<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
---------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 000-22609
-----------------
QWEST COMMUNICATIONS INTERNATIONAL INC.
(EXACT NAME OF REGISTRANT SPECIFIED IN ITS CHARTER)
-----------------
DELAWARE 84-1339282
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
555 SEVENTEENTH STREET, SUITE 1000
DENVER, COLORADO 80202
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(303) 291-1400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 [ ] No [X]
The number of shares of Common Stock, $.01 par value, outstanding (the only
class of common stock of the Company outstanding) was 103,320,766, as of July
31, 1997.
This quarterly report on Form 10-Q contains 35 pages, of which this is page 1.
<PAGE>
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QWEST COMMUNICATIONS INTERNATIONAL INC.
QUARTER ENDED JUNE 30, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C>
Item 1. Consolidated Balance Sheets of Qwest Communications
International Inc. and Subsidiaries as of June 30, 1997
(Unaudited) and December 31, 1996............................... 3
Consolidated Statements of Operations of Qwest Communications
International Inc. and Subsidiaries for the Periods Ended
June 30, 1997 and 1996 (Unaudited).............................. 5
Consolidated Statement of Stockholders' Equity of Qwest
Communications International Inc. and Subsidiaries for the Six
Months Ended June 30, 1997 (Unaudited).......................... 6
Consolidated Statements of Cash Flows of Qwest Communications
International Inc. and Subsidiaries for the Six Months Ended
June 30, 1997 and 1996 (Unaudited).............................. 7
Notes to Consolidated Financial Statements of Qwest
Communications International Inc. and Subsidiaries (Information
as of June 30, 1997 and 1996 and for the Three and Six Months
Ended June 30, 1997 and 1996 Is Unaudited)...................... 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations for the Three and Six Months Ended
June 30, 1997 and 1996.......................................... 19
Item 3. Quantitative and Qualitative Disclosures About Market Risks... 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 32
Item 2. Changes in Securities......................................... 32
Item 3. Defaults Upon Senior Securities............................... 32
Item 4. Submission of Matters to a Vote of Security Holders........... 32
Item 5. Other Information............................................. 32
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE.................................................................... 33
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1.
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1997 AND DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
- --------------------------------------------------------------------------------
1997 1996
----------- -----------
(unaudited)
ASSETS
- ------
Current Assets:
Cash and cash equivalents $ 314,367 $ 6,905
Accounts receivable, net 34,923 29,248
Costs and estimated earnings in
excess of billings 80,247 4,989
Deferred income tax asset -- 6,301
Notes and other receivables 14,958 14,934
Other current assets 5,264 328
----------- -----------
Total current assets 449,759 62,705
Property and equipment, net 312,293 186,535
Deferred income tax asset 10,761 --
Notes and other receivables 121 11,052
Intangible and other long-term assets, net 17,157 3,967
----------- -----------
Total assets $ 790,091 $ 264,259
=========== ===========
3
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
JUNE 30, 1997 AND DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
- --------------------------------------------------------------------------------
1997 1996
----------- -----------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 135,473 $ 80,129
Deferred revenue 2,946 2,649
Billings in excess of costs and
estimated earnings 187 5,034
Deferred income tax liability 1,315 --
Current portion of long-term debt 15,824 25,193
Advances from parent -- 19,138
----------- ----------
Total current liabilities 155,745 132,143
Long-term debt 250,988 109,268
Deferred income tax liability -- 1,708
Other liabilities 62,095 11,698
----------- ----------
Total liabilities 468,828 254,817
----------- ----------
Stockholders' equity:
Preferred Stock, $.01 par value.
Authorized 25,000,000 shares. No
shares issued and outstanding. -- --
Common Stock, $.01 par value.
Authorized 400,000,000 shares.
102,025,000 shares and 86,500,000
shares issued and outstanding at
June 30, 1997 and December 31, 1996,
respectively. 1,020 865
Additional paid-in capital 377,081 55,027
Accumulated deficit (56,838) (46,450)
----------- ----------
Total stockholders' equity 321,263 9,442
----------- ----------
Commitments and contingencies
Total liabilities and
stockholders' equity $ 790,091 $ 264,259
=========== ==========
See accompanying notes to consolidated financial statements.
4
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIODS ENDED JUNE 30, 1997 AND JUNE 30, 1996
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
- --------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
-------- -------- -------- --------
1997 1996 1997 1996
-------- -------- -------- --------
Revenue:
Carrier services $ 13,765 $ 17,366 $ 24,964 $ 35,859
Commercial services 10,261 9,299 19,672 16,312
-------- -------- -------- --------
24,026 26,665 44,636 52,171
Network construction services 204,647 24,206 256,730 33,332
-------- -------- -------- --------
228,673 50,871 301,366 85,503
-------- -------- -------- --------
Operating expenses:
Telecommunications services 20,830 24,139 38,893 48,001
Network construction services 140,047 15,097 176,312 21,944
Selling, general and administrative 18,724 10,047 32,671 24,574
Growth share plan 52,089 -- 65,189 --
Depreciation and amortization 4,081 3,850 8,043 7,899
-------- -------- -------- --------
235,771 53,133 321,108 102,418
Loss from operations (7,098) (2,262) (19,742) (16,915)
Other (expense) income:
Gain on sale of contract rights 1,586 -- 9,296 --
Interest expense, net (3,743) (1,709) (4,727) (3,060)
Interest income 1,306 401 1,986 1,170
Other (expense) income, net (5) 34 (2,001) (20)
-------- -------- -------- --------
Loss before income tax
benefit (7,954) (3,536) (15,188) (18,825)
Income tax benefit 2,342 1,160 4,800 6,470
-------- -------- -------- --------
Net loss $ (5,612) $ (2,376) $(10,388) $(12,355)
======== ======== ======== ========
Net loss per share $ (0.06) $ (0.03) $ (0.12) $ (0.14)
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
5
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1997
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
Common Stock
---------------------- Additional Total
Number of paid-in Accumulated stockholders'
shares Amount capital deficit equity
----------- ------ -------- -------- ----------
<S> <C> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1996 86,500,000 $ 865 $ 55,027 $(46,450) $ 9,442
Issuance of common stock, net 15,525,000 155 319,754 - 319,909
Issuance of common stock warrants - - 2,300 - 2,300
Net loss - - - (10,388) (10,388)
----------- ------ -------- -------- ----------
BALANCES, JUNE 30, 1997 (UNAUDITED) 102,025,000 $1,020 $377,081 $(56,838) $ 321,263
=========== ====== ======== ======== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND JUNE 30, 1996
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
1997 1996
---------- ---------
Cash flows from operating activities:
Net loss $ (10,388) $ (12,355)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Gain on sale of contract rights (9,296) --
Depreciation and amortization 8,043 7,899
Deferred income tax (benefit) expense (4,853) 2,236
Changes in operating assets and liabilities:
Receivables - accounts and notes, net 5,232 (43)
Costs and estimated earnings in excess
of billings (75,258) (8,449)
Accounts payable and accrued expenses 55,327 (2,281)
Payable to related parties, net -- (337)
Billings in excess of costs and
estimated earnings (4,847) 5,307
Accrued growth share plan expense and
deferred compensation 29,362 --
Other changes 7,573 (229)
---------- ---------
Net cash provided by (used in)
operating activities 895 (8,252)
---------- ---------
Cash flows from investing activities:
Proceeds from sale of contract rights 9,000 --
Expenditures for property and equipment (129,355) (25,383)
---------- ---------
Net cash used in investing activities (120,355) (25,383)
---------- ---------
7
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND JUNE 30, 1996
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
- --------------------------------------------------------------------------------
1997 1996
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 319,909 --
Proceeds from issuance of common stock warrants 2,300 --
Borrowings of long-term debt 298,000 25,500
Repayments of long-term debt (165,649) (11,904)
Debt issuance costs (8,500) (343)
Net (payments to) advances from Parent (19,138) 19,577
--------- ---------
Net cash provided by financing activities 426,922 32,830
--------- ---------
Net increase (decrease) in cash and cash
equivalents 307,462 (805)
Cash and cash equivalents, beginning of period 6,905 1,484
--------- ---------
Cash and cash equivalents, end of period $ 314,367 $ 679
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest, net $ 2,334 $ 2,758
========= =========
Cash paid for taxes, other than Parent $ 132 $ 129
========= =========
Supplemental disclosure of significant
non-cash investing and financing activities:
Capital lease obligation $ -- $ 664
========= =========
Accrued capital expenditures $ 4,465 $ --
========= =========
See accompanying notes to consolidated financial statements.
