<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------- -----------
Commission file number 333-64717
US XCHANGE, L.L.C.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-3305418
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
20 MONROE AVENUE NW, SUITE 450, GRAND RAPIDS, MICHIGAN 49503
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (616) 988-7000
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
At November 12, 1999, all of the membership interests of the registrant
were held by two affiliates of the registrant.
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US XCHANGE, L.L.C.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
Page No.
PART I FINANCIAL INFORMATION..................................................3
Item 1. Financial Statements...................................................3
Consolidated Balance Sheets.................................................3
Consolidated Statements Of Operations.......................................4
Consolidated Statements Of Cash Flows.......................................5
Notes To Consolidated Financial Statements..................................6
PART II OTHER INFORMATION....................................................16
Item 3. Defaults Upon Senior Securities.......................................16
Item 6. Exhibits and Reports on Form 8-K......................................16
SIGNATURES....................................................................17
INDEX TO EXHIBITS.............................................................18
2
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
US XCHANGE, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
---------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and equivalents.................................................... $ 907,208 $ 40,018,552
Restricted investments.................................................. 27,989,544 28,525,109
Accounts receivable, less allowance for doubtful accounts of $502,890
and $174,000............................................................ 9,133,473 1,865,503
Other current assets.................................................... 1,011,206 700,411
---------------------------------------
TOTAL CURRENT ASSETS.............................................. 39,041,431 71,109,575
---------------------------------------
NETWORKS AND EQUIPMENT
Networks and networks in process (cost to complete of $14,873,000)...... 117,811,589 85,821,872
Furniture and equipment................................................. 18,863,375 14,017,604
Leasehold improvements.................................................. 7,418,587 3,937,223
---------------------------------------
144,093,551 103,776,699
Less accumulated depreciation and amortization.......................... 12,293,712 3,432,193
---------------------------------------
NET NETWORKS AND EQUIPMENT................................................. 131,799,839 100,344,506
---------------------------------------
OTHER ASSETS
Restricted investments.................................................. 28,911,687 56,206,738
Debt issuance costs, net................................................ 7,226,835 6,793,770
Miscellaneous........................................................... 1,650,474 261,328
---------------------------------------
TOTAL OTHER ASSETS...................................................... 37,788,976 63,261,836
=======================================
TOTAL ASSETS............................................................ $ 208,630,246 $234,715,917
=======================================
LIABILITIES AND MEMBERS' CAPITAL (DEFICIT)
CURRENT LIABILITIES
Accounts payable........................................................... $ 5,009,608 $ 11,264,241
Accrued interest........................................................... 7,786,557 15,521,634
Accrued other liabilities.................................................. 2,534,837 1,185,820
Current maturities of long-term debt....................................... 800,000 800,000
---------------------------------------
TOTAL CURRENT LIABILITIES.................................................. 16,131,002 28,771,695
UNEARNED REVENUE........................................................... 4,505,984 --
LONG-TERM DEBT, LESS CURRENT MATURITIES
15% Senior Notes........................................................... 200,000,000 200,000,000
Notes payable.............................................................. 2,000,000 2,533,333
Senior Secured Facility.................................................... 42,000,000 --
Subordinated Debt.......................................................... 8,000,000 --
---------------------------------------
TOTAL LIABILITIES.......................................................... 272,636,986 231,305,028
MEMBERS' CAPITAL (DEFICIT)
Capital contributions...................................................... 60,000,000 60,000,000
Accumulated deficit........................................................ (124,006,740) (56,589,111)
---------------------------------------
TOTAL MEMBERS' CAPITAL (DEFICIT)........................................... (64,006,740) 3,410,889
=======================================
$ 208,630,246 $234,715,917
=======================================
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
3
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US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-----------------------------------------------------------------------------
1999 1998 1999 1998
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES.................................... $ 7,480,351 $ 2,144,552 $ 17,767,779 $ 4,128,955
COSTS AND EXPENSES
Cost of communication services......... 10,270,971 5,448,129 27,755,885 9,455,275
Selling, general and administrative.... 10,526,342 8,178,850 30,722,179 18,903,455
Depreciation and amortization.......... 4,070,887 1,390,319 9,491,529 2,476,978
------------ ------------ ------------- ------------
TOTAL COSTS AND EXPENSES......... 24,868,200 15,017,298 67,969,593 30,835,708
------------ ------------ ------------- ------------
Loss from operations................... (17,387,849) (12,872,746) (50,201,814) (26,706,753)
