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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 38-33505418
(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) 493-7000
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 August 13, 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
<TABLE>
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Page No.
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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
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................9
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................................14
PART II OTHER INFORMATION..........................................................................................15
Item 3. Defaults Upon Senior Securities.............................................................................15
Item 6. Exhibits and Reports on Form 8-K............................................................................15
SIGNATURES..........................................................................................................16
INDEX TO EXHIBITS...................................................................................................17
</TABLE>
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
US XCHANGE, L.L.C.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------------- ----------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
<S> <C> <C>
Cash and equivalents.................................................... $2,569,029 $40,018,552
Restricted investments.................................................. 28,402,198 28,525,109
Accounts Receivable, less allowance for doubtful accounts of
$345,177 and $174,000................................................... 4,465,842 1,865,503
Other current assets.................................................... 1,172,791 700,411
-------------------------------------
TOTAL CURRENT ASSETS.............................................. 36,609,860 71,109,575
-------------------------------------
NETWORKS AND EQUIPMENT
Networks and networks in process (cost to complete of $14,771,000) 114,055,771 85,821,872
Furniture and equipment................................................. 17,751,943 14,017,604
Leasehold improvements.................................................. 6,193,379 3,937,223
-------------------------------------
138,001,093 103,776,699
Less accumulated depreciation and amortization.......................... 8,454,393 3,432,193
-------------------------------------
NET NETWORKS AND EQUIPMENT................................................. 129,546,700 100,344,506
-------------------------------------
OTHER ASSETS
Restricted investments.................................................. 42,731,097 56,206,738
Debt issuance costs, net................................................ 7,429,704 6,793,770
Miscellaneous........................................................... 1,023,255 261,328
-------------------------------------
TOTAL OTHER ASSETS...................................................... 51,184,056 63,261,836
=====================================
TOTAL ASSETS............................................................ $217,340,616 $234,715,917
=====================================
LIABILITIES AND MEMBERS' CAPITAL (DEFICIT)
CURRENT LIABILITIES
Accounts payable........................................................... $7,363,722 $11,264,241
Accrued interest........................................................... 15,127,035 15,521,634
Accrued other liabilities.................................................. 2,690,190 1,185,820
Current maturities of long-term debt....................................... 800,000 800,000
-------------------------------------
TOTAL CURRENT LIABILITIES.................................................. 25,980,947 28,771,695
UNEARNED REVENUE........................................................... 1,141,963 --
LONG-TERM DEBT, LESS CURRENT MATURITIES
15% Senior Notes........................................................... 200,000,000 200,000,000
Notes payable.............................................................. 2,200,000 2,533,333
Senior Secured Facility.................................................... 27,637,500 --
-------------------------------------
TOTAL LIABILITIES.......................................................... 256,960,410 231,305,028
MEMBERS' CAPITAL (DEFICIT)
Capital contributions...................................................... 60,000,000 60,000,000
Accumulated deficit........................................................ (99,619,794) (56,589,111)
-------------------------------------
TOTAL MEMBERS' CAPITAL (DEFICIT)........................................... (39,619,974) 3,410,889
=====================================
$217,340,616 $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 JUNE 30, SIX MONTHS ENDED JUNE 30,
-----------------------------------------------------------------------------------
1999 1998 1999 1998
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES.................................. $5,947,990 $1,419,200 $10,287,428 $1,984,403
Costs and Expenses.........................
Cost of communication services........ 9,276,915 2,877,172 17,484,914 4,007,146
Selling, general and administrative... 10,109,331 6,240,263 20,195,837 10,723,009
Depreciation and amortization......... 3,191,122 871,558 5,420,642 1,084,805
---------------------- ------------------- -------------------- ----------------
TOTAL COSTS AND EXPENSES........ 22,577,368 9,988,993 43,101,393 15,814,960
---------------------- -------------------
Loss from operations.................. (16,629,378) (8,569,793) (32,813,965) (13,830,557)
---------------------- ------------------- -------------------- ----------------
Interest Expense........................... (6,605,059) (569,398) (12,538,903) (630,196)
---------------------- ------------------- -------------------- ----------------
Interest Income............................ 1,011,998 211,602 2,322,185 211,665
---------------------- ------------------- -------------------- ----------------
NET LOSS.............................. $(22,222,439) $(8,927,589) $(43,030,683) $(14,249,088)
====================== =================== ==================== ================
</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>
SIX MONTHS ENDED
JUNE 30,
---------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................................... $(43,030,683) $(14,249,088)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.......................................... 5,420,642 1,084,805
Provision for doubtful accounts........................................ 171,177 52,500
Interest earned on restricted investments.............................. (1,901,449) (76,132)
Increase in unearned revenue........................................... 1,141,693 --
Changes in assets and liabilities:
Accounts receivable................................................ (2,771,516) (852,009)
Other current assets............................................... (472,380) (400,498)
Accounts payable................................................... (3,900,519) 13,625,396
Accrued liabilities................................................ 1,109,771 947,128
---------------- ----------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES................ (44,232,993) 132,102
---------------- ----------------
INVESTING ACTIVITIES
Purchase of restricted investments.......................................... -- (82,469,784)
Decrease in restricted investments.......................................... 15,500,000 --
Purchase of networks and equipment.......................................... (34,224,394) (34,069,212)
Increase in other assets.................................................... (785,354) (23,224)
---------------- ----------------
NET CASH USED IN INVESTING ACTIVITIES.............................. (19,509,748) (116,562,220)
---------------- ----------------
FINANCING ACTIVITIES
Proceeds from long-term debt................................................ 27,637,500 201,211,000
Repayment of long-term debt................................................. (333,333) (200,000)
Advances from affiliated company............................................ -- 61,211
Direct costs of financing................................................... (1,010,949) (6,804,788)
Members' capital contributions.............................................. -- 33,900,000
---------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES.......................... 26,293,218 228,167,423
---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS.................... (37,449,523) 111,737,305
Cash and equivalents, beginning of period................................... 40,018,552 100,590
---------------- ----------------
Cash and equivalents, end of period......................................... $2,569,029 $111,837,895
================ ================
Supplemental Disclosure of Cash Flow Information
Interest Paid (net of amounts capitalized)......................... $12,933,502 $130,379
================ ================
</TABLE>
During the six months ended June 30, 1998, affiliated company advances
of $21,100,000 were converted to members' capital contributions.
