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, 2001
-------------
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-11258
----------
WORLDCOM, INC.
(Exact name of registrant as specified in its charter)
----------
Georgia 58-1521612
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 |_|
Common shares outstanding, net of treasury shares, at July 31, 2001:
WorldCom group common stock 2,957,029,833
MCI group common stock 118,270,279
- --------------------------------------------------------------------------------
<Page>
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
December 31, 2000 and June 30, 2001........................ 3
Consolidated Statements of Operations for the
three and six months ended June 30, 2000
and June 30, 2001.......................................... 4
Consolidated Statements of Cash Flows for the
six months ended June 30, 2000 and June 30, 2001........... 5
Notes to Consolidated Financial Statements.................... 6
Combined Financial Statements of WorldCom group
(an integrated business of WorldCom, Inc.).................25
Combined Financial Statements of MCI group
(an integrated business of WorldCom, Inc.).................33
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..............38
Item 3. Quantitative and Qualitative Disclosures about Market Risk....58
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................58
Item 2. Changes in Securities and Use of Proceeds.....................58
Item 3. Defaults Upon Senior Securities...............................59
Item 4. Submission of Matters to a Vote of Securities Holders.........59
Item 5. Other Information.............................................60
Item 6. Exhibits and Reports on Form 8-K..............................60
Signature ..............................................................61
Exhibit Index ..............................................................62
2
<Page>
WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited, In Millions, Except Share Data)
<Table>
<Caption>
December 31, June 30,
2000 2001
------------ --------
ASSETS
Current assets:
Cash and cash equivalents $ 761 $ 6,624
Accounts receivable, net of allowance for bad debts of $1,532 in 2000 and $1,299 in 2001 6,815 5,556
Deferred tax asset 172 224
Other current assets 2,007 2,005
--------- ---------
Total current assets 9,755 14,409
--------- ---------
Property and equipment:
Transmission equipment 20,288 20,191
Communications equipment 8,100 7,321
Furniture, fixtures and other 9,342 9,222
Construction in progress 6,897 7,489
--------- ---------
44,627 44,223
Accumulated depreciation (7,204) (8,241)
--------- ---------
37,423 35,982
--------- ---------
Goodwill and other intangible assets 46,594 46,113
Other assets 5,131 5,440
--------- ---------
$ 98,903 $ 101,944
========= =========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
Short-term debt and current maturities of long-term debt $ 7,200 $ 3,264
Accounts payable and accrued line costs 6,022 4,415
Other current liabilities 4,451 3,782
--------- ---------
Total current liabilities 17,673 11,461
--------- ---------
Long-term liabilities, less current portion:
Long-term debt 17,696 28,820
Deferred tax liability 3,611 3,938
Other liabilities 1,124 677
--------- ---------
Total long-term liabilities 22,431 33,435
--------- ---------
Commitments and contingencies
Minority interests 2,592 --
Company obligated mandatorily redeemable preferred securities 798 798
Shareholders' investment:
Series B preferred stock, par value $.01 per share; authorized, issued and
outstanding: 10,693,437 shares in 2000 and 9,682,557 shares in 2001 (liquidation
preference of $1.00 per share plus unpaid dividends) -- --
Preferred stock, par value $.01 per share; authorized: 31,155,008 shares
in 2000 and 2001; none issued -- --
Common stock:
WorldCom, Inc. common stock, par value $.01 per share; authorized: 5,000,000,000 shares in
2000 and none in 2001; issued and outstanding: 2,887,960,378 shares in 2000 and none in 2001 29 --
WorldCom group common stock, par value $.01 per share; authorized: none in 2000 and 4,850,000,000
shares in 2001; issued and outstanding: none in 2000 and 2,896,497,552 shares in 2001 -- 29
MCI group common stock, par value $.01 per share; authorized: none in 2000
and 150,000,000 shares in 2001; issued and outstanding: none in 2000 and 115,865,980 in 2001 -- 1
Additional paid-in capital 52,877 53,002
Retained earnings 3,160 3,835
Unrealized holding gain on marketable equity securities 345 99
Cumulative foreign currency translation adjustment (817) (531)
Treasury stock, at cost, 6,765,316 shares of WorldCom, Inc. in 2000,
6,765,316 shares of WorldCom group stock
and 270,613 shares of MCI group stock in 2001 (185) (185)
--------- ---------
Total shareholders' investment 55,409 56,250
--------- ---------
$ 98,903 $ 101,944
========= =========
</Table>
The accompanying notes are an integral part of these statements.
3
<Page>
WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, In Millions, Except Per Share Data)
<Table>
<Caption>
For the Three Months Ended For the Six Months Ended
June 30, June 30,
-------------------------- ------------------------
2000 2001 2000 2001
---------- --------- -------- ---------
Revenues $ 9,807 $ 8,910 $ 19,419 $ 17,735
------- ------- -------- --------
Operating expenses:
Line costs 3,776 3,730 7,509 7,426
Selling, general and administrative 2,458 3,389 4,766 5,986
Depreciation and amortization 1,186 1,407 2,333 2,742
------- ------- -------- --------
Total 7,420 8,526 14,608 16,154
------- ------- -------- --------
Operating income 2,387 384 4,811 1,581
Other income (expense):
Interest expense (236) (348) (454) (653)
Miscellaneous 109 123 220 223
------- ------- -------- --------
Income before income taxes, minority interests and
cumulative effect of accounting change 2,260 159 4,577 1,151
Provision for income taxes 919 62 1,866 444
------- ------- -------- --------
Income before minority interests and cumulative effect
of accounting change 1,341 97 2,711 707
Minority interests (68) -- (150) --
------- ------- -------- --------
Income before cumulative effect of accounting change 1,273 97 2,561 707
Cumulative effect of accounting change (net of income tax of $50 in 2000) -- -- (85) --
------- ------- -------- --------
Net income 1,273 97 2,476 707
Distributions on mandatorily redeemable preferred securities 16 16 32 32
Preferred dividend requirement -- -- 1 --
------- ------- -------- --------
Net income applicable to common shareholders $ 1,257 $ 81 $ 2,443 $ 675
======= ======= ======== ========
Net income attributed to WorldCom group before
cumulative effect of accounting change $ 716 $ 110 $ 1,440 $ 642
======= ======= ======== ========
Cumulative effect of accounting change $ -- $ -- $ (75) $ --
======= ======= ======== ========
Net income attributed to WorldCom group $ 716 $ 110 $ 1,365 $ 642
======= ======= ======== ========
Net income (loss) attributed to MCI group before
cumulative effect of accounting change $ 541 $ (29) $ 1,088 $ 33
======= ======= ======== ========
Cumulative effect of accounting change $ -- $ -- $ (10) $ --
======= ======= ======== ========
Net income (loss) attributed to MCI group $ 541 $ (29) $ 1,078 $ 33
======= ======= ======== ========
<Caption>
Earnings per common share: PRO FORMA
WorldCom group: ---------------------------------------------------
Net income attributed to WorldCom group before
cumulative effect of accounting change:
Basic $ 0.25 $ 0.04 $ 0.50 $ 0.22
======= ======= ======== ========
Diluted $ 0.25 $ 0.04 $ 0.49 $ 0.22
======= ======= ======== ========
Cumulative effect of accounting change $ -- $ -- $ (0.03) $ --
======= ======= ======== ========
Net income attributed to WorldCom group:
Basic $ 0.25 $ 0.04 $ 0.48 $ 0.22
======= ======= ======== ========
Diluted $ 0.25 $ 0.04 $ 0.47 $ 0.22
======= ======= ======== ========
MCI group:
Net income (loss) attributed to MCI group before cumulative effect
of accounting change:
Basic $ 4.75 $ (0.25) $ 9.54 $ 0.28
======= ======= ======== ========
Diluted $ 4.75 $ (0.25) $ 9.54 $ 0.28
======= ======= ======== ========
Cumulative effect of accounting change $ -- $ -- $ (0.09) $ --
======= ======= ======== ========
Net income (loss) attributed to MCI group:
Basic $ 4.75 $ (0.25) $ 9.46 $ 0.28
======= ======= ======== ========
Diluted $ 4.75 $ (0.25) $ 9.46 $ 0.28
======= ======= ======== ========
</Table>
The accompanying notes are an integral part of these statements.
4
<Page>
WORLDCOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, In Millions)
<Table>
<Caption>
For the Six Months Ended
June 30,
------------------------
2000 2001
---------- --------
Cash flows from operating activities:
Net income $ 2,476 $ 707
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change 85 --
Minority interests 150 --
Depreciation and amortization 2,333 2,742
Provision for deferred income taxes 1,144 191
Change in assets and liabilities, net of effect of
business combinations:
Accounts receivable, net (1,234) (47)
Other current assets (466) (38)
Accounts payable and other current liabilities (373) (592)
All other operating activities (194) 613
------- -------
Net cash provided by operating activities 3,921 3,576
------- -------
Cash flows from investing activities:
Capital expenditures (5,197) (4,268)
Acquisitions and related costs (14) (142)
Increase in intangible assets (681) (379)
Decrease in other liabilities (688) (267)
All other investing activities (455) (204)
------- -------
Net cash used in investing activities (7,035) (5,260)
------- -------
Cash flows from financing activities:
Principal borrowings on debt, net 2,765 7,953
Common stock issuance 431 103
Distributions on mandatorily redeemable preferred securities
and dividends paid on preferred stock (33) (32)
Redemption of Series C preferred stock (190) --
All other financing activities (73) (272)
------- -------
Net cash provided by financing activities 2,900 7,752
Effect of exchange rate changes on cash 2 11
------- -------
Net increase (decrease) in cash and cash equivalents (212) 6,079
Cash and cash equivalents at beginning of period 876 761
Deconsolidation of Embratel -- (216)
------- -------
Cash and cash equivalents at end of period $ 664 $ 6,624
======= =======
</Table>
The accompanying notes are an integral part of these statements.
5
<Page>
WORLDCOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(A) GENERAL
The financial statements included herein, are unaudited and have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial reporting and SEC regulations. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of our 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 our
Annual Report on Form 10-K/A for the year ended December 31, 2000. The results
for the three- and six- month periods ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001.
(B) RECAPITALIZATION
On June 7, 2001, our shareholders approved a recapitalization involving the
creation of two separately traded tracking stocks:
o WorldCom group stock, which is intended to reflect the performance
of our data, Internet, international and commercial voice businesses
and is quoted on The Nasdaq National Market under the trading symbol
"WCOM", and
o MCI group stock, which is intended to reflect the performance of our
consumer, small business, wholesale long distance voice and data,
wireless messaging and dial-up Internet access businesses and is
quoted on The Nasdaq National Market under the trading symbol
"MCIT".
In connection with the recapitalization, we amended our articles of
incorporation to replace our existing common stock with two new series of common
stock that are intended to reflect, or track, the performance of the businesses
attributed to the WorldCom group and the MCI group. Effective with the
recapitalization on June 7, 2001, each share of our existing common stock was
changed into one share of WorldCom group stock and 1/25 of a share of MCI group
stock.
A tracking stock is a separate class of a company's common stock intended to
provide a return to investors based upon the financial performance of a distinct
business unit of the company, sometimes referred to as the targeted business.
These targeted businesses are collections of businesses that we have grouped
together in order for us to issue WorldCom group stock and MCI group stock. The
ownership of the targeted business does not change, and while each of the
classes of stock trade separately, all shareholders are common shareholders of a
single company, WorldCom, and are subject to all risks of an investment in
WorldCom as a whole.
We intend to initially pay a quarterly dividend of $0.60 per share on the MCI
group stock. The MCI group was initially allocated notional debt of $6 billion
and our remaining debt was allocated on a notional basis to the WorldCom group.
We intend, for so long as the WorldCom group stock and the MCI group stock
remains outstanding, to include in filings by WorldCom under the Securities
Exchange Act of 1934, as amended, the combined financial statements of each of
the WorldCom group and the MCI group. These combined financial statements will
be prepared in accordance with accounting principles generally accepted in the
United States, and in the case of annual financial statements, will be audited.
These combined financial statements are not legally required under current law
or SEC regulations.
Voting rights of the holders of the WorldCom group and the MCI group stock are
prorated based on the relative market values of WorldCom group stock and MCI
group stock. We will conduct shareholder meetings that encompass all holders of
voting stock. The WorldCom group and the MCI group shareholders will vote
together as a single class on all matters brought to a vote of shareholders,
including the election of our directors.
6
<Page>
Our board of directors may at any time convert each outstanding share of MCI
group stock into shares of WorldCom group stock at 110% of the relative trading
value of MCI group stock for the 20 days prior to the announcement of the
conversion. No premium will be paid on a conversion that occurs three years
after the issuance of MCI group stock.
If all or substantially all of the WorldCom group or MCI group assets are sold,
either: (i) the relevant shareholders will receive a distribution equal to the
fair value of the net proceeds of the sale, either by special dividend or by
redemption of shares; or (ii) each outstanding share of MCI group stock will be
converted into shares of WorldCom group stock at 110% or 100% of the relative
trading value of MCI group stock for a 10 trading day period following the sale.
(C) EMBRATEL DECONSOLIDATION
During the second quarter of 2001, we reached a long-term strategic decision to
restructure our investment in Embratel Participacoes S.A., or Embratel. The
restructuring included the resignation of certain Embratel Board of Directors
seats, the irrevocable obligation to vote a portion of our common shares in a
specified manner and the transfer of certain economic rights associated with
such shares to an unrelated third party. Based on these actions, the accounting
principles generally accepted in the United States prohibit the continued
consolidation of Embratel's results. Accordingly, we have deconsolidated
Embratel's results effective January 1, 2001.
(D) EARNINGS PER SHARE
Our consolidated financial statements present basic and diluted earnings per
share for WorldCom group stock and MCI group stock using the two-class method.
The two-class method is an earnings formula that determines the attributed
earnings per share for WorldCom group stock and MCI group stock according to
participation rights in undistributed earnings. The combined financial
statements of the WorldCom group and the MCI group do not separately present
earnings per share because WorldCom group stock and MCI group are series of our
common stock, and the WorldCom group and the MCI group are not legal entities
with a capital structure.
For purposes of our consolidated financial statements, basic earnings per share
attributed to WorldCom group stock and MCI group stock is computed by dividing
the respective attributed net income (loss) for the period by the respective
number of weighted-average shares of WorldCom group stock and MCI group stock
then outstanding. Diluted earnings per share attributed to WorldCom group stock
and MCI group stock is computed by dividing the respective attributed net income
(loss) for the period by the respective weighted-average number of shares of
WorldCom group stock and MCI group stock outstanding, including the respective
dilutive effect of WorldCom group stock and MCI group stock equivalents.
The following is a reconciliation of the numerators and the denominators of the
basic and diluted earnings per share computations for the WorldCom group and the
MCI group for the three and six months ended June 30, 2000 and 2001 (in
millions, except share and per share data):
7
<Page>
<Table>
<Caption>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2000 2001 2000 2001
------ ------- ------ ------
PRO FORMA
---------------------------------------------
WORLDCOM GROUP STOCK
BASIC
Income attributed to WorldCom group before cumulative
effect of accounting change $ 732 $ 126 $1,473 $ 674
Distributions on mandatorily redeemable preferred securities 16 16 32 32
Preferred dividend requirement -- -- 1 --
------ ------- ------ ------
Net income attributed to WorldCom group
before cumulative effect of accounting change $ 716 $ 110 $1,440 $ 642
====== ======= ====== ======
Weighted-average shares of WorldCom group stock outstanding 2,865 2,888 2,859 2,887
====== ======= ====== ======
Basic earnings per share attributed to WorldCom group stock
before cumulative effect of accounting change $ 0.25 $ 0.04 $ 0.50 $ 0.22
====== ======= ====== ======
DILUTED
Net income attributed to WorldCom group
before cumulative effect of accounting change $ 716 $ 110 $1,440 $ 642
====== ======= ====== ======
Weighted-average shares of WorldCom group stock outstanding 2,865 2,888 2,859 2,887
WorldCom group common stock equivalents 55 13 60 12
WorldCom group common stock issuable upon conversion of
preferred stock 2 2 2 2
------ ------- ------ ------
Diluted shares of WorldCom group stock outstanding 2,922 2,903 2,921 2,901
====== ======= ====== ======
Diluted earnings per share attributed to WorldCom group stock
before cumulative effect of accounting change $ 0.25 $ 0.04 $ 0.49 $ 0.22
====== ======= ====== ======
MCI GROUP STOCK
BASIC AND DILUTED
Net income (loss) attributed to MCI group before cumulative
effect of accounting change $ 541 $ (29) $1,088 $ 33
====== ======= ====== ======
Basic and diluted weighted average MCI group shares outstanding 114 116 114 116
====== ======= ====== ======
Basic and diluted earnings (loss) per share attributed to MCI group
stock before cumulative effect of accounting change $ 4.75 $ (0.25) $ 9.54 $ 0.28
====== ======= ====== ======
</Table>
As discussed in Note B, the recapitalization of WorldCom was effective June 7,
2001, and each share of WorldCom stock was changed into one share of WorldCom
group stock and 1/25 of a share of MCI group stock. The weighted-average shares
outstanding and attributed earnings per share information above is pro forma for
all periods and assumes the recapitalization occurred at the beginning of 2000
and the WorldCom group and MCI group stock existed for all periods presented.
(E) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid during the six months ended June 30, 2000 and 2001, amounted to
$388 million and $473 million, respectively. Income taxes paid during the six
months ended June 30, 2000 and 2001, totaled $43 million and $107 million,
respectively. In conjunction with business combinations during the six months
ended June 30, 2000 and 2001, assets acquired and liabilities assumed were as
follows (in millions):
<Table>
<Caption>
2000 2001
---- ----
Fair value of assets acquired $ -- $ 13
Excess of cost over net tangible assets acquired 29 142
Liabilities assumed (15) (13)
---- -----
Net cash paid $ 14 $ 142
==== =====
</Table>
(F) COMPREHENSIVE INCOME
The following table reflects the calculation of our comprehensive income for the
three and six months ended June 30, 2000 and 2001 (in millions):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2000 2001 2000 2001
------- ------ ------- ------
Net income applicable to common shareholders $ 1,257 $ 81 $ 2,443 $ 675
------- ------ ------- ------
Other comprehensive income (loss):
Foreign currency translation losses (238) (9) (202) (48)
Derivative financial instrument gains (losses):
Cumulative effect of adoption of SFAS 133 as of January 1, 2001 -- -- -- 28
Reclassification of derivative financial instruments to current earnings -- (26) -- (65)
Change in fair value of derivative financial instruments -- 15 -- 47
Unrealized holding gains (losses):
</Table>
8
<Page>
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2000 2001 2000 2001
------- ------ ------- ------
Unrealized holding gains (losses) during the period (120) 22 381 (387)
Reclassification adjustment for investment writeoffs
included in net income -- 181 -- 181
Reclassification adjustment for gains included in net income (132) (65) (215) (206)
------- ------ ------- ------
Other comprehensive income (loss) before tax (490) 118 (36) (450)
Income tax benefit (expense) 94 (51) (63) 156
------- ------ ------- ------
Other comprehensive income (loss) (396) 67 (99) (294)
------- ------ ------- ------
Comprehensive income applicable to common shareholders $ 861 $ 148 $ 2,344 $ 381
======= ====== ======= ======
</Table>
(G) SEGMENT INFORMATION
Based on our organizational structure, we operate in six reportable segments:
Commercial voice, data and Internet; International operations; Consumer;
Wholesale; Alternative channels and small business and Dial-up Internet. Our
reportable segments represent business units that primarily offer similar
products and services; however, the business units are managed separately due to
the type and class of customer as well as the geographic dispersion of their
operations. The Commercial voice, data and Internet segment includes voice, data
and other types of domestic communications services for commercial customers,
and Internet services including dedicated access and web and application hosting
services. International operations provide voice, data, Internet and other
similar types of communications services to customers primarily in Europe and
the Asia Pacific region. Consumer includes domestic voice communications
services for consumer customers. Wholesale includes long distance voice and data
domestic communications services for wholesale customers. Alternative channels
and small business includes domestic long distance voice and data, agents,
prepaid calling cards and paging services provided to alternative wholesale and
small business customers. Dial-up Internet includes dial-up Internet access
services.
Our chief operating decision-maker utilizes revenue information in assessing
performance and making overall operating decisions and resource allocations.
Communications services are generally provided utilizing our fiber optic
networks, which do not make a distinction between the types of services
provided. Profit and loss information for WorldCom, the WorldCom group and the
MCI group is reported only on a consolidated basis to the chief operating
decision-maker and our board of directors.
