchmark or where the foreign country's
rules concerning provision of international switched services over private lines
are deemed equivalent to United States rules. On January 12, 1999, the FCC's
benchmark rules were upheld in their entirety by the U.S. Court of Appeals for
the District of Columbia Circuit. On March 11, 1999, the District of Columbia
Circuit denied petitions for rehearing of the case.
In April 1999, the FCC modified its rules to permit United States international
carriers to exchange international public switched voice traffic on many routes
to and from the United States outside of the traditional settlement rate and
proportionate return regimes.
On June 3, 1999, the FCC enforced the benchmark rates on two non-compliant
routes. Settlement rates have fallen to the benchmarks or below on many other
routes.
14
Although the FCC's new policies and implementation of the WTO Agreement may
result in lower settlement payments by MCI WorldCom to terminate international
traffic, there is a risk that the payments that MCI WorldCom will receive from
inbound international traffic may decrease to an even greater degree. The
implementation of the WTO Agreement may also make it easier for foreign carriers
with market power in their home markets to offer United States and foreign
customers end-to-end services to the disadvantage of MCI WorldCom. The Company
may continue to face substantial obstacles in obtaining from foreign governments
and foreign carriers the authority and facilities to provide such end-to-end
services.
Embratel. The 1996 General Telecommunications Law (the "General Law") provides
a framework for telecommunications regulation for Embratel. Article 8 of the
General Law created Agencia Nacional de Telecomunicacoes ("Anatel") to implement
the General Law through development of regulations and to enforce such
regulations. According to the General Law, companies wishing to offer
telecommunications services to consumers are required to apply to Anatel for a
concession or an authorization. Concessions are granted for the provision of
services under the public regime (the "Public Regime") and authorizations are
granted for the provision of services under the private regime (the "Private
Regime"). The Public Regime is differentiated from the Private Regime primarily
by the obligations imposed on the companies rather than the type of services
offered by those companies. Service providers subject to the Public Regime
(concessionaires) are subject to obligations concerning network expansion and
continuity of service provision and are subject to rate regulation. These
obligations and the tariff conditions are provided in the General Law and in
each company's concession contract. The network expansion obligations (called
universal service obligations) are also provided in the Plano Geral de
Universalizacao ("General Plan on Universal Service").
The only services provided under the Public Regime are the switched fixed
telephone services (local and national and international long distance) provided
by Embratel and the three regional holding companies ("Teles"). All other
telecommunications companies, including other companies providing switched fixed
telephone services ("SFTS"), operate in the Private Regime and, although they
are not subject to the Public Regime, individual authorizations may contain
certain specific expansion and continuity obligations.
Therefore, when providing SFTS, Embratel and the Teles are subject to the Public
Regime obligations provided in the General Law, in their concession contracts
and in the General Plan on Universal Service, among other regulations.
The main restriction imposed on these companies by the General Plan on Universal
Service, is that, until December 31, 2003, the three Teles are prohibited from
offering inter-regional and international long distance service, while Embratel
is prohibited from offering local services. These companies can start providing
the mentioned services two years sooner if they meet their network expansion
obligations by December 31, 2001.
Embratel and the three Teles were granted their concessions at no fee, until
2005. After 2005, the concessions may be renewed for a period of 20 years, upon
the payment, every two years, of a fee equal to 2% of annual net revenues
calculated based on the provision of SFTS in the prior year, excluding taxes and
social contributions.
Embratel also offers a number of ancillary telecommunications services pursuant
to authorizations granted in the Private Regime. Such services include the
provision of dedicated analog and digital lines, packet switched network
services, circuit switched network services, mobile marine telecommunications,
telex and telegraph, radio signal satellite retransmission and television signal
satellite retransmission. Some of these services are subject to specific
continuity obligations and rate conditions.
All providers of telecommunications services are subject to quality and
modernization obligations provided in the Plano Geral de Qualidade ("General
Plan on Quality").
Litigation. On November 4, 1996, and thereafter, and on August 25, 1997, and
thereafter, MCI and all of its directors were named as defendants in a total of
15 complaints filed in the Court of Chancery in the State of Delaware. BT was
named as a defendant in 13 of the complaints. The complaints were brought by
alleged stockholders of MCI, individually and purportedly as class actions on
behalf of all other stockholders of MCI. In general, the complaints allege that
MCI's directors breached their fiduciary duty in connection with the MCI BT
15
Merger Agreement, dated November 3, 1996 (the "MCI BT Merger Agreement"), that
BT aided and abetted those breaches of duty, that BT owes fiduciary duties to
the other stockholders of MCI and that BT breached those duties in connection
with the MCI BT Merger Agreement. The complaints seek damages and injunctive
and other relief.
One of the purported stockholder class actions pending in Delaware Chancery
Court has been amended, one of the purported class actions has been dismissed
with prejudice, and plaintiffs in four of the other purported stockholder class
actions have moved to amend their complaints to name MCI WorldCom and TC
Investments Corp., a wholly owned subsidiary of the Company, as additional
defendants. These plaintiffs generally allege that the defendants breached
their fiduciary duties to stockholders in connection with the MCI Merger and the
agreement to pay a termination fee to WorldCom. They further allege
discrimination in favor of BT in connection with the MCI Merger. The plaintiffs
seek, inter alia, damages and injunctive relief prohibiting the consummation of
the MCI Merger and the payment of the inducement fee to BT.
Three complaints were filed in the U.S. District Court for the District of
Columbia, as class actions on behalf of purchasers of MCI shares. The three
cases were consolidated on April 1, 1998. On or about May 8, 1998, the
plaintiffs in all three cases filed a consolidated amended complaint alleging,
on behalf of purchasers of MCI's shares between July 11, 1997 and August 21,
1997, inclusive, that MCI and certain of its officers and directors failed to
disclose material information about MCI, including that MCI was renegotiating
the terms of the MCI BT Merger Agreement. The consolidated amended complaint
seeks damages and other relief. The Company and the other defendants have moved
to dismiss the consolidated amended complaint.
At least nine class action complaints have been filed that arise out of the
FCC's decision in Halprin, Temple, Goodman and Sugrue v. MCI Telecommunications
-------------------------------------------------------------
Corp., and allege that MCI WorldCom has improperly charged "Pre-Subscribed"
- -----
customers "Non-Subscriber" or so-called "casual" rates for certain direct-dialed
calls. Plaintiffs further challenge MCI WorldCom's credit policies for this
"non-subscriber" traffic. Plaintiffs assert that MCI WorldCom's conduct
violates the Communications Act and various state laws; they seek rebates to all
affected customers, punitive damages and other relief. In response to a motion
filed by MCI WorldCom, the Judicial Panel on Multi-District Litigation has
consolidated these matters in the United States District Court for the Southern
District of Illinois. The Company has moved to dismiss the state law claims and
for an order staying the Communications Act claims pending the FCC's resolution
of MCI WorldCom's outstanding motion for reconsideration.
On September 3, 1998, WorldCom and MCI entered into a Stock Purchase Agreement
("SPA") with Cable & Wireless plc and Cable & Wireless Internet Holdings, Inc.
(collectively, "C&W"), pursuant to which MCI sold the iMCI business to C&W.
That transaction closed on September 14, 1998, simultaneously with the closing
of the MCI Merger.
On February 18, 1999, pursuant to the indemnity provisions of the SPA, C&W
notified MCI WorldCom that it was claiming that MCI WorldCom had breached
representations and warranties in, and had failed to comply with other
provisions of, the SPA. C&W alleged that it had suffered damages of
approximately $1.16 billion. MCI WorldCom advised C&W on March 19, 1999, that
the Company denies these allegations.
On March 31, 1999, C&W filed a complaint against MCI WorldCom in the United
States District Court for the District of Delaware, alleging that MCI WorldCom
had breached the SPA. In the lawsuit, C&W seeks unspecified damages and
specific performance. On May 11, 1999, MCI WorldCom filed a motion to stay the
litigation and to compel compliance with the dispute resolution/arbitration
provisions in the SPA and affiliated agreements. On July 12, 1999, the district
court entered an order compelling C&W to comply with the dispute
resolution/arbitration provisions of the SPA and affiliated agreements with
respect to five of the 11 claims in its complaint and denying a stay of the
action. On July 29, 1999, the district court set a trial date of September 12,
2000. On July 30, 1999, MCI WorldCom filed an answer denying C&W's claims and
asserting four counterclaims that alleged that C&W breached the SPA and its duty
of good faith and fair dealing.
