1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/x/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1996
------------------
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 0-21602
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LCI INTERNATIONAL, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3498232
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8180 Greensboro Drive, Suite 800
McLean, Virginia 22102
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(703) 442-0220
----------------------------------------------------
(Registrant's telephone number, including area code)
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
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
---------- ---------
As of October 31, 1996, there were 77,250,249 shares of LCI International, Inc.
Common Stock (par value $.01 per share) outstanding.
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LCI INTERNATIONAL, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Operations--
For the Three and Nine Months Ended September 30, 1996 and 1995 3
Unaudited Condensed Consolidated Balance Sheets--
As of September 30, 1996 and December 31, 1995 4 - 5
Unaudited Condensed Consolidated Statement of Shareowners, Equity--
For the Nine Months Ended September 30, 1996 6
Unaudited Condensed Consolidated Statements of Cash Flows--
For the Nine Months Ended September 30, 1996 and 1995 7
Notes to Interim Unaudited Condensed Consolidated Financial Statements 8 - 17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 18 - 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURE 31
EXHIBIT INDEX
32
EXHIBITS
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ITEM 1. FINANCIAL STATEMENTS
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except for per share amounts)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------- ------------------------
1996 1995 1996 1995
-------- --------- --------- ---------
REVENUES $289,195 $172,992 $809,173 $469,207
Cost of services 166,575 101,203 472,828 276,852
-------- --------- -------- --------
GROSS MARGIN 122,620 71,789 336,345 192,355
Selling, general and administrative expenses 67,665 38,939 185,887 104,065
Depreciation and amortization 16,345 11,195 46,002 31,144
-------- --------- -------- --------
OPERATING INCOME 38,610 21,655 104,456 57,146
Interest and other expense, net 7,746 4,451 22,908 11,578
-------- --------- -------- --------
INCOME BEFORE INCOME TAXES 30,864 17,204 81,548 45,568
Income tax expense 10,802 4,129 28,542 10,936
-------- --------- -------- --------
NET INCOME 20,062 13,075 53,006 34,632
Preferred dividends 513 1,437 2,808 4,311
-------- --------- -------- --------
INCOME ON COMMON STOCK $ 19,549 $ 11,638 $ 50,198 $ 30,321
======== ========= ======== ========
PER SHARE DATA
--------------
Income Per Share $ 0.23 $ 0.16 $ 0.61 $ 0.43
======== ========= ======== ========
Weighted Average Number of Common Shares 87,685 82,360 87,472 81,254
======== ========= ======== ========
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
ASSETS 1996 1995
------ ----------- ------------
(unaudited)
CURRENT ASSETS:
Trade accounts receivable, net $ 88,853 $ 161,640
Current deferred tax assets, net 22,206 23,121
Prepaids and other 7,800 10,120
Other accounts and notes receivable, net 9,685 9,451
--------- -------------
Total current assets 128,544 204,332
--------- -------------
PROPERTY, PLANT AND EQUIPMENT:
Fiber optic network 394,532 357,294
General office equipment and building lease 124,316 90,806
Less - Accumulated depreciation and amortization (196,927) (181,487)
--------- -------------
321,921 266,613
Plant under construction 57,687 35,334
--------- -------------
Total property, plant and equipment, net 379,608 301,947
--------- -------------
OTHER ASSETS:
Excess of cost over net assets acquired, net 344,667 245,600
Other, net 45,115 21,480
--------- -------------
Total other assets 389,782 267,080
--------- -------------
Total Assets $ 897,934 $ 773,359
========= =============
(Continued on next page)
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(in thousands)
September 30, December 31,
LIABILITIES AND SHAREOWNERS' EQUITY 1996 1995
----------------------------------- ------------ ------------
(unaudited)
CURRENT LIABILITIES:
Accounts payable $ 13,407 $ 39,168
Facility costs accrued and payable 117,645 66,688
Accrued expenses and other 58,742 21,997
------------ ------------
Total current liabilities 189,794 127,853
------------ ------------
LONG-TERM DEBT 257,000 260,700
------------ ------------
CAPITAL LEASE OBLIGATIONS 13,221 14,160
------------ ------------
OTHER LIABILITIES AND DEFERRED CREDITS 33,330 25,868
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREOWNERS' EQUITY:
Preferred stock - Authorized 15,000 shares, Issued and
Outstanding 4,578.1 shares at December 31, 1995 -- 114,453
Common stock - Authorized 300,000 shares,
Issued and Outstanding 77,167 shares at September 30, 1996
and Authorized 100,000 shares,
Issued and Outstanding 64,434 shares at December 31, 1995 772 644
Paid-in capital 422,867 298,929
Retained deficit (19,050) (69,248)
------------ ------------
Total shareowners' equity 404,589 344,778
------------ ------------
Total Liabilities and Shareowners' Equity $ 897,934 $ 773,359
============ ============
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(Unaudited)
(in thousands)
Preferred Common Paid- Retained
Stock Stock In Capital Deficit Total
--------- --------- ------------ ---------- --------
BALANCE AT DECEMBER 31, 1995 $ 114,453 $ 644 $298,929 $(69,248) $344,778
Employee stock purchases -- 3 4,445 -- 4,448
Exercise of options/warrants
and related tax benefits -- 5 5,160 -- 5,165
Conversion/redemption of preferred stock (114,453) 120 114,333 -- --
Net Income -- -- -- 53,006 53,006
Preferred dividends -- -- -- (2,808) (2,808)
---------- -------- -------- -------- --------
BALANCE AT SEPTEMBER 30, 1996 $ -- $ 772 $422,867 $(19,050) $404,589
========== ======== ======== ======== ========
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
For the Nine Months
Ended September 30,
------------------------------
1996 1995
--------- ---------
OPERATING ACTIVITIES:
Net cash provided by operating activities $ 238,900 $ 19,354
--------- ---------
INVESTING ACTIVITIES:
Capital expenditures (105,834) (54,068)
Payments for acquisitions and other (118,142) (78,383)
--------- ---------
Net cash used in investing activities (223,976) (132,451)
--------- ---------
FINANCING ACTIVITIES:
Net debt (payments) borrowings (18,695) 114,665
Preferred dividend payments (2,808) (4,311)
Proceeds from employee stock plans and warrants 6,579 2,743
--------- ---------
Net cash (used in) provided by financing activities (14,924) 113,097
--------- ---------
Net increase in cash and cash equivalents -- --
--------- ---------
CASH AND CASH EQUIVALENTS AT THE
BEGINNING OF THE PERIOD -- --
--------- ---------
CASH AND CASH EQUIVALENTS AT THE
END OF THE PERIOD $ -- $ --
========= =========
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Unaudited)
(1) GENERAL
The results of operations for the interim periods shown are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all
adjustments necessary to make the results of operations for the interim periods
a fair presentation for the three and nine months ended September 30, 1996 and
1995. All such adjustments are of a normal recurring nature.
(2) BUSINESS ORGANIZATION AND PURPOSE
The financial statements presented herein include the condensed
consolidated statements of operations of LCI International, Inc., a Delaware
corporation, and its subsidiaries (collectively LCI or the Company), for the
three and nine month periods ended September 30, 1996 and 1995, the condensed
consolidated balance sheets as of September 30, 1996 and December 31, 1995, the
condensed consolidated statement of shareowners' equity for the nine months
ended September 30, 1996, and the condensed consolidated statement of cash
flows for the nine month periods ended September 30, 1996 and 1995.
LCI is a facilities-based telecommunications carrier that provides a
broad range of domestic and international telecommunications service offerings
in all market segments: commercial, wholesale and residential/small business.
The Company serves its customers primarily through owned and leased digital
fiber optic facilities.
(3) ACCOUNTING POLICIES
Note 2 of the Notes to Consolidated Financial Statements in LCI's 1995
Annual Report summarizes the Company's significant accounting policies.
