1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1996 ------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- ----------- Commission file number: 0-11258 WorldCom, Inc. (Exact name of registrant as specified in its charter) Georgia 58-1521612 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 515 East Amite Street, Jackson, Mississippi 39201-2702 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (601) 360-8600 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 ----- ----- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ----- ----- The number of outstanding shares of the registrant's Common Stock, par value $.01 per share, was 396,210,381 on July 31, 1996. 2 FORM 10-Q INDEX Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 1996 and December 31, 1995 . . . . . . . . . . . . . . 3 Consolidated Statements of Operations for the three and six months ended June 30, 1996 and June 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . 4 Consolidated Statements of Cash Flows for the six months ended June 30, 1996 and June 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . 5 Notes to Consolidated Financial Statements . . . . . . . . . . . 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 13 Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . . . . 13 Item 3. Defaults upon Senior Securities . . . . . . . . . . . . . . . . 13 Item 4. Submission of Matters to a Vote of Securities Holders . . . . . . . . . . . . . . . . . . . . . 13 Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . 14 Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 14 Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Page 2 3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands of Dollars, Except Per Share Data) June 30, December 31, 1996 1995 ------------- ------------ ASSETS Current assets: Cash and cash equivalents $ 16,584 $ 41,679 Accounts receivable, net of allowance for bad debts of $75,139 in 1996 and $57,980 in 1995 673,910 528,763 Income taxes receivable 17,887 17,499 Deferred tax asset 32,573 16,899 Other current assets 71,375 49,992 ------------- ------------ Total current assets 812,329 654,832 ------------- ------------ Property and equipment: Transmission equipment 1,438,091 1,376,242 Communications equipment 277,370 401,454 Furniture, fixtures and other 251,755 278,716 ------------- ------------ 1,967,216 2,056,412 Less - accumulated depreciation (333,620) (487,080) ------------- ------------ 1,633,596 1,569,332 ------------- ------------ Excess of cost over net tangible assets acquired, net of accumulated amortization 4,059,911 4,292,752 Other assets 167,416 117,655 ------------- ------------ $ 6,673,252 $ 6,634,571 ============= ============ LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 998 $ 1,112,853 Accounts payable 184,970 137,342 Accrued line costs 478,415 391,604 Other current liabilities 329,316 337,013 ------------- ------------ Total current liabilities 993,699 1,978,812 ------------- ------------ Long-term liabilities, less current portion: Long-term debt 3,346,596 2,278,428 Deferred income taxes payable 77,407 26,172 Other liabilities 159,500 163,873 ------------- ------------ Total long-term liabilities 3,583,503 2,468,473 ------------- ------------ Commitments and contingencies Shareholders' investment: Series 2 preferred stock, par value $.01 per share; authorized, issued and outstanding: none in 1996 and 1,244,048 shares in 1995 (liquidation preference of $31,101 in 1995) - 12 Preferred stock, par value $.01 per share; authorized: 50,000,000 shares in 1996 and 48,755,952 shares in 1995; none issued - - Common stock, par value $.01 per share; authorized: 750,000,000 shares; issued and outstanding: 395,920,528 shares in 1996 and 386,485,278 shares in 1995 3,959 3,865 Additional paid-in capital 1,942,490 1,896,377 Unrealized holding gain on marketable securities 46,032 - Retained earnings 103,569 287,032 ------------- ------------ Total shareholders' investment 2,096,050 2,187,286 ------------- ------------ $ 6,673,252 $ 6,634,571 ============= ============ The accompanying notes are an integral part of these statements. Page 3 4 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data) For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------------- ---------------------------- 1996 1995 1996 1995 ------------ ------------ ------------ ------------ Revenues $ 1,061,400 $ 894,719 $ 2,087,586 $ 1,759,754 ------------ ------------ ------------ ------------ Operating expenses: Line costs 577,012 492,543 1,135,201 972,378 Selling, general and administrative 195,109 162,321 384,332 322,569 Depreciation and amortization 71,642 77,100 155,353 151,514 Provision to reduce carrying value of certain assets 402,000 - 402,000 - ------------ ------------ ------------ ------------ Total 1,245,763 731,964 2,076,886 1,446,461 ------------ ------------ ------------ ------------ Operating income (loss) (184,363) 162,755 10,700 313,293 Other income (expense): Interest expense (55,863) (64,558) (112,889) (126,866) Miscellaneous 2,017 3,139 4,143 3,373 ------------ ------------ ------------ ------------ Net income (loss) before taxes and extraordinary items (238,209) 101,336 (98,046) 189,800 Provision for income taxes 5,459 39,521 60,122 74,022 ------------ ------------ ------------ ------------ Net income (loss) before extraordinary items (243,668) 61,815 (158,168) 115,778 Extraordinary items (net of income taxes of $15,621 in 1996) (24,434) - (24,434) - ------------ ------------ ------------ ------------ Net income (loss) (268,102) 61,815 (182,602) 115,778 ------------ ------------ ------------ ------------ Preferred dividend requirement 355 6,936 860 13,875 ------------ ------------ ------------ ------------ Net income (loss) applicable to common shareholders $ (268,457) $ 54,879 $ (183,462) $ 101,903 ============ ============ ============ ============ Earnings (loss) per common share - Net income (loss) applicable to common shareholders before extraordinary items: Primary $ (0.62) $ 0.16 $ (0.41) $ 0.30 Fully diluted (0.62) 0.16 (0.41) 0.30 Extraordinary items (0.06) - (0.06) - Net income (loss) applicable to common shareholders: Primary (0.69) 0.16 (0.47) 0.30 Fully diluted (0.69) 0.16 (0.47) 0.30 Weighted average shares outstanding: Primary 391,160 337,622 389,363 335,584 Fully diluted 391,160 400,684 389,363 398,620 The accompanying notes are an integral part of these statements. Page 4 5 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands of Dollars) For the Six Months Ended June 30, ----------------------------- 1996 1995 -------------- ------------- Cash flows from operating activities: Net income (loss) $ (182,602) $ 115,778 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary items 24,434 - Provision to reduce carrying value of certain assets 402,000 - Depreciation and amortization 155,353 151,514 Provision for losses on accounts receivable 27,553 21,113 Provision for deferred income taxes 30,428 28,722 Change in assets and liabilities, net of effect of business combinations: Accounts receivable (172,700) 27,808 Income taxes, net 18,521 39,042 Other current assets (49,352) 6,810 Accrued line costs 64,811 (7,042) Shareholder litigation reserve - (75,000) Accounts payable and other current liabilities 15,885 (63,108) Other (9,442) (2,715) -------------- ------------- Net cash provided by operating activities 324,889 242,922 -------------- ------------- Cash flows from investing activities: Capital expenditures (251,581) (181,196) Acquisitions and related costs (580) (2,689,372) Increase in intangible assets (57,547) (3,653) Increase in other assets (9,623) (13,911) Decrease in other liabilities (20,991) (13,671) Proceeds from sale of long-term assets 8,724 17,406 Other - 1,000 -------------- ------------- Net cash used in investing activities (331,598) (2,883,397) -------------- ------------- Cash flows from financing activities: Borrowings - 2,748,208 Principal payments on debt (43,601) (125,948) Common stock issuance 26,075 47,531 Dividends paid on preferred stock (860) (13,875) -------------- ------------- Net cash provided by (used in) financing activities (18,386) 2,655,916 -------------- ------------- Net increase (decrease) in cash and cash equivalents (25,095) 15,441 Cash and cash equivalents at beginning of period 41,679 19,259 -------------- ------------- Cash and cash equivalents at end of period $ 16,584 $ 34,700 ============== ============= The accompanying notes are an integral part of these statements. Page 5 6 WORLDCOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) GENERAL The financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission ("SEC") regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with the Annual Report of the Company on Form 10-K for the year ended December 31, 1995. The results for the six month period ended June 30, 1996, are not necessarily indicative of the results that may be expected for the year ending December 31, 1996. (B) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid by the Company during the six months ended June 30, 1996 and 1995 amounted to $116.3 million and $94.9 million, respectively. Income taxes paid during the six months ended June 30, 1996 and 1995 were $11.2 million and $5.5 million, respectively. In conjunction with business combinations during the six months ended June 30, 1996 and 1995, assumed assets and liabilities were as follows (in thousands): FOR THE SIX MONTHS ENDED JUNE 30, --------------------------------- 1996 1995 ---------- ------------ Fair value of assets acquired $ 595 $ 837,380 Excess of cost over net tangible assets acquired 26,267 2,173,537 Liabilities assumed (26,282) (308,695) Common stock issued - (12,850) ---------- ------------ Net cash paid $ 580 $ 2,689,372 ========== ============ Acquisition and related costs for the six months ended June 30, 1996 reflect additional costs related to the acquisitions in 1995. (C) UNREALIZED HOLDING GAIN ON MARKETABLE SECURITIES In the second quarter of 1996, one of the Company's equity investments became publicly traded. This investment, previously recorded at cost, has been classified as an available for sale security under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("FASB 115"). Accordingly, this investment is recorded at its fair value of approximately $77 million at June 30, 1996, and is included in other assets in the accompanying consolidated financial statements. The unrealized holding gain on this marketable equity security is included as a component of shareholders' investment at June 30, 1996. (D) LONG-TERM DEBT On June 28, 1996, WorldCom replaced its then existing $3.41 billion credit facilities (the "Previous Facilities") with a new $3.75 billion revolving credit facility (the "Credit Facility"). Borrowings under the Credit Facility were used to refinance the Previous Facilities and will be used to finance capital expenditures and provide additional working capital. As a result of the refinancing, WorldCom