Back to GetFilings.com
1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-20803
IXC COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2644120
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
1122 CAPITAL OF TEXAS HIGHWAY SOUTH, AUSTIN, TEXAS 78746
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (512) 328-1112
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
TITLE OF CLASS
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock of the Registrant held by
non-affiliates of the Registrant on February 27, 1998, based on the closing
price of the Common Stock on the Nasdaq National Market on such date, was
$940,746,077.
The number of shares of the Registrant's Common Stock outstanding as of
February 27, 1998 was 31,674,484 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days of December 31, 1997 in connection with
the Annual Meeting of Stockholders are incorporated by reference into Part III
hereof.
================================================================================
2
IXC COMMUNICATIONS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
INDEX
PAGE
----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 27
Item 3. Legal Proceedings........................................... 28
Item 4. Submission of Matters to a Vote of Security Holders......... 28
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 29
Item 6. Selected Financial Data..................................... 30
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 31
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 40
Item 8. Financial Statements and Supplementary Data................. 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 40
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 41
Item 11. Executive Compensation...................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 41
Item 13. Certain Relationships and Related Transactions.............. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 42
Signatures............................................................ 46
Glossary.............................................................. A-1
Financial Statements.................................................. F-1
i
3
PART I
Certain of the information contained in the Registrant's Form 10-K (the
"Form 10-K"), including information regarding the Registrant's expectations with
respect to its network expansion, related financings and fiber sale and
cost-saving agreements, future operations and other information, which can be
identified by the use of forward-looking terminology, such as "may," "will,"
"expect," "anticipate," "estimate," "believe," "seek" or "continue" or the
negative thereof or other variations thereon or comparable terminology, are
forward-looking statements which involve risk and uncertainty. The Registrant's
actual results may differ significantly from the results discussed in the
forward-looking statements. For a discussion of important factors that could
cause actual results to differ materially from the matters described in the
forward-looking statements, see "Business -- Risk Factors." Certain terms used
herein are defined in the Glossary at page A-1. As used herein, unless the
context otherwise requires, the term "Company" refers to IXC Communications,
Inc. ("IXC Communications") and its subsidiaries, including predecessor
corporations.
ITEM 1. BUSINESS
OVERVIEW
The Company
The Company is a leading provider of voice and data transmission services
to communications companies and end users. The Company owns and operates one of
the newest and most advanced coast-to-coast digital communications networks (the
"Network"), which is expected to include over 11,500 route miles of digital
transmission facilities ("digital route miles") by the end of the first quarter
of 1998. Substantial additions to the Network are currently under construction,
and the Company expects the Network to include over 18,000 digital route miles
by the end of 1998, and over 20,000 digital route miles by the end of 1999. The
Company's facilities also include seven long distance switches and 15 Frame
Relay-ATM switches, which the Company is using to capitalize on the growing
demand for Internet and electronic data transfer services. Through a combination
of its own facilities and the facilities of other carriers, the Company
originates and terminates long distance traffic in all 50 U.S. states, and
terminates long distance traffic in over 200 foreign countries. The Company's
revenues have grown rapidly, from $91.0 million in 1995 to $203.8 million in
1996 and $420.7 million in 1997.
The Company provides two principal products: transmission of voice and data
over dedicated circuits ("private lines") and transmission of long distance
traffic processed through the Company's switches ("long distance switched
services"), including Frame Relay and ATM-based switched data services. The
Company's customers include AT&T, MCI, Sprint, WorldCom, Cable & Wireless,
Excel, Frontier and over 300 other long distance companies, wireless companies,
cable television providers, Internet service providers, governmental agencies,
and, with the pending acquisition of Network Long Distance, Inc. ("NLD"), a long
distance company, small- and medium-sized businesses.
Private Line Business. The Company's private line customers include
non-facilities-based carriers requiring dedicated long distance transmission
capacity to carry their customers' long distance traffic and facilities-based
carriers that require long distance transmission capacity where they have
geographic gaps in their facilities, need additional capacity or require
geographically diverse routing. The Company has private line circuit contracts
with over 230 customers, including AT&T, MCI, Sprint, WorldCom, Cable &
Wireless, Frontier and LCI. Pursuant to these contracts, customers are required
to make fixed monthly payments, generally in advance. Many of the contracts
contain substantial "take or pay" commitments.
Long Distance Switched Services Business. The long distance switched
services that the Company provides are processed through the Company's digital
switches and carried over long distance circuits and other transmission
facilities owned or leased by the Company. The Company sells these services on a
per-call basis, charging by minutes of use ("MOUs"), with payment due monthly
after services are rendered. The Company's primary customers for switched
services include long distance resellers (both switchless resellers and switched
resellers that lack a switch in a geographic region) that use the Company's
network to provide long distance service to end-user customers. The Company has
long distance switched services contracts with over 100 long distance resellers.
1
4
The Company provides retail switched long distance services to small- and
medium-sized businesses through Telecom One, which it acquired in July 1997. The
Company believes that its planned acquisition of NLD, which had 1997 revenues of
over $100 million, will provide an important foundation for further growth in
the business retail long distance market. The Company seeks to make additional
targeted acquisitions of resellers that provide significant network or product
synergies. The Company has also entered into a joint venture with Unidial
Communications to sell communications services using the Company's network
through a full-time, national direct sales force.
Data Services. The Company's Network, which includes 15 Frame Relay-ATM
switches, has been built with SONET technology and broadband capabilities to
provide a platform to support advanced, capacity-intensive products such as
Frame Relay, ATM, multimedia, and Internet-related applications. The Company has
recently begun marketing a full line of data transport services to its
customers. Additionally, the Company recently announced the acquisition of
Network Evolutions, Inc. ("NEI"), a company that provides data consulting
services and designs internal and external data networking solutions for
corporations. In February 1998, the Company entered into a strategic alliance
with PSINet Inc. ("PSINet"), a major Internet service provider, whereby the
Company will provide transmission capacity for PSINet and will resell PSINet's
broad spectrum of Internet services. In addition, the Company acquired 20% of
PSINet's common stock.
Fiber Sales. The Company has sold excess fiber to MCI and LCI, and expects
to continue to use its excess fibers to lower the Company's effective network
construction cost by selling or swapping such fibers. In 1997, the Company
received cash proceeds of approximately $57.0 million from such sales, but
because of its accounting policies, only recorded $0.8 million as revenue from
fiber sales during the year. Instead of recognizing fiber sale revenues
immediately, the Company records such revenues over the term of the sale/use
agreements, usually 20 years or more. In addition to fiber sales, the Company
has swapped excess fibers on certain sections of its network with other carriers
and in 1997 acquired rights to routes being constructed from Los Angeles to San
Francisco, Las Vegas to Portland, and Washington, D.C. to Houston and New York
City to Washington, D.C. in such exchanges.
International Joint Ventures. The Company is involved in a joint venture
with Telenor AS, the Norwegian national telephone company, to provide
telecommunication services to carriers and resellers in 11 European countries.
The Company also indirectly holds a minority interest in Marca-Tel, a Mexican
telecommunications provider.
The principal executive offices of IXC Communications are located at 1122
Capital of Texas Highway South, Austin, Texas, 78746 and its telephone number is
(512) 328-1112.
INDUSTRY
Development and Regulation
The development of the long distance telecommunications industry was
strongly influenced by a 1982 court decree requiring the divestiture by AT&T of
its seven RBOCs and dividing the country into approximately 200 LATAs. The seven
RBOCs were allowed to provide local telephone service, local access service to
long distance carriers and intra-LATA long distance service (service within a
LATA), but were prohibited from providing inter-LATA service (service between
LATAs). The right to provide inter-LATA service was given to AT&T and the other
interexchange carriers, including the LECs that are not RBOCs. The FCC requires
all interexchange carriers to allow the resale of their inter-LATA services to
long distance carriers, and the 1982 court decree substantially eliminated
different access arrangements as distinguishing features among long distance
carriers. These and other legislative and judicial factors have helped smaller
long distance carriers emerge as alternatives to AT&T, MCI and Sprint for long
distance services.
In 1996, the federal government enacted the Telecommunications Act of 1996
(the "Telecom Act"), which, among other things, allows the RBOCs and others such
as electric utilities and cable television companies to enter the long distance
business. The Company expects that the Telecom Act will substantially alter the
way in which the telecommunications industry is regulated. Such changes are,
however, difficult to predict accurately, because FCC proceedings and appellate
review of the numerous administrative regulations
2
5
adopted to implement the Telecom Act, including universal service and access
charge reform, are still ongoing. Entry of the RBOCs or other entities such as
electric utilities, cable television companies or foreign companies into the
long distance business may result in reduced market shares for existing long
distance companies and additional pricing pressure on long distance providers
such as the Company. See "-- Risk Factors -- Competition," "-- Risk
Factors -- Recent Legislation and Regulatory Uncertainty" and "-- Regulation."
Market and Competition
General. The long distance market is highly competitive. Competition among
the Company's customers and other retail long distance providers for end-user
customers is based upon pricing, advertising, customer service, network quality
and value-added services. Industry observers estimate that over 400 smaller
companies have emerged to compete in the long distance business. See "-- Risk
Factors -- Competition."
Private Line Services. Long distance companies may be categorized as
facilities-based carriers and non-facilities-based carriers. Sellers of private
line services are generally facilities-based carriers that own long distance
transmission facilities, such as fiber optic cable or digital microwave
equipment. The first-tier and some second-tier long distance companies are
facilities-based carriers offering private line services nationwide.
Facilities-based carriers in the third tier of the market generally offer
private line services only in a limited geographic area. Customers using private
line services include: (i) facilities-based carriers that require long distance
transmission capacity where they have geographic gaps in their facilities, need
additional capacity or require geographically different alternative routing; and
(ii) non-facilities-based carriers requiring long distance transmission capacity
to carry their customers' long distance traffic. The Company's competitors in
the private line business include AT&T, MCI, Sprint, WorldCom, Qwest and certain
regional carriers. MCI and WorldCom have announced a planned merger, and
applications for approval of that merger are pending. If the MCI/WorldCom merger
is approved, the result would be an even larger, and potentially stronger,
entity with whom the Company would have to compete. Qwest is constructing a
coast-to-coast fiber optic network and Frontier has agreed to pay $500.0 million
for fibers in Qwest's network. Qwest is, and Frontier may become, a competitor
of the Company, in the private line business. In addition, Qwest and LCI have
also recently announced a planned merger. The Qwest/LCI merger would result in
another larger, and potentially stronger, competitor. Furthermore, Level 3, a
telecommunications and information service company, has announced that it will
spend approximately $3.0 billion to construct a 20,000 mile fiber optic
communications network entirely based on Internet technology. The Williams
Companies, a competitor of the Company, has also announced that it is
accelerating the expansion of its national fiber optic network with a $2.7
billion investment to create a 32,000 mile system by the end of 2001. Important
competitive factors in the private line business are price, customer service,
network location and quality, reliability and availability. See "-- Private Line
Services."
Long Distance Switched Services. Long distance companies may be
characterized as switched or switchless carriers. Sellers of long distance
switched services are generally switched carriers, such as the Company, that own
one or more switches that direct telecommunications traffic. Facilities-based
carriers are generally switched carriers. However, many non-facilities based
carriers (e.g., many long distance resellers) have switches. The Company's
customers for switched services are switchless carriers that depend on switched
carriers to provide long distance switched services to their end users. The
Company's competitors in the long distance switched services business include
AT&T, MCI, Sprint, WorldCom and Frontier and many non-facilities-based switched
carriers. Important competitive factors in the long distance switched services
business are price, customer service (particularly with respect to speed in
delivery of computer billing records and set-up of new end users with the LECs),
ability of the network to complete calls with a minimum of network-caused busy
signals, scope of services offered, reliability and transmission quality.
Call Routing
An inter-LATA long distance telephone call begins with the caller's LEC
transmitting the call by means of its local switched network to a point of
connection with an interexchange carrier. The interexchange carrier, through its
switches and long distance transmission network, transmits the call to the
called party's LEC,
3
6
which then completes the call over its local facilities. For each long distance
call, the originating LEC charges an access fee. The interexchange carrier also
charges a fee for its transmission of the call, a portion of which consists of a
fee charged by the LEC used to deliver the call. Under the Telecom Act, state
proceedings may in certain instances determine LEC access charge rates. Further,
ongoing access charge proceedings at the federal level may affect the access
charges long distance carriers pay to LECs. It is uncertain at this time what
effect such proceedings may have on such rates.
Technology
Long distance voice traffic generally is transmitted through digital
microwave or fiber optic systems. Long distance data traffic is generally
transmitted through fiber optic systems or satellites.
Fiber Optic Systems. Fiber optic systems use laser-generated light to
transmit voice and data in digital format through fine strands of glass. Fiber
optic systems are characterized by large circuit capacity, good sound quality,
resistance to external signal interference and direct interface with digital
switching equipment. A pair of modern fiber optic strands, using current
technology, is capable of carrying four OC-192s. Because fiber optic signals
disperse over distance, they must be regenerated at sites located along the
fiber optic cable (on older fiber optic systems the interval is 20 to 25 miles;
on newer systems that utilize modern fiber optic cable and splicing methods,
such as will be used in the expansion of the Company's digital
telecommunications network (the "Network"), it is approximately 50 to 75 miles).
Microwave Systems. Although limited in capacity in comparison with fiber
optic systems (generally, no more than 28 DS-3s can be transmitted by microwave
between two antennae), digital microwave systems offer an effective and reliable
means of transmitting voice and data signals over intermediate and longer
distances. Microwaves are very high frequency radio waves that can be reflected,
focused and beamed in a line-of-sight transmission path. Because of their
electro-physical properties, microwaves can be used to transmit signals through
the air, with relatively little power. To create a communications circuit,
microwave signals are transmitted through a focusing antenna, received by an
antenna at the next station in the network, then amplified and retransmitted.
Because microwaves attenuate as they travel through the air, this transmission
process must be repeated at repeater stations, which consist of radio equipment,
antennae and back-up power sources, located on average every 25 miles along the
transmission network.
BUSINESS STRATEGY
The Company's objective is to become the preferred provider of integrated
network-based information delivery solutions, utilizing its high-capacity,
state-of-the-art national fiber network. The Company's primary near-term goals
are to: (i) increase revenues by using the expanded Network to generate new
customers and increasing business from existing customers; (ii) improve
profitability by migrating traffic from circuits leased from other carriers onto
the Network; (iii) enter into additional cost-saving arrangements with other
carriers to reduce the cost of the existing Network construction and develop
additional Network expansion opportunities; (iv) leverage the relationship with
PSINet to generate new Internet services customers and large account customers
who require bundled voice, data and Internet transmission services; and (v)
complete the acquisition and integration of NLD, including the migration of its
traffic onto the Network.
In order to achieve these goals the Company intends to pursue the following
strategy:
Enter Into Cost-Saving Arrangements. The Company has included excess fiber
in its Network expansion which it is using to reduce the net cost of
construction through: (i) leasing or selling excess fiber to other carriers; and
(ii) exchanging excess fiber for fibers or capacity on other carriers' networks.
Additionally, the Company seeks to obtain the right to install Company-owned
fibers in new routes being constructed by other carriers along the proposed
Network expansion routes in exchange for the Company (a) sharing network
construction costs; (b) allowing the other carrier to use excess fiber along
certain routes in the Network; or (c) allowing the other carrier to add its own
fiber to certain segments of the Network.
4
7
The Company has already entered into cost-saving agreements with other
carriers that are expected to reduce the per-route-mile cost of construction,
including:
(i) a contract with WorldCom pursuant to which each company has
constructed a fiber route approximately 1,100 miles long and placed fibers
for both companies along the route;
(ii) contracts with LCI pursuant to which LCI has agreed to purchase
an IRU in fibers from Chicago to Los Angeles for approximately $97.9
million (the "Chicago-LA LCI Fiber Sale") and from Cleveland to New York
for approximately $20.0 million (the "Cleveland-NY LCI Fiber Sale");
(iii) a contract with MCI pursuant to which MCI has agreed to purchase
an IRU in fibers from New York to Los Angeles for approximately $121.0
million (the "MCI Fiber Sale");
(iv) a contract with Vyvx to exchange the use of certain fibers on the
Company's New York to Los Angeles route for the use of fibers on an
approximately 1,760-mile route under construction by Vyvx from Washington
D.C. to Houston;
(v) joint construction agreements with LCI, DTI and CCTS allowing the
Company to share the costs of constructing certain routes in Illinois, Ohio
and Missouri;
(vi) a contract with MFS pursuant to which MFS will include fibers for
the Company in a route it is constructing from Cleveland to New York;
(vii) contracts with GST and WorldCom providing for the sale of fiber
along certain routes;
(viii) a contract with FTV to exchange the use of certain fibers on
the Company's Las Vegas to Los Angeles route for the use of fibers on FTV's
Las Vegas to Portland route;
(ix) a contract with MFN to exchange the use of certain fibers on the
Company's Chicago to New York route for the use of fibers on MFN's
Washington D.C. to New York route; and
(x) a contract with GST to exchange the use of certain fibers on the
Company's Phoenix to Los Angeles route for the use of fibers on GST's route
from Los Angeles to Oakland (near San Francisco).
Reduce Operating Costs. The Company expects to achieve substantial
operating cost savings from the Network expansion by replacing a portion of the
capacity it leases from other carriers with its own Network capacity. The
Company incurred costs of approximately $92.2 million for leased off-net fiber
optic capacity from other carriers in 1997. Although revenue growth may result
in increased future off-net usage, the Company believes the Network expansion
will result in reduced expenditures for capacity currently leased off-net (as
well as reduced expenditures for future capacity otherwise required to support
revenue growth) and increased operating cash flow, because the new fiber routes
(i) are targeted for geographic areas that the Network currently does not reach
or is capacity limited or where the Company leases off-net capacity and (ii)
will allow the Company to enter into additional exchanges of fiber capacity on
new routes with other carriers.
Increase Private Line Revenues. Geographic limitations and nearly full
utilization of the then-existing Network previously limited the Company's
ability to expand its private line business. The Network expansion has added
high-capacity new routes and substantially increased the capacity of certain
existing routes, allowing the Company to lease additional circuits to its
customers, including high-capacity, high-margin circuits such as OC-3s, OC-12s
and OC-48s. The Company has already generated significant orders for capacity on
the new routes. The Company continues to seek significant new orders over the
Network expansion routes and believes that it is well positioned to obtain such
orders.
Additionally, the Company specifically designed the Network expansion along
routes geographically diverse from those of other facilities-based carriers. In
recent years, companies such as AT&T and MCI have used the Company to provide
alternative routes to help protect their networks in the event of a service
outage. Such companies prefer routes separated geographically from their own
networks to increase the possibility that the alternative route will be
functional in the event of a natural disaster. The Company believes that the
5
8
Network expansion greatly increases the attractiveness of the Company's Network
as an alternative routing network backup to the major carriers.
Expand the Long Distance Switched Services Business. The Company has
established itself as an alternative provider of long distance switched services
with nation-wide origination and domestic and international termination
capability with switched services revenues in 1997 of $258.3 million. The
Company currently has over 100 customers and believes that it is well positioned
to attract other long distance resellers for its long distance switched
services. The Company believes that the low embedded cost of its Network
provides a significant advantage when competing to provide long distance
switched traffic to resellers, cable companies, RBOCs, utility companies and
others which are permitted to enter the long distance business under recent
changes in telecommunications law. By the end of 1998, the Company intends to
add four additional long distance voice/data switches which, if installed, will
provide additional capacity to originate and terminate traffic. Although the
Company has not yet achieved positive EBITDA in its long distance switched
services business, the Company is seeking to improve the results in this
business by continuing to seek a more efficient customer traffic mix and by
increasing the scale and scope of traffic carried over its Network.
Specifically, the Company's focus is on (i) obtaining traffic that meets its
profitability requirements and aligns with the Company's current and planned
Network, (ii) identifying new products and customers with large capacity
requirements, (iii) identifying Internet, intranet and data traffic
opportunities and (iv) identifying joint venture and acquisition candidates that
will increase the flow and mix of traffic in the Company's Network and increase
its reach.
Expand Data and Internet Business. The Company is using advanced fiber
optic technology in its Network expansion. The expanded Network's SONET
technology and broadband capabilities provide a platform to support advanced,
capacity-intensive products such as Frame Relay, ATM, multimedia, and
Internet-related applications. The Company has equipped its network with 15 data
switches (8 more are expected by the end of 1998) and other equipment necessary
to enter into the Frame Relay and ATM transmission business. The Company has
agreed to acquire a small company with data communications expertise to increase
its data engineering capabilities. The acquisition, in which the Company will
issue approximately 42,000 shares of Common Stock, is scheduled to close in the
first half of 1998.
To enhance the Company's product and service offerings, in February 1998,
the Company consummated agreements with PSINet which allow each party to market
and sell the products and services of the other party. Under the terms of the
agreements, the Company will provide PSINet with a 20-year IRU in 10,000 miles
of OC-48 transmission capacity on its Network in exchange for approximately 10.2
million shares representing 20% (post-issuance) of PSINet's common stock.
Establish Long-Term Customer Relationships. The Company seeks to establish
a dependable revenue stream through long-term relationships with its customers.
The Company has private line contracts (generally on a long-term basis) with
over 230 long distance carriers, including AT&T, MCI, Sprint, WorldCom, Cable &
Wireless, Frontier and LCI. The Company has historically enjoyed a high customer
retention rate in its private line business. Although the Company's switches
first became fully operational in the first quarter of 1996, the Company has
already entered into contracts with over 100 long distance resellers.
Provide a Sophisticated Automated Software Interface. The Company seeks to
increase its attractiveness to existing and potential customers of switched long
distance services by providing a sophisticated automated interface to the
Company's computer system through its proprietary IXC Online software. Utilizing
IXC Online, customers are able to access up-to-date information regarding their
end-user customers and the calls made by such end-users. IXC Online is designed
to allow each of the Company's carrier customers to: (i) download call detail
records for its end-users for billing purposes; (ii) arrange with the
appropriate LEC to register the carrier as the designated long distance carrier
for its new end-users; and (iii) file trouble reports for resolution.
6
9
THE COMPANY'S NETWORK
Facilities
As of December 31, 1997, the Network included over 10,500 digital route
miles (including over 5,500 fiber route miles). The Network is expected to
include over 11,500 digital route miles (including over 6,500 fiber route miles)
by the end of the first quarter of 1998. Prior to beginning construction of the
Network expansion in late 1995, the Company owned a digital coast-to-coast
network containing over 1,900 route miles of fiber optic cable and over 5,000
route miles of digital microwave. As of December 31, 1997, the Company had over
3,600 route miles of advanced fiber optic cable and electronics in operation.
The Company is expected to have over 5,000 route miles of advanced fiber optic
cable and electronics in operation by the end of the first quarter of 1998.
The Company's owned facilities are supplemented with approximately 240,000
equivalent DS-3 miles of fiber capacity obtained from other carriers. Of such
capacity, over 200,000 DS-3 miles are leased by the Company. Approximately
39,000 DS-3 miles of such capacity are obtained by the Company through long-
term capacity-exchange agreements with MCI and WorldCom whereby the Company
trades capacity or fibers on its fiber network for capacity on the other
carriers' networks. In addition, the Company has agreements with CCTS and LCI to
exchange OC-48 capacity on certain routes. The Company has been able to
negotiate these significant exchange agreements because of the placement of the
Company's existing Network in locations where other facilities-based carriers
require additional capacity and the comparatively large expense to such other
carriers of constructing new fiber optic facilities. Such exchange agreements
increase the scope of the Network through the addition of the exchanged capacity
while reducing the Company's cash expenditures for off-net facilities.
The Network includes seven digital long distance voice/data switches
located in Los Angeles, Dallas, Chicago, Philadelphia, Atlanta, Joplin, Missouri
and New York, New York each directly connected over either on-net or off-net
private line circuits: (i) to at least two other switching centers; (ii) to
certain of the Company's over 50 Hubs (local connection points); and (iii) to
certain LEC Central Office switches. The Company plans to install four
additional voice/data switches in 1998. The Hubs are connected (generally by
off-net circuits) to LEC Central Office switches, which in turn are connected to
end-user telephone lines. The switches utilize common channel signaling (SS7),
which reduces connect time delays. The Network also includes 15 Frame Relay-ATM
data switches located in major cities. The Company's switched operations are
supplemented by agreements with Frontier and WorldCom. Under such agreements,
Frontier and WorldCom supply switched capacity to the Company on a per-minute
basis, automatically handling calls routed through LEC Central Offices not
connected to the Company's Hubs or switches and calls which exceed the capacity
of the Company's switched network.
The capacity of the Company's switches may be expanded with processor
upgrades, additional memory and ports. The Company plans to add more ports and
other equipment for its existing switches and to add additional switches as
required to accommodate customer demand, including 8 additional Frame Relay-ATM
switches by the end of 1998.
The new fiber optic routes are being constructed with fiber capable of
supporting bi-directional SONET rings for enhanced network reliability. As each
new route is completed and placed into service, it will be equipped with an
OC-48 in order to provide initial transmission capacity. The Company is
currently in the process of equipping certain of its routes with additional
OC-48s in order to meet customer demand for its services.
Network Reliability
The Network offers a reliable means of transmitting large volumes of voice
and data signals. To assist in providing reliable and high-quality transmission
service, all important functions of the network are monitored during regular
business hours from regional operations centers in Columbus, Kansas City, Fort
Worth and Tucson. Thereafter, monitoring is conducted from the Company's
national operations center in its Austin headquarters. The national center also
provides overall system monitoring on a 24-hour basis. This system
7
10
alerts the Company to situations which could affect customer transmission and
generally allows the Company to take remedial actions before customer service is
affected. In addition, at December 31, 1997, the Company employed approximately
83 operations personnel who are based along the Network to perform preventative
maintenance as well as repair functions on its private line network. Company
operations personnel conduct annual system performance testing and make periodic
unannounced visits to terminal sites to evaluate technician performance. At
December 31, 1997, the Company maintained a staff of 31 technicians to provide
maintenance and other technical support services for switched long distance
services.
Network Expansion
In 1995 the Company began a significant expansion of the Network. The
expanded Network is expected to deliver the following significant strategic and
financial benefits to the Company:
(i) substantial savings by allowing the Company to move on to its own
Network a significant portion of its traffic that it currently carries on
circuits which it leases from other carriers;
(ii) high-capacity new routes and substantially increased capacity on
certain existing routes, allowing the Company to increase revenues by
leasing additional circuits to its customers, including high-capacity
circuits such as OC-3s, OC-12s and OC-48s;
(iii) lower underlying transmission and network operating costs;
(iv) sufficient capacity to support increasing demand expected from
Internet and multimedia applications, Frame Relay and ATM; and
(v) reduced capital costs through sales and exchanges of excess fiber
which the Company is including in its Network expansion specifically for
that purpose.
The Network expansion is planned to add thousands of additional fiber route
miles to increase the geographic scope and capacity of the Company's previously
existing network. It will connect the Company's switches with high-capacity
private line circuits, utilizing advanced fiber optic technology capable of
efficiently transmitting capacity-intensive services, such as Internet, Intranet
and multimedia applications, Frame Relay and ATM. The routes of the Network
expansion are planned to be generally geographically diverse from the existing
fiber networks of AT&T, MCI, Sprint and WorldCom.
The Company expects that the Network expansion will produce additional cost
savings by supporting growth in its private line and long distance switched
services businesses which would otherwise require significant off-net capacity
usage. The Network expansion will enable the Company to avoid increased
expenditures for leasing off-net capacity because the new fiber routes: (i)
should carry much of the traffic that would otherwise be transmitted over
off-net circuits and (ii) may enable the Company to enter into additional
exchanges of fiber capacity with other carriers. In this way, the Company seeks
to improve cash flow through increasing revenues and reducing certain costs. The
Network expansion has already enabled the Company to obtain significant orders
for capacity on the new routes. The Company continues to seek significant new
orders over the Network expansion routes and believes that it is well positioned
to obtain such orders.
Frame Relay, ATM and Internet Services. During the first quarter of 1997,
the Company began providing Frame Relay and ATM-based switched data services in
order to capitalize on the growing demand for Internet and electronic data
transfer services. To enhance the Company's product and service offerings, in
February 1998, the Company consummated agreements with PSINet which allow each
party to market and sell the products and services of the other party. Under the
terms of the agreements, the Company will provide PSINet with a 20-year IRU in
10,000 miles of OC-48 transmission capacity on its Network in exchange for
approximately 10.2 million shares representing 20% (post-issuance) of PSINet
common stock. If the value of the PSINet common stock received by the Company is
less than $240.0 million at the earlier of one year after the final delivery of
the transmission capacity (scheduled for late-1999) or four years after the
transaction's closing, PSINet, at its option, will pay the Company cash and/or
deliver additional PSINet common stock to bring the value of the Company's
investment to $240.0 million. Upon delivery of the transmission capacity to
8
11
PSINet, the Company will begin to receive a maintenance fee which, as the full
capacity has been delivered, should increase to approximately $11.5 million per
year.
Construction. The Company has planned the Network expansion to cover, to
the greatest extent practicable, routes where one or more of the following
factors are present: (i) customer demand indicates a need for high-capacity
fiber network on the route; (ii) the route is attractive as a complement to the
routes of other carriers, which may enable the Company to lease its new capacity
on the route to other carriers or exchange a portion of its new capacity on the
route for capacity from other carriers; or (iii) the capacity will replace
capacity leased by the Company from other carriers.
Plans to complete the Network expansion along the following routes (the
routes and expected delivery dates are subject to change) are as follows:
(i) One route will consist of a fiber optic route to supplement the
Company's existing New York-Los Angeles route, which consists primarily of
digital microwave facilities which are now used to capacity. This
coast-to-coast route is to extend from New York to Los Angeles over new
fiber optic cable through upstate New York, Cleveland, Chicago, St. Louis,
Dallas, Phoenix and Las Vegas. This route, much of which is already
complete, is scheduled for completion during the first quarter of 1998.