PRINCIPLES OF CONSOLIDATION. The accompanying Condensed Consolidated
Financial Statements (Unaudited) include the accounts of LCI and its
wholly-owned, direct and indirect, subsidiaries. All material intercompany
transactions and balances have been eliminated.
WEIGHTED AVERAGE NUMBER OF COMMON SHARES. The weighted average number
of common shares used to calculate earnings per share includes the Company's
Common Stock, par value $.01 per share (the Common Stock), and Common Stock
equivalents, and the assumed conversion of the previously outstanding 5%
Cumulative Convertible Exchangeable Preferred Stock, par value $.01 per share
(Preferred Stock) into shares of Common Stock. For all periods presented the
weighted average number of common shares includes the actual common shares
issued for Preferred Stock conversions and the assumed conversion of any
remaining Preferred Stock outstanding. The treasury stock method was used to
reflect the impact of outstanding stock options and Common Stock warrants for
all periods presented.
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INCOME PER SHARE. For the three and nine months ended September 30,
1996 and 1995, the income per share is calculated as net income before
preferred dividends divided by the weighted average number of common shares, as
defined above. Primary and fully diluted income per share for the three and
nine months ended September 30, 1996 and 1995, were the same amounts.
RECLASSIFICATIONS. Certain reclassifications have been made to the
consolidated financial statements for 1995 to conform with the 1996
presentation.
(4) ACQUISITIONS
In June 1996, the Company purchased the long-distance business of
Pennsylvania Alternative Communications, Inc. (PACE). The Company acquired the
Greensburg, Pennsylvania- based company for approximately $8 million in cash,
with an additional maximum payment of approximately $5 million contingent on
achieving certain revenue performance over a seven-month period commencing at
the closing date. The acquisition was accounted for as a purchase and was not
considered significant for financial reporting purposes. The results of
operations for PACE were included in the consolidated statement of operations
from June 1, 1996.
In January 1996, the Company purchased the long-distance businesses of
Teledial America, Inc. (Teledial America), which did business as U.S. Signal
Corporation, and an affiliated company, ATS Network Communications, Inc. (ATS).
Headquartered in Grand Rapids, Michigan, Teledial America provided
long-distance services to commercial customers located primarily in Michigan
and throughout the Midwest. ATS was a regional long-distance carrier that
operated primarily in Tennessee, Mississippi and Arkansas. The Company
acquired both companies for approximately $99 million in cash, with an
additional maximum payment of $24 million contingent on achieving certain
revenue performance and customer retention over an eighteen-month period
commencing at the closing date. The acquisitions were accounted for as
purchases.
In September 1995, the Company acquired Corporate Telemanagement
Group, Inc. (CTG), a Greenville, South Carolina-based provider of long-distance
services to commercial customers throughout the U.S. The Company acquired all
of the outstanding shares of CTG and shares underlying certain outstanding
warrants in exchange for $45 million in cash and 4.6 million shares of Common
Stock. The shares of Common Stock issued were valued at approximately $93.2
million based on the market price of the shares on the date of the acquisition.
The acquisition was accounted for as a purchase.
The following unaudited pro forma summary presents the net revenues,
net income and earnings per share from the combination of the operations of the
Company and its two significant acquisitions, CTG and Teledial America, as if
the acquisitions had occurred at the beginning of the 1995 fiscal year. Pro
forma information is not provided for 1996, as both acquisitions were included
in the results of operations from January 1, 1996. The pro forma information is
provided for informational purposes only.
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The information is not intended to reflect the actual results that would have
occurred nor is it necessarily indicative of the future results for operations
of the combined enterprise:
Three Months Ended Nine Months Ended
(in thousands, except per share amounts) September 30, 1995 September 30, 1995
------------------ ------------------
Net revenues $210,526 $590,614
Net income 14,089 37,672
Earnings per share $0.17 $0.44
(5) ACCOUNTS RECEIVABLE SECURITIZATION
On August 29, 1996, the Company entered into an agreement to sell a
percentage ownership interest in a defined pool of the Company's trade accounts
receivable (Securitization Program). LCI SPC I, Inc., was established as a
wholly-owned, bankruptcy-remote subsidiary of the Company to faciliate the sale
of receivables. Under this Securitization Program, the Company can transfer an
undivided interest in a designated pool of its accounts receivable on an
ongoing basis to maintain the participation interest up to a maximum of $150
million. At September 30, 1996, the pool of trade accounts receivable which
were available for sale totaled approximately $114.9 million. The amount of
receivables sold totaled $108.0 million and the proceeds were used to reduce
the outstanding balance of the Company's long-term debt. The accounts
receivable balances sold are not included in the accompanying condensed
consolidated balance sheet at September 30, 1996. The Company retains
substantially the same risk of credit loss as if the receivables had not been
sold, and has established reserves for such estimated credit losses.
The cost of the Securitization Program is based on a short-term
commercial paper rate plus certain fees and expenses. The costs of the
Securitization Program, which were incurred at the end of the third quarter,
are included in interest and other expense in the accompanying condensed
consolidated statement of operations. The cash proceeds are included in
operating activities, while the use of the proceeds to pay down long-term debt
is included in financing activities in the accompanying condensed consolidated
statement of cash flows.
Under the agreement relating to the Securitization Program, the
Company acts as agent for the purchaser of the receivables by performing
recordkeeping and collection functions on the participation interest sold. The
agreement contains certain covenants regarding the quality of the accounts
receivable portfolio, as well as financial covenants which are substantially
identical to those contained in the Company's Credit Facility (See Note 6).
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(6) LONG-TERM DEBT
The Company can borrow up to $700 million from a syndicate of banks
under a Revolving Credit Facility (Credit Facility). The Credit Facility is
subject to various principal reductions depending on the outstanding balance,
until maturity on March 31, 2001. This Credit Facility bears interest at a rate
consisting of two components: the base rate component is dependent upon a
market indicator; the second component varies from 0.625% to 1.5% based on the
level of borrowings (leverage ratio). The weighted average interest rate on the
outstanding borrowings under the Credit Facility on September 30, 1996 was
6.54%. The Credit Facility contains various financial covenants, the most
restrictive being the leverage ratio requirement. As of September 30, 1996, the
Company was in compliance with all Credit Facility covenants and had $252
million outstanding under the Credit Facility. An additional $10 million of the
Credit Facility was reserved for letters of credit as of September 30, 1996.
In September 1996, the Company obtained a $25 million Discretionary
Line of Credit. As of September 30, 1996, $5 million was outstanding under the
Discretionary Line of Credit.
The Company has an interest rate cap agreement with a syndicate of
banks that limits the Company's base interest rate exposure to 7.5%. The
agreement is for a two-year period ending February 1998 on a $130 million
notional principal balance of the Credit Facility. In an event of
non-performance by the commercial banks, the Company would have exposure to the
extent of any increase in the base rate component above 7.5%. The Company
believes the probability of such an event is remote.
(7) COMMITMENTS AND CONTINGENCIES
VENDOR AGREEMENTS. The Company has agreements with certain
telecommunications interexchange carriers and third party vendors that require
the Company to maintain minimum monthly and/or annual billings based on usage.
The Company has a single five-year contract with a particular third party
carrier which began in August 1995, with minimum annual usage requirements and
an increasing cumulative minimum usage requirement, which, if not met subject
the Company to an underutilization charge. Through September 30, 1996, the
Company has exceeded the first year minimum annual usage requirement of $48
million and the cumulative minimum usage of $103 million established for the
second year. The Company's minimum monthly billing commitments under all other
vendor agreements are approximately $6 million through the end of 1996. The
Company has historically met all minimum billing requirements and believes that
the minimum usage commitments will be met.
LEGAL MATTERS. Thomas J. Byrnes and Richard C. Otto v. LCI
Communications Holdings Co. et al. was filed by two former members of the
Company's management on June 28, 1991 in Common Pleas Court, Franklin County,
Ohio. The suit alleged age discrimination by the Company among other things,
and sought $42.8 million in compensatory and punitive damages. During 1993, a
jury returned a verdict in favor of the Plaintiffs and the Common Pleas Court
awarded approximately $8.1 million in damages and attorney's fees.