------------ ------------ ------------- ------------
Interest Expense............................ (7,805,624) (6,362,348) (20,344,527) (6,992,544)
------------ ------------ ------------- ------------
Interest Income............................. 806,527 2,452,377 3,128,712 2,667,494
------------ ------------ ------------- ------------
NET LOSS............................... $(24,386,946) $(16,782,717) $ (67,417,629) $(31,031,803)
============ ============ ============= ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
4
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US XCHANGE, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................................... $(67,417,629) $(31,031,803)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.......................................... 9,491,529 2,476,978
Provision for doubtful accounts........................................ 328,890 113,000
Interest earned on restricted investments.............................. (2,669,384) (1,243,489)
Gain on sale of assets................................................. (1,200) -
Increase in unearned revenue........................................... 4,505,984 -
Changes in assets and liabilities:
Accounts receivable................................................ (7,596,860) (1,493,891)
Other current assets............................................... (310,795) (823,541)
Accounts payable................................................... (6,254,633) 6,518,133
Accrued liabilities................................................ (6,386,060) 10,138,874
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES.............................. $(76,310,158) (15,345,739)
------------ ------------
INVESTING ACTIVITIES
Purchase of restricted investments.......................................... - (82,469,784)
Decrease in restricted investments.......................................... 30,500,000 -
Purchase of networks and equipment.......................................... (40,349,017) (58,252,380)
Proceeds from sale of assets................................................ 24,185 -
Increase in other assets.................................................... (1,423,758) (38,258)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES.............................. (11,248,590) (140,760,422)
------------ ------------
FINANCING ACTIVITIES
Proceeds from long-term debt................................................ 50,000,000 201,211,000
Repayment of long-term debt................................................. (533,333) (400,000)
Advances from affiliated company............................................ - 61,211
Direct costs of financing................................................... (1,019,263) (6,929,354)
Members' capital contributions.............................................. - 33,900,000
NET CASH PROVIDED BY FINANCING ACTIVITIES.......................... 48,447,404 227,842,857
------------ ------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.................... (39,111,344) 71,736,696
Cash and equivalents, beginning of period................................... 40,018,552 100,590
------------ ------------
Cash and equivalents, end of period......................................... $ 907,208 $ 71,837,286
============ ============
Supplemental Disclosure of Cash Flow Information
Interest Paid (net of amounts capitalized)......................... $ 28,079,602 $ 213,869
============ ============
</TABLE>
During the nine months ended September 30, 1998, affiliated company
advances of $21,100,000 were converted to members' capital contributions.
See accompanying notes to unaudited consolidated financial statements.
5
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US XCHANGE, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated balance sheet of US Xchange, L.L. C. (the "Company")
at December 31, 1998 was obtained from the Company's audited balance sheet
as of that date. All other financial statements contained herein are
unaudited and, in the opinion of management, contain all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation. Operating results for the three and nine months ended
September 30, 1999 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1999. The Company's accounting
policies and certain other disclosures are set forth in the notes to the
Company's audited consolidated financial statements as of and for the year
ended December 31, 1998.
2. RESTRICTED INVESTMENTS
Restricted investments consist of U.S. government securities and money
market funds plus accrued interest thereon purchased in connection with the
15% Notes (see Note 4) to secure the first three years' (six semi-annual)
interest payments on these notes, which payments the Company commenced on
January 1, 1999. All these investments are classified as held-to-maturity
securities. Such investments are stated at cost, which approximates fair
value, and are reported in both current and long-term assets, based upon
the maturity dates of the individual securities.
3. UNEARNED REVENUES
Sales of indefeasible rights to use fiber or capacity ("IRU") are
recorded as unearned revenue at the earlier of the acceptance of the
applicable portion of the network by the customer or the receipt of cash.
The revenue is recognized over the life of the agreement as services are
provided beginning on the date of customer acceptance. For the nine months
ended September 30, 1999, no IRU revenues were earned.
4. LONG-TERM DEBT
In August 1999, the majority member of the Company agreed to provide
the Company with up to $25.0 million in subordinated debt. Borrowings under
this arrangement totaled $8.0 million at September 30, 1999. Under this
subordinated line of credit, interest accrues on outstanding borrowings at
a floating rate equal to prime rate less 1.25% (effectively 7.0% at
September 30, 1999), and borrowings are secured by all present and future
assets of the Company and are subordinated to the indebtedness under the
Company's current and any future secured credit facilities. Repayment of
borrowings under this line of credit and accrued interest will commence
upon the repayment of all obligations under the Company's current and any
future secured credit facilities.
