1
EXHIBIT 13
Excerpt from 1996 Annual Report to Shareowners
LCI INTERNATIONAL, INC.
Selected Consolidated Financial Data
(In Millions, Except Revenue per MOU and Earnings per Common Share)
1996 1995 1994(A) 1993(A) 1992(A)
- -------------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
Revenues $ 1,103.0 $ 672.9 $ 464.0 $ 341.2 $ 260.5
Operating Expenses 959.5 590.3 413.1 320.0 267.0
Operating Income 143.5 82.6 50.9 21.2 (6.5)
Income (Loss) Before Extraordinary Items 74.8 50.8 6.8 (2.6) (41.7)
Net Income (Loss) 74.8 50.8 6.8 (10.9) (41.7)
Income (Loss) on Common Stock $ 72.0 $ 45.1 $ 1.0 $ (13.0) $ (46.9)
OPERATING DATA
Minutes of Use (MOUs) 8,159.1 4,862.6 3,288.4 2,270.4 1,677.2
Revenue per MOU $ 0.1245 $ 0.1236 $ 0.1226 $ 0.1273 $ 0.1263
EBITDA(B) $ 207.0 $ 126.5 $ 87.0 $ 67.6 $ 50.3
BALANCE SHEET DATA
Total Assets $ 950.0 $ 773.4 $ 469.7 $ 359.8 $ 323.6
Long-term Debt and Capital Lease Obligations 235.9 274.9 144.8 84.3 255.9
Redeemable Preferred Stock -- -- -- -- 4.1
Shareowners' Equity (Deficit) $ 430.7 $ 344.8 $ 201.7 $ 195.3 $ (38.0)
EARNINGS PER COMMON SHARE(C)
Income (Loss) per Share
Before Extraordinary Items $ 0.86 $ 0.62 $ 0.02 $ (0.10) $ (1.33)
Extraordinary Loss per Share -- -- -- (0.18) --
- ----------------------------------------------------------------------------------------------------------------------------
Income (Loss) per Share $ 0.86 $ 0.62 $ 0.02 $ (0.28) $ (1.33)
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES(C) 87.3 82.1 66.7 47.2 31.4
CASH DIVIDENDS PER SHARE -- -- -- -- --
(A) Includes write-off of assets, loss contingency expenses and
restructuring charges of $62.5 in 1994, $13.8 in 1993, and $24.4 in 1992.
(B) Earnings before interest, income taxes, depreciation and amortization
(EBITDA) excludes nonrecurring charges discussed in note (A) above.
(C) Earnings per common share and weighted average number of common shares are
presented on a fully diluted basis.
1
2
Excerpt from 1996 Annual Report to Shareowners
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
LCI International, Inc., together with its subsidiaries (LCI or the Company),
is a facilities-based, long-distance 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 provides service to its customers through leased and owned digital
fiber-optic facilities. Collectively, these facilities constitute the Company's
network (the Network).
Historically, the Company has operated in the $80 billion long-distance
telecommunications industry. The long-distance industry is highly competitive
and is currently dominated by the three largest interexchange carriers: AT&T
Corporation (AT&T), MCI Communications Corporation (MCI) and Sprint
Corporation (Sprint). In 1996, fewer than ten other publicly traded
interexchange carriers, including the Company, had annual revenues exceeding $1
billion. The balance of the long-distance industry comprises several hundred
smaller interexchange carriers. Recent legislative and regulatory activity is
designed to create one telecommunications industry to encompass both
long-distance and local telecommunications services. The local
telecommunications industry is approximately $95 billion and is dominated by
the seven Regional Bell Operating Companies (RBOCs) and GTE Communi-cations
Corporation (GTE). The RBOCs and GTE have been granted the authority to provide
Local Access Transport Area (interLATA) long-distance service outside their
respective regions. The nature of competition in this combined industry is
expected to change significantly as legislative and regulatory activities
progress. The Company intends to provide combined local and long-distance
services to compete in what is expected to be a $150 billion combined market.
While the revenue of long-distance telecommunications industry providers has
grown between 5% and 8% annually in recent years, the Company has experienced
64%, 45% and 36% growth in revenues in 1996, 1995 and 1994, respectively, as
well as 68%, 48% and 45% growth in the volume of switched minutes of use (MOUs)
during the same periods. This growth has been primarily generated by internal
growth in all service areas of the Company's business. The Company's
residential/small business revenues grew in excess of 125%, 170% and 120% in
1996, 1995 and 1994, respectively, while international service revenues from
all segments grew in excess of 100% in each of the same periods. Revenues from
the Company's business segment exhibited overall growth rates of 45%, 28% and
31% in 1996, 1995 and 1994, respectively. The Company intends to continue
expanding sales, marketing and promotional efforts across all customer
segments, to expand its service lines and to provide local service.
The Company's ability to compete and grow is subject to changing industry
conditions. Recent legislation and the resulting judicial and regulatory action
have had a significant impact on the current industry environment. These
changes will alter the nature and degree of competition in both the local and
long-distance segments of the industry.
INDUSTRY ENVIRONMENT
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 RBOCs to provide
long-distance service in exchange for opening their local networks to
competition. Under the legislation, the RBOCs can immediately provide interLATA
long-distance service 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 the RBOC currently
operates. The
2
3
Excerpt from 1996 Annual Report to Shareowners
RBOCs must satisfy several pro-competitive criteria before the
FCC will approve an RBOC's request to provide in-region interLATA long-distance
services. 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 local-service facilities.
Under the Act, a telecommunications provider can request initiation of
interconnection/resale negotiations with a LEC. The Company is currently in
formal negotiations with various LECs to reach local-service agreements and LCI
intends to vigorously compete in the local-service market. Initially, the
Company will provide local service to customers on a bundled resale basis. The
Company's decision to sell unbundled services or to build local-service
facilities is dependent on eco-nomic viability and favorable regulation.
REGULATORY MATTERS
Interconnection Order. In order to implement the Act, the FCC is required to
undertake a variety of regulatory actions which can impact competition in the
telecommunications industry. These regulatory actions include the adoption of a
comprehensive order to implement policies, rules and procedures regarding
local-service competition as required under the Act (Interconnection Order).
The Interconnection Order establishes a minimum national framework for
interconnection with LECs, the purchase of unbundled local network elements
from LECs, local-service resale discounts and procedures by which agreements
for the provision of local service through LECs are to be arbitrated. Several
LECs, state regulatory agencies and other parties have appealed the FCC's
Interconnection Order. The United States Court of Appeals for the Eighth
Circuit issued a stay of the Interconnection Order, pending the outcome of the
appeals. Because the legal outcome of these appeals is uncertain, 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 interLATA
long-distance services.
Geographic Rate Averaging. The FCC also released an order regarding rate
averaging. Under the FCC's rate averaging order, the rates charged by all
providers of interexchange telecommunications services to customers in rural
and high-cost areas cannot be higher than the rates charged by such providers
to their customers in urban areas. The Company is unable to predict how this
order will affect its results of operations or financial position.
Access Charge Reform. In December 1996, the FCC proposed changes to access
charges levied by LECs on long-distance service providers. These charges
currently represent approximately one-half of the long-distance industry
revenues. The FCC's intention is to require the charges for access services to
be consistent with actual economic cost. The FCC has proposed two approaches
for access charge reform: The first proposed solution is a market-based
approach that relies on competitive pressure, while the second is a
prescriptive approach which would involve FCC intervention. It is widely
expected that material changes to current industry cost structures could result
from these proceedings. The Company intends to actively participate in these
proceedings. In light of the uncertainty regarding the FCC's ultimate actions
in these proceedings, the Company is unable to predict what impact the pending
proceedings will have on the Company's cost structure.
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 Company has received approval to resell local
service in 21 states (Alabama, California, Colorado, Connecticut, Florida,
Georgia, Illinois, Indiana, Iowa, Maryland, Michigan, Minnesota, Mississippi,
Nevada, New York, Pennsylvania, South Carolina, Tennessee, Texas, Washington
and Wisconsin) and the District of Columbia, and has applications for
local-service authority pending in another seven states. The Company is
currently reselling local telecommunications service in California, Illinois
and New York.
INDUSTRY STRUCTURE
The current long-distance telecommunications market is highly competitive.
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, MCI and Sprint. The Company also competes with other interexchange
carriers and resellers in various types of long-distance services.
3
4
Excerpt from 1996 Annual Report to Shareowners
The Company's growth is based on a marketing strategy that focuses on
differentiating LCI through "Simple, Fair and Inexpensive" domestic and
international telecommunications service offerings in all market segments. This
strategic direction is supported by geographic expansion of sales presence and
Network operating facilities, as well as expansion in sales channels, targeted
service offerings to each market segment and selective acquisitions.
The principal competitive factors affecting the implementation of the Company's
strategy are the industry environment as described above, pricing, efficient
low-cost operations, customer service and diversity of services and features.
The Company's pricing approach is to offer a simple, flat-rate pricing
structure with rates generally below those of AT&T, MCI and Sprint. This
pricing strategy is supported by a continuous focus on lowering the unit cost
of the Company's cost of service, which enables the Company to competitively
price its services. Recently, certain long-distance carriers have introduced
flat-rate pricing programs whose impact on the Company has not yet been
determined. The Company's ability to compete effectively will depend on
maintaining high-quality, market-driven services at prices generally equal to
or below those charged by its major competitors.
As a result of the passage of the Act and the effect of other regulatory
matters discussed above, the structure of the industry is expected to change by
facilitating the provision of local service by carriers other than LECs, while
permitting RBOCs to provide interLATA long-distance service within their
service territories. Consequently, the Company expects competition within the
industry to increase in both the long-distance and local markets.
REVIEW OF OPERATIONS
The Company's revenues primarily consist of switched and private-line revenues.
