AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON April 29, 1998
REGISTRATION NO. 333-_____
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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QWEST COMMUNICATIONS INTERNATIONAL INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 4813 84-1339282
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NO.)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
555 SEVENTEENTH STREET, SUITE 1000
DENVER, COLORADO 80202
(303) 291-1400
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
ROBERT S. WOODRUFF
EXECUTIVE VICE PRESIDENT--FINANCE
QWEST COMMUNICATIONS INTERNATIONAL INC.
555 SEVENTEENTH STREET, SUITE 1000
DENVER, COLORADO 80202
(303) 291-1400
(NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF AGENT FOR SERVICE FOR THE REGISTRANT)
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COPIES TO:
MARTHA D. REHM, ESQ. DAVID J. BEVERIDGE, ESQ.
HOLME ROBERTS & OWEN LLP SHEARMAN & STERLING
1700 LINCOLN STREET, SUITE 4100 599 LEXINGTON AVENUE
DENVER, COLORADO 80203 NEW YORK, NEW YORK 10022-6069
(303) 861-7000 (212) 848-4000
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable after this Registration Statement becomes
effective.
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If the Securities registered on this Form are to be offered in connection with
the formation of a holding company and there is compliance with General
Instruction G, check the following box. [_]
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<PAGE>
CALCULATION OF REGISTRATION FEE
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PROPOSED PROPOSED
TITLE OF EACH CLASS AMOUNT OFFERING MAXIMUM MAXIMUM
OF SECURITIES TO TO BE PRICE AGGREGATE AMOUNT OF
BE REGISTERED REGISTERED PER UNIT(1) OFFERING PRICE(1) REGISTRATION
FEE(2)
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8.29% Senior
Discount Notes
Due 2008...... $450,505,000 66.592% $300,000,000 $92,423
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(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457 of the Securities Act of 1933, as amended.
(2) Calculated pursuant to Rule 457(f)(2) based upon the book value on April 27,
1998 of the Notes to be received by the Registrant in the exchange described
herein.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS Subject to Completion
Dated April 29, 1998
QWEST COMMUNICATIONS INTERNATIONAL INC.
OFFER TO EXCHANGE 8.29% SERIES B SENIOR DISCOUNT NOTES DUE 2008 FOR ANY AND ALL
OF ITS OUTSTANDING 8.29% SENIOR DISCOUNT NOTES DUE 2008
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON
[_____DAY, ___ __, 1998, UNLESS EXTENDED; PROVIDED IT MAY NOT BE EXTENDED BEYOND
____ __], 1998.
Qwest Communications International Inc., a Delaware corporation ("Qwest" or the
"Company"), hereby offers, upon the terms and subject to the conditions set
forth in this Prospectus and the accompanying Letter of Transmittal (which
together constitute the "Exchange Offer"), to exchange $1,000 principal amount
at maturity of its 8.29% Series B Senior Discount Notes Due 2008 (the "Exchange
Notes") for each $1,000 principal amount at maturity of its outstanding 8.29%
Senior Discount Notes Due 2008 (the "Old 8.29% Notes") of which $450,505,000 in
aggregate principal amount at maturity are outstanding as of the date hereof,
which exchange has been registered under the Securities Act of 1933, as amended
(the "Securities Act"), pursuant to a registration statement of which this
Prospectus is a part (the "Registration Statement"). The form and terms of the
Exchange Notes will be identical in all material respects to the form and terms
of the Old 8.29% Notes except that (i) the exchange will have been registered
under the Securities Act and therefore the Exchange Notes will not bear legends
restricting the transfer thereof, (ii) the interest, interest rate step-up,
original issue discount and cash interest provisions will be modified or
eliminated as appropriate and (iii) holders of the Exchange Notes will not be
entitled to certain rights of holders of the Old 8.29% Notes under the
Registration Agreement (as defined herein), which rights with respect to Old
8.29% Notes will terminate upon the consummation of the Exchange Offer. See
"Description of the 8.29% Notes--Exchange Offer; Registration Rights." The
Exchange Notes will evidence the same debt as the Old 8.29% Notes (which they
replace) and will be entitled to the benefits of the Indenture dated as of
January 29, 1998 governing the Old 8.29% Notes and the Exchange Notes. The
Exchange Notes and the Old 8.29% Notes are considered collectively to be a
single class for all purposes under the Indenture, including, without
limitation, waivers, amendments, redemptions and Offers to Purchase, and are
sometimes referred to herein collectively as the "8.29% Notes." See "The
Exchange Offer" and "Description of the 8.29% Notes."
The Company will accept for exchange any and all validly tendered Old 8.29%
Notes not withdrawn prior to 5:00 p.m., New York City time, on [_____day, ___
__], 1998 ("Expiration Date"); provided, however, that if the Company, in its
sole discretion, has extended the period of time for which the Exchange Offer is
open, the term "Expiration Date" means the latest time and date to which the
Exchange Offer is extended; provided further, that in no event will the Exchange
Offer be extended beyond [______], 1998. Tenders of Old 8.29% Notes may be
withdrawn at any time prior to the Expiration Date. Old 8.29% Notes may be
tendered only in integral multiples of $1,000.
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The 8.29% Notes will mature on February 1, 2008, unless previously redeemed. The
Old 8.29% Notes were issued at a price of $665.92 per $1,000 original principal
amount at maturity, representing a yield to maturity of 8.29%. The Exchange
Notes will be issued without coupons and in fully registered form only, in
minimum denominations of $1,000 and integral multiples thereof. Cash interest on
the 8.29% Notes will not accrue until February 1, 2003, and thereafter will
accrue at a rate of 8.29% per annum and will be payable semiannually in arrears
commencing on August 1, 2003 and thereafter on February 1 and August 1 of each
year; provided, however, that the Company may elect to commence the accrual of
cash interest on an interest payment date on or after February 1, 2001 and prior
to February 1, 2003, in which case the outstanding principal amount at maturity
of each Note will on such interest payment date be reduced to the Accreted Value
(as defined) of the Note as of such interest payment date and cash interest will
be payable on each interest payment date thereafter. The 8.29% Notes will be
redeemable at the option of Qwest, in whole or in part, at any time on or after
February 1, 2003, upon not less than 30 nor more than 60 days' notice, at the
redemption prices set forth herein, plus accrued and unpaid interest thereon, if
any, to the redemption date. In addition, at any time prior to February 1, 2001,
Qwest may redeem up to 35% of the 8.29% Notes at a redemption price of 108.29%
of the Accreted Value of the 8.29% Notes, plus accrued and unpaid interest
thereon, if any, to the redemption date, with the net proceeds of one or more
Public Equity Offerings (as defined). Within 30 days of the occurrence of a
Change of Control (as defined), Qwest will be required to make an Offer to
Purchase (as defined) all outstanding 8.29% Notes at a purchase price equal to
101% of the Accreted Value of the 8.29% Notes on the purchase date plus any
accrued and unpaid interest and premium, if any, not otherwise included in the
Accreted Value to such purchase date. There can be no assurance that Qwest will
have the financial resources necessary to purchase the 8.29% Notes in such
circumstances. See "Description of the 8.29% Notes--Optional Redemption" and
"--Certain Covenants-- Change of Control."
The Exchange Notes will be senior unsecured obligations of Qwest, ranking pari
passu in right of payment with all existing and future senior unsecured
indebtedness of Qwest, including its 10 7/8% Series B Senior Notes Due 2007 ("10
7/8% Notes") and its 9.47% Series B Senior Discount Notes Due 2007 ("9.47%
Notes"), and will be senior in right of payment to all existing and future
indebtedness of Qwest expressly subordinated in right of payment to the 8.29%
Notes. See "Capitalization" and "Description of the 8.29% Notes--General."
SEE "RISK FACTORS" BEGINNING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS TO
BE CONSIDERED BY HOLDERS WHO TENDER THEIR OLD NOTES IN THE EXCHANGE OFFER.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is April 29, 1998.
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The Old 8.29% Notes were sold by the Company on January 29, 1998 to Salomon
Brothers Inc (the "Initial Purchaser") pursuant to a Purchase Agreement dated
January 22, 1998 by and between the Company and the Initial Purchaser (the
"Purchase Agreement"). Pursuant to the Purchase Agreement, the Company and the
Initial Purchaser entered into a Registration Agreement dated as of January 29,
1998 (the "Registration Agreement") which granted the holders of the Old 8.29%
Notes certain exchange and registration rights. The Exchange Offer is being made
to satisfy certain of the Company's obligations under the Registration
Agreement.
Based upon no-action letters issued by the staff of the Securities and
Exchange Commission (the "Commission") to third parties, the Company believes
that the Exchange Notes issued pursuant to the Exchange Offer in exchange for
Old 8.29% Notes would in general be freely transferable after the Exchange Offer
without further registration under the Securities Act if the holder of the
Exchange Notes represents (i) that it is not an "affiliate," as defined in Rule
405 of the Securities Act, of the Company, (ii) that it is acquiring the
Exchange Notes in the ordinary course of its business and (iii) that it has no
arrangement or understanding with any person to participate in the distribution
(within the meaning of the Securities Act) of the Exchange Notes; provided that,
in the case of broker-dealers, a prospectus meeting the requirements of the
Securities Act be delivered as required. However, the Commission has not
considered the Exchange Offer in the context of a no-action letter and there can
be no assurance that the staff of the Commission would make a similar
determination with respect to the Exchange Offer as in such other circumstances.
Holders of Old 8.29% Notes wishing to accept the Exchange Offer must represent
to the Company that such conditions have been met. Each broker-dealer that
receives Exchange Notes for its own account pursuant to the Exchange Offer,
where it acquired the Old 8.29% Notes exchanged for such Exchange Notes for its
own account as a result of market-making or other trading activities, must
acknowledge that it will deliver a prospectus in connection with the resale of
such Exchange Notes. The Letter of Transmittal states that by so acknowledging
and by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act. This
Prospectus, as it may be amended or supplemented from time to time, may be used
by a broker-dealer in connection with resales of Exchange Notes received in
exchange for Old 8.29% Notes where such Old 8.29% Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities. The Company has agreed that, for a period of one year after
consummation of the Exchange Offer, it will make this Prospectus available to
any broker-dealer for use in connection with any such resale. A broker-dealer
that delivers such a prospectus to purchasers in connection with such resales
will be subject to certain of the civil liability provisions under the
Securities Act, and will be bound by the provisions of the Registration
Agreement (including certain indemnification and contribution rights and
obligations). See "The Exchange Offer--Resale of the Exchange Notes" and "Plan
of Distribution."
The Company will not receive any proceeds from the Exchange Offer and will pay
all of its expenses incident thereto. Tenders of Old 8.29% Notes pursuant to the
Exchange Offer may be withdrawn at any time prior to the Expiration Date. In the
event that the Company terminates the Exchange Offer and does not accept for
exchange any Old 8.29% Notes, the Company will promptly return the Old 8.29%
Notes to the holders thereof. See "The Exchange Offer."
Prior to this Exchange Offer, there has been no public market for the 8.29%
Notes. The Company does not intend to list the Exchange Notes on any securities
exchange or to seek approval for quotation through any automated quotation
system. There can be no assurance that an active market for the Exchange Notes
will develop. To the extent that a market for the Exchange Notes does develop,
the market value of the Exchange Notes will depend upon many factors, including
prevailing interest rates, market conditions, yields on alternative investments,
general economic conditions, the Company's financial condition and results of
operations and other conditions. Such conditions might cause the Exchange Notes,
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to the extent that they are actively traded, to trade at a significant discount
from face value. See "Risk Factors--Absence of Public Market."
The Exchange Notes will bear interest at the same rate and on the same terms
as the Old 8.29% Notes. Consequently, cash interest on the Exchange Notes will
not accrue until February 1, 2003, and thereafter will accrue at a rate of 8.29%
per annum and will be payable semiannually in arrears commencing on August 1,
2003 and thereafter on February 1 and August 1 of each year; provided, however,
that the Company may elect to commence the accrual of cash interest on an
interest payment date on or after February 1, 2001 and prior to February 1,
2003, in which case the outstanding principal amount at maturity of each Note
will on such interest payment date be reduced to the Accreted Value of the Note
as of such interest payment date and cash interest will be payable on each
interest payment date thereafter. Amortization of original issue discount on
each Exchange Note should accrue from the date of original issue of the
surrendered Old Note (see "Certain United States Federal Income Tax
Considerations") and interest, if any, on each Exchange Note will accrue from
the last interest payment date on which interest was paid on the surrendered Old
Note or, if no interest has been paid on such Old Note, from the date on which
cash interest on such Old Note would begin to accrue. Consequently, holders
whose Old 8.29% Notes are accepted for exchange will be deemed to have waived
the right to receive any accrued but unpaid interest on the Old 8.29% Notes.
----------------
ADDITIONAL INFORMATION
The Company is required to file reports and other information with the
Securities and Exchange Commission (the "Commission") pursuant to the
information requirements of the Securities and Exchange Act of 1934, as amended
(the "Exchange Act"). The Company intends to furnish the holders of the Exchange
Notes with annual reports containing consolidated financial statements audited
by independent certified public accountants following the end of each fiscal
year and with quarterly reports containing unaudited financial information for
each of the first three quarters of each fiscal year following the end of such
quarter.
The Company has filed with the Commission a Registration Statement on Form S-4
under the Securities Act with respect to the Exchange Offer. As permitted by the
rules and regulations of the Commission, this Prospectus, which is a part of the
Registration Statement, omits certain information, exhibits, schedules and
undertakings set forth in the Registration Statement. For further information
pertaining to the Company and the securities offered hereby, reference is made
to such Registration Statement and the exhibits and schedules thereto.
Statements contained in this Prospectus as to the contents or provisions of any
documents referred to herein are not necessarily complete, and in each instance,
reference is made to the copy of the document filed as an exhibit to the
Registration Statement.
The Registration Statement may be inspected without charge at the office of
the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of the
Registration Statement may be obtained from the Commission at prescribed rates
from the Public Reference Section of the Commission at such address, and at the
Commission's regional offices located at 7 World Trade Center, 13th Floor, New
York, New York 10048, and at Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. In addition, registration
statements and certain other filings made with the Commission through its
Electronic Data Gathering, Analysis and Retrieval ("EDGAR") system are publicly
available through the Commission's site on the Internet's World Wide Web,
located at http://www.sec.gov.
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OLD NOTES IN ANY JURISDICTION IN WHICH
THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE WITH THE
SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements that include, among
others, statements concerning (a) the benefits expected to result from the
planned merger (the "LCI Merger") of a subsidiary of Qwest with and into LCI
International, Inc. ("LCI"), pursuant to which LCI would become a wholly owned
subsidiary of Qwest, including, without limitation, synergies in the form of
increased revenues, decreased expenses and avoided expenses and expenditures
that are expected to be realized by Qwest and LCI together after the closing of
the LCI Merger and (b) the complementary nature of LCI's customer and marketing
base and operational systems and the Qwest Network (as defined herein), (ii)
Qwest's plans to complete the Qwest Network, (iii) Qwest's expectations as to
funding Qwest's capital requirements, (iv) Qwest's anticipated expansion of
Carrier Services and Commercial Services (each as defined herein) and (v) other
statements of expectations, beliefs, future plans and strategies, anticipated
developments and other matters that are not historical facts. 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. Such risks and uncertainties
include those risks, uncertainties and risk factors identified, among other
places, under "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The most important factors that
could prevent the Company from achieving its stated goals include, but are not
limited to,(a) failure by Qwest and LCI to consummate the LCI Merger on a timely
basis or at all, (b) failure by Qwest to manage effectively, cost efficiently
and on a timely basis the construction of the Qwest Network route segments, (c)
failure by Qwest 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, (d) failure by Qwest to obtain and maintain
all necessary rights-of-way, (e) intense competition in Qwest's and LCI's
carrier services and commercial services markets and in LCI's residential
services markets, (f) the potential for rapid and significant changes in
technology and their effect on Qwest's and/or LCI's operations, (g) operating
and financial risks related to managing rapid growth and integrating acquired
businesses, (h) adverse changes in the regulatory environment affecting Qwest
and/or LCI, (i) risks of being highly leveraged and sustaining operating cash
deficits and (j) if the LCI Merger is consummated, failure by Qwest to integrate
the respective operations of Qwest and LCI or to achieve the synergies expected
from the LCI Merger.
The cautionary statements contained or referred to in this section should be
considered in connection with any subsequent written or oral forward-looking
statements that may be issued by Qwest or persons acting on its behalf. Qwest
does not undertakes any obligation to release publicly any revisions to any
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including the Historical Consolidated Financial Statements and the
notes thereto, appearing elsewhere in this Prospectus. A glossary of relevant
terms used in the telecommunications business is included at the end of this
Prospectus. References to "Qwest" or the "Company" mean Qwest Communications
International Inc. and its predecessors and subsidiaries, including Qwest
Communications Corporation ("QCC").
THE COMPANY
The Company is a facilities-based provider of multimedia 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 is expanding its existing long distance
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network into an approximately 16,250 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 ring architecture equipped with the most advanced
commercially available fiber and transmission electronics manufactured by Lucent
Technologies ("Lucent") 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 contracts for the sale of dark fiber along the route of
the Qwest Network, which will reduce Qwest's net cost per fiber mile with
respect to the fiber it retains for its own use. As a result of these cost
advantages, Qwest believes it will be well-positioned to capture market share
and take advantage of the rapidly growing demand for long haul voice and data
transmission capacity and services.
Under Qwest's current plan, the Qwest Network will extend approximately 16,250
route miles coast-to-coast and connect approximately 125 metropolitan areas that
represent approximately 80% of the originating and terminating long distance
traffic in the United States. Construction of the Qwest Network is scheduled to
be completed in 1999. Through a combination of the Qwest Network and leased
facilities, the Company will continue to offer interstate services in all 48
contiguous states. The Qwest Network will connect to three trans-Atlantic cable
heads and two trans-Pacific cable heads, as well as cross-border points to
Canada and Mexico. In addition to the 16,250 route mile U.S. network, the
Company recently extended its network to the United Kingdom through an exchange
of capacity for two 155 megabit circuits that will carry international data and
voice traffic between London and New York. The Company also is extending its
network approximately 1,400 route miles into Mexico through dark fiber to be
owned by the Company on the fiber optic system of a third party. Completion of
the Mexican network is scheduled for late 1998. These connections will allow the
Company to participate in the anticipated growth in demand for international
long distance data and voice services.
The Company believes that demand from interexchange carriers and other
communications entities for advanced, high bandwidth voice, data and video
transmission capacity will increase over the next several years due to
regulatory and technological changes and other industry developments. These
anticipated changes and developments include: (i) continued growth in capacity
requirements for high-speed data transmission, ATM and Frame Relay services,
Internet and multimedia services and other new technologies and applications;
(ii) continued growth in demand for existing long distance services; (iii) entry
into the market of new communications providers; (iv) requirements of the four
principal nationwide carriers (AT&T Corporation ("AT&T"), MCI Communications
Corporation ("MCI"), Sprint Corporation ("Sprint") and WorldCom, Inc.
("WorldCom")) to replace or augment portions of their older systems and (v)
reform in regulation of domestic access charges and international settlement
rates, which the Company expects will lower long distance rates and fuel primary
demand for long distance services. See "Industry Overview," "Business of Qwest"
and "Regulation."
The Company recently completed certain acquisitions and the Company has
previously announced the LCI Merger. See "Business of Qwest--Recent
Developments."
Qwest's principal executive offices are located at 1000 Qwest Tower, 555
Seventeenth Street, Denver, Colorado 80202, and its telephone number is (303)
291-1400.
THE EXCHANGE OFFER
The Exchange Offer... The Company is offering to exchange $1,000 principal
amount at maturity of Exchange Notes for each $1,000
principal amount at maturity of Old 8.29% Notes that is
properly tendered and accepted. The form and terms of
the Exchange Notes are the same as the form and terms of
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the Old 8.29% Notes except that (i) the exchange
will have been registered under the Securities Act and
therefore the Exchange Notes will not bear legends
restricting the transfer thereof, (ii) the interest,
interest rate step- up, original issue discount and
cash interest provisions will be modified or eliminated
as appropriate and (iii) holders of the Exchange Notes
will not be entitled to certain rights of holders of
the Old 8.29% Notes under the Registration Agreement
(as defined herein), which rights with respect to Old
8.29% Notes will terminate upon the consummation
of the Exchange Offer. See "--The Exchange Notes."
The issuance of the Exchange Notes is intended to
satisfy certain obligations of the Company contained
in the Registration Agreement. Subject to certain
conditions, a holder who wishes to tender must transmit
a properly completed and duly executed Letter of
Transmittal to Bankers Trust Company (the "Exchange
Agent") on or prior to the Expiration Date.
For procedures for tendering, see "The Exchange Offer."
Based upon no-action letters issued by the staff of the
Commission to third parties, the Company believes that
the Exchange Notes issued pursuant to the Exchange
Offer in exchange for Old 8.29% Notes would in
general be freely transferable after the Exchange
Offer without further registration under the Securities
Act if the holder of the Exchange Notes represents (i)
that it is not an "affiliate," as defined in Rule 405
of the Securities Act, of the Company, (ii) that it is
acquiring the Exchange Notes in the ordinary course
of its business and (ii) that it has no arrangement or
understanding with any person to participate in the
distribution (within the meaning of the Securities Act)
of the Exchange Notes; provided that, in the case
of broker-dealers, a prospectus meeting the
requirements of the Securities Act be delivered as
required. However, the Commission has not
considered the Exchange Offer in the context of a
no-action letter and there can be no assurance that the
staff of the Commission would make a similar
determination with respect to the Exchange Offe as in
such other circumstances. Holders of Old 8.29% Notes
wishing to accept the Exchange Offer must represent to
the Company that such conditions have been met. Each
broker-dealer that receives Exchange Notes for its own
account pursuant to the Exchange Offer, where it
acquired the Old 8.29% Notes exchanged for such
Exchange Notes for its own account as a result of
market-making or other trading activities, may be
deemed to be an "underwriter" within the meaning of the
Securities Act and must acknowledge that it will
deliver a prospectus in connection with the resale of
such Exchange Notes. See "The Exchange Offer--
Resale of the Exchange Notes" and "Plan of Distribution."
Registration
Agreement........... The Old 8.29% Notes were sold by the Company on
January 29, 1998 to the Initial Purchaser pursuant to
the Purchase Agreement. Pursuant to the Purchase
Agreement, the Company and the Initial Purchaser
entered into the Registration Agreement. This Exchange
Offer is intended to satisfy certain obligations of the
Company contained in the Registration Agreement, which
terminate upon the consummation of the Exchange Offer.
The holders of the Exchange Notes are not entitled to
any exchange or registration rights with respect to the
Exchange Notes. The Old 8.29% Notes are subject to the
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<PAGE>
payment of additional interest under certain
circumstances if the Company is not in compliance with
its obligations under the Registration Agreement. See
"Description of the 8.29% Notes-- Exchange Offer;
Registration Rights."
Expiration Date...... The Exchange Offer will expire at 5:00 p.m., New York
City time, on the "Expiration Date." As used herein, the
term "Expiration Date" means 5:00 p.m., New York City
time, on [_____day, _______], 1998; provided, however,
that if the Company, in its sole discretion, has
extended the period of time for which the Exchange Offer
is to remain open, the term "Expiration Date" means the
latest time and date to which the Exchange Offer is
extended; provided further that in no event will the
Exchange Offer be extended beyond [_______], 1998.
Withdrawal........... Tenders of Old 8.29% Notes pursuant to the Exchange
Offer may be withdrawn at any time prior to the
Expiration Date by sending a written notice of
withdrawal to the Exchange Agent. Any Old 8.29% Notes so
withdrawn will be deemed not to have been validly
tendered for exchange for purposes of the Exchange
Offer. Any Old 8.29% Notes not accepted for exchange for
any reason will be returned without expense to the
tendering holder thereof as promptly as practicable
after the expiration or termination of the Exchange
Offer. See "The Exchange Offer--Terms of the Exchange
Offer; Period for Tendering Old 8.29% Notes."
Certain Conditions
to the Exchange
Offer............... The Exchange Offer is subject to certain customary
conditions, which may be waived by the Company. See "The
Exchange Offer--Certain Conditions to the Exchange
Offer."
Federal Income Tax
Consequences........ In the opinion of counsel to the Company, the exchange
of the Old 8.29% Notes for Exchange Notes pursuant to
the Exchange Offer should not constitute a taxable
exchange for federal income tax purposes. See "Certain
United States Federal Income Tax Considerations."
Use of Proceeds...... There will be no proceeds to the Company from the
exchange pursuant to the Exchange Offer.
Exchange Agent....... Bankers Trust Company is serving as Exchange Agent in
connection with the Exchange Offer.
CONSEQUENCES OF FAILURE TO EXCHANGE OLD NOTES
Holders of Old 8.29% Notes who do not exchange their Old 8.29% Notes for
Exchange Notes pursuant to the Exchange Offer will continue to be subject to the
restrictions on transfer of such Old 8.29% Notes as set forth in the legends
thereon as a consequence of the issuance of the Old 8.29% Notes pursuant to
exemptions from, or in transactions not subject to, the registration
requirements of the Securities Act and applicable state securities laws.
Accordingly, such Old 8.29% Notes may only be offered, sold, pledged or
otherwise transferred (A)(i) to a person whom the seller reasonably believes is
a qualified institutional buyer within the meaning of Rule 144A under the
Securities Act ("Rule 144A") in a transaction meeting the requirements of Rule
144A, (ii) in an offshore transaction meeting the requirements of Rule 903 or
Rule 904 of Regulation S under the Securities Act, or (iii) pursuant to an
exemption from registration under the Securities Act provided by Rule 144
thereunder (if available) and (B) in accordance with all applicable securities
laws of the states of the United States. The Company does not anticipate that it
8
<PAGE>
will register the Old 8.29% Notes under the Securities Act. See "Risk
Factors--Consequences of Failure to Exchange Old 8.29% Notes" and "The Exchange
Offer--Consequences of Failure to Exchange."
THE EXCHANGE NOTES
The form and terms of the Exchange Notes are identical in all material
respects to the form and terms of the Old 8.29% Notes except that (i) the
exchange will have been registered under the Securities Act and therefore the
Exchange Notes will not bear legends restricting the transfer thereof, (ii) the
interest, interest rate step-up, original issue discount and cash interest
provisions will be modified or eliminated as appropriate and (iii) holders of
the Exchange Notes will not be entitled to certain rights of holders of the Old
8.29% Notes under the Registration Agreement, which rights with respect to Old
8.29% Notes will terminate upon the consummation of the Exchange Offer. See
"Description of the 8.29% Notes--Exchange Offer; Registration Rights." The
Exchange Notes will evidence the same debt as the Old 8.29% Notes (which they
replace) and will be issued under, and be entitled to the benefits of, the
Indenture. See "Description of the 8.29% Notes" for further information and for
definitions of certain capitalized terms used below.
In the Exchange Offer, the holders of Old 8.29% Notes will receive Exchange
Notes with the same interest rate as the interest rate on the Old 8.29% Notes.
Amortization of original issue discount on each Exchange Note should accrue from
the date of original issue of the surrendered Old 8.29% Note (see "Certain
United States Federal Income Tax Considerations") and interest, if any, on each
Exchange Note will accrue from the last interest payment date on which interest
was paid on the surrendered Old 8.29% Note or, if no interest has been paid on
such Old 8.29% Note, from the date on which cash interest on such Old 8.29% Note
would begin to accrue. Consequently, holders whose Old 8.29% Notes are accepted
for exchange will be deemed to have waived the right to receive any accrued but
unpaid interest on the Old 8.29% Notes.
The 8.29% Notes............ The Old 8.29% Notes were issued at an issue price
of $665.92 per $1,000 stated principal amount at
maturity and generated gross proceeds to the
Company of approximately $300.0 million. The 8.29%
Notes will accrete at a rate of 8.29% per annum,
compounded semiannually, to an aggregate principal
amount of $450,505,000 by February 1, 2008
(subject to the Company's option to elect to
commence the accrual of cash interest as provided
herein). The 8.29% Notes will mature on February
1, 2008. The yield to maturity of the 8.29% Notes
is 8.29% per annum (computed on a semiannual bond
equivalent basis) calculated from January 22,
1998.
Interest............... Cash interest on the 8.29% Notes will not accrue
until February 1, 2003, and thereafter will accrue
at a rate of 8.29% per annum and will be payable
semiannually in arrears commencing on August 1,
2003 and thereafter on February 1 and August 1 of
each year; provided, however, that Qwest may
elect, upon not less than 60 days' prior notice,
to commence the accrual of cash interest on all
outstanding 8.29% Notes on any interest payment
date on or after February 1, 2001 and prior to
February 1, 2003.
Ranking............... The 8.29% Notes are senior unsecured obligations of
Qwest, ranking pari passu in right of payment with
all existing and future senior unsecured
indebtedness of Qwest, including the 10 7/8% Notes
and the 9.47% Notes, and are senior in right of
payment to all existing and future
9
<PAGE>
indebtednes of Qwest expressly subordinated in
right of payment to the 8.29% Notes. The 8.29%
Notes are not secured by any assets and are
effectively subordinated to any future secured
indebtedness of Qwest to the extent of the value
of the assets securing such indebtedness. As of
December 31, 1997, on a pro forma basis, after
giving effect to the sale of the 8.29% Notes,
Qwest would have had approximately $906.9 million
of indebtedness outstanding, none of which would
have constituted secured indebtedness. The
8.29% Notes are effectively subordinated to all
existing and future third-party indebtedness and
other liabilities of Qwest's subsidiaries
(including trade payables). As of December 31,
1997, on a pro forma basis as if the acquisitions
of Phoenix and LCI had been consummated at that
date, the total liabilities of Qwest's
subsidiaries (after the elimination of loans
and advances by Qwest to its subsidiaries) would
have been approximately $1,435.0 million. Of that
amount, approximately $83.2 million in
indebtedness was secured by certain assets of
the borrowers. See "Description of Certain
Indebtedness." Any rights of Qwest and its
creditors, including the holders of 8.29% Notes,
to participate in the assets of any of Qwest's
subsidiaries upon any liquidation or reorganization
of any such subsidiary will be subject to the
prior claims of that subsidiary's creditors
(including trade creditors).
Sinking Fund............. None.
Optional Redemption...... The 8.29% Notes will be redeemable at the
option of Qwest, in whole or in part, at any
time or from time to time, on or after
February 1, 2003, upon not less than 30 nor
more than 60 days' notice, at the redemption
prices set forth herein, plus accrued and
unpaid interest thereon (if any) to the
redemption date. In addition, prior to
February 1, 2001, Qwest may redeem up to 35%
of the Accreted Value (as defined) of the
8.29% Notes at a redemption price equal to
108.29% of the Accreted Value at the
redemption date of the 8.29% Notes so
redeemed, plus accrued and unpaid interest
thereon (if any) to the redemption date,
with the net proceeds of one or more Public
Equity Offerings (as defined) resulting in
gross proceeds of at least $100.0 million in
the aggregate; provided that at least 65% of
the Accreted Value of the originally issued
8.29% Notes would remain outstanding
immediately after any such redemption.
Original Issue Discount.. The 8.29% Notes are issued with substantial
amounts of original issue discount for
United States federal income tax purposes.
Thus, although there will be no periodic
payments of cash interest on the 8.29% Notes
10
<PAGE>
prior to August 1, 2003 (subject to Qwest's
option to elect to commence the accrual of cash
interest on or after February 1, 2001), original
issue discount (i.e., the difference between
the stated redemption price at maturity and the
issue price of the 8.29% Notes) will accrue from
the issue date and will be includable as
interest income periodically in a holder's
gross income for United States federal
income tax purposes in advance of
receipt of the cash payments to which the
income is attributable. See "Certain United
States Federal Income Tax Considerations."
Change of Control......... Within 30 days of the occurrence of a Change of
Control (as defined), Qwest will be required to
make an Offer to Purchase (as defined) all
outstanding 8.29% Notes at a price in cash equal
to 101% of the Accreted Value of the 8.29% Notes
on the purchase date plus any accrued and unpaid
interest and premium, if any, not otherwise
included in the Accreted Value to such purchase
date. Qwest may not have the financial resources
necessary to satisfy its obligations to repurchase
the 8.29% Notes and other debt that may become
repayable upon a Change of Control. See
"Description of the 8.29% Notes--Certain
Covenants--Change of Control."
Certain Covenants......... The Indenture contains certain covenants that,
among other things, limit the ability of Qwest and
its subsidiaries to incur additional indebtedness,
issue stock of subsidiaries, pay dividends or make
other distributions, repurchase equity interests
or subordinated indebtedness, engage in sale and
leaseback transactions, create certain liens,
enter into certain transactions with affiliates,
sell assets of Qwest and its subsidiaries, and
enter into certain mergers and consolidations. The
covenants contained in the Indenture are subject
to certain significant exceptions. See
"Description of the 8.29% Notes"Certain
Covenants."
For additional information concerning the 8.29% Notes and the definitions of
certain capitalized terms used above, see "Description of the 8.29% Notes" and
"Description of the 8.29% Notes--Exchange Offer; Registration Rights."
RISK FACTORS
Prospective participants in the Exchange Offer should consider all the
information contained in this Prospectus in connection with the Exchange Offer.
In particular, prospective participants should consider the factors set forth
herein under "Risk Factors."
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected data presented below under the captions "Statement of
Operations and Other Financial Data" and "Summary Balance Sheet Data" as of the
end of and for each of the years in the five-year period ended December 31, 1997
have been taken or derived from the historical audited Consolidated Financial
Statements of the Company. Consolidated Financial Statements of the Company as
of December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997 are included elsewhere in this Prospectus. The
information set forth below should be read in conjunction with the discussion
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations," "Business" and the Historical Consolidated Financial Statements
and the unaudited Pro Forma Combined Financial Statements of the Company and the
notes thereto, appearing elsewhere in this Prospectus.
11
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS AND
OTHER
FINANCIAL DATA:
Total revenue............... $ 69,327 $ 70,873 $125,102 $230,996 $ 696,703
Total operating expenses.... 80,247 81,488 161,158 243,010 673,222
Earnings (loss) from
operations................. (10,920) (10,615) (36,056) (12,014) 23,481
Other income (expense)(1)... 122,631 (70) (2,411) 1,813 99
Earnings (loss) before
income taxes............... 111,711 (10,685) (38,467) (10,201) 23,580
Net earnings (loss)......... $ 68,526 $ (6,898) $(25,131) $ (6,967) $ 14,523
======== ======== ======== ======== =========
Earnings (loss) per share--
basic...................... $ 0.40 $ (0.04) $ (0.15) $ (0.04) $ 0.08
Earnings (loss) per share--
diluted.................... $ 0.40 $ (0.04) $ (0.15) $ (0.04) $ 0.07
EBITDA(2)................... $ (824) $ (6,338) $(26,007) $ 6,912 $ 41,733
Net cash provided by (used
in) operating activities... $ (7,125) $ 3,306 $(56,635) $ 32,524 $ (36,488)
Net cash provided by (used
in) investing activities... $107,496 $(41,712) $(58,858) $(52,622) $(356,824)
Net cash provided by (used
in) financing activities... $(95,659) $ 34,264 $113,940 $ 25,519 $ 766,191
Capital expenditures(3)..... $ 3,794 $ 40,926 $ 48,732 $ 85,842 $ 444,659
Ratio of earnings to fixed
charges (4) 5.68 - - - 1.15
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
SUMMARY BALANCE SHEET DATA:
Total assets....................... $60,754 $89,489 $184,178 $262,551 $1,398,105
Long-term debt..................... $ 2,141 $27,034 $ 68,793 $109,268 $ 630,463
Total stockholders' equity(5)...... $12,079 $24,581 $ 26,475 $ 9,442 $ 381,744
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
-----------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING DATA:
Route miles of conduit installed............ 3,200 3,650 9,500
Route miles of lit fiber installed.......... 580 900 3,400
Total minutes of use(6)..................... 237,000,000 382,000,000 669,000,000
</TABLE>
12
<PAGE>
- --------
(1) In November 1993, Qwest sold substantially all of its then owned fiber optic
network capacity and related equipment and assets to a third-party purchaser
for $185.0 million (the "1993 Capacity Sale"). After deducting the carrying
value of the assets sold and direct costs associated with the 1993 Capacity
Sale, Qwest recognized a gain of approximately $126.5 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business."
(2) EBITDA represents net earnings (loss) before interest, income taxes,
depreciation and amortization, a nonrecurring expense of $2.6 million in the
year ended December 31, 1996 to restructure operations, the gain on sale of
telecommunications agreements of $6.1 million (which is non-recurring) in
the year ended December 31, 1996, and the gain on sale of contract rights of
approximately $9.3 million (which is non-recurring) in the year ended
December 31, 1997. EBITDA includes earnings from the construction
contracts for the sale of dark fiber that the Company will use to provide
cash for the construction cost 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. Without
the effect of Growth Share Plan (as defined below) expense, EBITDA would
have been $115.2 million, $20.0 million, and $1.8 million for the years
ended December 31, 1997, 1996 and 1993, respectively.
(3) Capital expenditures include expenditures for property and equipment,
accrued capital expenditures, capital expenditures financed with the
equipment credit facility and initial obligations under capital leases.
(4) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of earnings (loss) before income taxes, plus fixed charges
excluding capitalized interest. Fixed charges consist of interest expensed
and capitalized, plus amortization of deferred financing costs, plus the
portion of rent expense under operating leases deemed by the Company to be
representative of the interest factor, plus preferred stock dividends on
preferred stock of QCC (increased to an amount representing the pre-tax
earnings which would be required to cover such dividend requirements). The
Company had a deficiency of earnings to fixed charges of $12.6 million,
$40.3 million and $11.0 million in 1996, 1995 and 1994, respectively.
(5) Qwest has not declared or paid cash dividends on its Common Stock since
becoming a public company in June 1997 (the "Initial Public Offering").
(6) Represents total minutes of use for the years ended December 31, 1997, 1996
and 1995.
RISK FACTORS
In addition to the other information in this Prospectus, the following risk
factors should be considered carefully in evaluating the Company and its
business before participating in the Exchange Offer.
Consequences of Failure to Exchange Old Notes
The Exchange Notes will be issued in exchange for Old 8.29% Notes only after
timely receipt by the Exchange Agent of such Old 8.29% Notes, a properly
completed and duly executed Letter of Transmittal and all other required
documents. Therefore, holders of Old 8.29% Notes desiring to tender such Old
8.29% Notes in exchange for Exchange Notes should allow sufficient time to
ensure timely delivery. Neither the Exchange Agent nor the Company is under any
duty to give notification of defects or irregularities with respect to tenders
of Old 8.29% Notes for exchange. Holders of Old 8.29% Notes who do not exchange
their Old 8.29% Notes for Exchange Notes pursuant to the Exchange Offer will
continue to be subject to the restrictions on transfer of such Old 8.29% Notes
as set forth in the legends thereon as a consequence of the issuance of the Old
8.29% Notes pursuant to exemption from, or in transactions not subject to, the
registration requirements of the Securities Act and applicable state securities
laws. In general, the Old 8.29% Notes may not be offered or sold, unless
registered under the Securities Act, except pursuant to an exemption from, or in
a transaction not subject to, the Securities Act and applicable securities laws
of states and other jurisdictions. In addition, any holder of Old 8.29% Notes
who tenders in the Exchange Offer for the purpose of participating in a
distribution of the Exchange Notes will be required to comply with the
registration and prospectus delivery requirements of the Securities Act in
13
<PAGE>
connection with any resale transaction. Each broker-dealer that receives
Exchange Notes for its own account in exchange for Old 8.29% Notes, where such
Old 8.29% Notes were acquired by such broker-dealer as a result of market-making
activities or any other trading activities, may be deemed to be an "underwriter"
within the meaning of the Securities Act and must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. See
"Plan of Distribution," "Description of the 8.29% Notes--Exchange Offer;
Registration Rights," and "The Exchange Offer--Consequences of Failure to
Exchange."
Absence of Public Market
The Exchange Notes are being offered to the holders of the Old 8.29% Notes.
The Old 8.29% Notes were resold by the Initial Purchaser to (i) qualified
institutional buyers pursuant to Rule 144A under the Securities Act and (ii)
qualified buyers outside the United States in reliance upon Regulation S under
the Securities Act. The Old 8.29% Notes are eligible for trading in the Private
Offerings, Resales and Trading through Automated Linkages ("PORTAL") Market, the
National Association of Securities Dealers' screen based, automated market for
trading of securities eligible for resale under Rule 144A. The Exchange Notes
are new securities for which there currently is no market and the Exchange Offer
is not conditioned upon any minimum or maximum aggregate principal amount of
8.29% Notes being tendered for exchange. Although the Initial Purchaser is
making a market in the Old 8.29% Notes and has advised the Company that it
currently intends to make a market in the Exchange Notes, it is not obligated to
do so and may discontinue such market making at any time without notice. The
Company does not currently intend to apply for listing of the Old 8.29% Notes or
the Exchange Notes on a national securities exchange or automated quotation
system. Accordingly, no assurance can be given that an active market will
develop for any of the Notes or as to the liquidity of the trading market for
any of the 8.29% Notes. If a trading market does not develop or is not
maintained, holders of the 8.29% Notes may experience difficulty in reselling
such 8.29% Notes or may be unable to sell them at all. If a market for the 8.29%
Notes develops, any such market may be discontinued at any time. To the extent
that a market for the 8.29% Notes does develop, the market value of the 8.29%
Notes will depend upon many factors, including prevailing interest rates, market
conditions, yields on alternative investments, general economic conditions, the
Company's financial condition and results of operations and other conditions.
Historically, the market for non-investment grade debt has been subject to
disruptions that have caused substantial volatility in the prices of securities
similar to the 8.29% Notes. There can be no assurance that, if a market for the
8.29% Notes were to develop, such a market would not be subject to similar
disruptions.
Risks Related to Completing the Qwest Network; Increasing Traffic Volume
Qwest's ability to achieve its strategic objective will depend in large part
upon the successful, timely and cost-effective completion of the Qwest Network,
as well as on achieving substantial traffic volumes on the Qwest Network. The
construction of the Qwest Network will be affected by a variety of factors,
uncertainties and contingencies, including Qwest's ability to manage effectively
and cost efficiently the construction of the route segments and obtain
additional rights-of-way. Many of these factors are beyond Qwest's control.
There can be no assurance that the entire Qwest Network will be completed as
planned for the costs and in the time frame currently estimated. Although Qwest
believes that its cost estimates and the build-out schedule are reasonable,
there can be no assurance that the actual construction costs or time required to
complete the Qwest Network will not substantially exceed current estimates. In
addition, Qwest must substantially increase its current traffic volume in order
to realize the anticipated cash flow, operating efficiencies and cost benefits
of the Qwest Network. There can be no assurance that Qwest will be able to
achieve such increased traffic volume. See "-- Competition" and "--Pricing
Pressures and Industry Capacity."
Operating Losses and Working Capital Deficits
14
<PAGE>
Qwest's operations have generated operating losses in recent years and
insufficient cash flow to enable it to meet its debt service requirements,
capital expenditures and other cash needs. Qwest had net earnings of
approximately $14.5 million for the year ended December 31, 1997 and a net loss
of approximately $7.0 million for the year ended December 31, 1996; and Qwest
had an accumulated deficit of approximately $31.9 million as of December 31,
1997. Although Qwest had positive working capital of approximately $408.5
million as of December 31, 1997, Qwest expects to incur approximately $592.0
million of total capital expenditures for the year ending December 31, 1998.
Qwest has had working capital deficits for each of the four fiscal years prior
to 1997.
Working capital deficits would limit Qwest's cash resources, resulting in
reduced liquidity. There can be no assurance that Qwest will be able to achieve
or sustain operating profitability to pay the principal of and interest on the
8.29% Notes. Qwest may require additional capital in order to offset operating
losses and working capital deficits and to support its strategic objective.
High Leverage; Ability to Service Indebtedness
The Company is highly leveraged. As of December 31, 1997, Qwest had
approximately $642.5 million of long-term debt (including the current portion
thereof) and stockholders' equity of approximately $381.7 million. As of
December 31, 1997, on a pro forma basis, as if the acquisitions of Phoenix and
LCI had been consummated at that date and as adjusted to give effect to the sale
of the 8.29% Notes in January 1998, Qwest would have had approximately $1,369.9
million of long-term debt (including the current portion thereof) and a
debt-to-equity ratio of .28 to 1.0. Certain debt instruments to which Qwest and
Qwest's subsidiaries are parties limit but do not prohibit the incurrence of
additional indebtedness by Qwest, and Qwest expects additional indebtedness to
be incurred by Qwest or its subsidiaries in the future. However, there can be no
assurance that Qwest will be successful in obtaining additional borrowings when
required, or that the terms of such indebtedness will not impair the ability of
Qwest to develop its business.
The Company's leverage could result in adverse consequences to the holders of
the 8.29% Notes. Such consequences may include, among other things: (i) the cash
generated by the Company's operations may be insufficient to meet the payment
obligations on the 8.29% Notes, in addition to paying other indebtedness and
obligations of the Company and its subsidiaries as they become due; (ii) the
Company's ability to obtain any necessary financing in the future for completion
of the Qwest Network or other purposes may be impaired; (iii) certain of the
future borrowings by Qwest or its subsidiaries may be at variable rates of
interest that could cause Qwest to be vulnerable to increases in interest rates;
(iv) the 10 7/8% Notes and the 9.47% Notes mature prior to the maturity of the
8.29% Notes and future indebtedness of Qwest's subsidiaries may mature prior to
the maturity of the 8.29% Notes; (v) the Company may be more leveraged than
certain of its competitors, which may be a competitive disadvantage; and (vi)
the Company's vulnerability to the effects of general economic downturns or to
delays or increases in costs of constructing the Qwest Network will be
increased. In addition, the Indenture and other debt instruments governing
existing and future indebtedness contain, or may contain, covenants that limit
the operating and financial flexibility of Qwest and its subsidiaries.
The ability of Qwest to meet its obligations will be subject to financial,
business and other factors, including factors beyond its control, such as
prevailing economic conditions. In addition, the ability of Qwest's operating
subsidiaries to pay dividends or to make other payments to Qwest may be
restricted by the terms of various credit arrangements entered into by such
operating subsidiaries, as well as legal restrictions, and such payments may
have adverse tax consequences. The debt instruments governing existing and
future indebtedness of Qwest contain, or may contain, covenants that limit the
operating and financial flexibility of Qwest and its subsidiaries. Failure to
generate sufficient cash flow may impair Qwest's ability to obtain additional
equity or debt financing or to meet its debt service requirements (including
those with respect to the 8.29% Notes). Although the Company currently
anticipates that it will repay the 8.29% Notes at maturity with cash flow from
operations, there can be no assurance in this regard.
15
<PAGE>
Failure to generate sufficient cash flow may impair the Company's ability to
obtain additional equity or debt financing or to meet its debt service
requirements, including the payment obligations under the 8.29% Notes. In such
circumstances, Qwest may be required to renegotiate the terms of the instruments
relating to its long-term debt or to refinance all or a portion thereof. There
can be no assurance that Qwest would be able to renegotiate successfully such
terms or refinance its indebtedness when required or that the terms of any such
refinancing would be acceptable to management. If Qwest were unable to refinance
its indebtedness or obtain new financing under these circumstances, it would
have to consider other options such as the sale of certain assets to meet its
debt service obligations, the sale of equity, negotiations with its lenders to
restructure applicable indebtedness or other options available to it under the
law. See "Management's Discussion And Analysis of Financial Condition and
Results of Operations."
Uncertainties in Integrating Qwest and LCI and Realizing LCI Merger Benefits
Qwest and LCI have entered into an Agreement and Plan Of Merger dated as of
March 8, 1998 (The "LCI Merger Agreement") with the expectation that the LCI
Merger will result in benefits including, without limitation, operating
efficiencies, cost savings and other synergies. Achieving the benefits of the
LCI Merger will depend in part upon the integration of the businesses of Qwest
and LCI in an efficient manner. Qwest has not previously had significant
experience integrating the operations of acquired companies, as Qwest's only
acquisitions since the Initial Public Offering have been the SuperNet
transaction, which was consummated in October 1997, the Phoenix transaction,
which was consummated in March 1998, and the EUnet transaction, which was
consummated in April 1998. In addition, the consolidation of operations will
require substantial attention from management. The diversion of management
attention and any difficulties encountered in the transition and integration
process could have a material adverse effect on the revenues, levels of expenses
and operating results of the combined company. No assurance can be given that
Qwest will succeed in integrating the operations of LCI without encountering
difficulties or that the expected operating efficiencies, cost savings,
synergies and other benefits from such integration will be realized.
Risks Relating to the Renegotiation of Lci Debt
LCI has two revolving credit facilities (collectively, the "LCI Credit
Facilities"), three discretionary lines of credit (collectively, the "LCI Lines
of Credit") and a receivables securitization program (the "LCI Securitization
Program") as sources of capital to fund operations. LCI maintains the LCI
Securitization Program to sell a percentage ownership interest in a defined pool
of LCI's trade accounts receivable. In addition, LCI has entered into an
operating lease agreement for a headquarters building in Arlington, Virginia
(the "LCI Headquarters Lease"). The LCI Headquarters Lease includes a maximum
residual guarantee of $62.0 million.
The consummation of the LCI Merger will constitute a change in control of LCI,
which is an event of default under the LCI Credit Facilities and the LCI
Securitization Program. In addition, an event of default under the LCI Credit
Facilities also constitutes an event of default under the LCI Headquarters
Lease. The LCI Lines of Credit are discretionary lines which may be discontinued
at any time at the sole discretion of the providing banks. Certain other debt
securities issued by LCI permit mergers and consolidations, subject to
compliance with certain terms of the governing indenture.
There can be no assurance that Qwest will be able to renegotiate the terms of
the LCI Credit Facilities, the LCI Securitization Program or the LCI
Headquarters Lease on terms and conditions similar to the current arrangements,
or that the syndicate of banks and other parties which have participated in
these arrangements with LCI will renegotiate such arrangements or enter into
similar arrangements with Qwest after the LCI Merger. There also can be no
assurance that the LCI Lines of Credit will continue to be extended by the
respective commercial banks after the LCI Merger.
Holding Company Structure; Effective Subordination of the 8.29% Notes
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Qwest is a holding company with no material assets other than the stock of its
subsidiaries, and the 8.29% Notes will be obligations exclusively of Qwest. The
8.29% Notes are unsecured and rank pari passu in right of payment with all
existing and future senior unsecured indebtedness and trade payables of Qwest,
including the 10 7/8% Notes and the 9.47% Notes. Because Qwest's operations are
conducted through its subsidiaries, Qwest's cash flow and its ability to meet
its own obligations, including payment of interest and principal obligations on
the 8.29% Notes, are dependent upon the earnings of such subsidiaries and the
distributions of those earnings to Qwest, or upon loans or other payments of
funds made by such subsidiaries to Qwest. Existing debt agreements of Qwest's
subsidiaries impose, and future debt instruments of Qwest's subsidiaries likely
will impose, significant restrictions that affect, among other things, the
ability of Qwest's subsidiaries to pay dividends or make other distributions or
loans and advances to Qwest. The ability of Qwest's subsidiaries to pay
dividends and make other distributions also will be subject to, among other
things, applicable state laws. See "Description of Certain Indebtedness."
The operating assets of the Company are owned by Qwest's subsidiaries,
effectively subordinating the 8.29% Notes to all existing and future
indebtedness, trade payables and other obligations of Qwest's subsidiaries.
Therefore, Qwest's rights and the rights of its creditors, including the holders
of the 8.29% Notes, to participate in the assets of any subsidiary upon the
subsidiary's liquidation or reorganization will be subject to the prior claims
of such subsidiary's creditors, except to the extent that Qwest may itself be a
creditor with recognized claims against the subsidiary, in which case the claims
of Qwest would still be effectively subordinated to any security interests in or
mortgages or other liens on the assets of such subsidiary and would be
subordinate to any indebtedness of such subsidiary senior to that held by Qwest.
As of December 31, 1997, on a pro forma basis as if the acquisitions of Phoenix
and LCI had been consummated as of that date, the total liabilities of Qwest's
subsidiaries (after elimination of loans and advances by Qwest to its
subsidiaries) would have been approximately $1,435.0 million, of which
approximately $83.2 million in indebtedness was secured by certain assets of the
borrowers. In addition, as of December 31, 1997, the Company had future
obligations of approximately $100.8 million under long-term non-cancelable
operating leases, capacity service agreements and right-of-way agreements
requiring future minimum lease payments through the year 2028. The Indenture
limits, but does not prohibit, the incurrence of additional indebtedness by
Qwest and its subsidiaries. Therefore, both Qwest and its subsidiaries will
retain the ability to incur substantial additional indebtedness and lease
obligations, and Qwest expects that it or its subsidiaries may incur substantial
additional indebtedness in the future. See "Description of the 8.29%
Notes--Certain Covenants."
A portion of the assets of Qwest's subsidiaries is encumbered by
mortgages or other security interests or liens, including purchase money
equipment financings. Qwest expects that future indebtedness incurred by its
subsidiaries also may be secured. As a result, any claims of Qwest against its
subsidiaries will be effectively subordinated to indebtedness secured by the
mortgages or other security interests or liens on the assets of such
subsidiaries, which could have material consequences to holders of the 8.29%
Notes. Such security may include substantially all of the fixed assets of
Qwest's subsidiaries. The value of a substantial portion of such fixed assets is
derived from employing such assets in a telecommunications business. These
assets are highly specialized and, taken individually, can be expected to have
limited marketability. Consequently, in the event of a realization by secured
creditors on the assets of Qwest's subsidiaries, creditors would likely seek to
sell the business as a going concern in order to maximize the proceeds realized.
The price obtained upon any such sale could be adversely affected by the
necessity to obtain approval of the sale from the applicable regulatory
authorities and compliance with other applicable governmental regulations.
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Competition
The telecommunications industry is highly competitive. Many of Qwest's
existing and potential competitors have financial, personnel, marketing and
other resources significantly greater than those of Qwest, as well as other
competitive advantages. Increased consolidation and strategic alliances in the
industry resulting from the Telecommunications Act of 1996 (the
"Telecommunications Act") could give rise to significant new competitors to
Qwest.
The success of Qwest's business plan depends in large part on significant
increases in its share of the Carrier Services and Commercial Services markets
in the medium and long term. In the Carrier Services market, Qwest's primary
competitors are other carrier service providers. Within the Carrier Services
market, Qwest competes with large and small facilities-based interexchange
carriers. For high volume capacity services, Qwest competes primarily with other
coast-to-coast and regional fiber optic network providers. There are currently
four principal facilities-based long distance fiber optic networks (AT&T, MCI,
Sprint and WorldCom, although a proposed WorldCom/MCI merger is pending). Qwest
is aware that others are planning additional networks that, if constructed,
could employ similar advanced technology as the Qwest Network. In addition,
Qwest has sold dark fiber along major portions of the Qwest Network to Frontier
Corporation ("Frontier") and GTE Corporation ("GTE"). Accordingly, upon
completion of the Qwest Network, Frontier and GTE will each have a fiber network
similar in geographic scope and potential operating capability to that of Qwest.
Another competitor is constructing, and has already obtained a significant
portion of the financing for, a fiber optic network. As publicly announced, the
scope of such competitor's network is less than that of Qwest. Nevertheless, it
is expected to compete directly with the Qwest Network for many of the same
customers along a significant portion of the same routes. A carrier's carrier
announced in January 1998 that it plans to sell wholesale capacity on its fiber
optic network and that it has entered into an agreement with one of the RBOCs to
be the primary user of its network. Qwest believes that this network, although
potentially competitive, is different in operating capability from the Qwest
Network. Another potential competitor, a new telecommunications company, has
announced its intention to create a telecommunications network based on Internet
technology. Qwest also sells switched services to both facilities-based carriers
and nonfacilities-based carriers (switchless resellers), competing with
facilities-based carriers such as AT&T, MCI, Sprint, WorldCom and certain
regional carriers. Qwest competes in the Carrier Services market on the basis of
price, transmission quality, network reliability and customer service and
support. The ability of Qwest to compete effectively in this market will depend
upon its ability to maintain high quality services at prices equal to or below
those charged by its competitors. In the Commercial Services market, Qwest's
primary competitors include AT&T, MCI, Sprint and WorldCom, all of which have
extensive experience in the long distance market. On November 10, 1997, MCI and
WorldCom announced a proposed merger, and on March 11, 1998, the stockholders of
both companies approved the merger. The impact on Qwest of such a merger or
other consolidation in the industry is uncertain. In addition, the
Telecommunications Act will allow the RBOCs and others to enter the long
distance market. There can be no assurance that Qwest will be able to compete
successfully with existing competitors or new entrants in its Commercial
Services markets. Failure by Qwest to do so would have a material adverse effect
on Qwest's business, financial condition and results of operations.
Dependence on Significant Customers
Qwest has substantial business relationships with a few large customers.
During 1997 and 1996, Qwest's top ten customers accounted for approximately
83.6% and 69.3%, respectively, of its consolidated gross revenue. Frontier,
WorldCom and GTE accounted for 31.2%, 6.1% and 36.6% of such revenue in 1997,
respectively, and 26.3%, 27.8% and 0.0% of such revenue, respectively, in 1996,
attributable primarily to construction contracts for the sale of dark fiber to
these customers that extend through 1998 or into 1999 pursuant to the applicable
contract. In 1997, Qwest entered into two substantial construction contracts for
the sale of dark fiber to GTE. The Frontier and GTE contracts provide for
reduced payments and varying penalties for late delivery of route segments, and
allow the purchaser, after expiration of substantial grace periods (ranging
generally from 12 to 18 months depending on the reason for late delivery and the
segment affected), to delete such non- delivered segment from the system route
to be delivered. See
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"Business--The Qwest Network--Dark Fiber Sales." A default by any of Qwest's
dark fiber purchasers would require Qwest to seek alternative funding sources
for capital expenditures. A significant reduction in the level of services Qwest
provides for any of its large customers could have a material adverse effect on
Qwest's results of operations or financial condition. In addition, Qwest's
business plan assumes increased revenue from its Carrier Services operations to
fund the expansion of the Qwest Network. Many of Qwest's customer arrangements
are subject to termination on short notice and do not provide Qwest with
guarantees that service quantities will be maintained at current levels. Qwest
is aware that certain interexchange carriers are constructing or considering new
networks. Accordingly, there can be no assurance that any of Qwest's Carrier
Services customers will increase their use of Qwest's services, or will not
reduce or cease their use of Qwest's services, which could have a material
adverse effect on Qwest's ability to fund the completion of the Qwest Network.
Managing Rapid Growth
Part of Qwest's strategy is to achieve rapid growth by completing the Qwest
Network and using the Qwest Network to exploit opportunities expected to arise
from regulatory and technological changes and other industry developments.
Qwest's growth strategy also includes exploring opportunities for strategic
acquisitions, and in this regard, Qwest has completed two acquisitions since the
Initial Public Offering. See "Business--Strategy" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Overview." As a
result of its strategy, Qwest is experiencing rapid expansion that management
expects will continue for the foreseeable future. This growth has increased the
operating complexity of Qwest. Qwest's ability to manage its expansion
effectively will depend on, among other things: (i) expansion, training and
management of its employee base, including attracting and retaining highly
skilled personnel; (ii) expansion and improvement of Qwest's customer interface
systems and improvement or cost-effective outsourcing of Qwest's operational and
financial systems; (iii) development, introduction and marketing of new
products, particularly in Commercial Services; (iv) integration of acquired
operations and (v) control of Qwest's expenses related to the expansion of
Carrier Services and Commercial Services. Failure of Qwest to satisfy these
requirements, or otherwise manage its growth effectively, would have a material
adverse effect on Qwest's business, financial condition and results of
operations, including its ability to pay the principal of and interest on the
8.29% Notes.
Pricing Pressures and Industry Capacity
The long distance transmission industry has generally been characterized as
having overcapacity and declining prices since shortly after the AT&T
divestiture in 1984. Although Qwest believes that, in the last several years,
increasing demand has resulted in a shortage of capacity and slowed the decline
in prices, Qwest anticipates that prices for Carrier Services and Commercial
Services will continue to decline over the next several years due primarily to
(i) installation by Qwest and its competitors (certain of which are expanding
capacity and constructing or considering new networks) of fiber that provides
substantially more transmission capacity than will be needed over the short or
medium term, (ii) recent technological advances that permit substantial
increases in the transmission capacity of both new and existing fiber, and (iii)
strategic alliances or similar transactions, such as long distance capacity
purchasing alliances among certain RBOCs, that increase the parties' purchasing
power. Also, Qwest's existing construction contracts for the sale of dark fiber
and other potential contracts or arrangements with other carriers will increase
supply and may lower prices for traffic on the Qwest Network. Such pricing
pressure could have a material adverse effect on the business of Qwest and on
its financial condition and results of operations, including its ability to
complete the Qwest Network successfully and its ability to pay the principal of
and interest on the 8.29% Notes. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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Rapid Technological Changes
The telecommunications industry is subject to rapid and significant changes in
technology. For instance, recent technological advances permit substantial
increases in transmission capacity of both new and existing fiber, and the
introduction of new products or emergence of new technologies may reduce the
cost or increase the supply of certain services similar to those provided by
Qwest. While Qwest believes that for the foreseeable future technology changes
will neither materially affect the continued use of fiber optic cable nor
materially hinder Qwest's ability to acquire necessary technologies, the effect
of technological changes on Qwest's operations cannot be predicted and could
have a material adverse effect on Qwest's business, financial condition and
results of operations, including its ability to pay the principal of and
interest on the 8.29% Notes.
Need to Obtain and Maintain Rights-of-Way
Although as of December 31, 1997, Qwest already had right-of-way agreements
covering approximately 94% of the Qwest Network, Qwest must obtain additional
rights-of-way and other permits to install underground conduit from railroads,
utilities, state highway authorities, local governments and transit authorities.
There can be no assurance that Qwest will be able to maintain all of its
existing rights and permits or to obtain and maintain the additional rights and
permits needed to implement its business plan on acceptable terms. Loss of
substantial rights and permits or the ability to use such rights or the failure
to enter into and maintain required arrangements for the Qwest Network could
have a material adverse effect on Qwest's business, financial condition and
results of operations, including its ability to pay the principal of and
interest on the 8.29% Notes.
Regulation Risks
Qwest's operations are subject to extensive federal and state regulation.
Carrier Services and Commercial Services (but not Network Construction Services)
are subject to the provisions of the Communications Act of 1934, as amended,
including the Telecommunications Act and the FCC regulations thereunder, as well
as the applicable laws and regulations of the various states, including
regulation by PUCs and other state agencies. Generally, Qwest must obtain and
maintain certificates of authority from regulatory bodies in most states where
it offers intrastate services and must obtain prior regulatory approval of
tariffs for its intrastate services in most of these jurisdictions.
Regulation of the telecommunications industry is changing rapidly, and the
regulatory environment varies substantially from state to state. Moreover, as
deregulation at the federal level occurs, some states are reassessing the level
and scope of regulation that may be applicable to Qwest. Some of Qwest's
operations are also subject to a variety of environmental, safety, health and
other governmental regulations. There can be no assurance that future
regulatory, judicial or legislative activities will not have a material adverse
effect on Qwest.
The Telecommunications Act may have potentially significant effects on the
operations of Qwest. The Telecommunications Act, among other things, allows the
RBOCs and GTE to enter the long distance business and enables other entities,
including entities affiliated with power utilities and ventures between local
exchange carriers ("LECs") and cable television companies, to provide an
expanded range of telecommunications services. Entry of such companies into the
long distance business would result in substantial additional competition in
Commercial Services and Carrier Services, affecting Qwest and its customers,
which may have a material adverse effect on Qwest and such customers. However,
Qwest believes that entry by the RBOCs and other companies into the market will
create opportunities for Qwest to sell fiber or lease long distance high volume
capacity.
Qwest monitors compliance with federal, state and local regulations governing
the discharge and disposal of hazardous and environmentally
20
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sensitive materials, including the emission of electromagnetic radiation.
Although Qwest believes that it is in compliance with such regulations, there
can be no assurance that any such discharge, disposal or emission might not
expose Qwest to claims or actions that could have a material adverse effect on
Qwest. See "Regulation."
Reliance on Key Personnel
Qwest's operations are, and after the consummation of the LCI Merger will
continue to be, managed by certain key executive officers, the loss of any of
whom could have a material adverse effect on Qwest. Qwest believes that its
growth and future success will depend in large part on its continued ability to
attract and retain highly skilled and qualified personnel. The competition for
qualified personnel in the telecommunications industry is intense and,
accordingly, there can be no assurance that Qwest will be able to hire or retain
necessary personnel. The loss of senior management or the failure to recruit
additional qualified personnel in the future could significantly impede
attainment of Qwest's financial, expansion, marketing and other objectives. See
"Management."
Concentration of Voting Power; Potential Conflicts of Interest
Philip F. Anschutz, a director and Chairman of Qwest, beneficially owns
approximately 83.7% of the issued and outstanding shares of Qwest Common Stock.
As a result, Mr. Anschutz currently has, and even after the consummation of the
LCI Merger will continue to have, the power to elect all the directors of Qwest
and to control the vote on all other matters, including significant corporate
actions. Also, Mr. Anschutz is a director and holds approximately 5% of the
stock of Union Pacific Railroad Company, subsidiaries of which own railroad
rights-of-way on which a significant portion of the Qwest Network has been and
will be built. In recent years, Qwest has relied upon capital contributions,
advances and guarantees from Anschutz Company and affiliates. Qwest intends to
finance its own operations in the future through internally and externally
generated funds without financial support from its parent. See "--Operating
Losses and Working Capital Deficits" and "--High Leverage; Ability to Service
Indebtedness."
Original Issue Discount; Possible Unfavorable Tax and Other Legal Consequences
for Holders of 8.29% Notes and for Qwest
Because there will be no accrual of cash interest on the 8.29% Notes prior
to February 1, 2003 (subject to Qwest's option to elect to commence the accrual
of cash interest on or after February 1, 2001, and prior to February 1, 2003),
the 8.29% Notes are issued with a substantial amount of original issue discount
for United States federal income tax purposes. Consequently, purchasers of the
8.29% Notes will generally be required to include the original issue discount
(i.e., the difference between the stated redemption price at maturity and the
issue price of the 8.29% Notes) as interest income periodically in gross income
for United States federal income tax purposes in advance of receipt of the cash
payments to which the income is attributable. See "Certain United States Federal
Income Tax Considerations" for a more detailed discussion of the United States
federal income tax consequences applicable to certain purchasers of the 8.29%
Notes.
If a bankruptcy petition is filed by or against the Company under the
United States Bankruptcy Code after the issuance of the 8.29% Notes, the claim
of a holder of 8.29% Notes with respect to the principal amount thereof may be
limited to an amount equal to the sum of: (i) the initial offering price for the
8.29% Notes and (ii) that portion of the original issue discount that is not
deemed to constitute "unmatured interest" within the meaning of the United
States Bankruptcy Code. Any original issue discount that was not amortized as of
the date of any such bankruptcy filing would constitute "unmatured interest."
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THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
The Old 8.29% Notes were originally issued and sold on January 29, 1998 in an
offering that was exempt from registration under the Securities Act in reliance
upon the exemptions provided by Section 4(2), Rule 144A and Regulation S of the
Securities Act. Accordingly, the Old 8.29% Notes may not be reoffered, resold or
otherwise pledged, hypothecated or transferred in the United States unless so
registered or unless an exemption from the registration requirements of the
Securities Act and applicable state securities laws is available.
As a condition to the sale of the Old 8.29% Notes, the Company and the Initial
Purchaser entered into the Registration Agreement as of January 29, 1998.
Pursuant to the Registration Agreement, the Company agreed that it would (i)
file with the Commission a Registration Statement under the Securities Act with
respect to the Exchange Notes by April 29, 1998; (ii) use its best efforts to
cause such Registration Statement to be declared effective under the Securities
Act by June 28, 1998; and (iii) consummate an offer of the Exchange Notes in
exchange for surrender of the Old 8.29% Notes by July 28, 1998. A copy of the
Registration Agreement has been filed as an exhibit to the Registration
Statement of which this Prospectus is a part. The Registration Statement of
which this Prospectus is a part is intended to satisfy certain of the Company's
obligations under the Registration Agreement and the Purchase Agreement.
RESALE OF THE EXCHANGE NOTES
Based upon no-action letters issued by the staff of the Commission to third
parties, the Company believes that the Exchange Notes issued pursuant to the
Exchange Offer in exchange for Old 8.29% Notes would in general be freely
transferable after the Exchange Offer without further registration under the
Securities Act if the holder of the Exchange Notes represents (i) that it is not
an "affiliate," as defined in Rule 405 of the Securities Act, of the Company,
(ii) that it is acquiring the Exchange Notes in the ordinary course of its
business and (iii) that it has no arrangement or understanding with any person
to participate in the distribution (within the meaning of the Securities Act) of
the Exchange Notes; provided that, in the case of broker- dealers, a prospectus
meeting the requirements of the Securities Act be delivered as required.
However, the Commission has not considered the Exchange Offer in the context of
a no-action letter and there can be no assurance that the staff of the
Commission would make a similar determination with respect to the Exchange Offer
as in such other circumstances. Holders of Old 8.29% Notes wishing to accept the
Exchange Offer must represent to the Company that such conditions have been met.
Each broker-dealer that receives Exchange Notes for its own account pursuant to
the Exchange Offer, where it acquired the Old 8.29% Notes exchanged for such
Exchange Notes for its own account as a result of market-making or other trading
activities, may be deemed to be an "underwriter" within the meaning of the
Securities Act and must acknowledge that it will deliver a prospectus in
connection with the resale of such Exchange Notes. The Letter of Transmittal
states that by so acknowledging and by delivering a prospectus, a broker-dealer
will not be deemed to admit that it is an "underwriter" within the meaning of
the Securities Act. This Prospectus, as it may be amended or supplemented from
time to time, may be used by a broker-dealer in connection with resales of
Exchange Notes received in exchange for Old 8.29% Notes where such Old 8.29%
Notes were acquired by such broker- dealer as a result of market-making
activities or other trading activities. The Company has agreed that, for a
period of one year after consummation of the Exchange Offer, it will make this
Prospectus available to any broker- dealer for use in connection with any such
resale. A broker-dealer that delivers such a prospectus to purchasers in
connection with such resales will be subject to certain of the civil liability
provisions under the Securities Act, and will be bound by the provisions of the
Registration Agreement (including certain indemnification and contribution
rights and obligations). See "Plan of Distribution."
TERMS OF THE EXCHANGE OFFER; PERIOD FOR TENDERING OLD NOTES
Upon the terms and subject to the conditions set forth in this Prospectus and
in the accompanying Letter of Transmittal (which together constitute the
Exchange Offer), the Company will accept for exchange any and all Old 8.29%
Notes
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<PAGE>
which are properly tendered on or prior to the Expiration Date and not withdrawn
as permitted below. The Company will issue $1,000 principal amount at maturity
of Exchange Notes in exchange for each $1,000 principal amount at maturity of
outstanding Old 8.29% Notes surrendered pursuant to the Exchange Offer. Old
8.29% Notes may be tendered only in integral multiples of $1,000.
The form and terms of the Exchange Notes are the same as the form and terms of
the Old 8.29% Notes except that (i) the exchange will be registered under the
Securities Act and hence the Exchange Notes will not bear legends restricting
their transfer, (ii) the interest, interest rate step-up, original issue
discount and cash interest provisions will be modified or eliminated as
appropriate and (iii) holders of the Exchange Notes will not be entitled to
certain rights of holders of Old 8.29% Notes under the Registration Agreement,
which rights with respect to Old 8.29% Notes will terminate upon the
consummation of the Exchange Offer. The Exchange Notes will evidence the same
debt as the Old 8.29% Notes (which they replace) and will be issued under, and
be entitled to the benefits of, the Indenture.
As of the date of this Prospectus, an aggregate of $450,505,000 in principal
amount at maturity of the Old 8.29% Notes is outstanding. This Prospectus,
together with the Letter of Transmittal, is first being sent on or about May __,
1998, to all holders of Old 8.29% Notes known to the Company.
Holders of the Old 8.29% Notes do not have any appraisal or dissenters' rights
under the Indenture in connection with the Exchange Offer. The Company intends
to conduct the Exchange Offer in accordance with the provisions of the
Registration Agreement and the applicable requirements of the Securities Act,
the Exchange Act and the rules and regulations of the Commission thereunder. See
"Description of the 8.29% Notes--Exchange Offer; Registration Rights."
The Company expressly reserves the right, at any time or from time to time, to
extend the period of time during which the Exchange Offer is open, and thereby
delay acceptance for exchange of any Old 8.29% Notes, by giving written notice
of such extension to the holders thereof as described below. During any such
extension, all Old 8.29% Notes previously tendered will remain subject to the
Exchange Offer and may be accepted for exchange by the Company. Any Old 8.29%
Notes not accepted for exchange for any reason will be returned without expense
to the tendering holder thereof as promptly as practicable after the expiration
of the Exchange Offer.
The Company expressly reserves the right to amend or terminate the Exchange
Offer upon the occurrence of any of the conditions of the Exchange Offer
specified below under "--Certain Conditions of the Exchange Offer." The Company
will give written notice of any extension, amendment, nonacceptance or
termination to the holders of the Old 8.29% Notes as promptly as practicable,
such notice in the case of any extension to be issued by means of a press
release or other public announcement no later than 9:00 a.m., New York City
time, on the next business day after the previously scheduled Expiration Date.
PROCEDURES FOR TENDERING OLD NOTES
The tender to the Company of Old 8.29% Notes by a holder thereof as set forth
below and the acceptance thereof by the Company will constitute a binding
agreement between the tendering holder and the Company upon the terms and
subject to the conditions set forth in this Prospectus and in the accompanying
Letter of Transmittal. Except as set forth below, a holder who wishes to tender
Old 8.29% Notes for exchange pursuant to the Exchange Offer must transmit a
properly completed and duly executed Letter of Transmittal, including all other
documents required by such Letter of Transmittal, to the Exchange Agent at one
of the addresses set forth below under "--Exchange Agent" on or prior to the
Expiration Date. In addition, either (i) certificates for such Old 8.29% Notes
must be received by the Exchange Agent along with the Letter of Transmittal, or
(ii) a timely confirmation of a book-entry transfer including an Agent's Message
(a "Book-Entry Confirmation") of such Old 8.29% Notes, if such procedure is
available, into the Exchange Agent's account at The Depository
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<PAGE>
Trust Company (the "Book-Entry Transfer Facility") pursuant to the procedure for
book-entry transfer described below, must be received by the Exchange Agent
prior to the Expiration Date, or (iii) the holder must comply with the
guaranteed delivery procedures described below.
THE METHOD OF DELIVERY OF OLD NOTES, LETTERS OF TRANSMITTAL AND ALL OTHER
REQUIRED DOCUMENTS IS AT THE ELECTION AND RISK OF THE HOLDERS. IF SUCH DELIVERY
IS BY MAIL, IT IS RECOMMENDED THAT REGISTERED MAIL, PROPERLY INSURED, WITH
RETURN RECEIPT REQUESTED, BE USED. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE TIMELY DELIVERY. NO LETTERS OF TRANSMITTAL OR OLD NOTES SHOULD
BE SENT TO THE COMPANY.
Any beneficial owner whose Old 8.29% Notes are registered in the name of a
broker, dealer, commercial bank, trustee or other nominee and who wishes to
tender should contact such registered holder of Old 8.29% Notes promptly and
instruct such registered holder of Old 8.29% Notes to tender on behalf of the
beneficial owner. If such beneficial owner wishes to tender on its own behalf,
such beneficial owner must, prior to completing and executing the Letter of
Transmittal and delivering its Old 8.29% Notes, either make appropriate
arrangements to register ownership of the Old 8.29% Notes in such beneficial
owner's name or obtain a properly completed power of attorney from the
registered holder of Old 8.29% Notes. The transfer of record ownership may take
considerable time. If the Letter of Transmittal is signed by a person or persons
other than the registered holder or holders of Old 8.29% Notes, such Old 8.29%
Notes must be endorsed or accompanied by appropriate powers of attorney, in
either case signed exactly as the name or names of the registered holder or
holders that appear on the Old 8.29% Notes.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed unless the Old 8.29% Notes surrendered for exchange
pursuant thereto are tendered (i) by a registered holder of the Old 8.29% Notes
who has not completed the box entitled "Special Issuance Instructions" or
"Special Delivery Instructions" on the Letter of Transmittal or (ii) for the
account of an Eligible Institution (as defined herein below). In the event that
signatures on a Letter of Transmittal or a notice of withdrawal, as the case may
be, are required to be guaranteed, such guarantees must be by a firm which is a
member of a registered national securities exchange or a member of the National
Association of Securities Dealers, Inc. or by a commercial bank or trustee
having an office or correspondent in the United States (collectively, "Eligible
Institutions"). If Old 8.29% Notes are registered in the name of a person other
than a signer of the Letter of Transmittal, the Old 8.29% Notes surrendered for
exchange must be endorsed by, or be accompanied by a written instrument or
instruments of transfer or exchange, in satisfactory form as determined by the
Company in its sole discretion, duly executed by the registered holder with the
signature thereon guaranteed by an Eligible Institution.
All questions as to the validity, form, eligibility (including time of
receipt) and acceptance of Old 8.29% Notes tendered for exchange will be
determined by the Company in its sole discretion, which determination shall be
final and binding. The Company reserves the absolute right to reject any and all
tenders of any particular Old 8.29% Notes not properly tendered or not to accept
any particular Old 8.29% Notes whose acceptance might, in the judgment of the
Company or its counsel, be unlawful. The Company also reserves the absolute
right to waive any defects or irregularities or conditions of the Exchange Offer
as to any particular Old 8.29% Notes either before or after the Expiration Date
(including the right to waive the ineligibility of any holder who seeks to
tender Old 8.29% Notes in the Exchange Offer). The interpretation of the terms
and conditions of the Exchange Offer as to any particular Old 8.29% Notes either
before or after the Expiration Date (including the Letter of Transmittal and the
instructions thereto) by the Company shall be final and binding on all parties.
Unless waived, any defects or irregularities in connection with tenders of Old
8.29% Notes for exchange must be cured within such reasonable period of time as
the Company shall determine. Neither the Company, the Exchange Agent nor any
other person shall be under any duty to give notification of any defect or
irregularity with respect to any tender of Old 8.29% Notes for exchange, nor
shall any of them incur any liability for failure to give such notification.
24
<PAGE>
If the Letter of Transmittal or any Old 8.29% Notes or powers of attorney are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity, such persons should so indicate when signing, and, unless waived by
the Company, proper evidence satisfactory to the Company of their authority to
so act must be submitted.
By tendering, each holder will represent to the Company, among other things,
(i) that it is not an "affiliate," as defined in Rule 405 of the Securities Act,
of the Company, or if it is an affiliate, it will comply with the registration
and prospectus delivery requirements of the Securities Act to the extent
applicable, (ii) that it is acquiring the Exchange Notes in the ordinary course
of its business and (iii) at the time of the consummation of the Exchange Offer
it has no arrangement or understanding with any person to participate in the
distribution (within the meaning of the Securities Act) of the Exchange Notes.
If the holder is a broker-dealer that will receive Exchange Notes for its own
account in exchange for Old 8.29% Notes that were acquired as a result of
market-making activities or other trading activities, the holder may be deemed
to be an "underwriter" within the meaning of the Securities Act and is required
to acknowledge in the Letter of Transmittal that it will deliver a prospectus in
connection with any resale of such Exchange Notes; however, by so acknowledging
and by delivering a prospectus, the holder will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act.
ACCEPTANCE OF OLD NOTES FOR EXCHANGE; DELIVERY OF EXCHANGE NOTES
Upon satisfaction or waiver of all of the conditions to the Exchange Offer,
the Company will accept, promptly after the Expiration Date, all Old 8.29% Notes
properly tendered and will issue the Exchange Notes promptly after acceptance of
the Old 8.29% Notes. See "--Certain Conditions of the Exchange Offer" below. For
purposes of the Exchange Offer, the Company shall be deemed to have accepted
properly tendered Old 8.29% Notes for exchange when, as and if the Company has
given oral or written notice thereof to the Exchange Agent, with written
confirmation of any oral notice to be given promptly thereafter.
The Exchange Notes will bear interest at the same rate and on the same terms
as the Old 8.29% Notes. Consequently, cash interest on the Exchange Notes will
not accrue until February 1, 2003, and thereafter will accrue at a rate of 8.29%
per annum and will be payable semiannually in arrears commencing on August 1,
2003 and thereafter on February 1 and August 1 of each year; provided, however,
that the Company may elect to commence the accrual of cash interest on an
interest payment date on or after February 1, 2001 and prior to February 1,
2003, in which case the outstanding principal amount at maturity of each 8.29%
Note will on such interest payment date be reduced to the Accreted Value (as
defined) of the 8.29% Note as of such interest payment date and cash interest
will be payable on each interest payment date thereafter. Amortization of
original issue discount on each Exchange Note should accrue from the date of
original issue of the surrendered Old 8.29% Note (see "Certain United States
Federal Income Tax Considerations") and interest, if any, on each Exchange Note
will accrue from the last interest payment date on which interest was paid on
the surrendered Old 8.29% Note or, if no interest has been paid on such Old
8.29% Note, from the date on which cash interest on such Old 8.29% Note would
begin to accrue. Consequently, holders whose Old 8.29% Notes are accepted for
exchange will be deemed to have waived the right to receive any accrued but
unpaid interest on the Old 8.29% Notes.
In all cases, the issuance of Exchange Notes for Old 8.29% Notes that are
accepted for exchange pursuant to the Exchange Offer will be made only after
timely receipt by the Exchange Agent of certificates for such Old 8.29% Notes or
a timely Book-Entry Confirmation of such Old 8.29% Notes into the Exchange
Agent's account at the Book-Entry Transfer Facility, a properly completed and
duly executed Letter of Transmittal and all other required documents. If any
tendered Old 8.29% Notes are not accepted for any reason set forth in the terms
and conditions of the Exchange Offer, or if Old 8.29% Notes are submitted for a
greater amount than the holder desires to exchange, such unaccepted or
non-exchanged Old 8.29% Notes will be returned without expense to the tendering
holder thereof (or, in the case of Old 8.29% Notes tendered by book-entry
procedures described below, such non exchanged Old 8.29% Notes will be credited
to an account maintained with such Book-Entry
25
<PAGE>
Transfer Facility) designated by the tendering holder as promptly as practicable
after the expiration or termination of the Exchange Offer.
CERTAIN CONDITIONS OF THE EXCHANGE OFFER
Notwithstanding any other term of the Exchange Offer, the Company will not be
required to accept for exchange, or to issue Exchange Notes in exchange for, any
Old 8.29% Notes and may terminate or amend the Exchange Offer as provided herein
prior to the Expiration Date, if because of any changes in law, or applicable
interpretations thereof by the Commission, or because any action or proceeding
is instituted or threatened in any court or governmental agency with respect to
the Exchange Offer, the Company determines that it is not permitted to effect
the Exchange Offer.
Holders may have certain rights and remedies against the Company under the
Registration Agreement should the Company fail to consummate the Exchange Offer,
notwithstanding a failure of the conditions stated above. Such conditions are
not intended to modify those rights or remedies in any respect.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect to
the Old 8.29% Notes at the Book-Entry Transfer Facility for purposes of the
Exchange Offer within two business days after the date of this Prospectus, and
any financial institution that is a participant in the Book-Entry Transfer
Facility's systems may make book-entry delivery of Old 8.29% Notes by causing
the Book-Entry Transfer Facility to transfer such Old 8.29% Notes into the
Exchange Agent's account at the Book-Entry Transfer Facility in accordance with
such Book-Entry Transfer Facility's procedures for transfer. However, although
delivery of Old 8.29% Notes may be effected through book-entry transfer at the
Book- Entry Transfer Facility, the Letter of Transmittal or facsimile thereof,
or an Agent's Message, with any required signature guarantees and any other
required documents, must, in any case, be transmitted to and received by the
Exchange Agent at one of the addresses set forth below under "--Exchange Agent"
on or prior to the Expiration Date or the guaranteed delivery procedures
described below must be complied with.
The term "Agent's Message" means a message, transmitted by DTC to, and
received by, the Exchange Agent and forming a part of a book-entry confirmation,
which states that DTC has received an express acknowledgment from the tendering
participant, which acknowledgment states that such participant has received and
agrees to be bound by the terms of the Letter of Transmittal, and the
Corporation may enforce the Letter of Transmittal against such participant.