(ii) An additional route is now under construction from Washington,
D.C. to Atlanta and then to Houston. The Washington-Atlanta portion of the
route will be constructed by Vyvx and is scheduled for completion in
mid-1998. Additions to the route, from New York to Washington, D.C. and
Houston to Dallas, are scheduled to be completed by the end of 1998.
(iii) Routes are also planned for construction from Los Angeles to San
Francisco, and to link Toledo, Detroit and Chicago.
Additional routes will be added to the Network expansion as opportunities
for advantageous cost sharing or exchange arrangements arise or as customer
demand requires.
The Company plans generally to light initially only two to four of the new
fibers in the route from New York to Los Angeles via St. Louis and the route
from New York to Houston via Atlanta. Certain of the remaining fibers will be
reserved and used as a platform to support emerging capacity-intensive data and
multimedia applications. The Company intends to light additional fibers as
needed in the future and may use the other additional fibers for sale or
exchange arrangements, such as the PSINet transaction. See "-- Business
Strategy" and "-- Risk Factors -- Risks Relating to the Network Expansion."
The Company has already entered into cost-saving agreements with other
carriers that have reduced the per-route-mile cost of construction, including:
(i) a contract with WorldCom pursuant to which each company has
constructed a fiber route approximately 1,100 miles long and placed fibers
for both companies along the route;
(ii) the Chicago-LA LCI Fiber Sale and Cleveland-NY LCI Fiber Sale;
(iii) the MCI Fiber Sale;
(iv) a contract with Vyvx to exchange the use of certain fibers on the
Company's New York to Los Angeles route for the use of fibers on a
1,600-mile route under construction by Vyvx from Washington D.C. to
Houston;
(v) joint construction agreements with LCI, DTI and CCTS allowing the
Company to share the costs of constructing certain routes in Illinois, Ohio
and Missouri;
(vi) a contract with MFS pursuant to which MFS will include fibers for
the Company in a route it is constructing from Cleveland to New York (MFS
has been acquired by WorldCom);
(vii) contracts with GST and WorldCom providing for the sale of fiber
along certain routes;
(viii) a contract with FTV to exchange the use of certain fibers on
the Company's Las Vegas to Los Angeles route for the use of fibers on FTV's
Las Vegas to Portland route;
9
12
(ix) a contract with MFN to exchange the use of certain fibers on the
Company's Chicago to New York route for the use of fibers on MFN's
Washington D.C. to New York route; and
(x) a contract with GST to exchange the use of certain fibers on the
Company's Phoenix to Los Angeles route for the use of fibers on GST's route
from Los Angeles to Oakland (near San Francisco).
Cost. The principal components of the cost of the Network expansion will
include: (i) fiber optic cable; (ii) engineering and construction; (iii)
electronics; and (iv) rights-of-way. The rights-of-way will be provided pursuant
to long-term leases or other arrangements (some of which may provide for
substantial continuing payments) entered into with railroads, highway
commissions, pipeline owners, utilities or others. Although the Company has not
yet obtained all the necessary rights-of-way along the planned routes, the
Company anticipates that the rights-of-way will be available.
Through the WorldCom fiber construction agreement, the Vyvx fiber exchange
and the other cost-saving arrangements described above, the Company has reduced
its expected cost of the Network expansion. The Company seeks to enter into
additional cost-saving arrangements such as: (i) leasing or selling excess fiber
to other carriers; and (ii) exchanging excess fiber for fibers or capacity on
other carriers' networks. Additionally, the Company seeks to obtain the right to
install Company-owned fibers in new routes being constructed by other carriers
along the proposed Network expansion routes in exchange for the Company (a)
sharing network construction costs; (b) allowing the other carrier to use excess
fiber along certain routes in the Network; or (c) allowing the other carrier to
add its own fiber to certain segments of the Network. See "-- Risk Factors --
Negative Cash Flow and Capital Requirements." The Company has had experience
with arrangements of this type with several major carriers, including MCI,
Sprint, Cable & Wireless, WorldCom and LCI.
PRIVATE LINE SERVICES
Overview
Substantially all of the Company's 1995 revenues, approximately 49% of its
revenues in 1996 and approximately 39% of its revenues in 1997 were generated by
its private line business. The Company has over 230 active private line
customers.
Strategy
The Company is seeking to increase revenues in its private line business
through meeting these primary objectives: (i) expanding its Network to provide
additional capacity on its existing routes and high-capacity new routes to
provide access to major population centers (including routes which may be
attractive to major carriers as backup routes); (ii) providing high-quality,
reliable private line services on a fixed-cost basis at rates generally below
those currently offered by AT&T and competitive with those offered by other
carriers; and (iii) using the expanded Network as a platform to support
increased private line circuit demand which is expected to result in the future
from Frame Relay, ATM, multimedia, Internet and other capacity-intensive
applications.
The Company anticipates decreased expenses in its private line business
through the Network expansion, which will allow the Company to move traffic from
circuits leased from other carriers to its own Network.
Customers and Marketing
The Company has over 230 active private line customers, including AT&T,
MCI, Sprint, WorldCom, Cable & Wireless, Frontier and LCI. The Company's private
line contracts provide for fixed monthly payments, generally in advance. Many of
such contracts contain substantial "take or pay" commitments. The Company has
historically enjoyed a high customer retention rate in its private line
business.
The Company markets its private line circuit capacity generally to: (i)
facilities-based carriers that require private line capacity where they have
geographic gaps in their facilities, need additional capacity or require
geographically different, alternative routing; and (ii) non-facilities-based
carriers requiring private line capacity to carry their customers' long distance
traffic. The Company focuses most of its direct sales efforts on
10
13
providing customer support services to existing customers and on adding new
customers. The Company's long-haul circuit sales force at December 31, 1997
consisted of 13 account managers based at the Company's headquarters in Austin
and at direct sales offices in or near Washington, D.C., New Haven, San
Francisco, Kansas City, Chicago, St. Louis, Houston and Sunrise Beach, Missouri.
During 1997, AT&T, Frontier and WorldCom, the Company's three largest
private line customers, accounted for approximately 6.4%, 4.2% and 4.1%,
respectively, of the Company's revenues. The five largest private line customers
during 1997 accounted for approximately 20% of the Company's total revenue. See
"-- Risk Factors -- Reliance on Major Customers."
Prices and Contracts
The Company's strategy is to offer prices generally lower than those of
AT&T and competitive with the prices of other carriers, to permit the Company's
customers, through a stable, long-term fixed pricing structure, to maintain
control over transmission costs. The Company's private line transmission
agreements with its customers generally provide for original terms of one to
three years and for monthly payment in advance on a fixed-rate basis, calculated
according to the capacity and length of the circuit. Many of such contracts
contain substantial "take or pay" commitments. Furthermore, circuit orders under
private line agreements are generally for a term of one year or more and may not
be cancelled by the customer. However, the agreements generally provide that the
customer may terminate the affected service without penalty "for cause" in the
event of substantial and prolonged outages arising from causes within the
Company's control, and for certain other defined causes. Generally, the lease
agreements further provide that the customer may terminate the agreement "for
convenience" at its discretion at any time upon notice to the Company. However,
termination for convenience generally requires either full payment of all
charges through the end of the lease term or the payment of substantial
termination fees intended to allow the Company to recover certain costs and, in
some cases, lost profits. Damages attributable to a customer's termination of
the agreement are generally reduced, however, by an offset for any income the
Company earns from re-leasing the terminated capacity during the remaining
portion of the lease term.
Competition
In providing private line capacity, the Company competes with AT&T, which
is the largest supplier of long distance voice and data transmission services in
the United States, MCI, WorldCom and Sprint, all of which have substantially
greater financial resources than the Company and a far more extensive
transmission network than the Network and numerous regional carriers. MCI and
WorldCom have announced a planned merger, and applications for approval of that
merger are pending. If the MCI/WorldCom merger is approved, the result would be
an even larger, and potentially stronger, entity with which the Company would
have to compete. In addition, as a result of the Telecom Act and an agreement
(the "WTO Agreement") announced in February 1997 by the United States Trade
Representative with the World Trade Organization countries to open world
telecommunications markets to competition which became effective on February 5,
1998, the Company and its customers will also face competition from the RBOCs,
GTE and others such as electric utilities, cable television companies and
foreign companies. Qwest is constructing a coast-to-coast fiber optic network
and Frontier has agreed to pay $500 million for fibers in Qwest's network. Qwest
is, and Frontier may become, a competitor of the Company. In addition, Qwest and
LCI have also recently announced a planned merger. The Qwest/LCI merger would
result in another larger, and potentially stronger, competitor. Furthermore,
Level 3 has announced that it will spend approximately $3.0 billion to construct
a 20,000 mile fiber optic communications network entirely based on Internet
technology. The Williams Companies, a competitor of the Company, has also
announced that it is accelerating the expansion of its national fiber optic
network with a $2.7 billion investment to create a 32,000 mile system by the end
of 2001. Important competitive factors in the long-haul business are price,
customer service, network location and quality, reliability and availability.
See "-- Private Line Services" and "-- Risk Factors -- Competition."
11
14
LONG DISTANCE SWITCHED SERVICES
Overview
In late 1995, the Company expanded into the business of selling long
distance switched services to long distance resellers in order to complement its
private line business and to capitalize on its ability to provide long distance
switched services over its own Network. Long distance switched services are
telecommunications services that are processed through the Company's digital
switches and carried over long-haul circuits and other transmission facilities
owned or leased by the Company. During 1995, the Company set up the
infrastructure for its long distance switched services business by installing
its switches, connecting them to its Network and to the LECs, acquiring
software, hiring personnel and entering into contracts with customers. The
Company's switched network became fully operational in February 1996. The
Company sells long distance switched services on a per-call basis, charging by
MOUs, with payment due monthly after services are rendered.
Strategy
The Company seeks to rapidly increase revenues from its long distance
switched services business through: (i) long-term arrangements with significant
customers and customers the Company considers likely to grow quickly; (ii)
providing a sophisticated automated software interface with its customers; (iii)
offering pricing which is generally lower than that charged by AT&T and
competitive with that of other long distance service providers; and (iv)
acquisitions. The Company seeks to increase the profitability of its long
distance switched services business by decreasing its average cost per MOU
through efficiencies achieved with higher volumes and through reducing network
costs through the Network expansion. See "-- Business Strategy."
Customers and Marketing
The Company focuses its sales efforts on directly contacting large reseller
customers with monthly volumes of at least $1.0 million, and growing resellers
with volumes between $50,000 and $250,000 per month that the Company expects to
be reasonably likely to grow to the $1.0 million per month level. The Company's
switched-products sales force at December 31, 1997 included 18 sales executives
based at the Company's headquarters in Austin and at direct sales offices in
Atlanta, Dallas, Denver and Los Angeles. Although sales of long distance
switched services to end-user customers do not currently account for a
significant portion of the Company's switched long distance business, Telecom
One, a company which the Company acquired in July 1997, and NLD, a company which
the Company expects to acquire in 1998, each sell directly to end users. In
addition, the Company may, from time to time, consider acquiring other long
distance resellers or end-user customer bases.
Excel. Excel, the Company's largest customer of switched long distance
services, is contractually obligated to utilize at least 70 million minutes of
traffic per month. Excel's commitment continues through the earlier of the date
on which Excel has routed 4.2 billion minutes over the Network or June 30, 2001.
The minimum commitment is subject to reduction or termination: (i) if Excel
installs its own switches and invites the Company to bid along with other
carriers (to win such bids, the Company would have to be the lowest bidder) to
provide Excel with the long-haul circuits utilized by such switches (even if
this did occur, Excel would still have to meet the minimum commitment of 70
million minutes per month until June 30, 1998); or (ii) for breach of contract
by the Company or for other reasons which the Company believes should be under
its control. Although Excel's minimum commitment is 70 million minutes per
month, its usage increased substantially above the minimum commitment by
December 1996. At December 31, 1997, Excel had routed approximately 2.0 billion
minutes over the Network. The Company is Excel's main or sole supplier of 1 Plus
Switched Service in over 50 LATAs.
Customer Contracts. The Company's rates for switched long distance services
generally vary with the duration of the call, the day and the time of day the
call was made and whether the traffic is intrastate, interstate or
international. The rates charged are not affected by which facilities are
selected by the Company's switching centers for transmission of the call or by
the distance of the call. Different rates are applied to combined origination
and termination services than are applied to termination services. The
agreements
12
15
between the Company and its customers for long distance switched services
generally provide for payment in arrears based on MOUs. The agreements generally
also provide that the customer may terminate the affected service without
penalty in the event of substantial and prolonged outages arising from causes
within the Company's control, and for certain other defined causes. Generally,
the agreements provide that the customer, in order to avoid being obligated to
pay higher rates (or, in some cases, penalties), must utilize at least a minimum
dollar amount (measured by dollars or MOUs) of long distance switched services
per month for the term of the agreement. In certain new contracts, the Company
is including provisions to provide for financial penalties for a customer's
failure to provide the expected traffic distributions.
Customer Care. The Company believes that customer support is an important
factor in attracting and retaining customers for its long distance switched
services. Customer service for long distance switched services includes
processing new accounts, responding to inquiries and disputes relating to
billing, credit adjustments and cancellations and conducting technical repair
and other support services. IXC Online is designed to allow each of the
Company's carrier customers to: (i) download current call detail records for its
end-users for billing purposes; (ii) arrange with the appropriate LEC to
register the carrier as the designated long distance carrier for its new end
users; and (iii) file trouble reports for resolution. The Company employed
approximately 65 people in its long distance switched services customer service
group as of December 31, 1997. See "-- Risk Factors -- Development Risks and
Dependence on Long Distance Switched Services Business."
Decreased Costs through Increased Volumes or Greater Efficiency
Large MOU volumes should enable the Company to spread its fixed costs over
more MOUs and to more efficiently configure its network, reducing the cost per
MOU. The Company seeks to efficiently configure the circuits available so that
calls are completed on a cost-effective basis. The Company periodically analyzes
calling patterns using mathematical formulas to determine the circuit capacity
required to cost-effectively service the expected call volume. For example, if
there is sufficient calling traffic available, the Company may upgrade
transmission circuitry in an area from DS-1 to DS-3. A similar analysis will be
made when deciding whether to install a new switch in a region. The Company is
continuing to develop procedures to better analyze its expected traffic patterns
in order to enhance Network efficiency and identifying customers generating an
unprofitable mix of traffic. The Company's strategy of enhancing profitability
through efficiency may have the effect of reducing MOU volume and gross revenue
in the long distance switched services business.
Services
The Company markets a variety of switched long distance services, including
operator services, directory assistance, international service and the
following:
1 Plus Switched Service. Provides direct-dial service over the Company's
Network.
1 Plus Dedicated Service. Provides direct-dial service over the Company's
Network for end users that have arranged to connect to the Company's nearest Hub
through a local loop. This service is less expensive than 1 Plus Switched
Service because the access charges of the end-user's LEC are reduced.
800/888 Switched Service. Provides 800/888 service over the Company's
Network.
800/888 Dedicated Service. Provides 800/888 service over the Company's
Network for end users that have arranged to connect to the Company's nearest Hub
through a local loop. This service is less expensive than 800/888 Switched
Service because the access charges of the end-user's LEC are reduced.
Calling Card Service. Provides telephone card service.
Debit Card Service. Provides prepaid telephone card service.
Switched Termination Service. Provides carrier customers having use of a
switch in one area with termination services in other areas.
13
16
Acquisitions
As part of its growth strategy, the Company acquired Telecom One in July
1997 using shares of its Common Stock as consideration and entered into an
agreement in December 1997 to acquire NLD using shares of its Common Stock as
consideration. In addition, the Company has agreed to acquire with Common Stock
a small company with data communications expertise to increase its data
engineering capabilities. The Company may, from time to time, acquire other
businesses, assets or securities of companies which it believes provide a
strategic fit with its business and network. Although the Company currently has
no other commitments or agreements with respect to any material acquisitions, it
has reviewed potential acquisition candidates and has held preliminary
discussions with a number of these candidates. The Company may use Common Stock
as consideration for other acquisitions.
The Company has agreed to acquire NLD, a long-distance reseller with over
$100.0 million in revenue in 1997, for approximately 4.3 million shares of
Common Stock (including approximately 300,000 shares issuable with respect to
NLD options and warrants). NLD has a national direct sales force selling
primarily to small and medium-sized businesses. The Company believes it can
improve the profitability of NLD because it can lower its costs of call
transmission. This acquisition is a part of a Company strategy to expand by
acquiring select resellers on advantageous terms as opportunities arise. The
Company believes that its acquisition of NLD will provide an important
foundation for growth in the business retail long distance market, however,
there can be no assurances that the acquisition, if consummated, will have such
effect. See "-- Risk Factors -- Integration of Acquired Businesses; Business
Combinations."
Competition
The Company competes with numerous facilities-based interexchange carriers,
some of which are substantially larger, have substantially greater financial,
technical and marketing resources and utilize larger transmission systems than
the Company. AT&T is the largest supplier of long distance switched services in
the United States inter-LATA market. The Company also competes in selling long
distance switched services with: (i) other facilities-based carriers, such as
MCI, Sprint, WorldCom, Quest, The Williams Companies and certain regional
carriers, and (ii) certain non-facilities-based carriers. MCI and WorldCom have
announced a planned merger, and applications for approval of that merger are
pending. If the MCI/WorldCom merger is approved, the result would be an even
larger, and potentially stronger, entity with whom the Company would have to
compete. Frontier has agreed to pay $500.0 million for fibers in Qwest's
network. Qwest is, and Frontier may become, a competitor of the Company. In
addition, Qwest and LCI have also recently announced a planned merger. The
Qwest/LCI merger would result in another larger, and potentially stronger,
competitor. Furthermore, Level 3 has announced that it will spend approximately
$3.0 billion to construct a 20,000 mile fiber optic communications network
entirely based on Internet technology. The Williams Companies has also announced
that it is accelerating the expansion of its national fiber optic network with a
$2.7 billion investment to create a 32,000 mile system by the end of 2001. As a
result of the Telecom Act and recent WTO Agreement, the Company will also now
face competition from the RBOCs, GTE and others such as electric utilities,
cable television companies and foreign companies. The Company believes that the
principal competitive factors affecting it are price, customer service
(particularly with respect to speed in delivery of computer billing records and
set-up of new end users with the LECs), ability of the network to complete calls
with a minimum of network-caused busy signals, scope of services offered,
reliability and transmission quality. The ability of the Company to compete
effectively will depend upon its ability to maintain high-quality services at
prices generally equal to or below those charged by its competitors. In the
United States, price competition in the long distance business has been
intensive over the last five years. In 1995, the FCC reclassified AT&T as a
"non-dominant" carrier, freeing AT&T from price regulation of its long distance
services. Since the Company believes that its customers generally price their
service offerings at or below the prices charged by AT&T for its
telecommunications services, reductions by AT&T in its rates may necessitate
similar price decreases by the Company. See "-- Risk Factors -- Competition."
14
17
REGULATION
Certain subsidiaries of the Company operate as communications common
carriers. These subsidiaries are subject to applicable FCC regulations under the
Communications Act of 1934, as amended (the "Communications Act"), some of which
may be affected by the Telecom Act of 1996 and regulations being promulgated
thereunder. See "-- Risk Factors -- Recent Legislation and Regulatory
Uncertainty." In addition, those subsidiaries which operate the Company's
microwave Network are subject to applicable FCC regulations for use of the radio
frequencies. The FCC issues licenses to use certain radio frequency spectrum at
transmitter site locations. Each license gives the Company the right to operate
the microwave radio station for the term of the license. Currently, the Company
holds licenses to operate the microwave sites in the Network. The licenses all
expire in 2001. These licenses are renewable upon application containing a
statement that they are used in compliance with the applicable FCC rules. The
Company expects that the FCC will renew its licenses in due course. The
Communications Act currently limits ownership of an entity holding such licenses
by non-U.S. citizens, foreign corporations and foreign governments. The Company
is subject to regulation by the Federal Aviation Administration with respect to
the construction of transmission towers and to certain local zoning regulation
affecting construction of towers and other facilities.
Recent court decisions (which were issued before the Telecom Act of 1996)
require the FCC to require carriers to file tariffs. However, the FCC currently
does not actively exercise its authority to regulate such carriers' rates and
services. Moreover, the Telecom Act of 1996 gives the FCC authority to forbear
from applying certain provisions of the Communications Act, including the
requirement that carriers file tariffs. The FCC has recently issued an order
implementing a mandatory detariffing policy that eliminates the tariff
requirements for non-dominant interstate, interexchange carriers. An appeal of
the FCC's order resulted in the order being stayed. The appeal is being held in
abeyance, pending the FCC's action on motions for reconsideration. Regardless of
the outcome of the detariffing proceeding, the FCC will retain jurisdiction to
act upon complaints against any common carrier for failure to comply with its
statutory obligations as a common carrier.
The FCCs reclassification of AT&T as a non-dominant carrier may affect the
Company, because it competes with AT&T. The FCC's current and future actions
could result in decreases in the rates charged to end-user customers by AT&T and
other competitors for their services. Thus, one effect of the FCC's action may
be to further intensify price competition among long distance companies.
The FCC regulates many of the rates, charges and services provided by the
LECs. Such regulation can also affect the costs of business for the Company, its
customers and its competitors, because carriers such as the Company must
purchase local access services from LECs to originate and terminate calls. The
FCC's current price cap regulation of the RBOCs and other LECs provides them
with considerable flexibility in pricing their services. The FCC recently issued
two orders regarding access charge reform and transport rate structure and
pricing. Both orders have been appealed and in the interim, on January 1, 1998,
LEC tariffs implementing the requirements of the FCC orders went into effect.
The outcomes of the appeals, and the outcomes of any subsequent FCC rulemaking
proceedings, are impossible to predict, but future changes with respect to
access charges are likely. Although some increases in certain elements of access
charges are anticipated in mid-1998, the overall effect of access charge reform
on the Company is currently uncertain. Further, on July 18, 1997, in Iowa
Utilities Board v. FCC, the United States Court of Appeals for the Eighth
Circuit invalidated key portions of the FCC's August 29, 1996 interconnection
order, which the FCC had adopted to facilitate the emergence of local exchange
competition. The Supreme Court recently agreed to hear an appeal of the Eighth
Circuit's ruling. The further emergence and development of local exchange
competition may likely be delayed as a result. Consequently, the Company and its
customers may not benefit as quickly from the lower access costs that might
otherwise have resulted had competition in the provision of local access
services not been thus delayed.
The Telecom Act directed the FCC to establish a system for compensating
payphone service providers ("PSPs") on a per-call basis for calls made from
payphones, including coinless calls, such as calling card, collect, and "800"
calls. On October 9, 1997, the FCC released an order that set a $0.284 per-call
"default" rate that long distance carriers are required to pay to PSPs for
certain coinless calls. Although the FCC's order
15
18
has gone into effect, it is being appealed, and the amount of compensation long
distance carriers will ultimately be required to pay to PSPs is currently
uncertain.
In addition, the Telecom Act allows the RBOCs and others to enter the long
distance business. Entry of the RBOCs or other entities such as electric
utilities and cable television companies into the long distance business may
have a negative impact on the Company or its customers. The Telecom Act also
establishes criteria for RBOC re-entry into in-region long distance markets, and
RBOCs are required to obtain FCC approval before they can begin providing such
services. To date, the FCC has rejected four such RBOC applications, at least
one of which is being appealed. However, on December 31, 1997, the U.S. District
Court for the Northern District of Texas ruled that the provisions of the
Telecom Act that apply specifically to RBOCs are unconstitutional. On February
11, 1998, the District Court stayed its order, and the order has been appealed.
While the outcome of the appeal is impossible to predict, if the district
court's order is upheld, the re-entry of the RBOCs into the in-region long
distance market would likely be hastened. Further, the FCC has indicated that it
is attempting to establish a "collaborative process" with the RBOCs to
facilitate the review and ultimately the approval of such applications.
The Telecom Act also provides that state proceedings may in certain
instances determine access charge rates the Company and its customers are
required to pay to the LECs. It is uncertain at this time what effect such
proceedings may have on such rates. There can be no assurance that such rates
will not be increased. Such increases could have a material adverse effect on
the Company and its customers. See "-- Risk Factors -- Recent Legislation and
Regulatory Uncertainty" and "Industry Overview."
The ability of the Company to provide long distance services within any
state is generally subject to regulation by a regulatory board in that State. As
of December 31, 1997, the Company is operating and has obtained the requisite
licenses and approvals in the 48 contiguous continental United States.
MEXICAN JOINT VENTURE
The Company is indirectly participating in the development of a long
distance network to engage in the telecommunications business in Mexico through
Marca-Tel S.A. de C.V. ("Marca Tel"). As of December 31, 1997, the Company
indirectly owned 24.5% of Marca-Tel through its ownership of 50% of Progress
International LLC ("Progress International"), which owned 49% of Marca-Tel. The
remaining 51% of Marca-Tel is owned by a Mexican individual and Fomento Radio
Beep, S.A. de C.V. The other 50% of Progress International is owned by Westel
International, Inc. ("Westel").
As of December 31, 1997, the Company and Westel have jointly contributed or
loaned Progress International a total of $48.7 million, of which $37.0 million
has been provided by the Company. Substantially all of such funds have been used
by Progress International to fund Marca-Tel. The Company is recognizing its
share of the Progress International losses in accordance with its pro rata share
of funds provided to Progress International. The net carrying value for the
Company's interest in Progress International was $11.6 million at December 31,
1997.
In September, 1995, Marca-Tel entered into an agreement with a third party
to construct a portion of Marca-Tel's telecommunications network in Mexico and
to provide significant financing for such construction and related equipment and
fiber purchases. Such third party has been granted security interests in all of
Marca-Tel's assets, including the telecommunications network, and the owners of
Marca-Tel, including Progress International, have pledged their interests in
Marca-Tel to collateralize payment to the third party. As of December 31, 1997,
approximately $49.1 million was owed by Marca-Tel to such third party.
In February, 1998, Marca-Tel announced that it was putting further
investment in new fiber routes on hold, awaiting more suitable regulatory and
market conditions. Because of the continuing adverse regulatory environment in
Mexico, Marca-Tel has determined to limit further investment and to reduce its
scope of operations. At the present time, the Company does not anticipate
significant additional funding to Progress International for investment in
Marca-Tel until the regulatory and market conditions in Mexico improve. The
Company is not obligated to continue to fund Progress International and the
Senior Notes Indenture and the terms of the Exchangeable Preferred Stock contain
significant limitations on the amount the Company may
16
19
invest in Progress International and other non-majority owned entities. However,
failure to provide further significant funding to Progress International is
likely to result in a default under Marca-Tel's financial arrangements and could
result in the foreclosure of the third party's security interest. The Company's
interest in Progress International, and thus its indirect interest in Marca-Tel,
therefore could be diluted or lost entirely.
The forward-looking statements set forth above with respect to the capital
needs of Progress International and of Marca-Tel and the successful completion
and operation of Marca-Tel's fiber optic system in Mexico are based on certain
assumptions as to future events. Important assumptions, which if not met, could
adversely affect Marca-Tel's ability to achieve satisfactory results include
that: (i) there will be no significant delays or cost overruns with respect to
the network expansion; (ii) the Company's contractors and partners in cost-
saving arrangements will perform their obligations; (iii) rights-of-way can be
obtained in a timely, cost-effective basis; (iv) the routes of the network
expansion are substantially completed on schedule; (v) Marca-Tel can
successfully operate its long distance switched services business on a cost
effective basis (including the provision of billing information in an accurate
and timely manner) for volumes that it has not previously handled; (vi)
Marca-Tel can obtain sufficient funds from debt or equity offerings, joint
venture arrangements, accounts, additional vendor financing, or otherwise and
(vii) regulatory and market conditions improve.
EMPLOYEES
As of December 31, 1997, the Company employed 712 people, of whom 349
provided operational and technical services, 67 provided engineering services
and the balance were engaged in administration and marketing. The Company's
employees are not represented by any labor union. The Company considers its
employee relations to be good and has not experienced any work stoppages.
RISK FACTORS
Statements contained in this Annual Report on Form 10-K regarding the
Company's expectations with respect to its network expansion, related financings
and fiber sale and cost-saving agreements, future operations and other
information, which can be identified by the use of forward-looking terminology,
such as "may," "will," "expect," "anticipate," "estimate," "believe," "seek" or
"continue" or the negative thereof or other variations thereon or comparable
terminology, are forward-looking statements. The discussions set forth below
constitute cautionary statements identifying important factors with respect to
such forward-looking statements, including risks and uncertainties, that could
cause actual results to differ materially from results referred to in the
forward-looking statements. There can be no assurance that the Company's
expectations regarding any of these matters will be fulfilled.
Negative Cash Flow and Capital Requirements
The Company's capital expenditures were $314.3 million and interest expense
and capitalized interest were $38.6 million for 1997. The Company's EBITDA was
$15.5 million, its cash flow provided by operating activities was $14.3 million
and its net loss was $94.6 million for 1997. The Company expects to make
substantial capital expenditures in excess of $500.0 million (subject to the
availability of capital) during 1998 and substantial amounts thereafter.
Accordingly, the Company needs and will continue to need a substantial amount of
cash from outside sources. The Company anticipates meeting the cash requirements
relating to such capital expenditures from cash on hand, cash flow from fiber
sales and its operations, other vendor financing, if available, and additional
equity and/or debt financings. The Company intends to incur a substantial amount
of additional indebtedness and may issue a substantial amount of additional
equity securities over the near term. The amount of actual capital expenditures
may vary materially as a result of cost-saving arrangements, increases or
decreases in the amount of traffic on the Network, unexpected costs, delays or
advances in the timing of certain capital expenditures and other factors. The
Company's ability to meet the cash costs of such capital expenditures is
dependent in part upon the Company's ability to complete the construction of the
Network expansion in a timely manner and otherwise perform its obligations to
the satisfaction of each of LCI and MCI so that it can complete the Chicago-LA
LCI Fiber Sale and the MCI Fiber Sale, to enter into cost-saving arrangements
with carriers or other large users of fiber capacity, to
17
20
otherwise raise significant capital and/or to significantly increase its cash
flow. The failure of the Company to accomplish any of the foregoing may
significantly delay or prevent such capital expenditures, which would have a
material adverse effect on the Company and the value of the Common Stock and its
other securities.