The Company's switched revenues are a function of switched MOUs and rate
structure (rates charged per MOU), which in turn are based upon 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 over the Company's Network, and the cost of transmission
through other long-distance carriers. The Company's 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 Company's results of operations include
the acquisition of Corporate Telemanagement Group, Inc. (CTG) from September 1,
1995.
REVENUES
Total revenues increased 64% to $1.1 billion in 1996, from $672.9 million in
1995. Total revenues in 1995 increased 45% from $464.0 million in 1994.
Revenues for all periods presented are reduced by estimated allowances for
credits and uncollectible accounts (sales allowance).
Revenues from business customers increased approximately 45% during 1996 as
compared to approximately 30% during both 1995 and 1994. Business revenues
continue to represent more than half of the Company's total revenues.
Residential/small business revenues increased in excess of 100% for all years
presented. The residential/small business segment represented more than 30% of
total revenues for 1996, as compared to approximately 20% for 1995 and 10% for
1994. Growth in international service revenues across all revenue service lines
continued in excess of 100% for all years presented.
During the last half of 1996, several of the Company's competitors announced
new flat-rate pricing plans or promotions for the residential market. LCI
continues to believe that its Simple, Fair and Inexpensive marketing and
service pricing approach is very competitive in retaining existing customers,
as well as in obtaining new customers. 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% increase year-over-year in revenue per MOU for
both 1996 and 1995. 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.
4
5
Excerpt from 1996 Annual Report to Shareowners
Factors placing downward pressure on revenue per MOU include competitive market
conditions, a higher sales allowance for uncollectibles on the growing base of
residential/small business revenues and a change in the mix of business volumes
from switched services to dedicated access services. The Company's growth in
various segments has changed its revenue mix and consequently impacts revenue
per MOU. Changes in revenue per MOU are not necessarily indicative of the
performance that can be expected in the Company's gross margin, both in total
and as a percentage of revenue. The Company is committed to growing in all
market segments, which have different rate structures and generate a variety of
gross margins, but have similar operating margins.
The Company experienced an increase in its sales allowance in 1996 as a result
of the growth in revenue and a shift in the customer mix toward the
residential/small business service segment which, historically, has a higher
uncollectible rate than the business revenue segment. This increase in sales
allowance was also due to growth in specific geographic markets where the
Company experienced a higher level of sales allowance than the Company's
historical levels.
The Company uses a variety of 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 identified by
the agents. Service responsibilities, including billing and customer service
functions for such customers, are performed by the Company. American
Communications Network, Inc. (ACN), a nationwide network of third-party sales
agents, 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
sales growth. In June 1996, the Company extended its contract with ACN through
April 2011. In consideration for the contract extension, as well as exclusivity
and non-compete provisions, the Company 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 by ACN. The
agreement also contains a provision whereby ACN will receive a payment if there
is a change in the control of the Company. In consideration for this change in
control payment, the Company will receive a 31% reduction in the ongoing
commission rates paid to ACN. The change in control payment is calculated based
on a multiple of three times the average monthly collected revenue generated by
customers identified by ACN. Average monthly collected revenue is calculated
over a 24-month performance period subsequent to the change in control. The
amount of this payment is therefore dependent upon ACN's level of performance
during this period.
GROSS MARGIN
The Company's gross margin increased 67% to $460.7 million in 1996 from $276.7
million in 1995. Gross margin in 1995 increased 46% from $189.7 million in
1994. The following table provides information regarding gross margin:
(In Millions) 1996 1995 1994
------------------------------------------------------------------------
Revenues $ 1,103.0 $ 672.9 $ 464.0
Cost of Services 642.3 396.2 274.3
------------------------------------------------------------------------
Gross Margin $ 460.7 $ 276.7 $ 189.7
------------------------------------------------------------------------
Gross Margin % 41.8% 41.1% 40.9%
-------------------------------------------------------------------------
During 1996, 1995 and 1994, the gross margin as a percentage of revenue
increased to 41.8%, 41.1% and 40.9%, respectively. 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 gross margins. The improvements
in Network efficiencies and lower access costs due to LEC rate reductions
provided cost savings that also favorably impacted gross margin. The Network
efficiencies resulted from integration of traffic from acquired companies onto
the Network and improved application of Network optimization techniques. The
favorable impacts on gross margin were partially offset by competitive
pressures for lower pricing across all service lines and in some international
markets. The net impact
5
6
Excerpt from 1996 Annual Report to Shareowners
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 using its embedded fiber-optic capacity, expanding its
owned fiber-optic capacity and gaining 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 to continue to pursue opportunities to reduce its cost of services
per MOU.
OPERATING EXPENSES AND OPERATING INCOME
The following table provides information regarding operating expenses and
operating income:
(In Millions) 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
Gross Margin $ 460.7 $ 276.7 $ 189.7
Selling, General and Administrative Expenses 253.7 150.1 102.7
- ----------------------------------------------------------------------------------------------------
Earnings Before Interest, Income Taxes,
Depreciation and Amortization (EBITDA) 207.0 126.6 87.0
Depreciation and Amortization 63.5 44.0 36.1
- ----------------------------------------------------------------------------------------------------
Operating Income $ 143.5 $ 82.6 $ 50.9
- ----------------------------------------------------------------------------------------------------
As a Percent of Revenue:
Gross Margin 41.8 % 41.1 % 40.9 %
Selling, General and Administrative Expenses 23.0 % 22.3 % 22.1 %
- ----------------------------------------------------------------------------------------------------
EBITDA 18.8 % 18.8 % 18.8 %
Depreciation and Amortization 5.8 % 6.5 % 7.8 %
Operating Income 13.0 % 12.3 % 11.0 %
- ----------------------------------------------------------------------------------------------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 69% to $253.7 million in 1996 and increased
46% to $150.1 million in 1995 from $102.7 million in 1994. As a percentage of
revenues, selling, general and administrative expenses were 23.0%, 22.3% and
22.1% for 1996, 1995 and 1994, respectively. The Company's selling, general and
administrative expenses are impacted primarily by three expenses: payroll,
commissions and billing services. Payroll expenses increased $37.5 million,
$17.4 million and $13.5 million year-over-year for 1996, 1995 and 1994,
respectively, due to an increase in the number of employees that resulted from
the Company's acquisitions and expansion of the sales and customer support
infrastructure. This growth in the payroll expense year-over-year was less than
the corresponding growth in revenues for the same periods.
The growth in residential/small business revenue to more than 30% of the
Company's customer base in 1996 was responsible for a significant portion of
the growth in selling, general and administrative expenses during the past
three years. Although the residential/ small business service line resulted in
increased costs, it also provided a higher gross margin, allowing the Company
to manage EBITDA to a consistent percentage of revenue.
The increase in selling, general and administrative expenses reflects, in part,
the $35.3 million, $15.7 million and $5.5 million increase in commission
expenses for the years ended December 31, 1996, 1995 and 1994, respectively,
over the comparable prior periods. 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. The costs incurred for
commissions primarily replace other variable marketing and selling expenses for
this revenue segment. Billing services expenses increased $14.6 million, $6.5
million and $2.7 million year-over-year for 1996, 1995 and 1994, respectively,
primarily for residential/small business billing service expenses, which are
performed by LECs. LEC billing costs declined year-over-year on a per-bill
basis, but the increase in
6
7
Excerpt from 1996 Annual Report to Shareowners
residential/small business customers and the related revenue caused an overall
increase in this expense year-over-year. Both commission and billing services
expenses grew at a faster rate than total revenues due to the shift in customer
mix toward residential/small business services.
The Company anticipates an incremental increase in selling, general and
administrative expenses with the continued expansion of its geographic sales
presence and its entrance into the local-services market. The Company also
expects continued increases in selling, general and administrative expenses as
a result of the growth in the residential/small business segment, which incurs
higher proportional costs but also provides a higher gross margin than other
segments.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense
for 1996, 1995 and 1994 increased 44%, 22% and 10% year-over-year,
respectively, due to the Company's increased capital expenditures to support
its growth in revenues and volumes, as well as additional amortization expense
from acquisitions. The growth in revenue has exceeded the growth in
depreciation and amortization expense, which has caused depreciation and
amortization expense as a percentage of revenues to decrease to 6% in 1996,
from 7% in 1995 and 8% in 1994. The Company's revenue growth out-paced the
growth in the cost of additional Network and other capital assets, due to LCI's
ability to take advantage of improved technology with higher capacity at lower
costs.
OPERATING INCOME. Operating income increased 74% to $143.5 million in 1996 and
62% to $82.6 million in 1995 from $50.9 million in 1994. As a percentage of
revenues, operating income increased to 13%, 12% and 11% for the years ended
December 31, 1996, 1995 and 1994, respectively, reflecting the management of
the unit cost of services and selling, general and administrative expenses
during a period of significant growth in revenues and MOUs.
OTHER (INCOME)EXPENSE, NET
Other income, net of other expenses, was $.3 million in 1996 compared to $.9
million in 1995. Other income, net for the year ended December 31, 1996,
includes a gain on the sale of a wholly owned CTG subsidiary which provided
service to non-strategic geographic locations. In 1995, other income included a
gain related to the resolution of the STN Incorporated (STN) investment. In
1994, other expense, net, was $59.8 million, primarily a result of the
nonrecurring charge of $62.5 million relating to the loss of the STN
investments and accrued loss contingencies related to STN obligations.
INTEREST EXPENSE, NET
Interest expense, net of capitalized interest, increased to $28.8 million in
1996 from $16.3 million in 1995 and $8.8 million in 1994. Increased interest
expense in 1996 was primarily the result of higher levels of outstanding debt
and capital leases throughout 1996 as compared to 1995. The Company's
acquisitions of Teledial America, ATS and PACE increased outstanding debt by
$120 million in 1996. The proceeds from the sale of accounts receivable through
the Accounts Receivable Securitization Program (Securitization Program), in the
third and fourth quarters of 1996, were used to decrease the outstanding debt
to $235.8 million at December 31, 1996. The Company's acquisitions and capital
expenditures during 1995 increased outstanding debt and capital leases to
$274.7 million at December 31, 1995, from $144.8 million at December 31, 1994.
