1
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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, 1999
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
-------------------------------
MCI WORLDCOM, INC.
(Exact name of registrant as specified in its charter)
-------------------------------
Georgia 58-1521612
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
500 Clinton Center Drive, Clinton, Mississippi 39056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code : (601) 460-5600
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
--- ---
The number of outstanding shares of the registrant's Common Stock, par
value $.01 per share, was 1,873,110,367, net of treasury shares, on July 30,
1999.
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2
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 1999 and December 31, 1998............................................3
Consolidated Statements of Operations
for the three and six months ended June 30, 1999
and June 30, 1998...............................................................4
Consolidated Statements of Cash Flows for
the six months ended June 30, 1999 and
June 30, 1998...................................................................5
Notes to Consolidated Financial Statements......................................6
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations..................................16
Item 3. Quantitative and Qualitative Disclosure About Market Risk......................28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..............................................................29
Item 2. Changes in Securities and Use of Proceeds......................................29
Item 3. Defaults Upon Senior Securities................................................29
Item 4. Submission of Matters to a Vote
of Securities Holders....................................... ..................29
Item 5. Other Information .............................................................30
Item 6. Exhibits and Reports on Form 8-K...............................................30
Signature ...............................................................................31
Exhibit Index ...............................................................................32
Page 2
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited. In Millions, Except Share Data)
June 30, December 31,
1999 1998
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 599 $ 1,710
Accounts receivable, net of allowance for bad debts of $952 in 1999
and $897 in 1998 5,761 5,226
Deferred tax asset 2,353 2,523
Other current assets 1,383 1,180
---------- ----------
Total current assets 10,096 10,639
---------- ----------
Property and equipment:
Transmission equipment 12,126 12,052
Communications equipment 5,642 5,256
Furniture, fixtures and other 6,281 5,986
Construction in progress 3,695 3,080
---------- ----------
27,744 26,374
Accumulated depreciation (3,180) (2,067)
---------- ----------
24,564 24,307
---------- ----------
Goodwill and other intangible assets, net 46,200 47,018
Other assets 5,713 4,437
---------- ----------
$ 86,573 $ 86,401
========== ==========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
Short-term debt and current maturities of long-term debt $ 5,217 $ 4,756
Accounts payable 1,999 1,737
Accrued line costs 4,186 3,903
Accrued interest 508 505
Other current liabilities 4,929 5,128
---------- ----------
Total current liabilities 16,839 16,029
---------- ----------
Long-term liabilities, less current portion:
Long-term debt 13,550 16,083
Deferred tax liability 3,210 2,960
Other liabilities 1,492 1,852
---------- ----------
Total long-term liabilities 18,252 20,895
---------- ----------
Commitments and contingencies
Minority interests 2,435 3,676
Company obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely junior subordinated deferrable interest debentures
of the Company and other mandatorily redeemable preferred securities 798 798
Shareholders' investment:
Series B preferred stock, par value $.01 per share; authorized, issued and
outstanding: 11,360,334 shares in 1999 and 11,643,002 shares in 1998 (liquidation
preference of $1.00 per share plus unpaid dividends) -- --
Preferred stock, par value $.01 per share; authorized: 34,905,008 shares
in 1999 and 1998; none issued -- --
Common stock, par value $.01 per share; authorized: 5,000,000,000 shares; issued
and outstanding: 1,871,453,800 shares in 1999 and 1,840,280,479 shares in 1998 19 18
Additional paid-in capital 51,197 49,544
Retained earnings (deficit) (2,901) (4,473)
Unrealized holding gain on marketable equity securities 447 122
Cumulative foreign currency translation adjustment (328) (23)
Treasury stock, at cost, 4,510,211 shares in 1999 and 1998 (185) (185)
---------- ----------
Total shareholders' investment 48,249 45,003
---------- ----------
$ 86,573 $ 86,401
========== ==========
The accompanying notes are an integral part of these statements.
Page 3
4
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited. In Millions, Except Per Share Data)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues $ 8,944 $ 2,581 $ 17,945 $ 4,901
-------- -------- -------- --------
Operating expenses:
Line costs 3,937 1,230 8,053 2,347
Selling, general and administrative 2,179 524 4,490 1,002
Depreciation and amortization 1,064 332 2,143 631
In-process research and development and other charges -- -- -- 498
-------- -------- -------- --------
Total 7,180 2,086 14,686 4,478
-------- -------- -------- --------
Operating income 1,764 495 3,259 423
Other income (expense):
Interest expense (236) (108) (496) (210)
Miscellaneous 48 10 16 22
-------- -------- -------- --------
Income before income taxes, minority interests and extraordinary items 1,576 397 2,779 235
Provision for income taxes 652 170 1,195 288
-------- -------- -------- --------
Income (loss) before minority interests and extraordinary items 924 227 1,584 (53)
Minority interests (45) -- 20 --
-------- -------- -------- --------
Income (loss) before extraordinary items 879 227 1,604 (53)
Extraordinary items (net of income taxes of $78 in 1998) -- -- -- (129)
-------- -------- -------- --------
Net income (loss) 879 227 1,604 (182)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities 16 -- 32 --
Preferred dividend requirement -- 6 -- 13
-------- -------- -------- --------
Net income (loss) applicable to common shareholders $ 863 $ 221 $ 1,572 $ (195)
======== ======== ======== ========
Earnings (loss) per common share:
Net income (loss) applicable to common shareholders before
extraordinary items:
Basic $ 0.46 $ 0.21 $ 0.85 $ (0.06)
======== ======== ======== ========
Diluted $ 0.45 $ 0.21 $ 0.81 $ (0.06)
======== ======== ======== ========
Extraordinary items $ -- $ -- $ -- $ (0.13)
======== ======== ======== ========
Net income (loss) applicable to common shareholders:
Basic $ 0.46 $ 0.21 $ 0.85 $ (0.19)
======== ======== ======== ========
Diluted $ 0.45 $ 0.21 $ 0.81 $ (0.19)
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
Page 4
5
MCI WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited. In Millions)
For the Six Months
Ended June 30,
--------------------
1999 1998
------- -------
Cash flows from operating activities:
Net income (loss) $ 1,604 $ (182)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Minority interests (20) --
Extraordinary items -- 129
In-process research and development and other charges -- 498
Depreciation and amortization 2,143 631
Provision for losses on accounts receivable 447 53
Provision for deferred income taxes 953 270
Change in assets and liabilities, net of effect of
business combinations:
Accounts receivable (1,219) (676)
Other current assets (207) (109)
Accrued line costs 238 114
Accounts payable and other current liabilities 444 (57)
Other 123 (52)
------- -------
Net cash provided by operating activities 4,506 619
------- -------
Cash flows from investing activities:
Capital expenditures (3,674) (1,931)
Sale of short-term investments, net -- 53
Acquisitions and related costs (450) (195)
Increase in intangible assets (297) (87)
Proceeds from sale of SHL 1,390 --
Proceeds from disposition of long-term assets 93 105
Increase in other assets (1,345) (158)
Decrease in other liabilities (118) (12)
------- -------
Net cash used in investing activities (4,401) (2,225)
------- -------
Cash flows from financing activities:
Net borrowings -- 1,354
Principal payments on debt (1,692) --
Common stock issuance 722 194
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities (32) --
Dividends paid on preferred stock -- (13)
------- -------
Net cash provided by (used in) financing activities (1,002) 1,535
Effect of exchange rate changes on cash (214) --
------- -------
Net decrease in cash and cash equivalents (1,111) (71)
Cash and cash equivalents at beginning of period 1,710 155
------- -------
Cash and cash equivalents at end of period $ 599 $ 84
======= =======
The accompanying notes are an integral part of these statements.
Page 5
6
MCI WORLDCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(A) GENERAL
References herein to the "Company" or "MCI WorldCom" refer to MCI WORLDCOM,
Inc., a Georgia corporation, and its subsidiaries, which prior to September 15,
1998, was named WorldCom, Inc. ("WorldCom").
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, 1998 (the "Form 10-K"). The
results for the three and six month periods ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
(B) BUSINESS COMBINATIONS
On September 14, 1998, the Company acquired MCI Communications Corporation
("MCI") for approximately $40 billion, pursuant to the merger (the "MCI Merger")
of MCI with and into a wholly owned subsidiary of the Company. Through the MCI
Merger, the Company acquired one of the world's largest and most advanced
digital networks, connecting local markets in the United States to more than 280
countries and locations worldwide.
As a result of the MCI Merger, each outstanding share of MCI common stock was
converted into the right to receive 1.2439 shares of MCI WorldCom common stock,
par value $.01 per share (the "MCI WorldCom Common Stock"), or approximately 755
million MCI WorldCom common shares in the aggregate, and each share of MCI Class
A common stock outstanding (all of which were held by British Telecommunications
plc ("BT")) was converted into the right to receive $51.00 in cash or
approximately $7 billion in the aggregate. The funds paid to BT were obtained by
the Company from (i) available cash as a result of the Company's $6.1 billion
public debt offering in August 1998; (ii) the sale of MCI's Internet backbone
facilities and wholesale and retail Internet business (the "iMCI Business") to
Cable and Wireless plc ("Cable & Wireless") for $1.75 billion in cash on
September 14, 1998; (iii) the sale of MCI's 24.9% equity stake in Concert
Communications Services ("Concert") to BT for $1 billion in cash on September
14, 1998; and (iv) availability under the Company's commercial paper program and
credit facilities.
Upon effectiveness of the MCI Merger, the then outstanding and unexercised
options exercisable for shares of MCI common stock were converted into options
exercisable for an aggregate of approximately 83 million shares of MCI WorldCom
Common Stock having the same terms and conditions as the MCI options, except
that the exercise price and the number of shares issuable upon exercise were
divided and multiplied, respectively, by 1.2439. The MCI Merger was accounted
for as a purchase; accordingly, operating results for MCI have been included
from the date of acquisition.
The purchase price in the MCI Merger was allocated based on estimated fair
values at the date of acquisition. This resulted in an excess of purchase price
over net assets acquired of which $3.1 billion was allocated to in-process
research and development ("IPR&D") and $1.7 billion to developed technology,
which is being depreciated over 10 years on a straight-line basis. The remaining
excess has been allocated to goodwill and tradename, which are being amortized
over 40 years on a straight-line basis.
Page 6
7
On August 4, 1998, MCI acquired a 51.79% voting interest and a 19.26% economic
interest in Embratel Participacoes S.A. ("Embratel"), Brazil's only
facilities-based national communications provider, for approximately R$2.65
billion (US$2.3 billion). The purchase price will be paid in local currency
installments, of which R$1.06 billion (US$916 million) was paid on August 4,
1998, R$795 million (US$442 million) was paid on August 4, 1999 and the
remaining R$795 million (US$443 million at June 30, 1999) will be paid August 4,
2000. Embratel provides interstate long distance and international
telecommunications services in Brazil, as well as over 40 other communications
services, including leased high-speed data, satellite, Internet, frame relay and
packet-switched services. Operating results for Embratel are consolidated in the
accompanying consolidated financial statements and are included from the date of
the MCI Merger.