The Company's long distance switched services business will require cash to
meet operating expenses. In order to offer long distance switched services, the
Company installed switches, connected them to its Network and to the LECs (as
defined), acquired software and hired the personnel needed to establish a
national switched network. The Company's long distance switched services
business generated negative EBITDA for 1996 and 1997 and the Company believes it
may be negative during 1998, due to, among other things, access costs and uneven
traffic patterns creating high network overflow costs. Although the Company has
not yet achieved positive EBITDA in its long distance switched services
business, the Company is seeking to improve the results in this business by
increasing the scale and scope of traffic carried over its Network.
Specifically, the Company's focus is on (i) obtaining traffic that meets its
profitability requirements and aligns with the Company's current and planned
Network, (ii) identifying new products and customers with large capacity
requirements, (iii) identifying Internet, intranet and data traffic
opportunities and (iv) identifying joint venture and acquisition candidates that
will increase the flow and mix of traffic in the Company's Network and increase
its global reach. For a discussion of important factors that could cause the
Company's long distance switched services business to fail to generate positive
EBITDA, see "-- Risk Factors -- Development Risks and Dependence on Long
Distance Switched Services Business."
The Company is required to make annual interest payments of $35.6 million
with respect to the Company's outstanding $285.0 million principal amount of the
Senior Notes. The Company will also be required to make interest payments and,
beginning June 30, 1998, principal payments in connection with borrowings under
a secured equipment financing facility of up to $28.0 million (approximately
$18.0 million of which had been borrowed at March 1, 1998) entered into with
NTFC Capital Corporation and Export Development Corporation, in July 1997 (the
"NTFC Equipment Facility"). Delays in the Network expansion, larger than
anticipated capital expenditures for the Network or continued negative cash flow
from the long distance switched services business could impair the ability of
the Company to meet its obligations under the Senior Notes and other
indebtedness, to pay cash dividends on the Convertible Preferred Stock and the
Exchangeable Preferred Stock and to access additional sources of funding, any of
which would have a material adverse effect on the Company and the value of the
Common Stock and its other securities. See "-- Risk Factors -- Risks Relating to
the Network Expansion," and "-- Risk Factors -- Development Risks and Dependence
on Long Distance Switched Services Business."
The Company anticipates that in the event it is unable to obtain vendor
financing on acceptable terms, consummate the MCI Fiber Sale and the Chicago-LA
LCI Fiber Sale, or sell additional equity and/or debt securities in order to
complete its planned Network expansion, it may be required to curtail or delay
its planned Network expansion. Furthermore, before incurring additional
indebtedness, the Company may be required to obtain the consent of, or repay,
its debtholders. The Company's failure to obtain additional financing or, in the
alternative, its decision to curtail or delay its planned network expansion
could have a material adverse effect on its business, results of operations and
financial condition.
In October 1997, the Company formed a joint venture with Telenor AS, the
Norwegian national telephone company, to provide telecommunication services to
carriers and resellers in nine European countries. The joint venture is owned 40
percent by the Company, 40 percent by Telenor Global Services AS ("Telenor"),
and 20 percent by Clarion Resources Communications Corporation, a U.S.-based
telecommunications company in which Telenor owns a controlling interest.
Although the Company cannot accurately predict the capital that will be required
to implement such joint venture (the "European Joint Venture"), the Company
estimates that its 1997 funding of approximately $5.8 million will be sufficient
for 1998. However, there can be no assurance that the European Joint Venture
will not require more capital from the Company during 1998 and thereafter.
In December 1997, the Company formed Unidial Communications Services, LLC,
a joint venture with Unidial Incorporated ("Unidial"). The joint venture is
building a direct sales force to market and sell Unidial's and the Company's
products over the Company's Network. The joint venture is owned 80 percent by
18
21
Unidial and 20 percent by the Company. Subject to the terms of the joint venture
agreement, upon request of the President of the joint venture, the Company is
obligated to contribute up to an additional $7.5 million during 1998 and after
November 1, 1998, it may be obligated to contribute up to an additional $4.0
million. After its funding obligation is fulfilled, the Company is not required
to fund any future contributions to the joint venture, but to the extent Unidial
funds such contributions, the Company's interest in the joint venture may be
diluted.
The cash requirements described above do not include any cash which may be
required for acquisitions the Company may make. See "-- Risk
Factors -- Integration of Acquired Businesses; Business Combination."
Substantial Indebtedness
The Company is highly leveraged. As of December 31, 1997, the Company had
outstanding approximately $320.3 million of long-term debt and capital lease
obligations (including the current portion thereof) principally consisting of
its outstanding $285.0 million principal amount of the Senior Notes.
Furthermore, the Company may borrow an aggregate of up to $28.0 million
(approximately $18.0 million of which had been borrowed at March 1, 1998), under
the NTFC Equipment Facility. In addition, the Company is in discussions with
various investment bankers, vendors and lending institutions regarding several
substantial additional debt financings. If such additional debt financings
occur, they will substantially increase the Company's interest expense.
Furthermore, the Company will become more highly leveraged if it exchanges the
Exchangeable Preferred Stock for Exchange Debentures pursuant to the terms of
the Certificate of Designation in connection with the Exchangeable Preferred
Stock.
The Company's significant debt burden could have several important
consequences to the holders of the Common Stock, including, but not limited to:
(i) all or a significant portion of the Company's cash flow from operations must
be used to service its debt instead of being used in the Company's business (in
1997, the Company's cash flow from operations was $14.3 million and interest
expense was $31.3 million); (ii) the Company's significant degree of leverage
could increase its vulnerability to changes in general economic conditions or
increases in prevailing interest rates; (iii) the Company's flexibility to
obtain additional financing in the future, as needed to continue the Network
expansion or for any other reason, may be impaired by the amount of debt
outstanding and the restrictions imposed by the covenants contained in the
Senior Notes Indenture and in agreements relating to other indebtedness; and
(iv) the Company may be more leveraged than certain of its competitors, which
may be a competitive disadvantage. There can be no assurance that the Company's
cash flow from operations will be sufficient to meet its obligations under the
Senior Notes or other indebtedness or the Convertible Preferred Stock or the
Exchangeable Preferred Stock as payments become due or that the Company will be
able to refinance the Senior Notes or other indebtedness at maturity or the
Convertible Preferred Stock or the Exchangeable Preferred Stock upon mandatory
redemption.
The Company anticipates that earnings will be insufficient to cover fixed
charges and cash dividends on preferred stock for the next several years. In
order for the Company to meet its debt and dividend service obligations, and its
dividend and redemption obligations with respect to its preferred stock, the
Company will need to substantially improve its operating results. There can be
no assurance that the Company's operating results will be sufficient to enable
the Company to meet its debt service obligations, and its dividend and
redemption obligations with respect to its preferred stock. In the absence of a
substantial improvement in operating results, the Company would face substantial
liquidity problems and would be required to raise additional financing through
the issuance of debt or equity securities; however, there can be no assurance
that the Company would be successful in raising such financing.
Recent and Expected Losses
The Company reported a net loss of $37.4 million for the year ended
December 31, 1996 and a net loss of $94.6 million for the year ended December
31, 1997, primarily due to substantial depreciation related to capital
expenditures, interest expense associated with the Senior Notes and operational
expenses associated with the long distance switched services business. During
1998 and thereafter, the Company's ability to
19
22
generate operating income, EBITDA and net income will depend to a great extent
on demand for the private line circuits constructed in the Network expansion and
the success of the Company's switched long distance and data services. There can
be no assurance that the Company will return to profitability in the future.
Failure to generate operating income, EBITDA and net income will impair the
Company's ability to: (i) meet its obligations under the Senior Notes or other
indebtedness; (ii) pay cash dividends on the Convertible Preferred Stock and the
Exchangeable Preferred Stock; (iii) expand its long distance switched services
business; and (iv) raise additional equity or debt financing which will be
necessary to continue the Network expansion or which may be required for other
reasons. Such events could have a material adverse effect on the Company and the
value of the Common Stock and its other securities.
Risks Relating to the Network Expansion; Maintenance of Network, Rights-of-Way
and Permits
The continuing Network expansion is an essential element of the Company's
future success. The Company has, from time to time, experienced delays with
respect to the construction of certain portions of the Network expansion and may
experience similar delays in the future. These delays have postponed the
Company's ability to transfer long distance traffic from leased facilities to
owned facilities. Although the Company has made significant progress,
construction of the New York to Los Angeles via St. Louis route is not yet
complete. The Company has substantial existing commitments to purchase materials
and labor for construction of the Network expansion, and will need to obtain
additional materials and labor which may cost more than anticipated. Substantial
portions of the route from New York to Los Angeles via St. Louis and all of the
route from Washington to Houston via Atlanta are being constructed by
contractors or, pursuant to cost-saving arrangements, by third parties that will
include the Company's fiber in routes such carriers are constructing for their
own use. Difficulties or delays with respect to any of the foregoing may
significantly delay or prevent the completion of the Network expansion, which
would have a material adverse effect on the Company, its financial results and
the value of the Common Stock and its other securities.
The expansion of the Company's Network and its construction or acquisition
of new networks will be dependent, among other things, on its ability to acquire
rights-of-way and required permits from railroads, utilities and governmental
authorities on satisfactory terms and conditions and on its ability to finance
such expansion, acquisition and construction. Once expansion of the Network is
completed and requisite rights and permits are obtained, there can be no
assurance that the Company will be able to maintain all of its existing rights
and permits. Loss of substantial rights and permits or the failure to enter into
and maintain required arrangements for the Company's Network could have a
material adverse effect on the Company's business, financial condition and
results of operations and on the value of the Common Stock and its other
securities.
Dependence Upon Network Infrastructure; Risk of System Failure; Security Risks
The Company's success in marketing its services to business and government
users requires that the Company provide superior reliability, capacity and
security via its Network. The Company's Network and networks upon which it
depends are subject to physical damage, power loss, capacity limitations,
software defects, breaches of security (by computer virus, break-ins or
otherwise) and other disruptions which may cause interruptions in service or
reduced capacity for customers, which could have a material adverse effect on
the Company's business, financial condition and results of operations and on the
value of the Common Stock and its other securities.
Pricing Pressures and Risks of Industry Over-Capacity
The long distance transmission industry has generally been characterized by
over-capacity and declining prices since shortly after the AT&T divestiture in
1984. The Company believes that, in the last several years, increasing demand
has ameliorated the over-capacity and that pricing pressure has been reduced.
However, the Company anticipates that prices for its services will continue to
decline over the next several years. The Company is aware that certain long
distance carriers (WorldCom, MCI, LCI, Qwest and others) are expanding their
capacity and believes that other long distance carriers, as well as potential
new entrants to the industry, are considering the construction of new fiber
optic and other long distance transmission networks. If the MCI/WorldCom merger
or the Qwest/LCI merger is approved, the result would be even larger, and
20
23
potentially stronger, competitor (or competitors) with expanded capacity.
Although the Company believes that there are significant barriers to entry for
some new entrants that may consider building a new fiber optic network, such as
substantial construction costs and the difficulty and expense of securing
appropriate rights-of-way, establishing and maintaining a sufficient customer
base, recruiting and retaining appropriate personnel and maintaining a reliable
network, certain of these barriers may not apply to some new entrants (such as
Qwest, utility companies or railroads which already have significant
rights-of-way). In addition, Level 3 has announced that it will spend
approximately $3.0 billion to construct a 20,000 mile fiber optic communications
network entirely based on Internet technology. The Williams Companies has also
announced that it is accelerating the expansion of its national fiber optic
network with a $2.7 billion investment to create a 32,000 mile system by the end
of 2001. Since the cost of the actual fiber is a relatively small portion of the
cost of building new transmission lines, companies building such lines are
likely to install fiber that provides substantially more transmission capacity
than will be needed over the short or medium term. Further, recent technological
advances have shown the potential to greatly expand the capacity of existing and
new fiber optic cable. Although such technological advances may enable the
Company to increase its capacity, an increase in the capacity of the Company's
competitors could adversely affect the Company's business. If industry capacity
expansion results in capacity that exceeds overall demand in general or along
any of the Company's routes, severe additional pricing pressure could develop.
As a result, certain industry observers have predicted that, within a few years,
there may be dramatic and substantial price reductions and that long distance
calls will not be materially more expensive than local calls. In addition,
several companies (including AT&T and ICG Communications, Inc.) have announced
plans to offer long distance voice telephony over the Internet, at substantially
reduced prices. Price reductions could have a material adverse effect on the
Company and the value of the Common Stock. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview."
Development Risks and Dependence on Long Distance Switched Services Business
The success of the Company in the long distance switched services business
is dependent on the Company's ability to generate significant customer traffic,
to manage an efficient switched long distance network and related customer
service and the timely completion of the Network expansion. Prior to 1996 the
Company had not previously managed a switched long distance network and there
can be no assurance that its long distance switched services business can
generate positive EBITDA or net income. The failure of the Company to generate
increased customer traffic, to complete new routes in a timely manner, or to
effectively manage the switched network and related customer service or to
generate positive EBITDA or net income from the long distance switched services
business would have a material adverse effect on the Company. The Company's long
distance switched services business will require cash to meet its operating
expenses. The Company's long distance switched services business generated
negative EBITDA for each of the four quarters of 1996 and 1997 and the Company
believes it may be negative during 1998, due to access costs and uneven traffic
patterns creating high network overflow costs. Although the Company is
attempting to control such costs and improve EBITDA from long distance switched
services, there is no assurance it will be successful. The Company expects that
the Network expansion will result in an improvement in the gross margins and
EBITDA generated by its long distance switched services business. The Company
has experienced and expects to continue to experience difficulties in commencing
services for end users of carrier customers. Although the Company believes that
its performance with respect to these matters has met or exceeded industry
norms, such difficulties may adversely affect the Company's relationships with
its customers.
Important factors that could cause the Company's long distance switched
services business to fail to generate positive EBITDA include changes in the
businesses of the Company's reseller customers, an inability to attract new
customers or to quickly transfer new customers to its Network without problems,
the loss of existing customers, problems in the operation of the switched
network, the Company's lack of experience with long distance switched services,
increases in operating expenses or other factors affecting the Company's revenue
or expenses, including delays in the construction of the Network expansion and
increased expenses related to access charges and network overflow, not all of
which can be controlled by the Company. If traffic does not increase and costs
are not adequately controlled there can be no assurance that the long distance
switched services business will ever generate positive EBITDA. In addition, to
the extent that LECs grant
21
24
volume discounts with respect to local access charges, the Company may have a
cost disadvantage versus the larger carriers. Furthermore, the credit risk for
the Company's long distance switched services business is substantially greater
than the credit risk for the Company's private line business, because switched
long distance customers are charged in arrears on the basis of MOUs (which are
frequently subject to dispute), and because many switched long distance
customers (in particular, resellers of debit card services) are not as well
capitalized as most of the Company's private line customers. The Company's
provision for bad debt was $3.0 million in 1996 (when it had $104.0 million of
long distance switched services revenue) and $17.4 million in 1997 (when it had
$258.3 million of long distance switched services revenue). See "-- Switched
Long Distance Services."
Risks Inherent in Rapid Growth
Part of the Company's strategy is to achieve rapid growth through expanding
its long distance switched services business and through expanding the Network.
In addition, the Company may from time to time make acquisitions of resellers,
such as NLD and Telecom One, which it believes provide a strategic fit with its
business and Network. See "Risk Factors -- Integration of Acquired Businesses;
Business Combinations." The Company's rapid growth has placed, and its planned
future growth will continue to place, a significant and increasing strain on the
Company's financial, management, technical, information and accounting
resources. See "-- Risk Factors -- Dependence on Billing, Customer Services and
Information Systems." Continued rapid growth would require: (i) the retention
and training of new personnel; (ii) the satisfactory performance by the
Company's customer interface and billing systems; (iii) the development and
introduction of new products; and (iv) the control of the Company's expenses
related to the expansion into the long distance switched services business and
the Network expansion. The failure by the Company to satisfy these requirements,
or otherwise to manage its growth effectively, would have a material adverse
effect on the Company and the value of the Common Stock and its other
securities.
Dependence on Billing, Customer Services and Information Systems
Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. Billing and information systems for
the Company's historical lines of business have been produced largely in-house
with partial reliance on third-party vendors. These systems have generally met
the Company's needs due in part to the low volume of customer billing. As the
Company's long distance operation continues to expand, the need for
sophisticated billing and information systems will increase significantly. For
example, during the first half of 1997, the Company had negative gross margins
in its long distance switched services business, due in part to certain
customers which were using the Company's services for termination in LATAs where
the Company's prices were too low relative to access costs in such LATAs. The
Company's plans for the development and implementation of its billing systems
rely, for the most part, on the delivery of products and services by third party
vendors. Failure of these vendors to deliver proposed products and services in a
timely and effective manner and at acceptable costs, failure of the Company to
adequately identify all of its information and processing needs, failure of the
Company's related processing or information systems or the failure of the
Company to upgrade systems as necessary could have a material adverse effect on
the ability of the Company to reach its objectives, on its financial condition
and on its results of operations and on the value of the Common Stock and its
other securities.
Year 2000 Risks
Certain of the Company's older computer programs identify years with two
digits instead of four. This is likely to cause problems because the programs
may recognize the year 2000 as the year 1900. These problems (the "Year 2000
Problems") could result in a system failure or miscalculations disrupting
operations, including a temporary inability to process transactions, send
invoices or engage in similar normal business activities. The Company has
completed an assessment identifying which programs will have to be modified or
replaced in order to function properly with respect to dates in the year 2000
and thereafter. The Company believes that the cost of modifying those systems
that were not already scheduled for replacement for business
22
25
reasons prior to 2000 is immaterial. Updating the current software to be Year
2000-compliant is scheduled to be completed by mid-1999, prior to any
anticipated impact on operating systems. Although the Company does not expect
Year 2000 Problems to have a material adverse effect on its internal operations,
it is possible that Year 2000 Problems could have a material adverse effect on
(i) the Company's suppliers and their ability to service the Company, to
accurately invoice for services rendered and to accurately process payments
received; and (ii) the Company's customers and their ability to continue to
utilize the Company's services, to collect from their customers and to pay the
Company for services received. The cumulative effect of such problems, if they
occur, could have a material adverse effect on the Company and the value of the
Common Stock and its other securities.
Integration of Acquired Businesses; Business Combinations
As part of its growth strategy, the Company may, from time to time, acquire
businesses, assets or securities of companies which it believes provide a
strategic fit with its business and the Network. Although the Company currently
has no commitments or agreements with respect to any material acquisitions
(other than with respect to NLD), it has reviewed potential acquisition
candidates and has held preliminary discussions with a number of these
candidates. The acquisition of NLD and any other companies will be accompanied
by the risks commonly associated with acquisitions. These risks include
potential exposure to unknown liabilities of acquired companies, the difficulty
and expense of integrating the operations and personnel of the companies, the
potential disruption to the business of the Company, the potential diversion of
management time and attention, the impairment of relationships with and the
possible loss of key employees and customers of the acquired business, the
incurrence of amortization expenses if an acquisition is accounted for as a
purchase and dilution to the stockholders of the Company if the acquisition is
made for stock. Any acquired businesses will need to be integrated with the
Company's existing operations. This will entail, among other things, integration
of switching, transmission, technical, sales, marketing, billing, accounting,
quality control, management, personnel, payroll, regulatory compliance and other
systems and operating hardware and software, some or all of which may be
incompatible with the Company's existing systems. The Company has limited
expertise dealing with these problems. There can be no assurance that services,
technologies or businesses of acquired companies will be effectively assimilated
into the business or product offerings of the Company or that they will
contribute to the Company's revenues or earnings to any material extent. In
particular, transferring substantial amounts of additional traffic to the
Network (as will be required in connection with the acquisition of NLD) can
cause service interruptions and integration problems. The risks associated with
acquisitions could have a material adverse effect on the Company and the value
of the Common Stock and its other securities.
Reliance on Major Customers
The Company's ten largest customers in 1997 accounted for approximately 61%
of its revenues, with Excel, AT&T, WorldCom and Frontier, its four largest
customers, accounting for approximately 28.6%, 6.4%, 4.2% and 4.1% of the
Company's revenue in 1997, respectively. Excel, WorldCom and Frontier, the
Company's three largest customers in 1996, accounted for 35%, 8% and 10% of the
Company's revenues in 1996, respectively.
Most of the Company's arrangements with large customers do not provide the
Company with guarantees that customer usage will be maintained at current
levels. In addition, construction by certain of the Company's customers of their
own facilities, construction of additional facilities by competitors or further
consolidations in the telecommunications industry involving the Company's
customers would lead such customers to reduce or cease their use of the
Company's services which could have a material adverse effect on the Company and
the value of the Common Stock and its other securities.
The Company's strategy for establishing and growing its long distance
switched services business is based in large part on its relationship with
Excel. The failure by the Company to fulfill its obligations to provide a
reliable switched network for use by Excel or the failure by Excel: (i) to
fulfill its obligations to utilize the Company's switched long distance services
(even though such failure could give rise in certain circumstances
23
26
to claims by the Company); (ii) to utilize the volume of MOUs that the Company
expects it to utilize or (iii) to maintain and expand its business, could result
in a material adverse effect on the Company.
Dependence Upon Sole and Limited Sources of Supply
The Company relies on other companies to supply certain key components of
its network infrastructure, including telecommunications services, network
capacity and switching and networking equipment, which, in the quantities and
quality demanded by the Company, are available only from sole or limited
sources. The Company is also dependent upon LECs to provide telecommunications
services and facilities to the Company and its customers. The Company has from
time to time experienced delays in receiving telecommunications services and
facilities, and there can be no assurance that the Company will be able to
obtain such services or facilities on the scale and within the time frames
required by the Company at an affordable cost, or at all. Any such difficulty in
obtaining such services or additional capacity on a timely basis at an
affordable cost, or at all, would have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
also is dependent on its suppliers' ability to provide products and components
that comply with various Internet and telecommunications standards, interoperate
with products and components from other vendors and fulfill their intended
function as a part of the network infrastructure. Any failure of the Company's
suppliers to provide such products could have a material adverse effect on the
Company's business, financial condition and results of operations.
Competition
The telecommunications industry is highly competitive. Many of the
Company's competitors and potential competitors have substantially greater
financial, personnel, technical, marketing and other resources than those of the
Company and a far more extensive transmission network than the Company. Such
competitors may build additional fiber capacity in the geographic areas to be
served by the Network or to be served by the Network expansion. Qwest is
building a new nationwide long distance fiber optic network and Frontier has
agreed to pay $500.0 million to obtain fibers in Qwest's network. If the
MCI/WorldCom merger or the Qwest/LCI merger is approved, the result would be
even larger, and potentially stronger, competitor (or competitors). In addition,
Level 3 has announced that it will spend approximately $3.0 billion to construct
a 20,000 mile fiber optic communications network entirely based on Internet
technology. The Williams Companies, a competitor of the Company, has also
announced that it is accelerating the expansion of its national fiber optic
network with a $2.7 billion investment to create a 32,000 mile system by the end
of 2001. Furthermore, many telecommunications companies are acquiring switches
and the Company's reseller customers will have an increasing number of
alternative providers of switched long distance services. The Company competes
primarily on the basis of pricing, availability, transmission quality, customer
service (including the capability of making rapid additions to add end users and
access to end-user traffic records) and variety of services. The ability of the
Company to compete effectively will depend on its ability to maintain
high-quality services at prices generally equal to or below those charged by its
competitors.
An alternative method of transmitting telecommunications traffic is through
satellite transmission. Satellite transmission is superior to fiber optic
transmission for distribution communications, for example, video broadcasting.
Although satellite transmission is not preferred to fiber optic transmission for
voice traffic in most parts of the United States because it exhibits a slight
(approximately one-quarter-second) time delay, such delay is not important for
many data-oriented uses. In the event the market for data transmission grows,
the Company will compete with satellite carriers in such market. Also, at least
one satellite company, Orion Network Systems, Inc., has announced its intention
to provide Internet access services to businesses through satellite technology.
The Company competes with large and small facilities-based interexchange
carriers as well as with other coast-to-coast and regional fiber optic network
providers. There are currently four principal facilities-based long distance
fiber optic networks (AT&T, MCI, Sprint and WorldCom) and Qwest is building
another. The Company anticipates that each of Qwest and Frontier will have a
fiber network similar in geographic scope and potential operating capability to
that of the Company. The Company also sells long distance switched services to
both facilities-based carriers and nonfacilities-based carriers (switchless
resellers), competing with
24
27
facilities-based carriers such as AT&T, MCI, Sprint, WorldCom and certain
regional carriers. The Company competes in its markets on the basis of price,
transmission quality, network reliability and customer service and support. The
ability of the Company to compete effectively in its markets will depend upon
its ability to maintain high quality services at prices equal to or below those
charged by its competitors many of whom have extensive experience in the long
distance market. In addition, the Telecom Act of 1996 (as defined) will allow
the RBOCs and others to enter the long distance market. When RBOCs enter the
long distance market, they may acquire, or take substantial business from, the
Company's reseller customers. There can be no assurance that the Company will be
able to compete successfully with existing competitors or new entrants in its
markets. Failure by the Company to do so would have a material adverse effect on
the Company's business, financial condition and results of operations. See
"-- Risks Related to Technological Change" and "-- Regulation."
On February 15, 1997, the United States Trade Representative designate
announced that an agreement had been reached with World Trade Organization
("WTO") countries to open world telecommunications markets to competition. The
agreement, known as the WTO Basic Telecommunications Services Agreement, became
effective on February 5, 1998. The WTO Agreement will provide U.S. companies
with foreign market access for local, long distance, and international services,
either on a facilities basis or through resale of existing network capacity. The
WTO Agreement also provides that U.S. companies can acquire, establish or hold a
significant stake in telecommunications companies around the world. Conversely,
foreign companies will be permitted to enter domestic U.S. telecommunications
markets and acquire ownership interest in U.S. companies. On June 4, 1997, the
FCC initiated a rulemaking proceeding to bring FCC policies and procedures into
conformance with the WTO Agreement, and on November 26, 1997 released an order
on foreign entry, although a petition for reconsideration of the order is
pending. While the outcome of the petition for reconsideration cannot be
predicted, foreign telecommunications companies could also be significant new
competitors to the Company or the Company's customers. See "-- Industry
Overview," "-- Business -- Private Line Services" and "-- Business -- Long
Distance Switched Services."
Dependence on Key Personnel
The Company's businesses are managed by a small number of key executive
officers, the loss of whom could have a material adverse effect on the Company.
The Company believes that its growth and future success will depend in large
part on its continued ability to attract and retain highly skilled and qualified
personnel. As a result of the recent growth in the telecommunications industry,
competition for qualified operations and management personnel has intensified.
The loss of one or more members of senior management or the failure to recruit
additional qualified personnel in the future could significantly impede
attainment of the Company's financial, expansion, marketing and other
objectives.
Development Risks of the Frame Relay and ATM Transmission Business
The Company began offering Frame Relay, ATM and other data transmission
services during the first quarter of 1997. Although the Company has not yet
generated material revenues from this business, the Company believes that data
transmission services present a promising opportunity for the Company. To
succeed in providing these services, the Company must compete with AT&T, MCI,
Sprint, WorldCom and other large competitors. In addition, the Company expects
that it will be necessary to continue to make upgrades to its Network (in
advance of related revenues) to be competitive in providing these services. The
provision of data transmission services involves technical issues with which the
Company has very limited experience. In addition, the provision of these
services must be successfully integrated with the Company's existing businesses.
To the extent the Company does not successfully compete in providing these
services, it will not realize a return on its investment in data switches and
other equipment and it will not benefit from the growth, if any, in demand for
these services. A failure to successfully compete in data transmission services
could have a material adverse effect on the Company and the value of the Common
Stock and its other securities.
25
28
Recent Legislation and Regulatory Uncertainty
Certain of the Company's operations are subject to regulation by the FCC
under the Communications Act. In addition, certain of the Company's businesses
are subject to regulation by state public utility or public service commissions.
Changes in the regulation of, or the enactment or changes in interpretation of
legislation affecting, the Company's operations could have a material adverse
affect on the Company and the Common Stock. In 1996 the federal government
enacted the Telecom Act, which, among other things, allows the RBOCs and others
to enter the long distance business. Entry of the RBOCs or other entities such
as electric utilities and cable television companies into the long distance
business may have a negative impact on the Company or its customers. The Company
anticipates that certain of such entrants will be strong competitors because,
among other reasons, they may enjoy one or more of the following advantages:
they may (i) be well capitalized; (ii) already have substantial end-user
customer bases; and/or (iii) enjoy cost advantages relating to local loops and
access charges. The introduction of additional strong competitors into the
switched long distance business would mean that the Company and its customers
would face substantially increased competition. This could have a material
adverse effect on the Company and the value of the Common Stock. On July 18,
1997, in Iowa Utilities Board v. FCC, the United States Court of Appeals for the
Eighth Circuit invalidated key portions of the FCC's August 29, 1996
interconnection order, which the FCC had adopted to facilitate the emergence of
local exchange competition. The Supreme Court recently agreed to hear an appeal
of the Eighth Circuit's ruling. The further emergence and development of local
exchange competition may likely be delayed as a result. Consequently, the
Company and its customers may not benefit as quickly from the lower access costs
that might otherwise have resulted had competition in the provision of local
access services not been thus delayed. Further, the FCC has issued orders
relating to universal service funding by interstate telecommunications carriers,
and to the access charges the Company and its customers are required to pay to
LECs. These orders have been appealed. The outcomes of the appeals, and the
outcomes of future FCC proceedings on these issues, are impossible to predict.