The effective weighted average interest rate on all indebtedness outstanding
was 8.24% in 1996, as compared to 8.20% in 1995 and 7.35% in 1994. The Company
expects lower interest rates due to the reduction of the outstanding balances
under the Revolving Credit Facility (Credit Facility) for a full year in 1997.
INCOME TAXES
Income tax expense was $40.2 million and $16.4 million in 1996 and 1995,
respectively, and a benefit of $24.5 million in 1994. Increased income tax
expense resulted from an increase in the effective tax rate to 35% in 1996 from
24% in 1995 and the increase in income before income taxes for the year ended
December 31, 1996 as
7
8
Excerpt from 1996 Annual Report to Shareowners
compared to the same period in 1995. The effective income tax rate was lower
than the statutory rate in 1996 and 1995 and was a benefit in 1994, primarily
due to the Company's expected utilization of available net operating losses
(NOLs). Previously generated NOLs for financial reporting purposes have been
fully realized as of December 31, 1996. (See Note 10 to the Consolidated
Financial Statements.)
PREFERRED DIVIDENDS
Preferred dividends were $2.8 million, $5.7 million and $5.8 million for 1996,
1995 and 1994, respectively, as a result of the dividend requirements on the
Company's previously outstanding 5% Cumulative Convertible Exchangeable
Preferred Stock (Preferred Stock). During 1996, nearly all of the 4.6 million
shares of Preferred Stock outstanding at December 31, 1995 were converted into
shares of the Company's Common Stock, par value $.01 per share (Common Stock).
On September 3, 1996, the remaining shares of Preferred Stock were redeemed by
the Company. The conversion of Preferred Stock will result in an annual savings
of $5.8 million, based upon the original 4.6 million shares issued in August
1993.
NET INCOME AND EARNINGS PER COMMON SHARE
Net income increased to $74.8 million for 1996, $50.8 million for 1995 and $6.8
million for 1994. Income on common stock was $72.0 million, $45.1 million and
$1.0 million for 1996, 1995 and 1994, respectively.
For the years ended December 31, 1996 and 1995, the earnings per common share
were calculated as net income before preferred dividends divided by the
weighted average number of common shares. For the year ended December 31, 1994,
the earnings per common share were calculated as the income on common stock
divided by the weighted average number of common shares. For the years ended
December 31, 1996 and 1995, the weighted average number of common shares
included the assumed conversion of any Preferred Stock then outstanding during
any point in the period, into 12.1 million shares of Common Stock. For the
years ended December 31, 1994, the assumed conversion of the Preferred Stock
into Common Stock was excluded from the weighted average number of common
shares as such stock was anti-dilutive. For all years presented, Common Stock
equivalents were reflected in the weighted average number of common shares
using the treasury stock method. (See Note 2 to the Consolidated Financial
Statements.)
LIQUIDITY AND CAPITAL RESOURCES
LCI International, Inc. is a holding company and conducts its operations
through its direct and indirect wholly owned subsidiaries. LCI SPC I, Inc.
(SPC) is a wholly owned subsidiary of LCI and facilitates the Securitization
Program. Except in certain limited circumstances, SPC is subject to certain
contractual prohibitions concerning the payment of dividends and the making of
loans and advances to LCI. There are, however, no restrictions on the movement
of cash within the remainder of 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 consolidated
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 $303.7 million of cash from operations, which includes the
proceeds of $112.0 million from the Securitization Program for the year ended
December 31, 1996. Cash provided from operations, excluding the proceeds from
the Securitization Program, was $188.1 million, compared to $53.9 million and
$38.1 million for 1995 and 1994, respectively. The increase in 1996, as well as
in 1995 and 1994, 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 during 1996 when compared to 1995 and 1994.
8
9
Excerpt from 1996 Annual Report to Shareowners
CASH FLOWS -- INVESTING ACTIVITIES
The Company has supported its growth strategy with both capital additions and
acquisitions. In 1996, the Company spent $144.3 million in capital expenditures
to acquire additional switching, transmission and distribution capacity, as
well as to develop information systems support. Capital expenditures increased
$47.0 million in 1996 when compared to 1995, and increased $31.3 million in
1995 when compared to 1994. The Company's acquisitions of Teledial America, ATS
and PACE, as well as other intangible assets, resulted in the use of $124.6
million in cash for the year ended December 31, 1996. In 1995, the Company
spent $66.4 million to acquire CTG and $97.3 million for capital additions. In
1994, the Company spent $7.9 million for acquisitions and $66.0 million for
capital expenditures. The remaining investing activities in 1995 and 1994
reflect the payment for the investment in STN.
CASH FLOWS -- FINANCING ACTIVITIES
In 1996, financing activities used a net $34.8 million. During 1996, the
Company experienced net borrowing of $70.7 million under its debt agreements,
to fund its acquisitions and capital expenditures as discussed in investing
activities, above. The net borrowings were offset by the $112.0 million in
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. In 1995 and 1994, financing activities provided a net
$121.8 million and $67.3 million, respectively, primarily from borrowings under
the Credit Facility.
CAPITAL RESOURCES
In February 1996, the Company obtained a $700 million Credit Facility with a
syndicate of banks, which allows the Company to borrow funds on a daily basis.
As a result, the Company uses its available cash to reduce the balance of its
Credit Facility and maintains no cash on hand. Under the Credit Facility, the
Company had $215.0 million and $260.7 million outstanding and $10.0 million and
$10.4 million reserved for letters of credit issued for various business
matters, as of December 31, 1996 and 1995, respectively. As of December 31,
1996 and 1995, respectively, the Company had $475.0 million and $178.9 million
available under the Credit Facility.
The amount that can be borrowed under the Credit Facility is subject to
reduction based on the outstanding balance beginning June 30, 1998 until
maturity on March 31, 2001. The interest rate on the debt outstanding is
variable based on several indices. (See Note 5 to the Consolidated Financial
Statements.) The weighted average interest rates on the debt outstanding under
the Credit Facility were 6.09% and 6.88% on December 31, 1996 and 1995,
respectively. The Credit Facility contains certain balance sheet, operating
cash flow, capital expenditure and negative covenant requirements. As of
December 31, 1996, the Company was in compliance with all covenants.
In September 1996, the Company entered into two separate discretionary line of
credit agreements (Lines of Credit) with commercial banks for a total of $50
million. The Lines of Credit provide flexible short-term borrowing facilities
at competitive rates. As of December 31, 1996, $8.0 million was outstanding on
the Lines of Credit.
In August 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 sell 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. As of December 31, 1996, the pool of trade
accounts receivable that was available for sale totaled approximately $120
million, and the amount of receivables sold totaled $112.0 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. The Company has not yet determined
when or if any new capital financing will be completed.
9
10
Excerpt from 1996 Annual Report to Shareowners
CAPITAL REQUIREMENTS
During 1997, the Company expects that its non-binding commitment for capital
expenditures (excluding acquisitions) will increase from the 1996 levels and
are dependent on the Company's geographic and revenue growth. These capital
requirements are primarily for switching and transmission facilities,
technology platforms and information systems applications. In addition to its
ongoing capital requirements, the Company entered into an agreement, in
February 1997, to extend its Network. This commitment will extend the Company's
fiber-optic network by over 3,100 route miles, and is expected to require
capital expenditures of approximately $120 million, including equipment.
The Company has relied upon strategic acquisitions as one 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 or
complete acquisition agreements on acceptable terms.
In May 1996, the Company entered into two separate agreements with a
third-party sales agent and an affiliated party to this agent. In consideration
for the contract extensions, as well as exclusivity and non-compete provisions
in the agreements, the Company has made and will make payments on various
designated dates over several years in accordance with the two agreements.
Certain of these payments are contingent upon achievement of defined
performance measures. The Company believes that these payments, if required,
can be funded by operations or borrowing capacity under the Credit Facility.
During 1996, the Company executed lease agreements for a new corporate
headquarters and an additional facility for its operating subsidiaries. The
agreement for the new corporate headquarters building is a three-year operating
lease with a maximum residual guarantee payment at the end of the lease term.
The agreement for the facility for the operating subsidiaries is a capital
lease. Occupancy for the subsidiaries' facility will begin in mid-1997 and
extend for a 15-year term. (See Note 6 to the Consolidated Financial
Statements.)
COMMITMENTS AND CONTINGENCIES
The Company has agreements with certain interexchange carriers, LECs and
third-party vendors to lease facilities for originating, terminating and
transporting services. These agreements require the Company to maintain minimum
monthly and/or annual billings based on usage. The Company has met and expects
to continue to meet such minimum usage requirements. The third-party carriers
include WorldCom Network Services, Inc. d/b/a WilTel, Sprint and MCI. In
addition, the Company uses services provided by each RBOC, GTE and other smaller
LECs. The Company currently has one significant contract with a third-party
carrier. Subject to the ability of that carrier to meet the Company's
operational requirements, the Company is obligated to use this carrier for a
significant percentage of services that the Company provides through its leased
facilities. The amounts payable under that contract, however, represent less
than 10% of the Company's revenue on an annual basis. (See Note 7 to the
Consolidated Financial Statements.) 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, neither the Company nor the industry has
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 Consolidated Financial Statements.)
10
11
Excerpt from 1996 Annual Report to Shareowners
FEDERAL INCOME TAXES
The Company generated significant NOLs in prior years that are available to
reduce current cash requirements for income taxes. See Note 10 of the
Consolidated Financial Statements for a discussion of the availability and
utilization of the NOLs.
IMPACT OF INFLATION AND SEASONALITY
The Company does not believe that the relatively moderate levels of inflation
that have been experienced in the United States in recent years have had a
significant effect on its revenues or earnings.
The Company's long-distance revenue is subject to seasonal variations based on
each 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 revenues increase as a proportion of the Company's
total revenues, the seasonal impact due to changes in commercial calling
patterns will be reduced.