recorded an extraordinary charge of $4.2 million, net of $2.7 million in taxes, related to the charge-off of the unamortized portion of costs associated with the refinanced debt. Page 6 7 The Credit Facility has a five-year term and bears interest, payable quarterly, at variable rates selected by the Company under the terms of the Credit Facility including a Base Rate or the London Interbank Offering Rate ("LIBOR"), plus applicable margin. The applicable margin for LIBOR rate borrowings varies from 0.35% to 0.875% based upon a specified financial test. The Credit Facility is unsecured and requires compliance with certain financial and other operating covenants which limit, among other things, the incurrence of additional indebtedness by WorldCom and restricts the payment of cash dividends to WorldCom's shareholders. The Credit Facility is also subject to an annual commitment fee not to exceed 0.25% of any unborrowed portion of the Credit Facility. On July 15, 1996, WorldCom announced that it had exercised its option to redeem on August 16, 1996, all of the outstanding IDB WorldCom, Inc. 5% Convertible Subordinated Notes due 2003 (the "Notes"), at a price equal to 103.5% of the principal amount, plus accrued and unpaid interest. The conversion price for the Notes is $19.034975 per share, resulting in the receipt of 52 shares of WorldCom, Inc. common stock per $1,000 principal amount of the Notes plus cash in lieu of a fractional share. The Company expects that all holders of the Notes ($195.5 million principal amount) will elect to convert their Notes into common stock prior to the redemption. (E) STOCK SPLIT On May 23, 1996, the Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend which was distributed on July 3, 1996 to shareholders of record on June 6, 1996. All per share data and numbers of common shares have been retroactively restated to reflect the stock split. (F) PREFERRED STOCK In connection with the announcement in May 1996, that the Company would redeem its Series 2 Preferred Stock on June 5, 1996, all of the remaining outstanding Series 2 Preferred Stock (1,244,048 shares) was converted into 5,266,160 shares of common stock of the Company in the second quarter of 1996. (G) PROVISION TO REDUCE THE CARRYING VALUE OF CERTAIN ASSETS In the second quarter of 1996, the Company incurred non-cash charges related to a write-down in the carrying value of certain assets, including goodwill and equipment. Because of events resulting from the passage of the Telecommunications Act of 1996, and changes in circumstances impacting certain non-core operations, management estimates of the Company's fair value of operating assets within its core and non-core businesses resulted in a non-cash charge of $344 million after tax or $.88 per share. On a pretax basis, the write-down was $402 million and included $139 million for network facilities and $263 million for non-core businesses, primarily operator services goodwill. Fair value of the non-core business was determined by estimating the present value of future cash flows to be generated from those operations while the majority of the network facilities were recorded at net salvage value due to anticipated early disposal. In connection with the signing of agreements to provide long distance telecommunications services to certain local exchange carriers, and after the successful assimilation of recent facilities-based acquisitions, WorldCom evaluated the impact that the increased traffic volumes would have on the Company's network. This review resulted in the Company's current plans to expand and upgrade its existing network switching, transmission and other communications equipment. This capital project directly affected the estimated useful lives of certain network facilities which will result in replacement of these facilities within the next twelve months. Additionally, due to the decreasing emphasis on operator services, including non-renewal of existing long-term contracts, management adjusted the fair value of this non-core business based upon its projections of future cash flow. Operator services now comprise less than 3% of WorldCom's consolidated revenues. (H) EXTRAORDINARY ITEMS In the second quarter of 1996, the Company recorded extraordinary items totaling $24.4 million, net of income tax benefit of $15.6 million. The items included $4.2 million in connection with the Company's debt refinancing, as discussed in Note C and $20.2 million related to a write-off of deferred international costs. Previously, a portion of the outbound call fee due the foreign carrier Page 7 8 was deferred and accounted for as a cost attributable to the revenue associated with the inbound call. Currently, the outbound call fee due the foreign carrier is expensed as incurred. (I) CONTINGENCIES IDB RELATED INVESTIGATIONS. On June 9, 1994, the SEC issued a formal order of investigation concerning certain matters, including IDB Communication Group, Inc.'s ("IDB") financial position, books and records and internal controls and trading in IDB securities on the basis of non-public information. The SEC has issued subpoenas to WorldCom, IDB and others, including certain former officers of IDB, in connection with its investigation. The National Association of Securities Dealers and other self-regulatory bodies have also made inquiries of IDB concerning similar matters. The U.S. Attorney's Office for the Central District of California has issued grand jury subpoenas to IDB seeking documents