On January 31, 1998, MCI WorldCom acquired CompuServe Corporation
("CompuServe"), for approximately $1.3 billion, pursuant to the merger (the
"CompuServe Merger") of a wholly owned subsidiary of the Company with and into
CompuServe. Upon consummation of the CompuServe Merger, CompuServe became a
wholly owned subsidiary of MCI WorldCom.
As a result of the CompuServe Merger, each share of CompuServe common stock was
converted into the right to receive 0.40625 shares of MCI WorldCom Common Stock,
or approximately 37.6 million MCI WorldCom common shares in the aggregate. Prior
to the CompuServe Merger, CompuServe operated primarily through two divisions:
Interactive Services and Network Services. Interactive Services offered
worldwide online and Internet access services for consumers, while Network
Services provided worldwide network access, management and applications, and
Internet service to businesses. The CompuServe Merger was accounted for as a
purchase; accordingly, operating results for CompuServe have been included from
the date of acquisition.
On January 31, 1998, the Company also acquired ANS Communications, Inc. ("ANS"),
from America Online, Inc. ("AOL"), for approximately $500 million, and has
entered into five year contracts with AOL under which MCI WorldCom and its
subsidiaries provide network services to AOL (collectively, the "AOL
Transaction"). As part of the AOL Transaction, AOL acquired CompuServe's
Interactive Services division and received a $175 million cash payment from MCI
WorldCom. MCI WorldCom retained the CompuServe Network Services division. ANS
provides Internet access to AOL and AOL's subscribers in the United States,
Canada, the United Kingdom, Sweden and Japan. The AOL Transaction was accounted
for as a purchase; accordingly, operating results for ANS have been included
from the date of acquisition.
The purchase price in the CompuServe Merger and AOL Transaction was allocated
based on estimated fair values at the date of acquisition. This resulted in an
excess of purchase price over net assets acquired of which $429 million was
allocated to IPR&D. The remaining excess has been recorded as goodwill, which is
being amortized over 10 years on a straight-line basis.
On January 29, 1998, MCI WorldCom acquired Brooks Fiber Properties, Inc.
("BFP"), pursuant to the merger (the "BFP Merger") of a wholly owned subsidiary
of MCI WorldCom, with and into BFP. Upon consummation of the BFP Merger, BFP
became a wholly owned subsidiary of MCI WorldCom. BFP is a leading
facilities-based provider of competitive local telecommunications services,
commonly referred to as a competitive local exchange carrier, in selected cities
within the United States. BFP acquires and constructs its own state-of-the-art
fiber optic networks and facilities and leases network capacity from others to
provide long distance carriers ("IXCs"), Internet service providers ("ISPs"),
wireless carriers and business, government and institutional end users with an
alternative to the incumbent local exchange carriers ("ILECs") for a broad array
of high quality voice, data, video transport and other telecommunications
services.
Page 7
8
As a result of the BFP Merger, each share of BFP common stock was converted into
the right to receive 1.85 shares of MCI WorldCom Common Stock or approximately
72.6 million MCI WorldCom common shares in the aggregate. The BFP Merger was
accounted for as a pooling-of-interests; and accordingly, the Company's
financial statements for periods prior to the BFP Merger have been restated to
include the results of BFP for all periods presented.
Upon effectiveness of the BFP Merger, the then outstanding and unexercised
options and warrants exercisable for shares of BFP common stock were converted
into options and warrants, respectively, exercisable for shares of MCI WorldCom
Common Stock having the same terms and conditions as the BFP options and
warrants, except that the exercise price and the number of shares issuable upon
exercise were divided and multiplied, respectively, by 1.85.
The following unaudited pro forma combined results of operations for the Company
for the six months ended June 30, 1998 assumes that the MCI Merger was completed
on January 1, 1998 (in millions, except per share data):
Revenues $ 14,650
Loss before extraordinary items (3,228)
Net loss (3,357)
Loss per common share:
Loss before extraordinary items $ (1.84)
Net loss $ (1.91)
These pro forma amounts represent the historical operating results of MCI
combined with those of the Company with appropriate preliminary adjustments
which give effect to an IPR&D charge of $3.1 billion in 1998, depreciation,
amortization, interest and the common shares issued. These pro forma amounts do
not include amounts with respect to Embratel because it is not material to MCI
WorldCom. These pro forma amounts are not necessarily indicative of operating
results which would have occurred if MCI had been operated by current management
during the periods presented because these amounts do not reflect cost savings
related to full network optimization and the redundant effect on operating,
selling, general and administrative expenses.
(C) EARNINGS PER SHARE
The following is a reconciliation of the numerators and the denominators of the
basic and diluted per share computations for the three and six months ended June
30, 1999 and 1998 (in millions, except per share data):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
Basic
Income (loss) before extraordinary items $ 879 $ 227 $ 1,604 $ (53)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities 16 -- 32 --
Preferred stock dividends -- 6 -- 13
-------- -------- -------- --------
Net income (loss) applicable to common shareholders
before extraordinary items $ 863 $ 221 $ 1,572 $ (66)
======== ======== ======== ========
Weighted average shares outstanding 1,862 1,045 1,855 1,028
===== ===== ===== =====
Basic earnings (loss) per share before extraordinary items $ 0.46 $ 0.21 $ .85 $ (0.06)
======== ======== ======== ========
Page 8
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FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ---------------------
1999 1998 1999 1998
---- ---- ---- ----
Diluted
Net income (loss) applicable to common shareholders
before extraordinary items $ 863 $ 221 $ 1,572 $ (66)
Add back:
Preferred stock dividends -- 6 -- --
--------- --------- --------- ---------
Net income (loss) applicable to common shareholders
before extraordinary items $ 863 $ 227 $ 1,572 $ (66)
========= ========= ========= =========
Weighted average shares outstanding 1,862 1,045 1,855 1,028
Common stock equivalents 75 34 74 --
Common stock issuable upon conversion of
preferred stock 1 22 1 --
--------- --------- --------- ---------
Diluted shares outstanding 1,938 1,101 1,930 1,028
========= ========= ========= =========
Diluted earnings (loss) per share before
extraordinary items $ 0.45 $ 0.21 $ 0.81 $ (0.06)
========= ========= ========= =========
(D) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid by the Company during the six months ended June 30, 1999 and 1998
amounted to $554 million and $316 million, respectively. Income taxes paid
during the six months ended June 30, 1999 and 1998 were $51 million and $7
million, respectively. In conjunction with business combinations during the six
months ended June 30, 1999 and 1998, assumed assets and liabilities were as
follows (in millions):
1999 1998
------- -------
Fair value of assets acquired $ 64 $ 335
Excess of cost over net tangible assets acquired 912 1,542
Liabilities assumed (298) (384)
Common stock issued (228) (1,298)
------- -------
Net cash paid $ 450 $ 195
======= =======
Acquisition and related costs for the six months ended June 30, 1999 reflect
additional costs related to the acquisitions that occurred in 1998 and smaller
acquisitions completed during 1999.
(E) COMPREHENSIVE INCOME
The following table reflects the calculation of comprehensive income (loss) for
MCI WorldCom for the three and six months ended June 30, 1999 and 1998 (in
millions):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Net income (loss) applicable to common shareholders $ 863 $ 221 $ 1,572 $ (195)
------- ------- ------- -------
Other comprehensive income (loss):
Foreign currency translation losses (23) (1) (305) (9)
Unrealized holding gains (losses):
Page 9
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FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Unrealized holding gains (losses) during the period 291 (44) 536 (18)
Reclassification adjustment for gains included in
net income (15) (13) (15) (13)
------- ------- ------- -------
Other comprehensive income (loss) before tax 253 (58) 216 (40)
Income tax expense (104) 21 (196) 11
------- ------- ------- -------
Other comprehensive income (loss) 149 (37) 20 (29)
------- ------- ------- -------
Comprehensive income (loss) applicable to
common shareholders $ 1,012 $ 184 $ 1,592 $ (224)
======= ======= ======= =======
(F) SEGMENT INFORMATION
Based on its organizational structure, the Company operates in five reportable
segments: MCI WorldCom Communications, MCI WorldCom International Operations,
Embratel, Operations and technology and Other. The Company's reportable segments
represent business units that primarily offer similar products and services;
however, the business units are managed separately due to the geographic
dispersion of their operations. MCI WorldCom Communications provides voice, data
and other types of domestic communications services including Internet services.
MCI WorldCom International Operations provides voice, data, Internet and other
similar types of communications services to customers primarily in Europe.
Embratel provides communications services in Brazil. Operations and technology
includes network operations, information services, engineering and technology,
and customer service. Other includes primarily the operations of MCI Systemhouse
Corp. and SHL Systemhouse Co., wholly owned subsidiaries of the Company
(collectively, "SHL"), and other non-communications services. In April 1999, the
Company completed the previously announced sale of SHL to Electronic Data
Systems Corporation ("EDS").
The Company's chief operating decision maker utilizes revenue information in
assessing performance and making overall operating decisions and resource
allocations. Communications services are generally provided utilizing the
Company's fiber optic networks, which do not make a distinction between the
types of services. As a result, the Company does not allocate line costs or
assets by segment. Profit and loss information is reported only on a
consolidated basis to the chief operating decision maker and the Company's board
of directors.
Information about the Company's segments for the three and six months ended June
30, 1999 and 1998 is as follows (in millions):
REVENUES FROM EXTERNAL CUSTOMERS
-------------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
MCI WorldCom Communications $ 7,717 $ 2,269 $ 15,272 $ 4,319
MCI WorldCom International Operations 420 270 777 500
Operations and technology -- -- -- --
Other 120 42 523 82
Corporate -- -- -- --
---------- ---------- ---------- ----------
Total before Embratel 8,257 2,581 16,572 4,901
Page 10
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REVENUES FROM EXTERNAL CUSTOMERS
----------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
Embratel 716 -- 1,402 --
Elimination of intersegment revenues (29) -- (29) --
-------- -------- -------- --------
Total $ 8,944 $ 2,581 $ 17,945 $ 4,901
======== ======== ======== ========
The following is a reconciliation of the segment information to income before
income taxes, minority interests and extraordinary items for the three and six
months ended June 30, 1999 and 1998 (in millions):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues $ 8,944 $ 2,581 $ 17,945 $ 4,901
Operating expenses 7,180 2,086 14,686 4,478
-------- -------- -------- --------
Operating income 1,764 495 3,259 423
Other income (expense):
Interest expense (236) (108) (496) (210)
Miscellaneous 48 10 16 22
-------- -------- -------- --------
Income before income taxes, minority interests
and extraordinary items $ 1,576 $ 397 $ 2,779 $ 235
======== ======== ======== ========
(G) CONTINGENCIES
The Company is involved in legal and regulatory proceedings generally incidental
to its business and has included loss contingencies in other current liabilities
and other liabilities for certain of these matters. In some instances, rulings
by federal and some state regulatory authorities may result in increased
operating costs to the Company. Except as described herein, and while the
results of these various legal and regulatory matters contain an element of
uncertainty, MCI WorldCom believes that the probable outcome of these matters
should not have a material adverse effect on the Company's consolidated results
of operations or financial position.
