================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 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: 0-11258 ---------------------------------------------------------------- WorldCom, Inc. (Exact name of registrant as specified in its charter) ---------------------------------------------------------------- Georgia 58-1521612 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 515 East Amite Street, Jackson, Mississippi 39201-2702 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (601) 360-8600 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No___ The number of outstanding shares of the registrant's Common Stock, par value $.01 per share, was 892,827,126 on April 30, 1997. ================================================================================
FORM 10-Q Index <TABLE> <CAPTION> Page Number ------ PART I. FINANCIAL INFORMATION <S> <C> <C> Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 1997 and December 31, 1996.................3 Consolidated Statements of Operations for the three months ended March 31, 1997 and March 31, 1996...................................4 Consolidated Statements of Cash Flows for the three months ended March 31, 1997 and March 31, 1996.......................................5 Notes to Consolidated Financial Statements...........6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................9 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................14 Item 2. Changes in Securities................................14 Item 3. Defaults upon Senior Securities......................15 Item 4. Submission of Matters to a Vote of Securities Holders................................15 Item 5. Other Information....................................15 Item 6. Exhibits and Reports on Form 8-K.....................15 Signature .....................................................16 Exhibit Index .....................................................17 </TABLE> Page 2
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands of Dollars, Except Per Share Data) <TABLE> <CAPTION> March 31, December 31, 1997 1996 ----------------- ---------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 68,348 $ 222,729 Marketable securities 57,079 772,510 Accounts receivable, net of allowance for bad debts of $108,831 in 1997 and $110,041 in 1996 1,110,480 999,962 Income taxes receivable 15,526 12,301 Deferred tax asset - 276 Other current assets 379,159 288,314 ----------------- ---------------- Total current assets 1,630,592 2,296,092 ----------------- ---------------- Property and equipment: Transmission equipment 2,584,757 2,371,376 Communications equipment 1,476,023 1,296,723 Furniture, fixtures and other 681,056 614,476 ----------------- ---------------- 4,741,836 4,282,575 Less - accumulated depreciation (481,040) (385,451) ----------------- ---------------- 4,260,796 3,897,124 ----------------- ---------------- Excess of cost over net tangible assets acquired, net of accumulated amortization 12,939,446 12,947,432 Deferred income taxes 465,149 392,634 Other assets 299,286 328,695 ----------------- ---------------- $ 19,595,269 $ 19,861,977 ================= ================ LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 19,191 $ 22,424 Accounts payable 454,841 588,738 Accrued line costs 735,996 649,324 Income taxes payable 1,500 1,481 Current deferred taxes payable 14,958 - Other current liabilities 555,391 648,070 ----------------- ---------------- Total current liabilities 1,781,877 1,910,037 ----------------- ---------------- Long-term liabilities, less current portion: Long-term debt 4,617,431 4,803,581 Other liabilities 174,808 188,383 ----------------- ---------------- Total long-term liabilities 4,792,239 4,991,964 ----------------- ---------------- Commitments and contingencies Shareholders' investment: Series A preferred stock, par value $.01 per share; authorized, issued and outstanding: 94,992 shares in 1997 and 1996 (variable liquidation preference) 1 1 Series B preferred stock, par value $.01 per share; authorized, issued and outstanding: 12,626,908 shares in 1997 and 12,699,948 in 1996 (liquidation preference of $1.00 per share plus unpaid dividends) 127 127 Preferred stock, par value $.01 per share; authorized: 34,905,008 shares in 1997 and 1996 - - Common stock, par value $.01 per share; authorized: 2,500,000,000 shares; issued and outstanding: 891,331,263 shares in 1997 and 885,080,264 shares in 1996 8,913 8,851 Additional paid-in capital 14,883,189 14,855,881 Unrealized holding gain on marketable equity securities 19,585 28,832 Retained earnings (deficit) (1,890,662) (1,933,716) ----------------- ---------------- Total shareholders' investment 13,021,153 12,959,976 ----------------- ---------------- $ 19,595,269 $ 19,861,977 ================= ================ </TABLE> The accompanying notes are an integral part of these statements. Page 3
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data) <TABLE> <CAPTION> For the Three Months Ended March 31, ------------------------------------ 1997 1996 ---------------- ---------------- <S> <C> <C> Revenues $ 1,677,239 $ 1,034,060 ---------------- ---------------- Operating expenses: Line costs 911,469 562,831 Selling, general and administrative 372,347 191,601 Depreciation and amortization 222,903 83,771 ---------------- ---------------- Total 1,506,719 838,203 ---------------- ---------------- Operating income 170,520 195,857 Other income (expense): Interest expense (75,455) (57,048) Miscellaneous 8,401 2,161 ---------------- ---------------- Income before income taxes 103,466 140,970 Provision for income taxes 53,802 54,663 ---------------- ---------------- Net income 49,664 86,307 Preferred dividend requirement 6,610 505 ---------------- ---------------- Net income applicable to common shareholders $ 43,054 $ 85,802 ================ ================ Earnings per common share - Primary $ 0.05 $ 0.22 Fully diluted 0.05 0.21 </TABLE> The accompanying notes are an integral part of these statements. Page 4
WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) <TABLE> <CAPTION> For the Three Months Ended March 31, ------------------------------------ 1997 1996 -------------- -------------- <S> <C> <C> Cash flows from operating activities: Net income $ 49,664 $ 86,307 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 222,903 83,711 Provision for losses on accounts receivable 24,965 13,529 Provision for deferred income taxes 43,845 41,891 Accreted interest on debt 28,757 - Change in assets and liabilities, net of effect of business combinations: Accounts receivable (136,380) (77,529) Income taxes, net 3,848 5,948 Other current assets (35,600) (62,314) Accrued line costs 4,225 23,490 Accounts payable and other current liabilities (34,406) 14,926 Other 1,806 (1,793) -------------- -------------- Net cash provided by operating activities 173,627 128,166 -------------- -------------- Cash flows from investing activities: Capital expenditures (492,769) (110,547) Sale of marketable securities, net 704,095 - Acquisitions and related costs (244,204) (550) Increase in intangible assets (21,570) (23,722) Proceeds from disposition of long-term assets 5,922 4,069 Increase in other assets (64,852) (6,222) Decrease in other liabilities (25,959) (15,193) -------------- -------------- Net cash used in investing activities (139,337) (152,165) -------------- -------------- Cash flows from financing activities: Principal payments on debt (217,654) (12,213) Common stock issuance 35,593 14,746 Dividends paid on preferred stock (6,610) (505) -------------- -------------- Net cash provided by (used in) financing activities (188,671) 2,028 -------------- -------------- Net decrease in cash and cash equivalents (154,381) (21,971) Cash and cash equivalents at beginning of period 222,729 41,679 -------------- -------------- Cash and cash equivalents at end of period $ 68,348 $ 19,708 ============== ============== </TABLE> The accompanying notes are an integral part of these statements. Page 5
WORLDCOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) General - ----------- The financial statements of WorldCom, Inc. (the "Company" or "WorldCom") included herein, are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission ("SEC") regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with the Annual Report of the Company on Form 10-K for the year ended December 31, 1996. The results for the three month period ended March 31, 1997, are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. (B) Business Combinations - ------------------------- On December 31, 1996, WorldCom, through a wholly owned subsidiary, merged with MFS Communications Company, Inc. ("MFS"). MFS provides telecommunications services and systems for business and government customers. MFS is a leading provider of alternative local network access facilities via digital fiber optic cable networks that it has installed in and around approximately 41 United States cities, and in several major European cities. MFS also provides domestic and international long distance telecommunications services via its network platform, which consists of MFS-owned transmission and switching facilities, and network capacity leased from other carriers primarily in the United States and Western Europe. As a result of the merger (the "MFS Merger"), each share of MFS common stock was converted into the right to receive 2.1 shares of WorldCom common stock (the "Common Stock") or approximately 471.0 million WorldCom common shares in the aggregate. Each share of MFS Series A 8% Cumulative Convertible Preferred Stock ("MFS Series A Preferred Stock") was converted into the right to receive one share of Series A 8% Cumulative Convertible Preferred Stock of WorldCom ("WorldCom Series A Preferred Stock") or 94,992 shares of WorldCom Series A Preferred Stock in the aggregate. Each share of MFS Series B Convertible Preferred Stock was converted into the right to receive one share of Series B Convertible Preferred Stock of WorldCom ("WorldCom Series B Preferred Stock") or approximately 12.7 million shares of WorldCom Series B Preferred Stock in the aggregate. In addition, each depositary share representing 1/100th of a share of MFS Series A Preferred Stock was exchanged for a depositary share representing 1/100th of a share of WorldCom Series A Preferred Stock. Upon effectiveness of the MFS Merger, the then outstanding and unexercised options and warrants exercisable for shares of MFS common stock were converted into options and warrants, respectively, exercisable for shares of Common Stock having substantially the same terms and conditions as the MFS options and warrants, except that (i) the exercise price and the number of shares issuable upon exercise were divided and multiplied, respectively, by 2.1 and (ii) the holders of each then outstanding and unexercised MFS "Shareworks Plus Award" granted under the MFS 1993 Stock Plan instead received the cash value of such award in accordance with the terms of such plan. On August 12, 1996, MFS acquired UUNET Technologies, Inc. ("UUNET") through a merger of a subsidiary of MFS with and into UUNET (the "UUNET Acquisition"). UUNET is a leading worldwide provider of a comprehensive range of Internet access options, applications, and consulting services to businesses, professionals and on-line services providers. UUNET provides both dedicated and dial-up Internet access, and other applications and services which include Web server hosting and integration services, client software and security products, training, and network integration and consulting services. The MFS Merger is being accounted for as a purchase for financial reporting purposes. Page 6