See accompanying notes to unaudited consolidated financial statements.
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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 six months ended June 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 3) to secure the first three years' (six semi-annual) interest
payments on these notes. 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. LONG-TERM DEBT
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 June 30, 1999, were $27,637,500. 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 rate was 9.0% at June 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. 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 which the Company did not meet for the quarter ended June 30, 1999. GE
Capital has agreed to waive non-compliance with these covenants. (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 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 15% Notes are non-callable and mature in full on July 1, 2008.
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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 June 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 June 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:
YEAR ENDING DECEMBER 31,
----------------------------------------------------------------------
1999 (6 months) $400,000
2000 800,000
2001 800,000
2002 3,300,000
2003 6,450,000
4. RELATED PARTY TRANSACTIONS
In connection with the Company's issuance of the 15% Notes, advances
from an affiliated company owned by the Company's majority member of $21.1
million were converted to members' capital as of March 31, 1998. Under an
expense sharing agreement with the affiliated company, the Company incurred
$172,086 and $168,351 relating to management and administrative services for the
six months ended June 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 travel costs
incurred under this arrangement for the six months ended June 30, 1999 and 1998
were $62,330 and $75,002, respectively.
5. 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 six months ended June 30, 1999 and 1998
was $2,861,257 and $447,933, respectively.
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Future minimum lease payments under noncancelable operating leases at
June 30, 1999 were as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING SITE
DECEMBER 31, OFFICE FACILITIES FACILITIES EQUIPMENT TOTAL
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999 (6 months)...... $1,061,151 $309,249 $487,879 $1,858,278
2000................. 2,096,834 614,557 948,429 3,659,820
2001................. 2,078,594 622,561 471,514 3,172,669
2002................. 1,860,429 615,639 202,897 2,678,965
2003-2007............ 1,780,200 1,397,005 5,378 3,182,583
2008-2012............ -- 203,481 -- 203,481
==========================================================================================================================
</TABLE>
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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.
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. In each of our
markets, we initially resell incumbent carrier services to establish a market
presence. After our network switching system becomes commercially operational in
a market, we transition our resale customers to our own switch-based network. We
believe that this strategy results in faster penetration of the available
customer base. 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, high degree of 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 have begun
offering our local and internet access services on a wholesale basis to internet
service providers in certain of our markets and have concluded 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.
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 Communication 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 support
services outsourced to Lucent, and costs of
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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
expenses. 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.
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 Six Months Ended June 30, 1999 Compared to Three and Six Months
Ended June 30, 1998.
Revenues for the second quarter of 1999 totaled $5.9 million, an
increase of 37% over the first quarter's $4.3 million and up 419% over the
comparable quarter's revenues of $1.4 million in 1998. The Company continues to
show strong growth in revenues from its business customers primarily as a result
of increased products and services available and increased usage by its current
customers. Revenues derived from our facilities-based switched operations during
the second quarter of 1999 were $1.9 million, an increase of 279% over the first
quarter's total of $648,000. This increase was the result of three additional
switches becoming commercially operational during the second quarter of 1999 and
the continued conversion of resale customers to our own switches in all of our
facility-based markets. Revenues during the second quarter of 1998 were
substantially all derived from resale services. For the six months ended June
30, 1999, revenues totaled $10.3 million, up 518% over the $2.0 million for the
comparable period in 1998. At June 30, 1999, we had approximately 38,000
installed local access lines in service, of which approximately 37% were served
by our own facilities.
Cost of communication services increased to $9.3 million for the second
quarter of 1999, or 156% of revenues, from $2.9 million, or 203% 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. Our facilities-based network
operating costs also increased approximately $1.6 million due to the continued
expansion of our networks into planned markets. For the six months ended June
30, 1999, cost of communication services was $17.5 million, or 170% of revenues,
compared to $4.0 million, or 202% of revenues, for the same period in 1998.