GENERAL. MCI WorldCom is subject to varying degrees of federal, state, local and
international regulation. In the United States, the Company's subsidiaries are
most heavily regulated by the states, especially for the provision of local
exchange services. The Company must be certified separately in each state to
offer local exchange and intrastate long distance services. No state, however,
subjects MCI WorldCom to price cap or rate of return regulation, nor is the
Company currently required to obtain Federal Communications Commission ("FCC")
authorization for installation or operation of its network facilities used for
domestic services, other than licenses for specific terrestrial microwave and
satellite earth station facilities that utilize radio frequency spectrum. FCC
approval is required, however, for the installation and operation of its
international facilities and services. MCI WorldCom is subject to varying
degrees of regulation in the foreign jurisdictions in which it conducts business
including authorization for the installation and operation of network
facilities. Although the trend in federal, state and international regulation
appears to favor increased competition, no assurance can be given that changes
in current or future regulations adopted by the FCC, state or foreign regulators
or legislative initiatives in the United States or abroad would not have a
material adverse effect on MCI WorldCom.
Page 11
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In implementing the Telecommunications Act of 1996 (the "Telecom Act"), the FCC
established nationwide rules designed to encourage new entrants to participate
in the local services markets through interconnection with the ILECs, resale of
ILECs' retail services and use of individual and combinations of unbundled
network elements. Appeals of the FCC order adopting those rules were
consolidated before the United States Court of Appeals for the Eighth Circuit
(the "Eighth Circuit"). Thereafter, the Eighth Circuit held that constitutional
challenges to various practices implementing cost provisions of the Telecom Act
that were ordered by certain Public Utility Commissions ("PUCs") were premature;
it vacated, however, significant portions of the FCC's nationwide pricing rules
and an FCC rule requiring that unbundled network elements be provided on a
combined basis. The United States Supreme Court (the "Supreme Court") reviewed
the decision of the Eighth Circuit and on January 25, 1999, reversed the Eighth
Circuit in part and reinstated, with one exception, all of the FCC local
competition rules. The Court vacated and remanded to the FCC for reconsideration
the rule determining which unbundled network elements must be provided by ILECs
to new entrants. The Eighth Circuit is now considering the ILECs' challenges to
the substance of pricing rules which it previously had found to be premature.
Access charges, both interstate and intrastate, are a principal component of MCI
WorldCom's telecommunications expense. Regulators have historically permitted
access charges to be set at levels that are well above ILECs' costs. As a
result, access charges have been a source of universal service subsidies that
enable local exchange rates to be set at levels that are affordable. MCI
WorldCom has actively participated in a variety of state and federal regulatory
proceedings with the goal of bringing access charges to cost-based levels and to
fund universal service using explicit subsidies funded in a competitively-
neutral manner.
On May 21, 1999, the United States Court of Appeals for the District of Columbia
Circuit remanded to the FCC its recent decision to adjust its price cap
regulation of ILECs to require access charges to fall 6.5% per year adjusted for
inflation. On June 22, 1999, that Court stayed the effect of its decision
pending a further order by the FCC justifying or modifying its decision in
response to the Court's opinion. On August 5, 1999, the FCC adopted a decision
that will give price cap regulated ILECs the ability to request permission to
offer customer-specific pricing in the form of contract tariffs. Once
implemented, this decision will allow price cap ILECs to compete against long
distance carriers who have previously been able to offer contract type pricing
for access arrangements. FCC officials stated that they expect price cap ILECs
to be able to obtain pricing flexibility quickly for most of their dedicated
transport and special access services. Some price cap ILECs serving the nation's
largest cities are expected to qualify for additional pricing flexibility for
all dedicated transport and special access services. The FCC has also opened a
proceeding to consider additional pricing flexibility for all switched access
services.
On May 27, 1999, the FCC amended its prior universal service decisions in two
significant respects. First, the FCC raised the funding level for universal
service support to schools and libraries to $2.25 billion per year, the current
maximum that FCC rules allow. This brings the total amount of federal universal
service funds collected from telecommunications carriers to $4.2 billion in the
current year. Second, the FCC modified its approach to subsidizing non-rural
high cost areas by rejecting its prior approach of sizing the subsidy based on
forward-looking cost models, and instead adopted a more complex approach that
the FCC said it hoped would produce a small high cost fund. A final decision
regarding the amount to be collected to support non-rural high cost areas is
expected later this year. On July 30, 1999, the United States Court of Appeals
for the Fifth Circuit issued a decision reversing and vacating in part portions
of a June 1997 FCC universal service decision. Among other things, the Court
held that the FCC may collect universal service subsidies from interstate
carriers based only on interstate revenues, and that the FCC could not force the
ILECs to recover their universal service contributions through interstate access
charges. While access charges are likely to decrease as a result of this
decision, direct assessments on interstate carriers such as MCI WorldCom are
likely to increase.
In August 1998, in response to petitions filed by several ILECs under the guise
of Section 706 of the Telecom Act, the FCC issued its Advanced Services Order.
This order clarifies that the interconnection, unbundling, and resale
requirements of Section 251(c) of the Telecom Act, and the interLATA
restrictions of Section 271 of this Act, apply fully to so-called "advanced
telecommunications services," such as Digital Subscriber Line ("DSL"). An appeal
of this
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order by US WEST Communications Group is currently pending before the U.S. Court
of Appeals for the District of Columbia Circuit. The FCC has asked the court to
remand the case for further proceedings. In a companion notice, the FCC sought
comment on how to implement Section 706 of the Telecom Act, which directs the
FCC to (1) encourage the deployment of advanced telecommunications capability to
Americans on a reasonable and timely basis, and (2) complete an inquiry
concerning the availability of such services no later than February 8, 1999. The
Commission's rulemaking notice included a proposal that, if adopted, would allow
the ILECs the option of providing advanced services via a separate subsidiary
free from the unbundling and resale obligations of Section 251(c), as well as
other dominant carrier regulatory requirements.
In early February 1999, the FCC issued its report to Congress, concluding that
the deployment of advanced services is proceeding at a reasonable and timely
pace. The FCC has not yet issued its Section 706 rulemaking order.
On February 26, 1999, the FCC issued a Declaratory Ruling and Notice of Proposed
Rulemaking regarding the regulatory treatment of calls to ISPs. Prior to the
FCC's order, approximately thirty PUCs issued orders unanimously finding that
carriers, including MCI WorldCom, are entitled to collect reciprocal
compensation for completing calls to ISPs under the terms of their
interconnection agreements with ILECs. Many of these PUC decisions have been
appealed by the ILECs and, since the FCC's order, many have filed new cases at
the PUCs or in court. Moreover, MCI WorldCom has appealed the FCC's order to the
Court of Appeals for the District of Columbia Circuit. MCI WorldCom cannot
predict either the outcome of these appeals and the FCC's rulemaking proceeding
or whether or not the result(s) will have a material adverse impact upon its
consolidated financial position or results of operations.
On July 22, 1999, the Senate amended the Commerce, Justice, State and the
Judiciary Fiscal Year 2000 appropriations bill to include language that
prohibits the FCC from requiring entities it regulates to use any form or method
of accounting that does not conform to Generally Accepted Accounting Principles
established by the Financial Accounting Standards Board. On August 5, 1999, the
House of Representatives adopted a similar amendment on its version of the
Commerce, Justice, State, and the Judiciary appropriations bill. If agreed to in
conference and enacted into law, such a provision may make it more difficult for
the FCC and state regulatory commissions to detect and prevent inappropriate
accounting practices by ILECs and thereby permit ILECs to engage in
anti-competitive practices.
Several bills have been introduced during the 106th Congress that would exclude
the transmission of data services or high-speed Internet access from the Telecom
Act's bar on the transmission of in-region interLATA services by the Bell
Operating Companies. These bills also would make it more difficult for
competitors to resell the high-speed Internet access services of the ILECs or to
lease some of the network components used for the provision of such services.
In 1996 and in 1997, the FCC issued decisions that would require nondominant
telecommunications carriers to eliminate interstate service tariffs, except in
limited circumstances. MCI WorldCom has challenged this decision in the U.S.
Court of Appeals for the District of Columbia Circuit, and has successfully
obtained a stay of the FCC's decision. MCI WorldCom's appeal has been held in
abeyance pending FCC action with respect to petitions for reconsideration. The
FCC recently issued an order addressing those petitions for reconsideration, and
the U.S. Court of Appeals for the District of Columbia Circuit has approved a
briefing schedule. No argument date has been set. MCI WorldCom cannot predict
the ultimate outcome of its appeal. Should the FCC prevail, MCI WorldCom could
no longer rely on its federal tariff to limit liability or to establish its
interstate rates for customers. Per the FCC's decision, MCI WorldCom would need
to develop a means to contract individually with its millions of customers in
order to establish lawfully enforceable rates.
In 1997 and 1998, the FCC rejected five applications filed by Bell Operating
Companies ("BOCs") to provide in-region long distance service in competition
with long distance carriers. Pursuant to the Telecom Act, BOCs must file, in
each state in their service area, an application conforming to the requirements
of section 271 of the Telecom Act if they wish to offer in-region long distance
service. Among other things, the applications must demonstrate that the BOC has
met a 14-point competitive checklist to open its local network to competition
and demonstrate that the application is in the public interest. As of August
1999, no applications were on file with the FCC. However, BOCs in two states -
Bell Atlantic Corporation in New York and SBC Corporation in Texas - have
announced their intent to file applications
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during 1999 after concluding extensive state regulatory proceedings to assess
their compliance with checklist requirements. If filed, these would be the first
applications to have been subjected to rigorous operational testing of readiness
to meet the section 271 requirements. It is not known if the BOCs will meet
their publicly-stated filing goals. The FCC must reach its decision on
applications within 90 days from the date they are filed.
INTERNATIONAL. In February 1997, the United States entered into a World Trade
Organization Agreement (the "WTO Agreement") that is designed to have the effect
of liberalizing the provision of switched voice telephone and other
telecommunications services in scores of foreign countries over the next several
years. The WTO Agreement became effective in February 1998. In light of the
United States commitments to the WTO Agreement, the FCC implemented new rules in
February 1998 that liberalize existing policies regarding (1) the services that
may be provided by foreign affiliated United States international common
carriers, including carriers controlled or more than 25 percent owned by foreign
carriers that have market power in their home markets, and (2) the provision of
alternative traffic routing. The new rules make it much easier for foreign
affiliated carriers to enter the United States market for the provision of
international services.
