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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 1997
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or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
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Commission file number 0-21602
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LCI INTERNATIONAL, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3498232
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8180 Greensboro Drive, Suite 800
McLean, Virginia 22102
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(703) 442-0220
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of July 31, 1997, there were 78,432,516 shares of LCI International, Inc.
Common Stock (par value $.01 per share) outstanding.
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LCI INTERNATIONAL, INC.
INDEX
PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Operations--
For the Three Months and Six Months Ended June 30, 1997 and 1996 3
Condensed Consolidated Balance Sheets--
As of June 30, 1997 (unaudited) and December 31, 1996 4 - 5
Unaudited Condensed Consolidated Statement of Shareowners' Equity--
For the Six Months Ended June 30, 1997 6
Unaudited Condensed Consolidated Statements of Cash Flows--
For the Six Months Ended June 30, 1997 and 1996 7
Notes to Interim Unaudited Condensed Consolidated Financial Statements 8 - 14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 15 - 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURE 29
EXHIBIT INDEX 30
EXHIBITS
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ITEM 1. FINANCIAL STATEMENTS
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in millions, except for earnings per common share)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------------------ --------------------------------
1997 1996 1997 1996
---------------- --------------- ------------- --------------
REVENUES $ 338.4 $ 269.4 $ 653.0 $ 520.0
Cost of services 199.5 157.6 383.0 306.3
---------------- --------------- ------------- --------------
GROSS MARGIN 138.9 111.8 270.0 213.7
Selling, general and administrative expenses 76.3 61.5 147.8 118.2
Depreciation and amortization 20.0 15.6 38.7 29.7
---------------- --------------- ------------- --------------
OPERATING INCOME 42.6 34.7 83.5 65.8
Interest and other expense, net 7.0 7.5 13.7 15.1
---------------- --------------- ------------- --------------
INCOME BEFORE INCOME TAXES 35.6 27.2 69.8 50.7
Income tax expense 14.2 9.5 27.9 17.7
---------------- --------------- ------------- --------------
NET INCOME 21.4 17.7 41.9 33.0
Preferred dividends -- .9 -- 2.3
---------------- --------------- ------------- --------------
INCOME ON COMMON STOCK $ 21.4 $ 16.8 $ 41.9 $ 30.7
================ =============== ============= ==============
PER SHARE DATA
- --------------
Earnings Per Common Share $ 0.25 $ 0.20 $ 0.49 $ 0.38
================ =============== ============= ==============
Weighted Average Number of Common Shares 85.8 87.6 85.6 87.5
================ =============== ============= ==============
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
ASSETS June 30, December 31,
------ 1997 1996
--------------------- ---------------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 30.2 $ --
Trade accounts receivable, net 142.8 85.2
Current deferred tax assets, net 37.2 48.9
Prepaids and other 20.3 16.4
--------------------- ---------------------
Total current assets 230.5 150.5
--------------------- ---------------------
PROPERTY AND EQUIPMENT:
Fiber optic network 408.9 392.5
Technology platforms, equipment and building 185.5 123.2
leases
Less - Accumulated depreciation and amortization (172.7) (171.8)
--------------------- ---------------------
421.7 343.9
Property and equipment under construction 83.3 58.9
--------------------- ---------------------
Total property and equipment, net 505.0 402.8
--------------------- ---------------------
OTHER ASSETS:
Excess of cost over net assets acquired, net 346.6 350.5
Other, net 52.4 46.2
--------------------- ---------------------
Total other assets 399.0 396.7
--------------------- ---------------------
Total Assets $ 1,134.5 $ 950.0
===================== =====================
(Continued on next page)
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(in millions)
LIABILITIES AND SHAREOWNERS' EQUITY June 30, December 31,
----------------------------------- 1997 1996
---------------------- ---------------------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable $ 20.0 $ 37.1
Facility costs accrued and payable 115.5 123.0
Accrued expenses and other 57.5 53.3
---------------------- ---------------------
Total current liabilities 193.0 213.4
---------------------- ---------------------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
378.9 235.8
---------------------- ---------------------
OTHER LIABILITIES AND DEFERRED CREDITS 79.4 70.0
---------------------- ---------------------
COMMITMENTS AND CONTINGENCIES
SHAREOWNERS' EQUITY:
Preferred Stock - Authorized 15.0 shares, no
shares issued and outstanding -- --
Common stock - Authorized 300.0 shares,
issued and outstanding 78.4 shares as of
June 30, 1997 and 77.5 shares as of 0.8 0.8
December 31, 1996
Paid-in capital 437.7 427.2
Retained earnings 44.7 2.8
---------------------- ---------------------
Total shareowners' equity 483.2 430.8
---------------------- ---------------------
Total Liabilities and Shareowners'
Equity $ 1,134.5 $ 950.0
====================== =====================
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(Unaudited)
(in millions)
Common Stock
-------------------------------
Issued
and $.01 Par Paid- Retained
Outstanding Value In Capital Earnings Total
----------------- ------------ --------------- -------------- -----------
BALANCE AT DECEMBER 31, 1996 77.5 $ 0.8 $ 427.2 $ 2.8 $ 430.8
Employee stock purchases and
exercise of options/warrants,
including related tax benefits 0.9 -- 10.5 -- 10.5
Net Income -- -- -- 41.9 41.9
----------------- ------------ --------------- -------------- -----------
BALANCE AT JUNE 30, 1997 78.4 $ 0.8 $ 437.7 $ 44.7 $ 483.2
================= ============ =============== ============== ===========
The accompanying notes are an integral part of this statement.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in millions)
For the Six Months
Ended June 30,
1997 1996
---------------- ------------------
OPERATING ACTIVITIES:
Net cash provided by operating activities $ 35.9 $ 68.0
---------------- ------------------
INVESTING ACTIVITIES:
Capital expenditures (116.4) (64.0)
Payments for acquisitions and other (7.8) (118.1)
---------------- ------------------
Net cash used in investing activities (124.2) (182.1)
---------------- ------------------
FINANCING ACTIVITIES:
Net debt (payments) borrowings (234.0) 115.1
Senior Notes issuance proceeds 350.0 --
Financing fee payments (8.0) (2.5)
Preferred dividend payments -- (2.3)
Proceeds from employee stock plans and warrants 10.5 3.8
---------------- ------------------
Net cash provided by financing activities 118.5 114.1
---------------- ------------------
Net increase in cash and cash equivalents 30.2 --
---------------- ------------------
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD
-- --
---------------- ------------------
CASH AND CASH EQUIVALENTS AT THE
END OF THE PERIOD $ 30.2 $ --
================ ==================
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
June 30, 1997
(Unaudited)
(1) GENERAL
The results of operations for the interim periods shown are not
necessarily indicative of results to be expected for the fiscal year. In the
opinion of management, the information contained herein reflects all adjustments
necessary to make a fair statement of the results for the three and six months
ended June 30, 1997 and 1996. All such adjustments are of a normal recurring
nature.