In addition, the Telecom Act provides that state proceedings may in certain
instances determine access charges the Company and its customers are required to
pay to the LECs. There can be no assurance that such proceedings will not result
in increases in such rates. Such increases could have a material adverse effect
on the Company or its customers. See "-- Industry Overview;" and
"-- Regulation."
Some members of Congress have expressed dissatisfaction with the FCC's
implementation of the Telecom Act, and in particular with respect to the
development of local exchange competition, RBOC re-entry into in-region long
distance markets and universal service funding. It is possible that new
legislation will be introduced, seeking to amend the Telecom Act. However, it is
impossible to predict the scope or likelihood of success of any such possible
further legislation, or the potential impact on the Company of any such possible
further legislation.
Risks Relating to Mexican Joint Venture
In February, 1998, Marca-Tel announced that it was putting further
investment in new fiber routes on hold, awaiting more suitable market and
regulatory conditions. Because of the continuing adverse market and regulatory
environment in Mexico, Marca-Tel has determined to limit further investment and
to reduce its scope of operations. At the present time, the Company does not
anticipate significant additional funding to Progress International for
investment in Marca-Tel until the market and regulatory conditions in Mexico
improve. Failure to provide further significant funding to Progress
International is likely to result in a default under Marca-Tel's financial
arrangements and could result in the foreclosure of a security interest held by
a third party. The Company's carrying value for the Company's investment in
Progress International at December 31, 1997 was $11.6 million. The Company's
interest in Progress International, and thus its indirect interest in Marca-Tel,
therefore could be diluted or lost entirely, which could have a material adverse
effect on the Company and the value of the Common Stock and its other
securities.
Potential Liability of Internet Access Providers
The law governing the liability of on-line services providers and Internet
access providers for participating in the hosting or transmission of
objectionable materials or information currently is unsettled. Under the terms
26
29
of the Telecom Act, both civil and criminal penalties can be imposed for the use
of interactive computer services for the transmission of certain indecent or
obscene communications. However, this provision was recently found to be
unconstitutional by the United States Supreme Court in American Civil Liberties
Union v. Janet Reno. Nonetheless, many states have adopted or are considering
adopting similar requirements, and the constitutionality of such state
requirements remains unsettled at this time. In addition, several private
lawsuits have been filed seeking to hold Internet access providers accountable
for information which they transmit. In one such case, the court ruled that an
Internet access provider is not directly liable for copies that are made and
stored on its computer but may be held liable as a contributing infringer where,
with knowledge of the infringing activity, the Internet access provider induces,
causes or materially contributes to another person's infringing conduct. While
the outcome of these activities is uncertain, the ultimate imposition of
potential liability on Internet access providers for information which they
host, distribute or transport could materially change the way they must conduct
business. To avoid undue exposure to such liability, Internet access providers
could be compelled to engage in burdensome investigation of subscriber materials
or even discontinue offering the service altogether.
Risks Relating to Switched Services Resellers
Revenues derived from switched services resellers account for substantially
all of the Company's switched long distance revenue. A substantial portion of
such revenues are produced by a limited number of resellers. Sales to switched
services resellers generate low margins for the Company. In addition, these
customers frequently choose to move their business based solely on small price
changes and generally are perceived in the telecommunications industry as
presenting a high risk of payment delinquency or non-payments. The Company's
provision for service credits and bad debt was $3.0 million or 1.5% of total
revenues in 1996 (when it had $104.0 million of long distance switched services
revenue) and $17.4 million or 4.1% of total revenues in 1997 (when it had $258.3
million of long distance switched services revenue). The Company expects service
credit and bad debt expense to continue to increase, but seeks to control it so
that it will not increase as a percentage of revenues. The Company is continuing
to implement procedures to control its exposure to service credit and bad debt
expense. Any material increase in service credit and bad debt expense as a
percentage of revenues could have a material adverse effect on the Company's
results of operations and financial position and on the value of the Common
Stock and its other securities.
Risks Related to Technological Change
The market for the Company's telecommunications services is characterized
by rapidly changing technology, evolving industry standards, emerging
competition and frequent new product and service introductions. There can be no
assurance that the Company will successfully identify new service opportunities
and develop and bring new services to market. The Company is also at risk from
fundamental changes in the way telecommunications services are marketed and
delivered. The Company's data communications service strategy assumes that
technology such as Frame Relay and ATM protocols, utilizing fiber optic or
copper-based telecommunications infrastructures, will continue to be the primary
protocols and transport infrastructure for data communications services. Future
technological changes, including changes related to the emerging wireline and
wireless transmission and switching technologies, could have a material adverse
effect on the Company's business, results of operations, and financial
condition. The Company's pursuit of necessary technological advances may require
substantial time and expense, and there can be no assurance that the Company
will succeed in adapting its telecommunications services business to alternate
access devices, conduits and protocols.
In addition, recent technological advances that show the potential to
greatly expand the capacity of existing and new fiber optic cable, which could
greatly increase supply, could have a material adverse effect on the Company.
ITEM 2. PROPERTIES
The principal properties owned by the Company consist of: (i) the portion
of the Network completed or under construction; and (ii) the coast-to-coast
microwave system, consisting of microwave transmitters,
27
30
receivers, towers and antennae, auxiliary power equipment, transportation
equipment, equipment shelters and miscellaneous components. Generally, the
Company's fiber optic system and microwave relay system components are standard
commercial products available from a number of suppliers.
The principal offices of the Company are located in approximately 105,000
square feet of space in Austin (the "City View Space"). The Company leases the
City View Space pursuant to the terms of a lease which expires in December 2004,
at a current annual base rental of approximately $1,680,000, and has an option
to renew the lease for two seven-year terms at the then-prevailing market rate
(but not less than the then-current rental rate) at the time of renewal. The
Company has additional offices in Austin, consisting of approximately 76,000
square feet (the "Braker Space"). The Company leases the Braker Space under an
agreement which expires in January 2003, at an annual base rental of
approximately $570,000. In addition, the Company subleases former office space
in two other locations in Austin covering approximately 44,000 square feet and
16,000 square feet. The sublease payments satisfy the Company's monthly rental
obligations under the original leases.
The Company leases sites for its switches in or near Los Angeles, Dallas,
Chicago, Atlanta, Philadelphia and Joplin, Missouri under lease agreements that
expire between 2000 and 2005. The total current rental commitments for the
switch site leases are approximately $30,000 per month. The Company's six
switches are leased under capital leases from DSC Finance Corporation over a
term of five years.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings, all of which have
arisen in the ordinary course of business and some of which are covered by
insurance. In the opinion of the Company's management, none of the claims
relating to such proceedings are likely to have a material adverse effect on the
financial condition or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
28
31
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the Nasdaq National Market (the
"NNM") under the trading symbol "IIXC." The following table sets forth, on a per
share basis for the periods indicated, the high and low closing sale prices for
the Common Stock as reported by the NNM.
PRICE RANGE
------------
HIGH LOW
---- ----
Fiscal Year 1996
Third quarter (from July 3, 1996)......... $ 21 1/8 $ 11 1/2
Fourth quarter............................ 30 3/4 19 5/8
Fiscal Year 1997
First Quarter............................. 36 1/4 18 3/4
Second Quarter............................ 27 7/8 17
Third Quarter............................. 33 19 1/2
Fourth Quarter............................ 40 1/8 29 3/8
As of March 1, 1998, there were approximately 151 holders of record of the
Common Stock.
DIVIDEND POLICY
IXC Communications has never paid any cash dividends on its Common Stock
and does not expect to pay cash dividends on its Common Stock in the foreseeable
future. The terms of the Senior Notes Indenture restrict the payment of cash
dividends. No dividends may be paid on the Common Stock until all dividends are
paid in full on the Company's Convertible Preferred Stock, the Company's 10%
Junior Series 3 Cumulation Redeemable Preferred Stock (the "Series 3 Preferred
Stock") and the Exchangeable Preferred Stock. Dividends on the Convertible
Preferred Stock and the Exchangeable Preferred Stock are payable quarterly in
cash (or on or prior to March 31, 1999 and February 15, 2001, at the option of
the Company, in additional shares of Convertible Preferred Stock or Exchangeable
Preferred Stock, respectively) in arrears at the annual rate of 7 1/4% and
12 1/2% of the aggregate liquidation preference therefore, respectively. The
Company's ability to pay cash dividends on shares of Convertible Preferred Stock
and the Exchangeable Preferred Stock is limited by the terms of the Senior Notes
Indenture and by the terms of the Series 3 Preferred Stock. As of December 31,
1997 the aggregate liquidation preference of the Series 3 Preferred Stock, the
Convertible Preferred Stock and the Exchangeable Preferred Stock was $.7
million, $105.5 million and $309.0 million respectively. Dividends on the Series
3 Preferred Stock accumulate at an annual rate of 10% (based on the liquidation
preference) plus interest. IXC Communications currently intends to retain future
earnings, if any, to finance its operations and fund the growth of its business.
Any payment of future dividends on its Common Stock will be at the discretion of
the Board of Directors of IXC Communications and will depend upon, among other
things, IXC Communications' earnings, financial condition, capital requirements,
level of indebtedness, contractual and legal restrictions with respect to the
payment of dividends and other factors that IXC Communications' Board of
Directors deems relevant.
RECENT SALES OF UNREGISTERED SECURITIES
On October 31, 1997, the Company consummated an offer (the "Series 3 Tender
Offer") to exchange shares of the Company's common stock (the "Common Stock")
for all its issued and outstanding shares of the Series 3 Preferred Stock. Each
holder that tendered its shares of Series 3 Preferred Stock received
approximately 49.85 shares of Common Stock for each share of Series 3 Preferred
Stock tendered. An aggregate of 604,970 shares of Common Stock were issued in
the Series 3 Tender Offer. The number of shares of Common Stock issued for each
share of Series 3 Preferred Stock tendered was calculated by dividing the
aggregate per share liquidation preference, including accrued and unpaid
dividends, on one share of Series 3
29
32
Preferred Stock as of October 31, 1997 (the expiration date of the Series 3
Tender Offer) by $33.00 (the last reported sale price of the Common Stock on the
NNM on October 31, 1997). The aggregate liquidation preference, including
accrued and unpaid dividends, on the Series 3 Preferred Stock at October 31,
1997, was approximately $20.6 million (or $1,645 per share). The Common Stock
issued in connection with the Series 3 Tender Offer was not registered under the
Securities Act. Over 95% of the shares of Series 3 Preferred Stock were tendered
prior to the expiration of the Series 3 Tender Offer. The Common Stock issued in
the Series 3 Tender Offer was deemed to be exempt from registration under the
Securities Act in reliance upon Section 3(a)(9) thereof. No underwriters or
placement agents were employed in connection with the Series 3 Tender Offer. The
Company intends to redeem the remaining shares of Series 3 Preferred Stock in
1998.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected historical financial data
of the Company. The historical financial data for the Company has been derived
from the audited Consolidated Financial Statements of the Company. The selected
historical financial data set forth below is qualified in its entirety by, and
should be read in conjunction with, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Business" and the Company's
Consolidated Financial Statements, related notes thereto and other financial
information included herein.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net operating revenue..................... $ 71,123 $ 80,663 $ 91,001 $203,761 $420,710
Operating income (loss)................... (10,596) 14,085 1,429 (14,016) (45,235)
Income (loss) before extraordinary gain
(loss)................................. (31,812) 5,017 (3,218) (37,448) (94,555)
Extraordinary gain (loss)(1).............. 8,495 2,298 (1,747) -- --
Net income (loss)......................... $(23,317) $ 7,315 $ (4,965) $(37,448) $(94,555)
Basic and diluted income (loss) per
share(2):
Before extraordinary gain (loss)....... $ (1.43) $ .13 $ (.21) $ (1.42) $ (3.75)
Extraordinary gain (loss).............. .36 .10 (.07) -- --
Net income (loss)...................... $ (1.07) $ .23 $ (.28) $ (1.42) $ (3.75)
Weighted average basic shares............. 23,332 24,310 24,335 27,525 30,961
Weighted average diluted shares........... 23,332 24,318 24,335 27,525 30,961
BALANCE SHEET DATA:
Cash and cash equivalents................. $ 6,230 $ 6,048 $ 6,915 $ 61,340 $152,720
Total assets.............................. 94,281 105,409 336,475 459,151 917,095
Total debt and capital lease
obligations............................ 59,954 69,124 298,794 302,281 320,295
Redeemable preferred stock................ -- -- -- -- 403,368
Stockholders' equity (deficit)............ 6,871 14,189 6,858 63,479 (47,955)
OTHER FINANCIAL DATA:
EBITDA(3)................................. $ 10,465 $ 26,206 $ 18,867 $ 13,225 $ 15,513
Capital expenditures...................... 27,008 7,087 23,670 136,391 314,327
- ---------------
(1) The extraordinary items for all periods result from early extinguishment of
debt (involving a related party in 1994), including capital lease
obligations, net of applicable income taxes.
(2) The basic and diluted income (loss) per share amounts prior to 1997 have
been restated as required to comply with Statement of Financial Accounting
Standards No. 128, Earnings Per Share and the Securities and Exchange
Commission Staff Accounting Bulletin No. 98. For further discussion of basic
and diluted income (loss) per share and the impact of Statement No. 128, see
note 2 to the notes to the consolidated financial statements.
30
33
(3) EBITDA is operating income (loss) plus depreciation and amortization. The
Company has included information concerning EBITDA because it believes that
EBITDA is used by certain investors as one measure of an issuer's historical
ability to service its debt. EBITDA is not a measurement determined in
accordance with GAAP, should not be considered in isolation or as a
substitute for measures of performance prepared in accordance with GAAP and
is not necessarily comparable with similarly titled measures for other
companies.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations contains statements that constitute "forward-looking" statements
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements relate to future events or the future financial
performance of the Company and involve known and unknown risks, uncertainties
and other factors that may cause the actual results, performance or achievements
of the Company to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. Such
factors include, among other things, the following: general economic and
business conditions; industry capacity; uncertainty regarding and changes in
customer preferences; demographic changes; competition; changes in methods of
marketing and technology; changes in political, social and economic conditions
and regulatory factors; and various other factors beyond the Company's control.
In addition, prospective investors should specifically consider the various
factors identified in this Form 10-K including the matters set forth under
"Business -- Risk Factors," which could cause actual results to differ
materially from those indicated by such forward-looking statements. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks and uncertainties, there can be no assurance that the
results referred to in forward-looking statements contained in this Form 10-K
will in fact transpire. The following discussion should be read in conjunction
with the Consolidated Financial Statements and the related Notes thereto,
included elsewhere in this Form 10-K.
OVERVIEW
The Company is a leading provider of telecommunications transmission,
switched long distance and associated services to long distance and other
communications companies. The Company's Network is expected to include over
11,500 digital route miles by the end of the first quarter of 1998. Additions to
the Network are currently under construction. Subject to the availability of
capital and the completion of cost-sharing arrangements currently being
negotiated, the Network is planned to include over 18,000 digital route miles by
the end of 1998, and over 20,000 digital route miles by the end of 1999. The
Company provides two principal products: transmission of voice and data over
dedicated circuits ("private lines") and transmission of long distance traffic
processed through the Company's switches ("long distance switched services").
During the first quarter of 1997, the Company began providing Frame Relay and
ATM-based switched data services in order to capitalize on the growing demand
for Internet and electronic data transfer services.
Private Line Business. Substantially all of the Company's revenue in 1995
and prior years, approximately 49% of its revenue for 1996 and 39% for 1997 was
generated by its private line business, which has historically provided positive
EBITDA and cash flow (even in years when the Company incurred net losses). The
Company provides private line service to customers generally either on a "take
or pay" long-term basis or, after contract expiration, on a month-to-month
basis. The Company's private line transmission agreements are generally
long-term leases which provide for monthly payment in advance on a fixed-rate
basis, calculated according to the capacity and length of the circuit used.
During 1997, the Company leased transmission capacity to over 230 customers,
with the five largest private line customers during that year accounting for
approximately 52% of private line revenue and approximately 20% of the Company's
total revenue. Three of the Company's largest private line customers, AT&T,
WorldCom and Frontier, accounted for approximately 6.4%, 4.2% and 4.1%,
respectively, of the Company's total revenue in 1997.
The largest component of the cost of services of the private line business
is the expense of leasing off-net capacity from other carriers to meet customer
needs which the Company cannot currently meet with its own Network due to
capacity or geographic constraints. In the normal course of business the Company
has entered
31
34
into capacity-exchange agreements with other carriers. Pursuant to such
agreements, the Company exchanges excess capacity on its Network with other
carriers for capacity on the other carriers' networks. Such exchange agreements
generally do not provide for cash payments to be made, but rather allow the
Company to substantially reduce the cash payments it must make for off-net
capacity from other carriers. Such exchanges are accounted for at the fair value
of the capacity exchanged, as non-cash revenue and expense in equal amounts over
the term of the agreements. In 1997, 1996 and 1995 the Company recorded revenue
and expense of $14.0 million, $14.0 million and $13.8, respectively, relating to
such exchanges.
Long Distance Switched Services Business. At the end of 1995, the Company
expanded into the business of selling long distance switched services to long
distance resellers. In 1997 and 1996, this business contributed 61% and 51%,
respectively, of the Company's total revenue. The Company sells these services
on a per-call basis, charging by the MOUs, with payment due monthly after
services are rendered. The Company's rates for calls generally vary with the
duration of the call, the day and time of day the call was made and whether the
traffic is intrastate, interstate or international. At December 31, 1997, the
Company had over 100 long distance reseller customers. The Company has achieved
significant revenue growth since it began offering long distance switched
services. The Company's largest switched services customer, Excel, accounted for
approximately 46.5% of the switched long distance business and approximately
28.6% of the Company's total revenue in 1997.
The three main components of long distance switched services business costs
are access costs with LECs and other providers, the expense of leasing off-net
capacity from other carriers, and operations and administration expenses. The
LEC access charges, which are usage-based and vary according to the LATA in
which calls originate and terminate, represent a majority of the total costs for
the long distance switched services business. Long distance network leasing
costs are incurred as the Company leases capacity to carry traffic to areas
where its Network does not reach or is already running at or near capacity. As
the Company transfers traffic onto its newly constructed network routes, the
Company expects to realize cost savings because it will be able to reduce the
amount of long distance network capacity that otherwise would be required to be
leased from other parties. However, the Company does not intend to expand its
Network to all areas of the United States. Accordingly, the Company anticipates
that it will continue to lease capacity from other carriers regardless of the
Network expansion. Because the long distance switched services business
generally has lower margins than the private line business, increases in
switched long distance volumes have caused and will continue to cause a decrease
in the Company's overall margins.
Although the Company has been successful in establishing its nationwide
long distance switched services business with significant revenue, EBITDA for
the long distance switched services business has historically been negative
through 1997 and may be negative in 1998. EBITDA losses in the long distance
switched services business were greatly reduced during the second half of 1997,
with consecutive quarter losses being reduced over 50% from the second to the
third quarter and over 25% from the third quarter to the fourth quarter. The
Company believes the improvements in operating results from long distance
switched services are the result of three major factors:
First, the Company historically priced its interstate services to customers
at a blended rate based upon the expected usage and mix of traffic between
high-access-cost and low-access-cost LATAs. During 1997 certain of the Company's
customers generated switched traffic comprised of a substantially higher mix of
minutes originating or terminating in high-access-cost LATAs than was
anticipated at the time the customer contracts were negotiated and pricing
established. During the second half of 1997, this situation improved
significantly as the Company established rates more directly related to the
customer's actual mix of traffic. However, the Company experienced substantial
negative gross profits in the fourth quarter of 1997 with respect to
international services delivered to a high-volume customer due to unfavorable
international settlement costs not adequately covered by the prices charged to
the customer. The Company no longer offers such services to the customer.
Second, the Company configures its switched network to account for the
expected traffic distribution of its customers. In certain areas during the
first half of 1997, traffic volume was higher than expected causing certain of
the Company's switches to run at capacity and requiring the Company to overflow
excess traffic onto
32
35
other carriers' switched networks. The Company has added ports to its existing
switches and deployed two additional switches to better manage the current and
projected volumes and mixes of traffic in order to enhance Network efficiency.
Third, the Company benefitted from the impact of the FCC mandated rate
reductions for the connection charges paid by the long distance carriers to
LEC's.
There can be no assurance that the improvements in long distance switched
services' EBITDA experienced during the last half of 1997 will continue in the
future. In addition, some increases in certain elements of access charges are
anticipated in mid-1998, although the overall effect of access charge reform on
the Company is uncertain.
The Company expects that as competition increases, prices for both private
line and long distance switched services will decline. These price declines will
effect both the Company's revenue and its cost of services.
Capital Expenditures. The Company has spent significant amounts of capital
to develop its coast-to-coast Network to service its private line, long distance
switched services and other businesses and is continuing a substantial expansion
of its Network. On a cash basis, the Company spent $314.3 million for capital
expenditures during 1997 and estimates that it will spend approximately $525.0
million in 1998. The Company expects to continue making substantial capital
expenditures thereafter for additional fiber expansion and the deployment of
additional optronics to provide capacity for revenue growth, as well as
additional voice and data switches for anticipated growth in voice and data
traffic.
Acquisition Transactions. In December 1997, the Company entered into an
agreement to acquire NLD, a provider of long distance services to businesses and
association programs, agents and other long distance carriers. NLD has
annualized revenue in excess of $100.0 million. The transaction is intended to
be a tax-free, pooling-of-interests merger in which the NLD shares will be
acquired for approximately 4.3 million shares of the Company's Common Stock. The
transaction, which requires regulatory approvals and NLD shareholder approval,
is anticipated to close in mid-1998.
Joint Ventures. Marca-Tel, a joint venture in which the Company indirectly
holds a minority interest, obtained a license from the Mexican government to
provide certain telecommunication services in Mexico. The Company has
contributed $37.0 million as of December 31, 1997 to Progress International
which owns a 49.0% interest in Marca-Tel, substantially all of which funds have
been used to fund Marca-Tel at December 31, 1997. The Company accounts for its
investment in Progress International (and indirect investment in Marca-Tel)
using the equity method and, as a result, records a percentage of Marca-Tel's
operating results (profits or losses).
In October 1997, the Company formed a joint venture with Telenor AS, the
Norwegian national telephone company, to provide telecommunication services to
carriers and resellers in nine European countries. The joint venture is owned 40
percent by the Company, 40 percent by Telenor, and 20 percent by Clarion
Resources Communications Corporation, a U.S.-based telecommunications company in
which Telenor owns a controlling interest.
In December 1997, the Company formed Unidial Communications Services, LLC,
a joint venture with Unidial. The joint venture is building a direct sales force
to market and sell Unidial's and the Company's products over the Company's
Network. The joint venture is owned 80 percent by Unidial and 20 percent by the
Company. Subject to the terms of the joint venture agreement, upon request of
the President of the joint venture, the Company is obligated to invest up to an
additional $7.5 million during 1998 and after November 1, 1998, it may be
obligated to invest up to an additional $4.0 million. After its funding
obligation is fulfilled, the Company is not required to fund any future
investments to the joint venture, but to the extent Unidial funds such
investments alone, the Company's interest in the joint venture may be diluted.
PSINet Transaction. To enhance the Company's product and service offerings,
in February 1998, the Company consummated agreements with PSINet which allow
each party to market and sell the products and services of the other party.
Under the terms of the agreements, the Company will provide PSINet with an
33
36
IRU in 10,000 miles of OC-48 transmission capacity on its Network over a 20-year
period in exchange for approximately 10.2 million shares representing 20%
(post-issuance) of PSINet common stock. If the value of the PSINet common stock
received by the Company is less than $240.0 million at the earlier of one year
after the final delivery of the transmission capacity (scheduled for late-1999)
or four years after the transaction's closing, PSINet, at its option, will pay
the Company cash and/or deliver additional PSINet common stock to increase the
value of the cash and Common Stock paid by PSINet to $240.0 million. Upon
delivery of the transmission capacity to PSINet, the Company will begin to
receive a maintenance fee which, as the full capacity has been delivered, should
increase to approximately $11.5 million per year. The Company will account for
its investment in PSINet using the equity method and, as a result will record a
percentage of PSINet's operating results (profits or losses).
Fiber Sales and IRUs. In connection with the Network expansion, the Company
has entered into various agreements to sell fiber usage rights. Sales of fiber
usage rights are recorded as deferred revenue and are included in other
non-current liabilities in the accompanying consolidated balance sheets. Revenue
is recognized over the terms of the related agreements. In 1997, the Company
received approximately $57.0 million in cash from these sales but recognized
only approximately $.8 million as revenue from these sales.
Financing Transactions. In October 1995, the Company issued $285.0 million
of Senior Notes primarily to finance a portion of the Network expansion.
In July 1996, the Company raised gross proceeds of approximately $83.3
million (before deducting certain expenses) through its initial public offering
of the Company's Common Stock (the "IPO") and $12.5 million from the private
placement of the Company's Common Stock with GEPT (the "GEPT Private
Placement").
In April 1997, the Company raised gross proceeds of $100 million (before
deducting discounts and certain expenses) through the sale of its Convertible
Preferred Stock.
In August 1997, the Company raised gross proceeds of $300 million (before
deducting discounts and certain expenses) through the sale of its Exchangeable
Preferred Stock.
34
37
QUARTERLY RESULTS OF OPERATIONS
The following table presents certain unaudited quarterly financial
information for each of the Company's quarters in 1996 and 1997. This quarterly
information has been prepared on the same basis as the audited financial
statements appearing elsewhere in this Form 10-K and includes all adjustments
(which consist only of normal recurring adjustments) necessary to present fairly
the unaudited quarterly results set forth herein. The Company's quarterly
results have in the past been subject to fluctuations, and thus, the operating
results for any quarter are not necessarily indicative of results for any future
period. The Company may experience substantial fluctuations in quarterly results
in the future as a result of various factors, including customer turnover,
variations in the success of its customers' businesses and price competition. In
addition, delays in completion of the construction of new network routes could
cause quarterly results to vary.
1996 QUARTER ENDED 1997 QUARTER ENDED
------------------------------------------------ ------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ ----------- -------- -------- ------------ -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS
DATA:
Net operating revenue:
Private line circuits..... $ 22,628 $ 24,003 $25,766 $27,396 $ 30,869 $ 38,494 $ 41,948 $ 51,087
Switched long distance.... 3,622 19,004 35,250 46,092 53,041 50,371 70,292 84,608
-------- -------- ------- ------- -------- -------- -------- --------
Net operating revenue....... 26,250 43,007 61,016 73,488 83,910 88,865 112,240 135,695
Operating expenses:
Cost of services.......... 15,600 31,643 43,774 52,452 68,982 74,150 83,889 98,106
Operations and
administration.......... 10,417 10,786 12,083 13,781 16,567 18,664 22,240 22,599
Depreciation and
amortization............ 6,010 6,644 7,280 7,307 10,002 13,363 19,402 17,981
-------- -------- ------- ------- -------- -------- -------- --------
Total operating
expenses.............. 32,027 49,073 63,137 73,540 95,551 106,177 125,531 138,686
-------- -------- ------- ------- -------- -------- -------- --------
Operating loss.............. $ (5,777) $ (6,066) $(2,121) $ (52) $(11,641) $(17,312) (13,291) (2,991)
======== ======== ======= ======= ======== ======== ======== ========
Net loss.................... $(11,699) $(12,067) $(5,624) $(8,058) $(19,878) $(28,810) (26,788) (19,079)
======== ======== ======= ======= ======== ======== ======== ========
Basic and diluted loss per
share(2).................. $ (.50) $ (.51) $ (.20) $ (.28) $ (.66) $ (1.01) $ (1.08) $ (.99)
======== ======== ======= ======= ======== ======== ======== ========
OTHER FINANCIAL AND
OPERATIONS DATA:
EBITDA(1)................. $ 233 $ 578 $ 5,159 $ 7,255 $ (1,639) $ (3,949) 6,111 14,990
Minutes of use
(in millions)........... 33.9 199.3 375.1 496.9 606.0 636.2 825.3 966.9
- ---------------
(1) EBITDA is operating loss plus depreciation and amortization. The Company has
included information concerning EBITDA because it believes that EBITDA is
used by certain investors as one measure of an issuer's historical ability
to service its debt. EBITDA is not a measurement determined in accordance
with GAAP, should not be considered in isolation or as a substitute for
measures of performance prepared in accordance with GAAP and is not
necessarily comparable with similarly titled measures for other companies.
(2) Basic and diluted loss per share calculations for each of the quarters were
based on the weighted average number of shares outstanding for each period,
therefore the sum of the quarters may not necessarily be equal to the full
year basic and diluted loss per share amount. The 1996 and first three
quarters of 1997 loss per share amounts have been restated to comply with
Statement of Financial Accounting Standards No. 128, Earnings per Share and
the Securities and Exchange Commission Staff Accounting Bulletin No. 98. See
note 2 to the consolidated financial statements.
RESULTS OF OPERATIONS
1997 Compared With 1996
Net operating revenue for 1997 increased 106.5% to $420.7 million from
$203.8 million for 1996. The increase is primarily a result of both the
increased growth of the Company's long distance switched services
35
38
business and private line business. Long distance switched services revenue
increased 148.5% to $258.3 million for 1997 compared to $104.0 million for 1996.
Billable MOUs were 3.03 billion in 1997, compared to 1.11 billion for 1996.
Revenue per MOU decreased from 9.3c in the fourth quarter of 1996 to 8.8c in the
fourth quarter of 1997 due to competitive price pressure, which is expected to
continue. Revenue for the Company's private line business for 1997 increased
62.7% to $162.4 million from $99.8 million for 1996. The private line increase
in revenue correlates with the additional fiber capacity available, or
anticipated to be available, on the Network.
Cost of services consists principally of access charges paid to LECs and
transmission lease payments to, and exchanges with, other carriers. Cost of
services for 1997 increased 126.6% to $325.1 million from $143.5 million for
1996. The increase is primarily a result of additional leases for transmission
capacity supporting the Company's private line and switched long distance
services businesses, MOUs provided by other carriers and access charges paid to
LECs in connection with the increased long distance switched services revenue.