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Both the Plaintiffs and the Company appealed this matter to the Court
of Appeals in Ohio, which in a two-to-one decision overruled each of the
Company's assignments of error and two of the Plaintiffs' claims, and sustained
the Plaintiffs' request for approximately $0.1 million in pre- judgment
interest in addition to the previous award. The Company filed a Notice of
Appeal at the Supreme Court of Ohio (the Court) and the Court agreed to review
the decision by the Court of Appeals. Oral arguments took place in May 1996.
To date the Court has not rendered an opinion on the matter, although the
Company expects an opinion to be rendered during the fourth quarter of 1996.
The appeal process has extended the resolution of this matter for several years
and, depending on the disposition and timing of the ultimate outcome, it is
reasonably possible that between $0 and $3 million of additional interest
expense could be incurred.
The Company also has been named as a defendant in various other
litigation matters. Management intends to vigorously defend these outstanding
claims. The Company believes it has adequate accrued loss contingencies and,
although the ultimate outcome of these claims cannot be ascertained at this
time, that current pending or threatened litigation matters will not have a
material adverse impact on the Company's results of operations or financial
position.
(8) SHAREOWNERS' EQUITY
COMMON STOCK. The Company has stock option plans under which options
to purchase shares of Common Stock may be granted to directors and key
employees. During the nine months ended September 30, 1996, the Company granted
options to purchase 2,249,500 shares of Common Stock. The option price for all
options granted was the fair market value of the shares on the date of grant.
The Company issued 390,492 shares of Common Stock during the nine months ended
September 30, 1996 pursuant to exercises of options under all stock option
plans. The Company also has an Employee Stock Purchase Plan and maintains a
defined contribution plan for its employees. The Company issued 187,692 shares
of Common Stock under its Employee Stock Purchase Plan and 46,742 shares of
Common Stock under the defined contribution plan for the nine months ended
September 30, 1996.
PREFERRED STOCK. The Company's previously outstanding Preferred Stock
was convertible into shares of Common Stock at the option of the holder.
Shareholders converted 4,577,995 shares of Preferred Stock into 12,047,030
shares of Common Stock during the nine months ended September 30, 1996. On
September 3, 1996 the remaining outstanding shares of Preferred Stock were
redeemed by the Company. Neither the conversion nor the redemption of the
Preferred Stock had an impact on earnings per share as the assumed conversion
of the Preferred Stock was reflected in the weighted average number of common
shares calculation for all periods.
COMMON STOCK WARRANTS. In 1993, the Company issued warrants
exercisable for 5,408,900 shares of Common Stock at $2.83 per share that expire
in 2003. During the nine months ended September 30, 1996, warrant owners
exercised 69,968 warrants for an aggregate net 61,923 shares of Common Stock.
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(9) INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 1996 and 1995, consisted of :
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
(in thousands) 1996 1995 1996 1995
-------- ------ -------- -------
Current tax expense:
Federal $ 1,718 $ 307 $ 2,623 $ 873
State 1,270 272 1,677 1,020
-------- ------ -------- -------
Total current tax expense 2,988 579 4,300 1,893
-------- ------ -------- -------
Deferred tax expense:
(Decrease) increase in deferred tax liabilities (668) (1,812) 736 738
Decrease in deferred tax asset 10,957 8,260 28,549 16,305
Decrease in valuation allowance, net (2,475) (2,898) (5,043) (8,000)
-------- ------ -------- -------
Total deferred tax expense 7,814 3,550 24,242 9,043
-------- ------ -------- -------
Total income tax expense $ 10,802 $4,129 $ 28,542 $10,936
======== ====== ======== =======
The decrease in the valuation allowance for the three and nine months
ended September 30, 1996 and 1995 resulted from the Company's expected
realization of a portion of its net operating loss (NOL) carryforwards in future
years based on the Company's growth in recurring operating income in 1996 and
1995, and its expectation of future taxable income, net of a minor increase
relating to expected state tax credits.
The effective income tax rate varies from the Federal statutory income
tax rate for the three and nine months ended September 30, 1996 and 1995, as
follows:
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1996 1995 1996 1995
------- ------ ----- ------
Expected tax at Federal
statutory income tax rate: 35.0% 35.0% 35.0% 35.0%
Effect of:
State income tax expense 5.2 3.9 5.2 3.9
Non-deductible expenses 1.5 1.5 1.5 1.2
Decrease in valuation allowance, net (5.0) (16.9) (5.0) (17.6)
Other, net (1.7) 0.5 (1.7) 1.5
----- ----- ----- -----
35.0% 24.0% 35.0% 24.0%
===== ===== ===== =====
The effective tax rate of 35% for the three and nine months ended
September 30, 1996 and 24% for the same periods in 1995 represents the
Company's estimated effective tax rate for the periods. This effective tax
rate is adjusted quarterly based on the Company's estimate of future taxable
income, use of NOLs and the related impact on the valuation allowance. The tax
rate reconciliation for the three and nine months ended September 30, 1996,
reflects the expected
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financial reporting use of $6.1 million and $14.2 million, respectively, of
NOLs which resulted in a $2.4 million and $5.7 million reduction of income tax
expense, respectively. As of September 30, 1996, the Company had available
$6.8 million of NOLs for financial reporting purposes.
The Company has generated significant NOLs that may be used to offset
future taxable income. Each year's NOL has a maximum 15-year carryforward
period. The Company's ability to fully use its NOL carryforwards is dependent
upon future taxable income. As of September 30, 1996, the Company had total NOL
carryforwards for income tax purposes of $119 million, subject to various
expiration dates beginning in 1998 and ending in 2010.
The Company's deferred income tax balances include $22.2 million in
current deferred tax assets and $10.7 million in other noncurrent liabilities
as of September 30, 1996. As of December 31, 1995, deferred income tax
balances included $23.1 million in current deferred tax assets, net and $8.8
million in noncurrent other assets.
The Company has a valuation allowance remaining of $3.4 million as of
September 30, 1996 and $8.4 million as of December 31, 1995.
(10) SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The Company has filed a shelf registration statement with the
Securities and Exchange Commission to register $300 million of debt and/or
equity securities, for issuance on a delayed or continuous basis. Any debt
securities issued may be guaranteed by certain of the Company's wholly-owned
subsidiaries (Guarantor Subsidiaries). Such guarantees will be full,
unconditional and joint and several. Separate financial statements of the
Guarantor Subsidiaries have not been presented because the Company's
management has determined that they would not be material to investors. The
following supplemental financial information sets forth, on an unconsolidated
basis, statement of operations, balance sheet, and statement of cash flow
information for the Company (Parent Company Only), for the Guarantor
Subsidiaries and for the Company's other subsidiaries (Non-Guarantor
Subsidiaries). The comparative statements for 1995 have not been presented as
the Non-Guarantor information is not material to the consolidated financial
statements for that period. The supplemental financial information reflects the
Company's investments in subsidiaries using the equity method of accounting.
Certain immaterial reclassifications have been made to provide for uniform
disclosure for the period presented.