On September 10, 1999, C&W commenced an arbitration against MCI WorldCom before
the arbitration firm, J.A.M.S./Endispute. In its Notice of Claims filed on
September 20, 1999, C&W asserted the claims dismissed from the Delaware action
as well as certain other disputes between the companies. On October 4, 1999,
MCI WorldCom
16
responded to the Notice of Claims by denying all of C&W's claims and asserting
six counterclaims that alleged contractual breaches by C&W. A hearing is
currently scheduled to begin December 8, 1999.
(I) Subsequent Event - SkyTel Merger
- -------------------------------------
On October 1, 1999, MCI WorldCom acquired SkyTel Communications, Inc., a
Delaware corporation ("SkyTel"), pursuant to the merger (the "SkyTel Merger") of
SkyTel with and into Empire Merger Inc. ("Acquisition Subsidiary"), a wholly
owned subsidiary of MCI WorldCom. Upon consummation of the SkyTel Merger,
Acquisition Subsidiary was renamed SkyTel Communications, Inc. SkyTel is a
leading provider of nationwide messaging services in the United States.
SkyTel's principal operations include one-way messaging services in the United
States, advanced messaging services on the narrow band personal communications
services network in the United States and international one-way messaging
operations.
As a result of the SkyTel Merger, each outstanding share of SkyTel common stock
was converted into the right to receive 0.2566 shares of MCI WorldCom Common
Stock, or 15.5 million MCI WorldCom common shares in the aggregate. Holders of
SkyTel's $2.25 Cumulative Convertible Exchangeable Preferred Stock (the "SkyTel
Preferred Stock") received one share of MCI WorldCom Series C $2.25 Cumulative
Convertible Exchangeable Preferred Stock (the "MCI WorldCom Preferred Stock")
for each share of SkyTel Preferred Stock held. The MCI WorldCom Preferred Stock
is convertible into MCI WorldCom Common Stock on a basis that gives effect to
the exchange ratio in the SkyTel Merger and otherwise has substantially the same
terms as the SkyTel Preferred Stock. The SkyTel Merger is being accounted for
under the pooling-of-interests method.
SkyTel's net loss for the three and nine month periods ended September 30, 1999
and 1998, has been restated due to the anticipated utilization of previously
reserved net operating losses as a result of the SkyTel Merger. Separate and
combined results of operations are as follows (in millions, except per share
data):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Revenues:
MCI WorldCom $9,186 $ 3,758 $27,131 $ 8,661
SkyTel 141 133 422 380
Intercompany elimination (20) (20) (59) (57)
------ ------- ------- -------
Combined $9,307 $ 3,871 $27,494 $ 8,984
====== ======= ======= =======
Net income (loss) before extraordinary items and
cumulative effect of a change in accounting
principle:
MCI WorldCom $1,091 $(2,947) $ 2,663 $(3,012)
SkyTel (12) (5) (6) (24)
------ ------- ------- -------
Combined $1,079 $(2,952) $ 2,657 $(3,036)
====== ======= ======= =======
Combined earnings (loss) per share before
extraordinary items and cumulative effect of a
change in accounting principle:
Basic $ 0.57 $ (2.41) $ 1.42 $ (2.75)
Diluted 0.55 (2.41) 1.36 (2.75)
17
(J) Subsequent Event - Sprint Merger Agreement
- -----------------------------------------------
On October 5, 1999, MCI WorldCom announced that it had entered into an Agreement
and Plan of Merger dated as of October 4, 1999 (the "Merger Agreement"), between
MCI WorldCom and Sprint Corporation ("Sprint"). Under the terms of the Merger
Agreement, Sprint shall be merged with and into MCI WorldCom (the "Sprint
Merger").
Sprint is a diversified telecommunications company, providing long distance,
local and wireless communications services. Sprint's business is organized in
two groups: the Sprint PCS group and the Sprint FON group. Sprint built and
operates the United States' first nationwide all-digital, fiber-optic network
and is a leader in advanced data communications services. Sprint has $17 billion
in annual revenues and serves more than 20 million business and residential
customers.
Under the Merger Agreement, each outstanding share of Sprint's FON common stock
will be exchanged for $76.00 of MCI WorldCom Common Stock, subject to a collar.
In addition, each share of Sprint's PCS common stock will be exchanged for one
share of a new MCI WorldCom PCS tracking stock and 0.1547 shares of MCI WorldCom
Common Stock. The terms of the MCI WorldCom PCS tracking stock will be
virtually identical to the terms of Sprint's PCS common stock and will be
designed to track the performance of the PCS business of the surviving company
in the Sprint Merger. Holders of shares of the other classes or series of
Sprint capital stock will receive one share of a class or series of the
Company's capital stock with virtually identical terms, which will be
established in connection with the Sprint Merger, for each share of Sprint
capital stock that they own. Sprint will redeem for cash each outstanding share
of the Sprint first and second series preferred stock before completion of the
Sprint Merger. The Sprint Merger, valued at approximately $129 billion, will be
accounted for as a purchase and will be tax-free to Sprint stockholders.
The actual number of shares of MCI WorldCom Common Stock to be exchanged for
each share of Sprint's FON common stock will be determined based on the average
trading prices of MCI WorldCom Common Stock prior to the closing, but will not
be less than 0.9400 shares (if MCI WorldCom's average stock price equals or
exceeds $80.85) or more than 1.2228 shares (if MCI WorldCom's average stock
price equals or is less than $62.15).
Consummation of the Sprint Merger is subject to various conditions set forth in
the Merger Agreement, including the adoption of the Merger Agreement by
stockholders of Sprint, the approval of the Sprint Merger by shareholders of MCI
WorldCom, the approval of the issuance of MCI WorldCom capital stock in the
Sprint Merger by shareholders of MCI WorldCom, certain U.S. and foreign
regulatory approvals and other customary conditions. It is anticipated that the
Sprint Merger will close in the second half of 2000.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations may be deemed to include forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, that involve risk and
uncertainty, including financial, regulatory environment and trend projections,
estimated costs to complete or possible future revenues from IPR&D programs, the
likelihood of successful completion of such programs, and the outcome of year
2000 or Euro conversion efforts, as well as any statements preceded by, followed
by, or that include the words "intends," "estimates," "believes," "expects,"
"anticipates," "should," "could," or similar expressions; and other statements
contained herein regarding matters that are not historical facts.
Although the Company believes that its expectations are based on reasonable
assumptions, it can give no assurance that its expectations will be achieved.
The important factors that could cause actual results to differ materially from
those in the forward-looking statements herein (the "Cautionary Statements")
include, without limitation: (1) whether the Sprint Merger is completed and the
ability to integrate the operations of the Company and Sprint, including their
respective products and services; (2) the effects of vigorous competition in the
markets in which the Company operates; (3) the impact of technological change on
the Company's businesses, new entrants and alternative technologies in the
Company's business and dependence on the availability of transmission
facilities; (4) uncertainties associated with the success of acquisitions and
the integration thereof; (5) risks of international business; (6) regulatory
risks, including the impact of the Telecom Act; (7) contingent liabilities; (8)
the impact of
18
competitive services and pricing; (9) risks associated with year 2000
uncertainties and Euro conversion efforts; (10) risks associated with debt
service requirements and interest rate fluctuations; (11) the Company's degree
of financial leverage; and (12) other risks referenced from time to time in the
Company's filings with the SEC, including the Form 10-K.
All subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the Cautionary Statements. The Company does not undertake any
obligation to release publicly any revisions to such forward-looking statements
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
The following discussion and analysis relates to the financial condition and
results of operations of the Company for the three and nine months ended
September 30, 1999, and 1998, after giving effect to the BFP Merger, which was
accounted for as a pooling-of-interests. The information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and consolidated financial statements and notes
thereto contained herein and in the Form 10-K and the Company's Current Report
on Form 8-K dated November 5, 1999 (filed November 5, 1999).
Unless otherwise defined, capitalized terms used herein have the meanings
assigned to them in the Notes to Consolidated Financial Statements contained
herein.
General
The Company is one of the largest telecommunications companies in the United
States, serving local, long distance and Internet customers domestically and
internationally. The Company's operations have grown significantly in each year
of its operations as a result of internal growth, the selective acquisition of
other telecommunications companies and international expansion.
On September 14, 1998, the Company, through a wholly owned subsidiary, merged
with MCI. Through the MCI Merger, the Company acquired one of the world's
largest and most advanced digital networks, connecting local markets in the
United States to more than 280 countries and locations worldwide.