GUARANTEED DELIVERY PROCEDURES
If a registered holder of the Old 8.29% Notes desires to tender such Old 8.29%
Notes and the Old 8.29% Notes are not immediately available, or time will not
permit such holder's Old 8.29% Notes or other required documents to reach the
Exchange Agent before the Expiration Date, or the procedure for book-entry
transfer cannot be completed on a timely basis, a tender may be effected if (i)
the tender is made through an Eligible Institution, (ii) prior to the Expiration
Date, the Exchange Agent has received from such Eligible Institution a properly
completed and duly executed Letter of Transmittal (or a facsimile thereof) and
Notice of Guaranteed Delivery, substantially in the form provided by the Company
(by telegram, telex, facsimile transmission, mail or hand delivery), setting
forth the name and address of the holder of the Old 8.29% Notes and the amount
of Old 8.29% Notes, stating that the tender is being made thereby and
guaranteeing that within five trading days (on the Nasdaq Stock Market's
National Market (the "Nasdaq National Market")) after the date of execution of
the Notice of Guaranteed Delivery, the certificates for all physically tendered
Old 8.29% Notes, in proper form for transfer, or a Book-Entry Confirmation, as
the case may be, and any other documents required by the Letter of Transmittal
will be deposited by the Eligible Institution with the Exchange Agent, and (iii)
the certificates for all physically tendered Old 8.29% Notes, in proper form for
transfer, or a Book-Entry Confirmation, as the case may be, and all other
documents required by the Letter of Transmittal, are received by the Exchange
Agent within five Nasdaq National
26
<PAGE>
Market trading days after the date of execution of the Notice of Guaranteed
Delivery.
WITHDRAWAL RIGHTS
Tenders of Old 8.29% Notes may be withdrawn at any time prior to the
Expiration Date.
For a withdrawal to be effective, a written notice of withdrawal must be
received by the Exchange Agent at one of the addresses set forth below under
"--Exchange Agent." Any such notice of withdrawal must specify the name of the
person having tendered the Old 8.29% Notes to be withdrawn, identify the Old
8.29% Notes to be withdrawn (including the amount of such Old 8.29% Notes), and
(where certificates for Old 8.29% Notes have been transmitted) specify the name
in which such Old 8.29% Notes are registered, if different from that of the
withdrawing holder. If certificates for Old 8.29% Notes have been delivered or
otherwise identified to the Exchange Agent, then, prior to the release of such
certificates the withdrawing holder must also submit the serial numbers of the
particular certificates to be withdrawn and a signed notice of withdrawal with
signatures guaranteed by an Eligible Institution unless such holder is an
Eligible Institution. If Old 8.29% Notes have been tendered pursuant to the
procedure for book-entry transfer described above, any notice of withdrawal must
specify the name and number of the account at the Book-Entry Transfer Facility
to be credited with the withdrawn Old 8.29% Notes and otherwise comply with the
procedures of such facility. All questions as to the validity, form and
eligibility (including time of receipt) of such notices will be determined by
the Company whose determination shall be final and binding on all parties. Any
Old 8.29% Notes so withdrawn will be deemed not to have been validly tendered
for exchange for purposes of the Exchange Offer. Any Old 8.29% Notes which have
been tendered for exchange but which are not exchanged for any reason will be
returned to the holder thereof without cost to such holder (or, in the case of
Old 8.29% Notes tendered by book-entry transfer into the Exchange Agent's
account at the Book-Entry Transfer Facility pursuant to the book-entry transfer
procedures described above, such Old 8.29% Notes will be credited to an account
with such Book-Entry Transfer Facility specified by the holder) as soon as
practicable after withdrawal, rejection of tender or termination of the Exchange
Offer. Properly withdrawn Old 8.29% Notes may be retendered by following one of
the procedures described under "--Procedures for Tendering Old 8.29% Notes"
above at any time on or prior to the Expiration Date.
EXCHANGE AGENT
Bankers Trust Company has been appointed as the Exchange Agent for the
Exchange Offer. All executed Letters of Transmittal should be directed to the
Exchange Agent at the addresses set forth below. Questions and requests for
assistance, requests for additional copies of this Prospectus or of the Letter
of Transmittal and requests for Notices of Guaranteed Delivery should be
directed to the Exchange Agent addressed as follows:
Delivery To: Bankers Trust Company, Exchange Agent
BY MAIL: BY HAND:
BT Services Tennessee, Inc. Bankers Trust Company
Reorganization Unit Corporate Trust and Agency Group
P.O. Box 292737 Receipt & Delivery Window
Nashville, TN 37229-2737 123 Washington Street, 1st Floor
New York, NY 10006
For information, call:
(800) 735-7777
Confirm: (615) 835-3572
Fax: (615) 835-3701
BY OVERNIGHT MAIL OR COURIER:
BT Services Tennessee, Inc.
Corporate Trust and Agency Group
Reorganization Unit
648 Grassmere Park Road
Nashville, TN 37211
27
<PAGE>
DELIVERY OF A LETTER OF TRANSMITTAL TO AN ADDRESS OTHER THAN AS SET FORTH
ABOVE OR TRANSMISSION OF INSTRUCTIONS VIA FACSIMILE OTHER THAN AS SET FORTH
ABOVE DOES NOT CONSTITUTE A VALID DELIVERY OF SUCH LETTER OF TRANSMITTAL.
FEES AND EXPENSES
The Company will not make any payment to brokers, dealers or others soliciting
acceptances of the Exchange Offer.
The estimated cash expenses to be incurred in connection with the Exchange
Offer of approximately $245,000 will be paid by the Company.
ACCOUNTING TREATMENT
For accounting purposes, the Company will recognize no gain or loss as a
result of the Exchange Offer. The expenses of the Exchange Offer will be
amortized over the term of the Exchange Notes.
TRANSFER TAXES
Holders who tender their Old 8.29% Notes for exchange will not be obligated to
pay any transfer taxes in connection therewith, except that holders who instruct
the Company to register Exchange Notes in the name of, or request that Old 8.29%
Notes not tendered or not accepted in the Exchange Offer be returned to, a
person other than the registered tendering holder will be responsible for the
payment of any applicable transfer tax thereon.
REGULATORY MATTERS
The Company is not aware of any governmental or regulatory approvals that are
required in order to consummate the Exchange Offer.
CONSEQUENCES OF FAILURE TO EXCHANGE
Participation in the Exchange Offer is voluntary. Holders of the Old 8.29%
Notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take. See "Certain United States Federal Income Tax
Considerations."
The Old 8.29% Notes that are not exchanged for the Exchange Notes pursuant to
the Exchange Offer will remain restricted securities. Accordingly, such Old
8.29% Notes may only be offered, sold, pledged or otherwise transferred (A)(i)
to a person whom the seller reasonably believes is a qualified institutional
buyer within the meaning of Rule 144A under the Securities Act ("Rule 144A") in
a transaction meeting the requirements of Rule 144A, (ii) in an offshore
transaction meeting the requirements of Rule 903 or Rule 904 of Regulation S
under the Securities Act, or (iii) pursuant to an exemption from registration
under the Securities Act provided by Rule 144 thereunder (if available) and (B)
in accordance with all applicable securities laws of the states of the United
States. Under certain circumstances, the Company is required to file a Shelf
Registration Statement. See "Description of the 8.29% Notes--Exchange Offer;
Registration Rights."
PAYMENT OF ADDITIONAL INTEREST UPON REGISTRATION DEFAULT
In the event of a Registration Default (as hereinafter defined), additional
interest ("Liquidated Interest") will accrue on the 8.29% Notes (in addition to
the stated interest on the 8.29% Notes) from and including the date on which any
such Registration Default shall occur to but excluding the date on which all
Registration Defaults have been cured. Liquidated Interest will be payable in
cash semiannually in arrears each April 15 and October 15, at a rate per annum
equal to 0.50% of the principal amount at maturity of the 8.29% Notes during the
90-day
28
<PAGE>
period immediately following the occurrence of any Registration Default and
shall increase by 0.25% per annum of the principal amount at maturity of the
8.29% Notes at the end of each subsequent 90-day period, but in no event shall
such rates exceed 2.0% per annum in the aggregate regardless of the number of
Registration Defaults. See "Description of the 8.29% Notes--Exchange Offer;
Registration Rights."
USE OF PROCEEDS
The Company will not receive any proceeds from the issuance of the Exchange
Notes or the consummation of the Exchange Offer or any sale of Exchange Notes to
any broker-dealer.
CAPITALIZATION
The following table sets forth as of December 31, 1997 (i) the historical
consolidated capitalization of the Company, and (ii) the pro forma
capitalization of the Company as adjusted to give effect to the issuance of the
8.29% Notes and assuming the acquisitions of Phoenix and LCI had occurred on
December 31, 1997. All share and per share information with respect to Qwest
included herein gives effect to the Qwest two-for-one stock split effected in
February 1998 in the form of a stock dividend (the "Qwest Stock Split"). This
table should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Historical
Consolidated Financial Statements and the notes thereto, appearing elsewhere in
this Prospectus.
December 31, 1997
Actual Pro Forma(1)
(in thousands)
Current portion of long-term debt $ 12,011 $ 14,035
=========- ===========
10 7/8% Notes 250,000 250,000
9.47% Notes 356,908 356,908
8.29% Notes - 300,000
Other long-term debt . 35,566 448,952
----------- -----------
Total long-term debt (excluding current portion) 630,463 1,355,860
---------- -----------
.
Stockholders' equity
Preferred stock, $.01 par value;
25,000,000 shares authorized; no -- --
shares issued and outstanding.
Common stock, $.01 par value;
400,000,000 shares authorized;
206,669,874 shares issued and 2,086 3,106
outstanding(2) .
Additional paid-in capital 411,605 4,977,462
Accumulated deficit . (31,927) (31,927)
----------- -----------
Total stockholders' equity 381,744 4,948,641
---------- -----------
.
Total capitalization $1,012,207 $6,304,501
========== ==========
.
(1) For additional information concerning the pro forma adjustments, see
the unaudited Pro Forma Combined Financial Statements of the Company and the
notes thereto, included elsewhere in this Prospectus.
(2) 20,000,000 of the authorized shares of Common Stock are reserved for
issuance under the Equity Incentive Plan, 4,000,000 of the authorized shares of
Common Stock are reserved for issuance under the Growth Share Plan and 8,600,000
of the authorized shares of Common Stock are reserved for issuance under the
warrant issued to Anschutz Family Investment Company LLC. See
"Management--Equity Incentive Plan," "Management--Growth Share Plan" and
"Certain Transactions."
29
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected data presented below under the captions "Statement of
Operations and Other Financial Data" and "Summary Balance Sheet Data" as of the
end of and for each of the years in the five-year period ended December 31, 1997
have been taken or derived from the historical audited Consolidated Financial
Statements of the Company. Consolidated Financial Statements of the Company as
of December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997 are included elsewhere in this Prospectus. The
information set forth below should be read in conjunction with the discussion
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations," "Business" and the Historical Consolidated Financial Statements
and the unaudited Pro Forma Combined Financial Statements of the Company and the
notes thereto, appearing elsewhere in this Prospectus.
SELECTED HISTORICAL FINANCIAL DATA OF QWEST
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS AND
OTHER
FINANCIAL DATA:
Total revenue............... $ 69,327 $ 70,873 $125,102 $230,996 $ 696,703
Total operating expenses.... 80,247 81,488 161,158 243,010 673,222
Earnings (loss) from
operations................. (10,920) (10,615) (36,056) (12,014) 23,481
Other income (expense)(1)... 122,631 (70) (2,411) 1,813 99
Earnings (loss) before
income taxes............... 111,711 (10,685) (38,467) (10,201) 23,580
Net earnings (loss)......... $ 68,526 $ (6,898) $(25,131) $ (6,967) $ 14,523
======== ======== ======== ======== =========
Earnings (loss) per share--
basic...................... $ 0.40 $ (0.04) $ (0.15) $ (0.04) $ 0.08
Earnings (loss) per share--
diluted.................... $ 0.40 $ (0.04) $ (0.15) $ (0.04) $ 0.07
EBITDA(2)................... $ (824) $ (6,338) $(26,007) $ 6,912 $ 41,733
Net cash provided by (used
in) operating activities... $ (7,125) $ 3,306 $(56,635) $ 32,524 $ (36,488)
Net cash provided by (used
in) investing activities... $107,496 $(41,712) $(58,858) $(52,622) $(356,824)
Net cash provided by (used
in) financing activities... $(95,659) $ 34,264 $113,940 $ 25,519 $ 766,191
Capital expenditures(3)..... $ 3,794 $ 40,926 $ 48,732 $ 85,842 $ 444,659
Ratio of earnings to fixed
charges (4) 5.68 - - - 1.15
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
SUMMARY BALANCE SHEET DATA:
Total assets....................... $60,754 $89,489 $184,178 $262,551 $1,398,105
Long-term debt..................... $ 2,141 $27,034 $ 68,793 $109,268 $ 630,463
Total stockholders' equity(5)...... $12,079 $24,581 $ 26,475 $ 9,442 $ 381,744
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
-----------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING DATA:
Route miles of conduit installed............ 3,200 3,650 9,500
Route miles of lit fiber installed.......... 580 900 3,400
Total minutes of use(6)..................... 237,000,000 382,000,000 669,000,000
</TABLE>
- --------
(1) In November 1993, Qwest sold substantially all of its then owned fiber optic
network capacity and related equipment and assets to a third-party purchaser
for $185.0 million (the "1993 Capacity Sale"). After deducting the carrying
value of the assets sold and direct costs associated with the 1993 Capacity
Sale, Qwest recognized a gain of approximately $126.5 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" AND "Business."
(2) EBITDA represents net earnings (loss) before interest, income taxes,
depreciation and amortization, a nonrecurring expense of $2.6 million in the
year ended December 31, 1996 to restructure operations, the gain on sale of
telecommunications agreements of $6.1 million (which is non-recurring) in
the year ended December 31, 1996, and the gain on sale of contract rights of
approximately $9.3 million (which is non-recurring) in the year ended
December 31, 1997. EBITDA includes earnings from the construction
contracts for the sale of dark fiber that the Company will use to provide
cash for the construction cost 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. Without
the effect of Growth Share Plan (as defined below) expense, EBITDA would
have been $115.2 million, $20.0 million, and $1.8 million for the years
ended December 31, 1997, 1996 and 1993, respectively.
(3) Capital expenditures include expenditures for property and equipment,
accrued capital expenditures, capital expenditures financed with the
equipment credit facility and initial obligations under capital leases.
(4) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of earnings (loss) before income taxes, plus fixed charges
excluding capitalized interest. Fixed charges consist of interest expensed
and capitalized, plus amortization of deferred financing costs, plus the
portion of rent expense under operating leases deemed by the Company to be
representative of the interest factor, plus preferred stock dividends on
preferred stock of QCC (increased to an amount representing the pre-tax
earnings which would be required to cover such dividend requirements). The
Company had a deficiency of earnings to fixed charges of $12.6 million,
$40.3 million and $11.0 million in 1996, 1995 and 1994, respectively.
(5) Qwest has not declared or paid cash dividends on the Qwest Common Stock
since becoming a public company in June 1997.
(6) Represents total minutes of use for the years ended December 31, 1997, 1996
and 1995.
#396822
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
Qwest's audited Consolidated Financial Statements and the notes thereto,
appearing elsewhere in this Prospectus.
OVERVIEW
Qwest is a facilities-based provider of multimedia communications services to
interexchange carriers and other telecommunications entities, businesses and
consumers and constructs and installs fiber optic communications systems for
interexchange carriers and other telecommunications entities, as well as for its
own use.
Qwest is expanding its existing voice and data network into the Qwest Network,
an approximately 16,250 route-mile, coast-to-coast, technologically advanced
fiber optic telecommunications network. The domestic network is expected to be
completed in 1999. Qwest is also expanding its network to carry international
data and voice traffic into Mexico and the United Kingdom through London.
Completion of the Mexico network is scheduled for late 1998. The network
extension to London will be obtained through the exchange of telecommunications
capacity with Teleglobe Inc., including two 155-megabit circuits crossing the
Atlantic Ocean from New York City to London. The transatlantic
telecommunications capacity supports Qwest's growth into the European market.
Qwest's European services will be terminated in London.
In October 1997, Qwest acquired SuperNet, an ISP, for $20.2 million in cash,
including acquisition costs.
In March 1998, Qwest acquired Phoenix, a non-facilities-based reseller of long
distance services, for 785,175 shares of Qwest Common Stock. Additional cash
consideration to the Phoenix Stockholders of up to $4.0 million is being
withheld pending the outcome of litigation for which Phoenix or its affiliates
may have potential liability. At the time of the acquisition, Phoenix had
approximately 40,000 customers, primarily in the business market.
In April 1998, Qwest acquired EUnet, a leading, Amsterdam-based, European
Internet service provider with business units operating in 13 European
countries. Certain EUnet stockholders and optionholders received 3,621,590
shares of newly issued shares of Qwest Common Stock, having a deemed value of
approximately $135.5 million (based upon a deemed value of approximately $37.42
per share), and approximately $4.5 million in cash. In addition, in connection
with the registration of the resale of the shares of Qwest Common Stock issued
in the transaction under the Securities Act, as described below, EUnet
stockholders will receive at Qwest's option, either (i) approximately $14.4
million in cash (plus interest to the date of payment) or (ii) additional newly
issued shares of Qwest Common Stock having the value of such cash payment, based
upon an average of the Qwest Common Stock closing prices for 15 consecutive
trading days commencing 20 trading days before the effective date of
registration. Of the number of shares of Qwest Common Stock to be issued in the
transaction, 614,645 shares have been placed in escrow for two years, and may be
recovered by Qwest, to satisfy any indemnification claims. EUnet has
approximately 60,000, primarily business, customers throughout Europe. The
shares of Qwest Common Stock were issued to EUnet stockholders in a private
placement exempt from registration under the Securities Act. Qwest has agreed to
undertake the registration of the resale of the shares of Qwest Common Stock
under the Securities Act not later than, and such shares will not be freely
tradeable until, the earlier of (i) three weeks after the closing of the LCI
Merger or (ii) September 30, 1998 (or, under certain circumstances, a later
date, but no later than October 31, 1998).
On March 8, 1998, the Company and LCI entered into the LCI Merger Agreement
that will result in LCI becoming a wholly-owned subsidiary of the Company. The
board of directors of each company has approved the LCI Merger.
#396822
32
<PAGE>
The LCI Merger will create the fourth largest U. S. long distance company,
based on revenue, after giving effect to the proposed merger of WorldCom and
MCI. The combined companies had 1997 revenue of approximately $2.3 billion,
serve over two million business and residential customers and have a total
current equity market capitalization of over $11.0 billion. The LCI Merger
enables the LCI nationwide customer base to fully leverage the capabilities and
efficiencies of the Qwest Network and allows the Company to take full advantage
of LCI's sales and marketing expertise, distribution channels, intelligent
network platform and LCI's customer care and billing system.
The all-stock transaction is valued at approximately $4.4 billion. The actual
number of shares of the Company's Common Stock to be exchanged for each LCI
share will be determined by dividing $42.00 by a volume weighted average of
trading prices for the Company's Common Stock for a specified 15-day period
prior to the closing, but will not be less than 1.0625 shares (if the Company's
average stock price exceeds $39.53) or more than 1.5583 shares (if the Company's
average stock price is less than $26.95). If the Company's average stock price
is less than $26.95, LCI may terminate the merger unless the Company then agrees
to exchange for each share of LCI the number of Qwest shares determined by
dividing $42.00 by such average price. The LCI Merger is intended to qualify as
a tax-free reorganization and will be accounted for as a purchase.
Completion of the transaction is anticipated to occur by the end of the second
quarter of 1998. The transaction is subject to the majority vote of the
shareholders of the Company and LCI and to other customary conditions such as
receipt of regulatory approvals. Anschutz Company (the "Majority Shareholder"),
owning approximately 83.7% of the Company's Common Stock, has agreed to vote in
favor of the transaction.
Carrier Services. Carrier Services provides high-volume and conventional
dedicated line services over Qwest's owned capacity and switched services over
owned and leased capacity to interexchange carriers and other telecommunications
providers. Qwest is currently focusing on expanding Carrier Services to increase
its revenue stream and reduce per unit costs, targeting capacity sales on a
segment-by-segment basis as the Qwest Network is deployed and activated, and is
increasingly seeking longer-term, high-volume capacity agreements from major
carriers. In addition to traditional telecommunications carriers, Qwest is
marketing to ISPs and other data service companies. For the years ended December
31, 1997, and 1996, Qwest's five largest carrier customers accounted for
approximately 42.3% and 41.3% of Carrier Services revenue, respectively.
Commercial Services. Commercial Services provides voice, data and video
services to businesses and consumers. Qwest plans to expand its presence in the
Commercial Services market by developing its distinctive "Ride the LightTM"
brand identity and aggressively marketing its existing and planned voice, data
and other transmission products and services. Qwest plans to build direct,
end-user relationships by developing strong distribution channels, providing
competitive pricing and superior network quality and offering enhanced,
market-driven services to businesses and consumers.
Revenue from Commercial Services is recognized primarily on a minutes-of-use
basis. Commercial Services has generated revenue using four primary sales
channels: direct sales, direct mail, agent and telemarketing. In September 1997,
Qwest entered into an arrangement with a third party under which they will
jointly define and test new broadband business multimedia services. Qwest also
entered into marketing agreements in September 1997 with two additional third
parties. Under one agreement a marketing company that wholesales and retails
telecommunications products on a national basis will act as an authorized sales
representative of Qwest and will market Qwest's long distance products through
affinity groups. Under the other agreement, Qwest will offer its One Plus and
Calling Card services (with competitive international pricing for both) and
other services to utilities in the United States under the Simple Choice SM
brand name of that third party.
Network Construction Services. Network Construction Services constructs and
installs fiber optic communication systems for interexchange carriers and
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other telecommunications providers, as well as for Qwest's own use. Qwest began
operations in 1988 constructing fiber optic conduit systems primarily for major
long distance carriers in exchange for cash and capacity rights. In 1996, Qwest
entered into major construction contracts for the sale of dark fiber to Frontier
and WorldCom whereby Qwest has agreed to install and provide dark fiber to each
along portions of the Qwest Network. The company also entered into two
substantial construction contracts with GTE in 1997 for the sale of dark fiber
along portions of the route of the Qwest Network. After completion of the Qwest
Network, Qwest expects that revenue from Network Construction Services will be
less significant to Qwest's operations. See "Business--The Qwest Network --Dark
Fiber Sales."
Revenue from Network Construction Services generally is recognized under the
percentage of completion method as performance milestones relating to the
contract are satisfactorily 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.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996. Qwest
reported net earnings of $14.5 million in the year ended December 31, 1997,
compared to a net loss of $7.0 million in the same period of the prior year.
Excluding the effect of the compensation expense relating to the Growth Share
Plan, net of income tax, Qwest's reported net earnings would have been
approximately $61.6 million and $1.5 million for the years ended December 31,
1997 and 1996, respectively.
Revenue. Total revenue increased $465.7 million, or 202% during the year ended
December 31, 1997, as compared to 1996. Carrier Services revenue decreased $1.9
million, or 3% for the year ended December 31, 1997, as compared to 1996,
primarily due to Qwest's sale of its resale dedicated line services on leased
capacity on July 1, 1996. The sold business generated revenue of $18.8 million
for the year ended December 31, 1996. Exclusive of this revenue, Carrier
Services revenue increased $16.9 million, or 44%, during the year ended December
31, 1997, as compared to 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 $25.4 million, or 74% for the year ended December 31, 1997, as
compared to 1996. The increase was due primarily to growth in switched services
provided to small- and medium-sized businesses and to consumers as a result of
continued expansion of Qwest's direct sales, direct mail, agent and
telemarketing sales channels. Revenue from Network Construction Services
increased $442.2 million, or 318% during the year ended December 31, 1997, as
compared to the corresponding period in 1996. The increase was due primarily to
revenue from dark fiber sales to WorldCom, GTE and Frontier.
Operating Expenses. Qwest's principal operating expenses consist of expenses
for telecommunications services, network construction incurred by Network
Construction Services, SG&A, Growth Share Plan expense and depreciation and
amortization. Total operating expenses increased $430.2 million, or 177% during
the year ended December 31, 1997 as compared to the corresponding period in
1996. Expenses for telecommunications services primarily consist of the cost of
leased capacity, LEC access charges, engineering and other operating costs.
Expenses for telecommunications services increased $10.8 million, or 13% for the
year ended December 31, 1997, as compared to 1996. The growth in
telecommunications services expenses was primarily attributable to the continued
growth in switched services and network engineering and operations, partially
offset by the reduction in expenses resulting from the sale on July 1, 1996 of
Qwest's resale dedicated line services on leased capacity and an increase in
on-net traffic over the Qwest Network. When the Qwest Network is completed and
activated, Qwest will be able to serve more customer needs over its own capacity
on the Qwest Network.
Expenses for Network Construction Services consist primarily of costs to
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construct the Qwest Network, including conduit, fiber cable, construction crews
and rights-of-way. Costs attributable to the construction of the Qwest Network
for Qwest's own use are capitalized. Expenses for Network Construction Services
increased $309.6 million, or 354% in the year ended December 31, 1997, as
compared to 1996, due to costs of construction contracts relating to increased
dark fiber sales revenue.
SG&A includes the cost of salaries, benefits, occupancy costs, commissions,
sales and marketing expenses and administrative expenses. SG&A increased $45.4
million, or 99% in the year ended December 31, 1997, as compared to 1996. The
increase was due primarily to increases in expenses related to Qwest's direct
mail sales program, the development of Qwest's new brand identity,
administrative and information services support of Qwest's growth, and the
recruiting and hiring of additional personnel. Qwest is in the process of
opening commercial sales offices in selected major geographic markets to
implement Qwest's strategy, as segments of the Qwest Network become operational.
In addition, SG&A expenses will increase as Qwest continues to expand its
Carrier and Commercial Services, initiate its United States and international
direct sales operations, and recruit experienced telecommunications industry
personnel to implement Qwest's strategy.
Qwest has a Growth Share Plan for certain of its employees and directors.
Growth Share Plan expense, reflects Qwest'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 Qwest over a specified measuring
period. Qwest estimated an increase in the value of growth shares, primarily
triggered by the Qwest Initial Public Offering, and has recorded $73.5 million
of additional compensation expense in the year ended December 31, 1997, and
$13.1 million in the year ended December 31, 1996. Qwest anticipates total
additional expense of up to approximately $23.4 million through the year 2002 in
connection with this plan. Qwest does not anticipate any future grants under the
Growth Share Plan.
Qwest's depreciation and amortization expense increased $4.0 million, or 25%
during the year ended December 31, 1997 as compared to 1996. This increase
resulted primarily from activating segments of the Qwest Network during 1997,
purchases of additional equipment used in constructing the Qwest Network and
purchases of other fixed assets to accommodate Qwest's growth. Qwest expects
that depreciation and amortization expense will continue to increase in
subsequent periods as Qwest continues to activate additional segments of the
Qwest Network and amortizes the goodwill acquired with the SuperNet purchase
(discussed above).
Other Income (Expense). Pursuant to a capacity sale in 1993, Qwest 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 the first quarter of 1997, Qwest 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, which Qwest received in
1997 and has recorded as gain on sale of contract rights.
During 1997, Qwest's net interest income (expense) increased $2.8 million as
compared to 1996. The increase resulted from an increase in interest on long-
term indebtedness, related primarily to the 10 7/8% Notes and the 9.47% Notes
(see "--Liquidity and Capital Resources"), partially offset by increases in
capitalized interest resulting from construction of the Qwest Network and
interest income attributable to the increase in cash equivalent balances. In
January 1998, Qwest issued the 8.29% Notes (see "--Liquidity and Capital
Resources"), which are expected to increase net interest expense in subsequent
periods.
As previously discussed, Qwest sold a portion of its dedicated line services
on leased capacity in July 1996. During the transition of the service agreements
to the buyer, Qwest incurred certain facilities costs on behalf of the buyer,
which were to be reimbursed to Qwest. A dispute arose with respect to the
reimbursement of such costs and, as a result, Qwest made a provision of
approximately $2.0 million in the first quarter of 1997.
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Income Taxes. Qwest is included in the consolidated federal income tax return
of Anschutz Company. A tax sharing agreement provides for allocation of tax
liabilities and benefits to Qwest, in general, as though it filed a separate tax
return. Qwest's effective tax rate in 1997 was higher than the statutory federal
rate as a result of permanent differences between book and tax expense relating
to the Growth Share Plan and amortization of goodwill. Qwest's effective tax
rate in the year ended December 31, 1996 approximated the statutory federal
rate.
Net Earnings (Loss). Qwest realized net earnings of $14.5 million in the year
ended December 31, 1997, as compared to a net loss of $7.0 million in the
corresponding period of 1996 as a result of the factors discussed above.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenue. Total revenue increased $105.9 million, or 85%, due primarily to
significantly higher revenue from Network Construction Services, as well as
increased revenue from Commercial Services, offset in part by lower revenue from
Carrier Services. Revenue from Network Construction Services increased $102.3
million, or 277%, due to revenue from dark fiber sales of approximately $121.0
million to WorldCom and Frontier. Commercial Services revenue increased $13.9
million, or 68%. This increase is largely attributable to growth in switched
services provided to small- and medium-sized business and consumers as a result
of the expansion of Qwest's agent, telemarketing and direct mail sales channels.
Carrier Services revenue decreased $10.2 million or 15%, primarily due to
decreases in revenue resulting from Qwest's sale of a portion of its dedicated
line services on leased capacity on July 1, 1996. The sold business generated
revenues of $18.8 million for the year ended December 31, 1996 and $39.7 million
for the year ended December 31, 1995. The decrease in Carrier Services revenue
was partially offset by an increase in revenue from carrier switched services,
which increased to $19.4 million in 1996 from $13.8 million in 1995.
Operating Expenses. Total operating expenses increased $81.9 million, or 51%,
due primarily to increases in Network Construction Services, SG&A and
compensation expenses associated with the Growth Share Plan. Expenses for
telecommunications services decreased $0.8 million or 1%. The sale on July 1,
1996 of Qwest's dedicated line services on leased capacity generated a reduction
in expenses, which was partially offset by an increase in telecommunications
services expenses associated with the growth in switched services and servicing
the Qwest Network. Expenses for Network Construction Services increased $54.8
million or 167%. This increase was due to cost of construction contracts
relating to increased dark fiber sales.
SG&A expenses increased $8.6 million, or 23%. Qwest incurred additional SG&A
expenses as a result of growth in Qwest's telecommunications services and the
construction of the Qwest Network, including additional sales commissions on
higher revenue, expenses incurred in the implementation of Qwest's direct mail
sales channel and expenses for customer service personnel added to support
Qwest's expansion of its commercial customer base. The SG&A expenses in 1996
also included restructuring expenses of $1.6 million incurred by Qwest as a
result of its decision to close 13 sales offices and the termination of
approximately 130 employees involved in sales, marketing and administrative
functions. As a result of this restructuring, Qwest experienced a reduction in
payroll, commissions and rental expense. Qwest anticipates that, as it deploys
the Qwest Network and expands its Carrier Services and Commercial Services, SG&A
expenses will continue to increase.
Qwest estimated a $13.1 million increase in value of the growth shares at
December 31, 1996, due to the Frontier dark fiber sale. No expense was
recognized for the year ended December 31, 1995, as there were no significant
compensatory elements in those periods.
Qwest's depreciation and amortization expense increased $6.3 million, or 63%.
This increase was primarily due to Qwest's investment in the Qwest Network.
Qwest expects that depreciation and amortization expense will continue to
increase in subsequent periods as Qwest continues to activate
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additional segments of the Qwest Network.
Other Income (Expense). Qwest's net interest and other expenses increased
$1.9 million, or 79%. This increase was primarily attributable to additional
debt incurred in 1996 to finance capital expenditures and to provide working
capital. For a discussion of additional indebtedness, see "--Liquidity and
Capital Resources."
Income Taxes. Qwest is included in the consolidated federal income tax return
of Anschutz Company. A tax sharing agreement provides for allocation of tax
liabilities and benefits to Qwest, in general, as though it filed a separate tax
return. Qwest's effective tax rate in 1996 and 1995 approximated the statutory
federal rate. The difference between the income tax benefit of $3.2 million in
1996 as compared to $13.3 million in 1995 resulted from a $28.3 million decrease
in loss before income taxes.
Net Loss. Qwest experienced a net loss of $7.0 million in 1996 compared to a
net loss of $25.1 million in 1995 as a result of the factors discussed above.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, Disclosure About Segments of an Enterprise and Related Information ("SFAS
131"). SFAS 131 establishes standards for the manner in which business
enterprises are to report information about operating segments in its annual
statements and requires those enterprises to report selected information
regarding operating segments in interim financial reports issued to
shareholders. SFAS 131 is effective for fiscal years beginning after December
15, 1997.
LIQUIDITY AND CAPITAL RESOURCES
From January 1, 1995 through March 31, 1997, Qwest funded capital
expenditures, debt service and cash used in operations through a combination of
stockholder advances, capital contributions and external borrowings supported by
collateral owned by Anschutz Company or affiliates, as well as external
borrowings collateralized by certain of Qwest's assets. During the remainder of
1997, Qwest funded capital expenditures and long-term debt repayments primarily
through net proceeds from the issuance of debt and equity securities aggregating
approximately $903.6 million. Qwest also received net proceeds of $299.2 million
from the issuance of the 8.29% Notes in January 1998. Qwest intends to finance
its operations in the future through internally and externally generated funds
without relying on cash advances, contributions or guarantees from Anschutz
Company.
Total cash expended during the three years ended December 31, 1997 to fund
capital expenditures, repayments of long-term debt to third parties, repayment
of net advances from Anschutz Company, and for acquisitions was $449.2 million,
$223.9 million, $9.9 million and $32.6 million, respectively. Total cash used in
operations was $60.6 million during the same period. Total cash provided during
this same period from revolving loans secured by collateral owned by Anschutz
Company or an affiliate was $138.0 million, and capital contributions from
Anschutz Company were approximately $28.0 million. The loans from Anschutz
Company were repaid in 1997. In addition, during this same period, Qwest's net
cash provided by secured borrowings under long-term debt agreements with third
parties aggregated $67.6 million. As of December 31, 1997, Qwest had positive
working capital of $408.5 million resulting primarily from the issuance of the
9.47% Notes in October 1997. At December 31, 1996 and 1995, Qwest had working
capital deficits of approximately $75.7 million and $2.6 million, respectively.
Qwest estimates the total cost to construct and activate the Qwest Network and
complete construction of the dark fiber sold to Frontier, WorldCom and GTE will
be approximately $1.9 billion. Of this amount, Qwest had already expended
approximately $850.0 million as of December 31, 1997. Qwest anticipates
remaining total cash outlays (including capital expenditures) for these purposes
of approximately $881.0 million in 1998 and $195.0 million in 1999. Estimated
total Qwest Network expenditures for 1998 include Qwest's commitment to purchase
a minimum quantity of fiber for approximately $399.0 million
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(subject to quality and performance specifications), of which approximately
$252.0 million had been expended as of December 31, 1997. Estimated total
expenditures for 1998 and 1999 together also include approximately $92.0 million
for the purchase of electronic equipment. In addition, Qwest anticipates
approximately $557.0 million of capital expenditures in 1998 and 1999 to support
growth in Carrier Services and Commercial Services.
As of December, 1997, Qwest has obtained the following sources of funds which
are available to complete the build-out: (i) approximately $1.2 billion under
the Frontier, WorldCom and GTE contracts and additional smaller construction
contracts for sales of dark fiber, of which approximately $430.0 million had
already been received and $770.0 million remained to be paid at December 31,
1997; (ii) $90.0 million of vendor financing; (iii) $242.0 million in net
proceeds from the sale of the 10 7/8% Notes, of which approximately $124.4
million was used to pay down certain existing debt; (iv) $342.1 million in net
proceeds from the sale of the 9.47% Notes; and (v) approximately $319.5 million
in net proceeds from the Initial Public Offering. Qwest believes that its
available cash and cash equivalent balances at December 31, 1997, the net
proceeds from issuance of the 8.29% Notes in January 1998 and cash flow from
operations will satisfy its currently anticipated cash requirements at least
through the end of 1998.
In January 1998, Qwest issued its 8.29% Notes, generating net proceeds of
approximately $299.2 million, after deducting offering costs. The 8.29% Notes
will accrete at a rate of 8.29% per annum, compounded semiannually, to an
aggregate principal amount of $450.5 million by February 1, 2003. The 8.29%
Notes mature on February 1, 2008. The 8.29% Notes are redeemable at Qwest's
option, in whole or in part, at any time on or after February 1, 2003, at
specified redemption prices. Cash interest on the 8.29% Notes will not accrue
until February 1, 2003, and thereafter will accrue at a rate of 8.29% per annum,
and will be payable semiannually in arrears commencing on August 1, 2003 and
thereafter on February 1 and August 1 of each year. The 8.29% Notes indenture
contains certain covenants that, among other things, limit the ability of Qwest
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
Qwest or its Restricted Subsidiaries, issue or sell capital stock of Qwest's
Restricted Subsidiaries or enter into certain mergers and consolidations.
In connection with the sale of the 8.29% Notes, Qwest agreed to make an offer
to exchange new notes, registered under the Securities Act and with terms
identical in all material respects to the 8.29% Notes, for the 8.29% Notes or,
alternatively, to file a shelf registration statement under the Act with respect
to the 8.29% Notes. If the registration statement for the exchange offer or the
shelf registration statement, as applicable, is not filed or declared effective
within specified time periods or, after being declared effective, ceases to be
effective or usable for resale of the 8.29% Notes during specified time periods
(each a "Registration Default"), additional cash interest will accrue at a rate
per annum equal to 0.50% of the principal amount at maturity of the 8.29% Notes
during the 90-day period immediately following the occurrence of a Registration
Default and increasing in increments of 0.25% per annum of the principal amount
at maturity of the 8.29% Notes 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 October 1997, Qwest issued and sold its 9.47% Notes, generating net
proceeds of approximately $342.1 million, after deducting offering costs. The
9.47% Notes will accrete at a rate of 9.47% per annum, compounded semiannually,
to an aggregate principal amount of $555.9 million by October 15, 2002. The
9.47% Notes mature on October 15, 2007. The 9.47% Notes are redeemable at
Qwest's option, in whole or in part, at any time on or after October 15, 2002,
at specified redemption prices. Cash interest on the 9.47% Notes will not accrue
until October 15, 2002, and thereafter will accrue at a rate of 9.47% per annum,
and will be payable semiannually in arrears commencing on April 15, 2003 and
thereafter on April 15 and October 15 of each year. The indenture for the 9.47%
Notes contains certain covenants that are substantially identical to the 8.29%
Notes described above. In February 1998, Qwest completed an exchange of
identical notes, registered under the Securities Act, for all of the 9.47%
Notes.
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In June 1997, Qwest received approximately $319.5 million in net proceeds from
the sale of 31,050,000 shares of Qwest's Common Stock in the Qwest Initial
Public Offering.
In May 1997, Qwest and Nortel, individually and as agent for itself and other
specified lenders, entered into a $90.0 million credit agreement (the "Equipment
Credit Facility") to fund a portion of certain capital expenditures required to
equip the Qwest Network. Under the Equipment Credit Facility, Qwest may borrow
funds up to 75% of the purchase price of such equipment and related engineering
and installation services provided by Nortel as vendor as it purchases the
equipment, with the purchased equipment and related items serving as collateral
for the loans of a third party lender. Qwest is committed to purchase from
Nortel a minimum of $100.0 million of such equipment and services under a
separate procurement agreement. Qwest's total remaining commitment under the
procurement agreement was approximately $68.4 million as of December 31, 1997.
Principal amounts outstanding under the Equipment Credit Facility will be
payable in quarterly installments commencing on June 30, 2000, with full
repayment due on March 31, 2004. Borrowings bear interest at Qwest'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.
In March 1997, Qwest issued and sold its 10 7/8% Notes, generating net
proceeds of approximately $242.0 million, after deducting offering costs. A
portion of the net proceeds were used to repay amounts due under the then
existing revolving credit facility, the construction term loan, equipment loans
and term notes, described below. Interest on the 10 7/8% Notes is payable
semiannually in arrears on April 1 and October 1 of each year, commencing
October 1, 1997. The 10 7/8% Notes mature on April 1, 2007. The 10 7/8% Notes
are subject to redemption at the option of Qwest, in whole or in part, at any
time on or after April 1, 2002, at specified redemption prices. The indenture
for the 10 7/8% Notes contains certain covenants that are substantially
identical to the 8.29% Notes and 9.47% Notes described above.
In 1996, Qwest entered into and subsequently amended a long-term $100.0
million revolving credit facility agreement, which was collateralized by shares
of common stock owned and pledged by Anschutz Company. In October 1997, Qwest
repaid the outstanding balance and terminated this facility.
In April 1995, Qwest entered into a secured construction loan facility used to
fund certain conduit installation projects. The facility converted to a term
loan upon completion of the construction projects in 1996 and 1995 and became
secured by notes receivable issued in connection with the projects. The term
loan bore interest at Qwest's option at either (i) the higher of (a) the bank's
base rate of interest, or (b) the Federal Funds Rate plus 1/2%; or (ii) LIBOR
plus 9/16%. The outstanding balance of $10.9 million at December 31, 1997 was
repaid subsequent to year end.
Qwest also incurred other indebtedness during the three-year period ended
December 31, 1997, including five equipment loans in 1995 and 1996 aggregating
$10.0 million and two term notes in January 1995 aggregating $12.0 million, the
proceeds of which were used to repay a portion of the prior advance from
Anschutz Company. In addition, Qwest had other outstanding indebtedness in 1997
which it had incurred prior to 1995, including amounts payable under a network
credit facility and an additional equipment loan. Such indebtedness had a
weighted average interest rate of approximately 9% in 1997, and was repaid in
the second quarter of 1997 with proceeds from the 10 7/8% Notes.
YEAR 2000
Qwest has created a project team including internal and external resources
that is in the process of identifying and addressing the impact of problems and
uncertainties related to the year 2000 on its operating and application software
and products. Qwest expects to resolve year 2000 compliance issues primarily
through replacement and normal upgrades of its software and
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products. However, there can be no assurance that such replacements and
upgrades can be completed on schedule and within the estimated costs.
INFLATION
Inflation has not significantly affected Qwest's operations during the past
three years.
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INDUSTRY OVERVIEW
GENERAL
The telecommunications industry involves the transmission of voice, data and
video communications. The industry has been undergoing rapid change due to
deregulation, the construction of additional infrastructure and the introduction
of new technologies, which has resulted in increased competition and demand for
telecommunications services.
United States Domestic Long Distance. The structure of the domestic long
distance telecommunications industry was strongly influenced by a 1982 court
decree that required the divestiture by AT&T of local telephone businesses and
divided the country into approximately 200 LATAs that range in size from
metropolitan areas to entire states. The seven resulting RBOCs were initially
limited to providing local telephone service, access to long distance carriers
and "in-region" long distance service (service within a LATA). The right to
provide inter-LATA service was initially ceded to AT&T and other long distance
carriers, as well as to LECs other than the RBOCs. However, under the
Telecommunications Act, the RBOCs may now provide inter-LATA long distance
service, subject to certain conditions. See "Regulation--General Regulatory
Environment."
For each long distance call, the originating and terminating LECs charge the
long distance carrier an access fee to carry the call across their local
networks. The long distance carrier charges the customer a fee for its
transmission of the call, a portion of which consists of the access fees charged
by the originating and terminating LECs. To encourage the development of
competition in the long distance market, the LECs are required to provide all
long distance carriers with access to local exchange service that is "equal in
type, quality and price" to that provided to AT&T. These "equal access" and
related provisions were intended to prevent preferential treatment of AT&T and
to require that the LECs charge the same access fees to all long distance
carriers, regardless of their volume of traffic. These provisions, along with
the development and evolution of fiber optic technology with its increased
capacity and transmission quality, have helped smaller long distance carriers
emerge as alternatives to the largest companies for long distance
telecommunications services. See "Regulation--General Regulatory Environment."
United States International Long Distance. The United States international
long distance industry is large and growing. The onset of competition gave rise
to deregulation and a decrease in prices, which led to the initial growth in the
market and improvements in service offerings and customer service. Subsequent
growth has been largely attributable to the worldwide trend toward deregulation
and privatization, technological improvements, the expansion of
telecommunications infrastructure and the globalization of the world's
economies.
The profitability of the United States international long distance market is
principally driven by the difference between settlement rates (i.e., the rates
paid to other carriers to terminate an international call) and billed revenue.
The difference in cost between providing domestic long distance and
international service is minimal, and increased worldwide competition has
already brought about certain reductions in settlement rates and end user
prices, thereby reducing overseas termination costs for United States-based
carriers. However, it is believed that certain foreign countries use settlement
rates to subsidize their domestic call rates, contributing to significantly
higher rates for certain international calls compared to domestic long distance
calls. The FCC recently adopted measures intended to overhaul the system of
international settlements by mandating that U.S. carriers negotiate settlement
rates with foreign correspondents at or below FCC-mandated benchmark levels.
Several parties have filed petitions for reconsideration with the FCC or court
appeals or both following this order, so it remains subject to modification.
Additionally, recent worldwide trade negotiations may lead to reduced settlement
rates. See "Regulation--General Regulatory Environment."
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Multimedia. Continuing developments in multimedia applications are bringing
new entrants to the telecommunications market. Internet service providers and
cable television, entertainment and data transmission companies, for instance,
are potential customers for voice, data and video communications over high
bandwidth networks such as the Qwest Network.
LONG DISTANCE NETWORK SERVICES
Switched voice and data services originate and terminate with end users and
require varying amounts of bandwidth, depending on the nature of the
communication. Traditional telephony services such as "1 Plus" dialing require
only limited bandwidth (such as 64 Kbps). Emerging broadband services, such as
the Internet, private networks and multimedia applications, require higher
bandwidth for effective communication. Such services are increasingly
transmitted over SONET ring-protected Optical Carrier level paths (such as OC-
48 or OC-192) using advanced transmission protocols, such as Frame Relay and
ATM.
TELECOMMUNICATIONS TECHNOLOGY
The market for video, voice and data communications is served primarily
through fiber optic and coaxial copper cables, microwave systems and satellites.
Before the 1980s, telecommunications traffic generally was transmitted through
satellites, microwave radio or copper cable installed undersea or buried in the
ground. By 1990, copper cable had been largely replaced by fiber optic systems
that provided greater capacity at lower cost with higher quality and
reliability.
. Fiber Optic Systems. Fiber optic systems use laser-generated light to
transmit voice, data and video in digital format through ultra-thin strands of
glass. Fiber optic systems are characterized generally by large circuit
capacity, good sound quality, resistance to external signal interference and
direct interface to digital switching equipment or digital microwave systems. A
pair of modern fiber optic strands, using the most advanced technology
commercially available, is capable of carrying OC-192 level capacity, equal to
over 129,000 simultaneous telephone calls. Because fiber optic signals disperse
over distance, they must be regenerated/amplified at sites located along the
fiber optic cable. Fiber optic systems using earlier generation fiber, as
compared to the more advanced fiber being installed in the Qwest Network,
require frequent intervals between regeneration/amplifier sites, typically
between 20 and 45 miles. Qwest's advanced fiber allows for greater distances
between regeneration/amplifier sites, and the Qwest Network is designed to use a
maximum of 60-mile intervals. Greater distances between regeneration/amplifier
sites generally translate into substantially lower installation and operating
costs.
. Microwave Systems. Although limited in capacity compared with fiber optic
systems, digital microwave systems offer an effective and reliable means of
transmitting lower volume and narrower bandwidths of voice, data and video
signals. Generally no more than 21 DS-3s can be transmitted by microwave between
two antennae. Microwaves are very high frequency radio waves that can be
reflected, focused and beamed in a line-of-sight transmission path. Because of
their electro-physical properties, microwaves can be used to transmit signals
through the air, with relatively little power, in much the same way that
electrical signals are transmitted through a copper wire. To create a
communications circuit, microwave signals are transmitted through a focusing
antenna, received by an antenna at the next station in the network, then
amplified and retransmitted. Microwaves disperse as they travel through the air,
and as a result this transmission process must be repeated at repeater stations,
which consist of radio equipment, antennae and back-up power sources.
. Satellite Systems. Although satellites initially were used for point-to-
point long distance telephone and television transmissions, fiber optic cables
have proven to be a more cost effective delivery method for high volume point-
to-point applications. Currently, satellites are primarily used for
transmissions that must reach many locations over vast distances
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simultaneously, such as the distribution of television programming, for point-
to-point traffic in developing countries lacking terrestrial networks and for
other point-to-point traffic that cannot be connected efficiently or cost-
effectively by terrestrial transmission systems.
TELECOMMUNICATIONS MARKETS
AT&T, MCI, Sprint and WorldCom together constitute what are generally referred
to as the "Tier 1" companies in the long distance market.
Long distance companies may generally be categorized as "facilities-based"
carriers and "non-facilities-based" carriers. The four Tier 1 companies are
facilities-based carriers because each operates a network principally using its
own transmission facilities and extensive geographically dispersed switching
equipment. The completed Qwest Network will enable Qwest to become this type of
facilities-based carrier. All of the Tier 1 carriers, including AT&T, lease some
of their transmission facilities from other carriers to back up their service
routing, augment areas where they may have traffic bottlenecks or cover a
particular geographic area not covered by their own networks.
Medium-sized long distance companies, some with national capabilities,
constitute the "Tier 2" companies in the long distance market. Certain Tier 2
carriers are known as "partial facilities-based" carriers in that they own some
of their own transmission facilities but operate using mostly leased facilities.
However, most Tier 2 carriers are nonfacilities-based carriers in that they
lease substantially all of their transmission facilities. Tier 2 carriers
design, manage and operate their own networks just as the Tier 1 carriers, but
generally on a smaller regional scale, focusing on selling traffic originating
in their target geographic area. These carriers are also generally referred to
as "switch-based" or "switched" because they typically operate their own
switches. Some of these carriers lease high volume DS-3 capacity and resell
lower volume DS-1 capacity to other carriers at higher unit prices. DS-3 level
capacity is generally only sold by carriers that own facilities on the route on
which the service is sold.
The "Tier 3" carriers, often called "switchless" resellers, neither operate
networks nor own facilities, but rather resell "minutes" of service which they
purchase from other carriers. These companies, which vary significantly in size,
are primarily sales and marketing companies that generate their margins by
buying in large volumes to obtain a low price per minute from switch-based
carriers and reselling at higher prices. These companies may receive an invoice
from their underlying carrier and bill the end user or, in some cases, the
underlying carrier may bill the end user directly. The barriers to entry into
this segment of the long distance market are minimal and there are currently
numerous Tier 3 companies providing long distance services. As its business
increases, a Tier 3 company may install its own switch and move into the Tier 2
category.
Operator services companies concentrate on providing operator services and
other communications services to the long distance industry, private pay phone
operators, prisons and credit card companies. These carriers also manage their
own networks and switching networks and switching equipment while leasing
virtually all of their facilities.
Competition in the retail long distance industry is based upon pricing,
customer service, network quality and valued-added services, creating
opportunities for smaller long distance providers. Sales efforts of long
distance companies focus increasingly on telemarketing and the use of
independent contractors rather than full-time employees. This has created an
opportunity for smaller companies to compete in certain segments of the long
distance market, and many of them are quickly able to build sizable customer
bases on the strength of their marketing efforts and distribution channels.
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BUSINESS
Qwest is a facilities-based provider of multimedia communications services to
interexchange carriers and other communications entities, businesses and
consumers, and it constructs and installs fiber optic communications systems for
interexchange carriers and other communications entities, as well as for its own
use. Qwest is expanding its existing long distance network into the Qwest
Network, an approximately 16,250 route mile coast-to-coast, technologically
advanced, fiber optic telecommunications network. Qwest will employ, throughout
substantially all of the Qwest Network, a self-healing SONET ring architecture
equipped with the most advanced commercially available fiber and transmission
electronics manufactured by Lucent and Nortel, respectively. The Qwest Network's
advanced fiber and transmission electronics are expected to provide Qwest with
lower installation, operating and maintenance costs than older fiber systems in
commercial use today. In addition, Qwest has entered into construction contracts
for the sale of dark fiber along the route of the Qwest Network, which will
reduce Qwest's net cost per fiber mile with respect to the fiber it retains for
its own use. As a result of these cost advantages, Qwest believes it will be
well-positioned to capture market share and take advantage of the rapidly
growing demand for long haul voice and data transmission capacity and services.
The executive offices of Qwest Communications International Inc., a Delaware
corporation, are located at 1000 Qwest Tower, 555 Seventeenth Street, Denver, CO
80202, and its telephone number is (303) 291-1400.
RECENT DEVELOPMENTS
LCI Transaction. On March 8, 1998, the Company and LCI entered into the LCI
Merger Agreement that will result in LCI becoming a wholly-owned subsidiary of
the Company. The board of directors of each company has approved the LCI Merger.
The LCI Merger will create the fourth largest U. S. long distance company,
based on revenue, after giving effect to the proposed merger of WorldCom and
MCI. The combined companies had 1997 revenue of approximately $2.3 billion,
serve over two million business and residential customers and have a total
current equity market capitalization of over $11.0 billion. The LCI Merger
enables the LCI nationwide customer base to fully leverage the capabilities and
efficiencies of the Qwest Network and allows the Company to take full advantage
of LCI's sales and marketing expertise, distribution channels, intelligent
network platform and LCI's customer care and billing system.
The all-stock transaction is valued at approximately $4.4 billion. The actual
number of shares of the Company's Common Stock to be exchanged for each LCI
share will be determined by dividing $42.00 by a volume weighted average of
trading prices for the Company's Common Stock for a specified 15-day period
prior to the closing, but will not be less than 1.0625 shares (if the Company's
average stock price exceeds $39.53) or more than 1.5583 shares (if the Company's
average stock price is less than $26.95). If the Company's average stock price
is less than $26.95, LCI may terminate the merger unless the Company then agrees
to exchange for each share of LCI the number of Qwest shares determined by
dividing $42.00 by such average price. The LCI Merger is intended to qualify as
a tax-free reorganization and will be accounted for as a purchase.
Completion of the transaction is anticipated to occur by the end of the second
quarter of 1998. The transaction is subject to the majority vote of the
shareholders of the Company and LCI and to other customary conditions such as
receipt of regulatory approvals. The Majority Shareholder, owning approximately
83.7% of the Company's Common Stock, has agreed to vote in favor of the
transaction.
EUnet Transaction. In April 1998, Qwest acquired EUnet, an Amsterdam-based,
European internet service provider with business units operating in 13 European
countries. EUnet has approximately 60,000, primarily business, customers
throughout Europe. At the closing, certain EUnet stockholders and optionholders
received
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3,616,559 shares of newly issued shares of Qwest Common Stock, having a deemed
value of approximately $135.3 million (based upon a deemed value of
approximately $37.42 per share), and approximately $4.7 million in cash. In
addition, in connection with the registration of the resale of the shares of
Qwest Common Stock issued in the transaction under the Securities Act, as
described below, EUnet stockholders will receive at Qwest's option, either (i)
approximately $14.4 million in cash (plus interest to the date of payment) or
(ii) additional newly issued shares of Qwest Common Stock having the value of
such cash payment, based upon an average of the Qwest Common Stock closing
prices for 15 consecutive trading days commencing 20 trading days before the
effective date of registration. Of the number of shares of Qwest Common Stock to
be issued in the transaction, 613,856 shares have been placed in escrow for two
years, and may be recovered by Qwest, to satisfy any indemnification claims. The
EUnet acquisition will be accounted for as a purchase. The shares of Qwest
Common Stock were issued to EUnet stockholders and optionholders in a private
placement exempt from registration under the Securities Act. Qwest has agreed to
undertake the registration of the resale of the shares of Qwest Common Stock
under the Securities Act not later than the earlier of (i) three weeks after the
closing of the LCI Merger or (ii) September 30, 1998 (or, under certain
circumstances, a later date, but no later than October 31, 1998).
Phoenix Transaction. On March 30, 1998, Qwest acquired Phoenix, a non-
facilities-based reseller of long distance services. At the time of the
acquisition, Phoenix had approximately 40,000 customers, primarily in the
business market. Under the terms of the acquisition, 785,175 shares of Qwest
Common Stock having a deemed value of approximately $27,222,017 (based upon an
adjusted average price of $34.67 per share) were exchanged for the outstanding
shares of Phoenix. Additional cash consideration to the Phoenix Stockholders of
up to $4.0 million is being withheld pending the outcome of litigation for which
Phoenix or its affiliates may have certain potential liability.
AGIS Transaction. In January 1998, Qwest signed a long-term contract to
provide Apex Global Internet Services, Inc. ("AGIS") telecommunications capacity
along approximately 10,000 route miles of the Qwest Network. In consideration,
Qwest received 19.99% of AGIS's common stock and will receive up to $310.0
million in cash over an extended payment term. There are restrictions on the
sale by Qwest of AGIS's common stock, and AGIS has the right to repurchase the
common stock until the contract's second anniversary. Qwest will also receive
monthly operations and maintenance fees totaling approximately $251.0 million
over the term of the multi-year contract. Prior to delivery of the
telecommunications capacity and acceptance by AGIS, AGIS has the right to
purchase interim capacity from Qwest. The total cash consideration under the
contract will be reduced by 60% of the sums paid by AGIS for purchases of
interim capacity. Pursuant to the terms of the contract, AGIS may require Qwest
to purchase an additional $10.0 million of its common stock. If Qwest fails to
complete at least 75% of AGIS's network by the contract's third anniversary,
AGIS may, at its option, either accept the completed portion and pay for it on a
pro rata basis or terminate the contract and require Qwest to return all
consideration received. Under the terms of the contract, the companies will
enter into a joint marketing arrangement to expand their product and service
offerings to include internet protocol ("IP") telephony, video conferencing, ATM
and Frame Relay services. AGIS, founded in 1994, provides Internet access to
users via its extensive customer base of RBOCs, content providers, large
corporations and ISPs.
8.29% Note Offering. In January 1998, Qwest issued its 8.29% Notes, generating
net proceeds of approximately $299.2 million, after deducting offering costs
which are included in intangible and other long-term assets and will be
amortized to interest expense over the term of the 8.29% Notes. The net proceeds
will be used primarily to fund the activation and expansion of the Qwest Network
and the growth of its multimedia communications services and informational
systems infrastructure. In addition, Qwest may use a portion of the proceeds to
increase its presence in international markets, such as Mexico and Europe.
OPPORTUNITIES
Qwest believes that demand from interexchange carriers and other
communications entities for advanced, high bandwidth voice, data and video
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transmission capacity will increase over the next several years due to
regulatory and technological changes and other industry developments. These
anticipated changes and developments include: (i) continued growth in capacity
requirements for high speed data transmission, ATM and Frame Relay services,
Internet and multimedia services and other new technologies and applications;
(ii) continued growth in demand for existing long distance services; (iii) entry
into the market of new communications providers; (iv) requirements of the four
principal nationwide carriers (AT&T, MCI, Sprint and WorldCom) to replace or
augment portions of their older systems; and (v) reform in regulation of
domestic access charges and international settlement rates, which Qwest expects
will lower long distance rates and fuel primary demand for long distance
services.
. Accommodation of the Internet and Other New Applications. Qwest believes
that additional network transmission capacity and faster response times will
be required to accommodate multimedia (voice, data and video) and other
potential high bandwidth applications, such as increasing use of the
Internet by commercial users, the deployment of corporate intranets and the
use of telecommunications infrastructure for providing cable television and
other entertainment services. Qwest believes this growth will result in
increased demand for high bandwidth dedicated circuits and other network
services provided by Qwest (such as Frame Relay and ATM).
. Base Growth of Existing Telecommunications Providers. Domestic long distance
industry revenue has increased in recent years. The revenue increases were
achieved against a backdrop of declining unit prices for most
telecommunications services, which suggests that the demand for
telecommunications bandwidth has increased at an even higher rate. Qwest
believes that these growth trends generally will continue and that certain
companies that do not own most of their networks have potential needs to
invest in network facilities or lease high bandwidth network capacity in
order to remain competitive. In addition, Qwest believes that the Qwest
Network will allow Qwest to offer an attractive alternative for leased
capacity simply to meet current levels of demand for wholesale
telecommunications services.
. Capacity Required by New Communications Entrants. Competition and
deregulation are bringing new entrants into the telecommunications market.
Qwest anticipates that this trend will accelerate as a result of the
Telecommunications Act. The Telecommunications Act allows the RBOCs and GTE
to enter the long distance business and enables other entities, including
entities affiliated with power utilities and ventures between LECs and cable
television companies, to provide an expanded range of telecommunications
services. As these entities emerge as long distance competitors, Qwest
believes they will need their own facilities and additional high bandwidth
capacity to compete effectively with facilities-based providers.
. Augmentation of Older Systems. The coast-to-coast fiber systems currently
operated by the Tier 1 carriers were constructed for the most part prior to
1990, using standard, single mode fiber. Most of these systems were buried
directly in the ground without protective conduit. The conversion of these
older systems to the use of SONET ring architecture requires increasingly
more bandwidth over additional route miles. Accordingly, Qwest believes that
the Tier 1 carriers will generally need to replace or augment parts of their
networks to add more capacity, route diversity and redundancy to their
systems and to lower their overall operating costs. Qwest believes that the
older, legacy systems operated by certain of the Tier 1 carriers generally
face certain other disadvantages when compared to the Qwest Network, such
as:
(i) lower transmission speeds; (ii) lower overall capacity; (iii) shorter
distances between regeneration/amplifier facilities; (iv) more costly
maintenance requirements; (v) greater susceptibility to system interruption
from physical damage to the network infrastructure; and (vi) greater
difficulty in upgrading to more advanced fiber due to lack of a spare
conduit.
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. Access Charge and International Settlement Rate Reform. Qwest anticipates
that primary demand for long distance services will be stimulated by reforms
of domestic access charges and international settlement rates and recent
international trade negotiations. As long distance prices decline, Qwest
expects that overall demand for its services by carriers, businesses and
consumers will increase.
STRATEGY
Qwest's objective is to become a leading, coast-to-coast facilities-based
provider of multimedia communications services to other communications
providers, businesses and consumers. To achieve this objective, Qwest intends
to:
. Deploy a Technologically Advanced Network. Qwest believes the technical
characteristics of the Qwest Network will enable it to provide highly
reliable services to interexchange carriers and other communications
entities at low per unit costs as it expands its customer base and increases
network traffic volume. For instance, the Qwest Network's advanced fiber
optic cable and electronic equipment permit high capacity transmission over
longer distances between regeneration/amplifier facilities than older fiber
systems. This translates into generally lower installation and operating
costs. These costs typically constitute a significant portion of the overall
cost of providing telecommunications services.
. Build on Network Construction Expertise and Existing Network Assets. As of
December 31, 1997, Qwest had built over 9,800 route miles of
telecommunications conduit systems over the last eight years for itself and
major interexchange carriers including AT&T, MCI, Sprint and WorldCom. As of
December 31, 1997, Network Construction Services employed over 950
experienced construction personnel led by a senior construction management
team. Qwest utilizes its own fleet of owned and leased railroad equipment
and had in place railroad and other right-of-way agreements covering
approximately 94% of the Qwest Network and had installed approximately 60%
of the route miles of conduit required for the Qwest Network as of December
31, 1997. In addition, Qwest has fixed-price supply agreements for the
provision of all the fiber and transmission electronics necessary to
construct and activate the Qwest Network.
. Establish Low Cost Position. Qwest has entered into major construction
contracts for the sale of dark fiber in the Qwest Network that will allow
Qwest to achieve a low net capital investment in the Qwest Network and share
future operating and maintenance costs. Earnings from these agreements will
reduce Qwest's net cost per fiber mile with respect to the fiber that it
retains for its own use. Qwest believes that this network cost advantage,
coupled with the operating and maintenance cost advantages of owning an
entirely new network with advanced fiber and equipment uniformly deployed
systemwide, will enable it to establish a low cost position in the long
distance industry relative to its competitors.
. Build on Management Experience. Qwest's management team and board of
directors include individuals with significant experience at major
telecommunications companies. These executives have extensive management
experience in marketing, sales, finance, construction, information
technology, network operations and engineering, having served in various
capacities within large, rapidly growing organizations. See "Management."
. Grow Carrier Revenue Base. Qwest is currently expanding Carrier Services to
increase its revenue stream and reduce per unit costs, targeting capacity
sales on a segment-by-segment basis as the Qwest Network is deployed and
activated, and is increasingly seeking long-term, high volume capacity
agreements from major carriers. In addition to traditional
telecommunications carriers, Qwest is marketing to ISPs and other data
service companies.
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. Develop Commercial Services. Qwest plans to build on its Carrier Services
experience to expand its presence in the Commercial Services market by
developing its distinctive "Ride the Light(TM)" brand identity and
aggressively marketing its existing and planned voice, data and other
transmission products and services. Qwest plans to build direct end user
relationships by developing strong distribution channels, providing
competitive pricing and superior network quality and offering enhanced,
market-driven services to businesses and consumers.
. Acquire Complementary Businesses. Qwest continually evaluates
opportunities to acquire or invest in complementary, attractively valued
businesses, facilities, contract positions and assets to improve its
ability to offer new products and services to customers, to compete more
effectively and to facilitate further growth of its business. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources." See
"Recent Developments: for more information on acquisitions or proposed
acquisitions.
THE QWEST NETWORK
As of December 31, 1997, Qwest's network infrastructure included, among other
assets: (i) approximately 9,500 route miles of conduit in place, consisting of
approximately 3,400 route miles of lit fiber including the spans connecting Los
Angeles to Sacramento to Denver, to Kansas City, to Indianapolis, and Dallas to
Houston; approximately 3,300 route miles of dark fiber installed in conduit; and
approximately 2,800 route miles of vacant conduit; (ii) right-of-way agreements
in place for approximately 5,500 additional route miles of planned construction
for the Qwest Network; (iii) an approximately 3,500 mile operating digital
microwave system (the "Microwave System"); (iv) approximately 15,000 DS-3 miles
of fiber transmission capacity leased by Qwest from other carriers, used
primarily to extend Qwest's switched services for originating and terminating
traffic beyond the boundaries of Qwest's lit fiber network; and (v) five digital
switches (two of which are leased).
The physical components of the Qwest Network are: (i) high density
polyethylene conduit, which is hollow tubing 1 1/2 to 2 inches in diameter; (ii)
fiber optic cable, which consists of fiber strands placed inside a plastic
sheath and strengthened by metal; (iii) electronic equipment necessary to
activate the fiber for transmission; (iv) switches that enable Qwest to provide
switched services to carrier and commercial customers; and (v) approximately 125
points of presence, which allow Qwest to concentrate customers' traffic at
locations where Qwest does not have switches and carry the traffic to switching
centers over the Qwest Network.
With the completion of the Qwest Network, Qwest 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. Qwest expects to deploy
three new DMS 250 switches from Nortel. The new switches are planned to be
installed in Atlanta, Indianapolis, and New York City. The additional switches
will expand Qwest's on-net switch network to include key business centers in the
Northeast, Southeast and Midwest regions of the United States. Also, Qwest
continues to evaluate opportunities to acquire or invest in complementary,
attractively valued businesses, facilities, contract positions and assets to
improve its ability to offer new products and services to customers, to compete
more effectively and to facilitate further growth of its business.
Advanced Technology. Qwest is installing technologically advanced fiber optic
cable and electronic equipment in a uniform configuration throughout the Qwest
Network, using an advanced network management system. The Qwest Network's
technologies include Lucent's non-zero dispersion shifted fiber and Nortel's
dense wave division multiplexing, forward error correction technology and SONET
ring technology that enable OC-192 transmission capacity and high integrity
levels.
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The Qwest Network is designed for superior security and reliability, based on
(i) bi-directional SONET ring architecture, a self-healing system that allows
for nearly instantaneous rerouting and virtually eliminates downtime in the
event of a fiber cut; (ii) fiber cable installed in high density polyethylene
conduit generally buried 42-56 inches below the ground; and (iii) extensive use
of railroad rights-of-way, which typically offer greater protection of the fiber
system than other systems built over more public rights-of-way such as highways,
telephone poles or overhead power transmission lines.
The Qwest Network is designed for expandability and flexibility and will
contain two conduits along substantially all of its route. The first conduit
will contain a cable generally housing at least 96 fibers, and the second
conduit will serve as a spare. The spare conduit will allow for future
technology upgrades and expansion of capacity at costs significantly below the
cost of new construction. After existing and anticipated dark fiber sales, Qwest
generally plans to retain a minimum of 48 fibers for its own use in the Qwest
Network. With the combined use of non-zero dispersion shifted fiber, dense wave
division multiplexing and high bit rate transmission electronics, each of the
fibers retained by Qwest can achieve substantially greater capacity per fiber
than standard, single mode fiber now in use.
Qwest monitors its current network, and will monitor the Qwest Network, 24
hours a day, seven days a week from its Network Management Center in Denver,
Colorado. This facility provides centralized network surveillance,
troubleshooting and customer service, using technology that enables Qwest to
reduce service costs and customer downtime. The system currently allows Qwest's
technicians to detect a component malfunction in the Qwest Network, quickly
reroute the customer to an available alternate path and effect an expedited
repair. Upon completion of the Qwest Network with its SONET ring architecture,
the rerouting function will be fully automated. In addition, Qwest is deploying
new management tools, including Nortel's Integrated Network Management
Solutions, that will give Qwest's Carrier Services customers the ability to
monitor and reconfigure their leased capacity on an essentially real time basis
from their own network management centers and the ability to rapidly increase or
reduce bandwidth to better match their needs. The available software features
equipment inventory management, bandwidth inventory management, configuration
management, fault isolation management, "point-and-click" provisioning on
partitioned network and alarm monitoring. As of December 31, 1997, Qwest
maintained a staff of approximately 255 technicians and other related personnel
across the system to provide maintenance and technical support services. Qwest
has also implemented a "Call Before U Dig" ("CBUD") program, backed up by its
24-hour Network Management Center to reduce the risk of damage to the conduit or
fiber system. Additionally, above ground markers are placed at frequent
intervals along the route of the Qwest Network.
Railroad Rights-of-Way. Qwest has agreements in place with major railroads
that provide it with rights-of-way throughout the United States. Qwest believes
that use of railroad rights-of-way, along with the protective conduit, give
Qwest inherent advantages over other systems built over more public
rights-of-way, such as highways, telephone poles or overhead power transmission
lines. These advantages include higher security for the Qwest Network and
greater protection of the fiber system.
Railroad rights-of-way also provide the Qwest Network generally with a direct,
continuous route between cities. This eliminates the potential need, and the
associated time and costs, to piece together rights-of-way using a combination
of agreements with private owners and state or municipal agencies. In addition,
railroad rights-of-way typically extend into downtown areas of cities that are
strategically important to Qwest. Qwest's right-of-way agreements provide for
continuing or lump-sum cash payments, exchanges of rights-of-way for network
capacity or a combination of both. Between 70% and 80% of the Qwest Network will
be installed on railroad rights-of-way.
Qwest has other right-of-way agreements in place, where necessary or
economically preferable, with highway commissions, utilities, political
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subdivisions and others. As of December 31, 1997, Qwest had in place agreements
for approximately 94% of the rights-of-way needed to complete the Qwest Network.
As of December 31, 1997, the remaining rights-of-way needed for completion of
the Qwest Network consisted of approximately 1,100 route miles located primarily
in the Midwest and Mid-Atlantic regions. Qwest has identified alternative
rights-of-way for these route miles and is currently in negotiations with
respect to all of them.
Network Installation. As of December 31, 1997, Qwest employed over 950
experienced construction personnel and uses its own fleet of equipment, as well
as leased equipment. Qwest supplements these resources with independent
contractors.
Dark Fiber Sales. Qwest has entered into agreements with Frontier, WorldCom
and GTE and others whereby each is purchasing dark fiber along the Qwest
Network. The proceeds from these contracts for the sale of dark fiber will
provide cash for a significant portion of the total estimated costs to construct
the Qwest Network and provide the dark fiber sold to Frontier, WorldCom and GTE
and others. This is expected to provide Qwest with a strategic network cost
advantage on the fibers that Qwest retains for the Qwest Network. Each agreement
requires the purchaser to pay an aggregate price consisting of an initial
payment followed by installments during the construction period based on Qwest's
achievement of certain milestones (e.g., commencement of construction, conduit
installation and fiber installation), with final payment for each segment made
at the time of acceptance. Each agreement provides for the sharing of certain
maintenance costs. The Frontier and GTE agreements also provide for sharing of
certain operating costs. The agreements establish anticipated delivery dates for
construction and delivery of segments along the route of the Qwest Network.
Delivery may be extended under each agreement for force majeure events. The
Frontier and GTE agreements provide for penalties in the event of delay of
segments and, in certain circumstances, allow Frontier and GTE to delete
non-delivered segments from the contracts.
Qwest believes that significant opportunities exist to sell additional dark
fiber throughout the Qwest Network and management has identified and is in
various stages of negotiations with potential customers. However, Qwest does not
expect to enter into additional agreements of the size and scope of the Frontier
and GTE contracts. These potential customers include other interexchange
carriers, cable, entertainment and data transmission companies, RBOCs, ISPs,
LECs and CLECs. Qwest believes that these potential customers will view Qwest as
an attractive source for certain of their long distance transmission needs. In
order to meet the needs of this diverse group of customers, Qwest expects to
offer a wide variety of pricing and system options to meet specific needs of
each customer. For example, customers may purchase or lease dark fiber or
purchase capacity on a short- or long-term basis.
The Frontier and GTE agreements each provide for the purchase of 24 fibers
along major portions of the Qwest Network, while the WorldCom agreement
generally provides for the purchase of 24 or, in certain segments, 36 fibers.
Several smaller construction contracts for sales of dark fiber provide for the
sale of smaller numbers of fibers over a more limited number of segments. In
segments where Qwest agrees to sell dark fiber to others, it generally will
install enough fibers so that it can retain 48 fibers for its own use along
substantially all of the route of the Qwest Network.
SIGNIFICANT CUSTOMERS
During 1997 and 1996, Qwest's top ten customers accounted for approximately
83.6% and 69.3%, respectively, of its consolidated gross revenue. Frontier,
WorldCom and GTE accounted for 31.2%, 6.1% and 36.6% of such revenue,
respectively, in 1997 and 26.3%, 27.8% and 0.0% of such revenue, respectively,
in 1996, attributable primarily to construction contracts for the sale of dark
fiber to these customers that extend through 1998 or into 1999 pursuant to the
applicable contract.
CARRIER SERVICES
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General. Qwest has been positioned historically in the long distance business
as a "carrier's carrier," providing dedicated line and switched services to
other carriers over Qwest's owned or leased fiber optic network facilities.
Management believes that Qwest has earned a reputation of providing quality
services at competitive prices to meet specific customer needs. Total revenue
from Carrier Services was approximately $55.6 million, $57.6 million and $67.8
million for the years 1997, 1996 and 1995, respectively. These revenue amounts
have not been adjusted for the sale of Qwest's resale dedicated line services on
leased capacity which occurred in July 1996.
Products. Products offered by Carrier Services fall into three primary
categories: (i) high volume capacity services; (ii) conventional dedicated
line services; and (iii) switched services.
. High Volume Capacity Services. Qwest provides high volume transmission at or
above the OC-3 level (or its equivalent) through service agreements for
terms of one year or longer. As the Qwest Network is deployed, Qwest also is
targeting potential large users in the inter-LATA market that may seek to
augment their own networks or provide diverse routing alternatives in
strategic areas of their systems.
. Conventional Dedicated Line Services. Qwest provides dedicated line services
on owned capacity to a wide range of customers at capacities below the OC-3
level generally for terms of one year or less. Qwest expects the Qwest
Network will enable Qwest to offer these services over a significantly
expanded geographic area.
. Switched Services. Qwest provides switched terminating services over its
switched service network to large and small long distance carriers. The
carrier switched terminating service business is specifically used to
increase volume on Qwest's switched service network to allow for more
efficient "trunking" of calls. While the carrier switched services generate
revenue at lower margins than the dedicated line services, such services
facilitate cost effective management of the Qwest Network.
Qwest also plans to provide high speed ATM and Frame Relay data services to
carriers and Internet Service Providers ("ISPs") by installing ATM and Frame
Relay switching equipment. Qwest expects such services to become available in
1998.
Customers. Carrier Services' customer base in the inter-LATA carrier market
consists of the following:
. Tier 1 and Tier 2 Carriers. Qwest offers high volume transmission capacity,
conventional dedicated line services and dedicated switched services to the
Tier 1 and Tier 2 carriers on a national or regional basis. As RBOCs enter
the long distance market, Qwest believes they will be potential customers to
lease high volume capacity from Qwest on a national basis.
. Tier 3 Carriers. Qwest currently offers switchless resale services to
Tier 3 carriers on a limited basis. Qwest anticipates that this business
will expand as coverage of Qwest's switched network grows.
. Internet Service Providers. Qwest currently offers high volume capacity
to ISPs on a limited basis.
. Operator Services Companies and Other Niche Companies. These companies
concentrate on providing operator services and other communications services
to the long distance industry, private payphone operators, prisons and
credit card companies. These carriers also manage their own networks and
switching equipment while leasing virtually all of their transmission
facilities. Qwest provides transmission services to these carriers.
Service Agreements. Qwest provides high volume transmission capacity
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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 Qwest and its competitors. Qwest, however, has not experienced
significant fluctuations to date.
COMMERCIAL SERVICES
General. Qwest began offering Commercial Services in 1993. Commercial Services
focuses primarily on the sale of inter-LATA long distance services to the retail
market, principally to small- and medium-sized businesses and to consumers.
Qwest currently provides facilities-based services along the majority of its lit
routes, and is a switch based reseller elsewhere. Total revenue from Commercial
Services was approximately $59.6 million, $34.3 million and $20.4 million in
1997, 1996 and 1995, respectively. Qwest plans to transfer carrier and
commercial switched traffic from leased facilities onto the Qwest Network as it
is activated. As traffic volume increases and Qwest carries a greater percentage
of traffic on the Qwest Network, Qwest believes it will realize economies of
scale and thereby lower its cost of sales as a percentage of revenue. See "Risk
Factors--Managing Rapid Growth."
Products. Qwest markets the following products:
. One Plus. This basic service offers customers the ability to make outbound
long distance calls from any local telephone line by simply dialing a 1,
plus the area code and phone number. Customers select Qwest as their primary
long distance provider by placing an order with it. This service may be used
for both domestic and international calling.
. 10056. This service allows the customer to access the Qwest Network by
dialing 10056 plus 1, plus the area code and phone number, with no need to
change their primary long distance provider. These customers are solicited
through direct mailing.
. Dedicated Access Service. These lines are designed for larger users with
enough traffic volume to warrant the use of a dedicated access line to
originate calls. Instead of a switched access line that is shared by many
users, this service uses a high capacity line that is used exclusively to
connect between the end user and the long distance carrier's switch. This
results in lower originating access cost and reduced rates to the user.
. Toll Free 800/888. This inbound service, where the receiving party pays for
the call, is accessed by dialing an 800/888 area code. This is used in a
wide variety of applications, many of which generate revenue for the user
(such as reservation centers or customer service centers). Qwest plans to
introduce additional enhanced features such as call routing by origination
point, time of day routing and other premium features in 1998.
. Calling Card. These traditional, basic telephone calling cards allow the
user to place calls from anywhere in the United States or Canada. Qwest
offers additional higher margin features such as conference calling,
international origination, information service access (such as weather or
stock quotes), speed dialing and voice messaging.
. Prepaid Card. Prepaid cards allow a customer to purchase and pay in
advance for a card with a fixed amount of calling time. The card is then
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used as a standard calling card. Prepaid cards may be purchased with
enhanced features similar to those of calling cards and also may be renewed
by purchasing additional time.
. Media Express(TM). This is an exclusive switched digital broadband service
that provides variable bandwidth for video communications and other data
applications on demand and allows users to control all the required
components of a video conference from a personal computer.
. Voice Over IP. In February 1998, Qwest began commercial service for its
voice over internet protocol ("IP") telephony service, Q.talkSM, with
customers using the service through a controlled introduction in nine
cities. Qwest expects to expand its service offering to approximately 25
cities by mid-1998, and continue the expansion of the service in conjunction
with the planned Qwest Network buildout. Qwest offers to customers
uncompressed voice over IP service at 7.5 cents per minute, 24 hours a day,
seven days a week.
Other services offered by Commercial Services include audio conferencing,
operator services, directory assistance, special rate structures, custom
services, special contract pricing and special local access arrangements in
selected markets. In addition, Qwest intends to develop and offer additional
value-added services to its customers, particularly business customers, to
differentiate Qwest from its competitors and enhance Commercial Services profit
margins. Qwest also is evaluating and intends to introduce in the future a
variety of services specifically designed to capture a share of the growing data
networking market.
In September 1997, Qwest entered into an arrangement with Cisco Systems Inc.
under which they will jointly define and test new broadband business multimedia
services.
Customers. Commercial Services currently targets small and medium to large
businesses. The strategy of Commercial Services is to develop a customer base
in geographic proximity to the Qwest Network.
NETWORK CONSTRUCTION SERVICES
General. Qwest's Network Construction Services operations commenced in 1988
with the construction of conduit systems for major interexchange carriers. Total
revenue from Network Construction Services was approximately $581.4 million,
$139.2 million and $36.9 million in 1997, 1996 and 1995, respectively.
Products. The principal product of Network Construction Services historically
has been turn-key conduit systems built for other carriers. In most cases, while
fulfilling customer contracts, Qwest installed additional conduit that it
retained for its own use. Qwest is using its Network Construction Services
resources to implement its strategic plan to complete the Qwest Network, in
addition to providing Network Construction Services to third party customers
along Qwest Network routes.
In 1996, Qwest began selling dark fiber to telecommunications entities to help
fund development of the Qwest Network. In 1996, Qwest's Network Construction
Services revenue was derived largely from two principal dark fiber sales
contracts with Frontier and WorldCom. These two contracts, along with the
contracts with GTE, generated the majority of Network Construction Services
revenue in 1997, and it is expected that these contracts will also generate the
majority of such revenue in 1998. In addition, Qwest expects to generate
additional revenue through the sale of dark fiber along various segments of the
Qwest Network to other carriers.
Customers. Network Construction Services customers historically have been
primarily interexchange carriers, as well as major LECs and other
telecommunications companies. For the year ended December 31, 1997, GTE was the
largest single Network Construction Services customer, accounting for
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approximately 36.6% of Qwest's consolidated gross revenue, with Frontier
accounting for approximately 31.2%. For the year ended December 31, 1996,
WorldCom was Qwest's largest single customer, accounting for approximately 27.8%
of Qwest's consolidated gross revenue, and Frontier accounted for approximately
26.3% of Qwest's consolidated gross revenue. No other customers accounted for
more than 10% of consolidated gross revenue in 1997 and 1996. For the year ended
December 31, 1995, MCI was Qwest's largest single customer, accounting for
approximately 35.4% of consolidated gross revenue. No other customer accounted
for more than 10% of consolidated gross revenue in 1995.
SALES AND MARKETING
Qwest sells network dedicated and switched services to carriers through its
carrier sales organization. This organization consists of senior level
management personnel and experienced sales representatives with extensive
knowledge of the industry and key contacts within the industry at various levels
in the carrier organizations.
In Commercial Services, Qwest currently solicits targeted businesses through
telemarketing personnel, independent contractors and a direct sales channel.
Qwest plans to expand its presence in the Commercial Services market by
developing its distinctive "Ride the Light(TM)" brand identity and aggressively
marketing its existing and planned voice, data and other transmission products
and services. Qwest plans to build direct end user relationships by developing
strong distribution channels, providing competitive pricing and superior network
quality and offering enhanced, market-driven services to businesses and
consumers.
In September 1997, Qwest entered into a marketing agreement with Innova, Inc.
("Innova") under which Innova will be an authorized sales representative of
Qwest marketing Qwest's long distance products through affinity groups. Innova
is a marketing company that wholesales and retails telecommunication products on
a national basis with an emphasis on developing bundled product packages.
Also in September 1997, Qwest entered into a marketing agreement with enable,
a joint venture of KN Energy, Inc. ("KN") and PacifiCorp. Jordan Haines, a
Director of Qwest, is also a Director of KN. Qwest's One Plus and Calling Card
services (with competitive international pricing for both) will be offered to
utilities across the nation along with other services provided by en-able under
its Simple ChoiceSM brand name.
In February 1998, Qwest introduced its QwestLinked(TM) partner marketing
program. Carriers, corporations and technology partners who choose the Qwest
Network for their data, multimedia and voice connections are eligible to become
QwestLinked and share the brand trademark.
COMPETITION
The telecommunications industry is highly competitive. Many of Qwest's
existing and potential competitors in the Carrier Services, Commercial Services
and Network Construction Services markets have financial, personnel, marketing
and other resources significantly greater than those of Qwest, as well as other
competitive advantages. Increased consolidation and strategic alliances in the
industry resulting from the Telecommunications Act could give rise to
significant new competitors to Qwest.