8
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997 AND DECEMBER 31, 1996
(INFORMATION AS OF JUNE 30, 1997, AND FOR THE THREE
AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996 IS UNAUDITED)
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) GENERAL AND BUSINESS
Qwest Communications International Inc. (the Company) was wholly-owned
by Anschutz Company (the Parent) until June 27, 1997, when the Company
issued common stock in an initial public offering (as described in note
(12) - Securities Offering). Subsequent to the initial public offering,
the Parent owns approximately 84.8% of the outstanding common stock of
the Company. The Company is the ultimate holding company for the
operations of Qwest Communications Corporation and subsidiaries
(Qwest).
The accompanying unaudited interim consolidated financial statements
include the accounts of the Company and all majority-owned
subsidiaries. Intercompany balances and transactions have been
eliminated in consolidation.
(B) LOSS PER SHARE
The loss per share for the three and six months ended June 30, 1997 and
1996 was computed by dividing net loss by the weighted average number
of common shares outstanding during such periods. Common stock
equivalent shares from options, warrants and common stock issuable for
Growth Shares (as described in note (11) - Growth Share Plan) are
excluded from the computation as their effect is antidilutive, except
that, pursuant to Securities and Exchange Commission Staff Accounting
Bulletin Number 83, Earnings per share Computations in an Initial
Public Offering, 1,658,000 common shares issuable for Growth Shares
granted during the 12-month period prior to the Company's initial
public offering at prices below the anticipated public offering price
were included in the calculation as if they were outstanding for all
periods presented, up to the close of the initial public offering.
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128).
SFAS 128 requires the presentation of basic earnings per share (EPS)
and, for companies with potentially dilutive securities, such as
convertible debt, options and warrants, diluted EPS. SFAS
9
<PAGE>
128 is effective for annual and interim periods ending after December
15, 1997. The Company does not believe that the adoption of SFAS 128
will significantly affect the calculation of the Company's net loss per
common share.
(C) MANAGEMENT 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 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.
The accompanying interim consolidated financial statements as of June
30, 1997, and for the three and six months ended June 30, 1997 and 1996
are unaudited but, in the opinion of management, reflect all
adjustments (consisting of normal recurring accruals) necessary for a
fair presentation of the results of such periods. The results of
operations for any interim period are not necessarily indicative of
results for the full year. Such financial statements should be read in
conjunction with the audited consolidated balance sheets of the Company
as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholder's equity and cash flows for each
of the years in the three-year period ended December 31, 1996, included
in the registration statement (no. 333-25391) on Form S-1 filed by the
Company (as described in note (12) - Securities Offering). The
information contained in these unaudited interim consolidated financial
statements as of December 31, 1996 has been derived from those
statements.
(D) INCOME TAXES
The Company is included in the consolidated income tax return of the
Parent, and a tax-sharing agreement provides for allocation of tax
liabilities and benefits to the Company, in general, as though it filed
a separate return.
(2) RELOCATION AND RESTRUCTURING
Relocation and restructuring costs of approximately $1.6 million were
recognized in the first quarter of 1996 and relate primarily to costs
incurred in connection with the restructuring of the direct sales group.
Such costs were substantially paid in 1996 and are included in selling,
general and administrative expenses.
(3) GAIN ON SALE OF CONTRACT RIGHTS
On March 10, 1997, the Company entered into an agreement (the Termination
Agreement) with an unrelated third party (the Purchaser) to terminate
certain equipment purchase and telecommunications capacity rights and
options of the Company exercisable against the Purchaser for $9.0 million
(the Termination Agreement Consideration). In the first quarter of 1997, the
Company received $7.0 million of the Termination Agreement Consideration
10
<PAGE>
in cash. During the second quarter of 1997, the Company received the
remaining $2.0 million consideration upon delivery of certain
telecommunications capacity to the Purchaser.
(4) GAIN ON SALE OF TELECOMMUNICATIONS SERVICE AGREEMENTS
On July 1, 1996, the Company sold its right, title and interest in certain
telecommunications service agreements to an unrelated third party (the
Buyer) for $5.5 million. During the transition of service agreements to the
Buyer, the Company has incurred certain facilities costs on behalf of the
Buyer, which are reimbursable to the Company. As of June 30, 1997 and
December 31, 1996, net amounts of approximately $5.9 million and $2.0
million, respectively, were due to the Company for such costs. On March 31,
1997, the arrangement relating to transition services expired and has not
yet been renegotiated. A dispute has arisen with respect to reimbursement of
these costs and, as a result, the Company has made a provision of $2.0
million in the three months ended March 31, 1997. Negotiations with the
Buyer are continuing, and subsequent to June 30, 1997, the Company has
received a cash payment of approximately $3.2 million, which has been
applied to reduce the then outstanding receivable balance. The Company
believes that the receivable balance as of June 30, 1997 is collectible.
11
<PAGE>
(5) NETWORK CONSTRUCTION SERVICES REVENUE AND EXPENSES
Costs and billings on uncompleted contracts included in the accompanying
consolidated financial statements are as follows (in thousands):
June 30, December 31,
1997 1996
----------- ------------
(unaudited)
Costs incurred on uncompleted contracts $253,737 $ 82,840
Estimated earnings 134,413 48,853
-------- --------
388,150 131,693
Less: billings to date 308,090 131,738
-------- --------
$ 80,060 $ (45)
======== ========
Included in the accompanying balance sheets
under the following captions:
Costs and estimated earnings in excess
of billings $ 80,247 $ 4,989
Billings in excess of costs and
estimated earnings (187) (5,034)
-------- --------
$ 80,060 $ (45)
======== ========
Revenue the Company expects to realize for
work to be performed on the above
uncompleted contracts $623,638 $328,688
======== ========
The Company entered into agreements with unrelated third parties whereby the
Company will provide indefeasible rights of use (IRUs) in multiple fibers along
a 13,000 route-mile coast-to-coast fiber optic telecommunications network (the
Network) that the Company began constructing in 1996, for a purchase price
of approximately $985.0 million. Earnings relating to these contracts are
estimated using allocations of the total cost of constructing the Network (as
described in note (10) - Commitments and Contingencies).