On April 30, 1999, pursuant to a Loan and Security Agreement among the
Company's wholly-owned subsidiary US Xchange Finance Company, L.L.C., as
borrower, the Company and its operating subsidiaries, as guarantors, the
lender parties thereto and General Electric Capital Corporation ("GE
Capital"), as Administrative Agent and lender, the Company obtained a $50.0
million senior secured revolving credit facility. Outstanding borrowings
under this facility as of September 30, 1999, were $42,000,000. Loans under
this facility bear interest at a floating rate equal to either a defined
base rate plus 3.0% or at LIBOR plus 4.0%, at the borrower's option. The
effective interest rate was 9.3% at September 30, 1999. Interest is payable
at least on a quarterly basis. During the initial two years, unused
portions of this facility are subject to a commitment fee ranging between
.75% and 1.25% of the unused amount. The aggregate outstanding
6
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principal is repayable in quarterly installments, commencing July 31, 2002
and continuing through April 30, 2007, based upon the following annual debt
reduction formula: 10%, 15%, 20%, 25% and 30%. Borrowings are secured by
all present and future real and personal property, assets and revenues of
the borrower and its subsidiaries. The Company and the subsidiaries of the
borrower have guaranteed the repayment of all indebtedness under this
facility.
The senior secured revolving credit facility contains quarterly
financial performance covenants regarding minimum revenues and maximum
EBITDA losses, with which the Company did not comply for the quarter ended
September 30, 1999. GE Capital has waived non-compliance with these
covenants for the quarter ended September 30, 1999. (EBITDA consists of
earnings (loss) before net interest, income taxes, depreciation and
amortization.)
On June 25, 1998, the Company completed a sale of $200 million
principal amount of 15% Senior Notes due 2008 (the "15% Notes"). Of the
total net proceeds approximating $193.0 million, the Company placed
approximately $82.5 million, representing funds, together with interest
thereon, sufficient to pay the first six semi-annual interest payments on
the 15% Notes, into an escrow account for the benefit of the holders.
Issuance costs approximating $7.0 million are being amortized ratably over
the term of the debt. Interest on the 15% Notes is payable semi-annually,
on January 1 and July 1, commencing January 1, 1999. The Company made
interest payments of $15.5 million and $15.0 million on January 1, 1999 and
July 1, 1999, respectively, to the holders of the 15% Notes. The 15% Notes
are non-callable and mature in full on July 1, 2008.
The 15% Notes are unsubordinated, unsecured senior indebtedness of the
Company. The Company's subsidiaries have no obligation to pay amounts due
on the 15% Notes and do not guarantee the 15% Notes. Therefore, the 15%
Notes are effectively subordinated to all existing and future liabilities
(including trade payables) of the Company's subsidiaries.
The 15% Notes are subject to certain covenants that, among other
things, restrict the ability of the Company and certain subsidiaries to
incur additional indebtedness, pay dividends or make distributions or
redemptions in respect of membership interests.
On August 28, 1997, the Company entered into a credit facility
agreement with a local bank that provided for borrowings of up to
$4,000,000 for the acquisitions of office furniture, equipment and computer
software and for construction costs related to leasehold improvements of
office and switch site locations. In March 1998, the credit facility was
fully utilized and converted into a term note payable in 60 equal monthly
installments commencing April 1998. Amounts borrowed bear interest at 1/2%
under the bank's prime rate or 2% over the bank's cost of funds, at the
Company's option. The effective rate was 7.0% at September 30, 1999.
Specific assets and the guarantee of an affiliated company owned by the
Company's majority member secure all borrowings. The credit facility also
provides that the affiliated company maintains minimum debt to tangible net
worth and current ratio levels. At September 30, 1999, the affiliated
company was in compliance with the covenant requirements.
The aggregate principal repayments of long-term debt over the next five
years are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
-------------------------------------------------------------------
<S> <C>
1999 (3 months) $ 200,000
2000 800,000
2001 800,000
2002 3,300,000
2003 6,450,000
</TABLE>
7
<PAGE> 8
5. RELATED PARTY TRANSACTIONS
In connection with the Company's issuance of the 15% Notes, advances
from an affiliate company owned by the Company's majority member of $21.1
million were converted to member's capital as of March 31, 1998. Under an
expense sharing agreement with the affiliated company, the Company incurred
$255,400 and $254,600 relating to management and administrative services
for the nine months ended September 30, 1999 and 1998, respectively.
The Company has a lease agreement with another affiliated company owned
by the majority member for aircraft transportation services. Total costs
incurred under this arrangement for the nine months ended September 30,
1999 and 1998 were $68,100 and $69,400, respectively.
See also Note 4 regarding the Company's borrowings under the
subordinated line of credit from the Company's majority member.
6. LEASES
The Company leases administrative and sales office facilities,
operating sites and certain equipment under noncancelable operating leases
having initial or remaining terms of more than one year. Certain of the
Company's facility leases include renewal options, and most leases include
provisions for rent escalation to reflect increased operating costs and/or
require the Company to pay certain maintenance and utility costs. Total
rental expense for all operating leases for the nine months ended September
30, 1999 and 1998 was $4,154,400 and $975,000 respectively.