In the Carrier Services market, Qwest's primary competitors are other carrier
service providers. Within the Carrier Services market, Qwest competes with large
and small facilities-based interexchange carriers. For high volume capacity
services, Qwest competes primarily with other coast-to-coast and regional fiber
optic network providers. There are currently four principal facilities-based
long distance fiber optic networks (AT&T, MCI, Sprint and WorldCom, although a
proposed WorldCom/MCI merger is pending). Qwest is aware that others are
planning additional networks that, if constructed, could employ advanced
technology similar to the Qwest Network. Upon completion of the Qwest Network,
Frontier and GTE will each have a fiber network similar in
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geographic scope and potential operating capability to that of Qwest. Another
competitor is constructing, and has already obtained a significant portion of
the financing for, a fiber optic network. The scope and capacity of that
competitor's network, as publicly announced, is less than that of Qwest, and
does not contain all of the advanced technologies designed for the Qwest
Network, but is expected to compete directly with the Qwest Network for many of
the same customers along a significant portion of the same routes. A carrier's
carrier announced in January 1998 that it plans to sell wholesale capacity on
its fiber optic network and that it has entered into an agreement with one of
the RBOCs to be the primary user of its network. Qwest believes that this
network, although potentially competitive, is different in operating capability
from the Qwest Network. Another potential competitor, a new telecommunications
company, has announced its intention to create a telecommunications network
based on Internet technology.
Qwest's competitors in Carrier Services include many large and small
interexchange carriers. Qwest's Carrier Services business competes primarily on
the basis of pricing, transmission quality, network reliability and customer
service and support. The ability of Qwest to compete effectively in this market
will depend upon its ability to maintain high quality services at prices equal
to or below those charged by its competitors.
Commercial Services has been and expects to continue to be a provider of high
quality, low cost service primarily to small- and medium-sized business
customers and consumers. Qwest intends to move into the market for higher volume
business customers as the Qwest Network is completed and new products are
introduced. In recent years the small- and medium-sized business market has
experienced increased competition. The industry wide changes in technology and
the effects of deregulation resulting from the Telecommunications Act are likely
to further increase competition. Many of Qwest's competitors and potential
competitors have financial, personnel and other resources substantially greater
than those of Qwest. In the Commercial Services market, Qwest's primary
competitors include AT&T, MCI, Sprint and WorldCom, all of whom have extensive
experience in the long distance market. On November 10, 1997, MCI and WorldCom
announced a proposed merger, and on March 11, 1998, the stockholders of both
companies approved the merger. The impact on Qwest of such a merger or other
consolidation in the industry is uncertain. In addition, the Telecommunications
Act will allow the RBOCs and others to enter the long distance market. See "Risk
Factors--Competition" and "Industry Overview--Telecommunications Markets."
In the future, Qwest may be subject to additional competition due to the
development of new technologies and increased supply of domestic and
international transmission capacity. The telecommunications industry is in a
period of rapid technological evolution, marked by the introduction of new
product and service offerings and increasing satellite transmission capacity for
services similar to those provided by Qwest. For instance, recent technological
advances permit substantial increases in transmission capacity of both new and
existing fiber, and the introduction of new products or emergence of new
technologies may reduce the cost or increase the supply of certain services
similar to those provided by Qwest.
High initial network cost and low marginal costs of carrying long distance
traffic have led to a trend among nonfacilities-based carriers to consolidate in
order to achieve economies of scale. Such consolidation could result in larger,
better capitalized competitors. However, Qwest believes that such competitors
would also be stronger prospects as potential Carrier Services customers.
PROPERTIES
The Qwest Network in progress and its component assets are the principal
properties owned by Qwest. Qwest owns substantially all of the
telecommunications equipment required for its business. Qwest's installed fiber
optic cable is laid under the various rights-of-way held by Qwest. Other fixed
assets are located at various leased locations in geographic areas served by
Qwest. Qwest is opening sales offices in selected major geographic
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locations.
Qwest's executive, administrative and sales offices and its Network Management
Center are located at its principal office in Denver, Colorado. Qwest leases
this space from an affiliate of Anschutz Company at market rates under an
agreement that expires in October 2004. Qwest also leases office space in the
Denver area for customer service operations. Qwest leases additional space in
Dallas, Texas, housing the headquarters for operation of its Microwave System.
In December 1995, Qwest entered into an agreement (as amended in January 1997)
with Ferrocarriles Nacionales de Mexico whereby Qwest was granted easements for
the construction of multiple conduit systems along railroad rights-of-way within
Mexico for consideration of approximately $7.7 million, including $1.1 million
in value-added taxes. Qwest has capitalized total costs, including right-of-way,
equipment, construction and design costs, relating to this investment of
approximately $13.0 million as of December 31, 1997.
In July 1997, Qwest entered into an agreement with an unrelated third party
whereby Qwest will receive (i) four dark fibers along a 2,220 kilometer route to
be constructed in Mexico by the third party, and (ii) certain construction
inventory and value-added tax refunds, totaling approximately $2.9 million. In
exchange for these assets, the third party will receive the stock of Qwest's
subsidiary, SP Servicios de Mexico S.A. de C.V., and approximately $6.7 million
in cash.
EMPLOYEES
As of December 31, 1997, Qwest employed approximately 1,600 employees of which
165 perform corporate and administrative services, 950 provide Network
Construction Services, 210 provide Commercial Services, 20 provide Carrier
Services, and 255 perform network engineering and related functions. Qwest uses
the services of independent contractors for installation and maintenance of
portions of the Qwest Network. None of the Qwest's employees are currently
represented by a collective bargaining unit. Qwest believes that its relations
with its employees are good.
LEGAL PROCEEDINGS
Qwest and its subsidiaries are subject to various claims and proceedings in
the ordinary course of business. Based on information currently available, Qwest
believes that none of such current claims or proceedings, individually or in the
aggregate, will have a material adverse effect on Qwest's financial condition or
results of operations, although there can be no assurances in this regard.
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REGULATION
GENERAL REGULATORY ENVIRONMENT
Qwest's operations are subject to extensive federal and state regulation.
Carrier Services and Commercial Services (but not Network Construction Services)
are subject to the provisions of the Communications Act of 1934, as amended,
including the Telecommunications Act and the FCC regulations thereunder, as well
as the applicable laws and regulations of the various states, including
regulation by PUCs and other state agencies. Federal laws and FCC regulations
apply to interstate telecommunications (including international
telecommunications that originate or terminate in the United States), while
state regulatory authorities have jurisdiction over telecommunications both
originating and terminating within the state. The regulation of the
telecommunications industry is changing rapidly, and the regulatory environment
varies substantially from state to state. Moreover, as deregulation at the
federal level occurs, some states are reassessing the level and scope of
regulation that may be applicable to Qwest. All of Qwest's operations are also
subject to a variety of environmental, safety, health and other governmental
regulations. There can be no assurance that future regulatory, judicial or
legislative activities will not have a material adverse effect on Qwest, or that
domestic or international regulators or third parties will not raise material
issues with regard to Qwest's compliance or noncompliance with applicable
regulations.
The Telecommunications Act may have potentially significant effects on the
operations of Qwest. The Telecommunications Act, among other things, allows the
RBOCs and GTE to enter the long distance business, and enables other entities,
including entities affiliated with power utilities and ventures between LECs and
cable television companies, to provide an expanded range of telecommunications
services. Entry of such companies into the long distance business would result
in substantial competition to Qwest's Commercial Services and Carrier Services
customers, and may have a material adverse effect on Qwest and such customers.
However, Qwest believes that the RBOCs' and other companies' participation in
the market will provide opportunities for Qwest to sell fiber or lease long
distance high volume capacity.
Under the Telecommunications Act, the RBOCs may immediately provide long
distance service outside those states in which they provide local exchange
service ("out-of-region" service), and long distance service within the regions
in which they provide local exchange service ("in-region" service) upon meeting
certain conditions. GTE may enter the long distance market without regard to
limitations by region. The Telecommunications Act does, however, impose certain
restrictions on, among others, the RBOCs and GTE in connection with their
provision of long distance services. Out-of-region services by RBOCs are subject
to receipt of any necessary state and/or federal regulatory approvals that are
otherwise applicable to the provision of intrastate and/or interstate long
distance service. In-region services by RBOCs are subject to specific FCC
approval and satisfaction of other conditions, including a checklist of
pro-competitive requirements. On December 31, 1997, the U.S. District Court,
Northern District of Texas (Wichita Falls) (the "District Court"), in SBC
Communications, Inc. v. FCC and U.S. (the "SBC Communications Case"), overturned
as unconstitutional the provisions of the Telecommunications Act which
prohibited RBOCs from providing inter-LATA long distance services within their
own region without demonstrating that the local exchange market was opened to
local competition. The decision, however, affects only SBC Communications, Inc.,
U.S. West Inc. and Bell Atlantic. Bell South has filed a recent suit making
similar claims. Ameritech has not yet filed such a suit. Following the filing of
respective petitions for stay by AT&T, MCI, the FCC and other intervenors in the
SBC Communications Case, the District Court on February 11, 1998, stayed its
decision, pending appellate review. In an order entered on January 22, 1998, the
Eighth Circuit Court of Appeals ruled that the FCC may not require the RBOCs to
comply with other checklist items, including the FCC's standard for pricing of
access and interconnection, as a condition of providing in-region service. Under
the Telecommunications Act, the RBOCs may provide in-region long distance
services only through separate subsidiaries with separate books and records,
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financing, management and employees, and all affiliate transactions must be
conducted on an arm's length and nondiscriminatory basis. The RBOCs are also
prohibited from jointly marketing local and long distance services, equipment
and certain information services unless competitors are permitted to offer
similar packages of local and long distance services in their market. Further,
the RBOCs must obtain in-region long distance authority before jointly marketing
local and long distance services in a particular state. Additionally, AT&T and
other major carriers serving more than 5% of presubscribed long distance access
lines in the United States are also restricted from packaging other long
distance services and local services provided over RBOC facilities. GTE is
subject to the provisions of the Telecommunications Act that impose
interconnection and other requirements on LECs, and must obtain regulatory
approvals otherwise applicable to the provision of long distance services in
connection with its providing long distance services.
FEDERAL REGULATION
The FCC has classified QCC, Qwest's principal operating subsidiary, as a
non-dominant carrier. Generally, the FCC has chosen not to exercise its
statutory power to closely regulate the charges, practices or classifications of
non-dominant carriers. However, the FCC has the power to impose more stringent
regulation requirements on Qwest and to change its regulatory classification. In
the current regulatory atmosphere, Qwest believes that the FCC is unlikely to do
so with respect to Qwest's domestic service offerings.
The FCC regulates many of the charges, practices and classifications of
dominant carriers to a greater degree than non-dominant carriers. Among domestic
carriers, large LECs and the RBOCs are currently considered dominant carriers
for the provision of interstate access services, while all other interstate
service providers are considered non-dominant carriers. On April 18, 1997, the
FCC ordered that the RBOCs and independent LECs offering domestic interstate
inter-LATA services, in-region or out-of-region, be regulated as non-dominant
carriers. However, such services offered in-region must be offered in compliance
with the structural separation requirements mentioned above. AT&T was classified
as a dominant carrier, but AT&T successfully petitioned the FCC for non-dominant
status in the domestic interstate interexchange market in October 1995 and in
the international market in May 1996. Therefore, certain pricing restrictions
that once applied to AT&T have been eliminated. A number of parties sought the
FCC's reconsideration of AT&T's status, but the FCC denied these petitions on
October 9, 1997.
As a non-dominant carrier, QCC may install and operate facilities for the
transmission of domestic interstate communications without prior FCC
authorization, so long as QCC obtains all necessary authorizations from the FCC
for use of any radio frequencies. Non-dominant carriers are required to obtain
prior FCC authorization to provide international telecommunications, and Qwest
has obtained international authority that permits it to operate as a
facilities-based carrier to all permissible international points and to operate
as a resale carrier (including the resale of private lines for the provision of
switched services) to all permissible points. The FCC also imposes prior
approval requirements on certain transfers of control and assignments of
operating authorizations. Non-dominant carriers are required to file periodic
reports with the FCC concerning their interstate circuits and deployment of
network facilities. International carriers are also required to file periodic
reports regarding traffic and revenue and regarding circuit status and
additions. Qwest is required to offer its interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remains subject to
FCC complaint procedures. While the FCC generally has chosen not to exercise
direct oversight over cost justification or levels of charges for services of
non-dominant carriers, the FCC acts upon complaints against such carriers for
failure to comply with statutory obligations or with the FCC's rules,
regulations and policies. Qwest or any of its operating subsidiaries could be
subject to legal actions seeking damages, assessment of monetary forfeitures
and/or injunctive relief filed by any party claiming to have been injured by
Qwest's practices. Qwest cannot predict either the likelihood of the filing of
any such complaints or the results if filed.
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Under existing regulations, non-dominant carriers are required to file with
the FCC tariffs listing the rates, terms and conditions of both interstate and
international services provided by the carrier. Pursuant to such regulations,
Qwest has filed with the FCC tariffs for its interstate and international
services. On October 29, 1996, the FCC adopted an order in which it eliminated,
as of September 1997, the requirement that non-dominant interstate carriers such
as Qwest maintain tariffs on file with the FCC for domestic interstate services
and in fact prohibited the filing of such tariffs, although tariffs for
international service must still be filed. Such carriers were given the option
to cease filing tariffs during a nine-month transition period that concluded on
September 22, 1997. The FCC's order was issued pursuant to authority granted to
the FCC in the Telecommunications Act to "forbear" from regulating any
telecommunications service provider if the FCC determines that the public
interest will be served. However, on February 19, 1997, the United States Court
of Appeals for the District of Columbia Circuit stayed the FCC's order pending
further expedited judicial review or FCC reconsideration or both. In August
1997, the FCC issued an order on reconsideration in which it affirmed its
decision to impose complete or mandatory detariffing, although it decided to
allow optional or permissive tariffing in certain limited circumstances
(including for interstate, domestic, interexchange dial-around services, which
end users access by dialing a carrier's 10XXX access code). Petitions for
further reconsideration of this order are pending, and this order also remains
subject to the Court of Appeals' stay pending further judicial review and the
pending appeals of the order on reconsideration. Qwest cannot predict the
ultimate outcome of these or other proceedings on its service offerings or
operations.
On May 8, 1997, the FCC released an order intended to reform its system of
interstate access charges to make that regime compatible with the pro-
competitive deregulatory framework of the Telecommunications Act. Access service
is the use of local exchange facilities for the origination and termination of
interexchange communications. The FCC's historic access charge rules were
formulated largely in anticipation of the 1984 divestiture of AT&T and the
emergence of long distance competition, and were designated to replace piecemeal
arrangements for compensating LECs for use of their networks for access, to
ensure that all long distance companies would be able to originate and terminate
long distance traffic at just, reasonable, and non-discriminatory rates, and to
ensure that access charge revenues would be sufficient to provide certain levels
of subsidy to local exchange service. While there has been pressure on the FCC
historically to revisit its access pricing rules, the Telecommunications Act has
made access reform timely. The FCC's access reform order adopts various changes
to its rules and policies governing interstate access service pricing designed
to move access charges, over time, to more economically efficient levels and
rate structures. Among other things, the FCC modified rate structures for
certain non-traffic sensitive access rate elements, moving some costs from a
per-minute-of-use basis to flat-rate recovery, including one new flat rate
element; changed its structure for interstate transport services; and affirmed
that ISPs may not be assessed interstate access charges. In response to claims
that existing access charge levels are excessive, the FCC stated that it would
rely on market forces first to drive prices for interstate access to levels that
would be achieved through competition but that a "prescriptive" approach,
specifying the nature and timing of changes to existing access rate levels,
might be adopted in the absence of competition. The FCC intends to address these
and other related matters in subsequent proceedings. Several parties have filed
petitions for reconsideration or judicial appeals or both of this order, many of
which are still pending. Though Qwest believes that access reform through
lowering and/or eliminating excessive access service charges will have a
positive effect on its service offerings and operations, it cannot predict how
or when such benefits may present themselves, or the outcome of the pending
judicial appeals or petitions for FCC reconsideration.
The FCC also released a companion order on universal service reform on May 8,
1997. The universal availability of basic telecommunications service at
affordable prices has been a fundamental element of U.S. telecommunications
policy since enactment of the Communications Act of 1934. The current system of
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universal service is based on the indirect subsidization of LEC pricing, funded
as part of a system of direct charges on some LEC customers, including
interexchange carriers such as QCC, and above-cost charges for certain LEC
services such as local business rates and access charges. In accordance with the
Telecommunications Act, the FCC adopted plans to implement the recommendations
of a Federal-State Joint Board to preserve universal service, including a
definition of services to be supported, and defining carriers eligible for
contributing to and receiving from universal service subsidies. The FCC ruled,
among other things, that: contributions to universal service funding be based on
all interexchange carriers' gross retail revenues from both interstate and
international telecommunications services; only common carriers providing a full
complement of defined local services be eligible for support; and up to $2.25
billion in new annual subsidies for discounted telecommunications services used
by schools, libraries, and rural health care providers be funded by an
assessment on total interstate and intrastate revenues of all interexchange
carriers. The FCC stated that it intends to study the mechanism for continued
support of universal service in high cost areas in a subsequent proceeding.
Several parties have filed petitions for reconsideration or judicial appeals or
both of this order, many of which are still pending. Further to its study of
support of universal service, the FCC on April 10, 1998 released a Report to
Congress suggesting that the FCC might, in a later proceeding, classify some
kinds of "phone-to-phone" voice services using the Internet protocol as
telecommunications. Such an outcome would extend new regulatory obligations and
associated costs, including the obligation to support universal service, to
providers of those services such as Qwest. Qwest is unable to predict the
outcome of the further FCC proceedings or of the pending judicial appeals or
petitions for FCC reconsideration on its operations. Qwest is required to
contribute in 1998 a percentage of its gross retail revenue to the universal
services fund and includes charges for these contributions in its 1998 billings.
On April 11, 1997, the FCC released an order requiring that all carriers
transition from three-digit to four-digit Carrier Identification Codes ("CICs")
by January 1, 1998. CICs are the suffix of a carrier's Carrier Access Code
("CAC"), and the transition will expand CACs from five (10XXX) to seven digits
(101XXXX). These codes permit customers to reach their carrier of choice from
any telephone. Parties filed petitions for reconsideration of this design,
arguing in part that this short transition (following the FCC's proposal for a
six-year transition) does not permit carriers sufficient time to make necessary
hardware and software upgrades or to educate their customers regarding the need
to dial additional digits to reach their carrier of choice. In response to these
petitions, the FCC on October 22, 1997 issued an order on reconsideration that
modified the transition to create a "two-step" process. LECs must have completed
switch changes to recognize the new codes by January 1, 1998, but interexchange
carriers have until June 30, 1998 to prepare for and educate their consumers
about the change to new codes. Petitions for reconsideration and judicial
appeals of the FCC's orders are pending. Qwest cannot predict the outcome of
these proceedings or whether this transition period will permit adequate
customer notification.
Qwest's Microwave System subsidiary is subject to applicable FCC regulations
for the use of radio frequencies. The FCC issues domestic microwave radio
licenses for limited periods not to exceed 10 years. Qwest must seek renewal of
such licenses prior to their expiration. Qwest knows of no facts that would
result in the denial of any such renewals, although there can be no assurance in
that regard. Although the FCC has never denied a microwave license application
made by Qwest, there can be no assurance that Qwest will receive all
authorizations or licenses necessary to implement its business plan or that
delays in the licensing process will not adversely affect Qwest's business.
The Communications Act of 1934 limits the ownership by non-U.S. citizens,
foreign corporations and foreign governments of an entity directly or indirectly
holding a common carrier radio license. These ownership restrictions apply to
Qwest's Microwave System but currently do not apply to non-radio facilities,
such as fiber optic cable. The FCC adopted rules relating to requests to exceed
the statutory limit on indirect foreign ownership of common carrier radio
licenses, and the participation of foreign carriers or U.S. entities with
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foreign carrier affiliates (generally an ownership interest greater than 25% or
a controlling interest) in an entity holding U.S. international authority. Under
those rules, the FCC has scrutinized either form of foreign participation to
determine whether the relevant foreign market offers "effective competitive
opportunities" ("ECO"). The FCC may impose restrictions (including prohibition
of the proposed participation or investment) on applicants not meeting the ECO
test. These rules have also required international carriers to notify the FCC 60
days in advance of an acquisition of a 10% or greater interest by a foreign
carrier in that U.S. carrier. The FCC has discretion to determine that unique
factors require application of the ECO test or a change in regulatory status of
the U.S. carrier even though the foreign carrier's interest is less than 25%.
These rules also reduce international tariff notice requirements for dominant,
foreign-affiliated carriers from 45 days' notice to 14 days' notice. Such
reduced tariff notice requirements may make it easier for dominant, foreign-
affiliated carriers to compete with Qwest. The Telecommunications Act partially
amends existing restrictions on foreign ownership of radio licenses by allowing
corporations with non-U.S. citizen officers or directors to hold radio licenses.
Other non-U.S. ownership restrictions, however, currently remain unchanged, but
the U.S. has agreed in recent world trade negotiations to allow for a
significant increase in permissible foreign investment, including 100% indirect
foreign ownership of U.S. common carrier radio licensees. On November 26, 1997,
the FCC issued an order that modified the continued applicability of its ECO
test in light of this agreement. In that order, which became effective February
9, 1998, the FCC eliminated the ECO test for applicants from the World Trade
Organization ("WTO") member countries seeking international authority from the
FCC or seeking to exceed the indirect foreign ownership limits on US common
carrier radio licenses. The FCC instead adopted an open entry standard with a
presumption that such participation by WTO member countries is permissible. The
FCC retained the ECO test, however, for applicants from non-WTO member
countries. The FCC also modified certain dominant carrier safeguards and further
reduced the tariff notice requirements from 14 to one day's notice. Finally, the
FCC raised the threshold for the required 60-day advance notification of foreign
carrier affiliations from 10% to 25%. Petitions for reconsideration of this
order are pending at the FCC. Qwest cannot predict the outcome of this
proceeding. Although Qwest believes these changes will have a positive effect on
its ability to identify potential sources of capital, they will also increase
the number of competitors for international traffic. The effect on Qwest of the
Telecommunications Act or other new legislation, negotiations or regulations
which may become applicable to Qwest cannot be determined.
INTERNATIONAL SETTLEMENTS
Under the international settlement system, international long distance traffic
is exchanged under bilateral correspondent agreements between facilities-based
carriers in two countries. Correspondent agreements generally are three to five
years in length and provide for the termination of traffic in, and return
traffic to, the carriers' respective countries at a negotiated accounting rate,
known as the Total Accounting Rate ("TAR"). In addition, correspondent
agreements provide for network coordination and accounting and settlement
procedures between the carriers. Both carriers are responsible for their own
costs and expenses related to operating their respective halves of the
end-to-end international connection.
Settlement costs, which typically equal one-half of the TAR, are the fees owed
to another international carrier for transporting traffic on its facilities.
Settlement costs are reciprocal between each party to a correspondent agreement
at a negotiated rate (which must be the same for all U.S. based carriers, unless
the FCC approves an exception). For example, if a foreign carrier charges a U.S.
carrier $0.30 per minute to terminate a call in the foreign country, the U.S.
carrier would charge the foreign carrier the same $0.30 per minute to terminate
a call in the United States. Additionally, the TAR is the same for all carriers
transporting traffic into a particular country, but varies from country to
country. The term "settlement costs" arises because carriers essentially pay
each other on a net basis determined by the difference between inbound and
outbound traffic between them.
The difference in cost between providing domestic long distance and
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international service is minimal, and technical advances in facilities deployed
for international calling are making distance largely irrelevant to cost.
Increased worldwide competition has already brought about certain reductions in
settlement rates and end user prices, thereby reducing overseas termination
costs for United States based carriers. However, it is believed that certain
foreign countries use settlement rates to subsidize their domestic call rates.
As a result, domestic customers currently pay significantly more for an
international call than they do for a domestic long distance call. The FCC has
adopted measures intended to overhaul the system of international settlements by
mandating that U.S. carriers negotiate settlement rates with foreign
correspondents at or below FCC-mandated benchmark levels. Several parties have
filed petitions for reconsideration with the FCC or judicial appeals or both
following this order, so it remains subject to modification. Additionally,
recent worldwide trade negotiations may have a significant impact on settlement
rates.
Qwest believes that the average cost of international telephone calls will be
reduced, and anticipates further international opportunities will be created as
a result of recent worldwide trade negotiations. On February 15, 1997,
representatives of 70 countries, including the United States, finalized the WTO
Basic Telecommunications Agreement ("WTO Agreement"), a compact addressing
market access, investment and pro-competitive regulatory principles in areas
currently generating over 95% of the world's telecommunications revenue. The WTO
Agreement took effect on February 5, 1998. Among other things, the agreement
provides U.S. companies market access for local, long distance and international
service in 53 historically monopolized countries through any means of network
technology, either as a facilities-based provider or as a reseller of existing
network capacity. The countries providing market access for telecommunications
services as a result of the WTO Agreement account for 99% of the world's
telecommunications revenue. Although some countries have reserved specific
exceptions, the agreement generally ensures that U.S. companies may acquire,
establish, or hold a significant stake in telecommunications companies around
the world, and that foreign companies may acquire, establish or hold such a
stake in U.S. telecommunications companies. Additionally, pro-competitive
regulatory principles based largely upon the Telecommunications Act were adopted
by 65 countries within the WTO Agreement. U.S. companies will be able to enforce
these principles, as well as the WTO Agreement's market access and investment
commitments, at the WTO and through enabling legislation in the U.S. Qwest
expects to benefit from the anticipated effects of the WTO Agreement, but cannot
predict where or when such opportunities may present themselves.
STATE REGULATION
Qwest's intrastate long distance telecommunications operations are subject to
various state laws and regulations including, in many jurisdictions,
certification and tariff filing requirements.
Generally, Qwest must obtain and maintain certificates of authority from
regulatory bodies in most states in which it offers intrastate services. In most
of these jurisdictions Qwest must also file and obtain prior regulatory approval
of tariffs for its intrastate services. Certificates of authority can generally
be conditioned, modified, canceled, terminated, or revoked by state regulatory
authorities for failure to comply with state law and/or the rules, regulations,
and policies of the state regulatory authorities. Fines and other penalties also
may be imposed for such violations. Qwest is currently authorized to provide
intrastate services in the 48 contiguous United States. Qwest intends to have
authority in all states where competition is allowed.
Those states that permit the offering of intrastate/intra-LATA service by
interexchange carriers generally require that end users desiring to use such
services dial special access codes. Historically, this has put Qwest at a
competitive disadvantage compared with LECs whose customers can make
intrastate/intra-LATA calls simply by dialing 1 plus the desired number. If a
long distance carrier's customer attempts to make an intra-LATA call by simply
dialing 1 plus the desired number, the call will be routed to and completed by
the LEC. Regulatory agencies in a number of states have issued decisions that
would permit Qwest and other interexchange carriers to provide intra-LATA
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calling on a 1 + basis. Further, the Telecommunications Act requires in most
cases that the RBOCs provide such dialing parity coincident to their providing
in-region inter-LATA services. Qwest expects to benefit from the ability to
offer 1 + intra-LATA services in states that allow this type of dialing parity.
LOCAL REGULATION
Qwest is occasionally required to obtain street use and construction permits
and licenses and/or franchises to install and expand its fiber optic network
using municipal rights-of-way. Termination of the existing franchise or license
agreements prior to their expiration dates or a failure to renew the franchise
or license agreements and a requirement that Qwest remove its facilities or
abandon its network in place could have a material adverse effect on Qwest. In
some municipalities where Qwest has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenue or on a per linear foot basis. There can be no
assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In addition, Qwest could be at a competitive
disadvantage if its competitors do not pay the same level of fees as Qwest.
However, the Telecommunications Act requires municipalities to manage public
rights-of-way in a competitively neutral and non-discriminatory manner.
OTHER
Qwest monitors compliance with federal, state and local regulations governing
the discharge and disposal of hazardous and environmentally sensitive materials,
including the emission of electromagnetic radiation. Qwest believes that it is
in compliance with such regulations, although there can be no assurance that any
such discharge, disposal or emission might not expose Qwest to claims or actions
that could have a material adverse effect on Qwest.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of Qwest, their ages and positions with
Qwest, and brief biographies are set forth below:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Philip F. Anschutz.................... 58 Director and Chairman
Joseph P. Nacchio..................... 48 Director, President and Chief
Executive Officer
Robert S. Woodruff.................... 49 Director, Executive Vice
President--Finance and Chief
Financial Officer and
Treasurer
Jordan L. Haines...................... 70 Director
Cannon Y. Harvey...................... 57 Director
Richard T. Liebhaber.................. 62 Director
Douglas L. Polson..................... 55 Director
Craig D. Slater....................... 40 Director
W. Thomas Stephens.................... 55 Director
Roy A. Wilkens........................ 55 Director
Joseph T. Garrity..................... 46 Secretary
</TABLE>
OTHER MANAGEMENT
In addition, senior management of QCC includes the individuals set forth
below:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Gregory M. Casey...................... 39 Senior Vice President--Carrier
Markets
Stephen M. Jacobsen................... 39 Senior Vice President--Consumer
Markets
Brij Khandelwal....................... 52 Executive Vice President and Chief
Information Officer
Reynaldo U. Ortiz..................... 51 Managing Director and Senior Vice
President-- International
Larry A. Seese........................ 52 Executive Vice President--Network
Engineering and Operations
Nayel S. Shafei....................... 38 Executive Vice President--Product
Development
August B. Turturro.................... 50 Senior Vice President--Network
Construction
A. Dean Wandry........................ 57 Senior Vice President--New
Business Development
Marc B. Weisberg...................... 40 Senior Vice President--Corporate
Development
Lewis O. Wilks........................ 44 President--Business Markets
</TABLE>
Philip F. Anschutz has been a Director and the Chairman of the Qwest Board
since February 1997. He was a Director and Chairman of the Board of QCC from
November 1993 until September 1997. He has been a Director and Chairman of the
Board of Anschutz Company, Qwest's majority stockholder, for more than five
years, and a Director and Chairman of the Board of The Anschutz Corporation, a
wholly owned subsidiary of Anschutz Company, for more than five years. Since
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the merger of Southern Pacific Rail Corporation ("SPRC") and Union Pacific
Corporation ("UP") in September 1996, Mr. Anschutz has served as Vice-Chairman
of UP. Prior to the merger, Mr. Anschutz was a Director of SPRC from June 1988
to September 1996, Chairman of SPRC from October 1988 to September 1996, and
President and Chief Executive Officer of SPRC from October 1988 to July 1993. He
also has been a Director of Forest Oil Corporation since 1995. Mr. Anschutz
serves as a member of the Compensation Committee of the Qwest Board (the
"Compensation Committee").
Joseph P. Nacchio became Director, President and Chief Executive Officer of
Qwest in February 1997, having been appointed to the same positions at QCC in
January 1997. Prior to joining Qwest he was Executive Vice President of AT&T's
Consumer and Small Business Division since January 1996. In that capacity he was
responsible for AT&T's core consumer long distance business, and AT&T's DirecTV,
AT&T Alascom and Language Line businesses. He was also responsible for marketing
and sales targeted at all consumer and small businesses in the United States. In
1994 and 1995 Mr. Nacchio was President of AT&T's Consumer Communications
Services long distance, a winner of the Malcolm Baldrige National Quality Award
for Excellence. From November 1991 until August 1994, Mr. Nacchio was President
of AT&T's Business Communications Services unit focused on the long distance
communications needs of business customers. Since joining AT&T in June 1970 he
held assignments in network operations, engineering, marketing and sales. Mr.
Nacchio earned an M.S. degree in management from the Massachusetts Institute of
Technology in the Sloan Fellows Program. He also received an M.B.A. degree and a
B.S. degree in electrical engineering, both from New York University.
Robert S. Woodruff became a Director and Executive Vice President--Finance
and Chief Financial Officer of Qwest in February 1997. He served as interim
Chief Operating Officer of Qwest and QCC from November 1996 through April
1997. He has served as a Director of QCC since December 1996. He became
Executive Vice President--Finance, Chief Financial Officer and Treasurer of
QCC in August 1994. He serves as a Director of FSI Acquisition Corp.,
Government Communications Inc., Qwest Transmission Inc., Qwest Properties,
Inc., and U.S. TeleSource, Inc., all of which are wholly owned subsidiaries of
QCC. He is also Sole Administrator of QCC's Mexican subsidiaries, Opticom,
S.A. de C.V., Servicios Derecho de Via, S.A. de C.V., and S.P. Servicios
Mexico, S.A. de C.V. Prior to joining Qwest he had been a partner in the
accounting firm of Coopers & Lybrand since 1984, where his responsibilities
included providing services to communications companies. Mr. Woodruff received
a B.B.A. degree in accounting, with honors, from the University of Wisconsin.
Jordan L. Haines was appointed a Director of Qwest in June 1997. He was
Chairman of the Board of Fourth Financial Corporation, a Kansas-based bank
holding company, and its subsidiary, Bank IV Wichita, N.A., from 1983 until his
retirement in 1991. He has been a member of the Board of Directors of KN Energy,
Inc. since 1983 and a Director of Forest Oil Corporation since 1996. Mr. Haines
serves as a member of the Audit Committee of the Qwest Board (the "Audit
Committee") and the Compensation Committee.
Cannon Y. Harvey has been a Director of Qwest since February 1997, and was
Director of QCC from December 1996 until September 1997. He has been President
and Chief Operating Officer of both Anschutz Company and The Anschutz
Corporation since December 1996. From February 1995 until September 1996 he
served as Executive Vice President--Finance and Law of SPRC; from September 1993
to February 1995 he served as Senior Vice President and General Counsel of SPRC;
from May 1993 to September 1993 he served as Vice President--Finance and Law and
General Counsel of SPRC. Prior to joining SPRC, Mr. Harvey was a Partner in the
law firm of Holme Roberts & Owen LLP for more than five years.
Mr. Harvey serves on the Audit Committee.
Richard T. Liebhaber has been a Director of Qwest since February 1997. He
has been a Managing Director of Veronis, Suhler & Associates, Inc., the New
York media merchant banking firm, since June 1, 1995. Mr. Liebhaber has been a
member of the board of directors of Objective Communications, Inc. since
August 1994, the board of directors of Alcatel Network Systems, Inc. since
June 1995, the board of directors of Geotek Communications, Inc. since April
1995, the Board of Directors of Internet Communications Corporation since May
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1997, and the Board of Directors of Scholz Master Builders since December 1985.
From December 1985 to his retirement in May 1995, Mr. Liebhaber served as
Executive Vice President of MCI Communications Corporation and as a member of
its Management Committee. Mr. Liebhaber was a member of the Board of Directors
of MCI Communications Corporation from July 1992 until his retirement in May
1995.
Douglas L. Polson has been a Director of Qwest since February 1997, and was
Director of QCC for more than five years until 1997. He has been a Director and
Vice President--Finance of both Anschutz Company and The Anschutz Corporation
for more than five years. He was a Director of SPRC from June 1988 to September
1996; Vice Chairman of SPRC from June 1988 to September 1996; and a Vice
President of SPRC from October 1988 to September 1996.
Craig D. Slater has been a Director of Qwest since February 1997 and a
Director of QCC since November 1996. He has been President of Anschutz
Investment Company since August 1997 and Vice President--Acquisitions and
Investments of both Anschutz Company and The Anschutz Corporation since August
1995. Mr. Slater served as Corporate Secretary of Anschutz Company and The
Anschutz Corporation from September 1991 to October 1996 and held various other
positions with those companies from 1988 to 1995. He has been a Director of
Forest Oil Corporation since 1995 and Internet Communications Corporation since
1996.
W. Thomas Stephens was appointed a Director of Qwest in June 1997. He is
President, Chief Executive Officer and a Director of MacMillan Bloedel Limited,
Canada's largest forest products company. He served from 1986 until his
retirement in 1996 as President and Chief Executive Officer of Manville
Corporation, an international manufacturing and resources company. He also
served as a member of the Manville Corporation Board of Directors from 1986 to
1996, and served as Chairman of the Board from 1990 to 1996. Mr. Stephens is a
Director of The Putnam Funds and New Century Energies. He serves as a member of
the Audit Committee and the Compensation Committee.
Roy A. Wilkens was appointed a Director of Qwest in March 1998. Mr. Wilkens
was President of Williams Pipeline Company when he founded WilTel Network
Services as an operating unit of The Williams Companies, Inc. in 1985. He was
Founder/CEO of WilTel Network Services from 1985 to 1997. In 1995, WilTel
Network Services was acquired by LDDS Communications, which now operates under
the name WorldCom. In 1997, Mr. Wilkens retired from WorldCom as Vice
Chairman. In 1992, Mr. Wilkens was appointed by President George Bush to the
National Security Telecommunications Advisory Council. He has also served as
Chairman of both the Competitive Telecommunications Association (CompTel) and
the National Telecommunications Network. Mr. Wilkens is a member of the Board
of Directors of Paging Network Inc., UniDial Inc. and Invensys Corporation
Inc.
Joseph T. Garrity has been Secretary of Qwest since February 1997, Secretary
of QCC since November 1996, and has been a Director of QCC since September 1997.
He is also Senior Director--Legal, Regulatory and Legislative Affairs of QCC
since November 1996 and was Director--Regulatory and Legislative Affairs of QCC
from March 1995 to November 1996. Prior to joining Qwest, from 1992 to March
1995, Mr. Garrity was Senior Attorney with MCI Telecommunications Corporation;
and from 1991 to 1992 he was President of Garrity, Inc. and Joseph T. Garrity,
P.C., where he was an attorney and consultant in the areas of domestic and
international telecommunications. From 1988 to 1991 he was Counsel and Assistant
Secretary to Jones International, Ltd., Jones Intercable, Inc. and Jones
Spacelink, Ltd. and from 1989 to 1991 was President, Jones Programming Services,
Inc. He has B.S. and M.S. degrees from Northwestern University and a J.D. degree
from DePaul University College of Law.
Gregory M. Casey became Senior Vice President--Carrier Markets of QCC in June
1997. In this capacity, he is responsible for all of Qwest's carrier marketing
and sales programs. Prior to joining QCC, Mr. Casey was, since 1996, Vice
President of Carrier Relations and Regulatory Affairs at LCI, with
responsibility for managing relationships with RBOCs and LECs and negotiating
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interconnection arrangements and wholesale pricing for resale of local
service. From 1991 to 1996, he was employed by ONCOR Communications Inc.,
where he served as Senior Vice President of Regulatory Affairs and Telephone
Company Relations. Prior to joining ONCOR, he was Senior Vice President and
General Counsel for Telesphere International Inc. Mr. Casey holds a B.A.
degree in political science from the University of Connecticut and a J.D.
degree from DePaul University College of Law.
Stephen M. Jacobsen became Senior Vice President--Consumer Markets of QCC in
March 1997. In this capacity, he is responsible for all of QCC's consumer
marketing and sales programs. Prior to joining QCC, Mr. Jacobsen was Regional
Vice President--Consumer and Small Business for AT&T in Southern California and
Nevada since 1996, with responsibility for all marketing functions for consumer
and small business customers in those geographic areas. During his nearly
sixteen-year career at AT&T, Mr. Jacobsen held key managerial positions in the
network services division, including responsibility for AT&T's network
operations center in the western region as well as positions in sales, marketing
and product management. Mr. Jacobsen holds an M.S. degree in management from the
Massachusetts Institute of Technology in the Sloan Fellows Program and a
B.S.B.A. degree from the University of Arizona.
Brij Khandelwal became Executive Vice President and Chief Information Officer
of QCC in October 1997. Prior to joining Qwest he was Vice President and Chief
Information Officer at Lucent Technologies Network Systems from November 1995 to
October 1997. At Lucent from August 1994 to October 1997, he was responsible for
global delivery of enterprise information systems and services aligned with
corporate strategic and tactical goals. He is experienced in a wide range of
information technologies, systems and processes affecting the business
enterprise, including sales, marketing, financial, operations, and R&D. From
August 1990 through August 1994 he was Director, Systems Development at GE
Aerospace/Martin Marietta, where he was responsible for architecture and
delivery of enterprise information systems. Mr. Khandelwal holds a B.S. from the
University of Roorkee (Roorkee, India), an M.S. from the University of Nebraska,
and a Ph.D. from the University of Wisconsin.
Reynaldo U. Ortiz became Managing Director and Senior Vice President--
International of QCC in December 1997. Before joining Qwest full time, Mr. Ortiz
was a consultant to QCC. In this capacity, he negotiated with the government of
Mexico and arranged a transaction with Bestel S.A. de C.V. to extend the Qwest
network into 14 major cities in Mexico. Previously, Mr. Ortiz served as
President and CEO of US West International, Inc., where he developed and
implemented a successful strategy for US West's entry into the cable
television-telephony and wireless communications markets in Asia, Europe and
Latin America. He also developed international distribution sales and marketing
agreements and product sourcing for International Business Machines, Inc. Mr.
Ortiz received an honorary doctorate degree in law from New Mexico State
University for his international achievements. He also holds an M.S. in
management from Stanford University.
Larry A. Seese became Executive Vice President--Network Engineering and
Operations of QCC in October 1997. From 1968 to October 1997, he was employed
by AT&T, most recently as Vice President of Network Operations. During Mr.
Seese's 29 year tenure at AT&T, he was responsible for managing the
operations, reliability and cost performance of AT&T's voice and data networks
and worked on the development of advanced switching systems and the
development of lightwave systems. He has experience in all aspects of network
planning, development, certification and deployment. Mr. Seese holds a B.S.
from the University of Kentucky and an M.S. from Columbia University, both in
electrical engineering. He also received an M.S. from the Sloan School of
Management at Massachusetts Institute of Technology.
Nayel S. Shafei became Executive Vice President--Product Development of QCC
in August 1997. From August 1996 to August 1997 he was Senior Vice President
and General Manager of Arrowsmith Corporation's Telecommunications Division.
From July 1994 to August 1996, he was Vice President and General Manager for
AlliedSignal. From April 1992 to July 1994, he was Vice President, Development
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and General Manager for Computervision Corporation, and was Principal
Architect, Research and Development for Computervision from August 1986 to
February 1991. Mr. Shafei serves as a computer/communications consultant for
the United Nations Development Program and is a member of the IEEE Computer
Society, Association of Computer Machinery, Society of Cable Engineers and
Product Data Exchange Standards. He holds an undergraduate degree from Cairo
University and an M.S. and a Ph.D. in computer science from the school of
engineering at Massachusetts Institute of Technology.
August B. Turturro became Senior Vice President--Network Construction for QCC
in September 1997 and President and Chief Operating Officer of Qwest Network
Construction Services. From January 1996 to September 1997, Mr. Turturro was
President and Chief Operating Officer of Inliner American, a specialty
trenchless utility contractor. From January 1992 to January 1996 he was
President and Chief Executive Officer of Fishbach Corporation and its Natkin
Group, which is the second largest specialty contractor in the United States.
Mr. Turturro has over 27 years of construction experience as a professional
engineer and holds contractor licenses in several states. He holds a B.S. degree
in Mechanical Engineering from West Virginia University.
A. Dean Wandry became Senior Vice President--Cable & Access Services for QCC
in November 1994 and Senior Vice President--New Business Development for QCC in
December 1995. In 1981 Mr. Wandry formed Citation Cable Systems Limited, which
merged into Fanch Communications, Inc. in 1986. Following the merger, he served
as Vice President-Operations until he joined QCC. He joined Bayly Corp., a
multinational apparel manufacturer, in 1967 and served as President of the Sales
and Marketing Division from 1977 to 1981. He holds a B.S. degree in economics
from the University of Colorado.
Marc B. Weisberg became Senior Vice President--Corporate Development of QCC
in September 1997. Prior to joining QCC, he was the founder and owner of
Weisberg & Company, where he provided investment banking and advisory services
to clients in several industries, including telecommunications, multimedia and
emerging technologies. Mr. Weisberg holds a B.A. from Michigan State
University.
Lewis O. Wilks became President--Business Markets of QCC in October 1997. Mr.
Wilks, who previously was President of GTE Communications, has extensive
senior-level management experience in delivering communications services to the
corporate sector. While Mr. Wilks served as President of GTE Communications, he
oversaw national sales, service and marketing activities for the competitive
local exchange markets. The business unit, under his leadership, was responsible
for all consumer, business and strategic accounts as well as long distance,
media ventures and Internet product distribution. Before joining GTE, Mr. Wilks
was a senior executive with MCI Corporation, and held a variety of management
positions with Wang Laboratories. Mr. Wilks holds a B.S. degree in public
relations and data processing from Central Missouri State University.
BOARD OF DIRECTORS MEETINGS AND COMMITTEES
The Qwest Board held 14 meetings during 1997, including both regularly
scheduled and special meetings and actions by unanimous written consent.
Audit Committee. The Qwest Board established an Audit Committee in May 1997
to: (i) make recommendations concerning the engagement of independent public
accountants; (ii) review with Qwest management and the independent public
accountants the plans for, and scope of, the audit procedures to be utilized and
results of audits; (iii) approve the professional services provided by the
independent public accountants; (iv) review the adequacy and effectiveness of
Qwest's internal accounting controls; and (v) perform any other duties and
functions required by any organization under which Qwest's securities may be
listed. Cannon Y. Harvey, Jordan L. Haines and W. Thomas Stephens are the
members of the Audit Committee. The Audit Committee did not meet during 1997.
Compensation Committee. In December 1996, the Board of Qwest's predecessor
company created a Compensation Committee and appointed Philip F. Anschutz and
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Cannon Y. Harvey to serve on the committee. In July 1997, Mr. Harvey resigned
from the committee. Since July 1997, Philip F. Anschutz, Jordan L. Haines and W.
Thomas Stephens have served on the committee. The Compensation Committee
determines the salaries, cash bonuses and fringe benefits of the executive
officers, reviews the salary administration and benefit policies of Qwest and
administers the Growth Share Plan and the Equity Incentive Plan. Effective as of
November 1997, Mr. Anschutz elected not to participate in the grant of options
and other awards under the Equity Incentive Plan. During 1997, the Compensation
Committee held one formal meeting in conjunction with a meeting of the Board,
took action by unanimous written consent four times and had informal meetings
preceding the actions taken by unanimous written consent.
Each Director attended more than 75% of the aggregate number of the Qwest
Board and/or applicable committee meetings in 1997.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
DIRECTOR COMPENSATION
Directors who are officers or employees of Qwest or any of its affiliates do
not receive compensation, except as officers or employees of Qwest or its
affiliates.
Directors who are neither officers nor employees of Qwest or any of its
affiliates, other than Mr. Liebhaber, are entitled to receive $24,000 per annum
for serving as directors of Qwest. Each director who is neither an officer nor
an employee of Qwest or any of its affiliates, other than Mr. Liebhaber, is
entitled to receive an attendance fee of $2,000 per meeting of the Board and of
a committee of which he is a member. The Board has adopted the Qwest
Communications International Inc. Equity Compensation Plan for Non- Employee
Directors (the "Director Equity Plan") pursuant to which each director who is
not an employee of Qwest or any of its affiliates may elect to receive
directors' fees in the form of Qwest Common Stock. Directors may elect on a
quarterly basis to receive their directors' fees either in Qwest Common Stock or
in cash.
Mr. Liebhaber has a consulting agreement with QCC. The consulting agreement
provides that he will be paid an annual retainer fee of $250,000 plus
reimbursement for out-of-pocket expenses not to exceed $10,000 without QCC's
prior approval. Mr. Liebhaber agreed to waive director's fees in consideration
for these payments. See "Certain Transactions."
Messrs. Slater, Polson and Liebhaber, directors of Qwest, have been granted a
total of 20,000, 7,500 and 10,000 growth shares, respectively, under the Growth
Share Plan. All of Mr. Polson's growth shares became 100% vested and payable at
the time of the Qwest Initial Public Offering and he received compensation
attributable to his growth shares in 1997 of $1,772,449. 7,500 of Mr. Slater's
growth shares became 100% vested and payable at the time of the Qwest Initial
Public Offering and he received compensation attributable to such growth shares
in 1997 of $1,772,449. The balance of Mr. Slater's growth shares and all of Mr.
Liebhaber's growth shares remain outstanding, but the value of such growth
shares has been capped at a value generally determined by the $11.00 per share
price (as adjusted to reflect the Qwest Stock Split) of Qwest's Common Stock in
the Initial Public Offering and the performance cycle will end on a date in 2001
selected by Qwest in its sole discretion. Based upon the provisions of the
Growth Share Plan and their respective growth share agreements, as amended, the
maximum amount payable to Messrs. Slater and Liebhaber with respect to the
balance of their growth shares is $2.3 million and $1.8 million, respectively.
Messrs. Slater and Liebhaber also received stock options at the time of the
Qwest Initial Public Offering to provide incentive compensation with respect to
appreciation in the Qwest Common Stock subsequent to the Qwest Initial Public
Offering.
Messrs. Slater, Liebhaber and Harvey have each been granted stock options
pursuant to the Equity Incentive Plan. Mr. Slater has been granted stock
options covering a total of 650,000 shares of Qwest Common Stock with 250,000
options having an exercise price of $11.00 per share and vesting at the rate
#396822
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<PAGE>
of 20% per year beginning at the same time as Mr. Slater's growth shares and
400,000 options having an exercise price of $30.00 per share and vesting at the
rate of 20% per year beginning on December 1, 1998. Mr. Liebhaber has been
granted stock options covering a total of 300,000 shares of Qwest Common Stock,
with 200,000 options having an exercise price of $11.00 per share and vesting at
the rate of 20% per year beginning at the same time as Mr. Liebhaber's growth
shares and 100,000 shares having an exercise price of $30.00 per share and
vesting at the rate of 20% per year beginning on December 1, 1998. Mr. Harvey
has been granted stock options covering a total of 200,000 shares of Qwest
Common Stock with an exercise price of $30.00 per share and vesting at the rate
of 20% per year beginning on December 1, 1998.
EXECUTIVE COMPENSATION
The following table summarizes the compensation paid or accrued to Qwest's
Chief Executive Officer and four other most highly compensated executive
officers of Qwest and its operating subsidiaries (the "Named Executives") during
the fiscal years ended December 31, 1997, 1996, and 1995, together with the
compensation paid or accrued to additional executive officers of Qwest and its
operating subsidiaries who joined Qwest in 1997 whose annualized rate of salary
would place them among the four most highly compensated executive officers. The
position identified in the table for each person is that person's current
position at Qwest unless otherwise indicated. Mr. Nacchio joined Qwest as its
Chief Executive Officer effective January 4, 1997. Mr. Woodruff served as
interim Chief Operating Officer of QCC from November 1996 to April 28, 1997.
#396822
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SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
--------------------------------- ---------------------
AWARDS PAYOUTS
---------- ----------
NUMBER OF
SECURITIES
OTHER ANNUAL UNDERLYING LTIP ALL OTHER
NAME/PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS PAYOUTS COMPENSATION
----------------------- ---- -------- -------- ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Joseph P. Nacchio....... 1997 $593,461 $300,000 -- 6,000,000 -- $7,405,273(1)
President and Chief 1996 -- -- -- -- -- --
Executive Officer 1995 -- -- -- -- -- --
Robert S. Woodruff...... 1997 $200,000 $ 70,000 $25,000(2) 400,000 $9,453,025 $ 7,750(3)
Executive Vice
President-- 1996 182,200 25,000 2,083 -- -- 5,466
Finance and Chief 1995 167,766 16,500 -- -- -- 1,671
Financial Officer and
Treasurer
A. Dean Wandry........... 1997 $157,000 $ 47,100 -- 150,000 $8,271,383 $ 7,930(3)
Senior Vice President-- 1996 148,300 30,000 -- -- -- 7,725
New Business 1995 141,866 14,000 -- -- -- 2,310
Development of QCC
Anthony J. Brodman....... 1997 $157,000 $ -- -- 50,000 $5,908,127 $ 7,930(3)
Senior Vice President-- 1996 152,333 30,000 -- -- -- 7,945
Fiber Markets of QCC 1995 130,270 11,364 $15,752(4) -- -- 7,163
Stephen M. Jacobson...... 1997 $143,020(5) -- $132,085(6) 600,000 -- --
Senior Vice President-- 1996 -- -- -- -- -- --
Consumer Markets of QCC 1995 -- -- -- -- -- --
Lewis O. Wilks........... 1997 $ 50,750(7) -- $200,000(6) 700,000 -- --
President--Business 1996 -- -- -- -- -- --
Markets of QCC 1995 -- -- -- -- -- --
Brij Khandelwal.......... 1997 $ 47,740(8) -- $150,000(6) 700,000 -- --
Executive Vice President 1996 -- -- -- -- -- --
and Chief Information 1995 -- -- -- -- -- --
Officer of QCC
Larry A. Seese........... 1997 $ 54,994(9) -- $200,000(6) 750,000 -- --
Executive Vice President 1996 -- -- -- -- -- --
--Network Engineering
and 1995 -- -- -- -- -- --
Operations of QCC
</TABLE>
- --------
#396822
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<PAGE>
(1) The amount shown represents the first installment of the "equalization
payment" (see "--Employment Contracts and Termination of Employment and
Change-in-Control Arrangements") paid to Mr. Nacchio in 1997 together with
interest of $173,273 that accrued with respect to the remaining portion of
the "equalization payment." That interest was paid to Mr. Nacchio in January
1998.
(2) The amount shown represents QCC's forgiveness of a portion of a loan. (3)
The amount shown represents QCC's contribution to QCC's 401(k) plan.
(4) The amount shown represents commissions.
(5) Mr. Jacobsen began his employment with QCC in March 1997 and amounts
disclosed for Mr. Jacobsen for 1997 represent compensation paid after that
date. Mr. Jacobsen will receive an annual salary of $192,770 for 1998.
(6) The amount shown represents relocation payments. (7) Mr. Wilks began his
employment with QCC in October 1997 and amounts
disclosed for Mr. Wilks for 1997 represent compensation paid after that
date. Mr. Wilks will receive an annual salary of $273,000 for 1998.
(8) Mr. Khandelwal began his employment with QCC in October 1997 and amounts
disclosed for Mr. Khandelwal for 1997 represent compensation paid after that
date. Mr. Khandelwal will receive an annual salary of $225,000 for 1998.
(9) Mr. Seese began his employment with QCC in October 1997 and amounts
disclosed for Mr. Seese for 1997 represent compensation paid after that
date. Mr. Seese will receive an annual salary of $230,000 for 1998.
STOCK OPTION GRANTS
The following table sets forth information with respect to the Named
Executives concerning the grant of stock options in 1997.
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<PAGE>
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATE OF STOCK
PRICE APPRECIATION
INDIVIDUAL GRANTS AWARDS FOR OPTION
--------------------------------------------------- -----------------------
NUMBER OF % OF TOTAL EXERCISE
SECURITIES OPTIONS GRANTED OR BASE
UNDERLYING TO EMPLOYEES IN PRICE EXPIRATION
NAME OPTIONS GRANTED FISCAL YEAR ($/SH) DATE 5%($) 10%($)
---- --------------- --------------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Joseph P. Nacchio....... 6,000,000(1) 43.18% $ 11.00 6/30/03 $22,617,341 $51,375,214
Robert S. Woodruff...... 400,000(2) 2.88% $ 30.00 12/1/07 7,546,736 19,124,910
Lewis O. Wilks.......... 700,000(3) 5.04% $ 23.75 10/3/07 10,455,373 26,495,968
Brij Khandelwal......... 700,000(4) 5.04% $22.875 9/27/07 10,070,175 25,519,801
Larry A. Seese.......... 750,000(5) 5.40% $22.875 9/26/07 10,789,473 27,342,644
A. Dean Wandry.......... 150,000(2) 1.08% $ 30.00 12/1/07 2,830,026 7,171,841
Stephen M. Jacobsen..... 600,000(6) 4.32% $ 11.00 9/24/03 2,299,861 5,248,074
Anthony J. Brodman...... 50,000(7) 0.36% $ 11.00 4/1/03 182,584 413,888
</TABLE>
- --------
(1) Granted on June 23, 1997 and exercisable in five annual increments of 20%
each commencing December 31, 1997.
(2) Granted on December 1, 1997 and exercisable in five annual increments of 20%
each commencing December 1, 1998.
(3) Granted on October 3, 1997 and exercisable in increments of 140,000 shares
each year for four years beginning October 27, 1998 and in two additional
increments of 70,000 shares each on October 27, 2002 and October 27, 2003.
(4) Granted on September 27, 1997 and exercisable in five annual increments of
20% each commencing October 16, 1998.
(5) Granted on September 26, 1997 and exercisable in two annual increments of
200,000 shares each commencing October 6, 1998, three annual increments of
100,000 shares for each of three years beginning October 6, 2000 and a final
increment of 50,000 shares on October 6, 2003.
(6) Granted on June 23, 1997 and exercisable in 15% increments on each of March
24, 1998 through March 24, 2001 and in an increment of 40% on March 24,
2002.
(7) Granted on June 23, 1997 and exercisable in 15% increments commencing
October 1, 1997 through October 1, 2000 and in an increment of 40% on
October 1, 2001.
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OPTION EXERCISES AND HOLDINGS
The following table sets forth information with respect to the Named
Executives concerning unexercised options held at the end of 1997. None of the
Named Executives exercised options during 1997.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT FISCAL YEAR OPTIONS AT FISCAL YEAR
END END
------------------------- -------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Joseph P. Nacchio........... 1,200,000 4,800,000 $22,500,000 $90,000,000
Robert S. Woodruff.......... -- 400,000 -- --
Lewis O. Wilks.............. -- 700,000 -- 4,200,000
Brij Khandelwal............. -- 700,000 -- 4,812,500
Larry A. Seese.............. -- 750,000 -- 5,156,250
A. Dean Wandry.............. -- 150,000 -- --
Stephen M. Jacobsen......... -- 600,000 -- 11,250,000
Anthony J. Brodman.......... 7,500 42,500 140,625 796,875
</TABLE>
GROWTH SHARE PLAN
Qwest's Growth Share Plan (the "Growth Share Plan"), as amended, provides for
the grant of "growth shares" to selected employees and directors of Qwest and
certain affiliates who can significantly affect the long-term financial success
of Qwest. The Growth Share Plan is unfunded and is a general, unsecured
obligation of Qwest. A growth share is a unit of value based on the increase in
the value of Qwest over a specified performance cycle or other specified
measuring period. The value of a growth share is generally equal to (i) the
value of Qwest at or near the date of a "triggering event" (as defined below),
minus (ii) the value of Qwest as of a date determined by the Qwest Board in its
sole discretion at the time of grant of a growth share ("Beginning Company
Value"), minus (iii) the value of contributions to capital during the period
beginning with the date as of which Qwest's value for purposes of the growth
share grant is determined and ending with the date as of which the value of the
growth shares is determined (the "Measuring Period") together with an amount
equal to 9% of each such contribution made by entities controlled by Philip F.
Anschutz, compounded annually, reduced for any return of capital, plus (iv)
dividends paid during the Measuring Period, divided by (v) 10,000,000 (the total
number of growth shares authorized). The value of Qwest for this purpose will be
based on the trading price of Qwest's equity securities over the 20 consecutive
trading days ending on the last day of the Measuring Period if all classes of
Qwest's outstanding equity securities are publicly traded and Qwest is subject
to the reporting and disclosure rules of the Exchange Act, otherwise the value
will be determined by independent appraisal. Payment for growth shares is
generally made at the end of the performance cycle or upon the occurrence of
certain "triggering events", which consist of termination of the Growth Share
Plan and a "change in control" (see "--Employment Contracts and Termination of
Employment and Change-in-Control Arrangements"). Qwest has entered into
amendments to the growth share arrangements with Messrs. Nacchio and Jacobsen
which provide that (i) following completion of the Qwest Initial Public
Offering, the value of the growth shares is capped at a value generally
determined by the $11 per share price (as adjusted to reflect the Qwest Stock
Split) of the Qwest Common Stock in the Qwest Initial Public Offering and (ii)
the performance cycle will end on a date in 2001 selected by Qwest in its sole
discretion. Based upon the provisions of the Growth Share Plan and their
respective growth share agreements, as amended, the maximum amount payable to
Messrs. Nacchio and Jacobsen with respect to their growth shares is $27.7
million and $2.8
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<PAGE>
million, respectively. The growth shares vest at the rate of 20% per year,
beginning on January 1, 1998 for Mr. Nacchio and March 24, 1998 for Mr.
Jacobsen. In addition, the growth shares will become fully vested in the event
of death, disability or retirement after age 65. See "--Employment Contracts and
Termination of Employment and Change-in-Control Arrangements" for a more
detailed description of Mr. Nacchio's growth share grant.
The following table sets forth the growth shares that were granted to the
Named Executives in 1997.
LONG-TERM INCENTIVE PLANS--AWARDS IN FISCAL YEAR 1997
<TABLE>
<CAPTION>
NUMBER
OF GROWTH
NAME SHARES PERFORMANCE PERIOD
---- --------- -----------------------
<S> <C> <C>
Joseph P. Nacchio............................. 300,000 January 1, 1997 to 2001
Stephen M. Jacobsen........................... 30,000 January 1, 1997 to 2001
</TABLE>
EQUITY INCENTIVE PLAN
Qwest adopted the Qwest Communications International Inc. Equity Incentive
Plan (the "Equity Incentive Plan") effective June 23, 1997. The purposes of the
Equity Incentive Plan are to provide those who are selected for participation
with added incentives to continue in the long-term service of Qwest and to
create in such persons a more direct interest in the future success of the
operations of Qwest by relating incentive compensation to increases in
shareholder value, so that the income of those participating in the Equity
Incentive Plan is more closely aligned with the income of the Qwest
Stockholders. The Equity Incentive Plan is also designed to provide a financial
incentive that will help Qwest attract, retain and motivate the most qualified
employees and consultants.
The Equity Incentive Plan provides for the grant of non-qualified stock
options, incentive stock options, stock appreciation rights, restricted stock,
stock units and other stock grants to employees of Qwest and affiliated
companies and consultants to Qwest and affiliated companies. A maximum of
20,000,000 shares of Qwest Common Stock may be subject to awards under the
Equity Incentive Plan. The number of shares is subject to adjustment on account
of stock splits, stock dividends and other dilutive changes in the Qwest Common
Stock. Shares of Qwest Common Stock covered by unexercised non-qualified or
incentive stock options that expire, terminate or are canceled, together with
shares of Qwest Common Stock that are forfeited pursuant to a restricted stock
grant or any other award (other than an option) under the Equity Incentive Plan
or that are used to pay withholding taxes or the option exercise price, will
again be available for option or grant under the Equity Incentive Plan.
Participation. The Equity Incentive Plan provides that awards may be made to
eligible employees and consultants who are responsible for Qwest's growth and
profitability. Qwest currently considers all of its employees and consultants to
be eligible for grant of awards under the Equity Incentive Plan. As of December
31, 1997, there were approximately 1,600 eligible participants.
Administration. The Equity Incentive Plan is administered by the Compensation
Committee. The Compensation Committee must be structured at all times so that
the Equity Incentive Plan satisfies the requirements of Rule 16b-3 under the
Exchange Act. To the extent practicable, Qwest intends to satisfy the
requirement for administration by "outside" directors under Section 162(m) of
the Code ("Section 162(m)") with respect to grants to employees whose
compensation is subject to Section 162(m). The Compensation Committee has the
sole discretion to determine the employees and consultants to whom awards may be
granted under the Equity Incentive Plan and the manner
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in which such awards will vest. Options, stock appreciation rights, restricted
stock and stock units are granted by the Compensation Committee to employees and
consultants in such numbers and at such times during the term of the Equity
Incentive Plan as the Compensation Committee shall determine, except that the
maximum number of shares subject to one or more awards that can be granted
during the term of the Equity Incentive Plan to any employee or consultant is
20,000,000 shares of Qwest Common Stock, and except that incentive stock options
may be granted only to employees. In granting options, stock appreciation
rights, restricted stock and stock units, the Compensation Committee will take
into account such factors as it may deem relevant in order to accomplish the
Equity Incentive Plan's purposes, including one or more of the following: the
extent to which performance goals have been met, the duties of the respective
employees and consultants and their present and potential contributions to
Qwest's success.
Exercise of Options. The Compensation 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 Qwest Common Stock on the
date the incentive stock option is granted (at least equal to 110% of fair
market value in the case of an incentive stock option granted to an employee who
owns Qwest Common Stock having more than 10% of the voting power). An option
holder may exercise an option by written notice and payment of the exercise
price in (i) cash or certified funds, (ii) by the surrender of a number of
shares of Qwest Common Stock already owned by the option holder for at least six
months with a fair market value equal to the exercise price, or (iii) through a
broker's transaction by directing the broker to sell all or a portion of the
Qwest Common Stock to pay the exercise price or make a loan to the option holder
to permit the option holder to pay the exercise price. Option holders who are
subject to the withholding of federal and state income tax as a result of
exercising an option may satisfy the income tax withholding obligation through
the withholding of a portion of the Qwest Common Stock to be received upon
exercise of the option. Options, stock appreciation rights, stock units and
restricted stock awards granted under the Equity Incentive Plan are not
generally transferable other than by will or by the laws of descent and
distribution.
Option Term. The Compensation Committee determines the term of each Option,
which shall be no longer than ten years (five years in the case of an incentive
stock option granted to an employee who owns Qwest Common Stock having more than
10% of the voting power). Unless the Compensation Committee provides otherwise,
the following provisions apply in the event of an employee's termination of
employment. If the option holder's services are terminated for cause, as
determined by Qwest, the option terminates immediately. If the option holder
becomes disabled, the option may be exercised for one year after the option
holder terminates employment on account of disability. If the option holder dies
during employment or in the one-year period referred to in the preceding
sentence, the option may be exercised for one year after the option holder's
death. If the option holder terminates employment for any reason other than
cause, disability, or death, the option may be exercised for three months after
termination of employment. In all cases, the option can be exercised only to the
extent it is vested at the time of termination of employment.
Restricted Stock. The Compensation Committee may grant a Participant a number
of shares of restricted stock as determined by the Compensation Committee in its
sole discretion. Grants of restricted stock may be subject to such restrictions,
including for example, continuous employment with Qwest for a stated period of
time or the attainment of performance goals and objectives, as determined by the
Compensation Committee in its sole discretion. The restrictions may vary among
awards and participants. If a participant dies or becomes disabled or retires
pursuant to Qwest's retirement policy, the restricted stock will become fully
vested as to a pro rata portion of each award based on the ratio of the number
of months of employment completed at termination of employment from the date of
the award to the total number of months of employment required for each award to
become fully vested. The remaining portion of the restricted stock will be
forfeited. If a participant terminates employment for any other reason, all
unvested shares of restricted stock will be forfeited.
#396822
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Stock Units. The Compensation Committee may grant stock units to participants.
The Compensation Committee determines the number of stock units to be granted,
the goals and objectives to be satisfied, the time and manner of payment, and
any other terms and conditions applicable to the stock units.
Stock Appreciation Rights. The Compensation Committee may grant stock
appreciation rights to participants, either separately or in tandem with the
grant of options. The Compensation Committee determines the period during which
a stock appreciation right may be exercised and the other terms and conditions
applicable to the stock appreciation rights. Upon exercise of a stock
appreciation right, a participant is entitled to a payment equal to the number
of shares of Qwest Common Stock as to which the stock appreciation right is
exercised times the excess of the fair market value of a share of Qwest Common
Stock on the date the stock appreciation right is exercised over the fair market
value of a share of Qwest Common Stock on the date the stock appreciation right
was granted. The amount may be paid in shares of Qwest Common Stock, in cash, or
in a combination of cash and Qwest Common Stock as the Compensation Committee
determines in its sole discretion. Upon termination of employment, stock
appreciation rights are exercisable in the same manner as options. See "--Option
Term." If a stock appreciation right is granted in tandem with an option,
exercise of the stock appreciation right or the option will result in an equal
reduction in the number of shares subject to the corresponding option or stock
appreciation right.
Other Stock Grants. The Compensation Committee may award stock bonuses to such
participants, subject to such conditions and restrictions, as it determines in
its sole discretion. Stock bonuses may be outright grants or may be conditioned
on continued employment or attainment of performance goals as the Compensation
Committee determines in its sole discretion. The Qwest Board may, in its sole
discretion, establish other incentive compensation arrangements pursuant to
which participants may acquire Qwest Common Stock or provide that other
incentive compensation will be paid in Qwest Common Stock under the Equity
Incentive Plan.
Nontransferability. Except as may be otherwise permitted by the Compensation
Committee, options, stock appreciation rights, stock units and restricted stock
awards granted under the Equity Incentive Plan are not transferable other than
by will or by the laws of descent and distribution.
Change in Control. All awards granted under the Equity Incentive Plan shall
immediately vest upon any "change in control" of Qwest unless provided otherwise
by the Compensation Committee at the time of grant. A "change in control" occurs
if (i) 20% or more of Qwest's voting stock or outstanding stock is acquired by
persons or entities (other than Anschutz Company, The Anschutz Corporation, a
Delaware corporation wholly owned by Anschutz Company, or any other entity
controlled by Philip F. Anschutz ("Anschutz Entities")) and the beneficial
ownership so acquired exceeds the beneficial ownership of the Anschutz Entities
or (ii) the Anschutz Entities no longer have beneficial ownership of at least
20% of Qwest's voting stock or outstanding stock.
Merger and Reorganization. Upon the occurrence of (i) the reorganization
(other than a bankruptcy reorganization), merger or consolidation of Qwest
(other than a reorganization, merger or consolidation in which Qwest is the
continuing company and that does not result in any change in the outstanding
shares of Qwest Common Stock), (ii) the sale of all or substantially all of the
assets of Qwest (other than a sale in which Qwest continues as a holding company
of an entity that conducts the business formerly conducted by Qwest), or (iii)
the dissolution or liquidation of Qwest, all outstanding options will terminate
automatically when the event occurs if Qwest gives the option holders 30 days'
prior written notice of the event. Notice is also given to holders of other
awards. Notice is not required for a merger or consolidation or for a sale if
Qwest, the successor, or the purchaser makes adequate provision for the
assumption of the outstanding options or the substitution of new options or
awards on terms comparable to the outstanding options or awards. When the notice
is given, all awards shall immediately vest and all restrictions shall lapse and
all outstanding options can be immediately exercised prior to the event and all
other awards become exercisable and/or payable.
#396822
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Amendment and Termination. The Qwest Board may amend the Equity Incentive Plan
in any respect at any time provided stockholder approval is obtained when
necessary or desirable, but no amendment can impair any option, stock
appreciation right, award or unit previously granted or deprive an option
holder, without his or her consent, of any Qwest Common Stock previously
acquired. The Equity Incentive Plan will terminate in 2007 unless sooner
terminated by the Qwest Board.
Federal Income Tax Consequences of Issuance and Exercise of Options Under the
Equity Incentive Plan. When a non-qualified stock option is granted, there are
no income tax consequences for the option holder or Qwest. When a non-qualified
stock option is exercised, in general, the option holder recognizes compensation
equal to the excess of the fair market value of the Qwest Common Stock on the
date of exercise over the exercise price. If, however, the sale of the Qwest
Common Stock at a profit would subject the option holder to liability under
Section 16(b) of the Exchange Act ("Section 16(b)"), the option holder will
recognize compensation income equal to the excess of (i) the fair market value
of the Qwest Common Stock on the earlier of the date that is six months after
the date of exercise or the date the option holder can sell the Qwest Common
Stock without Section 16(b) liability over (ii) the exercise price. The option
holder who is subject to Section 16(b) can make an election under Section 83(b)
of the Code to measure the compensation as of the date the non-qualified option
is exercised. The compensation recognized by an employee is subject to income
tax withholding. Qwest is entitled to a deduction equal to the compensation
recognized by the option holder for Qwest's taxable year that ends with or
within the taxable year in which the option holder recognized the compensation,
assuming that the compensation amounts satisfy the ordinary and necessary and
reasonable compensation requirements for deductibility and that the deduction is
not limited by Section 162(m).
When an incentive stock option is granted, there are no income tax
consequences for the option holder or Qwest. When an incentive option is
exercised, the option holder does not recognize income and Qwest does not
receive a deduction. The option holder, however, must treat the excess of the
fair market value of the Qwest Common Stock on the date of exercise over the
exercise price as an item of adjustment for purposes of the alternative minimum
tax. If the option holder makes a "disqualifying disposition" of the Qwest
Common Stock (described below) in the same taxable year the incentive stock
option was exercised, there are no alternative minimum tax consequences.
If the option holder disposes of the Qwest Common Stock after the option
holder has held the Qwest Common Stock for at least two years after the
incentive stock option was granted and one year after the incentive stock option
was exercised, the amount the option holder receives upon the disposition over
the exercise price is treated as capital gain for the option holder. Qwest is
not entitled to a deduction. If the option holder makes a "disqualifying
disposition" of the Qwest Common Stock by disposing of the Qwest Common Stock
before a date at least two years after the date the incentive option was granted
and one year after the date the incentive option was exercised, the option
holder recognizes compensation income equal to the excess of (i) the fair market
value of the Qwest Common Stock on the date the incentive option was exercised
or, if less, the amount received on the disposition over (ii) the exercise
price. In the event of a disqualifying disposition, Qwest is entitled to a
deduction equal to the compensation recognized by the option holder for Qwest's
taxable year that ends with or within the taxable year in which the option
holder recognized the compensation, assuming that the compensation amounts
satisfy the ordinary and necessary and reasonable compensation requirements for
deductibility and that the deduction is not limited by Section 162(m).
The Equity Incentive Plan provides that option holders are responsible for
making appropriate arrangements with Qwest to provide for any additional
withholding amounts. Furthermore, Qwest shall have no obligation to deliver
shares of Qwest Common Stock upon the exercise of any options, stock
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appreciation rights, awards or units under the Equity Incentive Plan until all
applicable federal, state and local income and other tax withholding
requirements have been satisfied.
The following table sets forth the options granted from inception of the
Equity Incentive Plan to the specified individuals and groups and outstanding as
of March 27, 1998.
<TABLE>
<CAPTION>
OPTIONS
NAME AND POSITION GRANTED
- ----------------- ----------
<S> <C>
Joseph P. Nacchio.................................................... 5,824,451
Robert S. Woodruff................................................... 400,000
A. Dean Wandry....................................................... 150,000
Anthony J. Brodman................................................... 50,000
Steven M. Jacobson................................................... 600,000
Lewis O. Wilks....................................................... 700,000
Brij Khandelwal...................................................... 700,000
Larry M. Seese....................................................... 750,000
All Current Executive Officers as a Group............................ 11,174,000
All Current Directors who are not Executive Officers as a Group...... 1,150,000
All Employees as a Group other than Executive Officers............... 3,647,600
</TABLE>
- --------
Detailed information with respect to option grants under Qwest's Equity
Incentive Plan with respect to the Named Executives is set forth above (see
"--Stock Option Grants"). The options reflected in the above table were granted
at exercise prices ranging between $7.50 and $36.25 per share. The options
generally provide for vesting at the rate of 20% per year commencing on the
first anniversary of the date of grant and expire either five years or ten years
from the date of grant, as determined by the Compensation Committee at the time
of grant. The market value of the shares of Qwest's Common Stock covered by all
outstanding options under the Equity Incentive Plan as of March 25, 1998 was
approximately $621 million.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
Mr. Nacchio. Qwest and Joseph P. Nacchio entered into an employment agreement
dated as of December 21, 1996 and amended as of January 3, 1997, pursuant to
which Mr. Nacchio joined Qwest as its President and Chief Executive Officer
effective January 4, 1997 for a term through the close of business on December
31, 2001, unless terminated earlier by either party. The agreement provides for
an annual base salary of $600,000, a $300,000 bonus for 1997, and a $300,000
bonus for 1998. Mr. Nacchio may participate in the employee benefit plans
available to Qwest's senior executives according to the plans' terms and
conditions. Under the agreement, Mr. Nacchio has been granted 300,000 growth
shares under the Growth Share Plan, with a five year performance cycle
commencing January 1, 1997 and a "beginning company value" of $1 billion. See
"--Growth Share Plan."
The value of the growth shares is capped at a value generally determined by
the $11.00 per share price (as adjusted to reflect the Qwest Stock Split) of the
Qwest Common Stock in the Qwest Initial Public Offering. The growth shares will
vest in 20% increments on each January 1 beginning January 1, 1998, provided
that the final 20% increment will vest on the date in 2001 that ends the
performance cycle, as determined by Qwest in its sole discretion. The growth
share agreement between Qwest and Mr. Nacchio provides for terms that are
different from the general terms of the Growth Share Plan in certain respects.
Annually, Mr. Nacchio may elect to receive payment for up to 20% of his vested
growth shares in shares of Qwest Common Stock; the growth shares for which he
has received payment will be canceled. The number of growth shares granted to
Mr. Nacchio are subject to adjustment upon changes in Qwest's capital structure
in connection with mergers and other reorganizations. If Mr. Nacchio's
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employment is terminated for good reason (generally, resignation after a
reduction in title or responsibility) or other than for cause (as defined
below), he will vest in one-twelfth of the 20% of growth shares subject to
annual vesting for the year of termination for each full month of employment in
such calendar year. A change in control (as defined in the employment agreement)
will not result in full vesting of, or payment for, the growth shares unless Mr.
Nacchio is terminated without cause or resigns for good reason after the change
in control. If his employment is terminated for cause, he will be paid for his
vested growth shares based on the value of Qwest as of the end of the
immediately preceding calendar year. Upon payment of certain dividends, the
growth shares will vest 100% and Mr. Nacchio will be paid for a portion of the
growth shares. Termination of the Plan will not be a "triggering event," see
"--Growth Share Plan," with respect to Mr. Nacchio's growth shares.
Qwest has granted Mr. Nacchio an option under Qwest's Equity Incentive Plan to
purchase six million shares of Qwest Common Stock. See "--Equity Incentive
Plan." The exercise price is $11.00 per share. The option will vest 20% per year
beginning on December 31, 1997 and will become fully vested upon Mr. Nacchio's
death, disability or retirement. If Mr. Nacchio resigns for good reason (as
defined in the growth share agreement) or if Qwest terminates his employment
other than for cause, he will vest in one-twelfth of the 20% increment scheduled
to vest for the year of termination for each full month of employment with Qwest
during such year. If Qwest terminates his employment without cause or if he
resigns for good reason (as defined in the employment agreement, provided that
for this purpose the occurrence of a change in control by itself is not good
reason), in each case following a change in control, the option will become
fully vested. If Mr. Nacchio's employment terminates for any other reason, he
will forfeit the unvested portion of his option and retain the vested portion of
his option, provided that if his employment is terminated for cause, he can
exercise the vested portion of the option only until the first to occur of (1)
the date that is six months after the day after his termination or (2) June 30,
2003. He can exercise the vested portion of the option at any time before the
option expires. Generally, the option will terminate and expire on June 30,
2003.
The employment agreement also provides that in order to compensate Mr. Nacchio
for certain benefits from his former employer, AT&T, that Mr. Nacchio may lose
or forfeit as a result of his termination of employment and commencement of
employment with Qwest, Qwest will pay him $10,735,861, as adjusted (the
"equalization payment"). The equalization payment is to be made in three
installments. The first installment of $7,232,000 was paid in 1997 and the
second installment of $1,469,861, together with interest of $173,273, was paid
in January 1998. The remaining installment of $2,034,000 is scheduled to be paid
on January 1, 1999, with annual interest at the rate of 5% from January 7, 1997
to the date of payment. If Mr. Nacchio's employment is terminated for cause
(including any willful misconduct materially detrimental to Qwest, felony
conviction, or nonfeasance with respect to duties set forth in the employment
agreement) on or before December 31, 1999, the agreement provides that he will
repay to Qwest a portion of the equalization payment previously paid. If a
termination for cause occurs after December 31, 1999, the equalization payment
will not be repaid. If Qwest terminates Mr. Nacchio's employment other than for
cause or if Mr. Nacchio resigns for good reason, which for this purpose includes
a change in control of Qwest or certain other events, Qwest will be obligated to
make certain payments to him, including an amount equal to two times his base
salary at the rate in effect on the date of employment termination and any
installments of the equalization payment that have not yet been made, with
interest. Mr. Nacchio will also be entitled to continuation of certain benefits,
including welfare benefits and participation in the Growth Share Plan for a
two-year period following termination. For this purpose, change in control means
the acquisition of 20% or more of Qwest by an individual, entity (not controlled
by Philip F. Anschutz) or group if the new acquirors own a larger percentage of
Qwest than entities controlled by Philip F. Anschutz. The agreement provides
that if Mr. Nacchio receives any payments upon a change in control that are
subject to the excise tax of Section 4999 of the Code, Qwest will pay Mr.
Nacchio an amount that reimburses him in full for the excise tax.
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Mr. Woodruff. In November 1996 QCC extended Robert S. Woodruff an unsecured,
noninterest-bearing loan in the principal amount of $100,000. The principal
amount is forgiven in monthly increments of $2,083 beginning December 1, 1996.
As of December 1997 the outstanding principal balance of the loan was $72,921.
If Mr. Woodruff terminates employment voluntarily or if QCC terminates his
employment on account of willful misconduct, QCC may declare the unforgiven
outstanding principal amount due and payable within 45 days after the date he
terminates employment. If Mr. Woodruff's employment terminates for any other
reason, the outstanding principal balance will be forgiven. In December 1996,
QCC and Mr. Woodruff entered into a letter agreement to provide that if his
employment is terminated for reasons other than willful misconduct, he will
receive either a lump sum payment equal to one year's compensation at his then
current rate or payment in accordance with QCC's severance policy then in
effect, as he elects.
Mr. Wilks. Qwest and Lewis O. Wilks entered into an employment letter
agreement dated October 8, 1997 pursuant to which Mr. Wilks joined Qwest as
President--Business Markets. Under the agreement, Mr. Wilks is entitled to an
annual base salary of $273,000 and a minimum bonus at the end of his first year
of employment of $100,000. Mr. Wilks also received reimbursement for relocation
expenses in the amount of $200,000. The agreement also provides for the grant to
Mr. Wilks of a stock option pursuant to the Equity Incentive Plan covering
700,000 shares of Qwest Common Stock with an exercise price per share of $23.75.
The option becomes exercisable as to 140,000 shares of Qwest Common Stock at the
end of each of the first four years of employment and an additional 70,000
shares at the end of each of the fifth and sixth years of employment. Mr. Wilks
will also receive a transition payment of $200,000 in 1998, payable $50,000
during each calendar quarter beginning January 1, 1998. If Mr. Wilks' employment
with Qwest terminates for any reason other than cause during his first year of
employment, he will be entitled to a lump sum payment of one year's base salary.
Mr. Khandelwal. Qwest and Brij Khandelwal entered into an employment letter
agreement dated September 26, 1997 pursuant to which Mr. Khandelwal joined Qwest
as its Executive Vice President and Chief Information Officer. Under the
agreement, Mr. Khandelwal is entitled to an annual base salary of $225,000 and a
minimum bonus at the end of the first year of employment of $112,500. Mr.
Khandelwal also received reimbursement for relocation expenses of $150,000. The
agreement also provides for the grant to Mr. Khandelwal of a stock option
pursuant to the Equity Incentive Plan covering 700,000 shares of Qwest Common
Stock with an exercise price of $22.875. The option becomes exercisable as to
140,000 shares of Qwest Common Stock at the end of each of the first five years
of employment. If Mr. Khandelwal's employment with Qwest terminates for any
reason other than cause during his first year of employment, he will be entitled
to a lump sum payment of one year's base salary.
Mr. Seese. Qwest and Larry A. Seese entered into an employment letter
agreement dated September 19, 1997 pursuant to which Mr. Seese joined Qwest as
Executive Vice President--Network Engineering and Operations. Mr. Seese is
entitled to an annual base salary of $230,000 and a minimum bonus at the end of
his first year of employment of $92,000. Mr. Seese also received reimbursement
for relocation expenses of $200,000. The agreement also provides for the grant
to Mr. Seese of a stock option pursuant to Qwest's Equity Incentive Plan
covering 750,000 shares of Qwest Common Stock with an exercise price per share
of $22.875. The option becomes exercisable as to 200,000 shares of Qwest Common
Stock at the end of each of the first two years of employment, an additional
100,000 shares of Qwest Common Stock at the end of each of the third through the
fifth years of employment and an additional 50,000 shares of Qwest Common Stock
at the end of the sixth year of employment. If the value of Mr. Seese's options
is less than $1,000,000 on the sixth anniversary of his employment Qwest will
pay him the difference. If Mr. Seese's employment is terminated for any reason
other than cause during his first two years of employment, he will be entitled
to a lump sum payment of one year's base salary.
Mr. Jacobsen. Qwest and Stephen M. Jacobsen entered into an employment letter
agreement dated March 7, 1997 pursuant to which Mr. Jacobsen joined Qwest as its
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Senior Vice President--Consumer Markets. Under the agreement, Mr. Jacobsen is
entitled to an annual base salary of $185,000, which has been increased to
$192,770 for 1998. Mr. Jacobsen also received reimbursement for relocation
expenses in the amount of $132,085. The agreement provides for the grant to Mr.
Jacobsen of 30,000 growth shares pursuant to the Growth Share Plan. If Mr.
Jacobsen's employment with Qwest terminates for any reason other than cause, he
will be entitled to a lump sum payment of one year's base salary.