relating to IDB's first quarter of 1994 results, the Deloitte & Touche LLP resignation, trading in IDB securities and other matters, including information concerning certain entities in which certain former officers of IDB are personal investors and transactions between such entities and IDB. IDB has been informed that a criminal investigation has commenced. The U.S. Attorney's Office has issued a grand jury subpoena to WorldCom arising out of the same investigation seeking certain documents relating to IDB. OTHER. On February 8, 1996, President Clinton signed legislation, known as the Telecommunications Act of 1996, that: permits, without limitation, the Bell Operating Companies (the "BOCs") to provide domestic and international long distance services to customers located outside of the BOC's home regions; permits a petitioning BOC to provide domestic and international long distance service to customers within its home regions upon a finding by the Federal Communications Commission (the "FCC") that a petitioning BOC has satisfied certain criteria for opening up its local exchange network to competition and that its provision of long distance services would further the public interest; and removes existing barriers to entry into local service markets. Additionally, there are significant changes in: the manner in which carrier-to-carrier arrangements are regulated at the federal and state level; procedures to revise universal service standards; and, penalties for unauthorized switching of customers. The FCC has instituted proceedings addressing the implementation of this legislation. On August 8, 1996 the FCC released its First Report and Order in the Matter of Implementation of the Local Competition Provisions in the Telecommunications Act of 1996 (the "Order"). In that Order, the FCC established nationwide rules designed to encourage new entrants to participate in the local service markets through interconnection with the incumbent local exchange carriers ("ILEC"), resale of the ILEC's retail services and unbundled network elements. These rules set the groundwork for the statutory criteria governing BOC entry into the long distance market. The Company cannot predict the effect such legislation or the implementing regulations will have on the Company or the industry. However, the Company believes that it is positioned to take advantage of business opportunities in the rapidly changing telecommunications market. On August 1, 1996, the FCC announced its intention to conduct a proceeding in the Fall of 1996 leading to the reform of access charges. Such charges are a principal component of the Company's line cost expense. The Company cannot predict whether or not the result of such a proceeding will have a material impact upon the Company. The Company is involved in other legal and regulatory proceedings generally incidental to its business. In some instances, rulings by regulatory authorities in some states may result in increased operating costs to the Company. While the results of these various legal and regulatory matters contain an element of uncertainty, the Company believes that the probable outcome of any of the legal or regulatory matters, or all of them combined, should not have a material adverse effect on the Company's consolidated results of operations or financial position. (J) CONCENTRATION OF CREDIT RISK A portion of the Company's revenues is derived from services provided to others in the telecommunications industry, mainly resellers of long distance telecommunications service. As a result, the Company has some concentration of credit risk among its customer base. The Company performs ongoing credit evaluations of its larger customers' financial condition and, at times, requires collateral from its customers to support its receivables, usually in the form of assignment of its customers' receivables to the Company in the event of nonpayment. Page 8 9 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q may be deemed to include forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risk and uncertainty, including financial, regulatory environment and trend projections. Although the Company believes that its expectations are based on reasonable assumptions, it can give no assurance that its expectations will be achieved. The important factors that could cause actual results to differ materially from those in the forward looking statements herein include, without limitation, the Company's high degree of financial leverage, risks associated with debt service requirements and interest rate fluctuations, risks associated with acquisitions and the integration thereof, risks of international business, dependence on availability of transmission facilities, regulation risks including the impact of the Telecommunications Act of 1996, contingent liabilities, and the impact of competitive services and pricing, as well as other risks referenced from time to time in the Company's filings with the SEC. The following discussion and analysis relates to the financial condition and results of operations of the Company for the three and six months ended June 30, 1996 and 1995, and should be read in conjunction with the consolidated financial statements and notes thereto. GENERAL The Company's continued emphasis on acquisitions has taken the Company from a small regional long distance carrier to one of the largest long distance telecommunications companies in the industry, serving customers domestically and