In August 1997, the FCC adopted mandatory settlement rate benchmarks. These
benchmarks are intended to reduce the rates that United States carriers pay
foreign carriers to terminate traffic in their home countries. The FCC will also
prohibit a United States carrier affiliated with a foreign carrier from
providing facilities-based service to the foreign carrier's home market until
and unless the foreign carrier has implemented a settlement rate at or below the
benchmark. The FCC also adopted new rules that will liberalize the provision of
switched services over private lines to World Trade Organization member
countries. These rules allow such services on routes where 50% or more of United
States billed traffic is being terminated in the foreign country at or below the
applicable settlement rate benchmark or where the foreign country's rules
concerning provision of international switched services over private lines are
deemed equivalent to United States rules. On January 12, 1999, the FCC's
benchmark rules were upheld in their entirety by the U.S. Court of Appeals for
the District of Columbia Circuit. On March 11, 1999 the D. C. Circuit denied
petitions for rehearing of the case.
In April 1999, the FCC modified its rules to permit United States international
carriers to exchange international public switched voice traffic on many routes
to and from the United States outside of the traditional settlement rate and
proportionate return regimes.
Although the FCC's new policies and implementation of the WTO Agreement may
result in lower settlement payments by MCI WorldCom to terminate international
traffic, there is a risk that the payments that MCI WorldCom will receive from
inbound international traffic may decrease to an even greater degree. The
implementation of the WTO Agreement may also make it easier for foreign carriers
with market power in their home markets to offer United States and foreign
customers end-to-end services to the disadvantage of MCI WorldCom. The Company
meanwhile, may continue to face substantial obstacles in obtaining from foreign
governments and foreign carriers the authority and facilities to provide such
end-to-end services.
EMBRATEL. The 1996 General Telecommunications Law (the "General Law") provides a
framework for telecommunications regulation for Embratel. Article 8 of the
General Law created Agencia Nacional de Telecomunicacoes ("Anatel") to implement
the General Law through development of regulations and to enforce such
regulations. According to the General Law, companies wishing to offer
telecommunications services to consumers are required to apply to Anatel for a
concession or an authorization. Concessions are granted for the provision of
services under the public regime (the "Public Regime") and authorizations are
granted for the provision of services under the private regime (the "Private
Regime"). The Public Regime is differentiated from the Private Regime primarily
by the obligations imposed on the companies rather than the type of services
offered by those companies. Service providers subject to the Public Regime
(concessionaires) are subject to obligations concerning network expansion and
continuity of service provision and are subject to rate regulation. These
obligations and the tariff conditions are provided in the General Law and in
each company's concession contract. The network expansion obligations (called
universal service obligations) are also provided in the Plano Geral de
Universalizacao ("General Plan on Universal Service").
The only services provided under the Public Regime are the switched fixed
telephone services (local and national and international long distance) provided
by Embratel and the three regional holding companies ("Teles"). All other
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telecommunications companies, including other companies providing switched fixed
telephone services ("SFTS"), operate in the Private Regime and, although they
are not subject to the Public Regime, individual authorizations may contain
certain specific expansion and continuity obligations.
Therefore, when providing SFTS, Embratel and the Teles are subject to the Public
Regime obligations provided in the General Law, in their concession contracts
and in the General Plan on Universal Service, among other regulations.
The main restriction imposed on these companies by the General Plan on Universal
Service, is that, until December 31, 2003, the three Teles are prohibited from
offering inter-regional and international long distance service, while Embratel
is prohibited from offering local services. These companies can start providing
the mentioned services two years sooner if they meet their network expansion
obligations by December 31, 2001.
Embratel and the three Teles were granted their concessions at no fee, until
2005. After 2005, the concessions may be renewed for a period of 20 years, upon
the payment, every two years, of a fee equal to 2% of annual net revenues
calculated based on the provision of SFTS in the prior year, excluding taxes and
social contributions.
Embratel also offers a number of ancillary telecommunications services pursuant
to authorizations granted in the Private Regime. Such services include the
provision of dedicated analog and digital lines, packet switched network
services, circuit switched network services, mobile marine telecommunications,
telex and telegraph, radio signal satellite retransmission and television signal
satellite retransmission. Some of these services are subject to specific
continuity obligations and rate conditions.
All providers of telecommunications services are subject to quality and
modernization obligations provided in the Plano Geral de Qualidade ("General
Plan on Quality").
LITIGATION. On November 4, 1996, and thereafter, and on August 25, 1997, and
thereafter, MCI and all of its directors were named as defendants in a total of
15 complaints filed in the Court of Chancery in the State of Delaware. BT was
named as a defendant in 13 of the complaints. The complaints were brought by
alleged stockholders of MCI, individually and purportedly as class actions on
behalf of all other stockholders of MCI. In general, the complaints allege that
MCI's directors breached their fiduciary duty in connection with the MCI BT
Merger Agreement, dated November 3, 1996 (the "MCI BT Merger Agreement"), that
BT aided and abetted those breaches of duty, that BT owes fiduciary duties to
the other stockholders of MCI and that BT breached those duties in connection
with the MCI BT Merger Agreement. The complaints seek damages and injunctive and
other relief.
One of the purported stockholder class actions pending in Delaware Chancery
Court has been amended, one of the purported class actions has been dismissed
with prejudice, and plaintiffs in four of the other purported stockholder class
actions have moved to amend their complaints to name MCI WorldCom and TC
Investments Corp., a wholly owned subsidiary of the Company, as additional
defendants. These plaintiffs generally allege that the defendants breached their
fiduciary duties to stockholders in connection with the MCI Merger and the
agreement to pay a termination fee to WorldCom. They further allege
discrimination in favor of BT in connection with the MCI Merger. The plaintiffs
seek, inter alia, damages and injunctive relief prohibiting the consummation of
the MCI Merger and the payment of the inducement fee to BT.
Three complaints were filed in the U.S. District Court for the District of
Columbia, as class actions on behalf of purchasers of MCI shares. The three
cases were consolidated on April 1, 1998. On or about May 8, 1998, the
plaintiffs in all three cases filed a consolidated amended complaint alleging,
on behalf of purchasers of MCI's shares between July 11, 1997 and August 21,
1997, inclusive, that MCI and certain of its officers and directors failed to
disclose material information about MCI, including that MCI was renegotiating
the terms of the MCI BT Merger Agreement. The consolidated amended complaint
seeks damages and other relief. The Company and the other defendants have moved
to dismiss the consolidated amended complaint.
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At least nine class action complaints have been filed that arise out of the
FCC's decision in Halprin, Temple, Goodman and Sugrue v. MCI Telecommunications
Corp., and allege that MCI WorldCom has improperly charged "Pre-Subscribed"
customers "Non-Subscriber" or so-called "casual" rates for certain direct-dialed
calls. Plaintiffs assert that this conduct violates the Communications Act and
various state laws; they seek rebates to all affected customers and punitive
damages. In response to a motion filed by MCI WorldCom, the Judicial Panel on
Multi-District Litigation has consolidated these matters in the U.S. District
Court for the Southern District of Illinois. The Company has moved to dismiss
the state law claims and for an order staying the Communications Act claims
pending the FCC's resolution of MCI WorldCom's outstanding motion for
reconsideration and any subsequent appeal of the FCC decision.
On September 3, 1998, WorldCom and MCI entered into a Stock Purchase Agreement
("SPA") with Cable & Wireless plc and Cable & Wireless Internet Holdings, Inc.
(collectively, "C&W"), pursuant to which MCI sold the iMCI business to C&W. That
transaction closed on September 14, 1998, simultaneously with the closing of the
MCI Merger.
On February 18, 1999, pursuant to the indemnity provisions of the SPA, C&W
notified MCI WorldCom that it was claiming that MCI WorldCom had breached
representations and warranties in, and had failed to comply with other
provisions of, the SPA. C&W alleged that it had suffered damages of
approximately $1.16 billion. As MCI WorldCom advised C&W on March 19, 1999, the
Company denies these allegations.
On March 31, 1999, C&W filed a complaint against MCI WorldCom in the United
States District Court for the District of Delaware, alleging that MCI WorldCom
had breached the SPA. In the lawsuit, C&W seeks unspecified damages and specific
performance. On May 11, 1999, MCI WorldCom filed a motion to stay the litigation
and to compel compliance with the dispute resolution/arbitration provisions in
the SPA and affiliated agreements. On July 12, 1999, the district court entered
an order compelling C&W to comply with the dispute resolution/arbitration
provisions of the SPA and affiliated agreements with respect to five of the 11
claims in its complaint and denying a stay of the action. On July 29, the
district court set a trial date of September 12, 2000.
The Company believes that all of the complaints are without merit, and based on
information currently available, MCI WorldCom presently does not expect that the
above actions will have a material adverse effect on the Company's consolidated
results of operations or financial position.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of
Operations 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,
estimated costs to complete or possible future revenues from IPR&D programs, the
likelihood of successful completion of such programs, and the outcome of year
2000 or Euro conversion efforts, as well as any statements preceded by, followed
by, or that include the words "intends," "estimates," "believes," "expects,"
"anticipates," "should," "could," or similar expressions; and other statements
contained herein regarding matters that are not historical facts.
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 (the "Cautionary Statements")
include, without limitation: (1) uncertainties associated with the success of
acquisitions and the integration thereof; (2) risks of international business;
(3) the impact of technological change on the Company's business and dependence
on availability of transmission facilities; (4) regulation risks including the
impact of the Telecom Act; (5) contingent liabilities; (6) the impact of
competitive services and pricing; (7) risks associated with year 2000
uncertainties and Euro conversion efforts; (8) risks associated with debt
service requirements and interest rate fluctuations; (9) the Company's degree of
financial leverage; and (10) other risks referenced from time to time in the
Company's filings with the SEC, including the Form 10-K. All subsequent written
and oral forward-looking statements attributable to the Company or persons
acting on its behalf are
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expressly qualified in their entirety by the Cautionary Statements. The Company
does not undertake any obligation to release publicly any revisions to such
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
The following discussion and analysis relates to the financial condition and
results of operations of the Company for the three and six month periods ended
June 30, 1999 and 1998, after giving effect to the BFP Merger, which was
accounted for as a pooling-of-interests. The information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and consolidated financial statements and notes
thereto contained herein and in the Form 10-K.
Unless otherwise defined, capitalized terms used herein have the meanings
assigned to them in the Notes to Consolidated Financial Statements contained
herein.
GENERAL
The Company is one of the largest telecommunications companies in the United
States, serving local, long distance and Internet 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
other telecommunications companies and international expansion.
On September 14, 1998, the Company, through a wholly owned subsidiary, merged
with MCI. Through the MCI Merger, the Company acquired one of the world's
largest and most advanced digital networks, connecting local markets in the
United States to more than 280 countries and locations worldwide.
As a result of the MCI Merger, each share of MCI common stock was converted into
the right to receive 1.2439 shares of MCI WorldCom Common Stock or approximately
755 million MCI WorldCom common shares in the aggregate, and each share of MCI
Class A common stock outstanding (all of which were held by BT) was converted
into the right to receive $51.00 in cash or approximately $7 billion in the
aggregate. The funds paid to BT were obtained by the Company from (i) available
cash as a result of the Company's $6.1 billion public debt offering in August
1998; (ii) the sale of MCI's iMCI Business to Cable & Wireless for $1.75 billion
in cash on September 14, 1998; (iii) the sale of MCI's 24.9% equity stake in
Concert to BT for $1 billion in cash on September 14, 1998; and (iv)
availability under the Company's credit facilities and commercial paper program.