Cost of services increased faster on a percentage basis than revenue principally
because switched long distance services revenues (which represent an increasing
portion of total revenues) generate substantially lower gross margins than
private line revenues and because of certain uneconomic customer contracts that
the Company had in the first two quarters of 1997 and an uneconomic customer
contract that the Company had in the fourth quarter of 1997. The Company has
historically had a relatively low cost of services as a percentage of revenue
because substantially all its revenue was derived from private line services,
generally made at a relatively low cost over its own network. Cost of services
in the switched long distance services business are substantially greater than
in the private line business due to the additional costs of LEC access charges,
leases for long distance circuits and MOUs obtained from other carriers. In July
1997 the FCC mandated rate reductions for the connection charges paid by the
long distance carriers to LEC's. The favorable impact of these rate reductions
are reflected in the financial statements. The Company expects its cost of
services as a percentage of revenue to increase over historical results as the
switched services revenue becomes a larger share of the Company's business.
Operations and administration expenses for 1997 increased 70.1% to $80.1
million from $47.1 million for 1996. This increase is primarily the result of
employee costs and other operating expenses associated with the growth in the
Company's Network. The Company anticipates that as it expands its long distance
switched services business and its fiber network, including the projected
integration of NLD's operations into the Company, operations and administration
expenses will continue to increase, but will continue to decline as a percentage
of revenue.
Depreciation and amortization for 1997 increased 123.2% to $60.7 million
from $27.2 million for 1996. The increase is primarily the result of
depreciation related to portions of the Company's Network completed during 1997.
Depreciation and amortization will increase in subsequent periods, as the
Company's continuing investment in newly constructed routes and other Network
equipment is depreciated.
Interest income for 1997 decreased from $10.2 million for 1996 to $7.7
million as proceeds from the Company's 1996 and 1997 debt and equity placements
were used to construct the Company's network and operate its business. The
decrease from 1996 was offset partially by the interest earned on the proceeds
of the Company's sale of $100.0 million of the Convertible Preferred Stock in
April 1997 and $300.0 million of the Exchangeable Preferred Stock in August
1997.
Interest expense decreased from $37.1 million in 1996 to $31.2 million in
1997. The decrease is primarily the result of additional capitalization of
interest related to the fiber network construction.
Equity in losses of unconsolidated subsidiaries for 1997 were $23.8 million
compared to $2.0 million in 1996. These losses primarily relate to the Company's
share of losses in the Mexican joint venture, which began operations during the
first quarter of 1997, while continuing to complete its network construction. At
December 31, 1997, the Company's net carrying value in its investment in the
Mexican joint venture was $11.6 million. In February 1998, Marca-Tel announced
that it was putting further investment on new fiber routes on hold, awaiting
more suitable regulatory and market conditions. Failure to provide further
significant funding to Progress International is likely to result in a default
under Marca-Tel's financing arrangements and could result in the foreclosure of
a third party's security interest in Progress International's interest in
36
39
Marca-Tel. The Company's interest in Progress International, and thus its
indirect interest in Marca-Tel, therefore could be diluted or lost entirely.
Income tax expense for 1997 was $1.4 million compared to a benefit of $6.0
million for 1996. The increase occurred because the Company recognized tax
benefits related to the favorable resolution of federal income tax examinations
in 1996. For accounting purposes, the Company is not recognizing any tax
benefits relating to losses incurred during both 1996 and 1997.
The Company experienced a net loss applicable to common shareholders of
$116.2 million for 1997 compared to $39.2 million for 1996 as a result of the
factors discussed above and the increase in preferred stock dividends in 1997.
The increase in preferred stock dividends of $19.9 million is the result of
issuance of the Convertible Preferred Stock in April 1997 and the Exchangeable
Preferred Stock in August 1997.
1996 Compared With 1995
Net operating revenue for 1996 increased 124.0% to $203.8 million from
$91.0 million for 1995. The increase is primarily a result of the successful
commencement of the Company's long distance switched services business
(particularly the addition of Excel as a customer). Switched long distance
services revenue were $104.0 million for 1996 (compared to $1.4 million for
1995). The vast majority of this revenue was generated in the third and fourth
quarters of 1996. Billable MOUs were 1.1 million for 1996. Revenue per MOU
decreased from 10.7c in the first quarter of 1996 to 9.3c in the fourth quarter
of 1996. This decrease resulted from competitive price pressure, which is
expected to continue. Revenue for the Company's private line business for 1996
increased 11.4% to $99.8 million from $89.6 million for 1995.
Cost of services for 1996 increased 259.6% to $143.5 million from $39.9
million for 1995. The increase is primarily a result of the addition of long
distance leases supporting the long distance switched services business, MOUs
leased from other carriers and access charges paid to LECs in connection with
the long distance switched services business. The Company did not incur any
significant expenses for the long distance switched services business during
1995.
Operations and administration expenses for 1996 increased 45.8% to $47.1
million from $32.3 million for 1995. This increase is primarily the result of
employee costs and other operating expenses associated with the Company's long
distance switched services business.
Depreciation and amortization for 1996 increased 56.3% to $27.2 million
from $17.4 million for 1995. The increase is primarily the result of
depreciation related to capital expenditures associated with the Company's
expansion and improvement of its Network.
Interest income for 1996 increased to $10.2 million from $3.0 million for
1995. The increase is primarily related to interest earned on the investment of
the proceeds from the sale of the Senior Notes issued in October 1995 and the
interest earned in 1996 on the investment of the proceeds from the IPO and the
GEPT Private Placement.
Interest expense for 1996 increased to $37.1 million from $14.6 million for
1995. The increase is primarily the result of interest expense attributable to
the Senior Notes, which were issued during the fourth quarter of 1995.
Equity in the net loss of unconsolidated subsidiaries for 1996 was $2.0
million in 1996 compared to slight income for 1995. The loss was primarily the
result of start-up losses relating to the Company's investment in its Mexican
Joint Venture.
Income taxes for 1996 resulted in a $6.0 million tax benefit compared to a
benefit of $1.7 million for 1995. The difference between the tax benefits
recorded for 1996 and the expected benefit at the federal statutory rate is
primarily due to state taxes, losses incurred (the tax benefit of which is not
recorded due to uncertainty regarding its realization), and resolution of
Federal income tax examinations which were concluded in the second and third
quarters of 1996.
37
40
The Company experienced a net loss of $37.4 million for 1996 compared to a
net loss of $5.0 million for 1995 as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Except for the historical information contained below, the matters
discussed in this section are forward-looking statements that involve a number
of risks and uncertainties. The Company's actual liquidity needs, capital
resources and results may differ materially from the discussion set forth below
in such forward-looking statements. For a discussion of important factors that
could materially affect such matters, see "Business-Risk Factors."
Through 1995, the Company's private line operations provided positive cash
flow with adequate liquidity to meet the Company's operational needs. However,
the Company's capital expenditures and, since the issuance of the Senior Notes
in the fourth quarter of 1995, its interest expense and operating losses, have
been financed with the proceeds of debt and equity securities. For 1997 and
1996, the Company's EBITDA minus interest expense minus capital expenditures
plus the increases in working capital were negative $284.1 million and negative
$130.2 million, respectively.
Cash provided by operating activities increased $43.1 million to $14.3
million in 1997, compared to cash used in operating activities of $28.7 million
in 1996, primarily due to the current year's proceeds relating to fiber rights
sales in 1997 of $69.7 million, off-set primarily by increases in net losses.
Cash used in investing activities in 1997 was $298.4 million, primarily
from the Company's capital spending of $314.3 million and investment in
non-consolidated subsidiaries (chiefly the Mexican joint venture) of $35.5
million being partially offset by the release of $51.4 million of funds from
escrow under the Senior Notes. In 1996 cash provided by investing activities was
$3.1 million as $136.4 million in capital expenditures and $7.3 million of
investments in unconsolidated subsidiaries were offset by $146.8 million in net
release of funds from escrow under the Senior Notes.
Cash provided by financing activities was $375.5 million in 1997 compared
to $80.0 million in 1996. The year over year increase was due to $95.4 million
in net proceeds from issuing the Convertible Preferred Stock in April 1997 and
$288.0 in net proceeds from issuing the Exchangeable Preferred Stock in August
1997. In 1996, the net cash provided by financing activities was largely due to
$94.1 million from issuing common stock offset mainly by payments of debt
service.
As of February 28, 1998, the Company had approximately $106.0 million in
cash. The Company anticipates incurring a substantial amount of additional
indebtedness in 1998. The Company is in discussions with various investment
bankers, vendors and lending institutions regarding substantial additional
equity and/or debt financing for 1998 and beyond. The Company seeks to obtain
sufficient funding from these sources plus cash receipts from fiber sales and
operations for the following major uses of cash: (i) the Network expansion and
other capital expenditures; (ii) debt service; (iii) lease payments; (iv)
funding its joint ventures; and (v) working capital. Capital spending in 1998 is
projected to be approximately $525.0 million. After 1998, capital expenditures
are expected to be reduced, but continue to be substantial. There can be no
assurance that the Company will be successful in obtaining the necessary
financing to meet its needs. A failure to raise cash would delay or prevent such
capital expenditures and the construction of the Network expansion. Also, the
foregoing capital expenditure and cash requirements for 1998 do not take into
account any acquisitions.
The Company is required to make interest payments in the amount of $35.6
million on the Senior Notes each year. For 1997, EBITDA was insufficient to
cover the Company's debt service requirements under the Senior Notes. The
Company anticipates that such payments during 1998 will be made from cash on
hand. The Company is also required to make principal payments of $4.0 million on
other debt in 1998 including quarterly principal payments of $560,000 from March
31, 1998 through December 31, 1999.
In October 1997, the Company exchanged 96.7% of its Series 3 Preferred
Stock for Common Stock. Each stockholder of Series 3 Preferred Stock received
49.85 shares of Common Stock for each share of Series 3 Preferred Stock. As a
result of this exchange 12,136 shares of Series 3 Preferred Stock were retired
38
41
and 604,871 shares of Common Stock were issued. At December 31, 1997, the
aggregate liquidation preference of the remaining outstanding Series 3 Preferred
Stock was $692,000. The Company expects to redeem the remaining Series 3
Preferred Stock during 1998.
The Company is required to make minimum annual lease payments for
facilities, equipment and transmission capacity used in its operations. In 1998,
1999 and 2000 the Company is currently required to make payments of
approximately $10.7 million, $10.7 million and $9.3 million, respectively, on
capital leases and $32.6 million, $8.7 million and $6.3 million, respectively,
on operating leases. The Company expects to incur additional operating and
capital lease costs in connection with the Network expansion.
In connection with its Network expansion, the Company has entered into
various construction and installation agreements with contractors. Total
commitments remaining under these agreements were approximately $77.6 million at
December 31, 1997. These commitments are expected to be paid during 1998.
In connection with the Network expansion, as of December 31, 1997, the
Company had committed to pay $42.0 million in shared construction costs for
fiber usage rights on other long distance carriers' networks. Estimates of these
shared construction costs are included in the Company's 1998 capital expenditure
estimates. Pursuant to these agreements relating to the construction of the
Network expansion, the Company has committed to pay a total of $30.4 million for
periods ranging from twenty to twenty-five years for maintenance and license
fees.
At the present time, the Company does not anticipate significant additional
funding to Progress International for investment in Marca-Tel until the
regulatory and market conditions in Mexico improve. The Company is not obligated
to continue to fund Progress International and the Senior Notes Indenture and
the terms of the Exchangeable Preferred Stock contain significant limitations on
the amount the Company may invest in Progress International and other
non-majority owned entities. However, failure to provide further significant
funding to Progress International is likely to result in a default under
Marca-Tel's financing arrangements and could result in the foreclosure of the
third party's security interest. The Company's interest in Progress
International, and thus its indirect interest in Marca-Tel, therefore could be
diluted or lost entirely. See "Business -- Mexican Joint Venture."
The forward-looking statements set forth above with respect to the
estimated cash requirements relating to capital expenditures, the Company's
ability to meet such cash requirements and the Company's ability to service its
debt are based on certain assumptions as to future events. Important
assumptions, which if not met, could adversely affect the Company's ability to
achieve satisfactory results include that: (i) there will be no significant
delays or cost overruns with respect to the Network expansion; (ii) the
Company's contractors and partners in cost-saving arrangements will perform
their obligations; (iii) rights-of-way can be obtained in a timely,
cost-effective basis; (iv) the routes of the Network expansion scheduled for
completion in 1998 are substantially completed on schedule; (v) the Company will
continue to increase traffic on its Network; and (vi) the Company can obtain
vendor financing.
Year 2000 Risks
Certain of the Company's older computer programs identify years with two
digits instead of four. This is likely to cause problems because the programs
may recognize the year 2000 as the year 1900. These Year 2000 Problems could
result in a system failure or miscalculations disrupting operations, including a
temporary inability to process transactions, send invoices or engage in similar
normal business activities. The Company has completed an assessment identifying
which programs will have to be modified or replaced in order to function
properly with respect to dates in the year 2000 and thereafter. The Company
believes that the cost of modifying those systems that were not already
scheduled for replacement for business reasons prior to 2000 is immaterial.
Updating the current software to be Year 2000-compliant is scheduled to be
completed by mid-1999, prior to any anticipated impact on operating systems.
Although the Company does not expect Year 2000 Problems to have a material
adverse effect on its internal operations, it is possible that Year 2000
Problems could have a material adverse effect on (i) the Company's suppliers and
their ability to service the Company, to accurately invoice for services
rendered and to accurately process payments received; and (ii) the Company's
customers and their ability to continue to utilize the Company's services, to
collect from
39
42
their customers and to pay the Company for services received. The cumulative
effect of such problems, if they occur, could have a material adverse effect on
the Company and the value of the Common Stock and its other securities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Meeting of Stockholders to be filed with the
Commission within 120 days after December 31, 1997 and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Meeting of Stockholders to be filed with the
Commission within 120 days after December 31, 1997 and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Meeting of Stockholders to be filed with the
Commission within 120 days after December 31, 1997 and is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Meeting of Stockholders to be filed with the
Commission within 120 days after December 31, 1997 and is incorporated herein by
reference.
41
44
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
PAGE
----
(1) Index to Financial Statements:
Report of Independent Auditors.............................. F-1
Consolidated Balance Sheets as of December 31, 1997 and F-2
1996........................................................
Consolidated Statements of Operations for the years ended F-3
December 31, 1997, 1996 and 1995............................
Consolidated Statements of Changes in Stockholders' Equity F-4
for the years ended December 31, 1997, 1996 and 1995........
Consolidated Statements of Cash Flows for the years ended F-5
December 31, 1997, 1996 and 1995............................
Notes to Consolidated Financial Statements.................. F-7
(2) Index to Financial Statement Schedules:
All Financial Statement Schedules for which provision is
made in the applicable accounting regulations of the
Commission (i) are included in the notes to the financial
statements included in this report, (ii) are not required
under the related instruction or (iii) are inapplicable and,
therefore, have been omitted.
(3)(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1 Stock Acquisition Agreement and Plan of Merger by and among
IXC Communications, Inc., IXC Long Distance, Inc., Pisces
Acquisition Corp. and Network Long Distance, Inc. dated as
of December 19, 1997 (incorporated by reference to Exhibit
2.1 of IXC Communications, Inc.'s Current Report on Form 8-K
dated December 19, 1997 and filed with the Commission on
December 23, 1997).
3.1+ Restated Certificate of Incorporation of IXC Communications,
Inc., as amended.
3.2 Bylaws of IXC Communications, Inc., as amended (incorporated
by reference to Exhibit 3.2 of IXC Communications, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997 filed with the Commission on November 14,
1997 (the "September 30, 1997 10-Q")).
4.1 Indenture dated as of October 5, 1995 by and among IXC
Communications, Inc., on its behalf and as
successor-in-interest to I-Link Holdings, Inc. and IXC
Carrier Group, Inc., each of IXC Carrier, Inc., on its
behalf and as successor-in-interest to I-Link, Inc., CTI
Investments, Inc., Texas Microwave Inc. and WTM Microwave
Inc., Atlantic States Microwave Transmission Company,
Central States Microwave Transmission Company, Telcom
Engineering, Inc., on its behalf and as
successor-in-interest to SWTT Company and Microwave Network,
Inc., Tower Communication Systems Corp., West Texas
Microwave Company, Western States Microwave Transmission
Company, Rio Grande Transmission, Inc., IXC Long Distance,
Inc., Link Net International, Inc. (collectively, the
"Guarantors"), and IBJ Schroder Bank & Trust Company, as
Trustee (the "Trustee), with respect to the 12 1/2% Series A
and Series B Senior Notes due 2005 (incorporated by
reference to Exhibit 4.1 of IXC Communications, Inc.'s and
each of the Guarantor's Registration Statement on Form S-4
filed with the Commission on April 1, 1996 (File No.
333-2936) (the "S-4")).
4.2 Form of 12 1/2% Series A Senior Notes due 2005 (incorporated
by reference to Exhibit 4.6 of the S-4).
42
45
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
4.3 Form of 12 1/2% Series B Senior Notes due 2005 and
Subsidiary Guarantee (incorporated by reference to Exhibit
4.8 of Amendment No. 1 to IXC Communications, Inc.'s
Registration Statement on Form S-1 filed with the Commission
on June 13, 1996 (File No. 333-4061) (the "S-1 Amendment")).
4.4 Amendment No. 1 to Indenture and Subsidiary Guarantee dated
as of June 4, 1996 by and among IXC Communications, Inc.,
the Guarantors and the Trustee (incorporated by reference to
Exhibit 4.11 of the S-1 Amendment).
4.5 Purchase Agreement dated as of March 25, 1997 by and among
IXC Communications, Inc., Credit Suisse First Boston
Corporation ("CS First Boston") and Dillon Read & Co. Inc.
("Dillon Read") (incorporated by reference to Exhibit 4.12
of IXC Communications, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 filed with the
Commission on May 15, 1997 (the "March 31, 1997 10-Q")).
4.6 Registration Rights Agreement dated as of March 25, 1997 by
and among IXC Communications, Inc., CS First Boston and
Dillon Read (incorporated by reference to Exhibit 4.13 of
the March 31, 1997 10-Q).
4.7 Amendment to Registration Rights Agreement dated as of March
25, 1997 by and between IXC Communications, Inc. and GEPT
(incorporated by reference to Exhibit 4.14 of the March 31,
1997 10-Q).
4.8 Registration Rights Agreement dated as of July 8, 1997 among
IXC Communications, Inc. and each of William G. Rodi, Gordon
Hutchins, Jr. and William F. Linsmeier (incorporated by
reference to Exhibit 4.15 of IXC Communications, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended June 30,
1997, as filed with the Commission on August 6, 1997 (the
"June 30, 1997 10-Q")).
4.9 Registration Rights Agreement dated as of July 8, 1997 among
IXC Communications, Inc. and each of William G. Rodi, Gordon
Hutchins, Jr. and William F. Linsmeier (incorporated by
reference to Exhibit 4.16 of the June 30, 1997 10-Q).
4.10 Purchase Agreement dated as of August 14, 1997 by and among
IXC Communications, Inc. and the initial purchasers named in
Schedule A thereto (incorporated by reference to Exhibit 4.1
of IXC Communications, Inc.'s Current Report on Form 8-K
dated August 20, 1997 and filed with the Commission on
August 28, 1997 (the "8-K")).
4.11 Indenture dated as of August 15, 1997 between IXC
Communications, Inc. and The Bank of New York (incorporated
by reference to Exhibit 4.2 of the 8-K).
4.12 Registration Rights Agreement dated as of August 14, 1997 by
and among IXC Communications, Inc. and the purchasers named
therein (incorporated by reference to Exhibit 4.3 of the
8-K).
4.13+ First Supplemental Indenture dated as of October 23, 1997
among IXC Communications, Inc., the Guarantors, IXC
International, Inc. and IBJ Schroder Bank of Trust Company.
4.14+ Second Supplemental Indenture dated as of December 22, 1997
among IXC Communications, Inc., the Guarantors, IXC Internet
Services, Inc., IXC International, Inc. and IBJ Schroder
Bank & Trust Company.
4.15+ Third Supplemental Indenture dated as of January 6, 1998
among IXC Communications, Inc., the Guarantors, IXC Internet
Services, Inc., IXC International, Inc. and IBJ Schroder
Bank & Trust Company.
10.1 Office Lease dated June 21, 1989 with USAA Real Estate
Company, as amended (incorporated by reference to Exhibit
10.1 of the S-4).
43
46
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.2 Equipment Lease dated as of December 1, 1994 by and between
DSC Finance Corporation and Switched Services
Communications, L.L.C.; Assignment Agreement dated as of
December 1, 1994 by and between Switched Services
Communications, L.L.C. and DSC Finance Corporation; and
Guaranty dated December 1, 1994 made in favor of DSC Finance
Corporation by IXC Communications, Inc. (incorporated by
reference to Exhibit 10.2 of the S-4).
10.3* Amended and Restated 1994 Stock Plan of IXC Communications,
Inc., as amended (incorporated by reference to Exhibit 10.3
of the June 30, 1997 10-Q).
10.4* Form of Non-Qualified Stock Option Agreement under the 1994
Stock Plan of IXC Communications, Inc. (incorporated by
reference to Exhibit 10.4 of the S-4).
10.5 Amended and Restated Development Agreement by and between
Intertech Management Group, Inc. and IXC Long Distance, Inc.
(incorporated by reference to Exhibit 10.7 of IXC
Communications, Inc.'s and the Guarantors' Amendment No. 1
to Form S-4 filed with the Commission on May 20, 1996 (File
No. 333-2936) ("Amendment No. 1 to S-4")).
10.6 Second Amended and Restated Service Agreement dated as of
January 1, 1996 by and between Switched Services
Communications, L.L.C. and Excel Telecommunications, Inc.
(incorporated by reference to Exhibit 10.8 of the S-4).
10.7 Equipment Purchase Agreement dated as of January 16, 1996 by
and between Siecor Corporation and IXC Carrier, Inc.
(incorporated by reference to Exhibit 10.9 of the S-4).
10.8* 1996 Stock Plan of IXC Communications, Inc., as amended
(incorporated by reference to Exhibit 10.10 of IXC
Communications, Inc. Annual Report on Form 10-K for the year
ended December 31, 1996 filed with the Commission on March
28, 1997 (the "10-K")).
10.9 IRU Agreement dated as of November 1995 between WorldCom,
Inc. and IXC Carrier, Inc. (incorporated by reference to
Exhibit 10.11 of Amendment No. 1 to the S-4).
10.10* Outside Directors' Phantom Stock Plan of IXC Communications,
Inc., as amended (incorporated by reference to Exhibit 10.12
of the 10-K).
10.11* Business Consultant and Management Agreement dated as of
March 1, 1997 by and between IXC Communications, Inc. and
Culp Communications Associates (incorporated by reference to
Exhibit 10.13 of IXC Communications, Inc.'s Registration
Statement on Form S-4 as filed with the Commission on
October 3, 1997 (File No. 333-37157) (the "EPS S-4")).
10.12* Employment Agreement dated December 28, 1995 by and between
IXC Communications, Inc. and James F. Guthrie (incorporated
by reference to Exhibit 10.14 of the S-1 Amendment).
10.13* Employment Agreement dated August 28, 1995, by and between
IXC Communications, Inc. and David J. Thomas (incorporated
by reference to Exhibit 10.15 of the S-1 Amendment).
10.14* Special Stock Plan of IXC Communications, Inc. (incorporated
by reference to Exhibit 10.16 of the 10-K).
10.15 Lease dated as of June 4, 1997 between IXC Communications,
Inc. and Carramerca Realty, L.P. (incorporated by reference
to Exhibit 10.17 of the June 30, 1997 10-Q).
10.16 Loan and Security Agreement dated as of July 18, 1997 among
IXC Communications, Inc., IXC Carrier, Inc. and NFTC Capital
Corporation ("NTFC") (incorporated by reference to Exhibit
10.18 of the June 30, 1997 10-Q).
10.17 IRU and Stock Purchase Agreement dated as of July 22, 1997
between IXC Internet Services, Inc. and PSINet Inc.
(incorporated by reference to Exhibit 10.19 of IXC
Communications, Inc.'s Amendment No. 1 to Form 10-Q/A for
the quarter ended September 30, 1997 filed with the
Commission on December 12, 1997 (the "September 30, 1997
10-Q/A")).
10.18 Joint Marketing and Services Agreement dated July 22, 1997
between IXC Internet Services, Inc. and PSINet Inc.
(incorporated by reference to Exhibit 10.20 of the September
30, 1997 10-Q/A).
44
47
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.19* Employment Agreement dated as of September 9, 1997 between
Benjamin L. Scott and IXC Communications, Inc. (incorporated
by reference to Exhibit 10.21 of IXC Communication Inc.'s
Amendment No. 1 to Registration Statement on S-4 filed with
the Commission on December 15, 1997 (File No. 333-37157)
("Amendment No. 1 to the EPS S-4")).
10.20* IXC Communications, Inc. 1997 Special Executive Stock Plan
(incorporated by reference to Exhibit 10.22 of Amendment No.
1 to the EPS S-4).
10.21+ First Amendment to Loan and Security Agreement dated as of
December 23, 1997 among IXC Communications, Inc., IXC
Carrier, Inc., NTFC and Export Development Corporation
("EDC").
10.22+ Second Amendment to Loan and Security Agreement dated as of
January 21, 1998 among IXC Communications, Inc., IXC
Carrier, Inc., NTFC and EDC.
21.1+ Subsidiaries of IXC Communications, Inc.
23.1+ Consent of Ernst & Young LLP.
23.2+ Consent of Arthur Andersen LLP.
24.1 Powers of Attorney (included as the signature page of this
Form 10-K).
27.1+ Financial Data Schedule.
99.1+ Marca-Tel Combining Financial Statements as of December 31,
1997 and 1996 together with Auditors' Report.
- ---------------
* Management contract or executive compensation plan or arrangement required to
be indicated as such and filed as an exhibit pursuant to applicable rules of
the Commission.
+ Filed herewith.
(b) Reports on Form 8-K:
1. Form 8-K dated September 29, 1997 and filed with the Commission on
October 3, 1997 with respect to three press releases reporting on Benjamin L.
Scott becoming the President and Chief Executive Officer of the Company, Stuart
Coppens becoming the Vice President of Finance and Chief Accounting Officer of
the Company and Mike Jones becoming the Vice President of Construction and
Facilities Engineering.
2. Form 8-K dated October 3, 1997 and filed with the Commission on October
3, 1997 with respect to a press release reporting on the commencement of the
Company's offer (the "Series 3 Tender Offer") to exchange shares of its Common
Stock for all outstanding shares of its Series 3 Preferred Stock.
3. Form 8-K dated October 3, 1997 and filed with the Commission on October
7, 1997 with respect to information regarding an employment agreement entered
into between the Company and Benjamin L. Scott.
4. Form 8-K dated November 3, 1997 and filed with the Commission on
November 4, 1997 with respect to a press release reporting a fiber exchange
transaction with FTV Communications, LLC.
5. Form 8-K dated November 4, 1997 and filed with the Commission on
November 5, 1997 with respect to a press release announcing the Company's
results of operations for the quarter ended September 30, 1997.
6. Form 8-K dated November 6, 1997 and filed with the Commission on
November 7, 1997 with respect to a press release reporting the consummation and
results of the Series 3 Tender Offer.
7. Form 8-K dated November 7, 1997 and filed with the Commission on
November 10, 1997 with respect to a press release reporting the termination of
the Company's solicitation of consents in connection with its Senior Notes.
8. Form 8-K dated December 16, 1997 and filed with the Commission on
December 17, 1997 with respect to a press release reporting on the commencement
of the Company's offer to exchange shares of its 12 1/2% Series B Junior
Exchangeable Preferred Stock Due 2009 which have been registered under the
Securities Act for each of its outstanding shares of 12 1/2% Junior Exchangeable
Preferred Stock Due 2009.
45
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
IXC COMMUNICATIONS, INC.
By: /s/ JAMES F. GUTHRIE
------------------------------------
James F. Guthrie
Executive Vice President and Chief
Financial Officer
Dated: March 13, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ BENJAMIN L. SCOTT President, Chief Executive March 13, 1998
- ----------------------------------------------------- Officer and Director
Benjamin L. Scott (Principal Executive
Officer)
/s/ RALPH J. SWETT Chairman and Director March 13, 1998
- -----------------------------------------------------
Ralph J. Swett
/s/ JAMES F. GUTHRIE Executive Vice President and March 13, 1998
- ----------------------------------------------------- Chief Financial Officer
James F. Guthrie (Principal Financial and
Accounting Officer)
/s/ RICHARD D. IRWIN Director March 13, 1998
- -----------------------------------------------------
Richard D. Irwin
/s/ WOLFE H. BRAGIN Director March 13, 1998
- -----------------------------------------------------
Wolfe H. Bragin
/s/ CARL W. MCKINZIE Director March 13, 1998
- -----------------------------------------------------
Carl W. McKinzie
/s/ PHILLIP L. WILLIAMS Director March 13, 1998
- -----------------------------------------------------
Phillip L. Williams
/s/ JOE C. CULP Director March 13, 1998
- -----------------------------------------------------
Joe C. Culp
46
49
GLOSSARY
Access charges -- The fees paid by long distance carriers to LECs for
originating and terminating long distance calls on their local networks.
Ameritech -- Ameritech Communications, Inc.
ATM (asynchronous transfer mode) -- An information transfer standard that
is one of a general class of technologies that relay traffic by way of an
address contained within the first five bytes of a standard 53-byte-long packet
or cell. The ATM format can be used by many different information systems,
including local area networks, to deliver traffic at varying rates, permitting a
mix of voice, video and data (multimedia).
AT&T -- AT&T Corp.
Backbone -- The through-portions of a transmission network, as opposed to
spurs which branch off the through-portions.
