1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1997
------------------
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
-------------- --------------
Commission file number 0-21602
-------
LCI INTERNATIONAL, INC.
-----------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3498232
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8180 Greensboro Drive, Suite 800
McLean, Virginia 22102
- --------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(703) 442-0220
----------------------------------------------------
(Registrant's telephone number, including area code)
---------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of October 31, 1997, there were 83,500,312 shares of LCI International,
Inc. Common Stock (par value $.01 per share) outstanding.
2
LCI INTERNATIONAL, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Operations--
For the Three Months and Nine Months Ended
September 30, 1997 and 1996 3
Condensed Consolidated Balance Sheets--
As of September 30, 1997 (unaudited) and December 31, 1996 4 - 5
Unaudited Condensed Consolidated Statement of Shareowners' Equity--
For the Nine Months Ended September 30, 1997 6
Unaudited Condensed Consolidated Statements of Cash Flows--
For the Nine Months Ended September 30, 1997 and 1996 7
Notes to Interim Unaudited Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
EXHIBIT INDEX
EXHIBITS
2
3
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 Nine Months
Ended September 30, Ended September 30,
-------------------------------- -------------------------------
1997 1996 1997 1996
--------------- ------------- --------------- ------------
REVENUES $ 364.8 $ 289.2 $ 1,017.9 $ 809.1
Cost of services 213.5 166.6 596.6 472.8
--------------- ------------- --------------- ------------
GROSS MARGIN 151.3 122.6 421.3 336.3
Selling, general and administrative expenses 83.0 67.7 230.8 185.9
Depreciation and amortization 22.8 16.3 61.4 46.0
--------------- ------------- --------------- ------------
OPERATING INCOME 45.5 38.6 129.1 104.4
Interest and other expense, net 8.5 7.7 22.2 22.9
--------------- ------------- --------------- ------------
INCOME BEFORE INCOME TAXES 37.0 30.9 106.9 81.5
Income tax expense 14.4 10.8 42.4 28.5
--------------- ------------- --------------- ------------
NET INCOME 22.6 20.1 64.5 53.0
Preferred dividends -- .5 -- 2.8
--------------- ------------- --------------- ------------
INCOME ON COMMON STOCK $ 22.6 $ 19.6 $ 64.5 $ 50.2
=============== ============= =============== ============
PER SHARE DATA
- --------------
Earnings Per Common Share
Primary $ 0.26 $ 0.23 $ 0.75 $ 0.61
=============== ============= =============== ============
Fully Diluted $ 0.26 $ 0.23 $ 0.74 $ 0.61
=============== ============= =============== ============
Weighted Average Number of Common Shares 86.9 87.7 86.6 87.5
=============== ============= =============== ============
The accompanying notes are an integral part of these statements.
3
4
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
ASSETS September 30, December 31,
------ 1997 1996
------------------ -----------------
(Unaudited)
CURRENT ASSETS:
Trade accounts receivable, net $ 162.5 $ 85.2
Current deferred tax assets, net 34.3 48.9
Prepaids and other 20.0 16.4
------------------ -----------------
Total current assets 216.8 150.5
------------------ -----------------
PROPERTY AND EQUIPMENT:
Fiber optic network 437.0 392.5
Technology platforms, equipment and building leases 203.9 123.2
Less - Accumulated depreciation and amortization (187.5) (171.8)
------------------ -----------------
453.4 343.9
Property and equipment under construction 140.9 58.9
------------------ -----------------
Total property and equipment, net 594.3 402.8
------------------ -----------------
OTHER ASSETS:
Excess of cost over net assets acquired, net 348.1 350.5
Other, net 54.2 46.2
------------------ -----------------
Total other assets 402.3 396.7
------------------ -----------------
Total Assets $ 1,213.4 $ 950.0
================== =================
(Continued on next page)
4
5
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(in millions)
LIABILITIES AND SHAREOWNERS' EQUITY September 30, December 31,
----------------------------------- 1997 1996
---------------------- -------------------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable $ 37.2 $ 37.1
Facility costs accrued and payable 108.4 123.0
Accrued expenses and other 72.5 53.3
---------------------- -------------------
Total current liabilities 218.1 213.4
---------------------- -------------------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 396.1 235.8
---------------------- -------------------
OTHER LIABILITIES AND DEFERRED CREDITS 89.4 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 78.6 shares as of September 30, 1997 and 77.5
shares as of December 31, 1996 0.8 0.8
Paid-in capital 441.7 427.2
Retained earnings 67.3 2.8
---------------------- -------------------
Total shareowners' equity 509.8 430.8
---------------------- -------------------
Total Liabilities and Shareowners' Equity $ 1,213.4 $ 950.0
====================== ===================
The accompanying notes are an integral part of these statements.