The MCI Merger was accounted for as a purchase; accordingly, operating results
for MCI have been included from the date of acquisition.
On August 4, 1998, MCI acquired a 51.79% voting interest and a 19.26% economic
interest in Embratel, Brazil's only facilities-based national communications
provider, for approximately R$2.65 billion (US$2.3 billion). The purchase price
will be paid in local currency installments of which R$1.06 billion (US$916
million) was paid on August 4, 1998, R$795 million (US$442 million) was paid
August 4, 1999 and the remaining R$795 million (US$443 million at June 30, 1999)
will be paid August 4, 2000. Embratel provides interstate long distance and
international telecommunications services, as well as over 40 other
communications services, including leased high-speed data, satellite, Internet,
frame relay and packet-switched services. Operating results for Embratel are
included from the date of the MCI Merger.
On January 31, 1998, MCI WorldCom, through a wholly owned subsidiary, merged
with CompuServe. As a result of the CompuServe Merger, each share of CompuServe
common stock was converted into the right to receive 0.40625 shares of MCI
WorldCom Common Stock, or approximately 37.6 million MCI WorldCom common shares
in the aggregate. Prior to the CompuServe Merger, CompuServe operated primarily
through two divisions: Interactive Services and Network Services. Interactive
Services offered worldwide online and Internet access services for consumers,
while Network Services provided worldwide network access, management and
applications, and Internet services to business. The CompuServe Merger was
accounted for as a purchase; accordingly, operating results for CompuServe have
been included from the date of acquisition.
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On January 31, 1998, MCI WorldCom also acquired ANS from AOL, and has entered
into five year contracts with AOL under which MCI WorldCom and its subsidiaries
will provide network services to AOL. As part of the AOL Transaction, AOL
acquired CompuServe's Interactive Services Division and received a $175 million
cash payment from MCI WorldCom. MCI WorldCom retained the CompuServe Network
Services division. ANS provides Internet access to AOL and AOL's subscribers in
the United States, Canada, the United Kingdom, Sweden and Japan. The AOL
Transaction was accounted for as a purchase, accordingly, operating results for
ANS have been included from the date of acquisition.
In connection with the above business combinations, the Company made allocations
of the purchase price to acquired IPR&D totaling $429 million in the first
quarter of 1998 related to the CompuServe Merger and AOL Transaction and $3.1
billion in the third quarter of 1998 related to the MCI Merger.
Management expects to continue supporting these research and development ("R&D")
efforts and believes the Company has a reasonable chance of successfully
completing the R&D programs. However, there is risk associated with the
completion of the R&D projects and the Company cannot give any assurance that
any will meet with either technological or commercial success.
If none of these R&D projects are successfully developed, the sales and
profitability of the Company may be adversely affected in future periods. The
failure of any particular individual project in-process would not materially
impact the Company's financial condition, results of operations or the
attractiveness of the overall investment in MCI, CompuServe Network Services or
ANS. Operating results are subject to uncertain market events and risks which
are beyond the Company's control, such as trends in technology, government
regulations, market size and growth, and product introduction or other actions
by competitors.
The integration and consolidation of MCI, CompuServe Network Services and ANS
requires substantial management and financial resources. While the Company
believes the early results of these efforts are encouraging, the MCI Merger,
CompuServe Merger and AOL Transaction necessarily involve a number of
significant risks, including potential difficulties in assimilating the
technologies and services of these companies and in achieving the expected
synergies and cost reduction.
On January 29, 1998, MCI WorldCom, through a wholly owned subsidiary, merged
with BFP in a transaction accounted for as a pooling-of-interests. BFP is a
leading facilities-based provider of competitive local telecommunications
services, commonly referred to as a competitive local exchange carrier, in
selected cities within the United States. BFP acquires and constructs its own
state-of-the-art fiber optic networks and facilities and leases network capacity
from others to provide IXCs, ISPs, wireless carriers and business, government
and institutional end users with an alternative to the ILECs for a broad array
of high quality voice, data, video transport and other telecommunications
services.
The Company's strategy is to further develop as a fully integrated
telecommunications company positioned to take advantage of growth opportunities
in global telecommunications. Consistent with this strategy, the Company
believes that transactions such as the MCI Merger, the CompuServe Merger and the
AOL Transaction enhance the combined entity's opportunities for future growth,
create a stronger competitor in the changing telecommunications industry and
allow provision of end-to-end bundled service over global networks, which will
provide new or enhanced capabilities for the Company's customers.
The Company's profitability is dependent upon, among other things, its ability
to achieve line costs that are less than its revenues. The principal components
of line costs are access charges and transport charges. Regulators have
historically permitted access charges to be set at levels that are well above
ILECs' costs. As a result, access charges have been a source of universal
service subsidies that enable local exchange rates to be set at levels that are
affordable. MCI WorldCom has actively participated in a variety of state and
federal regulatory proceedings with the goal of bringing access charges to
cost-based levels and to fund universal service using explicit subsidies funded
in a competitively-neutral manner.
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On May 21, 1999, the United States Court of Appeals for the District of Columbia
Circuit remanded to the FCC its recent decision to adjust its price cap
regulation of ILECs to require access charges to fall 6.5% per year adjusted for
inflation. On June 22, 1999, that Court stayed the effect of its decision
pending a further order by the FCC justifying or modifying its decision in
response to the Court's opinion. On August 5, 1999, the FCC adopted a decision
that will give price cap regulated ILECs the ability to request permission to
offer customer-specific pricing in the form of contract tariffs. Once
implemented, this decision will allow price cap ILECs to compete against long
distance carriers who have previously been able to offer contract type pricing
for access arrangements. FCC officials stated that they expect price cap ILECs
to be able to obtain pricing flexibility quickly for most of their dedicated
transport and special access services. Some price cap ILECs serving the nation's
largest cities are expected to qualify for additional pricing flexibility for
all dedicated transport and special access services. The FCC has also opened a
proceeding to consider additional pricing flexibility for all switched access
services.
On May 27, 1999, the FCC amended its prior universal service decisions in two
significant respects. First, the FCC raised the funding level for universal
service support to schools and libraries to $2.25 billion per year, the current
maximum that FCC rules allow. This brings the total amount of federal universal
service funds collected from telecommunications carriers to $4.2 billion in the
current year. Second, the FCC modified its approach to subsidizing non-rural
high cost areas by rejecting its prior approach of sizing the subsidy based on
forward-looking cost models, and instead adopted a more complex approach that
the FCC said it hoped would produce a small high cost fund. A final decision
regarding the amount to be collected to support non-rural high cost areas is
expected later this year. On July 30, 1999, the United States Court of Appeals
for the Fifth Circuit issued a decision reversing and vacating in part portions
of a June 1997 FCC universal service decision. Among other things, the Court
held that the FCC may collect universal service subsidies from interstate
carriers based only on interstate revenues, and that the FCC could not force the
ILECs to recover their universal service contributions through interstate access
charges. While access charges are likely to decrease as a result of this
decision, direct assessments on interstate carriers such as MCI WorldCom are
likely to increase. The Company will continue to seek to manage transport costs
through effective utilization of its networks, favorable contracts with carriers
and network efficiencies made possible as a result of expansion of the Company's
customer base through acquisitions and internal growth.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the Company's
statements of operations as a percentage of its revenues for the three and six
months ended June 30, 1999 and 1998:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Revenues .............................................. 100% 100% 100% 100%
Line costs ............................................ 44.0 47.6 44.9 47.9
Selling, general and administrative ................... 24.4 20.3 25.0 20.4
Depreciation and amortization ......................... 11.9 12.9 11.9 12.9
In-process research and development and other charges . -- -- -- 10.2
------- ------- ------- -------
Operating income ...................................... 19.7 19.2 18.2 8.6
Other income (expense):
Interest expense ................................... (2.6) (4.2) (2.8) (4.3)
Miscellaneous ...................................... 0.5 0.4 0.1 0.5
------- ------- ------- -------
Income before income taxes, minority interests, and
extraordinary items ................................ 17.6 15.4 15.5 4.8
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FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ---------------------
1999 1998 1999 1998
------- -------- -------- --------
Provision for income taxes ................................. 7.3 6.6 6.6 5.9
------- ------- -------- --------
Income (loss) before minority interests and extraordinary
items ................................................... 10.3 8.8 8.9 (1.1)
Minority interests ......................................... (0.5) -- 0.1 --
Extraordinary items ........................................ -- -- -- (2.6)
Distributions on subsidiary trust and other mandatorily
redeemable preferred securities ......................... 0.2 -- 0.2 --
Preferred dividend requirement ............................. -- 0.2 -- 0.3
------- ------- -------- --------
Net income (loss) applicable to common shareholders ........ 9.6% 8.6% 8.8% (4.0)%
======= ======= ======== ========
THREE AND SIX MONTHS ENDED JUNE 30, 1999 VS.
THREE AND SIX MONTHS ENDED JUNE 30, 1998
Revenues for the three months ended June 30, 1999 increased 247% to $8.9 billion
as compared to $2.6 billion for the three months ended June 30, 1998. For the
six months ended June 30, 1999, revenues increased 266% to $17.9 billion versus
$4.9 billion for the same period in the prior year. The increase in total
revenues is attributable to the MCI Merger and Embratel transaction as well as
internal growth. Results include MCI and Embratel operations from September 14,
1998 and CompuServe Network Services and ANS from February 1, 1998.
Actual reported revenues by category for the three and six months ended June 30,
1999 and 1998 reflect the following changes by category (dollars in millions):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------- ----------------------------------
ACTUAL ACTUAL PERCENT ACTUAL ACTUAL PERCENT
1999 1998 CHANGE 1999 1998 CHANGE
-------- -------- ------- -------- -------- -------
REVENUES
Voice $ 5,090 $ 1,208 321 $ 10,185 $ 2,370 330
Data 1,791 536 234 3,493 1,032 238
Internet 836 525 59 1,594 917 74
International 420 270 56 777 500 55
-------- -------- -------- --------
COMMUNICATIONS SERVICES 8,137 2,539 220 16,049 4,819 233
Other 120 42 186 523 82 538
-------- -------- -------- --------
TOTAL REVENUES BEFORE EMBRATEL 8,257 2,581 220 16,572 4,901 238
Embratel 716 -- -- 1,402 -- --
Elimination of intersegment revenues (29) -- -- (29) -- --
-------- -------- -------- --------
TOTAL REPORTED REVENUES $ 8,944 $ 2,581 247 $ 17,945 $ 4,901 266
======== ======== ======== ========
The following table provides supplemental pro forma detail for MCI WorldCom
revenues. Since actual results for the six months ended June 30, 1998 do not
reflect the operations of MCI and only five months of CompuServe Network
Services and ANS, the pro forma results are more indicative of internal growth
for the combined company. The pro forma revenues, excluding Embratel, for the
three and six months ended June 30, 1999 and 1998 reflect the following changes
by category (dollars in millions):
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THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------------------- ---------------------------------------
ACTUAL PRO FORMA PERCENT ACTUAL PRO FORMA PERCENT
1999 1998 CHANGE 1999 1998 CHANGE
--------- --------- ------- --------- --------- -------
REVENUES
Voice $ 5,090 $ 4,822 6 $ 10,185 $ 9,576 6
Data 1,791 1,387 29 3,493 2,691 30
Internet 836 525 59 1,594 999 60
International 420 270 56 777 500 55
--------- --------- --------- ---------
COMMUNICATIONS SERVICES 8,137 7,004 16 16,049 13,766 17
Other 120 477 (75) 523 967 (46)
--------- --------- --------- ---------
TOTAL REVENUES $ 8,257 $ 7,481 10 $ 16,572 $ 14,733 12
========= ========= ========= =========
The following discusses the revenue increases for the three and six month
periods ended June 30, 1999 as compared to pro forma results for the comparable
prior year period. The pro forma revenues assume that the MCI Merger, CompuServe
Merger and the AOL Transaction occurred at the beginning of 1998. These pro
forma revenues do not include Embratel or the iMCI Business that was sold.