As a result of the MCI Merger, each share of MCI common stock was converted into
the right to receive 1.2439 shares of MCI WorldCom Common Stock or approximately
755 million MCI WorldCom common shares in the aggregate, and each share of MCI
Class A common stock outstanding (all of which were held by BT) was converted
into the right to receive $51.00 in cash or approximately $7 billion in the
aggregate. The funds paid to BT were obtained by the Company from (i) available
cash as a result of the Company's $6.1 billion public debt offering in August
1998; (ii) the sale of MCI's iMCI Business to Cable & Wireless for $1.75 billion
in cash on September 14, 1998; (iii) the sale of MCI's 24.9% equity stake in
Concert to BT for $1 billion in cash on September 14, 1998; and (iv)
availability under the Company's Credit Facilities and commercial paper program.
The MCI Merger was accounted for as a purchase; accordingly, operating results
for MCI have been included from the date of acquisition.
On August 4, 1998, MCI acquired a 51.79% voting interest and a 19.26% economic
interest in Embratel, Brazil's only facilities-based national communications
provider, for approximately R$2.65 billion (U.S. $2.3 billion). The purchase
price is being paid in local currency installments of which R$1.06 billion (U.S.
$916 million) was paid on August 4, 1998, R$795 million (U.S. $442 million) was
paid August 4, 1999 with the remaining R$795 million (U.S. $414 million at
September 30, 1999) to be paid August 4, 2000. Embratel provides interstate
long distance and international telecommunications services, as well as over 40
other communications services, including leased high-speed data, satellite,
Internet, frame relay and packet-switched services. Operating results for
Embratel are included from the date of the MCI Merger.
On January 31, 1998, MCI WorldCom, through a wholly owned subsidiary, merged
with CompuServe. As a result of the CompuServe Merger, each share of CompuServe
common stock was converted into the right to receive 0.40625 shares of MCI
WorldCom Common Stock, or approximately 37.6 million MCI WorldCom common shares
in the aggregate. Prior to the CompuServe Merger, CompuServe operated primarily
through two divisions: Interactive Services and Network Services. Interactive
Services offered worldwide online and Internet access
19
services for consumers, while Network Services provided worldwide network
access, management and applications, and Internet services to business. The
CompuServe Merger was accounted for as a purchase; accordingly, operating
results for CompuServe have been included from the date of acquisition.
On January 31, 1998, MCI WorldCom also acquired ANS from AOL and has entered
into five year contracts with AOL under which MCI WorldCom and its subsidiaries
will provide network services to AOL. As part of the AOL Transaction, AOL
acquired CompuServe's Interactive Services Division and received a $175 million
cash payment from MCI WorldCom. MCI WorldCom retained the CompuServe Network
Services division. ANS provides Internet access to AOL and AOL's subscribers in
the United States, Canada, the United Kingdom, Sweden and Japan. The AOL
Transaction was accounted for as a purchase, accordingly, operating results for
ANS have been included from the date of acquisition.
In connection with the above business combinations, the Company made allocations
of the purchase price to acquired IPR&D totaling $429 million in the first
quarter of 1998 related to the CompuServe Merger and AOL Transaction and $3.1
billion in the third quarter of 1998 related to the MCI Merger.
Management expects to continue supporting these research and development ("R&D")
efforts and believes the Company has a reasonable chance of successfully
completing the R&D programs. However, there is risk associated with the
completion of the R&D projects due to uncertainties in developing new
technologies, risks of delays, product defects, changing customer needs,
competitive product and service offerings, emerging industry standards, changing
technology and other factors. The Company cannot give any assurance that any
R&D programs will meet with either technological or commercial success.
If none of these R&D projects are successfully developed, the sales and
profitability of the Company may be adversely affected in future periods. The
failure of any particular individual project in-process would not materially
impact the Company's financial condition, results of operations or the
attractiveness of the overall investment in MCI, CompuServe Network Services or
ANS. 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.
The integration and consolidation of MCI, CompuServe Network Services and ANS
requires substantial management and financial resources. While the Company
believes the early results of these efforts are encouraging, the MCI Merger,
CompuServe Merger and AOL Transaction necessarily involve a number of
significant risks, including potential difficulties in assimilating the
technologies and services of these companies and in achieving the expected
synergies and cost reduction.
On January 29, 1998, MCI WorldCom, through a wholly owned subsidiary, merged
with BFP in a transaction accounted for as a pooling-of-interests. BFP is a
leading facilities-based provider of competitive local telecommunications
services, commonly referred to as a competitive local exchange carrier, in
selected cities within the United States. BFP acquires and constructs its own
state-of-the-art fiber optic networks and facilities and leases network capacity
from others to provide IXCs, ISPs, wireless carriers and business, government
and institutional end users with an alternative to the ILECs for a broad array
of high quality voice, data, video transport and other telecommunications
services.
On October 1, 1999, MCI WorldCom, through a wholly owned subsidiary, merged with
SkyTel in a transaction accounted for as a pooling-of-interests. SkyTel is a
leading provider of nationwide messaging services in the United States.
SkyTel's principal operations include one-way messaging services in the United
States, advanced messaging services on the narrow band personal communications
services network in the United States and international one-way messaging
operations.
On October 5, 1999, MCI WorldCom announced that it had entered into the Merger
Agreement with Sprint. Sprint is a diversified telecommunications company,
providing long distance, local and wireless communications services. Sprint's
business is organized in two groups: the Sprint PCS group and the Sprint FON
group. Sprint built and operates the United States' first nationwide all-
digital, fiber-optic network and is a leader in advanced data
20
communications services. Sprint has $17 billion in annual revenues and serves
more than 20 million business and residential customers.
Under the Merger Agreement, each outstanding share of Sprint's FON common stock
will be exchanged for $76.00 of MCI WorldCom Common Stock, subject to a collar.
In addition, each share of Sprint's PCS common stock will be exchanged for one
share of a new MCI WorldCom PCS tracking stock and 0.1547 shares of MCI WorldCom
Common Stock. The terms of the MCI WorldCom PCS tracking stock will be
virtually identical to the terms of Sprint's PCS common stock and will be
designed to track the performance of the PCS business of the surviving company
in the Sprint Merger. Holders of shares of the other classes or series of
Sprint capital stock will receive one share of a class or series of the
Company's capital stock with virtually identical terms, which will be
established in connection with the Sprint Merger, for each share of Sprint
capital stock that they own. Sprint will redeem for cash each outstanding share
of the Sprint first and second series preferred stock before completion of the
Sprint Merger. The Sprint Merger, valued at approximately $129 billion, will be
accounted for as a purchase and will be tax-free to Sprint stockholders.
The actual number of shares of MCI WorldCom Common Stock to be exchanged for
each share of Sprint's FON common stock will be determined based on the average
trading prices of MCI WorldCom Common Stock prior to the closing, but will not
be less than 0.9400 shares (if MCI WorldCom's average stock price equals or
exceeds $80.85) or more than 1.2228 shares (if MCI WorldCom's average stock
price equals or is less than $62.15).
Consummation of the Sprint Merger is subject to various conditions set forth in
the Merger Agreement, including the adoption of the Merger Agreement by
stockholders of Sprint, the approval of the Merger by shareholders of MCI
WorldCom, the approval of the issuance of MCI WorldCom capital stock in the
Merger by shareholders of MCI WorldCom, certain U.S. and foreign regulatory
approvals and other customary conditions. It is anticipated that the Sprint
Merger will close in the second half of 2000. Additionally, if the Sprint Merger
is consummated, the integration and consolidation of Sprint would require
substantial management and financial resources and involve a number of
significant risks, including potential difficulties in assimilating the
technologies and services of Sprint and in achieving anticipated synergies and
cost reductions.
The Company's strategy is to further develop as a fully integrated
telecommunications company positioned to take advantage of growth opportunities
in global telecommunications. Consistent with this strategy, the Company
believes that transactions such as the MCI Merger, the CompuServe Merger, the
AOL Transaction, the SkyTel Merger and, if consummated, the Sprint Merger,
enhance the combined entity's opportunities for future growth, create a stronger
competitor in the changing telecommunications industry and allow provision of
end-to-end bundled services over global networks, which will provide new or
enhanced capabilities for the Company's residential and business customers. In
particular, the Company believes that if consummated, the Sprint Merger will
enable the combined company to: (i) offer a unique broadband access alternative
to both cable and traditional telephony providers in the United States through a
combination of digital subscriber line facilities and fixed wireless access
using the combined company's "wireless cable" spectrum; (ii) continue to lead
the industry with innovative service offerings for consumer and business
customers; and (iii) continue as an effective competitor in the wireless market
in the United States.