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 future outlook; the Company's plans to enter
the local-service market; the effect of FCC and judicial rulings pertaining to
the Telecommunications Act of 1996, local-service competition and RBOC entry
into the long-distance market; the impact of marketplace competition on pricing
strategies and rates; expected revenue growth; the cost reduction strategies and
opportunities to expand the Network which may allow for increased gross margin;
the expected future interest rates and interest savings from 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 interLATA 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; the availability of leased capacity to support
the Company's geographic expansion; the ability to negotiate appropriate
local-service agreements with LECs; and other risks described from time to time
in the Company's periodic filings with the Securities and Exchange Commission.
The Company is not required to publicly release any changes to these
forward-looking statements for events occurring after the date hereof or to
reflect other unanticipated events.
OTHER MATTERS
ACCOUNTING PRONOUNCEMENTS NOT YET EFFECTIVE
A new accounting pronouncement on accounting for transfers and servicing of
financial assets was issued in 1996 and is effective for fiscal years beginning
after December 15, 1996. As explained in Note 2 to the Consolidated Financial
Statements, the Company does not expect any significant impact from the
adoption of this pronouncement.
11
12
Excerpt from 1996 Annual Report to Shareowners
REPORT OF MANAGEMENT
The management of LCI International, Inc. is responsible for the preparation of
all information, including the financial statements and related notes, included
in this Annual Report. The financial statements have been prepared in
conformity with generally accepted accounting principles appropriate in the
circumstances, and include amounts based on the best judgment of management.
Financial information included elsewhere in this Annual Report is consistent
with these financial statements.
In recognition of its responsibility for the integrity and objectivity of data
in the financial statements, management maintains a system of internal
accounting controls. This system has been established to ensure, within
reasonable limits, that assets are safeguarded, that transactions are properly
recorded and executed in accordance with management's authorization and that
accounting records provide a solid foundation from which to prepare the
financial statements. The system is supported by an internal auditing function
which assesses the effectiveness of internal controls and reports its findings
to management throughout the year. It is recognized that no system of internal
controls can detect and prevent all errors and irregularities. Management
believes that the established system provides an acceptable balance between
benefits to be gained and their related costs.
The Company's independent public accountants are engaged to express an opinion
on the year-end financial statements. As part of their audit of the Company's
1996 financial statements, they considered the Company's system of internal
controls to the extent they deemed necessary to determine the nature, timing
and extent of their audit tests.
The Audit Committee of the Board of Directors meets regularly with the
independent public accountants and management to review the work performed and
to ensure that each is properly discharging its responsibilities. The
independent public accountants have full and free access to the Audit
Committee, without the presence of management, to discuss the results of their
audits, internal accounting controls and financial reporting.
Joseph A. Lawrence Jeffrey H. VonDeylen
Senior Vice President - Corporate Controller
Finance and Development
and Chief Financial Officer
12
13
Excerpt from 1996 Annual Report to Shareowners
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREOWNERS OF LCI INTERNATIONAL, INC.:
We have audited the accompanying consolidated balance sheets of LCI
International, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1996 and 1995, and the related consolidated statements of operations,
shareowners equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of LCI International, Inc. and
subsidiaries, as of December 31, 1996 and 1995, and the results of their
operations and cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
February 6, 1997
13
14
Excerpt from 1996 Annual Report to Shareowners
LCI International, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Millions Except for Earnings per Common Share)
For the Year Ended December 31,
1996 1995 1994
- -----------------------------------------------------------------------------------------------------
REVENUES $ 1,103.0 $ 672.9 $ 464.0
Cost of Services 642.3 396.2 274.3
- -----------------------------------------------------------------------------------------------------
GROSS MARGIN 460.7 276.7 189.7
Selling, General and Administrative Expenses 253.7 150.1 102.7
Depreciation and Amortization 63.5 44.0 36.1
- -----------------------------------------------------------------------------------------------------
OPERATING INCOME 143.5 82.6 50.9
Other (Income) Expense, Net (.3) (.9) 59.8
Interest Expense, Net 28.8 16.3 8.8
- -----------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES 115.0 67.2 (17.7)
Income Tax Expense (Benefit) 40.2 16.4 (24.5)
- -----------------------------------------------------------------------------------------------------
NET INCOME 74.8 50.8 6.8
Preferred Dividends 2.8 5.7 5.8
- -----------------------------------------------------------------------------------------------------
INCOME ON COMMON STOCK $ 72.0 $ 45.1 $ 1.0
- -----------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
PRIMARY $ 0.86 $ 0.63 $ 0.02
- -----------------------------------------------------------------------------------------------------
FULLY DILUTED $ 0.86 $ 0.62 $ 0.02
- -----------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Primary 87.3 81.0 65.5
Fully Diluted 87.3 82.1 66.7
The accompanying notes are an integral part of these statements.
14
15
Excerpt from 1996 Annual Report to Shareowners
LCI International, Inc.
CONSOLIDATED BALANCE SHEETS
(In Millions)
December 31,
- ----------------------------------------------------------------------------------------------------------------
1996 1995
- ----------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Trade Accounts Receivable, Less Allowance for Doubtful Accounts
of $23.4 and $9.8 for 1996 and 1995, Respectively $ 85.2 $ 161.6
Current Deferred Tax Assets, Net 48.9 23.1
Prepaids and Other 16.4 19.6
- ----------------------------------------------------------------------------------------------------------------
Total Current Assets 150.5 204.3
- ----------------------------------------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT
Fiber-Optic Network 392.5 357.3
Technology Platforms, Equipment and Building Lease 123.2 90.8
Less - Accumulated Depreciation and Amortization (171.8) (181.4)
- ----------------------------------------------------------------------------------------------------------------
343.9 266.7
Plant Under Construction 58.9 35.3
- ----------------------------------------------------------------------------------------------------------------
Total Property, Plant and Equipment, Net 402.8 302.0
- ----------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Excess of Cost over Net Assets Acquired, Net of
Accumulated Amortization of $25.8 and $16.8
for 1996 and 1995, Respectively 350.5 245.6
Other, Net 46.2 21.5
- ----------------------------------------------------------------------------------------------------------------
Total Other Assets 396.7 267.1
- ----------------------------------------------------------------------------------------------------------------
Total Assets $ 950.0 $ 773.4
- ----------------------------------------------------------------------------------------------------------------
15
16
Excerpt from 1996 Annual Report to Shareowners
December 31,
- -----------------------------------------------------------------------------------------------------------------
1996 1995
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREOWNERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 37.1 $ 39.2
Facility Costs Accrued and Payable 123.0 66.7
Accrued Expenses and Other 53.3 22.0
- -----------------------------------------------------------------------------------------------------------------
Total Current Liabilities 213.4 127.9
- -----------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 235.8 274.7
- -----------------------------------------------------------------------------------------------------------------
OTHER LIABILITIES AND DEFERRED CREDITS 70.0 26.0
- -----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
SHAREOWNERS' EQUITY
Preferred Stock - Authorized 15 Shares, Issued and
Outstanding 4.6 Shares in 1995 -- 114.5
Common Stock - Authorized 300 Shares, Issued and
Outstanding 77.5 Shares in 1996 and Authorized 100 Shares,
Issued and Outstanding 64.4 Shares in 1995 .8 .6
Paid-in Capital 427.2 298.9
Retained Earnings (Deficit) 2.8 (69.2)
- -----------------------------------------------------------------------------------------------------------------
Total Shareowners' Equity 430.8 344.8
- -----------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareowners' Equity $ 950.0 $ 773.4
- -----------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
16
17
Excerpt from 1996 Annual Report to Shareowners
LCI International, Inc.
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(In Millions)
Preferred Common
Stock Stock
--------- ----------------------- Retained Total
$.01 Par Issued and $.01 Par Paid-in Earnings Shareowners'
Value Outstanding Value Capital (Deficit) Equity
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1993 $ 115.0 58.5 $ .6 $195.0 $(115.3) $195.3
- -------------------------------------------------------------------------------------------------------------------------
Employee Stock Purchases and
Exercise of Options/Warrants,
Including Related Tax Benefit -- .5 -- 2.1 -- 2.1
STN Incorporated Stock Exchange -- .3 -- 3.0 -- 3.0
Other -- -- -- .4 -- .4
Net Income -- -- -- -- 6.8 6.8
Preferred Dividends -- -- -- -- (5.8) (5.8)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 $ 115.0 59.3 $ .6 $200.5 $(114.3) $201.8
- -------------------------------------------------------------------------------------------------------------------------
Acquisition of CTG, Inc. -- 4.6 -- 93.1 -- 93.1
Employee Stock Purchases and
Exercise of Options/Warrants,
Including Related Tax Benefit -- .4 -- 4.8 -- 4.8
Conversion/Redemption of
Preferred Stock (.5) .1 -- .5 -- --
Net Income -- -- -- -- 50.8 50.8
Preferred Dividends -- -- -- -- (5.7) (5.7)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 $ 114.5 64.4 $ .6 $298.9 $ (69.2) $344.8
- -------------------------------------------------------------------------------------------------------------------------
Employee Stock Purchases and
Exercise of Options/Warrants,
Including Related Tax Benefit -- 1.0 -- 14.0 -- 14.0
Conversion/Redemption of
Preferred Stock (114.5) 12.1 .2 114.3 -- --
Net Income -- -- -- -- 74.8 74.8
Preferred Dividends -- -- -- -- (2.8) (2.8)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 $ -- 77.5 $ .8 $427.2 $ 2.8 $430.8
- -------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
17
18
Excerpt from 1996 Annual Report to Shareowners
LCI International, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Millions)
For the Year Ended December 31,
- --------------------------------------------------------------------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $ 74.8 $ 50.8 $ 6.8
Adjustments to Net Income:
Depreciation and Amortization 63.5 44.0 36.1
Provision for Bad Debt 15.8 8.2 5.8
Change in Deferred Taxes 36.4 (1.2) (30.7)
Loss Contingencies and Other Charges -- -- 62.5
Change in Assets/Liabilities:
Trade Accounts Receivable (59.0) (71.3) (35.6)
Net Securitization Activity 112.0 -- --
Accounts Payable and Facility Costs Accrued and Payable 49.0 20.9 1.4
Other Assets/Liabilities 7.6 2.5 (8.2)
- --------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 300.1 53.9 38.1
- --------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Capital Expenditures - Property, Plant and Equipment (144.3) (97.3) (66.0)
Payment for Acquisitions and Other (121.0) (66.4) (7.9)
Payments for STN Incorporated -- (12.0) (31.5)
- --------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (265.3) (175.7) (105.4)
- --------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net Debt (Payments) Borrowings (41.3) 122.8 70.9
Preferred Dividend Payments (2.8) (5.8) (5.7)
Proceeds from Employee Stock Plans and Warrants 9.3 4.8 2.1
- --------------------------------------------------------------------------------------------------------------
Net Cash (Used in) Provided by Financing Activities (34.8) 121.8 67.3
- --------------------------------------------------------------------------------------------------------------
Change in Cash and Cash Equivalents -- -- --
- --------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at the Beginning of the Year -- -- --
- --------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at the End of the Year $ -- $ -- $ --
- --------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid for Interest $ 26.1 $ 15.1 $ 8.8
- --------------------------------------------------------------------------------------------------------------
Cash Paid for Income Taxes $ 1.3 $ 2.9 $ 1.1
- --------------------------------------------------------------------------------------------------------------
NON-CASH ACTIVITY:
During 1996, shareowners converted 4.6 million shares of Preferred Stock into
12.1 million shares of Common Stock. In September 1995, the Company issued 4.6
million shares of its Common Stock as partial consideration to purchase CTG,
with a market value of approximately $93.2 million. The reconciliation of net
income to net cash provided by operating activities is net of assets purchased
and liabilities assumed through the acquisition.
