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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 March 31, 1998
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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
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8180 Greensboro Drive, Suite 800
McLean, Virginia 22102
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(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
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As of April 30, 1998, there were 98,062,750 shares of LCI International, Inc.
Common Stock (par value $.0l per share) outstanding.
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LCI INTERNATIONAL, INC.
INDEX
PAGE
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NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Statements of Operations--
For the Three Months Ended March 31, 1998 and 1997 3
Condensed Consolidated Balance Sheets--
As of March 31, 1998 (unaudited) and December 31, 1997 4 - 5
Unaudited Condensed Consolidated Statement of Shareowners' Equity--
For the Three Months Ended March 31, 1998 6
Unaudited Condensed Consolidated Statements of Cash Flows--
For the Three Months Ended March 31, 1998 and 1997 7
Notes to Interim Unaudited Condensed Consolidated Financial Statements 8 - 13
Item 2. Management's Discussion and Analysis of Financial Condition and Results 14 - 25
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION 26
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURE 28
EXHIBIT INDEX 29
EXHIBITS
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(in millions, except for per share amounts)
1998 1997
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REVENUES $ 448 $ 368
Cost of services 259 219
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GROSS MARGIN 189 149
Selling, general and administrative expenses 106 84
Depreciation and amortization 27 21
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OPERATING INCOME 56 44
Interest and other expense, net 8 7
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INCOME BEFORE INCOME TAXES 48 37
Income tax expense 19 15
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NET INCOME $ 29 $ 22
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PER SHARE DATA
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Earnings Per Common Share
Basic $ 0.30 $ 0.25
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Diluted $ 0.29 $ 0.22
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Weighted Average Number of Common Shares
Basic 97 89
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Diluted 102 99
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The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
ASSETS March 31, December 31,
------ 1998 1997
--------------- ----------------
(Unaudited)
CURRENT ASSETS:
Trade accounts receivable, net $ 164 $ 190
Current deferred tax assets, net 51 59
Prepaids and other 25 22
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Total current assets 240 271
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PROPERTY AND EQUIPMENT:
Fiber optic network 593 558
Technology platforms, equipment and building leases 255 231
Less - Accumulated depreciation and amortization (224) (206)
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624 583
Property and equipment under construction 118 88
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Total property and equipment, net 742 671
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OTHER ASSETS:
Excess of cost over net assets acquired, net 356 359
Other, net 61 53
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Total other assets 417 412
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Total Assets $1,399 $1,354
=============== ================
(Continued on next page)
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Continued)
(in millions)
LIABILITIES AND SHAREOWNERS' EQUITY March 31, December 31,
----------------------------------- 1998 1997
--------------- ----------------
(Unaudited)
CURRENT LIABILITIES:
Accounts payable $ 64 $ 43
Facility costs accrued and payable 127 154
Accrued expenses and other 111 91
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Total current liabilities 302 288
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LONG-TERM DEBT AND CAPITAL LEASE
OBLIGATIONS 395 413
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OTHER LIABILITIES AND DEFERRED CREDITS 103 101
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COMMITMENTS AND CONTINGENCIES
SHAREOWNERS' EQUITY:
Preferred Stock - Authorized 15 shares, no shares
issued and outstanding -- --
Common stock - Authorized 300 million shares,
issued and outstanding 97 million shares
as of March 31, 1998 and 96 million shares as of
December 31, 1997 1 1
Paid-in capital 529 511
Retained earnings 69 40
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Total shareowners' equity 599 552
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Total Liabilities and Shareowners' Equity $1,399 $1,354
=============== ================
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 THREE MONTHS ENDED MARCH 31, 1998
(Unaudited)
(in millions)
Common Stock
---------------------------
Issued
and $.01 Par Paid- Retained
Outstanding Value In Capital Earnings Total
------------- ----------- ------------ ---------- -------
BALANCE AT DECEMBER 31, 1997 96 $ 1 $ 511 $ 40 $ 552
Employee stock purchases and
exercise of options/warrants, 1 -- 18 -- 18
including related tax benefits
Net Income -- -- -- 29 29
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BALANCE AT MARCH 31, 1998 97 $ 1 $ 529 $ 69 $ 599
============= =========== ============ ========== =======
The accompanying notes are an integral part of this statement.
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LCI INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31,
(Unaudited)
(in millions)
1998 1997
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OPERATING ACTIVITIES:
Net cash provided by operating activities $ 78 $ 41
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INVESTING ACTIVITIES:
Capital expenditures (97) (47)
Other payments -- (6)
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Net cash used in investing activities (97) (53)
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FINANCING ACTIVITIES:
Net debt borrowings 5 3
Proceeds from employee stock plans and warrants 14 6
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Net cash provided by financing activities 19 9
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Net increase (decrease) in cash and cash
equivalents -- (3)
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CASH AND CASH EQUIVALENTS AT THE
BEGINNING OF THE PERIOD -- 12
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CASH AND CASH EQUIVALENTS AT THE
END OF THE PERIOD $ -- $ 9
========= =========
The accompanying notes are an integral part of these statements.