Change in Control. The Growth Share Plan provides that upon a "change of
control" of Qwest or a termination of the Growth Share Plan, the outstanding
growth shares will become fully vested. For this purpose, "change of control" is
defined as either (A) the acquisition by an individual, entity or group (as
defined in the Exchange Act), other than the Anschutz Entities, of beneficial
ownership of 20% or more of either (1) the then-outstanding shares of Qwest
Common Stock or (2) the combined voting power of the then-outstanding voting
securities of Qwest entitled to vote generally in the election of directors and
the beneficial ownership of the individual, entity or group exceeds the
beneficial ownership of the Anschutz Entities or (B) the Anschutz Entities no
longer have beneficial ownership of at least 20% of the then-outstanding shares
of Qwest Common Stock or 20% of the combined voting power. See "-- Growth Share
Plan" above.
The Equity Incentive Plan provides that, upon a change in control, all awards
granted under the Equity Incentive Plan will vest immediately. See "-- Equity
Incentive Plan" above.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Anschutz, a member of the Compensation Committee, is a Director and
Chairman (not an executive officer position) of Qwest, a Director and Chairman
of Anschutz Company, Qwest's majority stockholder, and a Director and Chairman
of The Anschutz Corporation, a subsidiary of Anschutz Company. Mr. Harvey, who
served on the Compensation Committee until July 1997, is a Director of Qwest and
President and Chief Operating Officer of Anschutz Company and The Anschutz
Corporation. Certain transactions and relationships between Qwest and Anschutz
Company or one of its affiliates are described directly below under "CERTAIN
TRANSACTIONS."
PRINCIPAL STOCKHOLDER
Philip F. Anschutz is the sole beneficial owner of approximately 173,000,000
shares (the "Anschutz Shares") of Qwest Common Stock, which constitute
approximately 83.7% of the outstanding shares of Qwest Common Stock. Qwest has
granted a warrant to Anschutz Family Investment Company LLC, an affiliate of
Anschutz Company, to purchase 8,600,000 shares of Qwest Common Stock. See
"Certain Transactions." Anschutz Company has granted or expects to grant from
time to time security interests in all or part of its shares of the Qwest Common
Stock in connection with transactions entered into by it or its affiliates.
Although not anticipated, under certain circumstances, shares of Qwest Common
Stock could be sold pursuant to such security interests, which could result in a
change of control of Qwest for purposes of Delaware law.
In connection with the execution of the LCI Merger Agreement, LCI, Mr.
Anschutz, the beneficial owner of the Anschutz Shares, and Anschutz Company, the
record holder of the Anschutz Shares, entered into the Voting Agreement pursuant
to which, among other things, Mr. Anschutz has agreed to cause Anschutz Company,
and Anschutz Company has agreed, to vote the Anschutz Shares in favor of certain
matters in connection with the LCI Merger.
CERTAIN TRANSACTIONS
Certain affiliates of Anschutz Company indirectly provide facilities to Qwest
at prevailing market rates. Qwest rents its corporate office in Denver, Colorado
from a limited partnership in which Mr. Anschutz serves as a general partner and
indirectly holds limited partner interests and rents certain
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telecommunications equipment used by Qwest at its corporate office from an
affiliate of Anschutz Company. Such expenses totaled $1.4 million for the year
ended December 31, 1997.
Affiliates of Anschutz Company incur certain costs on Qwest's behalf,
including primarily insurance and corporate transportation services, and
allocate such costs to Qwest based on actual usage. The cost to Qwest for such
services was approximately $4.3 million for the year ended December 31, 1997.
Qwest historically has received capital contributions and noninterest- bearing
advances from Anschutz Company and an affiliate of Anschutz Company to fund
operations. Outstanding advances totaled $19.1 million at December 31, 1996. In
May 1997, all outstanding advances, then totaling approximately $28.0 million,
were repaid, and no further advances are expected to be made.
Effective May 23, 1997, Qwest sold to the Anschutz Family Investment Company
LLC, for $2.3 million in cash, a warrant to acquire 8,600,000 shares of Qwest
Common Stock at an exercise price of $14.00 per share, exercisable on May 23,
2000, with certain exceptions. The warrant is not transferable. Shares of Qwest
Common Stock issued upon exercise of the warrant would be subject to
restrictions on sale and transfer for two years after exercise. Anschutz Company
is the manager of, and owns a 1% equity interest in, the Anschutz Family
Investment Company LLC, and a trust, of which members of Mr. Anschutz's
immediate family are beneficiaries, owns the remainder of the equity interests.
Qwest has a tax sharing agreement with Anschutz Company that provides for the
allocation of tax liabilities and benefits. In general, the agreement requires
Qwest to pay to Anschutz Company the applicable income taxes for which Qwest
would be liable if it filed a separate return and requires Anschutz Company to
pay Qwest for losses or credits which would have resulted in a refund of taxes
if Qwest had filed a separate return. The payments under the agreement may be
made in the form of cash, setoffs, contributions of capital, dividends, notes or
any combination of the foregoing. The tax benefits payable to Qwest under the
existing agreement through December 31, 1996 of $11.1 million were forgiven. The
tax sharing agreement was amended, effective as of January 1, 1997, to provide
that Qwest will be responsible to Anschutz Company to the extent of income taxes
for which Qwest would have been liable if it had filed a separate return after
giving effect to any loss or credit carryover belonging to Qwest from taxable
periods after January 1, 1997. Anschutz Company will be responsible to Qwest to
the extent an unused loss or credit can be carried back to an earlier taxable
period after January 1, 1997.
Qwest had a $100.0 million three-year revolving credit facility with ABN AMRO
that was collateralized by shares owned and pledged by an affiliate of Anschutz
Company. In October 1997, Qwest repaid the then outstanding balance and
terminated this credit facility.
Anschutz Company guaranteed a QCC construction loan with an outstanding
balance at December 31, 1997, of approximately $10.9 million. The construction
loan, which was repaid in 1998, pertained to a network construction project
undertaken by QCC for an interexchange carrier. The guarantee was limited to
indemnification against defective construction, warranty or other claims of the
interchange carrier that would reduce or eliminate the interexchange carrier's
obligation to pay QCC. In addition, Anschutz Company has guaranteed bonds
totaling $175.0 million furnished by Qwest to support its construction
obligations under a contract for sale of dark fiber. Qwest has agreed to
indemnify Anschutz Company and its subsidiaries against any cost or losses
incurred by any of them as a result of their providing credit support to Qwest
(in the form of collateral pledges, guarantees, bonds or otherwise).
Richard T. Liebhaber, a Director of Qwest, entered into a consulting agreement
with an affiliate of Anschutz Company in December 1996 to provide consulting
services in 1997 and serve on the boards of directors of Qwest and its
subsidiaries upon request. The agreement was assigned to Qwest in February 1997.
Mr. Liebhaber was required under the contract to provide a minimum of 30
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days of consulting services to QCC during 1997 and was paid $250,000 plus out-
of-pocket expenses during 1997. The agreement was renewed for 1998.
Mr. Liebhaber was granted 10,000 growth shares, effective December 1, 1996,
with a performance cycle ending in 2001 under the Growth Share Plan. See
"Compensation of Directors and Executive Officers--Growth Share Plan" and "--
Equity Incentive Plan."
No director or executive officer of Qwest and its operating subsidiaries was
indebted to Qwest or its subsidiaries at any time since the beginning of 1997 in
excess of $60,000, except Mr. Woodruff as described above under the description
of his employment contract. See "Compensation of Directors and Executive
Officers--Employment Contracts and Termination of Employment and
Change-In-Control Arrangements."
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DESCRIPTION OF THE 8.29% NOTES
GENERAL
The Exchange Notes will be issued under the Indenture between the Company and
Bankers Trust Company, as trustee under the Indenture (the "Trustee"). Copies of
the Indenture are available from the Company on request. For purposes of this
Description of the 8.29% Notes, the term "Company" refers to Qwest
Communications International Inc. and does not include its subsidiaries except
for purposes of financial data determined on a consolidated basis. For purposes
of this Description of the 8.29% Notes, the term "8.29% Notes" refers to the
Exchange Notes and the Old 8.29% Notes collectively. The Exchange Notes and the
Old 8.29% Notes are considered collectively to be a single class for all
purposes under the Indenture, including, without limitation, waivers,
amendments, redemptions and Offers to Purchase.
The following summary of certain provisions of the Indenture does not purport
to be complete and is subject to, and is qualified in its entirety by reference
to, the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"), and
to all of the provisions of the Indenture, including the definitions of certain
terms therein and those terms made a part of the Indenture by reference to the
Trust Indenture Act, as in effect on the date of the Indenture. The definitions
of certain capitalized terms used in the following summary are set forth below
under "--Certain Definitions."
The 8.29% Notes will be senior unsecured obligations of the Company,
ranking pari passu in right of payment with all existing and future senior
unsecured indebtedness of the Company, including the 10 7/8% Notes and the 9.47%
Notes, and will be senior in right of payment to all existing and future
indebtedness of the Company expressly subordinated in right of payment to the
8.29% Notes. As of December 31, 1997, on a pro forma basis after giving effect
to the Offering, Qwest would have had $906.9 million of indebtedness
outstanding, none of which would have constituted secured indebtedness or
subordinated indebtedness.
The operations of the Company are conducted through its subsidiaries and,
therefore, the Company is dependent upon cash flow from those entities to meet
its obligations. The Company's subsidiaries will have no direct obligation to
pay amounts due on the 8.29% Notes and currently have no obligation to guarantee
the 8.29% Notes. As a result, the 8.29% Notes effectively will be subordinated
to all existing and future third-party indebtedness and other liabilities of the
Company's subsidiaries (including trade payables). As of December 31, 1997, on a
pro forma basis, as if the proposed acquisitions of LCI and Phoenix had been
consummated, the total liabilities of the Company's subsidiaries (after the
elimination of loans and advances by the Company to its subsidiaries) would have
been approximately $1,435.0 million, of which approximately $83.2 million in
indebtedness was secured by the assets of the borrowing subsidiaries. See
"Description of Certain Indebtedness." The Company expects that it or its
subsidiaries will incur substantial additional indebtedness in the future. Any
rights of the Company and its creditors, including the holders of 8.29% Notes,
to participate in the assets of any of the Company's subsidiaries upon any
liquidation or reorganization of any such subsidiary will be subject to the
prior claims of that subsidiary's creditors (including trade creditors). In
addition, the Company's operations have generated operating losses in recent
years, and there can be no assurance that the Company will be able to achieve or
sustain operating profitability, or generate sufficient positive cash flow to
pay the principal of and interest on the 8.29% Notes. See "Risk Factors--
Holding Company Structure; Effective Subordination of the 8.29% Notes," "Risk
Factors--High Leverage; Ability to Service Indebtedness," and "Risk
Factors--Operating Losses and Working Capital Deficits."
Principal, Maturity and Interest
The 8.29% Notes will be limited in aggregate principal amount at maturity
to $450,505,000 and will mature on February 1, 2008. The 8.29% Notes will be
issued
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at a discount to their aggregate principal amount at maturity to generate
proceeds to the Company of approximately $300.0 million. The 8.29% Notes will
accrete at a rate of 8.29% per annum, compounded semiannually, to an aggregate
principal amount of $450,505,000 by February 1, 2003. Cash interest will not
accrue on the 8.29% Notes prior to February 1, 2003; provided, however, that the
Company may elect, upon not less than 60 days' prior notice, to commence the
accrual of cash interest on all outstanding 8.29% Notes on any August 1 or
February 1 on or after February 1, 2001 and prior to February 1, 2003, in which
case the outstanding principal amount at maturity of each 8.29% Note will on
such commencement date be reduced to the Accreted Value of such 8.29% Note as of
such date and cash interest shall be payable with respect to such note on each
August 1 and February 1 thereafter. Except as otherwise described in this
paragraph, interest on the 8.29% Notes will accrue at the rate of 8.29% per
annum and will be payable in cash semiannually on August 1 and February 1,
commencing August 1, 2003. Interest will be computed on the basis of a 360-day
year comprised of twelve 30-day months.
Principal of, premium, if any, and interest on the 8.29% Notes will be
payable, and the 8.29% Notes may be exchanged or transferred, at the office or
agency of the Company, which, unless otherwise provided by the Company, will be
the offices of the Trustee. At the option of the Company, interest may be paid
by check mailed to the registered holders at their registered addresses. The
8.29% Notes will be issued without coupons and in fully registered form only, in
minimum denominations of $1,000 and integral multiples thereof. The 8.29% Notes
will be issued only against payment in immediately available funds. No service
charge will be made for any registration of transfer or exchange of the 8.29%
Notes, but the Company may require payment of a sum sufficient to cover any
transfer tax or other similar governmental charge payable in connection
therewith.
The interest rate on the 8.29% Notes is subject to increase in the
circumstances (such additional interest being referred to as "Liquidated
Interest") described under "Exchange Offer; Registration Rights." All references
herein to interest on the 8.29% Notes shall include such Liquidated Interest, if
appropriate.
BOOK-ENTRY SYSTEM
All Exchange Notes will be represented by permanent Global Notes in fully
registered form without coupons (the "Global Notes"), which will be deposited
with the Trustee as custodian for the Depository and registered in the name of
the Depository or of a nominee of the Depository.
Upon issuance of a Global Note, the Depository will credit, on its internal
system, the respective amount of the individual beneficial interests in the
Global Note to persons who have accounts with the Depository ("Participants").
Such accounts initially were designated by or on behalf of the Initial
Purchaser. Ownership of beneficial interests in the Global Note will be shown
on, and the transfer of such beneficial interests will be effected only through,
records maintained by the Depository or its nominee (with respect to interests
of Participants) and the records of Participants (with respect to interests of
persons other than Participants). Holders may hold their interests in the Global
Note directly through the Depository if they are Participants, or indirectly
through organizations which are Participants.
So long as the Depository or its nominee is the registered owner of a Global
Note, the Depository or such nominee, as the case may be, will be considered the
sole owner of the Exchange Notes represented by the Global Note for all purposes
under the Indenture and the Exchange Notes. Accordingly, beneficial owners of an
interest in the Global Note must rely on the procedures of the Depository, and
if such person is not a participant, on the procedures of the Participant
through which such person owns its interest, to exercise any rights and fulfill
any obligations of a holder under the Indenture. No beneficial owner of an
interest in the Global Note will be able to transfer that interest except in
accordance with the Depository's applicable procedures, in addition to those
provided for in the Indenture.
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Payments of the principal of, premium, if any, and interest on, the Global
Notes will be made to the Depository or its nominee, as the case may be, as the
registered owner thereof. Neither the Company, the Trustee or any paying agent
will have any responsibility or liability for any aspect of the records relating
to, or payments made on account of, beneficial interests in the Global Notes or
for maintaining, supervising or reviewing any records relating to such
beneficial interests. The Company expects that the Depository or its nominee,
upon receipt of any payment of principal, premium or interest in respect of the
Global Notes will credit Participants' accounts with payments in amounts
proportionate to such Participants' respective beneficial interests in the
principal amount of such Global Notes as shown on the records of the Depository
or its nominee. The Company also expects that payments by Participants to owners
of beneficial interests in the Global Notes held through such Participants will
be governed by standing instructions and customary practices, as is now the case
with securities held for the accounts of customers registered in the names of
nominees for such customers. Such payments will be the responsibility of such
Participants.
The Depository has advised the Company that it will take any action permitted
to be taken by a holder of Exchange Notes (including the presentation of Old
8.29% Notes for exchange as described below) only at the direction of one or
more Participants to whose accounts interests in the Global Notes is credited
and only in respect of such portion of the aggregate principal amount of
Exchange Notes, as the case may be, as to which such Participant or Participants
has or have given such direction.
The Depository has advised the Company as follows: The Depository is a limited
purpose trust company organized under the laws of the State of New York, a
"banking organization" within the meaning of New York Banking Law, a member of
the Federal Reserve System, a "clearing corporation" within the meaning of the
Uniform Commercial Code and a "clearing agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. The Depository was created to
hold securities for its Participants and facilitate the clearance and settlement
of securities transactions between Participants through electronic book-entry
changes in accounts of its Participants, thereby eliminating the need for
physical movement of certificates. Indirect access to the Depository system is
available to others such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a Participant ("Indirect
Participants").
Although the Depository and its Participants are expected to follow the
foregoing procedures in order to facilitate transfers of interests in the Global
Notes among Participants, they are under no obligation to perform or continue to
perform such procedures, and such procedures may be discontinued at any time.
Neither the Company, its paying agent or the Trustee will have any
responsibility for the performance by the Depository, Participants or Indirect
Participants of their respective obligations under the rules and procedures
governing their operations.
Owners of beneficial interests in the Global Notes will be entitled to receive
Exchange Notes in definitive form ("Definitive Notes") if the Depository is at
any time unwilling or unable to continue as, or ceases to be, a "clearing
agency" registered under Section 17A of the Exchange Act, and a successor to the
Depository registered as a "clearing agency" under Section 17A of the Exchange
Act is not appointed by the Company within 90 days. Any Definitive Notes issued
in exchange for beneficial interests in the Global Notes will be registered in
such name or names as the Depository shall instruct the Trustee. It is expected
that such instructions will be based upon directions received by the Depository
from Participants with respect to ownership of beneficial interests in the
Global Notes.
In addition to the foregoing, on or after the occurrence of an Event of
Default under the Indenture, owners of beneficial interests in the Global Notes
will be entitled to request and receive Definitive Notes. Such Definitive Notes
will be registered in such name or names as the Depositary shall instruct the
Trustee.
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Optional Redemption
The 8.29% Notes will be subject to redemption at the option of the Company,
in whole or in part, at any time or from time to time on or after February 1,
2003, upon not less than 30 nor more than 60 days' prior notice, at the
redemption prices (expressed as percentages of Accreted Value) set forth below,
plus accrued and unpaid interest thereon (if any) to the redemption date, if
redeemed during the twelve months beginning February 1 of the years indicated
below:
Year Redemption
Price
2003................... 104.145%
2004................... 102.763%
2005................... 101.382%
2006 and 100.000%
thereafter..................
In addition, prior to February 1, 2001, the Company may redeem up to 35% of
the Accreted Value of the 8.29% Notes at a redemption price equal to 108.29% of
the Accreted Value at the redemption date of the 8.29% Notes so redeemed, plus
accrued and unpaid interest thereon (if any) to the redemption date, with the
net proceeds of one or more Public Equity Offerings resulting in gross proceeds
of at least $100 million in the aggregate; provided that at least 65% of the
Accreted Value of the originally issued 8.29% Notes would remain outstanding
immediately after giving effect to such redemption.
Mandatory Redemption
Except as set forth under "--Certain Covenants--Change of Control" and
"--Certain Covenants--Limitation on Asset Dispositions," the Company is not
required to make mandatory redemption payments or sinking fund payments with
respect to the 8.29% Notes.
Certain Covenants
The Indenture contains, among others, the following covenants:
Limitation on Consolidated Debt. (a) The Company may not, and may not
permit any Restricted Subsidiary to, Incur any Debt, unless, after giving effect
to the application of the proceeds thereof, no Default or Event of Default would
occur as a consequence of such Incurrence or be continuing following such
Incurrence and either (i) the ratio of (A) the aggregate consolidated principal
amount of Debt of the Company outstanding as of the most recent available
quarterly or annual balance sheet, after giving pro forma effect to the
Incurrence of such Debt and any other Debt Incurred or repaid since such balance
sheet date and the receipt and application of the proceeds thereof, to (B)
Consolidated Cash Flow Available for Fixed Charges for the four full fiscal
quarters next preceding the Incurrence of such Debt for which consolidated
financial statements are available, determined on a pro forma basis as if any
such Debt had been Incurred and the proceeds thereof had been applied at the
beginning of such four fiscal quarters, would be less than 5.5 to 1.0 for Debt
Incurred on or prior to April 1, 2000 and 5.0 to 1.0 for Debt Incurred
thereafter, or (ii) the Company's Consolidated Capital Ratio as of the most
recent available quarterly or annual balance sheet, after giving pro forma
effect to the Incurrence of such Debt and any other Debt Incurred or repaid
since such balance sheet date and the receipt and application of the proceeds
thereof, is less than 2.0 to 1.0.
(b) Notwithstanding the foregoing limitation, the Company and any
Restricted Subsidiary may Incur any and all of the following (each of which
shall be given independent effect):
(i) Debt under the 8.29% Notes, the Indenture and any Restricted
Subsidiary Guarantee;
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(ii) (A) Debt Incurred subsequent to March 31, 1997 under Credit
Facilities in an aggregate principal amount at any time outstanding not to
exceed $150 million plus (B) Debt Incurred subsequent to March 31, 1997
under one or more Credit Facilities that are revolving credit facilities in
an aggregate principal amount at any time outstanding not to exceed the
greater of (x) $100 million or (y) 85% of Eligible Receivables;
(iii) Purchase Money Debt, provided that the amount of such
Purchase Money Debt does not exceed 100% of the cost of the construction,
installation, acquisition or improvement of the applicable
Telecommunications Assets;
(iv) Debt owed by the Company to any Restricted Subsidiary of the
Company or Debt owed by a Restricted Subsidiary of the Company to the
Company or a Restricted Subsidiary of the Company; provided, however, that
upon either (x) the transfer or other disposition by such Restricted
Subsidiary or the Company of any Debt so permitted to a Person other than
the Company or another Restricted Subsidiary of the Company or (y) the
issuance (other than directors' qualifying shares), sale, lease, transfer
or other disposition of shares of Capital Stock (including by consolidation
or merger) of such Restricted Subsidiary to a Person other than the Company
or another such Restricted Subsidiary, the provisions of this clause (iv)
shall no longer be applicable to such Debt and such Debt shall be deemed to
have been Incurred by the issuer thereof at the time of such transfer or
other disposition;
(v) Debt Incurred to renew, extend, refinance, defease or refund
(each, a "refinancing") the 8.29% Notes, the 10 7/8% Notes or 9.47% Notes
or Debt of the Company Incurred pursuant to clause (iii) of this paragraph
(b), in an aggregate principal amount not to exceed the aggregate principal
amount of and accrued interest on the Debt so refinanced plus the amount of
any premium required to be paid in connection with such refinancing
pursuant to the terms of the Debt so refinanced or the amount of any
premium reasonably determined by the board of directors of the Company as
necessary to accomplish such refinancing by means of a tender offer or
privately negotiated repurchase, plus the expenses of the Company Incurred
in connection with such refinancing; provided, however, that Debt the
proceeds of which are used to refinance the 8.29% Notes or Debt which is
pari passu to the 8.29% Notes or Debt which is subordinate in right of
payment to the 8.29% Notes shall only be permitted under this clause (v) if
(A) in the case of any refinancing of the 8.29% Notes or Debt which is pari
passu to the 8.29% Notes, the refinancing Debt is made pari passu to the
8.29% Notes or constitutes Subordinated Debt, and, in the case of any
refinancing of Subordinated Debt, the refinancing Debt constitutes
Subordinated Debt and (B) in any case, the refinancing Debt by its terms,
or by the terms of any agreement or instrument pursuant to which such Debt
is issued, (x) does not provide for payments of principal of such Debt at
stated maturity or by way of a sinking fund applicable thereto or by way of
any mandatory redemption, defeasance, retirement or repurchase thereof by
the Company (including any redemption, retirement or repurchase which is
contingent upon events or circumstances, but excluding any retirement
required by virtue of the acceleration of any payment with respect to such
Debt upon any event of default thereunder), in each case prior to the time
the same are required by the terms of the Debt being refinanced and (y)
does not permit redemption or other retirement (including pursuant to an
offer to purchase made by the Company) of such Debt at the option of the
holder thereof prior to the time the same are required by the terms of the
Debt being refinanced, other than a redemption or other retirement at the
option of the holder of such Debt (including pursuant to an offer to
purchase made by the Company) which is conditioned upon a change of control
pursuant to provisions substantially similar to those described under
"--Change of Control";
(vi) Debt consisting of Permitted Interest Rate and Currency
Protection Agreements;
(vii) Debt secured by Receivables originated by the Company or any
Restricted Subsidiary and related assets, provided that such Debt is
nonrecourse to the Company and any of its other Restricted Subsidiaries and
provided further that Receivables shall not be available at any time to
secure Debt of the Company under this clause (vii) to the extent that they
are used
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at such time as the basis for the Incurrence of Debt in excess of $100
million pursuant to clause (ii)(B)(y) of this paragraph (b); and
(viii) Debt not otherwise permitted to be Incurred pursuant to
clauses (i) through (vii) above, which, together with any other outstanding
Debt Incurred pursuant to this clause (viii), has an aggregate principal
amount not in excess of $25 million at any time outstanding.
Limitation on Debt and Preferred Stock of Restricted Subsidiaries. The
Company may not permit any Restricted Subsidiary that is not a Guarantor to
Incur any Debt or issue any Preferred Stock except any and all of the following
(each of which shall be given independent effect):
(i) Restricted Subsidiary Guarantees;
(ii) Debt of Restricted Subsidiaries under Credit Facilities
permitted to be Incurred pursuant to clause (ii) of paragraph (b) of
"--Limitation on Consolidated Debt";
(iii) Purchase Money Debt of Restricted Subsidiaries permitted to
be Incurred pursuant to clause (iii) of paragraph (b) of "--Limitation on
Consolidated Debt";
(iv) Debt owed by a Restricted Subsidiary of the Company to the
Company or a Restricted Subsidiary of the Company permitted to be Incurred
pursuant to clause (iv) of paragraph (b) of
"--Limitation on Consolidated Debt";
(v) Debt of Restricted Subsidiaries consisting of Permitted
Interest Rate and Currency Protection Agreements permitted to be Incurred
pursuant to clause (vi) of paragraph (b) of "--Limitation on Consolidated
Debt";
(vi) Debt of Restricted Subsidiaries secured by Receivables
originated by the Company or any Restricted Subsidiary and related assets
permitted to be Incurred pursuant to clause (vii) of paragraph (b) of
"--Limitation on Consolidated Debt";
(vii) Debt of Restricted Subsidiaries permitted to be Incurred
pursuant to clause (viii) of paragraph (b) of "--Limitation on Consolidated
Debt";
(viii) Preferred Stock issued to and held by the Company or a
Restricted Subsidiary;
(ix) Debt Incurred or Preferred Stock issued by a Person prior to
the time (A) such Person became a Restricted Subsidiary, (B) such Person
merges into or consolidates with a Restricted Subsidiary or (C) another
Restricted Subsidiary merges into or consolidates with such Person (in a
transaction in which such Person becomes a Restricted Subsidiary), which
Debt or Preferred Stock was not Incurred or issued in anticipation of such
transaction and was outstanding prior to such transaction; and
(x) Debt or Preferred Stock which is exchanged for, or the proceeds
of which are used to renew, extend, refinance, defease, refund or redeem
any Debt of a Restricted Subsidiary permitted to be Incurred pursuant to
clause (iii) of this paragraph or any Debt or Preferred Stock of a
Restricted Subsidiary permitted to be Incurred pursuant to clause (ix)
hereof (or any extension or renewal thereof) (for purposes hereof, a
"refinancing"), in an aggregate principal amount, in the case of Debt, or
with an aggregate liquidation preference, in the case of Preferred Stock,
not to exceed the aggregate principal amount of the Debt so refinanced or
the aggregate liquidation preference of the Preferred Stock so refinanced,
plus the amount of any premium required to be paid in connection with such
refinancing pursuant to the terms of the Debt or Preferred Stock so
refinanced or the amount of any premium reasonably determined by the
Company as necessary to accomplish such refinancing by means of a tender
offer or privately negotiated repurchase, plus the amount of expenses of
the Company and the applicable Restricted Subsidiary Incurred in connection
therewith and provided the Debt or Preferred Stock Incurred or issued upon
such refinancing,
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by its terms, or by the terms of any agreement or instrument pursuant to
which such Debt or Preferred Stock is Incurred or issued, (x) does not
provide for payments of principal or liquidation value at the stated
maturity of such Debt or Preferred Stock or by way of a sinking fund
applicable to such Debt or Preferred Stock or by way of any mandatory
redemption, defeasance, retirement or repurchase of such Debt or Preferred
Stock by the Company or any Restricted Subsidiary (including any
redemption, retirement or repurchase which is contingent upon events or
circumstances, but excluding any retirement required by virtue of
acceleration of such Debt upon an event of default thereunder), in each
case prior to the time the same are required by the terms of the Debt or
Preferred Stock being refinanced and (y) does not permit redemption or
other retirement (including pursuant to an offer to purchase made by the
Company or a Restricted Subsidiary) of such Debt or Preferred Stock at the
option of the holder thereof prior to the stated maturity of the Debt or
Preferred Stock being refinanced, other than a redemption or other
retirement at the option of the holder of such Debt or Preferred Stock
(including pursuant to an offer to purchase made by the Company or a
Restricted Subsidiary) which is conditioned upon the change of control of
the Company pursuant to provisions substantially similar to those contained
in the Indenture described under "--Change of Control," and provided
further that in the case of any exchange or redemption of Preferred Stock
of a Restricted Subsidiary, such Preferred Stock may only be exchanged for
or redeemed with Preferred Stock of such Restricted Subsidiary.
Limitation on Restricted Payments. The Company (i) may not, and may not
permit any Restricted Subsidiary to, directly or indirectly, declare or pay any
dividend, or make any distribution, in respect of its Capital Stock or to the
holders thereof, excluding any dividends or distributions which are made solely
to the Company or a Restricted Subsidiary (and, if such Restricted Subsidiary is
not a Wholly Owned Subsidiary, to the other stockholders of such Restricted
Subsidiary on a pro rata basis) or any dividends or distributions payable solely
in shares of its Capital Stock (other than Disqualified Stock) or in options,
warrants or other rights to acquire its Capital Stock (other than Disqualified
Stock); (ii) may not, and may not permit any Restricted Subsidiary to, purchase,
redeem, or otherwise retire or acquire for value (x) any Capital Stock of the
Company, any Restricted Subsidiary or any Related Person of the Company (other
than a permitted refinancing) or (y) any options, warrants or rights to purchase
or acquire shares of Capital Stock of the Company, any Restricted Subsidiary or
any Related Person of the Company or any securities convertible or exchangeable
into shares of Capital Stock of the Company, any Restricted Subsidiary or any
Related Person of the Company (other than a permitted refinancing), except, in
any such case, any such purchase, redemption or retirement or acquisition for
value paid to the Company or a Restricted Subsidiary (or, in the case of any
such purchase, redemption or other retirement or acquisition for value with
respect to a Restricted Subsidiary that is not a Wholly Owned Subsidiary, paid
to the Company or a Restricted Subsidiary, or to the other stockholders of such
Restricted Subsidiary that is not a Wholly Owned Subsidiary, on a pro rata
basis); (iii) may not make, or permit any Restricted Subsidiary to, make, any
Investment in, or payment on a Guarantee of any obligation of, any Person, other
than the Company or a Restricted Subsidiary; and (iv) may not, and may not
permit any Restricted Subsidiary to, redeem, defease, repurchase, retire or
otherwise acquire or retire for value, prior to any scheduled maturity,
repayment or sinking fund payment, Debt of the Company which is subordinate in
right of payment to the 8.29% Notes (other than a permitted refinancing) (each
of clauses (i) through (iv) being a "Restricted Payment") if: (1) an Event of
Default, or an event that with the passing of time or the giving of notice, or
both, would constitute an Event of Default, shall have occurred and be
continuing, or (2) upon giving effect to such Restricted Payment, the Company
could not Incur at least $1.00 of additional Debt pursuant to the terms of the
Indenture described in paragraph (a) of "--Limitation on Consolidated Debt"
above, or (3) upon giving effect to such Restricted Payment, the aggregate of
all Restricted Payments from March 31, 1997 exceeds the sum of: (a) 50% of
cumulative Consolidated Net Income (or, in the case that Consolidated Net Income
shall be negative, 100% of such negative amount) since the end of the last full
fiscal quarter prior to March 31, 1997 through the last day of the last full
fiscal quarter ending at least 45 days prior to the date of such Restricted
Payment, (b) plus $5 million, (c) less, in the case of any Designation with
respect to a Restricted Subsidiary that was made after March 31, 1997, an amount
equal to the
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Designation Amount with respect to such Restricted Subsidiary, (d) plus, in the
case of any Revocation made after March 31, 1997, an amount equal to the lesser
of the Designation Amount with respect to the Subsidiary with respect to which
such Designation was made or the Fair Market Value of the Investment of the
Company and its Restricted Subsidiaries in such Subsidiary at the time of
Revocation; provided, however, that the Company or a Restricted Subsidiary of
the Company may make any Restricted Payment with the aggregate net cash proceeds
received after March 31, 1997 as capital contributions to the Company or from
the issuance (other than to a Subsidiary) of Capital Stock (other than
Disqualified Stock) of the Company and warrants, rights or options on Capital
Stock (other than Disqualified Stock) of the Company and the principal amount of
Debt of the Company that has been converted into Capital Stock (other than
Disqualified Stock and other than by a Subsidiary) of the Company after March
31, 1997.
Notwithstanding the foregoing limitation, (i) the Company and any
Restricted Subsidiary may make Permitted Investments; (ii) the Company may pay
any dividend on Capital Stock of any class of the Company within 60 days after
the declaration thereof if, on the date when the dividend was declared, the
Company could have paid such dividend in accordance with the foregoing
provisions; (iii) the Company may repurchase any shares of its Common Stock or
options to acquire its Common Stock from Persons who were formerly directors,
officers or employees of the Company or any of its Subsidiaries or Affiliates,
provided that the aggregate amount of all such repurchases made pursuant to this
clause (iii) shall not exceed $1 million in any twelve-month period; (iv) the
Company and any Restricted Subsidiary may refinance any Debt otherwise permitted
by clause (v) of paragraph (b) under "--Limitation on Consolidated Debt" above
or clause (x) under "--Limitation on Debt and Preferred Stock of Restricted
Subsidiaries" above; and (v) the Company and any Restricted Subsidiary may
retire or repurchase any Capital Stock of the Company or of any Restricted
Subsidiary in exchange for, or out of the proceeds of the substantially
concurrent sale (other than to a Subsidiary of the Company) of, Capital Stock
(other than Disqualified Stock) of the Company.
Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries. (a) The Company may not, and may not permit any Restricted
Subsidiary to, directly or indirectly, create or otherwise cause or suffer to
exist or become effective any consensual encumbrance or restriction on the
ability of any Restricted Subsidiary (i) to pay dividends (in cash or otherwise)
or make any other distributions in respect of its Capital Stock owned by the
Company or any other Restricted Subsidiary or pay any Debt or other obligation
owed to the Company or any other Restricted Subsidiary; (ii) to make loans or
advances to the Company or any other Restricted Subsidiary; or (iii) to transfer
any of its property or assets to the Company or any other Restricted Subsidiary.
(b) Notwithstanding the foregoing limitation, the Company may, and may
permit any Restricted Subsidiary to, create or otherwise cause or suffer to
exist any such encumbrance or restriction (i) pursuant to any agreement in
effect on March 31, 1997; (ii) any customary encumbrance or restriction
applicable to a Restricted Subsidiary that is contained in an agreement or
instrument governing or relating to Debt contained in any Credit Facilities or
Purchase Money Debt, provided that the provisions of such agreement permit the
payment of interest and mandatory payment or prepayment of principal pursuant to
the terms of the Indenture and the 8.29% Notes and other Debt that is solely an
obligation of the Company, but provided further that such agreement may
nevertheless contain customary net worth, leverage, invested capital and other
financial covenants, customary covenants regarding the merger of or sale of all
or any substantial part of the assets of the Company or any Restricted
Subsidiary, customary restrictions on transactions with Affiliates, and
customary subordination provisions governing Debt owed to the Company or any
Restricted Subsidiary; (iii) pursuant to an agreement relating to any Acquired
Debt, which encumbrance or restriction is not applicable to any Person, or the
properties or assets of any Person, other than the Person so acquired; (iv)
pursuant to an agreement effecting a renewal, refunding, permitted refinancing
or extension of Debt Incurred pursuant to an agreement referred to in clause
(i), (ii) or (iii) of this paragraph (b), provided, however, that the provisions
contained in such renewal, refunding or extension agreement relating to such
encumbrance or restriction are no more restrictive in any material respect than
the provisions contained in the agreement the subject thereof; (v) in the case
of clause (iii) of paragraph (a) above, restrictions contained in any security
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agreement (including a Capital Lease Obligation) securing Debt of the Company or
a Restricted Subsidiary otherwise permitted under the Indenture, but only to the
extent such restrictions restrict the transfer of the property subject to such
security agreement; (vi) in the case of clause (iii) of paragraph (a) above,
customary nonassignment provisions entered into in the ordinary course of
business in leases and other agreements and customary restrictions contained in
asset sale agreements limiting the transfer of such property or assets pending
the closing of such sale; (vii) any restriction with respect to a Restricted
Subsidiary imposed pursuant to an agreement which has been entered into for the
sale or disposition of all or substantially all of the Capital Stock or assets
of such Restricted Subsidiary, provided that the consummation of such
transaction would not result in a Default or an Event of Default, that such
restriction terminates if such transaction is not consummated and that the
consummation or abandonment of such transaction occurs within one year of the
date such agreement was entered into; (viii) pursuant to applicable law; and
(ix) pursuant to the Indenture, the 8.29% Notes, the Senior Notes and the Senior
Note Indentures.
Limitation on Liens. The Company may not, and may not permit any Restricted
Subsidiary to, Incur or suffer to exist any Lien on or with respect to any
property or assets now owned or acquired after March 31, 1997 to secure any Debt
without making, or causing such Restricted Subsidiary to make, effective
provision for securing the 8.29% Notes (x) equally and ratably with such Debt as
to such property for so long as such Debt will be so secured or (y) in the event
such Debt is Debt of the Company which is subordinate in right of payment to the
8.29% Notes, prior to such Debt as to such property for so long as such Debt
will be so secured.
The foregoing restrictions shall not apply to: (i) Liens existing on March
31, 1997 and securing Debt outstanding on March 31, 1997; (ii) Liens in favor of
the Company or any Restricted Subsidiary; (iii) Liens to secure the 8.29% Notes;
(iv) Liens to secure Restricted Subsidiary Guarantees; (v) Liens to secure Debt
under Credit Facilities permitted to be Incurred pursuant to clause (ii) of
paragraph (b) of "--Limitation on Consolidated Debt"; (vi) Liens on real or
personal property of the Company or a Restricted Subsidiary constructed,
installed, acquired or constituting improvements made after the date of original
issuance of the 8.29% Notes to secure Purchase Money Debt permitted to be
Incurred pursuant to clause (iii) of paragraph (b) of "--Limitation on
Consolidated Debt"; provided, however, that (a) the principal amount of any Debt
secured by such a Lien does not exceed 100% of such purchase price or cost of
construction, installation or improvement of the property subject to such Lien,
(b) such Lien attaches to such property prior to, at the time of or within 270
days after the acquisition, the completion of construction, installation or
improvement or the commencement of operation of such property and (c) such Lien
does not extend to or cover any property other than the specific item of
property (or portion thereof) acquired, constructed, installed or constituting
the improvements financed by the proceeds of such Purchase Money Debt; (vii)
Liens to secure Acquired Debt, provided, however, that (a) such Lien attaches to
the acquired asset prior to the time of the acquisition of such asset and (b)
such Lien does not extend to or cover any other asset; (viii) Liens to secure
Debt Incurred to extend, renew, refinance or refund (or successive extensions,
renewals, refinancings or refundings), in whole or in part, Debt secured by any
Lien referred to in the foregoing clauses (i), (iii), (iv), (v), (vi) and (vii)
so long as such Lien does not extend to any other property and the principal
amount of Debt so secured is not increased except as otherwise permitted under
clause (v) of paragraph (b) under "--Limitation on Consolidated Debt" above or
clause (x) under "--Limitation on Debt and Preferred Stock of Restricted
Subsidiaries" above; (ix) Liens to secure debt consisting of Permitted Interest
Rate and Currency Protection Agreements permitted to be Incurred pursuant to
clause (vi) of paragraph (b) under "--Limitation on Consolidated Debt"; (x)
Liens to secure Debt secured by Receivables permitted to be Incurred pursuant to
clause (vii) of paragraph (b) under "--Limitation on Consolidated Debt"; (xi)
Liens to secure Debt of Restricted Subsidiaries permitted to be Incurred
pursuant to clause (viii) of paragraph (b) under "--Limitation on Consolidated
Debt"; (xii) Liens not otherwise permitted by the foregoing clauses (i) through
(xi) in an amount not to exceed 5% of the Company's Consolidated Tangible
Assets; and (xiii) Permitted Liens.
Limitation on Issuances of Certain Guarantees by, and Debt Securities of,
Restricted Subsidiaries.The Company may not (i) permit any Restricted Subsidiary
to, directly or indirectly, guarantee any Debt Securities of the Company or (ii)
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permit any Restricted Subsidiary to issue any Debt Securities unless, in either
such case, such Restricted Subsidiary simultaneously executes and delivers
Restricted Subsidiary Guarantees providing for a Guarantee of payment of the
8.29% Notes.
Limitation on Sale and Leaseback Transactions. The Company may not, and may
not permit any Restricted Subsidiary to, directly or indirectly, enter into,
assume, Guarantee or otherwise become liable with respect to any Sale and
Leaseback Transaction, other than a Sale and Leaseback Transaction between the
Company or a Restricted Subsidiary on the one hand and a Restricted Subsidiary
or the Company on the other hand, unless (i) the Company or such Restricted
Subsidiary would be entitled to Incur a Lien to secure Debt by reason of the
provisions described under "--Limitation on Liens" above, equal in amount to the
Attributable Value of the Sale and Leaseback Transaction without equally and
ratably securing the 8.29% Notes and (ii) the Sale and Leaseback Transaction is
treated as an Asset Disposition and all of the conditions of the Indenture
described under "--Limitation on Asset Dispositions" below (including the
provisions concerning the application of Net Available Proceeds) are satisfied
with respect to such Sale and Leaseback Transaction, treating all of the
consideration received in such Sale and Leaseback Transaction as Net Available
Proceeds for purposes of such covenant.
Limitation on Asset Dispositions. The Company may not, and may not permit
any Restricted Subsidiary to, make any Asset Disposition unless: (i) the Company
or the Restricted Subsidiary, as the case may be, receives consideration for
such disposition at least equal to the Fair Market Value for the assets sold or
disposed of as determined by the board of directors of the Company in good faith
and evidenced by a resolution of the board of directors of the Company filed
with the Trustee; and (ii) at least 75% of the consideration for such
disposition consists of cash or Cash Equivalents or the assumption of Debt of
the Company (other than Debt that is subordinated to the 8.29% Notes) or of the
Restricted Subsidiary and release from all liability on the Debt assumed. If the
aggregate amount of Net Available Proceeds within any 12-month period exceeds $5
million, then all such Net Available Proceeds shall be applied within 360 days
of the last such Asset Disposition (1) first, to the permanent repayment or
reduction of Debt then outstanding under any Credit Facility, to the extent such
agreements would require such application or prohibit payments pursuant to
clause (2) following; (2) second, to the extent of remaining Net Available
Proceeds, to make an Offer to Purchase outstanding 8.29% Notes at a price in
cash equal to 100% of the Accreted Value of the 8.29% Notes on the purchase date
plus accrued and unpaid interest thereon and premium, if any, not otherwise
included in the Accreted Value to such purchase date and, to the extent required
by the terms thereof, any other Debt of the Company that is pari passu with the
8.29% Notes at a price no greater than 100% of the principal amount thereof plus
accrued and unpaid interest to the purchase date (or 100% of the accreted value
plus accrued and unpaid interest and premium, if any, to the purchase date in
the case of original issue discount Debt); (3) third, to the extent of any
remaining Net Available Proceeds following the completion of the Offer to
Purchase, to the repayment of other Debt of the Company or Debt of a Restricted
Subsidiary, to the extent permitted under the terms thereof; and (4) fourth, to
the extent of any remaining Net Available Proceeds, to any other use as
determined by the Company which is not otherwise prohibited by the Indenture.
Limitation on Issuances and Sales of Capital Stock of Restricted Subsidiaries.
The Company may not, and may not permit any Restricted Subsidiary to, issue,
transfer, convey, sell or otherwise dispose of any shares of Capital Stock of a
Restricted Subsidiary or securities convertible or exchangeable into, or
options, warrants, rights or any other interest with respect to, Capital Stock
of a Restricted Subsidiary to any Person other than the Company or a Restricted
Subsidiary except (i) a sale of all of the Capital Stock of such Restricted
Subsidiary owned by the Company and any Restricted Subsidiary that complies with
the provisions described under "--Limitation on Asset Dispositions" above to the
extent such provisions apply, (ii) in a transaction that results in such
Restricted Subsidiary becoming a Permitted Joint Venture, provided (x) such
transaction complies with the provisions described under "--Limitation on Asset
Dispositions" above to the extent such provisions apply and (y) the Company's
remaining Investment in such Permitted Joint Venture would have been permitted
as a new Investment under the provisions of "--Limitation on Restricted
Payments" above, (iii) the transfer, conveyance, sale or other disposition of
shares required by
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applicable law or regulation, (iv) if required, the issuance, transfer,
conveyance, sale or other disposition of directors' qualifying shares, or (v)
Disqualified Stock issued in exchange for, or upon conversion of, or the
proceeds of the issuance of which are used to redeem, refinance, replace or
refund shares of Disqualified Stock of such Restricted Subsidiary, provided that
the amounts of the redemption obligations of such Disqualified Stock shall not
exceed the amounts of the redemption obligations of, and such Disqualified Stock
shall have redemption obligations no earlier than those required by, the
Disqualified Stock being exchanged, converted, redeemed, refinanced, replaced or
refunded.
Transactions with Affiliates and Related Persons. The Company may not, and
may not permit any Restricted Subsidiary to, enter into any transaction (or
series of related transactions) with an Affiliate or Related Person of the
Company (other than the Company or a Restricted Subsidiary), including any
Investment, unless such transaction is on terms no less favorable to the Company
or such Restricted Subsidiary than those that could be obtained in a comparable
arm's-length transaction with an entity that is not an Affiliate or Related
Person and is in the best interests of the Company or such Restricted
Subsidiary, provided that the Company or any Restricted Subsidiary may enter
into (i) transactions pursuant to the Company's existing tax sharing agreement
entered into with Anschutz Company described under the caption "Certain
Transactions" in this Prospectus, provided that any amendment of, supplement to
or substitute for such agreement is on terms that are no less favorable to the
Company or such Restricted Subsidiary than such existing agreement, (ii)
transactions pursuant to employee compensation arrangements approved by the
board of directors of the Company, either directly or indirectly, and (iii)
Receivables Sales between the Company or a Restricted Subsidiary and an
Affiliate of the Company or such Restricted Subsidiary, provided that such
Receivables Sales satisfy the provisions of clauses (i) and (ii) of
"--Limitation on Asset Dispositions." For any transaction that involves in
excess of $10 million but less than or equal to $15 million, the Company shall
deliver to the Trustee an Officers' Certificate stating that the transaction
satisfies the above criteria. For any transaction that involves in excess of $15
million, a majority of the disinterested members of the board of directors of
the Company shall determine that the transaction satisfies the above criteria
and shall evidence such a determination by a board resolution filed with the
Trustee or, in the event that there shall not be disinterested members of the
board of directors with respect to the transaction, the Company shall file with
the Trustee a written opinion stating that the transaction satisfies the above
criteria from an investment banking firm of national standing in the United
States which, in the good faith judgment of the board of directors of the
Company, is independent with respect to the Company and its Affiliates and
qualified to perform such task.
Change of Control. Within 30 days of the occurrence of a Change of Control,
the Company will be required to make an Offer to Purchase all outstanding 8.29%
Notes at a price in cash equal to 101% of the Accreted Value of the 8.29% Notes
on the purchase date plus any accrued and unpaid interest thereon and premium,
if any, not otherwise included in the Accreted Value to such purchase date. A
"Change of Control" will be deemed to have occurred at such time as (x) a Rating
Decline shall have occurred and (y) either (A) the sale, conveyance, transfer or
lease of all or substantially all of the assets of the Company to any Person or
any Persons acting together that would constitute a "group" (a "Group") for
purposes of Section 13(d) of the Exchange Act, together with any Affiliates or
Related Persons thereof, other than any Permitted Holder or any Restricted
Subsidiary, shall have occurred; (B) any Person or Group, together with any
Affiliates or Related Persons thereof, other than any Permitted Holder or any
Restricted Subsidiary, shall beneficially own (within the meaning of Rule 13d-3
under the Exchange Act, except that a Person will be deemed to have beneficial
ownership of all shares that such Person has the right to acquire, whether such
right is exercisable immediately or only after the passage of time) at least 50%
of the aggregate voting power of all classes of Voting Stock of the Company at a
time when Permitted Holders own less than or equal to 25% of the aggregate
voting power of all classes of Voting Stock of the Company; or (C) during any
period of two consecutive years, Continuing Directors cease for any reason to
constitute a majority of the Company's board of directors then in office.
In the event that the Company makes an Offer to Purchase the 8.29% Notes,
the Company intends to comply with any applicable securities laws and
regulations,
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including any applicable requirements of Section 14(e) of, and Rule 14e-1 under,
the Exchange Act.
The existence of the holders' right to require, subject to certain
conditions, the Company to repurchase 8.29% Notes upon a Change of Control may
deter a third party from acquiring the Company in a transaction that constitutes
a Change of Control. If an Offer to Purchase is made, there can be no assurance
that the Company will have sufficient funds to pay the Purchase Price for all
8.29% Notes tendered by holders seeking to accept the Offer to Purchase. In
addition, instruments governing other Debt of the Company may prohibit the
Company from purchasing any 8.29% Notes prior to their Stated Maturity,
including pursuant to an Offer to Purchase. See "Description of Certain
Indebtedness." In the event that an Offer to Purchase occurs at a time when the
Company does not have sufficient available funds to pay the Purchase Price for
all 8.29% Notes tendered pursuant to such Offer to Purchase or a time when the
Company is prohibited from purchasing the 8.29% Notes (and the Company is unable
either to obtain the consent of the holders of the relevant Debt or to repay
such Debt), an Event of Default would occur under the Indenture. In addition,
one of the events that constitutes a Change of Control under the Indenture is a
sale, conveyance, transfer or lease of all or substantially all of the property
of the Company. The Indenture will be governed by New York law, and there is no
established definition under New York law of "substantially all" of the assets
of a corporation. Accordingly, if the Company were to engage in a transaction in
which it disposed of less than all of its assets, a question of interpretation
could arise as to whether such disposition was of "substantially all" of its
assets and whether the Company was required to make an Offer to Purchase.
Except as described herein with respect to a Change of Control, the
Indenture does not contain any other provisions that permit holders of 8.29%
Notes to require that the Company repurchase or redeem 8.29% Notes in the event
of a takeover, recapitalization or similar restructuring.
Reports. The Company will file with the Trustee on the date on which it
files them with the Commission copies of the annual and quarterly reports and
the information, documents, and other reports that the Company is required to
file with the Commission pursuant to Section 13(a) or 15(d) of the Exchange Act
("SEC Reports"). In the event the Company shall cease to be required to file SEC
Reports pursuant to the Exchange Act, the Company will nevertheless continue to
file such reports with the Commission (unless the Commission will not accept
such a filing) and the Trustee. The Company will furnish copies of the SEC
Reports to the holders of 8.29% Notes at the time the Company is required to
file the same with the Trustee and will make such information available to
investors who request it in writing.
Limitation on Designations of Unrestricted Subsidiaries. The Indenture will
provide that the Company will not designate any Subsidiary of the Company (other
than a newly created Subsidiary in which no Investment has previously been made)
as an "Unrestricted Subsidiary" under the Indenture (a "Designation") unless:
(a) no Default or Event of Default shall have occurred and be
continuing at the time of or after giving effect to such Designation;
(b) immediately after giving effect to such Designation, the Company
would be able to Incur $1.00 of Debt under paragraph (a) of "--Limitation
on Consolidated Debt"; and
(c) the Company would not be prohibited under the Indenture from making
an Investment at the time of Designation (assuming the effectiveness of
such Designation) in an amount (the "Designation Amount") equal to the Fair
Market Value of the net Investment of the Company or any other Restricted
Subsidiary in such Restricted Subsidiary on such date.
In the event of any such Designation, the Company shall be deemed to have
made an Investment constituting a Restricted Payment pursuant to the covenant
"--Limitation on Restricted Payments" for all purposes of the Indenture in the
Designation Amount. The Indenture will further provide that neither the Company
nor any Restricted Subsidiary shall at any time (x) provide credit support for,
or a
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guarantee of, any Debt of any Unrestricted Subsidiary (including any
undertaking, agreement or instrument evidencing such Debt); provided that the
Company or a Restricted Subsidiary may pledge Capital Stock or Debt of any
Unrestricted Subsidiary on a nonrecourse basis such that the pledgee has no
claim whatsoever against the Company other than to obtain such pledged property,
(y) be directly or indirectly liable for any Debt of any Unrestricted Subsidiary
or (z) be directly or indirectly liable for any Debt which provides that the
holder thereof may (upon notice, lapse of time or both) declare a default
thereon or cause the payment thereof to be accelerated or payable prior to its
final scheduled maturity upon the occurrence of a default with respect to any
Debt of any Unrestricted Subsidiary (including any right to take enforcement
action against such Unrestricted Subsidiary), except in the case of clause (x)
or (y) to the extent permitted under "--Limitation on Restricted Payments" and
"--Transactions with Affiliates and Related Persons."
The Indenture will further provide that a Designation may be revoked (a
"Revocation") by a resolution of the board of directors of the Company delivered
to the Trustee, provided that the Company will not make any Revocation unless:
(a) no Default or Event of Default shall have occurred and be
continuing at the time of and after giving effect to such Revocation; and
(b) all Liens and Debt of such Unrestricted Subsidiary outstanding
immediately following such Revocation would, if Incurred at such time, have
been permitted to be Incurred at such time for all purposes of the
Indenture.
All Designations and Revocations must be evidenced by resolutions of the
board of directors of the Company delivered to the Trustee certifying compliance
with the foregoing provisions.
Mergers, Consolidations and Certain Sales of Assets
The Company may not, in a single transaction or a series of related
transactions, (i) consolidate with or merge into any other Person or Persons or
permit any other Person to consolidate with or merge into the Company (other
than a merger of Qwest Corporation into the Company in which the Company shall
be the surviving Person) or (ii) directly or indirectly, transfer, sell, lease
or otherwise dispose of all or substantially all of its assets to any other
Person or Persons unless: (a) in a transaction in which the Company is not the
surviving Person or in which the Company sells, leases or otherwise disposes of
all or substantially all of its assets to any other Person, the resulting
surviving or transferee Person (the "successor entity") is organized under the
laws of the United States of America or any State thereof or the District of
Columbia and shall expressly assume, by a supplemental indenture executed and
delivered to the Trustee in form satisfactory to the Trustee, all of the
Company's respective obligations under the Indenture; (b) immediately before and
after giving effect to such transaction and treating any Debt which becomes an
obligation of the Company or a Restricted Subsidiary as a result of such
transaction as having been Incurred by the Company or such Restricted Subsidiary
at the time of the transaction, no Default or Event of Default shall have
occurred and be continuing; (c) immediately after giving effect to such
transaction, the Consolidated Net Worth of the Company (or other successor
entity to the Company) is equal to or greater than that of the Company
immediately prior to the transaction; (d) immediately after giving effect to
such transaction and treating any Debt which becomes an obligation of the
Company or a Restricted Subsidiary as a result of such transaction as having
been Incurred by the Company or such Restricted Subsidiary at the time of the
transaction, the Company (including any successor entity to the Company) could
Incur at least $1.00 of additional Debt pursuant to the provisions of the
Indenture described in paragraph (a) under "--Limitation on Consolidated Debt"
above; (e) if, as a result of any such transaction, property or assets of the
Company would become subject to a Lien prohibited by the provisions of the
Indenture described under "--Limitation on Liens" above, the Company or the
successor entity to the Company shall have secured the 8.29% Notes as required
by said covenant; and (f) certain other conditions are met.
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Certain Definitions
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any other terms used herein for which no definition is
provided.
"Accreted Value" means, with respect to any 8.29% Note, (i) as of any date
prior to February 1, 2003, an amount per $1,000 principal amount at maturity of
8.29% Notes that is equal to the sum of (a) the offering price ($665.92 per
$1,000 principal amount at maturity of 8.29% Notes) of such 8.29% Notes and (b)
the portion of the excess of the principal amount at maturity of such 8.29%
Notes over such offering price which shall have been amortized through such
date, such amount to be so amortized on a daily basis and compounded
semiannually on each August 1 and February 1 at a rate of 8.29% per annum from
the date of original issue of the 8.29% Notes through the date of determination
computed on the basis of a 360-day year of twelve 30-day months, and (ii) as of
any date on or after February 1, 2003, the principal amount at maturity of each
8.29% Note; provided, however, that if the Company elects to commence the
accrual of cash interest on the 8.29% Notes on or after February 1, 2001 and
prior to February 1, 2003, the 8.29% Notes shall cease to accrete, and the
Accreted Value and the principal amount at maturity thereof shall be the
Accreted Value on the date of commencement of such accrual as calculated in
accordance with the foregoing.
"Acquired Debt" means, with respect to any specified Person, (i) Debt of
any other Person existing at the time such Person merges with or into or
consolidates with or becomes a Subsidiary of such specified Person and (ii) Debt
secured by a Lien encumbering any asset acquired by such specified Person, which
Debt was not incurred in anticipation of, and was outstanding prior to, such
merger, consolidation or acquisition.
"Affiliate" of any Person means any other Person directly or indirectly
controlling or controlled by or under direct or indirect common control with
such Person. For the purposes of this definition, "control" when used with
respect to any Person means the power to direct the management and policies of
such Person, directly or indirectly, whether through the ownership of voting
securities, by contract or otherwise; and the terms "controlling" and
"controlled" have meanings correlative to the foregoing.
"Asset Disposition" means any transfer, conveyance, sale, lease or other
disposition by the Company or any Restricted Subsidiary in one or more related
transactions occurring within any 12-month period (including a consolidation or
merger or other sale of any such Restricted Subsidiary with, into or to another
Person in a transaction in which such Restricted Subsidiary ceases to be a
Restricted Subsidiary of the Company, but excluding a disposition by a
Restricted Subsidiary to the Company or a Restricted Subsidiary or by the
Company to a Restricted Subsidiary) of (i) shares of Capital Stock or other
ownership interests of a Restricted Subsidiary (other than as permitted by the
provisions of the Indenture described in clauses (iii), (iv) and (v) under the
caption "--Limitation on Issuances and Sales of Capital Stock of Restricted
Subsidiaries"), (ii) substantially all of the assets of the Company or any
Restricted Subsidiary representing a division or line of business or (iii) other
assets or rights of the Company or any Restricted Subsidiary outside of the
ordinary course of business (excluding any transfer, conveyance, sale, lease or
other disposition of equipment that is obsolete or no longer used by or useful
to the Company, provided that the Company has delivered to the Trustee an
Officers' Certificate stating that such criteria are satisfied); provided in
each case that the aggregate consideration for such transfer, conveyance, sale,
lease or other disposition is equal to $500,000 or more in any 12-month period
and provided further that the following shall not be Asset Dispositions: (x)
Permitted Telecommunications Capital Asset Dispositions, (y) exchanges of
Telecommunications Assets for other Telecommunications Assets where the Fair
Market Value of the Telecommunications Assets received is at least equal to the
Fair Market Value of the Telecommunications Assets disposed of or, if less, the
difference is received in cash and such cash is Net Available Proceeds and (z)
Liens permitted to be Incurred pursuant to the second paragraph under
"--Limitation on Liens."
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"Attributable Value" means, as to any particular lease under which any
Person is at the time liable other than a Capital Lease Obligation, and at any
date as of which the amount thereof is to be determined, the total net amount of
rent required to be paid by such Person under such lease during the initial term
thereof as determined in accordance with generally accepted accounting
principles, discounted from the last date of such initial term to the date of
determination at a rate per annum equal to the discount rate which would be
applicable to a Capital Lease Obligation with like term in accordance with
generally accepted accounting principles. The net amount of rent required to be
paid under any such lease for any such period shall be the aggregate amount of
rent payable by the lessee with respect to such period after excluding amounts
required to be paid on account of insurance, taxes, assessments, utility,
operating and labor costs and similar charges. In the case of any lease which is
terminable by the lessee upon the payment of penalty, such net amount shall also
include the lesser of the amount of such penalty (in which case no rent shall be
considered as required to be paid under such lease subsequent to the first date
upon which it may be so terminated) or the rent which would otherwise be
required to be paid if such lease is not so terminated. "Attributable Value"
means, as to a Capital Lease Obligation, the principal amount thereof.
"Capital Lease Obligation" of any Person means the obligation to pay rent
or other payment amounts under a lease of (or other Debt arrangements conveying
the right to use) real or personal property of such Person which is required to
be classified and accounted for as a capital lease or a liability on the face of
a balance sheet of such Person in accordance with generally accepted accounting
principles (a "Capital Lease"). The stated maturity of such obligation shall be
the date of the last payment of rent or any other amount due under such lease
prior to the first date upon which such lease may be terminated by the lessee
without payment of a penalty. The principal amount of such obligation shall be
the capitalized amount thereof that would appear on the face of a balance sheet
of such Person in accordance with generally accepted accounting principles.
"Capital Stock" of any Person means any and all shares, interests,
participations or other equivalents (however designated) of corporate stock or
other equity participations, including partnership interests, whether general or
limited, of such Person.
"Cash Equivalents" means (i) any Debt with a maturity of 365 days or less
issued or directly and fully guaranteed as insured by the United States or any
agency or instrumentality thereof (provided that the full faith and credit of
the United States is pledged in support thereof or such Debt constitutes a
general obligation of such country); (ii) deposits, certificates of deposit or
acceptances with a maturity of 365 days or less of any financial institution
that is a member of the Federal Reserve System, in each case having combined
capital and surplus and undivided profits (or any similar capital concept) of
not less than $500 million and whose senior unsecured debt is rated at least
"A-1" by Standard & Poor's Corporation or "P-1" by Moody's Investors Service,
Inc.; (iii) commercial paper with a maturity of 365 days or less issued by a
corporation (other than an Affiliate of the Company) organized under the laws of
the United States or any State thereof and rated at least "A-1" by Standard &
Poor's Corporation or "P-1" by Moody's Investors Service, Inc.; and (iv)
repurchase agreements and reverse repurchase agreements relating to marketable
direct obligations issued or unconditionally guaranteed by the United States or
issued by any agency or instrumentality thereof and backed by the full faith and
credit of the United States maturing within 365 days from the date of
acquisition.
"Common Stock" of any Person means Capital Stock of such Person that does
not rank prior, as to the payment of dividends or as to the distribution of
assets upon any voluntary or involuntary liquidation, dissolution or winding up
of such Person, to shares of Capital Stock of any other class of such Person.
"Consolidated Capital Ratio" of any Person as of any date means the ratio
of (i) the aggregate consolidated principal amount of Debt of such Person then
outstanding to (ii) the greater of either (a) the aggregate consolidated paid-in
capital of such Person as of such date or (b) the stockholders' equity as of
such date as shown on the consolidated balance sheet of such Person in
accordance with generally accepted accounting principles.
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"Consolidated Cash Flow Available for Fixed Charges" for any period means
the Consolidated Net Income of the Company and its Restricted Subsidiaries for
such period increased by the sum of (i) Consolidated Interest Expense of the
Company and its Restricted Subsidiaries for such period, plus (ii) Consolidated
Income Tax Expense of the Company and its Subsidiaries for such period, plus
(iii) the consolidated depreciation and amortization expense or other non-cash
write-offs of assets included in the income statement of the Company and its
Restricted Subsidiaries for such period, plus (iv) any charge related to any
premium or penalty paid in connection with redeeming or retiring any Debt prior
to its stated maturity; provided, however, that there shall be excluded
therefrom the Consolidated Cash Flow Available for Fixed Charges (if positive)
of any Restricted Subsidiary (calculated separately for such Restricted
Subsidiary in the same manner as provided above for the Company) that is subject
to a restriction which prevents the payment of dividends or the making of
distributions to the Company or another Restricted Subsidiary to the extent of
such restrictions.
"Consolidated Income Tax Expense" for any period means the aggregate
amounts of the provisions for income taxes of the Company and its Subsidiaries
for such period calculated on a consolidated basis in accordance with generally
accepted accounting principles.
"Consolidated Interest Expense" means for any period the interest expense
included in a consolidated income statement (excluding interest income) of the
Company and its Restricted Subsidiaries for such period in accordance with
generally accepted accounting principles, including without limitation or
duplication (or, to the extent not so included, with the addition of), (i) the
amortization of Debt discounts; (ii) any payments or fees with respect to
letters of credit, bankers' acceptances or similar facilities; (iii) fees with
respect to interest rate swap or similar agreements or foreign currency hedge,
exchange or similar agreements; (iv) Preferred Stock dividends of the Company
and its Subsidiaries (other than dividends paid in shares of Preferred Stock
that is not Disqualified Stock) declared and paid or payable; (v) accrued
Disqualified Stock dividends of the Company and its Restricted Subsidiaries,
whether or not declared or paid; (vi) interest on Debt guaranteed by the Company
and its Restricted Subsidiaries; and (vii) the portion of any Capital Lease
Obligation paid during such period that is allocable to interest expense.
"Consolidated Net Income" for any period means the net income (or loss) of
the Company and its Restricted Subsidiaries for such period determined on a
consolidated basis in accordance with generally accepted accounting principles;
provided that there shall be excluded therefrom (a) the net income (or loss) of
any Person acquired by the Company or a Restricted Subsidiary in a
pooling-of-interests transaction for any period prior to the date of such
transaction, (b) the net income (or loss) of any Person that is not a Restricted
Subsidiary except to the extent of the amount of dividends or other
distributions actually paid to the Company or a Restricted Subsidiary by such
Person during such period, (c) gains or losses on Asset Dispositions by the
Company or its Restricted Subsidiaries, (d) all extraordinary gains and
extraordinary losses, determined in accordance with generally accepted
accounting principles, (e) the cumulative effect of changes in accounting
principles, (f) non-cash gains or losses resulting from fluctuations in currency
exchange rates, (g) any non-cash expense related to the issuance to employees or
directors of the Company or any Restricted Subsidiary or any Affiliate of the
Company of (i) options to purchase Capital Stock of the Company or such
Restricted Subsidiary or (ii) other compensatory rights (including under the
Company's Growth Share Plan), provided, in either case, that such options or
rights, by their terms, can be redeemed only for Capital Stock, (h) with respect
to a Restricted Subsidiary that is not a Wholly Owned Subsidiary, any aggregate
net income (or loss) in excess of the Company's or any Restricted Subsidiary's
prorata share of the net income (or loss) of such Restricted Subsidiary that is
not a Wholly Owned Subsidiary shall be excluded and (i) the tax effect of any of
the items described in clauses (a) through (h) above; provided further that for
purposes of any determination pursuant to the provisions described under
"--Limitation on Restricted Payments," there shall further be excluded therefrom
the net income (but not net loss) of any Restricted Subsidiary that is subject
to a restriction which prevents the payment of dividends or the making of
distributions to the Company or another Restricted Subsidiary to the extent of
such restriction.
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"Consolidated Net Worth" of any Person means the stockholders' equity of
such Person, determined on a consolidated basis in accordance with generally
accepted accounting principles, less amounts attributable to Disqualified Stock
of such Person; provided that, with respect to the Company, adjustments
following March 31, 1997 to the accounting books and records of the Company in
accordance with Accounting Principles Board Opinions Nos. 16 and 17 (or
successor opinions thereto) or otherwise resulting from the acquisition of
control of the Company by another Person shall not be given effect to.
"Consolidated Tangible Assets" of any Person means the total amount of
assets (less applicable reserves and other properly deductible items) which
under generally accepted accounting principles would be included on a
consolidated balance sheet of such Person and its Subsidiaries after deducting
therefrom all goodwill, trade names, trademarks, patents, unamortized debt
discount and expense and other like intangibles, which in each case under
generally accepted accounting principles would be included on such consolidated
balance sheet.
"Continuing Director" means, as of any date of determination, any member of
the board of directors of the Company who (i) was a member of such board of
directors of the Company on March 31, 1997, or (ii) was nominated for election
or elected to the board of directors of the Company with the affirmative vote of
a majority of the Continuing Directors who were members of the board of
directors of the Company at the time of such nomination or election or the
affirmative vote of Permitted Holders.
"Credit Facilities" means one or more credit agreements, loan agreements or
similar facilities, secured or unsecured, entered into from time to time by the
Company and its Restricted Subsidiaries, and including any related notes,
Guarantees, collateral documents, instruments and agreements executed in
connection therewith, as the same may be amended, supplemented, modified,
restated or replaced from time to time.
"Debt" means (without duplication), with respect to any Person, whether
recourse is to all or a portion of the assets of such Person and whether or not
contingent, (i) every obligation of such Person for money borrowed, (ii) every
obligation of such Person evidenced by bonds, debentures, notes or other similar
instruments, including obligations incurred in connection with the acquisition
of property, assets or businesses, (iii) every reimbursement obligation of such
Person with respect to letters of credit, bankers' acceptances or similar
facilities issued for the account of such Person, (iv) every obligation of such
Person issued or assumed as the deferred purchase price of property or services
(including securities repurchase agreements but excluding trade accounts payable
or accrued liabilities arising in the ordinary course of business), (v) every
Capital Lease Obligation of such Person, (vi) all Receivables Sales of such
Person, together with any obligation of such Person to pay any discount,
interest, fees, indemnities, penalties, recourse, expenses or other amounts in
connection therewith, (vii) all obligations to redeem Disqualified Stock issued
by such Person, (viii) every obligation under Interest Rate and Currency
Protection Agreements of such Person and (ix) every obligation of the type
referred to in clauses (i) through (viii) of another Person and all dividends of
another Person the payment of which, in either case, such Person has Guaranteed.
The "amount" or "principal amount" of Debt at any time of determination as used
herein represented by (a) any Debt issued at a price that is less than the
principal amount at maturity thereof, shall be the amount of the liability in
respect thereof determined in accordance with generally accepted accounting
principles, (b) any Receivables Sale shall be the amount of the unrecovered
capital or principal investment of the purchaser (other than the Company or a
Wholly Owned Subsidiary of the Company) thereof, excluding amounts
representative of yield or interest earned on such investment or (c) any
Disqualified Stock shall be the maximum fixed redemption or repurchase price in
respect thereof.
"Debt Securities" means any debt securities (including any guarantee of
such securities) issued by the Company or any Restricted Subsidiary of the
Company in connection with a public offering or a private placement (excluding
Debt permitted to be Incurred under paragraph (b) of "--Limitation on
Consolidated Debt").
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"Default" means any event, act or condition the occurrence of which is, or
after notice or the passage of time or both would be, an Event of Default.
"Disqualified Stock" of any Person means any Capital Stock of such Person
which, by its terms (or by the terms of any security into which it is
convertible or for which it is exchangeable), or upon the happening of any
event, matures or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or is redeemable at the option of such Person, any
Subsidiary of such Person or the holder thereof, in whole or in part, on or
prior to the final Stated Maturity of the 8.29% Notes; provided, however, that
any Preferred Stock which would not constitute Disqualified Stock but for
provisions thereof giving holders thereof the right to require the Company to
repurchase or redeem such Preferred Stock upon the occurrence of a Change of
Control occurring prior to the final Stated Maturity of the 8.29% Notes shall
not constitute Disqualified Stock if the change of control provisions applicable
to such Preferred Stock are no more favorable to the holders of such Preferred
Stock than the provisions applicable to the 8.29% Notes contained in the
covenant described under "--Change of Control" and such Preferred Stock
specifically provides that the Company will not repurchase or redeem any such
stock pursuant to such provisions prior to the Company's repurchase of such
8.29% Notes as are required to be repurchased pursuant to the covenant described
under "--Change of Control."
"Eligible Institution" means a commercial banking institution that has
combined capital and surplus of not less than $500 million or its equivalent in
foreign currency, whose debt is rated "A" (or higher) according to Standard &
Poor's Corporation or Moody's Investors Service, Inc. at the time as of which
any investment or rollover therein is made.
"Eligible Receivables" means, at any time, Receivables of the Company and
its Restricted Subsidiaries, as evidenced on the most recent quarterly
consolidated balance sheet of the Company as at a date at least 45 days prior to
such time, less Receivables of the Company or any Restricted Subsidiary employed
to secure Debt Incurred under clause (vii) of paragraph (b) of "--Limitation on
Consolidated Debt."
"Event of Default" has the meaning set forth under "Events of Default" below.
"Exchange Act" means the Securities Exchange Act of 1934, as amended (or
any successor act) and the rules and regulations thereunder (or respective
successors thereto).
"Fair Market Value" means, with respect to any asset or property, the price
that could be negotiated in an arm's-length free market transaction, for cash,
between a willing seller and a willing buyer, neither of whom is under pressure
or compulsion to complete the transaction. Unless otherwise specified in the
Indenture, Fair Market Value shall be determined by the board of directors of
the Company acting in good faith and shall be evidenced by a resolution of the
board of directors of the Company delivered to the Trustee.
"Government Securities" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which guarantee
or obligations the full faith and credit of the United States is pledged and
which have a remaining weighted average life to maturity of not less than one
year from the date of investment therein.
"Guarantee" by any Person means any obligation, contingent or otherwise, of
such Person guaranteeing, or having the economic effect of guaranteeing, any
Debt of any other Person (the "primary obligor") in any manner, whether directly
or indirectly, and including, without limitation, any obligation of such Person,
(i) to purchase or pay (or advance or supply funds for the purchase or payment
of) such Debt or to purchase (or to advance or supply funds for the purchase of)
any security for the payment of such Debt, (ii) to purchase property, securities
or services for the purpose of assuring the holder of such Debt of the payment
of such Debt, or (iii) to maintain working capital, equity capital or other
financial statement condition or liquidity of the primary obligor so as to
enable the primary obligor to pay such Debt (and "Guaranteed", "Guaranteeing"
and "Guarantor" shall have meanings correlative to the foregoing); provided,
however, that the Guarantee
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by any Person shall not include endorsements by such Person for collection or
deposit, in either case, in the ordinary course of business.
"Guarantor" means a Restricted Subsidiary of the Company that has executed
a Restricted Subsidiary Guarantee.
"Incur" means, with respect to any Debt or other obligation of any Person,
to create, issue, incur (by conversion, exchange or otherwise), assume,
Guarantee or otherwise become liable in respect of such Debt or other obligation
including by acquisition of Subsidiaries or the recording, as required pursuant
to generally accepted accounting principles or otherwise, of any such Debt or
other obligation on the balance sheet of such Person (and "Incurrence",
"Incurred", "Incurrable" and "Incurring" shall have meanings correlative to the
foregoing); provided, however, that a change in generally accepted accounting
principles that results in an obligation of such Person that exists at such time
becoming Debt shall not be deemed an Incurrence of such Debt and that neither
the accrual of interest nor the accretion of original issue discount shall be
deemed an Incurrence of Debt.
"Interest Rate or Currency Protection Agreement" of any Person means any
forward contract, futures contract, swap, option or other financial agreement or
arrangement (including, without limitation, caps, floors, collars and similar
agreements) relating to, or the value of which is dependent upon, interest rates
or currency exchange rates or indices.
"Investment" by any Person means any direct or indirect loan, advance or
other extension of credit or capital contribution (by means of transfers of cash
or other property to others or payments for property or services for the account
or use of others, or otherwise) to, or purchase or acquisition of Capital Stock,
bonds, notes, debentures or other securities or evidence of Debt issued by, any
other Person, including any payment on a Guarantee of any obligation of such
other Person.
"Lien" means, with respect to any property or assets, any mortgage or deed
of trust, pledge, hypothecation, assignment, Receivables Sale, deposit
arrangement, security interest, lien, charge, easement (other than any easement
not materially impairing usefulness), encumbrance, preference, priority or other
security agreement or preferential arrangement of any kind or nature whatsoever
on or with respect to such property or assets (including, without limitation,
any conditional sale or other title retention agreement having substantially the
same economic effect as any of the foregoing). For purposes of this definition
the sale, lease, conveyance or other transfer by the Company or any Subsidiary
of, including the grant of indefeasible rights of use or equivalent arrangements
with respect to, dark or lit communications fiber capacity or communications
conduit shall not constitute a Lien.
"Net Available Proceeds" from any Asset Disposition by any Person means
cash or cash equivalents received (including amounts received by way of sale or
discounting of any note, installment receivable or other receivable, but
excluding any other consideration received in the form of assumption by the
acquiror of Debt or other obligations relating to such properties or assets)
therefrom by such Person, net of (i) any portion thereof Invested within 360
days of such Asset Disposition in Telecommunications Assets, (ii) all legal,
title and recording tax expenses, commissions and other fees and expenses
Incurred and all federal, state, provincial, foreign and local taxes required to
be accrued as a liability as a consequence of such Asset Disposition, (iii) all
payments made by such Person or its Subsidiaries on any Debt which is secured by
such assets in accordance with the terms of any Lien upon or with respect to
such assets or which must by the terms of such Lien, or in order to obtain a
necessary consent to such Asset Disposition or by applicable law, be repaid out
of the proceeds from such Asset Disposition, (iv) all distributions and other
payments made to minority interest holders in Subsidiaries of such Person or
Permitted Joint Ventures as a result of such Asset Disposition and (v)
appropriate amounts to be provided by such Person or any Subsidiary thereof, as
the case may be, as a reserve in accordance with generally accepted accounting
principles against any liabilities associated with such assets and retained by
such Person or any Subsidiary thereof, as the case may be, after such Asset
Disposition, including, without limitation, liabilities under any
indemnification obligations and severance and other employee termination costs
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associated with such Asset Disposition, in each case as determined by the board
of directors of such Person, in its reasonable good faith judgment evidenced by
a resolution of the board of directors filed with the Trustee; provided,
however, that any reduction in such reserve within twelve months following the
consummation of such Asset Disposition will be for all purposes of the Indenture
and the 8.29% Notes as a new Asset Disposition at the time of such reduction
with Net Available Proceeds equal to the amount of such reduction.
"Offer to Purchase" means a written offer (the "Offer") sent by the Company
by first class mail, postage prepaid, to each holder of 8.29% Notes at its
address appearing in the 8.29% Note Register on the date of the Offer offering
to purchase up to the principal amount of 8.29% Notes specified in such Offer at
the purchase price specified in such Offer (as determined pursuant to the
Indenture). Unless otherwise required by applicable law, the Offer shall specify
an expiration date (the "Expiration Date") of the Offer to Purchase which shall
be, subject to any contrary requirements of applicable law, not less than 30
days or more than 60 days after the date of such Offer and a settlement date
(the "Purchase Date") for purchase of 8.29% Notes within five Business Days
after the Expiration Date. The Company shall notify the Trustee at least 15
Business Days (or such shorter period as is acceptable to the Trustee) prior to
the mailing of the Offer of the Company's obligation to make an Offer to
Purchase, and the Offer shall be mailed by the Company or, at the Company's
request, by the Trustee in the name and at the expense of the Company. The Offer
shall contain information concerning the business of the Company and its
Subsidiaries which the Company in good faith believes will enable such holders
to make an informed decision with respect to the Offer to Purchase (which at a
minimum will include (i) the most recent annual and quarterly financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contained in the documents required to be filed with the
Trustee pursuant to the Indenture (which requirements may be satisfied by
delivery of such documents together with the Offer), (ii) a description of
material developments in the Company's business subsequent to the date of the
latest of such financial statements referred to in clause (i) (including a
description of the events requiring the Company to make the Offer to Purchase),
(iii) if applicable, appropriate pro forma financial information concerning the
Offer to Purchase and the events requiring the Company to make the Offer to
Purchase and (iv) any other information required by applicable law to be
included therein). The Offer shall contain all instructions and materials
necessary to enable such holders to tender 8.29% Notes pursuant to the Offer to
Purchase. The Offer shall also state:
a. the Section of the Indenture pursuant to which the Offer to Purchase
is being made;
b. the Expiration Date and the Purchase Date;
c. the aggregate principal amount at maturity of the outstanding 8.29%
Notes offered to be purchased by the Company pursuant to the Offer to
Purchase (including, if less than 100%, the manner by which such has been
determined pursuant to the section hereof requiring the Offer to Purchase)
(the "Purchase Amount");
d. the purchase price to be paid by the Company for each $1,000
aggregate principal amount at maturity of 8.29% Notes accepted for payment
(as specified pursuant to the Indenture) (the "Purchase Price");
e. that the holder may tender all or any portion of the 8.29% Notes
registered in the name of such holder and that any portion of a 8.29% Note
tendered must be tendered in an integral multiple of $1,000 principal
amount;
f. the place or places where 8.29% Notes are to be surrendered for
tender pursuant to the Offer to Purchase;
g. that any 8.29% Notes not tendered or tendered but not purchased by
the Company will continue to accrete and/or accrue interest, as the case
may be;
h. that on the Purchase Date the Purchase Price will become due and
payable upon each 8.29% Note being accepted for payment pursuant to the
Offer to
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Purchase and that interest thereon, if any, shall cease to accrue on and
after the Purchase Date;
i. that each holder electing to tender a 8.29% Note pursuant to the
Offer to Purchase will be required to surrender such 8.29% Note at the
place or places specified in the Offer prior to the close of business on
the Expiration Date (such 8.29% Note being, if the Company or the Trustee
so requires, duly endorsed by, or accompanied by a written instrument of
transfer in form satisfactory to the Company and the Trustee duly executed
by, the holder thereof or his attorney duly authorized in writing);
j. that holders will be entitled to withdraw all or any portion of
8.29% Notes tendered if the Company (or their Paying Agent) receives, not
later than the close of business on the Expiration Date, a telegram, telex,
facsimile transmission or letter setting forth the name of the holder, the
principal amount at maturity of the 8.29% Note the holder tendered, the
certificate number of the 8.29% Note the holder tendered and a statement
that such holder is withdrawing all or a portion of his tender;
k. that (a) if 8.29% Notes in an aggregate principal amount at maturity
less than or equal to the Purchase Amount are duly tendered and not
withdrawn pursuant to the Offer to Purchase, the Company shall purchase all
such 8.29% Notes and (b) if 8.29% Notes in an aggregate principal amount at
maturity in excess of the Purchase Amount are tendered and not withdrawn
pursuant to the Offer to Purchase, the Company shall purchase 8.29% Notes,
having an aggregate principal amount at maturity equal to the Purchase
Amount on a pro rata basis (with such adjustments as may be deemed
appropriate so that only 8.29% Notes in denominations of $1,000 or integral
multiples thereof shall be purchased); and
l. that in the case of any holder whose 8.29% Note is purchased only in
part, the Company shall execute, and the Trustee shall authenticate and
deliver to the holder of such 8.29% Note without service charge, a new
8.29% Note or 8.29% Notes, of any authorized denomination as requested by
such holder, in an aggregate principal amount at maturity equal to and in
exchange for the unpurchased portion of the 8.29% Note so tendered.
Any Offer to Purchase shall be governed by and effected in accordance with the
Offer for such Offer to Purchase.
"Officers' Certificate" means a certificate signed by the Chairman of the
board of directors of the Company, a Vice Chairman of the board of directors of
the Company, the President or a Vice President, and by the Chief Financial
Officer, the Chief Accounting Officer, the Treasurer, an Assistant Treasurer,
the Secretary or an Assistant Secretary of the Company and delivered to the
Trustee, which shall comply with the Indenture.
"Opinion of Counsel" means an opinion of counsel acceptable to the Trustee
(who may be counsel to the Company, including an employee of the Company).
"Permitted Holders" means any Person who was the beneficial owner (within
the meaning of Rule 13d-3 under the Exchange Act) of stock of the Company on
March 31, 1997 and any Affiliates of such Person (i) who were Affiliates of such
Person on March 31, 1997 or (ii) who were formed, directly or indirectly, by any
such Person after March 31, 1997 provided, however, that Persons who were
beneficial owners (within the meaning of Rule 13d-3 under the Exchange Act) of
such Person on March 31, 1997 continued to be beneficial owners (within the
meaning of Rule 13d-3 under the Exchange Act) at the time of formation of such
Affiliate.
"Permitted Interest Rate or Currency Protection Agreement" of any Person
means any Interest Rate or Currency Protection Agreement entered into with one
or more financial institutions in the ordinary course of business that is
designed to protect such Person against fluctuations in interest rates or
currency exchange rates with respect to Debt Incurred and which shall have a
notional amount no greater than the payments due with respect to the Debt being
hedged thereby and not for purposes of speculation.
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"Permitted Investments" means (a) Cash Equivalents; (b) Investments in
prepaid expenses, negotiable instruments held for collection and lease, utility
and workers' compensation, performance and other similar deposits; (c) loans,
advances or extensions of credit to employees and directors made in the ordinary
course of business and consistent with past practice; (d) obligations under
Interest Rate or Currency Protection Agreements; (e) bonds, notes, debentures
and other securities received as a result of Asset Dispositions pursuant to and
in compliance with "--Limitation on Asset Dispositions"; (f) Investments made in
the ordinary course of business as partial payment for constructing a network
relating to a Telecommunications Business; (g) commercially reasonable
extensions of trade credit; (h) Investments in any Person as a result of which
such Person becomes a Restricted Subsidiary; (i) Investments in Permitted Joint
Ventures in an aggregate amount not to exceed $25 million; (j) Investments in
Affiliates or Related Persons in an aggregate amount not to exceed $11 million,
provided that the making of such Investments is permitted under "--Transactions
with Affiliates and Related Persons"; and (k) Investments in an aggregate amount
not to exceed $15 million consisting of the contribution by the Company or any
Restricted Subsidiary of assets located in Mexico to joint ventures in which the
Company or a Restricted Subsidiary has an interest.