internationally. The Company's operations have grown significantly in each year of its operations as a result of internal growth, the selective acquisition of smaller long distance companies with limited geographic service areas and market shares, the consolidation of certain third tier long distance carriers with larger market shares and international expansion. The Company's long distance revenues are derived principally from the number of minutes of use billed by the Company. Minutes billed are those conversation minutes during which a call is actually connected at the Company's switch (except for minutes during which the customer receives a busy signal or the call is unanswered at its destination). The Company's profitability is dependent upon, among other things, its ability to achieve economies of scale in line cost expenditures and to control and maintain selling, general and administrative overhead costs. The principal components of line costs are access charges and transport charges. Access charges are expenses incurred by all interexchange carriers ("IXCs") for accessing the local networks of the local exchange carriers ("LECs") in order to originate and terminate calls and payments made to foreign telephone administrations to complete calls made from the U.S. by the Company's customers. Transport charges are the expenses incurred in transmitting calls between or within local access and transport areas. The most significant portion of the Company's line costs is access charges, which are highly regulated. The FCC regulates international communications services and interstate telephone service and certain states, through the appropriate regulatory agency, regulate intrastate telephone service. Accordingly, the Company cannot predict what effect continued regulation and increased competition between LECs and other IXCs will have on future access charges. However, the Company believes that it will be able to continue to reduce transport costs through effective utilization of its network, favorable contracts with carriers and network efficiencies made possible as a result of expansion of the Company's customer base by acquisitions and internal growth. On February 8, 1996, President Clinton signed legislation, known as the Telecommunications Act of 1996, that: permits, without limitation, the BOCs to provide domestic and international long distance services to customers located outside of the BOC's home regions; permits a petitioning BOC to provide domestic and international long distance service to customers within its home regions upon a finding by the FCC that a petitioning BOC has satisfied certain criteria for opening up its local exchange network to competition and that its provision of long distance services would further the public interest; and removes existing barriers to entry into local service markets. Additionally, there are significant changes in: the manner in which carrier-to-carrier arrangements are regulated at the federal and state level; procedures to revise universal service standards; and, penalties for unauthorized switching of customers. The FCC has instituted proceedings addressing the implementation of this legislation. On August 8, 1996 the FCC released its First Report and Order in the Matter of Implementation of the Local Competition Provisions in the Telecommunications Act of 1996 (the "Order"). In that Order, the FCC established nationwide rules designed to encourage new entrants to participate in the local service markets through interconnection with the incumbent local exchange carriers ("ILEC"), resale of the ILEC's retail services and unbundled network elements. These rules set the groundwork for the statutory criteria Page 9 10 governing BOC entry into the long distance market. The Company cannot predict the effect such legislation or the implementing regulations will have on the Company or the industry. However, the Company believes that it is positioned to take advantage of business opportunities in the rapidly changing telecommunications market. The enactment of this legislation has made it possible for the Company to form business associations to provide long distance telecommunications services with certain LECs and the Company expects to pursue resale of local service in those markets where it is both economically and technically feasible. While the effects of this legislation or the implementing regulations on the Company and the industry remain uncertain, the Company believes that it is positioned to take advantage of business opportunities in the rapidly changing telecommunications market. In the first quarter of 1996, the Company signed agreements to provide long distance telecommunications services to GTE Long Distance, Ameritech Communications, Inc. and Southwestern Bell Mobile Systems, Inc. WorldCom also entered into an agreement to become a major provider of data telecommunications services for Electronic Data Systems Corporation, a global information services company. Additionally, in response to the changing regulatory environment, WorldCom has filed applications with public utility commissions in several states to offer customers a full range of local telephone exchange services, an important capability that will serve as a complement to the Company's national and international service offerings. To date, WorldCom has received permission to provide local service on a resale basis in California, Connecticut, Florida, Illinois and Texas, and WorldCom has applications pending in other states. RESULTS OF OPERATIONS The following table sets forth for the periods indicated the Company's statement of operations as a percentage of its operating revenues. For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------ ------------------ 1996 1995 1996 1995 ---- ---- ---- ---- Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0% 100.0% ----- ----- ----- ----- Line costs . . . . . . . . . . . . . . . . . . . . . . . . . 