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LCI INTERNATIONAL, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 1998
(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 months ended
March 31, 1998 and 1997. 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 months ended March 31, 1998 and 1997, the condensed consolidated
balance sheets as of March 31, 1998 and December 31, 1997, the condensed
consolidated statement of shareowners' equity for the three months ended March
31, 1998, and the condensed consolidated statements of cash flows for the three
months ended March 31, 1998 and 1997.
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 1997
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. In December 1997, the Company acquired USLD Communications
Corp. (USLD) and accounted for the acquisition as a pooling of interests. The
Company's Condensed Consolidated Financial Statements have been restated to
include the results for USLD, as though the companies had always been a combined
entity.
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(4) ACCOUNTS RECEIVABLE SECURITIZATION
Under the Company's agreement to sell a percentage ownership interest in
a defined pool of its 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 March 31, 1998 and December 31, 1997. SPC had
approximately $140 million of accounts receivable available for sale and had
sold, but not yet collected, a total of approximately $100 million as of March
31, 1998. 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 five 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 March 31, 1998, 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 March 31, 1998, the Company was in compliance
with all Credit Facility covenants.
The Company has three separate Discretionary Line of Credit Agreements
(Lines of Credit) with commercial banks for a total of $75 million. As of March
31, 1998, there was a $14 million outstanding balance on the Lines of Credit. In
addition, the Company had approximately $3 million in various fixed-rate notes
as of March 31, 1998.
(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
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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 1998, 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 1997. 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.
During the first quarter of 1998, the Company made progress payments totaling
$14 million to expand its Network between Cleveland, Ohio and New York, New
York; Chicago, Illinois and Los Angeles, California; and Dallas, Texas and
Washington, D.C. The timing of other payments will depend on the delivery and
acceptance of facilities, which is expected to be completed in 1998.
PROPOSED MERGER. On March 8, 1998, the Company entered into a merger
agreement with Qwest Communications International Inc. (Qwest) and a subsidiary
of Qwest pursuant to which the Company will become a wholly owned subsidiary of
Qwest. The all-stock transaction is valued at approximately $4.4 billion. Under
the terms of the agreement, each of the outstanding shares of the Company's
common stock, par value $.0l per share, will be converted into $42 of Qwest
common stock, subject to certain exceptions. The number of shares of Qwest
common stock to be exchanged for each share of the Company's common stock will
be determined by dividing $42 by a 15-day volume weighted average of trading
prices for Qwest common stock prior to the closing, but will not be less than
1.0625 shares (if Qwest's average stock price exceeds $39.53) or more than
1.5583 shares (if Qwest's average stock price is less than $26.95). The Company
may terminate the merger agreement if Qwest's average stock price is less than
$26.95, unless Qwest then agrees to exchange for each share of common stock of
the Company the number of Qwest shares determined by dividing $42 by such
average price. The merger is intended to qualify as a tax-free reorganization
and will be accounted for as a purchase. It is anticipated that the merger will
occur by the second or third quarter of 1998. The transaction is subject to the
majority vote of the outstanding shares of Qwest and LCI and to other customary
conditions such as receipt of regulatory approvals. The majority shareholder of
Qwest has entered into an agreement to vote in favor of the merger. There can be
no assurances that the conditions to closing the merger will be met; however the
Company does not currently anticipate any impediments to completing the merger.
LEGAL MATTERS. The Company has been named as a defendant in various
litigation matters incident to the character of its business. In addition, the
Company, certain of its directors, and Qwest have been named as defendants in
suits in connection with the Qwest merger agreement. Management intends to
vigorously defend these outstanding claims. The Company believes it has adequate
accrued loss contingencies and that current or threatened litigation matters
will not have a material adverse impact on the Company's results of operations
or financial condition.
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(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 March 31, 1998, no such
preferred stock was issued or outstanding. On March 8, 1998 the Company's Board
of Directors approved an amendment to exempt the proposed merger with Qwest from
the application of the Rights Agreement.
COMMON STOCK. The Company has stock option plans that grant options to
purchase shares of Common Stock to directors and key employees. During the three
months ended March 31, 1998, the Company granted options to purchase
approximately 3 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 1 million shares of Common Stock during the three months ended
March 31, 1998 pursuant to options exercised under all stock option plans. The
stock option plans contain a provision which accelerates vesting in the event of
a change in control of the Company. The merger with Qwest, as proposed, would
result in accelerated vesting of the Company's options outstanding.
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 approximately 0.1
million of Common Stock under these employee benefit plans during the three
months ended March 31, 1998.