The accounting policies of the segments are the same policies as those used by
us in preparing our consolidated financial statements. Information about our
segments for the three and six months ended June 30, 2000 and 2001, is as
follows (in millions):
<Table>
<Caption>
REVENUES FROM EXTERNAL CUSTOMERS
---------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2000 2001 2000 2001
------- ------- -------- --------
Voice, data and Internet $ 4,199 $ 4,624 $ 8,282 $ 9,117
International operations 585 738 1,105 1,448
Consumer 1,943 1,836 3,901 3,643
Wholesale 876 698 1,808 1,393
Alternative channels and small business 962 610 1,838 1,305
Dial-up Internet 405 404 822 829
------- ------- -------- --------
Total before Embratel 8,970 8,910 17,756 17,735
Embratel 876 -- 1,737 --
Elimination of intersegment revenues (39) -- (74) --
------- ------- -------- --------
Total $ 9,807 $ 8,910 $ 19,419 $ 17,735
======= ======= ======== ========
<Caption>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
---------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2000 2001 2000 2001
------- ------- -------- --------
Voice, data and Internet $ 789 $ 961 $ 1,533 $ 1,960
International operations 276 336 529 686
Consumer 686 745 1,399 1,493
Wholesale 128 157 263 316
Alternative channels and small business 245 264 493 557
</Table>
9
<Page>
<Table>
<Caption>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
---------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2000 2001 2000 2001
------- ------- -------- --------
Dial-up Internet 102 130 199 268
Corporate 93 888 93 888
Elimination of intergroup expenses (62) (92) (130) (182)
------- ------- -------- --------
Total before Embratel 2,257 3,389 4,379 5,986
Embratel 210 -- 405 --
Elimination of intersegment expenses (9) -- (18) --
------- ------- -------- --------
Total $ 2,458 $ 3,389 $ 4,766 $ 5,986
======= ======= ======== ========
</Table>
As discussed in Note C, we deconsolidated our investment in Embratel as of
January 1, 2001. Embratel, which provides communications services in Brazil, was
designated as a separate reportable segment for periods prior to January 1,
2001. Accordingly, we have included Embratel in our segment information
presented for 2000.
See Note L for a reconciliation of the WorldCom group's and the MCI group's
operating results to our consolidated results of operations.
(H) CONTINGENCIES
We are involved in legal and regulatory proceedings that are incidental to our
business and have included loss contingencies in other current liabilities and
other liabilities for these matters. In some instances, rulings by federal and
state regulatory authorities may result in increased operating costs to us. The
results of these various legal and regulatory matters are uncertain and could
have a material adverse effect on our consolidated results of operations or
financial position.
GENERAL
WorldCom is subject to varying degrees of federal, state, local and
international regulation. In the United States, our subsidiaries are most
heavily regulated by the states, especially for the provision of local exchange
services. We must be certified separately in each state to offer local exchange
and intrastate long distance services. No state, however, subjects us to price
cap or rate of return regulation, nor are we currently required to obtain FCC
authorization for installation or operation of our network facilities used for
domestic services, other than licenses for specific multichannel multipoint
distribution services, wireless communications service and terrestrial microwave
and satellite earth station facilities that utilize radio frequency spectrum.
FCC approval is required, however, for the installation and operation of our
international facilities and services. We are subject to varying degrees of
regulation in the foreign jurisdictions in which we conduct 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 us.
DOMESTIC
In August 1996, the FCC established nationwide rules pursuant to the Telecom Act
designed to encourage new entrants to compete in local service markets through
interconnection with the incumbent local telephone companies, resale of
incumbent local telephone companies' retail services, and use of individual and
combinations of unbundled network elements, owned by the incumbent local
telephone companies. Unbundled network elements are defined in the Telecom Act
as any "facility or equipment used in the provision of a telecommunication
service," as well as "features, function, and capabilities that are provided by
means of such facility or equipment." Implementation of these rules has been
delayed by various appeals by incumbent local telephone companies. In January
1999, the Supreme Court of the United States confirmed the FCC's authority to
issue nationwide local competition rules, including a pricing methodology for
unbundled network elements. On remand, the FCC clarified the requirement that
incumbent local telephone companies make specific unbundled network elements
available to new entrants. The
10
<Page>
incumbent local telephone companies have sought reconsideration of the FCC's
order and have petitioned for review of the order in the United States Court of
Appeals for the D.C. Circuit. That case is pending.
In its January 1999 decision, the Supreme Court remanded to the United States
Court of Appeals for the Eighth Circuit various substantive questions concerning
the FCC's rules for pricing unbundled network elements. In July 2000, the Eighth
Circuit upheld the use of a forward-looking methodology but struck down the
portion of the rule that calculates costs based on efficient technology and
design choices. At the request of various parties, including WorldCom, the
Supreme Court will review the Eighth Circuit's decision. A ruling from the
Supreme Court is expected in early 2002.
The Telecom Act requires Bell Operating Companies to petition the FCC for
permission to offer long distance services for each state within their region.
Section 271 of the Act provides that for these applications to be granted, the
FCC must find, among other things, that the Bell Operating Companies have
demonstrated that they have met a 14-point competitive checklist to open their
local network to competition and that granting the petition is in the public
interest. To date, the FCC has rejected five traditional phone company
applications and it has granted six: Verizon's for New York, Massachusetts, and
Connecticut and SBC's for Texas, Kansas and Oklahoma. WorldCom, and other new
entrants to the local market, have appealed to the D.C. Circuit the approvals
for Kansas, Oklahoma and Massachusetts alleging that the FCC erred in concluding
that the incumbent local telephone companies had satisfied the section 271
checklist prior to granting the application. Briefing of the Kansas and Oklahoma
case concluded in July 2001 and argument is scheduled for September 17, 2001; a
briefing schedule has not been established for the Massachusetts appeal. Verizon
has filed its application for Pennsylvania and other applications may be filed
at any time. WorldCom has challenged, and will continue to challenge, any
application that does not satisfy the requirements of section 271 or the FCC's
local competition rules. To date, these challenges have focused on the pricing
of unbundled network elements and on the adequacy of the Bell Operating
Companies' operations support systems. In addition, legislation has been
introduced in Congress that would have the effect of allowing Bell Operating
Companies to offer in-region long distance data services without satisfying
section 271 of the Act and/or of making it more difficult for competitors to
resell incumbent local telephone company high-speed Internet access services or
to lease the unbundled network elements used to provide these services. To date,
WorldCom and others have successfully opposed these legislative initiatives.
In December 1999, the FCC concluded that in providing high speed digital
subscriber line services, the incumbent local telephone companies should be
required to share primary telephone lines with competitive local exchange
carriers, and identified the high frequency portion of the loop as a network
element. In February 2000, Qwest and the United States Telephone Association
petitioned for review of the order in the United States Court of Appeals for the
D.C. Circuit; the court held the case in abeyance pending reconsideration at the
FCC. On January 19, 2001, the FCC issued its order on reconsideration which
again is favorable to WorldCom and other firms seeking to gain access to the
high bandwidth portion of the local loop. More specifically, the FCC clarified
that the requirement to share lines applies to the entire loop, even where the
traditional phone company has deployed fiber in the loop. Under the order, the
incumbent local telephone companies must permit competing carriers to
self-provision or partner with a data carrier in order to furnish voice and data
service on the same line. The incumbent local telephone companies have appealed
this ruling and we have intervened to support the FCC's order.
In February 1999, the FCC issued a Declaratory Ruling and Notice of Proposed
Rulemaking regarding the regulatory treatment of calls to Internet service
providers. Prior to the FCC's order, over thirty state public utility
commissions issued orders finding that carriers, including WorldCom, are
entitled to collect reciprocal compensation for completing calls to Internet
service providers under the terms of their interconnection agreements with
incumbent local telephone companies. Many of these public utility commission
decisions were appealed by the incumbent local telephone companies and, since
the FCC's order, many incumbent local telephone companies have filed new cases
at the public utility commissions or in court. WorldCom petitioned for review of
the FCC's order in the United States Court of Appeals for the D.C. Circuit,
which vacated the order and remanded the case to the FCC for further
proceedings. In April 2001, the FCC issued an Order on Remand and Report and
Order asserting jurisdiction over calls to Internet service providers and
establishing a three-year transitional scheme of decreasing reciprocal
compensation rates. WorldCom has filed a petition for review of the FCC's order
with the D.C. Circuit.
On May 3, 2001, the United States Court of Appeals for the Fifth Circuit, ruling
on a petition for review of a November 1999 FCC decision, held that the FCC
cannot allow any incumbent local telephone company to recover
11
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universal service costs implicitly in access charges. Pending reconsideration
petitions at the FCC seek retroactive treatment for implementation of this
decision. On July 31, 2001, the United States Court of Appeals for the Tenth
Circuit remanded to the FCC an order that provided high cost support for rural
high cost areas. Additional petitions for rulemaking are pending at the FCC
seeking additional support for rural high cost areas. Depending on the
resolution of these rural issues, the federal universal service fund could grow
substantially, by as much as $1 billion.
In 1999 the FCC issued an order that would require non-dominant
telecommunications carriers to eliminate domestic interstate service tariffs,
except in limited circumstances. In April 2000, the United States Court of
Appeals for the D.C. Circuit affirmed the FCC's order and the FCC subsequently
required compliance by August 1, 2001. WorldCom has complied with this order. On
March 20, 2001, the FCC released an order governing the detariffing of
international interexchange services. It established a nine-month transition
period during which carriers may file new or revised tariffs only for mass
market international exchange services. WorldCom has accordingly withdrawn its
affected international tariffs for its business markets services and will comply
with the FCC's directives regarding mass markets customers at or before the end
of the transition period.
It is possible that rights held by WorldCom to multi-channel multipoint
distribution service and/or instructional television fixed service spectrum may
be disrupted by FCC decisions to re-allocate some or all of that spectrum to
other services. If this re-allocation were to occur, we cannot predict whether
current deployment plans for our multi-channel multipoint distribution service
services will be sustainable.
INTERNATIONAL
In February 1997, the United States entered into a World Trade Organization, or
WTO, agreement that is designed to liberalize the provision of
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 liberalized existing policies regarding (1) the services
that may be provided by foreign-affiliated U.S. 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. Although the WTO agreement affords WorldCom greater
market access opportunities overseas, the implementation of the WTO agreement in
the United States may also make it easier for foreign carriers with market power
in their home markets to offer U.S. and foreign customers end-to-end services to
our disadvantage. WorldCom may continue to face substantial obstacles in
obtaining from foreign governments and foreign carriers the authority and
facilities to provide these end-to-end services.
LITIGATION
In November 2000, class action complaints were filed in the United States
District Courts for the Southern District of Mississippi, the Southern District
of New York, and the District of Columbia against WorldCom and some of its
executive officers. All of these actions were consolidated in the Southern
District of Mississippi on March 27, 2001, along with another purported class
action lawsuit filed on behalf of individuals who purchased stock in Intermedia
Communications Inc. between September 5 and November 1, 2000, which action
asserts substantially similar claims and alleges that after the announcement of
the WorldCom-Intermedia merger, the price of Intermedia stock was tied to the
price of WorldCom stock. On June 1, 2001, the plaintiffs filed a consolidated
amended complaint. Among other things, the consolidated amended complaint
alleged that statements regarding WorldCom's revenues, the integration of MCI,
the success of UUNET, and the expansion of WorldCom's network were false;
WorldCom's financial disclosures were false; and WorldCom's announcement of its
"generation d" initiative was misleading. Based on these allegations, the
consolidated amended complaint asserts claims for violation of Section 10(b) of
the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and
Section 20(a) of the Securities Exchange Act of 1934. The consolidated amended
complaint seeks to certify a class of persons who purchased WorldCom shares
between February 10, 2000 and November 1, 2000, inclusive; it does not assert
separate claims on behalf of purchasers of Intermedia shares. On August 7, 2001,
WorldCom and the individual defendants filed a motion to dismiss the
consolidated amended complaint in its entirety. We believe that the factual
allegations and legal claims asserted in the consolidated amended complaint are
without merit and intend to defend them vigorously.
On November 4, 1996, and thereafter, and on August 25, 1997, and thereafter, MCI
and all of its directors were
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<Page>
named as defendants in a total of 15 complaints filed in the Court of Chancery
in the State of Delaware. British Telecommunications plc, or 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. The complaints allege that MCI's directors
breached their fiduciary duty in connection with the merger agreement between
MCI and BT, 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 WorldCom and a subsidiary
as additional defendants. These plaintiffs generally allege that the defendants
breached their fiduciary duties to stockholders in connection with the merger
with MCI 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, among other things, 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 United States 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 some 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. WorldCom and the other defendants have moved to
dismiss the consolidated amended complaint.
Nine class action complaints were filed arising out of the FCC's decision in
HALPRIN, TEMPLE, GOODMAN AND SUGRUE V. MCI TELECOMMUNICATIONS CORP., which
allege that WorldCom improperly charged "pre-subscribed" customers
"non-subscriber" or so-called "casual" rates for some direct-dialed calls.
Plaintiffs further challenge our credit policies for this "non-subscriber"
traffic. Plaintiffs assert that our conduct violates the Communications Act and
various state laws; the complaint seeks rebates to all affected customers as
well as punitive damages and other relief. In response to a motion filed by
WorldCom, the Judicial Panel on Multi-District Litigation consolidated these
matters in the United States District Court for the Southern District of
Illinois. On April 16, 2001, the district court issued a written order granting
final approval of the parties' agreement to settle the litigation for a payment
of $88 million. Appeals were filed challenging the settlement, all but two of
which have been dismissed. Separately, WorldCom's appeal of the FCC's HALPRIN
decision to the United States Court of Appeals for the District of Columbia
Circuit has been stayed pending judicial review of the proposed settlement.
(I) LONG-TERM DEBT
On June 8, 2001, we replaced our existing $7 billion 364-Day Revolving Credit
and Term Loan Agreement with two new credit facilities consisting of a $2.65
billion 364-Day Revolving Credit Agreement (the "364-Day Facility") and a $1.6
billion Revolving Credit Agreement (the "Multi-Year Facility"). The 364-Day
Facility and the Multi-Year Facility, together with our existing $3.75 billion
Amended and Restated Facility A Revolving Credit Agreement (the "Existing
Facility"), provide us with aggregate credit facilities of $8 billion. These
credit facilities provide liquidity support for our commercial paper program and
for other general corporate purposes.
The Existing Facility and the Multi-Year Facility mature on June 30, 2002 and
June 8, 2006, respectively. The 364-Day Facility has a 364-day term, which may
be extended for successive 364-day terms to the extent of the committed amounts
from those lenders consenting thereto, with a requirement that lenders holding
51% of the committed amounts consent and so long as the final maturity date does
not extend beyond June 8, 2006. Additionally, we may elect to convert the
principal debt outstanding under the 364-Day Facility to a term loan maturing no
later than one year after the conversion date, so long as the final maturity
date does not extend beyond June 8, 2006. The Existing Facility is subject to
annual commitment fees not to exceed 0.25% of any unborrowed portion of the
facilities. The 364-Day Facility and the Multi-Year Facility are subject to
annual facility fees not to exceed 0.20% or 0.25%, respectively, of the average
daily commitment under each such facility (whether used or unused).
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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 us
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 generally varies from 0.35% to 0.75% as to loans under the Existing
Facility, from 0.29% to 0.80% as to loans under the 364-Day Facility and 0.27%
to 0.75% as to loans under the Multi-Year Facility, in each case based upon our
then current debt ratings.
The credit facilities are unsecured but include a negative pledge of our assets
and, subject to exceptions, the covered subsidiaries. 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 operating covenants which limit, among other things, the
incurrence of additional indebtedness by us and the covered subsidiaries and
sales of assets and mergers and dissolutions. The credit facilities do not
restrict distributions to shareholders, provided we are not in default under the
credit facilities. As of the date of this filing, we were in compliance with
these covenants.
On May 9, 2001, we completed the pricing of a public debt offering of
approximately $11.9 billion principal amount of debt securities, based on
currency exchange rates on May 8, 2001. The net proceeds of $11.7 billion will
be used for general corporate purposes, including to repay commercial paper, and
repayment of $1.5 billion of our 6.125% notes due August 15, 2001 and $1.5
billion of our floating rate notes due November 26, 2001. The public debt
offering consisted of the following series of notes:
<Table>
<Caption>
Principal Interest First
Amount Maturity Payable Interest Date
- ------------------------------------------------------------------------------------------------------------------------
6.50% Notes due 2004 $1.5 billion May 15, 2004 Semiannually on May 15 and November 15 November 15, 2001
7.50% Notes due 2011 $4.0 billion May 15, 2011 Semiannually on May 15 and November 15 November 15, 2001
8.25% Notes due 2031 $4.6 billion May 15, 2031 Semiannually on May 15 and November 15 November 15, 2001
6.75% Notes due 2008 (euro)1.25 billion May 15, 2008 Annually on May 15 May 15, 2002
7.25% Notes due 2008 (pound)500 million May 15, 2008 Annually on May 15 May 15, 2002
</Table>
All of the notes, except for the 6.50% Notes due 2004 are redeemable, as a whole
or in part, at our option, at any time or from time to time, at respective
redemption prices equal to:
In the case of the U.S. dollar notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the sum of the present values of the Remaining Scheduled Payments,
as defined therein, discounted, on a semiannual basis, assuming a
360-day year consisting of twelve 30-day months, at the Treasury
Rate, as defined therein, plus:
o 30 basis points for the Notes due 2011, and
o 35 basis points for the Notes due 2031;
In the case of the euro notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the sum of the present values of the Remaining Scheduled Payments,
as defined therein, discounted, on an annual basis (based on the
actual number of days elapsed divided by 365 or 366, as the case may
be), at the Reference Euro Dealer Rate, as defined therein, plus 25
basis points; and
In the case of the sterling notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the price expressed as a percentage (rounded to three decimal
places, with .0005 being rounded up) at which the Gross Redemption
Yield, as defined therein, on the outstanding principal amount of
the notes on the Reference Date, as defined therein, is equal to the
Gross Redemption Yield (determined by reference to
14
<Page>
the middle-market price) at 3:00 p.m. (London time) on that date on
the Benchmark Gilt, as defined therein, plus 25 basis points;
plus, in the case of the U.S. dollar notes, the euro notes and the sterling
notes, accrued interest to the date of redemption which has not been paid.
The following table sets forth our outstanding debt as of June 30, 2001 (in
millions):
<Table>
Commercial paper and credit facilities $ 99
Floating rate notes due 2001 through 2002 1,560
7.88% - 8.25% Notes Due 2003 - 2010 3,500
7.38% Notes Due 2006 - 2011 2,000
6.13% - 6.95% Notes Due 2001 - 2028 6,100
7.13% - 7.75% Notes Due 2004 - 2027 2,000
8.88% Senior Notes Due 2002 - 2006 667
7.13% - 8.25% Senior Debentures Due 2023 - 2027 1,435
6.13% - 7.50% Senior Notes Due 2004 - 2012 1,929
6.50% - 8.25% Notes Due 2004 - 2031 11,869
Capital lease obligations (maturing through 2002) 373
Other debt (maturing through 2008) 552
--------
32,084
Short-term debt and current maturities of long-term debt (3,264)
--------
$ 28,820
========
</Table>
(J) DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, we adopted the Financial Accounting Standards
Board's, or FASB's, Statement of Financial Accounting Standard, or SFAS, No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
This statement establishes accounting and reporting standards requiring that
derivative instruments (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at 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 either offset related results on the
hedged item in the income statement or be recognized in other comprehensive
income until the hedged item is recorded in current earnings, and requires a
company to formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. The ineffective portion of a
derivative hedge's change in fair value, if any, is recognized currently in
earnings. 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 our
election, before January 1, 1998).
As of January 1, 2001, our exposure to derivative financial instruments
primarily consisted of option collar transactions designated as cash flow hedges
of anticipated sales of an equity investment, which we maintain to minimize the
impact of adverse changes in the market price of the related equity investment,
and various equity warrants. The initial adoption of SFAS No. 133 provided a net
transition gain from our designated cash flow hedges resulting in an increase in
other comprehensive income of approximately $28 million. We recorded no net
impact from adoption of SFAS No. 133 related to the various equity warrants.
During the six months ended June 30, 2001, shares of the hedged equity
investment were sold and we reclassified respective hedging gains of $65 million
from accumulated comprehensive income to miscellaneous income. As of June 30,
2001, we estimate during the next twelve months we will reclassify from
accumulated comprehensive income into earnings approximately $10 million
relating to our derivative financial instruments as the underlying hedged equity
investment is sold. The actual amounts that will be reclassified to earnings
over the next twelve months will vary from this amount as a result of changes in
market conditions. No amounts were reclassified to earnings resulting from any
ineffective portion of the designated derivative hedges or from the
discontinuance of designation of any cash flow hedges.
15
<Page>
(K) SUBSEQUENT EVENTS
On July 1, 2001, we acquired Intermedia Communications Inc. for approximately
$5.3 billion, including long-term debt, pursuant to the merger of a wholly owned
subsidiary with and into Intermedia, with Intermedia continuing as the surviving
corporation and as a subsidiary of WorldCom. In connection with the Intermedia
merger, stockholders of Intermedia received 1.0 shares of WorldCom group common
stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a
share of MCI group common stock (or 2.3 million MCI group shares in the
aggregate) for each share of Intermedia common stock they owned. Holders of
Intermedia preferred stock, other than Intermedia series B preferred stock,
received one share of a class or series of our preferred stock, with
substantially identical terms, which were established upon consummation of the
Intermedia merger. As a result of the merger with Intermedia, we own
approximately 90% of the voting securities of Intermedia.
Upon effectiveness of the merger with Intermedia, the then outstanding and
unexercised options for shares of Intermedia common stock were converted into
options exercisable for an aggregate of approximately 10 million shares of
WorldCom group common stock having the same terms and conditions as the
Intermedia options, except that the exercise price and the number of shares
issuable upon exercise were divided and multiplied, respectively, by 1.0319. The
merger with Intermedia will be accounted for as a purchase and will be allocated
to the WorldCom group.