"Permitted Joint Venture" means a corporation, partnership or other entity
other than a Restricted Subsidiary engaged in one or more Telecommunications
Businesses over which the Company and/or one or more Strategic Investors have,
directly or indirectly, the power to direct the policies, management and
affairs.
"Permitted Liens" means (a) Liens for taxes, assessments, governmental
charges, levies or claims which are not yet delinquent or which are being
contested in good faith by appropriate proceedings, if a reserve or other
appropriate provision, if any, as shall be required in conformity with generally
accepted accounting principles shall have been made therefor; (b) other Liens
incidental to the conduct of the Company's and its Restricted Subsidiaries'
businesses or the ownership of its property and assets not securing any Debt,
and which do not in the aggregate materially detract from the value of the
Company's and its Restricted Subsidiaries' property or assets when taken as a
whole, or materially impair the use thereof in the operation of its business;
(c) Liens with respect to assets of a Restricted Subsidiary granted by such
Restricted Subsidiary to the Company or a Restricted Subsidiary to secure Debt
owing to the Company or such Restricted Subsidiary; (d) Liens, pledges and
deposits made in the ordinary course of business in connection with workers'
compensation, unemployment insurance and other types of statutory obligations;
(e) Liens, pledges or deposits made to secure the performance of tenders, bids,
leases, public or statutory obligations, sureties, stays, appeals, indemnities,
performance or other similar bonds and other obligations of like nature Incurred
in the ordinary course of business (exclusive of obligations for the payment of
borrowed money); (f) zoning restrictions, servitudes, easements, rights-of-way,
restrictions and other similar charges or encumbrances Incurred in the ordinary
course of business which, in the aggregate, do not materially detract from the
value of the property subject thereto or materially interfere with the ordinary
conduct of the business of the Company or its Restricted Subsidiaries; (g) Liens
arising out of judgments or awards against or other court proceedings concerning
the Company or any Restricted Subsidiary with respect to which the Company or
such Restricted Subsidiary is prosecuting an appeal or proceeding for review and
the Company or such Restricted Subsidiary is maintaining adequate reserves in
accordance with generally accepted accounting principles; and (h) any interest
or title of a lessor in the property subject to any lease other than a Capital
Lease.
"Permitted Telecommunications Capital Asset Disposition" means the
transfer, conveyance, sale, lease or other disposition of a capital asset that
is a Telecommunications Asset (including fiber, conduit and related equipment),
(i) the proceeds of which are treated as revenues by the Company in accordance
with generally accepted accounting principles and (ii) that, in the case of the
sale of fiber, would not result in the Company retaining less than 24 fibers per
route mile on any segment of the Company's network.
"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust, unincorporated organization, government
or agency or political subdivision thereof or any other entity.
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"Preferred Dividends" for any Person means for any period the quotient
determined by dividing the amount of dividends and distributions paid or accrued
(whether or not declared) on Preferred Stock of such Person during such period
calculated in accordance with generally accepted accounting principles, by 1
minus the maximum statutory income tax rate then applicable to the Company
(expressed as a decimal).
"Preferred Stock" of any Person means Capital Stock of such Person of any
class or classes (however designated) that ranks prior, as to the payment of
dividends or as to the distribution of assets upon any voluntary or involuntary
liquidation, dissolution or winding up of such Person, to shares of Capital
Stock of any other class of such Person.
"Public Equity Offering" means an underwritten public offering of common
stock made on a primary basis by the Company pursuant to a registration
statement filed with, and declared effective by, the Commission in accordance
with the Securities Act.
"Purchase Money Debt" means Debt Incurred at any time within 270 days of,
and for the purposes of financing all or any part of the cost of, the
construction, installation, acquisition or improvement by the Company or any
Restricted Subsidiary of the Company of any new Telecommunications Assets
constructed, installed, acquired or improved after March 31, 1997, provided that
the proceeds of such Debt are expended for such purposes within such 270-day
period.
"Rating Decline" means the 8.29% Notes cease to be rated B+ (or the
equivalent thereof) or better by Standard & Poor's Corporation or B2 (or the
equivalent thereof) or better by Moody's Investors Service, Inc.
"Receivables" means receivables, chattel paper, instruments, documents or
intangibles evidencing or relating to the right to payment of money, excluding
allowances for doubtful accounts.
"Receivables Sale" of any Person means any sale of Receivables of such
Person (pursuant to a purchase facility or otherwise), other than in connection
with a disposition of the business operations of such Person relating thereto or
a disposition of defaulted Receivables for purposes of collection and not as a
financing arrangement.
"Related Person" of any Person means any other Person directly or
indirectly owning (a) 5% or more of the outstanding Common Stock of such Person
(or, in the case of a Person that is not a corporation, 5% or more of the
outstanding equity interest in such Person) or (b) 5% or more of the combined
outstanding voting power of the Voting Stock of such Person.
"Restricted Subsidiary" means a Subsidiary of the Company, or of a
Restricted Subsidiary that is a Wholly Owned Subsidiary of the Company, that has
not been designated by the board of directors of the Company (by a board
resolution delivered to the Trustee) as an Unrestricted Subsidiary pursuant to
and in compliance with "--Limitations on Designations of Unrestricted
Subsidiaries."
"Restricted Subsidiary Guarantee" means a supplemental indenture to the
Indenture in form satisfactory to the Trustee, providing for an unconditional
Guarantee of payment in full of the principal of, premium, if any, and interest
on the 8.29% Notes. Any such Restricted Subsidiary Guarantee shall not be
subordinate in right of payment to any Debt of the Restricted Subsidiary
providing the Restricted Subsidiary Guarantee.
"Sale and Leaseback Transaction" of any Person means an arrangement with
any lender or investor or to which such lender or investor is a party providing
for the leasing by such Person of any property or asset of such Person which has
been or is being sold or transferred by such Person more than 365 days after the
acquisition thereof or the completion of construction or commencement of
operation thereof to such lender or investor or to any Person to whom funds have
been or are to be advanced by such lender or investor on the security of such
property or asset. The stated maturity of such arrangement shall be the date of
the last payment of rent or any other amount due under such arrangement prior to
the first
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date on which such arrangement may be terminated by the lessee without payment
of a penalty.
"Senior Notes" means (i) the 10 7/8% Notes and (ii) the 9.47% Notes.
"Senior Note Indentures" means (i) the Indenture dated March 31, 1997
between the Company and Bankers Trust Company, as trustee thereunder, relating
to the 10 7/8% Notes and (ii) the Indenture dated October 15, 1997 between the
Company and Bankers Trust Company, as trustee thereunder, relating to the 9.47%
Notes.
"Stated Maturity," when used with respect to a 8.29% Note or any
installment of interest thereon, means the date specified in such 8.29% Note as
the fixed date on which the principal of such 8.29% Note or such installment of
interest is due and payable.
"Strategic Investor" means a corporation, partnership or other entity
engaged in one or more Telecommunications Businesses that has, or 80% or more of
the Voting Stock of which is owned by a Person that has, an equity market
capitalization, at the time of its initial Investment in the Company or in a
Permitted Joint Venture with the Company, in excess of $2 billion.
"Subordinated Debt" means Debt of the Company as to which the payment of
principal of (and premium, if any) and interest and other payment obligations in
respect of such Debt shall be subordinate to the prior payment in full of the
8.29% Notes to at least the following extent: (i) no payments of principal of
(or premium, if any) or interest on or otherwise due in respect of such Debt may
be permitted for so long as any default in the payment of principal (or premium,
if any) or interest on the 8.29% Notes exists; (ii) in the event that any other
Default exists with respect to the 8.29% Notes, upon notice by 25% or more in
principal amount of the 8.29% Notes to the Trustee, the Trustee shall have the
right to give notice to the Company and the holders of such Debt (or trustees or
agents therefor) of a payment blockage, and thereafter no payments of principal
of (or premium, if any) or interest on or otherwise due in respect of such Debt
may be made for a period of 179 days from the date of such notice; and (iii)
such Debt may not (x) provide for payments of principal of such Debt at the
stated maturity thereof or by way of a sinking fund applicable thereto or by way
of any mandatory redemption, defeasance, retirement or repurchase thereof by the
Company (including any redemption, retirement or repurchase which is contingent
upon events or circumstances but excluding any retirement required by virtue of
acceleration of such Debt upon an event of default thereunder), in each case
prior to the final Stated Maturity of the 8.29% Notes or (y) permit redemption
or other retirement (including pursuant to an offer to purchase made by the
Company) of such other Debt at the option of the holder thereof prior to the
final Stated Maturity of the 8.29% Notes, other than a redemption or other
retirement at the option of the holder of such Debt (including pursuant to an
offer to purchase made by the Company) which is conditioned upon a change of
control of the Company pursuant to provisions substantially similar to those
described under "--Change of Control" (and which shall provide that such Debt
will not be repurchased pursuant to such provisions prior to the Company's
repurchase of the 8.29% Notes required to be repurchased by the Company pursuant
to the provisions described under "--Change of Control").
"Subsidiary" of any Person means (i) a corporation more than 50% of the
combined voting power of the outstanding Voting Stock of which is owned,
directly or indirectly, by such Person or by one or more other Subsidiaries of
such Person or by such Person and one or more Subsidiaries thereof or (ii) any
other Person (other than a corporation) in which such Person, or one or more
other Subsidiaries of such Person or such Person and one or more other
Subsidiaries thereof, directly or indirectly, has at least a majority ownership
and power to direct the policies, management and affairs thereof.
"Telecommunications Assets" means all assets, rights (contractual or
otherwise) and properties, whether tangible or intangible, used or intended for
use in connection with a Telecommunications Business.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, video or data through
owned or leased transmission facilities, (ii) constructing, creating, developing
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or marketing communications related network equipment, software and other
devices for use in a telecommunications business or (iii) evaluating,
participating or pursuing any other activity or opportunity that is primarily
related to those identified in (i) or (ii) above; provided that the
determination of what constitutes a Telecommunications Business shall be made in
good faith by the board of directors of the Company.
"Unrestricted Subsidiary" means any Subsidiary of the Company designated as
such pursuant to and in compliance with "--Limitation on Designations of
Unrestricted Subsidiaries."
"Voting Stock" of any Person means Capital Stock of such Person which
ordinarily has voting power for the election of directors (or persons performing
similar functions) of such Person, whether at all times or only for so long as
no senior class of securities has such voting power by reason of any
contingency.
"Wholly Owned Subsidiary" of any Person means a Subsidiary of such Person
all of the outstanding Voting Stock or other ownership interests (other than
directors' qualifying shares) of which shall at the time be owned by such Person
or by one or more Wholly Owned Subsidiaries of such Person or by such Person and
one or more Wholly Owned Subsidiaries of such Person.
Events of Default
The following will be Events of Default under the Indenture: (a) failure to
pay principal of (or premium, if any, on) any 8.29% Note when due; (b) failure
to pay any interest on any 8.29% Note when due, continued for 30 days; (c)
default in the payment of principal and interest on 8.29% Notes required to be
purchased pursuant to an Offer to Purchase as described under "--Change of
Control" when due and payable; (d) failure to perform or comply with the
provisions described under "--Mergers, Consolidations and Certain Sales of
Assets" and "--Limitation on Asset Dispositions"; (e) failure to perform any
other covenant or agreement of the Company under the Indenture or the 8.29%
Notes continued for 60 days after written notice to the Company by the Trustee
or holders of at least 25% in aggregate principal amount at maturity of the
outstanding 8.29% Notes; (f) default under the terms of any instrument
evidencing or securing Debt of the Company or any Restricted Subsidiary having
an outstanding principal amount of $10 million individually or in the aggregate
which default results in the acceleration of the payment of such indebtedness or
constitutes the failure to pay such indebtedness when due (after expiration of
any applicable grace period); (g) the rendering of a final judgment or judgments
(not subject to appeal) against the Company or any Restricted Subsidiary in an
amount in excess of $10 million which remains undischarged or unstayed for a
period of 45 days after the date on which the right to appeal has expired; and
(h) certain events of bankruptcy, insolvency or reorganization affecting the
Company or any Restricted Subsidiary. Subject to the provisions of the Indenture
relating to the duties of the Trustee in case an Event of Default (as defined)
shall occur and be continuing, the Trustee will not be under any obligation to
exercise any of its rights or powers under the Indenture at the request or
direction of any of the holders of 8.29% Notes, unless such holders shall have
offered to the Trustee reasonable indemnity. Subject to such provisions for the
indemnification of the Trustee, the holders of a majority in aggregate principal
amount of the outstanding 8.29% Notes will have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
Trustee or exercising any trust or power conferred on the Trustee.
If any Event of Default (other than an Event of Default described in clause
(h) above) shall occur and be continuing, either the Trustee or the holders of
at least 25% in aggregate principal amount at maturity of the outstanding 8.29%
Notes may accelerate the maturity of all 8.29% Notes; provided, however, that
after such acceleration, but before a judgment or decree based on acceleration,
the holders of a majority in aggregate principal amount at maturity of the
outstanding 8.29% Notes may, under certain circumstances, rescind and annul such
acceleration if all Events of Default, other than the non-payment of accelerated
principal, have been cured or waived as provided in the Indenture. If an Event
of Default specified in clause (h) above occurs, the outstanding 8.29% Notes
will ipso facto become immediately due and payable without any declaration or
other act on the part of the Trustee
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or any holder. For information as to waiver of defaults, see "--Amendment,
Supplement and Waiver."
Notwithstanding the foregoing, upon an acceleration of 8.29% Notes or an
Event of Default specified in clause (h) above, in each case prior to February
1, 2003, the holders of 8.29% Notes will be entitled to receive only a default
amount equal to the Accreted Value of the 8.29% Notes (plus any accrued and
unpaid interest and premium, if any, not otherwise included in the Accreted
Value to such date), which until February 1, 2003 will be less than the face
amount of such 8.29% Notes.
No holder of any 8.29% Note will have any right to institute any proceeding
with respect to the Indenture or for any remedy thereunder, unless such holder
shall have previously given to the Trustee written notice of a continuing Event
of Default (as defined) and unless also the holders of at least 25% in aggregate
principal amount at maturity of the outstanding 8.29% Notes shall have made
written request and offered reasonable indemnity to the Trustee to institute
such proceeding as trustee, and the Trustee shall not have received from the
holders of a majority in aggregate principal amount at maturity of the
outstanding 8.29% Notes a direction inconsistent with such request and shall
have failed to institute such proceeding within 60 days. However, such
limitations do not apply to a suit instituted by a holder of a 8.29% Note for
enforcement of payment of the principal of and premium, if any, or interest on
such 8.29% Note on or after the respective due dates expressed in such 8.29%
Note.
The Company will be required to furnish to the Trustee quarterly a
statement as to the performance by the Company of certain of its obligations
under the Indenture and as to any default in such performance.
Amendment, Supplement and Waiver
The Company and the Trustee may, at any time and from time to time, without
notice to or consent of any holder of 8.29% Notes, enter into one or more
indentures supplemental to the Indenture (1) to evidence the succession of
another Person to the Company and the assumption by such successor of the
covenants of the Company in the Indenture and the 8.29% Notes; (2) to add to the
covenants of the Company, for the benefit of the holders, or to surrender any
right or power conferred upon the Company by the Indenture; (3) to add any
additional Events of Default; (4) to provide for uncertificated 8.29% Notes in
addition to or in place of certificated 8.29% Notes; (5) to evidence and provide
for the acceptance of appointment under the Indenture of a successor Trustee;
(6) to secure the 8.29% Notes; or (7) to cure any ambiguity in the Indenture to
correct or supplement any provision in the Indenture which may be inconsistent
with any other provision therein or to add any other provisions with respect to
matters or questions arising under the Indenture; provided such actions shall
not adversely affect the interests of the holders in any material respect.
With the consent of the holders of not less than a majority in principal
amount at maturity of the outstanding 8.29% Notes, the Company and the Trustee
may enter into one or more indentures supplemental to the Indenture for the
purpose of adding any provisions to or changing in any manner or eliminating any
of the provisions of the Indenture or modifying in any manner the rights of the
holders, provided that no such supplemental indenture shall, without the consent
of the holder of each outstanding 8.29% Note (1) change the Stated Maturity of
the principal of, or any installment of interest on, any 8.29% Note, or alter
the redemption provisions thereof, or reduce the principal amount thereof (or
premium, if any), or the interest thereon that would be due and payable upon
maturity thereof, or change the place of payment where, or the coin or currency
in which, any 8.29% Note or any premium or interest thereon is payable, or
impair the right to institute suit for the enforcement of any such payment on or
after the maturity thereof; (2) reduce the percentage in principal amount at
maturity of the outstanding 8.29% Notes, the consent of whose holders is
necessary for any such supplemental indenture or required for any waiver of
compliance with certain provisions of the Indenture or certain Defaults
thereunder; (3) subordinate in right of payment, or otherwise subordinate, the
8.29% Notes to any other Debt; (4) modify any provision of the Indenture
relating to the calculation of Accreted Value; or (5) modify any provision of
this paragraph (except to increase any percentage set forth herein).
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The holders of not less than a majority in principal amount at maturity of
the outstanding 8.29% Notes may, on behalf of the holders of all the 8.29%
Notes, waive any past Default under the Indenture and its consequences, except
Default (1) in the payment of the principal of (or premium, if any) or interest
on any 8.29% Note, or (2) in respect of a covenant or provision hereof which
under the proviso to the prior paragraph cannot be modified or amended without
the consent of the holder of each outstanding 8.29% Note affected.
Satisfaction and Discharge of the Indenture, Defeasance
The Company may terminate its obligations under the Indenture when (i)
either (A) all outstanding 8.29% Notes have been delivered to the Trustee for
cancellation or (B) all such 8.29% Notes not theretofore delivered to the
Trustee for cancellation have become due and payable, will become due and
payable within one year or are to be called for redemption within one year under
irrevocable arrangements satisfactory to the Trustee for the giving of notice of
redemption by the Trustee in the name and at the expense of the Company, and the
Company has irrevocably deposited or caused to be deposited with the Trustee
funds in an amount sufficient to pay and discharge the entire indebtedness on
the 8.29% Notes not theretofore delivered to the Trustee for cancellation, for
principal of (or premium, if any, on) and interest to the date of deposit or
maturity or date of redemption on such 8.29% Notes; (ii) the Company has paid or
caused to be paid all other sums payable by the Company under the Indenture; and
(iii) the Company has delivered an Officers' Certificate and an Opinion of
Counsel relating to compliance with the conditions set forth in the Indenture.
The Company, at its election, shall (a) be deemed to have paid and
discharged its debt on the 8.29% Notes and the Indenture shall cease to be of
further effect as to all outstanding 8.29% Notes (except as to (i) rights of
registration of transfer, substitution and exchange of 8.29% Notes and the
Company's right of optional redemption, (ii) rights of holders to receive
payments of principal of, premium, if any, and interest on such 8.29% Notes (but
not the Purchase Price referred to under "--Change of Control") and any rights
of the holders with respect to such amounts, (iii) the rights, obligations and
immunities of the Trustee under the Indenture and (iv) certain other specified
provisions in the Indenture) or (b) cease to be under any obligation to comply
with certain restrictive covenants including those described under "--Certain
Covenants," after the irrevocable deposit by the Company with the Trustee, in
trust for the benefit of the holders, at any time prior to the maturity of the
8.29% Notes, of (A) money in an amount, (B) Government Securities which through
the payment of interest and principal will provide, not later than one day
before the due date of payment in respect of the 8.29% Notes, money in an
amount, or (C) a combination thereof, sufficient to pay and discharge the
principal of, and interest on, the 8.29% Notes then outstanding on the dates on
which any such payments are due in accordance with the terms of the Indenture
and of the 8.29% Notes. Such defeasance or covenant defeasance shall be deemed
to occur only if certain conditions are satisfied, including, among other
things, delivery by the Company to the Trustee of an Opinion of Counsel
acceptable to the Trustee to the effect that (i) such deposit, defeasance and
discharge will not be deemed, or result in, a taxable event for federal income
tax purposes with respect to the holders; and (ii) the Company's deposit will
not result in the Trust or the Trustee being subject to regulation under the
Investment Company Act of 1940.
Governing Law
The Indenture and the 8.29% Notes will be governed by the laws of the State
of New York.
The Trustee
Bankers Trust Company will be the Trustee under the Indenture. The
Trustee's current address is Four Albany Street, New York, New York 10006.
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The holders of not less than a majority in principal amount at maturity of
the outstanding 8.29% Notes will have the right to direct the time, method and
place of conducting any proceeding for exercising any remedy available to the
Trustee, subject to certain exceptions. Except during the continuance of an
Event of Default, the Trustee will perform only such duties are specifically set
forth in the Indenture. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured or waived), the Trustee will be required,
in the exercise of its rights and powers under the Indenture, to use the degree
of care of a prudent person in the conduct of such person's own affairs.
No Personal Liability of Directors, Officers, Employees and Stockholders
No director, officer, employee, incorporator or stockholder of the Company,
as such, shall have any liability for any obligations of the Company under the
8.29% Notes or the Indenture or for any claim based on, in respect of, or by
reason of, such obligations or their creation, solely by reason of its status as
a director, officer, employee, incorporator or stockholder of the Company. By
accepting an 8.29% Note each holder waives and releases all such liability (but
only such liability). The waiver and release are part of the consideration for
issuance of the 8.29% Notes. Nevertheless, such waiver may not be effective to
waive liabilities under the federal securities laws and it has been the view of
the Commission that such a waiver is against public policy.
Transfer and Exchange
A holder may transfer or exchange 8.29% Notes in accordance with the
Indenture. The Company, the Registrar and the Trustee may require a holder,
among other things, to furnish appropriate endorsements and transfer documents
and the Company may require a holder to pay any taxes and fees required by law
or permitted by the Indenture.
EXCHANGE OFFER; REGISTRATION RIGHTS
The Company has entered into a registration rights agreement with the Initial
Purchaser (the "Registration Agreement") pursuant to which the Company agreed,
for the benefit of the holders of the Old 8.29% Notes, at the Company's cost,
(a) by April 29, 1998, to file a registration statement (a "Registration
Statement") with the Commission with respect to a registered offer to exchange
the Old 8.29% Notes for the Exchange Notes, (b) to use its best efforts to cause
such Registration Statement to be declared effective under the Securities Act by
June 28, 1998, and (c) to consummate the Exchange Offer by July 28, 1998. For
each Old 8.29% Note surrendered to the Company pursuant to the Exchange Offer,
the holder of such Old 8.29% Note will receive an Exchange Note having a
principal amount at maturity equal to that of the surrendered Old 8.29% Note.
Based upon no-action letters issued by the staff of the Commission to third
parties, the Company believes that the Exchange Notes issued pursuant to the
Exchange Offer in exchange for Old 8.29% Notes would in general be freely
transferable after the Exchange Offer without further registration under the
Securities Act if the holder of the Exchange Notes represents (i) that it is not
an "affiliate," as defined in Rule 405 of the Securities Act, of the Company,
(ii) that it is acquiring the Exchange Notes in the ordinary course of its
business and (iii) that it has no arrangement or understanding with any person
to participate in the distribution (within the meaning of the Securities Act) of
the Exchange Notes; provided that, in the case of broker- dealers, a prospectus
meeting the requirements of the Securities Act be delivered as required.
However, the Commission has not considered the Exchange Offer in the context of
a no-action letter and there can be no assurance that the staff of the
Commission would make a similar determination with respect to the Exchange Offer
as in such other circumstances. Holders of Old 8.29% Notes wishing to accept the
Exchange Offer must represent to the Company that such conditions have been met.
Each broker-dealer that receives Exchange Notes for its own account pursuant to
the Exchange Offer, where it acquired the Old 8.29% Notes exchanged for such
Exchange Notes for its own account as a result of market-making or other trading
activities, may be deemed to be an "underwriter" within the meaning of the
Securities Act and must acknowledge
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that it will deliver a prospectus in connection with the resale of such Exchange
Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it is
an "underwriter" within the meaning of the Securities Act. This Prospectus, as
it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with resales of Exchange Notes received in exchange
for Old 8.29% Notes where such Old 8.29% Notes were acquired by such broker-
dealer as a result of market-making activities or other trading activities. The
Company has agreed that, for a period of one year after consummation of the
Exchange Offer, it will make this Prospectus available to any broker- dealer for
use in connection with any such resale. A broker-dealer that delivers such a
prospectus to purchasers in connection with such resales will be subject to
certain of the civil liability provisions under the Securities Act, and will be
bound by the provisions of the Registration Agreement (including certain
indemnification and contribution rights and obligations). See "The Exchange
Offer--Resale of the Exchange Notes" and "Plan of Distribution."
Each holder of the Old 8.29% Notes (other than certain specified holders) who
wishes to exchange Old 8.29% Notes for Exchange Notes in the Exchange Offer will
be required to represent that (a) it is not an affiliate of the Company, (b) any
Exchange Notes to be received by it will be acquired in the ordinary course of
its business and (c) at the time of commencement of the Exchange Offer, it has
no arrangement with any person to participate in the distribution (within the
meaning of the Securities Act) of the Exchange Notes. If the holder is a
broker-dealer (a "Participating Broker-Dealer") who acquired the 8.29% Notes for
its own account as a result of market-making or other trading activities, it may
be deemed to be an "underwriter" within the meaning of the Securities Act and
will be required to acknowledge that it must deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of such
Exchange Notes. The Commission has taken the position that Participating
Broker-Dealers may fulfill their prospectus delivery requirements with respect
to the Exchange Notes (other than a resale of an unsold allotment from the
original sale of the Old 8.29% Notes) with the prospectus contained in the
Exchange Offer Registration Statement. Under the Registration Agreement, the
Company is required to allow Participating Broker-Dealers and other persons, if
any, subject to similar prospectus delivery requirements to use the prospectus
contained in the Exchange Offer Registration Statement in connection with the
resale of such Exchange Notes.
If, (i) because of any change in law or applicable interpretations thereof by
the Commission's staff, the Company determines upon advice of its outside
counsel that it is not permitted to effect the Exchange Offer as contemplated by
the Registration Agreement, or (ii) for any other reason the Exchange Offer is
not consummated within 180 days of the closing date of the Old 8.29% Notes, or
(iii) any Initial Purchaser so requests with respect to Old 8.29% Notes held by
it following consummation of the Exchange Offer, or (iv) any holder of Old 8.29%
Notes (other than an Initial Purchaser) is not eligible to participate in the
Exchange Offer or (v) in the case of any Initial Purchaser that participates in
the Exchange Offer or acquires Exchange Notes issued and delivered to it by the
Company in exchange for Old 8.29% Notes, such Purchaser does not receive freely
tradeable Exchange Notes in exchange for Old 8.29% Notes constituting any
portion of an unsold allotment, the Company will, at its cost, (a) as promptly
as practicable, file a shelf registration statement (a "Shelf Registration
Statement") with the Commission relating to the offer and sale of the Old 8.29%
Notes or the Exchange Notes, (b) cause such Shelf Registration Statement to be
declared effective under the Securities Act and (c) use its best efforts to keep
such Shelf Registration Statement continuously effective under the Securities
Act for a period of three years or such shorter period that will terminate when
all the Old 8.29% Notes or Exchange Notes, as applicable, covered by such Shelf
Registration Statement have been sold. The Company will, in the event of filing
such a Shelf Registration Statement, provide to each holder of the Old 8.29%
Notes copies of the prospectus that is a part of such Shelf Registration
Statement, notify each such holder when such Shelf Registration Statement for
the Old 8.29% Notes has been filed with the Commission and when such Shelf
Registration Statement or any post-effective amendment thereto has become
effective and take certain other actions as are required to permit unrestricted
resales of the 8.29% Notes. A holder of 8.29% Notes that sells such 8.29% Notes
pursuant to a Shelf Registration Statement generally will be required to be
named as a selling security holder in the related prospectus
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and to deliver a prospectus to purchasers, will be subject to certain of the
civil liability provisions under the Securities Act in connection with such
sales and will be bound by the provisions of the Registration Agreement which
are applicable to such a holder (including certain indemnification and
contribution rights and obligations).
The Old 8.29% Notes provide that if (i) the Registration Statement has not
been filed with the Commission within 90 days after the closing date of the Old
8.29% Notes or declared effective within 150 days after the closing date of the
Old 8.29% Notes, or the Exchange Offer has not been consummated within 180 days
after the closing date of the Old 8.29% Notes or (ii) in lieu thereof, the Shelf
Registration Statement has not been filed with the Commission and declared
effective within 210 days after the closing date of the Old 8.29% Notes or (iii)
after either the Registration Statement or the Shelf Registration Statement has
been declared effective, as the case may be, such Registration Statement
thereafter ceases to be effective or usable (subject to certain exceptions) in
connection with resales of Old 8.29% Notes or Exchange Notes in accordance with
and during the periods specified in the Registration Agreement (each such event
referred to in clauses (i) through (iii), a "Registration Default"), additional
interest ("Liquidated Interest") will accrue on the Old 8.29% Notes (in addition
to the stated interest on the Old 8.29% Notes) from and including the date on
which any such Registration Default shall occur to but excluding the date on
which all Registration Defaults have been cured. Liquidated Interest will be
payable in cash semiannually in arrears each April 15 and October 15, at a rate
per annum equal to 0.50% of the principal amount of the Old 8.29% Notes during
the 90-day period immediately following the occurrence of any Registration
Default and shall increase by 0.25% per annum of the principal amount of the Old
8.29% Notes at the end of each subsequent 90-day period, but in no event shall
such rates exceed 2.00% per annum in the aggregate regardless of the number of
Registration Defaults.
The summary herein of certain provisions of the Registration Agreement does
not purport to be complete and is subject to, and is qualified in its entirety
by reference to, all the provisions of the Registration Agreement, a copy of
which is filed as an exhibit to the Registration Statement of which this
Prospectus is a part.
DESCRIPTION OF CERTAIN INDEBTEDNESS
In March 1997, the Company issued and sold $250.0 million in principal
amount of the 10 7/8% Notes, the proceeds of which were used to repay certain
indebtedness of the Company and also to fund capital expenditures for the
construction and activation of the Qwest Network. Unamortized issuance costs
totaling approximately $8.0 million are being amortized over the term of the 10
7/8% Notes. Interest on the 10 7/8% 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 10 7/8% Notes is due and payable in full on April 1, 2007. The 10
7/8% Note 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 10 7/8%
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 10 7/8% Note
Indenture), holders of the 10 7/8% Notes will have the right to require the
Company to purchase all of their 10 7/8% Notes at a price equal to 101% of the
aggregate principal amount thereof plus accrued and unpaid interest. Generally,
the 10 7/8% Notes are redeemable, at the option of the Company, at stated
premiums over par on or after April 1, 2002, and up to 35% of the 10 7/8% Notes
may be redeemed at a premium over par prior to April 1, 2000 with the proceeds
of certain public stock offerings.
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In August 1997, the Company completed a registered exchange of new 10
7/8% Notes (with terms identical in all material respects to the originally
issued 10 7/8% Notes) for all of the originally issued 10 7/8% Notes. The
Company received no proceeds from and recognized no profit on the exchange
transaction, and no change in the financial condition of the Company occurred as
a result of the exchange transaction.
In October 1997, the Company issued $555,890,000 in principal amount at
maturity of the 9.47% Notes, generating net proceeds of approximately $342.6
million, after deducting offering costs which are included in intangible and
other long-term assets and will be amortized to interest expense over the term
of the notes. The net proceeds will be used to fund capital expenditures for
continuing construction and activation of the Qwest Network and to fund further
growth in the business. The 9.47% Notes will accrete at a rate of 9.47% per
annum, compounded semi-annually, to an aggregate principal amount of
$555,890,000 by October 15, 2002. The principal amount of the 9.47% Notes is due
and payable in full on October 15, 2007. The 9.47% Notes are redeemable at the
Company's option, in whole or in part, at any time on or after October 15, 2002,
at specified redemption prices. In addition, prior to October 15, 2000, the
Company may use the net cash proceeds from certain specified equity transactions
to redeem up to 35% of the 9.47% Notes at specified redemption prices. Cash
interest on the 9.47% Notes will not accrue until October 15, 2002, and
thereafter will accrue at a rate of 9.47% per annum, and will be payable
semi-annually in arrears commencing on April 15, 2003 and thereafter on April 15
and October 15 (each an interest payment date) of each year. The Company has the
option of commencing the accrual of cash interest on an interest payment date on
or after October 15, 2000, in which case the outstanding principal amount at
maturity of the 9.47% Notes will, on such interest payment date, be reduced to
the then accreted value, and cash interest will be payable on each interest
payment date thereafter. The indenture for the 9.47% Notes contains certain
covenants that are substantially identical to the 10 7/8% Notes described above
and the Old 8.29% Notes. See "Description of the 8.29% Notes."
In February 1998, the Company completed a registered exchange of new
9.47% Notes (with terms identical in all material respects to the originally
issued 9.47% Notes) for all of the originally issued 9.47% Notes. The Company
received no proceeds from and recognized no profit on the exchange transaction,
and no change in the financial condition of the Company occurred as a result of
the exchange transaction.
Credit Facilities
Qwest Corporation, a subsidiary of Qwest, was the borrower under a $100.0
million revolving credit facility with certain commercial lending institutions
and ABN AMRO North America, Inc. as agent for the lenders. The credit facility
was secured by pledges of publicly traded stock owned by an affiliate of
Anschutz Company and was being used to provide working capital and capital
expansion funds to QCC. The credit facility was structured as a three-year
revolving bank credit facility, convertible to a two-year term loan maturing on
April 2, 2001. Borrowings bear interest at an adjustable rate based on the
agent's prime rate or LIBOR plus an applicable margin. At September 30, 1997,
$10.0 million was outstanding under this facility. In October 1997, the Company
repaid the outstanding balance and terminated this credit facility.
The Company is considering obtaining a new bank credit facility of equal or
lesser amount, which may be secured or unsecured, as permitted under the
Indenture. The Company also may issue other public or private debt. No credit
support will be provided by the Company's parent for any new facilities. No
assurance can be given as to when or whether the Company will obtain a new
credit facility on acceptable terms.
Vendor Financing
The Company and Nortel, individually and as agent for itself and other
specified lenders, entered into a $90.0 million equipment credit facility dated
as of May 6, 1997 to finance the transmission electronics equipment to be
purchased
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from Nortel under a procurement agreement. The facility subsequently was
assigned by Nortel to another institution, which assumed the credit facility and
currently acts as the agent. Under this equipment credit facility, 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 Nortel, with the purchased equipment and related items serving as
the collateral for the loans. Principal amounts outstanding under the equipment
credit facility 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 December 31, 1997, approximately $22.6
million was outstanding under this equipment credit facility.
The equipment credit facility contains covenants that, among other things,
restrict application of the loan proceeds to the purchase of the Nortel
equipment and related engineering and installation services provided by Nortel,
place limitations on certain asset dispositions and sales of collateral, and
require QCC's direct compliance with the debt-service ratios to which it is
subject as a Restricted Subsidiary under the Indenture for the Notes. Initial
extensions of credit are subject to certain conditions, among others, requiring
that QCC deliver to the agent for the benefit of the lenders security interests,
in form and substance satisfactory to the agent, in the equipment to be
purchased. The equipment credit facility generally permits QCC to pay dividends
and make distributions in respect to its capital stock except where such
payments would impair QCC's ability, for the three-month period following such
dividend or distribution, to repay indebtedness incurred under the equipment
credit facility, and authorizes QCC to pay dividends and make distributions to
Qwest in order to allow Qwest to satisfy its obligations with respect to the
Notes and other debt that is solely an obligation of Qwest. The equipment credit
facility contains certain events of default including, among other things,
failure to pay, breach of the agreement and insolvency. Upon the occurrence of
an event of default, the equipment credit facility agreement permits the agent
to declare all borrowings to be immediately due and payable, terminate loan
commitments and/or proceed against the collateral.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following is a general discussion of certain of the expected United States
federal income tax consequences applicable to holders of the Old 8.29% Notes who
purchased the Old 8.29% Notes for cash pursuant to the Offering, exchange the
Old 8.29% Notes for Exchange Notes pursuant to this Exchange Offer, and hold the
Old 8.29% Notes and will hold the Exchange Notes as capital assets (such persons
are referred to herein as "Holders"). This discussion is intended only as a
descriptive summary and does not purport to be a complete technical analysis or
listing of all potential tax considerations that may be relevant to holders of
the 8.29% Notes. Qwest has received an opinion of its counsel, Holme Roberts &
Owen LLP, that the following describes the material United States federal income
tax consequences expected to result to Holders, subject to the conditions and
limitations described herein. This discussion is based on the current provisions
of the Internal Revenue Code of 1986, as amended (the "Code"), the applicable
Treasury regulations ("Regulations"), and public administrative and judicial
interpretations of the Code and Regulations, all of which are subject to change,
which changes could be applied retroactively. This discussion is also based on
the information contained in this Prospectus and the related documents, and on
certain representations from Qwest as to factual matters. This discussion does
not cover all aspects of federal taxation that may be relevant to, or the actual
tax effect that any of the matters described herein will have on, particular
Holders and does not address foreign, state, or local tax consequences.
Qwest has not sought and will not seek any ruling from the Internal Revenue
Service (the "Service") with respect to the 8.29% Notes. There can be no
assurance that the Service will not take a different position concerning the tax
consequences of the exchange of Old 8.29% Notes for Exchange Notes or the
ownership or
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disposition of the Exchange Notes, or that the Service's position would not be
sustained by a court.
The federal income tax consequences to a Holder may vary depending upon the
Holder's particular situation or status. Holders that are subject to special
rules under the Code (including insurance companies, tax-exempt organizations,
mutual funds, retirement plans, financial institutions, dealers in securities or
foreign currency, persons that hold the 8.29% Notes as part of a "straddle" or
as a "hedge" against currency risk or in connection with a conversion
transaction, persons that have a functional currency other than the United
States dollar, investors in pass-through entities, and except as expressly
addressed herein, Non-U.S. Holders (as defined below)) may be subject to special
rules not discussed below.
As used in this discussion, the term "U.S. Holder" means a Holder that, for
United States federal income tax purposes, is (i) a citizen or resident of the
United States, (ii) a corporation, partnership, or other entity created or
organized in or under the laws of the United States or of any State, (iii) an
estate the income of which is subject to United States federal income tax,
regardless of its source, or (iv) a trust if (a) a court within the United
States is able to exercise primary supervision over the administration of the
trust and (b) one or more United States persons have the authority to control
all substantial decisions of the trust. The term "Non-U.S. Holder" means a
Holder that is, for United States federal income tax purposes, not a U.S.
Holder.
THIS DISCUSSION IS FOR GENERAL INFORMATION PURPOSES ONLY. EACH HOLDER IS
EXPECTED AND URGED TO CONSULT ITS TAX ADVISOR AS TO THE PARTICULAR TAX
CONSEQUENCES TO SUCH PERSON OF EXCHANGING OLD NOTES FOR EXCHANGE NOTES AND OF
HOLDING AND DISPOSING OF THE EXCHANGE NOTES, INCLUDING THE APPLICABILITY AND
EFFECT OF ALL FOREIGN, STATE, OR LOCAL TAX LAWS AND OF ANY CHANGE IN FEDERAL
INCOME TAX LAW OR ADMINISTRATIVE OR JUDICIAL INTERPRETATION THEREOF SINCE THE
DATE OF THIS PROSPECTUS.
EXCHANGE OF NOTES
Although there is no direct authority as to whether the exchange of Old 8.29%
Notes for Exchange Notes pursuant to the Exchange Offer will be treated as a
taxable exchange for United States federal income tax purposes, it is the
opinion of Holme Roberts & Owen LLP, counsel to Qwest, that based on its
analysis of applicable law, the exchange should not be treated as a taxable
exchange for United States federal income tax purposes. A Holder should not
recognize gain or loss upon the exchange of Old 8.29% Notes for Exchange Notes
and, upon such exchange, should have the same adjusted tax basis in and holding
period for the Exchange Notes as it had in the Old 8.29% Notes immediately prior
to the exchange.
ORIGINAL ISSUE DISCOUNT
General. Because the 8.29% Notes are issued at a significant discount from
their stated redemption price at maturity (defined below), the 8.29% Notes will
have substantial original issue discount for United States federal income tax
purposes. As a result, a U.S. Holder will generally be required to include
original issue discount in gross income on a constant yield/economic accrual
basis for United States federal income tax purposes, regardless of the U.S.
Holder's regular method of tax accounting. Therefore, inclusion of original
issue discount in gross income will occur in advance of the receipt of cash
payments on the 8.29% Notes.
See "--Taxation of Original Issue Discount" below.
Amount of Original Issue Discount. The amount of original issue discount with
respect to each 8.29% Note is the excess of the "stated redemption price at
maturity" of the 8.29% Note over its "issue price." The "stated redemption price
at maturity" of each 8.29% Note is the sum of all payments required to be made
on the 8.29% Note through and including maturity (whether denominated as
principal or interest), other than payments of "qualified stated interest."
"Qualified stated interest" is generally defined as stated interest that is
unconditionally payable in cash or other property (other than debt instruments
of the issuer) at least annually and at a single fixed rate that appropriately
takes into account the length of intervals between payments. Subject to Qwest's
right to elect early commencement of interest accruals, no cash interest will be
payable on the 8.29%
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Notes until August 1, 2003; therefore, none of the stated interest will be
qualified stated interest, but instead, all of it will be included in the stated
redemption price at maturity of the 8.29% Notes. The "issue price" of an
Exchange Note should be the same as the issue price of the Old 8.29% Notes,
which is the first price at which a substantial amount of the Old 8.29% Notes
were sold to the public for money (excluding sales to any person acting in the
capacity of an underwriter, placement agent, or wholesaler). Each 8.29% Note
will be issued subject to a very substantial amount of original issue discount.
Taxation of Original Issue Discount. Each U.S. Holder will be required to
include in gross income an amount equal to the sum of the "daily portions" of
the original issue discount with respect to the 8.29% Note for each day during
the taxable year on which such U.S. Holder holds the 8.29% Note. The "daily
portions" of original issue discount are determined by allocating to each day in
an accrual period (generally a six-month period or shorter period from the date
of original issue) a ratable portion of the original issue discount attributable
to that accrual period. The amount of the original issue discount attributable
to each full accrual period will equal the product of the "adjusted issue price"
of the 8.29% Note at the beginning of the accrual period, multiplied by the
"yield to maturity" of the 8.29% Notes (determined on the basis of compounding
at the close of each accrual period and properly adjusted for the length of the
accrual period). The "adjusted issue price" of an 8.29% Note at the beginning of
an accrual period is the original issue price of the 8.29% Note increased by the
aggregate amount of original issue discount that has accrued in all prior
accrual periods previously includible in the gross income of any holder and
decreased by the amount of any payment previously made on the 8.29% Note
(excluding payments not taken into account in computing the stated redemption
price at maturity of the 8.29% Note). The "yield to maturity" of an 8.29% Note
is the discount rate that, when used in computing the present value of all
principal and interest payments to be made on the 8.29% Note, produces an amount
equal to the issue price of the 8.29% Note.
Early Commencement of Cash Interest Accruals. On or after February 1, 2001,
and prior to February 1, 2003, Qwest may elect to commence the accrual of cash
interest with respect to the 8.29% Notes (the "Cash Interest Option"), in which
case cash interest will become payable on the 8.29% Notes semiannually
thereafter. See "Description of the 8.29% Notes--Principal, Maturity and
Interest of the 8.29% Notes." For purposes of determining the yield to maturity
and maturity date of the 8.29% Notes under the Regulations, Qwest will be deemed
to exercise any option with respect to the 8.29% Notes if the exercise of such
option would lower the yield to maturity of the 8.29% Notes. Qwest has
determined that the exercise of the Cash Interest Option would not lower the
yield to maturity of the 8.29% Notes. On these facts, and for purposes of the
Regulations, there is a presumption that Qwest will not exercise the Cash
Interest Option. If Qwest does exercise the Cash Interest Option, contrary to
the presumption set forth above, then solely for purposes of computing original
issue discount, the 8.29% Notes should be treated as having been retired and
then reissued, as of the date of such exercise, for an amount equal to the
adjusted issue price of the 8.29% Notes on that date. It is possible that the
Service could take the position that payments made on an 8.29% Note pursuant to
the Cash Interest Option should be treated as a "pro rata prepayment" of a
portion of the 8.29% Note. A pro rata prepayment would be treated as a payment
in retirement of a portion of the 8.29% Note, which may result in gain or loss
to the U.S. Holder. See "--Sale, Retirement, or Other Taxable Disposition."
Information Requirements. Qwest is required to furnish certain information to
the Service regarding the original issue discount amounts. Qwest will furnish
annually to record holders of the 8.29% Notes, information with respect to
original issue discount that accrued during the calendar year, as well as
interest paid during that year. This information will be based on the adjusted
issue price of the debt instrument as if such holder were the original holder of
the debt instrument. Qwest will classify the 8.29% Notes as debt under section
385 of the Code.
EFFECT OF REDEMPTION PROVISIONS ON COMPUTATION OF ORIGINAL ISSUE DISCOUNT
Redemption Rights. Qwest may redeem the 8.29% Notes, in whole or in part,
at any time on or after February 1, 2003, at the redemption prices set forth
herein, plus accrued and unpaid interest thereon (if any) to the redemption
date. See
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"Description of the 8.29% Notes--Optional Redemption." For purposes of
determining the yield to maturity and maturity date of the 8.29% Notes under the
Regulations, Qwest will be deemed to exercise any redemption option with respect
to the 8.29% Notes if the exercise of such option would lower the yield to
maturity of the debt instrument. Qwest has determined that the exercise of its
right to redeem the 8.29% Notes prior to their stated maturity would not lower
the yield to maturity of the 8.29% Notes. On these facts, and for purposes of
the Regulations, there is a presumption that Qwest will not exercise its right
to redeem the 8.29% Notes prior to their stated maturity.
Prior to February 1, 2001, Qwest may redeem up to 35 percent of the Accreted
Value of the 8.29% Notes at a redemption price set forth herein, plus accrued
and unpaid interest, with the net proceeds of one or more Public Equity
Offerings resulting in gross proceeds of at least $100 million in the aggregate;
provided that at least 65 percent of the Accreted Value of the originally issued
8.29% Notes would remain outstanding immediately after giving effect to such
redemption. See "Description of the 8.29% Notes--Optional Redemption." In
addition, as described in "Description of the 8.29% Notes--Certain
Covenants--Change of Control" and "Description of the 8.29% Notes--Certain
Covenants--Limitation on Asset Dispositions," Qwest will, upon the occurrence of
certain events, be required to make an Offer to Purchase all outstanding 8.29%
Notes at redemption prices specified under those headings. Such redemption
rights and obligations will be treated by Qwest as not affecting the
determination of the yield to maturity or maturity date of the 8.29% Notes.
Subsequent Adjustments. If one or more of the contingencies described under
this "--Effect of Redemption Provisions on Computation of Original Issue
Discount" actually occurs, contrary to the presumptions set forth above (a
"change in circumstances"), then solely for purposes of computing original issue
discount, the 8.29% Notes will be treated as having been retired and then
reissued as of the date of the change in circumstances for an amount equal to
the adjusted issue price of the 8.29% Notes on that date.
MARKET DISCOUNT
Under the market discount rules of the Code, a U.S. Holder who purchases an
8.29% Note at a "market discount" will generally be required to treat any gain
recognized on the disposition of the 8.29% Note as ordinary income to the extent
of the lesser of such gain or the portion of the market discount that accrued
during the period that the U.S. Holder held such 8.29% Note. Market discount is
generally defined as the amount by which a U.S. Holder's purchase price for an
8.29% Note is less than the revised issue price of the 8.29% Note on the date of
purchase, subject to a statutory de minimis exception. A U.S. Holder who
acquires an 8.29% Note at a market discount may be required to defer a portion
of any interest expense that otherwise may be deductible on any indebtedness
incurred or continued to purchase or carry such 8.29% Note until the U.S. Holder
disposes of the 8.29% Note in a taxable transaction. A U.S. Holder who has
elected under applicable Code provisions to include market discount in income
annually as such discount accrues will not, however, be required to treat any
gain recognized as ordinary income or to defer any deductions for interest
expense under these rules. This election to include market discount in income
currently, once made, applies to all market discount obligations acquired on or
after the first day of the taxable year to which the election applies and may
not be revoked without the consent of the Service. Holders should consult their
tax advisors as to the portion of any gain that would be taxable as ordinary
income under these provisions and any other consequences of the market discount
rules that may apply to them in particular.
ACQUISITION PREMIUM
A U.S. Holder who acquires an 8.29% Note for an amount that is less than or
equal to its stated redemption price at maturity, but in excess of the adjusted
issue price will be considered to have purchased the 8.29% Note at acquisition
premium. Under the acquisition premium rules, generally, such U.S. Holder will
be permitted to offset a portion of the acquisition premium against the amount
of original issue discount otherwise includible in income with respect to the
8.29% Note. The information reported by Qwest to the record holders of the 8.29%
Notes on an annual basis will not account for an offset against original issue
discount for any
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portion of the acquisition premium. Accordingly, each holder should consult its
tax advisor as to the determination of the acquisition premium amount and the
resulting adjustments to the amount of reportable original issue discount.
SALE, RETIREMENT, OR OTHER TAXABLE DISPOSITION
Upon the sale, retirement, or other taxable disposition of an 8.29% Note, a
U.S. Holder will generally recognize gain or loss measured by the difference
between (i) the amount of cash plus the fair market value of property received
in exchange therefor (except to the extent attributable to accrued interest not
previously taken into account) and (ii) the U.S. Holder's adjusted tax basis in
the 8.29% Note. A U.S. Holder's initial tax basis in a 8.29% Note will equal the
price paid by such U.S. Holder for such 8.29% Note and will be increased from
time to time by the amount of original issue discount included in gross income
to the date of disposition, as adjusted by acquisition premium, if any (and
further increased by the accruals of market discount, if any, that the U.S.
Holder has previously elected to include in gross income on an annual basis),
and decreased from time to time by the amount of any payments (excluding
payments of qualified stated interest and any other payment that is not taken
into account in computing the stated redemption price at maturity of the debt
instrument) received with respect to the 8.29% Note. Any gain or loss on the
sale, retirement, or other taxable disposition of an 8.29% Note, measured as
described above, will generally be capital gain or loss (except as discussed
under "-- Market Discount"), provided that the 8.29% Note was a capital asset in
the hands of the U.S. Holder. In the case of an individual U.S. Holder, such
capital gain will be taxable at various preferential rates, depending on such
U.S. Holder's holding period for the 8.29% Note at the time of disposition.
With respect to tax matters related to legal defeasance and covenant
defeasance in certain circumstances, see "Description of 8.29%
Notes--Satisfaction and Discharge of the Indenture, Defeasance."
BACKUP WITHHOLDING
The backup withholding rules of the Code require a payor to deduct and
withhold a tax amount if (i) the payee fails to furnish a taxpayer
identification number ("TIN") to the payor, (ii) the Service notifies the payor
that the TIN furnished by the payee is incorrect, (iii) the payee has failed to
report properly the receipt of a "reportable payment" and the Service has
notified the payor that withholding is required, or (iv) there has been a
failure on the part of the payee to certify under penalty of perjury that the
payee is not subject to withholding under section 3406 of the Code. If any one
of the events discussed above occurs, Qwest or its paying agent or other
withholding agent will be required to withhold a tax equal to 31 percent of any
"reportable payment" which includes, among other things, interest actually paid,
original issue discount, and amounts paid through brokers in retirement of
securities. Any amount withheld from a payment to a U.S. Holder under the backup
withholding rules will be allowed as a refund or credit against such U.S.
Holder's United States federal income tax, provided that the required
information is furnished to the Service. Certain U.S. Holders
(including, among others, corporations) are not subject to the backup
withholding or information reporting requirements.
CERTAIN TAX CONSEQUENCES TO NON-U.S. HOLDERS
General. The following discussion is for general information purposes only and
does not purport to cover all aspects of Untied States federal income taxation
that may apply to, or the actual tax effect that any of the matters described
herein will have on, any particular Non-U.S. Holder. Non-U.S. Holders are
expected and urged to consult their tax advisors as to the particular tax
consequences to them of exchanging Old 8.29% Notes for Exchange Notes and of
owning and disposing of the Exchange Notes.
Portfolio Interest Exemption. A Non-U.S. Holder will generally, under the
portfolio interest exemption of the Code, not be subject to United States
federal
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income taxes or United States federal withholding tax, on payments of principal,
if any, on the 8.29% Notes, and original issue discount on the 8.29% Notes or
interest paid on the 8.29% Notes, provided that (i) the Non-U.S. Holder does not
actually or constructively own 10 percent or more of the total combined voting
power of all classes of stock of Qwest entitled to vote, (ii) the Non-U.S.
Holder is not (a) a bank receiving original issue discount or interest pursuant
to a loan agreement entered into in the ordinary course of its trade or business
or (b) a controlled foreign corporation that is related to Qwest through stock
ownership, (iii) such original issue discount or interest is not effectively
connected with a United States trade or business and (iv) either (a) the
beneficial owner of the 8.29% Notes certifies to Qwest or its agent, under
penalties of perjury, that it is not a U.S. Holder and provides a completed IRS
Form W-8 ("Certificate of Foreign Status") or (b) a securities clearing
organization, bank, or other financial institution which holds customers'
securities in the ordinary course of its trade or business (a "financial
institution") and holds the 8.29% Notes, certifies to Qwest or it agent, under
penalties of perjury, that it has received Form W-8 from the beneficial owner or
that it has received from another financial institution a Form W-8 and furnishes
the payor with a copy thereof. If any of the situations described in proviso
(i), (ii), or (iv) of the preceding sentence do not exist, interest on the 8.29%
Notes, when received, is subject to United States withholding tax at the rate of
30 percent, unless an income tax treaty between the United States and the
country of which the Non-U.S. Holder is a tax resident provides for the
elimination or reduction in the rate of United States federal withholding tax.
Interest for this purpose includes income, other than capital gains, received
from the sale or exchange of the 8.29% Notes or from a payment on the 8.29%
Notes to the extent original issue discount accrued while the 8.29% Notes were
held by a Non-U.S. Holder and the amounts so accrued were not previously subject
to United States withholding tax.
If a Non-U.S. Holder is engaged in a trade or business in the United States
and interest (including original issue discount) on the 8.29% Note is
effectively connected with the conduct of such trade or business, such Non-U.S.
Holder, although exempt from United States federal withholding tax as discussed
in the preceding paragraph (or by reason of the delivery of a properly completed
IRS Form 4224), will be subject to United States federal income tax on such
interest (including original issue discount) and on any gain realized on the
sale, exchange, or other disposition of an 8.29% Note in the same manner as if
it were a U.S. Holder. In addition, if such Non-U.S. Holder is a foreign
corporation, it may be subject to a branch profits tax equal to 30 percent of
its effectively connected earnings and profits for that taxable year, unless it
qualifies for a lower rate under an applicable income tax treaty.
Federal Estate Tax. 8.29% Notes owned or treated as owned by an individual who
is neither a United States citizen nor a United States resident (as defined for
United States federal estate tax purposes) at the time of death will be excluded
from the individual's gross estate for United States federal estate tax purposes
and will not be subject to United States federal estate tax if the nonresident
qualifies for the portfolio interest exemption discussed above.
Disposition of 8.29% Notes. A Non-U.S. Holder generally will not be subject to
United States federal income tax on any gain realized in connection with the
sale, exchange, or retirement of an 8.29% Note, unless: (i)(a) the gain is
effectively connected with a trade or business carried on by the Non-U.S. Holder
within the United States or (b) if a tax treaty applies, the gain is generally
attributable to the United States permanent establishment maintained by the
Non-U.S. Holder, (ii) in the case of a Non-U.S. Holder who is an individual,
such Non-U.S. Holder is present in the United States for 183 days or more in the
taxable year of disposition, and certain other conditions are satisfied, or
(iii) the Non-U.S. Holder is subject to tax pursuant to provisions of the Code
applicable to United States expatriates.
Information Reporting and Backup Withholding Tax. In general, there is no
United States information reporting requirement or backup withholding tax on
payments to Non-U.S. Holders who provide the appropriate certification described
above regarding qualification for the portfolio interest exemption from United
States federal income tax for payments of interest (including original issue
discount) on the 8.29% Notes.
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In general, backup withholding and information reporting will not apply to a
payment of the gross proceeds of a sale of 8.29% Notes effected at a foreign
office of a broker. If, however, such broker is, for United States federal
income tax purposes, a United States person, a controlled foreign corporation,
or a foreign person, 50 percent or more of whose gross income for certain
periods is derived from activities that are effectively connected with the
conduct of a trade or business in the United States, such payments will not be
subject to backup withholding, but will be subject to information reporting,
unless (i) such broker has documentary evidence in its records that the
beneficial owner is a Non-U.S. Holder and certain other conditions are met or
(ii) the beneficial owner otherwise establishes an exemption.
Payment by Qwest of principal on the 8.29% Notes or payment by a United States
office of a broker of the proceeds of a sale of 8.29% Notes is subject to both
backup withholding and information reporting unless the beneficial owner
provides a completed IRS Form W-8 which certifies under penalties of perjury
that it is a Non-U.S. Holder who meets all the requirements for exemption from
United States federal income tax on any gain from the sale, exchange, or
retirement of the 8.29% Notes. Backup withholding is not an additional tax. Any
amounts withheld under the backup withholding rules will be allowed as a refund
or a credit against such Non-U.S. Holder's United States federal income tax
liability, provided the required information is furnished to the Service.
Recently promulgated Regulations (the "New Regulations") could affect the
procedures to be followed by Non-U.S. Persons and payors of interest and sale
proceeds in complying with the United States federal withholding, backup
withholding, and information reporting rules, and the availability of any
exemption therefrom. The New Regulations are not currently effective, but will
generally be effective for payments made after December 31, 1999. Each Holder of
8.29% Notes is strongly urged to consult its tax advisor regarding the effect of
the New Regulations on the exchange of the Old 8.29% Notes for Exchange Notes
pursuant to the Exchange Offer and on the ownership and disposition of the
Exchange Notes.
PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. This Prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with resales of Exchange Notes received in exchange for Old 8.29%
Notes where such Old 8.29% Notes were acquired as a result of market-making
activities or other trading activities. The Company has agreed that for a period
of one year after consummation of the Exchange Offer, it will make this
Prospectus, as amended or supplemented, available to any broker-dealer for use
in connection with any such resale.
The Company will not receive any proceeds from any sale of Exchange Notes by
any broker-dealer. Exchange Notes received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the Exchange Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at prices
related to such prevailing market prices or negotiated prices. Any such resale
may be made directly to purchasers or to or through brokers or dealers who may
receive compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such Exchange Notes. Any
broker-dealer that resells Exchange Notes that were received by it for its own
account pursuant to the Exchange Offer and any broker or dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit on any
such resale of Exchange Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will deliver
and by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act.
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For a period of one year after consummation of the Exchange Offer, the Company
will promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such documents
in the letter of transmittal. The Company has agreed to pay all expenses
incident to the Company's performance of, or compliance with, the Registration
Agreement and all expenses incident to the Exchange Offer (including the
expenses of one counsel for the holders of the Old 8.29% Notes) other than
commissions or concessions of any brokers or dealers, and will indemnify the
holders (including any broker-dealers) and certain parties related to the
holders against certain liabilities, including liabilities under the Securities
Act.
The Company has not entered into any arrangements or understandings with any
person to distribute the Exchange Notes to be received in the Exchange Offer.
LEGAL MATTERS
The validity of the Exchange Notes and certain other legal matters in
connection with the Exchange Notes offered hereby are being passed upon for the
Company by Holme Roberts & Owen LLP, Denver, Colorado with respect to matters of
United States law. Certain United States federal income tax matters will be
passed upon for the Company by Holme Roberts & Owen LLP, Denver, Colorado.
EXPERTS
The consolidated financial statements and schedule of Qwest Communications
International Inc. and subsidiaries as of December 31, 1997 and 1996 and for
each of the years in the three year period ended December 31, 1997 have been
included herein and in the Registration Statement in reliance upon the report
pertaining to such consolidated financial statements, dated February 24, 1998,
except as to note 22, which is as of March 8, 1998, and the report dated
February 24, 1998 pertaining to such schedule, of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein and in the
Registration Statement, and upon the authority of said firm as experts in
accounting and auditing.
The consolidated financial statements and schedules of LCI International, Inc.
and subsidiaries as of December 31, 1997 and 1996 and for each of the years in
the three year period ended December 31, 1997 included in this Registration
Statement have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report dated February 16, 1998 (except with
respect to the matter discussed in Note 15, as to which the date is March 16,
1998) with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
reports.
The consolidated financial statements of Phoenix as of December 31, 1997 and
1996 and for each of the years in the three year period ended December 31, 1997
included in this Prospectus have been audited by Grant Thornton LLP, independent
certified public accountants, as indicated in its reports with respect thereto,
and are included herein in reliance on the reports of Grant Thornton LLP and
upon the authority of said firm as experts in accounting and auditing.
#396822
123
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
<TABLE>
<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996.............. F-3
Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995......................................... F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-7
Notes to Consolidated Financial Statements................................ F-8
LCI INTERNATIONAL, INC.
Report of Independent Public Accountants.................................. F-27
Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-28
Consolidated Balance Sheets as of December 31, 1997 and 1996.............. F-29
Consolidated Statements of Shareowners' Equity for the Years Ended
December 31, 1997, 1996 and 1995......................................... F-30
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-31
Notes to Consolidated Financial Statements................................ F-32
PHOENIX NETWORK, INC.
Report of Independent Certified Public Accountants........................ F-47
Consolidated Balance Sheets as of December 31, 1997 and 1996.............. F-48
Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-49
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995......................................... F-50
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995...................................................... F-51
Notes to Consolidated Financial Statements................................ F-53
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Qwest Communications International Inc. and Subsidiaries
Pro Forma Consolidated Balance Sheet as of December 31, 1997 (Unaudited) F-67
Pro Forma Consolidated Statement of Operations for the Twelve Months Ended
December 31, 1997 (Unaudited)............................................ F-68
Notes to Pro Forma Consolidated Financial Statements (Unaudited)......... F-69
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS
QWEST COMMUNICATIONS INTERNATIONAL INC.:
We have audited the accompanying consolidated balance sheets of Qwest
Communications International Inc. and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Qwest
Communications International Inc. and subsidiaries as of December 31, 1997 and
1996, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1997, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Denver, Colorado
February 24, 1998,
except as to note 22,
which is as of
March 8, 1998
F-2
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 379,784 $ 6,905
Accounts receivable, net.................................. 67,395 29,248
Costs and estimated earnings in excess of billings........ 256,566 4,989
Notes and other receivables............................... 10,855 14,934
Other current assets...................................... 9,342 328
---------- --------
Total current assets.................................... 723,942 56,404
Property and equipment, net................................. 614,640 186,535
Deferred income tax asset................................... 17,988 4,593
Notes and other receivables................................. 59 11,052
Intangible and other long-term assets, net.................. 41,476 3,967
---------- --------
Total assets............................................ $1,398,105 $262,551
========== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--CONTINUED
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................. $ 253,313 $ 80,129
Billings in excess of costs and estimated earnings..... 21,390 5,034
Deferred income tax liability.......................... 22,344 --
Current portion of long-term debt...................... 12,011 25,193
Payable to Majority Shareholder........................ 2,091 19,138
Deferred revenue....................................... 4,273 2,649
---------- --------
Total current liabilities............................ 315,422 132,143
Long-term debt......................................... 630,463 109,268
Other liabilities...................................... 70,476 11,698
---------- --------
Total liabilities.................................... 1,016,361 253,109
---------- --------
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.
206,669,874 shares and 173,000,000 shares issued and
outstanding at December 31, 1997 and December 31,
1996, respectively.................................... 2,066 1,730
Additional paid-in capital............................. 411,605 54,162
Accumulated deficit.................................... (31,927) (46,450)
---------- --------
Total stockholders' equity............................. 381,744 9,442
---------- --------
Commitments and contingencies
Total liabilities and stockholders' equity........... $1,398,105 $262,551
========== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- ---------
<S> <C> <C> <C>
Revenue:
Carrier services.............................. $ 55,644 $ 57,573 $ 67,789
Commercial services........................... 59,649 34,265 20,412
-------- -------- ---------
115,293 91,838 88,201
Network construction services................. 581,410 139,158 36,901
-------- -------- ---------
696,703 230,996 125,102
-------- -------- ---------
Operating expenses:
Telecommunications services................... 91,166 80,368 81,215
Network construction services................. 397,153 87,542 32,754
Selling, general and administrative........... 91,190 45,755 37,195
Growth share plan............................. 73,451 13,100 --
Depreciation and amortization................. 20,262 16,245 9,994
-------- -------- ---------
673,222 243,010 161,158
Earnings (loss) from operations................. 23,481 (12,014) (36,056)
Other income (expense):
Interest expense, net......................... (18,895) (6,827) (4,248)
Interest income............................... 11,708 2,454 1,782
Other income, net............................. 7,286 6,186 55
-------- -------- ---------
Earnings (loss) before income taxes......... 23,580 (10,201) (38,467)
Income tax expense (benefit).................... 9,057 (3,234) (13,336)
-------- -------- ---------
Net earnings (loss)......................... $ 14,523 $ (6,967) $ (25,131)
======== ======== =========
Earnings (loss) per share--basic................ $ 0.08 $ (0.04) $ (0.15)
======== ======== =========
Earnings (loss) per share--diluted.............. $ 0.07 $ (0.04) $ (0.15)
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(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, JANUARY 1,
1995................... 173,000,000 $1,730 $ 37,203 $(14,352) $ 24,581
Cash contribution from
Majority Shareholder... -- -- 28,000 -- 28,000
Reduction in additional
paid-in capital
attributable to effect
of the tax allocation
agreement with Majority
Shareholder............ -- -- (975) -- (975)
Net loss................ -- -- -- (25,131) (25,131)
----------- ------ -------- -------- --------
BALANCES, DECEMBER 31,
1995................... 173,000,000 1,730 64,228 (39,483) 26,475
Cancellation of income
tax benefit receivable
from Majority
Shareholder............ -- -- (11,088) -- (11,088)
Equity contribution from
Majority Shareholder... -- -- 1,022 -- 1,022
Net loss................ -- -- -- (6,967) (6,967)
----------- ------ -------- -------- --------
BALANCES, DECEMBER 31,
1996................... 173,000,000 1,730 54,162 (46,450) 9,442
Issuance of common stock
in initial public
offering, net.......... 31,050,000 310 319,171 -- 319,481
Issuance of common stock
warrants............... -- -- 2,300 -- 2,300
Issuance of common stock
for Growth Shares...... 2,591,532 26 35,284 -- 35,310
Issuance of common stock
upon exercise of
employee stock
options................ 9,644 -- 132 -- 132
Issuance of common stock
under Equity Incentive
Plan................... 18,698 -- 556 -- 556
Net earnings............ -- -- -- 14,523 14,523
----------- ------ -------- -------- --------
BALANCES, DECEMBER 31,
1997................... 206,669,874 $2,066 $411,605 $(31,927) $381,744
----------- ------ -------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss)........................... $ 14,523 $ (6,967) $ (25,131)
Adjustments to reconcile net earnings (loss)
to net cash (used in) provided by operating
activities:
Depreciation and amortization................. 20,262 16,245 9,994
Gain on sale of contract rights............... (9,296) -- --
Gain on sale of telecommunications service
agreements................................... -- (6,126) --
Deferred income tax expense (benefit)......... 8,949 (1,123) (2,839)
Changes in operating assets and liabilities:
Receivables--accounts and notes, net......... (22,397) (25,680) (21,379)
Costs and estimated earnings in excess of
billings, net............................... (235,221) 24,172 (21,650)
Accounts payable and accrued liabilities..... 189,797 34,455 5,852
Payable to related parties, net.............. -- (2,983) 1,263
Other changes................................ (3,105) 531 (2,745)
--------- -------- ---------
Net cash (used in) provided by operating
activities................................. (36,488) 32,524 (56,635)
--------- -------- ---------
Cash flows from investing activities:
Proceeds from sale of contract rights......... 9,000 -- --
Proceeds from sale of telecommunications
service agreements........................... -- 4,500 --
Expenditures for property and equipment....... (345,788) (57,122) (46,313)
Cash paid for acquisitions, net of cash
acquired..................................... (20,036) -- (12,545)
--------- -------- ---------
Net cash used in investing activities....... (356,824) (52,622) (58,858)
--------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock in
initial public offering, net................. 319,481 -- --
Proceeds from issuance of common stock
warrants..................................... 2,300 -- --
Proceeds from exercise of employee stock
options...................................... 132 -- --
Borrowings of long-term debt.................. 678,003 65,000 62,606
Repayments of long-term debt.................. (200,233) (21,322) (2,331)
Debt issuance costs........................... (16,445) (112) (591)
Net (payments to) advances from Majority
Shareholder.................................. (17,047) (19,069) 26,256
Contributions from Majority Shareholder....... -- 1,022 28,000
--------- -------- ---------
Net cash provided by financing activities... 766,191 25,519 113,940
--------- -------- ---------
Net increase (decrease) in cash and cash
equivalents................................ 372,879 5,421 (1,553)
Cash and cash equivalents, beginning of
period........................................ 6,905 1,484 3,037
--------- -------- ---------
Cash and cash equivalents, end of period....... $ 379,784 $ 6,905 $ 1,484
========= ======== =========
Supplemental disclosure of cash flow information:
Cash paid for interest, net................... $ 16,696 $ 8,825 $ 3,972
========= ======== =========
Cash paid for taxes, other than to Majority
Shareholder.................................. $ 244 $ 160 $ 725
========= ======== =========
Supplemental disclosure of significant non-cash investing and financing
activities:
Accrued capital expenditures.................. $ 76,267 $ 28,000 $ --
========= ======== =========
Capital expenditures financed with equipment
credit facility.............................. $ 22,604 $ -- $ --
========= ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(1) ORGANIZATION AND BACKGROUND
Qwest Communications International Inc. (the "Company") was wholly-owned by
Anschutz Company (the "Majority Shareholder") until June 27, 1997, when the
Company issued common stock in an initial public offering (the "IPO"). As of
December 31, 1997, the Majority Shareholder owns approximately 83.7% 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 Company is a developer and operator of telecommunications networks and
facilities and operates in a single business segment, the telecommunications
industry. It principally provides the following services within that industry:
--Telecommunications Services--the Company provides dedicated line and
switched services to interexchange carriers and competitive access providers
("Carrier Services") and long distance voice, data and video services to
businesses and consumers ("Commercial Services").
--Network Construction Services--the Company installs fiber optic
communications systems for interexchange carriers, local telephone companies,
cable television companies, competitive access providers and other
communications entities, as well as for its own use.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation
The accompanying audited consolidated financial statements as of December 31,
1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995 include
the accounts of the Company and all majority-owned subsidiaries. Intercompany
balances and transactions have been eliminated in consolidation.
(b) Telecommunications Services Revenue
Revenue from telecommunications services is recognized monthly as the services
are provided. Amounts billed in advance of the service month are recorded as
deferred revenue.
(c) Long-Term Construction Contracts
The Company accounts for long-term construction contracts relating to the
development of telecommunications networks using the percentage of completion
method. Under the percentage of completion method, progress is generally
measured on performance milestones relating to the contract where such
milestones fairly reflect progress toward contract completion.
Network construction costs include all direct material and labor costs and
those indirect costs related to contract performance. General and administrative
costs are charged to expense as incurred. When necessary, the estimated loss on
an uncompleted contract is expensed in the period in which it is identified.
Contract costs are estimated using allocations of the total cost of constructing
the Qwest Network, a coast-to-coast, technologically advanced, fiber optic
telecommunications network (the "Qwest Network"). Revisions to estimated profits
on contracts are recognized in the period they become known.
(d) Cash and Cash Equivalents
The Company classifies cash on hand and deposits in banks, including
commercial paper, money market accounts, and any other investments with an
original maturity of three months or less, that the Company may hold from time
to time, as cash and cash equivalents.
F-8
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(e) Property and Equipment
Property and equipment is stated at cost. Depreciation is computed on a
straight-line basis using the estimated useful lives of the assets, commencing
when they are available for service. Leasehold improvements are amortized over
the lesser of the useful lives of the assets or the lease term. Expenditures for
maintenance and repairs are expensed as incurred. Network construction costs,
including interest during construction, are capitalized. Interest capitalized in
the years ended December 31, 1997, 1996 and 1995 was approximately $17.7
million, $2.4 million and $1.9 million, respectively.
The useful lives of property and equipment are as follows:
<TABLE>
<S> <C>
Facility and leasehold improvements................ 5--25 years or lease term
Communications and construction equipment.......... 3--10 years
Fiber and conduit systems.......................... 15--25 years
Office equipment and furniture..................... 3--7 years
Capital leases..................................... lease term
</TABLE>
While constructing network systems for customers, the Company may install
additional conduit for its own use. This additional conduit is capitalized at
the incremental cost of construction. Costs of the initial conduit, fiber and
facilities are allocated to the customer and the Company based upon the number
of fibers retained by the Company relative to the total fibers installed, or
square footage in the case of facilities.
(f) Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment when events or
changes in circumstances indicate that the carrying value of such assets may not
be recoverable, in accordance with Statement of Accounting Standards No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of ("SFAS 121"). This review consists of a comparison of the
carrying value of the asset with the asset's expected future undiscounted cash
flows without interest costs. Estimates of expected future cash flows are to
represent management's best estimate based on reasonable and supportable
assumptions and projections. If the expected future cash flow exceeds the
carrying value of the asset, no impairment is recognized. If the carrying value
of the asset exceeds the expected future cash flows, an impairment exists and is
measured by the excess of the carrying value over the fair value of the asset.
Any impairment provisions recognized are permanent and may not be restored in
the future. No impairment expense was recognized in 1997, 1996 or 1995.
(g) Income Taxes
The Company uses the asset and liability method of accounting for income
taxes, whereby deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
(h) Intangible and Other Long-Term Assets
Intangible and other long-term assets include debt issuance costs, deferred
compensation, goodwill and acquired intangibles such as customer contracts and
non-compete covenants. Such costs are amortized on a straight-line basis over a
period ranging from three to fifteen years.
F-9
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(i) Earnings Per Share
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 128, Earnings Per Share, which requires the
presentation of basic earnings per share and, for companies with potentially
dilutive securities, such as convertible debt, options and warrants, diluted
earnings per share. Basic earnings per share amounts are determined on the basis
of the weighted average number of common shares outstanding during the year.
Potentially dilutive instruments for the periods prior to the Company's IPO, as
defined by Securities and Exchange Commission Staff Accounting Bulletin Number
98, Earnings Per Share, were not material and were excluded from the computation
of earnings per share. Diluted earnings per share give effect to all potential
dilutive common shares that were outstanding during the year.
(j) Stock-Based Compensation
As permitted by Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, the Company accounts for compensation
expense under the Growth Share Plan and the Equity Incentive Plan in
accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees.
(k) 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 revenue and expenses during the
reporting period. Actual results could differ from those estimates.
(l) Reclassifications
Certain prior year balances have been reclassified to conform with 1997
presentation.
(3) OTHER INCOME (EXPENSE)
On March 10, 1997, the Company entered into an agreement with an unrelated
third party to terminate certain equipment purchase and telecommunications
capacity rights and options of the Company exercisable against the third party
for $9.0 million in cash, which the Company received in 1997 and has recorded as
gain on sale of contract rights.
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 incurred certain facilities costs on behalf of the Buyer, which are
reimbursable to the Company. On March 31, 1997, the arrangement relating to the
transition services agreements expired and has not yet been renegotiated. A
dispute has arisen with respect to reimbursement of these costs and, as a
result, the Company made a provision of $2.0 million in the three months ended
March 31, 1997. Negotiations with the Buyer are continuing. As of December 31,
1997 and 1996, net amounts of approximately $5.0 million and $2.0 million,
respectively, were due to the Company for such costs. The Company believes that
the receivable balance as of December 31, 1997 is collectible.
(4) ACQUISITIONS
On October 22, 1997, the Company and an unrelated third party consummated an
agreement whereby the Company acquired from the third party all of the issued
and outstanding shares of capital stock of SuperNet, Inc.
F-10
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
("SNI"), a regional internet service provider, and the capital stock of SNI
issued at the closing of the acquisition, for approximately $20.0 million in
cash, plus acquisition costs. The acquisition was accounted for using the
purchase method of accounting. The purchase price was allocated as follows (in
thousands):
<TABLE>
<S> <C>
Working capital.................................................... $(1,517)
Property and equipment............................................. 2,890
Goodwill........................................................... 19,200
Other.............................................................. ( 423)
-------
$20,150
=======
</TABLE>
The accompanying consolidated statements of operations include the operating
results of SNI since October 22, 1997. The following pro forma operating results
of the Company and SNI for the years ended December 31, 1997 and 1996 have been
prepared assuming the acquisition had been consummated as of January 1, 1996 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Revenue.................................................. $702,260 $236,538
Net earnings (loss)...................................... $ 10,783 $(14,226)
Earnings (loss) per share -- basic....................... $ 0.06 $ (0.08)
Earnings (loss) per share--diluted....................... $ 0.06 $ (0.08)
</TABLE>
(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):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
--------- --------
<S> <C> <C>
Costs incurred on uncompleted contracts................ $ 473,760 $ 82,840
Estimated earnings..................................... 238,191 48,853
--------- --------
711,951 131,693
Less: billings to date 476,775 131,738
--------- --------
$ 235,176 $ (45)
========= ========
Costs and estimated earnings in excess of billings..... $ 256,566 $ 4,989
Billings in excess of costs and estimated earnings..... (21,390) (5,034)
--------- --------
$ 235,176 $ (45)
Revenue the Company expects to realize for work to be
performed on the above uncompleted contracts.......... $ 506,791 $328,688
========= ========
</TABLE>
The Company has entered into various agreements to provide indefeasible rights
of use of multiple fibers along the Qwest Network. Such agreements include
contracts with three major customers for an aggregate purchase price of
approximately $1.0 billion. The Company obtained construction performance bonds
totaling $175.0 million which have been guaranteed by the Majority Shareholder.
Network Construction Services revenue relating to the contracts with these major
customers was approximately $513.0 million and $121.0 million in 1997 and 1996,
respectively. Progress billings are made upon customers' acceptance of
performance milestones.
F-1
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The Company expects to bill and collect all costs and estimated earnings in
excess of billings as of December 31, 1997, in 1998.
Although these construction agreements provide for certain penalties if the
Company does not complete construction within the time frames specified within
the agreements, management does not anticipate that the Company will incur any
substantial penalties under these provisions.
(6) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
------- -------
<S> <C> <C>
Carrier services........................................... $11,833 $ 9,978
Commercial services........................................ 14,095 5,736
Network construction services.............................. 37,085 13,751
Due from affiliate......................................... 1,804 --
Other...................................................... 7,189 3,452
------- -------
72,006 32,917
Less allowance for doubtful accounts..................... (4,611) (3,669)
------- -------
Accounts receivable, net................................... $67,395 $29,248
======= =======
</TABLE>
(7) NOTES AND OTHER RECEIVABLES
In 1994, an unrelated third party entered into a $45.0 million agreement to
purchase a single conduit from the Company. Contract revenue from this agreement
was approximately $3.1 million and $29.7 million in the years ended December 31,
1996 and 1995, respectively. The Company may be required to pay up to $13.0
million to the third party in the event of the sale of the Company-owned
conduits. The balance of the notes receivable related to the contract was paid
subsequent to year end.
(8) PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
Land...................................................... $ 991 $ 506
Facility and leasehold improvements....................... 17,910 7,951
Communications and construction equipment................. 83,313 52,076
Fiber and conduit systems................................. 118,192 42,446
Office equipment and furniture............................ 16,019 6,360
Capital leases............................................ 3,778 3,197
Work in progress.......................................... 417,042 99,915
-------- --------
657,245 212,451
Less accumulated depreciation and amortization.......... (42,605) (25,916)
-------- --------
Property and equipment, net............................... $614,640 $186,535
======== ========
</TABLE>
F-12
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(9) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consists of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
-------- -------
<S> <C> <C>
Accounts payable........................................... $ 80,862 $41,642
Construction accrual....................................... 75,543 18,071
Property, sales and other taxes............................ 33,926 3,582
Capacity service obligation................................ 8,196 3,658
Accrued interest........................................... 7,704 707
Right-of-way obligations................................... 34,006 3,290
Other...................................................... 13,076 9,179
-------- -------
Accounts payable and accrued expenses...................... $253,313 $80,129
======== =======
</TABLE>
(10) OTHER LIABILITIES
Other liabilities consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- -------
<S> <C> <C>
Right-of-way obligations.................................... $39,014 $ 1,297
Growth share accrual........................................ 17,686 9,291
Equipment to be financed.................................... 10,756 --
Other....................................................... 3,020 1,110
------- -------
Other liabilities........................................... $70,476 $11,698
======= =======
</TABLE>
(11) RIGHT-OF-WAY OBLIGATIONS
The Company has easement agreements with railroads and public transportation
authorities. The following is a schedule by years of future minimum payments
under easement agreements together with the present value of the net minimum
payments as of December 31, 1997.
<TABLE>
<S> <C>
Year ended December 31:
1998............................................................. $ 34,225
1999............................................................. 4,228
2000............................................................. 4,228
2001............................................................. 4,250
2002............................................................. 6,099
Thereafter....................................................... 83,788
--------
Total minimum payments........................................... $136,818
Less amount representing interest................................ (63,798)
--------
Present value of net minimum payments............................ $ 73,020
========
</TABLE>
The present value of net minimum payments is included in accounts payable and
accrued expenses and other liabilities. (See note 9--Accounts Payable and
Accrued Expenses and note 10--Other Liabilities.)
F-13
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
In certain limited instances the Company may be obligated to pay costs of
relocating certain conduits owned by third parties on approximately 500 miles of
railroad rights-of-way. The majority of such commitments expire in February
2001. The Company has made a provision of approximately $2.9 million for such
costs in 1997.
Pursuant to certain easement agreements, the Company is required to provide
easement grantors with communications capacity for their own internal use.
(12) LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
9.47% Notes.............................................. $356,908 $ --
10 7/8% Notes............................................ 250,000 --
Revolving credit facility................................ -- 60,000
Equipment credit facility................................ 22,604 --
Network credit facility.................................. -- 27,077
Equipment loans.......................................... -- 9,820
Term notes............................................... -- 9,416
Capital lease and other obligations...................... 12,962 28,148
-------- --------
Total debt............................................... 642,474 134,461
Less current portion................................... (12,011) (25,193)
-------- --------
Long-term debt........................................... $630,463 $109,268
======== ========
</TABLE>
In October 1997, the Company issued and sold $555.9 million in principal
amount at maturity of 9.47% Senior Discount Notes, due 2007 (the "9.47% Notes"),
generating net proceeds of approximately $342.1 million, after deducting
offering costs which are included in intangible and other long-term assets. The
9.47% Notes will accrete at a rate of 9.47% per annum, compounded semiannually,
to an aggregate principal amount of $555.9 million by October 15, 2002. The
principal amount of the 9.47% Notes is due and payable in full on October 15,
2007. The 9.47% Notes are redeemable at the Company's option, in whole or in
part, at any time on or after October 15, 2002, at specified redemption prices.
In addition, prior to October 15, 2000, the Company may use the net cash
proceeds from certain equity transactions to redeem up to 35% of the 9.47% Notes
at specified redemption prices. Cash interest on the 9.47% Notes will not accrue
until October 15, 2002, and thereafter will accrue at a rate of 9.47% per annum,
and will be payable semiannually in arrears commencing on April 15, 2003 and
thereafter on April 15 and October 15 of each year. The Company has the option
of commencing the accrual of cash interest on an interest payment date on or
after October 15, 2000, in which case the outstanding principal amount at
maturity of the 9.47% Notes will, on such interest payment date, be reduced to
the then accreted value, and cash interest will be payable thereafter. In
February 1998, the Company completed an exchange of the 9.47% Series B Senior
Discount Notes (the "9.47% Exchange Notes"), registered under the Securities Act
of 1933 (the "Act"), for all of the 9.47% Notes. The 9.47% Exchange Notes are
identical in all material
respects to the originally issued 9.47% Notes.
In May 1997, the Company entered into a $90.0 million credit agreement (the
"Equipment Credit Facility") with an unrelated third party supplier of
transmission electronics equipment (the "Supplier") to fund a portion of certain
capital expenditures required to equip the Qwest Network currently under
construction. The facility subsequently was assigned by the Supplier to another
institution, which assumed the Equipment Credit Facility
F-14
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
and currently acts as the agent. Under the Equipment Credit Facility, the
Company may borrow up to 75% of the price of purchased equipment and related
engineering and installation services provided by the Supplier, 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. The Company's total remaining commitment under the
procurement agreement was approximately $68.4 million as of December 31, 1997.