The accompanying notes are an integral part of these statements.
18
19
Excerpt from 1996 Annual Report to Shareowners
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS ORGANIZATION AND PURPOSE
The financial statements presented herein include the consolidated balance
sheets of LCI International, Inc., a Delaware corporation, and its wholly owned
subsidiaries (LCI or the Company) as of December 31, 1996 and 1995, and the
related consolidated statements of operations, shareowners' equity and cash
flows for the three years ended December 31, 1996.
LCI is a facilities-based telecommunications carrier that provides a broad
range of domestic and international voice and data services offerings to the
commercial, wholesale and residential/small business market segments. The
Company serves its customers primarily through leased and owned digital
fiber-optic facilities.
2. ACCOUNTING POLICIES
ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. The Company uses its
available cash to reduce the balance of its Revolving Credit Facility (Credit
Facility) and generally maintains no cash on hand.
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable represent amounts due from customers for
telecommunications services. Switched revenues include amounts recognized for
services provided, but not yet billed. A portion of the residential accounts
receivable balance is billed through local exchange carriers (LECs) who are
responsible for the collection of these accounts. The Company receives
information from the LECs about uncollectible accounts three to thirteen months
after the account is billed. The Company's reserve includes an estimate for
these future uncollectible accounts.
ACCOUNTS RECEIVABLE SECURITIZATION PROGRAM
In accordance with Statement of Financial Accounting Standards (SFAS) No. 77,
"Reporting by Transferors for Transfers of Receivables with Recourse," the
transfers of receivable balances meet the criteria to be classified as a sale
for accounting purposes. As such, amounts sold under the Accounts Receivable
Securitization Program (Securitization Program) are not included in the
accompanying consolidated financial statements. The costs of the Securitization
Program are included in other (income) expense, net in the accompanying
consolidated statements of operations. The cash proceeds are included in
operating activities, while the use of the proceeds are included in financing
activities in the accompanying consolidated statements of cash flows.
PREPAIDS AND OTHER
Prepaids and other assets include deferred customer promotion costs that are
amortized over the life of the related contracts, and various other accounts
and notes receivable expected to be received within the next year.
19
20
Excerpt from 1996 Annual Report to Shareowners
PROPERTY, PLANT AND EQUIPMENT
These assets are stated at cost or at fair market value if obtained as part of
an acquisition. Construction costs include material, labor, interest and
overhead for certain general and payroll related costs. Property, plant and
equipment as of December 31, 1996 and 1995, includes the net book value of $9.3
million and $10.2 million for a capitalized building lease for the Company's
operating subsidiaries' headquarters. Routine repairs and maintenance of
property and replacements of minor items are charged to expense as incurred.
Depreciation of buildings and equipment is provided using the composite method
over the estimated useful lives of these assets. The cost of equipment retired
in the ordinary course of business, less proceeds, is charged to accumulated
depreciation. The capitalized building lease is amortized on a straight-line
basis over the term of the lease.
The estimated depreciation and amortization periods by asset type are as
follows:
Asset Category Years
- -----------------------------------------------------------
Fiber Optic Network:
Outside Plant and Buildings 30
Transmission, Distribution and Switching 10
Installations 3
Technology Platforms 5
Information Systems - Hardware and Software 3 - 5
General Office Equipment 5 - 10
Capitalized Building Lease 15
EXCESS OF COST OVER NET ASSETS ACQUIRED
Excess of cost over net assets acquired (goodwill) consists of the excess of
the cost to acquire an entity over the estimated fair market value of the net
assets acquired. Goodwill is amortized on a straight-line basis over 40 years.
The Company continually evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful life of goodwill may
warrant revision or that the remaining balance of goodwill may not be
recoverable. In evaluating whether goodwill is recoverable, the Company
estimates the sum of the expected future cash flows, undiscounted and without
interest charges, derived from such goodwill over its remaining life. The
Company believes that no such impairment existed at December 31, 1996.
Amortization of goodwill was $9.2 million, $4.0 million and $2.8 million for
the years ended December 31, 1996, 1995 and 1994, respectively.
OTHER ASSETS
Other assets consist of debt issuance costs, rights of way, customer lists,
non-compete agreements and other deferred costs. Other assets as of December
31, 1995 included a net deferred tax asset of $8.8 million. Debt issuance costs
are amortized over the life of the applicable debt agreements. Rights-of-way
costs are amortized over the life of the respective agreements. Customer lists
and non-compete agreements are amortized over the estimated life or contract
term of the customer list or non-compete agreement.
OTHER LIABILITIES AND DEFERRED CREDITS
Other liabilities and deferred credits primarily include long-term deferred
income taxes and other long-term liabilities. As of December 31, 1996, net
long-term deferred tax liabilities of $53.4 million were included in other
liabilities and deferred credits.
REVENUE RECOGNITION
Telecommunications revenues are recognized when services are provided and are
net of estimated credits and uncollectible amounts.
ADVERTISING COST
Costs for advertising are expensed as incurred within the fiscal year.
20
21
Excerpt from 1996 Annual Report to Shareowners
INCOME TAXES
The Company follows SFAS No. 109 "Accounting for Income Taxes." (See Note 10.)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND EARNINGS PER COMMON SHARE
The weighted average number of common shares used to calculate earnings per
common share included the Company's Common Stock, par value $.01 per share
(Common Stock) and Common Stock equivalents. Common Stock equivalents include
Common Stock issuable pursuant to stock options and Common Stock warrants.
During 1996, substantially all of the previously outstanding 5% Cumulative
Convertible Exchangeable Preferred Stock, par value $.01 per share (Preferred
Stock), was converted into Common Stock. For 1996 and 1995, the weighted
average number of common shares included the assumed conversion of any
Preferred Stock then outstanding during any point in the period. In 1994, the
assumed conversion of the Preferred Stock into Common Stock was excluded from
the weighted average number of common shares as such stock was anti-dilutive.
For all years presented, outstanding stock options and Common Stock warrants
were reflected in the weighted average number of common shares using the
treasury stock method. The primary weighted average number of common shares was
calculated using the average daily closing price of the Common Stock for the
period. The fully diluted weighted average number of common shares was
calculated using the higher of the end of the period closing price of the
Common Stock or the average daily closing price of the Common Stock.
For 1996 and 1995, earnings per common share are calculated as net income
before preferred dividends divided by the weighted average number of common
shares, as defined above. For 1994, earnings per common share are calculated as
the income on common stock divided by the respective weighted average number of
common shares, as defined above.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of current assets and liabilities approximate their fair
market value because of the short- term maturity of these financial
instruments. The fair market value of long-term debt is discussed further in
Note 5.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of trade accounts receivable. The risk is
limited due to the number of market segments, the large number of entities
comprising the Company's customer base and the dispersion of those entities
across many different industries and geographic regions. As of December 31,
1996, the Company had no significant concentrations of credit risk.
RECLASSIFICATIONS
Certain reclassifications have been made to the consolidated financial
statements for 1995 and 1994 to conform with the 1996 presentation.
ACCOUNTING PRONOUNCEMENTS NOT YET EFFECTIVE
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." SFAS 125 is required for financial statements for fiscal years
beginning after December 15, 1996; earlier adoption is not permitted. The
Securiti-zation Program was structured to comply with the provisions of SFAS
125, which the Company will adopt in 1997, and accordingly, the Company does
not expect any significant impact to its results of operations or financial
condition from adoption of this statement.
3. ACQUISITIONS
The Company has supplemented growth from its base business with several
strategic acquisitions. Each acquisition over the last three years was
accounted for as a purchase.
In June 1996, the Company purchased the long-distance business assets of
Pennsylvania Alternative Communications, Inc. (PACE). The results of operations
for PACE were included in the Company's consolidated
21
22
Excerpt from 1996 Annual Report to Shareowners
statement of operations from June 1, 1996 and the acquisition was not
considered significant for financial reporting purposes.