The following unaudited pro forma combined results of operations for the Company assume that the MFS Merger and the UUNET Acquisition were completed on January 1, 1996 (in thousands, except per share data): <TABLE> <CAPTION> For the Three Months Ended March 31, 1996 -------------- <S> <C> Revenues $1,243,760 Net loss applicable to common shareholders (81,875) Loss per common share (0.10) </TABLE> These pro forma amounts represent the historical operating results of these acquired entities combined with those of the Company with appropriate adjustments which give effect to amortization and the common shares issued. These pro forma amounts are not necessarily indicative of operating results which would have occurred if MFS and UUNET had been operated by current management during the periods presented because these amounts do not reflect full network optimization and the synergistic effect on operating, selling, general and administrative expenses. (C) Supplemental Disclosure of Cash Flow Information - ---------------------------------------------------- Interest paid by the Company during the three months ended March 31, 1997 and 1996 amounted to $60.5 million and $62.0 million, respectively. Income taxes paid during the three months ended March 31, 1997 and 1996 were $6.9 million and $6.8 million, respectively. In conjunction with business combinations during the three months ended March 31, 1997 and 1996, assumed assets and liabilities were as follows (in thousands): <TABLE> <CAPTION> For the Three Months Ended March 31, ------------------------------- 1997 1996 ------------ ------------ <S> <C> <C> Fair value of assets acquired $ - $ 595 Excess of cost over net tangible assets acquired 55,272 26,237 Liabilities paid (assumed) 188,932 (26,282) Common stock issued - - ------------ ------------ Net cash paid $ 244,204 $ 550 ============ ============ </TABLE> (D) Long-term Debt - ------------------ On April 1, 1997, the Company completed the public offering of $2.0 billion principal amount of debt securities. The net proceeds of the offering ($1.98 billion) were used to pay down commercial bank debt. The following table sets forth the long-term debt of the Company as of March 31, 1997, and as adjusted to give effect to the public offering (in thousands): Page 7
<TABLE> <CAPTION> March 31, 1997 ------------------------------ Actual As adjusted ----------- ------------ <S> <C> <C> Revolving credit agreement $ 3,164,300 $ 1,184,603 7.55% Senior Notes Due 2004 - 600,000 7.75% Senior Notes Due 2007 - 1,100,000 7.75% Senior Notes Due 2027 - 300,000 Senior Discount Notes Due 2004 699,861 699,861 Senior Discount Notes Due 2006 678,660 678,660 Other debt 93,801 93,801 ----------- ------------ $ 4,636,622 $ 4,656,925 Less: Short-term debt and current maturities 19,191 19,191 ----------- ------------ $ 4,617,431 $ 4,637,734 =========== ============ </TABLE> The 7.55% Senior Notes Due 2004 (the "Notes Due 2004"), which will mature on April 1, 2004, the 7.75% Senior Notes Due 2007 (the "Notes Due 2007"), which will mature on April 1, 2007, and the 7.75% Senior Notes Due 2027 (the "Notes Due 2027"), which will mature on April 1, 2027 (collectively, with the Notes Due 2004 and the Notes Due 2007, the "Notes"), bear interest payable semiannually on April 1 and October 1 of each year, commencing October 1, 1997, and limit the incurrence of liens. Each holder of the Notes Due 2027 may require the Company to repurchase all or a portion of the Notes Due 2027 owned by such holder on April 1, 2009 at a purchase price equal to 100% of the principal amount thereof. The Notes Due 2004 and the Notes Due 2007 will be redeemable, as a whole or in part, at the option of the Company, at any time or from time to time, and the Notes Due 2027 will be redeemable, as a whole or in part, at the option of the Company, at any time and from time to time beginning April 2, 2009, at respective redemption prices equal to the greater of (i) 100% of the principal amount of the Notes to be redeemed or (ii) the sum of the present values of the Remaining Scheduled Payments (as defined therein) discounted at the Treasury Rate (as defined therein) plus 15 basis points for the Notes Due 2004 or plus 20 basis points for the Notes Due 2007 and the Notes Due 2027, plus in the case of each of clause (i) and (ii) accrued interest to the date of redemption. (E) Contingencies - ----------------- IDB Related Investigations. On June 9, 1994, the SEC issued a formal order of investigation concerning certain matters, including financial position, books and records and internal controls of IDB Communications Group, Inc. ("IDB"), a company acquired by WorldCom in December 1994, and trading in IDB securities on the basis of non-public information. In April 1997, the SEC Staff advised WorldCom and IDB that the investigation has been terminated and that, at this time, the SEC has determined not to bring an enforcement action against IDB. Other. On February 8, 1996, President Clinton signed the Telecommunications Act of 1996 (the "Telecom Act"), which permits, without limitation, the Bell Operating Companies (the "BOCs") to provide domestic and international long distance services to customers located outside of the BOC's home regions; permits a petitioning BOC to provide domestic and international long distance service to customers within its home region upon a finding by the Federal Communications Commission (the "FCC") that a petitioning BOC has satisfied certain criteria for opening up its local exchange network to competition and that its provision of long distance services would further the public interest; and removes existing barriers to entry into local service markets. Additionally, there are significant changes in: the manner in which carrier-to-carrier arrangements are regulated at the federal and state level; procedures to revise universal service standards; and, penalties for unauthorized switching of customers. The FCC has instituted proceedings addressing the implementation of this legislation. On August 8, 1996 the FCC released its First Report and Order in the Matter of Implementation of the Local Competition Provisions in the Telecom Act (the "FCC Interconnect Order"). In the FCC Interconnect Order, the FCC established nationwide rules designed to encourage new entrants to participate in the local service markets through interconnection with the incumbent local exchange carriers ("ILEC"), resale of the ILEC's retail services and unbundled network elements. These Page 8