(2) BUSINESS ORGANIZATION AND PURPOSE
The financial statements presented herein are for LCI International,
Inc., a Delaware corporation, and its subsidiaries (collectively LCI or the
Company). Included are the condensed consolidated statements of operations for
the three and six months ended June 30, 1997 and 1996, the condensed
consolidated balance sheets as of June 30, 1997 and December 31, 1996, the
condensed consolidated statement of shareowners' equity for the six months ended
June 30, 1997, and the condensed consolidated statements of cash flows for the
six months ended June 30, 1997 and 1996.
LCI is a facilities-based telecommunications company that provides
voice and data transmission services to residential and business customers, as
well as other telecommunications carriers, throughout the United States and
international locations. The Company serves its customers through owned and
leased digital fiber-optic facilities (the Network).
(3) ACCOUNTING POLICIES
Note 2 of the Notes to Consolidated Financial Statements in LCI's 1996
Annual Report to Shareowners summarize the Company's significant accounting
policies.
PRINCIPLES OF CONSOLIDATION. The accompanying Condensed Consolidated
Financial Statements (Unaudited) include the accounts of LCI and its
wholly-owned subsidiaries. All material intercompany transactions and balances
have been eliminated.
WEIGHTED AVERAGE NUMBER OF COMMON SHARES. For all periods presented,
the weighted average number of common shares includes the Company's Common
Stock, par value $.01 per share (Common Stock), and the impact of Common Stock
equivalents using the treasury stock method. For 1996, the weighted average
number of common shares includes the actual common shares issued for the
conversion of previously outstanding 5% Cumulative Convertible Exchangeable
Preferred Stock, par value $.01 per share (Preferred Stock) and the assumed
conversion of any remaining Preferred Stock outstanding during the period.
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EARNINGS PER COMMON SHARE. For the three and six months ended June 30,
1997 and 1996, earnings per common share is calculated as net income before
preferred dividends divided by the weighted average number of common shares, as
defined above. Primary earnings per common share were not materially different
from fully diluted earnings per share, for the three and six months ended June
30, 1997 and 1996.
(4) ACCOUNTS RECEIVABLE SECURITIZATION
Under the Company's agreement to sell trade accounts receivable
(Securitization Program), LCI SPC I, Inc. (SPC), a bankruptcy-remote subsidiary
of the Company, sells accounts receivable. Receivables sold are not included in
the accompanying condensed consolidated balance sheets as of June 30, 1997 and
December 31, 1996. SPC had approximately $122.0 million of accounts receivable
available for sale and had sold, but not yet collected, a total of $73.1 million
as of June 30, 1997. The Company retains substantially the same risk of credit
loss as if the receivables had not been sold, and has established reserves for
such estimated credit losses.
Under the Securitization Program, the Company acts as agent for the
purchaser of the receivables by performing recordkeeping and collection
functions on the participation interest sold. The agreement also 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 Revolving 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) LONG-TERM DEBT
On June 23, 1997, the Company issued $350 million of 7.25% Senior
Notes (Notes), which mature on June 15, 2007. The net proceeds from the issuance
of the Notes were used to repay outstanding indebtedness and for working capital
and general corporate purposes.
The Company also has a $700 million Revolving Credit Facility (Credit
Facility) from a syndicate of banks. 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 June 30, 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 relationship of the level of borrowings to operating cash flow
(leverage ratio). As of June 30, 1997, the Company had no outstanding balance
under the Credit Facility. The Credit Facility contains various financial
covenants, the most restrictive being the leverage ratio requirement. As of June
30, 1997, the Company was in compliance with all Credit Facility covenants.
The Company has an interest rate cap agreement to manage interest rate
risk on the Credit Facility. The agreement limits the base interest rate
exposure to 7.5% on $130 million notional principal balance of the Credit
Facility. In the event of non-performance by the syndicate banks, the Company
would be obligated to make the contractual payments under the Credit Facility,
and 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.
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(6) COMMITMENTS AND CONTINGENCIES
VENDOR AGREEMENTS. The Company has agreements with certain
telecommunications interexchange carriers and third party vendors that require
the Company to maintain minimum monthly and/or annual billings based on usage.
The Company has a five-year contract with a particular third party carrier that
began in August 1995. This contract has minimum annual usage requirements and an
increasing cumulative minimum usage requirement, which if not met, subject the
Company to an underutilization charge. Through June 30, 1997, the Company has
exceeded the cumulative minimum annual usage of $103 million established for the
second year. The Company's minimum monthly billing commitments under all other
vendor and carrier agreements are approximately $5 million through the end of
1997. The Company has historically met all minimum billing requirements and
believes the minimum usage commitments will continue to be met.
CAPITAL REQUIREMENTS. During 1997, the Company expects its nonbinding
commitment for capital expenditures, which is dependent on the Company's
geographic and revenue growth, to increase from the level expended in 1996. 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 has
entered into agreements to extend its fiber-optic network. These commitments
will extend the Network throughout the United States, and are expected to
require incremental capital expenditures of approximately $155 million. The
timing of payments will depend on the delivery and acceptance of the facilities,
which is expected to occur in the second half of 1997 and the first half of
1998.
LEGAL MATTERS. Thomas J. Byrnes and Richard C. Otto v. LCI
Communications Holdings Co. et al. was filed by two former members of the
Company's management on June 28, 1991 in Common Pleas Court, Franklin County,
Ohio. During 1993, a jury returned a verdict in favor of the Plaintiffs. The
Company ultimately appealed the matter to the Supreme Court of Ohio, which found
that, as a matter of law, there was insufficient evidence to sustain the verdict
for the Plaintiffs. On June 23, 1997, the United States Supreme Court (the
Court) denied the Plaintiffs' Petition for Writ of Certiorari asking the Court
to review the case. The matter has been dismissed with no further impact on the
Company's results of operations or financial condition.
The Company also has been named as a defendant in various other
litigation matters. Management intends to vigorously defend these outstanding
claims. The Company believes it has adequate accrued loss contingencies and,
that although the ultimate outcome of these claims cannot be ascertained at this
time, current pending or threatened litigation matters will not have a material
adverse impact on the Company's results of operations or financial position.
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(7) SHAREOWNERS' EQUITY
RIGHTS AGREEMENT AND PREFERRED STOCK. In January 1997, the Company
adopted a rights agreement (Rights Agreement), designed to ensure that its
shareowners receive fair and equal treatment in the event of any proposed
takeover of the Company. One preferred share purchase right (Right) has been
attached to each share of the Company's Common Stock, and until distributed, may
be transferred only with the Common Stock. The Rights will be distributed and
become exercisable only in the event that any person or entity, together with
its affiliates or associates, acquires more than a certain percentage of Common
Stock of the Company. As of June 30, 1997, no such preferred stock was issued or
outstanding.