Principal amounts outstanding under the Equipment Credit Facility will be
payable in quarterly installments commencing on June 30, 2000, with full
repayment due 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 margin.
On March 31, 1997, the Company issued and sold 10 7/8% Senior Notes due 2007
having an aggregate principal amount at maturity of $250.0 million. The net
proceeds of the 10 7/8% Senior Notes were approximately $242.0 million, after
deducting offering costs which are included in intangible and other long-term
assets. Interest on the 10 7/8% Senior Notes is payable semiannually in arrears
on April 1 and October 1 of each year, commencing October 1, 1997. The 10 7/8%
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 10 7/8%
Senior Notes at specified redemption prices. In August 1997, the Company
completed an exchange of 10 7/8% Series B Senior Notes (the "10 7/8% Notes"),
registered under the Act, for all of the 10 7/8% Senior Notes. The 10 7/8% Notes
are identical in all material respects to the originally issued 10 7/8% Senior
Notes.
In April 1996, the Company entered into a long-term $100.0 million revolving
credit facility agreement as amended in September 1996 (the "Facility") which
was collateralized by shares of common stock owned and pledged by the Majority
Shareholder. In October 1997, the Company repaid the outstanding balance and
terminated the Facility.
In April 1995, the Company entered into a $45.0 million customer contract
credit facility agreement to finance certain construction projects undertaken at
that time. The facility converted to a term loan upon completion of the
construction projects in 1996 and 1995 and is now secured by notes receivable
issued in connection with these construction projects. The facility bears
interest at the Company's option at either (i) the higher of (a) the bank's base
rate of interest, or (b) the Federal Funds Rate plus 1/2%; or (ii) LIBOR
plus 9/16%. The outstanding balance was repaid in February 1998.
The Company also incurred other indebtedness during the three-year period
ended December 31, 1997, including in 1995 and 1996 $10.0 million in aggregate
under five equipment loans and in January 1995 $12.0 million in aggregate under
two term notes, the proceeds of which were used to repay a portion of the
advance from the Majority Shareholder used to purchase Qwest Transmission Inc.
In addition, the Company had other outstanding indebtedness in 1997 which it had
incurred prior to 1995, including amounts payable under a network credit
facility and an additional equipment loan. Such indebtedness had a weighted
average interest rate of approximately 9% in 1997, and was repaid in the second
quarter of 1997 with proceeds from the 10 7/8% Senior Notes.
The indentures for the 10 7/8%, 9.47% and 8.29% Notes (defined below) contain
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
F-15
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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.
The Company leases certain network construction equipment under capital lease
agreements. The amortization charge applicable to capital leases is included in
depreciation expense. Future minimum payments under capital lease obligations is
included in contractual maturities of long-term debt summarized below.
Contractual maturities of long-term debt as of December 31, 1997 are as
follows (in thousands):
<TABLE>
<CAPTION>
1997
--------
<S> <C>
Year ended December 31:
1998.............................................................. $ 12,011
1999.............................................................. 622
2000.............................................................. 3,671
2001.............................................................. 5,078
2002.............................................................. 5,877
Thereafter........................................................ 615,215
--------
$642,474
========
</TABLE>
The carrying amounts of the Term Loan and the Equipment Credit Facility
approximate fair value since the interest rates are variable and reset
periodically. The estimated fair values of the 9.47% Notes and the 10 7/8%
Notes, each with a carrying value at December 31, 1997 of approximately $356.9
million and $250.0 million, respectively, were approximately $382.2 million and
$283.8 million, respectively, at December 31, 1997, based on current rates
offered for debt of similar terms and maturity.
In January 1998, the Company issued and sold $450.5 million in principal
amount at maturity of 8.29% Senior Discount Notes, due 2008 (the "8.29% Notes"),
generating net proceeds of approximately $299.2 million, after deducting
offering costs. The 8.29% Notes will accrete at a rate of 8.29% per annum,
compounded semiannually. The principal amount of the 8.29% Notes is due and
payable in full on February 1, 2008. The 8.29% Notes are redeemable at the
Company's option, in whole or in part, at any time on or after February 1, 2003
at specified redemption prices. In addition, prior to February 1, 2001, the
Company may use the net cash proceeds from certain equity transactions to redeem
up to 35% of the 8.29% Notes at specified redemption prices. Cash interest on
the 8.29% Notes will not accrue until February 1, 2003, and thereafter will
accrue at a rate of 8.29% per annum, and will be payable semiannually in arrears
commencing on August 1, 2003, and thereafter on February 1 and August 1 of each
year. The Company has the option of commencing cash interest on an interest
payment date on or after February 1, 2001, in which case the outstanding
principal amount at maturity of the 8.29% Notes will, on such interest payment
date, be reduced to the then accreted value, and cash interest will be payable
on each interest payment date thereafter.
In connection with the sale of the 8.29% Notes, the Company agreed to make an
offer to exchange new notes, registered under the Act and with terms identical
in all material respects to the 8.29% Notes, for the 8.29% Notes or,
alternatively, to file a shelf registration statement under the Act with respect
to the 8.29% Notes. If the registration statement for the exchange offer or the
shelf registration statement, as applicable, is not declared effective within
specified time periods or, after being declared effective, ceases to be
effective or usable for resale of the 8.29% Notes during specified time periods
(each a "Registration Default"), additional cash interest will
F-16
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
accrue at a rate per annum equal to 0.50% of the principal amount at maturity of
the 8.29% Notes during the 90-day period immediately following the occurrence of
a Registration Default and increasing in increments of 0.25% per annum of the
principal amount at maturity of the Discount Notes up to a maximum of 2.0% per
annum, at the end of each subsequent 90-day period until the Registration
Default is cured.
(13) INCOME TAXES
Income tax expense (benefit) for the years ended December 31, 1997, 1996 and
1995 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------- --------
<S> <C> <C> <C>
Current:
Federal.......................................... $ -- $(1,673) $(10,497)
State............................................ 108 (438) --
------ ------- --------
Total current income tax expense (benefit)..... 108 (2,111) (10,497)
------ ------- --------
Deferred:
Federal.......................................... 8,949 (1,123) (2,839)
State............................................ -- -- --
------ ------- --------
Total deferred income tax expense (benefit).... 8,949 (1,123) (2,839)
------ ------- --------
Total income tax expense (benefit)............. $9,057 $(3,234) $(13,336)
====== ======= ========
</TABLE>
Total income tax expense (benefit) differed from the amounts computed by
applying the federal statutory income tax rate (35%) to earnings (loss) before
income tax expense (benefit) as a result of the following items for the years
ended December 31, 1997, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------- --------
<S> <C> <C> <C>
Expected income tax expense (benefit)............ $8,253 $(3,570) $(13,463)
State income taxes, net of federal income tax
expense (benefit).................................. 70 (279) --
Goodwill amortization............................ 306 568 56
Compensation and growth share expenses........... 345 -- --
Other, net....................................... 83 47 71
------ ------- --------
Total income tax expense (benefit)........... $9,057 $(3,234) $(13,336)
====== ======= ========
</TABLE>
F-17
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 1997 and
1996 are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
-------- -------
<S> <C> <C>
Current deferred tax assets (liabilities):
Allowance for doubtful accounts........................ $ 1,130 $ 1,283
Accrued liabilities.................................... 1,219 1,277
Deferred compensation.................................. 492 --
-------- -------
2,841 2,560
Network construction contracts......................... (25,185) (2,560)
-------- -------
$(22,344) $ --
======== =======
Long-term deferred tax assets (liabilities):
Deferred compensation.................................. $ 6,503 $ 3,252
Depreciation........................................... 4,337 2,205
Accrued liabilities.................................... 1,235 --
Net operating loss carryforward........................ 34,773 --
-------- -------
46,848 5,457
Intangible assets, principally due to differences in
basis and amortization................................ (71) (112)
Property and equipment................................. (28,789) (752)
-------- -------
(28,860) (864)
-------- -------
$ 17,988 $ 4,593
======== =======
</TABLE>
The Company has analyzed the sources and expected reversal periods of its
deferred tax assets. The Company believes that the tax benefits attributable to
deductible temporary differences will be realized by recognition of future
taxable amounts. Accordingly, the Company believes a valuation allowance for its
federal deferred tax assets is not necessary.
At December 31, 1997, the Company has net operating loss carryforwards for
income tax purposes of approximately $99.4 million which, if not utilized to
reduce taxable income in future periods, will expire in 2012.
The Company is included in the consolidated federal income tax return of the
Majority Shareholder, which has a July 31 year-end for income tax purposes.
There is a tax allocation agreement between the Company and the Majority
Shareholder which encompasses U. S. federal tax consequences. The Company is
responsible to the Majority Shareholder to the extent of income taxes for which
the Company and its subsidiaries would have been liable if the Company had filed
a consolidated federal income tax return, giving effect to any loss or credit
carryover belonging to the Company and its subsidiaries from periods after the
Effective Date (defined below). The Majority Shareholder would be responsible to
the Company to the extent an unused loss or credit can be
carried back to an earlier taxable period after the Effective Date.
The tax agreement was amended effective as of January 1, 1997 (the "Effective
Date"). Prior to the amendment, the Company was responsible to the Majority
Shareholder for its share of the current consolidated income tax liabilities.
The Majority Shareholder was responsible to the Company to the extent that the
Company's income tax attributes were utilized by the Majority Shareholder to
reduce its consolidated income
F-18
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
tax liabilities, subject to certain limitations on net operating loss and credit
carryforwards. At December 31, 1996, the income tax benefit receivable from
Majority Shareholder of approximately $11.1 million was canceled, which resulted
in a reduction of additional paid-in capital.
In certain cases, differences may arise between amounts reported in the
financial statements under generally accepted accounting principles and the
amounts actually payable or receivable under the tax allocation agreement. Those
differences are generally reported as adjustments to capital, as in-substance
dividends.
(14) RELATED PARTY TRANSACTIONS
(a) Transactions with Majority Shareholder
The Majority Shareholder incurs certain costs on the Company's behalf,
including primarily insurance and corporate transportation services, and
allocates such costs to the Company based on actual usage. The cost to the
Company for such services was approximately $4.3 million, $2.1 million and $2.5
million in the years ended December 31, 1997, 1996 and 1995, respectively. In
addition, accounts receivable from (payable to) the Majority Shareholder are
recognized to reflect federal income tax benefits receivable (income taxes
payable) pursuant to the tax allocation agreement between the Company and the
Majority Shareholder. Advances from Majority Shareholder of approximately $19.1
million outstanding at December 31, 1996 were repaid in 1997.
The Company has agreed to indemnify the Majority Shareholder and its
subsidiaries against any costs or losses incurred by them as a result of their
providing credit support to the Company (in the form of collateral pledges,
guarantees, performance bonds or otherwise).
(b) Transactions with Other Related Parties
The Company leases its corporate office in Denver, Colorado from an affiliate
of the Majority Shareholder. The cost to the Company for such lease was
approximately $1.4 million, $1.2 million and $1.0 million in the years ended
December 31, 1997, 1996 and 1995, respectively.
The Majority Shareholder owned approximately 25% of Southern Pacific Rail
Corporation and its subsidiaries ("SPRC") at December 31, 1995. In September
1996, SPRC was acquired by Union Pacific Corporation. As a result of this
transaction, the Majority Shareholder's ownership was reduced to approximately
5% of Union Pacific Corporation, and SPRC ceased to be a related party. While a
related party, the Company provided telecommunications services to SPRC and
charged SPRC approximately $1.5 million and $3.6 million in the years ended
December 31, 1996 and 1995, respectively. Additionally, the Company purchased
and has made future commitments relating to right-of-way easements from SPRC and
utilizes specialized SPRC personnel and equipment for its construction projects.
While a related party, SPRC charged the Company approximately $3.3 million and
$2.2 million for these services in the years ended December 31, 1996 and 1995,
respectively.
(c) Equity Contribution From Majority Shareholder
On November 11, 1996, the former president and chief executive of the Company
resigned his position. Upon his resignation, the Majority Shareholder forgave a
note receivable from him in the amount of approximately $1.0 million. This
charge was allocated to the Company in 1996 and is included in selling, general
and administrative expenses and additional paid-in capital in
the Company's consolidated financial statements.
F-19
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash, cash equivalents, accounts receivable, accounts
payable and accrued expenses approximate fair value due to the short-term
maturities of these assets and liabilities. The carrying amounts of notes and
other receivables approximate fair value due to the relatively short period of
time between the origination of these instruments and their expected
realization. The carrying amount of long-term right-of-way obligation
approximates fair value since it is based upon current interest rates of
obligations with similar maturities.
(16) COMMITMENTS AND CONTINGENCIES
(a) Network Construction Project
In 1996, the Company commenced construction of the Qwest Network. The Company
projects its total remaining cost at December 31, 1997 for completing the
construction of the Qwest Network will be approximately $1.1 billion. This
amount includes the Company's remaining commitment through December 31, 1998 to
purchase a minimum quantity of materials for approximately $147.0 million as of
December 31, 1997, subject to quality and performance expectations, and
contracts for the construction of conduit systems aggregating approximately
$24.7 million.
(b) Network and Telecommunications Capacity Exchanges
The Company enters into agreements to exchange telecommunications capacity
rights and to exchange network assets. In 1997, the Company entered into
agreements to acquire network assets from unrelated third parties in exchange
for certain of the Company's network assets under construction. Title to the
network assets will pass to the exchange parties upon completion of construction
and consummation of the exchange.
In January 1998, the Company entered into an agreement to acquire long-term
telecommunications capacity rights from an unrelated third party in exchange for
long-term telecommunications capacity rights along segments of the Qwest Network
under construction. The exchange agreement provides for the payment of cash by
either of the parties for any period during the contract term in which a party
provides less than the contracted telecommunications capacity. It is anticipated
that the Company will make cash payments for a portion of the telecommunications
capacity it receives pursuant to the agreement until it completes construction
of the Qwest Network. The exchange agreement provides for liquidating damages to
be levied against the Company in the event the Company fails to deliver the
telecommunications capacity, in accordance with the agreed-upon timetable.
F-20
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(c) Leases and Telecommunications Service Commitments
The Company leases certain terminal locations and office space under operating
lease agreements and has committed to use certain telecommunications capacity
services. Future minimum payments under noncancelable operating lease and
service commitments as of December 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
CAPACITY
SERVICE OPERATING
COMMITMENTS LEASES TOTAL
----------- --------- -------
<S> <C> <C> <C>
Year ended December 31:
1998........................................ $3,977 $ 6,187 $10,164
1999........................................ 250 5,113 5,363
2000........................................ -- 3,170 3,170
2001........................................ -- 2,280 2,280
2002........................................ -- 1,950 1,950
Thereafter.................................. -- 4,848 4,848
------ ------- -------
Total minimum payments.................... $4,227 $23,548 $27,775
====== ======= =======
</TABLE>
Capacity service expenses are included in telecommunications service expenses.
Amounts expensed related to capacity service commitments in the years ended
December 31, 1997, 1996 and 1995 were approximately $7.3 million, $19.0 million
and $19.6 million, respectively.
Amounts expensed in the years ended December 31, 1997, 1996 and 1995 related
to operating leases were approximately $6.2 million, $5.0 million and $4.6
million, respectively.
(d) 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 2,220
kilometer route to be constructed in Mexico by the third party, and (ii) certain
construction inventory and value-added tax refunds, totaling approximately $2.9
million. In exchange for these assets, the third party will receive the stock of
the Company's subsidiary, SP Servicios de Mexico S. A. de C. V., and
approximately $6.7 million upon the achievement of certain milestones.
(17) GROWTH SHARE PLAN
The Company has a Growth Share Plan (the "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 measurement period. All Growth
Share grants made through December 31, 1997 have been made based on a beginning
Company value that was greater than or equal to the fair value of the Company at
the grant date. The total number of Growth Shares is set at 10 million and the
maximum presently available for grant under the Plan is 850,000. All
participants, except those granted Growth Shares under the October 1996 Plan,
vested fully upon completion of the Company's IPO and settlement was made with
2,591,532 common shares, net of amounts relating to tax withholdings of
approximately $21.9 million. Growth Shares granted under the October 1996 Plan
vest at the rate of 20% for each full year of service completed after the grant
date subject to risk of forfeiture and are to be settled with the Company's
Common Stock. The future compensation expense associated with the remaining
shares has been capped at $11.00 per share, or approximately $23.4 million, and
will be amortized as expense over the remaining approximately four-year vesting
period. At December 31, 1997, approximately $14.9 million is included in other
long-term liabilities related to outstanding Growth Shares. The Company does not
presently
F-21
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
intend to make any additional Growth Share grants under this plan. Certain
triggering events, such as a change in control of the Company, cause immediate
vesting of the remaining Growth Shares and would result in accelerated expense
recognition of all unamortized compensation. Participants receive their vested
portion of the increase in value of the Growth Shares upon a triggering event,
which includes the end of a Growth Share performance cycle.
The Company has estimated an increase in value of the Growth Shares during
1997 and has recorded approximately $73.5 million of additional compensation
expense for this plan in the year ended December 31, 1997. Had the Company
accounted for compensation under the Growth Share Plan pursuant to the fair
value method in Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation, the amount of compensation would not have been
different from what has been reflected in the accompanying consolidated
financial statements.
The following table summarizes Growth Share grants and Growth Shares
outstanding:
<TABLE>
<CAPTION>
OUTSTANDING
GROWTH SHARES
-------------
<S> <C>
December 31, 1994.............................................. 676,000
1995 grants.................................................. 11,000
1995 forfeitures............................................. (42,500)
--------
December 31, 1995.............................................. 644,500
1996 grants.................................................. 67,500
1996 forfeitures and settlements............................. (436,600)
--------
December 31, 1996.............................................. 275,400
1997 grants.................................................. 358,050
1997 settlements............................................. (253,950)
--------
December 31, 1997.............................................. 379,500
========
</TABLE>
The Company estimated an increase in value of the Growth Shares at December
31, 1996 due to the signing of an agreement to provide an indefeasible right of
use to a major customer and recorded approximately $13.1 million of additional
compensation expense in 1996, approximately $6.0 million of which is payable
subsequent to December 31, 1997. No expense was recognized in the accompanying
consolidated financial statements for the year ended December 31, 1995, as there
were no significant compensatory elements in that period.
(18) CAPITAL STOCK
On January 20, 1998, the Board of Directors declared a stock dividend of one
share for every share outstanding to stockholders of record as of February 2,
1998, to be distributed on February 24, 1998. This dividend was accounted for as
a two for one stock split. All share and per share information included in the
consolidated financial statements and the notes hereto have been adjusted to
give retroactive effect to the change in capitalization.
On May 23, 1997, the Board of Directors approved a change in the Company's
capital stock to authorize 400 million shares of $.01 par value Common Stock
(of which 20 million shares are reserved for issuance under the Equity Incentive
Plan, 2 million shares are reserved for issuance under the Growth Share Plan,
and 8.6 million shares are reserved for issuance upon exercise of warrants, as
described below), and 25 million shares of $.01 par value Preferred Stock. On
May 23, 1997, the Board of Directors declared a stock dividend to the existing
F-22
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
stockholder of 172,980,000 shares of Common Stock, which was paid immediately
prior to the effectiveness of the registration statement on June 23, 1997. This
dividend was accounted for as a stock split. The Company completed the IPO of
31,050,000 shares of Common Stock on June 27, 1997, raising net proceeds of
approximately $319.5 million.
Effective May 23, 1997, the Company sold to an affiliate of the Majority
Shareholder for $2.3 million in cash, a warrant to acquire 8.6 million shares of
Common Stock at an exercise price of $14.00 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.
Effective June 23, 1997, the Company adopted 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 20 million 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, 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
stock option is granted, subject to certain restrictions.
Stock option awards generally vest in equal increments over a five-year
period, and 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. Options granted in 1997 have terms
ranging from six to ten years.
Stock option transactions during 1997 were as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
---------- ----------------
<S> <C> <C>
Outstanding January 1, 1997..................... -- --
Granted......................................... 13,958,000 $15.88
Exercised....................................... (12,000) $11.00
----------
Outstanding December 31, 1997................... 13,946,000 $15.89
==========
Exercisable December 31, 1997................... 1,340,000 $11.00
==========
</TABLE>
The following table summarizes certain information about the Company's stock
options at December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
RANGE OF EXERCISE OPTIONS REMAINING WEIGHTED AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE
------------------------------- ----------- ---------------- ----------------
<S> <C> <C> <C>
$ 7.50 - $11.00................ 8,654,000 5.6 $10.80
$14.69 - $18.06................ 535,000 9.6 $15.84
$22.88 - $24.00................ 3,100,000 9.7 $23.15
$25.13 - $30.19................ 1,657,000 9.9 $29.39
----------
$ 7.50 - $30.00................ 13,946,000 7.2 $15.88
==========
</TABLE>
F-23
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Compensation expense recognized for grants under the Equity Incentive Plan was
not material in 1997. If compensation expense for the Equity Incentive Plan had
been determined using the fair value method described in SFAS 123, the Company's
net earnings and earnings per share for 1997 would have been reduced to the pro
forma amounts shown in the following table (in thousands, except per share
information):
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Net earnings
As reported....................................................... $14,523
Pro forma......................................................... 861
Earnings per share--basic
As reported....................................................... 0.08
Pro forma......................................................... --
Earnings per share--diluted
As reported....................................................... 0.07
Pro forma......................................................... --
</TABLE>
The weighted-average fair value of each option grant is estimated as of the
date of grant to be $7.94 using the Black-Scholes option pricing model, with the
following weighted average assumptions: risk-free interest rate of 5.8%, no
expected dividend yields, expected option lives of 7.6 years, and expected
volatility of 31%.
(19) EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the denominators of the basic and diluted
earnings per share computations (in thousands, except per share information):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net earnings (loss)........................... $ 14,523 $ (6,967) $(25,131)
======== ======== ========
Shares:
Weighted average number of shares outstanding
during the period for computing basic
earnings per share........................... 190,505 173,000 173,000
-------- -------- --------
Incremental common shares attributable to dilutive securities:
Common shares issuable for warrants.......... 1,635 -- --
Common shares issuable under stock option
plan........................................ 1,621 -- --
Common shares issuable for outstanding growth
shares...................................... 294 -- --
-------- -------- --------
Number of shares as adjusted for purposes of
computing diluted earnings per share......... 194,055 173,000 173,000
======== ======== ========
Earnings per share--basic..................... $ 0.08 $ (0.04) $ (0.15)
======== ======== ========
Earnings per share--diluted................... $ 0.07 $ (0.04) $ (0.15)
======== ======== ========
</TABLE>
The weighted average number of options to purchase common stock that was
excluded from the computation of diluted earnings per share because the exercise
price of the option was greater than the average market price of the common
stock was 800,000 for 1997.
F-24
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(20) 401(K) PLAN
The Company sponsors a 401(k) Plan (the "Plan") which permits employees to
make contributions to the Plan on a pre-tax salary reduction basis in accordance
with the Internal Revenue Code. All full-time employees are eligible to
participate after one year of service. The Company contributes a base percentage
and matches a portion of the voluntary employee contributions. The cost of the
Plan charged to expense was not material in the periods presented in the
consolidated financial statements.
(21) SIGNIFICANT CUSTOMERS
During the years ended December 31, 1997, 1996 and 1995, two or more
customers, in aggregate, have accounted for 10% or more of the Company's total
revenue in one or more periods, as follows:
<TABLE>
<CAPTION>
CUSTOMER A CUSTOMER B CUSTOMER C CUSTOMER D
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1997............................. 6% 31% 37% --
1996............................. 28% 26% -- 4%
1995............................. 7% -- -- 35%
At December 31, 1997 and 1996, one or more of the customers described above
have accounted for 10% or more of the Company's combined accounts receivable,
net, and costs and estimated earnings in excess of billings, as follows:
<CAPTION>
CUSTOMER A CUSTOMER B CUSTOMER C
---------- ---------- ----------
<S> <C> <C> <C>
1997............................. -- 26% 32%
1996............................. 11% 20% --
</TABLE>
(22) SUBSEQUENT EVENTS
In January 1998, the Company entered into a merger agreement (the "Merger
Agreement") with an unrelated third party non-facilities-based reseller of long
distance services. In the Merger, each outstanding share of the third party's
Common Stock (including shares of the third party's Common Stock issued upon
conversion of its Series I Stock) will be acquired for that many shares of the
Qwest's Common Stock having an aggregate market value equal to $28.5 million,
reduced by certain adjustments and limitations to $26.8 million, and future
payments of $4.0 million. The proposed acquisition is subject to certain closing
conditions that include requisite shareholder approval. If consummated, the
proposed acquisition will be accounted for using the purchase method of
accounting.
Also in January 1998, the Company signed a long-term contract to provide an
unrelated third party telecommunications capacity along approximately 10,000
route miles of the Qwest Network (the "Contract"). In consideration, the Company
will receive 19.99% of the third party's common stock and up to $310.0 million
in cash over an extended payment term. There are restrictions on the sale by the
Company of the unrelated third party's common stock, and the unrelated third
party has the right to repurchase the common stock until the
Contract's second anniversary. The Company will also receive monthly operations
and maintenance fees over the term of the multi-year Contract. Prior to delivery
of the telecommunications capacity and acceptance by the unrelated third party,
the unrelated third party has the right to purchase interim capacity from the
Company. The total cash consideration under the Contract will be reduced by 60%
of the sums paid by the unrelated third party for purchases of interim capacity.
Pursuant to the terms of the Contract, the unrelated third party may require the
Company to purchase an additional $10.0 million of its common stock. If the
Company fails to complete at least 75% of the unrelated third party's network by
the Contract's third anniversary, the unrelated third party may at
F-25
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
its option either: (i) accept the completed portion and pay for it on a pro
rata basis; or (ii) terminate the Contract and require the Company to return
all consideration received.
On March 8, 1998, the Company signed a definitive merger agreement with an
unrelated third party communications services provider. The boards of directors
of each company have approved the merger. The terms of the merger agreement call
for the acquisition of all of the third party's outstanding common shares and
the assumption of all of the third party's stock options by the Company. The
purchase price of the all-stock transaction is anticipated to be approximately
$4.4 billion. The merger is intended to qualify as a tax-free reorganization and
will be accounted for as a purchase.
(23) SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER
SHARE INFORMATION) (UNAUDITED)
<TABLE>
<CAPTION>
1997
---------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue................. $ 72,693 $228,673 $188,955 $206,382
Earnings (loss) from
operations............. (12,644) (7,098) 19,860 23,363
Net earnings (loss)..... (4,776) (5,612) 12,651 12,260
Earnings (loss) per
share--basic........... (0.03) (0.03) 0.06 0.06
Earnings (loss) per
share--diluted......... (0.03) (0.03) 0.06 0.06
<CAPTION>
1996
---------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue................. $ 34,632 $ 50,871 $ 44,333 $101,160
Earnings (loss) from
operations............. (14,653) (2,262) 571 4,330
Net earnings (loss)..... (9,979) (2,376) 3,454 1,934
Earnings (loss) per
share--basic........... (0.06) (0.01) 0.02 0.01
Earnings (loss) per
share--diluted......... (0.06) (0.01) 0.02 0.01
</TABLE>
The Company adopted SFAS 128 in the fourth quarter of 1997. All per share
information reflected in the selected consolidated quarterly financial data
above has been restated.
F-26
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS
AND SHAREOWNERS OF LCI INTERNATIONAL, INC.:
We have audited the accompanying consolidated balance sheets of LCI
International, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations,
shareowners' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of LCI
International, Inc. and subsidiaries, as of December 31, 1997 and 1996, and the
results of their operations and cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.
February 16, 1998
(except with respect to the matter
Discussed in Note 15, as to which
the date is March 16, 1998)
F-27
<PAGE>
LCI INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT EARNINGS PER COMMON SHARE)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Revenues....................................... $ 1,642 $ 1,304 $ 824
Cost of services............................. 986 778 496
---------- ---------- ---------
Gross margin................................... 656 526 328
Selling, general and administrative expenses. 408 305 193
Merger charges............................... 45 -- --
Restructuring charges........................ 9 16 --
Depreciation and amortization................ 96 75 54
---------- ---------- ---------
Operating income............................... 98 130 81
Interest and other expense, net.............. 36 29 16
---------- ---------- ---------
Income from continuing operations before income
taxes......................................... 62 101 65
Income tax expense........................... 31 38 16
---------- ---------- ---------
Income from continuing operations.............. 31 63 49
Discontinued operations:
Income from discontinued operations, net of
income taxes of $7 and $9 for 1996 and 1995,
respectively................................ -- 11 15
---------- ---------- ---------
Net income..................................... 31 74 64
---------- ---------- ---------
Preferred dividends............................ -- 3 6
---------- ---------- ---------
Income on common stock......................... $ 31 $ 71 $ 58
========== ========== =========
Earnings per common share Continuing operations:
Basic........................................ $ 0.34 $ 0.73 $ 0.60
========== ========== =========
Diluted...................................... $ 0.32 $ 0.64 $ 0.53
========== ========== =========
Earnings per common share:
Basic........................................ $ 0.34 $ 0.86 $ 0.81
========== ========== =========
Diluted...................................... $ 0.32 $ 0.75 $ 0.69
========== ========== =========
Weighted average number of common shares:
Basic........................................ 91 83 71
Diluted...................................... 99 99 92
</TABLE>
The accompanying notes are an integral part of these statements.
F-28
<PAGE>
LCI INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1997 1996
------ ------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents.................................... $ -- $ 12
Trade accounts receivable, less allowance for doubtful
accounts of $52 and $30 for 1997 and 1996, respectively..... 190 121
Current deferred tax assets, net............................. 59 51
Prepaids and other........................................... 22 22
------ ------
Total current assets....................................... 271 206
------ ------
Property and equipment
Fiber-optic network.......................................... 558 450
Technology platforms, equipment and building lease........... 231 125
Less--accumulated depreciation and amortization.............. (206) (204)
------ ------
583 371
Property under construction.................................. 88 61
------ ------
Total property and equipment, net.......................... 671 432
------ ------
Other assets
Excess of cost over net assets acquired, net of accumulated
amortization of $38 and $28 for 1997 and 1996, respectively. 359 364
Other, net................................................... 53 51
------ ------
Total other assets......................................... 412 415
------ ------
Total assets............................................... $1,354 $1,053
====== ======
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities
Accounts payable............................................. $ 43 $ 40
Facility costs accrued and payable........................... 154 135
Accrued expenses and other................................... 91 63
------ ------
Total current liabilities.................................. 288 238
------ ------
Long-term debt and capital lease obligations................. 413 252
------ ------
Other liabilities and deferred credits....................... 101 73
------ ------
Commitments and contingencies
Shareowners' equity
Preferred Stock--authorized 15 million shares, no shares
issued and outstanding in 1997 and 1996..................... -- --
Common Stock--authorized 300 million shares, issued and
outstanding 96 million shares in 1997 and 89 million shares
in 1996..................................................... 1 1
Paid-in capital.............................................. 511 480
Retained earnings............................................ 40 9
------ ------
Total shareowners' equity.................................... 552 490
------ ------
Total liabilities and shareowners' equity.................. $1,354 $1,053
====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-29
<PAGE>
LCI INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(IN MILLIONS)
<TABLE>
<CAPTION>
PREFERRED COMMON
STOCK STOCK
--------- -------------------- RETAINED TOTAL
$.01 PAR ISSUED AND $.01 PAR PAID-IN EARNINGS SHAREOWNERS'
VALUE OUTSTANDING VALUE CAPITAL (DEFICIT) EQUITY
--------- ----------- -------- ------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1994................... $115 69 $ 1 $242 $(104) $254
Acquisition of CTG...... -- 5 -- 93 -- 93
Employee stock purchases
and exercises of
options/warrants,
including related tax
benefits............... -- 1 -- 10 -- 10
Conversion/redemption of
Convertible Preferred
Stock.................. (1) -- -- 1 -- --
Other transactions...... -- -- 1 -- 1
Net income.............. -- -- -- -- 64 64
Preferred dividends..... -- -- -- -- (6) (6)
---- --- --- ---- ----- ----
BALANCE AT DECEMBER 31,
1995................... $114 75 $ 1 $347 $ (46) $416
---- --- --- ---- ----- ----
Employee stock purchases
and exercises of
options/warrants,
including related tax
benefits............... -- 2 -- 19 -- 19
Conversion/redemption of
Convertible Preferred
Stock.................. (114) 12 -- 114 -- --
Spin-off of Billing..... (16) (16)
Net income.............. -- -- -- -- 74 74
Preferred dividends..... -- -- -- -- (3) (3)
---- --- --- ---- ----- ----
BALANCE AT DECEMBER 31,
1996................... $-- 89 $ 1 $480 $ 9 $490
---- --- --- ---- ----- ----
Employee stock purchases
and exercises of
options/warrants,
including related tax
benefits............... -- 7 -- 31 -- 31
Net income.............. -- -- -- -- 31 31
---- --- --- ---- ----- ----
BALANCE AT DECEMBER 31,
1997................... $-- 96 $ 1 $511 $ 40 $552
---- --- --- ---- ----- ----
</TABLE>
The accompanying notes are an integral part of these statements.
F-30
<PAGE>
LCI INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Operating activities
Income from continuing operations...................... $ 31 $ 63 $ 49
Adjustments to income from continuing operations:
Depreciation and amortization........................ 96 75 54
Change in deferred taxes............................. 20 36 (1)
Merger and restructuring charges..................... 43 -- --
Change in assets/liabilities:
Trade accounts receivable............................ (16) (52) (67)
Net securitization activity.......................... (53) 112 --
Accounts payable and facility costs accrued and
payable............................................. 34 53 21
Other assets/liabilities............................. 32 21 (2)
------ ------ ------
Net cash provided by operating activities.......... 187 308 54
------ ------ ------
Net cash provided by discontinued operations....... -- 15 8
------ ------ ------
Investing activities
Capital expenditures--property and equipment......... (321) (156) (106)
Payment for acquisitions and other................... (17) (124) (79)
------ ------ ------
Net cash (used in) investing activities............ (338) (280) (185)
------ ------ ------
Financing activities
Proceeds from issuance of debt....................... 350 6 5
Net debt (payments) borrowings....................... (228) (48) 115
Preferred dividend payments.......................... -- (3) (6)
Proceeds from employee stock plans and warrants...... 17 14 9
------ ------ ------
Net cash provided by (used in) financing
activities........................................ 139 (31) 123
------ ------ ------
Change in cash and cash equivalents.................... (12) 12 --
------ ------ ------
Cash and cash equivalents at the beginning of the year. 12 -- --
------ ------ ------
Cash and cash equivalents at the end of the year....... $ -- $ 12 $ --
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-31
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS ORGANIZATION AND PURPOSE
The financial statements presented herein include the Consolidated Balance
Sheets of LCI International, Inc., a Delaware corporation, and its wholly owned
subsidiaries (LCI or the Company) as of December 31, 1997 and 1996, and the
related Consolidated Statements of Operations, Shareowners' Equity and Cash
Flows for the three years ended December 31, 1997.
LCI is a facilities-based telecommunications carrier that provides a broad
range of domestic and international voice and data services to the commercial,
wholesale, residential/small business and local market segments, and operator
assisted services. The Company serves its customers primarily through owned and
leased digital fiber-optic facilities.
On December 22, 1997, the Company acquired USLD Communications Corp. (USLD) in
a stock-for-stock transaction that has been accounted for as a pooling of
interests. The Company exchanged approximately 12 million shares of its common
stock, par value $.01 per share (Common Stock) for all of the outstanding shares
of USLD common stock. The Company's Consolidated Financial Statements have been
restated to include the results for USLD, as though the companies had always
been a combined entity.
2. ACCOUNTING POLICIES
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, disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of the
Company and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated. Certain reclassifications have
been made to the Consolidated Financial Statements for 1996 and 1995 to conform
with the 1997 presentation. In August 1996, USLD completed the spin-off of its
billing clearinghouse and information management services business, Billing
Information Concepts Corp. (Billing). The spin-off has been accounted for as
discontinued operations and, accordingly, the Company restated its Consolidated
Financial Statements for all periods presented prior to that date in accordance
with Accounting Principles Board Opinion (APB) No. 30. Financial disclosures for
all periods presented reflect that restatement.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. The Company uses its
available cash to reduce the balance of its revolving credit facility (Credit
Facility) and generally maintains no cash on hand.
Trade Accounts Receivable
Trade accounts receivable represent amounts due from customers for
telecommunications services, less an allowance for uncollectible accounts.
Revenues and, therefore, trade accounts receivable, include amounts recognized
for services provided but not yet billed.
Accounts Receivable Securitization Program
In accordance with Statement of Financial Accounting Standards (SFAS) No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," the transfers of receivable balances meet the
criteria to be classified as a sale for accounting purposes. As such, amounts
sold under the
F-32
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
accounts receivable securitization program (Securitization Program) are not
included in the accompanying Consolidated Financial Statements. The costs of the
Securitization Program are included in interest and other expense, net in the
accompanying Consolidated Statements of Operations. The cash proceeds are
included in operating activities in the accompanying Consolidated Statements of
Cash Flows.
Prepaids and Other
Prepaids and other assets include deferred customer promotion costs and
customer acquisition costs that are amortized over the estimated life of the
related contract term, and various other accounts and notes receivable expected
to be received within the next year.
Property and Equipment
These assets are stated at cost or at fair market value if obtained as part of
an acquisition. Construction costs include material, labor, interest and
overhead costs. Property and equipment as of December 31, 1997 and 1996 includes
the net book value of $25 million and $9 million for a capitalized building
lease for the Company's operating subsidiaries' headquarters. Routine repairs
and maintenance of property and replacements of minor items are charged to
expense as incurred. Depreciation of buildings and equipment is provided using
the composite method over the estimated useful lives of these assets. The cost
of equipment retired in the ordinary course of business, less proceeds, is
charged to accumulated depreciation. The capitalized building lease is amortized
on a straight-line basis over the term of the lease.
The estimated depreciation and amortization periods by asset type:
<TABLE>
<CAPTION>
ASSET CATEGORY YEARS
-------------- -----
<S> <C>
Fiber-optic network:
Fiber-optic cable and buildings...................................... 30
Transmission, distribution and switching equipment................... 10-15
Installation costs................................................... 3
Technology platforms................................................... 5
Equipment:
Information systems--hardware and software........................... 3-5
General office equipment............................................. 5-10
Capitalized building lease............................................. 15
</TABLE>
Excess of Cost Over Net Assets Acquired
Excess of cost over net assets acquired (goodwill) consists of the excess of
the cost to acquire an entity over the estimated fair market value of the net
assets acquired. Goodwill is amortized on a straight-line basis over 40 years.
The Company continually evaluates whether events and circumstances have occurred
which indicate that the remaining estimated useful life of goodwill may warrant
revision or that the remaining balance of goodwill may not be recoverable. If
such an event has occurred, the Company estimates the sum of the expected future
cash flows, undiscounted and without interest charges, derived from such
goodwill over its remaining life. The Company believes that no such impairment
existed at December 31, 1997. Amortization of goodwill was $10 million, $10
million and $5 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
Other Assets
Other assets consist of debt issuance costs, rights-of-way, customer lists,
non-compete agreements and other deferred costs, which are amortized over the
estimated life or contract term of the agreement.
F-33
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Other Liabilities and Deferred Credits
Other liabilities and deferred credits primarily include long-term deferred
income taxes and other long-term liabilities. As of December 31, 1997 and 1996,
net long-term deferred tax liabilities of $84 million and $56 million,
respectively, were included in other liabilities and deferred credits.
Revenue Recognition
Telecommunications revenues are recognized when services are provided and are
net of estimated credits and uncollectible amounts.
Advertising Cost
In accordance with Statement of Position 93-7, "Reporting on Advertising
Costs," costs for advertising are expensed as incurred within the fiscal year.
If it is determined that the advertising costs will provide a future economic
benefit, the costs are capitalized and amortized over the period of benefit, not
to exceed one year.
Income Taxes
The Company follows SFAS No. 109, "Accounting for Income Taxes" (see Note
13).
Fair Value of Financial Instruments
The carrying amounts of current assets and liabilities approximate their fair
market value. The fair market value of long-term debt is discussed further in
Note 7.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of trade accounts receivable. The risk is
limited due to the number of market segments, the large number of entities
comprising the Company's customer base and the dispersion of those entities
across many different industries and geographic regions. As of December 31,
1997, the Company had no significant concentrations of credit risk.
Statements of Cash Flows
Cash payments and significant non-cash activity:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Cash payments for interest............................. $ 30 $ 27 $ 17
Cash payments for income taxes......................... $ 4 $ 2 $ 3
Non-cash investing and financing activities:
Tax benefit recognized in connection with stock
option exercises.................................... $ 12 $ 6 $ 1
Capital lease obligations incurred................... $ 17 $ 1 $ --
Dividend pursuant to spin-off of Billing............. $ -- $ 34 $ --
</TABLE>
During 1997, the Company exchanged approximately 12 million shares of Common
Stock for all of the outstanding common stock of USLD to affect the business
combination, and 5 million shares of Common Stock were issued in connection with
the non-cash exercise of warrants. During 1996, shareowners converted
approximately 5 million shares of Convertible Preferred Stock into approximately
12 million shares of Common Stock. During 1995, the Company issued 5 million
shares of Common Stock with a market value of approximately $93 million, as
partial consideration in a purchase acquisition.
F-34
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Accounting Pronouncements Not Yet Effective
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." Both are required for
financial statements in fiscal years beginning after December 15, 1997.
SFAS No. 130 requires comprehensive income to be reported in a financial
statement that is displayed with the same prominence as other financial
statements. As the Company does not currently have any components of
comprehensive income, it is not expected that this statement will affect the
Consolidated Financial Statements.
SFAS No. 131 requires entities to disclose financial and detailed information
about its operating segments in a manner consistent with internal segment
reporting used by the Company to allocate resources and assess financial
performance. The Company has not completed the analyses required to determine
the additional disclosures requirements, if any, for the adoption of SFAS No.
131.
In anticipation of the year 2000 (Year 2000), management has developed a plan
to review software that was internally developed and/or externally purchased or
licensed for compliance with Year 2000 processing requirements. In accordance
with Emerging Issues Task Force Opinion No. 96-14, "Accounting for the Costs
Associated with Modifying Computer Software for the Year 2000," the Company will
expense all costs as incurred.
3. MERGER & RESTRUCTURING
Merger
On December 22, 1997, the Company acquired USLD in a stock-for-stock
transaction that resulted in USLD becoming a wholly owned subsidiary of LCI.
Under the terms of the agreement, USLD shareholders received .7576 of a share of
Common Stock of the Company for each USLD share. Accordingly, the Company issued
approximately 12 million shares of Common Stock for all outstanding shares of
USLD common stock. Additionally, outstanding options and warrants to acquire
USLD common stock were converted to options and warrants to purchase
approximately 2 million shares of Common Stock of the Company.
The merger qualified as a tax-free reorganization and was accounted for as a
pooling of interests. Accordingly, the Company's financial statements have been
restated to include the accounts and operations of USLD for all periods
presented as though the two companies had always been a combined entity.
Combined and separate results of LCI and USLD during the periods preceding the
merger:
<TABLE>
<CAPTION>
LCI USLD COMBINED
------ ---- --------
(IN MILLIONS)
<S> <C> <C> <C>
Nine months ended September 30, 1997
Revenues............................................. $1,018 $178 $1,196
Net income........................................... $ 65 $ 4 $ 69
------ ---- ------
Year ended December 31, 1996
Revenues............................................. $1,103 $201 $1,304
Net income........................................... $ 75 $ (1) $ 74
------ ---- ------
Year ended December 31, 1995
Revenues............................................. $ 673 $151 $ 824
Net income........................................... $ 51 $ 13 $ 64
------ ---- ------
</TABLE>
F-35
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
No adjustments were necessary to the combined financial results presented
above to conform the accounting policies of the two companies, other than
reclassifications of certain revenue and expense reporting to conform financial
statement presentation. There were no material intercompany transactions between
the two companies for the periods presented.
In connection with the merger, the Company recorded a $45 million one-time
merger charge during 1997. The charge included $7 million of transaction costs
for investment bank and other professional fees, $31 million for the elimination
of duplicate facilities and the write-off of assets, and $7 million for employee
severance and termination costs.
Restructuring
In the fourth quarter of 1997, the Company recorded restructuring charges of
$8 million for the costs associated with relocation to the new headquarters
building and for employee severance and termination costs. In addition, during
the second quarter of 1997, there was a $1 million one-time charge by USLD for
the resignation of its former chairman of the board of directors.
In 1996, USLD charged $13 million for the direct spin-off costs related to
Billing. In addition, $3 million of restructuring charges were recorded for the
costs associated with consolidating support functions and the write-off of
assets.
4. ACQUISITIONS
The Company has supplemented growth from its base business with several
strategic acquisitions. Each acquisition during 1996 and 1995 was accounted for
as a purchase.
In January 1996, the Company purchased the long-distance business assets of
Teledial America, Inc. (Teledial America), which did business as U.S. Signal
Corporation, and an affiliated company, ATS Network Communications, Inc. (ATS).
The Company acquired both companies for approximately $99 million in cash, and
the amount of goodwill recorded in the purchase transactions was $100 million.
The results of operations for Teledial America and ATS were included in the
Consolidated Statement of Operations from January 1, 1996.
In September 1995, the Company acquired Corporate Telemanagement Group, Inc.
(CTG), for approximately $140 million in cash and Common Stock, and assumed
approximately $24 million in debt. The amount of goodwill recorded in the
purchase transaction was $157 million. The Consolidated Statements of Operations
include the results of CTG from September 1, 1995. The combination of the
operations of the Company and CTG provided pro forma net revenues of $815
million, pro forma net income of $54 million and pro forma earnings per common
share of $0.63. The pro forma information is provided as if the acquisition had
occurred at the beginning of the 1995 fiscal year and is for informational
purposes only.
USLD had insignificant business combinations in 1997 and 1995 that were not
material for financial statement purposes.
5. DISCONTINUED OPERATIONS
In August 1996, USLD completed the spin-off of Billing. The spin-off has been
accounted for as discontinued operations and, accordingly, the Company restated
its Consolidated Financial Statements for all periods presented prior to that
date. The spin-off was a tax-free distribution of 100% of the common stock of
Billing to USLD's shareowners. Revenue of the discontinued operations of Billing
was $86 million and $81 million for the years ended December 31,
1996 and 1995, respectively. Basic and diluted earnings per share for
F-36
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
discontinued operations for the year ended December 31, 1996 were $0.13 and
$0.11, respectively, and for the year ended December 31, 1995 were $0.21 and
$0.16.
In connection with the spin-off, USLD distributed, for financial statement
purposes, a dividend of $16 million to record the net effect of forgiven
intercompany payable/receivable balances, the reimbursement by Billing of direct
spin-off costs, and the transfer of a working capital balance of $22 million to
USLD. Direct spin-off costs of $13 million were included in restructuring
charges in the Consolidated Statements of Operations for the year ended December
31, 1996. These costs included professional fees, tax payments triggered by the
spin-off, payments under employment agreements and costs associated with
accelerated stock grants.
6. ACCOUNTS RECEIVABLE SECURITIZATION
In August 1996, the Company entered into an agreement to sell a percentage
ownership interest in a defined pool of its trade accounts receivable
(Securitization Program). Under the Company's Securitization Program, LCI SPC I,
Inc. (SPC), a wholly owned, bankruptcy-remote subsidiary of the Company, sells
accounts receivable. Under this Securitization Program, the Company can transfer
an undivided interest in a designated pool of its accounts receivable on an
ongoing basis to maintain the participation interest up to a maximum of $150
million. The accounts receivable balances sold, but not yet collected, of
approximately $59 million and $112 million at December 31, 1997 and 1996,
respectively, are not included in the accompanying Consolidated Balance Sheets.
SPC had approximately $130 million and $120 million of accounts receivable
available for sale as of December 31, 1997 and 1996. The cost of the
Securitization Program is based on a discount rate equal to the short-term
commercial paper rate plus certain fees and expenses. The Company retains
substantially all the same risk of credit loss as if the receivables had not
been sold, and has established reserves for such estimated credit losses.
Under the Securitization Program agreement, the Company acts as agent for the
purchaser of the receivables by performing recordkeeping and collection
functions on the interest sold and receives a fee providing adequate
compensation for such services. The agreement also contains certain covenants
regarding the quality of the accounts receivable portfolio, as well as financial
covenants that are substantially identical to those contained in the Company's
Credit Facility (see Note 7). Except in limited circumstances, SPC is subject to
certain contractual prohibitions concerning the payment of dividends and the
making of loans and advances to LCI.
7. DEBT
In June 1997, the Company issued $350 million of 7.25% Senior Notes (Notes),
which mature June 15, 2007. The net proceeds from the issuance of the Notes were
used to repay outstanding indebtedness and for working capital and general
corporate purposes. As of December 31, 1997, the fair market value of the Notes
was approximately $361 million.
The Company had approximately $10 million in various fixed-rate notes as of
December 31, 1997. These notes are expected to be repaid during early 1998.
Credit Facility
The Company has an aggregate $750 million revolving credit (Credit Facility)
from a syndicate of banks. The Credit Facility is comprised of two separate
facilities of $500 million and $250 million. The first facility has a term of
five years, while the second facility has a one-year term. Each facility may be
extended for a limited number of periods. Both facilities bear interest at
a rate consisting of two components: The base rate component is dependent upon a
market indicator; the second component varies from 0.30% to 0.75% based on the
more favorable of the relationship of borrowing levels to operating cash flow
(leverage ratio) or the Company's senior unsecured debt rating.
F-37
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Credit Facility contains various financial covenants, the most restrictive
being the leverage ratio requirement. As of December 31, 1997 and 1996, the
Company was in compliance with all Credit Facility covenants. The company had no
outstanding balance under the Credit Facility as of December 31, 1997, compared
to $215 million outstanding as of December 31, 1996. The weighted average
interest rate on the outstanding borrowings under the Credit Facility as of
December 31, 1996 was 6.09%. The carrying amount of the Credit Facility
approximates its fair value, as the underlying instruments are variable rate
notes that reprice frequently.
The Company also has an interest rate cap agreement with certain banks to
manage interest rate risk on the Credit Facility. The agreement is for a
two-year period ending February 1998 and limits the base interest rate exposure
to 7.5% on $130 million notional principal balance of the Credit Facility. In
the event of non-performance by the banks, the Company would be obligated to
make the contractual payments under the Credit Facility, and would have exposure
to the extent of any increase in the base rate component above 7.5%. The Company
believes the probability of such an event is remote.
Lines of Credit
The Company has three separate discretionary line of credit agreements (Lines
of Credit) with commercial banks for a total of $75 million. The Lines of Credit
provide flexible short-term borrowing at competitive rates dependent upon a
market indicator. As of December 31, 1997 and 1996, the outstanding balances
under the Lines of Credit were $25 million and $8 million, respectively, with
interest rates of 6.26% and 5.93%, respectively.
The outstanding balance in the accompanying Consolidated Balance Sheets is
reflected in long-term debt, due to the borrowing availability under the Credit
Facility to repay such balances. The carrying value of the Lines of Credit
approximates its fair market value.
8. LEASES
The Company's capital leases primarily include two building leases, which
expire at various times through 2012. The noncurrent portions of all capital
lease obligations were $28 million and $13 million as of December 31, 1997 and
1996, respectively. The Company has operating leases for other office space and
equipment with lease terms from three to ten years with options for renewals.
During 1996, the Company entered into an operating lease agreement for the
rental of a new corporate headquarters being developed in Arlington, Virginia.
This agreement has a three-year base term with two options to renew for one year
each. The agreement includes a maximum residual guarantee of $62 million at the
end of the base term, which is included in the minimum lease payments, below.
However, the Company expects to exercise the renewal options, which will extend
the lease term and defer the residual guarantee payment. The property is owned
by an unrelated entity that is leasing the facility to the Company. The Company
plans to occupy the building in June 1998.
F-38
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Total expenses for operating leases for the years ended December 31, 1997,
1996 and 1995 were $15 million, $12 million and $9 million, respectively. The
Company is required, at a minimum, to make the following payments on capital and
operating leases:
<TABLE>
<CAPTION>
CAPITAL OPERATING
------- ---------
(IN MILLIONS)
<S> <C> <C>
1998....................................................... $ 5 $ 19
1999....................................................... 5 80
2000....................................................... 5 14
2001....................................................... 5 11
2002....................................................... 5 10
Thereafter................................................. 28 49
--- ----
Total minimum lease payments............................... 53 $183
====
Less--amounts representing interest........................ 23
---
Capital lease obligations.................................. 30
Less--amounts due within one year.......................... 2
---
Noncurrent portion of capital lease obligations............ $28
===
</TABLE>
9. COMMITMENTS AND CONTINGENCIES
Capital Requirements
During 1998, the Company expects that its nonbinding commitment for capital
expenditures (excluding acquisitions) will increase from the levels expended in
1997 and is dependent on the Company's geographic and revenue growth. The
Company's capital requirements are primarily for switching and transmission
facilities and technology platforms arising from the Company's strategic
expansion plans. In addition to its ongoing capital requirements, the Company
has entered into several agreements to extend its fiber-optic network. These
commitments will extend the Network throughout several geographic areas of the
United States, and are expected to require incremental capital expenditures of
approximately $250 million for fiber-optic capacity and related equipment. The
timing of payments will depend on the delivery and acceptance of facilities,
which are expected to be completed in the first half of 1998.
Vendor Agreements
The Company has agreements with certain interexchange carriers, LECs and
third-party vendors to lease facilities for originating, terminating and
transport services. Some agreements require the Company to maintain minimum
monthly and/or annual billings based on usage. The Company has met and expects
to continue to meet these minimum usage requirements.
During 1997, the Company amended an agreement with its largest provider of
leased and international services. Under the terms of the amended contract, the
Company is no longer obligated to use that carrier for its leased facilities and
the minimum usage commitments were significantly reduced. In addition, the
Company received a usage credit in exchange for agreeing to increases in certain
domestic and international switch services. The Company ects to mitigate the
impact of increased rates by applying the credit against future use of services
during the two-year agreement period, as well as using alternative arrangements
and strategic investments to reduce the reliance on this third-party carrier.
Legal Matters
The Company has been named as a defendant in various litigation matters.
Management intends to vigorously defend these outstanding claims. The Company
believes it has adequate accrued loss contingencies.
F-39
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Although the ultimate outcome of these claims cannot be ascertained at this
time, in management's opinion, current pending or threatened litigation matters
will not have a material adverse impact on the Company's results of operations
or financial condition.
10. SHAREOWNERS' EQUITY
Preferred Stock
In January 1997, the Board of Directors adopted a shareholder rights agreement
(Rights Agreement) designed to ensure that shareowners receive fair and equal
treatment in the event of a proposed takeover of the Company. One preferred
share purchase right (Right) has been attached to each share of the Company's
Common Stock to shareowners of record on January 22, 1997 (and all subsequently
issued shares) and, until distributed, may be transferred only with the Common
Stock. Each Right, when exercisable, represents the right to purchase one
one-thousandth of a share of a newly issued series of preferred stock of the
Company, designated as Junior Participating Preferred Stock, par value $.01 per
share or, in certain circumstances, to purchase shares of Common Stock at less
than the prevailing market price. The exercise price is $100 per Right, the
redemption price is $.01 per Right, and the Right expires on January 22, 2007.
The Rights will be distributed and become exercisable only in the event that any
person or entity, together with its affiliates or associates, acquires more than
a certain specified percentage of Common Stock of the Company.
On September 3, 1996, the remaining outstanding shares of the Company's
previously outstanding 5% Cumulative Convertible Exchangeable Preferred Stock
(Convertible Preferred Stock) were redeemed by the Company. Preferred dividends,
cumulative from the date of issuance, were paid quarterly at an annual rate of
$1.25 per share on the outstanding shares until redemption. Prior to redemption,
shareowners converted 4.6 million shares of Convertible Preferred Stock into
12.1 million shares of Common Stock.
Common Stock
In December 1997, the Company issued 12.4 million shares of Common Stock in
connection with the merger of USLD with LCI Acquisition Corp., a wholly owned
subsidiary of the Company. In September 1995, the Company issued 4.6 million
shares of Common Stock to purchase CTG.
Common Stock Warrants
In 1993, the Company issued warrants for 5.4 million shares of Common Stock,
at $2.83 per share. During 1997 and 1996, respectively, warrant holders
exercised 5.2 million and 0.2 million warrants for an aggregate amount of 4.6
million and 0.2 million shares of Common Stock. As of December 31, 1997, all
Common Stock warrants had been exercised. USLD had granted warrants to purchase
shares of Common Stock pursuant to telecommunications service agreements in
1992, 1995 and 1997. Pursuant to the merger agreement, each outstanding warrant
was converted into a warrant to purchase Common Stock of LCI based on the
conversion ratio stated in the terms of the merger agreement. As of December 31,
1997, approximately 0.2 million of these warrants were outstanding.
Employee Benefit Plans
The Company maintains a defined contribution retirement plan for its
employees. Under this plan, eligible employees may contribute a percentage of
their base salary, subject to certain limitations. Beginning in 1994, the
Company elected to match a portion of the employees' contributions. The expense
of the Company's matching contribution was approximately $1 million
for each year ending December 31, 1997, 1996 and 1995.
F-40
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. INCENTIVE STOCK PLANS
Stock Options
The Company has stock option plans under which options to purchase shares of
Common Stock may be granted to directors and key employees. Under the plans, the
Company may grant incentive stock options (ISOs), as defined by the Internal
Revenue Code, or non-qualified options (NQOs). Stock options generally have a
five-year vesting period. In the event of a change in control of the Company,
all options outstanding would become 100% exercisable. Under the plans, options
expire up to 10 years after the date of the grant and shares of Common Stock
underlying surrendered options may be re-granted by the Board of Directors.
Options that had been issued pursuant to USLD option plans were converted to
options to purchase Common Stock of LCI based on the conversion ratio stated in
the terms of the merger agreement. Upon the effective date of the merger, all
USLD options became fully vested and exercisable, but otherwise have the same
terms and conditions in effect prior to the merger.
The option price under all plans is fixed at the discretion of the
Compensation Committee of the Board of Directors at the time of grant. During
1997, 1996 and 1995, the option prices for all options granted were the fair
market value of the shares on the date of grant. As of December 31, 1997, there
were 18 million options authorized under the Company's stock option plans.
<TABLE>
<CAPTION>
NUMBER WEIGHTED
OF EXERCISABLE AVERAGE
SHARES OPTIONS EXERCISE PRICE
------ ----------- --------------
(IN MILLIONS)
<S> <C> <C> <C>
OUTSTANDING AS OF DECEMBER 31, 1994....... 7 3 $ 5.28
Options granted........................... 4 12.49
Options exercised......................... (1) 6.52
Options surrendered....................... (1) 14.09
--- --- ------
OUTSTANDING AS OF DECEMBER 31, 1995....... 9 4 7.37
--- --- ------
Options granted........................... 3 18.92
Options exercised......................... (1) 7.17
Options surrendered....................... -- 16.66
--- --- ------
OUTSTANDING AS OF DECEMBER 31, 1996....... 11 5 10.27
--- --- ------
Options granted........................... 4 19.76
Options exercised......................... (2) 5.18
Options surrendered....................... (1) 19.67
--- --- ------
OUTSTANDING AS OF DECEMBER 31, 1997....... 12 7 $13.44
--- --- ------
Options available for grant as of December
31, 1997................................. 4
</TABLE>
The following table presents information for the 12 million options
outstanding as of December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ -------------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER OF EXERCISE CONTRACTUAL NUMBER OF EXERCISE
PRICE OPTIONS PRICE LIFE (YEARS) OPTIONS PRICE
-------- --------- -------- ------------ ---------- -----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
$ 0.17 -
$ 2.83 1 $ 2.00 4 1 $ 2.00
$ 4.56 -
$ 8.91 3 $ 6.93 5 2 $ 6.88
$ 9.75 -
$11.21 2 $ 11.05 7 2 $ 10.94
$11.25 -
$19.31 3 $ 18.68 8 1 $ 15.55
$19.35 -
$35.13 3 $ 22.62 8 1 $ 22.65
</TABLE>
F-41
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Employee Stock Purchase Plan
The Company has an employee stock purchase plan (ESPP) that enables
substantially all employees to purchase shares of Common Stock on monthly
offering dates at a purchase price equal to the lesser of 85% of the fair market
value of the Common Stock on the date of its purchase or 85% of the fair market
value of the Common Stock, as established at intervals from time to time. In
August 1997, the Company amended the ESPP to extend the offering period through
February 2000 or until shares authorized under the ESPP are exhausted. A maximum
of 1.8 million shares of Common Stock were authorized for purchase under the
ESPP. During 1997, 1996 and 1995, respectively, 0.4 million, 0.3 million and 0.2
million shares were issued under the ESPP at average prices of $19.02, $24.64
and $11.59. As of December 31, 1997, the amount of Common Stock available for
issuance under the ESPP was 0.7 million shares.
Stock-Based Compensation Plans
The Company follows the requirements of APB No. 25 to account for its stock
option plans and ESPP and, accordingly, no compensation cost is recognized in
the Consolidated Statements of Operations for these plans. In 1996, the Company
adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which requires
certain disclosures about stock-based employee compensation arrangements. SFAS
No. 123 requires pro forma disclosure of the impact on net income and earnings
per share if the fair value method defined in SFAS No. 123 had been used.
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model, with the following weighted average
assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free
interest rates of 6.2%, 5.7% and 6.7% for the stock option plans and 5.6%, 5.5%
and 5.6% for the ESPP; no expected dividend yields; expected lives of 5.2 years,
3.9 years and 4.0 years for the stock option plans and 0.7 years, 1.5 years and
2.2 years for the ESPP; and expected volatility of 46.7%, 39.6% and 48.3% for
the stock option plans and 44.1%, 45.3% and 47.5% for the ESPP. The weighted
compiled average fair values of options granted during 1997, 1996 and 1995 for
the stock option plans were $8.48, $6.69 and $4.53, respectively, and for the
employee stock purchase plan were $6.02, $9.48 and $7.17, respectively.
Pro forma net income, as if the fair value method had been applied, was $15
million, $66 million and $60 million for the years ended December 31, 1997, 1996
and 1995, respectively. The pro forma earnings per share on a diluted basis for
the same periods were $0.16, $0.66 and $0.65.
In accordance with SFAS No. 123, the fair value method was not applied to
options granted prior to January 1, 1995. The resulting pro forma impact may not
be representative of results to be expected in future periods and is not
reflective of actual stock performance.
F-42
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. EARNINGS PER SHARE
In February 1997, SFAS No. 128, "Earnings per Share," was issued, which
required the Company to change the method used to calculate earnings per share.
Basic earnings per share were calculated as income available to common
shareowners divided by the weighted average number of common shares outstanding.
Diluted earnings per share were calculated as net income divided by the diluted
weighted average number of common shares. Diluted weighted average number of
common shares was calculated using the treasury stock method for Common Stock
equivalents, which included Common Stock issuable pursuant to stock options,
Common Stock warrants and Convertible Preferred Stock. The following is provided
to reconcile the earnings per share calculations:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
INCOME:
Net income............................................ $ 31 $ 74 $ 64
Less--preferred dividends........................... -- (3) (6)
------ ------ ------
Income available to common shareowners................ $ 31 $ 71 $ 58
====== ====== ======
Shares:
Weighted average shares (Basic)....................... 91 83 71
------ ------ ------
Effect of dilutive securities:
Stock options....................................... 4 6 5
Warrants............................................ 4 5 4
Convertible Preferred Stock......................... -- 5 12
------ ------ ------
Diluted weighted average shares....................... 99 99 92
------ ------ ------
PER SHARE AMOUNTS:
Basic earnings per share.............................. $ 0.34 $ 0.86 $ 0.81
====== ====== ======
Diluted earnings per share............................ $ 0.32 $ 0.75 $ 0.69
====== ====== ======
</TABLE>
13. INCOME TAXES
Income tax expenses for the years ended December 31, 1997, 1996 and 1995,
consisted of:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(IN MILLIONS)
<S> <C> <C> <C>
Current tax expense (benefit):
Federal................................................... $ 1 $ 3 $ (4)
State..................................................... 3 1 --
Deferred tax expense:
Increase in deferred tax liability........................ 22 4 5
Decrease in deferred tax asset............................ 5 38 27
Decrease in valuation allowance........................... -- (8) (12)
--- --- ----
Income tax expense....................................... $31 $38 $ 16
=== === ====
</TABLE>
The decrease in the valuation allowance in 1996 and 1995 resulted from the
Company's realization of its net operating loss (NOL) carryforwards based on the
Company's growth in recurring operating income.
F-43
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company pays state income taxes on the greater of a net worth basis or an
income basis in a majority of the states in which it operates. The Company
records state deferred tax assets and liabilities, net of its federal benefit,
at an average blended rate of 4%.
The effective income tax rate varies from the federal statutory rate for the
years ended December 31, 1997, 1996 and 1995, as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Expected tax expense at federal statutory
income tax rate........................... $ 22 35% $ 35 35% $ 23 35%
Effect of:
State income tax expense................. 2 3 5 5 2 3
Merger-related expenses.................. 5 9 -- -- -- --
Non-deductible expenses.................. 2 3 4 4 1 2
Change in valuation allowance............ -- -- (8) (8) (12) (18)
Other, net............................... -- -- 2 2 2 3
---- --- ---- --- ---- ---
Income tax expense..................... $ 31 50% $ 38 38% $ 16 25%
==== === ==== === ==== ===
</TABLE>
The significant items giving rise to the deferred tax (assets) and liabilities
as of December 31, 1997 and 1996, were:
<TABLE>
<CAPTION>
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
Deferred tax liabilities:
Property and equipment..................................... $ 65 $ 42
Acquisition related........................................ 26 24
Deferred expenses.......................................... 4 3
------ ------
Total deferred tax liabilities........................... 95 69
------ ------
Deferred tax (assets):
Other loss contingencies................................... (2) (6)
Property and other taxes................................... (8) (4)
Accrued expenses........................................... (9) (5)
Acquired assets............................................ (5) (5)
NOLs and tax credit carryforwards.......................... (46) (44)
------ ------
Total deferred tax (assets).............................. (70) (64)
------ ------
Net deferred tax liability............................. $ 25 $ 5
====== ======
</TABLE>
The Company's 1997 deferred income tax balances were included in current
deferred tax assets, net of $59 million, and in other liabilities and other
deferred credits of $84 million. The 1996 deferred income tax balances were
included in current deferred tax assets, net of $51 million, and in other
liabilities and other deferred credits of $56 million.
The Company has generated significant NOLs that may be used to offset future
taxable income. Each year's NOL has a maximum 15-year carryforward period. The
Company's ability to fully use its NOL carryforwards is dependent on future
taxable income. As of December 31, 1997, the Company has NOL carryforwards of
$104 million for income tax return purposes subject to various expiration dates
beginning in 1998 and ending in 2010. The future tax benefit of these NOL
carryforwards of $43 million and $41 million in 1997 and 1996, respectively, has
been recorded as a deferred tax asset.
F-44
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations
for the two years ended December 31:
<TABLE>
<CAPTION>
1997
--------------------------------------------------
FIRST SECOND THIRD FOURTH
----------- ------------ ----------- -------------
(IN MILLIONS, EXCEPT EARNINGS PER COMMON SHARE)
<S> <C> <C> <C> <C>
Revenues................. $ 368 $ 399 $ 430 $ 446
Cost of services......... 219 240 256 271
----------- ----------- ----------- -------------
Gross margin........... 149 159 174 175
Selling, general and
administrative expenses. 84 90 98 136
Merger charges........... -- -- 1 44
Restructuring charges.... -- 1 -- 8
Depreciation and
amortization............ 21 23 26 25
----------- ----------- ----------- -------------
Operating income
(loss)................ 44 45 49 (38)
Interest and other
expense, net............ 7 7 9 13
----------- ----------- ----------- -------------
Income (loss) before
income taxes.......... 37 38 40 (51)
Income tax expense
(benefit)............... 15 15 16 (14)
----------- ----------- ----------- -------------
Net income (loss)...... 22 23 24 (37)
----------- ----------- ----------- -------------
EARNINGS PER COMMON SHARE
Earnings per share--
basic................. $ 0.25 $ 0.25 $ 0.27 $ (0.39)
----------- ----------- ----------- -------------
Earnings per common
share--diluted........ $ 0.22 $ 0.23 $ 0.24 $ (0.39)
----------- ----------- ----------- -------------
Basic weighted average
shares................ 89 90 91 95
----------- ----------- ----------- -------------
Diluted weighted
average shares........ 99 98 99 95(a)
----------- ----------- ----------- -------------
<CAPTION>
1996
--------------------------------------------------
FIRST SECOND THIRD FOURTH
----------- ------------ ----------- -------------
(IN MILLIONS, EXCEPT EARNINGS PER COMMON SHARE)
<S> <C> <C> <C> <C>
Revenues................. $ 297 $ 321 $ 341 $ 344
Cost of services......... 180 193 201 203
----------- ----------- ----------- -------------
Gross margin........... 117 128 140 141
Selling, general and
administrative expenses. 70 75 81 80
Restructuring charges.... -- 7 9 --
Depreciation and
amortization............ 17 18 20 20
----------- ----------- ----------- -------------
Operating income....... 30 28 30 41
Interest and other
expense, net............ 8 7 8 6
----------- ----------- ----------- -------------
Income before income
taxes................... 22 21 22 35
Income tax expense..... 8 7 10 12
----------- ----------- ----------- -------------
Income from continuing
operations.............. 14 14 12 23
Discontinued operations.. 5 4 2 --
----------- ----------- ----------- -------------
Net income............. 19 18 14 23
Income on common stock. $ 18 $ 17 $ 14 $ 23
----------- ----------- ----------- -------------
EARNINGS PER COMMON SHARE
Earnings per common
share--basic.......... $ 0.23 $ 0.21 $ 0.16 $ 0.26
----------- ----------- ----------- -------------
Earnings per common
share--diluted........ $ 0.20 $ 0.18 $ 0.14 $ 0.23
----------- ----------- ----------- -------------
Basic weighted average
shares................ 77 81 86 89
----------- ----------- ----------- -------------
Diluted weighted
average shares........ 98 99 99 100
----------- ----------- ----------- -------------
</TABLE>
- --------
(a) Common Stock equivalents were antidilutive and therefore excluded from
weighted average shares.
F-45
<PAGE>
LCI INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. SUBSEQUENT EVENT
On March 8, 1998, the Company entered into a merger agreement with Qwest
Communications International Inc. (Qwest) and a subsidiary of Qwest pursuant to
which LCI will become a wholly owned subsidiary of Qwest. The all-stock
transaction is valued at approximately $4.4 billion. Under the terms of the
agreement, each of the outstanding shares of the Company's common stock, par
value $.01 per share, will be converted into $42 of Qwest common stock, subject
to certain exceptions. The number of shares of Qwest common stock to be
exchanged for each share of the Company's common stock will be determined by
dividing $42 by a 15-day volume weighted average of trading prices for Qwest
common stock prior to the closing, but will not be less than 1.0625 shares (if
Qwest's average stock price exceeds $39.53) or more than 1.5583 shares (if
Qwest's average stock price is less than $26.95). The Company may terminate the
merger agreement if Qwest's average stock price is less than $26.95, unless
Qwest then agrees to exchange for each share of common stock of the Company the
number of Qwest shares determined by dividing $42 by such average price. The
merger is intended to qualify as a tax-free reorganization and will be accounted
for as a purchase. It is anticipated that the merger will occur by the end of
the third quarter of 1998. The transaction is subject to the majority vote of
the outstanding shares of Qwest and LCI and to other customary conditions such
as receipt of regulatory approvals. The majority shareholder of Qwest has
entered into an agreement to vote in favor of the merger. There can be no
assurances that the conditions to closing of the merger will be met.
F-46
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Phoenix Network, Inc.
We have audited the accompanying consolidated balance sheets of Phoenix
Network, Inc. (a Delaware Corporation) and Subsidiaries as of December 31, 1996
and 1997, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Phoenix
Network, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
The accompanying consolidated financial statements as of December 31, 1997 and
1996, have been prepared assuming that the Company will continue as a going
concern. However, the Company has sustained substantial losses from operations
in recent years and has continually used, rather than provided, cash in its
operations. Such losses, and other items discussed in note B, raise substantial
doubt about the Company's ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. Management's plans in regard to
these matters are also discussed in note B.
GRANT THORNTON LLP
Denver, Colorado
February 19, 1998
F-47
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
<TABLE>
<CAPTION>
ASSETS 1996 1997
------ ------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents........................ $ 1,548,061 $ 447,983
Accounts receivable, net of allowance for
doubtful accounts of $3,600,830 in 1996 and
$1,280,444 in 1997.............................. 14,419,829 9,623,721
Prepaid carrier costs............................ -- 1,274,790
Deferred commissions............................. 969,940 405,329
Other current assets............................. 686,271 459,808
------------ ------------
Total current assets........................... 17,624,101 12,211,631
Furniture, equipment and data processing systems--
at cost, less accumulated depreciation of
$2,495,701 in 1996 and $3,479,973 in 1997......... 5,522,771 3,078,020
Deferred commissions............................... 414,873 71,617
Customer acquisition costs, less accumulated
amortization of $3,145,245 in 1996 and $4,664,092
in 1997........................................... 2,725,275 1,177,043
Goodwill, less accumulated amortization of
$1,059,613 in 1996 and $2,049,731 in 1997......... 18,553,332 17,816,119
Other assets....................................... 953,831 779,245
------------ ------------
$ 45,794,183 $ 35,133,675
============ ============
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
CURRENT LIABILITIES
Current maturities of capital lease.............. $ -- $ 140,635
Current maturities of note payable to
stockholder..................................... -- 1,388,206
Current maturities of note payable to finance
company......................................... 444,839 483,283
Note payable to vendor........................... 1,161,148 --
Line of credit--finance company.................. 4,698,645 6,663,349
Accounts payable................................. 16,686,690 14,533,446
Accrued liabilities.............................. 2,418,627 1,842,685
------------ ------------
Total current liabilities...................... 25,409,949 25,051,604
LONG-TERM DEBT
Note payable to stockholder...................... 1,388,206 --
Note payable to finance company, less current
maturities...................................... 824,306 355,364
Capital lease, less current maturities........... -- 30,464
COMMITMENTS AND CONTINGENCIES...................... -- --
STOCKHOLDERS' EQUITY
Preferred stock--$.001 par value, authorized 5,000,000 shares, issued and
outstanding 546,458 in 1996 and 39,500 in 1997, liquidation preference
aggregating $3,368,020 and $808,181
at December 31, 1996 and 1997, respectively..... 546 39
Common stock--$.001 par value, authorized
50,000,000 shares, issued 25,851,894 in 1996 and
33,575,902 in 1997.............................. 25,851 33,576
Additional paid-in capital....................... 45,225,554 52,587,282
Accumulated deficit.............................. (27,077,707) (42,922,132)
Treasury stock--1,300 common shares at cost...... (2,522) (2,522)
------------ ------------
18,171,722 9,696,243
------------ ------------
$ 45,794,183 $ 35,133,675
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-48
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
Revenue............................... $75,854,969 $ 99,307,277 $ 76,947,454
Cost of revenue....................... 53,775,779 73,438,757 57,195,121
----------- ------------ ------------
Gross profit...................... 22,079,190 25,868,520 19,752,333
Selling, general and administrative
expenses............................. 22,323,202 31,114,723 25,940,774
Depreciation and amortization......... 1,125,563 4,357,720 3,972,924
Relocation expenses................... -- 1,133,158 -
Acquisition expenses.................. -- 1,308,634 513,457
Loss on abandonment of fixed assets... 1,019,648 15,238 3,260,204
Aborted bond offering expenses........ -- 246,083 --
----------- ------------ ------------
24,468,413 38,175,556 33,687,359
----------- ------------ ------------
Operating loss.................... (2,389,223) (12,307,036) (13,935,026)
Other income (expense)
Interest income..................... 103,125 84,627 70,518
Interest expense.................... (260,639) (625,817) (1,091,489)
Miscellaneous income (expense)...... (6,767) 4,264 11,013
----------- ------------ ------------
Loss before income taxes.......... (2,553,504) (12,843,962) (14,944,984)
Income tax expense.................... (500,000) -- --
----------- ------------ ------------
Net loss.......................... $(3,053,504) $(12,843,962) $(14,944,984)
Net loss attributable to common shares
Net loss............................ $(3,053,504) $(12,843,962) $(14,944,984)
Preferred dividends................. (594,381) (1,206,042) (179,126)
----------- ------------ ------------
$(3,647,885) $(14,050,004) $(15,124,110)
=========== ============ ============
Basic loss per common share........... $ (0.24) $ (0.68) $ (0.52)
=========== ============ ============
Weighted average common shares........ 15,335,268 20,673,276 28,951,196
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-49
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED COMMON PAID-IN ACCUMULATED TREASURY
STOCK STOCK CAPITAL DEFICIT STOCK
--------- -------- ----------- ------------ --------
<S> <C> <C> <C> <C> <C>
Balance at January 1,
1995................... $ 1,622 $ 13,825 $14,227,069 $ (9,728,142) $ (2,522)
Exercise of stock
options and
warrants............. -- 418 525,914 -- --
Conversion of
preferred stock into
common stock......... (4) 24 7,200 (7,220) --
Issuance of common
stock, net of
expenses............. -- 2,685 6,314,779 -- --
Issuance of preferred
stock, net of
expenses, and
conversion of Series
E and Series F....... 1,119 -- 11,071,674 -- --
Preferred dividends... -- -- -- (187,288) --
Net loss.............. -- -- -- (3,053,504) --
------- -------- ----------- ------------ --------
Balance at December 31,
1995................... 2,737 16,952 32,146,636 (12,976,154) (2,522)
Exercise of stock
options and
warrants............. -- 792 1,327,243 -- --
Conversion of
preferred stock into
common stock......... (2,191) 5,307 1,254,475 (1,257,591) --
Issuance of common
stock in connection
with a business
acquisition.......... -- 2,800 10,497,200 -- --
Net loss.............. -- -- -- (12,843,962) --
------- -------- ----------- ------------ --------
Balance at December 31,
1996................... 546 25,851 45,225,554 (27,077,707) (2,522)
Exercise of stock
options and
warrants............. -- 942 921,563 -- --
Conversion of
preferred
stock into common
stock................ (782) 6,783 893,440 (899,441) --
Issuance of preferred
stock................ 275 -- 5,224,725 -- --
Issuance of 200,000
common stock purchase
warrants............. -- -- 322,000 -- --
Net loss.............. -- -- -- (14,944,984) --
------- -------- ----------- ------------ --------
Balance at December 31,
1997................... $ 39 $ 33,576 $52,587,282 $(42,922,132) $ (2,522)
======= ======== =========== ============ ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-50
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1995 1996 1997
------------ ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities
Cash received from customers...... $ 72,103,864 $ 98,612,681 $ 78,250,720
Interest received................. 83,227 84,627 70,518
Cash paid to suppliers and
employees........................ (73,638,371) (102,047,484) (82,823,340)
Interest paid..................... (259,919) (625,817) (1,091,489)
Cash paid for income taxes........ (3,340) (2,245) --
------------ ------------- ------------
Net cash used in operating
activities..................... (1,714,539) (3,978,238) (5,593,591)
Cash flows from investing activities
Note receivable--
director/shareholder............. (3,000) -- -
Purchases of furniture, equipment
and data processing systems...... (589,419) (3,620,989) (1,652,566)
Notes receivable--agents.......... (23,115) -- -
Payments on agents notes
receivable....................... 70,900 -- -
Customer base acquisitions........ (1,553,238) (468,002) -
Business acquisitions, net of cash
acquired......................... (4,692,153) (4,085,093) -
Additions to goodwill............. -- -- (252,907)
------------ ------------- ------------
Net cash used in investing
activities..................... (6,790,025) (8,174,084) (1,905,474)
Cash flows from financing activities
Proceeds from issuance of common
stock, net of offering costs..... 6,317,464 -- -
Proceeds from issuance of
preferred stock, net of offering
costs............................ 11,072,793 -- 5,225,000
Proceeds from notes payable to
bank and finance company......... 6,143,950 6,060,358 3,575,000
Payments on notes payable to bank
and finance company.............. (8,686,625) (134,036) (2,040,794)
Payments on note payable to
vendor........................... -- (1,851,977) (1,161,148)
Payments on capital lease
obligation....................... -- -- (121,576)
Preferred stock dividends......... (187,288) -- -
Proceeds from exercise of options
and warrants..................... 526,332 1,328,035 922,505
------------ ------------- ------------
Net cash provided by financing
activities..................... 15,186,626 5,402,380 6,398,987
------------ ------------- ------------
NET INCREASE (DECREASE) IN
CASH........................... 6,682,062 (6,749,942) (1,100,078)
Cash and cash equivalents at
beginning of year.................. 1,615,941 8,298,003 1,548,061
------------ ------------- ------------
Cash and cash equivalents at end of
year............................... $ 8,298,003 $ 1,548,061 $ 447,983
============ ============= ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-51
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
Reconciliation of net loss to net cash
provided by (used in) operating
activities
Net loss............................ $(3,053,504) $(12,843,962) $(14,944,984)
Adjustments to reconcile net loss to
net cash used in operating
activities
Provision for doubtful accounts... 2,689,250 3,147,077 3,407,842
Abandonment of fixed assets....... 1,019,648 15,238 3,260,204
Depreciation and amortization..... 1,125,563 4,357,720 3,972,924
Deferred taxes.................... 500,000 -- --
Changes in assets and liabilities
Accounts receivable............. (3,751,105) (959,900) 1,388,266
Deferred commissions............ (1,467,519) 1,718,450 907,867
Prepaid carrier costs........... -- -- (1,274,790)
Other current assets............ (163,740) (217,473) 226,464
Other assets.................... 511 (67,893) 191,802
Accounts payable and accrued
liabilities.................... 1,386,357 872,505 (2,729,186)
----------- ------------ ------------
Net cash used in operating ac-
tivities..................... $(1,714,539) $ (3,978,238) $ (5,593,591)
=========== ============ ============
Noncash financing and investing
activities
Conversion of preferred stock into
common stock....................... $ 7,224 $ 1,259,782 $ 900,223
Capital lease obligation............ -- -- 292,675
Noncash components of consideration
issued in connection with business
combination
Common stock...................... -- 10,500,000 --
Note payable to stockholder....... -- 1,388,206 --
Assumption of net liabilities..... -- 1,603,576 --
</TABLE>
The accompanying notes are an integral part of these statements.
F-52
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--DESCRIPTION OF COMPANY AND SUMMARY OF ACCOUNTING POLICIES
Phoenix Network, Inc. ("Phoenix" or the "Company") was a switchless reseller
of long distance telecommunication services marketing primarily to small- to
medium-sized commercial accounts located throughout the United States. Effective
January 1, 1996, as a result of the acquisition of Automated Communications,
Inc. ("ACI"), the Company became a facilities based reseller. The Company
provides its customers with long distance services utilizing the networks of
facilities-based carriers such as AT&T Corporation, MCI Communications
Corporation, Sprint Communications, L.P., Frontier Corp., WorldCom, Inc.
(formerly Wiltel, Inc.) and others, who handle the actual transmission services.
The carriers bill Phoenix at contractual rates for the combined usage of
Phoenix's customers utilizing their network. Phoenix then bills its customers
individually at rates established by Phoenix.
The following is a summary of the Company's significant accounting policies
applied in the preparation of the accompanying consolidated financial
statements.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions are eliminated in
consolidation.
Revenue Recognition
Revenue is recognized in the month in which the Company's customers complete
the telephone call.
Cash and Cash Equivalents
The Company considers demand deposits, certificates of deposit and United
States Treasury bills purchased with a maturity of three months or less as cash
and cash equivalents.
Prepaid Carrier Costs
Prepaid carrier costs consist of contract shortfall billings which are
anticipated to be recovered through increased usage during the remaining term of
the contract.
Deferred Commissions
Deferred commissions consist of direct commissions paid on a one-time basis to
third parties upon the acquisition of new customers. Deferred commissions are
amortized on a four year sum-of-the-year's-digits method.
Furniture, Equipment and Data Processing Systems
Depreciation of furniture, equipment and data processing systems is provided
utilizing the straight-line method over five years.
Customer Acquisition Costs
Customer acquisition costs represent the value of acquired billing bases of
customers and are amortized using the sum-of-the-years-digits method over a
four-year period.
Goodwill
Goodwill represents the excess of cost over the fair value of the net assets
acquired and is being amortized by the straight-line method over 20 years.
F-53
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Impairment of Long-Lived Assets
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 121, Accounting for the Impairment of Long- Lived
Assets and for Long-Lived Assets to Be Disposed of (SFAS 121). SFAS 121 requires
that long-lived assets and certain identifiable intangibles held and used by an
entity be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If the sum
of the expected future cash flows (undiscounted and without interest) is less
than the carrying amount of the asset, an impairment loss is recognized.