rules set the groundwork for the statutory criteria governing BOC entry into the long distance market. The Company cannot predict the effect such legislation or the implementing regulations will have on the Company or the industry. Motions to stay implementation of the FCC Interconnect Order have been filed with the FCC and federal courts of appeal. Appeals challenging, among other things, the validity of the FCC Interconnect Order have been filed in several federal courts of appeal and assigned to the Eighth Circuit Court of Appeals for disposition. The Eighth Circuit Court of Appeals has stayed the pricing provisions of the FCC Interconnect Order. The Circuit Justice of the Supreme Court has declined to review the propriety of the stay. The Company cannot predict either the outcome of these challenges and appeals or the eventual effect on its business or the industry in general. On December 24, 1996, the FCC released a Notice of Proposed Rulemaking ("NPRM") seeking to reform the FCC's current access charge policies and practices to comport with a competitive or potentially competitive local access service market. On May 7, 1997, the FCC announced that it will issue a series of orders that reform Universal Service Subsidy allocations, adopt various reforms to the existing rate structure for interstate access that are designed to reduce access charges, over time, to more economically efficient levels and rate structures. In particular, the Commission adopted changes to its rate structures for Common Line, Local Switching and Local Transport rate elements. The Commission generally removed from minute-of-use access charges costs that are not incurred on a per-minute-of-use basis, with such costs being recovered through flat rated charges. Additional charges and details of the FCC's actions are to be addressed when Orders are released within the near future. Access charges are a principal component of the Company's line cost expense. The Company cannot predict whether or not the result of this proceeding will have a material impact upon its financial position or results of operations. In the NPRM, the FCC tentatively concluded that information services providers (including among others Internet service providers) should not be subject to existing interstate access charges. However, the FCC recognized that these services and recent technological advances may be constrained by current regulatory practices that have their foundations in traditional services and technologies. The FCC issued on December 24, 1996, a Notice of Inquiry to seek comment on whether it should, in addition to access charge reform, consider actions relating to interstate information services and the Internet. Changes in the regulatory environment relating to the telecommunications or Internet-related services industry could have an adverse effect on the Company's Internet-related services business. The Telecom Act may permit telecommunications companies, BOCs or others to increase the scope or reduce the cost of their Internet access services. The Company cannot predict the effect that the Notice of Inquiry, the Telecom Act or any future legislation, regulation or regulatory changes may have on its business. The Company is involved in other legal and regulatory proceedings generally incidental to its business. In some instances, rulings by regulatory authorities in some states may result in increased operating costs to the Company. While the results of these various legal and regulatory matters contain an element of uncertainty, the Company believes that the probable outcome of any of the legal or regulatory matters, or all of them combined, should not have a material adverse effect on the Company's consolidated financial position or results of operations. ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q may be deemed to include forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risk and uncertainty, including financial, regulatory environment and trend projections. Although the Company believes that its expectations are based on reasonable assumptions, it can give no assurance that its expectations will be achieved. The important factors that could cause actual results to differ materially from those in the forward looking statements herein include, without limitation, the Company's high degree of financial leverage, risks associated with debt service requirements and interest rate fluctuations, risks associated with acquisitions and the integration thereof, risks of international business, dependence on availability of transmission facilities, regulation risks including the impact of the Telecom Act, contingent liabilities, and the impact of competitive services and pricing, as well as other risks referenced from time to time in the Company's filings with the SEC. The following discussion and analysis relates to the financial condition and results of operations of the Company for the three months ended March 31, 1997 and 1996, and should be read in conjunction with the consolidated financial statements and notes thereto. Page 9