12
<PAGE>
(6) PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
----------- -----------
(unaudited)
<S> <C> <C>
Land $ 558 $ 506
Facility and leasehold improvements 8,013 7,951
Communications and construction
equipment 56,970 52,076
Fiber and conduit systems 31,732 42,446
Office equipment and furniture 7,065 6,360
Network construction and other assets
held under capital leases 3,071 3,197
Work in progress 236,173 99,915
----------- -----------
343,582 212,451
Less accumulated depreciation and
amortization (31,289) (25,916)
----------- -----------
Property and equipment, net $ 312,293 $ 186,535
=========== ===========
</TABLE>
(7) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consists of the following
(in thousands):
June 30, December 31,
1997 1996
----------- -----------
(unaudited)
Accounts payable $ 28,049 $ 44,766
Construction accounting accrual 35,455 18,071
Growth share expenses 28,864 3,810
Capacity service expenses 5,078 3,658
Property, sales and other taxes 20,878 3,793
Accrued interest 7,125 707
Other 10,024 5,324
----------- -----------
Accounts payable and accrued
expenses $ 135,473 $ 80,129
=========== ===========
(8) LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
June 30, December 31,
1997 1996
----------- -----------
(unaudited)
Senior notes $ 250,000 $ --
Revolving credit facility -- 60,000
Customer contract credit facility 15,000 25,918
Network credit facility -- 27,077
Equipment loans -- 9,820
Term notes -- 9,416
Capital lease obligation 1,612 2,010
Other 200 220
----------- -----------
Total debt 266,812 134,461
Less current portion (15,824) (25,193)
----------- -----------
Long-term debt $ 250,988 $ 109,268
=========== ===========
On March 31, 1997, the Company issued 10 7/8% Senior Notes due 2007 (the
Senior Notes), having an aggregate principal amount of $250.0 million. The
net proceeds of the Senior Notes were approximately $242.0 million, after
deducting offering costs which are
13
<PAGE>
included in intangible and other long-term assets. The net proceeds were
used to repay amounts due under the revolving credit facility, network
credit facility, equipment loans and term notes, and to fund a portion of
capital expenditures required to complete construction of segments of the
Network currently under construction (as described in note (10) -Commitments
and Contingencies).
Interest on the Senior Notes is payable semi-annually in arrears on April 1
and October 1 of each year, commencing October 1, 1997. The Senior Notes
are subject to redemption at the option of the Company, in whole or in part,
at any time on or after April 1, 2002, at specified redemption prices. In
addition, prior to April 1, 2000, the Company may use the net cash proceeds
from certain specified equity transactions to redeem up to 35% of the Senior
Notes at specified redemption prices.
In July 1997, the Company's registration statement (no. 333-30449) on
Form S-4 relating to its 10 7/8% Series B Senior Notes (the Exchange Notes),
having terms identical in all material respects to the Senior Notes, became
effective. The Company expects to consummate an exchange of the Exchange
Notes for all of the Senior Notes in the third quarter of 1997. The Company
will receive no proceeds from and will recognize no profit on the exchange
transaction, and no change in financial position of the Company will occur
as a result of the exchange transaction if it occurs. If certain conditions
to closing the exchange offer have not been satisfied within specified time
periods (each a Registration Default) and a shelf registration statement has
not been made effective and available for resale of the Senior Notes,
additional interest will accrue at a rate per annum equal to 0.50% of the
principal amount of the Senior Notes during the 90-day period immediately
following the occurrence of a Registration Default and increasing in
increments of 0.25% per annum up to a maximum of 2.0% per annum, at the end
of each subsequent 90-day period until the Registration Default is cured.
In February 1997, the Company entered into a one-year $50.0 million line of
credit from a commercial bank. No amounts were ever drawn under this credit
line, and the facility was canceled by the Company in July 1997.
Under the terms of certain loan agreements described above, at June 30, 1997
and December 31, 1996 certain assets of the Company's subsidiaries are
restricted.
In May 1997, the Company entered into a $90.0 million credit agreement (the
Credit Agreement) with an unrelated third-party supplier (the Supplier) of
transmission electronics equipment to fund a portion of certain capital
expenditures required to equip the Network currently under construction (as
described in note (10) - Commitments and Contingencies). Under the Credit
Agreement, the Company may borrow from the Supplier up to 75% of the
purchase price of equipment and related engineering and installation
services, with the purchased equipment and related items serving as
collateral for the loans. The Company is committed to purchase from the
Supplier a minimum of $100.0 million of such equipment and services under a
separate procurement agreement which was executed in May 1997. Principal
amounts outstanding under the Credit Agreement will be payable in quarterly
installments commencing on June 30, 2000, with repayment in full due and
payable on March 31, 2004. Borrowings will bear interest at the Company's
option at either: (i) a floating base rate offered by a designated reference
bank plus an applicable margin, or (ii) LIBOR plus an applicable
14
<PAGE>
margin. No amounts were outstanding on this credit agreement as of
June 30, 1997.
(9) ADVANCES FROM PARENT
Advances from Parent at December 31, 1996, which were non-interest
bearing, included costs charged to the Company by the Parent and advances
received from the Parent to fund operations, net of repayments. In May
1997, all outstanding advances from Parent, totaling approximately $28.0
million, were repaid.
(10) COMMITMENTS AND CONTINGENCIES
(A) NETWORK CONSTRUCTION PROJECT
In 1996, the Company commenced construction of the Network, which
is scheduled for completion in 1998. The Company projects its total
remaining cost at June 30, 1997 for completing the construction of
the Network will be approximately $962.0 million. This amount
includes the Company's remaining commitment to purchase a minimum
quantity of materials for approximately $136.3 million as of June
30, 1997, subject to quality and performance expectations. The
Company has the option to extend the materials purchase agreement
through December 31, 1999 and may assign some or all of its
remaining purchase commitment to a third party or cancel the
agreement by paying the seller an amount equal to 7% of any
remaining commitment. The Company has contracted to provide a
portion of the fibers in the Network to third parties (see
note (5) - Network Construction Services Revenue and Expenses).
(B) EASEMENT AGREEMENTS
In February 1997, the Company entered into a right-of-way agreement
with an unrelated third party which provides for advance payment of
$1.9 million for the initial five-year period of the agreement and
$1.9 million in advance of each subsequent five-year period during
the remainder of the 25-year term of the agreement.
In July 1997, the Company entered into a 25-year right-of-way
agreement with an unrelated third party that allows the Company to
construct and operate a fiber optic network over up to
approximately 1,000 route miles along such right-of-way. The
agreement provides for annual payments of approximately $2,500 per
route mile based upon the number of miles used by the Company.
(C) EXECUTIVE EMPLOYMENT AGREEMENT
In January 1997, the Company entered into an employment agreement
(the Agreement) with its new president and chief executive officer
(the Executive),
15
<PAGE>
effective through the close of business December 31, 2001, unless
terminated earlier by either party. The Agreement provides for an
annual salary and bonuses of specific amounts, as well as an
approximately $10.7 million payment (the Equalization Payment) to the
Executive to compensate him for certain benefits from his former
employer that he may lose or forfeit as a result of his resignation
and commencement of employment with the Company. Such payment is
subject to reduction in the event the Executive retains or receives a
substitute payment for any of the benefits he expected to forfeit.
The Equalization Payment is payable in cash in three installments. The
first installment of approximately $7.2 million was paid in January
1997. The remaining two installments of approximately $1.5 million and
$2.0 million are payable on January 1, 1998 and 1999, respectively,
with accrued interest thereon at the rate of 5% per annum. The Company
is amortizing the cost of the Equalization Payment on a straight-line
basis through December 31, 1999. At June 30, 1997, $3.6 million of
such costs is included in other current assets, and $5.4 million is
included in intangible and other long-term assets.