21
Results of Operations
The following table sets forth for the periods indicated the Company's statement
of operations as a percentage of its revenues for the three and nine months
ended September 30, 1999 and 1998:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------- -------------- ------------- --------------
Revenues.................................................... 100% 100% 100% 100%
Line costs.................................................. 42.3 47.7 44.0 47.8
Selling, general and administrative......................... 22.2 24.0 24.1 22.0
Depreciation and amortization............................... 11.5 12.5 11.8 12.7
In-process research and development and other charges....... - 85.9 - 43.0
---- ----- ---- -----
Operating income (loss)..................................... 24.0 (70.0) 20.1 (25.5)
Other income (expense):
Interest expense.......................................... (2.3) (3.8) (2.6) (4.1)
Miscellaneous............................................. 0.3 0.4 0.2 0.4
---- ----- ---- -----
Income (loss) before income taxes, minority interests and
extraordinary items........................................ 22.0 (73.4) 17.7 (29.2)
Provision for income taxes.................................. 8.7 4.6 7.4 5.3
---- ----- ---- -----
Net income (loss) before minority interests and
extraordinary items........................................ 13.3 (78.0) 10.3 (34.5)
Minority interests.......................................... (1.2) (0.3) (0.3) (0.1)
Extraordinary items......................................... - - - (1.5)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities............................ 0.2 0.1 0.2 -
Preferred dividend requirement.............................. - - - 0.2
---- ----- ---- -----
Net income (loss) applicable to common shareholders......... 11.9% (78.4%) 9.8% (36.3%)
==== ===== ==== =====
22
Three and nine months Ended September 30, 1999 vs.
Three and nine months Ended September 30, 1998
Revenues for the three months ended September 30, 1999, increased 144% to $9.2
billion as compared to $3.8 billion for the three months ended September 30,
1998. For the nine months ended September 30, 1999, revenues increased 213% to
$27.1 billion versus $8.7 billion for the same period in the prior year. The
increase in total revenues is attributable to the MCI Merger and Embratel
acquisition as well as internal growth. Results include MCI and Embratel
operations from September 14, 1998, and CompuServe Network Services and ANS from
February 1, 1998.
Actual reported revenues by category for the three and nine months ended
September 30, 1999, and 1998 reflect the following changes by category (dollars
in millions):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------------- -------------------------------------------
Actual Actual Percent Actual Actual Percent
1999 1998 Change 1999 1998 Change
-------------- ------------- ------------- ------------- ------------- -------------
Revenues
Voice $5,206 $1,877 177 $15,391 $4,247 262
Data 1,938 735 164 5,431 1,768 207
Internet 924 589 57 2,518 1,507 67
International 464 302 54 1,241 802 55
------ ------ --- ------- ------ -----
Communications services 8,532 3,503 144 24,581 8,324 195
Other (10) 81 NM 513 163 215
------ ------ --- ------- ------ -----
Total revenues before Embratel 8,522 3,584 138 25,094 8,487 196
Embratel 689 174 296 2,091 174 1,102
Elimination of intersegment revenues (25) - NM (54) - NM
------ ------ --- ------- ------ -----
Total reported revenues $9,186 $3,758 144 $27,131 $8,661 213
====== ====== === ======= ====== =====
The following table provides supplemental pro forma detail for MCI WorldCom
revenues. Since actual results for the nine months ended September 30, 1998,
only reflect the operations of MCI after September 14, 1998, and eight months of
CompuServe Network Services and ANS, the pro forma results are more indicative
of internal growth for the combined company. The pro forma revenues, excluding
Embratel, for the three and nine months ended September 30, 1999 and 1998,
reflect the following changes by category (dollars in millions):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------------- --------------------------------------------
Actual Actual Percent Actual Actual Percent
1999 1998 Change 1999 1998 Change
-------------- ------------- ------------- ------------- ------------- --------------
Revenues
Voice $5,206 $4,907 6 $15,391 $14,483 6
Data 1,938 1,520 28 5,431 4,211 29
Internet 924 589 57 2,518 1,588 59
International 464 302 54 1,241 802 55
------ ------ -- ------- ------- ---
Communications services 8,532 7,318 17 24,581 21,084 17
Other (10) 356 NM 513 1,323 (61)
------ ------ -- ------- ------- ---
Total revenues $8,522 $7,674 11 $25,094 $22,407 12
====== ====== == ======= ======= ===
The following discusses the revenue increases for the three and nine month
periods ended September 30, 1999, as compared to pro forma results for the
comparable prior year period. The pro forma revenues assume that the MCI
Merger, CompuServe Merger and the AOL Transaction occurred at the beginning of
1998. These pro forma revenues do not include Embratel or the iMCI Business
that was sold. Changes in actual results of operations are shown in the
Consolidated Statements of Operations and the foregoing tables and, as noted
above, primarily reflect the MCI Merger, Embratel transaction and internal
growth of the Company.
23
Voice revenues for the third quarter and the nine month period ended September
30, 1999, experienced six percent pro forma increases over the prior year pro
forma amounts, driven by a gain of 10% and 9% in traffic, respectively, as a
result of customers purchasing "all-distance" voice services from the Company.
This marketing, combined with aggressive pricing in both consumer and business
markets also contributed to this favorable performance, as traffic volume gains
more than offset pricing declines. These volume and revenue gains were offset
partially by anticipated year-over-year declines in carrier wholesale traffic.
Implementation of access charge reforms along with declining network costs
facilitated the reduction in pricing, without impacting gross margins. Voice
revenues include both long distance and local domestic switched revenues.
Data revenues for the three and nine months ended September 30, 1999, increased
28% and 29%, respectively, over the same pro forma period of the prior year.
During the quarter, the Company experienced intermittent service interruptions
on one of its frame relay network platforms. The Company credited all customers
on this platform at a rate of two days of service for every one day of possible
service disruption. This resulted in a $29 million non-recurring impact on data
revenues, which has been separately included as an offset to other revenues.
Data includes both long distance and local dedicated bandwidth sales. The
revenue growth for data services continued to be driven by significant
commercial end-user demand for high-speed data and by Internet-related growth on
both a local and long-haul basis. This growth was not only being fueled by
connectivity demands, but also by applications that have become more strategic,
far reaching and complex; additionally, bandwidth consumption has driven an
acceleration in growth for higher capacity circuits. As of September 30, 1999,
the Company had approximately 26.4 million domestic local voice grade
equivalents and approximately 37,000 buildings in the United States connected
over its high-capacity circuits. Domestic local route miles of connected fiber
exceed 8,000 and domestic long distance route miles exceed 47,000.
Internet revenues for the three and nine months ended September 30, 1999,
increased 57% and 59%, respectively, over the prior year pro forma amounts.
Growth was driven by both dial up and dedicated connectivity to the Internet as
more and more business customers have migrated their data networks and
applications to Internet-based technologies. The Company has increased its
global Internet network to capacities as high as OC-48 in response to the
increasing backbone transport requirements of both its commercial and wholesale
accounts. The Company's dial access network has grown over 80% to 1.4 million
modems, compared with the same period in the prior year. MCI's Internet
revenues for 1998 have been excluded from the above table, due to the
divestiture of the iMCI Business on September 14, 1998.
International revenues - those revenues originating outside of the United
States, excluding Embratel - for the third quarter of 1999 were $464 million, an
increase of 54% as compared with $302 million for the same pro forma period of
the prior year. For the nine month period ended September 30, 1999,
international revenues increased 55% to $1.2 billion versus $802 million for the
same period of the prior year. In July 1998, the Pan-European network was
commissioned for service and, along with the Gemini undersea cable, now provides
MCI WorldCom the capability to connect from end-to-end over 8,500 buildings in
Europe all over its own high-capacity circuits.
The Pan-European networks and newly constructed national networks in the U.K.,
France, Germany and Belgium drove higher growth of enhanced data sales
internationally. The resulting revenue mix shift is expected to contribute to
improved margins in spite of the competitive pricing environment.