GENERAL The Company is one of the four largest long distance telecommunications companies in the United States, serving customers domestically and internationally. The Company's operations have grown significantly in each year of its operations as a result of the MFS Merger as well as internal growth, the selective acquisition of smaller long distance companies with limited geographic service areas and market shares, the consolidation of certain third tier long distance carriers with larger market shares, and international expansion. As a result of the MFS Merger on December 31, 1996, each share of MFS common stock was converted into the right to receive 2.1 shares of WorldCom Common Stock or approximately 471.0 million WorldCom common shares in the aggregate. Each share of MFS Series A Preferred Stock was converted into the right to receive one share of WorldCom Series A Preferred Stock or 94,992 shares in the aggregate. Each share of MFS Series B Convertible Preferred Stock was converted into the right to receive one share of WorldCom Series B Convertible Preferred Stock or approximately 12.7 million shares in the aggregate. In addition, each depositary share representing 1/100th of a share of MFS Series A Preferred Stock was exchanged for a depositary share representing 1/100th of a share of WorldCom Series A Preferred Stock. Upon effectiveness of the MFS Merger, the then outstanding and unexercised options and warrants exercisable for shares of MFS common stock were converted into options and warrants, respectively, exercisable for shares of Common Stock having substantially the same terms and conditions as the MFS options and warrants, except that (i) the exercise price and the number of shares issuable upon exercise were divided and multiplied, respectively, by 2.1 and (ii) the holders of each then outstanding and unexercised MFS "Shareworks Plus Award" granted under the MFS 1993 Stock Plan instead received the cash value of such option in accordance with the terms of such plan. MFS provides telecommunications services and systems for business and government customers. MFS is a leading provider of alternative local network access facilities via digital fiber optic cable networks that it has installed in and around approximately 41 United States cities, and in several major European cities. MFS also provides domestic and international long distance telecommunications services via its network platform, which consists of MFS-owned transmission and switching facilities, and network capacity leased from other carriers primarily in the United States and Western Europe. The MFS Merger is being accounted for as a purchase; accordingly, the operating results of MFS are reflected in the Company's results of operations from the acquisition date. On August 12, 1996, MFS completed the UUNET Acquisition. UUNET is a leading worldwide provider of a comprehensive range of Internet access options, applications, and consulting services to businesses, professionals and on-line services providers. UUNET provides both dedicated and dial-up Internet access, and other applications and services which include Web server hosting and integration services, client software and security products, training, and network integration and consulting services. The MFS Merger has allowed the Company to take advantage of the congressional intent behind the Telecom Act and the FCC Interconnect Order by bringing together the leading growth companies from four key telecom industry segments: long distance, local, Internet and international. The Company believes that the MFS Merger enhances the combined entity's opportunities for future growth, creates a stronger competitor in the changing telecommunications industry, allows provision of end-to-end bundled services over a global network, and provides the opportunity for significant cost savings for the combined organization. The most significant portion of the Company's line costs is access charges which are highly regulated. The FCC has announced that it will revise its rules regarding access charges in a manner that will, over time, revamp the access rate element structure and, over the near term, reduce the overall access revenues collected by the incumbent local exchange carriers. The FCC's rate element restructuring is intended to align costs with the manner in which they are incurred by the incumbent local exchange carriers. As a result the current usage based system will be replaced with a system composed of flat rate charges and usage based charges. The FCC has also announced that subsidy systems for local telephone services and services to schools, libraries, and hospitals will be implemented. A portion of those subsidies are funded by access charges today. Accordingly, access charges will be reduced by an amount to be transferred to the subsidy systems. The subsidy systems will result in additional charges being placed on all carriers, which charges may be directly recovered from the end users. The Company cannot predict what effect continued regulation and increased competition between LECs and other IXCs will have on future access charges. However, the Company believes that it will be able to continue to reduce transport costs through effective utilization of its network, favorable contracts with carriers and network efficiencies made possible as a result of expansion of the Company's customer base by acquisitions and internal growth. Page 10