(L) CONSOLIDATING INFORMATION
Below is the consolidating financial information of the WorldCom group and the
MCI group. The financial information reflects the businesses attributed to the
WorldCom group and the MCI group including the allocation of revenues and
expenses between the WorldCom group and the MCI group in accordance with our
allocation policies.
The attribution of the assets, liabilities, equity, revenues and expenses for
each group, as reflected in our interim consolidated financial statements, which
are consolidated in accordance with accounting principles generally accepted in
the United States, is primarily based on specific identification of the
businesses included in each group. Where specific identification was
impractical, other methods and criteria were used that our management believes
are equitable and provide a reasonable estimate of the assets, liabilities,
equity, revenues and expenses attributable to each group. Our shared corporate
services and related balance sheet amounts (such as executive management, human
resources, legal, regulatory, accounting, tax, treasury, strategic planning and
information systems support) have been attributed to the WorldCom group or the
MCI group based upon identification of such services specifically benefiting
each group. Where determinations based on specific usage alone are impractical,
other methods and criteria were used that our management believes are equitable
and provide a reasonable estimate of the cost attributable to each group. Our
management believes that the allocation methods developed will be comparable to
the expected future allocation methods.
Our board of directors or any special committee appointed by the board of
directors may, without shareholder approval, change the polices set forth in our
tracking stock policy statement, including any resolution implementing the
provisions of our tracking stock policy statement. Our board of directors or any
special committee appointed by the board of directors also may, without
shareholder approval, adopt additional policies or make exceptions with respect
to the application of the policies described in our tracking stock policy
statement in connection with particular facts and circumstances, all as our
board of directors or any special committee appointed by the board of directors
may determine to be in our best interests as a whole. Any such change, adoption
or exception shall be final, binding and conclusive unless otherwise determined
by our board of directors or any special committee appointed by the board of
directors.
16
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING BALANCE SHEET
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
AT DECEMBER 31, 2000
------------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Current assets $ 8,092 $ 2,312 $ (649) $ 9,755
Property and equipment, net 35,177 2,246 -- 37,423
Goodwill and other intangibles 36,685 9,909 -- 46,594
Other assets 5,939 168 (976) 5,131
------- ------- ------- -------
Total assets $85,893 $14,635 $(1,625) $98,903
======= ======= ======= =======
Current liabilities $14,213 $ 4,109 $ (649) $17,673
Long-term debt 11,696 6,000 -- 17,696
Noncurrent liabilities 3,648 2,063 (976) 4,735
Minority interests 2,592 -- -- 2,592
Company obligated mandatorily redeemable
preferred securities 798 -- -- 798
Shareholders' investment 52,946 2,463 -- 55,409
------- ------- ------- -------
Total liabilities and shareholders' investment $85,893 $14,635 $(1,625) $98,903
======= ======= ======= =======
</Table>
17
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF INCOME
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, 2000
-----------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Revenues $ 5,621 $ 4,186 $ -- $ 9,807
------- ------- ----- -------
Operating expenses:
Line costs:
Attributed costs 2,091 1,685 -- 3,776
Intergroup allocated expenses 21 99 (120) --
Selling, general and administrative:
Attributed costs 839 713 906 2,458
Shared corporate services 520 386 (906) --
Intergroup allocated expenses -- 62 (62) --
Depreciation and amortization:
Attributed costs 947 239 -- 1,186
Intergroup allocated expenses (161) (21) 182 --
------- ------- ----- -------
Total 4,257 3,163 -- 7,420
------- ------- ----- -------
Operating income 1,364 1,023 -- 2,387
Interest expense (109) (127) -- (236)
Miscellaneous income 109 -- -- 109
------- ------- ----- -------
Income before income taxes and minority interests 1,364 896 -- 2,260
Provision for income taxes 564 355 -- 919
------- ------- ----- -------
Income before minority interests 800 541 -- 1,341
Minority interests (68) -- -- (68)
------- ------- ----- -------
Net income before distributions on mandatorily
redeemable preferred securities 732 541 -- 1,273
Distributions on mandatorily redeemable preferred securities 16 -- -- 16
------- ------- ----- -------
Net income $ 716 $ 541 $ -- $ 1,257
======= ======= ===== =======
</Table>
18
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF INCOME
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2000
---------------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Revenues $ 11,050 $ 8,369 $ -- $ 19,419
-------- ------- ------- --------
Operating expenses:
Line costs:
Attributed costs 4,159 3,350 -- 7,509
Intergroup allocated expenses 41 185 (226) --
Selling, general and administrative:
Attributed costs 1,614 1,456 1,696 4,766
Shared corporate services 928 768 (1,696) --
Intergroup allocated expenses -- 130 (130) --
Depreciation and amortization:
Attributed costs 1,869 464 -- 2,333
Intergroup allocated expenses (315) (41) 356 --
-------- ------- ------- --------
Total 8,296 6,312 -- 14,608
-------- ------- ------- --------
Operating income 2,754 2,057 -- 4,811
Interest expense (200) (254) -- (454)
Miscellaneous income 220 -- -- 220
-------- ------- ------- --------
Income before income taxes, minority interests and
cumulative effect of accounting change 2,774 1,803 -- 4,577
Provision for income taxes 1,151 715 -- 1,866
-------- ------- ------- --------
Income before minority interests and cumulative effect of
accounting change 1,623 1,088 -- 2,711
Minority interests (150) -- -- (150)
-------- ------- ------- --------
Income before cumulative effect of accounting change 1,473 1,088 -- 2,561
Cumulative effect of accounting change (75) (10) -- (85)
-------- ------- ------- --------
Net income before distributions on mandatorily
redeemable preferred securities 1,398 1,078 -- 2,476
Distributions on mandatorily redeemable preferred securities 32 -- -- 32
Preferred dividend requirements 1 -- -- 1
-------- ------- ------- --------
Net income $ 1,365 $ 1,078 $ -- $ 2,443
======== ======= ======= ========
</Table>
19
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2000
------------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Cash flows from operating activities:
Net income $ 1,398 $ 1,078 $ -- $ 2,476
Adjustments to reconcile net income to net cash provided
by operating activities: 1,598 (153) -- 1,445
------- ------- ------ -------
Net cash provided by operating activities 2,996 925 -- 3,921
------- ------- ------ -------
Cash flows from investing activities:
Capital expenditures (4,970) (227) -- (5,197)
Acquisitions and related costs (14) -- -- (14)
All other investing activities, net (1,694) (130) -- (1,824)
------- ------- ------ -------
Net cash used in investing activities (6,678) (357) -- (7,035)
------- ------- ------ -------
Cash flows from financing activities:
Principal borrowings on debt, net 2,765 -- -- 2,765
Attributed stock activity of WorldCom, Inc. 431 -- -- 431
Intergroup advances, net 570 (570) -- --
All other financing activities, net (296) -- -- (296)
------- ------- ------ -------
Net cash provided by (used in) financing activities 3,470 (570) -- 2,900
Effect of exchange rates changes on cash 2 -- -- 2
------- ------- ------ -------
Net decrease in cash and cash equivalents (210) (2) -- (212)
Cash and cash equivalents beginning of period 806 70 -- 876
------- ------- ------ -------
Cash and cash equivalents end of period $ 596 $ 68 $ -- $ 664
======= ======= ====== =======
</Table>
20
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING BALANCE SHEET
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
AT JUNE 30, 2001
-------------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Current assets $13,228 $ 2,016 $ (835) $ 14,409
Property and equipment, net 33,861 2,121 -- 35,982
Goodwill and other intangibles 36,277 9,836 -- 46,113
Other assets 6,191 225 (976) 5,440
------- ------- ------- --------
Total assets $89,557 $14,198 $(1,811) $101,944
======= ======= ======= ========
Current liabilities $ 8,372 $ 3,924 $ (835) $ 11,461
Long-term debt 22,973 5,847 -- 28,820
Noncurrent liabilities 3,675 1,916 (976) 4,615
Company obligated mandatorily redeemable
preferred securities 798 -- -- 798
Shareholders' investment 53,739 2,511 -- 56,250
------- ------- ------- --------
Total liabilities and shareholders' investment $89,557 $14,198 $(1,811) $101,944
======= ======= ======= ========
</Table>
21
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF INCOME
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, 2001
-----------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Revenues $ 5,362 $ 3,548 $ -- $ 8,910
------- ------- ----- -------
Operating expenses:
Line costs:
Attributed costs 2,014 1,716 -- 3,730
Intergroup allocated expenses 25 91 (116) --
Selling, general and administrative:
Attributed costs 1,588 943 858 3,389
Shared corporate services 463 395 (858) --
Intergroup allocated expenses -- 92 (92) --
Depreciation and amortization:
Attributed costs 1,145 262 -- 1,407
Intergroup allocated expenses (183) (25) 208 --
------- ------- ----- -------
Total 5,052 3,474 -- 8,526
------- ------- ----- -------
Operating income 310 74 -- 384
Interest expense (222) (126) -- (348)
Miscellaneous income 123 -- -- 123
------- ------- ----- -------
Income (loss) before income taxes 211 (52) -- 159
Provision for income taxes 85 (23) -- 62
------- ------- ----- -------
Net income (loss) before distributions on mandatorily
redeemable preferred securities 126 (29) -- 97
Distributions on mandatorily redeemable preferred securities 16 -- -- 16
------- ------- ----- -------
Net income (loss) $ 110 $ (29) $ -- $ 81
======= ======= ===== =======
</Table>
22
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF INCOME
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2001
---------------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ------- ------------ --------
Revenues $ 10,565 $ 7,170 $ -- $ 17,735
-------- ------- ------- --------
Operating expenses:
Line costs:
Attributed costs 3,977 3,449 -- 7,426
Intergroup allocated expenses 49 184 (233) --
Selling, general and administrative:
Attributed costs 2,362 1,878 1,746 5,986
Shared corporate services 1,038 708 (1,746) --
Intergroup allocated expenses -- 182 (182) --
Depreciation and amortization:
Attributed costs 2,229 513 -- 2,742
Intergroup allocated expenses (366) (49) 415 --
-------- ------- ------- --------
Total 9,289 6,865 -- 16,154
-------- ------- ------- --------
Operating income 1,276 305 -- 1,581
Interest expense (401) (252) -- (653)
Miscellaneous income 223 -- -- 223
-------- ------- ------- --------
Income before income taxes 1,098 53 -- 1,151
Provision for income taxes 424 20 -- 444
-------- ------- ------- --------
Net income before distributions on mandatorily
redeemable preferred securities 674 33 -- 707
Distributions on mandatorily redeemable preferred securities 32 -- -- 32
-------- ------- ------- --------
Net income $ 642 $ 33 $ -- $ 675
======== ======= ======= ========
</Table>
23
<Page>
(L) CONSOLIDATING INFORMATION - (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
(UNAUDITED, IN MILLIONS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30, 2001
-----------------------------------------------
WORLDCOM MCI
GROUP GROUP ELIMINATIONS WORLDCOM
-------- ----- ------------ --------
Cash flows from operating activities:
Net income $ 674 $ 33 $ -- $ 707
Adjustments to reconcile net income to net cash provided
by operating activities: 2,265 604 -- 2,869
------- ----- ----- -------
Net cash provided by operating activities 2,939 637 -- 3,576
------- ----- ----- -------
Cash flows from investing activities:
Capital expenditures (4,136) (132) -- (4,268)
Acquisitions and related costs (142) -- -- (142)
All other investing activities, net (469) (381) -- (850)
------- ----- ----- -------
Net cash used in investing activities (4,747) (513) -- (5,260)
------- ----- ----- -------
Cash flows from financing activities:
Principal borrowings (repayments) on debt, net 8,106 (153) -- 7,953
Attributed stock activity of WorldCom, Inc. 103 -- -- 103
Intergroup advances, net (15) 15 -- --
All other financing activities, net (304) -- -- (304)
------- ----- ----- -------
Net cash provided by (used in) financing activities 7,890 (138) -- 7,752
Effect of exchange rates changes on cash 11 -- -- 11
------- ----- ----- -------
Net increase (decrease) in cash and cash equivalents 6,093 (14) -- 6,079
Cash and cash equivalents beginning of period 720 41 -- 761
Deconsolidation of Embratel (216) -- -- (216)
------- ----- ----- -------
Cash and cash equivalents end of period $ 6,597 $ 27 $ -- $ 6,624
======= ===== ===== =======
</Table>
24
<Page>
WORLDCOM GROUP (an integrated business of WorldCom, Inc.)
COMBINED BALANCE SHEETS
(Unaudited, In Millions)
<Table>
<Caption>
December 31, June 30,
2000 2001
------------ --------
ASSETS
Current assets:
Cash and cash equivalents $ 720 $ 6,597
Accounts receivable, net of allowance for bad debts of $1,018 in 2000 and $788 in 2001 4,980 3,924
Deferred tax asset 131 221
Other current assets 1,612 1,651
Receivable from MCI group, net 649 835
-------- --------
Total current assets 8,092 13,228
-------- --------
Property and equipment:
Transmission equipment 19,883 19,802
Communications equipment 5,873 4,892
Furniture, fixtures and other 8,666 8,540
Construction in progress 6,727 7,398
-------- --------
41,149 40,632
Accumulated depreciation (5,972) (6,771)
-------- --------
35,177 33,861
-------- --------
Goodwill and other intangible assets 36,685 36,277
Long-term receivable from MCI group, net 976 976
Other assets 4,963 5,215
-------- --------
$ 85,893 $ 89,557
======== ========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
Short-term debt and current maturities of long-term debt $ 7,200 $ 3,264
Accounts payable and accrued line costs 3,584 2,322
Other current liabilities 3,429 2,786
-------- --------
Total current liabilities 14,213 8,372
-------- --------
Long-term liabilities, less current portion:
Long-term debt 11,696 22,973
Deferred tax liability 2,683 3,073
Other liabilities 965 602
-------- --------
Total long-term liabilities 15,344 26,648
-------- --------
Commitments and contingencies
Minority interests 2,592 --
Company obligated mandatorily redeemable preferred securities 798 798
Allocated net worth 52,946 53,739
-------- --------
$ 85,893 $ 89,577
======== ========
</Table>
The accompanying notes are an integral part of these statements.
25
<Page>
WORLDCOM GROUP (an integrated business of WorldCom, Inc.)
COMBINED STATEMENTS OF OPERATIONS
(Unaudited, In Millions)
<Table>
<Caption>
For the Three Months Ended For the Six Months Ended
June 30, June 30,
-------------------------- ------------------------
2000 2001 2000 2001
----------- ---------- --------- ----------
Revenues $ 5,621 $ 5,362 $ 11,050 $ 10,565
------- ------- -------- --------
Operating expenses:
Line costs 2,112 2,039 4,200 4,026
Selling, general and administrative 1,359 2,051 2,542 3,400
Depreciation and amortization 786 962 1,554 1,863
------- ------- -------- --------
Total 4,257 5,052 8,296 9,289
------- ------- -------- --------
Operating income 1,364 310 2,754 1,276
Other income (expense):
Interest expense (109) (222) (200) (401)
Miscellaneous 109 123 220 223
------- ------- -------- --------
Income before income taxes, minority interests and
cumulative effect of accounting change 1,364 211 2,774 1,098
Provision for income taxes 564 85 1,151 424
------- ------- -------- --------
Income before minority interests and cumulative effect
of accounting change 800 126 1,623 674
Minority interests (68) -- (150) --
------- ------- -------- --------
Income before cumulative effect of accounting change 732 126 1,473 674
Cumulative effect of accounting change (net of income tax of $43 in 2000) -- -- (75) --
------- ------- -------- --------
Net income before distributions on mandatorily redeemable preferred securities 732 126 1,398 674
Distributions on mandatorily redeemable preferred securities 16 16 32 32
Preferred dividend requirements -- -- 1 --
------- ------- -------- --------
Net income $ 716 $ 110 $ 1,365 $ 642
======= ======= ======== ========
</Table>
The accompanying notes are an integral part of these statements.
26
<Page>
WORLDCOM GROUP (an integrated business of WorldCom, Inc.)
COMBINED STATEMENTS OF CASH FLOWS
(Unaudited, In Millions)
<Table>
<Caption>
For the Six Months Ended
June 30,
------------------------
2000 2001
--------- --------
Cash flows from operating activities:
Net income before distributions on mandatorily redeemable preferred securities $ 1,398 $ 674
Adjustments to reconcile net income before distributions on mandatorily
redeemable preferred securities to net cash provided by operating activities:
Cumulative effect of accounting change 75 --
Minority interests 150 --
Depreciation and amortization 1,554 1,863
Provision for deferred income taxes 1,050 216
Change in assets and liabilities, net of effect of
business combinations:
Accounts receivable, net (1,228) (166)
Receivable from MCI group, net (329) (186)
Other current assets (344) (79)
Accounts payable and other current liabilities 864 144
All other operating activities (194) 473
------- -------
Net cash provided by operating activities 2,996 2,939
------- -------
Cash flows from investing activities:
Capital expenditures (4,970) (4,136)
Acquisitions and related costs (14) (142)
Increase in intangible assets (664) (199)
Decrease in other liabilities (646) (183)
All other investing activities (384) (87)
------- -------
Net cash used in investing activities (6,678) (4,747)
------- -------
Cash flows from financing activities:
Principal borrowings on debt, net 2,765 8,106
Attributed stock activity of WorldCom, Inc. 431 103
Distributions on mandatorily redeemable preferred securities (33) (32)
Redemption of Series C preferred stock (190) --
Advances (to) from MCI group, net 570 (15)
All other financing activities (73) (272)
------- -------
Net cash provided by financing activities 3,470 7,890
Effect of exchange rate changes on cash 2 11
------- -------
Net increase (decrease) in cash and cash equivalents (210) 6,093
Cash and cash equivalents at beginning of period 806 720
Deconsolidation of Embratel -- (216)
------- -------
Cash and cash equivalents at end of period $ 596 $ 6,597
======= =======
</Table>
The accompanying notes are an integral part of these statements.
27
<Page>
WORLDCOM GROUP (AN INTEGRATED BUSINESS OF WORLDCOM, INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
(A) GENERAL
The combined financial statements included herein for the WorldCom group (an
integrated business of WorldCom, Inc.), are unaudited and have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial reporting and SEC regulations. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of our management, the combined financial statements of the WorldCom
group 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 our Annual Report on Form 10-K/A for the year ended December
31, 2000. The results for the three- and six- month periods ended June 30, 2001
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2001.
(B) RECAPITALIZATION
On June 7, 2001, our shareholders approved a recapitalization involving the
creation of two separately traded tracking stocks:
o WorldCom group stock, which is intended to reflect the performance
of our data, Internet, international and commercial voice businesses
and is quoted on The Nasdaq National Market under the trading symbol
"WCOM", and
o MCI group stock, which is intended to reflect the performance of our
consumer, small business, wholesale long distance voice and data,
wireless messaging and dial-up Internet access businesses and is
quoted on The Nasdaq National Market under the trading symbol
"MCIT".
In connection with the recapitalization, we amended our articles of
incorporation to replace our existing common stock with two new series of common
stock that are intended to reflect, or track, the performance of the businesses
attributed to the WorldCom group and the MCI group. Effective with the
recapitalization on June 7, 2001, each share of our existing common stock was
changed into one share of WorldCom group stock and 1/25 of a share of MCI group
stock.
A tracking stock is a separate class of a company's common stock intended to
provide a return to investors based upon the financial performance of a distinct
business unit of the company, sometimes referred to as the targeted business.
These targeted businesses are collections of businesses that we have grouped
together in order for us to issue WorldCom group stock and MCI group stock. The
ownership of the targeted business does not change, and while each of the
classes of stock trade separately, all shareholders are common shareholders of a
single company, WorldCom, and are subject to all risks of an investment in
WorldCom as a whole.
We intend to initially pay a quarterly dividend of $0.60 per share on the MCI
group stock. The MCI group was initially allocated notional debt of $6 billion
and our remaining debt was allocated on a notional basis to the WorldCom group.
We intend, for so long as the WorldCom group stock and the MCI group stock
remains outstanding, to include in filings by WorldCom under the Securities
Exchange Act of 1934, as amended, the combined financial statements of each of
the WorldCom group and the MCI group. These combined financial statements will
be prepared in accordance with accounting principles generally accepted in the
United States, and in the case of annual financial statements, will be audited.
These combined financial statements are not legally required under current law
or SEC regulations.
28
<Page>
Voting rights of the holders of the WorldCom group and the MCI group stock are
prorated based on the relative market values of WorldCom group stock and MCI
group stock. We will conduct shareholder meetings that encompass all holders of
voting stock. The WorldCom group and the MCI group shareholders will vote
together as a single class on all matters brought to a vote of shareholders,
including the election of our directors.
Our board of directors may at any time convert each outstanding share of MCI
group stock into shares of WorldCom group stock at 110% of the relative trading
value of MCI group stock for the 20 days prior to the announcement of the
conversion. No premium will be paid on a conversion that occurs three years
after the issuance of MCI group stock.
If all or substantially all of the WorldCom group or MCI group assets are sold,
either: (i) the relevant shareholders will receive a distribution equal to the
fair value of the net proceeds of the sale, either by special dividend or by
redemption of shares; or (ii) each outstanding share of MCI group stock will be
converted into shares of WorldCom group stock at 110% or 100% of the relative
trading value of MCI group stock for a 10 trading day period following the sale.