Future minimum lease payments under noncancelable operating leases at
September 30, 1999 were as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING SITE
DECEMBER 31, OFFICE FACILITIES FACILITIES EQUIPMENT TOTAL
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999 (3 months).... $ 507,179 $ 162,332 $ 244,652 $ 914,163
2000............... 2,096,834 639,566 948,429 3,684,829
2001............... 2,078,594 648,387 471,514 3,198,495
2002............... 1,860,429 642,306 202,897 2,705,632
2003-2007.......... 1,780,200 1,543,883 5,378 3,329,461
2008-2012.......... -- 235,573 -- 235,573
=============================================================================================
</TABLE>
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Except for historical information, the discussion in this Item 2
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those set forth in these
forward-looking statements as a result of a number of factors. These factors
include, but are not limited to, the risks we discuss below and under the
caption "Risk Factors" in Exhibit 99.1 to our Annual Report on Form 10-K for the
fiscal year ended December 31, 1998, which is incorporated herein by reference.
OVERVIEW
Our operations have resulted in significant losses, negative cash flows
from operating and investing activities and negative EBITDA since our inception
in August 1996. We expect that planned capital expenditures, together with the
associated operating expenses in each of our markets, will result in operating
losses, negative cash flows from operating and investing activities and negative
EBITDA for approximately 24 to 36 months after we commence facilities-based
switched operations in each market. Accordingly, we expect to experience
increasing consolidated losses as we expand our operations, deploy our networks
and switching facilities and develop our customer base.
As of the end of the third quarter of 1999, networks in all of our
markets were commercially operational. We continue to transition to our own
facilities-based services customers to whom we resold services of other carriers
prior to beginning the commercial operation of our own networks. We are also
continuing to deploy, through swap and joint build arrangements, long-haul fiber
interconnecting certain of our networks.
FACTORS AFFECTING RESULTS OF OPERATIONS
REVENUES
We direct our sales and marketing efforts primarily towards small to
medium-sized business customers, Internet service providers and governmental and
other institutional end users in selected underserved markets. Upon first
entering each of our markets, we initially resold incumbent carrier services to
establish a market presence. After each of our network switching systems became
commercially operational, we began transitioning our resale customers to our own
switch-based network in each market. We believe that this strategy has allowed
us to improve our penetration of the available customer base in each of our
markets. We compete primarily on the basis of competitive pricing, superior
service and products, and innovative service and product offerings.
We also generate revenues from the sale of our services to residential
customers. We believe that our bundled service offerings, front office and back
office automation and automated customer care, billing and credit-checking
systems and procedures enhance our ability to offer services to residential
customers in our markets. In addition, we believe we have significant operating
leverage and a relatively low marginal cost of providing service to residential
customers. We target creditworthy residential customers who we believe are
likely to have needs for multiple services. We market our residential services
through various affinity group and other cost-effective marketing programs and
service packages specifically designed to appeal to these customers.
To further leverage our fixed costs, we have identified selective
channels for the sale of our services on a wholesale basis. For example, we
offer our local and Internet access services on a wholesale basis to Internet
service providers in certain of our markets and have an exclusive distribution
arrangement with an interconnect company. We intend to establish strategic
alliances with, and supply wholesale services to, electric utilities and other
selected telecommunications providers for resale to their own customers. We also
expect to generate revenues from the sale of dark fiber along our long-haul
routes and certain of our local network rings. During the third quarter of 1999,
we sold indefeasible rights to use our fiber to several other carriers and are
pursuing similar arrangements with certain other carriers as a source of
additional revenues. We have not yet earned any revenues from IRUs, which
revenues we will earn over the life of the IRU as services are provided.
9
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OPERATING EXPENSES
Our primary operating expenses consist of the cost of communication
services, selling, general and administrative expenses and depreciation and
amortization charges.
Cost of Communications Services. Cost of communication services
consists of the fixed costs of leased facilities, minutes-of-use charges for
origination and termination services and access line charges for local and long
distance services, including the costs to use incumbent local telephone company
unbundled network elements, costs for installation and initial service turn-up,
and costs of network personnel. We also incur rights-of-way costs and, in
certain markets, franchise fees and taxes paid to local governments based on
revenue. After we install our network infrastructure and activate our switching
systems, we can add customers and associated revenues with lower incremental
cost of communication services, so that such customers provide greater
contributions to our operating cash flows and EBITDA. While we primarily target
businesses, Internet service providers, and governmental and other institutional
customers, we believe that, once a network is operational, the marginal cost of
providing our services to residential customers is low enough to allow us to
economically address these customers because they generally require less complex
services than other customers. Cost of communication services does not include
depreciation and amortization.
Selling, General and Administrative. Our selling, general and
administrative expenses include sales and marketing costs, customer service and
technical support, billing and collection, and general management and overhead
expense. These costs grow significantly as we expand our operations, and
administrative overhead is a large portion of these expenses during the
deployment of our networks. However, as we expand our customer base, we expect
these expenses will represent a smaller percentage of our revenues.