5
6
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 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 1.1 -- 14.5 -- 14.5
Net Income -- -- -- 64.5 64.5
----------- -------- ---------- ---------- ----------
BALANCE AT SEPTEMBER 30, 1997 78.6 $ 0.8 $ 441.7 $ 67.3 $ 509.8
=========== ======== ========== ========== ==========
The accompanying notes are an integral part of these statements.
6
7
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in millions)
For the Nine Months
Ended September 30,
1997 1996
----------------- ------------------
OPERATING ACTIVITIES:
Net cash provided by operating activities $ 80.6 $ 238.9
----------------- ------------------
INVESTING ACTIVITIES:
Capital expenditures (224.5) (105.8)
Payments for acquisitions and other (7.8) (118.2)
----------------- ------------------
Net cash used in investing activities (232.3) (224.0)
----------------- ------------------
FINANCING ACTIVITIES:
Net debt (payments) borrowings (204.2) (16.0)
Senior Notes issuance proceeds 350.0 --
Financing fee payments (8.6) (2.7)
Preferred dividend payments -- (2.8)
Proceeds from employee stock plans and warrants 14.5 6.6
----------------- ------------------
Net cash provided by financing activities 151.7 (14.9)
----------------- ------------------
Net increase in cash and cash equivalents -- --
----------------- ------------------
CASH AND CASH EQUIVALENTS AT THE
BEGINNING OF THE PERIOD -- --
----------------- ------------------
CASH AND CASH EQUIVALENTS AT THE
END OF THE PERIOD $ -- $ --
================= ==================
The accompanying notes are an integral part of these statements.
7
8
LCI INTERNATIONAL, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
September 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
nine months ended September 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 nine months ended September 30, 1997 and 1996, the condensed
consolidated balance sheets as of September 30, 1997 and December 31, 1996, the
condensed consolidated statement of shareowners' equity for the nine months
ended September 30, 1997, and the condensed consolidated statements of cash
flows for the nine months ended September 30, 1997 and 1996.
LCI is a facilities-based telecommunications company that provides
voice and data transmission services to business, residential and local
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 summarizes the Company's significant accounting
policies.
PRINCIPLES OF CONSOLIDATION. The accompanying Condensed Consolidated
Financial Statements (Unaudited) include the accounts of LCI and its
wholly-owned 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.
8
9
EARNINGS PER COMMON SHARE. For the three and nine months ended
September 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.
(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 September 30,
1997 and December 31, 1996. SPC had approximately $141 million of accounts
receivable available for sale and had sold, but not yet collected, a total of
approximately $70 million as of September 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) DEBT AGREEMENTS
In June 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 $750 million Revolving Credit Facility (Credit
Facility) from a syndicate of banks. The Credit Facility is comprised of two
separate facilities of $500 million and $250 million. The first facility has a
term of 5-years, while the second facility has a one-year term. Each facility
may be extended for a limited number of periods. Both facilities bear interest
at a rate consisting of two components: The base rate component is dependent
upon a market indicator; the second component varies from 0.30% to 0.75% based
on the more favorable of the relationship of borrowings levels to operating
cash flow (leverage ratio) or senior unsecured debt rating. As of September 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 September 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.
9
10
(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 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 on-going 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 several agreements to extend its fiber-optic network. These
commitments will extend the Network throughout several geographic areas of the
United States, and are expected to require incremental capital expenditures of
approximately $270 million for fiber-optic capacity and related equipment. In
September 1997, the Company accepted approximately 1,500 route-miles of fiber
between Chicago, Illinois and Dallas, Texas, and paid $40 million for the
position in the fiber. The timing of other payments will depend on the delivery
and acceptance of facilities, which is expected to be completed in the first
half of 1998.
On September 18, 1997, the Company signed a definitive agreement to
acquire USLD Communications Corp. (USLD), in a stock-for-stock transaction that
will be accounted for as a pooling of interests. USLD provides long-distance
telecommunications services principally to business customers in the Southwest,
Southeast, Pacific Northwest and Western regions of the United States. In
addition, USLD offers operator services for the hospitality and pay phone
industries, and local telephone services in selected markets. The Company
expects the acquisition to close by the end of the year. The Company will
exchange that fraction of a share of Common Stock having a value of $20 per
share (valued pursuant to the formula contained in the agreement) for each
outstanding share of USLD common stock resulting in a purchase price between
$350 and $370 million. This acquisition is contingent on regulatory approval
and on the ability to qualify as a pooling transaction.