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(10) SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION
(CONTINUED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1996
(in thousands)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------ ------------ -------------
Revenues $ -- $804,293 $ 4,880 $ -- $ 809,173
Cost of services -- 468,928 3,900 -- 472,828
---------- -------- --------- --------- -----------
Gross margin -- 335,365 980 -- 336,345
Selling, general and
administrative expenses 68 184,919 900 -- 185,887
Depreciation and amortization -- 45,952 50 -- 46,002
---------- -------- --------- --------- -----------
Operating income (68) 104,494 30 -- 104,456
Interest and other (income)
expense, net 19,279 6,555 (2,926) -- 22,908
Intercompany (income) expense (22,660) 22,660 -- -- --
Equity in earnings of subsidiaries (50,853) -- -- 50,853 --
---------- -------- --------- --------- -----------
Income before income taxes 54,166 75,279 2,956 (50,853) 81,548
Income tax expense 1,160 26,348 1,034 -- 28,542
---------- -------- --------- --------- -----------
Net income 53,006 48,931 1,922 (50,853) 53,006
Preferred dividends 2,808 -- -- 2,808
---------- -------- --------- --------- -----------
Income on common stock $ 50,198 $ 48,931 $ 1,922 $ (50,853) $ 50,198
========== ======== ========= ========= ===========
(Continued on next page)
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(10) SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1996
(in thousands)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------ ------------ ------------
ASSETS
------
CURRENT ASSETS:
Trade accounts receivable, net $ -- $ 33,373 $ 55,480 $ -- $ 88,853
Current deferred tax assets, net 9,138 13,068 -- -- 22,206
Prepaids and other 23,384 7,018 556 (23,158) 7,800
Intercompany receivable 278,533 -- 12,139 (290,672) --
Other accounts and notes receivable, net 5,584 4,101 -- -- 9,685
-------- -------- --------- --------- ---------
Total current assets 316,639 57,560 68,175 (313,830) 128,544
Property, plant and equipment, net -- 379,288 320 -- 379,608
Excess of cost over net assets acquired, net -- 344,667 -- -- 344,667
Investment in affiliates 325,041 -- -- (325,041) --
Other, net 24,064 30,816 674 (10,439) 45,115
-------- -------- --------- --------- ---------
Total Assets $665,744 $812,331 $ 69,169 $(649,310) $ 897,934
======== ======== ========= ========= =========
LIABILITIES AND SHAREOWNERS' EQUITY
-----------------------------------
CURRENT LIABILITIES:
Accounts payable $ -- $ 13,407 $ -- $ -- $ 13,407
Facility costs accrued and payable -- 116,685 960 -- 117,645
Intercompany payable -- 284,507 6,165 (290,672) --
Accrued expenses and other -- 81,607 293 (23,158) 58,742
-------- -------- --------- --------- ---------
Total current liabilities -- 496,206 7,418 (313,830) 189,794
Long-term debt 257,000 -- -- -- 257,000
Capital lease obligations -- 13,221 -- -- 13,221
Other liabilities and deferred credits 4,155 39,614 -- (10,439) 33,330
SHAREOWNERS' EQUITY:
Preferred stock -- 66,500 -- (66,500) --
Common stock 772 1 12,046 (12,047) 772
Paid-in capital 422,867 136,331 60,500 (196,831) 422,867
Retained (deficit) earnings (19,050) 60,458 (10,795) (49,663) (19,050)
-------- -------- --------- --------- ---------
Total shareowners' equity 404,589 263,290 61,751 (325,041) 404,589
-------- -------- --------- --------- ---------
Total Liabilities and
Shareowners' Equity $665,744 $812,331 $ 69,169 $ 649,310) $ 897,934
======== ======== ========== ========= =========
(Continued on next page)
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(10) SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1996
(in thousands)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------- ------------ ------------ ------------
OPERATING ACTIVITIES:
Net cash provided by (used in)
operating activities $ 59,440 $ 239,960 $ (60,500) $ -- $ 238,900
--------- ----------- ---------- --------- ----------
INVESTING ACTIVITIES:
Investment in SPC (60,500) -- 60,500 -- --
Capital expenditures -- (105,834) -- -- (105,834)
Payments for acquisitions and other -- (118,142) -- -- (118,142)
--------- ----------- ---------- --------- ----------
Net cash (used in) provided by
investing activities (60,500) (223,976) 60,500 -- (223,976)
--------- ----------- ---------- --------- ----------
FINANCING ACTIVITIES:
Net debt payments (2,711) (15,984) -- -- (18,695)
Preferred dividend payments (2,808) -- -- -- (2,808)
Proceeds from employee stock
plans and warrants 6,579 -- -- -- 6,579
--------- ----------- ---------- --------- ----------
Net cash provided by (used in)
financing activities 1,060 (15,984) -- -- (14,924)
--------- ----------- ---------- --------- ----------
Net increase in cash and
cash equivalents -- -- -- -- --
--------- ----------- ---------- --------- ----------
Cash and Cash Equivalents at the
Beginning of the Period -- -- -- -- --
--------- ----------- ---------- --------- ----------
Cash and Cash Equivalents at the
End of the Period $ -- $ -- $ -- $ -- $ --
========= =========== ========== ========= ==========
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION - INDUSTRY ENVIRONMENT
The Company has historically operated in the almost $80 billion
long-distance telecommunications industry. Recent legislative activity is
designed to create one telecommunications industry to encompass both
long-distance and local services. The Company intends to provide combined local
and long-distance services to compete in what is estimated to be a $150 billion
market. The current industry environment subjects the Company to varying
degrees of legislative and regulatory oversight on both the national and state
levels. The following potential changes in the legislative and regulatory
environment can impact the nature and degree of the competition in the
telecommunications industry and impact the Company's ability to compete.
LEGISLATIVE MATTERS
TELECOMMUNICATIONS ACT OF 1996. In February 1996, the
Telecommunications Act of 1996 (the Act) was passed by the United States
Congress and signed into law by President Clinton. This comprehensive
telecommunications legislation was designed to increase competition in the
long- distance and local telecommunications industries. The legislation will
allow the Regional Bell Operating Companies (RBOCs) to provide long-distance
service in exchange for opening their networks to local competition. Under the
legislation, the RBOCs can immediately provide interstate long-distance
services outside of their local service territories. However, an RBOC must
apply to the Federal Communications Commission (FCC) to provide long-distance
services within any of the states in which such RBOC currently operates. The
RBOCs must satisfy several pro- competition criteria before the FCC will
approve an RBOC's request to provide in-region long- distance services and
several RBOC requests have been approved. The legislation provides a framework
for the Company and other long-distance carriers to compete with incumbent
local exchange carriers (LECs), by reselling service of local telephone
companies, interconnecting with LEC network facilities, or building new
facilities.
Under the Act, a telecommunications provider can request initiation of
interconnection/resale negotiations with a LEC. In early March, the Company
requested in writing to begin good faith negotiations with the RBOCs and
several other LECs. On June 27, 1996, the Company withdrew from formal
negotiations as a result of the Company's unsuccessful attempts to reach local
service agreements with each of the respective LECs. Several LECs failed to
provide the necessary technical and pricing information fundamental to the
provision of competitive local telephone service. The Act provides that if the
parties have not reached an agreement between 135 to 160 days from the
beginning of negotiations, a party may request arbitration from the appropriate
state regulatory agency. The Company's withdrawal, which occurred before the
160- day deadline, preserved LCI's rights to arbitrate any unresolved issues.
In the case of Ameritech, BellSouth and Sprint United, the parties mutually
consented to withdraw from negotiations.
The Company continues to have discussions with various LECs,
competitive access providers and other telecommunications service providers
regarding the provision of local service outside of formal negotiations. The
Company has since reinitiated formal negotiations with various LECs and intends
to vigorously compete in the local service market.
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REGULATORY MATTERS
In order to implement the Act, the FCC was required to undertake a
variety of regulatory actions which can impact competition in the
telecommunications industry. Certain of these regulatory actions are described
below.
LOCAL INTERCONNECTION AND RESALE. On August 1, 1996, the FCC adopted a
comprehensive order (Interconnection Order) to implement policies, rules, and
procedures regarding local service competition as required under the Act. The
Interconnection Order establishes a minimum national framework for
interconnection, the purchase of unbundled local network elements, resale
discounts, and procedures by which agreements for the provision of local
service through LECs are to be arbitrated. Under the Interconnection Order,
the states will have an important role implementing and applying local
interconnection policies, rules and procedures. Several states, companies,
associations, and other entities appealed the Interconnection Order.