Other revenues which, prior to April 1999, primarily consisted of the operations
of SHL, were $19 million, before being impacted by the frame relay service
credits of $29 million for the third quarter of 1999. For the nine month period
ended September 30, 1999, other revenues decreased 61% to $513 million versus
$1.3 billion for the same period of the prior year. In April 1999, the Company
completed the sale of SHL to EDS for $1.39 billion in cash. Additionally, in
October 1999, the Company and EDS finalized dual outsourcing agreements which
are expected to capitalize on the individual strengths of each company, as
discussed below under "Liquidity and Capital Resources."
The following discusses the actual results of operations for the three and nine
months ended September 30, 1999, as compared to the three and nine months ended
September 30, 1998.
24
Line costs. Line costs as a percentage of revenues for the third quarter of
1999 were 42.3% as compared to 47.7% reported for the same period of the prior
year. On a year-to-date basis, line costs as a percentage of revenues decreased
to 44.0% as compared to 47.8% reported for the same period of the prior year.
Overall decreases are attributable to changes in the product mix and synergies
and economies of scale resulting from network efficiencies achieved from the
assimilation of MCI, CompuServe Network Services and ANS into the Company's
operations. Additionally, access charge reductions that occurred in January
1999 and July 1999 reduced total line cost expense by approximately $93 million
for the third quarter of 1999 and $259 million for the nine months ended
September 30, 1999. While access charge reductions were primarily passed
through to customers, line costs as a percentage of revenues were positively
affected by over half a percentage point for both the third quarter of 1999 and
the nine month period ended September 30, 1999. The Company anticipates that
line costs as a percentage of revenues may continue to decline as a result of
synergies and economies of scale resulting from network efficiencies achieved
from the continued assimilation of the former MCI and WorldCom networks.
Additionally, local revenues have increased rapidly to date and line costs
related to local are primarily fixed in nature leading to lower line costs as a
percentage of revenues.
Selling, general and administrative. Selling, general and administrative
expenses for the third quarter of 1999 were $2.0 billion or 22.2% of revenues as
compared to $902 million or 24.0% of revenues for the third quarter of 1998. On
a year-to-date basis, these expenses increased to $6.5 billion or 24.1% of
revenues from $1.9 billion or 22.0% of revenues reported for the nine months
ended September 30, 1998. The increase in selling, general and administrative
expenses as a percentage of revenues for the nine months ended September 30,
1999, reflects the Company's expanding operations, primarily through the MCI
Merger. The Company expects to achieve additional selling, general and
administrative synergies in connection with the MCI Merger through the further
assimilation of MCI into the Company's strategy of cost control. However, as
revenues are impacted by the pass through of access charge reductions, selling,
general and administrative expenses as a percentage of revenues may increase.
Depreciation and amortization. Depreciation and amortization expense for the
third quarter of 1999 increased to $1.1 billion or 11.5% of revenues from $469
million or 12.5% of revenues for the comparable quarter of 1998. On a year-to-
date basis, this expense increased to $3.2 billion or 11.8% of revenues from
$1.1 billion or 12.7% of revenues for the comparable 1998 period. These
increases reflect increased amortization and depreciation associated with the
MCI Merger, CompuServe Merger and AOL Transaction as well as additional
depreciation related to capital expenditures. As a percentage of revenues,
these costs decreased due to the higher revenue base.
In-process research and development and other charges. In the first quarter of
1998, the Company recorded a pre-tax charge of $38 million for employee
severance, alignment charges, loss contingencies and direct merger costs
associated with the BFP Merger and $31 million for the write-down of a
permanently impaired asset. Additionally, in the third quarter of 1998, the
Company recorded a pre-tax charge of $127 million primarily in connection with
the MCI Merger. The third quarter 1998 charge included severance costs
associated with the termination of certain employees which was completed in the
first quarter of 1999. Also included are other exit activities which include
exit costs under long-term commitments and certain asset write-downs.
In connection with the CompuServe Merger and the AOL Transaction, the Company
made allocations of the purchase price to acquired IPR&D totaling $429 million
in the first quarter of 1998. The in-process technology acquired in the
CompuServe Merger and the AOL Transaction consisted of three main R&D efforts
underway at CompuServe Network Services and two main R&D efforts underway at
ANS. These projects included next generation network technologies and new
value-added networking applications, such as applications hosting, multimedia
technologies and virtual private data networks.
In connection with the MCI Merger, the Company made allocations of the purchase
price to acquired IPR&D totaling $3.1 billion in the third quarter of 1998. The
in-process technology acquired in the MCI Merger consisted of seventy
significant R&D projects grouped into six categories including R&D related to an
all-optical network, R&D related to data transmission service/other transmission
efforts, next generation tools, specific new customer care capabilities, R&D
related to local services and new products and services. These projects were
all targeted at: (1) developing and deploying an all-optical network, new
architecture of the telephone system using Internet protocol and developing the
systems and tools necessary to manage the voice and data traffic; (2) creating
new products and services; and (3) developing certain information systems that
may enhance the management of MCI WorldCom's products and service offerings.
25
Interest expense. Interest expense in the third quarter of 1999 was $214
million or 2.3% of revenues, as compared to $141 million or 3.8% of revenues
reported in the third quarter of 1998. For the nine months ended September 30,
1999, interest expense was $710 million or 2.6% of revenues as compared to $351
million or 4.1% of revenues for the first nine months of 1998. The increase in
interest expense is attributable to higher debt levels as a result of the MCI
Merger, higher capital expenditures and the 1998 fixed rate debt financings,
offset by lower interest rates as a result of certain tender offers for
outstanding debt in the first quarter of 1998 and slightly lower rates in effect
on the Company's variable rate debt. Interest expense was favorably impacted in
the three and nine month periods ended September 30, 1999 as a result of the SHL
sale proceeds, investment sales proceeds and proceeds from the increase in the
Company's receivables purchase agreement being utilized to repay indebtedness
under the Company's Credit Facilities and commercial paper program. For the
three months ended September 30, 1999, and 1998, weighted average annual
interest rates on the Company's long-term debt, including Embratel, were 7.09%
and 7.03% respectively, while weighted average annual levels of borrowings,
including Embratel, were $17.9 billion and $11.9 billion, respectively. For the
nine months ended September 30, 1999, and 1998, weighted average annual interest
rates on the Company's long-term debt, including Embratel, were 7.0% and 7.12%
respectively, while weighted average annual levels of borrowings, including
Embratel, were $19.2 billion and $9.7 billion, respectively.
Miscellaneous income and expense. Miscellaneous income for the third quarter
of 1999 was $28 million or 0.3% of revenues. For the nine months ended September
30, 1999, miscellaneous income was $44 million or 0.2% of revenues.
Miscellaneous income includes investment income, interest income, equity in
income and losses of affiliated companies, the effects of fluctuations in
exchange rates for transactions denominated in foreign currencies, gains and
losses on the sale of assets and other nonoperating items. Miscellaneous income
and expense for the nine months ended September 30, 1999, includes $208 million
of foreign currency translation losses related to the impact of the local
currency devaluation in Brazil and its effect on Embratel's holdings of U.S.
dollar and other foreign currency denominated debt. Also included was a $28
million charge related to the redemption of certain outstanding senior notes of
the Company. These amounts were offset by $155 million in gains on the sales of
equity investments, interest income of $95 million (including Embratel) and
preferred dividends on News Corporation Limited ("News Corp") preferred stock of
$32 million.
Extraordinary items. In the first quarter of 1998, the Company recorded an
extraordinary item totaling $129 million, net of income tax benefit of $78
million. The charge was recorded in connection with the tender offers and
certain related refinancings of the Company's outstanding debt from the BFP
Merger.
Net income (loss) applicable to common shareholders. For the quarter ended
September 30, 1999, the Company reported net income of $1.1 billion as compared
to a net loss of $2.9 billion reported in the third quarter of 1998. Diluted
income per common share was $0.56 compared to a loss per share of $2.44 for the
comparable 1998 period.
For the nine months ended September 30, 1999, the Company reported net income of
$2.7 billion as compared to a net loss of $3.1 billion before extraordinary
items reported for the comparable prior year period. Diluted income per common
share was $1.38 compared to loss per common share before extraordinary items of
$2.77 for the comparable 1998 period.
Liquidity and Capital Resources
As of September 30, 1999, the Company's total debt was $16.9 billion, a decrease
of $3.9 billion from December 31, 1998. Additionally, at September 30, 1999,
the Company had available liquidity of $9.3 billion under its Credit Facilities
and commercial paper program (which is described below) and from available cash.