(C) EMBRATEL DECONSOLIDATION
During the second quarter of 2001, we reached a long-term strategic decision to
restructure our investment in Embratel. The restructuring included the
resignation of certain Embratel Board of Directors seats, the irrevocable
obligation to vote a portion of our common shares in a specified manner and the
transfer of certain economic rights associated with such shares to an unrelated
third party. Based on these actions, the accounting principles generally
accepted in the United States prohibit the continued consolidation of Embratel's
results. Accordingly, we have deconsolidated Embratel's results effective
January 1, 2001.
(D) EARNINGS PER SHARE
Our consolidated financial statements present basic and diluted earnings per
share for WorldCom group stock and MCI group stock using the two-class method.
The two-class method is an earnings formula that determines the attributed
earnings per share for WorldCom group stock and MCI group stock according to
participation rights in undistributed earnings. The combined financial
statements of the WorldCom group do not present earnings per share because
WorldCom group stock is a series of our common stock, and the WorldCom group is
not a legal entity with a capital structure.
For purposes of our consolidated financial statements, basic earnings per share
attributed to WorldCom group stock is computed by dividing attributed net income
for the period by the number of weighted-average shares of WorldCom group stock
then outstanding. Diluted earnings per share attributed to WorldCom group stock
is computed by dividing attributed net income for the period by the
weighted-average number of shares of WorldCom group stock outstanding, including
the dilutive effect of WorldCom group stock equivalents.
(E) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid by the WorldCom group during the six months ended June 30, 2000
and 2001, amounted to $139 million and $232 million, respectively. Income taxes
paid by the WorldCom group during the six months ended June 30, 2000 and 2001
totaled $3 million and $93 million, respectively. In conjunction with business
combinations attributed to the WorldCom group during the six months ended June
30, 2000 and 2001, assets acquired and liabilities assumed were as follows (in
millions):
<Table>
<Caption>
2000 2001
---- ----
Fair value of assets acquired $ -- $ 13
Excess of cost over net tangible assets acquired 29 142
Liabilities assumed (15) (13)
---- -----
Net cash paid $ 14 $ 142
==== =====
</Table>
(F) COMPREHENSIVE INCOME
The following table reflects the calculation of comprehensive income attributed
to the WorldCom group for the three and six months ended June 30, 2000 and 2001
(in millions):
29
<Page>
<Table>
<Caption>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2000 2001 2000 2001
------- ------ ------- ------
Net income $ 716 $ 110 $ 1,365 $ 642
----- ------ ------- ------
Other comprehensive income (loss):
Foreign currency translation losses (238) (9) (202) (48)
Derivative financial instrument gains (losses):
Cumulative effect of adoption of SFAS 133 as of January 1, 2001 -- -- -- 28
Reclassification of derivative financial instruments to current earnings -- (26) -- (65)
Change in fair value of derivative financial instruments -- 15 -- 47
Unrealized holding gains (losses):
Unrealized holding gains (losses) during the period (120) 22 381 (387)
Reclassification adjustment for investment writeoffs included in net
income -- 181 -- 181
Reclassification adjustment for gains included in net income (132) (65) (215) (206)
----- ------ ------- ------
Other comprehensive income (loss) before tax (490) 118 (36) (450)
Income tax benefit (expense) 94 (51) (63) 156
----- ------ ------- ------
Other comprehensive income (loss) (396) 67 (99) (294)
----- ------ ------- ------
Comprehensive income $ 320 $ 177 $ 1,266 $ 348
===== ====== ======= ======
</Table>
(G) SEGMENT INFORMATION
Based on its organizational structure, the WorldCom group operates in two
reportable segments: Commercial voice, data and Internet, and International
operations. The WorldCom group's reportable segments represent business units
that primarily offer similar products and services; however, the business units
are managed separately due to the type and class of customer as well as the
geographic dispersion of their operations. The Commercial voice, data and
Internet segment includes voice, data and other types of domestic communications
services for commercial customers, and Internet services including dedicated
access and web and application hosting services. International operations
provide voice, data, Internet and other similar types of communications services
to customers primarily in Europe and the Asia Pacific region.
Our chief operating decision-maker utilizes revenue information in assessing
performance and making overall operating decisions and resource allocations.
Communications services are generally provided utilizing our fiber optic
networks, which do not make a distinction between the types of services
provided. Profit and loss information is reported only on a combined basis to
our chief operating decision-maker and our board of directors.
The accounting policies of the segments are the same policies as those used by
the WorldCom group in preparing its combined financial statements. Information
about the WorldCom group's segments for the three and six months ended June 30,
2000 and 2001, is as follows (in millions):
<Table>
<Caption>
REVENUES FROM EXTERNAL CUSTOMERS
-------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS ENDED
ENDED JUNE 30, JUNE 30,
-------------------- ------------------------
2000 2001 2000 2001
------- ------ --------- --------
Voice, data and Internet $ 4,199 $4,624 $ 8,282 $ 9,117
International operations 585 738 1,105 1,448
------- ------ -------- -------
Total before Embratel 4,784 5,362 9,387 10,565
Embratel 876 -- 1,737 --
Elimination of intersegment revenues (39) -- (74) --
------- ------ -------- -------
Total $ 5,621 $5,362 $ 11,050 $10,565
======= ====== ======== =======
<Caption>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
-------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS ENDED
ENDED JUNE 30, JUNE 30,
-------------------- ------------------------
2000 2001 2000 2001
------- ------ --------- --------
Voice, data and Internet $ 789 $ 961 $ 1,533 $ 1,960
International operations 276 336 529 686
Corporate 93 754 93 754
------- ------ -------- -------
Total before Embratel 1,158 2,051 2,155 3,400
Embratel 210 -- 405 --
Elimination of intersegment expenses (9) -- (18) --
------- ------ -------- -------
</Table>
30
<Page>
<Table>
<Caption>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
-------------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS ENDED
ENDED JUNE 30, JUNE 30,
-------------------- ------------------------
2000 2001 2000 2001
------- ------ --------- --------
Total $ 1,359 $2,051 $ 2,542 $ 3,400
======= ====== ======== =======
</Table>
As discussed in Note C, we deconsolidated our investment in Embratel as of
January 1, 2001. Embratel, which provides communications services in Brazil, was
designated as a separate reportable segment of the WorldCom group for periods
prior to January 1, 2001. Accordingly, we have included Embratel in our WorldCom
group segment information presented for 2000.
The following is a reconciliation of the segment information to income before
income taxes, minority interests and cumulative effect of accounting change for
the three and six months ended June 30, 2000 and 2001 (in millions):
<Table>
<Caption>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2000 2001 2000 2001
------- ------- -------- --------
Revenues $ 5,621 $ 5,362 $ 11,050 $ 10,565
Operating expenses 4,257 5,052 8,296 9,289
------- ------- -------- --------
Operating income 1,364 310 2,754 1,276
Other income (expense):
Interest expense (109) (222) (200) (401)
Miscellaneous 109 123 220 223
------- ------- -------- --------
Income before income taxes, minority interests
and cumulative effect of accounting change $ 1,364 $ 211 $ 2,774 $ 1,098
======= ======= ======== ========
</Table>
(H) LONG-TERM DEBT
As of January 1, 2000, $6.0 billion of our outstanding debt was notionally
allocated to the MCI group and the remaining outstanding debt was notionally
allocated to the WorldCom group. Our debt was allocated between the WorldCom
group and the MCI group based upon a number of factors including estimated
future cash flows and the ability to pay debt service and dividends of each of
the groups. In addition, we considered certain measures of creditworthiness,
such as coverage ratios and various tests of liquidity, in the allocation
process. Our management believes that the initial allocation is equitable and
supportable by both the WorldCom group and the MCI group. Each group's debt will
increase or decrease by the amount of any net cash generated by, or required to
fund, the group's operating activities, investing activities, share repurchases
and other financing activities.
Interest expense on borrowings incurred by us and allocated to the WorldCom
group reflects the difference between our actual interest expense and the
interest expense allocated to the MCI group. The MCI group was allocated
interest based on our weighted-average interest rate, excluding capitalized
interest, of our debt plus 1 1/4 percent.
See Note I to our interim consolidated financial statements for information
pertaining to our outstanding long-term debt.
(I) CONTINGENCIES
The WorldCom group's shareholders are subject to all of the risks related to an
investment in WorldCom and the WorldCom group, including the effects of any
legal proceedings and claims against the MCI group. See Note H to our interim
consolidated financial statements for information related to our contingencies.
(J) DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, we adopted the Financial Accounting Standards
Board's, or FASB's, Statement of Financial Accounting Standard, or SFAS, No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
This statement establishes accounting and reporting standards requiring that
derivative instruments (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at 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 either offset related results on the
hedged item in the income statement or be recognized in other comprehensive
income until the hedged item is recorded in current earnings, and requires a
company to formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. The ineffective portion of a
derivative hedge's change in fair value, if any, is recognized currently in
earnings. 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).
As of January 1, 2001, our exposure to derivative financial instruments
primarily consisted of option collar transactions designated as cash flow hedges
of anticipated sales of an equity investment, which we maintain to minimize the
impact of adverse changes in the market price of the related equity investment,
and various equity
31
<Page>
warrants. The initial adoption of SFAS No. 133 provided a net transition gain
from our designated cash flow hedges resulting in an increase in other
comprehensive income of approximately $28 million. We recorded no net impact
from adoption of SFAS No. 133 related to the various equity warrants. During the
six months ended June 30, 2001, shares of the hedged equity investment were sold
and we reclassified respective hedging gains of $65 million from accumulated
comprehensive income to miscellaneous income. As of June 30, 2001, we estimate
during the next twelve months we will reclassify from accumulated comprehensive
income into earnings approximately $10 million relating to our derivative
financial instruments as the underlying hedged equity investment is sold. The
actual amounts that will be reclassified to earnings over the next twelve months
will vary from this amount as a result of changes in market conditions. No
amounts were reclassified to earnings resulting from any ineffective portion of
the designated derivative hedges or from the discontinuance of designation of
any cash flow hedges. All of our derivative instruments are attributed to the
WorldCom group.
(K) SUBSEQUENT EVENTS
On July 1, 2001, we acquired Intermedia Communications Inc. for approximately
$5.3 billion, including long-term debt, pursuant to the merger of a wholly owned
subsidiary with and into Intermedia, with Intermedia continuing as the surviving
corporation and as a subsidiary of WorldCom. In connection with the Intermedia
merger, stockholders of Intermedia received 1.0 shares of WorldCom group common
stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a
share of MCI group common stock (or 2.3 million MCI group shares in the
aggregate) for each share of Intermedia common stock they owned. Holders of
Intermedia preferred stock, other than Intermedia series B preferred stock,
received one share of a class or series of our preferred stock, with
substantially identical terms, which were established upon consummation of the
Intermedia merger. As a result of the merger with Intermedia, we own
approximately 90% of the voting securities of Intermedia.
Upon effectiveness of the merger with Intermedia, the then outstanding and
unexercised options for shares of Intermedia common stock were converted into
options exercisable for an aggregate of approximately 10 million shares of
WorldCom group common stock having the same terms and conditions as the
Intermedia options, except that the exercise price and the number of shares
issuable upon exercise were divided and multiplied, respectively, by 1.0319. The
merger with Intermedia will be accounted for as a purchase and will be allocated
to the WorldCom group.
32
<Page>
MCI GROUP (an integrated business of WorldCom, Inc.)
COMBINED BALANCE SHEETS
(Unaudited, In Millions)
<Table>
<Caption>
December 31, June 30,
2000 2001
------------ --------
ASSETS
Current assets:
Cash and cash equivalents $ 41 $ 27
Accounts receivable, net of allowance for bad debts of $514 in 2000 and $511 in 2001 1,835 1,632
Deferred tax asset 41 3
Other current assets 395 354
-------- --------
Total current assets 2,312 2,016
-------- --------
Property and equipment:
Transmission equipment 405 389
Communications equipment 2,227 2,429
Furniture, fixtures and other 676 682
Construction in progress 170 91
-------- --------
3,478 3,591
Accumulated depreciation (1,232) (1,470)
-------- --------
2,246 2,121
-------- --------
Goodwill and other intangible assets 9,909 9,836
Other assets 168 225
-------- --------
$ 14,635 $ 14,198
======== ========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
Payable to WorldCom group, net $ 649 $ 835
Accounts payable and accrued line costs 2,438 2,093
Other current liabilities 1,022 996
-------- --------
Total current liabilities 4,109 3,924
-------- --------
Long-term liabilities, less current portion:
Long-term debt 6,000 5,847
Long-term payable to WorldCom group, net 976 976
Deferred tax liability 928 865
Other liabilities 159 75
-------- --------
Total long-term liabilities 8,063 7,763
-------- --------
Allocated net worth 2,463 2,511
-------- --------
$ 14,635 $ 14,198
======== ========
</Table>
The accompanying notes are an integral part of these statements.
33
<Page>
MCI GROUP (an integrated business of WorldCom, Inc.)
COMBINED STATEMENTS OF OPERATIONS
(Unaudited, In Millions)
<Table>
<Caption>
For the Three Months Ended For the Six Months Ended
June 30, June 30,
-------------------------- ------------------------
2000 2001 2000 2001
---------- ---------- --------- ---------
Revenues $ 4,186 $ 3,548 $ 8,369 $ 7,170
------- ------- ------- -------
Operating expenses:
Line costs 1,784 1,807 3,535 3,633
Selling, general and administrative 1,161 1,430 2,354 2,768
Depreciation and amortization 218 237 423 464
------- ------- ------- -------
Total 3,163 3,474 6,312 6,865
------- ------- ------- -------
Operating income 1,023 74 2,057 305
Other income (expense):
Interest expense (127) (126) (254) (252)
------- ------- ------- -------
Income (loss) before income taxes and cumulative effect of accounting change 896 (52) 1,803 53
Provision for income taxes 355 (23) 715 20
------- ------- ------- -------
Income (loss) before cumulative effect of accounting change 541 (29) 1,088 33
Cumulative effect of accounting change (net of income tax of $7 in 2000) -- -- (10) --
------- ------- ------- -------
Net income (loss) $ 541 $ (29) $ 1,078 $ 33
======= ======= ======= =======
</Table>
The accompanying notes are an integral part of these statements.
34
<Page>
MCI GROUP (an integrated business of WorldCom, Inc.)
COMBINED STATEMENTS OF CASH FLOWS
(Unaudited, In Millions)
<Table>
<Caption>
For the Six Months Ended
June 30,
------------------------
2000 2001
---------- --------
Cash flows from operating activities:
Net income $ 1,078 $ 33
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change 10 --
Depreciation and amortization 423 464
Provision for deferred income taxes 94 (25)
Change in assets and liabilities, net of effect of
business combinations:
Accounts receivable, net (6) 119
Other current assets (122) 41
Accounts payable and other current liabilities (881) (321)
Payable to WorldCom group, net 329 186
All other operating activities -- 140
------- -----
Net cash provided by operating activities 925 637
------- -----
Cash flows from investing activities:
Capital expenditures (227) (132)
Increase in intangible assets (17) (180)
Decrease in other liabilities (42) (84)
All other investing activities (71) (117)
------- -----
Net cash used in investing activities (357) (513)
------- -----
Cash flows from financing activities:
Principal repayments on debt, net -- (153)
Advances (to) from WorldCom group, net (570) 15
------- -----
Net cash used in financing activities (570) (138)
------- -----
Net decrease in cash and cash equivalents (2) (14)
Cash and cash equivalents at beginning of period 70 41
------- -----
Cash and cash equivalents at end of period $ 68 $ 27
======= =====
</Table>
The accompanying notes are an integral part of these statements.
35
<Page>
MCI GROUP (AN INTEGRATED BUSINESS OF WORLDCOM, INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
(A) GENERAL
The combined financial statements included herein for the MCI group (an
integrated business of WorldCom, Inc.), are unaudited and have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial reporting and SEC regulations. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of our management, the combined financial statements of the MCI group
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 our Annual Report on Form 10-K/A for the year ended December
31, 2000. The results for the three- and six- month periods ended June 30, 2001
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2001.
(B) RECAPITALIZATION
On June 7, 2001, our shareholders approved a recapitalization involving the
creation of two separately traded tracking stocks:
o WorldCom group stock, which is intended to reflect the performance
of our data, Internet, international and commercial voice businesses
and is quoted on The Nasdaq National Market under the trading symbol
"WCOM", and
o MCI group stock, which is intended to reflect the performance of our
consumer, small business, wholesale long distance voice and data,
wireless messaging and dial-up Internet access businesses and is
quoted on The Nasdaq National Market under the trading symbol
"MCIT".
In connection with the recapitalization, we amended our articles of
incorporation to replace our existing common stock with two new series of common
stock that are intended to reflect, or track, the performance of the businesses
attributed to the WorldCom group and the MCI group. Effective with the
recapitalization on June 7, 2001, each share of our existing common stock was
changed into one share of WorldCom group stock and 1/25 of a share of MCI group
stock.
A tracking stock is a separate class of a company's common stock intended to
provide a return to investors based upon the financial performance of a distinct
business unit of the company, sometimes referred to as the targeted business.
These targeted businesses are collections of businesses that we have grouped
together in order for us to issue WorldCom group stock and MCI group stock. The
ownership of the targeted business does not change, and while each of the
classes of stock trade separately, all shareholders are common shareholders of a
single company, WorldCom, and are subject to all risks of an investment in
WorldCom as a whole.
We intend to initially pay a quarterly dividend of $0.60 per share on the MCI
group stock. The MCI group was initially allocated notional debt of $6 billion
and our remaining debt was allocated on a notional basis to the WorldCom group.
We intend, for so long as the WorldCom group stock and the MCI group stock
remains outstanding, to include in filings by WorldCom under the Securities
Exchange Act of 1934, as amended, the combined financial statements of each of
the WorldCom group and the MCI group. These combined financial statements will
be prepared in accordance with accounting principles generally accepted in the
United States, and in the case of annual financial statements, will be audited.
These combined financial statements are not legally required under current law
or SEC regulations.
Voting rights of the holders of the WorldCom group and the MCI group stock are
prorated based on the relative market values of WorldCom group stock and MCI
group stock. We will conduct shareholder meetings that encompass all holders of
voting stock. The WorldCom group and the MCI group shareholders will vote
together as a single class on all matters brought to a vote of shareholders,
including the election of our directors.
36
<Page>
Our board of directors may at any time convert each outstanding share of MCI
group stock into shares of WorldCom group stock at 110% of the relative trading
value of MCI group stock for the 20 days prior to the announcement of the
conversion. No premium will be paid on a conversion that occurs three years
after the issuance of MCI group stock.
If all or substantially all of the WorldCom group or MCI group assets are sold,
either: (i) the relevant shareholders will receive a distribution equal to the
fair value of the net proceeds of the sale, either by special dividend or by
redemption of shares; or (ii) each outstanding share of MCI group stock will be
converted into shares of WorldCom group stock at 110% or 100% of the relative
trading value of MCI group stock for a 10 trading day period following the sale.
(C) EARNINGS PER SHARE
Our consolidated financial statements present basic and diluted earnings per
share for WorldCom group stock and MCI group stock using the two-class method.
The two-class method is an earnings formula that determines the attributed
earnings per share for WorldCom group stock and MCI group stock according to
participation rights in undistributed earnings. The combined financial
statements of the MCI group do not present earnings per share because MCI group
stock is a series of our common stock, and the MCI group is not a legal entity
with a capital structure.
For purposes of our consolidated financial statements, basic earnings per share
attributed to MCI group stock is computed by dividing attributed net income for
the period by the number of weighted-average shares of MCI group stock then
outstanding. Diluted earnings per share attributed to MCI group stock is
computed by dividing attributed net income for the period by the
weighted-average number of shares of MCI group stock outstanding, including the
dilutive effect of MCI group stock equivalents.
(D) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid by the MCI group during the six months ended June 30, 2000 and
2001, amounted to $249 million and $241 million, respectively. Income taxes paid
during the six months ended June 30, 2000 and 2001, totaled $40 million and $14
million, respectively.
(E) SEGMENT INFORMATION
Based on its organizational structure, the MCI group operates in four reportable
segments: Consumer; Wholesale; Alternative channels and small business and
Dial-up Internet. The MCI group's reportable segments represent business units
that primarily offer similar products and services; however, the business units
are managed separately due to the type and class of customer as well as the
geographic dispersion of their operations. Consumer includes domestic voice
communications services for consumer customers. Wholesale includes long distance
voice and data domestic communications services for wholesale customers.
Alternative channels and small business includes domestic long distance voice
and data, agents, prepaid calling cards and paging services provided to
alternative wholesale and small business customers. Dial-up Internet includes
dial-up Internet access services.
Our chief operating decision-maker utilizes revenue information in assessing
performance and making overall operating decisions and resource allocations.
Communications services are generally provided utilizing our network facilities,
which do not make a distinction between the types of services provided. Profit
and loss information is reported only on a combined basis to our chief operating
decision-maker and our board of directors.