RESULTS OF OPERATIONS The following table sets forth for the periods indicated the Company's statement of operations as a percentage of its operating revenues. <TABLE> <CAPTION> For the Three Months Ended March 31, ------------------------------------ Actual Actual Pro Forma 1997 1996 1996 ---- ---- ---- <S> <C> <C> <C> Revenues 100.0% 100.0% 100.0% ----- ----- ----- Operating expenses: Line costs 54.3% 54.4% 54.1% Selling, general and administrative 22.2% 18.5% 24.9% Depreciation and amortization 13.3% 8.1% 16.6% ----- ----- ----- Operating income 10.2% 18.9% 4.4% Other income (expense): Interest expense -4.5% -5.5% -6.5% Miscellaneous 0.5% 0.2% 0.6% ----- ----- ----- Income (loss) before income taxes 6.2% 13.6% -1.6% Income tax expense 3.2% 5.3% 4.4% ----- ----- ----- Net income (loss) 3.0% 8.3% -6.0% Preferred dividend requirement 0.4% 0.0% 0.6% ----- ----- ----- Net income (loss) applicable to common shareholders 2.6% 8.3% -6.6% ===== ===== ===== </TABLE> Revenues for the three months ended March 31, 1997 increased 62.2% to $1.68 billion on 8.52 billion revenue minutes as compared to $1.03 billion on 5.61 billion revenue minutes for the three months ended March 31, 1997. The increase in total revenues and minutes is primarily attributable to the MFS Merger and internal growth of the Company. On a pro forma basis, as though the MFS Merger and the UUNET Acquisition occurred at the beginning of 1996, both revenues and traffic for the first quarter of 1997 increased 35%, compared with pro forma revenues of $1.24 billion on 6.31 billion revenue minutes for the first quarter of 1996. The pro forma revenue increase for the first quarter reflect the following increases by category (dollars in millions): <TABLE> <CAPTION> Three Months Ended March 31, --------------------------------------- Actual Pro forma 1997 1996 Change --------- ---------- ------ <S> <C> <C> <C> Revenues Domestic switched $ 951.9 $ 774.0 23% Domestic private line 352.7 263.3 34% International 163.8 86.9 89% Internet 111.2 39.0 185% ------- ------- --- Core revenues $1,579.6 $1,163.2 36% Other revenues 97.6 80.6 21% ------- ------- --- Total revenues $1,677.2 $1,243.8 35% ======= ======= === </TABLE> Domestic switched services revenue for the first quarter experienced a 23 percent pro forma year-over-year increase driven by a gain of 31 percent in traffic. This increase was due primarily to strong volume gains and more stable pricing in the business market. Carrier traffic growth, year-over-year, was particularly strong. Page 11
Domestic private line revenues for the first quarter experienced a 34 percent pro forma year-over-year increase due primarily to increased demand for higher capacity circuits for corporate Intranet and other Internet related services. International revenues -- those revenues originating outside of the United States -- for the first quarter of 1997 were $164 million, an increase of 89 percent, as compared with $87 million for the pro forma prior year first quarter. This performance is due to continuing strong traffic growth in the United Kingdom and a growing presence in Continental Europe. Internet revenues for the first quarter were $111 million, up 185 percent over the pro forma prior year first quarter of $39 million. Other revenues for the first quarter were $98 million, up 21 percent, as compared with $81 million for the comparable pro forma period in the prior year. Other revenues include MFS Network Technologies, operator services, broadcast operations and other equipment and software sales. Line costs as a percentage of revenues for the first quarter of 1997 were 54.3% as compared to 54.4% reported for the same period in the prior year and 54.1% pro forma for the first quarter of 1996. These changes in line costs as a percentage of revenues are attributable to changes in the product mix and are offset by synergies and economies of scale resulting from network efficiencies achieved from the assimilation of the MFS Merger into the Company's operations. Selling, general and administrative expenses for the first quarter of 1997 increased to $372.3 million or 22.2% of revenues as compared to $191.6 million or 18.5% of revenues as reported for the first quarter of 1996. The increase in selling, general and administrative expenses as a percentage of revenues on a reported basis results from the Company's expanding operations, primarily through the MFS Merger. The decrease in selling, general and administrative expenses as compared to the 1996 pro forma percentage of revenues results from the assimilation of the MFS Merger into the Company's strategy of cost control. Depreciation and amortization expense for the first quarter of 1997 increased to $222.9 million or 13.3% of revenues from $83.8 million or 8.1% of revenues for the first quarter of 1996. This increase reflects increased amortization associated with the MFS Merger. Interest expense in the first quarter of 1997 was $75.5 million or 4.5% of revenues, as compared to $57.0 million or 5.5% of revenues reported in the first quarter of 1996. The increase in interest expense is attributable to higher debt levels as the result of additional debt acquired with the MFS Merger offset by lower interest rates in effect on the Company's long-term debt. For the first quarter ended March 31, 1997, net income, taking into account the increased amortization for intangibles of $84 million related to the MFS Merger, was $49.7 million, or $0.05 per common share, compared with net income of $86.3 million, or $0.21 per common share as reported for the first quarter of 1996. On a pro forma basis, loss per share was $0.10 per common share for the first quarter of 1996. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 1997, the Company's total debt was $4.64 billion, down $189.4 million from December 31, 1996 as a result of the application of available cash and marketable securities against such debt. Additionally, on April 1, 1997, the Company completed the public offering of $2.0 billion principal amount of debt securities. The proceeds from the offering ($1.98 billion) were used to pay down the Company's $3.75 billion revolving credit facility (the "Credit Facility"). As of April 1, 1997, the Company had access to an additional $2.7 billion under its Credit Facility and from available cash and marketable securities. The Credit Facility has a five-year term and bears interest, payable in varying periods, depending on the interest periods, not to exceed six months, at rates selected by the Company under the terms of the Credit Facility including a Base Rate or LIBOR, plus applicable margin. The applicable margin for a LIBOR rate borrowing varies from 0.35% to 0.875% based upon a specified financial test. The Credit Facility is unsecured and requires compliance with certain financial and other Page 12