(8) INCOME TAXES
The provision for income taxes for the three months ended March 31, 1998
and 1997, consists of:
Three Months
Ended March 31,
-----------------------------
(in millions) 1998 1997
-------- --------
Current tax expense:
Federal $ 4 $ 1
State 1 1
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Total current tax expense 5 2
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Deferred tax expense:
Increase in deferred tax liabilities 2 1
Decrease in deferred tax asset 12 12
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Total deferred tax expense 14 13
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Total income tax expense $ 19 $ 15
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The effective income tax rate varies from the Federal statutory income
tax rate for the three months ended March 31, 1998 and 1997, as follows:
Three Months
Ended March 31,
----------------------------
1998 1997
-------- --------
Expected tax expense at federal
statutory income tax rate: 35% 35%
Effect of:
State income tax expense 4 4
Non-deductible expenses 1 1
Other, net (1) --
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Income tax expense 39% 40%
======== ========
The effective tax rate of 39% and 40% for the three months ended March
31, 1998 and 1997, respectively, represents the Company's estimated effective
tax rate for the periods. This effective tax rate is adjusted quarterly based on
the Company's estimate of future taxable income.
The Company has generated significant net operating losses (NOLS) that
may be used to offset future taxable income. Each NOL has a maximum 15-year
carryforward period. The Company's ability to fully use its NOL carryforwards is
dependent upon future taxable income. As of March 31, 1998, the Company had NOL
carryforwards for income tax purposes of $74 million, subject to various
expiration dates from 2000 to 2010. The Company believes the utilization of such
NOLs is likely.
The Company's deferred income tax balances include $50 million in
current deferred tax assets, net and $86 million in other noncurrent liabilities
as of March 31, 1998. As of December 31, 1997, deferred income tax balances
included $59 million in current deferred tax assets, net and $84 million in
other noncurrent liabilities.
9. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standard Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share," which
changed the method used to calculate earnings per share. Basic earnings per
share has been calculated as income available to common shareowners divided by
the weighted average number of common shares outstanding. Diluted earnings per
share has been calculated as net income divided by the diluted weighted average
number of common shares. Diluted weighted average number of common shares has
been calculated using the treasury stock method for Common Stock equivalents,
which includes Common Stock issuable pursuant to stock options and Common Stock
warrants. The following is provided to reconcile the earnings per share
calculations:
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For the Three Months Ended
March 31,
(In millions, except per share amounts) 1998 1997
Income:
Net income $ 29 $ 22
========== ==========
Shares:
Weighted average shares (Basic) 97 89
Effect of dilutive securities:
Stock options 5 5
Warrants -- 5
Diluted weighted average shares 102 99
========== ==========
Per Share Amounts:
Basic earnings per share $ 0.30 $ 0.25
========== ==========
Diluted earnings per share $ 0.29 $ 0.22
========== ==========
Options to purchase 0.1 million and 2.4 million shares of Common Stock
were outstanding but not included in the computation of diluted earnings per
share during the three months ended March 31, 1998 and 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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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.
There are numerous judicial and regulatory actions that are ongoing which can
impact the nature and degree of competition in the telecommunications industry.
The Company is unable to predict the timing for resolution of these actions, or
the ultimate impact of these matters on the industry and competition. The
regulatory and legislative actions discussed below could impact the Company's
pricing and cost structure by changing access, per-line and payphone charges, or
by generally increasing competition. The Company is unable to predict what
impact these changes will have on its pricing, revenue growth or operating
margin.
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 is intended to open
competition in the local services market and, at the same time, contains
provisions intended to protect consumers and businesses 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 between LATAs to consumers inside their local service territories only
after meeting certain criteria, including a list of 14 specific "competitive
checklist" requirements for opening the local market to competition.
The Act also provides a framework for the Company and other
long-distance carriers to compete with LECs by reselling local telephone
service, leasing unbundled elements of the incumbent LEC networks or building
new local service facilities. The Company has signed local service resale
agreements with Ameritech Corporation (Ameritech), BellSouth Corporation
(BellSouth) and Bell Atlantic Corporation (Bell Atlantic). The Company has also
signed an
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interconnection agreement with Ameritech, and is currently in formal
negotiations with several other LECs for interconnection agreements. LCI intends
to vigorously compete in the local service market and is currently providing
local service to customers on a bundled resale basis. The Company is also
evaluating providing local service through the recombination of unbundled
network elements; however, a recent court ruling (see Local Competition Order,
below) does not require the LECs to recombine the various network elements on
behalf of local service competitors. The Company could also decide in the future
to build, or otherwise acquire, local service facilities or use a competitive
LEC other than incumbent LECs (such as the RBOCs or GTE Communications
Corporation (GTE)) to provide local service. The Company's decision on the
timing and method of providing local service is dependent on the economic
viability and profitability of the available options, the resolution of various
operational issues and the outcome of several pending regulatory and judicial
proceedings.