Changes in actual results of operations are shown in the Consolidated Statements
of Operations and the foregoing tables and, as noted above, primarily reflect
the MCI Merger, Embratel transaction and internal growth of the Company.
Voice revenues for the second quarter and the six month period ended June 30,
1999, experienced 6% increases over the prior year pro forma amounts, driven by
a gain of 10% in traffic for both periods, respectively. Voice revenues include
both long distance and local domestic switched revenues. Strong long distance
volume gains in domestic commercial sales channels, combined with an increasing
mix of local services, were the primary contributors to this increase. Local
voice revenues grew approximately 82% in the second quarter of 1999 and
approximately 88% for the six months ended June 30, 1999 versus the same periods
of the prior year. While the Company continued to show significant percentage
gains in switched local, it was still a relatively small component of total
Company revenues.
Data revenues for the three and six month periods ended June 30, 1999 increased
29% and 30%, respectively, over the same pro forma period of the prior year.
Data includes both long distance and local dedicated bandwidth sales. The
revenue growth for data services continued to be driven by significant
commercial end-user demand for high-speed data and by Internet-related growth on
both a local and long-haul basis. This growth was not only being fueled by
connectivity demands, but also by applications that are becoming more strategic,
far reaching and complex; additionally, bandwidth consumption is driving an
acceleration in growth for higher capacity circuits. Rapidly growing demand for
high-speed data access has contributed to a 36% pro forma year over year local
data revenue growth for the second quarter of 1999 and 38% for the six months
ended June 30, 1999. As of June 30, 1999, the Company had approximately 23.6
million domestic local voice grade equivalents and over 36,000 buildings in the
United States connected over its high-capacity circuits. Domestic local route
miles of connected fiber exceed 8,000 and domestic long distance route miles
exceed 47,000.
Internet revenues for the three and six month periods ended June 30, 1999
increased 59% and 60%, respectively, over the prior year pro forma amounts.
Growth was driven by both dial up and dedicated connectivity to the Internet as
more and more business customers migrate their data networks and applications to
Internet-based technologies. The Company has increased the capacity of its
global Internet network to OC-48 in response to the increasing backbone
transport requirements of both its commercial and wholesale accounts. The
Company's dial access network has grown over 70% to 1.2 million modems, compared
with the same period in the prior year. MCI's Internet revenues for 1998 have
been excluded from the above table, due to the divestiture of MCI's Internet
business on September 14, 1998.
International revenues - those revenues originating outside of the United
States, excluding Embratel - for the second quarter of 1999 were $420 million,
an increase of 56% as compared with $270 million for the same pro forma period
of the prior year. For the six month period ended June 30, 1999, international
revenues increased 55% to $777 million
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versus $500 million for the same period of the prior year. In July 1998, the
pan-European network was commissioned for service and, along with the Gemini
undersea cable, now provides MCI WorldCom the capability to connect from
end-to-end over 7,500 buildings in Europe all over its own high-capacity
circuits.
The Pan-European networks and newly constructed national networks in the U.K.,
France, Germany and Belgium drove higher growth of enhanced data sales
internationally. The resulting revenue mix shift is expected to contribute to
improved margins in spite of the competitive pricing environment.
Other revenues, which consist of the operations of SHL, for the second quarter
of 1999 were $120 million, down 75% as compared with the pro forma second
quarter of 1998. For the six month period ended June 30, 1999, other revenues
decreased 46% to $523 million versus $967 million for the same period of the
prior year. In April 1999, the Company completed the sale of SHL to EDS and
received $1.39 billion in cash. Additionally, in February 1999, both companies
agreed, in principal, to significant outsourcing contracts and a marketing
relationship to explore opportunities in electronic business and networking
solutions which are expected to capitalize on the individual strengths of each
company. The definitive agreements for the outsourcing contracts and marketing
relationship are currently being negotiated.
The following discusses the actual results of operations for the three and six
months ended June 30, 1999 as compared to the three and six months ended June
30, 1998.
LINE COSTS. Line costs as a percentage of revenues for the second quarter of
1999 were 44.0% as compared to 47.6% reported for the same period of the prior
year. On a year-to-date basis, line costs as a percentage of revenues decreased
to 44.9% as compared to 47.9% reported for the same period of the prior year.
Overall decreases are attributable to changes in the product mix and synergies
and economies of scale resulting from network efficiencies achieved from the
assimilation of MCI, CompuServe Network Services and ANS into the Company's
operations. Additionally, access charge reductions that occurred in July 1998
and January 1999 reduced total line cost expense by approximately $81 million
for the second quarter of 1999 and $166 million for the six months ended June
30, 1999. While access charge reductions were primarily passed through to
customers, line costs as a percentage of revenues were positively affected by
approximately half a percentage point for both the second quarter of 1999 and
the six month period ended June 30, 1999. The Company anticipates that line
costs as a percentage of revenues may continue to decline as a result of
synergies and economies of scale resulting from network efficiencies achieved
from the continued assimilation of the former MCI and WorldCom networks.
Additionally, local revenues have increased rapidly to date and line costs
related to local are primarily fixed in nature - leading to lower line costs as
a percentage of revenues.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the second quarter of 1999 were $2.18 billion or 24.4% of revenues
as compared to $524 million or 20.3% of revenues for the second quarter of 1998.
On a year-to-date basis, these expenses increased to $4.49 billion or 25.0% of
revenues from $1.0 billion or 20.4% of revenues reported for the six months
ended June 30, 1998. The increase in selling, general and administrative
expenses as a percentage of revenues for the three and six month periods ended
June 30, 1999 reflects the Company's expanding operations, primarily through the
MCI Merger. The Company expects to achieve additional selling, general and
administrative synergies in connection with the MCI Merger through the
assimilation of MCI into the Company's strategy of cost control.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the
second quarter of 1999 increased to $1.06 billion or 11.9% of revenues from $332
million or 12.9% of revenues for the second quarter of 1998. On a year-to-date
basis, this expense increased to $2.14 billion or 11.9% of revenues from $631
million or 12.9% of revenues for the comparable 1998 period. These increases
reflect increased amortization and depreciation associated with the MCI Merger,
CompuServe Merger and AOL Transaction as well as additional depreciation related
to capital expenditures. As a percentage of revenues, these costs decreased due
to the higher revenue base.
IN-PROCESS RESEARCH AND DEVELOPMENT AND OTHER CHARGES. In the first quarter of
1998, the Company recorded a pre-tax
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charge of $38 million for employee severance, alignment charges, loss
contingencies and direct merger costs associated with the BFP Merger and $31
million for the write-down of a permanently impaired asset.
In connection with the CompuServe Merger and the AOL Transaction, the Company
made allocations of the purchase price to acquired IPR&D totaling $429 million
in the first quarter of 1998. The in-process technology acquired in the
CompuServe Merger and the AOL Transaction consisted of three main R&D efforts
underway at CompuServe Network Services and two main R&D efforts underway at
ANS. These projects included next generation network technologies and new
value-added networking applications, such as applications hosting, multimedia
technologies and virtual private data networks.
INTEREST EXPENSE. Interest expense in the second quarter of 1999 was $236
million or 2.6% of revenues, as compared to $108 million or 4.2% of revenues
reported in the second quarter of 1998. For the six months ended June 30, 1999,
interest expense was $496 million or 2.8% of revenues as compared to $210
million or 4.3% of revenues for the first six months of 1998. The increase in
interest expense is attributable to higher debt levels as a result of the MCI
Merger, higher capital expenditures and the 1998 fixed rate debt financings,
offset by lower interest rates as a result of certain tender offers for
outstanding debt in the first quarter of 1998 and slightly lower rates in effect
on the Company's variable rate debt. Interest expense was favorably impacted in
the second quarter of 1999 as a result of the $1.39 billion SHL sale proceeds
being utilized to repay indebtedness under the Company's credit facilities and
commercial paper program. For the three and six months ended June 30, 1999 and
1998, weighted average annual interest rates on the Company's long-term debt
were 6.97% and 7.10%, respectively, while weighted average annual levels of
borrowings were $19.82 billion and $8.27 billion, respectively.
MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous income for the second quarter of
1999 was $48 million or 0.5% of revenues. For the six months ended June 30,
1999, miscellaneous income was $16 million or 0.1% of revenues. Miscellaneous
income includes investment income, equity in income and losses of affiliated
companies, the effects of fluctuations in exchange rates for transactions
denominated in foreign currencies, gains and losses on the sale of assets and
other nonoperating items. Miscellaneous income and expense for the six months
ended June 30, 1999, includes $169 million of foreign currency translation
losses related to the impact of the local currency devaluation in Brazil and its
effect on Embratel's holdings of U.S. dollar and other foreign currency
denominated debt. Also included was a $28 million charge related to the
redemption of certain outstanding senior notes of the Company. These amounts
were somewhat offset by an $81 million gain on the sale of an equity investment,
interest income of $67 million (including Embratel) and preferred dividends on
News Corporation Limited ("News Corp") preferred stock of $30 million.
EXTRAORDINARY ITEMS. In the first quarter of 1998, the Company recorded an
extraordinary item totaling $129 million, net of income tax benefit of $78
million. The charge was recorded in connection with the tender offers and
certain related refinancings of the Company's outstanding debt from the BFP
Merger.
NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS. For the quarter ended June
30, 1999, the Company reported net income of $863 million as compared to net
income of $221 million reported in the second quarter of 1998. Diluted income
per common share was $0.45 compared to $0.21 for the comparable 1998 period.
For the six months ended June 30, 1999, the Company reported net income of $1.57
billion as compared to a net loss of $66 million before extraordinary items
reported for the comparable prior year period. Diluted income per common share
was $0.81 compared to loss per common share before extraordinary items of $0.06
for the comparable 1998 period.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, the Company's total debt was $18.77 billion, a decrease of
$2.07 billion from December 31, 1998. Additionally, at June 30, 1999, the
Company had available liquidity of $7.07 billion under its credit facilities and
commercial paper program (which is described below) and from available cash.