On August 5, 1999, MCI WorldCom extended its existing $7 billion 364-Day
Revolving Credit and Term Loan Agreement for a successive 364-day term pursuant
to an Amended and Restated 364-Day Revolving Credit and Term Loan Agreement
("Facility C Loans"). The Facility C Loans together with the $3.75 billion
Amended and Restated Facility A Revolving Credit Agreement dated August 6, 1998
("Facility A Loans"), provide MCI WorldCom with aggregate credit facilities of
$10.75 billion (the "Credit Facilities"). The Credit Facilities provide
liquidity support for the Company's commercial paper program and are available
for other general corporate
26
purposes. The Facility A Loans mature on June 30, 2002. The Facility C Loans
have a 364-day term, which may be extended for a second successive 364-day term
thereafter to the extent of the committed amounts from those lenders consenting
thereto, with a requirement that lenders holding at least 51% of the committed
amounts consent. Additionally, effective as of the end of such 364-day term, the
Company may elect to convert up to $4 billion of the principal debt outstanding
under the Facility C Loans from revolving loans to term loans with a maturity
date no later than one year after the conversion. The Credit Facilities bear
interest payable in varying periods, depending on the interest period, not to
exceed six months, or with respect to any Eurodollar Rate borrowing, 12 months
if available to all lenders, at rates selected by the Company under the terms of
the Credit Facilities, including a Base Rate or Eurodollar Rate, plus the
applicable margin. The applicable margin for the Eurodollar Rate borrowing
varies from 0.35% to 0.75% as to Facility A Loans and from 0.225% to 0.45% as to
Facility C Loans, in each case based upon the better of certain debt ratings.
The Credit Facilities are unsecured but include a negative pledge of the assets
of the Company and its subsidiaries (subject to certain exceptions). The Credit
Facilities require compliance with a financial covenant based on the ratio of
total debt to total capitalization, calculated on a consolidated basis. The
Credit Facilities require compliance with certain operating covenants which
limit, among other things, the incurrence of additional indebtedness by the
Company and its subsidiaries, sales of assets and mergers and dissolutions, and
which covenants do not restrict distributions to shareholders, provided the
Company is not in default under the Credit Facilities. At September 30, 1999,
the Company was in compliance with these covenants. The Facility A Loans and the
Facility C Loans are subject to annual commitment fees not to exceed 0.25% and
0.15%, respectively, of any unborrowed portion of the facilities.
Additionally, in August 1999, the Company completed the private placement
offering of $1.0 billion principal amount of Floating Rate Notes due August
2000. Interest on the Floating Rate Notes is payable quarterly, equal to the
London Interbank Offered Rate for the three-month U.S. dollar deposits plus
0.18%. The net proceeds of the offering were used to pay down debt under the
Company's Credit Facilities and commercial paper program, and for general
corporate purposes.
In January 1999, the Company and one of its wholly owned subsidiaries redeemed
all of its outstanding 9.375% Senior Notes due January 15, 2004 (the "Senior
Notes"). Holders of the Senior Notes received 103.52% of the principal amount
plus accrued and unpaid interest to January 15, 1999, of $46.875 per $1,000
aggregate principal amount of such Senior Notes. The total redemption cost of
$743 million was obtained from available liquidity under the Company's Credit
Facilities and commercial paper program. The Company recorded a $28 million
charge related to the redemption.
In March 1999, $300 million and $200 million of MCI senior notes, with interest
rates of 6.25% and 6.37%, respectively, matured. The funds utilized to repay
the maturing MCI senior notes were obtained from available liquidity under the
Company's Credit Facilities and commercial paper program.
As noted below, the Brazilian real has experienced significant devaluation
against the U.S. dollar since MCI invested in Embratel in August 1998. The
Company previously designated the note payable in local currency installments,
resulting from the Embratel investment, as a hedge of its investment in
Embratel. As of September 30, 1999, the Company recorded the change in value of
the note as a reduction of the note payable with the offset through foreign
currency translation adjustment in shareholders' investment.
As of September 30, 1999, Embratel had $621 million of long-term debt
outstanding, of which approximately $517 million was denominated in U.S. dollars
and $104 million denominated in other currencies including the French Franc,
Deutsche Mark, Japanese Yen and Brazilian real. The effective cost to Embratel
of borrowing in foreign currencies, such as the U.S. dollar, depends principally
on the exchange rate between the Brazilian real and the currencies in which its
borrowings are denominated. As of September 30, 1999, the Brazilian real had
devalued over 37% against the U.S. dollar since December 31, 1998. As a result,
the Company recorded a $208 million foreign currency loss to miscellaneous
expense during the nine months ended September 30, 1999. After the elimination
of minority interests, this charge totaled approximately $40 million on a pretax
basis. If this devaluation is sustained, or worsens, Embratel would record a
similar charge to its future earnings equal to the increase in the U.S. dollar
liability resulting from such devaluation. The net effect to the Company's
operations
27
would be approximately 19% of such charge after elimination of minority
interests for the nine months ended September 30, 1999.
For the nine months ended September 30, 1999, the Company's cash flow from
operations increased $6.3 billion to $7.8 billion from the comparable period for
1998. The increase in cash flow from operations was primarily attributable to
the MCI Merger, internal growth and synergies and economies of scale resulting
from network efficiencies and selling, general and administrative cost savings
achieved from the assimilation of recent acquisitions into the Company's
operations.
During the third quarter, the Company replaced its existing $500 million
receivables purchase agreement with a new $2.0 billion purchase agreement to
include certain additional receivables and received additional proceeds of $1.2
billion. The Company used these proceeds to reduce the outstanding debt under
the Company's Credit Facilities and provide additional working capital. As of
September 30, 1999, the purchaser owned an undivided interest in a $3.4 billion
pool of receivables, which includes the $1.7 billion sold.
Cash used in investing activities for the nine months ended September 30, 1999,
totaled $5.8 billion. The sale of certain investments and the sale of SHL
provided $2.9 billion of proceeds that were used to partially cover capital
expenditures of $5.8 billion and acquisition and related costs of $769 million.
Primary capital expenditures include purchases of switching, transmission,
communications and other equipment. The Company anticipates that approximately
$1.7 billion to $2.2 billion will be spent during the remainder of 1999 for
transmission and communications equipment, construction and other capital
expenditures without regard to Embratel. These capital expenditures also
reflect the planned $1.4 billion increase for strategic initiatives resulting
from the redeployment of SHL sales proceeds. Acquisitions and related costs
includes the costs associated with the MCI Merger, CompuServe Merger, AOL
Transaction and smaller acquisitions completed during 1999.
Additionally, in October 1999, the Company and EDS finalized dual outsourcing
agreements that are expected to capitalize on the individual strengths of each
company. Under these agreements, MCI WorldCom will outsource portions of its
information technology (IT) operations to EDS. EDS will assume responsibility
for information technology system operations at more than a dozen MCI WorldCom
processing centers worldwide. The value of this IT outsourcing agreement is
approximately $6.4 billion. Approximately 1,300 MCI WorldCom employees will
transfer to EDS. EDS will outsource select functions of its global network
operations to MCI WorldCom including network operations, management and
engineering. The value of this network outsourcing agreement is approximately
$6 billion. Approximately 1,000 EDS employees will ultimately transfer to MCI
WorldCom.
In July 1999, the Company received $1.4 billion in cash from the sale of the
Company's interest in News Corp preferred stock. The proceeds were used to
repay existing indebtedness under the Company's Credit Facilities and commercial
paper program. This debt reduction is expected to reduce quarterly interest
expense by approximately $17 million. Additionally, miscellaneous income will
be reduced by $15 million per quarter due to preferred dividends which will no
longer be received.
In connection with the SkyTel Merger, the Company announced on November 8, 1999
SkyTel will redeem all of its outstanding 13-1/2 percent Senior Notes due
December 15, 2002 (the "SkyTel Notes",) and all of its outstanding 6.75 percent
Convertible Subordinated Debentures due May 15, 2002 (the "SkyTel Debentures").
MCI WorldCom has set December 15, 1999 as the redemption date for the SkyTel
Notes and the SkyTel Debentures.
The aggregate outstanding principal amount of the SkyTel Notes and SkyTel
Debentures is approximately $266 million. In connection with the redemptions,
MCI WorldCom will record a charge of approximately $35 million in the fourth
quarter of 1999. The funds required to pay all amounts required under the
redemptions will be obtained by MCI WorldCom from available liquidity under the
Company's Credit Facilities and commercial paper program.