Measurement of that loss would be based on the fair value of the asset. SFAS 121
also generally requires that long-lived assets and certain identifiable
intangibles to be disposed of be reported at the lower of the carrying amount or
the fair value, less cost to sell. SFAS 121 is effective for the Company's 1997
fiscal year end. Any impairment provisions recognized in accordance with SFAS
121 are permanent and may not be restored in the future. No impairment expense
was recognized in the years ended December 31, 1997 and 1996.
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, as
well as revenue and expenses during the period. Significant estimates made by
management include the allowance for doubtful accounts, estimated carrier
credits, and the amortization periods related to acquired customers and
goodwill. Actual results could differ from those estimates.
Income Taxes
Deferred income taxes are recognized for tax consequences of temporary
differences by applying current enacted tax rates to differences between the
financial reporting and the tax basis of existing assets and liabilities.
Loss per Common Share
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.
EPS is computed in accordance with SFAS 128 by dividing net income by the
weighted average number of shares outstanding during the period. All outstanding
securities at the end of 1997 which could be converted into common shares are
anti-dilutive (see note I). Therefore, the basic and diluted EPS are the same.
There is no impact on EPS for prior years as a result of the adoption of SFAS
128.
NOTE B--REALIZATION OF ASSETS
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles, which contemplate
continuation of the Company as a going concern. However, the Company has
sustained substantial losses from operations in recent years and has continually
used, rather than provided, cash in its operations. In addition, the Company is
delinquent on a payment of approximately $230,000 on a note payable to a
shareholder, which constitutes a default, rendering the entire
amount of the note payable (approximately $1.4 million) due and payable.
In view of the matters described in the preceding paragraph, recoverability of
a major portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent upon continued operations of the Company, which in turn is
dependent upon the Company's ability to meet its financial requirements on a
F-54
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
continuing basis, to maintain present financing and to succeed in its future
operations. The financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classifications of liabilities that might be necessary should the Company be
unable to continue in existence.
In 1998, management entered into a merger agreement with a subsidiary of Qwest
Communications International Inc., a facilities-based provider of multi- media
communications services to interexchange carriers and to businesses and
consumers. The merger, subject to approval by Phoenix's shareholders on March
30, 1998, would result in Phoenix shareholders receiving stock of Qwest with an
aggregate market value of approximately $28.5 million, subject to certain
adjustments and limitations described in the merger agreement, and up to $4
million in cash, contingent upon the outcome of certain litigation.
NOTE C--POOLING-OF-INTERESTS, ACQUISITIONS, AND MERGERS
On October 8, 1996, Phoenix Merger Corp., a wholly-owned subsidiary of
Phoenix, was merged with and into Americonnect, Inc. and 2,663,810 shares of the
Company's common stock were issued in exchange for all of the outstanding common
stock of Americonnect. The merger was accounted for as a pooling-of-interests
and, accordingly, the accompanying financial statements have been restated to
include the accounts and operations of Americonnect for all periods prior to the
merger.
Separate results of the combining entities for the year ended December 31,
1995, are as follows (amounts in 000s):
<TABLE>
<S> <C>
Net sales
Phoenix........................................................ $58,755
Americonnect................................................... 17,100
-------
$75,855
=======
Net income (loss)
Phoenix........................................................ $(1,334)
Americonnect................................................... (1,719)
-------
$(3,053)
=======
</TABLE>
In connection with the merger, approximately $1.3 million of merger costs and
expenses were incurred and have been charged to expense in the Company's fourth
quarter of 1996.
In August 1995, the Company acquired in purchase transactions the customer
bases and substantially all of the assets and liabilities of Tele-Trend
Communications, LLC ("Tele-Trend"), a Denver based switchless reseller, and
Bright Telecom L.P. ("Bright"), an international call-back provider, for
$4,369,317 and $356,388, respectively. The operations of Tele-Trend and Bright
are included from August 1, 1995. Additionally, during 1995, the Company
acquired three customer bases at a cost of $2,078,238.
In January 1996, the Company acquired, in a purchase transaction, Automated
Communications, Inc. (ACI), a Golden, Colorado, facilities-based long distance
phone service carrier operating switching centers in Colorado Springs,
Minneapolis, and Phoenix. Consideration for the acquisition was in the form of
$4,085,093 in cash, 2,800,000 shares of the Company's common stock valued at
approximately $10,500,000, a long-term note of $1,388,206 bearing interest at
9%, and the assumption of net liabilities of $1,603,576. The Company's
consolidated results of operations include ACI from January 1, 1996, the
effective date of the purchase transaction. The excess of the purchase price
over the fair market value of the assets and liabilities acquired has
F-55
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
been allocated to customer acquisition costs ($1,950,000) and to goodwill
($15,626,875). Customer acquisition costs are amortized over four years using
the sum-of-the-years-digits method, and goodwill is amortized on a straight-line
basis over 20 years.
The following unaudited condensed pro forma information presents the results
of operations of the Company as if the acquisition of ACI and Tele- Trend had
occurred on January 1, 1995.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1995
-----------------
<S> <C>
Revenue................................................. $104,729,000
Net loss................................................ $ (4,428,000)
Net loss attributable to common shares.................. $ (5,603,000)
Basic loss per common share............................. $ (0.31)
Weighted average number of shares outstanding........... 18,135,000
</TABLE>
NOTE D--FURNITURE, EQUIPMENT AND DATA PROCESSING SYSTEMS
Furniture, equipment and data processing systems consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
----------- -----------
<S> <C> <C>
Data processing systems......................... $ 4,872,174 $ 3,012,879
Switching equipment............................. 1,898,593 2,160,972
Furniture and fixtures.......................... 710,234 462,282
Other equipment................................. 537,471 921,860
----------- -----------
8,018,472 6,557,993
Less accumulated depreciation................... (2,495,701) (3,479,973)
----------- -----------
$ 5,522,771 $ 3,078,020
=========== ===========
</TABLE>
The loss on abandonment of assets in 1995 primarily relates to a write-off of
billing and customer service software development costs. Management decided to
minimize the risk of development and to have access to a new system on a more
timely basis and, accordingly, decided to license an existing billing and
customer service system from a vendor at a cost of approximately $3,000,000.
During the fourth quarter of 1997, management abandoned the current billing
system project, resulting in a loss on abandonment of assets in 1997 of
$3,260,204.
NOTE E--LINE OF CREDIT AND BRIDGE LOAN--FINANCE COMPANY
In September 1995, the Company renewed its Loan and Security Agreement (the
"Agreement") with a finance company to make available to the Company a line of
credit of up to $10,000,000. The Company may borrow up to the lesser of
$10,000,000 or its borrowing base, which is defined as a percentage of its
eligible receivables. The amended term of the Agreement is five years, expiring
October 2000, with automatic renewal options. There are penalties for early
termination by the Company. Borrowings bear interest at 1.75% over the
"reference rate," as defined. In connection with the renewal, fees and
transaction costs were incurred, which are being amortized on a straight-line
basis over the term of the agreement. The loan is collateralized by the
Company's accounts receivable, equipment, general intangibles and other personal
property assets. Among other provisions, the Company must maintain certain
minimum financial covenants, is prohibited from paying dividends without the
approval of the finance company, and is subject to limits on capital
expenditures. At December 31, 1997, the Company was in violation of certain
financial covenants. The finance company has waived the covenant violations in
connection with a restructuring of the line of credit agreement. At December 31,
1997, $6,663,349 was outstanding under the line and the interest rate was
10.25%.
F-56
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On March 12, 1997, the Phoenix Credit Facility was amended to provide for a
$2,000,000 bridge loan with the principal amount to be paid in eight equal
monthly installments between July 1, 1997 and January 1, 1998. The amendment
included the issuance of 200,000 common stock purchase warrants to the finance
company. Phoenix made installment payments of $250,000 in June, July and August
1997. On September 1, 1997, the parties entered into an amendment to provide for
a temporary moratorium on payments on the bridge loan with a final payment of
all outstanding principal and accrued and unpaid interest being due on January
9, 1998. On December 12, 1997, the Phoenix Credit Facility was again amended to
provide for an additional bridge loan of $1,825,000 and the retention of an
over-advance of $300,000. On December 31, 1997, the Phoenix Credit Facility was
further amended to provide that Foothill Capital Corporation may, in its sole
discretion, lend Phoenix an additional amount of up to $1.25 million, to be
treated either as an increase to the bridge loan amount or as an over-advance.
The bridge loan and any overadvance amounts must be repaid on the earliest to
occur of (a) April 30, 1998, (b) the effective time of the proposed merger with
the subsidiary of Qwest, or (c) termination of the Phoenix Credit Facility. On
February 2, 1998, the Phoenix Credit Facility was amended to provide for an
additional over-advance of $500,000 and to reduce the amount that Foothill
Capital Corporation may lend Phoenix from $1.25 million to $750,000.
Average daily outstanding borrowings for the year ended December 31, 1997, was
$4,092,859 at a weighted average interest rate of 10.25%. The highest month-end
balance outstanding for the year ended December 31, 1997 was $5,621,926.
NOTE F--LONG-TERM DEBT
During 1996, the Company entered into a note payable with a finance company to
fund the cost of new billing and customer service software. The note agreement
requires twelve quarterly payments of $138,854 plus accrued interest at 10.5%
commencing July 1996 through July 1999.
In addition, as part of the acquisition of Automated Communications, Inc., on
January 1, 1996, the Company issued a 9% note payable for $1,388,206 to a
current stockholder, which was payable in annual installments through 2001.
However, in January 1998, the Company failed to make the first installment on
the note and is currently in default thereon. On January 17, 1998, Phoenix
received a notice declaring a default under the note and notifying Phoenix that
if the scheduled payment is not received by February 2, 1998, the entire unpaid
principal balance of the note will become due and payable and that available
remedies would be pursued. Foothill Capital Corporation has waived the resulting
cross default in the Phoenix Credit Facility.
During 1997, the Company entered into a capital lease for the acquisition of
equipment with a cost of $292,675. The lease is payable in monthly installments
of $12,266 through March 1999.
Future minimum payments on long-term debt at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
NOTE PAYABLE TO NOTE PAYABLE CAPITAL
YEAR ENDED DECEMBER 31, FINANCE COMPANY TO STOCKHOLDER LEASE TOTAL
----------------------- --------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
1998..................... $483,283 $1,388,206 $140,635 $2,012,124
1999..................... 355,364 -- 30,464 385,828
-------- ---------- -------- ----------
$838,647 $1,388,206 $171,099 $2,397,952
======== ========== ======== ==========
</TABLE>
F-57
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE G--LEASES
The Company has operating leases for office space and equipment which expire
on various dates through 2001 and which require that the Company pay certain
maintenance, insurance and other operating expenses. Rent expense for the years
ended December 31, 1995, 1996 and 1997 was $1,028,462, $1,331,911 and
$1,162,274, respectively.
Future minimum lease payments for years ending December 31, are as follows:
<TABLE>
<S> <C>
1998........................................................... $1,896,558
1999........................................................... 1,680,892
2000........................................................... 820,160
2001........................................................... 358,386
----------
$4,755,996
==========
</TABLE>
NOTE H--COMMITMENTS AND CONTINGENCIES
Carrier Contracts
The Company has contracts with its major vendors to provide telecommunications
services to its customers. The agreements cover the pricing of the services and
are for various periods. Among other provisions, the agreements contain minimum
usage requirements which must be met to receive the contractual price and to
avoid shortfall penalties. The Company is currently in compliance with the
contractual requirements. Total future minimum usage commitments at December 31,
1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, COMMITMENT
------------------------ -----------
<S> <C>
1998........................................................ $18,350,000
1999........................................................ 1,000,000
-----------
Total....................................................... $19,350,000
===========
</TABLE>
Litigation
WorldCom, Inc. (formerly LDDS Communications, Inc.) commenced an action
against ACI and its former owner asserting claims relating to alleged breaches
of noncompete and confidentiality agreements signed in connection with two
transactions in which WorldCom was involved. The case was tried in federal court
in Jackson, Mississippi in October 1996. The trial judge has found that ACI and
its former owner breached the parties contracts, but has not ruled on whether
these breaches caused damage or, if so, in what amount. Damages in excess of $4
million have been requested by WorldCom. Phoenix believes it is entitled to be
indemnified for any liability with respect to the LDDS litigation pursuant to an
Indemnification and Hold Harmless Agreement entered into between ACI and its
former owner as part of the ACI merger. The ultimate liability to Phoenix, if
any, is not determinable at this time, nor is there any assurance that the
former owner of ACI has adequate financial resources to
pay Phoenix any or all amounts that may be owed pursuant to the Indemnification
and Hold Harmless Agreement. No provision has been made in the consolidated
financial statements for any potential loss related to this contingency.
In addition, Phoenix is a party, from time to time, in litigation incident to
its business. Management and legal counsel do not believe that any additional
current or pending litigation exists which will have a material adverse affect
on the Company's financial condition.
F-58
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE I--CAPITAL STOCK
Preferred Stock
The Company's certificate of incorporation authorizes it to issue up to
5,000,000 shares of $.001 par value preferred stock. At December 31, 1997, the
Company's authorized preferred stock is allocated as follows:
<TABLE>
<CAPTION>
AUTHORIZED ISSUED AND
SHARES OUTSTANDING
---------- -----------
<S> <C> <C>
Reserved shares:
Series A......................................... 300,000 --
Series B......................................... 200,000 --
Series C......................................... 1,000,000 --
Series D......................................... 666,666 --
Series F......................................... 1,200,000 --
Series G......................................... 150,000 --
Series I......................................... 125,000 39,500
Undesignated shares................................ 1,358,334 --
--------- ------
Total.............................................. 5,000,000 39,500
========= ======
</TABLE>
Series A Preferred Stock ("Series A"), which were fully converted into common
stock as of December 31, 1997, were entitled to 9% cumulative dividends and
voting rights and were convertible into common stock subject to certain
anti-dilution provisions. In connection with the initial offering, the Company
also issued a warrant for 62,200 shares of common stock with an exercise price
of $2.50 per share to an investment banking firm, controlled by an individual,
who was subsequently elected to the Company's Board of Directors. The warrant
expired in February 1997. During 1995, 3,000 shares of Series A were converted
into 14,449 shares of common stock. During 1996, 3,125 shares of Series A were
converted into 16,664 shares of common stock. During 1997, 98,625 shares of
Series A were converted into 564,779 shares of common stock. The conversions
also include unpaid dividends.
Series B Preferred Stock ("Series B"), which were fully converted into common
stock as of December 31, 1997, were entitled to 9% cumulative dividends and
voting rights and were convertible into shares of common stock subject to
certain anti-dilution provisions. In connection with the initial offering, the
Company issued a warrant to an investment banking firm, controlled by one of the
Company's directors, for 69,750 shares of common stock, with an exercise price
of $2.00 per share. The warrant expired in February 1997. During 1996, 11,750
shares of Series B were converted into 98,717 shares of common stock. During
1997, 114,500 shares of Series B were converted into 1,055,410 shares of common
stock. The conversions also include unpaid dividends.
In November 1992, the Company issued 1,000,000 shares of its Series C
Preferred Stock ("Series C") to one of its major vendors as collateral for
amounts due the vendor for services provided. The Company was released from all
collateral requirements during 1996 and the preferred stock reverted back to the
Company.
Series D Preferred Stock, which were fully converted into common stock as of
December 31, 1997, were entitled to 6% noncumulative dividends, when and if
declared by the Board of Directors and only after payment of dividends on
previously issued series of preferred stock. These shares were nonvoting and
convertible into 333,333 shares of common stock subject to certain anti-dilution
provisions. In connection with the initial offering, the Company issued a
warrant to an investment banking firm, controlled by one of the Company's
directors, for 22,000 shares of common stock, with an exercise price of $1.50
per share. The warrant expired in December 1997.
F-59
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In September 1994, the Company issued 55,893 shares of Series E Preferred
Stock at $10 per share under an agreement to convert a note payable to
stockholder, with a principal balance of $500,000 and accrued interest of
$58,930. In connection with the issuance of the stock, the Company issued the
stockholder a five-year warrant for 100,000 shares of the Company's common stock
which was canceled when the Series E shares were converted to Series F Preferred
Stock (see below).
During the period July 1995 through October 1995, the Company raised
approximately $11,024,207, net of offering costs of $129,963, through a private
placement of 1,115,417 shares of its Series F Preferred Stock at $10 per share.
Additionally, the holder of the Company's Series E Preferred Stock exchanged
their Series E shares, plus accumulated and unpaid dividends of $47,467, for
60,639 shares of Series F Preferred Stock. The Series F shares are entitled to
9% cumulative dividends, voting rights, demand registration rights for the
underlying common shares after six months and are convertible initially into
4,704,224 shares of common stock, subject to anti-dilution provisions. The
holders of the Series F also received warrants for the purchase of 470,422
shares of common stock with an exercise price of $3.00 per share which expire in
October 2000. The Series F shareholders have the right to place two directors on
the Company's board (the "Series F Directors") and the Company is subject to
certain covenants requiring it to obtain the consent of the Series F Directors
for certain transactions including mergers, acquisitions and incurring
additional indebtedness in excess of $20,000,000. During December 1996, the
outstanding Series F Preferred shares were converted into 5,191,064 shares of
common stock. This conversion also included unpaid dividends.
In March 1997, the Company raised $2,850,000 through a private placement of
150,000 shares of its Series G Preferred Stock at $20 per share. The shares are
entitled to cumulative dividends at a rate per share of 5% per annum when and as
declared by the Board of Directors. These shares are nonvoting and convertible
into common stock subject to certain anti-dilution provisions. In connection
with the initial offering, the Company issued warrants for 60,000 shares of
common stock with an exercise price of $2.34 per share. The warrants expire in
April 2002. During 1997, all outstanding shares of Series G Preferred Stock were
converted to 2,491,879 shares of common stock.
In July 1997, the Company raised $2,375,000 through a private placement of
125,000 shares of its Series I Preferred Stock at $20 per share. The shares are
entitled to cumulative dividends at a rate per share of 5% per annum when and as
declared by the Board of Directors. These shares are nonvoting and convertible
into common stock subject to certain anti-dilution provisions. In connection
with the initial offering, the Company issued warrants for 112,500 shares of
common stock, with an exercise price of $2.00 per share. The warrants expire in
July 2002. During 1997, 85,500 shares of Series I Preferred Stock were converted
to 2,337,355 shares of common stock. At December 31, 1997, the outstanding
Series I Preferred shares are convertible into 2,349,011 shares of common stock.
The common shares reserved for issuance upon the conversion of the remaining
Series I Preferred Stock have been registered for resale with the Securities and
Exchange Commission.
At December 31, 1997, the Company had cumulative, unpaid dividends on Series I
Preferred Stock of $18,072 ($.46 per share).
Common Stock
In May 1995, the Company closed a private placement of its common stock
which raised $727,519, net of offering costs of $119,481. The Company sold
385,000 units, at $2.20 per unit, in an off-shore financing pursuant to
Regulation S under the Securities Act of 1933. A unit consists of one share of
common stock and a five-year warrant for one-half share of common stock. Two
warrants can be exercised to purchase 38,500 units at $2.42
F-60
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
per unit. The Company closed another private placement of its common stock under
Regulation S in September 1995. In this transaction, the Company sold 2,300,000
shares of common stock for $2.75 per share. Proceeds to the Company, net of
offering costs of $735,055, were $5,589,945.
Stock Options and Warrants
The Company has various stock option plans accounted for under APB Opinion 25
and related interpretations. The options generally have a term of ten years when
issued, and generally vest over two to four years. No compensation cost has been
recognized for the plans. Had compensation cost for the plan been determined
based on the fair value of the options at the grant dates consistent with the
method of Statement of Financial Accounting Standards 123, Accounting for
Stock-Based Compensation ("SFAS 123"), the Company's net loss and loss per
common share would have been increased to the pro forma amounts indicated below.
Pro forma results for 1996 and 1997 may not be indicative of pro forma results
in future periods because the pro forma amounts do not include pro forma
compensation cost for options granted prior to January 1, 1996.
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Net loss attributable to common shares
As reported................................... $(14,050,004) $(15,124,110)
Pro forma..................................... (14,474,477) (15,745,339)
Basic loss per common share
As reported................................... $ (0.68) $ (0.52)
Pro forma..................................... (0.70) (0.54)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes options-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1997, respectively: no expected
dividends; expected volatility of 107%; weighted average risk-free interest rate
of 6.3%; and expected lives of four years.
In 1987, the Company granted certain directors stock options to purchase up to
900,000 shares of common stock at a price of $0.10 per share, expiring no
earlier than ten years from the grant date. All options have been exercised as
of December 31, 1997.
The Company's 1989 Stock Option Plan authorizes the grant of incentive stock
options or supplemental stock options for up to 5,000,000 shares of common
stock. The exercise price of each incentive stock option shall be not less than
100% of the fair market value of the stock on the date the option is granted.
The exercise price of each supplemental stock option shall be not less than
eighty-five percent (85%) of the fair market value of the stock on the date the
option is granted.
In November, 1992, the Board of Directors approved the 1992 Non-Employee
Directors' Stock Option Plan. Under the Plan, 480,000 shares of common stock
have been reserved for issuance to non-employee directors of the Company.
Options are granted annually based upon length of service at fair market value
at date of grant.
The Company's subsidiary, Americonnect, had two stock option plans. All
options have been converted into options for the Company common stock and are
included in the following summary. The options were granted at prices from $0.08
to $2.06 per share of Company common stock.
F-61
[
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the status of the Company's fixed stock option plans as of
December 31, 1997, and changes during each of the three years in the period
ended December 31, 1997 is presented below.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER PRICE
OF SHARES PER SHARE
--------- ---------
<S> <C> <C>
Outstanding at January 1, 1995.......................... 2,660,065 $ 1.58
Exercised............................................. (382,851) 1.16
Granted............................................... 898,414 2.58
Canceled.............................................. (156,458) 2.43
---------
Outstanding at December 31, 1995........................ 3,019,170 1.91
Exercised............................................. (724,567) 1.64
Granted............................................... 1,017,500 3.27
Canceled.............................................. (177,951) 3.23
---------
Outstanding at December 31, 1996........................ 3,134,152 2.32
Exercised............................................. (869,521) .91
Granted............................................... 127,500 3.38
Canceled.............................................. (151,479) 3.33
---------
Outstanding at December 31, 1997........................ 2,240,652 2.89
=========
</TABLE>
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
RANGE OPTIONS PROCEEDS EXERCISE PRICE
----------- --------- ---------- --------------
<S> <C> <C> <C> <C>
Exercisable at December 31,
1997...................... $1.00-$2.38 475,558 $ 798,937 $ 1.68
$2.39-$4.38 878,600 2,688,516 3.06
$4.39-$6.38 56,890 356,131 6.26
--------- ----------
1,411,048 $3,843,584 2.72
</TABLE>
Weighted average fair value of options granted during 1995, 1996 and 1997 is
$1.42, $1.70, and $2.51 per share, respectively.
The following information applies to options outstanding at December 31, 1997:
<TABLE>
<S> <C> <C> <C>
Range of exercise prices................... $1.00-$2.38 $2.39-$4.38 $4.38-$6.38
Options outstanding...................... 566,077 1,608,025 66,550
Weighted average exercise price.......... $ 1.79 $ 3.15 $ 6.05
Weighted average remaining contractual
life (years)............................ 6 8 7
Options exercisable...................... 475,558 878,600 56,890
Weighted average exercise price.......... $ 1.68 $ 3.06 $ 6.26
</TABLE>
F-62
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Common shares subject to warrants are summarized below:
<TABLE>
<CAPTION>
NUMBER PRICE
OF SHARES PER SHARE
--------- -----------
<S> <C> <C>
Outstanding at January 1, 1995....................... 511,533 $1.50-$7.00
Exercised.......................................... (34,675) $ 2.42
Granted............................................ 720,672 $2.42-$3.00
Canceled........................................... (100,000) $ 3.25
---------
Outstanding at December 31, 1995..................... 1,097,530 $1.50-$7.00
Exercised.......................................... (58,825) $ 2.42
Granted............................................ -- --
Canceled........................................... -- --
---------
Outstanding at December 31, 1996..................... 1,038,705 $1.50-$7.00
Exercised.......................................... (46,700) $1.81-$2.20
Granted............................................ 372,500 $2.00-$2.94
Canceled........................................... (114,750) $1.81-$2.20
---------
Outstanding at December 31, 1997..................... 1,249,755 $1.50-$7.00
=========
</TABLE>
All warrants are exercisable at grant.
NOTE J--INCOME TAXES
The Company accounts for income taxes under the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using current enacted tax rates. A valuation allowance is established
to reduce net deferred tax assets to their estimated realizable value.
As of December 31, 1997, the Company has available to offset future federal
taxable income, net operating loss carryforwards (NOLs) of approximately $35.3
million which expire in varying amounts from 2002 through 2012. The NOLs may be
subject to limitations as a result of provisions of the Internal Revenue Code
relating to changes in ownership and utilization of losses by successor
entities.
The Company's effective income tax rate is different from the Federal
statutory income tax rate because of the following factors:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Federal tax rate applied to loss before taxes....... (34.0)% (34.0)% (34.0)%
State tax rate applied to allowable carry-forward
losses............................................. (5.9) (4.6) (4.6)
Valuation allowance for deferred taxes.............. 59.5 38.6 38.6
Effective tax rate.................................. 19.6 % -- % -- %
===== ===== =====
</TABLE>
F-63
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Deferred federal and state tax assets and valuation allowance are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
----------- -----------
<S> <C> <C>
Current
Allowance for bad debts.......................... $ 1,326,000 $ 531,000
Noncurrent
Noncurrent assets................................ 1,187,000 2,232,000
Net operating loss carryforward.................. 8,496,000 14,774,000
----------- -----------
9,683,000 17,006,000
----------- -----------
11,009,000 17,537,000
Valuation allowance.............................. (11,009,000) (17,537,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
In 1993, the Company's subsidiary, Americonnect, Inc., reduced its valuation
allowance by $500,000 due to changes in circumstances subsequent to adoption of
SFAS No. 109. The changes in circumstances related to increased cash flows,
increased profitability, and anticipated continued increases. Due to operating
losses in 1995, Americonnect was no longer able to determine if it was more
likely than not that it would realize the deferred asset. As a result of this
change in estimate, the valuation allowance was increased by $500,000.
The components of income tax benefit (expense) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
---------------------
1995 1996 1997
--------- ----- ----
<S> <C> <C> <C>
Current................................................ $ -- $ -- $--
Deferred............................................... (500,000) -- --
--------- ----- ----
$(500,000) $ -- $--
========= ===== ====
</TABLE>
The increase in the valuation allowance was approximately $1,917,000,
$5,080,000 and $6,528,000 for the years ended December 31, 1995, 1996 and 1997,
respectively.
NOTE K--EMPLOYEE BENEFIT PLANS
On June 1, 1993, the Company established a 401(k) tax savings plan for all
employees. Employer and participant contributions to the plan vest immediately.
The plan is a defined contribution plan covering all of its employees. Under
this plan, employees with a minimum of one year of qualified
service can elect to participate by contributing a minimum of one percent of
their gross earnings up to a maximum of 20 percent.
For those eligible plan participants, the Company will contribute an amount
equal to 100 percent of each participant's personal contribution up to an annual
maximum of $1,000. The Company's contributions to the 401(k) plan for the years
ended December 31, 1995, 1996 and 1997, were approximately $59,000, $109,000 and
$95,000, respectively.
F-64
<PAGE>
PHOENIX NETWORK, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE L--DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practicable to estimate that
value:
<TABLE>
<C> <C> <S>
Cash and cash equivalents -- Carrying amount approximates fair value
because of the short-term maturity of this
instrument
Line of credit -- Carrying amount approximates fair value
because of the short-term maturity of this
instrument
Long-term debt -- Carrying amount approximates fair value
because the interest rate at December 31,
1997 approximates the market rate.
</TABLE>
NOTE M--FOURTH QUARTER ADJUSTMENTS
During the fourth quarter of 1997, the Company recorded adjustments increasing
their net loss by $3,260,204 related to the write-off of an abandoned billing
system.
F-65
<PAGE>
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(UNAUDITED)
The unaudited pro forma condensed combined financial statements presented
below are derived from the historical consolidated financial statements of
Qwest, SuperNet, Phoenix, and LCI. The unaudited pro forma condensed combined
balance sheet as of December 31, 1997 gives pro forma effect to (i) the
acquisition by Qwest of all the issued and outstanding shares of capital stock
of Phoenix as if the acquisition had occurred on December 31, 1997; (ii) the
proposed acquisition by Qwest of all the issued and outstanding shares of
capital stock of LCI as if the acquisition had occurred on December 31, 1997;
and (iii) the issuance in January 1998 by Qwest of $450,505,000 aggregate
principal amount at maturity of New Senior Discount Notes as if the issuance had
occurred as of December 31, 1997. The unaudited pro forma condensed combined
statement of operations for the year ended December 31, 1997 gives pro forma
effect to the acquisitions of SuperNet, Phoenix, and LCI as if such acquisitions
had occurred on January 1, 1997. The unaudited pro forma condensed combined
financial statements do not give effect to Qwest's proposed acquisition of EUnet
because it is not significant for purposes of Rule 3-05 of the Securities and
Exchange Commission Regulation S-X. No pro forma operating statement effects of
the New Senior Discount Notes have been presented.
The consummation of the LCI acquisition will constitute a change in control of
LCI, which is an event of default under the LCI Credit Facilities and the LCI
Securitization Program. In addition, an event of default under the LCI Credit
Facilities also constitutes an event of default under the LCI Headquarters
Lease. The LCI Lines of Credit are discretionary lines which may be discontinued
at any time at the sole discretion of the providing banks. The LCI Debt
Securities permit mergers and consolidations, subject to compliance with certain
terms of the governing indenture. There has been no effect of the potential
defaults or other features of the aforementioned LCI financing arrangements
reflected in the pro forma condensed combined financial statements as Qwest
intends to renegotiate the terms and conditions of these arrangements.
The unaudited pro forma condensed combined financial statements give effect to
the acquisitions described above under the purchase method of accounting and are
based on the assumptions and adjustments described in the accompanying notes to
the unaudited pro forma condensed combined financial statements presented on the
following pages. The fair value of the consideration will be allocated to the
assets and liabilities acquired based upon the fair values of such assets and
liabilities at the date of each respective acquisition and may be revised for a
period of up to one year. The preliminary estimates and assumptions as to the
value of the assets of Phoenix and LCI to the combined company is based upon
information available at the date of preparation of these unaudited pro forma
condensed combined financial statements, and will be adjusted upon the final
determination of such fair values. A final allocation of the purchase price to
the Phoenix and LCI assets acquired and liabilities assumed is dependent upon
analysis which has not progressed to a stage at which there is sufficient
information to make such an allocation in these pro forma condensed combined
financial statements. Qwest has undertaken a study to determine the allocation
of the purchase price to the various assets acquired, including in-process
research and development projects, and the liabilities assumed. To the extent
that a portion of the purchase price is allocated to in-process research and
development, a charge, which may be material to Qwest's results of operations,
would be recognized in the period in which the proposed mergers occur.
The unaudited pro forma condensed combined financial statements do not purport
to represent what Qwest's results of operations or financial condition would
have actually been or what operations would be if the transactions that give
rise to the pro forma adjustments had occurred on the dates assumed. The
unaudited pro forma condensed combined financial statements below should be read
in conjunction with the historical consolidated financial statements and related
notes thereto of Qwest, Phoenix, and LCI.
F-66
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 1997
(AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
--------------- PRO FORMA COMBINED, ---------- PRO FORMA COMBINED,
QWEST PHOENIX ADJUSTMENTS EXCLUDING LCI LCI ADJUSTMENTS INCLUDING LCI
------ ------- ----------- ------------- ---------- ----------- -------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash
equivalents........... $ 380 $-- 299 (6),(7) $ 679 $ -- $ 679
Other current assets... 344 12 356 271 13 (10) 640
------ ---- --- ------ ------ ----- ------
Total current assets.. 724 12 299 1,035 271 13 1,319
Property and equipment,
net.................... 615 3 618 671 1,289
Excess of cost over net
assets acquired, net... 21 18 22 (3) 61 359 4,202 (10) 4,622
Intangible and other
long-term assets, net.. 38 2 1 (7) 41 53 (33) (10) 61
------ ---- --- ------ ------ ----- ------
Total assets............ $1,398 $ 35 322 $1,755 $1,354 4,182 $7,291
====== ==== === ====== ====== ===== ======
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities..... $ 315 $ 25 1 (2) $ 341 $ 288 183 (10) $ 812
Long-term debt.......... 630 -- 300 (6) 930 413 11 (10) 1,354
Other liabilities....... 71 -- 4 (2) 75 101 176
------ ---- --- ------ ------ ----- ------
Total liabilities..... 1,016 25 305 1,346 802 194 2,342
Stockholders' equity:
Preferred stock........ -- -- -- -- --
Common stock........... 2 -- 2 1 1 (10) 3
(1) (11)
Additional paid-in
capital............... 412 53 27 (2) 439 511 4,067 (10) 4,978
(53) (4) 472 (10)
(511) (11)
(Accumulated deficit)
retained earnings..... (32) (43) 43 (4) (32) 40 (40) (11) (32)
------ ---- --- ------ ------ ----- ------
Total stockholders'
equity............... 382 10 17 409 552 3,988 4,949
Commitments and
contingencies..........
------ ---- --- ------ ------ ----- ------
Total liabilities and
stockholders' equity... $1,398 $ 35 322 $1,755 $1,354 4,182 $7,291
====== ==== === ====== ====== ===== ======
</TABLE>
See accompanyin notes to unaudited pro forma condensed combined financial
statements.
F-67
<PAGE>
QWEST COMMUNICATIONS INTERNATIONAL INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 1997
(IN MILLIONS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
-------------- PRO FORMA COMBINED, ---------- PRO FORMA COMBINED,
QWEST PHOENIX ADJUSTMENTS EXCLUDING LCI LCI ADJUSTMENTS INCLUDING LCI
----- ------- ----------- ------------- ---------- ----------- -------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Communications
services.............. $ 115 $ 77 6 (8) $ 198 $1,642 $1,840
Network construction
services.............. 581 -- 581 -- 581
----- ---- --- ------ ------ --- ------
696 77 6 779 1,642 2,421
----- ---- --- ------ ------ --- ------
Operating expenses:
Telecommunications
services.............. 91 57 3 (8) 151 986 1,137
Network construction
services.............. 397 -- 397 -- 397
Selling, general and
administrative........ 91 30 2 (8) 123 417 540
Merger costs........... 45 (45) (12) --
Growth share and stock
option plans.......... 73 -- 1 (8) 74 -- 74
Depreciation and
amortization.......... 20 4 2 (5) 30 96 103 (13) 229
1 (8)
3 (9)
----- ---- --- ------ ------ --- ------
672 91 12 775 1,544 58 2,377
----- ---- --- ------ ------ --- ------
Earnings (loss) from
operations............. 24 (14) (6) 4 98 (58) 44
Other (expense) income:
Interest expense, net.. (7) (1) (8) (36) 1 (14) (43)
Other income, net...... 7 -- 7 -- 7
----- ---- --- ------ ------ --- ------
Earnings (loss) before
income tax benefit.... 24 (15) (6) 3 62 (57) 8
Income tax expense...... 9 -- 9 31 12 (15) 52
----- ---- --- ------ ------ --- ------
Net earnings (loss).... $ 15 $(15) (6) $ (6) $ 31 (69) $ (44)
===== ==== === ====== ====== === ======
Earnings (loss) per
share--basic........... $0.08 $(0.03) $(0.15)
===== ====== ======
Earnings (loss) per
share--diluted......... $0.07 $(0.03) $(0.15)
===== ====== ======
Weighted-average shares
used in calculating
earnings (loss) per
share - basic 191 191 191
===== ===== =====
Weighted-average shares
used in calculating
earnings (loss) per
share - basic 194 191 294
===== ===== =====
</TABLE>
See accompanying notes to unaudited pro forma condensed combined
financial statements.
F-68
<PAGE>
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(UNAUDITED)
(1) In January 1998, Qwest and Phoenix entered into the Agreement and Plan of
Merger (as amended, the "Phoenix Merger Agreement"). Pursuant to the terms
of the Phoenix Merger Agreement, each outstanding share of Phoenix common
stock will be exchanged for shares of Qwest Common Stock having an
aggregate market value equal to approximately $27.2 million, and future
payments of up to $4.0 million. The acquisition was consummated on March
30, 1998.
On March 8, 1998, Qwest and LCI entered into the Merger Agreement. The terms
of the Merger Agreement call for each share of LCI common stock to be
exchanged for shares of Qwest common stock. The actual number of shares of
Qwest common stock to be exchanged for each LCI share will be determined by
dividing $42.00 by a volume weighted average of trading prices for Qwest
common stock for a specified 15-day period prior to the closing, but will
not be less than 1.0625 shares (if Qwest's average stock price exceeds
$39.53) or more than 1.5583 shares (if Qwest's average stock price is less
than $26.95). If Qwest's average stock price is less than $26.95, LCI may
terminate the merger unless Qwest then agrees to exchange for each share of
LCI the number of Qwest shares determined by dividing $42.00 by such average
price. The proposed acquisition is subject to certain closing conditions
that include approval by the stockholders of LCI.
(2) Represents the purchase by Qwest of Phoenix's outstanding capital stock and
the incurrence of related transaction costs. Additional information
regarding the aggregate purchase price is set forth below (amounts in
millions):
<TABLE>
<S> <C>
Aggregate value of stock consideration................................. $27
Future payments........................................................ 4
Estimated direct costs of the acquisition.............................. 1
---
Aggregate purchase price to be allocated to net assets acquired........ $32
===
</TABLE>
(3) Represents the increase to Phoenix's intangible assets to reflect the
preliminary allocation of the purchase price. For pro forma purposes, the
intangible assets have been amortized over an assumed weighted average
useful life of fifteen years. The actual purchase price allocation that
will be made may differ from such assumptions, and the actual useful lives
assigned to the intangible assets may differ from the assumed weighted
average useful life used in preparing the pro forma condensed combined
financial statements.
(4) Represents the elimination of the historical equity of Phoenix.
(5) Represents the amortization of intangible assets that results from the
preliminary Phoenix purchase price allocation. Such amortization is
calculated using an estimated weighted average useful life of 15 years.
See note 3.
(6) Represents the issuance in January 1998 by Qwest of the New Senior Discount
Notes yielding gross proceeds to Qwest of approximately $300 million. The
New Senior Discount Notes will mature on February 1, 2008.
(7) Represents debt issuance costs related to the New Senior Discount Notes.
(8) On October 22, 1997, Qwest acquired from an unrelated third party all the
outstanding shares of common stock, and common stock issued at the closing
of the acquisition of SuperNet for $20.0 million in cash. The acquisition
was accounted for using the purchase method of accounting, and the purchase
price was allocated on that basis to the net assets acquired. The
historical statement of operations of Qwest includes the operating results
of SuperNet beginning October 22, 1997. This pro forma adjustment
represents SuperNet's unaudited results of operations for the period
January 1, 1997 to October 21, 1997.
(9) Represents amortization for the period January 1, 1997 to October 21, 1997
of intangible assets that resulted from the SuperNet purchase price
allocation, totaling approximately $19.2 million.
F-69
<PAGE>
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(UNAUDITED)
(10) Represents the purchase by Qwest of the outstanding LCI Common Stock, the
assumption of certain liabilities, the incurrence of related transaction
costs, and the initial allocation of the pro forma purchase price.
<TABLE>
<CAPTION>
(AMOUNTS
IN MILLIONS)
<S> <C>
Aggregate value of stock consideration(a)..................... $4,068
Value of LCI outstanding stock options, to be assumed by
Qwest(b)..................................................... 472
Estimated direct costs of the acquisition..................... 10
------
Pro forma purchase price...................................... 4,550
Net book value of net assets acquired......................... 552
------
Excess of purchase price over net assets acquired............. $3,998
======
Allocation of excess of purchase price over net assets acquired:
Other intangible assets(d).................................. $ (33)
Goodwill (net of existing goodwill)(e)...................... 4,202
Debt premium(f)............................................. (11)
Change in control payments(c)............................... (38)
Deferred federal income taxes(g)............................ 13
Other merger costs and liabilities(h)....................... (135)
------
Total......................................................... $3,998
======
</TABLE>
(a) Represents the estimated value of Qwest Common Stock issuable for the
acquisition of the approximately 96.8 million shares of LCI Common Stock
outstanding. Assuming an average trading price of $39.53, Qwest would
issue approximately 102.9 million shares of Qwest Common Stock to acquire
the LCI outstanding shares.
(b) Represents the assumption by Qwest of the approximately 14.3 million
stock options outstanding under LCI's stock option plans.
(c) LCI has an agreement with an unrelated third-party sales agent, whereby
the sales agent would receive a payment in the event of a change in
control of LCI. The proposed acquisition of LCI by Qwest would constitute
a change in control and trigger the change in control payment pursuant to
this agreement.
(d) Represents a reduction to certain other assets of LCI to reflect their
fair value to the combined company.
(e) Represents the increase to LCI's intangible assets to reflect the
preliminary allocation of the purchase price. For pro forma purposes, the
intangible assets have been amortized over an assumed useful life of 40
years. The actual purchase price allocation that will be made may differ
from such assumptions, and the actual useful lives assigned to the
intangible assets may differ from the assumed useful life used in
preparing the pro forma condensed combined financial statements. In
addition, to the extent that a portion of the purchase price is allocated
to in-process research and development, a charge which may be material to
Qwest's results of operations, would be recognized in
the period in which the Merger occurs.
(f) Represents the difference between the carrying value and the fair value
of LCI's debt.
(g) Represents net deferred income tax assets related to purchase accounting
adjustments.
(h) Represents estimated provisions for purchase commitments, duplicate
facilities and equipment, severance costs, and LCI's costs related to the
acquisition.
(11) Represents the elimination of the historical equity of LCI.
F-70
<PAGE>
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(UNAUDITED)
(12) Represents the reversal of merger costs recognized by LCI in the
acquisition of USLD, which had been accounted for under the
pooling-of-interests method.
(13) Represents the amortization of intangible assets that results from the
preliminary LCI purchase price allocation, net of the reversal of
amortization expense recognized on certain LCI intangible assets for which
no purchase price has been assigned. Goodwill amortization is calculated
using an estimated useful life of 40 years. See note 10.
(14) Represents the amortization of debt premium over the 10-year life of the
underlying debt.
(15) Represents the assumed income tax effect of the pro forma adjustment
relating to the reversal of LCI's historical merger costs and the
amortization of debt premium.
(16) Transactions among Qwest, SuperNet, Phoenix, and LCI are not significant.
F-71
<PAGE>
GLOSSARY
<TABLE>
<C> <S>
Access charges.............. The fees paid by long distance carriers to LECs
for originating and terminating long distance
calls on the LEC's local networks.
AGIS........................ Apex Global Internet Services, Inc.
Anschutz Company............ This term has the meaning stated on the cover
page of the Prospectus.
Anschutz Entities........... This term has the meaning stated on page 77 of
the Prospectus.
Anschutz Shares............. This term has the meaning stated on the cover
page of the Prospectus.
ATM (Asynchronous
Transfer Mode.............. An information transfer standard that is one of
a general class of packet technologies that
relay traffic by way of an address contained
within the first five bytes of a standard
fifty-three-byte long packet or cell. The ATM
format can be used by many different
information systems, including local area
networks, to deliver traffic at varying rates,
permitting a mix of voice, data and video
(multimedia).
AT&T........................ AT&T Corporation.
Audit Committee............. This term has the meaning stated on page 106 of
the Prospectus.
Band........................ A range of frequencies between two defined
limits.
Bandwidth................... The relative range of analog frequencies or
digital signals that can be passed through a
transmission medium, such as glass fibers,
without distortion. The greater the bandwidth,
the greater the information carrying capacity.
</TABLE>
G-1
<PAGE>
<TABLE>
<C> <S>
CAC......................... Carrier Access Code.
Capacity.................... Refers to transmission.
Carrier..................... A provider of communications transmission
services by fiber, wire or radio.
Carrier Services............ This term has the meaning stated on page 33 of
the Prospectus.
CBUD........................ This term has the meaning stated on page 49 of
the Prospectus.
CICs........................ This term has the meaning stated on page 60 of
the Prospectus.
CLEC (Competitive Local A company that competes with LECs in the local
Exchange Carrier).......... services market.
Code........................ The Internal Revenue Code of 1986, as amended
Commission.................. Securities and Exchange Commission.
Common Carrier.............. A government-defined group of private
companies offering telecommunications services
or facilities to the general public on a non-
discriminatory basis.
Common Stock................ Common Stock, par value $.01 per share, of
Qwest.
Commercial Services......... This term has the meaning stated on page 52 of
the Prospectus.
Compensation Committee...... This term has the meaning stated on page 65
of the Prospectus.
</TABLE>
G-2
<PAGE>
<TABLE>
<C> <S>
Dark Fiber.................. Fiber that lacks the requisite electronic and
optronic equipment necessary to use the fiber
for transmission.
Digital..................... Describes a method of storing, processing and
transmitting information through the use of
distinct electronic or optical pulses that
represent the binary digits 0 and 1. Digital
transmission/ switching technologies employ a
sequence of discrete, distinct pulses to
represent information, as opposed to the
continuously variable analog signal.
Director Equity Plan........ This term has the meaning stated on page 69 of
the Prospectus.
DS-3 miles.................. A measure of the total capacity and length of a
transmission path, calculated as the capacity
of the transmission path in DS-3s multiplied by
the length of the path in miles.
DWDM (Dense Wave
Division Multiplexing)..... A technique for transmitting eight or more
different light wave frequencies on a single
fiber to increase the information carrying
capacity.
ECO........................ This term has the meaning stated on page 61 of
the Prospectus.
EBITDA..................... This term has the meaning stated on page 13 of
the Prospectus.
EPS........................ This term has the meaning stated on page F-54
of the Prospectus.
Equal access............... The basis upon which customers of interexchange
carriers are able to obtain access to their
Primary Interexchange Carriers' (PIC) long
distance telephone network by dialing "1", thus
eliminating the need to dial additional digits
and an authorization code to obtain such
access.
Equipment Credit Facility.. This term has the meaning stated on page 39 of
the Prospectus.
Equity Incentive Plan...... This term has the meaning stated on page 75 of
the Prospectus.
</TABLE>
G-3
<PAGE>
<TABLE>
<C> <S>
EUnet....................... EUnet International Limited.
Exchange Act................ The Securities Exchange Act of 1934, as
amended.
Exchange Agent.............. This term has the meaning stated on page 8 of
the Prospectus.
Exchange Notes.............. This term has the meaning stated on page 1 of
the Prospectus.
FBCs (Facilities Based Facilities based carriers that own and operate
Carriers).................. their own network and equipment.
FCC......................... Federal Communications Commission.
First Mile Connection....... The portion of a long distance telephone call
from origination at an originator's telephone
through the local access network of the LEC.
Frame Relay................. A high-speed, data packet switching service
used to transmit data between computers. Frame
Relay supports data units of variable lengths
at access speeds ranging from 56 kilobits per
second to 1.5 megabits per second. This
service is well-suited for connecting local
area networks, but is not presently well-
suited for voice and video applications due to
the variable delays which can occur. Frame
Relay was designed to operate at high speeds
on modern fiber optic networks.
Frontier.................... Frontier Corporation.
FTC......................... U.S. Federal Trade Commission.
GTE......................... GTE Corporation.
Growth Share Plan........... This term has the meaning stated on page 74 of
the Prospectus.
</TABLE>
G-4
<PAGE>
<TABLE>
<C> <S>
Hertz....................... The unit for measuring the frequency with which
an electromagnetic signal cycles through the
zero-value state between lowest and highest
states. One Hz (Hertz) equals one cycle per
second. Khz (kilohertz) stands for thousands of
Hertz; Mhz (megahertz) stands for millions of
Hertz.
Initial Purchaser........... Salomon Brothers Inc.
Innova...................... Innova, Inc.
Interconnect................ Connection of a telecommunications device or
service to the public switched telephone
network ("PSTN").
Interexchange carrier....... A company providing inter-LATA or long distance
services between LATAs on an intrastate or
interstate basis.
IP.......................... Internet protocol.
ISP (Internet Service A company that provides businesses and
Provider) .................. consumers with access to the Internet.
Kbps........................ Kilobits per second, which is a measurement of
speed for digital signal transmission
expressed in thousands of bits per second.
KN.......................... KN Energy, Inc.
LATAs (Local Access and
Transport Areas)........... The approximately 200 geographic areas that
define the areas between which the RBOCs
currently are prohibited from providing long
distance services.
LCI......................... LCI International, Inc.
</TABLE>
G-5
<PAGE>
<TABLE>
<C> <S>
LCI Credit Facilities....... This term has the meaning stated on page 16 of
the Prospectus.
LCI Headquarters Lease...... This term has the meaning stated on page 16 of
the Prospectus.
LCI Lines of Credit......... This term has the meaning stated on page 16 of
the Prospectus.
LCI Merger.................. This term has the meaning stated on page 5 of
the Prospectus..
LCI Merger Agreement The Agreement and Plan of Merger dated as of
March 8, 1998
LCI Securitization Program.. This term has the meaning stated on page 16 of
the Prospectus.
LEC (Local Exchange A company historically providing local
telephone
Carrier)................... services and access to end users through its
local access network.
</TABLE>
G-6
<PAGE>
<TABLE>
<C> <S>
Lit fiber................... Fiber activated or equipped with the requisite
electronic and optronic equipment necessary to
use the fiber for transmission.
Lucent...................... Lucent Technologies.
MCI......................... MCI Communications Corporation.
Measuring Period............ This term has the meaning stated on page 74 of
the Prospectus.
Microwave System............ This term has the meaning stated on page 48 of
the Prospectus.
Multiplexing................ An electronic or optical process that combines
a large number of lower speed transmission
lines into one high speed line by splitting
the total available bandwidth into narrower
bands (frequency division), or by allotting a
common channel to several different
transmitting devices, one at a time in
sequence (time division).
Named Executives............ This term has the meaning stated on page 70 of
the Prospectus.
Nasdaq National Market...... National Association of Securities Dealers
Automated Quotation System National Market.
Network Construction This term has the meaning stated on page 5 of
Services................... the Prospectus.
8.29% Notes................. This term has the meaning stated on page 1 of
the Prospectus..
10 7/8% Notes............... This term has the meaning stated on page 1
of the Prospectus..
9.47% Notes................. This term has the meaning stated on page 1 of
the Prospectus..
1993 Capacity Sale.......... This term has the meaning stated on page 13 of
the Prospectus.
Nortel...................... This term has the meaning stated on page 6 of
the Prospectus.
OC-3, OC-48 and OC-192...... OC is a measure of SONET transmission optical
carrier level, which is equal to the
corresponding number of DS-3s (e.g., OC-3 is
equal to 3 DS-3s and OC-48 is equal to 48 DS-
3s).
</TABLE>
G-7
<PAGE>
<TABLE>
<C> <S>
Phoenix..................... Phoenix Network, Inc.
PUC......................... State public utilities commission.
QCC......................... Qwest Communications Corporation, a wholly
owned subsidiary of Qwest.
Qwest....................... Qwest Communications International Inc.
Qwest Board................. The board of directors of Qwest.
Qwest Bylaws................ The bylaws of Qwest.
Qwest Initial Public The initial public offering of Qwest in June
Offering................... 1997.
Qwest Network............... This term has the meaning stated on page 6 of
the Prospectus.
Qwest Stock Split........... This term has the meaning stated on page 29 of
the Prospectus.
</TABLE>
G-8
<PAGE>
<TABLE>
<C> <S>
RBOCs (Regional Bell
Operating Companies)....... The seven local telephone companies (formerly
part of AT&T) established as a result of the
AT&T Divestiture Decree.
Regeneration/amplifier...... Devices which automatically re-transmit or
boost signals on an out- bound circuit.
Registration Default........ This term has the meaning stated on page 38 of
the Prospectus.
Registration Statement...... This term has the meaning stated on page 1 of
the Prospectus.
Restricted Subsidiaries..... This term has the meaning stated on page 38 of
the Prospectus.
Reseller.................... A carrier that does not own transmission
facilities, but obtains communications
services from another carrier for resale to
the public.
Rule 144A................... This term has the meaning stated on page 8 of
the Prospectus.
SBC Communications Case..... This term has the meaning stated on page 57 of
the Prospectus.
Section 16(b)............... This term has the meaning stated on page 78 of
the Prospectus.
Section 162(m).............. This term has the meaning stated on page 75 of
the Prospectus.
Securities Act.............. Securities Act of 1933, as amended.
Senior Notes................ This term has the meaning stated on page 108 of
the Prospectus.
</TABLE>
G-9
<PAGE>
<TABLE>
<C> <S>
SFAS 131.................... This term has the meaning stated on page 37 of
the Prospectus.
SG&A........................ Selling, general and administrative expenses.
SONET (Synchronous Optical
Network Technology)........ An electronics and network architecture for
variable-bandwidth products which enables
transmission of voice, data and video
(multimedia) at very high speeds.
SONET ring.................. A network architecture which provides for
instantaneous restoration of service in the
event of a fiber cut by automatically rerouting
traffic the other direction around the ring.
This occurs so rapidly (in 50 milliseconds) it
is virtually undetectable to the user.
SPRC........................ Southern Pacific Rail Corporation.
Sprint...................... Sprint Communications, Inc.
SuperNet.................... SuperNet, Inc.
Switch...................... A device that selects the paths or circuits to
be used for transmission of information and
establishes a connection. Switching is the
process of interconnecting circuits to form a
transmission path between users and it also
captures information for billing purposes.
TAR......................... Total Accounting Rate.
Telecommunications Act...... The Telecommunications Act of 1996.
Tier 1...................... This term has the meaning stated on page 43 of
the Prospectus.
Tier 2...................... This term has the meaning stated on page 43 of
the Prospectus.
Tier 3...................... This term has the meaning stated on page 43 of
the Prospectus.
</TABLE>
G-10
<PAGE>
<TABLE>
<C> <S>
Trunk....................... A communications channel between two switches.
"Trunking" calls reduces the likelihood of
traffic blockage due to network congestion. A
trunked system combines multiple channels with
unrestricted access in such a manner that user
demands for channels are automatically "queued"
and then allocated to the first available
channel.
UP.......................... Union Pacific Corporation.
USLD........................ USLD Communications Corp.
WorldCom.................... WorldCom, Inc., together with its subsidiaries,
including WilTel (formerly, LDDS
Communications, Inc.).
WTO......................... The World Trade Organization.
WTO Agreement............... This term has the meaning stated on page 61 of
the Prospectus.
</TABLE>
G-11
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER
MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION
IS GIVEN IN THIS PROSPECTUS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH SOLICITATION.
---------------
TABLE OF CONTENTS
PAGE
----
Additional Information................................................... 4
Information Regarding Forward-looking Statements......................... 5
Prospectus Summary....................................................... 5
Summary Consolidated Financial and Operating Data........................ 11
Risk Factors............................................................. 13
The Exchange Offer....................................................... 22
Use of Proceeds.......................................................... 29
Capitalization........................................................... 29
Selected Consolidated Financial Data..................................... 30
Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................... 32
Industry Overview........................................................ 41
Business................................................................. 44
Regulation............................................................... 57
Management............................................................... 64
Principal Stockholder.................................................... 82
Certain Transactions..................................................... 82
Description of the Notes................................................. 85
Description of Certain Indebtedness...................................... 114
Certain United States Federal Income Tax Considerations.................. 116
Plan of Distribution..................................................... 122
Legal Matters............................................................ 123
Experts.................................................................. 123
Index to Consolidated Financial Statements............................... F-1
Glossary................................................................. G-1
QWEST COMMUNICATIONS INTERNATIONAL INC.
OFFER TO EXCHANGE
8.29% SERIES B SENIOR DISCOUNT NOTES DUE 2008 FOR ANY AND ALL OF ITS
OUTSTANDING 8.29% SENIOR DISCOUNT NOTES DUE 2008
[LOGO OF QWEST APPEARS HERE]
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON ___DAY,
___________, 1998, UNLESS EXTENDED; PROVIDED IT MAY NOT BE EXTENDED BEYOND
___________, 1998.
PROSPECTUS
DATED ___________, 1998
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporation Law ("DGCL") empowers a
Delaware corporation to indemnify any persons who are, or are threatened to
be made, parties to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other
than an action by or in the right of such corporation), by reason of the fact
that such person is or was an officer or director of such corporation, or is
or was serving at the request of such corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust
or other enterprise. The indemnity may include expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection with such action, suit or
proceeding, if such officer or director acted in good faith and in a manner
such person reasonably believed to be in or not opposed to the best interests
of the corporation, and, with respect to any criminal action or proceeding,
had no reasonable cause to believe such officer's or director's conduct was
unlawful. A Delaware corporation may indemnify officers and directors in an
action by or in the right of the corporation under the same conditions,
except that no indemnification is permitted without judicial approval if the
officer or director is adjudged to be liable to the corporation in the
performance of his duty. Where an officer or director is successful on the
merits or otherwise in the defense of any action referred to above, the
corporation must indemnify such officer or director against the expenses
which such officer or director actually and reasonably incurred.
In accordance with Section 102(b)(7) of the DGCL, the Company's Certificate
of Incorporation provides that directors shall not be personally liable for
monetary damages for breaches of their fiduciary duty as directors except for
(i) breaches of their duty of loyalty to the Company or its stockholders,
(ii) acts or omissions not in good faith or which involve intentional
misconduct or knowing violations of law, (iii) certain transactions under
Section 174 of the DGLC (unlawful payment of dividends or unlawful stock
purchases or redemptions) or (iv) transactions from which a director derives
an improper personal benefit. The effect of this provision is to eliminate
the personal liability of directors for monetary damages for actions
involving a breach of their fiduciary duty of care, including any actions
involving gross negligence.
The Certificate of Incorporation and the By-laws of the Company provide for
indemnification of the Company's officers and directors to the fullest extent
permitted by applicable law, except that the By-laws provide that the Company
is required to indemnify an officer or director in connection with a
proceeding initiated by such person only if the proceeding was authorized by
the Board of Directors of the Company. In addition, the Company maintains
insurance policies which provide coverage for its officers and directors in
certain situations where the Company cannot directly indemnify such officers
or directors.
Pursuant to Section 145 of the DGCL and the Certificate of Incorporation
and the By-laws of the Company, the Company maintains directors' and
officers' liability insurance coverage.
ITEM 21. EXHIBITS AND FINANCIAL DATA SCHEDULES.
(a) The following is a complete list of Exhibits filed as part of this
Registration Statement, which are incorporated herein:
<TABLE>
<CAPTION>
II-1
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
1.1 Purchase Agreement dated January 22, 1998, between the Company and
Salomon Brothers Inc.
3.1* Amended and restated certificate of incorporation of the Company.
3.2 By-laws of the Company, incorporated by reference to Exhibit 3 in
Form 10-Q for the quarter ended September 30, 1997 (File No.
000-22609).
4.1(a) Indenture dated as of October 15, 1997 with Bankers Trust Company
(including form of the Company's 9.47% Senior Discount Notes Due
2007 and 9.47% Series B Senior Discount Notes Due 2007 as an exhibit
thereto), incorporated by reference to Exhibit 4.1 in Form S-4 as
declared effective on January 5, 1998 (File No. 333-42847).
4.1(b) Indenture dated as of August 28, 1997 with Bankers Trust Company
(including form of the Company's 10 7/8% Series B Senior Notes Due
2007 as an exhibit thereto), incorporated by reference to Exhibit
4.1(b) in Form 10-K for the year ended December 31, 1997 (File No.
000-22609).
4.1(c) Indenture dated as of January 29, 1998 with Bankers Trust Company
(including form of the Company's 8.29% Senior Discount Notes Due
2008 and 8.29% Series B Senior Discount Notes Due as an exhibit
thereto), incorporated by reference to Exhibit 4.1(b) in Form 10-K
for the year ended December 31, 1997 (File No. 000-22609).
4.2 Registration Agreement dated January 29, 1998 with Salomon Brothers
Inc. relating to the Company's 8.29% Senior Discount Notes Due 2008,
incorporated by reference to Exhibit 4.1(b) in Form 10-K for the
year ended December 31, 1997 (File No. 000-22609)..
5.1 Opinion of Holme Roberts & Owen LLP with respect to the legality of
the securities being registered.
8 Opinion of Holme Roberts & Owen LLP with respect to certain tax
matters.
9.1 Voting Agreement dated March 8, 1998, relating to the Agreement and
Plan of Merger referred to in Exhibit 2.1, incorporated by reference
to the same document filed as an exhibit to the Company's Form 8-K
filed on March 9, 1998.
10.1* Growth Share Plan, as amended, effective October 1, 1996. 10.2*
Employment Agreement dated December 21, 1996 with Joseph P. Nacchio.
10.3* Promissory Note dated November 20, 1996 and Severance Agreement dated
December 1, 1996 with Robert S. Woodruff.
10.4 Equity Compensation Plan for Non-Employee Directors filed herewith
10.5*+ IRU Agreement dated as of October 18, 1996 with Frontier
Communications International Inc.
10.6*+ IRU Agreement dated as of February 26, 1996 with WorldCom Network
Services, Inc.
10.7*+ IRU Agreement dated as of May 2, 1997 with GTE 10.8* Equity Incentive
Plan
10.9 Employment Agreement dated March 7, 1997 with Stephen M. Jacobsen
filed herewith
10.10 Employment Agreement dated October 8, 1997 with Lewis O. Wilks filed
herewith
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
10.11 Employment Agreement dated September 26, 1997 with Brij Khandelwal,
incorporated by reference to Exhibit 4.1(b) in Form 10-K for the
year ended December 31, 1997 (File No. 000-22609).
10.12 Employment Agreement dated September 19, 1997 with Larry Seese,
incorporated by reference to Exhibit 4.1(b) in Form 10-K for the
year ended December 31, 1997 (File No. 000-22609).
10.13 Growth Share Plan Agreement with Joseph P. Nacchio, effective
January 1, 1997, and Amendment thereto, incorporated by reference to
Exhibit 4.1(b) in Form 10-K for the year ended December 31, 1997
(File No.
000-22609).
10.14 NonQualified Stock Option Agreement with Joseph P. Nacchio,
effective June 1997, incorporated by reference to Exhibit 4.1(b) in
Form 10-K for the year ended December 31, 1997 (File No. 000-22609).
10.15 Agreement and Plan of Merger, dated March 8, 1998, among the
Company, LCI International, Inc. and a wholly-owned subsidiary of
the Company, incorporated by reference to the same document filed as
an exhibit to the Company's Form 8-K filed on March 9, 1998.
10.16 Amended and Restated Agreement and Plan of Merger dated as of
December 31, 1997 among Phoenix Network, Inc., Qwest Communications
International Inc. and Qwest 1997-5 Acquisition Corp., incorporated
by reference to Exhibit A to the Proxy Statement/Prospectus that is
part of the Registration Statement on Form S-4 as declared effective
on February 12, 1998 (File No. 333-46145).
12.1 Statement re Computation of Ratios.
21 Subsidiaries of the Registrant, incorporated by reference to Exhibit
21.1 in Form S-4 (File No. 333-49915)
23.1 Consent of KPMG Peat Marwick LLP.
23.2 Consent of Grant Thornton LLP
23.3 Consent of Arthur Andersen LLP
23.4 Consent of Holme Roberts & Owen LLP (contained in Exhibit 5.1).
25 Statement of Eligibility of Bankers Trust Company; Form T-1.
</TABLE>
Executive compensation plans and arrangements required to be filed and
identified as such are filed as exhibits 10.1, 10.2, 10.3, 10.4, 10.8, 10.9,
10.10, 10.11 and 10.12.
--------
+ Portions have been omitted pursuant to a previous request for
confidential treatment that was granted by the Commission.
* Incorporated by reference to the exhibit of the same number in Form S-1
as declared effective on June 23, 1997 (File No. 333-25391).
(b) Financial Statement Schedules. The following is a complete list of
financial statement schedules filed as part of this Registration Statement,
which are included herein:
Schedule Number
II Qwest Communications International Inc.
Valuation and Qualifying Accounts
II-3
<PAGE>
ITEM 22. UNDERTAKINGS.
(a) The undersigned Company hereby undertakes:
(1) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c) under the Securities Act of 1933, as amended (the
"Securities Act"), the issuer undertakes that such reoffering prospectus will
contain the information called for by the applicable registration form with
respect to reofferings by persons who may be deemed underwriters, in addition
to the information called for by the other Items of the applicable form.
(2) That every prospectus (i) that is filed pursuant to paragraph (1)
immediately preceding, or (ii) that purports to meet the requirements of
section 10(a)(3) of the Securities Act and is used in connection with an
offering of securities subject to Rule 415 under the Securities Act, will be
filed as a part of an amendment to the registration statement and will not
be used until such amendment is effective, and that, for purposes of
determining any liability under the Securities Act, each such post-effective
amendment shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Commission such indemnification
is against public policy as expressed in the Securities Act and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of
expenses incurred or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or proceedings) is
asserted by such director, officer or controlling person in connection with
the securities being registered, the registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent, submit
to a court of appropriate jurisdiction the question whether indemnification
by it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
(c) The undersigned Company hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through
the date of responding to the request.
(d) The undersigned Company hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
(e) The undersigned Company hereby undertakes that, for purposes of
determining any liability under the Securities Act, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(f) The undersigned Company hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act;
II-4
<PAGE>
(ii) to reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of Prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(iii) to include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.
(4) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of a
registration statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the Company pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed part of the registration
statement as of the time it was declared effective.
II-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THE
COMPANY HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF DENVER, STATE OF
COLORADO ON APRIL 28, 1998.
Qwest Communications International Inc.
By:
ROBERT S. WOODRUFF
Executive Vice President--Finance
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Qwest Communications
International Inc. hereby severally constitute and appoint Joseph P. Nacchio
and Robert S. Woodruff, and each of them singly, our true and lawful
attorneys, with full power to them and each of them singly, to sign for us in
our names in the capacities indicated below, all pre-effective and
post-effective amendments to this Registration Statement and any abbreviated
Registration Statement in connection with this Registration Statement pursuant
to Rule 462(b) under the Securities Act of 1933, as amended, and generally to
do all things in our names and on our behalf in such capacities to enable the
Company to comply with the provisions of the Securities Act of 1933, as
amended, and all requirements of the Securities and Exchange Commission.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
/s/ Chairman of the Board April 28,
- ------------------------------------ 1998
PHILIP F. ANSCHUTZ
/s/ Director, President April 28,
- ------------------------------------ and Chief Executive 1998
JOSEPH P. NACCHIO Officer (Principal
Executive Officer)
/s/ Director, April 28,
- ------------------------------------ Executive Vice 1998
ROBERT S. WOODRUFF President--Finance,
Chief Financial
Officer and
Treasurer (Principal
Financial Officer and
Principal Accounting
Officer)
/s/ Director April 28,
- --------------------------------- 1998
CANNON Y. HARVEY
Director _______________,
- ------------------------------------ 1998
RICHARD T. LIEBHABER
II-6
<PAGE>
/s/ Director April 28,
- ------------------------------------ 1998
DOUGLAS L. POLSON
/s/ Director April 28,
- ------------------------------------ 1998
CRAIG D. SLATER
Director _______________,
- ------------------------------------ 1998
JORDAN L. HAINES
/s/ Director April 28,
- ----------------------------------- 1998
W. THOMAS STEPHENS
/s/ Director April 28,
------------------------------------- 1998
ROY A. WILKENS
II-7
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Qwest Communications International Inc.
Under date of February 24, 1998, except as to note 22, which is as of March
8, 1998, we reported on the consolidated balance sheets of Qwest Communications
International Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1997
which are included in the Registration Statement. In connection with our audits
of the aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedule included in the Registration
Statement. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Denver, Colorado
February 24, 1998
II-8
<PAGE>
SCHEDULE II
QWEST COMMUNICATIONS INTERNATIONAL INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS DEDUCTIONS
BALANCE AT ------------------------- ----------------- BALANCE AT
BEGINNING OF CHARGED TO WRITE-OFFS, END OF
DESCRIPTION PERIOD PROFIT AND LOSS OTHER (1) NET OF RECOVERIES PERIOD
----------- ------------ --------------- --------- ----------------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31,
1997:
Allowance for doubtful
receivables--trade... $3,669 7,768 75 (6,901) $4,611
Year ended December 31,
1996:
Allowance for doubtful
receivables--trade... $2,621 2,841 -- (1,793) $3,669
Year ended December 31,
1995:
Allowance for doubtful
receivables--trade... $1,253 1,758 646 (1,036) $2,621
</TABLE>
- --------
(1) Represents additions resulting from acquisitions.
II-9
<PAGE>
EXHIBIT 1.1
QWEST COMMUNICATIONS INTERNATIONAL INC.
$450,505,000 8.29% Senior Discount Notes Due 2008
PURCHASE AGREEMENT
Dated: January 22, 1998
QWEST COMMUNICATIONS INTERNATIONAL INC.
$450,505,000 8.29% SENIOR DISCOUNT NOTES DUE 2008
PURCHASE AGREEMENT
New York, New York
January 22, 1998
Salomon Brothers Inc
Seven World Trade Center
New York, New York 10048
Ladies and Gentlemen:
Qwest Communications International Inc., a Delaware corporation (the "Company"),
proposes to issue and sell to Salomon Brothers Inc (the "Initial Purchaser")
$450,505,000 aggregate principal amount at maturity of its 8.29% Senior Discount
Notes Due 2008 (the "Securities"). The Securities are to be issued under an
indenture (the "Indenture") dated as of the Closing Date (as defined herein)
between the Company and Bankers Trust Company, as trustee.
The sale of the Securities to the Initial Purchaser will be made without
registration of the Securities under the Securities Act of 1933, as amended (the
"Securities Act"), in reliance upon exemptions from the registration
requirements of the Securities Act. The Initial Purchaser has advised the
Company that it will offer and sell the Securities purchased hereunder in
accordance with Section 4 hereof as soon as it deems advisable.
The holders of the Securities will be entitled to the benefits of a Registration
Agreement dated as of the Closing Date between the Company and Salomon Brothers
Inc (the "Registration Agreement"), pursuant to which the Company will file a
registration statement with the Securities and Exchange Commission (the
"Commission") registering the Securities or New Securities (referred to in the
Registration Agreement) under the Securities Act.
In connection with the sale of the Securities, the Company has prepared a final
offering memorandum, dated January 22, 1998 (the "Final Memorandum"). The Final
Memorandum sets forth certain information concerning the Company and the
Securities. The Company hereby confirms that it has authorized the use of the
Final Memorandum, and any amendment or supplement thereto, in connection with
the offer and sale of the Securities by the Initial Purchaser. Unless stated to
the contrary, all references herein to the Final Memorandum are to the Final
Memorandum at the Execution Time (as defined in Section 6 hereof) and are not
meant to include any amendment or supplement subsequent to the Execution Time.
1. Representations and Warranties. The Company represents and warrants
to the Initial Purchaser as set forth below in this Section 1.
(a) The Final Memorandum, at the date hereof, does not, and at the Closing Date
(as defined below) will not (and any amendment or supplement thereto, at the
date thereof and at the Closing Date, will not), contain any untrue statement of
a material fact or omit to state any material fact necessary to make the
statements therein, in the light of the circumstances under which they were
made, not misleading; provided, however, that the Company makes no
representation or warranty as to the information contained in or omitted from
the Final Memorandum, or any amendment or supplement thereto, in reliance upon
and in conformity with information furnished in writing to the Company by or on
behalf of the Initial Purchaser specifically for inclusion therein.
(b) Each of the Company and its subsidiaries has been duly incorporated, is
validly existing as a corporation in good standing under the laws of the
jurisdiction of its incorporation, has full power (corporate and other) to own
or lease its properties and conduct its business as described in the Final
Memorandum, and is duly qualified to do business as a foreign corporation and is
in good standing under the laws of each jurisdiction which requires such
qualification wherein it owns or leases material properties or conducts material
business, except where the failure to be qualified would not have a material
adverse effect on the Company or any of its subsidiaries.
(c) The Company has full power (corporate and other) to enter into and to
perform its obligations under this Agreement, the Indenture, the Registration
Agreement and the Securities.
(d) The issued shares of capital stock of each of the Company's subsidiaries
have been duly authorized and validly issued, are fully paid and nonassessable
and, except as otherwise set forth in the Final Memorandum, are owned
beneficially by the Company free and clear of any security interests, liens,
encumbrances, equities or claims.
(e) The Company has an authorized, issued and outstanding capitalization as set
forth in the Final Memorandum. All of the issued shares of capital stock of the
Company have been duly authorized and validly issued and are fully paid and
nonassessable.
(f) The consolidated financial statements and schedules of the Company and its
consolidated subsidiaries included in the Final Memorandum fairly present the
financial position of the Company and its consolidated subsidiaries and the
results of operations and changes in financial condition as of the dates and for
the periods therein specified. Such financial statements and schedules have been
prepared in accordance with generally accepted accounting principles
consistently applied throughout the periods involved (except as otherwise noted
therein). The selected financial data set forth under the caption "Selected
Consolidated Financial Data" in the Final Memorandum fairly present, on the
basis stated in the Final Memorandum, the information included therein. The pro
forma financial statements and other pro forma financial information included or
incorporated by reference in the Final Memorandum present fairly the information
shown therein, have been prepared in accordance with the Commission's rules and
guidelines with respect to pro forma financial statements, have been properly
compiled on the pro forma bases described therein and the assumptions used in
the preparation thereof are reasonable and the adjustments used therein are
appropriate to give effect to the transactions or circumstances referred to
therein.
(g) KPMG Peat Marwick LLP, who have certified certain financial statements of
the Company and its consolidated subsidiaries and delivered their report with
respect to the audited consolidated financial statements and schedules included
in the Final Memorandum, are independent public accountants within the meaning
of the Securities Act and the applicable rules and regulations thereunder.
Dollinger Smith & Co., who have audited certain financial statements of
SuperNet, Inc. included in the Final Memorandum and delivered their report with
respect thereto, are independent public accountants within the meaning of the
Securities Act and the applicable rules and regulations thereunder. Grant
Thornton LLC, who have audited certain financial statements of Phoenix Network,
Inc. included in the Final Memorandum and delivered their report with respect
thereto, are independent public accountants within the meaning of the Securities
Act and the applicable rules and regulations thereunder.
(h) This Agreement has been duly authorized, executed, and delivered by
the Company.
(i) The Registration Agreement has been duly authorized by the Company and, when
duly executed and delivered by the Company, will constitute a legal, valid and
binding obligation of the Company enforceable against the Company in accordance
with its terms (subject, as to the enforcement of remedies, to applicable
bankruptcy, reorganization, insolvency, moratorium or other laws affecting
creditors' rights generally from time to time in effect, general principles of
equity and to the enforcement of the indemnification or contribution provisions
contained therein).
(j) The Indenture has been duly authorized by the Company and, when duly
executed and delivered by the Company and the Trustee, will constitute a valid
and binding instrument enforceable against the Company in accordance with its
terms (subject, as to the enforcement of remedies, to applicable bankruptcy,
reorganization, insolvency, moratorium or other laws affecting creditors' rights
generally from time to time in effect, and general principles of equity); the
Securities have been duly and validly authorized and, when executed and
authenticated in accordance with the provisions of the Indenture and delivered
to and paid for by the Initial Purchaser pursuant to this Agreement, will
constitute valid and binding obligations of the Company entitled to the benefits
of the Indenture; and the statements set forth under the heading "Description of
the Notes" in the Final Memorandum, insofar as such statements purport to
summarize certain provisions of the Securities and the Indenture, provide a fair
summary of such provisions.
(k) No legal or governmental proceedings are pending to which the Company or any
of its subsidiaries is a party or to which the property of the Company or any of
its subsidiaries is subject that are not described in the Final Memorandum, and
no such proceedings have been threatened against the Company or any of its
subsidiaries or with respect to any of their respective properties, except in
each case for such proceedings that, if the subject of an unfavorable decision,
ruling or finding, would not, singly or in the aggregate, result in a material
adverse change in the condition (financial or otherwise), business prospects,
net worth or results of operations of the Company and its subsidiaries.
(l) The issuance, offering and sale of the Securities to the Initial Purchaser
by the Company pursuant to this Agreement, the performance by the Company of its
obligations under this Agreement, the Registration Agreement, the Indenture and
the Securities, the consummation of the transactions herein and therein and the
application of proceeds from the sale of the Securities as described in the
Final Memorandum do not (i) require the consent, approval, authorization,
registration or qualification of or with any governmental authority, except such
as have been obtained and such as may be required under state securities or blue
sky laws and except as may be required under the Securities Act and the rules
and regulations thereunder with respect to the Registration Agreement and
transactions contemplated thereunder or (ii) conflict with or result in a breach
or violation of any of the terms and provisions of, or constitute a default
under, any indenture, mortgage, deed of trust, lease or other agreement or
instrument to which the Company or any of its subsidiaries is a party or by
which the Company or any of its subsidiaries or any of their respective
properties are bound, or the charter documents or by-laws of the Company or any
of its subsidiaries, or any statute or any judgment, decree, order, rule or
regulation of any court or other governmental authority or any arbitrator
applicable to the Company or any of its subsidiaries.
(m) The Company has not (i) taken, directly or indirectly, any action designed
to cause or to result in, or that has constituted or which might reasonably be
expected to constitute, the stabilization or manipulation of the price of any
security of the Company to facilitate the sale or resale of the Securities or
(ii) paid or agreed to pay to any person any compensation for soliciting another
to purchase any securities of the Company (except for the sale of Securities by
the Initial Purchaser under this Agreement).
(n) Subsequent to the respective dates as of which information is given in the
Final Memorandum, (i) the Company and its subsidiaries have not incurred any
material liability or obligation, direct or contingent, nor entered into any
material transaction whether or not in the ordinary course of business; (ii) the
Company has not purchased any of its outstanding capital stock, nor declared,
paid or otherwise made any dividend or distribution of any kind on its capital
stock; (iii) there has not been any material change in the capital stock,
short-term debt or long-term debt of the Company and its consolidated
subsidiaries, except in each case as described in or contemplated by the Final
Memorandum; and (iv) there has not been any material adverse change in the
condition (financial or otherwise), earnings, business affairs or business
prospects of the Company and its consolidated subsidiaries whether or not
arising in the ordinary course of business.
(o) The Company and each of its subsidiaries own or hold all items of property
owned or held by each of them free and clear of any security interests, liens,
encumbrances, equities, claims and other defects, except such as do not
materially and adversely affect the value of such property and do not interfere
with the use made or proposed to be made of such property by the Company or such
subsidiary, and any real property and buildings held under lease by the Company
or any such subsidiary are held under valid, subsisting and enforceable leases,
with such exceptions as are not material and do not interfere with the use made
or proposed to be made of such property and buildings by the Company or such
subsidiary, in each case except as described in or contemplated by the Final
Memorandum.
(p) No labor dispute with the employees of the Company or any of its
subsidiaries exists or is threatened or imminent that could result in a material
adverse change in the condition (financial or otherwise), business prospects,
net worth or results of operations of the Company and its subsidiaries, except
as described in or contemplated by the Final Memorandum.
(q) The Company and its subsidiaries own or possess all material patents, patent
applications, trademarks, service marks, trade names, licenses, copyrights and
proprietary or other confidential information currently employed by them in
connection with their respective businesses, and neither the Company nor any
such subsidiary has received any notice of infringement of or conflict with
asserted rights of any third party with respect to any of the foregoing which,
singly or in the aggregate, if the subject of an unfavorable decision, ruling or
finding, would result in a material adverse change in the condition (financial
or otherwise), business prospects, net worth or results of operations of the
Company and its subsidiaries, except as described in or contemplated by the
Final Memorandum.
(r) The Company and each of its subsidiaries are insured by insurers of
recognized financial responsibility against such losses and risks and in such
amounts as are prudent and customary in the businesses in which they are
engaged; neither the Company nor any such subsidiary has been refused any
insurance coverage sought or applied for; and neither the Company nor any such
subsidiary has any reason to believe that it will not be able to renew its
existing insurance coverage as and when such coverage expires or to obtain
similar coverage from similar insurers as may be necessary to continue its
business at a cost that would not materially and adversely affect the condition
(financial or otherwise), business prospects, net worth or results of operations
of the Company and its subsidiaries, except as described in or contemplated by
the Final Memorandum.
(s) No subsidiary of the Company is currently prohibited, directly or
indirectly, from paying any dividends to the Company, from making any other
distribution on such subsidiary's capital stock, from repaying to the Company
any loans or advances to such subsidiary from the Company or from transferring
any of such subsidiary's property or assets to the Company or any other
subsidiary of the Company, except as described in or contemplated by the Final
Memorandum.
(t) The Company and its subsidiaries possess all certificates, orders, permits,
licenses, authorizations, consents and approvals of and from, and have made all
filings and registrations with, the appropriate federal, state or foreign
regulatory authorities necessary to own, lease, license and use their properties
and assets and to conduct their respective businesses, and neither the Company
nor any such subsidiary is in violation of or has received any notice of
proceedings relating to the revocation or modification of any such certificates,
orders, permits, licenses, authorizations, consents or approvals, or the
qualification or rejection of any such filing or registration which, singly or
in the aggregate, if the subject of an unfavorable decision, ruling or finding,
would result in a material adverse change in the condition (financial or
otherwise), business prospects, net worth or results of operations of the
Company and its subsidiaries, except as described in or contemplated by the
Final Memorandum.
(u) The Company has filed all foreign, federal, state and local tax returns that
are required to be filed or has requested extensions thereof and has paid all
taxes required to be paid by it and any other assessment, fine or penalty levied
against it, to the extent that any of the foregoing is due and payable, except
for any such tax, assessment, fine or penalty that is currently being contested
in good faith or as described in or contemplated by the Final Memorandum.
(v) Neither the Company nor any of its subsidiaries is in violation of any
federal or state law or regulation relating to occupational safety and health or
to the storage, handling or transportation of hazardous or toxic materials and
the Company and its subsidiaries have received all permits, licenses or other
approvals required of them under applicable federal and state occupational
safety and health and environmental laws and regulations to conduct their
respective businesses, and the Company and each such subsidiary is in compliance
with all terms and conditions of any such permit, license or approval, except
any such violation of law or regulation, failure to receive required permits,
licenses or other approvals or failure to comply with the terms and conditions
of such permits, licenses or approvals, which would not, singly or in the
aggregate, result in a material adverse change in the condition (financial or
otherwise), business prospects, net worth or results of operations of the
Company and its subsidiaries, except as described in or contemplated by the
Final Memorandum.
(w) Each certificate signed by any officer of the Company and delivered to the
Initial Purchaser or Counsel for the Initial Purchaser shall be deemed to be a
representation and warranty by the Company (and not individually by such
officer) to the Initial Purchaser as to the matters covered thereby.
(x) The Company and each of its subsidiaries maintain a system of internal
accounting controls sufficient to provide reasonable assurance that (i)
transactions are executed in accordance with management's general or specific
authorizations; (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain asset accountability; (iii) access to
assets is permitted only in accordance with management's general or specific
authorization; and (iv) the recorded accountability for assets is compared with
the existing assets at reasonable and appropriate intervals and appropriate
action is taken with respect to any differences.
(y) No default exists, and no event has occurred which, with notice or lapse of
time or both, would constitute a default in the due performance and observance
of any term, covenant or condition of any indenture, mortgage, deed of trust,
lease or other agreement or instrument to which the Company or any of its
subsidiaries is a party or by which the Company or any of its subsidiaries or
any of their respective properties is bound or may be affected in any material
adverse respect with regard to property, business or operations of the Company
and its subsidiaries.
(z) Neither the Company, nor any of its Affiliates (as defined in Rule 501(b) of
Regulation D under the Securities Act ("Regulation D")), nor any person acting
on its or their behalf has, directly or indirectly, made offers or sales of any
security, or solicited offers to buy any security, under circumstances that
would require the registration of the Securities under the Securities Act.
(aa) Neither the Company, nor any of its Affiliates, nor any person acting on
its or their behalf has engaged in any form of general solicitation or general
advertising (within the meaning of Regulation D) in connection with any offer or
sale of the Securities in the United States.
(bb) The Securities satisfy the eligibility requirements of Rule 144A(d)(3)
under the Securities Act.
(cc) Neither the Company, nor any of its Affiliates, nor any person acting on
its or their behalf has engaged in any directed selling efforts with respect to
the Securities, and each of them has complied with the offering restrictions
requirement of Regulation S ("Regulation S") under the Securities Act. Terms
used in this paragraph have the meanings given to them by Regulation S.
(dd) The Company as of the Execution Time expects to be and as of the Closing
Date will have been advised by the National Association of Securities Dealers,
Inc. PORTAL Market that the Securities have been designated "PORTAL-eligible
securities" in accordance with the rules and regulations of the National
Association of Securities Dealers, Inc.