COMMON STOCK. The Company has stock option plans under which options
to purchase shares of Common Stock may be granted to directors and key
employees. During the six months ended June 30, 1997, the Company granted
options to purchase 2.2 million shares of Common Stock. The option price for all
options granted was the fair market value of the shares on the date of grant.
The Company issued 0.7 million shares of Common Stock during the six months
ended June 30, 1997 pursuant to options exercised under all stock option plans.
The Company also has an Employee Stock Purchase Plan and a defined
contribution plan for its employees, which allow participants to invest in
Common Stock of the Company. The Company issued a total of 0.2 million shares of
Common Stock under these plans for the six months ended June 30, 1997.
(8) INCOME TAXES
The provision for income taxes for the three and six months ended June
30, 1997 and 1996, consists of:
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- -----------------------------
(in millions) 1997 1996 1997 1996
------------- ------------ ----------- --------------
Current tax expense:
Federal $ 0.3 $ 0.5 $ 1.0 $ 0.9
State 0.1 0.2 0.4 0.4
------------- ------------ ----------- --------------
Total current tax expense 0.4 0.7 1.4 1.3
------------- ------------ ----------- --------------
Deferred tax expense:
Increase in deferred tax liabilities 14.5 1.2 15.7 1.4
(Increase) decrease in deferred
tax assets (0.7) 9.0 10.8 17.6
Decrease in valuation allowance, net -- (1.4) -- (2.6)
------------- ------------ ----------- --------------
Total deferred tax expense 13.8 8.8 26.5 16.4
------------- ------------ ----------- --------------
Total income tax expense $ 14.2 $9.5 $ 27.9 $17.7
============= ============ =========== ==============
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The effective income tax rate reconciliation for the three and six
months ended June 30, 1997 and 1996, is as follows:
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Expected tax at Federal
statutory income tax rate: 35.0% 35.0% 35.0% 35.0%
Effect of:
State income tax expense 4.0 5.0 4.0 5.0
Non-deductible expenses 1.2 1.5 1.3 1.5
Decrease in valuation allowance, net -- (5.0) -- (5.1)
Other, net (0.2) (1.5) (0.3) (1.4)
------------ ------------ ------------ ------------
Effective income tax rate 40.0% 35.0% 40.0% 35.0%
============ ============ ============ ============
The effective tax rate of 40% and 35% for the six months ended June
30, 1997 and 1996, respectively, represents the Company's estimated effective
tax rate for the period. This effective tax rate is evaluated quarterly based on
the Company's estimate of future taxable income.
The Company has generated net operating losses (NOLs) that may be used
to offset future taxable income. Each NOL has a 15-year carryforward period. The
Company's ability to fully use its NOL carryforwards is dependent upon future
taxable income. As of June 30, 1997, the Company had NOL carryforwards for
income tax purposes of $66.7 million, subject to various expiration dates from
2000 to 2010. The Company believes the utilization of its NOLs is likely.
The Company's deferred income tax balances include $37.2 million in
current deferred tax assets, net and $64.4 million in other noncurrent
liabilities as of June 30, 1997. As of December 31, 1996, deferred income tax
balances included $48.9 million in current deferred tax assets, net and $53.4
million in other noncurrent liabilities.
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(9) EARNINGS PER SHARE
In February 1997, Statement of Financial Accounting Standards (SFAS)
No. 128 "Earnings per Share" was issued, which changes the method used to
calculate earnings per share. Implementation of SFAS 128 is required for
financial statements issued for periods ending after December 15, 1997,
including interim periods; earlier adoption is not permitted. Pro forma
information in accordance with SFAS 128 is:
FOR THE THREE MONTHS ENDED JUNE 30, 1997
------------------------------------------------------
Per Share
(in millions, except per share amounts) Income Shares Amount
--------------- --------------- ----------------
Net income $ 21.4
Less: preferred stock dividends --
---------------
Basic Earnings per Share:
Income available to common shareowners 21.4 78.2 $ 0.27
================
Effect of Dilutive Securities:
Stock options -- 2.8
Warrants -- 4.4
--------------- ---------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 21.4 85.4 $ 0.25
=============== =============== ================
FOR THE SIX MONTHS ENDED JUNE 30, 1997
------------------------------------------------------
Per Share
Income Shares Amount
--------------- --------------- ----------------
Net income $ 41.9
Less: preferred stock dividends --
---------------
Basic Earnings per Share:
Income available to common shareowners 41.9 77.9 $ 0.54
================
Effect of Dilutive Securities:
Stock options -- 2.9
Warrants -- 4.4
--------------- ---------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 41.9 85.2 $ 0.49
=============== =============== ================
Options to purchase 2.2 million and 2.3 million shares of Common Stock
were outstanding but were not included in the computation of diluted earnings
per share during the three months or the six months ended June 30, 1997,
respectively. The options were excluded because the exercise price of such
options was greater than the average market price of the Common Stock for the
period.
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(9) EARNINGS PER SHARE (CONTINUED)
FOR THE THREE MONTHS ENDED JUNE 30, 1996
------------------------------------------------------
Per Share
(in millions, except per share amounts) Income Shares Amount
--------------- --------------- ----------------
Net income $17.7
Less: preferred stock dividends (0.9)
---------------
Basic Earnings per Share:
Income available to common shareowners 16.8 70.0 $ 0.24
================
Effect of Dilutive Securities:
Stock options -- 5.7
Warrants -- 4.7
Convertible Preferred Stock 0.9 6.8
--------------- ---------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 17.7 87.2 $ 0.20
=============== =============== ================
FOR THE SIX MONTHS ENDED JUNE 30, 1996
------------------------------------------------------
Per Share
Income Shares Amount
--------------- --------------- ----------------
Net income $ 33.0
Less: preferred stock dividends (2.3)
---------------
Basic Earnings per Share:
Income available to common shareowners 30.7 67.5 $0.45
================
Effect of Dilutive Securities:
Stock options -- 5.3
Warrants -- 4.7
Convertible preferred stock 2.3 9.2
--------------- ---------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 33.0 86.7 $0.38
=============== =============== ================
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LCI International, Inc., together with its subsidiaries (LCI or the
Company), is a facilities-based telecommunications carrier that provides a broad
range of domestic and international telecommunications services, including
long-distance, data and local services. The Company targets all markets - retail
and wholesale business, residential and local - and sells through a variety of
channels, including an internal sales force and external channels. The Company
serves its customers primarily through owned and leased digital fiber-optic
facilities, including switches strategically located throughout the United
States. Collectively, these facilities constitute the Company's network (the
Network).