operating covenants which limit, among other things, the incurrence of additional indebtedness by WorldCom and restricts the payment of cash dividends to WorldCom's shareholders. The Credit Facility is also subject to an annual commitment fee not to exceed 0.25% of any unborrowed portion of the Credit Facility. Borrowings under the Credit Facility bear interest at rates that fluctuate with prevailing short-term interest rates. Under the provisions of the Credit Facility, the Company is required to hedge 25% of its debt against adverse interest movements in short-term rates. The Company complied with this hedging requirement prior to April 1, 1997 with interest rate hedging instruments and subsequent to April 1, 1997, with fixed rate debt issued in the $2.0 billion public offering of debt securities. The public offering on April 1, 1997 included $600 million principal amount of 7.55% Senior Notes due 2004, $1.1 billion principal amount of 7.75% Senior Notes due 2007 and $300 million principal amount of Senior Notes due 2027. The Notes bear interest payable semiannually on April 1 and October 1 of each year, commencing October 1, 1997, and limit the incurrence of lines. Each holder of the Notes Due 2027 may require the Company to repurchase all or a portion of the Notes Due 2027 owned by such holder on April 1, 2009 at a purchase price equal to 100% of the principal amount thereof. The Notes Due 2004 and the Notes Due 2007 will be redeemable, as a whole or in part, at the option of the Company, at any time or from time to time, and the Notes Due 2027 will be redeemable, as a whole or in part, at the option of the Company, at any time and from time to time beginning April 2, 2009, at respective redemption prices equal to the greater of (i) 100% of the principal amount of the Notes to be redeemed or (ii) the sum of the present values of the Remaining Scheduled Payments (as defined therein) discounted at the Treasury Rate (as defined therein) plus 15 basis points for the Notes Due 2004 or plus 20 basis points for the Notes Due 2007 and the Notes Due 2027, plus in the case of each of clause (i) and (ii) accrued interest to the date of redemption. The Company has historically utilized cash flow from operations to finance capital expenditures and a mixture of cash flow, debt and stock to finance acquisitions. The Company expects to experience increased capital intensity due to network expansions and believes that funding needs in excess of internally generated cash flow will be met by utilization of the Company's Credit Facility. In connection with the MFS Merger and pursuant to a change of control provision, WorldCom offered to repurchase the MFS $924.0 million 8 7/8% Senior Discount Notes due 2006 and the MFS $788.3 million 9 3/8% Senior Discount Notes due 2004 (collectively the "MFS Notes") at 101% of the accreted value as of February 27, 1997, which was $670.0 million and $666.1 million, respectively. The offer to repurchase began January 28, 1997 and ended February 27, 1997. As of the expiration approximately $14.3 million of the MFS Notes were repurchased. The MFS Notes contain certain covenants which, among other things, restrict MFS' ability to incur additional debt, create liens, enter into sale-leaseback transactions, pay dividends, make certain restricted payments, enter into transactions with affiliates and sell assets or merge with another company. For the three months ended March 31, 1997, the Company's cash flow from operations was $173.6 million, increasing from $128.2 million in the comparable period for 1996. The increase in cash flow from operations was primarily attributable to internal growth. In the first quarter of 1997, the Company's existing receivables purchase agreement generated additional proceeds of $7.5 million, bringing the total amount outstanding to $382.5 million. The Company used these proceeds to reduce outstanding debt under the Company's Credit Facility. As of March 31, 1997, the purchaser owned an undivided interest in a $849.1 million pool of receivables which includes the $382.5 million sold. Cash used in investing activities in the three months ended March 31, 1997 totaled $139.3 million. The sale of marketable securities provided $704.1 million of cash flow but was used to cover capital expenditures of $492.8 million and acquisition and related costs of $244.2 million primarily from the MFS Merger. Cash used in investing activities included $369.8 million for normal capital expenditures and an additional $123.0 million for additional city pair network construction. Primary capital expenditures include purchases of switching, transmission, communication and other equipment. Approximately $2.5 billion is currently anticipated for transmission and communications equipment purchases in 1997 without regard to possible Page 13