Depreciation and Amortization. We depreciate and amortize our property
and equipment using the straight-line method over the estimated useful life of
the assets, ranging from five to eight years for equipment, 20 years for fiber,
three to five years for third-party software costs and the lesser of 10 years or
the lease term for leasehold improvements. We amortize our debt financing costs
using the straight-line method over the term of the respective debt agreements.
INTEREST EXPENSE
Prior to our issuance of the 15% Senior Notes in June 1998, we did not
incur material interest expense. Since then, however, we have incurred and
expect to continue to incur substantial interest expense.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 1999 Compared to Three and
Nine Months Ended September 30, 1998.
Revenues for the third quarter of 1999 totaled $7.5 million, an
increase of 26% over the second quarter's $5.9 million and up 349% over the
comparable quarter's revenues of $2.1 million in 1998. Our revenues from
business customers grew primarily as a result of increased products and services
available and increased usage by our current customers. Revenues derived from
our facilities-based switched operations during the third quarter of 1999 were
$3.3 million, an increase of 74% over the second quarter's total of $1.9
million. This increase was the result of two additional switches becoming
commercially operational during the third quarter of 1999 and the continued
conversion of resale customers to our own switches in all of our
facilities-based markets. Revenues during the third quarter of 1998 included
$169,000 from our facilities-based switched operations and $4.0 million from
resale services. For the nine months ended September 30, 1999, revenues totaled
$17.8 million, up 430% over the $4.1 million for the comparable period in 1998.
At September 30, 1999, we had approximately 47,500 installed local access lines
in service, of which approximately 50% were served by our own facilities.
10
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Cost of communication services increased to $10.3 million for the third
quarter of 1999, or 137% of revenues, from $5.4 million, or 254% of revenues,
for the comparable period in 1998. The increase relates primarily to the costs
of leased telecommunications facilities and services in connection with the
growth of our local and long distance services. For the nine months ended
September 30, 1999, cost of communication services was $27.8 million, or 156% of
revenues, compared to $9.5 million, or 229% of revenues, for the same period in
1998.
Selling, general and administrative expenses were $10.5 million, or
141% of revenues, for the third quarter of 1999, compared to $8.2 million, or
381% of revenues, for the same period in 1998. For the nine months ended
September 30, 1999, these expenses totaled $30.7 million, or 173% of revenues,
compared to $18.9 million, or 457% of revenues, during the same period in 1998.
The increase was due primarily to personnel costs associated with the expansion
of our selling, customer and technical support services and administrative
activities to support our growth.
Depreciation and amortization expenses increased to $4.1 million for
the third quarter of 1999 from $1.4 million for the comparable period in 1998.
The increase primarily reflects the 13 switches and networks that were
commercially operational during the third quarter of 1999 compared to six in
operation for the same quarter of 1998. For the nine months ended September 30,
1999, depreciation and amortization expenses totaled $9.5 million compared to
$2.5 million for the same period in 1998. Amortization expense, consisting
primarily of the direct costs of issuing our 15% Senior Notes and the senior
secured credit facility, approximated $938,000 and $176,000 for the nine months
ended September 30, 1999 and 1998, respectively.
Gross interest expense for the nine months ended September 30, 1999
increased $15.4 million to $23.7 million compared to the same period in 1998.
Interest expense relates primarily to the accrual of interest on the 15% Notes
and the senior secured credit facility. Interest costs of $584,000 and $3.3
million were capitalized during the third quarter and nine months ended
September 30, 1999, respectively, relating to network construction projects.
Interest costs capitalized during the comparable periods in 1998 were $1.3
million and $1.3 million, respectively.
Interest income of $807,000 for the third quarter of 1999 and $3.1
million for the nine months ended September 30, 1999, resulted primarily from
interest earnings on the short-term investment of the cash proceeds from the
issuance of the 15% Senior Notes.
Net loss increased to $24.4 million for the third quarter of 1999, from
$16.8 million for the same period in 1998. The net loss for the nine months
ended September 30, 1999 was $67.4 million compared to $31.0 million for the
same period in 1998. The increase in the 1999 losses resulted primarily from
significant expenditures we incurred, before the realization of revenues, due to
expansion of our local and long distance services, the added depreciation
expense resulting from the construction and expansion of our networks and the
net interest expense on our indebtedness to fund our network development and
expansion.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1999, cash and cash
equivalents decreased $39.1 million to $900,000. Our deficiency in net cash used
in operations increased to $76.3 million for the nine months ended September 30,
1999, primarily the result of our net loss increasing to $67.4 million. For the
same period in 1998, cash from operating activities was used primarily to fund
our net loss of $31.0 million offset by an increase in accounts payable and
accrued liabilities of $16.6 million. We expect that negative cash flows will
continue because significant cash outlays will be necessary to expand our
operations, including the deployment of our networks and back office systems
infrastructure for the generation of customer revenues, and transition our
customers from resale services to facilities-based services.