In January 1996, the Company purchased the long-distance business assets of
Teledial America, Inc. (Teledial America), which did business as U.S. Signal
Corporation, and an affiliated company, ATS Network Communications, Inc. (ATS).
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 milestones over an 18-month period
commencing at the closing date. The amount of goodwill recorded in the purchase
transactions was $98.8 million. The results of operations for Teledial America
and ATS were included in the consolidated statement of operations from January
1, 1996. The purchase of ATS was not considered significant for financial
reporting purposes.
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 United States. Under the terms of the
agreement, the Company acquired all of the outstanding shares of CTG and shares
underlying certain outstanding warrants in exchange for $44.5 million in cash
and 4.6 million shares of the Company's Common Stock valued at $20.25 per
share, the market price on the date of the acquisition. In conjunction with the
transaction, the Company assumed approximately $24 million in debt, of which
$21.9 million was refinanced. The amount of goodwill recorded in the purchase
transaction was $156.6 million. The consolidated statements of operations
include the results of CTG from September 1, 1995.
The following unaudited pro forma summary presents the revenues, net income and
earnings per common share from the combination of the operations of the Company
and its significant acquisitions during the periods -- CTG and Teledial
America. The pro forma information is provided as if each acquisition had
occurred at the beginning of both the fiscal year of the purchase and the
immediately preceding fiscal year. Pro forma information is not provided for
1996, as both acquisitions were included in the consolidated results of
operations from January 1, 1996. The pro forma information is provided for
informational purposes only. It is based on historical information and does not
necessarily reflect the actual results that would have occurred, nor is it
necessarily indicative of the future results of operations of the combined
enterprise.
(In Millions Except Earnings per Unaudited Pro Forma Information
Common Share Amounts) for the Years Ended December 31,
- -----------------------------------------------------------------------
1995 1994
- -----------------------------------------------------------------------
Net Revenues $ 814.7 $ 520.0
Net Income 54.0 0.5
Earnings per Common Share $ 0.63 $ 0.01
During the fourth quarter of 1994, the Company recognized a loss of $62.5
million on its investment in STN Incorporated (STN). This loss, recorded in
other (income) expense, net in the accompanying consolidated statement of
operations, included $47.6 million for the full impairment of the STN
investments and $14.9 million for accrued loss contingencies related to future
STN obligations.
4. ACCOUNTS RECEIVABLE SECURITIZATION
In August 1996, the Company entered into an agreement to sell a percentage
ownership interest in a defined pool of its trade accounts receivable
(Securitization Program). LCI SPC I, Inc. (SPC), a wholly owned, bankruptcy-
remote subsidiary of the Company, was formed to execute 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 December 31, 1996, the pool of trade accounts receivable that were
available for sale totaled approximately $120 million. The amount of
receivables sold, but not yet collected at December 31, 1996, totaled $112
million and the proceeds were used to reduce the outstanding balance of the
Company's long-term debt. Total proceeds from the sale of accounts receivable
during the year was $535 million. The accounts receivable balances sold are not
included in the
22
23
Excerpt from 1996 Annual Report to Shareowners
accompanying consolidated balance sheet at December 31, 1996. The cost of the
Securitization Program is based on a discount rate equal to the short-term
commercial paper rate plus certain fees and expenses. The Company retains
substantially all the same risk of credit loss as if the receivables had not
been sold, and has established reserves for such estimated credit losses.
Under the Securitization Program agreement, 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 5.) Except in certain limited
circumstances, SPC is subject to certain contractual prohibitions concerning
the payment of dividends and the making of loans and advances to LCI.
5. DEBT
CREDIT FACILITY
The Company can borrow up to $700 million from a syndicate of banks under the
Credit Facility. The amount that can be borrowed under the Credit Facility is
subject to reduction based on the outstanding balance, beginning on June 30,
1998, 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 rates
on the outstanding borrowings under the Credit Facility as of December 31, 1996
and 1995 were 6.09% and 6.88%, respectively. The Credit Facility contains
various financial covenants, the most restrictive being the leverage ratio
requirement. As of December 31, 1996 and 1995, the Company was in compliance
with all Credit Facility covenants and had $215.0 million and $260.7 million,
respectively, outstanding under the Credit Facility. The carrying amount of the
Credit Facility approximates its fair value as the underlying instruments are
variable rate notes that reprice frequently.
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.
In November 1996, the Company entered into an interest rate swap agreement for
a one-year period. The agreement, with two commercial banks, is on a $100
million notional principal balance of the Credit Facility. Under the agreement,
the Company makes a fixed-rate payment to the banks at an interest rate of
5.58% in exchange for the receipt of a payment from the banks based on a
variable interest rate. As of December 31, 1996, the fair value of the
agreement was not material. In an event of non-performance by a commercial
bank, the Company would be required to make interest payments in accordance
with the Credit Facility. The Company believes that the probability of such an
event is remote.
LINES OF CREDIT
During 1996, the Company obtained two separate discretionary lines of credit
(Lines of Credit) for a total of $50 million. The Lines of Credit bear interest
at a rate dependent upon a market indicator. The interest rate as of December
31, 1996 on the $8.0 million outstanding balance under the Lines of Credit was
5.93%. The outstanding balance in the accompanying consolidated balance sheets
is reflected in long-term debt, due to the availability under the Credit
Facility.
6. LEASES
The Company's capital leases primarily include its operating subsidiaries'
headquarters building lease, which expires in 2005. The noncurrent portion of
capital lease obligations was $12.9 and $14.2 million as of December 31, 1996
and 1995, respectively. The Company has operating leases for office space and
equipment with lease terms from three to ten years with options for renewals.
The Company has entered into several rights-of-way (ROW) lease agreements that
allowed for installation of its fiber-optic network facilities. The terms of
these
23
24
Excerpt from 1996 Annual Report to Shareowners
agreements range from one to 30 years, and most contain renewal options. These
agreements also provide for rental payments to be made for use of other land
and buildings occupied in connection with the ROW agreements, maintenance and
repairs.
During 1996, the Company entered into an operating lease agreement for the
rental of a new corporate headquarters being developed in suburban Virginia.
This agreement has a three-year base term with two options to renew for one
year each. The agreement includes a maximum residual guarantee which is
included in the minimum lease payments, below. The property will be owned by an
unrelated entity that will lease the facility to the Company. Financing for the
project will be provided by a syndicate of banks. Also during 1996, the Company
executed a $19 million capital lease agreement for an additional headquarters
facility for its operating subsidiaries. The lease term begins July 1997 and,
therefore, is not included in the capital lease schedule.
Total expenses for operating leases for the years ended December 31, 1996, 1995
and 1994 were $10.0 million, $6.1 million and $4.2 million, respectively. The
Company is required, at a minimum, to make the following payments on capital
and operating leases:
(In Millions) Capital Operating
- ---------------------------------------------------------------------
1997 $ 3.3 $ 12.9
1998 3.1 13.0
1999 2.6 65.5
2000 2.9 9.3
2001 2.9 7.4
Thereafter 11.3 34.3
- ---------------------------------------------------------------------
Total Minimum Lease Payments 26.1 $142.4
Less - Amounts Representing Interest 12.0 ----------
- ----------------------------------------------------
Capital Lease Obligations 14.1
Less - Amounts Due Within One Year 1.2
- ----------------------------------------------------
Noncurrent Portion of Capital
Lease Obligations $ 12.9
- ----------------------------------------------------
7. COMMITMENTS AND CONTINGENCIES
CAPITAL EXPENDITURES
During 1997, the Company expects that its nonbinding commitment for capital
expenditures (excluding acquisitions) will increase from the levels expended in
1996 and is dependent on the Company's geographic and revenue growth. The
Company's capital requirements are primarily for switching and transmission
facilities and technology platforms arising from the Company's strategic
expansion plans. In addition to its ongoing capital requirements, the Company
entered into an agreement, in February 1997, to extend its fiber-optic network.
This commitment will extend the Company's fiber-optic network by over 3,100
route miles, and is expected to require capital expenditures of approximately
$120 million, including equipment.
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. This contract has minimum annual usage requirements and an increasing
cumulative minimum usage requirement, which if not met, subjects the Company to
an underutilization charge. Through December 31, 1996, the Company had
significantly exceeded both 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 $4 million through 1997. The Company
has historically met all minimum billing requirements and believes that the
minimum usage commitments will be met in the future.
24
25
Excerpt from 1996 Annual Report to Shareowners
LEGAL MATTERS
In 1991, 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 in
Common Pleas Court, Franklin County, Ohio. The suit alleged age discrimination
by the Company. In 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 the 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 $.1 million in pre-judgment interest in
addition to the previous award. The Company appealed the matter to the Supreme
Court of Ohio (the Court). On December 11, 1996, the Court reversed the Court
of Appeals, finding that, as a matter of law, there was insufficient evidence
to sustain the verdict for Plaintiffs. In December 1996, the Plaintiffs filed
with the Court a Motion for Reconsideration, which was denied by the Court in
January 1997. At this time, the Company is unable to determine whether the
Plaintiffs will file a petition asking the United States Supreme Court to
consider the case.
The Company 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 that current or
threatened litigation matters will not have a material adverse impact on the
Company's results of operations or financial condition.
8. SHAREOWNERS' EQUITY
PREFERRED STOCK
On September 3, 1996, the remaining outstanding shares of the Company's
previously outstanding 5% Cumulative Convertible Exchangeable Preferred Stock
(Preferred Stock) were redeemed by the Company. Preferred dividends, cumulative
from the date of issuance, were paid quarterly at an annual rate of $1.25 per
share on the outstanding shares until redemption. Prior to redemption,
shareowners converted 4,599,895 shares of Preferred Stock into 12,104,661
shares of Common Stock.