In July 1997, SBC Communications Inc. (SBC), followed by US WEST
Communications (US West) and Bell Atlantic, filed a lawsuit in the United States
District Court for the Northern District of Texas (the District Court)
challenging, on constitutional grounds, the restrictions contained in the Act
applicable only to RBOCs. The plaintiffs sought both a declaratory judgment and
an injunction against the enforcement of the challenged provisions. On December
31, 1997, the District Court ruled that the RBOC-specific provisions of the Act
were an unconstitutional bill of attainder. The Federal Communications
Commission (FCC), AT&T Corporation (AT&T), MCI Communications Corporation (MCI)
and Sprint Corporation (Sprint) have appealed this ruling to the United States
Court of Appeals for the Fifth Circuit and requested a stay of this ruling
pending the outcome of the appeal. On February 11, 1998, the District Court
granted a stay, pending appeals. If the ruling is ultimately upheld, the RBOCs
may be able to provide long-distance services within their local service
territories much sooner than expected and without the detailed review and
approval process by state regulators and the FCC that is currently required
under the Act. If this decision were upheld, the Company expects an increase in
competition for long-distance services which could result in the loss of market
share and/or a decrease in operating margins. The Company is unable to predict
the outcome of the pending appeal.
REGULATORY MATTERS
In order to implement the Act, the FCC is required to undertake a
variety of regulatory actions that impact competition in the telecommunications
industry. Many of the actions taken by the FCC to implement the Act, in addition
to the Act itself, face court challenges. Certain of these regulatory actions
are described below.
Local Competition Order. In August 1996, the FCC adopted a local
competition order (the Local Competition Order) which established a minimum
national framework for local service interconnection with the LECS. The Local
Competition Order covered several important interconnection issues including the
purchase of unbundled local network elements, resale discounts and arbitration
procedures between LECs and interexchange carriers.
Several states, companies, associations and other entities appealed the
Local Competition Order. In July 1997, the United States Court of Appeals for
the Eighth Circuit (the Eighth Circuit) overturned, on jurisdictional grounds,
many of the rules established in the Local Competition Order, including the
pricing of interconnection, resale and unbundled network elements. In addition,
the Eighth Circuit overturned the "pick-and-choose" rule, which would have
allowed
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potential competitors to receive the benefit of the most favorable provisions
contained in a LEC's interconnection agreements with other carriers. In October
1997, the Eighth Circuit further overturned the FCC's rules pertaining to the
unbundled network elements platform. The Eighth Circuit concluded that the FCC's
rules prohibiting a LEC from separating network elements that are currently
combined in the incumbent LEC's network are contrary to the Act. The FCC and
others filed a writ of certiorari asking the United States Supreme Court to
accept the case and consider the merits of various appeals. On January 26, 1998,
the Supreme Court announced that it will hear the appeal from the Eighth
Circuit.
The Eighth Circuit'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. If the Eighth
Circuit's decisions are upheld, it is likely that over time the rules governing
local competition could vary substantially from state to state. If a patchwork
of state regulations were to develop, it could make competitive entry in some
markets difficult and expensive and could increase the costs of regulatory
compliance associated with local entry. If the Supreme Court were to uphold the
Eighth Circuit's ruling, it could negatively impact the Company's ability to
offer competitive local service and increase the costs associated with local
service. The Company cannot predict the outcome of the current appeal to the
Supreme Court.
RBOC Applications to Provide In-Region InterLATA Long-Distance.
Throughout 1997, various RBOCs applied to the FCC for authority to provide
in-region interLATA service. The FCC has yet to approve any in-region
application for various reasons, including that the RBOCs had not demonstrated
compliance with the competitive checklist or the other safeguards of the Act.
BellSouth and SBC have appealed the denial of their applications by the FCC to
provide long distance service within the states of Louisiana and South Carolina,
and Oklahoma, respectively. On March 20, 1998, the United States Court of
Appeals for the D.C. Circuit (the D.C. Circuit) upheld the FCC's rejection of
SBC's request to provide long distance service within Oklahoma. Several appeals
by RBOCs and in-region interLATA applications are still pending. The Company is
unable to predict when one or more RBOCs may be actively competing in the
long-distance market, but expects that when able to compete, RBOCs will gain a
significant market share.
On April 6, 1998, the Chairman of the New York Public Service Commission
outlined a series of tests and conditions that Bell Atlantic has agreed to meet
prior to seeking approval from the FCC to provide long distance service within
New York. The conditions agreed upon by Bell Atlantic include among others;
access to unbundled network elements, including the network elements platform,
for a period of four to six years; however, after that period competitive local
exchange carriers (CLECs) will still have access to the network elements
platform by recombining the network elements themselves; third party testing of
operational support systems (OSS) supervised by the FCC and the Department of
Justice; and terms and conditions under which CLECs will be able to connect
their facilities with Bell Atlantic. Once Bell Atlantic has met the conditions
set forth in their pre-filing document, they still must seek approval from the
New York Public Service Commission and the FCC for authority to provide
in-region long distance service in New York. LCI is unable to predict when Bell
Atlantic will be able to comply with the conditions set forth in its pre-filing
document or the impact on the market if Bell Atlantic's application is approved.