11
<PAGE> 12
Our investing activities for the nine months ended September 30, 1999
used cash of $11.2 million primarily due to $40.3 million of capital
expenditures for the construction of our switching and fiber optic networks
offset by the $30.5 million reduction in our restricted investments for the
payment of interest on our 15% Senior Notes. Cash used for investing activities
during the same period in 1998 was $140.8 million primarily due to capital
expenditures of $58.3 million and the setting aside of $82.5 million of the
proceeds from the sale of our 15% Senior Notes to purchase U.S. government
securities and accrued interest thereon to secure and fund payments of the first
six interest payments on the 15% Senior Notes.
During the nine months ended September 30, 1999, cash of $48.4 million
was provided by financing activities. This relates primarily to $42.0 million of
proceeds received from borrowings under our senior secured credit facility and
$8.0 million received under a subordinated line of credit arrangement from our
majority member, offset slightly by $1.0 million of direct financing costs paid
in connection with obtaining the senior secured credit facility and the
repayment of principal on our bank credit facility of $533,000. Cash of $227.8
million was provided by financing activities in the nine months ended September
30, 1998, primarily the result of $200.0 million of proceeds from the sale of
our 15% Senior Notes, offset by related direct financing costs of $7.0 million,
additional member capital contribution of $33.9 million and borrowings of $1.2
million under our bank credit facility.
At September 30, 1999, we had $2.8 million of outstanding indebtedness
under our bank credit facility. The borrowings bear interest at an annual rate
equal to (1) 1/2% under the bank's prime lending rate or (2) 2% over the bank's
costs of funds, at our option. The effective annual interest rate of the bank
credit facility was 7.0% at September 30, 1999. The borrowings are repayable in
monthly installments of $66,667 through March 31, 2003 and are secured by
specific assets of US Xchange and one of our wholly owned subsidiaries and by
the guarantees of the same subsidiary and of RVP Development Corporation.
On June 25, 1998 we issued and sold $200 million aggregate principal
amount of our 15% Senior Notes due July 1, 2008. Of the $193.0 million of net
proceeds that we received for these Notes, we used approximately $82.5 million
to purchase U.S. government securities, including accrued interest, to secure
and fund our first six scheduled semi-annually payments of interest on these
Notes. During the first half of 1999, we used the entire net proceeds to fund
the installation and deployment of our networks and their associated operating
losses.
On April 30, 1999, we obtained a $50.0 million senior secured revolving
credit facility, pursuant to a Loan and Security Agreement among our
wholly-owned subsidiary US Xchange Finance Company, L.L.C., as borrower, US
Xchange and our operating subsidiaries, as guarantors, the lender parties
thereto and General Electric Capital Corporation, as Administrative Agent and
lender. As of September 30, 1999, we had outstanding borrowings of $42,000,000
under this facility. Loans under the senior secured credit facility bear
interest at a floating rate equal to either a defined base rate plus 3.0% or at
LIBOR plus 4.0% at our option. The effective rate was 9.3% as of September 30,
1999. Interest is payable at least on a quarterly basis. During the initial two
years, unused portions of this facility are subject to a commitment fee ranging
between .75% and 1.25% of the unused amount. The aggregate outstanding principal
is repayable in quarterly installments, commencing July 31, 2002 and continuing
through April 30, 2007 based upon the following annual debt reduction formula:
10%, 15%, 20%, 25% and 30%. Borrowings are secured by all present and future
real and personal property, assets and revenues of the borrower and its
subsidiaries. US Xchange and the subsidiaries of the borrower have guaranteed
the repayment of all indebtedness under this facility.
The terms of our indebtedness impose certain financial and operating
restrictions on us and our restricted subsidiaries. These restrictions limit,
among other things, our ability to:
- incur additional indebtedness;
- create liens;
- engage in sale-leaseback transactions;
12
<PAGE> 13
- sell assets;
- effect consolidations or mergers;
- make investments or certain other restricted payments
- pay dividends or make distributions in respect of membership
interest;
- redeem membership interests;
- issue or sell membership interest of our restricted
subsidiaries; and
- enter into transactions with any of our members or affiliates.
While these limitations are subject to a number of important
qualifications and exceptions, if we were to fail to comply with these
restrictions and, in some cases, were to fail to cure our noncompliance, the
lenders could declare a default. At September 30, 1999, we were not in
compliance with two of the financial performance covenants under the senior
secured credit facility. General Electric Capital Corporation has waived our
non-compliance with these covenants for the quarter ended September 30, 1999.