LEGAL MATTERS. The Company has been named as a defendant in various
litigation matters. Management intends to vigorously defend these outstanding
claims. The Company believes it has adequate accrued loss contingencies and,
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.
(7) SHAREOWNERS' EQUITY
RIGHTS AGREEMENT AND PREFERRED STOCK. In January 1997, the Company
adopted a shareholder 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 September 30, 1997, no such
preferred stock was issued or outstanding.
10
11
COMMON STOCK. The Company has stock option plans that grant options
to purchase shares of Common Stock to directors and key employees. During the
nine months ended September 30, 1997, the Company granted options to purchase
2.7 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 0.8 million shares of Common Stock during the nine months ended
September 30, 1997 pursuant to options exercised under all stock option plans.
The Company also has an Employee Stock Purchase Plan and a defined
contribution retirement plan for its employees which allow participants to
invest in Common Stock of the Company. The Company issued a total of 0.3
million shares of Common Stock under these employee benefit plans for the nine
months ended September 30, 1997.
(8) INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 1997 and 1996, consists of:
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- ----------------------------
(in millions) 1997 1996 1997 1996
-------------- ------------ ------------ -----------
Current tax expense:
Federal $ 0.5 $ 1.7 $ 1.6 $ 2.6
State 1.4 1.3 1.8 1.7
-------------- ------------ ------------ -----------
Total current tax expense 1.9 3.0 3.4 4.3
-------------- ------------ ------------ -----------
Deferred tax expense:
(Decrease) increase in deferred tax
liabilities (4.3) (0.7) 11.4 0.7
Decrease in deferred tax assets 16.8 11.0 27.6 28.5
Decrease in valuation allowance, net -- (2.5) -- (5.0)
-------------- ------------ ------------ -----------
Total deferred tax expense 12.5 7.8 39.0 24.2
-------------- ------------ ------------ -----------
Total income tax expense $ 14.4 $10.8 $ 42.4 $28.5
============== ============ ============ ===========
11
12
The effective income tax rate reconciliation for the three and nine
months ended September 30, 1997 and 1996, is as follows:
Three Months Nine Months
Ended September 30, Ended September 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 2.5 5.2 3.5 5.2
Non-deductible expenses 1.2 1.5 1.2 1.5
Decrease in valuation allowance, net -- (5.0) -- (5.0)
Other, net 0.3 (1.7) (0.2) (1.7)
------------ ----------- ----------- -----------
Effective income tax rate 39.0% 35.0% 39.5% 35.0%
============ =========== =========== ===========
The effective tax rate of 39.6% and 35.0% for the nine months ended
September 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 September 30, 1997, the Company had NOL
carryforwards for income tax purposes of $66.6 million, subject to various
expiration dates from 2000 to 2010. The Company believes the use of its NOLs
is likely.
The Company's deferred income tax balances include $34.3 million in
current deferred tax assets, net and $74.2 million in other noncurrent
liabilities as of September 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.
12
13
(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 September 30, 1997
---------------------------------------------------
Per Share
(in millions, except per share amounts) Income Shares Amount
-------------- ---------------- ---------------
Basic Earnings per Share:
Income available to common shareowners 22.6 78.5 $ 0.29
===============
Effect of Dilutive Securities:
Stock options -- 3.3
Warrants -- 4.5
-------------- ----------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 22.6 86.3 $ 0.26
============== ================ ===============
For the Nine Months Ended September 30, 1997
---------------------------------------------------
Per Share
Income Shares Amount
-------------- ---------------- ---------------
Basic Earnings per Share:
Income available to common shareowners 64.5 78.1 $ 0.83
===============
Effect of Dilutive Securities:
Stock options -- 3.0
Warrants -- 4.5
-------------- ----------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 64.5 85.6 $ 0.75
============== ================ ===============
Options to purchase 0.4 million and 2.1 million shares of Common Stock
were outstanding but not included in the computation of diluted earnings per
share during the three months and nine months ended September 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.