Access Charge Reform. In May 1997, the FCC issued an order designed to
reform the system of interstate access charge expenses, the Company's single
largest expense, levied by LECs on long-distance service carriers. In the May
order, the FCC used rate reductions and increased
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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 to lowering
access charge levels will have a material effect on the prices the Company and
its long-distance competitors pay for originating and terminating interstate
traffic. Various parties have filed petitions for reconsideration of the May
order with the FCC. Some parties, including the Company, have appealed the May
order to the Eighth Circuit, which heard oral arguments on January 15, 1998. The
Company cannot predict when the Eighth Circuit will issue a ruling on the
Company's appeal. Although the ultimate outcome of the FCC and resulting court
actions are uncertain, the Company does expect lower access charges in 1998.
This decrease, however, has been offset by increases in customer line charges
and charges for the universal service fund.
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 intraLATA toll providers (including LECS) on all
"dial-around" calls, including debit card and calling card calls. In orders
released in July and September 1997, the D.C. Circuit vacated and remanded some
of the FCC's rules. In October 1997, the FCC established a default per-call rate
of $0.284 for a two-year period to respond to the DC Circuit. The FCC's action
will increase the Company's costs to carry certain calls that originate from
payphones. This decision has been appealed by several parties. In the quarter
ended March 31, 1998, the Company implemented billing procedures to charge its
customers for the expected cost of these calls. In light of this appeal and any
court action in these proceedings, the Company is unable to predict the ultimate
impact that changes to the per-call compensation rate 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 that the FCC establish performance standards for incumbent
LECs to meet the OSS requirements of the Act and applicable FCC regulations. The
OSS requirements are critical in ensuring that access to the incumbent LECs'
internal systems is provided at a level of quality consistent with services
incumbent LECs provide to their customers. In its petition, 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, the Wisconsin Public Service Commission
and the National Association of Regulatory Utilities Commissioners, have filed
comments in support of LCI's petition. On April 17, 1998, the FCC issued a
notice of proposed rulemaking regarding OSS requirements based on LCI's
petition. At this time, the Company is unable to determine the outcome of this
proceeding.
Local Service. The Company is seeking state approval to resell local
services in various states, which would enable the Company to provide combined
local and long-distance services to existing and prospective customers. As of
March 31, 1998, the Company has received approval to resell local service in 37
states and the District of Columbia, and has applications pending to resell
local service in another seven states. The Company is currently reselling local
telecommunications service in more than 40 markets.
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To date, the Company's efforts to provide local resale service have not
been profitable. The Company continues to identify and evaluate alternatives to
reselling incumbent LEC service, such as purchasing service from competitive
access providers and investments in local facilities-based providers. In January
1998, LCI filed a petition with the FCC that identified three critical barriers
to local competition, including the absence of a nondiscriminatory OSS, no
practical and efficient unbundled network elements, and pricing that
discriminates in favor of the RBOCs' own retail operations. To mitigate
discrimination, the petition recommends that the RBOCs be given the option to
separate into wholesale and retail units. The wholesale units would be required
to provide comparable service to new local service providers, such as the
Company, and the RBOCs' retail operations. In return, the RBOC would benefit
from a rebuttable presumption in favor of being granted in-region interLATA
authority. On January 26, 1998, the FCC issued a Public Notice seeking comments
on LCI's Petition and on February 18, 1998, the Illinois Commerce Commission
issued its own Notice of Inquiry regarding LCI's proposal for structural
separation of the RBOC's retail operations.
INDUSTRY STRUCTURE
The long-distance telecommunications market is highly competitive. The
principal competitive factors affecting the Company's market share are pricing,
regulatory and judicial 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 interLATA long-distance services. As
RBOCs are allowed into the long-distance market, the Company expects competition
within the industry to increase in both the long-distance and local markets.
Several of the Company's competitors are larger and have greater
financial, technical and marketing resources. In addition to the largest
telecommunications companies, AT&T, MCI and Sprint, or the "Big Three," 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 with those of the Big Three. Although LCI is prepared to respond to
competitive offerings from other carriers, the Company continues to believe
that its Simple, Fair and Inexpensive(sm) marketing and service pricing
approach is competitive in retaining existing customers, as well as in
obtaining new customers. In 1997, the Company introduced Exact Billing(sm), a
differentiator that neither the Big Three nor any other nationwide
long-distance carrier offers, giving LCI a competitive advantage in some
markets. The Company believes that the nature of competition will continue to
change with consolidation in the industry. 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. The telecommunications industry has experienced
significant merger activity in the last year. Of the many mergers that have
occurred or have been announced in the last year, the most significant include:
the Company with Qwest (see Note 6), Bell Atlantic/NYNEX CableComms Group Inc.
(NYNEX); SBC/Pacific Telesis Group (PacTel); MCI/WorldCom, Inc.; SBC/Southern
New England Telephone Company; and, most recently, AT&T/Teleport Communications
Group. To date, only the Bell Atlantic/NYNEX and SBC/PacTel
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mergers have received federal and state regulatory approvals. At this time the
Company is unable to predict the impact of these mergers, if any, on the Company
or competition within the industry as a whole.