On September 27, 1996, the United States Court of Appeals for the 8th
Circuit (the 8th Circuit Court) issued a temporary stay of the Interconnection
Order, preventing the order from taking effect on September 30, 1996 while the
8th Circuit Court heard oral arguments. On October 15, 1996, the 8th Circuit
Court issued a stay on the implementation of various aspects of the
Interconnection Order, including the proxy pricing provisions for unbundled
network elements, resale discounts, and the "pick and choose" rule which allows
carriers to choose the best rates and terms for components of a phone network
from any previous agreements between the incumbent LEC and other carriers. The
FCC and other parties petitioned the U.S. Supreme Court to reverse the 8th
Circuit Court's decision and implement the Interconnection Order. On October
31, 1996, U.S. Supreme Court denied the petitions to overturn the stay.
Because of the uncertainty regarding whether the 8th Circuit Court will
overturn the Interconnection Order, the Company is unable to predict what
impact the pending judicial proceedings will have on local service competition
or on RBOC provision of in-region long distance services.
The FCC has also initiated a number of other rulemaking proceedings to
comply with the Act. These rulemaking proceedings include addressing certain
tariff-related issues, the definition of and funding for universal service, and
accounting and non-accounting safeguards relative to RBOC provision of
in-region long distance service. The Company is unable to predict what action
will be taken by the FCC or how such action will affect the Company's financial
position and results of operation.
GEOGRAPHIC RATE AVERAGING. On August 7, 1996, the FCC released an
order regarding rate averaging. The FCC's order applies only to providers of
intrastate and interstate interexchange telecommunications services. Under the
FCC's rate averaging order, the rates charged by all providers of interexchange
telecommunications services to subscribers in rural and high cost areas cannot
be higher than the rates charged by each such provider to its subscribers in
urban areas. The Company is unable to predict how the order will affect pricing
structures in different services areas.
LOCAL SERVICE. The Company is involved in state regulatory proceedings
in various states to secure approval to resell local service which would enable
the Company to provide combined local and long-distance services to existing
and prospective customers. The local service industry is estimated to be a $90
billion market and the Company believes that it has significant opportunities
in this industry. The Company has received different levels of approval to
resell local service in Illinois, Texas, Florida, Connecticut, Michigan,
California, Maryland, Tennessee, Nevada,
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Wisconsin, Georgia, South Carolina, New York and Minnesota and has applications
for local service authority pending in fourteen other states.
COMPETITION
The long-distance telecommunications market is highly competitive. The
principal competitive factors affecting the Company's market share are pricing,
regulatory developments as described above, customer service, and diversity of
services and features. The Company's ability to compete effectively will
depend on its continuing to maintain high quality, market-driven services at
prices generally equal to or below those charged by its major competitors.
Several of the Company's competitors are substantially larger and have
substantially greater financial, technical and marketing resources. As the
Company grows, it expects to face increased competition, particularly from AT&T
Corp. (AT&T) , MCI Telecommunications Corporation (MCI) and Sprint Corporation
(Sprint). The Company also competes with other interexchange carriers and
resellers as well as LECs in various types of long-distance services. The
Company's pricing strategy is to offer a simple, flat-rate pricing structure
with rates generally below those of AT&T, MCI and Sprint. Recently, certain
long-distance carriers have introduced flat-rate pricing programs.
As a result of the passage of the Act, the nature of the industry is
expected to change by allowing carriers other than LECs to provide local
service while RBOCs will be permitted to provide long-distance service. As a
result, the Company expects competition within the industry to increase in both
the long-distance and local markets.
REGULATION OF RBOC OUT-OF-REGION LONG DISTANCE. The Act granted the
RBOCs the authority to provide out-of-region long-distance services. In
response, the FCC granted the ability for an RBOC that provides interstate
interexchange services through an affiliate to obtain non- dominant (i.e., less
burdensome) regulatory treatment on an interim basis, if the affiliate complies
with certain safeguards. The safeguards require that the affiliate maintains
separate books of account, does not jointly own transmission or switching
facilities with the RBOC, and obtains any tariffed services from the affiliated
RBOC at tariffed rates and conditions. The Company is unable to predict what
impact, if any, the implementation of these requirements will have on
competition from RBOCs.
RBOC MERGERS. In early 1996, SBC Communications Inc. and Pacific
Telesis Group announced plans to merge, as did Bell Atlantic Corp. and NYNEX
Corp. (all are RBOCs). The mergers are subject to review and approval by
various state and Federal agencies. The Company is unable to predict what
impact, if any, these potential mergers, if approved, might have on competition
in the telecommunications industry or on the Company.
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GENERAL - RESULTS OF OPERATIONS
The Company's switched revenues are a function of switched minutes of
use (MOUs) and rate structure (rates charged per MOU), which in turn are a
function of the Company's customer and service mix. Private line revenues are
a function of fixed rates that do not vary with usage. The Company's cost of
services consists primarily of expenses incurred for origination, termination
and transmission of calls through LECs and transmission through other
long-distance carriers. The Company provides service to its customers through
digital fiber optic facilities which are both owned and leased. Collectively
these facilities constitute the Company's network (the Network). These results
of operations include the acquisition of Pennsylvania Alternative
Communications, Inc. (PACE) from June 1, 1996, and the acquisitions of Teledial
America, Inc. (Teledial America) and ATS Network Communications, Inc. (ATS)
from January 1, 1996. For the comparative periods presented, the results of
operations include the acquisition of Corporate Telemanagement Group, Inc.
(CTG) from September 1, 1995.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AS
COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1995
REVENUES. Revenues for the three months ended September 30, 1996
increased 67% to $289.2 million on 2.1 billion MOUs as compared to $173.0
million on 1.2 billion MOUs for the three months ended September 30, 1995. For
the nine months ended September 30, 1996, revenues increased 72% to $809.2
million on 5.9 billion MOUs versus $469.2 million on 3.4 billion MOUs for the
same period in 1995. The increases in total revenues and MOUs are attributable
to internal growth of approximately 40% for the three and nine months ended
September 30, 1996, with the Company's acquisitions representing the remaining
growth over prior periods. The following table provides further information
regarding the Company's revenues:
Three Months Nine Months
(in thousands, except switched revenue per MOU) Ended September 30, Ended September 30,
--------------------------------- -------------------------------
1996 1995 Change 1996 1995 Change
--------------------------------- -------------------------------
Total Revenues $289,195 $ 172,992 67% $809,173 $ 469,207 72%
MOUs 2,130,974 1,244,520 71% 5,895,629 3,425,423 72%
Switched Revenue per MOU (1) $ 0.1254 $ 0.1239 1% $ 0.1263 $ 0.1215 4%
(1) Switched revenue divided by MOUs
Revenues from business customers increased approximately 45% and 50%
year-over-year for the three and nine months ended September 30, 1996,
respectively, and continue to represent more than half of the Company's total
revenues. Residential/small business revenues increased in excess of 100%
year-over-year for the three and nine months ended September 30, 1996. The
residential/small business segment represented more than 30% of total revenues
for the three and nine months ended September 30, 1996 as compared to
approximately 20% for the same periods in the prior year.
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Growth in international service revenues across all revenue service
lines continued in excess of 100% for both the three months and nine months
ended September 30, 1996 compared to the same periods in 1995 and resulted from
the Company's efforts to take full advantage of opportunities in the global
telecommunications market.
During the third quarter, several of the Company's competitors
announced new "flat-rate" pricing plans or promotions for the residential
market. The impact of these efforts on the Company's residential customer base
has not been determined. LCI continues to believe its simple, fair and
inexpensive marketing and product pricing approach is very competitive in
retaining existing customers as well as obtaining new customers. The present
growth rate of the Company's residential/small business revenues in excess of
100% demonstrates the success of this marketing and pricing approach. As LCI's
residential/small business base grows, however, the year-over-year growth rates
are expected to decline from current reported growth rates.