13
14
(9) EARNINGS PER SHARE (CONTINUED)
For the Three Months Ended September 30, 1996
---------------------------------------------------
Per Share
(in millions, except per share amounts) Income Shares Amount
-------------- ---------------- ---------------
Net income $20.1
Less: preferred stock dividends (0.5)
--------------
Basic Earnings per Share:
Income available to common shareowners 19.6 74.6 $ 0.26
===============
Effect of Dilutive Securities:
Stock options -- 5.9
Warrants -- 4.8
Convertible Preferred Stock 0.5 2.4
-------------- ----------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $20.1 87.7 $ 0.23
============== ================ ===============
For the Nine Months Ended September 30, 1996
---------------------------------------------------
Per Share
Income Shares Amount
-------------- ---------------- ---------------
Net income $ 53.0
Less: preferred stock dividends (2.8)
--------------
Basic Earnings per Share:
Income available to common shareowners 50.2 70.0 $0.72
===============
Effect of Dilutive Securities:
Stock options -- 5.3
Warrants -- 4.7
Convertible preferred stock 2.8 7.0
-------------- ----------------
Diluted Earnings per Share:
Income available to common shareowners
plus assumed conversions $ 53.0 87.0 $0.61
============== ================ ===============
14
15
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 businesses, 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 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 after certain
pro-competition conditions, including a list of 14 specific "competitive
checklist" requirements for operating in the local market are 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 being able to provide long-distance services
within their local services territories.
The Act provides a framework for the Company and other long-distance
carriers to compete with LECs by reselling local retail telephone service,
leasing unbundled elements of the incumbent LEC networks or building new local
service facilities. The Company has signed local service agreements with
Ameritech, BellSouth, Bell Atlantic and NYNEX (for the state of Massachusetts)
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 also evaluating providing service through the recombination of
unbundled network elements in light of the recent ruling by the Court of
Appeals for the Eight Circuit which does not require the LECs to recombine the
various network
15
16
element on behalf of their local competitors. The Company could also decide in
the future to build, or otherwise acquire, local service facilities or use a
competitive LEC 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, the resolution of various operational issues, 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 an
Interconnection Order (the Interconnection 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
Interconnection Order covered several important interconnection issues
including unbundled local network elements purchases, resale discounts and
arbitration procedures between LECs and interexchange carriers. Under the
Interconnection 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 Interconnection Order. On July 18, 1997, the United Stated Court of Appeals
for the Eighth Circuit (the Court) overturned many of the rules established in
the 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. On October 14, 1997, the Court
further overturned the FCC's rules pertaining to the unbundled network elements
platform. The Court concluded that the FCC's rules prohibiting a LEC from
separating network elements that may be currently combined in the incumbent
LEC's network, are contrary to the Act. The FCC has announced its intent to
appeal the Court's July 18, 1997 and October 14, 1997 rulings to the United
States Supreme Courts.
The Court's decisions substantially limit the FCC's jurisdiction and
expand the jurisdiction of state regulators to establish 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. Because of the uncertainty regarding the outcome of any forthcoming
appeals and how various state commissions will seek to facilitate and regulate
local competition, the Company is unable to predict what impact the Court's
decisions will have on LCI's ability to offer competitive local service and the
cost associated with the local service.
Bell Operating Company (BOC) Applications to Provide In-Region
interLATA Long-Distance. In January 1997, Ameritech Michigan became the first
BOC to apply for authority to provide in-region interLATA service. It withdrew
its application in February 1997, after the FCC struck from the record the
interconnection agreement between Ameritech and AT&T which formed the basis for
the application. In May 1997, Ameritech Michigan refiled its application for
in-region
16
17
interLATA authority in Michigan, but on August 19, 1997, the FCC released an
order rejecting the application. The FCC determined that Ameritech Michigan had
not demonstrated compliance with the competitive checklist or the safeguards of
the Act. In the August order, the FCC also established conditions and standards
for future applications for in-region, interLATA relief, including the
requirement that RBOC applications comply with the pricing standards originally
adopted in the Interconnection Order. Several RBOCs have asked the Eighth
Circuit to declare these pricing requirements a violation of the Court's
Interconnection Order decision. Those requests are pending.
In April 1997, SBC applied to the FCC for authority to provide
in-region interLATA service in Oklahoma. In June 1997, the FCC released an
order rejecting SBC's application on the grounds that SBC had not demonstrated
that the prospective facilities-based carriers with which SBC had entered into
interconnection agreements were providing local telephone service over their
own facilities to residential and business customers in Oklahoma, as required
by the Act. In July 1997, SBC filed an appeal of the June 1997 order with
United States Court of Appeals for the District of Columbia Circuit, which is
currently pending.