54.4 55.1 54.4 55.3 Selling, general and administrative . . . . . . . . . . . . . 18.4 18.1 18.4 18.3 Depreciation and amortization . . . . . . . . . . . . . . . . 6.7 8.6 7.4 8.6 Provision to reduce carrying value of certain assets . . . . 37.9 - 19.3 - ----- ----- ----- ----- Operating income (loss) . . . . . . . . . . . . . . . . . . . (17.4) 18.2 0.5 17.8 Other income (expense): Interest expense . . . . . . . . . . . . . . . . . . . . (5.3) (7.2) (5.4) (7.2) Miscellaneous . . . . . . . . . . . . . . . . . . . . . . 0.2 0.3 0.2 0.2 ----- ----- ----- ----- Net income (loss) before income taxes and extraordinary items (22.5) 11.3 (4.7) 10.8 ----- ----- ----- ----- Provision for income taxes . . . . . . . . . . . . . . . . . 0.5 4.4 2.9 4.2 ----- ----- ----- ----- Net income (loss) before extraordinary items . . . . . . . . (23.0) 6.9 (7.6) 6.6 Extraordinary items, net of taxes . . . . . . . . . . . . . . (2.3) - (1.2) - Preferred dividend requirement . . . . . . . . . . . . . . . 0.0 0.8 0.0 0.8 ----- ----- ----- ----- Net income (loss) applicable to common shareholders . . . . . (25.3)% 6.1% 8.8% 5.8% ===== ===== ===== ====== Revenues for the three months ended June 30, 1996 increased 19% to $1.06 billion on 5.66 billion revenue minutes as compared to $894.7 million on 4.70 billion revenue minutes for the three months ended June 30, 1995. For the six months ended June 30, 1996, revenues increased 19% to $2.09 billion on 11.26 billion revenue minutes versus $1.76 billion on 9.27 billion revenue minutes. The increase in total revenues and minutes is attributable to internal growth of the Company. The Company's second quarter switched retail and wholesale revenue, excluding operator services traffic, increased 22% over 1995 results, while traffic growth from these businesses approximated 21%. Private line revenues for the three months ended June 30, 1996, also reflected positive growth, with an increase of 24% over the 1995 results. Page 10 11 Line costs as a percentage of revenues decreased to 54.4% during the second quarter of 1996 as compared to 55.1% for the same period in the prior year. On a year-to-date basis, line costs as a percentage of revenues decreased to 54.4% in 1996 from 55.3% in 1995. These decreases are attributable to changes in the product mix, rate reductions resulting from favorable contract negotiations and synergies and economies of scale resulting from network efficiencies achieved from the assimilation of recent acquisitions into the Company's operations. Selling, general and administrative expenses for the second quarter of 1996 increased to $195.1 million or 18.4% of revenues as compared to $162.3 million or 18.1% of revenues for the second quarter of 1995. On a year-to-date basis, these expenses increased to $384.3 million or 18.4% of revenues from $322.6 million or 18.3% of revenues for the six months ended June 30, 1995. The increase in selling, general and administrative expenses results from the Company's expanding operations, primarily through internal growth. Depreciation and amortization expense for the second quarter of 1996 decreased to $71.6 million or 6.7% of revenues from $77.1 million or 8.6% of revenues for the second quarter of 1995. This decrease reflects the reduction in depreciation and amortization associated with the second quarter 1996 write-down in the carrying value of goodwill and equipment. On a year-to-date basis, this expense increased to $155.4 million or 7.4% of revenues versus $151.5 million or 8.6% of revenues for the comparable 1995 period. This increase reflects additional depreciation related to capital expenditures offset by the reduction in depreciation and amortization associated with the second quarter write-downs. The reduction in the percentage is due to a relatively stable dollar of amortization on a higher revenue base. In the second quarter of 1996, the Company incurred non-cash charges related to a write-down in the carrying value of certain assets, including goodwill and equipment. Because of events resulting from the passage of the Telecommunications Act of 1996, and changes in circumstances impacting certain non-core operations, management estimates of the Company's fair value of operating assets within its core and non-core businesses resulted in a non-cash charge of $344 million after tax or $.88 per share. On a pretax basis, the write-down was $402 million and included $139 million for network facilities and $263 million for non-core businesses, primarily operator services goodwill. Interest expense in the second quarter of 1996 was $55.9 million or 5.3% of revenues, as compared to $64.6 million or 7.2% of revenues in the second quarter of 1995. For the six months ended June 30, 1996, interest expense was $112.9 million or 5.4% of revenues, as compared to $126.9 million or 7.2% of revenues for the first six months of 1995. The decrease in interest expense is attributable to lower interest rates in effect on the Company's long-term debt. For the six months ended June 30, 1996 and 