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 MONTHS ENDED MARCH 31, 1998 AS COMPARED TO
THE THREE MONTHS ENDED MARCH 31, 1997]
REVENUES. Revenues for the three months ended March 31, 1998 increased
22% to $448 million on 3.5 billion MOUs as compared to $368 million on 2.9
billion MOUs for the three months ended March 31, 1997. The following table
provides further information regarding the Company's revenues:
Three Months
Ended March 31,
---------------------------------
1998 1997 Change
---------------------------------
Total Revenues (in millions) $ 448 $ 368 22%
MOUs (in billions) 3.5 2.9 21%
Switched Revenue per MOU(1) $.120 $.118 2%
(1)Switched revenue divided by MOUs
Revenues from business customers increased in excess of 21% for the
three months ended March 31, 1998 over the comparable period in 1997, and
represented approximately three-fourths of the Company's total revenues.
Residential/small business revenues represented approximately one-fourth of
total revenues and increased in excess of 22% for the three months ended March
31, 1998 compared to the same period in 1997. Growth in international service
revenues across all revenue service lines was approximately 68% for the three
months ended March 31, 1998, compared to the same period in 1997.
The Company experienced an increase in average revenue per MOU for the
three months ended March 31, 1998, as compared to the same period in 1997.
Revenue per MOU reflects changing cost of services, changes in the mix of
services by market segments and competitive pricing. 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. The increase in revenue per MOU also reflects the impact of
certain changes in access charges in 1998 that have been reflected in billings
to our customers.
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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
obtained through the agents. The Company retains responsibility for the customer
relationship, including billing and customer service. American Communications
Network, Inc. (ACN), 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 27% to $189 million
for the three months ended March 31, 1998 from $149 million for the three months
ended March 31, 1997. During the first quarter of 1998, gross margin as a
percentage of revenue increased to 42% from 40% for the same period in 1997. The
increase as a percentage of revenue reflects efficiencies gained as the Company
expands its owned fiber network and traffic is moved from current leased
facilities to the new owned facilities. In addition, the improvement in gross
margin as a percentage of revenue reflects a favorable change in the mix of the
Company's services from wholesale to commercial and residential/small business.
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 26% to $106 million for the three months ended
March 31, 1998, as compared to the same periods in 1997. As a percentage of
revenues, selling, general and administrative expenses were 24% for the three
months ended March 31, 1998, as compared to 23% for the same period in 1997.
The increase in selling, general and administrative expenses is due to the
expansion of the Company's geographic sales presence, entrance into the local
service market, and temporarily, due to acquisition integration activity. The
increase also reflects the slow down of wholesale revenue which carries a lower
selling, general and administrative burden as compared to commercial revenue,
which became a larger part of the revenue mix.
The Company's selling, general and administrative expense increases
year-over-year were substantially impacted by payroll and commissions. Payroll
expenses increased 31% for the three months ended March 31, 1998, as compared
to the same period in 1997. The Company experienced increases in the number of
employees from acquisitions and the expansion of the sales and customer support
infrastructure.
The increase in selling, general and administrative expenses includes a
30% increase in commission expense for the three months ended March 31, 1998
over the comparable prior period. The increase in commission expense is
attributable to the growth in commercial and residential/small business revenue,
which carry a higher commission rate than wholesale revenue.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense for the three months ended March 31, 1998 was $27 million, a 29%
increase over the same period in 1997. 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
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increase in depreciation and amortization for the additional Network facilities
is expected to continue into the fourth quarter of 1998, but should be offset by
a decrease in the cost of the leased Network which is reflected in cost of
services. Depreciation and amortization expense as a percentage of revenues was
a consistent 6% for the three months ended March 31, 1998, and 1997.
OPERATING INCOME. Operating income increased 27% to $56 million for the
three months ended March 31, 1998, over the same period in 1997. As a percentage
of revenues, operating income was 13% for the three months ended March 31, 1998,
compared to 12% for the same period in 1997. The increase in operating income as
a percentage of revenue reflects operating efficiencies and management of the
Company's cost structures.
INTEREST AND OTHER EXPENSE, NET. Interest and other expense, net of
capitalized interest, increased to $8 million for the three months ended March
31, 1998, compared to $7 million for the same period in 1997. This increase is
primarily due to an increase in interest expense as a result of the higher
long-term debt balance when compared to the average debt balance for the period
a year ago.
INCOME TAX EXPENSE. Income tax expense was $19 million for the three
months ended March 31, 1998 as compared to $15 million for the same period in
1997. The increase in income tax expense resulted from the increase in the
growth in earnings before taxes. The Company analyzes and adjusts its effective
tax rate, if necessary, on a quarterly basis.