The accounting policies of the segments are the same policies as those used by
the MCI group in preparing its combined financial statements. Information about
the MCI group's segments for the three and six months ended June 30, 2000 and
2001, is as follows (in millions):
37
<Page>
<Table>
<Caption>
REVENUES FROM EXTERNAL CUSTOMERS
--------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
2000 2001 2000 2001
-------- ------ ------ ------
Consumer $1,943 $1,836 $3,901 $3,643
Wholesale 876 698 1,808 1,393
Alternative channels and small business 962 610 1,838 1,305
Dial-up Internet 405 404 822 829
------ ------ ------ ------
Total $4,186 $3,548 $8,369 $7,170
====== ====== ====== ======
<Caption>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
--------------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
2000 2001 2000 2001
-------- ------ ------ ------
Consumer $ 686 $ 745 $1,399 $1,493
Wholesale 128 157 263 316
Alternative channels and small business 245 264 493 557
Dial-up Internet 102 130 199 268
Corporate -- 134 -- 134
------ ------ ------ ------
Total $1,161 $1,430 $2,354 $2,768
====== ====== ====== ======
</Table>
The following is a reconciliation of the segment information to income (loss)
before income taxes and cumulative effect of accounting change for the three and
six months ended June 30, 2000 and 2001 (in millions):
<Table>
<Caption>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
2000 2001 2000 2001
------- ------- ------- -------
Revenues $ 4,186 $ 3,548 $ 8,369 $ 7,170
Operating expenses 3,163 3,474 6,312 6,865
------- ------- ------- -------
Operating income 1,023 74 2,057 305
Other income (expense):
Interest expense (127) (126) (254) (252)
------- ------- ------- -------
Income (loss) before income taxes and
cumulative effect of accounting change $ 896 $ (52) $ 1,803 $ 53
======= ======= ======= =======
</Table>
(F) LONG-TERM DEBT
As of January 1, 2000, $6.0 billion of our outstanding debt was notionally
allocated to the MCI group and the remaining outstanding debt was notionally
allocated to the WorldCom group. Our debt was allocated between the WorldCom
group and the MCI group based upon a number of factors including estimated
future cash flows and the ability to pay debt service and dividends of each of
the groups. In addition, we considered certain measures of creditworthiness,
such as coverage ratios and various tests of liquidity, in the allocation
process. Our management believes that the initial allocation is equitable and
supportable by both the WorldCom group and the MCI group. Each group's debt will
increase or decrease by the amount of any net cash generated by, or required to
fund, the group's operating activities, investing activities, share repurchases
and other financing activities.
Interest expense on borrowings incurred by us and allocated to the WorldCom
group reflects the difference between our actual interest expense and the
interest expense allocated to the MCI group. The MCI group was allocated
interest based on our weighted-average interest rate, excluding capitalized
interest, of our debt plus 1 1/4 percent.
See Note I to our interim consolidated financial statements for information
pertaining to our outstanding long-term debt.
(G) CONTINGENCIES
The MCI group's shareholders are subject to all of the risks related to an
investment in WorldCom and the MCI group, including the effects of any legal
proceedings and claims against the WorldCom group. See Note H to our interim
consolidated financial statements for information related to our contingencies.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
On June 7, 2001, our shareholders approved the creation of two separately traded
tracking stocks: WorldCom group stock, which is intended to track the separate
performance of our data, Internet, international and commercial voice
businesses; and MCI group stock, which is intended to reflect the performance of
our consumer, small business, wholesale long distance voice and data, wireless
messaging and dial-up Internet access businesses.
38
<Page>
Through the businesses that we have realigned as the WorldCom group, which have
an extensive, advanced facilities-based global communications network, we
provide a broad range of integrated communications and managed network services
to both U.S. and non-U.S. based corporations. Offerings include data services
such as frame relay, asynchronous transfer mode and Internet protocol networks;
Internet related services, including dedicated access, virtual private networks,
digital subscriber lines, web centers encompassing application and server
hosting and managed data services; commercial voice services; and international
services.
Through the businesses that we have realigned as the MCI group, we provide a
broad range of retail and wholesale communications services, including long
distance voice and data communications, consumer local voice communications,
wireless messaging, private line services and dial-up Internet access services.
Our retail services are provided to consumers and small businesses in the United
States. We are the second largest carrier of long distance telecommunications
services in the United States. We provide a wide range of long distance
telecommunications services, including: basic long distance telephone service,
dial around, collect calling, operator assistance and calling card services
(including prepaid calling cards) and toll free or 800 services. We offer these
services individually and in combinations. Through combined offerings, we
provide customers with benefits such as single billing, unified services for
multi-location companies and customized calling plans. Our wholesale businesses
include wholesale voice and data services provided to carrier customers and
other resellers and dial-up Internet access services.
On July 1, 2001, we acquired Intermedia Communications Inc. for approximately
$5.3 billion, including long-term debt, pursuant to the merger of a wholly owned
subsidiary with and into Intermedia, with Intermedia continuing as the surviving
corporation and as a subsidiary of WorldCom. In connection with the Intermedia
merger, stockholders of Intermedia received 1.0 shares of WorldCom group common
stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a
share of MCI group common stock (or 2.3 million MCI group shares in the
aggregate) for each share of Intermedia common stock they owned. Holders of
Intermedia preferred stock, other than Intermedia series B preferred stock,
received one share of a class or series of our preferred stock, with
substantially identical terms, which were established upon consummation of the
Intermedia merger. As a result of the merger with Intermedia, we own
approximately 90% of the voting securities of Intermedia.
Upon effectiveness of the merger with Intermedia, the then outstanding and
unexercised options for shares of Intermedia common stock were converted into
options exercisable for an aggregate of approximately 10 million shares of
WorldCom group common stock having the same terms and conditions as the
Intermedia options, except that the exercise price and the number of shares
issuable upon exercise were divided and multiplied, respectively, by 1.0319. The
merger with Intermedia will be accounted for as a purchase and will be allocated
to the WorldCom group.
During the second quarter of 2001, we reached a long-term strategic decision to
restructure our investment in Embratel. The restructuring included the
resignation of certain Embratel Board of Directors seats, the irrevocable
obligation to vote a portion of our common shares in a specified manner and the
transfer of certain economic rights associated with such shares to an unrelated
third party. Based on these actions, the accounting principles generally
accepted in the United States prohibit the continued consolidation of Embratel's
results. Accordingly, we have deconsolidated Embratel's results effective
January 1, 2001.
ADDITIONAL DISCUSSION RELATED TO THE WORLDCOM GROUP AND THE MCI GROUP FINANCIAL
STATEMENTS
Each of the WorldCom group and the MCI group includes the results of operations
shown in the combined statements of operations and the attributed assets and
liabilities shown in the combined balance sheets of the relevant group. If we
acquire interests in other businesses, we intend to attribute those assets and
any related liabilities to our WorldCom group or our MCI group in accordance
with our tracking stock policy statement. All net income and cash flows
generated by the assets will be attributed to the group to which the assets were
attributed and all net proceeds from any disposition of these assets will also
be attributed to that group.
Although we sometimes refer to such assets and liabilities as those of the
WorldCom group or the MCI group, neither of the groups is a separate legal
entity. Rather, all of the assets of a group are owned by WorldCom and holders
of the WorldCom group stock or the MCI group stock are shareholders of WorldCom
and subject to all of the risks of an investment in WorldCom and all of its
businesses, assets and liabilities.
We intend, for so long as the WorldCom group stock and the MCI group stock
remains outstanding, to include in filings by WorldCom under the Securities
Exchange Act of 1934, as amended, the combined financial statements of each of
the
39
<Page>
WorldCom group and the MCI group. These combined financial statements will be
prepared in accordance with accounting principles generally accepted in the
United States, and in the case of annual financial statements, will be audited.
These combined financial statements are not legally required under current law
or SEC regulations.
Our board of directors may at any time modify, make exceptions to, or abandon
any of the policies set forth in our tracking stock policy statement with
respect to the allocation of corporate opportunities, financing arrangements,
assets, liabilities, debt, interest and other matters, or may adopt additional
policies, in each case without shareholder approval. Our board is subject to
fiduciary duties to all of WorldCom's shareholders as one group, not to the
holders of any series of stock separately. Any changes or exceptions will be
made after a determination by our board of what is in the best interests of
WorldCom as a whole, which may be detrimental to the interests of the holders of
one series of stock. The ability to make these changes may make it difficult to
address the future of a group based on the group's past performance.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The following statements are or may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995:
(i) any statements contained or incorporated herein regarding possible
or assumed future results of operations of WorldCom's business,
anticipated cost savings or other synergies, the markets for
WorldCom's services and products, anticipated capital expenditures,
the outcome of euro conversion efforts, regulatory developments or
competition;
(ii) any statements preceded by, followed by or that include the words
"intends," "estimates," "believes," "expects," "anticipates,"
"should," "could," or similar expressions; and
(iii) other statements contained or incorporated by reference herein
regarding matters that are not historical facts.
Because such statements are subject to risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements; factors that could cause actual results to differ materially
include, but are not limited to:
o the effects of vigorous competition;
o the impact of technological change on our business, new entrants and
alternative technologies, and dependence on availability of
transmission facilities;
o uncertainties associated with the success of acquisitions;
o risks of international business;
o regulatory risks in the United States and internationally;
o contingent liabilities;
o risks associated with euro conversion efforts;
o uncertainties regarding the collectibility of receivables;
o risks associated with debt service requirements and interest rate
fluctuations;
o our financial leverage; and
o the other risks referenced from time to time in WorldCom's filings
with the SEC, including the risk factors described in our Form S-4,
as amended (Registration No. 333-52920).
Potential purchasers of WorldCom capital stock are cautioned not to place undue
reliance on such statements, which speak only as of the date thereof.
The cautionary statements contained or referred to in this section should be
considered in connection with any subsequent written or oral forward-looking
statements that may be issued by WorldCom or persons acting on its behalf.
40
<Page>
The following discussion and analysis relates to our financial condition and
results of operations for the three and six months ended June 30, 2000 and 2001.
This information should be read in conjunction with the consolidated financial
statements and notes thereto contained herein, and the combined financial
statements and notes thereto of each of the WorldCom group and the MCI group
contained herein.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated our statements of
operations as a percentage of its revenues for the periods indicated:
<Table>
<Caption>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
2000 2001 2000 2001
------- ------- ----- ------
Revenues ....................................................... 100.0% 100.0% 100.0% 100.0%
Line costs ..................................................... 38.5 41.9 38.7 41.9
Selling, general and administrative ............................ 25.1 38.0 24.5 33.8
Depreciation and amortization .................................. 12.1 15.8 12.0 15.5
----- ----- ----- -----
Operating income ............................................... 24.3 4.3 24.8 8.9
Other income (expense):
Interest expense .......................................... (2.4) (3.9) (2.3) (3.7)
Miscellaneous ............................................. 1.1 1.4 1.1 1.3
----- ----- ----- -----
Income before income taxes, minority interests and cumulative
effect of accounting change ............................... 23.0 1.8 23.6 6.5
Provision for income taxes ..................................... 9.4 0.7 9.6 2.5
----- ----- ----- -----
Income before minority interests and cumulative effect of
accounting change ......................................... 13.7 1.1 14.0 4.0
Minority interests ............................................. (0.7) -- (0.8) --
Cumulative effect of accounting change ......................... -- -- (0.4) --
----- ----- ----- -----
Net income ..................................................... 13.0 1.1 12.8 4.0
Preferred dividends and distributions on
mandatorily redeemable preferred securities ............... 0.2 0.2 0.2 0.2
----- ----- ----- -----
Net income applicable to common shareholders ................... 12.8% 0.9% 12.6% 3.8%
===== ===== ===== =====
</Table>
THREE AND SIX MONTHS ENDED JUNE 30, 2000 VS.
THREE AND SIX MONTHS ENDED JUNE 30, 2001
For the three and six months ended June 30, 2000 and 2001, our revenues were as
follows (dollars in millions):
<Table>
<Caption>
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------------------- -----------------------------------------------
2000 2001 2000 2001
-------------------- --------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT PERCENT
$ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL
------ -------- ------- -------- ------- -------- ------- --------
WorldCom group .. $5,621 57.3% $ 5,362 60.2% $11,050 56.9% $10,565 59.6%
MCI group ....... 4,186 42.7 3,548 39.8 8,369 43.1 7,170 40.4
------ ------- ------- ------- ------- ------- ------- -------
$9,807 100.0% $ 8,910 100.0% $19,419 100.0% $17,735 100.0%
====== ======= ======= ======= ======= ======= ======= =======
</Table>
Actual reported revenues by category for the three and six months ended June 30,
2000 and 2001 reflect the following changes by category (dollars in millions):
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ------------------------------
PERCENT PERCENT
2000 2001 CHANGE 2000 2001 CHANGE
------ ------ ------ ------- ------- -------
COMMERCIAL SERVICES REVENUES
Voice ............................. $1,773 $1,666 (6.0) $ 3,597 $ 3,392 (5.7)
Data .............................. 1,829 2,179 19.1 3,553 4,224 18.9
International ..................... 585 738 26.2 1,105 1,448 31.0
Embratel, net...................... 837 -- N/A 1,663 -- N/A
Internet .......................... 597 779 30.5 1,132 1,501 32.6
------ ------ ------- -------
TOTAL COMMERCIAL SERVICES REVENUES .. 5,621 5,362 (4.6) 11,050 10,565 (4.4)
</Table>
41
<Page>
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ------------------------------
PERCENT PERCENT
2000 2001 CHANGE 2000 2001 CHANGE
------ ------ ------ ------- ------- -------
Wholesale and consumer ............ $2,819 $2,534 (10.1) $ 5,709 $ 5,036 (11.8)
Alternative channels and small
business .......................... 962 610 (36.6) 1,838 1,305 (29.0)
Dial-up Internet .................. 405 404 (0.2) 822 829 0.9
------ ------ ------- -------
TOTAL ............................... $9,807 $8,910 (9.1) $19,419 $17,735 (8.7)
====== ====== ======= =======
</Table>
Commercial services revenues, which include the revenues generated from
commercial voice, data, international and Internet services, for the second
quarter of 2001 were $5.4 billion versus $5.6 billion for the second quarter of
2000. For the six months ended June 30, 2001, commercial services revenues were
$10.6 billion versus $11.1 billion for the prior year period. As indicated
above, during the second quarter of 2001, we took steps to restructure our
investment in Embratel which resulted in the deconsolidation of Embratel
effective January 1, 2001.
Voice revenues for the second quarter of 2001 decreased 6.0% over the prior year
period on traffic growth of 4.2%. For the six months ended June 30, 2001, voice
revenues decreased 5.7% on traffic growth of 5.3%. The revenue decreases were
partially offset by local voice revenue increases of 9.0% for the second quarter
of 2001 and 10.5% for the first half of 2001, and wireless voice revenue
increases of 55.9% for the second quarter of 2001 and 68.6% for the first six
months of 2001, as customers purchased "all-distance" voice services from us.
Data revenues for the second quarter of 2001 increased 19.1% over the prior year
period. For the six months ended June 30, 2001, data revenues increased 18.9%
over the prior year period. Data includes both commercial long distance and
local dedicated bandwidth sales. As of June 30, 2001, approximately 32% of data
revenues were derived from frame relay and asynchronous transfer mode services,
where we experienced strong demand for capacity increases across the product set
as businesses moved more of their mission-critical applications to their own
networks during the period. Additionally, we continue to experience strong price
pressure for data services in our emerging markets due to competition and the
general decline in economic condition of our customers, which we expect to
continue in the foreseeable future.
International revenues for the second quarter 2001 increased 26.2% to $738
million versus $585 million, excluding Embratel, for the second quarter of 2000.
For the six months ended June 30, 2001, international revenues increased 31.0%
to $1.4 billion versus $1.1 billion, excluding Embratel, for the prior year
period. Geographically, Europe grew 14.3%, and Asia Pacific and other areas grew
59.5% for the second quarter of 2001. For the first six months of 2001, Europe
grew 16.5% and Asia Pacific and other areas grew 72.1%. These increases were
partially offset by foreign currency fluctuations that had the effect of
reducing revenues by approximately $20 million in the second quarter of 2001 and
approximately $90 million for the first half of 2001. Although our retail mix is
improving towards a more profitable blend of data versus voice, and retail
versus wholesale, our international business continues to experience significant
price pressure on its products.
Internet revenues for the second quarter of 2001 increased 30.5% over the prior
year period. For the first six months of 2001, Internet revenues increased 32.6%
over the prior year period. Growth was driven by demand for dedicated circuits
as business customers migrated their data networks and applications to
Internet-based technologies requiring greater amounts of bandwidth. We began to
introduce our new managed hosting products and virtual private networks on
public
42
<Page>
and shared environments. These products, which are in the initial phases of
their life cycle, should gradually contribute to our revenue growth over the
next several quarters. Internet revenues include dedicated Internet access,
managed networking services and applications (such as virtual private networks),
web hosting and electronic commerce and transaction services (such as web
centers and credit card transaction processing).
Wholesale and consumer revenues for the second quarter of 2001 decreased 10.1%,
over the prior year period. For the first six months of 2001, wholesale and
consumer revenues decreased 11.8%. The wholesale market continues to be
extremely price competitive, although rate per minute began to stabilize in the
second quarter of 2001, and resulted in revenue decreases of 20.3% for the
second quarter of 2001 and 23% for the first half of 2001 versus the prior year
period. Wholesale revenues for the three and six months ended June 30, 2001 were
also impacted by proactive revenue initiatives over the past three quarters,
which were made to improve the quality of the wholesale revenue stream as we
shift the MCI group's focus from revenue growth to cash generation. Consumer
revenues for the second quarter of 2001 decreased 5.5% over the prior year
periods. For the first six months of 2001, consumer revenues decreased 6.6% over
the prior year period. The majority of this decrease is attributed to decreases
in calling card revenues as a result of consumers' substitution of wire line
services with wireless and e-mail, and pricing pressure, although rate per
minute began to stabilize in the fourth quarter of 2000. Our consumer local
initiatives continue to perform well as consumer local revenues increased over
168% for the second quarter of 2001 and 161% for the first half of 2001 versus
the prior year periods.
Alternative channels and small business revenues for the second quarter of 2001
decreased 36.6% and decreased 29.0% for the first half of 2001 over the prior
year periods. Alternative channels and small business includes sales agents and
affiliates, wholesale alternative channels, small business, prepaid calling card
and wireless messaging revenues. These decreases are attributed to pricing
pressures in the wholesale and small business markets which negatively affected
revenue growth and gross margins in this area, and proactive initiatives to
de-emphasize services with unacceptable gross margins as we shift the MCI
group's focus from revenue growth to cash generation.
Dial-up Internet revenues for the second quarter of 2001 decreased 0.2% and
increased 0.9% for the first half of 2001 over the prior year amounts. Our dial
access network has grown 38% to approximately 3.2 million modems as of June 30,
2001, compared with the prior year period. Additionally, Internet connect hours
increased 17% to 3.7 billion hours for the first half of 2001 versus the prior
year. These network usage increases were offset by pricing pressure resulting
from the impact of volume discounts and off-net traffic, which lowered average
revenue per hour by approximately 17% for the second quarter of 2001 and 19% for
the first half of 2001 versus the prior year periods, although revenue per hour
began to stabilize in the second quarter of 2001.
LINE COSTS. For the three and six months ended June 30, 2000 and 2001, our line
costs were as follows (dollars in millions):
<Table>
<Caption>
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------------------- -----------------------------------------------
2000 2001 2000 2001
-------------------- --------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT PERCENT
$ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL
------ -------- ------- -------- ------- -------- ------- --------
WorldCom group ........... $ 2,112 55.9% $ 2,039 54.7% $ 4,200 55.9% $ 4,026 54.2%
MCI group ................ 1,784 47.2 1,807 48.4 3,535 47.1 3,633 48.9
Intergroup eliminations .. (120) (3.1) (116) (3.1) (226) (3.0) (233) (3.1)
------- ----- ------- ----- ------- ----- ------- -----
$ 3,776 100.0% $ 3,730 100.0% $ 7,509 100.0% $ 7,426 100.0%
======= ===== ======= ===== ======= ===== ======= =====
</Table>
Line costs as a percentage of revenues for the second quarter of 2001 increased
to 41.9% as compared to 38.5% for the second quarter of 2000. On a year-to-date
basis, line costs as a percentage of revenues increased to 41.9% as compared to
38.7% reported for the same period of the prior year. Excluding Embratel for the
2000 periods, line costs for the second quarter of 2000 were $3.4 billion, or
37.8% of revenues and line costs for the six months ended June 30, 2000 were
$6.7 billion, or 37.9% of revenues. The increases as a percentage of revenues
reflect the pricing pressure in the commercial data, Internet and international
markets as well as the continued competitive pricing and off-net traffic in the
dial-up Internet business which resulted in a modest increase in average cost
per hour while average dial-up revenues per hour decreased 17% for the second
quarter of 2001 and 19% for the first half of 2001. Additionally, line costs as
a
43
<Page>
percentage of revenues have increased as a result of the decrease in higher
margin calling card and dial around revenues due to wireless substitution as
noted above.
Line costs were partially offset by foreign currency exchange fluctuations,
which had the effect of reducing line costs as a percentage of revenues by
almost one half of a percentage point for both the three- and six-month periods
ended June 30, 2001, and by increased data and dedicated Internet traffic over
our own facilities, which positively affected line costs as a percentage of
revenues by almost one percentage point for both the three- and six-month
periods ended June 30, 2001.
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 traditional phone companies' 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. We have 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. We cannot predict the
outcome of these proceedings or whether or not the results will have a material
adverse impact on our consolidated financial position or results of operations.