Increases in interest rates on MCI WorldCom's variable rate debt would have an
adverse effect upon MCI WorldCom's reported net income and cash flow. The
Company believes that it will generate sufficient cash flow to service MCI
WorldCom's debt and capital requirements; however, economic downturns, increased
interest rates and other adverse developments, including factors beyond MCI
WorldCom's control, could impair its ability to
28
service its indebtedness. In addition, the cash flow required to service MCI
WorldCom's debt may reduce its ability to fund internal growth, additional
acquisitions and capital improvements.
The development of the businesses of MCI WorldCom and the installation and
expansion of its domestic and international networks will continue to require
significant capital expenditures. Failure to have access to sufficient funds
for capital expenditures on acceptable terms or the failure to achieve capital
expenditure synergies may require MCI WorldCom to delay or abandon some of its
plans, which could have a material adverse effect on the success of MCI
WorldCom. The Company has historically utilized a combination of cash flow from
operations and debt to finance capital expenditures and a mixture of cash flow,
debt and stock to finance acquisitions.
The Company believes that, if consummated, the Sprint Merger will create
substantial opportunities for cost savings and operating efficiencies. These
savings are anticipated to result primarily from economies of scale and
procurement efficiencies. There can, however, be no assurance that any specific
level of cost savings or other operating efficiencies will be achieved.
Additionally, the Company expects that, after the proposed Sprint Merger, the
MCI WorldCom PCS group will continue to build its network and expand its
customer base, causing it to continue to incur significant operating losses and
to generate significant negative cash flow from operating activities for the
next 12 to 24 months, which could adversely affect the results and financial
condition of the combined company as a whole. There can be no assurance that
the MCI WorldCom PCS group will achieve or sustain operating profitability or
positive cash flow from operating activities in the future.
Absent significant capital requirements for other acquisitions, the Company
believes that cash flow from operations and available liquidity, including the
Company's Credit Facilities and commercial paper program and available cash will
be sufficient to meet the Company's capital needs for the next twelve months.
However, the Company continues to diversify its funding sources, and under
existing credit conditions, believes that funding needs in excess of internally
generated cash flow and availability under the Company's Credit Facilities and
commercial paper program could be met by accessing debt markets.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. This statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires a company to formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting. This statement is currently effective for fiscal years beginning
after June 15, 2000 and cannot be applied retroactively although earlier
adoption is encouraged. SFAS No. 133 must be applied to (a) derivative
instruments and (b) certain derivative instruments embedded in hybrid contracts
that were issued, acquired, or substantively modified after December 31, 1997
(and, at the Company's election, before January 1, 1998). The Company believes
that the adoption of this standard will not have a material effect on the
Company's consolidated results of operations or financial position.
Year 2000 Readiness Disclosure
Due to extensive use of computer technology, both MCI and WorldCom began
developing strategic plans in 1996 to address their respective year 2000 issues.
Since the MCI Merger, the Company has consolidated these strategies into a
single program. The Company's year 2000 compliance plan is an ongoing program
in which remediation strategies are being implemented by the Company's business
organizations to address noncompliant computer and network systems and
technology. The Company has a central project management organization that has
overall responsibility for coordinating the implementation of this strategy.
The remediation strategies followed by the Company's business organizations
generally involve a sequence of steps that include (i) identifying computer
hardware, software and network components and equipment potentially
29
impacted by year 2000 problems; (ii) analyzing the date sensitivity of those
elements; (iii) developing plans for remediation where necessary; (iv)
converting non-compliant code or equipment (or, in some cases, replacing or
decommissioning systems); (v) testing; and (vi) deploying and monitoring
remediation solutions. These steps will vary to meet the particular needs of a
business organization and, in some cases, will overlap. Testing, for example,
may be performed at several stages of the remediation process.
The Company's systems and network equipment that support customer voice and data
traffic have been remediated, tested and deployed. Additionally, the
application components that comprise the Company's major revenue products and
services are year 2000 ready. This highlights the fact that the Company has met
its September 30, 1999, year 2000 compliance milestone, and the Company is now
focusing on the next phase of this effort. MCI WorldCom has also recently
achieved several successful interoperability tests with both domestic and
international carriers.
In the remainder of 1999, the Company will be primarily focused on continued
integration and interoperability testing, testing of contingency plans,
independent verification and validation of the work already completed and change
management to achieve ongoing compliance. Finally, the Company plans to
complete decommissioning projects, customer specific migrations/upgrades and
selected internal and international systems.
As part of its year 2000 plan, the Company has sought confirmation from its
domestic and foreign interconnecting carriers (collectively, the
"Interconnecting Carriers") and major communications equipment vendors (the
"Primary Vendors") that they are developing and implementing plans to become
year 2000 compliant. The Company has contacted these carriers and vendors, and
will continue to do so, but has not yet received enough information from certain
domestic and foreign carriers to assess their year 2000 readiness. The Company
has received information from its Primary Vendors regarding their year 2000
readiness. This information indicates the Primary Vendors have documented plans
to become year 2000 compliant. Like all major telecommunication carriers, the
Company's ability to provide service is dependent on its Interconnecting
Carriers and Primary Vendors.
The Company is participating in industry efforts to test interoperability of
networks for industry segments as well as multiple carriers. The ATIS and
Network Reliability and Interoperability Council ("NRIC") testing are examples
of this effort to assess the readiness of Interconnecting Carriers for both data
and voice services.
The Company has completed contingency plans to address potential year 2000
related business interruptions that may occur on January 1, 2000 or thereafter.
Additional detailed documentation was completed before the end of the second
quarter 1999 and testing of the communications portions of those plans began in
the third quarter 1999. The Company anticipates that these contingency plans
will primarily address potential year 2000 problems due to unanticipated
failures in systems or equipment, or potential failure of the Company's
Interconnecting Carriers' and Primary Vendors' year 2000 compliance efforts.
The Company has incorporated many of the recommendations of the NRIC into the
contingency planning process. The Company plans to complete testing and
implementation of its contingency plans by December 31, 1999. Failure to meet
this target could materially impact the Company's operations.
To achieve its year 2000 compliance plan, the Company is utilizing both internal
and external resources to identify, correct or reprogram, and test its systems
for year 2000 compliance. The Company expects to incur internal labor as well
as consulting and other expenses related to infrastructure and facilities
enhancements necessary to prepare its systems for the year 2000. The Company's
use of internal resources to achieve its year 2000 compliance plan has not had a
material adverse effect on its ability to develop new products and services or
to maintain and upgrade, if necessary, its existing products and services.
The year 2000 costs incurred by MCI and WorldCom through September 30, 1999 were
approximately $507 million. This level of expenditures is consistent with the
planned expenditures for the related periods. The Company expects to incur
approximately $82 million in costs during the remainder of 1999 to support its
year 2000 compliance initiatives. The costs of the Company's year 2000
remediation efforts are based upon management's best estimates, which require
assumptions about future events, availability of resources and personnel, third-
party remediation actions, and other factors. There are no assurances that
these estimates will be accurate, and actual
30
amounts may differ materially based on a number of factors, including the
availability and cost of resources to undertake remediation activities and the
scope and nature of the work required to complete remediation.
The Company is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition due to the general uncertainty
inherent in the year 2000 problem, resulting in part from the uncertainty of the
year 2000 readiness of its Interconnecting Carriers and Primary Vendors, and
other suppliers, as well as uncertainties related to the Company's ongoing
remediation program. The Company's year 2000 compliance plan is expected to
reduce significantly the Company's level of uncertainty about the year 2000
problem and, in particular, about the year 2000 compliance and readiness of its
Interconnecting Carriers and Primary Vendors. The Company believes that, with
the implementation of new business systems, its Interconnecting Carriers and
Primary Vendors year 2000 readiness, and completion of the year 2000 compliance
plan as scheduled, it will maintain normal operations.
Embratel's year 2000 program began in 1997 and is managed separately from the
other MCI WorldCom year 2000 programs. The Embratel year 2000 program is
intended to address all its systems, infrastructure, networks and applications.
The critical corporate projects are now complete. The remaining systems and
equipment are scheduled to be remediated, tested and deployed by the end of
November 1999. The process is now beginning to focus on independent
verification and validation of work already done and contingency planning and
testing.
Embratel has spent approximately R$10.5 million of an estimated R$11.0 million
on the year 2000 program and expects to come within the estimated costs.