Bandwidth -- The range of frequencies that can be transmitted through a
medium, such as glass fibers, without distortion. The greater the bandwidth, the
greater the information-carrying capacity of such medium.
Broadband -- Broadband communications systems can transmit large quantities
of voice, data and video. Examples of broadband communication systems include
DS-3 fiber optic systems, which can transmit 672 simultaneous voice
conversations, or a broadcast television station signal, that transmits high
resolution audio and video signals into the home. Broadband connectivity is also
an essential element for interactive multimedia applications.
Cable & Wireless -- Cable & Wireless, P.L.C.
Capacity-intensive -- Refers to products which use comparatively large
amounts of bandwidth.
Carriers -- Companies that provide telecommunications transmission
services.
CCTS -- Consolidated Communications Telecom Services, Inc.
Central Offices -- The switching centers or central switching facilities of
the LECs.
Dedicated -- Refers to telecommunications lines dedicated or reserved for
use by particular customers along predetermined routes.
Digital -- A method of storing, processing and transmitting information
through the use of distinct electronic or optical pulses that represent the
binary digits 0 and 1. Digital transmission and switching technologies (both
fiber and microwave) employ a sequence of these pulses to represent information
as opposed to the continuously variable analog signal. The precise digital
numbers minimize distortion (such as graininess or snow in the case of video
transmission, or static or other background distortion in the case of audio
transmission). Both the Company's microwave and fiber optic facilities transmit
digital information.
Digital route miles -- Route miles of the Company's microwave and fiber
optic routes.
DS-1, DS-3 -- Standard telecommunications industry digital signal formats,
which are distinguishable by bit rate (the number of binary digits (0 and 1)
transmitted per second). DS-0 service has a bit rate of 64 kilobits per second
and can transmit only one voice or data transmission at a time. DS-1 service has
a bit rate of 1.544 megabits per second and can transmit 24 simultaneous voice
or data transmissions. DS-3 service has a bit rate of 45 megabits per second and
can transmit 672 simultaneous voice or data transmissions.
DS-3 miles -- A measure of the total capacity and length of a transmission
path, calculated as the capacity of the transmission path in DS-3s multiplied by
the length of the path in miles.
DTI -- Digital Teleport, Inc.
EBITDA -- Operating income (loss) plus depreciation and amortization.
EBITDA is not a measurement determined in accordance with GAAP, should not be
considered in isolation or as a substitute for measures of
A-1
50
performance prepared in accordance with GAAP and is not necessarily comparable
with similarly titled measures for other companies.
800/888 service -- A telecommunications service for businesses that allows
calls to be made to a specific location at no charge to the calling party. Use
of the "800" or "888" service code denotes calls that are to be billed to the
receiving party. A computer database in the provider's network translates the
800 or 888 number into a conventional telephone number.
Enhanced data services -- Products and services designed for the transport
and delivery of integrated information to include voice, data and video and any
combination thereof.
Excel -- EXCEL Communications, Inc.
Facilities-based carrier -- Carriers who own transmission facilities.
FCC -- Federal Communications Commission.
Fiber miles -- The number of fiber route miles of a fiber optic route
multiplied by the number of fiber strands in the route.
Frame Relay -- A high-speed, data-packet switching service used to transmit
data between computers. Frame Relay supports data units of variable lengths at
access speeds ranging from 56 kilobits per second to 1.5 megabits per second.
This service is well-suited for connecting local area networks, but is not
appropriate for voice and video applications due to the variable delays which
can occur. Frame Relay was designed to operate at high speeds on modern fiber
optic networks.
Frontier -- Frontier Corporation.
FTV -- FTV Communications, LLC.
GAAP -- Generally Accepted Accounting Principles.
GST -- GST Net, Inc.
GTE -- GTE Corporation.
Hubs -- Collection centers located centrally in an area where
telecommunications traffic can be aggregated for transport and distribution.
Interexchange Carrier -- A company providing inter-LATA or long distance
services between LATAs on an intrastate or interstate basis.
Inter-LATA -- InterLATA calls are calls that pass from one LATA to another.
Typically, these calls are referred to as long distance calls.
Intra-LATA -- IntraLATA calls are those local calls that originate and
terminate within the same LATA.
Intranet -- An infrastructure based on Internet standards and technologies
that provides access to information within limited and well-defined groups such
as universities, governments and other large organizations.
Kilobit -- One thousand bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "kilobits per
second."
LATAs (local access and transport areas) -- The approximately 200
geographic areas that define the areas between which the RBOCs were prohibited
from providing long distance services prior to the Telecommunications Act.
LCI -- LCI International Management Services, Inc.
LEC (local exchange carrier) -- A company providing local telephone
services.
Level 3 -- Level 3 Communications, Inc.
A-2
51
Local loop -- A circuit within a LATA.
Long distance switched services -- Telecommunications services such as
residential long distance services that are processed through digital switches
and delivered over long-haul circuits and other transmission facilities.
MCI -- MCI Communications Corporation.
Megabit -- One million bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "megabits per
second."
MFN -- Metromedia Fiber Network Services, Inc.
MFS -- MFS Network Technologies, Inc., a subsidiary of WorldCom.
MOUs -- Minutes of use of long distance service.
Non-facilities based carrier -- Carriers that do not own transmission
facilities.
OC-3, OC-12, OC-48 and OC-192 -- Standard telecommunications industry
measurements for optical transmission capacity distinguishable by bit rate
transmitted per second and the number of voice or data transmissions that can be
simultaneously transmitted through fiber optic cable. An OC-3 is generally
equivalent to three DS3s and has a bit rate of 155.52 megabits per second and
can transmit 2,016 simultaneous voice or data transmissions. An OC-12 has a bit
rate of 622.08 megabits per second and can transmit 8,064 simultaneous voice or
data transmissions. An OC-48 has a bit rate of 2,488.32 megabits per second and
can transmit 32,256 simultaneous voice or data transmissions. An OC-192 is the
equivalent of four OC-48s.
Off-net -- Refers to circuits on transmission facilities not owned by the
Company.
On-net -- Refers to circuits on transmission facilities owned by the
Company.
Optronic -- a combination of optical and electronic equipment.
Qwest -- Qwest Communications Corporation.
RBOCs (regional Bell operating companies) -- The seven local telephone
companies (formerly part of AT&T) established by court decree in 1982.
Rockwell International -- Rockwell International Corp.
Route miles -- The measure of the length of a transmission path in miles.
SONET (synchronous optical network technology) -- An electronics and
network architecture for variable-bandwidth products which enables transmission
of voice, video and data (multimedia) at very high speeds.
Sprint -- Sprint Corp.
Switch -- A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is a process of
interconnecting circuits to form a transmission path between users.
Telecom One -- Telecom One, Inc.
The Williams Companies -- The Williams Companies, Inc.
Vyvx -- Vyvx, Inc., a subsidiary of The Williams Companies, Inc.
Westel -- Westel International, Inc.
WilTech -- The WilTech Group, a subsidiary of The Williams Companies, Inc.
WilTel -- WilTel Network Services, Inc., a subsidiary of The Williams
Companies, Inc.
WorldCom -- WorldCom, Inc.
A-3
52
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
IXC COMMUNICATIONS, INC.
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Auditors............................ F-2
Consolidated Balance Sheets as of December 31, 1997 and
1996................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995....................... F-4
Consolidated Statements of Changes in Stockholders' Equity
(Deficit) for the years ended December 31, 1997, 1996
and 1995............................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995....................... F-6
Notes to Consolidated Financial Statements................ F-7
F-1
53
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
IXC Communications, Inc.
We have audited the accompanying consolidated balance sheets of IXC
Communications, Inc. and its subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, changes in stockholders'
equity (deficit) and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of MarcaTel S.A. de C.V. (MarcaTel), a corporation in which the
Company has an indirect interest, accounted for using the equity method, as of
and for the year ended December 31, 1997. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to data included for MarcaTel (see Note 20), is based solely on the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and, for 1997, the report of other auditors,
the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of IXC Communications, Inc. and
its subsidiaries at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Austin, Texas
February 28, 1998
F-2
54
IXC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
1997 1996
--------- --------
(IN THOUSANDS)
ASSETS
Cash and cash equivalents................................... $ 152,720 $ 61,340
Accounts receivable:
Trade, net of allowance for doubtful accounts of
$14,403,000 in 1997 and $4,030,000 in 1996.............. 91,730 45,102
Other..................................................... 1,556 2,466
--------- --------
93,286 47,568
Deferred tax assets......................................... 1,662 463
Prepaid expenses............................................ 1,838 1,734
--------- --------
Total current assets............................... 249,506 111,105
Property and equipment, net................................. 608,937 268,609
Escrow under Senior Notes................................... -- 51,412
Investment in unconsolidated subsidiaries................... 17,497 5,486
Deferred charges and other non-current assets............... 41,155 22,539
--------- --------
Total assets....................................... $ 917,095 $459,151
========= ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable -- trade................................... $ 81,679 $ 49,856
Accrued service cost........................................ 44,705 15,067
Accrued liabilities......................................... 43,122 18,928
Current portion of long-term debt and capital lease
obligations............................................... 12,171 6,750
--------- --------
Total current liabilities.......................... 181,677 90,601
Long-term debt and capital lease obligations................ 308,124 295,531
Deferred tax liability...................................... 3,206 2,434
Unearned fiber usage revenue................................ 60,957 5,302
Other noncurrent liabilities................................ 6,253 899
Minority interest........................................... 1,465 905
7 1/4% Junior Convertible Preferred Stock; $.01 par value;
3,000,000 shares of all classes of Preferred Stock
authorized; 1,055,367 shares issued and outstanding
(aggregate liquidation preference of $105,537,000 at
December 31, 1997)........................................ 101,239 --
12 1/2% Junior Exchangeable Preferred Stock; $.01 par value;
3,000,000 shares of all classes of Preferred Stock
authorized; 308,958 shares issued and outstanding
(aggregate liquidation preference of $313,786,000,
including accrued dividends of $4,828,000 at December 31,
1997)..................................................... 302,129 --
Stockholders' equity (deficit):
10% Junior Series 3 Cumulative Preferred Stock; 3,000,000
shares of all classes of Preferred Stock authorized;
$.01 par value; shares issued and outstanding 414 in
1997 and 12,550 in 1996 (aggregate liquidation
preference of $692,000 at December 31, 1997 and
$19,059,000 at December 31, 1996)....................... 1 13
Common Stock, $.01 par value; 100,000,000 shares
authorized; shares issued and outstanding 31,559,691 in
1997 and 30,795,014 in 1996............................. 316 308
Additional paid-in capital................................ 106,559 123,434
Accumulated deficit....................................... (154,831) (60,276)
--------- --------
Total stockholders' equity (deficit)...................... (47,955) 63,479
--------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity (deficit).................... $ 917,095 $459,151
========= ========
See accompanying notes.
F-3
55
IXC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
----------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net operating revenue:
(Net of service credit and bad debt provision of
$17,387,000, $3,060,000 and $1,505,000 during 1997,
1996, and 1995)
Private line............................................. $ 162,398 $ 99,793 $89,563
Long distance switched services.......................... 258,312 103,968 1,438
--------- -------- -------
420,710 203,761 91,001
Operating expenses:
Cost of services......................................... 325,127 143,469 39,852
Operations and administration............................ 80,070 47,067 32,282
Depreciation and amortization............................ 60,748 27,241 17,438
--------- -------- -------
Operating income (loss)............................... (45,235) (14,016) 1,429
Interest income............................................ 7,492 2,838 468
Interest income on escrow under Senior Notes............... 203 7,404 2,552
Interest expense........................................... (31,266) (37,076) (14,597)
Equity in net income (loss) of unconsolidated
subsidiaries............................................. (23,800) (1,961) 19
--------- -------- -------
Loss before income taxes, minority interest and
extraordinary loss....................................... (92,606) (42,811) (10,129)
Benefit (provision) for income taxes....................... (1,389) 5,981 1,693
Minority interest.......................................... (560) (618) 5,218
--------- -------- -------
Loss before extraordinary loss............................. (94,555) (37,448) (3,218)
Extraordinary loss on early extinguishment of debt, less
applicable provision for income taxes of $1,164,000...... -- -- (1,747)
--------- -------- -------
Net loss................................................... (94,555) (37,448) (4,965)
Dividends applicable to preferred stock.................... 21,636 1,739 1,843
--------- -------- -------
Net loss applicable to common stockholders................. $(116,191) $(39,187) $(6,808)
========= ======== =======
Basic and diluted loss per share:
Before extraordinary loss................................ $ (3.75) $ (1.42) $ (.21)
Extraordinary loss....................................... -- -- (.07)
--------- -------- -------
Net loss................................................. $ (3.75) $ (1.42) $ (.28)
========= ======== =======
See accompanying notes.
F-4
56
IXC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
10% JUNIOR
10% SENIOR SERIES 1 SERIES 3
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------- --------------- ---------------
NUMBER NUMBER NUMBER ADDITIONAL TOTAL
OF OF OF PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY (DEFICIT)
--------- ------- ------ ------ ------ ------ ---------- ----------- ----------------
(IN THOUSANDS)
Balance at December 31,
1994.................... 1 $1,460 13 $ 13 24,335 $243 $ 29,430 $ (16,957) $ 14,189
Redemption of preferred
stock................. (1) (1,460) -- -- -- -- -- -- (1,460)
Net loss................ -- -- -- -- -- -- -- (4,965) (4,965)
Dividends
paid -- preferred
stock -- 10% Senior
Series 1.............. -- -- -- -- -- -- -- (505) (505)
Dividends
paid -- preferred
stock of consolidated
subsidiary............ -- -- -- -- -- -- -- (401) (401)
-- ------- --- ---- ------ ---- -------- --------- --------
Balance at December 31,
1995.................... -- -- 13 13 24,335 243 29,430 (22,828) 6,858
Issuance of common
stock................. -- -- -- -- 6,460 65 94,004 -- 94,069
Net loss................ -- -- -- -- -- -- -- (37,448) (37,448)
-- ------- --- ---- ------ ---- -------- --------- --------
Balance at December 31,
1996.................... -- -- 13 13 30,795 308 123,434 (60,276) 63,479
-- ------- --- ---- ------ ---- -------- --------- --------
Exercise of options..... -- -- -- -- 62 1 683 -- 684
Accretion of Preferred
Stock................. -- -- -- -- -- -- (724) (724)
Dividends paid in kind
and
accrued -- Preferred
Stock................. -- -- -- -- -- -- (19,323) -- (19,323)
Conversion of Series 3
Preferred Stock....... -- -- (12) (12) 605 6 5 -- (1)
Issuance of common stock
for acquisition....... -- -- -- -- 98 1 2,742 -- 2,743
Other................... -- -- -- -- -- -- (258) -- (258)
Net loss................ -- -- -- -- -- -- -- (94,555) (94,555)
-- ------- --- ---- ------ ---- -------- --------- --------
Balance at December 31,
1997.................... -- $ -- 1 $ 1 31,560 $316 $106,559 $(154,831) $(47,955)
== ======= === ==== ====== ==== ======== ========= ========
See accompanying notes.
F-5
57
IXC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
--------- -------- ---------
(IN THOUSANDS)
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss.................................................... $ (94,555) $(37,448) $ (4,965)
Adjustments to reconcile net loss to cash provided (used in)
by operating activities:
Depreciation.............................................. 50,334 23,695 16,608
Amortization.............................................. 10,414 3,546 830
Amortization of debt issue costs and Senior Note
discount................................................ 1,702 1,086 858
Provision for doubtful accounts........................... 17,387 3,060 1,505
Equity in net (income) loss of unconsolidated
subsidiaries............................................ 23,800 1,961 (19)
Minority interest in net (income) loss of subsidiaries.... 560 618 (5,218)
Compensation expense on stock options and phantom stock... 349 182 --
Extraordinary loss on early extinguishment of debt........ -- -- 2,911
Other, net................................................ (803) -- --
Changes in assets and liabilities, net of effects of
acquisitions:
Increase in accounts receivable......................... (63,106) (44,309) (4,108)
Decrease (increase) in other current assets (104) 490 (1,466)
Increase in accounts payable -- trade................... 20,314 17,950 5,196
Increase in accrued liabilities and accrued service
costs................................................. 15,903 4,436 7,503
Decrease in deferred income taxes....................... (427) (5,882) (1,847)
Decrease in deferred charges and other non-current
assets................................................ (30,201) (4,538) (4,092)
Increase (decrease) in other noncurrent liabilities..... 62,768 6,466 (2,089)
--------- -------- ---------
Total adjustments..................................... 108,890 8,761 16,572
--------- -------- ---------
Net cash provided by (used in) operating
activities....................................... 14,335 (28,687) 11,607
--------- -------- ---------
CASH FLOW FROM INVESTING ACTIVITIES:
Release of funds from escrow under Senior Notes............. 69,564 154,244 4,300
Deposit into escrow under Senior Notes...................... (18,152) (7,404) (202,552)
Purchase of property and equipment.......................... (314,327) (136,391) (23,670)
Investment in unconsolidated subsidiaries................... (35,497) (7,319) --
--------- -------- ---------
Net cash used in investing activities.............. (298,412) 3,130 (221,922)
--------- -------- ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Senior Notes, net of
discount.................................................. -- -- 277,148
Payment of debt issue costs................................. -- (1,301) (10,407)
Proceeds from long-term debt................................ -- -- 18,695
Payments on long-term debt and capital lease obligations.... (8,288) (12,786) (76,490)
Net proceeds from issuance of Convertible Preferred Stock... 95,354 -- --
Net proceeds from issuance of Exchangeable Preferred
Stock..................................................... 287,967 -- --
Redemption of preferred stock............................... -- -- (1,460)
Redemption of preferred stock of consolidated subsidiary
held by minority interests................................ -- -- (1,400)
Issuance of common stock.................................... -- 94,069 --
Capital contribution in subsidiary by minority
shareholders.............................................. -- -- 6,002
Other financing activities.................................. 424 -- (906)
--------- -------- ---------
Net cash provided by financing activities.......... 375,457 79,982 211,182
--------- -------- ---------
Net increase in cash and cash equivalents................... 91,380 54,425 867
Cash and cash equivalents at beginning of year.............. 61,340 6,915 6,048
--------- -------- ---------
Cash and cash equivalents at end of year.................... $ 152,720 $ 61,340 $ 6,915
========= ======== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) for:
Income taxes............................................ $ 516 $ (832) $ 1,240
========= ======== =========
Interest expense net of amount capitalized.............. $ 30,174 $ 37,561 $ 4,955
========= ======== =========
See accompanying notes.
F-6
58
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION
IXC Communications, Inc. and its subsidiaries (collectively referred to as
"IXC" or the "Company") is an Austin, Texas based supplier of telecommunications
services. IXC provides two principal services to long distance companies: (i)
private line voice and data circuits and (ii) long distance switched services.
Long distance companies may be categorized as facilities-based carriers or
non-facilities-based carriers. Sellers of private line services are generally
facilities-based carriers, like IXC, that own private line transmission
facilities, such as fiber optic or digital microwave transmission facilities.
Customers using private line services include: (i) facilities-based carriers
that require private line capacity where they have geographic gaps in their
facilities, need additional capacity or require geographically different
routing; and (ii) non-facilities-based carriers requiring private line capacity
to carry their customers' long distance traffic. The Company provides private
line services to customers either on a "take-or-pay" long term basis, or after
contract expiration on a month-to-month basis.
In late 1995, the Company expanded into the business of selling long
distance switched services to long distance resellers. Sellers of switched long
distance services are generally switched carriers, like IXC, that own one or
more switches that direct telecommunications traffic or switchless carriers that
depend on switched carriers to provide long distance services to their users.
The Company sells switched long distance services on a per-call basis, with
payment due monthly after services are rendered.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
IXC, a Delaware corporation, was incorporated in 1992 and, through a series
of transactions through 1994, acquired various wholly-owned and majority-owned
subsidiaries which are included in the consolidated financial statements. The
consolidated financial statements of IXC include the accounts of IXC
Communications, Inc. and its wholly-owned and majority-owned subsidiaries. The
Company has a 50% interest in Progress International L.L.C. ("Progress"), a 40%
interest in a European Joint Venture, and a 20% interest in Unidial
Communications Services, L.L.C. ("Unidial"), all of which are accounted for
using the equity method. Progress has a 49% interest in Marca-Tel S.A. de C.V.
("Marca-Tel"), a telecommunications company located in Mexico. Significant
intercompany accounts and transactions have been eliminated in the consolidated
financial statements. Any difference between the amount at which the investment
is being carried and the amount of the underlying equity in the net assets of
the equity investee is being amortized over its expected life.
Revenues
Private line voice and data circuit revenues are generated primarily by
providing capacity on the Company's fiber optic and microwave transmission
network at rates established under long-term contractual arrangements or on a
month-to-month basis after contract expiration. Revenue is recognized as
services are provided.
Switched long-distance service revenues are generated primarily by
providing voice and data communication services. Revenue is recognized as
services are provided.
The Company accounts for capacity exchange agreements with other carriers
by recognizing the fair value of the revenue earned and expense incurred under
the respective agreements. Exchange agreements accounted for noncash revenue and
expense (in equal amounts) of $14.0 million in 1997, $14.0 million in 1996, and
$13.8 million in 1995.
F-7
59
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market funds and all
investments with an initial maturity of three months or less. All cash
equivalents are recorded at cost and classified as available for sale.
Short-term investments held in the Company's escrow related to the Senior Notes
(see Note 4) were not included as a cash equivalent.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the various assets,
ranging from three to twenty years. Maintenance and repairs are charged to
operations as incurred. Property and equipment recorded under capital leases is
included with the Company's owned assets. Amortization of assets recorded under
capital leases is included in depreciation expense.
Costs associated with uncompleted portions of the fiber optic network are
classified as construction in progress in the accompanying consolidated balance
sheets. Upon completion, the costs will be classified as transmission systems
and depreciated over their useful lives.
In accordance with FASB Statement No. 121, the Company reviews its
long-lived assets by comparing the undiscounted cash flows estimated to be
generated by those assets with the related carrying amount of the assets. Upon
an indication of an impairment, a loss is recorded if the discounted cash flows
projected for the assets is less than the assets' carrying value.
Fiber Exchange Agreements
In connection with its fiber optic network expansion, the Company has
entered into various agreements to purchase, sell or exchange fiber usage
rights. Purchases of fiber usage rights from other carriers are recorded at cost
as a separate component of property and equipment. The recorded assets are
amortized over the lesser of the term of the related agreement or the estimated
life of the fiber optic cable. Sales of fiber usage rights are recorded as
unearned revenue. Revenue is recognized over the terms of the related
agreements. Non-monetary exchanges of fiber usage rights (swaps of fiber usage
rights with other long distance carriers) are recorded at the cost of the asset
transferred or, if applicable, the fair value of the asset received.
Capitalization of Interest
Interest is capitalized as part of the cost of constructing the Company's
fiber optic network and for amounts invested in companies or joint ventures
accounted for using the equity method during pre-operating periods. Interest
capitalized during construction periods are computed by determining the average
accumulated expenditures for each interim capitalization period and applying the
interest rate related to the specific borrowings associated with each
construction project. Total interest incurred during the years ended December
31, 1997, 1996 and 1995 was $38.6 million, $40.0 million, and $15.0 million,
respectively, of which, $7.3 million, $2.9 million, and $0.4 million was
capitalized.
Income Taxes
The Company accounts for income taxes using the liability method as
required by Statement of Financial Accounting Standards ("SFAS") No. 109,
Accounting for Income Taxes.
Deferred income taxes are provided for net operating losses and for
temporary differences between the basis of assets and liabilities for financial
reporting and income tax reporting. Investment tax credits are accounted for by
the flow-through method.
F-8
60
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Deferred Charges and Other Non-current Assets
Costs incurred in connection with obtaining long-term financing have been
deferred and are being amortized as interest expense over the terms of the
related debt agreements. Deferred costs relating to long-term financing at
December 31, 1997 and 1996 were $28.1 million and $11.4 million, respectively.
Accumulated amortization of these costs at December 31, 1997 and 1996 were $3.3
million and $1.4 million, respectively.
Certain costs incurred in connection with installation of the switched long
distance network have been deferred and are being amortized on a straight-line
basis over two years. Deferred network costs at December 31, 1997 and 1996 were
$7.6 million and $5.0 million, with accumulated amortization of $3.4 million and
$1.0 million, respectively.
The acquisition cost of customer accounts obtained through an outside sales
organization have been deferred and amortized over two years. Acquisition costs
of customer accounts at December 31, 1997 and 1996 were $15.2 million and $2.3
million with accumulated amortization of $5.3 million and $0.7 million.
Stock-Based Compensation
The Company has elected to account for its employee stock options under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations, because, the alternative fair
value accounting provided for under SFAS No. 123, "Accounting for Stock-Based
Compensation," requires use of option valuation models that were not developed
for use in valuing employee stock options (Note 9). Under APB 25 compensation
expense is recognized when the exercise price of the Company's employee stock
options is less than the market price of the underlying stock on the date of
grant.
Basic and Diluted Loss Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share. Statement 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to the Statement 128 requirements.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, funds held
in escrow and trade receivables. The Company places its cash equivalents and
funds held in escrow in quality investments with reputable financial
institutions. Trade receivables include significant balances due from a small
number of customers. At December 31, 1997, $23.7 million in trade receivables
from the Company's private line services are due from ten customers. Switched
long distance services receivables are also concentrated, with $40.5 million in
trade receivables due from six customers, including $22.6 million from Excel
Communications, Inc. ("Excel"). If any of these
F-9
61
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
individually significant customers are unable to meet their financial
obligations, results of operations of the Company could be adversely affected.
The Company performs ongoing credit evaluations of its customers' financial
condition. IXC has not experienced significant losses from sales to any of its
significant customers (See Note 11).
Reclassifications
Certain amounts for prior years have been reclassified to conform to the
1997 presentation.
3. PROPERTY AND EQUIPMENT
The following table details the Company's property and equipment:
DECEMBER 31,
---------------------
1997 1996
--------- --------
(IN THOUSANDS)
Land and right of ways................................ $ 4,151 $ 2,345
Buildings and improvements............................ 21,451 5,048
Transmission systems.................................. 440,738 181,170
Furniture and other................................... 6,776 4,629
Fiber usage rights.................................... 34,991 38,533
Construction in progress.............................. 216,481 106,017
--------- --------
724,588 337,742
Less: Accumulated depreciation and amortization....... (115,651) (69,133)
--------- --------
Property and equipment, net........................... $ 608,937 $268,609
========= ========
4. ESCROW UNDER SENIOR NOTES
Under the terms of the Company's Senior Notes, issued in October 1995, the
Company was required to place $200 million of Senior Notes proceeds in an escrow
account, under which the proceeds and the earnings thereon were restricted in
their use to network expansion, capital expenditures, certain interest,
principal and other payments on the Senior Notes and other permitted uses (see
Note 6). Such funds were invested in short-term, investment-grade,
interest-bearing securities as follows:
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS)
Overnight investments.................................... $ -- $14,201
U.S. Government securities............................... -- 37,211
------- -------
$ -- $51,412
======= =======
The escrow account was subject to a security interest under the Company's
Senior Notes. The investments in the escrow account at December 31, 1996 were
all due in three months or less and classified as available for sale.
F-10
62
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
5. ACCRUED LIABILITIES
The following table details the Company's accrued liabilities:
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS)
Accrued taxes............................................ $ 4,814 $ 2,750
Deferred revenue......................................... 4,510 3,044
Accrued interest......................................... 8,906 8,906
Deposits................................................. 12,873 --
Other.................................................... 12,019 4,228
------- -------
$43,122 $18,928
======= =======
6. LONG-TERM DEBT
Long-term debt and capital lease obligations of IXC consisted of the
following:
DECEMBER 31,
--------------------
1997 1996
-------- --------
(IN THOUSANDS)
Senior Notes -- 12.5%, net of unamortized discount of
$6,862,000 and $7,344,000 at December 31, 1997 and
1996, respectively................................... $278,138 $277,656
Capital lease obligations.............................. 36,217 17,862
Other debt............................................. 5,940 6,763
-------- --------
Total long-term debt and capital lease
obligations................................ 320,295 302,281
Less current portion................................... (12,171) (6,750)
-------- --------
Long-term debt and capital lease obligations........... $308,124 $295,531
======== ========
Senior Notes
On October 5, 1995, the Company issued $285 million of 12 1/2% Senior Notes
(effective rate 12.8%) due October 1, 2005, with interest payable semi-annually.
The Senior Notes may be redeemed at the option of the Company, in whole or
in part, on or after October 1, 2000 at a premium declining to zero in 2004. At
any time prior to October 1, 1998, the Company may redeem Senior Notes with an
aggregate principal amount of up to $100 million at a redemption price of 112.5%
of the principal amount from the net proceeds of a sale of capital stock of the
Company, provided that at least $100 million in aggregate principal amount of
Senior Notes remains outstanding immediately after the occurrence of such
redemption and that the redemption occurs within 35 days of the date of the
closing of the offering of such equity securities. Also, the Senior Notes
contain provisions that, in the event of a Change in Control (which meets the
definition set forth in the Indenture) of the Company, provide their holders the
right to require the Company to repurchase all or any part of the Senior Notes
at a price equal to 101% of the principal amount thereof, plus accrued and
unpaid interest.
Of the net proceeds of approximately $277 million, $200 million was
deposited into an escrow account primarily restricted for the construction of a
major network expansion program (see Note 4). Approximately $53.7 million of the
net proceeds was used to repay or repurchase certain previously-existing
indebtedness of the Company, including $22.7 million paid to certain
stockholders. This resulted in an extraordinary loss on
F-11
63
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
early extinguishment of debt of $1.7 million in 1995, net of applicable income
tax benefit of $1.2 million. In addition, approximately $3.8 million was used to
redeem certain preferred stock.