However, our goal is to manage transport costs through effective utilization of
our networks, favorable contracts with carriers and network efficiencies made
possible as a result of expansion of our customer base.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three and six months ended
June 30, 2000 and 2001, our selling, general and administrative expenses were as
follows (dollars in millions):
<Table>
<Caption>
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------------------- -----------------------------------------------
2000 2001 2000 2001
-------------------- --------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT PERCENT
$ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL
------ -------- ------- -------- ------- -------- ------- --------
WorldCom group ........... $ 1,359 55.3% $ 2,051 60.5% $ 2,542 53.3% $ 3,400 56.8%
MCI group ................ 1,161 47.2 1,430 42.2 2,354 49.4 2,768 46.2
Intergroup eliminations .. (62) (2.5) (92) (2.7) (130) (2.7) (182) (3.0)
------- ----- ------- ----- ------- ----- ------- -----
$ 2,458 100.0% $ 3,389 100.0% $ 4,766 100.0% $ 5,986 100.0%
======= ===== ======= ===== ======= ===== ======= =====
</Table>
Selling, general and administrative expenses for the second quarter of 2001 were
$3.4 billion or 38.0% of revenues as compared to $2.5 billion or 25.1% of
revenues for the quarter ended June 30, 2000. Selling, general and
administrative expenses for the second quarter of 2001 include pre-tax costs of
$865 million ($742 million at WorldCom group and $123 million at MCI group)
related to the write-off of investments in certain publicly traded and privately
held companies and $23 million ($12 million at WorldCom group and $11 million at
MCI group) as a result of the costs associated with the tracking stock
capitalization. For the second quarter of 2000, selling, general and
administrative expenses included a $93 million pre-tax one-time charge
associated with the termination of the Sprint Corporation merger agreement.
Excluding these charges and Embratel in 2000, selling, general and
administrative expenses for the second quarter of 2001 would have been 28.1% as
compared to 24.1% for the second quarter of 2000.
On a year-to-date basis, selling, general and administrative expenses as a
percentage of revenues increased to $6.0 billion, or 33.8% of revenues as
compared to 24.5% for the same period of the prior year. Selling, general and
administrative expenses for the six months ended June 30, 2001 also includes
pre-tax costs of $125 million associated with domestic severance packages and
other costs related to our February 2001 workforce reductions. Excluding these
charges and Embratel in 2000, selling, general and administrative expenses as a
percentage of revenues would have been 28.0% for the first half of 2001 versus
24.1% for the first half of 2000.
Selling, general and administrative expenses for the three and six months ended
June 30, 2001, include increased costs associated with "generation d"
initiatives, which are designed to position us as a leading supplier of
e-business solutions, that include product marketing, customer care, information
systems and product development, employee retention costs, and costs associated
with multichannel multipoint distribution service product development.
44
<Page>
Additionally, selling, general and administrative expenses increased on a year
to year basis, as a result of increases to our consumer workforce in 2000 to
support consumer retail activities.
Selling, general and administrative expenses were offset in part by foreign
currency exchange fluctuations which had the effect of reducing selling, general
and administrative expenses as a percentage of revenues by less than one-half of
a percentage point for both the three- and six-month periods ended June 30,
2001. Additionally, workforce reductions in the first half of 2001 should help
to lower selling, general and administrative expenses in the second half of
2001.
DEPRECIATION AND AMORTIZATION. For the three and six months ended June 30, 2000
and 2001, our depreciation and amortization expense was as follows (dollars in
millions):
<Table>
<Caption>
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------------------- -----------------------------------------------
2000 2001 2000 2001
-------------------- --------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT PERCENT
$ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL
------ -------- ------- -------- ------- -------- ------- --------
WorldCom group ........... $ 786 66.3% $ 962 68.4% $ 1,554 66.6% $ 1,863 68.0%
MCI group ................ 218 18.4 237 16.8 423 18.1 464 16.9
Intergroup eliminations .. 182 15.3 208 14.8 356 15.3 415 15.1
------- ----- ------- ----- ------- ----- ------- -----
$ 1,186 100.0% $ 1,407 100.0% $ 2,333 100.0% $ 2,742 100.0%
======= ===== ======= ===== ======= ===== ======= =====
</Table>
Depreciation and amortization expense for the second quarter of 2001 increased
to $1.4 billion or 15.5% of revenues from $1.2 billion or 12.1% of revenues for
the second quarter of 2000. On a year-to-date basis, this expense increased to
$2.7 billion or 15.5% of revenues versus $2.3 billion or 12.0% of revenues for
the first half of 2000. Excluding Embratel in 2000, depreciation and
amortization would have been $1.1 billion or 11.9% of revenues for the second
quarter of 2000 and $2.1 billion or 11.8% of revenues for the first half of
2000. These increases reflect additional depreciation associated with 2000 and
2001 capital expenditures.
INTEREST EXPENSE. Interest expense for the second quarter of 2001 was $348
million or 3.9% of revenues as compared to $236 million or 2.4% of revenues for
the second quarter of 2000. For the six months ended June 30, 2001, interest
expense was $653 million, or 3.7% of revenues compared to $454 million, or 2.3%
of revenues for the first half of 2000. Excluding Embratel in 2000, interest
expense would have been $245 million or 2.7% of revenues for the second quarter
of 2000 and $469 million, or 2.6% of revenues for the first half of 2000. For
the three months ended June 30, 2000 and 2001, weighted-average annual interest
rates on our long-term debt, excluding Embratel in all periods, were 7.33% and
7.06% respectively, while weighted-average levels of borrowings were $20.0
billion and $29.1 billion, respectively. For the six months ended June 30, 2000
and 2001, weighted-average annual interest rates on our long-term debt,
excluding Embratel in all periods, were 7.26% and 7.14%, respectively, while
weighted-average levels of borrowings were $19.0 billion and $27.3 billion,
respectively. Interest expense for the three and six months ended June 30, 2001
increased as a result of higher debt levels from the May 2001 bond offering,
offset, in part, by lower interest rates on variable rate debt.
Interest expense on borrowings incurred by WorldCom and allocated to the
WorldCom group reflects the difference between WorldCom's actual interest
expense and the interest expense allocated to the MCI group. The MCI group was
allocated interest based on the weighted-average interest rate, excluding
capitalized interest, of WorldCom debt plus 1 1/4 percent. As of January 1,
2000, $6.0 billion of WorldCom's outstanding debt was notionally allocated to
the MCI group.
MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous income for the second quarter of
2001 was $123 million or 1.4% of revenues compared to $109 million or 1.1% of
revenues for the second quarter of 2000. For the six months ended June 30, 2001,
miscellaneous income was $223 million or 1.3% of revenues compared to $220
million or 1.1% of revenues for the first six months of 2000. 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 non-operating items.
45
<Page>
PROVISION FOR INCOME TAXES. The effective income tax rate was 39.0% of income
before taxes for the second quarter of 2001 and 38.6% of income before taxes for
the first half of 2001. The 2001 rates are greater than the expected federal
statutory rate of 35% primarily due to the amortization of non-deductible
goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which
requires certain activation and installation fee revenues to be amortized over
the average life of the related service rather than be recognized immediately.
Costs directly related to these revenues may also be deferred and amortized over
the customer contract life. This adoption resulted in a one-time expense of $85
million, net of income tax benefit of $50 million in the first quarter of 2000.
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS. For the three months ended June
30, 2001, we reported net income applicable to common shareholders of $81
million as compared to $1.3 billion for the three months ended June 30, 2000.
For the six months ended June 30, 2001, we reported net income applicable to
common shareholders of $675 million as compared to $2.4 billion for the six
months ended June 30, 2000.
ADDITIONAL DISCUSSION RELATED TO THE WORLDCOM GROUP AND THE MCI GROUP FINANCIAL
STATEMENTS
Each of the WorldCom group and the MCI group includes the results of operations
shown in the combined statements of operations and the attributed assets and
liabilities shown in the combined balance sheets of the relevant group. If we
acquire interests in other businesses, we intend to attribute those assets and
any related liabilities to our WorldCom group or our MCI group in accordance
with our tracking stock policy statement. All net income and cash flows
generated by the assets will be attributed to the group to which the assets were
attributed and all net proceeds from any disposition of these assets will also
be attributed to that group.
Although we sometimes refer to such assets and liabilities as those of the
WorldCom group or the MCI group, neither of the groups is a separate legal
entity. Rather, all of the assets of a group are owned by WorldCom and holders
of the WorldCom group stock or the MCI group stock are shareholders of WorldCom
and subject to all of the risks of an investment in WorldCom and all of its
businesses, assets and liabilities.
We intend, for so long as the WorldCom group stock and the MCI group stock
remains outstanding, to include in filings by WorldCom under the Securities
Exchange Act of 1934, as amended, the combined financial statements of each of
the WorldCom group and the MCI group. These combined financial statements will
be prepared in accordance with accounting principles generally accepted in the
United States, and in the case of annual financial statements, will be audited.
These combined financial statements are not legally required under current law
or SEC regulations.
Our board of directors may at any time modify, make exceptions to, or abandon
any of the policies set forth in our tracking stock policy statement with
respect to the allocation of corporate opportunities, financing arrangements,
assets, liabilities, debt, interest and other matters, or may adopt additional
policies, in each case without shareholder approval. Our board is subject to
fiduciary duties to all of WorldCom's shareholders as one group, not to the
holders of any series of stock separately. Any changes or exceptions will be
made after a determination by our board of what is in the best interests of
WorldCom as a whole, which may be detrimental to the interests of the holders of
one series of stock. The ability to make these changes may make it difficult to
address the future of a group based on the group's past performance.
ATTRIBUTION AND ALLOCATION OF ASSETS, LIABILITIES, REVENUES AND EXPENSES
The following is a discussion of the methods used to attribute and allocate
property and equipment, revenues, line costs, shared corporate services,
intangible assets and financing arrangements to the WorldCom group and the MCI
group.
PROPERTY AND EQUIPMENT. Property and equipment was attributed to the WorldCom
group and the MCI group based on specific identification consistent with the
assets necessary to support the continuing operations of the businesses
attributed to the respective groups. The balances of property and equipment
attributed to each of the groups as of June 30, 2001 are as follows:
46
<Page>
<Table>
<Caption>
WORLDCOM MCI
GROUP GROUP WORLDCOM
----- ----- --------
(IN MILLIONS)
Transmission equipment ............ $ 19,802 $ 389 $ 20,191
Communications equipment .......... 4,892 2,429 7,321
Furniture, fixtures and other ..... 8,540 682 9,222
Construction in progress .......... 7,398 91 7,489
-------- -------- --------
40,632 3,591 44,223
Accumulated depreciation .......... (6,771) (1,470) (8,241)
-------- -------- --------
$ 33,861 $ 2,121 $ 35,982
======== ======== ========
</Table>
Under our tracking policy statement, our board of directors may reallocate
assets to the other group for fair value at any time without shareholder
approval.
REVENUES. Revenues have been attributed to the WorldCom group and the MCI group
based on specific identification of the lines of business that are attributed to
the two groups.
LINE COSTS. Allocated costs and related liabilities within this caption include
the costs of the fiber optic systems attributed to the WorldCom group and the
costs of the business voice switched services attributed to the MCI group. Line
costs which are specifically identifiable to a particular group based on usage
of the network are allocated to that group; any remaining line costs that cannot
be specifically identified are allocated between the groups using methodologies
that our management believes are reasonable, such as the total revenues
generated by each group.
SHARED CORPORATE SERVICES. A portion of our shared corporate services and
related balance sheet amounts (such as executive management, human resources,
legal, regulatory, accounting, tax, treasury, strategic planning and information
systems support) has been attributed to the WorldCom group or the MCI group
based upon identification of such services specifically benefiting such group.
Where determinations based on specific usage alone have been impractical, other
allocation methods were used, including methods based on number of employees and
the total revenues generated by each group. Our management believes these
allocation methods are equitable and provide a reasonable estimate of the costs
attributable to each group.
ALLOCATION OF INTANGIBLE ASSETS. Intangible assets consist of the excess
consideration paid over the fair value of net tangible assets acquired by us in
business combinations accounted for under the purchase method and include
goodwill, channel rights, developed technology and tradenames. These assets have
been attributed to the respective groups based on specific identification and
where acquired companies have been divided between the WorldCom group and the
MCI group, the intangible assets have been allocated based on the respective
fair values at the date of purchase of the related operations attributed to each
group. Our management believes that this method of allocation is equitable and
provides a reasonable estimate of the intangible assets attributable to the
WorldCom group and the MCI group.
All tradenames, including the MCI tradename and the other related MCI
tradenames, have been attributed to the WorldCom group. The MCI group will be
allocated an expense, and the WorldCom group will be allocated a corresponding
decrease in costs, for the use of the MCI tradenames. For purposes of preparing
the historical financial statements for the groups, an expense of $27.5 million
per annum was allocated to the MCI group, and a corresponding decrease in costs
was allocated to the WorldCom group, in each case since the date of acquisition
of MCI, for use by the MCI group of the MCI tradenames. The charge for the next
five years will be based on the following schedule:
<Table>
2001: $27.5 million
2002: $30.0 million
2003: $35.0 million
2004: $40.0 million
2005: $45.0 million
</Table>
Any renewal or termination of use of the MCI tradename by the MCI group will be
subject to the general policy that our board of directors will act in the best
interests of WorldCom.
47
<Page>
Goodwill and other intangibles assigned or allocated to the WorldCom group and
the MCI group as of June 30, 2001 are as follows:
<Table>
<Caption>
WORLDCOM MCI
GROUP GROUP WORLDCOM
----- ----- --------
(IN MILLIONS)
Goodwill ....................... $ 35,673 $ 9,269 $ 44,942
Tradenames ..................... 1,100 -- 1,100
Developed technology ........... 1,590 510 2,100
Other intangibles .............. 2,841 1,296 4,137
-------- -------- --------
41,204 11,075 52,279
Accumulated depreciation ....... (4,927) (1,239) (6,166)
-------- -------- --------
$ 36,277 $ 9,836 $ 46,113
======== ======== ========
</Table>
FINANCING ARRANGEMENTS. As of January 1, 2000, $6.0 billion of our outstanding
debt was notionally allocated to the MCI group and $18.9 billion of our debt was
notionally allocated to the WorldCom group. Our debt was allocated between the
WorldCom group and the MCI group based upon a number of factors including
estimated future cash flows and the ability to pay debt service and dividends of
each of the groups. In addition, we considered certain measures of
creditworthiness, such as coverage ratios and various tests of liquidity, in the
allocation process. Our management believes that the initial allocation is
equitable and supportable by both the WorldCom group and the MCI group. The debt
allocated to the MCI group bears interest at a rate indicative of the rate at
which the MCI group would borrow from third parties if it was a wholly owned
subsidiary of WorldCom but did not have the benefit of any guarantee by
WorldCom. Interest rates will be calculated on a quarterly basis. For purposes
of the combined historical financial statements of each of the groups, debt
allocated to the MCI group was determined to bear an interest rate equal to the
weighted-average interest rate, excluding capitalized interest, of WorldCom debt
plus 1 1/4 percent. Interest allocated to the WorldCom group reflects the
difference between our actual interest expense and the interest expense charged
to the MCI group.
Each group's debt will increase or decrease by the amount of any net cash
generated by, or required to fund, the group's operating activities, investing
activities, share repurchases and other financing activities.
As of June 30, 2001, our receivables purchase program consisted of a $3.8
billion pool of receivables in which the purchaser had an undivided interest in
$2.0 billion of those receivables. The WorldCom group was allocated $2.7 billion
of the pool and $1.5 billion of the sold receivables. The MCI group was
allocated the balance. The receivables sold were attributed principally based on
specific identification, or allocated based on total revenues. Our management
believes that this method of allocation is equitable and provides a reasonable
estimate of the receivables attributable to the groups.
WORLDCOM GROUP RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the WorldCom group's
statements of operations in millions of dollars and as a percentage of its
revenues for the periods indicated:
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------- --------------------------------------
2000 2001 2000 2001
----------------- ---------------- ------------------ -----------------
Revenues ......................................... $ 5,621 100.0% $ 5,362 100.0% $ 11,050 100.0% $ 10,565 100.0%
Line costs ....................................... 2,112 37.6 2,039 38.0 4,200 38.0 4,026 38.1
Selling, general and administrative .............. 1,359 24.2 2,051 38.3 2,542 23.0 3,400 32.2
Depreciation and amortization .................... 786 14.0 962 17.9 1,554 14.1 1,863 17.6
------- ----- ------- ----- -------- ----- -------- -----
Operating income ................................. 1,364 24.3 310 5.8 2,754 24.9 1,276 12.1
Other income (expense):
Interest expense ............................ (109) (1.9) (222) (4.1) (200) (1.8) (401) (3.8)
Miscellaneous ............................... 109 1.9 123 2.3 220 2.0 223 2.1
------- ----- ------- ----- -------- ----- -------- -----
Income before income taxes, minority interests
and cumulative effect of accounting change .. 1,364 24.3 211 3.9 2,774 25.1 1,098 10.4
Provision for income taxes ....................... 564 10.0 85 1.6 1,151 10.4 424 4.0
------- ----- ------- ----- -------- ----- -------- -----
Income before minority interests and cumulative
effect of accounting change ................. 800 14.2 126 2.3 1,623 14.7 674 6.4
Minority interests ............................... (68) (1.2) -- -- (150) (1.4) -- --
Cumulative effect of accounting change ........... -- -- -- -- (75) (0.7) -- --
Preferred dividends and distributions on
mandatorily redeemable preferred securities . 16 0.3 16 0.3 33 0.3 32 0.3
------- ----- ------- ----- -------- ----- -------- -----
Net income ....................................... $ 716 12.7% $ 110 2.1% $ 1,365 12.4% $ 642 6.1%
======= ===== ======= ===== ======== ===== ======== =====
</Table>
48
<Page>
THREE AND SIX MONTHS ENDED JUNE 30, 2000 VS.
THREE AND SIX MONTHS ENDED JUNE 30, 2001
REVENUES. Actual reported revenues by category for the three and six months
ended June 30, 2000 and 2001 reflect the following changes by category (dollars
in millions):
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------ ------------------------------
PERCENT PERCENT
2000 2001 CHANGE 2000 2001 CHANGE
-------- ------ ------- -------- -------- -------
COMMERCIAL SERVICES REVENUES
Voice ............................. $ 1,773 $1,666 (6.0) $ 3,597 $ 3,392 (5.7)
Data .............................. 1,829 2,179 19.1 3,553 4,224 18.9
International ..................... 585 738 26.2 1,105 1,448 31.0
Embratel, net...................... 837 -- N/A 1,663 -- N/A
Internet .......................... 597 779 30.5 1,132 1,501 32.6
------- ------ -------- --------
TOTAL COMMERCIAL SERVICES REVENUES .. $ 5,621 $5,362 (4.6) $ 11,050 $ 10,565 (4.4)
======= ====== ======== ========
</Table>
WorldCom group revenues for the second quarter of 2001 were $5.4 billion versus
$5.6 billion for the prior year period. For the six months ended June 30, 2001,
WorldCom group revenues were $10.6 billion versus $11.1 billion for the prior
year period. As indicated above, during the second quarter of 2001, we took
steps to restructure our investment in Embratel which resulted in the
deconsolidation of Embratel effective January 1, 2001.
Voice revenues for the second quarter of 2001 decreased 6.0% over the prior year
period on traffic growth of 4.2%. For the six months ended June 30, 2001, voice
revenues decreased 5.7% on traffic growth of 5.3%. The revenue decreases were
partially offset by local voice revenue increases of 9.0% for the second quarter
of 2001 and 10.5% for the first half of 2001 and wireless voice revenue
increases of 55.9% for the second quarter of 2001 and 68.6% for the first six
months of 2001, as customers purchased "all-distance" voice services from us.
Voice revenues include both domestic commercial long distance and local switched
revenues.
Data revenues for the second quarter of 2001 increased 19.1% over the prior year
period. For the six months ended June 30, 2001, data revenues increased 18.9%
over the prior year period. Data includes both commercial long distance and
local dedicated bandwidth sales. As of June 30, 2001, approximately 32% of data
revenues were derived from frame relay and asynchronous transfer mode services,
where we experienced strong demand for capacity increases across the product set
as businesses moved more of their mission-critical applications to their own
networks during the period. Additionally, we continue to experience strong price
pressure for data services in our emerging markets due to competition and the
general decline in economic condition of our customers, which we expect to
continue in the foreseeable future.
International revenues for the second quarter 2001 increased 26.2% to $738
million versus $585 million, excluding Embratel, for the second quarter of 2000.
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For the six months ended June 30, 2001, international revenues increased 31.0%
to $1.4 billion versus $1.1 billion, excluding Embratel, for the prior year
period. Geographically, Europe grew 14.3%, and Asia Pacific and other areas grew
59.5% for the second quarter of 2001. For the first six months of 2001, Europe
grew 16.5% and Asia Pacific and other areas grew 72.1%. These increases were
partially offset by foreign currency fluctuations that had the effect of
reducing revenues by approximately $20 million in the second quarter of 2001 and
approximately $90 million for the first half of 2001. Although our retail mix is
improving towards a more profitable blend of data versus voice, and retail
versus wholesale, our international business continues to experience significant
price pressure on its products.