Under the Agreement, the Executive is required to repay to the Company
a portion of the Equalization Payment previously paid in the event the
Executive is terminated for cause on or before December 31, 1999.
(11) GROWTH SHARE PLAN
The Company has a Growth Share Plan for certain of its employees and
directors. A "Growth Share" is a unit of value based on the increase in
value of the Company over a specified measuring period. The Company has
estimated an increase in value of the Growth Shares during 1997 and has
recorded approximately $65.2 million of additional compensation expense
in the six months ended June 30, 1997. The compensation expense of $52.1
million recorded in the second quarter of 1997 was estimated based upon
the value of the Company as determined by the trading price of the
Company's Stock and the portion of the growth shares that were vested. In
July 1997, the Company issued 1,295,766 common shares, net of amounts
relating to tax withholdings of approximately $21.0 million, in
settlement of a portion of the accrued liability related to Growth
Shares. Compensation relating to certain nonvested Growth Shares will be
amortized as expense over the remaining approximately four and one-half
year vesting period.
(12) SECURITIES OFFERING
In April 1997, the Company filed a registration statement with the
Securities and Exchange Commission for an initial public offering (the
Offering) of 15,525,000 shares of Common Stock. On May 23, 1997, the
Board of Directors approved a change in the Company's capital stock to
authorize 400,000,000 shares of $.01 par value Common Stock (of which
10,000,000 shares are reserved for issuance under the Equity Incentive
Plan (as described in note (13) - Equity Incentive Plan), 2,000,000
shares are reserved for issuance under the Growth Share Plan, and
4,300,000 shares are reserved for issuance upon exercise of warrants, as
described below), and 25,000,000 shares of $.01 par value
16
<PAGE>
Preferred Stock. On May 23, 1997, the Board of Directors declared a stock
dividend to the existing stockholder of 86,490,000 shares of Common Stock,
which was paid immediately prior to the effectiveness of the registration
statement on June 23, 1997. This dividend is accounted for as a stock
split. All shares and per share information included in the accompanying
interim consolidated financial statements have been adjusted to give
retroactive effect to the change in capitalization. The Company completed
the initial public offering of 15,525,000 shares of Common Stock on June
27, 1997, raising net proceeds of approximately $319.9 million.
Effective May 23, 1997, the Company sold to an affiliate of the Parent for
$2.3 million in cash, a warrant to acquire 4,300,000 shares of Common
Stock at an exercise price of $28 per share, exercisable on May 23, 2000.
The warrant is not transferable. Stock issued upon exercise of the warrant
will be subject to restrictions on sale or transfer for two years after
exercise.
(13) EQUITY INCENTIVE PLAN
Effective June 23, 1997, the Company adopted the Qwest Communications
International Inc. Equity Incentive Plan (the Equity Incentive Plan). This
plan permits the grant of non-qualified stock options, incentive stock
options, stock appreciation rights, restricted stock, stock units and
other stock grants to key employees of the Company and affiliated
companies and key consultants to the Company and affiliated companies who
are responsible for the Company's growth and profitability. A maximum of
10,000,000 shares of Common Stock may be subject to awards under the
Equity Incentive Plan.
The Company's Compensation Committee (the Committee) determines the
exercise price for each option; however, incentive stock options must have
an exercise price that is at least equal to the fair market value of the
Common Stock on the date the incentive stock option is granted, subject to
certain restrictions.
All awards granted under the Equity Incentive Plan will immediately vest
upon any change in control of the Company, as defined, unless provided
otherwise by the Committee at the time of grant. All outstanding options
will automatically terminate upon the occurrence of certain merger and
reorganization transactions and appropriate notice by the Company to all
option holders, as defined.
In June 1997, the Company granted incentive options to purchase a total of
4,280,000 shares of Common Stock of the Company. The options are
exercisable over five years from the date of grant.
(14) MEXICO FIBER PURCHASE AGREEMENT
In July 1997, the Company entered into an agreement with an unrelated
third party whereby the Company will receive (i) four dark fibers along a
2,270 kilometer route to be constructed in Mexico (the Mexico Network) by
the third party, and (ii) certain construction inventory and value-added
tax refunds, totaling approximately $2.9 million, in exchange for the
stock of the Company's subsidiary, SP Servicios de Mexico S. A. de C. V.
(SPS), and approximately $4.6
17
<PAGE>
million in cash plus refundable value-added tax. Upon completion of the
Mexico Network and the extension of the Qwest Network to the Mexican
border, the Qwest Network will be linked to Mexico City, Mexico.
Consummation of the agreement is contingent upon performance of final due
diligence.
(15) SIGNIFICANT CUSTOMERS
During the six months ended June 30, 1997 and the year ended December 31,
1996, two or more customers, in aggregate, have accounted for 10% or more
of the Company's total revenues in one or more periods, as follows:
Customer Customer Customer
A B C
------------------------------
1996 27.8% 26.3% -
1997 3.9% 31.9% 43.5%
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<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
The following discussion and analysis should be read in conjunction
with the Company's unaudited interim financial statements and the notes thereto,
appearing elsewhere in this document.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q may be deemed to include forward-
looking statements within the meaning of federal securities laws. Forward-
looking statements herein may include, without limitation, the Company's plans
to complete the Qwest Network (defined below), expectations as to funding its
capital requirements, anticipated expansion of Carrier Services (defined below)
and Commercial Services (defined below) and other statements of expectations,
beliefs, future plans and strategies, anticipated developments, and other
matters that are not historical facts. Although the Company believes that its
expectations are based on reasonable assumptions, it can give no assurance that
its expectations will be achieved. Management cautions the reader that these
forward-looking statements are subject to risks and uncertainties, including
financial, regulatory environment, and trend projections, that could cause
actual events or results to differ materially from those expressed or implied by
the statements. Important factors that could prevent the Company from achieving
its stated goals include, but are not limited to, (i) failure by the Company to
manage effectively and cost efficiently the construction of the route segments,
(ii) failure by the Company to enter into additional customer contracts to sell
dark fiber or provide high-volume capacity and otherwise expand its
telecommunications customer base on the Qwest Network, (iii) failure by the
Company to obtain additional rights-of-way and maintain all necessary rights-of-
way, (iv) the impact of competitive services and pricing, and (v) other risks
referenced from time to time in the Company's filings with the SEC (see "Risk
Factors" included in the Company's registration statement filed on Form S-1 (No.
333-25391)).
OVERVIEW
The Company is a facilities-based provider of communications services to
interexchange carriers and other communications entities (Carrier Services) and
to businesses and consumers (Commercial Services), and it constructs and
installs fiber optic communications systems for interexchange carriers and other
communications entities, as well as for its own use (Network Construction
Services). The Company operates in a single business segment, the
telecommunications industry.
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<PAGE>
The Company is expanding its existing long distance network into an
approximately 13,000 route-mile, coast-to-coast, technologically advanced fiber
optic telecommunications network (the Qwest Network). The Company will employ,
throughout substantially all of the Qwest Network, a self-healing SONET four-
fiber ring architecture equipped with the most advanced commercially available
fiber and transmission electronics manufactured by Lucent Technologies and
Northern Telecom Inc. (Nortel), respectively. The Qwest Network's advanced
fiber and transmission electronics are expected to provide the Company with
lower installation, operating and maintenance costs than older fiber systems
generally in commercial use today. In addition, the Company has entered into
construction contracts for the sale of dark fiber along the route of the Qwest
Network, which will reduce the Company's net cost per fiber mile with respect to
the fiber it retains for its own use. As a result of these cost advantages, the
Company believes it will be well positioned to capture market share and take
advantage of the rapidly growing demand for data transmission, multimedia and
long haul voice capacity. The Company derives its revenue from Carrier
Services, Commercial Services and Network Construction Services.