The Company experienced a 1% and 4% increase year-over-year in revenue
per MOU for the three and nine months ended September 30, 1996, respectively.
Revenue per MOU is affected by several factors. Residential/small business and
international revenues have a higher rate structure per MOU, and the Company's
growth in these segments has favorably impacted revenue per MOU. Factors
placing downward pressure on revenue per MOU include competitive market
conditions and higher level of sales allowance on the growing base of
residential/small business revenues. As a result of the Company's varying
growth and changes in mix across business segments, and competitive rate
structures within segments, revenue per MOU is not an exclusive indicator of
gross margin. Changes in revenue per MOU is not always an accurate measure of
the impact on gross margin. The Company is committed to grow in all market
segments and will experience a wide diversity of rate structures which generate
a variety of margins.
The Company experienced an increase in its sales allowance as a result
of the growth in revenue during 1996 and the increase in the customer mix
toward the residential/small business service segment. The increase in sales
allowance was also due to growth in geographic markets, that require a higher
level of sales allowance than the historical levels in the Company's core
business.
The Company uses a variety of sales channels to market its services.
In addition to its internal sales force, the Company uses a combination of
advertising, telemarketing and third-party sales agents. With respect to
third-party sales agents, compensation for sales is paid to agents in the form
of an ongoing commission based upon collected revenue attributable to
customers generated by them. The billing and customer service functions for
such customers are performed by the Company. A nationwide network of
third-party sales agents managed by one vendor continued to be the most
successful of the Company's sales agents and accounted for a significant
portion of the Company's residential/small business revenue and sales growth.
In June 1996, the Company extended its contract with this vendor through April
2011. In consideration for the contract extension, as well as exclusivity and
non-compete provisions, the Company has committed to make two payments on
designated dates which will be amortized over the life of the contract. A
portion of these payments is contingent on future performance of this vendor.
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GROSS MARGIN. The Company's gross margin increased 71% to $122.6
million and 75% to $336.4 million for the three and nine months ended September
30, 1996, respectively, as compared to the prior year. During the three and
nine months ended September 30, 1996, the gross margin as a percentage of
revenue increased to 42.4% and 41.6%, year-over-year respectively, from 41.5%
and 41.0%, respectively, for the same periods in 1995. The increase in gross
margin as a percentage of revenue resulted from the net impact of several
items. The Company experienced the positive impact of growth in
residential/small business and international traffic, which provide higher
margins. The improvements in Network efficiencies and lower access costs due to
LEC rate reductions provided cost savings which also favorably impacted gross
margin. The Network efficiencies were a result of the integration of traffic
from acquired companies onto the Network and improved application of Network
optimization techniques. During the third quarter of 1996 approximately 95% of
the Company's domestic traffic was carried on the Network compared to
approximately 90% for the same period in 1995.
The favorable impacts on gross margin were partially offset by
competitive pressures in the business service line and some international
markets. The Company has experienced a reduction in the revenue per MOU in some
markets, but the cost savings discussed above have reduced the cost per MOU at
a greater rate than the revenue reductions. The net impact of all of these
factors resulted in an overall improvement in the gross margin as a percentage
of revenue.
The Company continues to evaluate strategies to reduce its cost of
services. These strategies include a review of the Company's ability to
leverage its embedded fiber optic capacity, as well as gain access to fiber
optic and broadband capacity through contract negotiations or other
arrangements with carriers. In addition, the Company continues to identify
variable-cost network traffic that can be cost effectively routed onto the
Company's fixed-cost Network. Through these strategies, LCI plans to improve
the reliability and efficiency of the Network and continue to pursue
opportunities to reduce its cost of services per MOU.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 74% to $67.7 million and 79% to $185.9
million for the three and nine months ended September 30, 1996, respectively,
as compared to the same periods in the prior year. As a percentage of revenues,
selling, general and administrative expenses were 23.4% and 23.0% for the three
and nine months ended September 30, 1996, respectively, as compared to 22.5%
and 22.2%, for the three and nine months ended September 30, 1995.
The Company's selling, general and administrative expenses are
impacted primarily by three expenses: payroll, commissions and billing
services. Payroll expenses increased $8.0 million and $21.9 million for the
three and nine months ended September 30, 1996, respectively, due to an
increase in the number of employees resulting from the Company's acquisitions
and infrastructure expansion. This growth in the payroll expense
year-over-year, was less than the corresponding growth in revenues for the same
periods. In addition revenue per employee remained above an annualized $500,000
per employee for the three and nine months ended September 30, 1996.
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The increase in selling, general and administrative expenses reflects,
in part, the $10.2 million and $29.0 million increase in commission expense for
the three months and nine months ended September 30, 1996, respectively, over
the comparable periods in 1995. The growth in residential/small business
revenue sold by third party sales agents with an ongoing commission was the
primary cause of the increase in commission expense. Billing services expense
increased $4.0 million and $11.2 million year-over-year for the three and nine
months ended September 30, 1996, due to improvements in the invoice for
business customers which resulted in an increase in the cost per bill. The
billing services expense for residential/small business customers, which is
performed by LECs, declined year-over-year on a per bill basis, but the
increase in residential/small business customers caused an overall increase in
this expense year-over-year. Both commission and billing services expenses grew
at a faster rate than revenues due to the shift in customer mix toward
residential/small business services. The Company expects continued increases in
these components of selling, general and administrative expenses as a result of
the growth in the residential/small business segments, which incur higher
proportional costs than other segments.
The Company anticipates an incremental increase in selling, general
and administrative expenses with the expansion of its geographic sales presence
and its entrance into the local services market. The increase in selling,
general and administrative expenses and the corresponding increase in these
expenses as a percentage of revenues is a demonstration of management's
decision to invest in the Company's future and continued growth.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense for the three and nine months ended September 30, 1996 increased 46%
and 48%, respectively, over the same periods in 1995. The dollar increase is a
result of the increased capital expenditures required to support the growth in
revenue and MOU volumes, as well as additional goodwill amortization from the
Company's recent acquisitions. The growth in revenue exceeded the growth in
depreciation and amortization expense which caused depreciation and
amortization expense as a percentage of revenues to decrease to 5.7% for both
the three and nine month periods ended September 30, 1996 from 6.5% and 6.6%
for the same periods in 1995, respectively. The reduction in depreciation and
amortization expense as a percentage of revenues reflects the Company's ability
to maximize the application of its facilities and achieve economies of scale
from its revenue growth.
OPERATING INCOME. Operating income increased 78% to $38.6 million and
83% to $104.5 million for the three and nine months ended September 30, 1996,
respectively, compared to the same period in 1995 due to the factors discussed
above. As a percentage of revenues, operating income increased to 13.4% and
12.9% for the three and nine months ended September 30, 1996, respectively,
compared to 12.5% and 12.2% for the same periods in 1995, reflecting management
of expenses during a period of significant growth in revenues and MOUs.
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INTEREST AND OTHER EXPENSE, NET. Interest and other expense, net of
capitalized interest, increased to $7.7 million and $22.9 million for the three
and nine months ended September 30, 1996, respectively, from $4.5 million and
$11.6 million for the same periods in 1995, respectively. Increased interest
expense was the result of higher levels of outstanding debt during most of 1996
as compared to the same periods in 1995. The Company's acquisitions of Teledial
America, ATS and PACE increased outstanding debt by approximately $107 million
for the three and nine months ended September 30, 1996 over the comparable
periods in 1995. The level of outstanding debt decreased toward the end of the
quarter as a result of the application of the proceeds from the accounts
receivable securitization program (Securitization Program). The Company is
expecting a lower cost of funding to be provided by the Securitization Program
as well as more favorable interest rates on the outstanding balances under the
Company's Revolving Credit Facility (Credit Facility).