INDUSTRY ENVIRONMENT
Historically, the Company has operated in the $80 billion long-distance
telecommunications industry. Recent legislative and regulatory activity is
designed to create one telecommunications industry to encompass both
long-distance and local telecommunications services. The Company intends to
provide combined local and long-distance services to compete in what is
estimated to be a $150 billion combined market. The current industry environment
subjects the Company to varying degrees of legislative and regulatory oversight
on both the national and state levels. The following developments in the
legislative and regulatory environment can impact the nature and degree of
competition in the telecommunications industry.
LEGISLATIVE MATTERS
Telecommunications Act of 1996. In February 1996, the Telecommunications Act of
1996 (the Act) was enacted to increase competition in the long-distance and
local telecommunications industries. The legislation opens competition in the
local services market and, at the same time, contains provisions intended to
protect consumers and business from unfair competition by incumbent local
exchange carriers (LECs), including the regional Bell operating companies
(RBOCs). The Act allows RBOCs to provide long-distance service outside of their
local service territories but bars them from immediately offering in-region
long-distance services between local access transport areas (interLATA) until
certain conditions are met. An RBOC must apply to the Federal Communications
Commission (FCC) to provide in-region interLATA long-distance services and
must satisfy a set of pro-competitive criteria intended to ensure that RBOCs
open their own local markets to competition before the FCC will approve such
application. Further, while the FCC has final authority on whether an RBOC
application is granted, the FCC must consult with the Department of Justice
(DOJ) to determine if, among other things, the entry of the RBOC would be in
the public interest, and with the relevant state to determine the
pro-competitive criteria have been met.
On July 2, 1997, SBC Communications Inc. (SBC) and its local exchange
carrier subsidiaries filed a lawsuit in the United States District Court for
the Northern District of Texas challenging on constitutional grounds the
restrictions contained in the Act applicable to RBOCs only. The plaintiffs in
the case seek both a declaratory judgment and an injunction against the
enforcement of the challenged provisions. If SBC's challenge were to succeed,
it could result in all RBOCs entering the in-region interLATA long-distance
market throughout the country.
The Act provides a framework for the Company and other long-distance
carriers to compete with LECs by reselling local telephone service,
interconnecting with LEC network facilities at various points in the network
(i.e., unbundled network elements) or building new local-
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service facilities. The Company has signed local-service agreements with
Ameritech, Bell South, Pacific Telesis and NYNEX, in several states, and is
currently in formal negotiations with several other LECs. LCI intends to
vigorously compete in the local service market. Initially, the Company will
provide local service to customers on a bundled resale basis. However, the
Company is currently testing the provisioning of local service through the
recombination of unbundled network elements with Ameritech and NYNEX. The
Company could also decide in the future to build local service facilities or use
a competitive access provider to provide local service. The Company's decision
on the timing and method of providing local service is dependent on the economic
viability of its options and the outcome of several regulatory proceedings,
which may differ state-by-state.
REGULATORY MATTERS
In order to implement the Act, the FCC was required to undertake a variety
of regulatory actions, which impact competition in the telecommunications
industry. Certain of these regulatory actions are described below.
Interconnection Order. In August 1996, the FCC adopted the Interconnection
Order (the Order) which established a minimum national framework relating to
the manner in which new entrants seeking entry into local services markets
would be able to interconnect with the LECs. The Order covered several
important interconnection issues including, unbundled local network elements
purchases, resale discounts and arbitration procedures between LECs and
interexchange carriers. Under the Order, state regulatory commissions would
have an important role implementing and applying local interconnection
policies, rules and procedures.
Several states, companies, associations and other entities appealed the
Order. On July 18, 1997, the United Stated Court of Appeals for the Eight
Circuit (the Court) overturned many of the rules established in the FCC's
Interconnection Order governing, among other things, the pricing of
interconnection, resale, and unbundled network elements. In addition, the
Court overturned the "pick and choose" rule, which would have allowed new
entrants to receive the benefit of the most favorable provisions contained in a
LEC's interconnection agreements with other carriers. The Court decision
substantially limits the FCC's jurisdiction and expands the state regulators'
jurisdiction to set and enforce rules governing the development of local
competition. As a result, it is more likely that the rules governing local
competition will vary substantially from state to state. If a patchwork of
state regulations were to develop, it could make competitive entry in some
markets more difficult and expensive than in others and could increase the
costs of regulatory compliance associated with local entry.
The FCC has announced its intent to appeal the Court's ruling to the United
States Supreme Court and other parties are also expected to appeal the Court's
decision. Because of the uncertainty regarding the outcome of any forthcoming
appeals and how various state commissions will seek to facilitate local
competition, the Company is unable to predict what impact the Court's decision
will have on LCI's ability to offer competitive local service.
Bell Operating Company (BOC) Applications to Provide In-Region
interLATA Long-Distance. On January 2, 1997, Ameritech Michigan became the
first BOC to apply for authority to provide in-region interLATA service.
Ameritech Michigan withdrew its application on February 11, 1997, after the FCC
struck from the record the interconnection agreement between Ameritech and AT&T
which formed the basis for the application. On May 21, 1997, Ameritech Michigan
refiled its application for in-region interLATA authority in Michigan. That
application is currently pending.
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On April 11, 1997, SBC applied to the FCC for authority to provide
in-region interLATA service in Oklahoma. On June 26, 1997, the FCC released an
order rejecting SBC's application on the grounds that SBC had not demonstrated
either that SBC had entered into an approved interconnection agreement with a
facilities-based competitive local exchange carrier (CLEC), nor had a CLEC
requested interconnection as of the statutory deadline. On July 3, 1997, SBC
filed an appeal of the June 26, 1997 order with United States Court of Appeals
for the District of Columbia. That appeal is currently pending. The Company
expects the other RBOCs to apply for in-region interLATA long distance
authority.
Access Charge Reform. In December 1996, the FCC proposed changes to access
charges levied by LECs on long-distance service carriers. Access charges
currently represent approximately one-half of the revenues for the long-distance
telecommunications industry. The FCC's intention is to require the charges for
access services to be consistent with actual economic cost.
On May 16, 1997, the FCC released its Access Charge Reform Order, which
revised rules governing interstate switched access charge rate structures. The
new rules are intended to eliminate implicit subsidies and to establish rate
structures that better reflect the manner in which costs are incurred. The new
rules substantially increase the costs that price cap LECs recover through
monthly, non-traffic sensitive access charges and substantially decrease the
costs that price cap LECs recover through traffic sensitive access charges. The
manner in which the FCC implements its approach to lowering access charge levels
will have a material effect on the prices the Company pays for originating and
terminating interstate traffic. Based on the Access Charge Reform Order, LCI
currently expects that its monthly switched access costs will decrease during
the remainder of 1997 and the first half of 1998. Beginning on July 1, 1998,
however, LCI believes that the access charge structure recommended by the FCC
will provide a less favorable cost structure for the Company than that of LCI's
three largest long-distance competitors. Various parties have filed petitions
for reconsideration with the FCC and some parties, including LCI, have appealed
the FCC's order. In light of the uncertainty regarding the FCC's and any
court's ultimate actions in these proceedings, the Company is unable
to predict what impact the FCC's revised access charge scheme will have on the
Company's access charge cost structure.