As of December 31, 1997, the Senior Notes are senior unsecured obligations
of the Company and are guaranteed on a senior unsecured basis by certain wholly
owned direct and indirect subsidiaries of IXC. The obligations of each guarantor
are limited to the minimum extent necessary to prevent the guarantee from
violating or becoming voidable under applicable law relating to fraudulent
conveyance or fraudulent transfer or similar laws affecting the rights of
creditors generally. See Note 24 for financial information for guarantor and
non-guarantor subsidiaries.
The Senior Notes contain certain covenants that restrict the ability of the
Company and its subsidiaries to incur additional indebtedness and issue certain
preferred stock, pay dividends or make other distributions, repurchase equity
interests or subordinated indebtedness, engage in sale and leaseback
transactions, create certain liens, enter into certain transactions with
affiliates, sell assets of the Company or its subsidiaries, issue or sell equity
interests of the Company's subsidiaries or enter into certain mergers and
consolidations.
In 1997, the Company entered into a secured equipment financing facility
with NTFC Capital Corporation under which the Company has available financing of
up to $28 million (as of December 31, 1997 approximately $18 million of which
had been borrowed).
Annual maturities of long-term debt at December 31, 1997 are as follows (in
thousands):
1998...................................................... $ 3,765
1999...................................................... 2,175
2005...................................................... 285,000
--------
290,940
Less discount on Senior Notes............................. (6,862)
--------
$284,078
========
7. CAPITAL AND OPERATING LEASES
The Company leases certain facilities, equipment and transmission capacity
used in its operations under noncancellable capital and operating leases. Future
minimum annual lease payments under these lease agreements at December 31, 1997,
are as follows (in thousands):
CAPITAL OPERATING
LEASES LEASES
------- ---------
1998............................................ $10,696 $35,585
1999............................................ 10,725 8,679
2000............................................ 9,328 6,257
2001............................................ 6,793 4,855
2002............................................ 4,766 4,593
-------
42,308
Less amounts related to interest................ (6,091)
-------
Present value of capital lease obligations...... 36,217
Less current portion............................ (8,195)
-------
Long-term capital lease obligations............. $28,022
=======
F-12
64
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The gross amount of assets recorded under capital leases at December 31,
1997 and 1996 was $38.1 million and $22.2 million, respectively. The related
accumulated amortization was $17.1 million and $5.9 million at December 31, 1997
and 1996, respectively.
Lease expense relating to facilities, equipment and transmission capacity
leases, excluding amortization of fiber exchange agreements, was approximately
$98.0 million, $49.9 million and $29.1 million for the years ended December 31,
1997, 1996 and 1995, respectively.
8. REDEEMABLE PREFERRED STOCK
In April 1997, the Company issued $100 million (1,000,000 shares) of 7 1/4%
Junior Convertible Preferred Stock Due 2007 ("Convertible Preferred Stock"). The
net proceeds of approximately $95.4 million from the offering were used to fund
capital expenditures, investments in the Company's unconsolidated subsidiaries
and general corporate purposes. The Convertible Preferred Stock and the common
stock issuable upon conversion thereof were registered under the Securities Act
of 1933, as amended (the "Securities Act") in August 1997 in compliance with the
registration rights agreement entered into by the Company with the initial
purchasers of the Convertible Preferred Stock. The Convertible Preferred Stock
is convertible at the option of the holder into shares of common stock at a
conversion rate of 4.263 shares of common stock for each share of Convertible
Preferred Stock. On March 31, 2007, the Convertible Preferred Stock must be
redeemed by the Company at a price equal to the liquidation preference ($100 per
share) plus accrued and unpaid dividends; thus it is "mandatorily redeemable"
and is not included in stockholders' equity. Dividends payable prior to or on
June 30, 1999 are, at the option of the Company, payable in cash or through the
issuance of additional shares of Convertible Preferred Stock equal to the
dividend amount divided by the liquidation preference of such additional shares.
After March 31, 1999, to the extent and for so long as the Company is not
permitted to pay cash dividends on the Convertible Preferred Stock by the terms
of any then outstanding indebtedness or any other agreement or instrument to
which the Company is subject, the Company will be required to pay dividends,
which shall accrue at the rate per annum of 8 3/4%, through the issuance of
additional shares of Convertible Preferred Stock. Payment of cash dividends on
the Convertible Preferred Stock is not currently permitted under the indenture
for the Company's 12 1/2% Senior Notes due 2005 until certain financial
conditions have been met. During 1997, the Company issued approximately 55,367
additional shares of Convertible Preferred Stock in satisfaction of its 1997
dividend requirements. Any difference between the carrying value and the
redemption amount of the Convertible Preferred Stock is accreted to additional
paid-in-capital for all periods through the mandatory redemption date.
In August 1997, the Company issued $300 million (300,000 shares) of 12 1/2%
Junior Exchangeable Preferred Stock Due 2009 (the "Exchangeable Preferred
Stock"). The net proceeds of approximately $288.0 million from the offering are
being used to fund capital expenditures, investments in the Company's
unconsolidated subsidiaries and general corporate purposes. The Exchangeable
Preferred Stock was registered under the Securities Act of 1933, as amended (the
"Securities Act") in December 1997 in compliance with the registration rights
agreement entered into by the Company with the initial purchasers of the
Exchangeable Preferred Stock. The Company may exchange all of the shares of
Exchangeable Preferred Stock for 12 1/2% Subordinated Exchange Debentures Due
2009 ("Exchange Debentures") in a principle amount equal to the liquidation
preference of the Exchangeable Preferred Stock at the time of the exchange. If
exchanged, the Exchange Debentures will bear interest at the rate of 12 1/2% per
annum, payable semiannually on February 15 and August 15, commencing with the
first of such dates to occur after the date of such exchange. The Exchange
Debentures will be general unsecured obligations of the Company, subordinated in
right of payment to all existing and future senior indebtedness of the Company
and to all indebtedness and other liabilities of the Company's subsidiaries. On
August 15, 2009, the Exchangeable Preferred Stock must be redeemed by the
Company at a price equal to the liquidation preference ($1,000 a share) plus
accrued and unpaid dividends; thus it is "mandatorily redeemable" and is not
included in stockholders' equity. Dividends on the Exchangea-
F-13
65
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
ble Preferred Stock will accrue at a rate of 12 1/2% per annum of the
liquidation preference thereof (including unpaid dividends) and will be payable
quarterly in arrears on February 15, May 15, August 15, and November 15 of each
year commencing November 15, 1997. Dividends payable prior to or on August 15,
2000 are, at the option of the Company, payable in cash or through issuance of
additional shares of Exchangeable Preferred Stock equal to the dividend amount
divided by the liquidation preference of such additional shares. After February
15, 2001, interest on the Exchangeable Preferred Stock may be paid only in cash.
Payment of cash dividends on the Exchangeable Preferred Stock is not currently
permitted under the indenture for the Company's 12 1/2% Senior Notes due 2005
until certain financial conditions have been met. During 1997, the Company
issued approximately 8,958 additional shares of Exchangeable Preferred Stock in
satisfaction of its 1997 dividend requirements. Any difference between the
carrying value and the redemption amount of the Exchangeable Preferred Stock is
accreted by a charge to additional paid-in-capital for all periods through the
mandatory redemption date.
9. COMMON AND PREFERRED STOCK
Preferred Stock
The 10% Junior Series 3 Cumulative Redeemable Preferred Stock ("Series 3
Preferred Stock") votes as a single class with IXC's common stock except in
matters impacting the rights of the Series 3, is entitled to elect one director
and may be redeemed at the Company's option in whole or in part at any time,
subject to certain debt covenants, at a price of $1,000 per share, plus
accumulated and unpaid dividends and accrued interest. The Series 3 Preferred
Stock is nonparticipatory and has no mandatory redemption requirements.
Dividends are payable at the determination of the Board of Directors, subject to
debt covenants. Interest accrues on unpaid dividends at an annual rate of 10%.
On October 31, 1997, the Company consummated its offer to exchange shares
of its Common Stock for its Series 3 Preferred Stock. Holders of approximately
96.7% of its Series 3 Preferred Stock accepted such offer. Each holder that
tendered shares of Series 3 Preferred Stock received approximately 49.85 shares
of Common Stock for each share of Series 3 Preferred Stock tendered prior to the
expiration date. The conversion rate was calculated by dividing the aggregate
per share liquidation preference of, and the accrued and unpaid dividend on, one
share of Series 3 Preferred Stock as of October 31, 1997 by $33.00 (the last
reported sales price of the Company's Common Stock on the Nasdaq National Market
on October 31, 1997). The aggregate liquidation preference and accrued and
unpaid dividends on the Series 3 Preferred Stock at October 31, 1997, was
approximately $20.6 million ($1,645 per share for the 12,550 shares
outstanding). Cumulative preferred dividends in arrears, including interest, at
December 31, 1997 and 1996 were $277,614 ($670.64 per share) and $6.5 million
($518.65 per share), respectively.
IXC's 10% Senior Series 1 Cumulative Redeemable Preferred Stock was
non-voting and was redeemed on October 6, 1995 from the proceeds of the Senior
Notes for $2.0 million, including cumulative dividends in arrears and related
interest of $505,000.
During 1993, an indirect subsidiary of IXC issued 1,400 shares of 10%
Senior Series 1 Cumulative Redeemable Preferred Stock (the "ILHI Series 1
Preferred Stock") at $1,000 per share to stockholders of IXC. The ILHI Series 1
Preferred Stock was redeemed on October 6, 1995 from the proceeds of the Senior
Notes for $1.8 million, including cumulative dividends in arrears and related
interest of $401,000.
See also Note 8 for Redeemable Preferred Stock.
Common Stock
During 1996, the Company issued 6,440,000 shares of Common Stock in an
initial public offering and a private placement, resulting in net proceeds of
$94.1 million.
At December 31, 1997, the Company has reserved approximately 8,319,000
shares for future issuance under stock option plans and the Convertible
Preferred Stock.
F-14
66
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Stock Option and Award Plans
In November 1994, the Company adopted the IXC Communications, Inc. Stock
Plan, as amended (the "1994 Stock Plan"), which provides for the issuance of
restricted stock or the granting of stock options for up to 1,212,450 shares of
common stock to key employees and others. Awards under the 1994 Stock Plan are
given at the discretion of the Board of Directors and include common stock
options with exercise prices at least equal to the fair market value at the date
of grant. Options granted may be either "incentive stock options," within the
meaning of Section 422(a) of the Internal Revenue Code, or non-qualified
options. The options expire after 10 years and generally vest at rates of 25%
and 33% per year commencing one year after the date of grant, with the exception
of two grants covering 84,871 shares which were 100% vested upon grant.
In 1996, the Company adopted the IXC Communications, Inc. 1996 Stock Plan,
as amended (the "1996 Stock Plan"), which provides for the issuance of
restricted stock or the granting of stock options for up to 2,121,787 shares of
common stock to key employees and others. Awards under the 1996 Stock Plan are
granted at the discretion of the Board of Directors and include common stock
options with exercise prices at least equal to the fair market value at the date
of grant. Options granted may be either "incentive stock options," within the
meaning of Section 422(a) of the Internal Revenue Code, or non-qualified
options. The options expire after 10 years and generally vest at rates of 25%
and 33% per year commencing one year after the date of grant. During 1997 and
1996, 744,900 and 476,600 options were granted, respectively, under the 1996
Stock Plan.
The Company has not issued any restricted stock under the 1994 Stock Plan
or the 1996 Stock Plan. All options granted under the 1994 Stock Plan and the
1996 Stock Plan were granted at estimated market value at the date of grant. In
the event of a change of control of the Company, the options outstanding
immediately following the consummation of such change of control fully vest, and
the options may be exercised in full to purchase the total number of shares
covered by the option.
In October 1996, the Company adopted a stock incentive plan (the "Special
Stock Plan") covering 67,900 shares of common stock. Any employee, director or
other person providing services to the Company is eligible to receive awards
under the Special Stock Plan, at the Board's discretion. Awards available under
the Special Stock Plan include common stock purchase options and restricted
common stock. All available options to acquire stock under the Special Stock
Plan were granted in 1996 at exercise prices less than market value at the date
of grant and vest over three to four years. In 1997 and 1996, the Company
recognized $247,000 and $182,000 in compensation expense respectively, related
to grants under the Special Stock Plan.
On May 14, 1996 the Company adopted the IXC Communications, Inc. Outside
Directors' Phantom Stock Plan (the "Directors' Plan"), pursuant to which $20,000
per year of outside director's fees for certain directors is deferred and
treated as if it were invested in shares of the Company's common stock. No
shares of common stock will be actually purchased and the participants will
receive cash benefits equal to the value of the shares that they are deemed to
have purchased under the Directors' Plan, with such value to be determined on
the date of distribution. Distribution of benefits generally will occur three
years after the deferral. Compensation expense is determined based on the market
price of the shares deemed to have been purchased and is charged to expense over
the related period. In 1997 and 1996, the Company recognized $102,000 and
$60,000 as compensation expense related to the Directors' Plan.
In September 1997, the Company adopted the 1997 Special Executive Stock
Plan, a stock incentive plan covering 500,000 shares of common stock. The
purposes of the new plan were to promote the interests of the Company and its
stockholders by enabling it to offer grants of stock to better attract, retain
and reward key executives and, to strengthen the mutuality of interests between
an executive and the Company's stockholders by providing an executive with a
proprietary interest in pursuing the Company's long-term growth and financial
success. The terms and conditions of the 1997 Special Executive Stock Plan were
essentially the same as those of the 1994 and 1996 Plans. All available options
to acquire stock under the 1997 Special
F-15
67
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Executive Stock Plan were granted in 1997 at market value at the date of grant.
The options granted will vest over a five year period.
Stock Based Compensation
The Company has elected to account for its employee stock options under APB
25. As a result, pro forma information regarding net loss and loss per share is
required by SFAS No. 123, which requires that the information be determined as
if the Company had accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 1997, 1996 and 1995, respectively: risk-free interest rates
ranging from 5.17% to 6.22%, 5.25% to 6.73% and 5.74% to 5.95%; no dividend
yield; volatility factor of the expected market price of the Company's common
stock of .551 in 1997 and .523 for 1996 and 1995; and a weighted-average
expected life of the options of approximately 5 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands except for loss per share
information):
1997 1996 1995
--------- -------- -------
Pro forma loss applicable to common stockholders... $(120,151) $(39,805) $(6,871)
Pro forma basic and diluted loss per share......... $ (3.88) $ (1.45) $ (0.28)
Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.
A summary of the Company's stock option activity, and related information
for the years ended December 31 follows:
1997 1996 1995
----------------------- ----------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- --------- ---------- --------- ------- ---------
Outstanding -- beginning
of year................. 1,700,573 $ 9.05 645,880 $ 3.01 206,113 $3.01
Granted................... 1,244,900 25.06 1,138,351 12.04 439,767 3.01
Exercised................. (62,226) 10.98 (19,702) 3.01 -- --
Forfeited................. (31,001) 17.89 (63,956) 3.01 -- --
---------- ------ ---------- ------ ------- -----
Outstanding -- end of
year.................... 2,852,246 $15.90 1,700,573 $ 9.05 645,880 $3.01
========== ====== ========== ====== ======= =====
Exercisable at end of
year.................... 687,041 257,527 121,243
========== ========== =======
Weighted-average fair
value of options granted
during the year......... $ 14.55 $ 7.34 $ 1.51
F-16
68
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following table summarizes outstanding options at December 31, 1997 by
price range:
OUTSTANDING EXERCISABLE
- --------------------------------------------------------------- ----------------------
WEIGHTED- WEIGHTED-AVERAGE WEIGHTED-
NUMBER AVERAGE REMAINING NUMBER AVERAGE
OF RANGE OF EXERCISE CONTRACTUAL OF EXERCISE
OPTIONS EXERCISE PRICE PRICE LIFE OF OPTIONS OPTIONS PRICE
- --------- --------------- --------- ---------------- ------- ---------
1,036,095 $ 3.01 $ 3.01 7.8 536,604 $3.01
1,045,651 15.38 to 26.25 19.69 9.0 150,437 19.87
770,500 27.50 to 36.88 28.10 9.7 -- --
- --------- --------------- ------ ------- -----
2,852,246 $3.01 to $36.88 $15.90 8.8 687,041 $6.70
========= =============== ====== ======= =====
10. LOSS PER SHARE
Loss per share data for the years ended December 31, 1997, 1996 and 1995
are as follows:
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS, EXCEPT PER-SHARE DATA)
For the Year Ended 1997:
Net loss............................... $ 94,555
Less: Preferred stock dividends........ 21,636
========
Basic and diluted loss per share....... $116,191 30,961 $(3.75)
======== ====== ======
Options to purchase 2,852,246 shares of common stock and 1,055,367 shares
of Convertible Preferred Stock (each share convertible into 4.263 shares of
common stock) were outstanding at December 31, 1997, but were not included in
the computation of diluted loss per share because they would have been
anti-dilutive due to the Company's net loss.
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS, EXCEPT PER-SHARE DATA)
For the Year Ended 1996:
Net loss............................... $(37,448)
Less: Preferred stock dividends........ (1,739)
========
Basic and diluted loss per share....... $(39,187) 27,525 $(1.42)
======== ====== ======
Options to purchase 1,700,573 shares of common stock were outstanding at
December 31, 1996, but were not included in the computation of diluted loss per
share because they would have been anti-dilutive due to the Company's net loss.
F-17
69
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS, EXCEPT PER-SHARE DATA)
For the Year Ended 1995:
Net loss............................... $(4,965)
Less: Preferred stock dividends........ (1,843)
-------
Basic and diluted loss per share....... $(6,808) 24,335 $(0.28)
======= ====== ======
Options to purchase 645,880 shares of common stock were outstanding at
December 31, 1995, but were not included in the computation of diluted loss per
share because they would have been anti-dilutive due to the Company's net loss.
11. MAJOR CUSTOMERS
Prior to 1996, substantially all of the Company's revenues were earned from
private line services. Private line services generally are provided to carriers
under long-term contractual arrangements or on a month-to-month basis after
contract expiration. In late 1995, the Company expanded into the business of
selling long distance switched services to long distance resellers. Excel
Communications is the Company's largest long distance switched service customer.
Only sales to Excel exceeded 10% of total revenues for each of the years ended
December 31, 1997 and 1996. The percentages of revenue for customers with 10% or
more of the Companys' business in any one year are as follows:
1997 1996 1995
---- ---- ----
Excel Communications, Inc........................... 29% 35% --
Frontier Communications............................. 4% 10% 21%
WorldCom, Inc. ..................................... 4% 8% 20%
12. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution retirement and 401(k) savings plan
which covers all full-time employees with one year of service. The Company
contributes 6% of eligible compensation, as defined in the plan, and matches 50%
of the employee's contributions up to a maximum of 6% of the employee's
compensation. Employees vest in the Company's contribution over five years.
Benefit expense for the years ended December 31, 1997, 1996 and 1995 was
approximately $1,263,000, $779,000 and $522,000, respectively.
F-18
70
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
13. INCOME TAXES
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31,
-------------------
1997 1996
-------- --------
(IN THOUSANDS)
Deferred tax assets:
Tax credit carryforwards............................... $ 2,068 $ 2,068
Net operating loss carryforwards....................... 37,363 22,240
Investment in joint venture............................ 9,465 794
Deferred revenue....................................... 19,787 --
Bad debts.............................................. 5,761 1,612
Accrued expenses....................................... 3,273 750
-------- --------
Gross deferred tax assets...................... 77,717 27,464
Valuation allowance............................ (54,793) (17,264)
-------- --------
Net deferred tax assets.................................. 22,924 10,200
-------- --------
Deferred tax liabilities:
Tax over book depreciation............................. (23,635) (10,372)
Other liability accruals............................... (833) (1,799)
-------- --------
Gross deferred tax liabilities................. (24,468) (12,171)
-------- --------
Net deferred tax liability............................... $ (1,544) $ (1,971)
======== ========
As recorded in the consolidated balance sheets:
Current deferred tax assets............................ $ 1,662 $ 463
Non current deferred tax liability..................... (3,206) (2,434)
-------- --------
$ (1,544) $ (1,971)
======== ========
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $93.4 million for income tax purposes that expire through 2012.
The Company has minimum tax and investment tax credit carryforwards at December
31, 1997 of approximately $0.7 million and $1.4 million, respectively. The
minimum tax credits can be carried forward indefinitely and the investment tax
credits expire in 2001.
Valuation allowances of $54.8 million and $17.3 million were established to
offset a portion of the Company's deferred tax assets at December 31, 1997 and
1996, respectively. The valuation allowance is related to deferred tax assets,
primarily net operating losses, that may not be realizable. During the years
ended December 31, 1997 and 1996, the valuation allowance was increased by $37.5
million and $17.3 million, respectively.
F-19
71
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Significant components of the benefit (provision) for income taxes
(excluding the effect attributable to extraordinary items) are as follows:
DECEMBER 31,
-----------------------------
1997 1996 1995
-------- ------- ------
(IN THOUSANDS)
Current:
Federal............................................. $ -- $ 829 $ 381
State............................................... (1,816) (250) --
-------- ------- ------
Total current......................................... (1,816) 579 381
Deferred:
Federal............................................. 363 4,136 1,144
State............................................... 64 1,266 168
-------- ------- ------
Total deferred........................................ 427 5,402 1,312
-------- ------- ------
Benefit (provision) for income taxes.................. $ (1,389) $ 5,981 $1,693
======== ======= ======
The reconciliation of income tax benefit (provision) attributable to
continuing operations computed at the U.S. federal statutory tax rates to income
tax benefit (provision) is as follows:
DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- ------
(IN THOUSANDS)
Tax benefit at federal statutory rates............... $ 32,608 $ 14,766 $1,670
State income tax benefit (provision) net of federal
effect............................................. 3,690 3,106 302
Net operating losses and other deferred tax assets
not benefited...................................... (37,529) (17,264) --
Resolution of tax examinations....................... -- 3,511 --
Permanent and other differences...................... (158) 1,862 (279)
-------- -------- ------
Benefit (provision) for income taxes................. $ (1,389) $ 5,981 $1,693
======== ======== ======
14. RELATED PARTY TRANSACTIONS
A law firm, of which a director and stockholder of the Company was a
principal, provided certain legal services to the Company and charged fees and
costs incurred to the Company in the amount of approximately $4.3 million in
1997, $3.5 million in 1996 and $2.6 million in 1995.
F-20
72
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the
balance sheets for cash and cash equivalents approximates fair value.
Accounts receivable and accounts payable: The carrying amounts
reported in the balance sheets for accounts receivable and accounts payable
approximate fair value.
Escrow under Senior Notes: The carrying amount reported in the
balance sheets for restricted short-term investments held in escrow
approximates fair value.
Long-term debt: The fair value of the Senior Notes is estimated at
$330 million based on the last trading price of the Senior Notes in 1997.
Redeemable preferred stock: The fair value of the Convertible and
Exchangeable Preferred Stock has not been determined due to the
impracticability of such a calculation based on the limited market of the
preferred stock and the lack of an actively quoted price.
16. COMMITMENTS AND CONTINGENCIES
In connection with its fiber optic network expansion, the Company has
entered into various construction and installation agreements with contractors.
Total commitments under these agreements are approximately $77.6 million at
December 31, 1997.
In connection with its fiber expansion agreements, the Company has
committed to pay $42.0 million for fiber usage rights on other long distance
carriers' networks, $8.4 million of which was paid by December 31, 1997.
Pursuant to the same agreements, the Company has committed to pay a total of
$30.4 million, in periodic installments for twenty to twenty-five years related
to maintenance and license fees. Several of these agreements require the Company
to share network construction costs with the other party. The exact amounts of
these construction costs are not specified in the related agreements and are
thus excluded from the figures above.
The Company is from time to time involved in various legal proceedings, all
of which have arisen in the ordinary course of business and some of which are
covered by insurance. In the opinion of the Company's management, none of the
claims relating to such proceedings will have a material adverse effect on the
financial condition or results of operations of the Company.
17. VALUATION AND QUALIFYING ACCOUNTS
Activity in the Company's allowance for doubtful accounts and service
credits was as follows (in thousands):
BALANCE AT OTHER BALANCE
BEGINNING CHARGED TO CHARGES TO AT END OF
FOR THE YEARS ENDED OF PERIOD REVENUE REVENUE DEDUCTIONS PERIOD
------------------- ---------- ---------- ---------- ---------- ---------
December 31, 1997............ $4,030 $17,387 $4,936 $11,950 $14,403
December 31, 1996............ $1,769 $ 3,060 $ -- $ 799 $ 4,030
December 31, 1995............ $ 762 $ 1,505 $ -- $ 498 $ 1,769
F-21
73
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
18. QUARTERLY RESULTS (UNAUDITED)
The Company's unaudited quarterly results are as follows:
FOR THE 1997 QUARTER ENDED:
---------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net operating revenues.............. $ 83,910 $ 88,865 $112,240 $135,695
Gross profit........................ 14,928 14,715 28,351 37,589
Net loss............................ (19,878) (28,810) (26,788) (19,079)
Basic and diluted loss per share.... $ (0.66) $ (1.01) $ (1.08) $ (0.99)
FOR THE 1996 QUARTER ENDED:
---------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- -------- ------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net operating revenues.............. $ 26,250 $ 43,007 $ 61,016 $ 73,488
Gross profit........................ 10,650 11,364 17,242 21,036
Net loss............................ (11,699) (12,067) (5,624) (8,058)
Basic and diluted loss per share.... $ (0.50) $ (0.51) $ (0.20) $ (0.28)
The 1996 and first three quarters of 1997 earnings per share amounts have
been restated immaterially to comply with Statement of Financial Accounting
Standards No. 128, Earnings per Share and the Securities and Exchange Commission
Staff Accounting Bulletin 98.
19. SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information (Statement 131), which is effective for years
beginning after December 15, 1997. Statement 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. Statement 131 is effective for financial
statements for fiscal years beginning after December 15, 1997, and therefore the
Company will adopt the new requirements retroactively in 1998. Management has
not completed its review of Statement 131, but anticipates that the adoption of
Statement 131 will not affect results of operations or financial position, but
may affect the disclosure of segment information. Under applicable accounting
literature effective prior to the adoption of FAS 131, the Company considers its
operations to be exclusively within a single industry.
20. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY
As of December 31, 1997, the Company indirectly owned 24.5% of Marca-Tel
S.A. de C.V. (Marca-Tel) through its ownership of 50% of Progress International
LLC, which owned 49% of Marca-Tel. The remaining 51% of Marca-Tel is owned by a
Mexican individual and Formento Radio Beep, S.A. de C.V. The other 50% of
Progress International is owned by Westel International, Inc.
F-22
74
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following are summarized financial information for Marca-Tel for the
years ending December 31, 1997 and 1996:
1997 1996
-------- ---------
(IN THOUSANDS)
INCOME STATEMENT DATA:
Net revenue............................................. $ 5,786 $ --
Gross profit (loss)..................................... (4,556) (3,110)
Net loss................................................ (25,395) (3,120)
BALANCE SHEET DATA:
Current assets.......................................... $ 10,123 $ 4,381
Non-current assets...................................... 80,351 34,733
Current liabilities..................................... 18,431 26,665
Non-current liabilities................................. 51,831 2,871
Marca-Tel is included in the financial statements of the Company as of and
for the years ended December 31, 1997 and 1996 as follows:
1997 1996
------ -----
(IN MILLIONS)
Investment in unconsolidated subsidiaries................... $ 11.6 $ 5.3
Equity in net income (loss) of unconsolidated
subsidiaries.............................................. $(23.6) $(1.8)
21. JOINT VENTURES AND ACQUISITIONS
In October 1997, the Company formed a joint venture with Telenor AS, the
Norwegian national telephone company, to provide telecommunication services to
carriers and resellers in nine European countries. The joint venture is owned 40
percent by the Company, 40 percent by Telenor Global Services AS, and 20 percent
by Clarion Resources Communications Corporation, a U.S.-based telecommunications
company in which Telenor owns a controlling interest. Under the terms of the
agreement, the Company has two seats on the joint venture's board. Approximately
$5.8 million was invested in this joint venture in 1997.
In December 1997, the Company entered into an agreement to exchange
approximately 4,000,000 shares of its common stock for all of the outstanding
common stock of Network Long Distance, Inc, a switchless reseller to
small/medium size companies. The Company intends to structure the transaction to
qualify for pooling of interests accounting and to qualify as a tax-free
reorganization. Under the terms of the agreement, Network Long Distance
shareholders will receive 0.2998 IXC common shares for each Network Long
Distance share at the close of the transaction. The transaction is expected to
close in the second quarter of 1998, subject to Network Long Distance
shareholder and regulatory approvals and other normal closing conditions.
In December 1997, the Company announced a joint venture with UniDial
Communications to sell UniDial products exclusively over the Company's network.
The joint venture will be known as UniDial Communications Services, LLC, and
will offer UniDial's full suite of wireless, voicemail, and paging products over
the Company's network backbone. The Company will provide the joint venture with
its full range of voice, video, Internet, and data services to be private
labeled under the UniDial name. The products will be marketed through a
full-time national sales force of UniDial network consultants. No amounts were
invested in this joint venture in 1997.
F-23
75
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
22. SUBSEQUENT EVENTS
PSINet Transaction. To enhance the Company's product and service offerings,
in February 1998, the Company consummated the agreements with PSINet which allow
each party to market and sell the products and services of the other party.
Under the terms of the agreements, the Company will provide PSINet with an IRU
in 10,000 miles of OC-48 transmission capacity on its Network over a 20-year
period in exchange for approximately 10.2 million shares representing 20%
(post-issuance) of PSINet common stock. If the value of the PSINet common stock
received by the Company is less than $240 million at the earlier of one year
after the final delivery of the transmission capacity (scheduled for late-1999)
or four years after the transaction's closing, PSINet, at its option, will pay
the Company cash and/or deliver additional PSINet common stock to increase the
value of the cash and common stock paid by PSINet to $240.0 million. Upon
delivery of the transmission capacity to PSINet, the Company will begin to
receive a maintenance fee which, as the full capacity has been delivered, should
increase to approximately $11.5 million per year.
23. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTOR
SUBSIDIARIES
IXC conducts a significant portion of its business through subsidiaries.
The Senior Notes are unconditionally guaranteed, jointly and severally, by
certain wholly-owned direct and indirect subsidiaries (the "Subsidiary
Guarantors"). The obligations of each Guarantor are limited to the minimum
extent necessary to prevent the guarantee from violating or becoming voidable
under applicable law relating to fraudulent conveyance or fraudulent transfer or
similar laws affecting the rights of creditors generally. Certain IXC
subsidiaries do not guarantee the Senior Notes (the "Non-Guarantor
Subsidiaries"). The claims of creditors of Non-Guarantor Subsidiaries have
priority over the rights of IXC to receive dividends or distributions from such
subsidiaries.
Presented below is condensed consolidating financial information for IXC,
the Subsidiary Guarantors and the Non-Guarantor Subsidiaries at December 31,
1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995.
The equity method has been used by IXC with respect to investments in
subsidiaries. The equity method has been used by Subsidiary Guarantors with
respect to investments in Non-Guarantor Subsidiaries. Separate financial
statements for Subsidiary Guarantors are not presented based on management's
determination that they do not provide additional information that is material
to investors.
Eliminations represents intercompany transactions, receivables, payables
and investments among the companies comprising the consolidated Company's
financial statements. These amounts must be eliminated in order to report the
Company on a consolidated basis.
F-24
76
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following table sets forth the Guarantor and Non-Guarantor
subsidiaries:
GUARANTOR SUBSIDIARIES NON-GUARANTOR SUBSIDIARIES
---------------------- --------------------------
Broadband Services, Inc. Mutual Signal Holding Corp.
IXC Carrier, Inc. Mutual Signal Corporation
Atlantic States Microwave Mutual Signal Corporation of
Transmission Company Michigan
Central States Microwave MSM Associates, Limited Partnership
Transmission Company Switched Services Communications, L.L.C.
Rio Grande Transmission, Inc.
Telecom Engineering, Inc.
Tower Communications System Corp.
West Texas Microwave Company
Western States Microwave Company
IXC Long Distance, Inc.
Link Net International, Inc.
IXC International , Inc.
IXC Internet Services, Inc.
F-25
77
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1997
--------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Current assets:
Cash and cash equivalents...... $ 122,572 $ 27,249 $ 2,899 $ -- $ 152,720
Accounts receivable and other,
net......................... 507 71,497 21,282 -- 93,286
Other current assets........... 1,310 1,546 644 -- 3,500
--------- --------- -------- --------- ---------
Total current assets... 124,389 100,292 24,825 -- 249,506
Property and equipment, net...... 8,246 543,506 57,445 (260) 608,937
Investments in and due from
affiliate...................... 512,535 255,797 -- (750,835) 17,497
Other assets..................... 17,330 10,638 16,621 (3,434) 41,155
--------- --------- -------- --------- ---------
Total assets........... $ 662,500 $ 910,233 $ 98,891 $(754,529) $ 917,095
========= ========= ======== ========= =========
Current liabilities:
Accounts payable and other
current liabilities......... $ 27,777 $ 97,191 $ 44,538 $ -- $ 169,506
Current portion of long-term
debt and lease
obligations................. 118 4,276 7,777 -- 12,171
--------- --------- -------- --------- ---------
Total current
liabilities.......... 27,895 101,467 52,315 -- 181,677
Long-term debt and capital lease
obligations.................... 278,427 18,156 11,541 -- 308,124
Deferred tax liability........... -- 10,583 -- (7,377) 3,206
Due to affiliate/parent.......... -- 882,885 83,259 (966,144) --
Other noncurrent liabilities..... -- 67,210 -- 67,210
Minority interest................ -- -- -- 1,465 1,465
Convertible Preferred Stock...... 101,239 101,239
Exchangeable Preferred Stock..... 302,129 -- 302,129
Stockholders' equity:
Preferred stock................ 1 -- 2,585 (2,585) 1
Common stock................... 316 3 -- (3) 316
Additional paid-in capital..... 106,559 42,553 23,848 (66,401) 106,559
Accumulated deficit............ (154,066) (212,624) (74,657) 286,516 (154,831)
--------- --------- -------- --------- ---------
Total stockholders' equity....... (47,190) (170,068) (48,224) 217,527 (47,955)
--------- --------- -------- --------- ---------
Total liabilities and
stockholders
equity............... $ 662,500 $ 910,233 $ 98,891 $(754,529) $ 917,095
========= ========= ======== ========= =========
F-26
78
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
DECEMBER 31, 1997
--------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Net operating revenues............... $ 43 $ 325,096 $ 247,693 $(152,122) $ 420,710
Operating expenses:
Cost of services................... 7 229,402 246,540 (150,822) 325,127
Operations and administration...... 6 57,638 23,726 (1,300) 80,070
Depreciation and amortization...... 4,341 45,401 11,102 (96) 60,748
--------- --------- --------- --------- ---------
(4,311) (7,345) (33,675) 96 (45,235)
Interest income...................... 6,418 942 335 -- 7,695
Intercompany interest income
(expense).......................... 85,376 (75,306) (10,070) -- --
Interest expense..................... (36,126) 7,112 (2,252) -- (31,266)
Equity in net loss of unconsolidated
subsidiaries....................... (146,471) (67,751) -- 190,422 (23,800)
--------- --------- --------- --------- ---------
Loss before income taxes and minority
interest........................... (95,114) (142,348) (45,662) 190,518 (92,606)
Benefit (provision) for income
taxes.............................. 559 (4,217) 2,269 -- (1,389)
Minority interest.................... -- -- -- (560) (560)
--------- --------- --------- --------- ---------
Net loss............................. $ (94,555) $(146,565) $ (43,393) $ 189,958 $ (94,555)
========= ========= ========= ========= =========
F-27
79
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
DECEMBER 31, 1997
--------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES............... $ (14,347) $ (71,592) $(16,600) $116,874 $ 14,335
CASH FLOWS FROM INVESTING ACTIVITIES:
Release of funds from escrow under
Senior Notes....................... 69,564 -- -- -- 69,564
Deposit into escrow under Senior
Notes.............................. (18,152) -- -- -- (18,152)
Purchase of property and equipment... (8,238) (239,495) (20,098) (46,496) (314,327)
Investment in unconsolidated
subsidiaries....................... 85,373 (35,497) -- (85,373) (35,497)
--------- --------- -------- -------- ---------
Net cash provided by (used in)
investing activities............... 128,547 (274,992) (20,098) (131,869) (298,412)
--------- --------- -------- -------- ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Payments on long-term debt and
capital lease obligations.......... 289 (43,952) (9,104) 44,479 (8,288)
Net proceeds from Convertible
Preferred Stock.................... 95,354 -- -- -- 95,354
Net proceeds from Exchangeable
Preferred Stock ................... 287,967 -- -- -- 287,967
Other Financing, net................. (172) -- -- 596 424
Advances to affiliates............... (440,429) 427,240 44,090 (30,901) --
--------- --------- -------- -------- ---------
Net cash provided by (used in)
financing activities............... (56,991) 383,288 34,986 14,174 375,457
--------- --------- -------- -------- ---------
Net increase (decrease) in cash and
cash equivalents................... 57,209 36,704 (1,712) (821) 91,380
Cash and cash equivalents at
beginning of period................ 65,363 (9,455) 4,611 821 61,340
--------- --------- -------- -------- ---------
Cash and cash equivalents at end of
period............................. $ 122,572 $ 27,249 $ 2,899 $ -- $ 152,720
========= ========= ======== ======== =========
F-28
80
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1996
-------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Current assets:
Cash and cash equivalents........... $ 65,363 $ (9,455) $ 4,611 $ 821 $ 61,340
Accounts receivable and other,
net.............................. 111 28,657 32,363 (13,563) 47,568
Other current assets................ 937 3,765 549 (3,054) 2,197
-------- -------- -------- --------- --------
Total current assets........ 66,411 22,967 37,523 (15,796) 111,105
Property and equipment, net........... 8 231,514 37,347 (260) 268,609
Escrow under Senior Notes............. 51,412 -- -- -- 51,412
Due from affiliate.................... 225,093 40,742 6,574 (272,409) --
Other assets.......................... 8,429 6,527 13,049 20 28,025
-------- -------- -------- --------- --------
Total assets................ $351,353 $301,750 $ 94,493 $(288,445) $459,151
-------- -------- -------- --------- --------
Current liabilities:
Accounts payable and other current
liabilities...................... $ 10,077 $ 70,207 $ 16,909 $ (13,342) $ 83,851
Due to affiliate.................... 141 523 40 (704) --
Current portion of long-term debt
and lease obligations............ -- 2,469 6,024 (1,743) 6,750
-------- -------- -------- --------- --------
Total current liabilities... 10,218 73,199 22,973 (15,789) 90,601
Long-term debt and capital lease
obligations......................... 277,656 1,487 21,548 (5,160) 295,531
Deferred tax liability................ -- 7,484 -- (5,050) 2,434
Due to affiliate/parent............... -- 231,666 40,743 (272,409) --
Other noncurrent liabilities.......... -- 6,201 749 (749) 6,201
Minority interest..................... -- -- -- 905 905
Stockholders' equity:
Preferred stock..................... 13 -- 2,585 (2,585) 13
Common stock........................ 308 4 2 (6) 308
Additional paid-in capital.......... 123,434 30,053 36,249 (66,302) 123,434
Accumulated deficit................. (60,276) (48,344) (30,356) 78,700 (60,276)
-------- -------- -------- --------- --------
Total stockholders'
equity.................... 63,479 (18,287) 8,480 9,807 63,479
-------- -------- -------- --------- --------
Total liabilities and
stockholders' equity...... $351,353 $301,750 $ 94,493 $(288,445) $459,151
======== ======== ======== ========= ========
F-29
81
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
DECEMBER 31, 1996
-------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Net operating revenues................ $ 66 $148,692 $104,156 $(49,153) $203,761
Operating expenses:
Cost of services.................... -- 86,929 103,912 (47,372) 143,469
Operations and administration....... 3,955 36,711 7,558 (1,157) 47,067
Depreciation and amortization....... 58 18,055 9,453 (325) 27,241
-------- -------- -------- -------- --------
(3,947) 6,997 (16,767) (299) (14,016)
Interest income....................... 17,572 6,738 596 (22,068) 2,838
Interest income on escrow under Senior
Notes............................... 7,404 -- -- -- 7,404
Interest expense...................... (38,181) (15,936) (5,027) 22,068 (37,076)
Equity in net income (loss) of
unconsolidated subsidiaries......... (26,277) (23,688) -- 48,004 (1,961)
-------- -------- -------- -------- --------
Loss before income taxes and minority
interest............................ (43,429) (25,889) (21,198) 47,705 (42,811)
Benefit (provision) for income
taxes............................... 5,981 2,915 2,344 (5,259) 5,981
Minority interest..................... -- -- -- (618) (618)
-------- -------- -------- -------- --------
Net loss.............................. $(37,448) $(22,974) $(18,854) $ 41,828 $(37,448)
======== ======== ======== ======== ========
F-30
82
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
DECEMBER 31, 1996
---------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR IXC
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ---------- -------------- ------------ ------------
(DOLLARS IN THOUSANDS)
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES.............. $ (25,099) $ 49,161 $(40,627) $(12,122) $ (28,687)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Release of funds from escrow under
Senior Notes...................... 154,244 -- -- -- 154,244
Deposit into escrow under Senior
Notes............................. (7,404) -- -- -- (7,404)
Purchase of property and
equipment......................... (9) (169,498) (7,259) 40,375 (136,391)
Investment in unconsolidated
subsidiaries...................... 12,422 (44,714) -- 24,973 (7,319)
--------- --------- -------- -------- ---------
Net cash provided by (used in)
investing activities.............. 159,253 (214,212) (7,259) 65,348 3,130
CASH FLOW FROM FINANCING ACTIVITIES:
Payment of debt issue costs......... (1,301) -- -- -- (1,301)
Payments on long-term debt and
capital lease obligations......... -- (9,018) (583) (3,185) (12,786)
Issuance of preferred stock......... -- -- 2,585 (2,585) --
Issuance of common stock............ 81,581 -- 15,500 (3,012) 94,069
Advances to affiliates.............. (150,489) 161,282 33,253 (44,046) --
--------- --------- -------- -------- ---------
Net cash provided by (used in)
financing activities.............. (70,209) 152,264 50,755 (52,828) 79,982
--------- --------- -------- -------- ---------
Net increase (decrease) in cash and
cash equivalents.................. 63,945 (12,787) 2,869 398 54,425
Cash and cash equivalents at
beginning of period............... 1,418 3,332 1,742 423 6,915
--------- --------- -------- -------- ---------
Cash and cash equivalents at end of
period............................ $ 65,363 $ (9,455) $ 4,611 $ 821 $ 61,340
========= ========= ======== ======== =========
F-31
83
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1995
-------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Current assets:
Cash and cash equivalents..................... $ 1,418 $ 3,332 $ 1,742 $ 423 $ 6,915
Accounts receivable and other, net............ -- 6,717 1,148 (1,546) 6,319
Other current assets.......................... 6,565 4,481 358 (8,589) 2,815
-------- -------- ------- --------- --------
Total current assets............................ 7,983 14,530 3,248 (9,712) 16,049
Property and equipment, net..................... -- 76,804 29,910 (315) 106,399
Escrow under Senior Notes....................... 198,266 -- -- -- 198,266
Due from affiliate.............................. 74,604 3,351 568 (78,523) --
Other assets.................................... 12,707 16,948 4,191 (18,085) 15,761
-------- -------- ------- --------- --------
Total assets.................................... $293,560 $111,633 $37,917 $(106,635) $336,475
======== ======== ======= ========= ========
Current liabilities:
Accounts payable and other current
liabilities................................ $ 8,984 $ 13,922 $ 2,720 $ (4,528) $ 21,098
Due to affiliate.............................. 258 6,458 1,832 (8,548) --
Current portion of long-term debt and lease
obligations................................ -- 1,511 3,023 -- 4,534
-------- -------- ------- --------- --------
Total current liabilities....................... 9,242 21,891 7,575 (13,076) 25,632
Long-term debt and capital lease obligations.... 277,238 3,207 17,215 (3,400) 294,260
Deferred tax liability.......................... 222 10,997 -- (2,916) 8,303
Due to affiliate/parent......................... -- 70,384 3,878 (74,262) --
Other noncurrent liabilities.................... -- 469 -- -- 469
Minority interest............................... -- 1 -- 952 953
Stockholders' equity:
Preferred stock............................... 13 -- -- -- 13
Common stock.................................. 243 3 1 (4)(b) 243
Additional paid-in capital.................... 29,430 30,051 20,750 (50,801) 29,430
Accumulated deficit........................... (22,828) (25,370) (11,502) 36,872 (22,828)
-------- -------- ------- --------- --------
Total stockholders' equity............ 6,858 4,684 9,249 (13,933) 6,858
-------- -------- ------- --------- --------
Total liabilities and stockholders'
equity.............................. $293,560 $111,633 $37,917 $(106,635) $336,475
======== ======== ======= ========= ========
F-32
84
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
DECEMBER 31, 1995
------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
Net operating revenues............................ $ 404 $89,339 $ 12,155 $(10,897) $ 91,001
Operating expenses:
Cost of services................................ -- 38,950 10,075 (9,173) 39,852
Operations and administration................... 1,116 26,155 6,322 (1,311) 32,282
Depreciation and amortization................... 57 12,728 4,653 -- 17,438
------- ------- -------- -------- --------
(769) 11,506 (8,895) (413) 1,429
Interest income................................... 3,766 399 67 (3,764) 468
Interest income on escrow under Senior Notes...... 2,552 -- -- -- 2,552
Interest expense.................................. (10,982) (5,838) (1,541) 3,764 (14,597)
Equity in net income (loss) of unconsolidated
subsidiaries.................................... (1,474) (7,678) -- 9,171 19
------- ------- -------- -------- --------
Loss before income taxes, minority interests and
extraordinary loss.............................. (6,907) (1,611) (10,369) 8,758 (10,129)
Benefit (provision) for income taxes.............. 2,246 546 (1,099) -- 1,693
Minority interests................................ -- -- -- 5,218 5,218
------- ------- -------- -------- --------
Loss before extraordinary items................... (4,661) (1,065) (11,468) 13,976 (3,218)
Extraordinary loss, net of taxes.................. (304) (1,309) (134) -- (1,747)
------- ------- -------- -------- --------
Net loss.......................................... $(4,965) $(2,374) $(11,602) $ 13,976 $ (4,965)
======= ======= ======== ======== ========
F-33
85
IXC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
DECEMBER 31, 1995
--------------------------------------------------------------------
SUBSIDIARY NON-GUARANTOR IXC
IXC GUARANTORS SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
(DOLLARS IN THOUSANDS)
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES................................... $ (8,324) $ 24,272 $(8,333) $ 3,992 $ 11,607
CASH FLOWS FROM INVESTING ACTIVITIES:
Release of funds from escrow under Senior
Notes........................................ 4,300 -- -- -- 4,300
Purchase of restricted short-term
investments.................................. (202,552) -- -- -- (202,552)
Purchase of property and equipment............. -- (14,282) (9,565) 177 (23,670)
--------- -------- ------- -------- ---------
Net cash used in investing activities.......... (198,252) (14,282) (9,565) 177 (221,922)
CASH FLOW FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Senior Notes, net
of discount.................................. 277,148 -- -- -- 277,148
Payment of debt issue costs.................... (10,407) -- -- -- (10,407)
Payments from (advances to) affiliates, net.... (50,827) 50,827 -- -- --
Proceeds from long-term debt................... -- 17,150 1,545 -- 18,695
Payments on long-term debt and capital lease
obligations.................................. (5,700) (63,606) (3,089) (4,095) (76,490)
Redemption of preferred stock.................. (1,460) (1,400) -- -- (2,860)
Capital contribution in subsidiary by minority
shareholders................................. -- (14,248) 20,250 -- 6,002
Dividend payments.............................. (906) -- -- -- (906)
--------- -------- ------- -------- ---------
Net cash provided by (used in) financing
activities................................... 207,848 (11,277) 18,706 (4,095) 211,182
--------- -------- ------- -------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. 1,272 (1,287) 808 74 867
Cash and cash equivalents at beginning of
year......................................... 146 4,619 934 349 6,048
--------- -------- ------- -------- ---------
Cash and cash equivalents at end of year....... $ 1,418 $ 3,332 $ 1,742 $ 423 $ 6,915
========= ======== ======= ======== =========
F-34
86
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
2.1 Stock Acquisition Agreement and Plan of Merger by and among
IXC Communications, Inc., IXC Long Distance, Inc., Pisces
Acquisition Corp. and Network Long Distance, Inc. dated as
of December 19, 1997 (incorporated by reference to Exhibit
2.1 of IXC Communications, Inc.'s Current Report on Form 8-K
dated December 19, 1997 and filed with the Commission on
December 23, 1997)..........................................
3.1+ Restated Certificate of Incorporation of IXC Communications,
Inc., as amended............................................
3.2 Bylaws of IXC Communications, Inc., as amended (incorporated
by reference to Exhibit 3.2 of IXC Communications, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997 filed with the Commission on November 14,
1997 (the "September 30, 1997 10-Q")).......................
4.1 Indenture dated as of October 5, 1995 by and among IXC
Communications, Inc., on its behalf and as
successor-in-interest to I-Link Holdings, Inc. and IXC
Carrier Group, Inc., each of IXC Carrier, Inc., on its
behalf and as successor-in-interest to I-Link, Inc., CTI
Investments, Inc., Texas Microwave Inc. and WTM Microwave
Inc., Atlantic States Microwave Transmission Company,
Central States Microwave Transmission Company, Telcom
Engineering, Inc., on its behalf and as
successor-in-interest to SWTT Company and Microwave Network,
Inc., Tower Communication Systems Corp., West Texas
Microwave Company, Western States Microwave Transmission
Company, Rio Grande Transmission, Inc., IXC Long Distance,
Inc., Link Net International, Inc. (collectively, the
"Guarantors"), and IBJ Schroder Bank & Trust Company, as
Trustee (the "Trustee), with respect to the 12 1/2% Series A
and Series B Senior Notes due 2005 (incorporated by
reference to Exhibit 4.1 of IXC Communications, Inc.'s and
each of the Guarantor's Registration Statement on Form S-4
filed with the Commission on April 1, 1996 (File No.
333-2936) (the "S-4"))......................................
4.2 Form of 12 1/2% Series A Senior Notes due 2005 (incorporated
by reference to Exhibit 4.6 of the S-4).....................
4.3 Form of 12 1/2% Series B Senior Notes due 2005 and
Subsidiary Guarantee (incorporated by reference to Exhibit
4.8 of Amendment No. 1 to IXC Communications, Inc.'s
Registration Statement on Form S-1 filed with the Commission
on June 13, 1996 (File No. 333-4061) (the "S-1
Amendment"))................................................
4.4 Amendment No. 1 to Indenture and Subsidiary Guarantee dated
as of June 4, 1996 by and among IXC Communications, Inc.,
the Guarantors and the Trustee (incorporated by reference to
Exhibit 4.11 of the S-1 Amendment)..........................
4.5 Purchase Agreement dated as of March 25, 1997 by and among
IXC Communications, Inc., Credit Suisse First Boston
Corporation ("CS First Boston") and Dillon Read & Co. Inc.
("Dillon Read") (incorporated by reference to Exhibit 4.12
of IXC Communications, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 filed with the
Commission on May 15, 1997 (the "March 31, 1997 10-Q")).....
4.6 Registration Rights Agreement dated as of March 25, 1997 by
and among IXC Communications, Inc., CS First Boston and
Dillon Read (incorporated by reference to Exhibit 4.13 of
the March 31, 1997 10-Q)....................................
4.7 Amendment to Registration Rights Agreement dated as of March
25, 1997 by and between IXC Communications, Inc. and GEPT
(incorporated by reference to Exhibit 4.14 of the March 31,
1997 10-Q)..................................................
87
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
4.8 Registration Rights Agreement dated as of July 8, 1997 among
IXC Communications, Inc. and each of William G. Rodi, Gordon
Hutchins, Jr. and William F. Linsmeier (incorporated by
reference to Exhibit 4.15 of IXC Communications, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended June 30,
1997, as filed with the Commission on August 6, 1997 (the
"June 30, 1997 10-Q"))......................................
4.9 Registration Rights Agreement dated as of July 8, 1997 among
IXC Communications, Inc. and each of William G. Rodi, Gordon
Hutchins, Jr. and William F. Linsmeier (incorporated by
reference to Exhibit 4.16 of the June 30, 1997 10-Q)........
4.10 Purchase Agreement dated as of August 14, 1997 by and among
IXC Communications, Inc. and the initial purchasers named in
Schedule A thereto (incorporated by reference to Exhibit 4.1
of IXC Communications, Inc.'s Current Report on Form 8-K
dated August 20, 1997 and filed with the Commission on
August 28, 1997 (the "8-K"))................................
4.11 Indenture dated as of August 15, 1997 between IXC
Communications, Inc. and The Bank of New York (incorporated
by reference to Exhibit 4.2 of the 8-K).....................
4.12 Registration Rights Agreement dated as of August 14, 1997 by
and among IXC Communications, Inc. and the purchasers named
therein (incorporated by reference to Exhibit 4.3 of the
8-K)........................................................
4.13+ First Supplemental Indenture dated as of October 23, 1997
among IXC Communications, Inc., the Guarantors, IXC
International, Inc. and IBJ Schroder Bank of Trust
Company.....................................................
4.14+ Second Supplemental Indenture dated as of December 22, 1997
among IXC Communications, Inc., the Guarantors, IXC Internet
Services, Inc., IXC International, Inc. and IBJ Schroder
Bank & Trust Company........................................
4.15+ Third Supplemental Indenture dated as of January 6, 1998
among IXC Communications, Inc., the Guarantors, IXC Internet
Services, Inc., IXC International, Inc. and IBJ Schroder
Bank & Trust Company........................................
10.1 Office Lease dated June 21, 1989 with USAA Real Estate
Company, as amended (incorporated by reference to Exhibit
10.1 of the S-4)............................................
10.2 Equipment Lease dated as of December 1, 1994 by and between
DSC Finance Corporation and Switched Services
Communications, L.L.C.; Assignment Agreement dated as of
December 1, 1994 by and between Switched Services
Communications, L.L.C. and DSC Finance Corporation; and
Guaranty dated December 1, 1994 made in favor of DSC Finance
Corporation by IXC Communications, Inc. (incorporated by
reference to Exhibit 10.2 of the S-4).......................
10.3* Amended and Restated 1994 Stock Plan of IXC Communications,
Inc., as amended (incorporated by reference to Exhibit 10.3
of the June 30, 1997 10-Q)..................................
10.4* Form of Non-Qualified Stock Option Agreement under the 1994
Stock Plan of IXC Communications, Inc. (incorporated by
reference to Exhibit 10.4 of the S-4).......................
10.5 Amended and Restated Development Agreement by and between
Intertech Management Group, Inc. and IXC Long Distance, Inc.
(incorporated by reference to Exhibit 10.7 of IXC
Communications, Inc.'s and the Guarantors' Amendment No. 1
to Form S-4 filed with the Commission on May 20, 1996 (File
No. 333-2936) ("Amendment No. 1 to S-4"))...................
10.6 Second Amended and Restated Service Agreement dated as of
January 1, 1996 by and between Switched Services
Communications, L.L.C. and Excel Telecommunications, Inc.
(incorporated by reference to Exhibit 10.8 of the S-4)......
88
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
10.7 Equipment Purchase Agreement dated as of January 16, 1996 by
and between Siecor Corporation and IXC Carrier, Inc.
(incorporated by reference to Exhibit 10.9 of the S-4)......
10.8* 1996 Stock Plan of IXC Communications, Inc., as amended
(incorporated by reference to Exhibit 10.10 of IXC
Communications, Inc. Annual Report on Form 10-K for the year
ended December 31, 1996 filed with the Commission on March
28, 1997 (the "10-K"))......................................
10.9 IRU Agreement dated as of November 1995 between WorldCom,
Inc. and IXC Carrier, Inc. (incorporated by reference to
Exhibit 10.11 of Amendment No. 1 to the S-4)................
10.10* Outside Directors' Phantom Stock Plan of IXC Communications,
Inc., as amended (incorporated by reference to Exhibit 10.12
of the 10-K)................................................
10.11* Business Consultant and Management Agreement dated as of
March 1, 1997 by and between IXC Communications, Inc. and
Culp Communications Associates (incorporated by reference to
Exhibit 10.13 of IXC Communications, Inc.'s Registration
Statement on Form S-4 as filed with the Commission on
October 3, 1997 (File No. 333-37157) (the "EPS S-4")).......
10.12* Employment Agreement dated December 28, 1995 by and between
IXC Communications, Inc. and James F. Guthrie (incorporated
by reference to Exhibit 10.14 of the S-1 Amendment).........
10.13* Employment Agreement dated August 28, 1995, by and between
IXC Communications, Inc. and David J. Thomas (incorporated
by reference to Exhibit 10.15 of the S-1 Amendment).........
10.14* Special Stock Plan of IXC Communications, Inc. (incorporated
by reference to Exhibit 10.16 of the 10-K)..................
10.15 Lease dated as of June 4, 1997 between IXC Communications,
Inc. and Carramerca Realty, L.P. (incorporated by reference
to Exhibit 10.17 of the June 30, 1997 10-Q).................
10.16 Loan and Security Agreement dated as of July 18, 1997 among
IXC Communications, Inc., IXC Carrier, Inc. and NFTC Capital
Corporation ("NTFC") (incorporated by reference to Exhibit
10.18 of the June 30, 1997 10-Q)............................
10.17 IRU and Stock Purchase Agreement dated as of July 22, 1997
between IXC Internet Services, Inc. and PSINet Inc.
(incorporated by reference to Exhibit 10.19 of IXC
Communications, Inc.'s Amendment No. 1 to Form 10-Q/A for
the quarter ended September 30, 1997 filed with the
Commission on December 12, 1997 (the "September 30, 1997
10-Q/A"))...................................................
10.18 Joint Marketing and Services Agreement dated July 22, 1997
between IXC Internet Services, Inc. and PSINet Inc.
(incorporated by reference to Exhibit 10.20 of the September
30, 1997 10-Q/A)............................................
10.19* Employment Agreement dated as of September 9, 1997 between
Benjamin L. Scott and IXC Communications, Inc. (incorporated
by reference to Exhibit 10.21 of IXC Communication Inc.'s
Amendment No. 1 to Registration Statement on S-4 filed with
the Commission on December 15, 1997 (File No. 333-37157)
("Amendment No. 1 to the EPS S-4")).........................
10.20* IXC Communications, Inc. 1997 Special Executive Stock Plan
(incorporated by reference to Exhibit 10.22 of Amendment No.
1 to the EPS S-4)...........................................
10.21+ First Amendment to Loan and Security Agreement dated as of
December 23, 1997 among IXC Communications, Inc., IXC
Carrier, Inc., NTFC and Export Development Corporation
("EDC").....................................................
89
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
10.22+ Second Amendment to Loan and Security Agreement dated as of
January 21, 1998 among IXC Communications, Inc., IXC
Carrier, Inc., NTFC and EDC.................................
21.1+ Subsidiaries of IXC Communications, Inc.....................
23.1+ Consent of Ernst & Young LLP................................
23.2+ Consent of Arthur Andersen LLP..............................
24.1 Powers of Attorney (included as the signature page of this
Form 10-K)..................................................
27.1+ Financial Data Schedule.....................................
99.1+ Marca-Tel Combining Financial Statements as of December 31,
1997 and 1996 together with Auditors' Report.
- ---------------
* Management contract or executive compensation plan or arrangement required to
be indicated as such and filed as an exhibit pursuant to applicable rules of
the Commission.
+ Filed herewith.