LIQUIDITY AND CAPITAL RESOURCES
LCI International, Inc. (LCII) is a holding company and conducts its
operations through its direct and indirect wholly owned subsidiaries. LCI SPC I,
Inc. (SPC) is a wholly owned subsidiary of LCI and facilitates the
Securitization Program. Except in limited circumstances, SPC is subject to
certain contractual prohibitions concerning the payment of dividends and the
making of loans and advances to LCI. There are, however, no restrictions on the
movement of cash within the remainder of the consolidated group. Therefore, the
Company's discussion of its liquidity is based on the consolidated group.
CASH FLOWS - OPERATING ACTIVITIES. The Company's operations provided $78
million of cash for the three months ended March 31, 1998, compared to $41
million for the same period in 1997. Excluding the securitization activity, cash
from operations was $47 million for the three month period ended March 31, 1998,
compared to $41 million for the same period in 1997.
CASH FLOWS - INVESTING ACTIVITIES. The Company has supported its growth
strategy with capital expenditures and acquisitions. During the three months
ended March 31, 1998, the Company used $97 million for investing activities as
compared to $53 million for the same period in 1997. In the first quarter of
1998, the Company spent $97 million, as compared to $47 million for the quarter
ended March 31, 1997, 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 $50 million. This
increase includes progress payments totaling $14 million for various fiber
routes which the Company is purchasing to extend its owned fiber-optic Network.
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CASH FLOWS-FINANCING ACTIVITIES. Financing activities provided a net $19
million for the three months ended March 31, 1998, compared with $9 million
provided by financing activities during the same period in 1997. Financing
activities for the quarter ended March 31, 1998 included proceeds of $14 million
from employee stock plans and warrants.
CAPITAL RESOURCES. The net proceeds from the issuance of Senior Notes in
June 1997 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 March 31, 1998, 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). The Credit Facility contains certain
financial and negative covenants. As of March 31, 1998, 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 March 31,
1998, there was a $14 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 March 31, 1998, the pool of trade accounts receivable which was
available for sale was approximately $140 million and the amount of receivables
sold, but not collected was approximately $100 million.
The consummation of the proposed merger with Qwest will constitute a
change in control of the Company, which is an event of default under the Credit
Facility and the Securitization Program. In addition, an event of default under
the Credit Facility also constitutes an event of default under the headquarters
lease. The Lines of Credit are discretionary lines which may be discontinued at
any time at the sole discretion of the providing banks. The Senior Notes permit
mergers and consolidations, subject to compliance with certain terms of the
governing indenture. The merged company intends to negotiate waivers of such
defaults prior to the consummation of the proposed merger, or shortly
thereafter. There can be no assurance that such waivers will be negotiated. In
the event that such waivers are not obtained, alternative sources of financing
will be required. There can be no assurance that such alternative sources of
financing will be available to the merged company on terms and at interest rates
comparable to the present credit facilities.
CAPITAL REQUIREMENTS. During 1998, 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 1997 levels. These
on-going capital requirements are primarily for switching and transmission
facilities, technology platforms and information systems applications.
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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 fiber-optic capacity and related equipment and will make
payments of approximately $270 million. During the first quarter of 1998, the
Company made progress payments totaling $14 million for such fiber expansion.
The timing of other payments will depend on the delivery and acceptance of
facilities, which is expected to be completed in 1998. The Company believes it
has adequate cash flow and borrowing capacity to fund planned capital
expenditures.
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. Since
October 1997, the Company has negotiated several contracts to provide
alternative sources of domestic and international services to reduce the
reliance from this significant carrier. If the Company is unable to identify
additional 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 its 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 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. 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
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payment is therefore dependent upon ACN's level of performance during the entire
performance period. The proposed merger between the Company and Qwest would
constitute a change in control as defined in the agreement with ACN. Should the
proposed merger occur in the second or third quarter of 1998, the change in
control payment has been estimated to be approximately $75 million to $90
million in total, half of which is due approximately six months after the merger
closes. The second half of the change in control payment is due twenty-five
months after the merger closes. In addition to the change in control provision,
the acquiring company would receive a 31% reduction in the ongoing commission
rates paid to ACN.
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.
IMPACT OF INFLATION AND SEASONALITY. The Company does not believe the
relatively moderate levels of inflation which have been experienced in the
United States in recent years have had a significant effect on its net revenues
or earnings.
The Company's revenue is subject to seasonal variations based on each
business segment. The number of business days and holidays in a period can
affect quarterly results, but seasonal variations have little impact on annual
revenue results.
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 federal and state
regulatory 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
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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 related to the implementation of 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; the Company's ability to identify lower priced vendors for
certain services; the proposed merger with Qwest 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.
PROPOSED MERGER. On March 8, 1998, the Company entered into a merger
agreement with Qwest Communications International Inc. (Qwest) and a subsidiary
of Qwest pursuant to which LCI will become a wholly owned subsidiary of Qwest.