INCOME TAX EXPENSE. Income tax expense was $10.8 million and $28.5
million for the three and nine months ended September 30, 1996, respectively,
as compared to $4.1 million and $10.9 million for the same periods in 1995,
respectively. The increase in income tax expense was a result of an increase in
the estimated effective tax rate to 35% in 1996 from 24% in 1995, as well as
the increase in income before income taxes for the periods in 1996 as compared
to 1995. The effective tax rate is lower than the statutory rate primarily due
to the Company's expectation that a portion of the available net operating
losses (NOLs) will be realized in future years as permitted by Statement of
Financial Accounting Standards No. 109 (See Note 9 to the Condensed
Consolidated Financial Statements).
PREFERRED DIVIDENDS. Preferred dividends were $0.5 million and $2.8
million for the three and nine months ended September 30, 1996, respectively,
as a result of the dividend requirements on the previously outstanding 5%
Cumulative Convertible Exchangeable Preferred Stock (Preferred Stock). There
were Preferred Stock conversions of approximately 1.7 million shares and
4.6 million shares during the three and nine months ended September 30, 1996,
respectively. The remaining shares of Preferred Stock were redeemed on
September 3, 1996. The conversions and redemptions decreased the balance of
Preferred Stock and the corresponding preferred dividend payments decreased
during 1996 as compared to 1995. The elimination of future dividend payments
will result in an annual savings of $5.8 million, based upon the original 4.6
million shares issued in August 1993.
INCOME ON COMMON STOCK. The Company generated income on common stock
(after preferred dividends) of $19.6 million and $50.2 million for the three
and nine months ended September 30, 1996, respectively, as compared to $11.6
million and $30.3 million for the same periods in 1995, respectively.
LIQUIDITY AND CAPITAL RESOURCES
LCI International, Inc. (LCI) is a holding company and conducts its
operations through direct and indirect wholly-owned subsidiaries. LCI SPC I,
Inc. was established as a wholly-owned subsidiary of LCI to facilitate the
Securitization Program, and is subject to certain contractual restrictions
concerning the payment of dividends or the making of loans or advances to LCI.
There are however, no restrictions on the movement of cash among the Company
and the other subsidiaries in the consolidated group and the Company's
discussion of its liquidity is based on the consolidated group. The Company
measures its liquidity based on cash flow as reported in its Condensed
Consolidated
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26
Statements of Cash Flow; however, the Company does use other operational
measures as outlined below to manage its operations.
CASH FLOWS - OPERATING ACTIVITIES. The Company provided $238.9
million of cash from operations for the nine months ended September 30, 1996
which is an increase of $219.5 million from the same period in 1995. The
proceeds from the Securitization Program provided $108.0 million during 1996.
The remaining increase is due to the significant growth in revenues and net
income for the periods, as well as improved management of working capital and
stronger cash collections in 1996 when compared to 1995.
CASH FLOWS - INVESTING ACTIVITIES. The Company has supported its
growth strategy with capital expenditures and acquisitions, resulting in $224.0
million in cash used for investing activities during 1996, representing an
increase of $91.5 million compared to 1995. During the nine months ended
September 30, 1996, the Company spent $105.8 million in capital expenditures to
acquire additional switching, transmission and distribution capacity as well as
to develop and license information systems support, representing an increase of
$51.8 million from the same period in 1995.
The Company's acquisitions of Teledial America and ATS in the first
quarter of 1996, as well as the acquisitions of PACE and other intangible
assets in the second quarter of 1996 resulted in the use of $118.1 million in
cash for the nine months ended September 30, 1996. During the third quarter of
1995, the Company used $78.4 million for the acquisition of CTG and payment for
a called letter of credit.
CASH FLOWS - FINANCING ACTIVITIES. Financing activities used a net
$14.9 million for the nine months ended September 30, 1996, compared with cash
provided by financing activities of $113.1 million during the same period in
1995. During the nine months ended September 30, 1996 the Company increased its
financing activities to fund its acquisitions and capital expenditures, as
discussed in investing activities, above. This increase was offset by the
proceeds provided by the sale of accounts receivable pursuant to the
Securitization Program, which were used to pay down outstanding balances under
the Credit Facility.
CAPITAL RESOURCES. In February 1996, the Company negotiated an
increase in the Credit Facility to $700 million for a five-year period, and in
September 1996, the Company entered into a Discretionary Line of Credit for $25
million. The Credit Facility and Discretionary Line of Credit allow the Company
to borrow on a daily basis, therefore the Company uses its available cash to
reduce the balance of its borrowings and maintains no cash on hand. As of
September 30, 1996, the Company had $252 million outstanding under the Credit
Facility with $10 million reserved as a result of issued letters of credit and,
based on covenant restrictions, the Company had $355 miliion available under
the Credit Facility. As of September 30, 1996, the Company had $5 million
outstanding on the Discretionary Line of Credit with $20 million available.
The banks' commitment under the Credit Facility is subject to various
principal reductions, depending on the outstanding balance, until maturity on
March 31, 2001. The Credit Facility contains certain balance sheet, operating
cash flow, capital expenditure and negative covenant requirements. As of
September 30, 1996, the Company was in compliance with all covenants. The
interest rate on the Credit Facility outstanding balance is variable based on
several indices (See Note 6 to the Condensed Consolidated Financial
Statements). The weighted average interest rate on
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the debt outstanding under the Credit Facility was 6.5% and 6.9% at September
30, 1996 and 1995, respectively.
On August 29, 1996, the Company entered into the Securitization
Program to sell a percentage ownership interest in a defined pool of the
Company's trade accounts receivable. The Company can transfer an undivided
interest in a designated pool of accounts receivable on an ongoing basis to
maintain the participation interest up to the limit of $150 million. At
September 30, 1996, the pool of trade accounts receivable which was available
for sale totaled approximately $114.9 million and the amount of receivables
sold totaled $108.0 million.
Although the Company believes it has sufficient operating cash flows
and available borrowing capacity to fund its current operations and anticipated
capital requirements, the Company continues to evaluate other sources of
financing. The Company has filed a shelf registration statement with the
Securities and Exchange Commission, which would allow the issuance of $300
million of debt and/or equity securities.
OPERATIONAL MEASURES. The Company uses earnings before interest,
income taxes, other expense, depreciation and amortization (EBITDA) and
borrowing capacity under its Credit Facility as operational measures of its
ability to fund growth and manage expansion. EBITDA should not be considered
(i) as an alternate to net income, (ii) as an indicator of operating
performance or cash flows generated by operating, investing or financing
activities or (iii) as a measure of liquidity.
EBITDA increased 67% to $55.0 million and 70% to $150.4 million for
the three and nine months ended September 30, 1996, respectively, compared to
the same period for 1995. The successful growth in operations, together with
the capital changes discussed above, have significantly improved EBITDA during
the periods presented.
CAPITAL REQUIREMENTS. The Company has utilized strategic acquisitions
as a means of expanding its network, sales and service presence and revenues
across the country. The Company evaluates each potential acquisition to
determine its strategic fit within the Company's growth, operating margin and
income objectives. The Company expects to continue to actively explore
potential acquisitions and may enter into discussions from time to time with
potential acquisition candidates, but there can be no assurance that the
Company will be able to enter into agreements in the future with respect to, or
consummate, acquisitions on acceptable terms.
The PACE and Teledial America acquisition agreements contain
provisions that may require the Company to make contingent purchase price
payments during the fourth quarter of 1996 and through 1997. These payments
will be based on achieving certain revenue performance and customer retention
as specified in the respective purchase agreements. The Company expects to
increase the level of capital expenditures through 1997 to support continued
growth.
In May 1996, the Company entered into two separate agreements with a
distributor and its affiliated party. In consideration for the contract
extensions as well as exclusivity and non-compete provisions in the agreements,
the Company will make payments on various designated dates over several years
in accordance with the two agreements. Certain of these payments are contingent
upon these parties meeting certain performance measures. These payments are
being amortized over the respective contract terms.
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COMMITMENTS AND CONTINGENCIES. The Company has agreements
with certain interexchange carriers and third-party vendors to lease facilities
for originating, terminating and transport services. These agreements require
the Company to maintain minimum monthly and/or annual billings based on usage.