Universal Service. On May 8, 1997, the FCC released an order establishing
a significantly expanded federal telecommunications subsidy regime. For
example, the FCC established new subsidies for schools and libraries with an
annual cap of $2.25 billion and for rural health care providers with an annual
cap of $400 million. Providers of interstate telecommunications service, such
as the Company, as well as certain other entities, must pay for the federal
programs. The Company's share of the schools, libraries and rural health care
funds will be based on its share of the total industry telecommunications
service and certain defined telecommunications end user revenues. The Company's
share of all other federal subsidy funds will be based on its share of the
total interstate (including certain international) telecommunications service
and certain defined telecommunications end user revenues. Several parties have
appealed the May 8, 1997 order, and those appeals have been transferred and
consolidated in the United States Court of Appeals for the Fifth Circuit.
Payphone Compensation. In September, 1996, the FCC adopted rules to
implement the Act's requirement establishing "a per call compensation plan to
ensure all payphone service providers are fairly compensated for each and every
completed call using their payphone." This order included a specific fee to be
paid to each payphone service provider by long-distance carriers and interLATA
toll providers (including LECs) on all "dial around" calls, including debit
card and calling card calls. Several parties, including LCI, appealed the FCC's
rules. On July 1, 1997, the United States Court of Appeals for the D.C. Circuit
overturned some of the FCC rules for the implementation plan.
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In addition, the court found unlawful both the methodology used to determine
the long-distance carriers' payment obligations and the absence of any
compensation for some types of payphones and services. These issues have been
remanded to the FCC. Although the Company expects to incur additional costs to
carry "dial-around" calls that originate from payphones, the Company is unable
to predict what impact the payphone rules will have on the Company's costs for
such calls until the FCC adopts revised payphone compensation rates based on
the Court's ruling.
RBOC Mergers. The proposed merger of Bell Atlantic and NYNEX announced on
April 22, 1996 has been approved by various state commissions and the DOJ. The
FCC, however, has not yet approved the proposed merger.
On July 19, 1997, Bell Atlantic and NYNEX proposed a set of commitments to
the FCC that are designed to secure approval of the companies' merger. It has
been reported that three of the four FCC commissioners have endorsed the merger
as a result of the proposed commitments, but no formal FCC ruling has been
issued. LCI believes the proposal is deficient in many regards. Specifically,
LCI believes that Bell Atlantic and NYNEX must publicly disclose their current
level of service they are providing for each measurement category. In addition,
the measurement formulas and default performance intervals should be disclosed
and Bell Atlantic and NYNEX should provide such level of service to all of
their competitors. This information is necessary to ensure competitors are
receiving local service at parity with what Bell Atlantic and NYNEX are
currently providing their customers. At this time, LCI is unable to predict
what impact, if any, the Bell Atlantic/NYNEX merger and accompanying proposal
will have on local and long-distance competition.
Petition For Expedited Rulemaking. On May 30, 1997, LCI and the Competitive
Telecommunications Association (CompTel) jointly filed a Petition For Expedited
Rulemaking requesting the FCC to establish performance standards for LECs to
meet the operations support systems (OSS) requirements of the Act and applicable
FCC regulations. The OSS requirements are critical because they provide
competitors with the necessary access to the LECs' internal systems to ensure
competitors obtain local service at the same level of quality that LECs are
currently providing to their customers. In its comments, LCI proposed that an
industry group consisting of local and long-distance carriers, trade
associations and regulators be given approximately six weeks to establish
measurement categories, measurement formulas and default performance intervals
for several OSS categories. On June 10, 1997, the FCC issued a public notice
requesting comments on LCI's petition. Numerous parties, including the
California Public Service Commission, Wisconsin Public Service Commission, and
the National Association of Regulatory Utilities Commissioners, filed comments
in support of LCI's petition.
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. As of June 30, 1997, the Company has received approval to
resell local service in 26 states and the District of Columbia,
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and has applications for local service authority pending in another 14 states.
The Company is currently reselling local telecommunications service in 22
markets.
COMPETITION
The long-distance telecommunications market is highly competitive. The
principal competitive factors affecting the Company's market share are pricing,
regulatory developments (as described above), customer service, and diversity
of services and features. The Act is expected to change the nature of the
industry by allowing carriers other than incumbent LECs to provide local
service while permitting RBOCs to provide long-distance services. As a result,
the Company expects competition within the industry to increase in both the
long-distance and local service markets.
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 hundreds of other
long-distance carriers, as well as LECs, in various types of
telecommunications services. The Company's principal pricing strategy is to
offer a simple, flat-rate pricing structure with rates generally below
those of AT&T, MCI and Sprint. Although LCI is prepared to respond to
competitive offerings from other carriers, the Company continues to believe
that its "Simple, Fair and Inexpensive" marketing and service pricing approach
is very competitive in retaining existing customers, as well as obtaining new
customers. The Company's ability to compete effectively will depend on
maintaining exceptional customer service and high quality, market-driven
services at prices generally equal to or below those charged by its major
competitors.
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GENERAL - RESULTS OF OPERATIONS
The Company's revenues primarily consist of switched and private line
revenues. Switched revenues are a function of switched minutes of use (MOUs) and
rate structure (rates charged per MOU), which are based on 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.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AS
COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 1996
REVENUES. Revenues increased 26% to $338.4 million and 26% to $653.0
million for the three and six months ended June 30, 1997, respectively, over the
comparable periods in 1996. MOUs increased 39% or 2,721 million for the three
months and 39% or 5,230 million for the six month periods in 1997 over 1996. The
following table provides further information regarding the Company's revenues:
(in millions, Three Months Six Months
except switched revenue per MOU) Ended June 30, Ended June 30,
------------------------------------ -------------------------------------
1997 1996 Change 1997 1996 Change
------------------------------------ -------------------------------------
Total Revenues $ 338.4 $ 269.4 26% $653.0 $520.0 26%
MOUs 2,721 1,955 39% 5,230 3,765 39%
Switched Revenue per MOU (1) $ 0.115 $ 0.127 (9)% $0.116 $0.127 (9)%
(1)Switched revenue divided by MOUs
Revenues from business customers increased in excess of 20% for the
three and six months ended June 30, 1997 over the comparable periods in 1996,
and represented approximately two-thirds of the Company's total revenues.