On September 30, 1997, BellSouth of South Carolina applied for
authority to provide in-region interLATA service. The Commission is currently
seeking comments on BellSouth's application. The Commission has 90 days to
make a ruling on BellSouth's application. The Company expects other RBOCs to
apply for in-region interLATA long-distance authority in the near future.
Access Charge Reform. In May 1997, the FCC issued orders designed to
reform the system of interstate 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. In the May
orders, the FCC decided to rely on a combination of prescriptive rate
reductions and increased competition in interstate access to bring interstate
access charges closer to actual economic cost. The FCC has stated that it will
issue a further order designed to permit incumbent LECs to lower interstate
access charges in response to competition. The manner in which the FCC
implements its approach in lowering access charge levels will have a material
effect on the prices the Company and its competitors pay for originating and
terminating interstate traffic. Various parties have filed petitions for
reconsideration with the FCC and some parties, including LCI, have appealed the
FCC's May orders to the appropriate federal court. The ultimate outcome of the
FCC and resultant court actions are uncertain and 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. In May 1997, the FCC released an order establishing
a significantly expanded federal telecommunications subsidy regime. Providers
of interstate telecommunications services, such as the Company, as well as
certain other entities, must pay to subsidize services for schools, libraries
and rural health care providers. The Company's share of the federal subsidy
will be based on its market share of defined telecommunications services and
certain defined telecommunications end user revenues. Several parties have
appealed the May 1997 order, and those appeals have been transferred and
consolidated in the United States Court of Appeals for the Fifth Circuit.
17
18
Payphone Compensation. In September 1996, the FCC adopted rules to
implement the Act's requirement to fairly compensate payphone service
providers. 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. In orders released July 1, and September 16, 1997, the United
States Court of Appeals for the D.C. Circuit vacated and remanded some of the
FCC rules. On October 9, 1997, the FCC issued an order addressing the default
per-call compensation rate in light of the Court's decision vacating and
remanding portions of the FCC's payphone orders. In response to the Court's
actions the FCC has established a default per-call rate of $0.284 for a
two-year period, which will increase the Company's costs to carry "dial-around"
calls that originate from payphones. This decision is expected to appeal. In
light of potential appeals and any court's ultimate actions in these
proceedings, the Company is unable to predict what impact, if any, this
decision will have on the Company.
Petition For Expedited Rulemaking. In May 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 in ensuring that
access to the LECs' internal systems are provided at a level of quality
consistent with LEC provided services. In its comments, LCI proposed that an
industry group consisting of local and long-distance carriers, trade
associations and regulators be given approximately nine weeks to establish
measurement categories, measurement formulas and default performance intervals
for several OSS categories. In June 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, have filed
comments in support of LCI's petition. This petition is currently pending.
Local Service. The Company is involved in 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 September 30, 1997, the Company has received
approval to resell local service in 35 states and the District of Columbia, and
has applications for local service authority pending in another 13 states. The
Company is currently reselling local telecommunications service in 31 markets.
Impact of Regulatory Issues. The regulatory actions discussed above
could impact the Company's cost structure by changing access, per-line and pay
phone charges. The Company is unable to predict whether these changes will
impact its pricing, revenue growth or gross margin.
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 markets.
18
19
Several of the Company's competitors are substantially larger and have
substantially greater financial, technical and marketing resources. In addition
to the largest telecommunications companies, 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
competitive to 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
responsive services at prices generally equal to or below those charged by its
major competitors.
Industry Mergers. Several very large mergers are currently being
contemplated in the telecommunications industry. Among these proposed mergers
are MCI and WorldCom, Inc.; MCI and British Telecommunications; and GTE and
MCI. At this time the Company is unable to predict the impact, if any, on the
Company or competition within the industry as a whole.
19
20
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 NINE MONTHS ENDED SEPTEMBER 30, 1997 AS
COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996
REVENUES. Revenues increased 26% to $364.8 million and 26% to
$1,017.9 million for the three and nine months ended September 30, 1997,
respectively, over the comparable periods in 1996. MOUs increased 33% to 2.8
billion minutes for the three months and 37% to 8.1 billion minutes for the
nine month periods in 1997 over 1996. The following table provides further
information regarding the Company's revenues:
(in millions, Three Months Nine Months
except switched revenue per MOU) Ended September 30, Ended September 30,
------------------------------------- ------------------------------------
1997 1996 Change 1997 1996 Change
------------------------------------- ------------------------------------
Total Revenues $ 364.8 $ 289.2 26% $1,017.9 $809.1 26%
MOUs 2,837 2,131 33% 8,067 5,896 37%
Switched Revenue per MOU (1) $ 0.119 $ 0.125 (5)% $ 0.117 $0.126 (7)%
(1)Switched revenue divided by MOUs
Revenues from business customers increased in excess of 25% for the
three and nine months ended September 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 in excess of 20% and 30% for the three and nine
months ended September 30, 1997, respectively, over the comparable periods in
the prior year. Growth in international service revenues across all revenue
service lines was approximately 100% and 70% for the three and nine months
ended September 30, 1997, respectively compared to the same periods in 1996.