During the third quarter of 1999, our majority member agreed to provide
us with a $25.0 million subordinated line of credit to help fund our capital
requirements and the operating losses of our networks. Borrowings under this
line of credit arrangement totaled $8.0 million at September 30, 1999. Under
this line of credit, interest accrues on outstanding borrowings at a floating
rate equal to prime rate less 1.25%. The effective rate at September 30, 1999
was 7.0%. Borrowings under this subordinated line of credit are secured by all
of our assets and the assets of our subsidiaries, and are subordinated in right
of payment to debt outstanding under our secured credit facility and any future
secured credit facilities. Repayment of borrowed amounts and accrued interest
will commence upon the repayment of all obligations under our current and any
future secured credit facilities.
Our operations have required a substantial capital investment for the
purchase of telecommunications equipment and the construction and development of
our networks. Since the beginning of fiscal 1997 and through September 30, 1999,
we have spent approximately $144.1 million on capital expenditures. We have
funded these expenditures through our existing equity capital, borrowings under
our credit facilities and the net proceeds from the sale of our 15% Senior
Notes.
The costs associated with the initial installation and expansion of
each of our networks, including development, installation, certain
organizational costs and early operating expenses, and the construction of our
planned long haul routes interconnecting our commercial regions are significant.
We expect to experience negative cash flow for each market until we establish an
adequate customer base and revenue stream. We estimate that, as of September 30,
1999, our future capital requirements (including requirements for capital
expenditures, working capital, debt service and operating losses) to fund the
operating losses of our networks, the expansion of certain of our local networks
and the planned installation of long-haul fiber interconnecting our networks
will total approximately $48.0 million. Of this amount, approximately $19.4
million was committed for capital expenditures required for the completion of
our long-haul routes and the expansion of certain of our local networks through
the second quarter of 2000. We plan to finance these capital requirements with
the available borrowings under our senior secured credit facility (approximately
$8.0 million as of September 30, 1999), available borrowings under our
subordinated line of credit from our majority member (approximately $17.0
million as of September 30, 1999), cash expected to be generated from future
revenues, and additional debt or equity financing, and possibly through sales of
dark fiber along our local and long-haul networks. We currently have no
commitments for additional debt or equity financing, and we can give no
assurance that additional debt or equity financing will be available to us on
terms we consider acceptable or at all. If we are unable to secure additional
debt or equity financing or to sell any dark fiber on acceptable terms, we may
be required to modify or delay some of our planned capital expenditures, which
could have a material adverse effect on our business.
The actual amount and timing of our capital requirements may vary
significantly from our estimates based upon a number of factors, including,
among other things:
13
<PAGE> 14
- the timing and success of our current development plans;
- shortfalls in our revenue and cost projections;
- demand for our services;
- regulatory, technological and competitive developments;
- any decision to expand our operations into additional
commercial regions or markets or within any of our current
networks; and
- any acquisitions or joint ventures that we decide to undertake.
Actual revenues and costs may vary materially from expected amounts,
and such variations will likely affect our future cash flow requirements.
Accordingly, we cannot assure you that our actual capital requirements will not
exceed our current estimates.
YEAR 2000 COMPLIANCE
The year 2000 issue is a matter of particular worldwide concern for
telecommunications carriers because it affects many aspects of
telecommunications technology, including the computer systems and software
applications that are essential for network administration and operations. A
significant portion of telecommunications voice and data networking and network
management devices have date-sensitive processing in them which affect network
administration and operations functions such as service activation, service
assurance and billing processes. However, because we have recently commenced
operations and acquired our key processing systems, our costs relating to year
2000 issues have not been material. Lucent and the other system vendors have
represented to us that their systems are year 2000 compliant without any
required modification. We will require confirmation of year 2000 compliance in
our future requests for proposals from Lucent and our other equipment and
software vendors. Pursuant to our year 2000 compliance plan, we have modified
and tested all of our mission-critical systems and believe they are now year
2000 compliant. However, until the year 2000, we cannot assure you that our
computer systems and software applications will accommodate the year 2000.
The failure of our computer systems and software applications to
accommodate the year 2000 could have a material adverse effect on our business
and financial condition. Further, if the networks and systems of the incumbent
local telephone companies, long distance carriers and others on whose services
we depend and with whom our networks and systems must interface are not year
2000 functional, it could have a material adverse effect on the operation of our
networks and, as a result, on our businesses and customers. The Telco Year 2000
Forum, a group representing the nation's largest local telephone companies, has
announced, based upon six months of interoperability testing, that such
companies remain confident that the public will be able to place telephone calls
at the start of 2000. However, other domestic and international carriers may not
be year 2000 functional. We have established a contingency plan that addresses
our response to any potential failure of our systems, and those of other
entities on whose services we depend or with whom our networks and systems must
interface, to accommodate year 2000 issues. We intend to continue to monitor the
performance of our accounting, information and processing systems and software
applications and those of our third-party constituents to identify and resolve
any year 2000 issues.