Page 23
24
On August 5, 1999, MCI WorldCom extended its existing $7 billion 364-Day
Revolving Credit and Term Loan Agreement for a successive 364-day term pursuant
to an Amended and Restated 364-Day Revolving Credit and Term Loan Agreement
("Facility C Loans"). The Facility C Loans together with the $3.75 billion
Amended and Restated Facility A Revolving Credit Agreement dated August 6, 1998
("Facility A Loans") provide MCI WorldCom with aggregate credit facilities of
$10.75 billion (the "Credit Facilities"). The Credit Facilities provide
liquidity support for the Company's commercial paper program and will be used
for other general corporate purposes. The Facility A Loans mature on June 30,
2002. The Facility C Loans have a 364-day term, which may be extended for a
second successive 364-day term thereafter to the extent of the committed amounts
from those lenders consenting thereto, with a requirement that lenders holding
at least 51% of the committed amounts consent. Additionally, effective as of the
end of such 364-day term, the Company may elect to convert up to $4 billion of
the principal debt outstanding under the Facility C Loans from revolving loans
to term loans with a maturity date no later than one year after the conversion.
The Credit Facilities bear interest payable in varying periods, depending on the
interest period, not to exceed six months, or with respect to any Eurodollar
Rate borrowing, 12 months if available to all lenders, at rates selected by the
Company under the terms of the Credit Facilities, including a Base Rate or
Eurodollar Rate, plus the applicable margin. The applicable margin for the
Eurodollar Rate borrowing varies from 0.35% to 0.75% as to Facility A Loans and
from 0.225% to 0.45% as to Facility C Loans, in each case based upon the better
of certain debt ratings. The Credit Facilities are unsecured but include a
negative pledge of the assets of the Company and its subsidiaries (subject to
certain exceptions). The Credit Facilities require compliance with a financial
covenant based on the ratio of total debt to total capitalization, calculated on
a consolidated basis. The Credit Facilities require compliance with certain
operating covenants which limit, among other things, the incurrence of
additional indebtedness by the Company and its subsidiaries, sales of assets and
mergers and dissolutions, and which covenants do not restrict distributions to
shareholders, provided the Company is not in default under the Credit
Facilities. At June 30, 1999, the Company was in compliance with these
covenants. The Facility A Loans and the Facility C Loans are subject to annual
commitment fees not to exceed 0.25% and 0.15%, respectively, of any unborrowed
portion of the facilities.
In January 1999, the Company and one of its wholly owned subsidiaries redeemed
all of its outstanding 9.375% Senior Notes due January 15, 2004 (the "Senior
Notes"). Holders of the Senior Notes received 103.52% of the principal amount
plus accrued and unpaid interest to January 15, 1999 of $46.875 per $1,000
aggregate principal amount of such Senior Notes. The total redemption cost of
$743 million was obtained from available liquidity under the Company's credit
facilities and commercial paper program. The Company recorded a $28 million
charge related to the redemption.
In March 1999, $300 million and $200 million of MCI senior notes, with interest
rates of 6.25% and 6.37%, respectively, matured. The funds utilized to repay the
maturing MCI senior notes were obtained from available liquidity under the
Company's credit facilities and commercial paper program.
As noted below, the Brazilian real has experienced significant devaluation
against the U.S. dollar since MCI invested in Embratel in August 1998. The
Company previously designated the note payable in local currency installments,
resulting from the Embratel investment, as a hedge of its investment in
Embratel. As of June 30, 1999, the Company recorded the change in value of the
note as a reduction of the note payable with the offset through foreign currency
translation adjustment in shareholders' investment.
As of June 30, 1999, Embratel had $609 million of long-term debt outstanding, of
which approximately $517 million was denominated in U.S. dollars and $92 million
denominated in other currencies including the French Franc, Deutsche Mark,
Japanese Yen and Brazilian real. The effective cost to Embratel of borrowing in
foreign currencies, such as the U.S. dollar, depends principally on the exchange
rate between the Brazilian real and the currencies in which its borrowings are
denominated. As of June 30, 1999, the Brazilian real devalued over 30% against
the U.S. dollar since December 31, 1998. As a result, the Company recorded a
$169 million foreign currency loss to miscellaneous expense during the six
months ended June 30, 1999. After the elimination of minority interests, this
charge totaled approximately $33 million on a pretax basis. If this devaluation
is sustained, or worsens, Embratel would record a similar charge to its future
earnings equal to the increase in the U.S. dollar liability resulting from such
devaluation. The net effect to the Company's operations would be approximately
19% of such charge after elimination of minority interests.
For the six months ended June 30, 1999, the Company's cash flow from operations
increased $3.89 billion to $4.51 billion from the comparable period for 1998.
The increase in cash flow from operations was primarily attributable to the MCI
Merger,
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internal growth and synergies and economies of scale resulting from network
efficiencies and selling, general and administrative cost savings achieved from
the assimilation of recent acquisitions into the Company's operations.
Cash used in investing activities for the six months ended June 30, 1999 totaled
$4.40 billion and included capital expenditures of $3.67 billion. Primary
capital expenditures include purchases of switching, transmission,
communications and other equipment. The Company anticipates that approximately
$4.2 billion to $4.7 billion will be spent during the remainder of 1999 for
transmission and communications equipment, construction and other capital
expenditures without regard to Embratel and including the redeployment of SHL
sales proceeds. These capital expenditures also reflect the planned $1.4 billion
increase for strategic initiatives. Acquisitions and related costs includes the
costs associated with the MCI Merger, CompuServe Merger, AOL Transaction and
smaller acquisitions completed during 1999.
In July 1999, the Company received $1.4 billion in cash from the sale of the
Company's interest in News Corp preferred stock. The proceeds were used to repay
existing indebtedness under the Company's credit facilities and commercial paper
program. This debt reduction is expected to reduce quarterly interest expense by
approximately $17 million. Additionally, miscellaneous income will be reduced by
$15 million per quarter due to preferred dividends which will no longer be
received.
Increases in interest rates on MCI WorldCom's variable rate debt would have an
adverse effect upon MCI WorldCom's reported net income and cash flow. The
Company believes that it will generate sufficient cash flow to service MCI
WorldCom's debt and capital requirements; however, economic downturns, increased
interest rates and other adverse developments, including factors beyond MCI
WorldCom's control, could impair its ability to service its indebtedness. In
addition, the cash flow required to service MCI WorldCom's debt may reduce its
ability to fund internal growth, additional acquisitions and capital
improvements.
The development of the businesses of MCI WorldCom and the installation and
expansion of its domestic and international networks will continue to require
significant capital expenditures. Failure to have access to sufficient funds for
capital expenditures on acceptable terms or the failure to achieve capital
expenditure synergies may require MCI WorldCom to delay or abandon some of its
plans, which could have a material adverse effect on the success of MCI
WorldCom. The Company has historically utilized a combination of cash flow from
operations and debt to finance capital expenditures and a mixture of cash flow,
debt and stock to finance acquisitions.
Absent significant capital requirements for other acquisitions, the Company
believes that cash flow from operations and available liquidity, including the
Company's credit facilities and commercial paper program and available cash,
will be sufficient to meet the Company's capital needs for the remainder of
1999. However, the Company continues to diversify its funding sources and
believes that funding needs in excess of internally generated cash flow and
availability under the Company's credit facilities and commercial paper program
could be met by accessing favorable debt markets.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. This statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires a company to formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting. This statement is effective for fiscal years beginning after June
15, 1999 and cannot be applied retroactively. SFAS No. 133 must be applied to
(a) derivative instruments and (b) certain derivative instruments embedded in
hybrid contracts that were issued, acquired, or substantively modified after
December 31, 1997 (and, at the Company's election, before January 1, 1998). The
Company believes that the adoption of this standard will not have a material
effect on the Company's consolidated results of operations or financial
position.
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YEAR 2000 READINESS DISCLOSURE
Due to extensive use of computer technology, both MCI and WorldCom began
developing strategic plans in 1996 to address their respective year 2000 issues.
Since the MCI Merger, the Company has consolidated these strategies into a
single program. The Company's year 2000 compliance plan is an ongoing program in
which remediation strategies are being implemented by the Company's business
organizations to address noncompliant computer and network systems and
technology. The Company has a central project management organization that has
overall responsibility for coordinating the implementation of this strategy.
The remediation strategies followed by the Company's business organizations
generally involve a sequence of steps that include (i) identifying computer
hardware, software and network components and equipment potentially impacted by
year 2000 problems; (ii) analyzing the date sensitivity of those elements; (iii)
developing plans for remediation where necessary; (iv) converting non-compliant
code or equipment (or, in some cases, replacing or decommissioning systems); (v)
testing; and (vi) deploying and monitoring remediation solutions. These steps
will vary to meet the particular needs of a business organization and, in some
cases, will overlap. Testing, for example, may be performed at several stages of
the remediation process.
The Company's systems and network equipment that support customer voice and data
traffic have been remediated and tested. Additionally, the application
components that comprise the Company's major revenue products and services are
year 2000 ready. This highlights the fact that the Company has met its June 30,
1999 year 2000 compliance milestone, and the Company is now focusing on the next
phase of this effort. MCI WorldCom has also recently achieved several successful
interoperability tests with both domestic and international carriers.
In the third quarter of 1999, the Company will be primarily focused on continued
integration and interoperability testing, testing of contingency plans,
independent verification and validation of the work already completed and change
management to achieve ongoing compliance. Finally, the Company plans to complete
decommissioning projects, customer specific migrations/upgrades and selected
internal and international systems.
As part of its year 2000 plan, the Company is seeking confirmation from its
domestic and foreign interconnecting carriers (collectively, the
"Interconnecting Carriers") and major communications equipment vendors (the
"Primary Vendors") that they are developing and implementing plans to become
year 2000 compliant. The Company has contacted these carriers and vendors, and
will continue to do so, but has not yet received enough information from certain
domestic and foreign carriers to assess their year 2000 readiness. The Company
has received information from its Primary Vendors regarding their year 2000
readiness. This information indicates the Primary Vendors have documented plans
to become year 2000 compliant. Like all major telecommunications carriers, the
Company's ability to provide service is dependent on its Interconnecting
Carriers and Primary Vendors.
The Company is participating in industry efforts to test interoperability of
networks for industry segments as well as multiple carriers. The ATIS and
Network Reliability and Interoperability Council ("NRIC") testing are examples
of this effort to assess the readiness of Interconnecting Carriers for both data
and voice services.
The Company has completed contingency plans to address potential year 2000
related business interruptions that may occur on January 1, 2000 or thereafter.
Additional detailed documentation was completed before the end of the second
quarter 1999. The Company anticipates that these contingency plans will
primarily address potential year 2000 problems due to unanticipated failures in
systems or equipment, or potential failure of the Company's Interconnecting
Carriers' and Primary Vendors' year 2000 compliance efforts. The Company is
incorporating many of the recommendations of the NRIC into the contingency
planning process. The Company plans to complete testing and implementation of
its contingency plans by December 31, 1999. Failure to meet this target could
materially impact the Company's operations.