(ee) The Company is not, and upon the issuance and sale of the Securities as
herein contemplated and the application of the net proceeds therefrom as
described in the Final Memorandum will not be, an "investment company" within
the meaning of the Investment Company Act of 1940, as amended (the "Investment
Company Act"), without taking account of any exemption arising out of the number
of holders of the Company's securities.
(ff) The Company will conduct its operations in a manner that will not subject
it to registration as an investment company under the Investment Company Act.
(gg) The information provided by the Company pursuant to Section 5(h) hereof
will not, at the date thereof, contain any untrue statement of a material fact
or omit to state any material fact necessary to make the statements therein, in
the light of the circumstances under which they were made, not misleading.
(hh) There is no franchise, contract or other document of a character that would
be required to be described or referred to in the Final Memorandum, if it were a
prospectus filed as part of a registration statement on Form S-1 under the
Securities Act, that is not described or referred to as would be so required,
and the description thereof or references thereto are correct in all material
respects.
(ii) Subject to compliance by the Initial Purchaser with the representations and
warranties set forth in Section 4, it is not necessary in connection with the
offer, sale and delivery of the Securities to the Initial Purchaser and the
resale to each subsequent purchaser in the manner contemplated by this Agreement
and the Final Memorandum to register the Securities under the Securities Act or
to qualify the Indenture under the Trust Indenture Act of 1939, as amended.
2. Purchase and Sale. Subject to the terms and conditions and in reliance upon
the representations and warranties herein set forth, the Company agrees to sell
to the Initial Purchaser, and the Initial Purchaser agrees to purchase from the
Company, at a purchase price of 66.474% of the aggregate principal amount at
maturity thereof, plus amortization of original issue discount, if any, from
January 29, 1998 to the Closing Date, $450,505,000 aggregate principal amount at
maturity of Securities.
3. Delivery and Payment. Delivery of and payment for the Securities shall be
made at 10:00 AM, New York City time, on January 29, 1998, or such later date
(not later than February 5, 1998) as the Initial Purchaser shall designate,
which date and time may be postponed by agreement between the Initial Purchaser
and the Company (such date and time of delivery and payment for the Securities
being herein called the "Closing Date"). Delivery of the Securities shall be
made to the Initial Purchaser against payment by the Initial Purchaser of the
purchase price thereof to or upon the order of the Company by wire transfer of
federal funds or other immediately available funds or such other manner of
payment as may be agreed by the Company and the Initial Purchaser. Delivery of
the Securities shall be made at such location as the Initial Purchaser shall
reasonably designate at least one business day in advance of the Closing Date
and payment for the Securities shall be made at the office of Shearman &
Sterling ("Counsel for the Initial Purchaser"), 599 Lexington Avenue, New York,
New York. Certificates for the Securities shall be registered in such names and
in such denominations as the Representatives may request not less than three
full business days in advance of the Closing Date.
The Company agrees to have the Securities available for inspection, checking and
packaging by the Initial Purchaser in New York, New York, not later than 1:00 PM
on the business day prior to the Closing Date.
4. Offering of Securities. The Initial Purchaser represents and warrants to
and agrees with the Company that:
(a) It has not offered or sold, and will not offer or sell, any Securities
except (i) to those it reasonably believes to be qualified institutional buyers
(as defined in Rule 144A under the Securities Act) and that, in connection with
each such sale, it has taken or will take reasonable steps to ensure that the
purchaser of such Securities is aware that such sale is being made in reliance
on Rule 144A, or (ii) in accordance with the restrictions set forth in Exhibit A
hereto.
(b) Neither it nor any person acting on its behalf has made or will make
offers or sales of the Securities by means of any form of general solicitation
or general advertising (within the meaning of Regulation D) in the United
States.
5. Agreements. The Company agrees with the Initial Purchaser that:
(a) The Company will furnish to the Initial Purchaser and to Counsel for the
Initial Purchaser, without charge, during the period referred to in paragraph
(c) below, as many copies of the Final Memorandum and any amendments and
supplements thereto as it may reasonably request. The Company will pay the
expenses of printing or other production of all documents relating to the
offering.
(b) The Company will not amend or supplement the Final Memorandum without the
prior written consent of the Initial Purchaser as contemplated by paragraph (c)
below.
(c) If at any time prior to the completion of the sale of the Securities by the
Initial Purchaser, any event occurs as a result of which the Final Memorandum,
as then amended or supplemented, would include any untrue statement of a
material fact or omit to state any material fact necessary to make the
statements therein, in the light of the circumstances under which they were
made, not misleading, or if it should be necessary to amend or supplement the
Final Memorandum to comply with applicable law, the Company will promptly notify
the Initial Purchaser of the same and, subject to the requirements of paragraph
(b) of this Section 5, will prepare and provide as promptly as practicable to
the Initial Purchaser pursuant to paragraph (a) of this Section 5 an amendment
or supplement which will correct such statement or omission or effect such
compliance.
(d) The Company will arrange for the qualification of the Securities for sale by
the Initial Purchaser under the laws of such jurisdictions as the Initial
Purchaser may reasonably designate and will maintain such qualifications in
effect so long as required for the sale of the Securities. The Company will
promptly advise the Initial Purchaser of the receipt by the Company of any
notification with respect to the suspension of the qualification of the
Securities for sale in any jurisdiction or the initiation or threatening of any
proceeding for such purpose.
(e) The Company will not, and will not permit any of its Affiliates to, resell
any Securities that have been acquired by any of them.
(f) Neither the Company, nor any of its Affiliates, nor any person acting on its
or their behalf will, directly or indirectly, make offers or sales of any
security, or solicit offers to buy any security, under circumstances that would
require the registration of the Securities under the Securities Act.
(g) Neither the Company, nor any of its Affiliates, nor any person acting on its
or their behalf will engage in any form of general solicitation or general
advertising (within the meaning of Regulation D) in connection with any offer or
sale of the Securities in the United States.
(h) So long as any of the Securities are "restricted securities" within the
meaning of Rule 144(a)(3) under the Securities Act, the Company will, unless it
becomes subject to and complies with Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), provide to each holder of
such restricted securities and to each prospective purchaser (as designated by
such holder) of such restricted securities, upon the request of such holder or
prospective purchaser, any information required to be provided by Rule
144A(d)(4) under the Securities Act. This covenant is intended to be for the
benefit of the holders, and the prospective purchasers designated by such
holders, from time to time of such restricted securities.
(i) Neither the Company nor any of its Affiliates nor any person acting on its
or their behalf will engage in any directed selling efforts with respect to the
Securities, and each of them will comply with the offering restrictions
requirement of Regulation S. Terms used in this paragraph have the meanings
given to them by Regulation S.
(j) The Company will cooperate with the Initial Purchaser and use its best
efforts to permit the Securities to be eligible for clearance and settlement
through The Depository Trust Company.
(k) The Company will not, until 180 days following the Closing Date, without the
prior written consent of the Initial Purchaser, offer, sell or contract to sell,
or otherwise dispose of, directly or indirectly, or announce the offering of,
any debt securities issued or guaranteed by the Company (other than the
Securities or as otherwise contemplated by the Registration Agreement).
(l) The Company will use the net proceeds received by it from the sale of
the Securities in the manner specified in the Final Memorandum under "Use of
Proceeds."
6. Conditions to the Obligations of the Initial Purchaser. The obligations of
the Initial Purchaser to purchase the Securities shall be subject to the
accuracy of the representations and warranties on the part of the Company
contained herein at the date and time that this Agreement is executed and
delivered by the parties hereto (the "Execution Time") and the Closing Date, to
the accuracy of the statements of the Company made in any certificates pursuant
to the provisions hereof, to the performance by the Company of its obligations
hereunder and to the following additional conditions:
(a) The Company shall have furnished to the Initial Purchaser the opinion of
Holme Roberts & Owen LLP, counsel for the Company, dated the Closing Date, to
the effect that:
(i) each of the Company, Qwest Corporation ("QC"), Qwest Communications
Corporation ("QCC") and Qwest Transmission Inc. ("QTI") (collectively, the
"Subsidiaries" and individually, a "Subsidiary") has been duly incorporated and
is validly existing as a corporation in good standing under the laws of the
jurisdiction in which it is organized, with full corporate power and authority
to own its properties and conduct its business as described in the Final
Memorandum, and is duly qualified to do business as a foreign corporation and is
in good standing under the laws of each jurisdiction that requires such
qualification in which it owns or leases material properties or conducts
material business, except for such jurisdictions where the failure to so qualify
or to be in good standing would not, singly or in the aggregate, have a material
adverse effect on the Company and the Subsidiaries, and the Company has full
corporate power and authority to enter into and perform its obligations under
this Agreement, the Registration Agreement, the Indenture and the Securities;
(ii) all of the outstanding shares of capital stock of the Company and each of
the Subsidiaries have been duly and validly authorized and issued and are fully
paid and nonassessable, and, except as otherwise set forth in the Final
Memorandum, all outstanding shares of capital stock of the Subsidiaries are
owned by the Company either directly or through a wholly owned Subsidiary, free
and clear of (to the best of such counsel's knowledge after due inquiry) any
security interests and any other claims, liens or encumbrances;
(iii) the Company's authorized equity capitalization is as set forth in
the Final Memorandum;
(iv) the Indenture has been duly authorized, executed and delivered and
constitutes a legal, valid and binding instrument enforceable against the
Company in accordance with its terms (subject, as to the enforcement of
remedies, to applicable bankruptcy, reorganization, insolvency, fraudulent
conveyance, moratorium or other laws affecting creditors' rights generally from
time to time in effect, and to general equitable principles); the Securities
have been duly and validly authorized and, when executed and authenticated in
accordance with the provisions of the Indenture and delivered to and paid for by
the Initial Purchaser pursuant to this Agreement, will constitute legal, valid
and binding obligations of the Company (subject, as to the enforcement of
remedies, to applicable bankruptcy, reorganization, insolvency, fraudulent
conveyance, moratorium or other laws affecting creditors' rights generally from
time to time in effect, and to general equitable principles) entitled to the
benefits of the Indenture; and the Securities and the Indenture conform as to
legal matters in all material respects to the descriptions thereof set forth
under the heading "Description of the Notes" in the Final Memorandum;
(v) the information contained in the Final Memorandum under the headings
"Description of Certain Indebtedness," "Certain United States Federal Income
Taxes" and "Certain Transactions" fairly summarizes in all material respects the
matters therein described and to the extent that such statements purport to
describe certain provisions of U.S. federal laws, rules or regulations, have
been reviewed by such counsel and are correct as to legal matters in all
material respects;
(vi) this Agreement has been duly authorized, executed and delivered
by the Company;
(vii) the Registration Agreement has been duly authorized, executed and
delivered by the Company, and constitutes legal, valid and binding obligations
of the Company enforceable against the Company in accordance with its terms
(subject, as to the enforcement of remedies, to applicable bankruptcy,
reorganization, insolvency, fraudulent conveyance, moratorium or other laws
affecting creditors' rights generally from time to time in effect, and to
general principles of equity), and further such counsel expresses no opinion as
to the enforceability of the indemnification or contribution provisions
contained therein, and the Registration Agreement conforms as to legal matters
in all material respects to the description thereof contained in the Final
Memorandum;
(viii) no consent, approval, authorization or order of any court or governmental
agency or body (other than such as may be required under the applicable
securities laws of the various jurisdictions in which the Securities will be
offered or sold, as to which such counsel expresses no opinion, or as required
in connection with the transactions contemplated by the Registration Agreement)
is required in connection with the due authorization, execution and delivery of
this Agreement, the Registration Agreement or the Indenture or for the offering,
issuance, sale or delivery of the Securities to the Initial Purchaser or the
resale of the Securities by the Initial Purchaser in accordance with this
Agreement;
(ix) the issue and sale of the Securities, the execution and delivery of this
Agreement, the Registration Agreement, the Indenture and the Securities, the
consummation of the transactions contemplated by this Agreement and the
application of proceeds from the sale of the Securities as described in the
Final Memorandum and the compliance by the Company with its obligations under
this Agreement, the Registration Agreement, the Indenture or the Securities,
will not conflict with, result in a breach or violation of, or constitute a
default under any applicable law or the charter or by-laws of the Company or any
of the Subsidiaries or the terms of any indenture or other agreement or
instrument known to such counsel to which the Company or any of the Subsidiaries
is a party or bound or any judgment, order or decree known to such counsel to be
applicable to the Company or any of the Subsidiaries of any court, regulatory
body, administrative agency, governmental body or arbitrator having jurisdiction
over the Company or any of the Subsidiaries;
(x) assuming the accuracy of the representations and warranties and compliance
with the agreements contained in this Agreement, no registration of the
Securities under the Securities Act is required, and no qualification of the
Indenture under the Trust Indenture Act of 1939 is necessary, for the purchase
by the Initial Purchaser of the Securities, or the offer and sale by the Initial
Purchaser of the Securities, in each case, in the manner contemplated by this
Agreement (and not taking into account the transactions contemplated by the
Registration Agreement);
(xi) the Company is not an "investment company" within the meaning of the
Investment Company Act of 1940 without taking account of any exemption arising
out of the number of holders of the Company's securities;
(xii) no legal or governmental proceedings are pending to which the Company or
any of its Subsidiaries is a party or to which the property of the Company or
any of its Subsidiaries is subject, as would be required to be described in the
Final Memorandum, that are not described in the Final Memorandum and, to the
best of such counsel's knowledge after due inquiry, no such proceedings have
been threatened against the Company or any of its subsidiaries or with respect
to any of their respective properties; there is no franchise, contract or other
document of a character that would be required to be described or referred to in
the Final Memorandum, if it were a prospectus filed as part of a registration
statement on Form S-1 under the Securities Act, that is not described or
referred to as would be so required, and the descriptions thereof or references
thereto are correct in all material respects; and the statements in the Final
Memorandum under the caption "Business ? Legal Proceedings" present the
information that would be called for, if the Final Memorandum were a prospectus
filed as part of a registration statement on Form S-1 under the Securities Act,
with respect to such legal matters, documents and proceedings and fairly
summarize the matters referred to therein;
(xiii) to the best of such counsel's knowledge, there are no statutes or
regulations that would be required to be described in the Final Memorandum, if
it were a prospectus filed as part of a registration statement on Form S-1 under
the Securities Act, that are not described as would be so required; and
(xiv) to the best of such counsel's knowledge, (a) neither the Company nor any
Subsidiary is in violation of its charter or by-laws and (b) no default by the
Company or any Subsidiary exists in the due performance or observance of any
material obligation, agreement, covenant or condition contained in any contract
or other document that is described or referred to in the Final Memorandum,
except in the case of (b) only, to the extent that any such default would not
have a material adverse effect on the condition (financial or otherwise) or
operations of the Company on a consolidated basis;
Such counsel shall also state that they have no reason to believe that at the
Execution Time or at the Closing Date the Final Memorandum contained an untrue
statement of a material fact or omitted to state a material fact necessary in
order to make the statements therein, in the light of the circumstances under
which they were made, not misleading; provided, however, that such counsel
expresses no belief as to the financial statements, including the notes thereto,
or supporting schedules or other financial and accounting data included in the
Final Memorandum.
In rendering such opinion, such counsel may rely (A) as to matters involving the
application of laws of any jurisdiction other than the State of New York, the
State of Colorado, the United States or the General Corporation Law of the State
of Delaware, to the extent such counsel deems proper and as specified in such
opinion, upon the opinion of other counsel (including internal counsel) of good
standing whom such counsel believes to be reliable and who are satisfactory to
Counsel for the Initial Purchaser and (B) as to matters of fact, to the extent
deemed proper, on certificates of responsible officers of the Company and public
officials.
All references in this Section 6(a) to the Final Memorandum shall be deemed to
include any amendment or supplement thereto at the Closing Date.
(b) The Company shall have furnished to the Initial Purchaser the opinion of
Morrison & Foerster LLP, special federal regulatory counsel for the Company,
dated the Closing Date, to the effect that:
(i) (A) the execution and delivery of this Agreement, the Registration Agreement
and the Indenture by the Company and the issue and sale of the Securities
contemplated hereby and thereby do not violate (1) the Communications Act of
1934 (the "Communications Act"), (2) the Telecommunications Act of 1996 (the
"Telecom Act of 1996") or (3) any rules or regulations of the Federal
Communications Commission (the "FCC") applicable to the Company or its
subsidiaries, and (B) no authorization of or filing with the FCC is necessary
for the execution and delivery of this Agreement, the Registration Agreement or
the Indenture by the Company and the issue and sale of the Securities
contemplated hereby and thereby in accordance with the terms hereof and thereof;
(ii) QCC is a nondominant carrier authorized by the FCC to provide domestic
interstate interexchange telecommunications services as described in such
opinion without any further order, license, permit or other authorization by the
FCC. QCC also has been granted Section 214 authority by the FCC to provide
international switched resale telecommunications services as described in such
opinion. QCC has on file with the FCC tariffs applicable to its domestic
interstate and international services. No other FCC authority is required, and
no other tariffs are required to be filed under the rules and regulations of the
FCC, for the conduct of QCC's telecommunications business as described in the
Final Memorandum;
(iii) QTI is a microwave carrier authorized by the FCC and holds the licenses
listed in such opinion. No further FCC authority is required for the conduct of
QTI's microwave telecommunications business as described in the Final
Memorandum, except to the extent that the absence of any such authority, singly
or in the aggregate, would not have a material adverse effect on the business or
operations of the Company or its subsidiaries taken as a whole;
(iv) FSI Acquisition Corp. is a private carrier not subject to Title II
common carrier regulation under the Communications Act, as amended by the
Telecom Act of 1996;
(v) (A) QCC and QTI in all material respects (1) have made all reports and
filings, and paid all fees, required by the FCC; and (2) have all certificates,
orders, permits, licenses, authorizations, consents and approvals of and from,
and have made all filings and registrations with, the FCC necessary to own,
lease, license and use their properties and assets and to conduct their business
in the manner described in the Final Memorandum; and (B) to the best of such
counsel's knowledge, neither QCC nor QTI has received any notice of proceedings
relating to the revocation or modification of any such certificates, orders,
permits, licenses, authorizations, consents or approvals, or the qualification
or rejection of any such filing or registration, the effect of which, singly or
in the aggregate, would have a material adverse effect on the business or
operations of the Company and its subsidiaries taken as a whole as described in
the Final Memorandum;
(vi) to the best of such counsel's knowledge, neither QCC nor QTI is in
violation of, or in default under, the Communications Act, as amended by the
Telecom Act of 1996, or the rules or regulations of the FCC, the effect of
which, singly or in the aggregate, would have a material adverse effect on the
business or operations of the Company and its subsidiaries taken as a whole as
described in the Final Memorandum;
(vii) (A) no decree or order of the FCC is outstanding against QCC or QTI and
(B) to the best of such counsel's knowledge, no formal litigation, proceeding,
inquiry or investigation has been commenced or threatened, and no formal notice
of violation or order to show cause has been issued, against QCC or QTI before
or by the FCC (except for any matters described in such opinion, which, if the
subject of an unfavorable decision, would not have a material adverse effect on
the business or operations of the Company and its subsidiaries taken as a whole
as described in the Final Memorandum); and
(viii) the statements in the Final Memorandum under the captions "Risk
Factors?Regulation Risks" and "Regulation," insofar as such statements
constitute a summary of the legal matters, documents or proceedings of the FCC
with respect to the telecommunications regulation referred to therein, are
accurate in all material respects and fairly summarize all matters referred to
therein.
(c) (A) The Company shall have furnished to the Initial Purchaser the opinion of
Goodin, MacBride, Squeri, Schlotz & Ritchie, LLP, special state regulatory
counsel for the Company for the State of California, dated the Closing Date, to
the effect that:
(i) (x) the execution and delivery of this Agreement, the Registration Agreement
and the Indenture by the Company and the issue and sale of the Securities
contemplated hereby and thereby do not violate (1) any laws administered by,
rules, regulations or published policies of, the California Public Utilities
Commission (the "California PUC") ("PUC Laws") or any other state laws governing
the provision of telecommunications services in the State of California
("Telecommunications Laws") applicable to the Company or its subsidiaries, or
(2) any decree from any California court relating to telecommunications matters,
and (y) no authorization of or filing with the California PUC in the State of
California is necessary for the execution and delivery of this Agreement, the
Registration Agreement or the Indenture by the Company and the issue and sale of
the Securities contemplated hereby and thereby in accordance with the terms
hereof and thereof;
(ii) QCC is certified, registered or otherwise authorized, or is not required to
obtain authority, to provide intrastate interexchange telecommunications
services in the State of California. QCC has a tariff on file in the State of
California and no further tariffs are required to be filed by QCC or the Company
in the State of California to conduct the Company's telecommunications business
as described in the Final Memorandum;
(iii) (x) QCC and the Company (1) have made all reports and filings, and paid
all fees, required by the California PUC in the State of California; and (2)
have all certificates, orders, permits, licenses, authorizations, consents and
approvals of and from, and have made all filings and registrations with, the
California PUC in the State of California necessary to own, lease, license and
use their properties and assets and to conduct their business in the manner
described in the Final Memorandum; and (y) neither QCC nor the Company has
received any notice of proceedings relating to the revocation or modification of
any such certificates, orders, permits, licenses, authorizations, consents or
approvals, or the qualification or rejection of any such filing or registration,
the effect of which, singly or in the aggregate, would have a material adverse
effect on the Company's, and its subsidiaries' taken as a whole,
telecommunications business or operations, as described in the Final Memorandum;
(iv) neither the Company nor QCC is in violation of, or in default under any PUC
Laws or any Telecommunications Laws, the effect of which, singly or in the
aggregate, would have a material adverse effect on the Company's, and its
subsidiaries' taken as a whole, telecommunications business or operations, as
described in the Final Memorandum; and
(v) (x) no decree or order of the California PUC in the State of California is
outstanding against the Company or any of its subsidiaries and (y) no formal
litigation, proceeding, inquiry or investigation has been commenced or
threatened, and no notice of violation or order to show cause has been issued,
against the Company or any of its subsidiaries before or by the California PUC
or any other regulatory agency in the State of California.
(B) The Company shall have furnished to the Initial Purchaser the opinion of
Bickerstaff, Heath Smiley, Pollan, Kever & McDaniel LLP, special state
regulatory counsel for the Company for the State of Texas, dated the Closing
Date, to the effect that:
(i) (x) the execution and delivery of this Agreement, the Registration Agreement
and the Indenture by the Company and the issue and sale of the Securities do not
violate any telecommunications laws of the State of Texas applicable to the
Company or QCC or, to the best of such counsel's knowledge, any decree from any
court of the State of Texas relating to the telecommunications operations of the
Company or QCC, and (y) no authorization of or filing with the Public Utility
Commission of Texas (the "Texas PUC") is necessary for the execution and
delivery of this Agreement, the Registration Agreement or the Indenture by the
Company or the issue and sale of the Securities contemplated hereby and thereby
in accordance with the terms of this Agreement;
(ii) QCC is duly registered with the Texas PUC and authorized to provide
intrastate telecommunications services in Texas and no further authority is
required to be obtained by QCC or the Company from the Texas PUC to conduct the
Company's telecommunications business as described in the Final Memorandum. QCC
has a registration and price list on file in Texas and no further tariffs are
required to be filed by QCC or the Company with the Texas PUC to conduct the
Company's telecommunications business as described in the Final Memorandum;
(iii) (x) QCC and the Company (1) have made all reports and filings required by
the Texas PUC; and (2) have all certificates, orders, permits, licenses,
authorizations, consents and approvals of and from, and have made all filings
and registrations with, the Texas PUC necessary to own, lease, license and use
their properties and assets and to conduct the Company's telecommunications
business in the manner described in the Final Memorandum; and (y) neither QCC
nor the Company has received any notice of proceedings from the Texas PUC
relating to the revocation or modification of any such certificates, orders,
permits, licenses, authorizations, consents or approvals, or the qualification
or rejection of any such filing or registration, the effect of which, singly or
in the aggregate, would have a material adverse effect on the business or
operations of the Company and its subsidiaries taken as a whole as described in
the Final Memorandum;
(iv) neither QCC nor the Company is in violation of, or in default under the
telecommunications laws of the State of Texas, the effect of which, singly or in
the aggregate, would have a material adverse effect on the business or
operations of the Company and its subsidiaries taken as a whole as described in
the Final Memorandum; and
(v) (x) no decree or order of the Texas PUC is outstanding against QCC or the
Company and (y) no formal litigation, proceeding, inquiry or investigation has
been commenced or threatened, and no formal notice of violation or order to show
cause has been issued, against QCC or the Company before or by the Texas PUC.
(d) The Company shall have furnished to the Initial Purchaser the opinion of
Joseph Garrity, internal counsel for the Company, dated the Closing Date, to the
effect that:
(i) (A) the execution and delivery of this Agreement, the Registration Agreement
and the Indenture by the Company and the issuance and sale of the Securities
contemplated hereby and thereby do not violate (1) any state telecommunications
laws or regulations ("State Telecommunications Laws") applicable to the Company
or QCC, QTI or FSI Acquisition Corp. (together, the "Operating Subsidiaries") or
(2) any decree from any court relating to the telecommunications operations of
the Company or the Operating Subsidiaries, and (B) no authorization of or filing
with any Public Utilities Commission or other state regulatory authority ("State
Regulatory Agency") is necessary for the execution and delivery of this
Agreement, the Registration Agreement or the Indenture by the Company and the
issuance and sale of the Securities contemplated hereby and thereby in
accordance with the terms hereof and thereof;
(ii) QCC is certified, registered or otherwise authorized, or is not required to
obtain authority to provide, intrastate interexchange telecommunications
services in the respective states listed in such opinion. No further authority
is required to be obtained by the Company or any of the Operating Subsidiaries
from any such state to conduct the telecommunications business as described in
the Final Memorandum. QCC has a tariff or price list on file in each of the
states requiring such a filing as identified in such opinion. No further tariffs
are currently required to be filed by the Company or any of the Operating
Subsidiaries in any such state to conduct the telecommunications business as
described in the Final Memorandum;
(iii) except to the extent that the following would not have, singly or in the
aggregate, a material adverse effect on the business or operations of the
Company and its subsidiaries as described in the Final Memorandum: (A) the
Company and QCC (1) have made all reports and filings, and paid all fees,
required by State Regulatory Agencies; and (2) have all certificates, orders,
permits, licenses, authorizations, consents and approvals of and from, and have
made all filings and registrations with, State Regulatory Authorities necessary
to own, lease, license and use their properties and assets and to conduct
business in the manner described in the Final Memorandum; and (B) neither the
Company nor QCC has received any notice of proceedings relating to the
revocation or modification of any such certificates, orders, permits, licenses,
authorizations, consents or approvals, or the qualification or rejection of any
such filing or registration;
(iv) to the best of such counsel's knowledge, neither the Company nor QCC is in
violation of, or in default under, any State Telecommunications Law, the effect
of which, singly or in the aggregate, would have a material adverse effect on
the business or operations of the Company and its subsidiaries as described in
the Final Memorandum;
(v) (A) no decree or order of any State Regulatory Agency is outstanding against
the Company or any of the Operating Subsidiaries and (B) no formal litigation,
proceeding, inquiry or investigation has been commenced or, to such counsel's
knowledge, threatened, and no formal notice of violation or order to show cause
has been issued, against the Company or any of the Operating Subsidiaries before
or by any State Regulatory Agency, the effect of which, singly or in the
aggregate, would have a material adverse effect on the business or operations of
the Company and its subsidiaries as described in the Final Memorandum; and
(vi) the statements in the Final Memorandum under the captions "Risk
Factors?Regulation Risks" and "Regulation," insofar as such statements
constitute a summary of the legal matters, documents or proceedings of the FCC
and State Regulatory Agencies with respect to telecommunications regulation
referred to therein, are accurate in all material respects and fairly summarize
all matters referred to therein, as of the date of publication of the Final
Memorandum.
(e) The Initial Purchaser shall have received from Counsel for the Initial
Purchaser such opinion or opinions, dated the Closing Date, with respect to the
issuance and sale of the Securities, the Final Memorandum (as amended or
supplemented at the Closing Date) and other related matters as the Initial
Purchaser may reasonably require, and the Company shall have furnished or made
available to such counsel such documents as they request for the purpose of
enabling them to pass upon such matters.
(f) The Company shall have furnished to the Initial Purchaser a certificate of
the Company, signed by (1) the President and Chief Executive Officer and (2) the
Vice President ? Finance, Treasurer and Chief Financial Officer of the Company,
dated the Closing Date, to the effect that the signers of such certificate have
carefully reviewed the Final Memorandum, any amendment or supplement to the
Final Memorandum and this Agreement and that:
(i) the representations and warranties of the Company in this Agreement are true
and correct in all material respects on and as of the Closing Date with the same
effect as if made on the Closing Date, and the Company has complied with all the
agreements and satisfied all the conditions on its part to be performed or
satisfied hereunder at or prior to the Closing Date; and
(ii) since the date of the most recent financial statements included in the
Final Memorandum, there has been no material adverse change in the condition
(financial or otherwise), earnings, business affairs or business prospects or
properties of the Company and its subsidiaries, whether or not arising from
transactions in the ordinary course of business, except as set forth in or
contemplated in the Final Memorandum (exclusive of any amendment or supplement
thereto).
(g) (i) (A) At the Execution Time, KPMG Peat Marwick LLP shall have furnished to
the Initial Purchaser a letter dated such date, in form and substance
satisfactory to the Initial Purchaser, containing statements and information of
the type ordinarily included in accountants' "comfort letters" to underwriters
with respect to the financial statements and certain financial information of
the Company contained in the Final Memorandum and (B) at the Closing Date, KPMG
Peat Marwick LLP shall have furnished to the Initial Purchaser a letter dated
such date, in form and substance satisfactory to the Initial Purchaser, to the
effect that they reaffirm the statements made in the letter furnished pursuant
to preceding sentence, except that the specified date referred to shall be a
date not more than three business days prior to the Closing Date.
(ii) At the Closing Date, Dollinger, Smith & Co. and Grant Thornton
LLP, each shall have furnished to the Initial Purchaser a letter dated such
date, in form and substance satisfactory to the Initial Purchaser, containing
statements and information of the type ordinarily included in accountants'
"comfort letters" to underwriters with respect to the financial statements and
certain financial information of SuperNet, Inc. and Phoenix Network, Inc.,
respectively, contained in the Final Memorandum.
(h) Subsequent to the Execution Time or, if earlier, the dates as of which
information is given in the Final Memorandum, there shall not have been (i) any
change or decrease specified in the letters referred to in paragraph (g) of this
Section 6 or (ii) any change, or any development involving a prospective change,
in or affecting the business or properties of the Company and its subsidiaries
the effect of which, in any case referred to in clause (i) or (ii) above, is, in
the judgment of the Initial Purchaser, so material and adverse as to make it
impractical or inadvisable to market the Securities as contemplated by the Final
Memorandum.
(i) Prior to the Closing Date, the Company shall have furnished to the Initial
Purchaser such reasonable further information, certificates and documents as the
Initial Purchaser may reasonably request.
(j) At the Closing Date, the Company's $250,000,000 Series B 10?% Senior Notes
Due 2007 (the "Series B Notes") shall be rated at least B+ by Standard & Poor's
Corporation and B2 by Moody's Investors Service Inc. and since the date of this
Agreement there shall not have occurred a downgrading in the rating assigned to
the Series B Notes by any "nationally recognized statistical rating agency", as
that term is defined by the Commission for purposes of Rule 436(g)(2) under the
Securities Act, and no such organization shall have publicly announced that it
has its rating of the Series B Notes under surveillance or review.
If any of the conditions specified in this Section 6 shall not have been
fulfilled in all material respects when and as provided in this Agreement, or if
any of the opinions and certificates mentioned above or elsewhere in this
Agreement shall not be in all material respects reasonably satisfactory in form
and substance to the Initial Purchaser and Counsel for the Initial Purchaser,
this Agreement and all obligations of the Initial Purchaser hereunder may be
cancelled at, or at any time prior to, the Closing Date by the Initial
Purchaser. Notice of such cancellation shall be given to the Company in writing,
by facsimile or by telephone confirmed in writing.
The documents required to be delivered by this Section 6 shall be delivered at
the office of Counsel for the Initial Purchaser, at 599 Lexington Avenue, New
York, New York, or such other place as the Initial Purchaser and the Company
shall mutually agree, on the Closing Date.
7. Reimbursement of Expenses. If the sale of the Securities provided for herein
is not consummated because any condition to the obligations of the Initial
Purchaser set forth in Section 6 hereof is not satisfied, because of any
termination pursuant to Section 10 hereof or because of any refusal, inability
or failure on the part of the Company to perform any agreement herein or comply
with any provision hereof other than by reason of a default by the Initial
Purchaser in payment for the Securities on the Closing Date, the Company will
reimburse the Initial Purchaser upon demand for all reasonable out-of-pocket
expenses (including reasonable fees and disbursements of counsel) that shall
have been incurred by it in connection with the proposed purchase and sale of
the Securities.
8. Indemnification and Contribution. (a) The Company agrees to indemnify and
hold harmless the Initial Purchaser, the directors, officers, employees and
agents of the Initial Purchaser and each person who controls the Initial
Purchaser within the meaning of either the Securities Act or the Exchange Act
against any and all losses, claims, damages or liabilities, joint or several, to
which they or any of them may become subject under the Securities Act, the
Exchange Act or other federal or state statutory law or regulation, at common
law or otherwise, insofar as such losses, claims, damages or liabilities (or
actions in respect thereof) arise out of or are based upon any untrue statement
or alleged untrue statement of a material fact contained in the Final Memorandum
or any information provided by the Company to any holder or prospective
purchaser of Securities pursuant to Section 5(h), or in any amendment thereof or
supplement thereto, or arise out of or are based upon the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein, in the light of the circumstances
under which they were made, not misleading, and agrees to reimburse each such
indemnified party, as incurred, for any legal or other expenses reasonably
incurred by them in connection with investigating or defending any such loss,
claim, damage, liability or action; provided, however, that the Company will not
be liable in any such case to the extent that any such loss, claim, damage or
liability arises out of or is based upon any such untrue statement or alleged
untrue statement or omission or alleged omission made in the Final Memorandum,
or in any amendment thereof or supplement thereto, in reliance upon and in
conformity with written information furnished to the Company by or on behalf of
the Initial Purchaser specifically for inclusion therein. This indemnity
agreement will be in addition to any liability which the Company may otherwise
have.
(b) The Initial Purchaser agrees to indemnify and hold harmless the Company, its
directors, its officers, and each person who controls the Company within the
meaning of either the Securities Act or the Exchange Act, to the same extent as
the foregoing indemnity from the Company to the Initial Purchaser, but only with
reference to written information relating to the Initial Purchaser furnished to
the Company by or on behalf of the Initial Purchaser specifically for inclusion
in the Final Memorandum (or in any amendment or supplement thereto). This
indemnity agreement will be in addition to any liability which the Initial
Purchaser may otherwise have. The Company acknowledges that the statements set
forth in the last paragraph of the cover page and under the heading "Plan of
Distribution" in the Final Memorandum constitute the only information furnished
in writing by or on behalf of the Initial Purchaser for inclusion in the Final
Memorandum (or in any amendment or supplement thereto).
(c) Promptly after receipt by an indemnified party under this Section 8 of
notice of the commencement of any action, such indemnified party will, if a
claim in respect thereof is to be made against the indemnifying party under this
Section 8, notify the indemnifying party in writing of the commencement thereof;
but the failure so to notify the indemnifying party (i) will not relieve the
indemnifying party from liability under paragraph (a) or (b) above unless and to
the extent the indemnifying party did not otherwise learn of such action and
such failure results in the forfeiture by the indemnifying party of substantial
rights and defenses and (ii) will not, in any event, relieve the indemnifying
party from any obligations to any indemnified party other than the
indemnification obligation provided in paragraph (a) or (b) above. The
indemnifying party shall be entitled to appoint counsel of the indemnifying
party's choice at the indemnifying party's expense to represent the indemnified
party in any action for which indemnification is sought (in which case the
indemnifying party shall not thereafter be responsible for the fees and expenses
of any separate counsel retained by the indemnified party or parties except as
set forth below); provided, however, that such counsel shall be satisfactory to
the indemnified party. Notwithstanding the indemnifying party's election to
appoint counsel to represent the indemnified party in an action, the indemnified
party shall have the right to employ separate counsel (including local counsel),
and the indemnifying party shall bear the reasonable fees, costs and expenses of
such separate counsel if (i) the use of counsel chosen by the indemnifying party
to represent the indemnified party would present such counsel with a conflict of
interest, (ii) the actual or potential defendants in, or targets of, any such
action include both the indemnified party and the indemnifying party and the
indemnified party shall have reasonably concluded that there may be legal
defenses available to it and/or other indemnified parties which are different
from or additional to those available to the indemnifying party, (iii) the
indemnifying party shall not have employed counsel satisfactory to the
indemnified party to represent the indemnified party within a reasonable time
after notice of the institution of such action or (iv) the indemnifying party
shall authorize the indemnified party to employ separate counsel at the expense
of the indemnifying party. An indemnifying party will not, without the prior
written consent of the indemnified parties, settle or compromise or consent to
the entry of any judgment with respect to any pending or threatened claim,
action, suit or proceeding in respect of which indemnification or contribution
may be sought hereunder (whether or not the indemnified parties are actual or
potential parties to such claim or action) unless such settlement, compromise or
consent includes an unconditional release of each indemnified party from all
liability arising out of such claim, action, suit or proceeding.
(d) In the event that the indemnity provided in paragraph (a) or (b) of this
Section 8 is unavailable to or insufficient to hold harmless an indemnified
party for any reason, the Company and the Initial Purchaser agree to contribute
to the aggregate losses, claims, damages and liabilities (including legal or
other expenses reasonably incurred in connection with investigating or defending
same) (collectively "Losses") to which the Company and the Initial Purchaser may
be subject in such proportion as is appropriate to reflect the relative benefits
received by the Company and by the Initial Purchaser from the offering of the
Securities; provided, however, that in no case shall the Initial Purchaser be
responsible for any amount in excess of the purchase discount or commission
applicable to the Securities purchased by the Initial Purchaser hereunder. If
the allocation provided by the immediately preceding sentence is unavailable for
any reason, the Company and the Initial Purchaser shall contribute in such
proportion as is appropriate to reflect not only such relative benefits but also
the relative fault of the Company and of the Initial Purchaser in connection
with the statements or omissions which resulted in such Losses as well as any
other relevant equitable considerations.
Benefits received by the Company shall be deemed to be equal to the total net
proceeds from the offering (before deducting expenses), and benefits received by
the Initial Purchaser shall be deemed to be equal to the total purchase
discounts and commissions received by the Initial Purchaser from the Company in
connection with the purchase of the Securities hereunder. Relative fault shall
be determined by reference to whether any alleged untrue statement or omission
relates to information provided by the Company or the Initial Purchaser. The
Company and the Initial Purchaser agree that it would not be just and equitable
if contribution were determined by pro rata allocation or any other method of
allocation which does not take account of the equitable considerations referred
to above. Notwithstanding the provisions of this paragraph (d), no person guilty
of fraudulent misrepresentation (within the meaning of Section 11(f) of the
Securities Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation. For purposes of this Section 8,
each person who controls the Initial Purchaser within the meaning of either the
Securities Act or the Exchange Act and each director, officer, employee and
agent of the Initial Purchaser shall have the same rights to contribution as the
Initial Purchaser, and each person who controls the Company within the meaning
of either the Securities Act or the Exchange Act and each officer and director
of the Company shall have the same rights to contribution as the Company,
subject in each case to the applicable terms and conditions of this paragraph
(d).
9. Intentionally Omitted.
10. Termination. This Agreement shall be subject to termination in the
absolute discretion of the Initial Purchaser, by notice given to the Company
prior to delivery of and payment for the Securities, if prior to such time (i)
trading in the Company's Common Stock shall have been suspended by the
Commission or the Nasdaq Stock Market's National Market ("Nasdaq") or trading in
securities generally on the New York Stock Exchange or Nasdaq shall have been
suspended or limited or minimum prices shall have been established on the New
York Stock Exchange or Nasdaq, (ii) a banking moratorium shall have been
declared either by federal or New York state authorities or (iii) there shall
have occurred any outbreak or escalation of hostilities, declaration by the
United States of a national emergency or war or other calamity or crisis the
effect of which on financial markets is such as to make it, in the judgment of
the Initial Purchaser, impracticable or inadvisable to proceed with the offering
or delivery of the Securities as contemplated by the Final Memorandum.
11. Representations and Indemnities to Survive. The respective agreements,
representations, warranties, indemnities and other statements of the Company or
its officers and of the Initial Purchaser set forth in or made pursuant to this
Agreement will remain in full force and effect, regardless of any investigation
made by or on behalf of the Initial Purchaser or the Company or any of the
officers, directors or controlling persons referred to in Section 8 hereof, and
will survive delivery of and payment for the Securities. The provisions of
Sections 7 and 8 hereof shall survive the termination or cancellation of this
Agreement.
12. Notices. All communications hereunder will be in writing and effective only
on receipt, and, if sent to the Initial Purchaser, will be mailed, delivered or
telecopied and confirmed to them, care of Salomon Brothers Inc, at Seven World
Trade Center, New York, New York 10048, attention: Legal Department; or, if sent
to the Company, will be mailed, delivered or telecopied and confirmed to it at
555 Seventeenth Street, Suite 1000, Denver, Colorado 80202, attention: Joseph T.
Garrity, Esq.
13. Successors. This Agreement will inure to the benefit of and be binding upon
the parties hereto and their respective successors and the officers and
directors and controlling persons referred to in Section 8 hereof, and, except
as expressly set forth in Section 5(h) hereof, no other person will have any
right or obligation hereunder.
14. Applicable Law. This Agreement will be governed by and construed in
accordance with the laws of the State of New York.
15. Business Day. For purposes of this Agreement, "business day" means each
Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which
banking institutions in The City of New York, New York are authorized or
obligated by law, executive order or regulation to close.
16. Counterparts. This Agreement may be executed in one or more
counterparts, each of which will be deemed to be an original, but all such
counterparts will together constitute one and the same instrument.
If the foregoing is in accordance with your understanding of our agreement,
please sign and return to us the enclosed duplicate hereof, whereupon this
Agreement and your acceptance shall represent a binding agreement between the
Company and you.
Very truly yours,
QWEST COMMUNICATIONS
INTERNATIONAL INC.
By /s/
Name:
Title:
The foregoing Agreement is hereby confirmed and accepted as of the date first
above written.
Salomon Brothers Inc
By: SALOMON BROTHERS INC
By /s/
Name:
Title:
EXHIBIT A
Selling Restrictions for Offers and
Sales outside the United States
(1) (a) The Securities have not been and will not be registered under the
Securities Act and may not be offered or sold within the United States or to, or
for the account or benefit of, U.S. persons except in accordance with Regulation
S under the Securities Act or pursuant to an exemption from the registration
requirements of the Securities Act. The Initial Purchaser represents and agrees
that, except as otherwise permitted by Section 4(a)(i) of the Agreement to which
this is an exhibit, it has offered and sold the Securities, and will offer and
sell the Securities, (i) as part of its distribution at any time and (ii)
otherwise until 40 days after the later of the commencement of the offering and
the Closing Date, only in accordance with Rule 903 of Regulation S under the
Securities Act. Accordingly, the Initial Purchaser represents and agrees that
neither it, nor any of its affiliates nor any person acting on its behalf has
engaged or will engage in any directed selling efforts with respect to the
Securities, and that it has complied and will comply with the offering
restrictions requirement of Regulation S. The Initial Purchaser agrees that, at
or prior to the confirmation of sale of Securities (other than a sale of
Securities pursuant to Section 4(a)(i) of the Agreement to which this is an
exhibit), it shall have sent to each distributor, dealer or person receiving a
selling concession, fee or other remuneration that purchases Securities from it
during the restricted period a confirmation or notice to substantially the
following effect:
"The Securities covered hereby have not been registered under the U.S.
Securities Act of 1933 (the "Securities Act") and may not be offered or sold
within the United States or to, or for the account or benefit of, U.S. persons
(i) as part of their distribution at any time or (ii) otherwise until 40 days
after the later of the commencement of the offering and January 29, 1997, except
in either case in accordance with Regulation S or Rule 144A under the Securities
Act. Terms used above have the meanings given to them by Regulation S."
(b) The Initial Purchaser also represents and agrees that it has not entered and
will not enter into any contractual arrangement with any distributor with
respect to the distribution of the Securities, except with its affiliates or
with the prior written consent of the Company.
(c) Terms used in this section have the meanings given to them by
Regulation S.
(2) The Initial Purchaser represents, warrants and agrees that (i) it has not
offered or sold, and will not offer or sell, any Securities to persons in the
United Kingdom, except to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or agent)
for the purposes of their business or in circumstances which have not resulted
and will not result in an offer to the public in the United Kingdom within the
meaning of the Public Offers of Securities Regulation 1995 (the "Regulations"),
(ii) it has complied and will comply with all applicable provisions of the
Financial Services Act 1986 of the United Kingdom and the Regulations with
respect to anything done by it in relation to the Securities in, from or
otherwise involving the United Kingdom, and (iii) it has only issued or passed
on, and will only issue or pass on, to any person in the United Kingdom any
document received by it in connection with the issue of the Securities if that
person is of a kind described in Article 11(3) of the Financial Services Act
1986 (Investment Advertisements) (Exemptions) Order 1995 or is a person to whom
the document may otherwise lawfully be issued or passed on.
<PAGE>
Exhibit 5.1
April 29, 1998
Securities and Exchange Commission
Judiciary Plaza
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Qwest Communications International Inc.
Form S-4 Registration Statement Filed April 29, 1998
Ladies and Gentlemen:
As counsel for Qwest Communications International Inc., a Delaware
corporation (the "Company"), we have examined the above-referenced
Registration Statement on Form S-4 under the Securities Act of 1933, as
amended (the "Registration Statement"), which the Company has filed covering
the exchange of the Company's 8.29% Series B Senior Discount Notes Due
2008(the "Exchange Notes") for its outstanding 8.29% Senior Discount Notes Due
2008 (the "Old Notes")
We have examined the Company's Amended and Restated Certificate of
Incorporation, By-Laws and the record of its corporate proceedings and have
made such other investigation as we have deemed necessary in order to express
the opinions set forth below.
Based on such investigation, it is our opinion that the Exchange Notes,
when sold as described in the prospectus included in the Registration
Statement, will be legally issued, fully paid and non-assessable.
We hereby consent to all references to us in the Registration Statement and
all amendments to the Registration Statement. We further consent to the use of
this opinion as an exhibit to the Registration Statement.
HOLME ROBERTS & OWEN LLP
By: /s/ Martha Dugan Rehm
------------------------
Martha Dugan Rehm
5.1-1
<PAGE>
EXHIBIT 8
April 29, 1998
Qwest Communications International Inc.
555 Seventeenth Street, Suite 1000
Denver, Colorado 80202
Re: 8.29% Series B Senior Discount Notes Due 2008
Form S-4 Registration Statement
Filed April 29, 1998
Ladies and Gentlemen:
This opinion is given in connection with the proposed offering by Qwest
Communications International Inc., a Delaware corporation (the "Company"), of
its 8.29% Series B Senior Discount Notes Due 2008 in exchange for its 8.29%
Senior Discount Notes Due 2008 issued on January 29, 1998, as described in the
registration statement on Form S-4 to be filed with the Securities and
Exchange Commission on April 29, 1998 (the "Registration Statement").
Capitalized terms used in this letter that are not otherwise defined herein
have the same meanings given to them in the Registration Statement.
Our opinion is based on the current provisions of the Internal Revenue Code of
1986, as amended (the "Code"), the applicable Treasury regulations
("Regulations"), and public administrative and judicial interpretations of the
Code and Regulations, all of which are subject to change, which changes could
be applied retroactively. Our opinion also is based on the facts set forth in
the Registration Statement, the Note Documents (as that term is defined in the
representation letter, dated April 29, 1998, from you), which we assume set
forth the complete agreement among the parties with respect to the Notes, and
on certain representations from you with respect to factual matters, which
representations we have not independently verified. We assume that all Note
Documents have been or will be properly executed and will be valid and binding
when executed.
We have prepared the discussion included in the Registration Statement under
the caption "Certain United States Federal Income Tax Considerations." It is
our opinion that the discussion under that caption describes the material
United States federal income tax consequences expected to result to the
Holders, subject to the conditions and limitations described therein.
The discussion does not cover all aspects of federal taxation that may be
relevant to, or the actual tax effect that any of the matters described
therein will have on, any particular Holder, and it does not address foreign,
state, or local tax consequences. The discussion does not cover the tax
consequences that might be applicable to Holders that are subject to special
rules under the Code (including insurance companies, tax-exempt organizations,
mutual funds, retirement plans, financial institutions, dealers in securities
or foreign currency, persons that hold the Notes as part of a "straddle" or as
a "hedge" against currency risk or in connection with a conversion
transaction, persons that have a functional currency other than the United
States dollar, investors in pass-through entities, and except as expressly
addressed therein, Non-U.S. Holders). The discussion does not address the
federal income tax consequences that may result from a modification of the
Notes.
Our opinion may change if the applicable law changes, if any of the facts with
respect to the Notes (as included in the Registration Statement, the Note
Documents, and the representations made by you) are inaccurate, incomplete, or
8-1
<PAGE>
change, or if the conduct of the parties is materially inconsistent with the
facts reflected in the Registration Statement, the Note Documents, or the
representations.
Our opinion represents only our legal judgment based on current law and the
facts as described above. Our opinion has no binding effect on the Internal
Revenue Service or the courts. The Service may take a position contrary to our
opinion, and if the matter is litigated, a court may reach a decision contrary
to the opinion.
We hereby consent to the filing of this opinion letter with the Securities and
Exchange Commission as an exhibit to the Registration Statement and to the use
of our name therein.
Very truly yours,
HOLME ROBERTS & OWEN LLP
By:/s/Charles B. Bruce, Jr.
-----------------------------
Charles B. Bruce, Jr. Partner
8-2
<PAGE>
EXHIBIT 12.1
QWEST COMMUNICATIONS INTERNATIONAL INC.
CALCULATION OF RATIOS OF EARNINGS TO COMBINED FIXED CHARGES
(Amounts in thousands, except for ratios)
(unaudited)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------
1997 1996 1995 1994 1993
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income (loss) before income taxes $23,580 $ (10,201) $ (38,467) $ (10,685) $111,711
Add:
Interest on debt, net of
capitalized interest 18,895 6,827 4,248 219 3,319
Interest expense portion of
rental expense 2,084 1,666 1,548 1,049 1,168
Other - 234 57 - -
Earnings available for fixed
charges $44,559 $ (1,474) $ (32,614) $ (9,417) $116,198
===============================================================
Fixed Charges:
Interest on debt $36,640 $ 9,426 $ 6,161 $ 502 $ 3,319
Interest expense portion of
rental expense 2,084 1,666 1,548 1,049 1,168
Preferred stock dividend - - - - 15,981
---------------------------------------------------------------
Total fixed charges $38,724 $ 11,092 $ 7,709 $ 1,551 $ 20,468
================================================================
Ratio of earnings to fixed charges 1.15 - - - 5.68
Deficiency of earnings to fixed
charges - $ (12,566) $ (40,323) $ (10,968) -
</TABLE>
12.1-1
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
STATE OR OTHER
JURISDICTION OF
INCORPORATION OTHER NAMES UNDER
NAME OF SUBSIDIARY OR ORGANIZATION WHICH SUBSIDIARY DOES BUSINESS
------------------ --------------- --------------------------------
Qwest Communications Delaware (a) Qwest Communications
Corporation(1) Corporation d/b/a Qwest
Communications The Power of
Connections
(b) Qwest Communications
Corporation of Delaware
(c) Qwest Communications d/b/a
The Power of Connections
(d) Qwest Communications The
Power of Connections, Inc.
Qwest Corporation Colorado None
SuperNet, Inc. Colorado None
Phoenix Network, Inc. Delaware None
Phoenix Telecom, Inc. Delaware None
Phoenix Network, Inc. of New
Hampshire New Hampshire None
Phoenix Network Acquisition
Corp. Delaware None
Phoenix TNC Corporation Delaware None
AmeriConnect, Inc. Delaware None
Qwest 1998-L Acquisition Corp. Delaware None
EUnet International Limited England None
- --------
(1) Qwest Communications Corporation also uses the trade name "SP Construction
Services."
21.1-1
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Qwest Communications International Inc.:
We consent to the use of our report, dated February 24, 1998, except as to
note 22, which is as of March 8, 1998, relating to the consolidated balance
sheets of Qwest Communications International Inc. and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1997, included herein, and of our report,
dated February 24, 1998, pertaining to the related consolidated financial
statement schedule included herein, and to the reference to our firm under the
heading "EXPERTS" in the Registration Statement.
KPMG Peat Marwick LLP
Denver, Colorado
April 28, 1998
23.1-1
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated February 19, 1998, accompanying the
consolidated financial statements of Phoenix Network Inc. and subsidiaries as of
December 31, 1996 and 1997, and for each of the years in the period ended
December 31, 1997, appearing in the Registration Statement. We hereby consent to
the use of our report on the aforementioned consolidated financial statements in
the Registration Statement and to the use of our name as it appears under the
caption "Experts."
GRANT THORNTON LLP
Denver, Colorado
April 29, 1998.
23.2-1
<PAGE>
Exhibit 23.3
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report dated February 16, 1998 (except with respect to the matter discussed in
Note 15, as to which the date is March 16, 1998) on LCI International, Inc.'s
consolidated balance sheets as of December 31, 1997 and 1996, and the related
statements of operations, shareowner's equity and cash flows for each of the
three years in the period ended December 31, 1997, included in this registration
statement and to all references to our Firm included in this registration
statement.
ARTHUR ANDERSEN LLP
Washington, D.C.,
April 29, 1998
23.3-1
<PAGE>
EXHIBIT 25.1
- -----------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM T-1
STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939
OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE
CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE
PURSUANT TO SECTION 305(b)(2) ___________
------------------------------
BANKERS TRUST COMPANY
(Exact name of trustee as specified in its charter)
NEW YORK 13-4941247
(Jurisdiction of Incorporation or (I.R.S. Employer
organization if not a U.S. national bank) Identification no.)
FOUR ALBANY STREET
NEW YORK, NEW YORK 10006
(Address of principal (Zip Code)
executive offices)
Bankers Trust Company
Legal Department
130 Liberty Street, 31st Floor
New York, New York 10006
(212) 250-2201
(Name, address and telephone number of agent for service)
---------------------------------
QWEST COMMUNICATIONS INTERNATIONAL, INC.
(Exact name of obligor as 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 100
Denver, CO 80202
(Address of principal executive offices (Zip Code)
8.29% SENIOR DISCOUNT NOTES DUE 2008
(Title of the indenture securities)
25.1-1
<PAGE>
Item 1. General Information.
Furnish the following information as to the trustee.
(a) Name and address of each examining or supervising authority to which it
is subject.
Name Address
Federal Reserve Bank (2nd District) New York, NY
Federal Deposit Insurance Corporation Washington, D.C.
New York State Banking Department Albany, NY
(b) Whether it is authorized to exercise corporate trust powers. Yes.
Item 2. Affiliations with Obligor.
If the obligor is an affiliate of the Trustee, describe each
such affiliation.
None.
Item 3. -15. Not Applicable
Item 16. List of Exhibits.
Exhibit 1 - Restated Organization Certificate of Bankers Trust Company
dated August 7, 1990, Certificate of Amendment of the Organization Certificate
of Bankers Trust Company dated June 21, 1995 - Incorporated herein by reference
to Exhibit 1 filed with Form T-1 Statement, Registration No. 33-65171,
Certificate of Amendment of the Organization Certificate of Bankers Trust
Company dated March 20, 1996, incorporate by referenced to Exhibit 1 filed with
Form T-1 Statement, Registration No. 333-25843 and Certificate of Amendment of
the Organization Certificate of Bankers Trust Company dated June 19, 1997, copy
attached.
Exhibit 2 - Certificate of Authority to commence business - Incorporated
herein by reference to Exhibit 2 filed with Form T-1 Statement, Registration No.
33-21047.
Exhibit 3 - Authorization of the Trustee to exercise corporate trust powers
- - Incorporated herein by reference to Exhibit 2 filed with Form T-1 Statement,
Registration No. 33-21047.
Exhibit 4 - Existing By-Laws of Bankers Trust Company, as amended on
November 18, 1997. Copy attached.
-2-
25.1-2
<PAGE>
Exhibit 5 - Not applicable.
Exhibit 6 - Consent of Bankers Trust Company required by Section 321(b) of
the Act. - Incorporated herein by reference to Exhibit 4 filed with Form T-1
Statement, Registration No. 22-18864.
Exhibit 7 - The latest report of condition of Bankers Trust Company dated
as of December 31, 1997. Copy attached.
Exhibit 8 - Not Applicable.
Exhibit 9 - Not Applicable.
25.1-3
<PAGE>
SIGNATURE
Pursuant to the requirements of the Trust Indenture Act of 1939, as
amended, the trustee, Bankers Trust Company, a corporation organized and
existing under the laws of the State of New York, has duly caused this statement
of eligibility to be signed on its behalf by the undersigned, thereunto duly
authorized, all in The City of New York, and State of New York, on the 24th day
of April, 1998.
BANKERS TRUST COMPANY
By: /s/ Susan Johnson
Susan Johnson
Assistant Vice President
25.1-4
<PAGE>
State of New York,
Banking Department
I, MANUEL KURSKY, Deputy Superintendent of Banks of the State of New
York, DO HEREBY APPROVE the annexed Certificate entitled "CERTIFICATE OF
AMENDMENT OF THE ORGANIZATION CERTIFICATE OF BANKERS TRUST COMPANY Under Section
8005 of the Banking Law," dated June 19, 1997, providing for an increase in
authorized capital stock from $1,601,666,670 consisting of 100,166,667 shares
with a par value of $10 each designated as Common Stock and 600 shares with a
par value of $1,000,000 each designated as Series Preferred Stock to
$2,001,666,670 consisting of 100,166,667 shares with a par value of $10 each
designated as Common Stock and 1,000 shares with a par value of $1,000,000 each
designated as Series Preferred Stock.
Witness, my hand and official seal of the Banking Department at the City of New
York, this 27th day of June in the Year of our Lord one thousand nine hundred
and ninety-seven.
Manuel Kursky
Deputy Superintendent of Banks
25.1-5
<PAGE>
CERTIFICATE OF AMENDMENT
OF THE
ORGANIZATION CERTIFICATE
OF BANKERS TRUST
Under Section 8005 of the Banking Law
-----------------------------
We, James T. Byrne, Jr. and Lea Lahtinen, being respectively a Managing
Director and an Assistant Secretary of Bankers Trust Company, do hereby certify:
1. The name of the corporation is Bankers Trust Company.
2. The organization certificate of said corporation was filed by the
Superintendent of Banks on the 5th of march, 1903.
3. The organization certificate as heretofore amended is hereby amended to
increase the aggregate number of shares which the corporation shall have
authority to issue and to increase the amount of its authorized capital stock in
conformity therewith.
4. Article III of the organization certificate with reference to the
authorized capital stock, the number of shares into which the capital stock
shall be divided, the par value of the shares and the capital stock outstanding,
which reads as follows:
"III. The amount of capital stock which the corporation is hereafter to
have is One Billion, Six Hundred and One Million, Six Hundred Sixty-Six
Thousand, Six Hundred Seventy Dollars ($1,601,666,670), divided into
One Hundred Million, One Hundred Sixty-Six Thousand, Six Hundred
Sixty-Seven (100,166,667) shares with a par value of $10 each
designated as Common Stock and 600 shares with a par value of One
Million Dollars ($1,000,000) each designated as Series Preferred
Stock."
is hereby amended to read as follows:
"III. The amount of capital stock which the corporation is hereafter to
have is Two Billion One Million, Six Hundred Sixty-Six Thousand, Six
Hundred Seventy Dollars ($2,001,666,670), divided into One Hundred
Million, One Hundred Sixty-Six Thousand, Six Hundred Sixty-Seven
(100,166,667) shares with a par value of $10 each designated as Common
Stock and 1000 shares with a par value of One Million Dollars
($1,000,000) each designated as Series Preferred Stock."
25.1-6
<PAGE>
5. The foregoing amendment of the organization certificate was
authorized by unanimous written consent signed by the holder of all outstanding
shares entitled to vote thereon.
IN WITNESS WHEREOF, we have made and subscribed this certificate this
19th day of June, 1997.
James T. Byrne, Jr.
James T. Byrne, Jr.
Managing Director
Lea Lahtinen
Lea Lahtinen
Assistant Secretary
State of New York )
) ss:
County of New York )
Lea Lahtinen, being fully sworn, deposes and says that she is an
Assistant Secretary of Bankers Trust Company, the corporation described in the
foregoing certificate; that she has read the foregoing certificate and knows the
contents thereof, and that the statements herein contained are true.
Lea Lahtinen
Lea Lahtinen
Sworn to before me this 19th day of June, 1997.
Sandra L. West
Notary Public
SANDRA L. WEST
Notary Public State of New York
No. 31-4942101
Qualified in New York County
Commission Expires September 19,
1998
25.1-7
<PAGE>
BY-LAWS
NOVEMBER 18, 1997
Bankers Trust Company
New York
25.1-8
<PAGE>
BY-LAWS
of
Bankers Trust Company
ARTICLE I
MEETINGS OF STOCKHOLDERS
SECTION 1. The annual meeting of the stockholders of this Company shall be held
at the office of the Company in the Borough of Manhattan, City of New York, on
the third Tuesday in January of each year, for the election of directors and
such other business as may properly come before said meeting.
SECTION 2. Special meetings of stockholders other than those regulated by
statute may be called at any time by a majority of the directors. It shall be
the duty of the Chairman of the Board, the Chief Executive Officer or the
President to call such meetings whenever requested in writing to do so by
stockholders owning a majority of the capital stock.
SECTION 3. At all meetings of stockholders, there shall be present, either in
person or by proxy, stockholders owning a majority of the capital stock of the
Company, in order to constitute a quorum, except at special elections of
directors, as provided by law, but less than a quorum shall have power to
adjourn any meeting.
SECTION 4. The Chairman of the Board or, in his absence, the Chief Executive
Officer or, in his absence, the President or, in their absence, the senior
officer present, shall preside at meetings of the stockholders and shall direct
the proceedings and the order of business. The Secretary shall act as secretary
of such meetings and record the proceedings.
ARTICLE II
DIRECTORS
SECTION 1. The affairs of the Company shall be managed and its corporate powers
exercised by a Board of Directors consisting of such number of directors, but
not less than ten nor more than twenty-five, as may from time to time be fixed
by resolution adopted by a majority of the directors then in office, or by the
stockholders. In the event of any increase in the number of directors,
additional directors may be elected within the limitations so fixed, either by
the stockholders or within the limitations imposed by law, by a majority of
directors then in office. One-third of the number of directors, as fixed from
time to time, shall constitute a quorum. Any one or more members of the Board of
Directors or any Committee thereof may participate in a meeting of the Board of
Directors or Committee thereof by means of a conference telephone or similar
communications equipment which allows all persons participating in the meeting
to hear each other at the same time. Participation by such means shall
constitute presence in person at such a meeting.
All directors hereafter elected shall hold office until the next annual meeting
of the stockholders and until their successors are elected and have qualified.
No person who shall have attained age 72 shall be eligible to be elected or
re-elected a director. Such director may, however, remain a director of the
Company until the next annual meeting of the stockholders of Bankers Trust New
York Corporation (the Company's parent) so that such director's retirement will
coincide with the retirement date from Bankers Trust New York Corporation.
No Officer-Director who shall have attained age 65, or earlier relinquishes his
responsibilities and title, shall be eligible to serve as a director.
SECTION 2. Vacancies not exceeding one-third of the whole number of the Board of
Directors may be filled by the affirmative vote of a majority of the directors
then in office, and the directors so elected shall hold office for the balance
of the unexpired term.
SECTION 3. The Chairman of the Board shall preside at meetings of the Board of
Directors. In his absence, the Chief Executive Officer or, in his absence, such
other director as the Board of Directors from time to time may designate shall
preside at such meetings.
SECTION 4. The Board of Directors may adopt such Rules and Regulations for the
conduct of its meetings and the management of the affairs of the Company as it
may deem proper, not inconsistent with the laws of the State of New York, or
these By-Laws, and all officers and employees shall strictly adhere to, and be
bound by, such Rules and Regulations.
SECTION 5. Regular meetings of the Board of Directors shall be held from time to
time on the third Tuesday of the month. If the day appointed for holding such
regular meetings shall be a legal holiday, the regular meeting to be held on
such day shall be held on the next business day thereafter. Special meetings of
the Board of Directors may be called upon at least two day's notice whenever it
may be deemed proper by the Chairman of the Board or, the Chief Executive
Officer or, in their absence, by such other director as the Board of Directors
may have designated pursuant to Section 3 of this Article, and shall be called
upon like notice whenever any three of the directors so request in writing.
SECTION 6. The compensation of directors as such or as members of committees
shall be fixed from time to time by resolution of the Board of Directors.
25.1-9
<PAGE>
ARTICLE III
COMMITTEES
SECTION 1. There shall be an Executive Committee of the Board consisting of not
less than five directors who shall be appointed annually by the Board of
Directors. The Chairman of the Board shall preside at meetings of the Executive
Committee. In his absence, the Chief Executive Officer or, in his absence, such
other member of the Committee as the Committee from time to time may designate
shall preside at such meetings.
The Executive Committee shall possess and exercise to the extent permitted by
law all of the powers of the Board of Directors, except when the latter is in
session, and shall keep minutes of its proceedings, which shall be presented to
the Board of Directors at its next subsequent meeting. All acts done and powers
and authority conferred by the Executive Committee from time to time shall be
and be deemed to be, and may be certified as being, the act and under the
authority of the Board of Directors.
A majority of the Committee shall constitute a quorum, but the Committee may act
only by the concurrent vote of not less than one-third of its members, at least
one of whom must be a director other than an officer. Any one or more directors,
even though not members of the Executive Committee, may attend any meeting of
the Committee, and the member or members of the Committee present, even though
less than a quorum, may designate any one or more of such directors as a
substitute or substitutes for any absent member or members of the Committee, and
each such substitute or substitutes shall be counted for quorum, voting, and all
other purposes as a member or members of the Committee.
SECTION 2. There shall be an Audit Committee appointed annually by resolution
adopted by a majority of the entire Board of Directors which shall consist of
such number of directors, who are not also officers of the Company, as may from
time to time be fixed by resolution adopted by the Board of Directors. The
Chairman shall be designated by the Board of Directors, who shall also from time
to time fix a quorum for meetings of the Committee. Such Committee shall conduct
the annual directors' examinations of the Company as required by the New York
State Banking Law; shall review the reports of all examinations made of the
Company by public authorities and report thereon to the Board of Directors; and
shall report to the Board of Directors such other matters as it deems advisable
with respect to the Company, its various departments and the conduct of its
operations.
In the performance of its duties, the Audit Committee may employ or retain, from
time to time, expert assistants, independent of the officers or personnel of the
Company, to make studies of the Company's assets and liabilities as the
Committee may request and to make an examination of the accounting and auditing
methods of the Company and its system of internal protective controls to the
extent considered necessary or advisable in order to determine that the
operations of the Company, including its fiduciary departments, are being
audited by the General Auditor in such a manner as to provide prudent and
adequate protection. The Committee also may direct the General Auditor to make
such investigation as it deems necessary or advisable with respect to the
Company, its various departments and the conduct of its operations. The
Committee shall hold regular quarterly meetings and during the intervals thereof
shall meet at other times on call of the Chairman.
SECTION 3. The Board of Directors shall have the power to appoint any other
Committees as may seem necessary, and from time to time to suspend or continue
the powers and duties of such Committees. Each Committee appointed pursuant to
this Article shall serve at the pleasure of the Board of Directors.
ARTICLE IV
OFFICERS
SECTION 1. The Board of Directors shall elect from among their number a Chairman
of the Board and a Chief Executive Officer; and shall also elect a President,
and may also elect a Senior Vice Chairman, one or more Vice Chairmen, one or
more Executive Vice Presidents, one or more Senior Managing Directors, one or
more Managing Directors, one or more Senior Vice Presidents, one or more
Principals, one or more Vice Presidents, one or more General Managers, a
Secretary, a Controller, a Treasurer, a General Counsel, one or more Associate
General Counsels, a General Auditor, a General Credit Auditor, and one or more
Deputy Auditors, who need not be directors. The officers of the corporation may
also include such other officers or assistant officers as shall from time to
time be elected or appointed by the Board. The Chairman of the Board or the
Chief Executive Officer or, in their absence, the President, the Senior Vice
Chairman or any Vice Chairman, may from time to time appoint assistant officers.
All officers elected or appointed by the Board of Directors shall hold their
respective offices during the pleasure of the Board of Directors, and all
assistant officers shall hold office at the pleasure of the Board or the
Chairman of the Board or the Chief Executive Officer or, in their absence, the
President, the Senior Vice Chairman or any Vice Chairman. The Board of Directors
may require any and all officers and employees to give security for the faithful
performance of their duties.
SECTION 2. The Board of Directors shall designate the Chief Executive Officer of
the Company who may also hold the additional title of Chairman of the Board,
President, Senior Vice Chairman or Vice Chairman and such person shall have,
subject to the supervision and direction of the Board of Directors or the
Executive Committee, all of the powers vested in such Chief Executive Officer by
law or by these By-Laws, or which usually attach or pertain to such office. The
other officers shall have, subject to the supervision and direction of the Board
of Directors or the Executive Committee or the Chairman of the Board or, the
Chief Executive Officer, the powers vested by law or by these By-Laws in them as
holders of their respective offices and, in addition, shall perform such other
duties as shall be assigned to them by the Board of Directors or the Executive
Committee or the Chairman of the Board or the Chief Executive Officer.
The General Auditor shall be responsible, through the Audit Committee, to the
Board of Directors for the determination of the program of the internal audit
function and the evaluation of the adequacy of the system of internal controls.
Subject to the Board of Directors, the General Auditor shall have and may
exercise all the powers and shall perform all the duties usual to such office
and shall have such other powers as may be prescribed or assigned to him from
time to time by the Board of Directors or vested in him by law or by these
By-Laws. He shall perform such other duties and shall make such investigations,
examinations and reports as may be prescribed or required by the Audit
Committee. The General Auditor shall have unrestricted access to all records and
premises of the Company and shall delegate such authority to his subordinates.
He shall have the duty to report to the Audit Committee on all matters
concerning the internal audit program and the adequacy of the system of internal
controls of the Company which he deems advisable or which the Audit Committee
may request. Additionally, the General Auditor shall have the duty of reporting
independently of all officers of the Company to the Audit Committee at least
quarterly on any matters concerning the internal audit program and the adequacy
of the system of internal controls of the Company that should be brought to the
attention of the directors except those matters responsibility for which has
been vested in the General Credit Auditor. Should the General Auditor deem any
matter to be of special immediate importance, he shall report thereon forthwith
to the Audit Committee. The General Auditor shall report to the Chief Financial
Officer only for administrative purposes.
The General Credit Auditor shall be responsible to the Chief Executive Officer
and, through the Audit Committee, to the Board of Directors for the systems of
internal credit audit, shall perform such other duties as the Chief Executive
Officer may prescribe, and shall make such examinations and reports as may be
required by the Audit Committee. The General Credit Auditor shall have
unrestricted access to all records and may delegate such authority to
subordinates.
SECTION 3. The compensation of all officers shall be fixed under such plan or
plans of position evaluation and salary administration as shall be approved from
time to time by resolution of the Board of Directors.
SECTION 4. The Board of Directors, the Executive Committee, the Chairman of the
Board, the Chief Executive Officer or any person authorized for this purpose by
the Chief Executive Officer, shall appoint or engage all other employees and
agents and fix their compensation. The employment of all such employees and
agents shall continue during the pleasure of the Board of Directors or the
Executive Committee or the Chairman of the Board or the Chief Executive Officer
or any such authorized person; and the Board of Directors, the Executive
Committee, the Chairman of the Board, the Chief Executive Officer or any such
authorized person may discharge any such employees and agents at will.
25.1-10
<PAGE>
ARTICLE V
INDEMNIFICATION OF DIRECTORS, OFFICERS AND OTHERS
SECTION 1. The Company shall, to the fullest extent permitted by Section 7018 of
the New York Banking Law, indemnify any person who is or was made, or threatened
to be made, a party to an action or proceeding, whether civil or criminal,
whether involving any actual or alleged breach of duty, neglect or error, any
accountability, or any actual or alleged misstatement, misleading statement or
other act or omission and whether brought or threatened in any court or
administrative or legislative body or agency, including an action by or in the
right of the Company to procure a judgment in its favor and an action by or in
the right of any other corporation of any type or kind, domestic or foreign, or
any partnership, joint venture, trust, employee benefit plan or other
enterprise, which any director or officer of the Company is servicing or served
in any capacity at the request of the Company by reason of the fact that he, his
testator or intestate, is or was a director or officer of the Company, or is
serving or served such other corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise in any capacity, against judgments,
fines, amounts paid in settlement, and costs, charges and expenses, including
attorneys' fees, or any appeal therein; provided, however, that no
indemnification shall be provided to any such person if a judgment or other
final adjudication adverse to the director or officer establishes that (i) his
acts were committed in bad faith or were the result of active and deliberate
dishonesty and, in either case, were material to the cause of action so
adjudicated, or (ii) he personally gained in fact a financial profit or other
advantage to which he was not legally entitled.
SECTION 2. The Company may indemnify any other person to whom the Company is
permitted to provide indemnification or the advancement of expenses by
applicable law, whether pursuant to rights granted pursuant to, or provided by,
the New York Banking Law or other rights created by (i) a resolution of
stockholders, (ii) a resolution of directors, or (iii) an agreement providing
for such indemnification, it being expressly intended that these By-Laws
authorize the creation of other rights in any such manner.
SECTION 3. The Company shall, from time to time, reimburse or advance to any
person referred to in Section 1 the funds necessary for payment of expenses,
including attorneys' fees, incurred in connection with any action or proceeding
referred to in Section 1, upon receipt of a written undertaking by or on behalf
of such person to repay such amount(s) if a judgment or other final adjudication
adverse to the director or officer establishes that (i) his acts were committed
in bad faith or were the result of active and deliberate dishonesty and, in
either case, were material to the cause of action so adjudicated, or (ii) he
personally gained in fact a financial profit or other advantage to which he was
not legally entitled.
SECTION 4. Any director or officer of the Company serving (i) another
corporation, of which a majority of the shares entitled to vote in the election
of its directors is held by the Company, or (ii) any employee benefit plan of
the Company or any corporation referred to in clause (i) in any capacity shall
be deemed to be doing so at the request of the Company. In all other cases, the
provisions of this Article V will apply (i) only if the person serving another
corporation or any partnership, joint venture, trust, employee benefit plan or
other enterprise so served at the specific request of the Company, evidenced by
a written communication signed by the Chairman of the Board, the Chief Executive
Officer or the President, and (ii) only if and to the extent that, after making
such efforts as the Chairman of the Board, the Chief Executive Officer or the
President shall deem adequate in the circumstances, such person shall be unable
to obtain indemnification from such other enterprise or its insurer.
SECTION 5. Any person entitled to be indemnified or to the reimbursement or
advancement of expenses as a matter of right pursuant to this Article V may
elect to have the right to indemnification (or advancement of expenses)
interpreted on the basis of the applicable law in effect at the time of
occurrence of the event or events giving rise to the action or proceeding, to
the extent permitted by law, or on the basis of the applicable law in effect at
the time indemnification is sought.
SECTION 6. The right to be indemnified or to the reimbursement or advancement of
expense pursuant to this Article V (i) is a contract right pursuant to which the
person entitled thereto may bring suit as if the provisions hereof were set
forth in a separate written contract between the Company and the director or
officer, (ii) is intended to be retroactive and shall be available with respect
to events occurring prior to the adoption hereof, and (iii) shall continue to
exist after the rescission or restrictive modification hereof with respect to
events occurring prior thereto.
SECTION 7. If a request to be indemnified or for the reimbursement or
advancement of expenses pursuant hereto is not paid in full by the Company
within thirty days after a written claim has been received by the Company, the
claimant may at any time thereafter bring suit against the Company to recover
the unpaid amount of the claim and, if successful in whole or in part, the
claimant shall be entitled also to be paid the expenses of prosecuting such
claim. Neither the failure of the Company (including its Board of Directors,
independent legal counsel, or its stockholders) to have made a determination
prior to the commencement of such action that indemnification of or
reimbursement or advancement of expenses to the claimant is proper in the
circumstance, nor an actual determination by the Company (including its Board of
Directors, independent legal counsel, or its stockholders) that the claimant is
not entitled to indemnification or to the reimbursement or advancement of
expenses, shall be a defense to the action or create a presumption that the
claimant is not so entitled.
SECTION 8. A person who has been successful, on the merits or otherwise, in the
defense of a civil or criminal action or proceeding of the character described
in Section 1 shall be entitled to indemnification only as provided in Sections 1
and 3, notwithstanding any provision of the New York Banking Law to the
contrary.
ARTICLE VI
SEAL
SECTION 1. The Board of Directors shall provide a seal for the Company, the
counterpart dies of which shall be in the charge of the Secretary of the Company
and such officers as the Chairman of the Board, the Chief Executive Officer or
the Secretary may from time to time direct in writing, to be affixed to
certificates of stock and other documents in accordance with the directions of
the Board of Directors or the Executive Committee.
SECTION 2. The Board of Directors may provide, in proper cases on a specified
occasion and for a specified transaction or transactions, for the use of a
printed or engraved facsimile seal of the Company.
ARTICLE VII
CAPITAL STOCK
SECTION 1. Registration of transfer of shares shall only be made upon the books
of the Company by the registered holder in person, or by power of attorney, duly
executed, witnessed and filed with the Secretary or other proper officer of the
Company, on the surrender of the certificate or certificates of such shares
properly assigned for transfer.
ARTICLE VIII
CONSTRUCTION
SECTION 1. The masculine gender, when appearing in these By-Laws, shall be
deemed to include the feminine gender.
ARTICLE IX
AMENDMENTS
SECTION 1. These By-Laws may be altered, amended or added to by the Board of
Directors at any meeting, or by the stockholders at any annual or special
meeting, provided notice thereof has been given.
25.1-11
<PAGE>
I, Susan Johnson, Assistant Vice President of Bankers Trust Company, New York,
New York, hereby certify that the foregoing is a complete, true and correct copy
of the By-Laws of Bankers Trust Company, and that the same are in full force and
effect at this date.
Susan Johnson
ASSISTANT VICE PRESIDENT
DATED: 4/16/98
25.1-12
<PAGE>
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<CAPTION>
<S> <C> <C> <C> <C>
Legal Title of Bank: Bankers Trust Company Call Date: 12/31/97 ST-BK: 36-4840 FFIEC 031
Address: 130 Liberty Street Vendor ID: D CERT: 00623 Page RC-1
City, State ZIP: New York, NY 10006 11
FDIC Certificatee No.: 00623
CONSOLIDATED REPORT OF CONDITION FOR INSURED COMMERCIAL
AND STATE-CHARTERED SAVINGS BANKS FOR DECEMBER 31, 1997
All schedules are to be reported in thousands of dollars. Unless otherwise
indicated, report the amount outstanding as of the last business day of the
quarter.
SCHEDULE RC - BALANCE SHEET
C400
Dollar Amounts in Thousands RCFD Bil Mil Thou
ASSETS
1. Cash and balances due from depository institutions (from Schedule RC-A):
a. Noninterest-bearing balances and currency and coin(1)................................. 0081 2,121,000
b. Interest bearing balances(2).......................................................... 0071 4,770,000
2. Securities:
a. Held-to-maturity securities (from Schedule RC-B, column A)............................ 1754 0
b. Available-for-sale securities (from Schedule RC-B, column D).......................... 1773 4,015,000
3. Federal funds sold and securities purchased under agreements to resell..................... 1350 28,927,000
4. Loans and lease financing receivables:
a. Loans and leases, net of unearned income (from Schedule RC-C)......................... 2122 17,692,000
b. LESS: Allowance for loan and lease losses............................................. 3123 659,000
c. LESS: Allocated transfer risk reserve................................................. 3128 0
d. Loans and leases, net of unearned income,
allowance, and reserve (item 4.a minus 4.b and 4.c).................................... 2125 17,033,000
5. Trading assets (from Schedule RC-D)........................................................ 3545 45,488,000
6. Premises and fixed assets (including capitalized leases)................................... 2145 766,000
7. Other real estate owned (from Schedule RC-M)............................................... 2150 188,000
8. Investments in unconsolidated subsidiaries and associated companies (from Schedule
RC-M)...................................................................................... 2130 58,000
9. Customers' liability to this bank on acceptances outstanding............................... 2155 633,000
10. Intangible assets (from Schedule RC-M)..................................................... 2143 83,000
11. Other assets (from Schedule RC-F).......................................................... 2160 5,957,000
12. Total assets (sum of items 1 through 11)................................................... 2170 110,039,000
(1) Includes cash items in process of collection and unposted debits.
(2) Includes time certificates of deposit not held for trading.
25.1-13
<PAGE>
Legal Title of Bank: Bankers Trust Company Call Date: 12/31/97 ST-BK: 36-4840 FFIEC 031
Address: 130 Liberty Street Vendor ID: D CERT: 00623 Page RC-2
City, State Zip: New York, NY 10006 12
FDIC Certificate Number: 00623
SCHEDULE RC -- CONTINUED
Dollar Amounts in Thousands Bil Mil Thou
LIABILITIES
13. Deposits:
a. In domestic offices (sum of totals of columns A and C from Schedule RC-E, Part I)........... RCON 2200 24,608,000
(1) Noninterest-bearing(1)................................................................... RCON 6631 2,856,000
(2) Interest-bearing......................................................................... RCON 6636 21,752,000
b. In foreign offices, Edge and Agreement subsidiaries, and IBFs (from Schedule RC-E, Part II). RCFN 2200 20,529,000
(1) Noninterest-bearing...................................................................... RCFN 6631 2,122,000
(2) Interest-bearing......................................................................... RCFN 6636 18,407,000
14. Federal funds purchased and securities sold under agreements to repurchase..................... RCFD 2800 13,777,000
15. a. Demand notes issued to the U.S. Treasury.................................................... RCON 2840 0
b. Trading liabilities (from Schedule RC-D).................................................... RCFD 3548 24,968,000
16. Other borrowed money (includes mortgage indebtedness and obligations under capitalized leases):
a. With a remaining maturity of one year or less............................................... RCFD 2332 5,810,000
b. With a remaining maturity of more than one year through three years......................... A547 4,702,000
c. With a remaining maturity of more than three years.......................................... A548 1,750,000
17. Not Applicable................................................................................. /
18. Bank's liability on acceptances executed and outstanding....................................... RCFD 2920 633,000
19. Subordinated notes and debentures (2).......................................................... RCFD 3200 1,307,000
20. Other liabilities (from Schedule RC-G)......................................................... RCFD 2930 5,961,000
21. Total liabilities (sum of items 13 through 20)................................................. RCFD 2948 104,045,000
22. Not Applicable................................................................................. /
EQUITY CAPITAL
23. Perpetual preferred stock and related surplus.................................. RCFD 3838 1,000,000
24. Common stock................................................................... RCFD 3230 1,352,000
25. Surplus (exclude all surplus related to preferred stock)....................... RCFD 3839 540,000
26. a. Undivided profits and capital reserves...................................... RCFD 3632 3,526,000
b. Net unrealized holding gains (losses) on available-for-sale securities...... RCFD 8434 (45,000)
27. Cumulative foreign currency translation adjustments............................ RCFD3284 (379,000)
28. Total equity capital (sum of items 23 through 27).............................. RCFD3210 5,994,000
29. Total liabilities and equity capital (sum of items 21 and 28).................. RCFD3300 110,039,000
Total liabilities and equity capital (sum of items 21 and 28)........................................ RCFD 3300 110,039,000
Memorandum
To be reported only with the March Report of Condition.
1. Indicate in the box at the right the number of the statement below that best describes the
most comprehensive level of auditing work performed for the bank by independent external Number
auditors as of any date during 1996 ................................................. RCFD 6724 N/A
1 = Independent audit of the bank conducted in accordance 4 = Directors' examination of the bank performed by other
with generally accepted auditing standards by a certified external auditors (may be required by state chartering
public accounting firm which submits a report on the bank authority)
2 = Independent audit of the bank's parent holding company 5 = Review of the bank's financial statements by external
conducted in accordance with generally accepted auditing auditors
standards by a certified public accounting firm which 6 = Compilation of the bank's financial statements by external
submits a report on the consolidated holding company auditors
(but not on the bank separately) 7 = Other audit procedures (excluding tax preparation work)
3 = Directors' examination of the bank conducted in 8 = No external audit work
accordance with generally accepted auditing standards by a certified
public accounting firm (may be required by state chartering
authority)
</TABLE>
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(1) Including total demand deposits and noninterest-bearing time and savings
deposits.
(2) Includes limited-life preferred stock and related surplus.
25.1-14
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