While we believe all of our mission-critical systems are now year 2000
compliant, we can give no assurance that we will not have to replace, upgrade or
reprogram certain existing systems and software applications to ensure that our
systems and interoperability applications are year 2000 functional. However,
based on current information, we do not believe that we will incur costs for any
replacement, upgrade or reprogramming of our computer systems and software
applications to resolve any year 2000 issues that will be material to our
business, financial condition or results of operations.
14
<PAGE> 15
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." Among other
provisions, this standard requires that entities recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. Gains and losses resulting from changes in the fair values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. This standard, as amended by SFAS
137 issued in June 1999, is effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000, though earlier adoption is encouraged and
retroactive application is prohibited. Historically, we have not entered into,
and we currently have no plans to enter into, any derivative instruments.
Accordingly, we believe that this standard will not have a material impact on
our consolidated financial position, results of operations or cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
15
<PAGE> 16
PART II
OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company's $50.0 million senior secured revolving credit facility
contains quarterly financial performance covenants regarding minimum revenues
and maximum EBITDA losses, which the Company did not satisfy for the quarter
ended September 30, 1999. General Electric Capital Corporation, as
Administrative Agent and lender under this facility, has waived the Company's
non-compliance with these covenants for the quarter ended September 30, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits filed with (or incorporated by reference into) this
report:
3.1 Articles of Organization of US Xchange, L.L.C.
(incorporated by reference to Exhibit 3.1 to the
registrant's registration statement on Form S-4
(Commission File No. 333-64717) filed September 30,
1998, the "Form S-4")
3.2 Operating Agreement of US Xchange, L.L.C. dated as of
August 1, 1996 (incorporated by reference to Exhibit
3.2 to the Form S-4)
4.1 Loan and Security Agreement dated as of April 29,
1999, among US Xchange Finance Company, L.L.C., as
Borrower, US Xchange, L.L.C. and certain operating
subsidiaries of US Xchange, L.L.C., as Guarantors, and
General Electric Capital Corporation, as
Administrative Agent and lender thereunder
(incorporated by reference to Exhibit 4.1 to the
registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1999, as amended)
4.2 Schedules to Loan and Security Agreement (incorporated
by reference to Exhibit 4.2 to the registrant's
Current Report on Form 8-K dated August 23, 1999)
27.1 Financial Data Schedule for Three Months Ended
September 30, 1999
27.2 Financial Data Schedule for Three Months Ended
September 30, 1998
27.3 Financial Data Schedule for Nine Months Ended
September 30, 1999
27.4 Financial Data Schedule for Nine Months Ended
September 30, 1998
99.1 Risk Factors, incorporated herein by reference to
Exhibit 99.1 to the registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998
(b) Reports on Form 8-K:
The Registrant filed a Current Report on Form 8-K on August 24, 1999,
including as Item 7 therein the Schedules to the Loan and Security Agreement
that is incorporated herein as Exhibit 4.1, which Schedules are herein
incorporated as Exhibit 4.2.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
US XCHANGE, L.L.C.
November 15, 1999 By: /s/ Richard Postma
--------------------------------------------
Richard Postma, Co-Chairman and Chief
Executive Officer
November 15, 1999 By: /s/ Joseph Miglore
--------------------------------------------
Joseph Miglore, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer)
17
<PAGE> 18
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------
3.1 Articles of Organization of US Xchange, L.L.C.
(incorporated by reference to Exhibit 3.1 to the
registrant's registration statement on Form S-4
(Commission File No. 333-64717) filed September 30,
1998, the "Form S-4")
3.2 Operating Agreement of US Xchange, L.L.C. dated as of
August 1, 1996 (incorporated by reference to Exhibit
3.2 to the Form S-4)
4.1 Loan and Security Agreement dated as of April 29,
1999, among US Xchange Finance Company, L.L.C., as
Borrower, US Xchange, L.L.C. and certain operating
subsidiaries of US Xchange, L.L.C., as Guarantors, and
General Electric Capital Corporation, as Administrative
Agent and lender thereunder (incorporated by reference
to Exhibit 4.1 to the registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1999, as
amended)
4.2 Schedules to Loan and Security Agreement (incorporated
by reference to Exhibit 4.2 to the registrant's
Current Report on Form 8-K dated August 23, 1999)
27.1 Financial Data Schedule for Three Months Ended
September 30, 1999
27.2 Financial Data Schedule for Three Months Ended
September 30, 1998
27.3 Financial Data Schedule for Nine Months Ended
September 30, 1999
27.4 Financial Data Schedule for Nine Months Ended
September 30, 1998
99.1 Risk Factors, incorporated herein by reference to
Exhibit 99.1 to the registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1998
18
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