Internet revenues for the second quarter of 2001 increased 30.5% over the prior
year period. For the first six months of 2001, Internet revenues increased 32.6%
over the prior year period. Growth was driven by demand for dedicated circuits
as business customers migrated their data networks and applications to
Internet-based technologies requiring greater amounts of bandwidth. We began to
introduce our new managed hosting products and virtual private networks on
public and shared environments. These products, which are in the initial phases
of their life cycle, should gradually contribute to our revenue growth over the
next several quarters. Internet revenues include dedicated Internet access,
managed networking services and applications (such as virtual private networks),
web hosting and electronic commerce and transaction services (such as web
centers and credit card transaction processing).
LINE COSTS. Line costs as a percentage of revenues for the second quarter of
2001 increased to 38.0% as compared to 37.6% reported for the second quarter of
2000. On a year-to-date basis, line costs as a percentage of revenues was 38.1%
as compared to 38.0% for the six months ended June 30, 2000. Excluding Embratel
in 2000, line costs would have been $1.7 billion, or 36.1% of revenues for the
second quarter of 2000 and $3.4 billion, or 36.4% of revenues for the first six
months of 2000. The increases as a percentage of revenues reflect the pricing
pressure in the data, international and Internet markets. Beginning in the
fourth quarter of 2000, pricing pressure began to stabilize as a result of our
actions to improve gross margins. Line costs were partially offset by foreign
currency exchange fluctuations which had the effect of reducing line costs as a
percentage of revenues by less than one percentage point for both the three- and
six-month periods ended June 30, 2001, and by increased data and dedicated
Internet traffic over our own facilities, which positively affected line costs
as a percentage of revenues by less than one percentage point for both the
three- and six-month periods ended June 30, 2001. Line costs for the three
months ended June 30, 2000 and 2001 included $21 million and $25 million,
respectively, of charges for business voice switched services provided by the
MCI group. Line costs for the six months ended June 30, 2000 and 2001 included
$41 million and $49 million, respectively, of charges for business voice
switched services provided by the MCI group.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the second quarter of 2001 were $2.1 billion or 38.3% of revenues
as compared to $1.4 billion or 24.2% of revenues for the prior year period.
Selling, general and administrative expenses for the second quarter of 2001
include pre-tax costs of $742 million related to the write-off of investments in
certain publicly traded and privately held companies and $12 million as a result
of the costs associated with the tracking stock capitalization. For the second
quarter of 2000, selling, general and administrative expenses included a $93
million pre-tax one-time charge associated with the termination of the Sprint
Corporation merger agreement. Excluding these charges and Embratel in 2000,
selling, general and administrative expenses for the second quarter of 2001
would have been 24.2% as compared to 22.3% for the second quarter of 2000.
On a year-to-date basis, selling, general and administrative expenses were $3.4
billion or 32.2% of revenues as compared to $2.5 billion or 23.0% of revenues
for the first six months of 2000. Selling, general and administrative expenses
for the first half of 2001 also includes pre-tax costs of $77 million associated
with domestic severance packages and other costs related to our February 2001
workforce reductions. Excluding these charges and Embratel in 2000, selling,
general and administrative expenses as a percentage of revenues would have been
24.3% for the first half of 2001 versus 22.0% for the first half of 2000.
Selling, general and administrative expenses for the three and six months ended
June 30, 2001, include increased costs associated with "generation d"
initiatives that include product marketing, customer care, information system
and product development, employee retention costs, and costs associated with
multichannel multipoint distribution service product development.
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<Page>
Selling, general and administrative expenses were offset in part by foreign
currency exchange fluctuations which had the effect of reducing selling, general
and administrative expenses as a percentage of revenues by less than one-half of
a percentage point for both the three- and six-month periods ended June 30,
2001. Additionally, workforce reductions in the first half of 2001 should help
to lower selling, general and administrative expenses in the second half of
2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the
second quarter of 2001 increased to $1.0 billion or 17.9% of revenues from $786
million or 14.0% of revenues for the prior year period. On a year-to-date basis,
depreciation increased to $1.9 billion, or 17.6% of revenues as compared to $1.6
billion, or 14.1% of revenues for the first six months of 2000. Excluding
Embratel in 2000, depreciation and amortization would have been $665 million or
13.9% of revenues for the second quarter of 2000 and $1.3 billion or 14.0% of
revenues for the first half of 2000. These increases reflect increased
depreciation associated with 2000 and 2001 capital expenditures. Depreciation
and amortization expense for the three months ended June 30, 2000 and 2001
excludes $161 million and $183 million, respectively, of charges allocated to
the MCI group for transit capacity requirements provided by the WorldCom group,
for the MCI group's proportionate share of costs associated with buildings,
furniture and fixtures and for the MCI group's use of the MCI tradename. For the
six months ended June 30, 2000 and 2001 depreciation and amortization expense
excludes $315 million and $366 million, respectively, for such costs.
INTEREST EXPENSE. Interest expense for the second quarter of 2001 was $222
million or 4.1% of revenues as compared to $109 million or 1.9% of revenues for
the second quarter of 2000. On a year-to-date basis, interest expense was $401
million, or 3.8% of revenues as compared to $200 million, or 1.8% of revenues
for the first half of 2000. Excluding Embratel in 2000, interest expense would
have been $118 million, or 2.5% of revenues for the second quarter of 2000 and
$215 million, or 2.3% of revenues for the first half of 2000. Interest expense
on borrowings incurred by WorldCom and allocated to the WorldCom group reflects
the difference between WorldCom's actual interest expense and the interest
expense allocated to the MCI group. The MCI group was allocated interest based
on the weighted-average interest rate, excluding capitalized interest, of
WorldCom debt plus 1 1/4 percent.
MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous income for the second quarter of
2001 was $123 million, or 2.3% of revenues as compared to $109 million, or 1.9%
of revenues for the second quarter of 2000. On a year-to-date basis,
miscellaneous income was $223 million, or 2.1% of revenues as compared to $220
million, or 2.0% of revenues for the first half of 2000. 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
non-operating items.
PROVISION FOR INCOME TAXES. The effective income tax rate was 40.3% of income
before taxes for the second quarter of 2001 and 38.6% of income before taxes for
the first half of 2001. The 2001 rates are greater than the expected federal
statutory rate of 35% primarily due to the amortization of non-deductible
goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which
requires certain activation and installation fee revenues to be amortized over
the average life of the related service rather than be recognized immediately.
Costs directly related to these revenues may also be deferred and amortized over
the customer contract life. This adoption resulted in a one-time expense of $75
million, net of income tax benefit of $43 million, for the WorldCom group in the
first quarter of 2000.
NET INCOME. For the three months ended June 30, 2001, the WorldCom group
reported net income of $110 million as compared to $716 million for the three
months ended June 30, 2000. Pro forma diluted income per common share for the
second quarter of 2001 was $0.04 compared to income per common share of $0.25
for the second quarter of 2000. On a year-to-date basis, pro forma diluted
income per common share was $0.22 as compared to $0.47 for the first half of
2000. Pro forma diluted income per share assumes the recapitalization occurred
at the beginning of 2000 and that the WorldCom group stock and MCI group stock
existed for all periods presented.
MCI GROUP RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the MCI group's
statements of operations in millions of dollars and as a percentage of its
revenues for the periods indicated:
51
<Page>
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------ -------------------------------------
2000 2001 2000 2001
---------------- ---------------- ---------------- ----------------
Revenues ..................................... $ 4,186 100.0% $ 3,548 100.0% $ 8,369 100.0% $ 7,170 100.0%
Line costs ................................... 1,784 42.6 1,807 50.9 3,535 42.2 3,633 50.7
Selling, general and administrative .......... 1,161 27.7 1,430 40.3 2,354 28.1 2,768 38.6
Depreciation and amortization ................ 218 5.2 237 6.7 423 5.1 464 6.5
------- ----- ------- ----- ------- ----- ------- -----
Operating income ............................. 1,023 24.4 74 2.1 2,057 24.6 305 4.3
Other income (expense):
Interest expense ........................ (127) (3.0) (126) (3.6) (254) (3.0) (252) (3.5)
------- ----- ------- ----- ------- ----- ------- -----
Income (loss) before income taxes and
cumulative effect of accounting change .. 896 21.4 (52) (1.5) 1,803 21.5 53 0.7
Provision for income taxes ................... 355 8.5 (23) (0.6) 715 8.5 20 0.3
------- ----- ------- ----- ------- ----- ------- -----
Income (loss) before cumulative effect of
accounting change ....................... 541 12.9 (29) (0.8) 1,088 13.0 33 0.5
Cumulative effect of accounting change ....... -- -- -- -- (10) (0.1) -- --
------- ----- ------- ----- ------- ----- ------- -----
Net income (loss) ............................ $ 541 12.9% $ (29) (0.8)% $ 1,078 12.9% $ 33 0.5%
======= ===== ======= ===== ======= ===== ======= =====
</Table>
THREE AND SIX MONTHS ENDED JUNE 30, 2000 VS.
THREE AND SIX MONTHS ENDED JUNE 30, 2001
REVENUES. Revenues for three months ended June 30, 2001 decreased 15.2% to $3.6
billion versus $4.2 billion for the prior year period. The decrease in total
revenues is primarily attributable to consumers' substitution of wire line
services with wireless and e-mail, and proactive revenue initiatives resulting
in services being de-emphasized as we shift the MCI group's focus from revenue
growth to cash generation.
Actual reported revenues by category for the three and six months ended June 30,
2000 and 2001 reflect the following changes by category (dollars in millions):
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
PERCENT PERCENT
2000 2001 CHANGE 2000 2001 CHANGE
------ ------ ------- ------ ------ -------
Wholesale and consumer ................... $2,819 $2,534 (10.1) $5,709 $5,036 (11.8)
Alternative channels and small business .. 962 610 (36.6) 1,838 1,305 (29.0)
Dial-up Internet ......................... 405 404 (0.2) 822 829 0.9
------ ------ ------ ------
TOTAL .................................... $4,186 $3,548 (15.2) $8,369 $7,170 14.3
====== ====== ====== ======
</Table>
Wholesale and consumer revenues for the second quarter of 2001 decreased 10.1%
over the prior year period. For the first six months of 2001, wholesale and
consumer revenues decreased 11.8%. The wholesale market continues to be
extremely price competitive, although rate per minute began to stabilize in the
second quarter of 2001, and resulted in revenue decreases of 20.3% for the
second quarter of 2001 and 23% for the first half of 2001 versus the prior year
periods. Wholesale revenues for the three and six months ended June 30, 2001
were also impacted by proactive revenue initiatives over the past three
quarters, which were made to improve the quality of the wholesale revenue stream
as we shift the MCI group's focus from revenue growth to cash generation.
Consumer revenues for the second quarter of 2001 decreased 5.5% over the prior
year periods. For the first six months of 2001, consumer revenues decreased 6.6%
over the prior year period. The majority of this decrease is attributed to
decreases in calling card revenues as a result of consumers' substitution of
wire line services with wireless and e-mail, and pricing pressure, although rate
per minute began to stabilize in the fourth quarter of 2000. Our consumer local
initiatives continue to perform well as consumer local revenues increased over
168% for the second quarter of 2001 and 161% for the first half of 2001 versus
the prior year periods.
Alternative channels and small business revenues for the second quarter of 2001
decreased 36.6% and decreased 29.0% for the first half of 2001 over the prior
year periods. Alternative channels and small business includes sales agents and
affiliates, wholesale alternative channels, small business, prepaid calling card
and wireless messaging revenues. These decreases are attributed to pricing
pressures in the wholesale and small business markets which negatively affected
52
<Page>
revenue growth and gross margins in this area, and proactive initiatives to
de-emphasize services with unacceptable gross margins as we shift the MCI
group's focus from revenue growth to cash generation.
Dial-up Internet revenues for the second quarter of 2001 decreased 0.2% and
increased 0.9% for the first half of 2001 over the prior year amounts. Our dial
access network has grown 38% to approximately 3.2 million modems as of June 30,
2001, compared with the prior year period. Additionally, Internet connect hours
increased 17% to 3.7 billion hours for the first half of 2001 versus the prior
year. These network usage increases were offset by pricing pressure resulting
from the impact of volume discounts and off-net traffic, which lowered average
revenue per hour by approximately 17% for the second quarter of 2001 and 19% for
the first half of 2001 versus the prior year periods, although revenue per hour
began to stabilize in the second quarter of 2001.
LINE COSTS. Line costs as a percentage of revenues for the second quarter of
2001 increased to 50.9% as compared to 42.6% reported for the prior year period.
On a year-to-date basis, line costs as a percentage of revenues increased to
50.7% of revenues as compared to 42.2% for the first half of 2000. These
increases were primarily the result of continued competitive pricing on the
dial-up Internet business as noted above, which resulted in a modest increase in
average cost per hour while average dial-up Internet revenues per hour decreased
by 17% for the second quarter of 2001 and 19% for the first half of 2001.
Additionally, line costs as a percentage of revenues increased as a result of
the decrease in higher margin calling card and dial around revenues due to
wireless substitution as noted above. Line costs for the three months ended June
30, 2000 and 2001 included $99 million and $91 million, respectively, of charges
allocated to the MCI group for use of our fiber optic systems, which have been
attributed to the WorldCom group. For the six months ended June 30, 2000 and
2001, these costs were $185 million and $184 million, respectively.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses for the second quarter of 2001 were $1.4 billion or 40.3% of revenues
as compared to $1.2 billion or 27.7% of revenues for the prior year period.
Selling, general and administrative expenses for the second quarter of 2001
include pre-tax costs of $123 million related to the write-off of investments in
certain publicly traded and privately held companies and $11 million as a result
of the costs associated with the tracking stock capitalization. Excluding these
charges, selling, general and administrative expenses for the second quarter of
2001 would have been 36.5%.
On a year-to-date basis, selling, general and administrative expenses were $2.8
billion, or 38.6% of revenues as compared to $2.4 billion or 28.1% of revenues
for the first half of 2000. Selling, general and administrative expenses for the
six months ended June 30, 2001 also includes pre-tax costs of $48 million
associated with domestic severance packages and other costs related to our
February 2001 workforce reductions. Excluding these costs, selling, general and
administrative expenses as a percentage of revenues were 36.1% for the first
half of 2001.
The increase in selling, general and administrative expenses can be attributed
to non-core wholesale initiatives in the last three quarters as discussed above,
which had no immediate effect on selling, general and administrative expenses
for both the wholesale and alternative channels and small business channels and
increases during 2000 to our consumer workforce to support retail activities.
Work force reductions in February 2001 have helped to stabilize selling, general
and administrative expenses in the second quarter of 2001 and should help to
lower selling, general and administrative expenses in the second half of 2001.
Selling, general and administrative expenses for the three months ended June 30,
2001 included $92 million of charges for the MCI group's proportionate share of
costs associated with buildings, furniture and fixtures ($85 million) and the
cost allocated to the MCI group for use of the MCI tradename ($7 million). For
the three months ended June 30, 2000, selling, general and administrative
expenses included $62 million of charges for the MCI group's proportionate share
of costs associated with buildings, furniture and fixtures ($55 million) and the
cost allocated to the MCI group for the use of the MCI tradename ($7 million).
Selling, general and administrative expenses for the six months ended June 30,
2001 included $182 million of charges for the MCI group's proportionate share of
costs associated with buildings, furniture and fixtures ($168 million) and the
cost allocated to the MCI group for use of the MCI tradename ($14 million). For
the six months ended June 30, 2000, selling, general and administrative expenses
included $130 million of charges for the MCI group's proportionate share of
costs associated with buildings, furniture and fixtures ($116 million) and the
cost allocated to the MCI group for the use of the MCI tradename ($14 million).
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the
second quarter of 2001 increased to $237 million or 6.7% of revenues from $218
million or 5.2% of revenues for the same period in the prior year. On a
year-to-date basis, depreciation increased to $464 million, or 6.5% of revenues
as compared to $423 million, or 5.1% of revenues for the first six months of
2000. These increases primarily reflect additional depreciation associated with
2000 and 2001 capital expenditures. Depreciation and amortization for the three
months ended June 30, 2000 and 2001 excludes $21 million and $25 million,
respectively, of charges for business voice switched services provided to the
WorldCom group by the MCI group. For the six months ended June 30, 2000 and
2001, depreciation and amortization expense excludes $41 million and $49
million, respectively, for such costs.
53
<Page>
INTEREST EXPENSE. Interest expense for the second quarter of 2001 was $126
million or 3.6% of revenues as compared to $127 million or 3.0% of revenues for
the same period in 2000. On a year-to-date basis, interest expense was $252
million, or 3.5% of revenues as compared to $254 million, or 3.0% of revenues
for the first half of 2000. Interest expense on borrowings incurred by WorldCom
and allocated to the MCI group was based on the weighted-average interest rate,
excluding capitalized interest, of WorldCom debt plus 1 1/4 percent. As of
January 1, 2000, $6.0 billion of WorldCom's outstanding debt was notionally
allocated to the MCI group.
PROVISION FOR INCOME TAXES. The effective income tax rate was 44.2% of the loss
before taxes for the second quarter of 2001 and 37.7% of income before taxes for
the first half of 2001. The 2001 rates are greater than the expected federal
statutory rate of 35% primarily due to the amortization of non-deductible
goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which
requires certain activation and installation fee revenues to be amortized over
the average life of the related service rather than be recognized immediately.
Costs directly related to these revenues may also be deferred and amortized over
the customer contract life. This adoption resulted in a one-time expense of $10
million, net of income tax benefit of $7 million for the MCI group in the first
quarter of 2000.
NET INCOME. For the three months ended June 30, 2001, the MCI group reported a
net loss of $29 million as compared to net income of $541 million for the three
months ended June 30, 2000. Pro forma diluted loss per common share for the
second quarter of 2001 was $0.25 compared to income per common share of $4.75
for the second quarter of 2000. On a year-to-date basis, pro forma diluted
income per common share was $0.28 as compared to $9.46 for the first half of
2000. Pro forma diluted income per share assumes the recapitalization occurred
at the beginning of 2000 and that the WorldCom group stock and MCI group stock
existed for all periods presented.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2001, our total debt, net of cash and cash equivalents was $25.5
billion. Additionally, at June 30, 2001, we had available liquidity of $14.5
billion under our credit facilities and commercial paper program and cash on
hand.
As of January 1, 2000, the MCI group was notionally allocated $6.0 billion of
WorldCom's debt and the remaining outstanding debt was notionally allocated to
the WorldCom group. WorldCom management has a wide degree of discretion over the
cash management policies of both the WorldCom group and the MCI group. Cash
generated by either group could be transferred to the other group without prior
approval of WorldCom's shareholders. Due to the discretion possessed by
management over the cash management policies of both groups, including the
timing and decision of whether to finance capital expenditures, it may be
difficult to assess each group's liquidity and capital resource needs, and, in
turn, the future prospects of each group based on past performance. For the six
months ended June 30, 2001, the MCI group had generated sufficient cash to repay
$153 million of its allocated notional debt.
On June 8, 2001, we replaced our existing $7 billion 364-Day Revolving Credit
and Term Loan Agreement with two new credit facilities consisting of a $2.65
billion 364-Day Facility, and a $1.6 billion Multi-Year Facility. The 364-Day
Facility and the Multi-Year Facility, together with our $3.75 billion Existing
Facility, provide us with aggregate credit facilities of $8 billion. These
credit facilities provide liquidity support for our commercial paper program and
for other general corporate purposes.
The Existing Facility and the Multi-Year Facility mature on June 30, 2002 and
June 8, 2006, respectively. The 364-Day Facility has a 364-day term, which may
be extended for successive 364-day terms to the extent of the committed amounts
from those lenders consenting thereto, with a requirement that lenders holding
51% of the committed amounts consent and so long as the final maturity date does
not extend beyond June 8, 2006. Additionally, we may elect to convert the
principal debt outstanding under the 364-Day Facility to a term loan maturing no
later than one year after the conversion date, so long as the final maturity
date does not extend beyond June 8, 2006. The Existing Facility is subject to
annual commitment fees not to exceed 0.25% of any unborrowed portion of the
facilities. The 364-Day Facility and the Multi-Year Facility are subject to
annual facility fees not to exceed 0.20% or 0.25%, respectively, of the average
daily commitment under each such facility (whether used or unused).
54
<Page>
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 us
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 generally varies from 0.35% to 0.75% as to loans under the Existing
Facility, from 0.29% to 0.80% as to loans under the 364-Day Facility and 0.27%
to 0.75% as to loans under the Multi-Year Facility, in each case based upon our
then current debt ratings.
The credit facilities are unsecured but include a negative pledge of our assets
and, subject to exceptions, the covered subsidiaries.
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 operating covenants which limit,
among other things, the incurrence of additional indebtedness by us and the
covered subsidiaries and sales of assets and mergers and dissolutions. The
credit facilities do not restrict distributions to shareholders, provided we are
not in default under the credit facilities. As of the date of this filing, we
were in compliance with these covenants.