Residential/small business revenues represented approximately one-third of total
revenues and increased approximately 30% and 40% for the three and six months
ended June 30, 1997, respectively, over the comparable periods in the prior
year. Growth in international service revenues across all revenue service lines
was approximately 50% for the three and six months ended June 30, 1997 compared
to the same periods in 1996.
The Company experienced a 9% decrease in average revenue per MOU for
both the three and six months ended June 30, 1997, as compared to the same
periods in 1996. Changes in the Company's revenue per MOU are not necessarily
indicative of the gross margin resulting from the Company's revenue mix. Revenue
per MOU reflects changing cost of services and changes in the mix of services by
market segments and competitive pricing. The Company has experienced MOU growth
from high volume business customers who have a lower pricing structure. These
customers primarily use dedicated access services rather than switched services,
which have a lower revenue per MOU due to lower costs per MOU. The growth in
business and international service volumes, as measured in MOUs, exceeded the
growth in revenue due to changes in the mix of international country traffic and
competitive pricing pressures. The Company's growth in various segments, which
have different rate structures and generate different gross margins, has changed
its revenue mix and consequently impacted the average revenue per MOU.
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The Company experienced an increase in its sales allowance in 1997,
reflected as a charge to gross revenue, as a result of the growth in revenue and
a shift in the customer mix toward the residential/small business service
segment. A significant portion of the residential/small business accounts
receivable balance is billed and collected through LECs. The Company receives
information from the LECs about uncollectible accounts three to thirteen months
after the account is billed. Due to the delay in information from the LECs, the
Company is continually updating its estimated liability for future uncollectible
accounts and has increased sales allowance to include a higher estimate for
these LEC billed receivables.
The Company uses a variety of channels to market its services. In
addition to its internal sales force, the Company uses a combination of other
channels, such as advertising and third party sales agents. For certain third
party sales agents, compensation is paid to agents in the form of an ongoing
commission based upon collected revenue attributable to customers signed up by
the agents to use the Company's long-distance services. The Company retains
responsibility for the customer relationship, including billing and customer
service. American Communications Network, Inc., a nationwide network of third
party sales agents, continued to be the largest and most successful of the
Company's sales agents for residential/small business customers. The Company
has, however, expanded its sales presence across the country using a variety of
channels.
GROSS MARGIN. The Company's gross margin increased 24% to $138.9
million and 26% to $270.0 million for the three and six months ended June 30,
1997, respectively, as compared to the same periods in 1996. During the three
and six months ended June 30, 1997, gross margin as a percentage of revenue
decreased to 41.0% and increased to 41.3%, respectively, from 41.5% and 41.1%
for the same periods in 1996, respectively. The quarter-over-quarter decrease as
a percentage of revenue reflects a shift in revenue mix to high volume customers
with slightly lower gross margins per MOU as well as continued competitive
pricing pressures. The increase in the year-over-year gross margin as a
percentage of revenue for the six months period in 1997 reflects Network
efficiencies due to the routing of higher cost off network traffic on to the
Company's fixed cost Network, as well as increased MOUs which have allowed for
cost effective purchases of long-haul capacity generating economies of scale.
The Company has controlled the cost per MOU during periods of high volumes of
MOUs as a result of Network efficiencies and optimization techniques.
The Company's fiber expansion planned for the second half of 1997 and
early 1998, will temporarily result in redundant facilities and increased costs
during a period of transitioning traffic from current leased facilities to the
new owned facilities. However, once this transition is completed, which is
expected to be in early 1998, the Company will realize a lower cost of service.
The Company continues to evaluate strategies to reduce its cost of services,
improve the reliability and efficiency of the Network, and pursue opportunities
to reduce its cost of service per MOU.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 24% to $76.3 million and 25% to $147.8 million
for the three and six months ended June 30, 1997, respectively, as compared to
the same periods in 1996. As a percentage of revenues, selling, general and
administrative expenses were 22.5% and 22.6% for the three and six months ended
June 30, 1997, respectively, as compared to 22.8% and 22.7% for the same periods
in 1996, respectively. Annualized revenue per employee has remained at
approximately $500,000 per employee through the first half of 1997.
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The Company's selling, general and administrative expense increases
year-over-year were substantially impacted by payroll and commissions. Payroll
expenses increased $6.3 million and $12.1 million for the three and six months
ended June 30, 1997, respectively, as compared to an increase of $9.4 million
and $17.8 million for the same periods in 1996, respectively. The increase in
payroll expenses resulted from increased headcount for sales and customer
support activities to directly support revenue growth.
The increase in selling, general and administrative expenses includes a
$4.5 million and $8.5 million increase in commission expense for the three and
six months ended June 30, 1997, respectively, over the comparable prior periods.
The growth in residential/small business revenue sold by third party sales
agents with an ongoing commission impacted commission expense. The costs
incurred for third party sales agents' commissions primarily replace other
variable marketing and selling expenses for this revenue segment.
The Company anticipates an incremental increase in selling, general and
administrative expenses due to the expansion of its geographic sales presence
and its entrance into the local service 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.
During the six months ended June 30, 1997, the growth in selling, general, and
administration expenses has been less than revenue growth, which reflects
productivity and operating efficiencies.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense for the three and six months ended June 30, 1997 was $20.0 million and
$38.7 million, respectively. The increase reflects the investments made in
infrastructure for sales, customer service and other service delivery systems in
support of the Company's growth in revenues and MOUs. The Company anticipates
that depreciation and amortization will continue to increase due to investments
in new technology that have shorter depreciable lives than the Company's
previous asset base. Depreciation and amortization expense as a percentage of
revenues remained at 6% for both the three and six months ended June 30, 1997,
as compared to 6% for the same periods in 1996.
OPERATING INCOME. Operating income increased 23% to $42.6 million and
27% to $83.5 million for the three and six months ended June 30, 1997,
respectively, over the same periods in 1996. Operating income for the six months
ended June 30, 1997 grew at a faster rate than the growth in revenues during
this period, reflecting efficient management of Network and selling, general and
administrative expenses during a period of significant growth in revenues and
MOUs. As a percentage of revenues, operating income remained consistent at 13%
for both the three and six months ended June 30, 1997.
INTEREST AND OTHER EXPENSE, NET. Interest and other expense, net of
capitalized interest, decreased to $7.0 million and $13.7 million for the three
and six months ended June 30, 1997, respectively, compared to $7.5 million and
$15.1 million for the same periods in 1996, respectively. The Company was able
to reduce the level of outstanding debt during the six months ended June 30,
1997 compared to the same period in 1996, as a result of strong operating cash
flow and the Securitization Program established in August 1996 (See Note 4 to
the Condensed Consolidated Financial Statements). Through the Securitization
Program, the Company reduced its long-term debt and thereby reduced the
Company's leverage ratio. The decrease in the leverage ratio resulted in a
reduction in the interest rate paid on the Company's Revolving Credit Facility
(Credit Facility) and accordingly decreased interest expense year-over-year.