Carrier Services. Carrier Services provide high-volume and
conventional dedicated line services over the Company's owned capacity and
switched services over owned and leased capacity to interexchange carriers and
other telecommunications providers. Revenue from Carrier Services is derived
from high-volume capacity services, dedicated line services and switched
services. The Company provides high-volume transmission capacity services
through service agreements for terms of one year or longer. Dedicated line
services are generally offered under service agreements for an initial term of
one year. High volume capacity service agreements and dedicated line service
agreements generally provide for "take or pay" monthly payments at fixed rates
based on the capacity and length of circuit used. Customers are typically
billed on a monthly basis and also may incur an installation charge or certain
ancillary charges for equipment. After contract expiration, the contracts may
be renewed or the services may be provided on a month-to-month basis. Switched
services agreements are generally offered on a month-to-month basis, and the
service is billed on a minutes-of-use basis. Revenue from carrier customers
that is billed on a minutes-of-use basis has the potential to fluctuate
significantly based on changes in usage that are highly dependent on differences
between the prices charged by the Company and its competitors. The Company,
however, has not experienced significant fluctuations to date. For the three
and six months ended June 30, 1997, the Company's five largest carrier customers
accounted for approximately 39.9% and 43.0% of Carrier Services revenue,
respectively.
Commercial Services. Commercial Services provide long distance voice,
data and video services to businesses and consumers. Revenue from Commercial
Services is recognized primarily on a minutes-of-use basis. Commercial Services
generates revenue using three primary sales channels: direct mail, agent and
telemarketing. The Commercial Services market is highly
20
<PAGE>
competitive and generally subject to significant customer churn. The Company's
churn rates vary by product line and sales channel, and the Company typically
has experienced an average monthly churn rate ranging from 4% to 9%. The Company
is implementing various customer retention programs designed to reduce its churn
rate, and expects that such churn rate will decline as it builds brand identity
and increasingly targets high-volume users. The average churn rates for the
three and six months ended June 30, 1997 have been consistent with historical
rates. The customer retention programs being implemented are not expected to
have a significant impact on operations prior to the fourth quarter of 1997.
Reductions in churn rates would lead to a reduction in selling expenses related
to account acquisition costs.
Network Construction Services. Network Construction Services consist
of the construction and installation of fiber optic communication systems for
interexchange carriers and other telecommunications providers, as well as for
the Company's own use. Revenue from Network Construction Services generally is
recognized under the percentage of completion method as performance milestones
relating to the contracts are completed. Losses, if any, on uncompleted
contracts are expensed in the period in which they are identified, and any
revisions to estimated profits on a contract are recognized in the period in
which they become known.
In 1996, the Company entered into construction contracts for the sale
of dark fiber to Frontier Communications International, Inc. (Frontier) and
WorldCom, Inc. (WorldCom) whereby the Company has agreed to install and provide
dark fiber to each along the Qwest Network. The Company also entered into a
construction contract with GTE Intelligent Network Services Incorporated (GTE)
in May 1997 for the sale of dark fiber along the Qwest Network. After completion
of the Qwest Network, the Company expects that revenues from Network
Construction Services will be less significant to the Company's operations.
In July 1997, the Company entered into an agreement with an unrelated
third party whereby the Company will receive (i) four dark fibers along a 2,270
kilometer route to be constructed in Mexico (the Mexico Network) by the third
party, and (ii) certain construction inventory and value-added tax refunds
totaling approximately $2.9 million, in exchange for the stock of the Company's
subsidiary, SP Servicios de Mexico S. A. de C. V. (SPS), and approximately $4.6
million in cash plus refundable value-added tax. Upon completion of the Mexico
Network and the extension of the Qwest Network to the Mexican border, the Qwest
Network will be linked to Mexico City, Mexico. Consummation of the agreement is
contingent upon performance of final due diligence.
Pricing. The Company believes that prices in the telecommunication
services industry will continue to decline as a result of reforms prompted by
the Telecommunications Act of 1996 and reform of the rules governing access
charges and international settlement rates. The Company also believes that the
effect of such decreases in prices on total revenue will be partially offset by
increased demand for telecommunications services, and that the low cost per unit
base of the Qwest Network will give it a competitive advantage relative to its
competitors.
Operating Expenses. The Company's principal operating expenses
consist of expenses for network construction incurred by Network Construction
Services, expenses for
21
<PAGE>
telecommunications services, selling, general and administrative expenses
(SG&A), and depreciation and amortization. Expenses for Network Construction
Services consist primarily of costs to construct the Qwest Network, including
conduit, fiber cable, construction crews and rights-of-way. Costs attributable
to the construction of the Qwest Network for the Company's own use are
capitalized.
Expenses for telecommunications services primarily consist of the cost
of leased capacity, Local Exchange Carrier (LEC) access charges, engineering and
other operating costs. Since the Company currently provides dedicated line
services primarily over its owned network, the cost of providing these
services generally does not include the cost of leased capacity or LEC access
charges. Expenses for switched services, however, include these costs. The
Company leases capacity from other carriers to extend its switched services for
originating and terminating traffic beyond its own network boundaries. LEC
access charges, which are variable, represent a significant portion of the total
cost for switched services. Due in part to these costs, revenue from switched
services has lower gross margins than revenue from dedicated line services.
When the Qwest Network is completed and activated, the Company will be able to
serve more customer needs over its own capacity on the Qwest Network.
Furthermore, with additional switched traffic on the Qwest Network, the Company
believes it will realize economies of scale and thereby lower its
telecommunications costs as a percentage of revenue.
SG&A includes the cost of salaries, benefits, occupancy costs,
commissions, sales and marketing expenses and administrative expenses. In March
1996, the Company changed the focus of its sales efforts for Commercial Services
from regional sales offices to agent, telemarketing and direct mail sales
channels. The Company redirected its sales efforts in order to reduce the fixed
selling expenses associated with having its own commercial sales offices and
sales employees and to concentrate on other sales channels that the Company
believed would be more cost effective in generating sales to the Company's
target market at that time. Notwithstanding the closure of its sales offices
and related cutbacks, SG&A expenses have increased since 1996, which is
consistent with the development of the Qwest Network and the growth of the
Company's revenue.
The Company expects this trend to continue and that increased SG&A
will be necessary to realize the anticipated growth in revenue for Carrier
Services and Commercial Services as the Company develops the Qwest Network. The
Company intends to open commercial sales offices in selected major geographic
markets to implement the Company's strategy, as segments of the Qwest Network
become operational. In addition, SG&A expenses will increase as the Company
continues to recruit experienced telecommunications industry personnel to
implement the Company's strategy.
22
<PAGE>
The Company has a Growth Share Plan for certain of its employees and
directors. Growth Share Plan expense, included in Operating Expenses, reflects
the Company's estimate of compensation expense with respect to the Growth Shares
issued to participants. A "Growth Share" is a unit of value based on the
increase in value of the Company over a specified measuring period. Growth
Shares granted under the Plan generally vest at the rate of 20% for each full
year of service completed after the grant date subject to risk of forfeiture.