In January 1997, the Board of Directors adopted a shareholder rights plan (the
Rights Plan). In order to implement the Rights Plan, the Board of Directors
declared a dividend of one preferred share purchase right (a Right) for each
share of the Company's Common Stock to shareowners of record on January 22,
1997. Each Right, when exercisable, represents the right to purchase one
one-thousandth of a share of a newly issued series of Preferred Stock of the
Company, designated as Junior Participating Preferred Stock, par value $.01 per
share, or, in certain circumstances, to purchase shares of Common Stock at less
than the prevailing market price. The exercise price is $100 per Right, the
redemption price is $.01 per Right, and the Right expires on January 22, 2007.
The Rights will be exercisable only in the event that any person or entity,
together with its affiliates or associates, acquires more than a certain
specified percentage of Common Stock of the Company. The Rights Plan was
designed to ensure that shareowners receive fair and equal treatment in the
event of any proposed takeover of the Company.
COMMON STOCK
In September 1995, the Company issued 4,601,586 shares of Common Stock to
purchase CTG at $20.25 per share, the market price at the date of acquisition.
COMMON STOCK WARRANTS
In 1993, the Company issued warrants for 5,408,900 shares of Common Stock, at
$2.83 per share, that expire in 2003. During 1996, 1995 and 1994, holders
exercised 164,336, 40,572 and 41,216 warrants for an aggregate amount of
148,253, 33,100 and 41,216 shares of Common Stock, respectively. As of December
31, 1996, there were 5,162,776 unexercised Common Stock warrants.
25
26
Excerpt from 1996 Annual Report to Shareowners
EMPLOYEE BENEFIT PLANS
The Company maintains a defined contribution retirement plan for its employees.
Under this plan, eligible employees may contribute a percentage of their base
salary, subject to certain limitations. Beginning in 1994, the Company elected
to match a portion of the employees' contributions. The expense of the
Company's matching contribution was $.7 million in 1996, $.6 million in 1995
and $.3 million in 1994. Under this plan, employees may purchase shares of
LCI's Common Stock at market prices. During 1996, 1995 and 1994, 63,200, 45,484
and 35,328 shares were issued under this plan at an average price of $27.76,
$15.62 and $9.32, respectively.
9. INCENTIVE STOCK PLANS
STOCK OPTIONS
The Company has stock option plans under which options to purchase shares of
Common Stock may be granted to directors and key employees. Under the plans,
the Company may grant incentive stock options (ISOs) as defined by the Internal
Revenue Code or non-qualified options (NQOs). Stock options generally have a
five-year vesting period. Twenty percent of each option granted generally
becomes exercisable on the first anniversary of the grant and 1.66% each month
thereafter for 48 months. In the event of a change in control of the Company,
all options outstanding would become 100% exercisable. Under the plans, options
expire up to 10 years after the date of the grant. Except in the case of ISOs,
the option price may be less than the fair market value of the Common Stock as
of the date of grant. The option price under all plans is fixed at the
discretion of an administrative committee of the Board of Directors at the time
of grant. During 1996, 1995 and 1994, the option price for all options granted
was the fair market value of the shares on the date of grant. The weighted
average fair value of options granted during 1996 and 1995 for the stock option
plans was $6.69 and $4.53, respectively, and for the ESPP was $9.48 and $7.17,
respectively. Shares of Common Stock underlying surrendered options may be
re-granted by the Board of Directors. As of December 31, 1996, there were
12,590,852 options authorized under the Company's stock option plans.
Information regarding these stock option plans is as follows:
Weighted
Number of Exercisable Average
Shares Options Exercise Price
- ----------------------------------------------------------------------------------------------
Outstanding as of December 31, 1993 4,167,316 1,466,448 $ 3.76
- ----------------------------------------------------------------------------------------------
Options Granted 1,813,600 9.07
Options Exercised (152,520) 2.69
Options Surrendered (456,520) 7.13
- ----------------------------------------------------------------------------------------------
Outstanding as of December 31, 1994 5,371,876 2,003,154 5.29
- ----------------------------------------------------------------------------------------------
Options Granted 2,799,798 12.91
Options Exercised (218,366) 4.88
Options Surrendered (340,522) 9.77
- ----------------------------------------------------------------------------------------------
Outstanding as of December 31, 1995 7,612,786 3,047,337 7.89
- ----------------------------------------------------------------------------------------------
Options Granted 2,352,000 23.14
Options Exercised (555,033) 6.91
Options Surrendered (431,810) 18.40
- ----------------------------------------------------------------------------------------------
Outstanding as of December 31, 1996 8,977,943 4,184,670 $ 11.48
- ----------------------------------------------------------------------------------------------
Options Available for Grant as of
December 31, 1996 2,686,090
- -----------------------------------------------------------
26
27
Excerpt from 1996 Annual Report to Shareowners
The following table presents information for the 8,977,943 options outstanding
as of December 31, 1996:
Options Outstanding Options Exercisable
- -----------------------------------------------------------------------------------------
Range of Number of Weighted Weighted Number of Weighted
Exercise Options Average Average Options Average
Price Exercise Contractual Exercise
Price Life (Years) Price
- -----------------------------------------------------------------------------------------
$ 0.17 - $ 2.83 1,837,464 $ 1.56 6.00 1,818,476 $ 1.55
$ 4.56 - $ 9.75 2,417,114 $ 7.54 6.83 1,448,604 $ 7.47
$ 9.94 - $11.22 1,942,537 $ 11.15 7.98 713,500 $ 11.15
$11.25 - $20.03 561,498 $ 16.39 8.56 161,349 $ 15.77
$20.53 - $35.13 2,192,500 $ 23.19 9.13 44,500 $ 26.77
- -----------------------------------------------------------------------------------------
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan (ESPP), which enables
substantially all employees to purchase shares of Common Stock on monthly
offering dates at a purchase price equal to the lesser of 85% of the fair
market value of the Common Stock on the date of its purchase, or 85% of the
fair market value of the Common Stock, as established at intervals from time to
time. In 1995, the Company's shareowners approved an extension of the ESPP
until no later than November 1997 or until shares authorized under the ESPP are
exhausted. A maximum of 1,800,000 shares of Common Stock were authorized for
purchase under the ESPP. During 1996, 1995 and 1994, 247,273, 192,396, and
218,638 shares were issued under the ESPP at an average price of $24.64, $11.59
and $5.88, respectively. As of December 31, 1996, the amount of Common Stock
available for issuance was 965,595 shares.
STOCK-BASED COMPENSATION PLANS
The Company follows the requirements of APB Opinion No. 25 to account for its
stock option plans and ESPP and, accordingly, no compensation cost is
recognized in the consolidated statements of operations for these plans. The
Company adopted SFAS No. 123 "Accounting for Stock-Based Compensation," which
requires certain disclosures about stock-based employee compensation
arrangements. SFAS 123 requires pro forma disclosure of the impact on net
income and earnings per share if the fair value method defined in SFAS 123 had
been used.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model, with the following weighted average
assumptions used for grants in 1996 and 1995, respectively: risk-free interest
rates of 5.7% and 6.7% for the stock options plans and 5.5% and 5.6% for the
ESPP; no expected dividend yields; expected lives of 3.9 years and 4.0 years
for the stock options plans and 1.5 years and 2.2 years for the ESPP; expected
volatility of 39.6% and 48.3% for the stock option plans and 45.3% and 47.5%
for the ESPP. Pro forma net income, as if the fair value method had been
applied, was $66.9 million and $47.5 million for the years ended December 31,
1996 and 1995, respectively. The pro forma earnings per share on a fully
diluted basis for the same periods were $0.77 and $0.58.
In accordance with SFAS 123, the fair value method was not applied to options
granted prior to January 1, 1995. The resulting pro forma impact may not be
representative of results to be expected in future periods and is not
reflective of actual stock performance.
27
28
Excerpt from 1996 Annual Report to Shareowners
10. INCOME TAXES
Income tax expense (benefit) for the years ended December 31, 1996, 1995 and
1994, consisted of:
(In Millions) 1996 1995 1994
- ----------------------------------------------------------------------------------
Current Tax Expense:
Federal $ 2.0 $ -- $ 0.6
State 1.2 0.5 0.4
Deferred Tax Expense (Benefit):
Increase in Deferred Tax Liability 4.0 1.7 15.1
Decrease (Increase) in Deferred Tax Asset 38.8 25.9 (22.9)
Decrease in Valuation Allowance (5.8) (11.7) (17.7)
- ----------------------------------------------------------------------------------
Income Tax Expense (Benefit) $ 40.2 $ 16.4 $ (24.5)
- ----------------------------------------------------------------------------------
The decrease in the valuation allowance in 1996, 1995 and 1994 resulted from
the Company's realization of its net operating loss (NOLs) carryforwards based
on the Company's growth in recurring operating income. The Company pays state
income taxes on the greater of a net worth basis or an income basis in a
majority of the states in which it operates. The Company records state deferred
tax assets and liabilities at an average blended rate of 5%.
The significant items giving rise to the deferred tax (assets) and liabilities
as of December 31, 1996 and 1995, were:
(In Millions) 1996 1995 1994
- --------------------------------------------------------------------------------------------------
$ % $ % $ %
- --------------------------------------------------------------------------------------------------
Expected Tax Expense (Benefit) at
Federal Statutory Income Tax Rate $ 40.2 35.0 $23.5 35.0 $ (6.2) (35.0)
Effect of:
State Income Tax Expense 5.0 4.4 2.0 2.9 0.5 2.5
Non-deductible Expenses 1.7 1.4 1.0 1.6 0.6 3.6
Change in Valuation Allowance (5.8) (5.0) (11.7) (17.4) (17.7) (99.9)
Other, Net (0.9) (0.8) 1.6 2.3 (1.7) (9.6)
- --------------------------------------------------------------------------------------------------
Income Tax Expense (Benefit) $40.2 35.0 $16.4 24.4 $(24.5) (138.4)
- --------------------------------------------------------------------------------------------------
The Company's 1996 deferred income tax balances were included in current
deferred tax assets, net $48.9 million, and in other non-current liabilities of
$53.4 million. The 1995 deferred income tax balances were included in current
deferred tax assets, net of $23.1 million and other assets of $8.8 million.