The third party carriers include WorldCom Network Services, Inc. d/b/a WilTel,
Sprint Corporation and MCI Telecommunications Corporation. In addition, the
Company uses services provided by each RBOC, GTE Telephone Operating Companies
and other smaller local exchange carriers. The Company currently has one
significant contract with a third-party carrier, however, the costs associated
with the contract represent less than 10% of the Company's revenue on an annual
basis (See Note 7 to the Condensed Consolidated Financial Statements). The
Company manages its Network in order to maximize reliability and redundancy and
minimize dependence on any particular third party carrier. The Company may,
however, increase its reliance on a particular third party carrier as a result
of service, quality and pricing considerations. The Company has engineered its
network to minimize the impact on its customers of a service failure by any
third party carrier and has established contingency plans to reroute traffic as
quickly as possible if a service failure by a third party carrier should occur.
Although most service failures that the Company has experienced have been
corrected in a relatively short time period, a catastrophic service failure
could interrupt the provision of service by both the Company and its
competitors for a lengthy time period. The restoration period for a
catastrophic service failure cannot be reasonably determined, however the
Company has not experienced a catastrophic service failure in its history.
The Company has been named as a defendant in various litigation
matters. Management intends to vigorously defend these outstanding claims.
The Company believes that it has adequate accrued loss contingencies and that
current pending or threatened litigation matters will not have a material
adverse impact on the Company's results of operations or financial condition
(See Note 7 to the Condensed Consolidated Financial Statements).
FEDERAL INCOME TAXES. The Company has generated significant NOLs in
prior years that are available to reduce current cash requirements for income
taxes. See Note 9 of the Condensed Consolidated Financial Statements for a
discussion of the availability and expected utilization of the existing NOLs.
IMPACT OF INFLATION AND SEASONALITY. The Company does not believe
that the relatively moderate levels of inflation which have been experienced in
the United States in recent years have had a significant effect on its net
revenues or earnings.
The Company's long-distance revenue is subject to seasonal variations
based on each business segment. Use of long-distance services by commercial
customers is typically lower on weekends throughout the year, and in the fourth
quarter due to holidays. As residential revenue increases as a proportion of
the Company's total revenues, the seasonal impact due to changes in commercial
calling patterns should be reduced. The Company is unable to predict the
impact of a shift to a larger residential customer base.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 - SAFE HARBOR
CAUTIONARY STATEMENT. This report contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995 (the Reform
Act). These forward-looking statements express the beliefs and expectations of
management regarding LCI's future results and performance and include, without
limitation, the following: statements concerning the Company's outlook for
1997; the Company's plans to enter the local service market; the effect of FCC
and judicial rulings pertaining to local service competition and RBOC entry
into the long-distance market; the impact of marketplace competition on pricing
strategies and rates; expected growth in the residential business segment; the
cost reduction strategies and opportunities in gross margin; the expected
interest savings from
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the Securitization Program; funding of capital expenditures and operations; the
Company's beliefs regarding a catastrophic service failure; and other similar
expressions concerning matters that are not historical facts.
Such statements are based on current expectations and involve a number
of known and unknown risks and uncertainties that could cause the actual
results, performance, and/or achievements of the Company to differ materially
from any future results, performance, or achievements, expressed or implied by
the forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements and any such statement is
qualified by reference to the following cautionary statements. In connection
with the safe harbor provisions of the Reform Act, the Company's management is
hereby identifying important factors that could cause actual results to differ
materially from management's expectations including, without limitation, the
following: increased levels of competition in the telecommunications industry,
including RBOC entry into the long-distance industry and the impact on pricing;
the ability of LCI's direct sales force and alternative channels of
distribution to obtain new sales; the adoption and application of rules and
regulations implementing the Act; and other risks described from time to time
in the Company's Securities and Exchange Commission filings. The Company
undertakes no obligation to publicly release the result of any revision to
these forward-looking statements which may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Thomas J. Byrnes and Richard C. Otto v. LCI Communications Holdings
Co. et al. was filed by two former members of the Company's management on June
28, 1991 in Common Pleas Court, Franklin County, Ohio. The suit alleged age
discrimination by the Company among other things and sought $42.8 million in
compensatory and punitive damages. During 1993, a jury returned a verdict in
favor of the Plaintiffs and the Common Pleas Court awarded approximately $8.1
million in damages and attorney's fees.
Both the Plaintiffs and the Company appealed this matter to the
Court of Appeals in Ohio, which in a two to one decision overruled
each of LCI's assignments of error and two of the Plaintiffs' claims, and
sustained the Plaintiffs' request for approximately $0.1 million in
pre-judgment interest in addition to the previous award. The Company filed a
Notice of Appeal at the Supreme Court of Ohio (the Court) and the Court agreed
to review the decision by the Court of Appeals. Oral arguments took place in
May 1996. To date the Court has not rendered an opinion on the matter,
although the Company expects an opinion to be rendered in the fourth quarter of
1996. The appeal process has extended the resolution of this matter for
several years and, depending on the disposition and timing of the ultimate
outcome, it is reasonably possible that between $0 and $3 million of additional
interest expense could be incurred.
Vanus James v. LCI International, Inc. et al. and American
Communications Network, Inc. was commenced in late May 1995 in the Supreme
Court, Kings County, New York. The plaintiff purports to bring a class action
lawsuit against the Company, certain of its affiliates, and American
Communications Network, Inc. (ACN), one of the Company's sales agents. The
lawsuit alleges that, in an effort to induce prospective customers to sign up
for the Company's long distance services, the Company and ACN violated various
laws by disseminating false and misleading statements concerning the Company's
rates for calls to certain foreign countries. The lawsuit seeks, among other
things, compensatory damages of $10 million dollars and punitive damages of $30
million dollars. Based upon its overall assessment of the matter, management
is of the opinion that the final resolution of these proceedings will not have
a material adverse effect on the consolidated financial position or results of
operations of the Company.
The Company has also been named as a defendant in various other
litigation matters incident to the character of its business. The Company
believes it has adequate accrued loss contingencies with respect to all
litigation matters and, although the ultimate outcome of these claims cannot be
ascertained at this time, that current pending or threatened litigation matters
will not have a material adverse effect on the consolidated financial position
or results of operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The exhibits filed as part of this report are set forth in
the Index of Exhibits on page 32 of this report.
(b) Reports on Form 8-K: The Company did not file any reports on Form 8-K
during the three months ended September 30, 1996.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LCI INTERNATIONAL, INC.
DATE: November 5, 1996 BY: /s/ Joseph A. Lawrence
----------------- ----------------------
Chief Financial Officer,
Senior Vice President Finance and
Corporate Development
(as duly authorized officer and
principal financial officer)
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EXHIBIT INDEX
The following Exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Exhibit
Number Description
- ------------- -------------------------------------------------------------------------------------------------------------
3(i)(a) Amended and Restated Certificate of Incorporation.(1)
3(ii) Amended and Restated By-laws(2)
10(r)(i) Transfer and Administrative Agreement among Enterprise Funding Corporation, LCI SPC I, Inc., LCI International
Telecom Corp., NationsBank, N.A. and certain other parties thereto, dated August 29, 1996.
10(r)(ii) Receivables Purchase Agreement, dated August 29, 1996, among LCI International Telecom Corp. and LCI
SPC I, Inc.,
10(r)(iii) Subordinated Intercompany Revolving Note, dated August 29, 1996, issued to LCI International Telecom Corp.
by LCI SPC I, Inc.
10(r)(iv) Support Agreement, dated August 29, 1996, by LCI International, Inc. in favor of LCI SPC I, Inc.
11 Statement Regarding Computation of Per Share Earnings
27 Financial Data Schedule
(1) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1996.
(2) Incorporated by referemce from the Company's Registration Statement on
Form S-1 (No. 33-60558).
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