The Company experienced a decrease in average revenue per MOU for both
the three and nine months ended September 30, 1997, as compared to the same
periods in 1996. Revenue per MOU reflects changing cost of services, changes in
the mix of services by market segments and competitive pricing. The growth in
business and international service volumes, as measured in MOUs, exceeded the
growth in revenue due to competitive pricing pressures and changes in the mix
of international country traffic. In addition, the Company has experienced MOU
growth from high volume business customers who primarily use dedicated access
services rather than switched services, which have a lower revenue per MOU. 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.
20
21
The Company has experienced an increase in 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 towards 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 continues
to evaluate and monitor performance of the LECs, as these costs of
uncollectible accounts have exceeded historical expectations. The Company's
experience with a higher level of uncollectible accounts in the
residential/small business segment is consistent with industry trends.
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 long distance revenue attributable to customers
sold by the agents. 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 of the Company's sales agents for residential/small business
customers. The Company does, however, continue to expand its sales presence
across the country using a variety of channels.
GROSS MARGIN. The Company's gross margin increased 23% to $151.3
million and 25% to $421.3 million for the three and nine months ended September
30, 1997, respectively, as compared to the same periods in 1996. During the
three and nine months ended September 30, 1997, gross margin as a percentage of
revenue decreased to 41.5% and 41.4%, respectively, from 42.4% and 41.6% for
the same periods in 1996, respectively. The decrease as a percentage of revenue
reflects a shift in revenue mix to high volume customers with lower gross
margins per MOU as well as continued competitive pricing pressures.
The Company's fiber expansion planned for the second half of 1997 and
early 1998, will temporarily result in redundant facilities and increased costs
while traffic is moved from current leased facilities to the new owned
facilities. However, once this transition is completed, which is expected to be
throughout 1998, the Company will realize a lower cost of service. The Company
continues to evaluate strategies to reduce its cost of services and improve the
reliability and efficiency of the Network.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 23% to $83.0 million and 24% to $230.8
million for the three and nine months ended September 30, 1997, respectively,
as compared to the same periods in 1996. As a percentage of revenues, selling,
general and administrative expenses were 22.8% and 22.7% for the three and nine
months ended September 30, 1997, respectively, as compared to 23.4% and 23.0%
for the same periods in 1996, respectively. Annualized revenue per employee has
remained at approximately $500,000 per employee through the nine months ended
September 30, 1997.
The Company's selling, general and administrative expense increases
year-over-year were substantially impacted by payroll and commissions. Payroll
expenses increased 23% and 26% for the three and nine months ended September
30, 1997, respectively. Payroll expenses increased at a slower rate than the
revenue increase which resulted from business segments which do not require
concurrent increases in selling, general and administrative expenses.
The increase in selling, general and administrative expenses includes
a $5.2 million and $13.7 million increase in commission expense for the three
and nine months ended September 30,
21
22
1997, respectively, over the comparable prior periods. The growth in
residential/small business revenue sold by third party sales agents with
upfront and ongoing commissions 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, entrance into the local service market, and temporarily, due to
acquisition activity. During the nine months ended September 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 nine months ended September 30, 1997 was $22.8
million and $61.4 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, as well as the expansion of the owned portion of
the Network. The increase in depreciation and amortization for the additional
Network facilities is expected in first quarter of 1998. Depreciation and
amortization expense as a percentage of revenues was 6.3% and 6.0% for the
three and nine months ended September 30, 1997, respectively, as compared to
5.6% and 5.7% for the same periods in 1996, respectively.
OPERATING INCOME. Operating income increased 18% to $45.5 million and
24% to $129.1 million for the three and nine months ended September 30, 1997,
respectively, over the same periods in 1996. As a percentage of revenues,
operating income was 12.5% and 12.7% for the three and nine months ended
September 30, 1997, respectively, compared to 13.4% and 12.9% for the same
periods in 1996. The decline in operating income as a percentage of revenue
reflects the competitive pressures on gross margin, and the increased
depreciation for the Company's capital expenditures prior to the full benefit
of these investments being reflected in the results of operations.