Embratel may, however, be affected by year 2000 problems to the extent that
other entities are unsuccessful in achieving compliance. Despite preventive
measures taken by Embratel, no assurances can be given that the year 2000 issue
will not have an effect on the financial condition and results of operations of
Embratel. Embratel is actively testing contingency plans and has scheduled
interoperability testing with other International Telecommunication Union member
companies for the fourth quarter 1999.
Statements concerning year 2000 issues which contain more than historical
information may be considered forward-looking statements (as that term is
defined in the Private Securities Litigation Reform Act of 1995), which are
subject to risks and uncertainties. Actual results may differ materially from
those expressed in the forward-looking statements, and readers are cautioned
that the Company's year 2000 discussion should be read in conjunction with the
Company's statement on forward-looking statements which appears at the beginning
of this Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Euro Conversion
On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies ("legacy currencies")
and the European Union's common currency ("Euro"). On January 4, 1999, the Euro
began trading on currency exchanges and became available for non-cash
transactions. The legacy currencies will remain legal tender through December
31, 2001. Beginning January 1, 2002, Euro-denominated bills and coins will be
introduced and by July 1, 2002, legacy currencies will no longer be legal
tender. All of the final rules and regulations have not yet been identified by
the European Commission with regard to the Euro. The Company is currently
evaluating methods to address the many issues involved with the introduction of
the Euro, including the conversion of information technology systems,
recalculating currency risk, recalibrating derivatives and other financial
instruments, strategies concerning continuity of contracts, and impacts on the
processes for preparing taxation and accounting records. At this time, the
Company has not yet determined the cost related to addressing this issue and
there can be no assurance as to the effect of the Euro on the consolidated
financial statements.
31
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of interest rate changes, foreign currency
fluctuations and changes in market values of investments.
The Company's policy is to manage interest rates through the use of a
combination of fixed and variable rate debt. Currently, the Company does not use
derivative financial instruments to manage its interest rate risk. The Company
has minimal cash flow exposure due to general interest rate changes for its
fixed rate, long-term debt obligations. The Company does not believe a
hypothetical 10% adverse rate change in the Company's variable rate debt
obligations would be material to the Company's results of operations.
The Company is exposed to foreign exchange rate risk primarily due to Embratel's
holding of approximately $517 million in U.S. dollar denominated debt, and
approximately $104 million of indebtedness indexed in other currencies including
the French Franc, Deutsche Mark, Japanese Yen and Brazilian real. The potential
immediate loss to the Company that would result from a hypothetical 10% change
in foreign currency exchange rates based on this position would be approximately
$12 million (after elimination of minority interests). During January 1999, the
Brazilian government allowed its currency to trade freely against other
currencies, resulting in an immediate devaluation of the Brazilian real. As of
September 30, 1999, the Brazilian real had devalued over 37% against the U.S.
dollar since December 31, 1998. As a result, the Company recorded a $208
million foreign currency loss to miscellaneous expense during the nine months
ended September 30, 1999. After the elimination of minority interests, this
charge totaled approximately $40 million on a pretax basis. If this devaluation
is sustained, or worsens, the future net impact to the Company's results of
operations could be significant.
The Company is also subject to risk from changes in foreign exchange rates for
its other international operations which use a foreign currency as their
functional currency and are translated into U.S. dollars. Additionally, the
Company has designated the note payable in local currency installments,
resulting from the Embratel investment, as a hedge of its investment in
Embratel. As of September 30, 1999, the Company recorded the change in value of
the note as a reduction to the note payable with the offset through foreign
currency translation adjustment in shareholders' investment.
The Company believes its market risk exposure with regard to its marketable
equity securities is limited to changes in quoted market prices for such
securities. Based upon the composition of the Company's marketable equity
securities at September 30, 1999, the Company does not believe a hypothetical
10% adverse change in quoted market prices would be material to net income.
32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material changes in the legal proceedings reported
in the Company's Annual Report on Form 10-K for the year ended December
31, 1998, except as may be reflected in the discussion under Note H of
the Notes to Consolidated Financial Statements in Part I, Item 1,
above, which is hereby incorporated by reference herein.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Securities Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
See Exhibit Index.
B. Reports on Form 8-K
(i) Current report on Form 8-K dated July 12, 1999 (filed July
12, 1999), reporting under Item 7(b), Pro Forma Financial
Information, the following:
MCI WORLDCOM, Inc. - For the year ended December 31, 1998
Pro Forma Condensed Combined Statement of Operations for
the year ended December 31, 1998
Notes to Pro Forma Condensed Combined Financial Statement
33
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by Scott D. Sullivan, thereunto duly authorized to sign on behalf of the
registrant and as the principal financial officer thereof.
MCI WORLDCOM, Inc.
By:/s/ Scott D. Sullivan
---------------------------------
Scott D. Sullivan
Chief Financial Officer
Dated: November 15, 1999.
34
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
2.1 Agreement and Plan of Merger dated October 4, 1999, between MCI
WORLDCOM, Inc. and Sprint Corporation (incorporated herein by
reference to Exhibit 2.1 to the Company's Current Report on Form
8-K dated October 4, 1999 (filed October 6, 1999) (File No.
0-11258))*
2.2 Agreement and Plan of Merger by and among MCI WORLDCOM, Inc.,
Empire Merger Inc. and SkyTel Communications, Inc. dated as of
May 28, 1999 (filed as Annex A to the Proxy Statement/Prospectus
dated August 26, 1999 included in MCI WorldCom's Registration
Statement on Form S-4, Registration No. 333-85919 and
incorporated herein by reference)*
4.1 Second Amended and Restated Articles of Incorporation of MCI
WORLDCOM, Inc. (including preferred stock designations), as
amended as of October 1, 1999 (incorporated herein by reference
to Exhibit 4.1 to the Company's Post-Effective Amendment No. 1 on
Form S-8 to Registration Statement on S-4 (filed October 1, 1999)
(Registration No. 333-85919))
4.2 Restated Bylaws of MCI WORLDCOM, Inc. (incorporated herein by
reference to Exhibit 3.2 to the Company's Current Report on Form
8-K dated September 14, 1998 (filed September 29, 1998) (File No.
0-11258))
4.3 Rights Agreement dated as of August 25, 1996, between the Company
and The Bank of New York, which includes the form of Certificate
of Designations, setting forth the terms of the Series 3 Junior
Participating Preferred Stock, par value $.01 per share, as
Exhibit A, the form of Rights Certificate as Exhibit B and the
Summary of Preferred Stock Purchase Rights as Exhibit C
(incorporated herein by reference to Exhibit 4 to the Current
Report on Form 8-K dated August 26, 1996 (as amended on Form
8-K/A filed August 31, 1996) filed by the Company with the
Securities and Exchange Commission on August 26, 1996 (as amended
on Form 8-K/A filed on August 31, 1996) (File No. 0-11258))
4.4 Amendment No. 1 to Rights Agreement dated as of May 22, 1997, by
and between MCI WORLDCOM, Inc. and The Bank of New York, as
Rights Agent (incorporated herein by reference to Exhibit 4.2 of
the Company's Current Report on Form 8-K dated May 22, 1997
(filed June 5, 1997) (File No. 0-11258))
10.1 Amended and Restated 364-Day Revolving Credit and Term Loan
Agreement among the Company and Bank of America, N.A.,
Administrative Agent; Bank of America Securities, LLC, Sole Lead
Arranger and Book Manager; Barclays Bank PLC, The Chase Manhattan
Bank, Citibank, N.A., Morgan Guaranty Trust Company of New York,
and Royal Bank of Canada, Co-Syndication Agents; and the lenders
named therein dated as of August 5, 1999 (incorporated herein by
reference to Exhibit 10.1 of the Company's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 1999) (File No.
0-11258))*
10.2 MCI WORLDCOM, Inc. 1999 Stock Option Plan (incorporated herein by
reference to Exhibit A to the Company's Proxy Statement dated
April 23, 1999 (File No. 0-11258)) (compensatory plan)
**
27.1 Financial Data Schedule
* The registrant hereby agrees to furnish supplementally a copy of any
omitted schedules to this Agreement to the Commission upon request.
** No other long-term debt securities entered into during the period covered
by this report, are filed since the total amount of securities authorized
under any such instrument does not exceed 10% of the total assets of the
Company and its subsidiaries on a consolidated basis. The Company agrees
to furnish a copy of such instruments to the Commission upon request.
35