Interest expense for
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the quarter included eight days of interest from the newly issued debt
securities. Interest expense is expected to increase due to a higher rate of the
interest associated with the debt securities compared to the short-term rates
currently available under existing facilities, as well as higher average
borrowings during the second half of 1997. As a result of issuing fixed-rate
securities, however, the interest rate on the Company's debt is less sensitive
to market rate fluctuations.
INCOME TAX EXPENSE. Income tax expense was $14.2 million and $27.9
million for the three and six months ended June 30, 1997, respectively, as
compared to $9.5 million and $17.7 million for the same periods in 1996,
respectively. The Company's net operating loss (NOL) carryforwards for financial
statement purposes were fully utilized in 1996. As a result, the Company's
estimated effective tax rate increased to 40% in 1997 from 35% in 1996. The
increase in income tax expense was a result of an increase in the estimated
effective tax rate and the growth in earnings before taxes. The Company analyzes
its effective tax rate on a quarterly basis.
PREFERRED DIVIDENDS. The Company's previously outstanding shares of 5%
Cumulative Convertible Exchangeable Preferred Stock (Preferred Stock) was
redeemed on September 3, 1996, thereby eliminating the corresponding preferred
dividend payments. The annual saving from the eliminated dividend payments is
approximately $5.8 million, based upon the original 4.6 million shares issued in
August 1993.
LIQUIDITY AND CAPITAL RESOURCES
LCI International, Inc. (LCI) is a holding company and conducts its
operations through its direct and indirect wholly-owned subsidiaries. LCI SPC I,
Inc. (SPC), a wholly-owned subsidiary of LCI, was formed to facilitate the
Securitization Program. Except in certain limited circumstances, SPC is subject
to contractual restrictions on the payment of cash dividends, or making loans
and advances to LCI. There are however, no restrictions on the movement of cash
among the Company and the other subsidiaries in the consolidated group. The
Company's discussion of its liquidity is based on the consolidated group.
CASH FLOWS - OPERATING ACTIVITIES. The Company provided $35.9 million
of cash from operations for the six months ended June 30, 1997, compared to
$68.0 million for the same period in 1996. Excluding the net securitization
activity, cash from operations was $74.8 million for the six month period ended
June 30, 1997. The Company continues to show growth in revenues and net income
as well as strong working capital results.
CASH FLOWS - INVESTING ACTIVITIES. The Company has supported its growth
strategy with capital expenditures and acquisitions, resulting in $124.2 million
in cash used for investing activities during six months ended June 30, 1997. The
decrease of $57.9 million compared to the same period in the prior year, was due
to $118.1 spent on acquisitions in the first half of 1996. During the six months
ended June 30, 1997, the Company spent $116.4 million in capital expenditures to
acquire additional switching, transmission and distribution capacity, as well as
to develop and license information systems support, representing an increase of
$52.4 million from the same period in 1996.
CASH FLOWS - FINANCING ACTIVITIES. Financing activities provided a net
$118.5 million for the six months ended June 30, 1997, compared with $114.1
million during the same period in 1996. On June 23, 1997, the Company received
proceeds of $350 million for the issuance of long-term debt (see Capital
Resources below) and the proceeds were used, in part, to repay short-term
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indebtedness. The first half of 1996 required higher borrowings for
acquisitions. There were no comparable acquisitions in the six months ended June
30, 1997.
CAPITAL RESOURCES. On June 23, 1997, the Company issued $350 million of
7.25% Senior Notes (Notes), which mature on June 15, 2007. The net proceeds from
the issuance of the Notes were used to repay outstanding indebtedness and for
working capital and general corporate purposes.
As of June 30, 1997, the Company had $30.2 million in cash and cash
equivalents from the remaining proceeds of the Note issuance. The cash balance
resulted from the timing of receipt and use of the proceeds to repay
indebtedness. The remaining Note proceeds were fully used in July 1997.
The Company has 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 borrowings and
usually maintains no cash on hand. As of June 30, 1997, there was no outstanding
balance on the Credit Facility due to the application of Notes proceeds. 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 June
30, 2001. The interest rate on the debt outstanding is variable based on several
indices (See Note 5 to the Condensed Consolidated Financial Statements). The
Credit Facility contains certain financial and negative covenant requirements.
As of June 30, 1997, the Company was in compliance with all covenants.
The Company has 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
dependent upon a market indicator. Any outstanding balance is reflected in
long-term debt in the accompanying consolidated balance sheets due to the
availability under the Credit Facility to repay such balances. As of June 30,
1997, there was no outstanding balance on the Lines of Credit.
The Company maintains a Securitization Program to sell a percentage
ownership interest in a defined pool of the Company's trade accounts receivable.
The Company can transfer an undivided interest in a designated pool of accounts
receivable on an ongoing basis to maintain the participation interest up to $150
million. At June 30, 1997, the pool of trade accounts receivable which was
available for sale was approximately $122.0 million and the amount of
receivables sold was $73.1 million.
CAPITAL REQUIREMENTS. During 1997, the Company expects that its non-binding
commitment for capital expenditures, which is dependent on the Company's
geographic and revenue growth, to increase from 1996 levels. 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 has entered
into agreements to extend its owned fiber-optic network across the United
States. The Company will make payments of approximately $155 million for the
fiber-optic network expansion. The timing of payments will depend on the
delivery and acceptance of the facilities, which is expected to occur in the
second half of 1997 and the first half of 1998. The Company believes it has
adequate cash flow and borrowing capacity under its Credit Facility to fund
planned capital expenditures.
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The Company has used 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 the Company will be able to enter into or complete
acquisition agreements on acceptable terms.
COMMITMENTS AND CONTINGENCIES. The Company has agreements with certain
interexchange carriers, LECs and third party vendors to lease facilities for
originating, terminating and transport services. The third party carriers
include WorldCom Network Services, Inc. d/b/a WilTel, Frontier Corporation,
Sprint and MCI. In addition, the Company uses services provided by each RBOC,
GTE and other smaller LECs. Some 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 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
annual revenue. (See Note 6 to the Condensed 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, the Company has not experienced a catastrophic service failure in its
history.
The Company has an agreement with American Communications Network, Inc.
(ACN), a third party sales agent, through April 2011. The agreement 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
acquiring company would 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 signed
up by ACN to use the Company's long-distance services. The monthly collected
revenue average is calculated over a 24-month performance period subsequent to
the change in control. The amount of this payment, if any, is therefore
dependent upon ACN's level of performance during the entire performance period,
and cannot be reasonably estimated at this time.