INTEREST AND OTHER EXPENSE, NET. Interest and other expense, net of
capitalized interest, increased to $8.5 million and decreased to $22.2 million
for the three and nine months ended September 30, 1997, respectively, compared
to $7.7 million and $22.9 million for the same periods in 1996, respectively.
Interest expense included a full quarter of interest from the newly issued
Senior Notes, which resulted in the increase for the third quarter 1997 over
1996. The Company was able to reduce the level of outstanding debt during the
first half 1997 compared to 1996, through the Securitization Program, which
provided a lower cost of capital, as well as a lower interest expense on the
Credit Facility. Although interest expense decreased year-over-year, interest
expense is expected to increase due to a higher rate of the interest associated
with the Senior Notes compared to the short-term rates currently available
under existing facilities. The Company also expects a higher average borrowing
as a result of the Senior Notes during the second half of 1997, compared to the
same period in 1996. However, the fixed interest rate on the Senior Notes
provides interest rate stability and frees capacity under the Company's other
short-term facilities.
INCOME TAX EXPENSE. Income tax expense was $14.4 million and $42.4
million for the three and nine months ended September 30, 1997, respectively,
as compared to $10.8 million and $28.5 million for the same periods in 1996,
respectively. The Company's net operating loss (NOL)
22
23
carryforwards for financial statement purposes were fully utilized in 1996,
resulting in an increase in the estimated effective tax rate to 39.5% in 1997
from 35% in 1996. The increase in income tax expense resulted from the increase
in the estimated effective tax rate and the growth in earnings before taxes.
The Company analyzes and adjusts its effective tax rate, if necessary, on a
quarterly basis.
PREFERRED DIVIDENDS. The Company's previously outstanding shares of 5%
Cumulative Convertible Exchangeable Preferred Stock (Preferred Stock) were
redeemed on September 3, 1996, thereby eliminating the corresponding preferred
dividend payments. The annual savings 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. (LCII) is a holding company and conducts its
operations through its direct and indirect wholly-owned subsidiaries. The
Company's discussion of its liquidity is based on the consolidated group.
CASH FLOWS - OPERATING ACTIVITIES. The Company provided $80.6 million
of cash from operations for the nine months ended September 30, 1997, compared
to $238.9 million for the same period in 1996. Excluding the net securitization
activity, cash from operations was $122.8 million for the nine month period
ended September 30, 1997, compared to $130.9 million for the same period in
1996. The Company's growth in revenues and net income has provided consistent
operating cash flows.
CASH FLOWS - INVESTING ACTIVITIES. The Company has supported its
growth strategy with capital expenditures and acquisitions, resulting in $232.3
million in cash used for investing activities during nine months ended
September 30, 1997, compared to $224.0 million in 1996. During the nine months
ended September 30, 1997, the Company spent $224.5 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 $118.7 million from the same period in 1996. This
increase includes the $40 million payment for the Chicago-Dallas fiber purchase
in September 1997.
CASH FLOWS - FINANCING ACTIVITIES. Financing activities provided a net
$151.7 million for the nine months ended September 30, 1997, compared with
$14.9 million used in financing activities during the same period in 1996. In
June 1997, the Company received proceeds of $350 million from the issuance of
long-term debt (see Capital Resources below) and the proceeds were used, in
part, to repay other then outstanding indebtedness.
CAPITAL RESOURCES. 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 has a $750 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 September 30, 1997, there was no
outstanding balance on the Credit Facility. The interest rate on the debt
outstanding is variable based on several indices (See Note 5 to the Condensed
Consolidated Financial Statements).
23
24
The Credit Facility contains certain financial and negative covenant
requirements. As of September 30, 1997, the Company was in compliance with all
covenants.
The Company has three separate Discretionary Line of Credit Agreements
(Lines of Credit) with commercial banks for a total of $75 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
borrowing availability under the Credit Facility to repay such balances. As of
September 30, 1997, there was a $17.9 million 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 September 30, 1997, the pool of trade accounts
receivable which was available for sale was approximately $141 million and the
amount of receivables sold was approximately $70 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
on-going 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 several agreements to extend its owned fiber-optic network
throughout several geographic areas of the United States. The Company has
binding commitments to purchase will make payments of approximately $270
million of fiber-optic capacity and related equipment. In September 1997, the
company accepted approximately 1,500 route-miles from Chicago, Illinois to
Dallas, Texas and paid approximately $40 million for the position in the fiber.