To achieve its year 2000 compliance plan, the Company is utilizing both internal
and external resources to identify, correct or reprogram, and test its systems
for year 2000 compliance. The Company expects to incur internal labor as well as
consulting and other expenses related to infrastructure and facilities
enhancements necessary to prepare its
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systems for the year 2000. The Company's use of internal resources to achieve
its year 2000 compliance plan has not had a material adverse effect on its
ability to develop new products and services or to maintain and upgrade, if
necessary, its existing products and services.
The year 2000 costs incurred by MCI and WorldCom over the past six quarters were
approximately $348 million. This level of expenditures is consistent with the
planned expenditures for the related periods. The Company expects to incur
approximately $190 million in costs during the remainder of 1999 to support its
year 2000 compliance initiatives. The costs of the Company's year 2000
remediation efforts are based upon management's best estimates, which require
assumptions about future events, availability of resources and personnel,
third-party remediation actions, and other factors. There are no assurances that
these estimates will be accurate, and actual amounts may differ materially based
on a number of factors, including the availability and cost of resources to
undertake remediation activities and the scope and nature of the work required
to complete remediation.
The Company is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition due to the general uncertainty
inherent in the year 2000 problem, resulting in part from the uncertainty of the
year 2000 readiness of its Interconnecting Carriers and Primary Vendors, and
other suppliers, as well as uncertainties related to the Company's ongoing
remediation program. The Company's year 2000 compliance plan is expected to
reduce significantly the Company's level of uncertainty about the year 2000
problem and, in particular, about the year 2000 compliance and readiness of its
Interconnecting Carriers and Primary Vendors. The Company believes that, with
the implementation of new business systems, its Interconnecting Carriers and
Primary Vendors year 2000 readiness, and completion of the year 2000 compliance
plan as scheduled, it will maintain normal operations.
Embratel's year 2000 program began in 1997 and is managed separately from the
other MCI WorldCom year 2000 programs. The Embratel year 2000 program is
intended to address all its systems, infrastructure, networks and applications.
Critical corporate systems and equipment are expected to complete remediation by
August 31, 1999. The process is now beginning to focus on integrated testing and
completion of the remaining noncritical systems.
Embratel has spent approximately R$13 million of an estimated R$14 million on
the year 2000 program and expects to come within the estimated costs. Embratel
may, however, be affected by year 2000 problems to the extent that other
entities are unsuccessful in achieving compliance. Despite preventive measures
taken by Embratel, no assurances can be given that the year 2000 issue will not
have an effect on the financial condition and results of operations of Embratel.
Embratel is active in developing contingency plans and working with the
International Telecommunications Union on interoperability testing.
Statements concerning year 2000 issues which contain more than historical
information may be considered forward-looking statements (as that term is
defined in the Private Securities Litigation Reform Act of 1995), which are
subject to risks and uncertainties. Actual results may differ materially from
those expressed in the forward-looking statements, and readers are cautioned
that the Company's year 2000 discussion should be read in conjunction with the
Company's statement on forward-looking statements which appears at the beginning
of this Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
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28
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies and the European
Union's common currency ("Euro"). The transition period for the introduction of
the Euro will be between January 1, 1999 to July 1, 2002. All of the final rules
and regulations have not yet been identified by the European Commission with
regard to the Euro. The Company is currently evaluating methods to address the
many issues involved with the introduction of the Euro, including the conversion
of information technology systems, recalculating currency risk, recalibrating
derivatives and other financial instruments, strategies concerning continuity of
contracts, and impacts on the processes for preparing taxation and accounting
records. At this time, the Company has not yet determined the cost related to
addressing this issue and there can be no assurance as to the effect of the Euro
on the consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of interest rate changes, foreign currency
fluctuations and changes in market values of investments.
The Company's policy is to manage interest rates through the use of a
combination of fixed and variable rate debt. Currently, the Company does not use
derivative financial instruments to manage its interest rate risk. The Company
has minimal cash flow exposure due to general interest rate changes for its
fixed rate, long-term debt obligations. The Company does not believe a
hypothetical 10% adverse rate change in the Company's variable rate debt
obligations would be material to the Company's results of operations.
The Company is exposed to foreign exchange rate risk primarily due to Embratel's
holding of approximately $517 million in U.S. dollar denominated debt, and
approximately $92 million of indebtedness indexed in other currencies including
the French Franc, Deutsche Mark, Japanese Yen and Brazilian real. The potential
immediate loss to the Company that would result from a hypothetical 10% change
in foreign currency exchange rates based on this position would be approximately
$12 million (after elimination of minority interests). During January 1999, the
Brazilian government allowed its currency to trade freely against other
currencies, resulting in an immediate devaluation of the Brazilian real. As of
June 30, 1999, the Brazilian real had devalued over 30% against the U.S. dollar
since December 31, 1998. As a result, the Company recorded a $169 million
foreign currency loss to miscellaneous expense during the six months ended June
30, 1999. After the elimination of minority interests, this charge totaled
approximately $33 million on a pretax basis. If this devaluation is sustained,
or worsens, the future net impact to the Company's results of operations could
be significant.
The Company is also subject to risk from changes in foreign exchange rates for
its other international operations which use a foreign currency as their
functional currency and are translated into U.S. dollars. Additionally, the
Company has designated the note payable in local currency installments,
resulting from the Embratel investment, as a hedge of its investment in
Embratel. As of June 30, 1999, the Company recorded the change in value of the
note as a reduction to the note payable with the offset through foreign currency
translation adjustment in shareholders' investment.
The Company believes its market risk exposure with regard to its marketable
equity securities is limited to changes in quoted market prices for such
securities. Based upon the composition of the Company's marketable equity
securities at June 30, 1999, the Company does not believe a hypothetical 10%
adverse change in quoted market prices would be material to net income.
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29
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,
1998, except as may be reflected in the discussion under Note G of the
Notes to Consolidated Financial Statements in Part I, Item 1, above,
which is hereby incorporated by reference herein.
Item 2. Changes in Securities and Use of Proceeds
On June 30, 1999, MCI WorldCom completed the acquisition of E. L.
Acquisition, Inc., pursuant to an Agreement and Plan of Merger dated as
of May 20, 1999 by and among MCI WorldCom, Purple Acquisition
Subsidiary, Inc., E. L. Acquisition, Inc., and Prime One, L. P. In
connection with the acquisition, MCI WorldCom made an approximate $33
million cash payment and issued a total of 2,656,151 shares of its
common stock to a limited number of sophisticated investors in reliance
on Section 4(2) and Regulation D under the Securities Act of 1933, as
amended.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Securities Holders
On May 20, 1999, the Company held the 1999 Annual Meeting of
Shareholders for the purposes of:
1. electing a Board of seventeen (17) directors;
2. considering and acting upon a proposal to amend the Company's
Second Amended and Restated Articles of Incorporation, as amended,
to increase the number of authorized shares of common stock, par
value $.01 per share, from 2,500,000,000 to 5,000,000,000; and
3. considering and acting upon a proposal to approve the Company's
1999 Stock Option Plan;
The tabulation of the voting, which includes the Company's Series B
Preferred Stock, is as follows:
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30
Against or Abstentions or
Election of Directors: For Withheld Broker Non-Votes
------------------------------------- ------------------ -------------------- ----------------------
Clifford L. Alexander, Jr. 1,370,251,846 170,137,069 0
James C. Allen 1,257,139,138 13,249,777 0
Judith Areen 1,527,117,778 13,271,137 0
Carl J. Aycock 1,527,211,011 13,177,904 0
Max E. Bobbitt 1,531,286,962 9,101,953 0
Stephen M. Case (1) 1,287,252,512 253,136,403 0
Bernard J. Ebbers 1,526,332,237 14,056,678 0
Francesco Galesi 1,530,986,406 9,402,509 0
Stiles A. Kellett, Jr. 1,531,219,675 9,169,240 0
Gordon S. Macklin 1,526,648,176 13,740,739 0
John A. Porter 1,526,969,001 13,419,914 0
Timothy F. Price 1,526,902,817 13,486,098 0
Bert C. Roberts, Jr. 1,527,017,779 13,371,136 0
John W. Sidgmore 1,527,190,016 13,198,899 0
Scott D. Sullivan 1,527,176,247 13,212,668 0
Lawrence C. Tucker 1,531,245,116 9,143,799 0
Juan Villalonga 1,526,772,718 13,616,197 0
Increase the number of authorized
shares of common stock from
2,500,000,000 to 5,000,000,000 1,448,416,755 87,221,773 4,750,387
1999 Stock Option Plan 945,545,541 587,261,366 7,582,008
(1) Subsequent to May 20, 1999, Mr. Case resigned from the Company's Board of
Directors.
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.
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31
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.
MCI WORLDCOM, Inc.
By: /s/ Scott D. Sullivan
-------------------------------------
Scott D. Sullivan
Chief Financial Officer
Dated: August 16, 1999.
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
4.1 Second Amended and Restated Articles of Incorporation of the
Company (including preferred stock designations), as amended
as of May 20, 1999
4.2 Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Current Report on Form 8-K dated
September 14, 1998) (filed September 29, 1998)) (File No.
0-11258)
4.3 Rights Agreement dated as of August 25, 1996 between MCI
WorldCom and The Bank of New York, which includes the form of
Certificate of Designations, setting forth the terms of the
Series 3 Junior Participating Preferred Stock, par value $.01
per share, as Exhibit A, the form of Rights Certificate as
Exhibit B and the Summary of Preferred Stock Purchase Rights
as Exhibit C (incorporated herein by reference to Exhibit 4 to
the Company's Current Report on Form 8-K dated August 26, 1996
(as amended) (filed August 26, 1996 (File No. 0-011258))
4.4 Amendment No. 1 to Rights Agreement dated as of May 22, 1997
by and between MCI WorldCom and The Bank of New York, as
Rights Agent (incorporated herein by reference to Exhibit 4.2
to the Company's Current Report on Form 8-K dated May 22, 1997
(filed June 6, 1997) File No. 0-11258))
10.1 Amended and Restated 364-Day Revolving Credit and Term Loan
Agreement among the Company and Bank of America, N.A.,
Administrative Agent; Bank of America Securities, LLC, Sole
Lead Arranger and Book Manager; Barclays Bank PLC, The Chase
Manhattan Bank, Citibank, N.A., Morgan Guaranty Trust Company
of New York, and Royal Bank of Canada, Co-Syndication Agents;
and the lenders named therein dated as of August 5, 1999.*
10.2 MCI WORLDCOM, Inc. 1999 Stock Option Plan (incorporated herein
by reference to Exhibit A to the Company's Proxy Statement
dated April 23, 1999 (File No. 0-11258)) (compensatory plan)
**
27.1 Financial Data Schedule
* The registrant hereby agrees to furnish supplementally a copy
of any omitted schedules to this Agreement to the Commission
upon request.
** No other long-term debt securities entered into during the
period covered by this report, are filed since the total
amount of securities authorized under any such instrument does
not exceed 10% of the total assets of the Company and its
subsidiaries on a consolidated basis. The Company agrees to
furnish a copy of such instruments to the Commission upon
request.
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