Participants receive their vested portion of the increase in value of the Growth
Shares upon a triggering event, as defined, which includes the end of a growth
share performance cycle. Upon completion of the common stock offering in June
1997, certain Growth Shares vested in full, which resulted in substantial
compensation expense under the Growth Share Plan in the second quarter of 1997,
and the issuance in July 1997 of 1,295,766 shares of Common Stock, which were
net of amounts related to tax withholdings, in settlement of the accrued
liability related to these Growth Shares. Effective with the initial public
offering, all holders of Growth Shares not vested by virtue of the initial
public offering have been granted nonqualified stock options under the Company's
Equity Incentive Plan, and the value of these Growth Shares has been capped
based upon the initial public offering price of $22 per share. Compensation
expense relating to these nonvested Growth Shares will be recognized over the
remaining approximately four and one-half year vesting period and is estimated
to be up to approximately $31.9 million in total. The Company does not
anticipate any future grants under the Growth Share Plan.
23
<PAGE>
RESULTS OF OPERATIONS
The table set forth below summarizes the Company's revenue by source,
operating expenses, other income (expense), and other financial and operating
data (amounts in thousands, except per share information, minutes of use, route
miles and switch information):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1997 1996 1997 1996
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenue:
Carrier services................... $ 13,765 $ 17,366 $ 24,964 $ 35,859
Commercial services................ 10,261 9,299 19,672 16,312
------- ------- ------- -------
24,026 26,665 44,636 52,171
Network construction services...... 204,647 24,206 256,730 33,332
------- ------- ------- -------
Total revenue.................... 228,673 50,871 301,366 85,503
Operating Expenses:
Telcommunications services......... 20,830 24,139 38,893 48,001
Network construction services...... 140,047 15,097 176,312 21,944
Selling, general and
administrative................... 18,724 10,047 32,671 24,574
Growth share plan.................. 52,089 - 65,189 -
Depreciation and amortization...... 4,081 3,850 8,043 7,899
------- ------- ------- -------
Total operating expenses......... 235,771 53,133 321,108 102,418
Loss from operations................. (7,098) (2,262) (19,742) (16,915)
Other income (expense):
Gain on sale of contract rights.... 1,586 - 9,296 -
Interest and other (expense)
income, net...................... (2,442) (1,274) (4,742) (1,910)
------- ------- ------- -------
Loss before income tax benefit... (7,954) (3,536) (15,188) (18,825)
Income tax benefit................. 2,342 1,160 4,800 6,470
------- ------- ------- -------
Net loss......................... $ (5,612) $ (2,376) $(10,388) $(12,355)
======= ======= ======= =======
Net loss per share............... $ (0.06) $ (0.03) $ (0.12) $ (0.14)
======= ======= ======= =======
Weighted average number of shares
outstanding........................ 87,865 88,158 87,186 88,158
======= ======= ======= =======
Other financial and operating data:
EBITDA(1).......................... $ (3,022) $ 1,622 $(13,700) $ (7,437)
======= ======= ======= =======
EBITDA, adjusted for growth
share plan expense(1)............ $ 49,067 $ 1,622 $ 51,489 $ (7,437)
======= ======= ======= =======
Capital expenditures, including
non-cash items $133,820 $ 26,047
======= =======
Minutes of use 234,000,000 168,000,000
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
<S> <C> <C>
Route miles of conduit installed............................ 6,220 3,650
Route miles of dark fiber installed......................... 3,680 1,800
Route miles of lit fiber installed.......................... 900 900
Switches.................................................... 5 5
</TABLE>
24
<PAGE>
- --------------------------------------------------------------------------------
(1) EBITDA represents net loss before interest, income tax benefit,
depreciation and amortization, a non-recurring expense of $1.6 million in
the six months ended June 30, 1996 to restructure its operations (including
the direct sales group) and the gain on sale of contract rights of
approximately $1.6 million and $9.3 million (which is non-recurring) in the
three and six months ended June 30, 1997, respectively. EBITDA includes
earnings from the construction contracts for the sale of dark fiber that
the Company will use to provide cash for construction costs of the Qwest
Network. EBITDA does not represent cash flow for the periods presented and
should not be considered as an alternative to net earnings (loss) as an
indicator of the Company's operating performance or as an alternative to
cash flows as a source of liquidity and may not be comparable with EBITDA
as defined by other companies. The Company believes that EBITDA is commonly
used by financial analysts and others in the telecommunications industry.
EBITDA adjusted for Growth Share Plan expense represents EBITDA (as defined
above), excluding the effect of Growth Share Plan expense.
- --------------------------------------------------------------------------------
THREE AND SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1996
The Company experienced net losses of $5.6 million and $10.4 million
in the three and six months ended June 30, 1997, respectively, compared to net
losses of $2.4 million and $12.4 million in the same periods of the prior year.
Excluding the effect of the compensation expense relating to the Growth Share
Plan, net of income tax, the Company's reported net income would have been
approximately $27.5 million and $31.3 million for the three and six months ended
June 30, 1997, respectively.
Revenue. Total revenue increased $177.8 million, or 350.0%, and $215.9
million, or 252.5%, during the three and six months ended June 30, 1997,
respectively, as compared to the corresponding periods in 1996. Revenue from
Network Construction Services increased $180.4 million and $223.4 million during
the three and six months ended June 30, 1997, respectively, as compared to the
corresponding periods in 1996. The increase was due primarily to network
construction revenue from dark fiber sales to WorldCom, GTE and Frontier
totaling approximately $188.9 million and $237.8 million in the three and six
months ended June 30, 1997, respectively, compared with $18.8 million and $25.6
million during the three and six months ended June 30, 1996, respectively. In
connection with the GTE contract, which was signed in May 1997, the Company was
able to satisfy certain construction milestones along segments with previous
construction activity and recognized revenue related to this previous
construction activity of approximately $95.8 million in the three months ended
June 30, 1997. For the remainder of this contract, revenue will be recognized
based upon progress measured along segments without significant previous
construction activity. Consequently, for this contract, the Company expects that
revenue to be recognized in future quarters may be significantly less than the
revenue recognized in the three months ended June 30, 1997. Carrier Services
revenue decreased $3.6 million, or 20.7%, and $10.9 million, or 30.4%, for the
three and six months ended June 30, 1997, respectively, compared with the
corresponding periods in 1996, primarily due to decreases in revenue resulting
from the Company's sale of its resale dedicated line services on July 1, 1996.
The sold business generated revenues of $9.2 million for the three months ended
June 30, 1996 and $18.8 million for the six months ended June 30, 1996.
Exclusive of this revenue, Carrier Services revenue increased $5.6 million, or
68.6%, and $7.9 million, or 46.3%, during the three and six months ended June
30, 1997, as compared to corresponding periods of 1996. This increase in Carrier
Services revenue was due primarily to increases in revenue from carrier switched
services and carrier dedicated line services provided on the Qwest Network.
Commercial Services revenue increased $1.0 million, or 10.3%, and $3.4 million,
or 20.6%, for the three and six months ended June 30, 1997, respectively, as
compared to the corresponding periods in 1996. The increase was due primarily to
growth in switched services provided to small- and medium-sized business and
consumers as a
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<PAGE>
result of continued expansion of the Company's direct mail, agent and
telemarketing sales channels.
Operating Expenses. Total operating expenses increased $182.6
million, or 343.7%, and $218.7 million, or 213.5%, during the three and six
months ended June 30, 1997, respectively, over the same periods in 1996, due
primarily to increases in Network Construction Services and Growth Share Plan
expense, partially offset by lower Telecommunication Services costs.