On May 9, 2001, we completed the pricing of a public debt offering of
approximately $11.9 billion principal amount of debt securities, based on
currency exchange rates on May 8, 2001. The net proceeds of $11.7 billion will
be used for general corporate purposes, including to repay commercial paper, and
repayment of $1.5 billion of our 6.125% notes due August 15, 2001 and $1.5
billion of our floating rate notes due November 26, 2001. The public debt
offering consisted of the following series of notes:
<Table>
<Caption>
PRINCIPAL INTEREST FIRST
AMOUNT MATURITY PAYABLE INTEREST DATE
-----------------------------------------------------------------------------------
6.50% Notes due 2004 $1.5 billion May 15, 2004 Semiannually on May 15 and November 15, 2001
November 15
Semiannually on May 15 and
7.50% Notes due 2011 $4.0 billion May 15, 2011 November 15 November 15, 2001
Semiannually on May 15 and
8.25% Notes due 2031 $4.6 billion May 15, 2031 November 15 November 15, 2001
6.75% Notes due 2008 (euro)1.25 billion May 15, 2008 Annually on May 15 May 15, 2002
7.25% Notes due 2008 (pound)500 million May 15, 2008 Annually on May 15 May 15, 2002
</Table>
All of the notes, except for the 6.50% Notes due 2004 are redeemable, as a whole
or in part, at our option, at any time or from time to time, at respective
redemption prices equal to:
In the case of the U.S. dollar notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the sum of the present values of the Remaining Scheduled Payments,
as defined therein, discounted, on a semiannual basis, assuming a
360-day year consisting of twelve 30-day months, at the Treasury
Rate, as defined therein, plus:
o 30 basis points for the Notes due 2011, and
o 35 basis points for the Notes due 2031;
In the case of the euro notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the sum of the present values of the Remaining Scheduled Payments,
as defined therein, discounted, on an annual basis (based on the
actual number of days elapsed divided by 365 or 366, as the case may
be), at the Reference Euro Dealer Rate, as defined therein, plus 25
basis points; and
55
<Page>
In the case of the sterling notes, the greater of:
o 100% of the principal amount of the notes to be redeemed and
o the price expressed as a percentage (rounded to three decimal
places, with .0005 being rounded up) at which the Gross Redemption
Yield, as defined therein, on the outstanding principal amount of
the notes on the Reference Date, as defined therein, is equal to the
Gross Redemption Yield (determined by reference to the middle-market
price) at 3:00 p.m. (London time) on that date on the Benchmark
Gilt, as defined therein, plus 25 basis points;
plus, in the case of the U.S. dollar notes, the euro notes and the sterling
notes, accrued interest to the date of redemption which has not been paid.
In connection with the Intermedia merger, the holder of Series G preferred stock
of WorldCom exercised its right to require us to redeem, on August 20, 2001, all
of the outstanding Series G preferred stock at par plus accrued interest, or
approximately $200 million.
OPERATING ACTIVITIES
For the six months ended June 30, 2000 and 2001, our cash flows from operations
was as follows (dollars in millions):
<Table>
<Caption>
2000 2001
------ ------
WorldCom group ....................................... $2,996 $2,939
MCI group ............................................ 925 637
------ ------
Net cash provided by operating activities ....... $3,921 $3,576
====== ======
</Table>
The decrease for the six months ended June 30, 2001 versus the prior year amount
reflects increases in working capital requirements in both the WorldCom group
and the MCI group.
INVESTING ACTIVITIES
For the six months ended June 30, 2000 and 2001, our net cash used in investing
activities was as follows (dollars in millions):
<Table>
<Caption>
2000 2001
------- -------
WorldCom group ................................... $(6,678) $(4,747)
MCI group ........................................ (357) (513)
------- -------
Net cash used in investing activities ....... $(7,035) $(5,260)
======= =======
</Table>
The WorldCom group's primary capital expenditures totaled $5.0 billion in the
first half of 2000 and $4.1 billion in the first half of 2001. Primary capital
expenditures include purchases of transmission, communications and other
equipment. The MCI group's capital expenditures totaled $227 million in the
first half of 2000 and $132 million in the first half of 2001. The MCI group's
capital expenditures include purchases of switching equipment, dial modems and
messaging and other equipment.
Investing activities include acquisitions and related costs of $14 million and
$142 million in the first half of 2000 and 2001, respectively.
FINANCING ACTIVITIES
For the six months ended June 30, 2000 and 2001, cash provided by financing
activities was as follows (dollars in millions):
<Table>
<Caption>
2000 2001
------- -------
WorldCom group ..................................... $ 3,470 $ 7,890
MCI group .......................................... (570) (138)
------- -------
Net cash provided by financing activities ..... $ 2,900 $ 7,752
======= =======
</Table>
Financing activities include net proceeds from borrowings on debt of $2.8
billion and $8.0 billion for the first half of 2000 and 2001, respectively. The
increase in the first six months of 2001 is a result of the May 2001, public
debt
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offering noted above. Financing activities for the MCI group reflect the
repayments of intergroup advances and repayment of notionally allocated debt
from WorldCom.
Also included in financing activities are proceeds from WorldCom's common stock
issuances of $431 million and $103 million in the first half of 2000 and 2001,
respectively, as a result of WorldCom common stock option and warrant exercises.
As previously announced, we intend to initially pay a quarterly dividend of
$0.60 per share on the MCI group stock. During the second quarter of 2001, we
declared the first quarterly dividend for the MCI group common stock. A cash
dividend of $0.60 per share of MCI group common stock, or approximately $70
million in the aggregate, will be paid on October 15, 2001 to shareholders of
record as of the close of business on September 28, 2001.
We believe that we will generate sufficient cash flow to service our debt and
capital requirements; however, economic downturns and other adverse
developments, including factors beyond our control, could impair our ability to
service our indebtedness. In addition, the cash flow required to service our
debt may reduce our ability to fund internal growth, additional acquisitions and
capital improvements.
We believe that the Intermedia merger should support our web hosting expansion
by providing a comprehensive portfolio of hosting products and services for
mid-sized and large businesses. This will allow us to accelerate our ability to
provide managed web and application hosting services by 12 to 18 months.
Additionally, we expect that, after consummation of the Intermedia merger, Digex
will continue to build its operations and expand its customer base, causing it
to continue to incur operating losses for the foreseeable future, which could
adversely affect our results of operations.
The development of our businesses and the installation and expansion of our
domestic and international networks will continue to require significant capital
expenditures. We anticipate that such capital expenditures will be approximately
$7.5 billion to $8.0 billion in 2001 for the WorldCom group, and approximately
$500 million for the MCI group. We have 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 acquisitions, we believe that cash
flow from operations and available liquidity, including our credit facilities
and commercial paper program and available cash will be sufficient to meet our
capital needs for the next twelve months.
RECENTLY ISSUED ACCOUNTING STANDARDS
In September 2000 the FASB issued SFAS No. 140 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities and also
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. SFAS No. 140 is
effective for recognition and reclassification of collateral and for disclosures
relating to securitization transactions and collateral for fiscal years ending
after December 15, 2000, and is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31,
2001. The adoption of this standard did not have a material effect on our
consolidated results of operations or financial position.
In June 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS No.
142 "Goodwill and Other Intangible Assets." SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting and broadens the criteria for recording intangible
assets separate from goodwill. Recorded goodwill and intangibles will be
evaluated against this new criteria and may result in certain intangibles being
subsumed into goodwill, or alternatively, amounts initially recorded as goodwill
may be separately identified and recognized apart from goodwill. Under the new
rules, goodwill and intangible assets deemed to have indefinite lives will no
longer be amortized but will be subject to annual impairment tests. The
statement includes provisions for the identification of reporting units for
purposes of assessing potential future impairments of goodwill. Goodwill and
other intangibles, acquired prior to July 1, 2001, will continue to be amortized
until the adoption of the statement. The provisions of each statement which
apply to goodwill and intangible assets will be adopted by us on January 1,
2002. We expect the adoption of these accounting standards will result in
certain of our intangibles being subsumed into
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goodwill and will have the impact of reducing our amortization of goodwill and
intangibles commencing January 1, 2002; however, impairment reviews may result
in future periodic write-downs.
EURO CONVERSION
On January 1, 1999, 11 out of the 15 member countries of the European Union
established the euro, a new common currency for member countries, and fixed
conversion rates between their existing currencies and the euro. The transition
period for the introduction of the euro is between January 1, 1999 to December
31, 2001. We are establishing plans 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, assessing strategies concerning continuity of contracts,
and refining the processes for preparing taxation and accounting records. At
this time, we have not yet determined the cost related to addressing this issue.
We believe that our business will potentially be affected by the impact of
increased price transparency, however, we expect to be able to maintain our
margins across our international operations as a result of any pricing changes
that we decide to make purely as a result of the euro transition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate changes, foreign currency
fluctuations and changes in market values of our investments.
Our policy is to manage interest rates through the use of a combination of fixed
and variable rate debt. We typically do not use derivative financial instruments
to manage our interest rate risk. We have minimal cash flow exposure due to
general interest rate changes for our fixed rate, long-term debt obligations. We
do not believe a hypothetical 10% adverse rate change in our variable rate debt
obligations would be material to our results of operations.
We are exposed to foreign exchange rate risk primarily due to other
international operation's holding of approximately $487 million in U.S. dollar
denominated debt, and our holding of approximately $1.8 billion of indebtedness
indexed in other foreign currencies including the Euro and Sterling Pound as of
June 30, 2001. Our potential immediate loss that would result from a
hypothetical 10% change in foreign currency exchange rates based on this
position would be approximately $200 million. In addition, if that change were
to be sustained, our cost of financing would increase in proportion to the
change.
We are also subject to risk from changes in foreign exchange rates for our
international operations which use a foreign currency as their functional
currency and are translated into U.S. dollars.
We believe our market risk exposure with regard to our marketable equity
securities is limited to changes in quoted market prices for the securities.
Based upon the composition of our marketable equity securities at June 30, 2001,
we do not believe a hypothetical 10% adverse change in quoted market prices
would be material to our results of operations or financial position.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material changes in the legal proceedings reported in
our Annual Report on Form 10-K/A for the year ended December 31, 2000,
except as reflected in the discussion under Note H 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 7, 2001, we filed an amendment to our articles of incorporation to
implement a tracking stock structure that was approved by our shareholders
on June 7, 2001. As a result, two new series of stock were created that
are intended to reflect, or track, the performance of our WorldCom group
businesses and our MCI group businesses. Pursuant to the amendment to our
charter, each share of our exiting common stock
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<Page>
was changed into one share of WorldCom group stock and 1/25 of a share of
MCI group stock. Additionally, our shareholders approved an amendment to
the fair price provisions of our charter to reflect the tracking stock
structure. A description of the rights of the holders of WorldCom group
stock and MCI group stock, and risk factors related to the new tracking
stock structure and to the businesses attributed to each of the WorldCom
group and the MCI group, is set forth in the description of the WorldCom
group stock and the MCI group stock, excerpted from our Registration
Statement on Form S-4, as amended (No. 333-52920), which description is
filed as Exhibit 99.1 to this Form 10-Q and incorporated herein by
reference.
On June 7, 2001, our board of directors approved, and WorldCom executed
and delivered, a Restated Rights Agreement between WorldCom and The Bank
of New York as Rights Agent, and declared a dividend on each share of
WorldCom group stock of a right to purchase 1/1000 of a share of series 4
preferred stock at a purchase price described in the Restated Rights
Agreement, and a dividend on each share of MCI group stock of a right to
purchase 1/1000 of a share of series 5 preferred stock at a purchase price
described in the Restated Rights Agreement. The dividend distribution was
made on June 7, 2001 to shareholders of record on that date. A summary of
the terms of the rights and the related series of preferred stock is set
forth under "Rights Plan" in the description of the WorldCom group stock
and the MCI group stock excerpted from our Registration Statement on Form
S-4, as amended (No. 333-52920), which description is filed as Exhibit
99.1 to this Form 10-Q and incorporated herein by reference.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Securities Holders
On June 7, 2001, we held our 2001 Annual Meeting of shareholders for the
purposes of:
o amending our charter to approve the tracking stock recapitalization;
o amending the fair price provisions of our charter to reflect the
tracking stock structure;
o electing a board of 12 directors; and
o adopting the MCI Group 2001 Employee Stock Purchase Plan.
The tabulation of the voting was as follows:
<Table>
<Caption>
AGAINST OR ABSTENTIONS OR
FOR WITHHELD BROKER NON-VOTES
------------- ----------- -----------
Tracking stock recapitalization 1,607,176,120 64,614,741 459,994,190
Fair price provision amendment 1,575,708,649 120,216,324 435,860,078
Election of Directors:
Clifford L. Alexander, Jr 2,054,990,216 76,794,835 0
James C. Allen 2,055,371,152 76,413,899 0
Judith Areen 2,055,496,001 76,289,050 0
Carl J. Aycock 2,055,356,760 76,428,291 0
Max E. Bobbitt 2,055,310,272 76,474,779 0
Bernard J. Ebbers 1,990,633,597 141,151,454 0
Francesco Galesi 2,054,468,225 77,316,826 0
Stiles A. Kellett, Jr 2,055,293,580 76,491,471 0
Gordon S. Macklin 2,054,457,859 77,327,192 0
Bert C. Roberts, Jr 2,054,366,052 77,418,999 0
John W. Sidgmore 2,055,098,244 76,686,807 0
Scott D. Sullivan 2,052,968,541 78,816,510 0
MCI Group 2001 Employee
Stock Purchase Plan 1,915,312,634 182,228,558 34,243,859
</Table>
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<Page>
Item 5. Other Information
As of June 30, 2000 and 2001, our ratio of earnings to fixed charges was
6.65:1 and 1.90:1, respectively. For the purpose of computing the ratio of
earnings to fixed charges, earnings consist of pretax income from
continuing operations, excluding minority interests in gains/losses of
consolidated subsidiaries, and fixed charges consist of pretax interest,
including capitalized interest, on all indebtedness, amortization of debt
discount and expense, and that portion of rental expense which we believe
to be representative of interest.
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
See Exhibit Index.
B. Reports on Form 8-K
Pursuant to Item 5, "Other Events", we filed Current Reports on Form
8-K dated April 26, 2001 (filed April 26, 2001), May 9, 2001 (filed
May 16, 2001), June 7, 2001 (filed June 7, 2001), and June 8, 2001
(filed June 12, 2001). Additionally, pursuant to Item 7(C) Exhibits,
we filed Current Reports on Form 8-K as noted above as well as a
Current Report on Form 8-K dated May 1, 2001 (filed May 1, 2001).
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report on Form 10-Q to be signed on its behalf
by Scott D. Sullivan, thereunto duly authorized to sign on behalf of the
registrant and as the principal financial officer thereof.
WORLDCOM, INC.
By: /s/ Scott D. Sullivan
------------------------------------
Scott D. Sullivan
Chief Financial Officer
Dated: August 14, 2001.
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<Page>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1.1 Underwriting Agreement dated May 9, 2001, among WorldCom, Inc.
("WorldCom") and J.P. Morgan Securities Inc., Salomon Smith Barney
Inc., J.P. Morgan Securities Ltd. and Salomon Brothers International
Limited, acting severally on behalf of themselves as Managers and
Underwriters and on behalf of the other several Underwriters, if
any, named in the Terms Agreement (incorporated herein by reference
to Exhibit 1.1 to WorldCom's Current Report on Form 8-K dated May 9,
2001 (filed May 16, 2001)(File No. 0-11258))
1.2 Terms Agreement, dated May 9, 2001, among WorldCom, and J.P. Morgan
Securities Inc., Salomon Smith Barney Inc., J.P. Morgan Securities
Ltd. and Salomon Brothers International Limited, acting severally on
behalf of themselves as Managers and Underwriters and on behalf of
the other several Underwriters named therein (incorporated herein by
reference to Exhibit 1.2 to WorldCom's Current Report on Form 8-K
dated May 9, 2001 (filed May 16, 2001)(File No. 0-11258))
2.1 Agreement and Plan of Merger between WorldCom, Wildcat Acquisition
Corp. and Intermedia Communications Inc. dated as amended May 14,
2001 (filed as Annex A to WorldCom's Registration Statement on Form
S-4, Registration No. 333-60482 and incorporated herein by
reference)*
4.1 Articles of Amendment to the Second Amended and Restated Articles of
Incorporation of WorldCom (amending former Article Seven by
inserting Articles Seven D, E, F and G)
4.2 Articles of Amendment to the Second Amended and Restated Articles of
Incorporation of WorldCom (amending former Article Four by deleting
the text thereof and substituting new Article Four)
4.3 Articles of Amendment to the Second Amended and Restated Articles of
Incorporation of WorldCom (amending former Article Eleven by
deleting the text thereof and substituting new Article Eleven)
4.4 Second Amended and Restated Articles of Incorporation of WorldCom
(including preferred stock designations), as amended as of May 1,
2000
4.5 Restated ByLaws of WorldCom, Inc.
4.6 Restated Rights Agreement dated as of June 7, 2001, between WorldCom
and The Bank of New York, which includes the form of Certificate of
Designations, setting forth the terms of the Series 4 Junior
Participating Preferred Stock, par value $.01 per share, and the
Series 5 Junior Participating Preferred Stock, par value $.01 per
share, as Exhibit A, and the form of Rights Certificates as Exhibits
B and C (incorporated by reference to Exhibit 4.4 to WorldCom's
Current Report on Form 8-K dated June 7, 2001 (filed June 7, 2001)
(File No. 0-11258))
4.7 Form of 6.50% Notes Due 2004 (incorporated herein by reference to
Exhibit 4.1 to WorldCom's Current Report on Form 8-K dated May 9,
2001 (filed May 16, 2001)(File No. 0-11258))
4.8 Form of 7.50% Notes Due 2011 (incorporated herein by reference to
Exhibit 4.2 to WorldCom's Current Report on Form 8-K dated May 9,
2001 (filed May 16, 2001)(File No. 0-11258))
4.9 Form of 8.25% Notes Due 2031 (incorporated herein by reference to
Exhibit 4.3 to WorldCom's Current Report on Form 8-K dated May 9,
2001 (filed May 16, 2001)(File No. 0-11258))
4.10 Form of 6.75% Euro Notes Due 2008 (incorporated herein by reference
to Exhibit 4.4 to WorldCom's Current Report on Form 8-K dated May 9,
2001 (filed May 16, 2001)(File No. 0-11258))
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4.11 Form of 7.25% Sterling Notes Due 2008 (incorporated herein by
reference to Exhibit 4.5 to WorldCom's Current Report on Form 8-K
dated May 9, 2001 (filed May 16, 2001)(File No. 0-11258))
4.12 Indenture dated as of May 15, 2000 by and between WorldCom and Chase
Manhattan Trust Company, National Association (incorporated herein
by reference to Exhibit 4.1 to WorldCom's Registration Statement on
Form S-3 (File No. 333-34578))
10.1 364-Day Revolving Credit Agreement among WorldCom and Bank of
America, N.A. and The Chase Manhattan Bank, Co-Administrative
Agents; Banc of America Securities LLC and J.P. Morgan Securities
Inc., Joint Lead Arrangers and Joint Book Managers; Banc of America
Securities LLC, J.P. Morgan Securities Inc., Salomon Smith Barney
Inc., ABN Amro Bank N.V. and Deutsche Banc Alex. Brown Inc.,
Co-Arrangers; Citibank, N.A., Syndication Agent; ABN Amro Bank N.V.
and Deutsche Bank AG New York Branch, Co-Documentation Agents; and
the lenders named therein dated as of June 8, 2001 (incorporated
herein by reference to Exhibit 10.1 to WorldCom's Current Report on
Form 8-K dated June 8, 2001 (filed June 12, 2001) (File No.
0-11258))*
10.2 Revolving Credit Agreement among WorldCom and Bank of America, N.A.
and The Chase Manhattan Bank, Co-Administrative Agents; Banc of
America Securities LLC and J.P. Morgan Securities Inc., Joint Lead
Arrangers and Joint Book Managers; Banc of America Securities LLC,
J.P. Morgan Securities Inc., Salomon Smith Barney Inc., ABN Amro
Bank N.V. and Deutsche Banc Alex. Brown Inc., Co-Arrangers; Citibank
N.A., Syndication Agent; ABN Amro Bank N.V. and Deutsche Bank AG New
York Branch, Co-Documentation Agents; and the lenders named therein
dated as of June 8, 2001 (incorporated herein by reference to
Exhibit 10.2 to WorldCom's Current Report on Form 8-K dated June 8,
2001 (filed June 12, 2001) (File No. 0-11258))*
10.3 Amended and Restated Facility A Revolving Credit Agreement among
WorldCom, NationsBank, N.A., NationsBanc Montgomery Securities LLC,
Bank of America NT & SA, Barclays Bank PLC, The Chase Manhattan
Bank, Citibank, N.A., Morgan Guaranty Trust Company of New York, and
Royal Bank of Canada and the lenders named therein dated as of
August 6, 1998 (incorporated herein by reference to Exhibit 10.1 to
WorldCom's Current Report on Form 8-K dated August 6, 1998 (filed
August 7, 1998) (File No. 0-011258)) (incorporated herein by
reference to Exhibit 10.3 to WorldCom's Current Report on Form 8-K
dated June 8, 2001 (filed June 12, 2001) (File No. 0-11258))*
12.1 Statement re: Computation of Ratio of Earnings to Fixed Charges
99.1 Description of WorldCom, Inc.-WorldCom group common stock and
WorldCom, Inc.-MCI group common stock excerpted from WorldCom's
Registration Statement on Form S-4, as amended (No. 333-52920)
* The registrant hereby agrees to furnish supplementally a copy of any
omitted schedules to this Agreement to the SEC upon request.
63