The timing of other payments will depend on the delivery and acceptance of
facilities, which is expected to occur in the first half of 1998. The Company
believes it has adequate cash flow and borrowing capacity to fund planned
capital expenditures.
On September 18, 1997, the Company signed a definitive agreement to
acquire USLD Communications Corp. (USLD), in a stock-for-stock transaction that
will be accounted for as a pooling of interests. USLD provides long-distance
telecommunications services primarily to business customers in the Southwest,
Southeast, Pacific Northwest and Western regions of the United States. In
addition, USLD offers operator services for the hospitality and pay phone
industries, and local telephone services in selected markets. The Company
expects the acquisition to close by the end of the year. The Company will
exchange the fraction of a share of Common Stock having a value of $20 per
share (valued pursuant to the formula contained in the agreement), for each
outstanding share of USLD common stock resulting in a purchase price of between
$350 -$370 million. This acquisition is contingent on regulatory approval and
on the ability to qualify as a pooling transaction.
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.
24
25
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,
AT&T, 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.
In October 1997, the Company amended a contract with a significant
carrier. Under the original contract, the Company had an obligation to use that
carrier for a significant percentage of domestic and international services
that the Company provides through its leased facilities. Under the terms of the
amended contract, the Company received a reduction in usage commitments and a
usage credit, in exchange for agreeing to increases in certain rates. The
Company expects to mitigate the impact of these increased rates by applying the
usage credit against future activity over the life of the amended contract and
by migrating traffic to other lower priced vendors. In addition, under the
amended contract the Company will swap fiber along routes with excess capacity
in exchange for fiber along strategic routes beneficial to the Company. If the
Company is unable to identify lower cost traffic routes, it may incur increased
facility costs when the available usage credit is exhausted. The Company does
not expect that the amended contract will have a material adverse impact on the
results of operations.
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
25
26
Consolidated Financial Statements for a discussion of the availability and
expected utilization of the existing NOLs.
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 in the fourth quarter due to holidays.
An increase in residential/small business revenue as a proportion of the
Company's total revenues would cause the seasonal impact due to changes in
commercial calling patterns to 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 Act, 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; expected future interest rates; 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 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 impact of
access charge reform; 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.
26
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 that became effective
as of April 25, 1997. The Company has complied with all aspects of the
settlement and the settlement did 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, these current pending or threatened litigation
matters are not expected to have a material adverse effect on the consolidated
financial position or results of operations of the Company.
27
28
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 30 of this report.
(b) Reports on Form 8-K: On September 23, 1997, the Company filed a report
on Form 8-K to report the signing of a definitive Agreement and Plan
of Merger between the Company and USLD Communications Corp.
28
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LCI INTERNATIONAL, INC.
DATE: November 12, 1997 BY: /s/ Joseph A. Lawrence
----------------- ----------------------
Joseph A. Lawrence
Chief Financial Officer,
Executive Vice President and
Chief Financial Officer
(as duly authorized officer and
principal financial officer)
29
30
EXHIBIT INDEX
The following Exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Exhibit
Number Description
- ----------- ---------------------------------------------------------------
2(b) Agreement and Plan of Merger, dated as of September 17, 1997,
by and among LCI International, Inc., LCI Acquisition Corp.
and USLD Communications Corp. (1)
3(i)(a) Amended and Restated Certificate of Incorporation. (2)
3(i)(c) Certification of Designation, Preferences and Rights of Junior
Participating Preferred Stock. (3)
3(ii) Amended and Restated By-laws. (4)
4(c)(xv) Third Amended and Restated Credit Agreement, dated as of
September 5, 1997, by and among LCI International, Inc., First
Union National Bank, Nationsbank of Texas, N.A., and The Bank
of New York.
4(c)(xvi) 364 Day Credit Agreement, dated as of September 5, 1997, by
and among LCI International, Inc., First Union National Bank,
Nationsbank of Texas, N.A., and The Bank of New York.
11 Statement Regarding Computation of Per Share Earnings
27 Financial Data Schedule
(1) Incorporated by reference from the Company's Current Report on
Form 8-K dated September 17, 1997.
(2) Incorporated by reference from the Company's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 1996.
(3) Incorporated by reference from the Company's Quarterly Report on
Form 10-Q/A for the quarterly period ended March 31, 1997.
(4) Incorporated by reference from the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1996.
30