Expenses for telecommunications services decreased $3.3 million and
$9.1 million, or 13.7% and 19.0%, for the three and six months ended June 30,
1997, respectively, compared to the corresponding periods in the prior year.
The sale on July 1, 1996 of the Company's dedicated line services on leased
capacity resulted in a reduction in expenses, which was partially offset by
telecommunications services expenses associated with continued growth in
switched services and network engineering and operations. Expenses for Network
Construction Services increased $125.0 million and $154.4 million, in the three
and six months ended June 30, 1997, respectively, compared to the corresponding
periods in 1996 due to costs of construction contracts relating to dark fiber
sales.
SG&A increased $8.7 million, or 86.4%, and $8.1 million, or 32.9%, in
the three and six months ended June 30, 1997, respectively, compared to the
corresponding periods of 1996. The increase was due primarily to increases in
expenses related to the Company's direct mail sales program and to recruiting
and hiring additional personnel. The Company anticipates that as it deploys the
Qwest Network and expands its Carrier Services and Commercial Services, SG&A
will continue to increase.
The Company has estimated an increase in the value of Growth Shares at
June 30, 1997, primarily triggered by the June 1997 initial public offering, and
has recorded approximately $52.1 million and $65.2 million of additional
compensation expense in the three and six months ended June 30, 1997,
respectively. No expense was recognized in the three and six months ended June
30, 1996, as there were no compensatory elements in those periods. As discussed
above, the Company anticipates total additional expense of up to approximately
$31.9 million through the year 2002 in connection with this plan.
The Company's depreciation and amortization expense increased $0.2
million, or 6.0%, and $0.1 million, or 1.8%, during the three and six months
ended June 30, 1997, respectively, from the corresponding periods in 1996. This
increase resulted primarily from purchases of additional equipment used in
constructing the Qwest Network and from purchases of other fixed assets to
accommodate the Company's growth. The Company expects that depreciation and
amortization expense will continue to increase in subsequent periods as the
Company continues to construct and activate the Qwest Network.
Interest and Other Income (Expense). Pursuant to a capacity sale in
1993, the Company obtained certain rights of first refusal to re-acquire network
communications equipment and terminal locations including leasehold improvements
should the purchaser, under that agreement, sell the network. In March 1997, the
Company sold certain of these rights to the purchaser in return for $9.0 million
in cash and the right to re-acquire certain terminal facilities. In the first
quarter of 1997,
26
<PAGE>
the Company received $7.0 million in cash consideration. The remaining
cash consideration of $2.0 million was received in May 1997 when the Company
completed the delivery of certain telecommunications capacity to the purchaser.
As previously discussed, the Company sold a portion of its dedicated
line services in July 1996. During the transition of the service agreements to
the buyer, the Company incurred certain facilities costs on behalf of the buyer,
which were to be reimbursed to the Company. A dispute arose with respect to the
reimbursement of such costs and, as a result, the Company made a provision of
approximately $2.0 million in the first quarter of 1997.
During the three and six months ended June 30, 1997 the Company's net
interest and other expenses increased $1.2 million and $2.8 million,
respectively, as compared to the corresponding periods of 1996. This increase is
due primarily to interest expense of approximately $6.8 million in the six
months ended June 30, 1997 related to the $250.0 million in principal amount of
10 7/8% Senior Notes, due 2007, (the Senior Notes) issued on March 31, 1997, as
well as the provision for transition service costs described in the previous
paragraph. The increase in net interest and other income (expense) was offset by
approximately $4.1 million and $5.3 million of additional capitalized interest
during the three and six months ended June 30, 1997, respectively, resulting
from construction of the Qwest Network, and an increase in interest income of
approximately $.9 million and $.8 million during the three and six months ended
June 30, 1997, respectively, as compared to the prior periods, attributable to
the increase in cash equivalent balances which resulted from the issuance of the
Senior Notes and the initial public offering.
Income Taxes. The Company is included in the consolidated federal
income tax return of Anschutz Company, and a tax sharing agreement provides for
allocation of tax liabilities and benefits to the Company, in general, as though
it filed a separate tax return. The Company's effective tax rates for the three
and six months ended June 30, 1997 were lower than the statutory federal rate as
a result of permanent differences between book and tax expense relating to the
Growth Share Plan. The Company's effective tax rate in the corresponding
periods of 1996 approximated the statutory federal rate.
Net Loss. The Company experienced net losses of $5.6 million and
$10.4 million in the three and six months ended June 30, 1997, respectively,
compared to net losses of $2.4 million and $12.4 million in the corresponding
periods of 1996 as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 1997, the Company has funded
capital expenditures and long-term debt repayments primarily through net
proceeds of approximately $319.9 million from its initial public offering and
net proceeds of approximately $242.0 million from the issuance of the Senior
Notes. The Company intends to finance its operations in the future
27
<PAGE>
through internally generated and external funds without relying on cash
advances, contributions or guarantees from its parent.
The Company's operations generated insufficient cash flows during the
six months ended June 30, 1997 to enable it to meet its capital expenditures,
debt service and other cash needs. Total cash expended during this period to
fund capital expenditures, repayments of long-term debt to third parties and net
repayments of advances from the Company's parent was approximately $129.4
million, $165.6 million and $19.1 million, respectively. Total cash provided by
operations was approximately $.9 million during the same period. During the
first six months of 1997, total cash provided by loans secured by collateral
owned by its parent or an affiliate was approximately $48.0 million. As of June
30, 1997, the Company had positive working capital of approximately $294.0
million. As of December 31, 1996, the Company had a working capital deficit of
approximately $69.4 million.
In March 1997, the Company issued and sold $250.0 million in principal
amount of the Senior Notes, the proceeds of which were used to repay certain
long-term debt and to fund a portion of capital expenditures required to
construct segments of the Qwest Network. Issuance costs totaling approximately
$8.0 million are being amortized to interest expense over the term of the Senior
Notes. Interest on the Senior Notes is payable semi-annually on April 1 and
October 1 of each year, commencing on October 1, 1997, and the principal amount
of the Senior Notes is due and payable in full on April 1, 2007. The Indenture
for the Senior Notes (the Indenture) contains certain covenants that, among
other things, limit the ability of the Company and certain of its subsidiaries
(the Restricted Subsidiaries) to incur additional indebtedness and issue
preferred stock, pay dividends or make other distributions, repurchase capital
stock or subordinated indebtedness, create certain liens, enter into certain
transactions with affiliates, sell assets of the Company or its Restricted
Subsidiaries, issue or sell capital stock of the Company's Restricted
Subsidiaries or enter into certain mergers and consolidations. In addition,
under certain limited circumstances, the Company will be required to offer to
purchase the Senior Notes at a price equal to 100% of the principal amount
thereof plus accrued and unpaid interest to the date of purchase with the excess
proceeds of certain asset sales. In the event of a Change of Control (as defined
in the Indenture), holders of the Senior Notes will have the right to require
the Company to purchase all of their Senior Notes at a price equal to 101% of
the aggregate principal amount thereof plus accrued and unpaid interest.