The all-stock transaction is valued at approximately $4.4 billion. Under the
terms of the agreement, each of the outstanding shares of the Company's common
stock, par value $.Ol per share, will be converted into $42 of Qwest common
stock, subject to certain exceptions. The number of shares of Qwest common stock
to be exchanged for each share of the Company's common stock will be determined
by dividing $42 by a 15-day volume weighted average of trading prices for Qwest
common stock prior to the closing, but will not be less than 1.0625 shares (if
Qwest's average stock price exceeds $39.53) or more than 1.5583 shares (if
Qwest's average stock price is less than $26.95). The Company may terminate the
merger agreement if Qwest's average stock price is less than $26.95, unless
Qwest then agrees to exchange for each share of common stock of the Company the
number of Qwest shares determined by dividing $42 by such average price. The
merger is intended to qualify as a tax-free reorganization and will be accounted
for as a purchase. It is anticipated that the merger will occur by the second or
third quarter of 1998. The transaction is subject to the majority vote of the
outstanding shares of Qwest and LCI and to other customary conditions such as
receipt of regulatory approvals. The majority shareholder of Qwest has entered
into an agreement to vote in favor of the merger. There can be no assurances
that the conditions to closing of the merger will be met.
ACCOUNTING PRONOUNCEMENTS NOT YET EFFECTIVE. Two new accounting
pronouncements, regarding comprehensive income and segment information, were
issued in 1997 and are effective for fiscal years beginning after December 15,
1997. The pronouncement concerning comprehensive income is not applicable to the
Company's operations. The Company does not expect any significant impact from
the adoption of the pronouncement concerning segment information. Disclosure of
interim segment information is not required in the year of adoption and
therefore is not incorporated in this quarterly report.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In 1997, the Company issued $350 million of 7.25% Senior Notes (Notes),
which mature on June 15, 2007 and pay interest semi-annually on June 15 and
December 15 of each year, beginning December 15, 1997. The effective interest
rate is 7.58%. As of March 31, 1998, the fair market value of the Notes was
approximately $345 million. As a result of issuing fixed interest rate
securities, the Company is less sensitive to market rate fluctuations.
The Company has three discretionary line of credit agreements (Lines of
Credit) with commercial banks for a total of $75 million. As of March 31, 1998,
the outstanding balance under the Lines of Credit was $14 million, with an
interest rate of 6.44%. The Lines of Credit provide flexible short-term
borrowing at competitive rates dependent upon a market indicator. The carrying
value of the Lines of Credit approximates its fair market value. The Lines of
Credit exposure to market rate fluctuations are limited since each borrowing is
repriced based on current market conditions.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of the date of this Form 10-Q, LCI is aware of three lawsuits that
have been filed in the Court of Chancery of the State of Delaware relating to
the merger. The first suit, Shapiro v. [Mc]Connell, was filed on March 9, 1998
and names LCI, certain of its directors and Qwest as defendants. The second
suit, Isquith v. LCI International, Inc., was filed on March 10, 1998 and names
LCI and certain of its directors as defendants. The third suit, Rehm v.
Thompson, was filed on March 12, 1998 and names LCI, certain of its directors
and Qwest as defendants. Each suit was brought by a purported stockholder of
LCI, individually and allegedly as a class action on behalf of all stockholders
of LCI. Generally these suits allege breach of fiduciary duty by the Board of
Directors of LCI in connection with the Qwest merger agreement. They seek
preliminary and permanent injunctive relief prohibiting the consummation of the
merger, unspecified damages and other relief. In addition, on April 3, 1998,
Phillips v. LCI International, Inc. was filed in U.S. District Court for the
Eastern District of Virginia. This suit, brought by a purported stockholder of
LCI individually and as a class action on behalf of certain LCI stockholders who
sold LCI stock between February 17, 1998 and March 9, 1998, alleges violations
of Section 10(b) of the Securities and Exchange Act of 1934 and Rule l0b-5
promulgated thereunder. The relief sought by plaintiff includes unspecified
damages, costs and disbursements. LCI believes that these suits are without
merit and intends to defend them vigorously.
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.
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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 29 of this report.
(b) Reports on Form 8-K:
On February 27, 1998, the Company filed a report on Form 8-K to publish
the financial results of postmerger combined operations for the Company
and USLD Communications Corp. in accordance with Item 5. Combined
revenue and combined net income were reported for the month ended
January 31, 1998.
On March 10, 1998, the Company filed a report on Form 8-K in connection
with the execution of a definitive Agreement and Plan of Merger between
the Company and Quest Communications International Inc in accordance
with Item 5.
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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: May 5, 1998 BY: /s/ Joseph A. Lawrence
----------- ----------------------
Executive Vice President and
Chief Financial Officer
(as duly authorized officer and
principal financial officer)
28
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EXHIBIT INDEX
The following Exhibits are included in this Quarterly Report on Form 10-Q:
Exhibit Exhibit
Number Description
- -------- -----------------------------------------------------------------------
2(c) Agreement and Plan of Merger, dated as of March 10, 1998, by and among
LCI International, Inc., and Qwest Communications International Inc.(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)
27 Financial Data Schedule
(1) Incorporated by reference from the Company's Current Report on Form 8-K
dated March 10, 1998.
(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 fiscal year 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.
29