1995, weighted average annual interest rates were 6.4% and 7.3%, respectively, while weighted average annual levels of borrowing were $3.47 billion and $3.44 billion, respectively. In the second quarter 1996, the Company recorded extraordinary items totaling $24.4 million, net of income tax benefit of $15.6 million. The items included $4.2 million in connection with the Company's debt refinancing, and $20.2 million related to a write-off of deferred international costs. Previously, a portion of the outbound call fee due the foreign carrier was deferred and accounted for as a cost attributable to the revenue associated with the inbound call. Currently, the outbound call fee due the foreign carrier is expensed as incurred. For the second quarter ended June 30, 1996, net income, before non-cash charges, increased 81% to $99.6 million compared with $54.9 million for the 1995 second quarter. Fully diluted earnings per common share, before non-cash charges, increased 56% to $0.25 compared with $0.16 a year ago. Including the non-cash, after-tax charges, the Company reported a net loss of $268.5 million or $0.69 per share, for the second quarter of 1996. For the six months ended June 30, 1996, net income, before non-cash charges, increased 81% to $184.6 million compared with $101.9 million for the 1995 first half. Fully diluted earnings per common share, before non-cash charges increased 53% to $0.46 compared with $0.30 a year ago. Including the non-cash, after-tax charges, the Company reported a net loss of $183.5 million or $0.47 for the first six months of 1996. Page 11 12 LIQUIDITY AND CAPITAL RESOURCES On June 28, 1996, WorldCom replaced its then existing $3.41 billion credit facilities (the "Previous Facilities") with a new $3.75 billion revolving credit facility (the "Credit Facility"). Borrowings under the Credit Facility were used to refinance the Previous Facilities and will be used to finance capital expenditures and provide additional working capital. As a result of the refinancing, WorldCom recorded an extraordinary charge of $4.2 million, net of $2.7 million in taxes, related to the charge-off of the unamortized portion of costs associated with the refinanced debt. The Credit Facility has a five-year term and bears interest, payable quarterly, at variable rates selected by the Company under the terms of the Credit Facility including a Base Rate or the London Interbank Offering Rate ("LIBOR"), plus applicable margin. The applicable margin for LIBOR rate borrowings varies from 0.35% to 0.875% based upon a specified financial test. The Credit Facility is unsecured and requires compliance with certain financial and other operating covenants which limit, among other things, the incurrence of additional indebtedness by WorldCom and restricts the payment of cash dividends to WorldCom's shareholders. The Credit Facility is also subject to an annual commitment fee not to exceed 0.25% of any unborrowed portion of the Credit Facility. The Company has historically utilized cash flow from operations to finance capital expenditures and a mixture of cash flow, debt and stock to finance acquisitions. The Company is committed to a priority plan of accelerating operating cash flow to reduce debt. Additional capital availability may be generated through a combination of commercial bank debt and public market debt. Successful execution of the priority plan would provide continued compliance with required operating ratio covenants and improved interest rate spread pricing, and would eliminate any type of equity financing other than equity issued in connection with acquisitions. No assurance can be given that the Company will achieve its priority plan. Borrowings under the Credit Facility bear interest at rates that fluctuate with prevailing short-term interest rates. To protect against the effect of rising interest rates, the Company has entered into financial hedging agreements with various financial institutions in connection with requirements under the Credit Facility. The hedging agreements establish capped fixed rates of interest ranging from 7.43% to 8.3125% on an aggregate notional value of $1.7 billion and mature in 1997. If interest rates do not reach this cap, the Company's interest rate remains variable. For the six months ended June 30, 1996, the Company's cash flow from operations was $324.9 million, increasing from $242.9 million in the comparable period for 1995. The increase in cash flow from operations was primarily attributable to internal growth. The Company's existing $300.0 million receivables purchase agreement generated additional proceeds of $4.6 million in the first quarter of 1996. The Company used these proceeds to reduce outstanding debt under the Company's credit facilities. As of June 30, 1996, the purchaser owned an undivided interest in a $692.2 million pool of receivables which includes the $300.0 million sold. Cash used in investing activities in the six months ended June 30, 1996 totaled $331.6 million and included $204.9 million for normal capital expenditures and an additional $46.7 million for additional city pair network construction. Primary capital expenditures include purchases of switching, transmission, communication and other equipment. The Company's current budgeted capital expenditures for 1996 approximates $400.0 million. In addition to this amount, the Company has additional city pair network construction opportunities which could approximate $700.0 million to $800.0 million