future acquisitions, if any. This amount includes additional city pair network construction opportunities which could approximate $500 million to $700 million. Included in cash flows from financing activities are payments of $6.6 million for preferred dividend requirements. The Company has never paid cash dividends on its Common Stock. WorldCom's Credit Facility restricts the payment of cash dividends on WorldCom capital stock without prior consent of the lenders. The Depositary Shares are entitled to receive dividends, when, as, and if they are declared by the Board of Directors, accruing at the rate of $2.68 per share per annum, payable quarterly in arrears on each February 28, May 31, August 31 and November 30. Dividends are payable in cash or in shares of Common Stock, at the election of the Company. The Company paid the initial dividend on February 28, 1997 in cash and expects to continue to pay cash dividends on the WorldCom Series A Preferred Stock. Dividends on the WorldCom Series B Preferred Stock accrue at the rate per share of $0.0775 per annum and are payable in cash. Dividends will be paid only when, as and if declared by the Board of Directors of the Company. The Company anticipates that dividends on the WorldCom Series B Preferred Stock will not be declared but will continue to accrue. Upon conversion, accrued but unpaid dividends are payable in cash or shares of Common Stock at the Company's election. Absent significant capital requirements for other acquisitions, the Company believes that cash flow from operations and funds available under the Credit Facility will be adequate to meet the Company's capital needs for the remainder of 1997. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." This Statement establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. The Statement provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The adoption of this standard did not have a material adverse effect on the Company's consolidated results of operations or financial position. In February 1997, the FASB issued SFAS 128 "Earnings Per Share." This Statement establishes standards for computing and presenting earnings per share ("EPS") and applies to entities with publicly held common stock or potential common stock. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. This Statement is effective for financial statements issued for periods ending after December 15, 1997. WorldCom believes that the adoption of this standard will not have a material effect on the Company's consolidated results of operations or financial position. In February 1997, the FASB issued SFAS 129 "Disclosure of Information About Capital Structure." This Statement establishes standards for disclosing information about an entity's capital structure and applies to all entities. This Statement is effective for financial statements for periods ending after December 15, 1997. WorldCom believes that the adoption of this standard will not have a material effect on the Company's consolidated results of operations or financial position. PART II. OTHER INFORMATION Item 1. Legal Proceedings. There have been no material changes in the legal proceedings reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1996, filed on March 18, 1997 except as may be reflected in the discussion under Note E of the Notes to Consolidated Financial Statements in Part I, Item 1, above. Item 2. Changes in Securities. None Page 14
Item 3. Defaults upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. A. Exhibits See Exhibit Index B. Reports on Form 8-K (i) Current Report on Form 8-K dated December 31, 1996 (filed January 15, 1997), reporting under Item 2, Acquisition or Disposition of Assets, and Item 7, Financial Statements and exhibits, information related to the completion of the MFS Merger. (ii) Current Report on Form 8-K dated March 18, 1997 (filed March 24, 1997) reporting under Item 5, Other Events, information related to the Company's announcement of its proposal to issued Senior Notes in a partial drawdown of its previously announced shelf registration statement. (iii) Current Report on Form 8-K dated March 26, 1997 (filed April 2, 1997) reporting under Item 7(c) Financial Statements and Exhibits, certain exhibits as required in accordance with Item 601 of Regulation S-K regarding the issuance of $2.0 billion in Senior Notes. Page 15
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q to be signed on its behalf by Scott D. Sullivan, thereunto duly authorized to sign on behalf of the registrant and as the principal financial officer thereof. WorldCom, Inc. By: /s/ Scott D. Sullivan -------------------------------- Scott D. Sullivan Chief Financial Officer Dated: May 15, 1997 Page 16
EXHIBIT INDEX Exhibit No. Description - --- ----------- 1.1 Form of Underwriting Agreement Standard Provisions for Debt Securities, with form of Terms Agreement (incorporated herein by reference to Exhibit 1.1 to the Current Report on Form 8-K dated March 26, 1997) 1.2 Terms Agreement dated March 26, 1997, by and among WorldCom, Inc. and Salomon Brothers Inc, Goldman, Sachs & Co., Credit Suisse First Boston and NationsBanc Capital Markets, Inc. (incorporated herein by reference to Exhibit 1.2 to the Current Report on Form 8-K dated March 26, 1997) 4.1 Second Amended and Restated Articles of Incorporation of WorldCom, Inc. (including preferred stock designations) as of December 31, 1996 (incorporated herein by reference to Exhibit 3.1 to the Current Report on Form 8-K dated December 31, 1996) 4.2 Restated Bylaws of WorldCom, Inc. (incorporated by reference to Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 4.3 Form of 7.55% Senior Note due 2004 (incorporated herein by reference to Exhibit 4.1 to the Current Report on Form 8-K dated March 26, 1997) 4.4 Form of 7.75% Senior Note due 2007 (incorporated herein by reference to Exhibit 4.2 to the Current Report on Form 8-K dated March 26, 1997) 4.5 Form of 7.75% Senior Note due 2027 (incorporated herein by reference to Exhibit 4.3 to the Current Report on Form 8-K dated March 26, 1997) 4.6 Senior Indenture dated March 1, 1997 by and between WorldCom, Inc. and Mellon Bank, N.A., as trustee 11.1 Computation of per share earnings 27.1 Financial Data Schedule Page 17