The Company has been named as a defendant in various litigation
matters. Management intends to vigorously defend these outstanding claims. The
Company believes it has adequate accrued loss contingencies and that 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 6 to
the Condensed Consolidated Financial Statements.)
FEDERAL INCOME TAXES. The Company has generated significant NOLs in
prior years that are available to reduce cash requirements for income taxes. See
Note 8 of the Condensed Consolidated Financial Statements for a discussion of
the availability and expected utilization of the existing NOLs.
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IMPACT OF SEASONALITY. The Company's revenue is subject to seasonal
variations based on each business segment. Use of long-distance services by
commercial customers is typically lower on weekends throughout the year, and in
the fourth quarter due to holidays. As residential/small business revenue
increases as a proportion of the Company's total revenues, the seasonal impact
due to changes in commercial calling patterns should be reduced. The Company is
unable to predict the revenue impact of a shift to a larger residential customer
base.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 - SAFE HARBOR
CAUTIONARY STATEMENT. This report contains forward-looking statements as defined
by the Private Securities Litigation Reform Act of 1995 (the Reform Act). These
forward-looking statements express the beliefs and expectations of management
regarding LCI's future results and performance and include, without limitation,
the following: statements concerning the Company's 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; cost 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 the competitive factors described in the Industry Environment),
including RBOC entry into the interLATA long-distance industry and the
corresponding impact on pricing; the adoption and application of rules and
regulations implementing the Act, including the decisions of Federal and state
regulatory agencies and courts interpreting and applying the Act; the ability to
negotiate appropriate local service agreements with LECs; the timely delivery of
planned Network expansions 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Thomas J. Byrnes and Richard C. Otto v. LCI Communications Holdings Co.
et al. was filed by two former members of the Company's management on June 28,
1991 in Common Pleas Court, Franklin County, Ohio. The suit alleged age
discrimination by the Company, among other things. During 1993, a jury returned
a verdict in favor of the Plaintiffs.
The Company ultimately appealed the matter to the Supreme Court of Ohio
(the Court). On December 11, 1996, the Court found 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. On April 15, 1997, the Plaintiffs
filed a Petition for Writ of Certiorari (Petition) asking the United States
Supreme Court to review the case. On June 23, 1997, the United States Supreme
Court denied the Plaintiffs' Petition and, therefore, the matter has been
dismissed with no further impact on the Company's results of operations or
financial condition.
Vanus James v. LCI International, Inc. et al. and American
Communications Network, Inc. was commenced in late May 1995 in the Supreme
Court, Kings County, New York. The plaintiff purported to bring a class action
lawsuit against the Company, certain of its affiliates, and American
Communications Network, Inc., one of the Company's sales agents. In March 1997,
the court approved a settlement of this class action suit which became effective
as of April 25, 1997. The Company expects the final resolution of this matter
during 1997 and that the settlement will not have a material adverse impact on
the Company's results of operations or financial condition.
The Company has also been named as a defendant in various other
litigation matters incident to the character of its business. The Company
believes it has adequate accrued loss contingencies with respect to all
litigation matters and, although the ultimate outcome of these claims cannot be
ascertained at this time, that current pending or threatened litigation matters
will not have a material adverse effect on the consolidated financial position
or results of operations of the Company.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 6, 1997, the Company held its Annual Meeting of Stockholders.
There were 77,920,698 shares of Common Stock of the Company which could be voted
at the meeting and 86% or 66,997,276 shares of Common Stock were represented at
such meeting, in person or by proxy, which constituted a quorum. The results
were as follows:
1. Election of two directors to serve for three-year terms until the 2000
Annual Meeting of Stockholders:
FOR WITHHELD
--- --------
William F. Connell 59,940,224 7,057,052
Julius W. Erving, II 59,874,126 7,123,150
Douglas M. Karp, George M. Perrin, H. Brian Thompson, John L. Vogelstein and
Thomas J. Wynne continue to serve as directors of the Company. Richard E.
Cavanagh was appointed to the Company's Board of Directors, to fill a vacancy,
on May 5, 1997.
2. Approval of the 1997/1998 LCI International, Inc. Stock Option Plan:
FOR AGAINST ABSTAIN
--- ------- -------
53,494,836 13,266,572 199,793
3. Approval of the Executive Incentive Compensation Plan:
FOR AGAINST ABSTAIN
--- ------- -------
65,283,203 2,045,508 228,723
4. Ratification of the selection by the Board of Directors of Arthur
Andersen LLP as the independent public accountants to audit the
Company's consolidated financial statements for 1997:
FOR AGAINST ABSTAIN
--- ------- -------
66,511,120 187,049 95,064
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The exhibits filed as part of this report are set forth in
the Index of Exhibits on page 27 of this report.
(b) Reports on Form 8-K:
On June 6, 1997, the Company filed a report on Form 8-K to file a
Statement of Eligibility under the Trust Indenture Act of 1939 relating
to the Trustee for the Notes.
On June 17, 1997, the Company filed a report on Form 8-K to file the
legality opinion relating to the Notes.
On June 20, 1997, the Company filed a report on Form 8-K for the
Underwriting Agreement relating to the Notes.
On June 26, 1997, the Company filed a report on Form 8-K to file the
Indenture relating to the Notes.
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SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LCI INTERNATIONAL, INC.
DATE: August 14, 1997 BY: /s/ Joseph A. Lawrence
--------------- ----------------------
Joseph A. Lawrence
Chief Financial Officer,
Senior Vice President Finance and
Corporate Development
(as duly authorized officer and
principal financial officer)
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EXHIBIT INDEX
The following Exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Exhibit
Number Description
- ------------------------------------------------------------------------------------------------------------------------
3(i)(a) Amended and Restated Certificate of Incorporation. (1)
3(i)(c) Certification of Designation, Preferences and Rights of Junior Participating Preferred Stock. (2)
3(ii) Amended and Restated By-laws. (3)
4(c) Indenture, dated as of June 23, 1997, between LCI International, Inc. and First Trust National
Association, as Trustee, Providing for the Issuance of Senior Debt Securities including
Resolutions of the Pricing Committee of the Board of Directors establishing the terms of the
7.25% Senior Notes due June 15, 2007. (4)
10(l)(xxiii) Employment Agreement, dated January 3, 1997, between LCI Management Services, Inc. and Anne K.
Bingaman.
11 Statement Regarding Computation of Per Share Earnings
27 Financial Data Schedule
1 Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1996.
2 Incorporated by reference from the Company's Quarterly Report on Form 10-Q/A for the quarterly
period ended March 31, 1997.
3 Incorporated by reference from the Company's Annual Report on Form 10-K for the period ended
December 31, 1996.
4 Incorporated by reference from the Company's Current Report on Form 8-K dated June 23, 1997.
30