over the next two years. Included in cash flows from financing activities are payments of $0.9 million for preferred dividend requirements. In connection with the announcement in May 1996, that the Company would redeem its Series 2 Preferred Stock on June 5, 1996, all of the remaining outstanding Series 2 Preferred Stock (1,244,048 shares) was converted into 5,266,160 shares of common stock of the Company in the second quarter of 1996. The fully diluted common shares outstanding are unaffected by the conversion and the Company has no further dividend requirements. On July 15, 1996, WorldCom announced that it had exercised its option to redeem on August 16, 1996, all of the outstanding IDB WorldCom, Inc. 5% Convertible Subordinated Notes due 2003 (the "Notes"). The Company expects that all holders of the Notes will elect to convert their Notes to common stock prior to the redemption. The fully diluted common shares outstanding are unaffected by the conversion, and the Company will have no further cash interest requirement related to the Notes. Page 12 13 Absent significant capital requirements for other acquisitions, the Company believes that cash flow from operations and funds available under the Credit Facility will be adequate to meet the Company's capital needs for the remainder of 1996. PART II. OTHER INFORMATION Item 1. Legal Proceedings. There have been no material changes in the legal proceedings reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1995, filed on March 30, 1996 except as may be reflected in the discussion under Note I of the Notes to Consolidated Financial Statements in Part I, Item 1, above. Item 2. Changes in Securities. None Item 3. Defaults upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders. On May 23, 1996, the Company held the Annual Meeting of Shareholders for the purposes of: 1. electing a Board of twelve (12) directors; 2. considering and acting upon a proposal to amend the Company's Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock, par value $.01 per share, from 500,000,000 to 750,000,000; 3. considering and acting upon a proposal to approve the Company's Third Amended and Restated 1990 Stock Option Plan; and 4. considering and acting upon a proposal to approve the Company's Special Performance Bonus Plan; The tabulation of the voting (on a pre-split basis), which includes 2,633,081 equivalent shares for the Series 2 Preferred Stock, is as follows: Page 13 14 Against or Abstentions and For Withheld Broker non-votes Election of Directors: Carl J. Aycock 151,704,954 4,507,406 0 Max E. Bobbitt 151,378,674 4,833,686 0 Bernard J. Ebbers 151,372,376 4,839,984 0 Francesco Galesi 151,707,183 4,505,177 0 Stiles A. Kellett, Jr. 151,699,979 4,512,381 0 Silvia Kessel 151,682,740 4,529,620 0 John W. Kluge 151,349,222 4,863,138 0 John A. Porter 151,374,820 4,837,540 0 Stuart Subotnick 151,367,296 4,845,064 0 Scott D. Sullivan 150,697,171 5,515,189 0 Lawrence C. Tucker 151,704,810 4,507,550 0 Roy A. Wilkens 150,694,160 5,518,200 0 Increase in Common Stock 128,987,563 24,585,079 2,639,718 Amendment to Stock Option Plan 121,847,588 32,794,995 1,569,777 Special Performance Bonus Plan 149,185,958 3,275,530 3,750,872 Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. A. Exhibits See Exhibit Index B. Reports on Form 8-K None Page 14 15 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q to be signed on its behalf by Scott D. Sullivan, thereunto duly authorized to sign on behalf of the registrant and as the principal financial officer thereof. WORLDCOM, INC. By: /s/ Scott D. Sullivan ----------------------------------- Scott D. Sullivan Chief Financial Officer Dated: August 14, 1996 Page 15 16 EXHIBIT INDEX Exhibit No. Description - ------- ----------- 3(i) Amended and Restated Articles of Incorporation of the Company (including preferred stock designations) as of September 15, 1993, as amended by Articles of Amendment dated May 26, 1994, as amended by Articles of Amendment dated May 25, 1995 (incorporated herein by reference to Exhibit 4.1 to the Annual Report on Form 10-K filed by the Company for the year ended December 31, 1995) 3(ii) Articles of Amendment to the Amended and Restated Articles of Incorporation dated May 23, 1996 3(iii) Bylaws of the Company 10.1 Amended and Restated Credit Agreement among the Company, Nations Bank of Texas, N.A. (Managing Agent and Administrative Agent), Bank of America Illinois, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Chemical Bank, Credit Lyonnais New York Branch, First Union National Bank of North Carolina, The Industrial Bank of Japan, Limited, Atlanta Agency, The First National Bank of Chicago, The Long-Term Credit Bank of Japan, Limited, New York Branch, Toronto Dominion (Texas), Inc., and Wachovia Bank of Georgia N.A., (Agents) and the Lenders named therein (Lenders) dated as of June 28, 1996. 10.2 WorldCom, Inc. Third Amended and Restated 1990 Stock Option Plan (incorporated herein by reference to Exhibit A to the Company's Proxy Statement dated April 22, 1996 used in connection with the Company's 1996 Annual Meeting of Shareholders) (Compensatory Plan) 10.3 WorldCom, Inc. Special Performance Bonus Plan (incorporated by reference to Exhibit B to the Company's Proxy Statement dated April 22, 1996 used in connection with the Company's 1996 Annual Meeting of Shareholders) (Compensatory Plan) 11.1 Computation of Per Share Earnings 18.1 Letter regarding change in accounting principles 27.1 Financial Data Schedule Page 16