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 on future
taxable income. As of December 31, 1996, the Company has NOL carryforwards of
$103 million for income tax return purposes subject to various expiration dates
beginning in 1998 and ending in 2008. The future tax benefit of these NOL
carryforwards of $41.3 million and $70.4 million using a 40% effective tax rate
in 1996 and 1995, has been recorded as a deferred tax asset.
11. 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. Certain of the Company's subsidiaries would not provide any
guarantees (Non-Guarantor Subsidiaries) primarily as a result of contractual
prohibitions. The primary Non-Guarantor Subsidiary is SPC, discussed in Note 4.
Separate financial statements of the Guarantor Subsidiaries have not been
presented because the Company's management has determined that they would not
be material. The following supplemental financial information sets forth, on an
unconsolidated basis, statement of
28
29
Excerpt from 1996 Annual Report to Shareowners
operations, balance sheet and statement of cash flow information for the parent
company only (Parent Company), for the Guarantor Subsidiaries and the
Non-Guarantor Subsidiaries. The comparative statements for 1995 and 1994 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.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
(In Millions)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------ ------------ ------------
Revenues $ -- $1,103.0 $ -- $ -- $ 1,103.0
Cost of Services -- 642.3 -- -- 642.3
------- -------- -------- ---------- ----------
Gross Margin -- 460.7 -- -- 460.7
Selling, General and
Administrative Expenses 0.1 253.6 -- -- 253.7
Depreciation and Amortization -- 63.5 -- -- 63.5
------- -------- -------- ---------- ----------
Operating (Loss) Income (0.1) 143.6 -- -- 143.5
Interest and Other (Income) Expense, Net 23.7 9.5 (4.7) -- 28.5
Intercompany (Income) Expense (28.6) 28.6 -- -- --
Equity in Earnings of Subsidiaries (71.6) -- -- 71.6 --
------- -------- -------- ---------- ----------
Income Before Income Taxes 76.4 105.5 4.7 (71.6) 115.0
Income Tax Expense 1.6 36.9 1.7 -- 40.2
------- -------- -------- ---------- ----------
Net Income 74.8 68.6 3.0 (71.6) 74.8
Preferred Dividends 2.8 -- -- -- 2.8
------- -------- -------- ---------- ----------
Income on Common Stock $ 72.0 $ 68.6 $ 3.0 $ (71.6) $ 72.0
======= ======== ======== ========== ==========
(Continued on next page.)
29
30
Excerpt from 1996 Annual Report to Shareowners
11. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996
(In Millions)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
------- ------------ ------------ ------------ ------------
ASSETS
------
CURRENT ASSETS:
Trade Accounts Receivable, Net $ -- $ 14.8 $ 70.4 $ -- $ 85.2
Current Deferred Tax Assets, Net 19.7 29.2 -- -- 48.9
Prepaids and Other 4.5 11.9 -- -- 16.4
Intercompany Receivable 370.4 -- -- (370.4) --
--------- -------- ------ --------- -------
Total Current Assets 394.6 55.9 70.4 (370.4) 150.5
Property, Plant and Equipment, Net -- 402.8 -- -- 402.8
Excess of Cost over Net Assets Acquired, Net -- 350.5 -- -- 350.5
Investment in Affiliates 250.4 -- -- (250.4) --
Other, Net 16.3 29.5 0.4 -- 46.2
--------- -------- ------ --------- -------
Total Assets $ 661.3 $ 838.7 $ 70.8 $ (620.8) $ 950.0
========= ======== ====== ========= =======
LIABILITIES AND SHAREOWNERS' EQUITY
-----------------------------------
CURRENT LIABILITIES:
Accounts Payable $ -- $ 37.1 $ -- $ -- $ 37.1
Facility Costs Accrued and Payable -- 123.0 -- -- 123.0
Intercompany Payable -- 363.2 7.3 (370.5) --
Accrued Expenses and Other 3.4 49.9 -- -- 53.3
--------- -------- ------ --------- -------
Total Current Liabilities 3.4 573.2 7.3 (370.5) 213.4
Long-term Debt and Capital Lease
Obligations 223.0 12.8 -- -- 235.8
Other Liabilities and Deferred Credits 4.1 65.9 -- -- 70.0
SHAREOWNERS' EQUITY:
Preferred Stock -- 66.4 -- (66.4) --
Common Stock 0.8 -- 12.0 (12.0) 0.8
Paid-in Capital 427.2 43.2 60.5 (103.7) 427.2
Retained (Deficit) Earnings 2.8 77.2 (9.0) (68.2) 2.8
--------- -------- ------ --------- -------
Total Shareowners' Equity 430.8 186.8 63.5 (250.3) 430.8
--------- -------- ------ --------- -------
Total Liabilities and
Shareowners' Equity $ 661.3 $ 838.7 $ 70.8 $ (620.8) $ 950.0
========= ======== ====== ========= =======
(Continued on next page.)
30
31
Excerpt from 1996 Annual Report to Shareowners
11. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1996
(In Millions)
Parent Non-
Company Guarantor Guarantor
Only Subsidiaries Subsidiaries Eliminations Consolidated
------- ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net Cash Provided by (Used in)
Operating Activities $ 91.7 $ 268.9 $ (60.5) $ -- $ 300.1
-------- -------- ------- ------- --------
INVESTING ACTIVITIES:
Investment in SPC (60.5) -- 60.5 -- --
Capital Expenditures -- (144.3) -- -- (144.3)
Payments for Acquisitions and Other -- (121.0) -- -- (121.0)
-------- -------- ------- ------- --------
Net Cash (Used in) Provided by
Investing Activities (60.5) (265.3) 60.5 -- (265.3)
-------- -------- ------- ------- --------
FINANCING ACTIVITIES:
Net Debt Payments (37.7) (3.6) -- -- (41.3)
Preferred Dividend Payments (2.8) -- -- -- (2.8)
Proceeds from Employee Stock
Plans and Warrants 9.3 -- -- -- 9.3
-------- -------- ------- ------- --------
Net Cash (Used in)
Financing Activities (31.2) (3.6) -- -- (34.8)
-------- -------- ------- ------- --------
Change in Cash and
Cash Equivalents -- -- -- -- --
-------- -------- ------- ------- --------
Cash and Cash Equivalents at the
Beginning of the Year -- -- -- -- --
-------- -------- ------- ------- --------
Cash and Cash Equivalents at the
End of the Year $ -- $ -- $ -- $ -- $ --
======== ======== ======= ======= ========
31
32
Excerpt from 1996 Annual Report to Shareowners
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations
for the two years ended December 31:
(In Millions, Except Earnings per Common Share) 1996
- ----------------------------------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
- ----------------------------------------------------------------------------------------------------------
Revenues $ 250.6 $ 269.4 $ 289.2 $ 293.8
Cost of Services 148.6 157.6 166.6 169.5
- ----------------------------------------------------------------------------------------------------------
Gross Margin 102.0 111.8 122.6 124.3
Selling, General and Administrative Expenses 56.7 61.5 67.7 67.8
Depreciation and Amortization 14.1 15.6 16.3 17.5
- ----------------------------------------------------------------------------------------------------------
Operating Income 31.2 34.7 38.6 39.0
Interest and Other Expense, Net 7.7 7.5 7.7 5.6
- ----------------------------------------------------------------------------------------------------------
Income Before Income Taxes 23.5 27.2 30.9 33.4
Income Tax Expense 8.2 9.5 10.8 11.7
- ----------------------------------------------------------------------------------------------------------
Net Income 15.3 17.7 20.1 21.7
Income on Common Stock $ 13.9 $ 16.8 $ 19.6 $ 21.7
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
Earnings per Common Share(A)
Income per Share $ 0.18 $ 0.20 $ 0.23 $ 0.25
- ----------------------------------------------------------------------------------------------------------
Primary Weighted Average Shares(B) 86.3 87.2 87.7 87.8
- ----------------------------------------------------------------------------------------------------------
Fully Diluted Weighted Average Shares(B) 86.6 87.6 87.7 87.8
- ----------------------------------------------------------------------------------------------------------
(In Millions, Except Earnings per Common Share) 1995
- ----------------------------------------------------------------------------------------------------------
First Second Third Fourth
- ----------------------------------------------------------------------------------------------------------
Revenues $144.2 $152.0 $173.0 $203.7
Cost of Services 85.8 89.8 101.2 119.4
- ----------------------------------------------------------------------------------------------------------
Gross Margin 58.4 62.2 71.8 84.3
Selling, General and Administrative Expenses 31.5 33.7 38.9 46.0
Depreciation and Amortization 9.7 10.2 11.2 12.9
- ----------------------------------------------------------------------------------------------------------
Operating Income 17.2 18.3 21.7 25.4
Interest and Other Expense, Net 3.4 3.7 4.5 3.8
- ----------------------------------------------------------------------------------------------------------
Income Before Income Taxes 13.8 14.6 17.2 21.6
Income Tax Expense 3.3 3.5 4.1 5.5
- ----------------------------------------------------------------------------------------------------------
Net Income 10.5 11.1 13.1 16.1
Income on Common Stock $ 9.0 $ 9.7 $ 11.6 $ 14.8
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
Earnings per Common Share(A)
Income per Share $ 0.13 $ 0.14 $ 0.16 $ 0.19
- ----------------------------------------------------------------------------------------------------------
Primary Weighted Average Shares(B) 78.4 79.3 82.1 85.2
- ----------------------------------------------------------------------------------------------------------
Fully Diluted Weighted Average Shares(B) 78.8 79.9 82.4 85.6
- ----------------------------------------------------------------------------------------------------------
(A) The quarterly per share amounts represent both primary and fully diluted
as both calculations yield the same result.
(B) The weighted average shares include the assumed conversion of preferred
stock. Income per share is calculated as net income divided by weighted
average shares outstanding.
32