In July 1997, the Company's registration statement relating to its
10 7/8% Series B Senior Notes (the Exchange Notes), having terms identical in
all material respects to the Senior Notes, became effective. The Company expects
to consummate an exchange of the Exchange Notes for all of the Senior Notes in
the third quarter of 1997. The Company will receive no proceeds from and will
recognize no profit on the exchange transaction, and no change in financial
position of the Company will occur as a result of the exchange transaction if it
occurs. If certain conditions to closing the exchange offer have not been
satisfied within specified time periods (each a Registration Default) and a
shelf registration has not been made effective and available for resale of the
Senior Notes, additional interest will accrue at a rate per annum equal to 0.50%
of the principal amount of the Senior Notes during the 90-day period immediately
following the occurrence of a Registration Default and
28
<PAGE>
increasing in increments of 0.25% per annum up to a maximum of 2.0% per annum,
at the end of each subsequent 90-day period until the Registration Default is
cured.
In February 1997, the Company entered into a one-year $50.0 million
line of credit from a commercial bank. No amounts were ever drawn under this
credit line, and the facility was canceled by the Company in July 1997.
The Company has an existing $100.0 million three-year revolving credit
facility that converts to a two-year term loan maturing on April 2, 2001. At
June 30, 1997, no amounts were outstanding under this credit facility. The
Company intends to terminate this credit facility and to obtain a new bank
credit facility, which may be secured or unsecured, as permitted under the
Indenture. The Company is in discussions with various potential lenders in this
regard.
In May 1997, the Company and an unrelated third party supplier (the
Supplier) entered into a $90.0 million credit agreement to finance the
transmission electronics equipment to be purchased from the Supplier under a
procurement agreement. Under this credit agreement, the Company may borrow funds
as it purchases the equipment to fund up to 75% of the purchase price of such
equipment and related engineering and installation services provided by the
Supplier, with the purchased equipment and related items serving as the
collateral for the loans. Principal amounts outstanding under the credit
agreement will be payable in quarterly installments commencing on June 30, 2000,
with repayment in full due and payable on March 31, 2004. Borrowings will bear
interest at the Company's option at either: (i) a floating base rate announced
by a designated reference bank plus an applicable margin, or (ii) LIBOR plus an
applicable margin. As of June 30, 1997, no amounts were outstanding under this
credit agreement.
In May 1997, the Company's board of directors approved a change in the
Company's capital stock to authorize 400,000,000 shares of $.01 par value Common
Stock (of which 10,000,000 shares are reserved for issuance under the equity
incentive plan, 2,000,000 shares are reserved for issuance under the Growth
Share Plan, and 4,300,000 shares are reserved for issuance upon exercise of
warrants), and 25,000,000 shares of $.01 par value Preferred Stock. In May 1997,
the Company declared a stock dividend to the existing stockholder of 86,490,000
shares of Common Stock, which was paid immediately prior to the effectiveness of
the registration statement on June 23, 1997. In June 1997, the Company
completed an initial public offering of 15,525,000 shares of its Common Stock.
Effective May 23, 1997, the Company sold to an affiliate of the Parent
for $2.3 million in cash, a warrant to acquire 4,300,000 shares of Common Stock
at an exercise price of $28 per share, exercisable on May 23, 2000. The warrant
is not transferable. Stock issued upon exercise of the warrant will be subject
to restrictions on sale or transfer for two years after exercise.
The Company estimates the total cost to construct and activate the
Qwest Network and complete construction relating to the dark fiber sold to
Frontier, WorldCom and GTE will be approximately $1.4 billion. Total anticipated
costs include approximately $438.0 million already expended by the Company as of
June 30, 1997. The Company anticipates remaining total cash outlays for these
purposes of approximately $462.0 million in 1997 and $500.0 million in 1998. The
total 1997 amount includes the Company's commitment to purchase a minimum
quantity of materials for approximately $257.0 million in the year ended
December 31, 1997, (subject to quality and performance specifications).
Estimated total expenditures for 1997 and 1998 together also include
approximately $100.0 million for the purchase of electronic equipment. In
addition,
29
<PAGE>
the Company anticipates approximately $97.0 million of aggregate capital
expenditures in 1997 and 1998 to support growth in Carrier Services and
Commercial Services.
As of June 30, 1997, the Company has obtained the following sources of
funds: (i) approximately $1.0 billion under the Frontier, WorldCom and GTE
contracts and additional smaller construction contracts for sales of dark fiber,
of which approximately $280.0 million had already been paid and $705.0 million
remained to be paid at June 30, 1997; (ii) $90.0 million of vendor financing;
(iii) approximately $242.0 million of net proceeds from the sale of the Senior
Notes; and (iv) approximately $319.9 million of net proceeds from the initial
public offering. The Company believes that its available cash and cash
equivalent balances at June 30, 1997, borrowing capacity under existing or
future credit facilities and cash flow from operations will satisfy its
anticipated cash requirements at least through the end of 1997.
With the completion of the 13,000 route mile network, the Company will
provide telecommunications services nationally to its customers primarily over
its own facilities, using leased facilities in those portions of the country not
covered by the Qwest Network. Qwest is evaluating the economics of extending its
core network versus continuing to lease network capacity. In this regard, the
Company is considering extensions in the Southeast United States, the California
Valley and, perhaps, the Pacific Northwest. Any decisions with respect to
extensions of the Qwest Network will be dependent upon, among other things, the
Company's assessment of the potential for dark fiber sales or long-term leases
of high volume capacity and the availability of additional capital on acceptable
terms.
30
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risks
Not applicable.
31
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
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
11. Statements re computation of per share loss
27. Financial data schedule
32
<PAGE>
SIGNATURE
Pursuant to the requirements 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.
Qwest Communications International Inc.,
a Delaware corporation
August 14, 1997 By: /s/ ROBERT S. WOODRUFF
--------------------------
Robert S. Woodruff
Executive Vice President-Finance
and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
33
<PAGE>
EXHIBIT 11
QWEST COMMUNICATIONS INTERNATIONAL INC.
AND SUBSIDIARIES
COMPUTATION OF PER SHARE LOSS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
_______________________________________________________________________________________________
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
1997 1996 1997 1996
--------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss to common stockholders $ (5,612) $ (2,376) $(10,388) $(12,355)
Weighted average number of shares of common
stock outstanding:
Total number of shares of common stock
outstanding 87,865 86,500 87,186 86,500
Common stock issuable under Growth Share
Plan - 1,658 - 1,658
------- ------- -------- -------
Weighted average number of shares of common
stock outstanding 87,865 88,158 87,186 88,158
Net loss per share $ (0.06) $ (0.03) $ (0.12) $ (0.14)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet as of June 30, 1997 and consolidated statement of
operations for the six months ended June 30, 1997 included in the Company's Form
10-Q, and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 314,367
<SECURITIES> 0
<RECEIVABLES> 39,224
<ALLOWANCES> 4,301
<INVENTORY> 0
<CURRENT-ASSETS> 449,759
<PP&E> 343,582
<DEPRECIATION> 31,289
<TOTAL-ASSETS> 790,091
<CURRENT-LIABILITIES> 155,745
<BONDS> 250,000
0
0
<COMMON> 1,020
<OTHER-SE> 320,243
<TOTAL-LIABILITY-AND-EQUITY> 790,091
<SALES> 301,366
<TOTAL-REVENUES> 301,366
<CGS> 0
<TOTAL-COSTS> 321,108
<OTHER-EXPENSES> (9,281)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,727
<INCOME-PRETAX> (15,188)
<INCOME-TAX> (4,800)
<INCOME-CONTINUING> (10,388)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,388)
<EPS-PRIMARY> (0.12)
<EPS-DILUTED> (0.12)
</TABLE>