Selling, general and administrative expenses were $10.1 million, or
170% of revenues, for the second quarter of 1999, compared to $6.2 million, or
440% of revenues, for the same period in 1998. For the six months ended June 30,
1999, these expenses totaled $10.2 million, or 196% of revenues, compared to
$10.7 million, or
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540% 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 $3.2 million for
the first quarter of 1999 from $872,000 for the comparable period in 1998. The
increase primarily reflects the eleven switches and networks that were
commercially operational during the second quarter of 1999 compared to two in
operation for the same quarter of 1998. For the first half of 1999, depreciation
and amortization expenses totaled $5.4 million compared to $1.1 million for the
same period in 1998. Amortization expense, consisting primarily of the direct
costs of issuing the 15% Senior Notes, approximated $727,000 and $14,000 for the
six months ended June 30, 1999 and 1998, respectively.
Gross interest expense for the six months ended June 30, 1999 increased
$14.7 million to $15.3 million compared to the same period in 1998. Interest
expense relates primarily to the accrual of interest on the 15% Notes. Interest
costs of $1.1 million and $2.7 million were capitalized during the second
quarter and the first half of 1999, respectively, relating to network
construction projects. Interest costs capitalized during the comparable periods
in 1998 were $0 and $10,300, respectively.
Interest income of $1.1 million for the second quarter of 1999 and $2.3
million for the first half of 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 $22.2 million for the second quarter of 1999,
from $8.9 million for the same period in 1998. The net loss for the first half
of 1999 was $43.0 million compared to $14.2 million for the same period in 1998.
The increase in the 1999 losses results primarily from significant expenditures
we incur, 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 six months ended June 30, 1999, cash and cash equivalents
decreased $37.4 million to $2.6 million. Our deficiency in net cash used in
operations increased to $44.2 million for the first half of 1999, primarily the
result of our net loss increasing to $43.0 million. For the same period in 1998,
cash from operating activities was used primarily to fund our net loss of $14.2
million offset by an increase in accounts payable and accrued liabilities of
$14.6 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.
Our investing activities for the six months ended June 30, 1999 used
cash of $19.5 million primarily due to $34.2 million of capital expenditures for
the construction of our switching and fiber optic networks offset by the $15.5
million reduction in our restricted investments for the semi-annual payment of
interest on our 15% Notes. Cash used for investing activities during the same
period in 1998 was $116.6 million primarily due to capital expenditures of $34.1
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 such
Notes.
During the first half of 1999, cash of $26.3 million was provided by
financing activities primarily relating to $27.6 million of proceeds received
from borrowings under our senior secured credit facility. This was offset
slightly by the payment of $1.0 million of direct financing costs in connection
with obtaining the senior secured credit facility and the repayment of principal
on our bank credit facility of $333,000. Cash of $228.2 million was provided by
financing activities in the first half of 1998, primarily the result of $200.0
million of proceeds from
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the sale of our 15% Senior Notes, offset by related direct financing costs of
$6.8 million, additional member capital contributions of $33.9 million and
borrowings of $1.2 million under our bank credit facility.
At June 30, 1999, we had $3.0 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 of (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 June 30, 1999. The borrowings are repayable in monthly
installments of $66,667 through March 31, 2003 and are secured by specific
assets of the Company 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-annual payments of interest on these
Notes. Through June 30, 1999, we have 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 June 30, 1999, we had outstanding borrowings of $27,637,500 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 9.0% at June 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
is 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;
- sell assets;
- effect consolidations or mergers;
- make investments or certain other restricted payments;
- pay dividends or make distributions in respect of membership interests;
- redeem membership interests;
- issue or sell membership interests 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 June 30, 1999, we were not in compliance with certain financial
performance covenants
12
<PAGE> 13
under the senior secured credit facility. General Electric Capital Corporation
has agreed to waive non-compliance with these covenants for the quarter ended
June 30, 1999.
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 June 30, 1999, we
have spent approximately $133.0 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 June 30,
1999, our future capital requirements (including requirements for capital
expenditures, working capital, debt service and operating losses) to fund the
installation, deployment and operating losses of our current networks and the
planned installation of long-haul fiber interconnecting these networks will
total approximately $61.0 million. We plan to finance these capital requirements
with the available borrowings under our senior secured credit facility
(approximately $22.4 million as of June 30, 1999), cash expected to be generated
from future revenues and additional debt financing. We currently have no
commitments for such additional debt financing, and we can give no assurance
that such additional debt financing will be available to us on terms we consider
acceptable or at all. If we are unable to secure additional debt financing 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.
However, 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:
- 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; 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
13
<PAGE> 14
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 business 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 not yet established a contingency plan that
addresses our response to any potential failure of our systems, or those of
other entities on whose services we depend or with whom our networks and systems
must interface, to accommodate year 2000 issues. However, we have been
participating in industry interoperability testing processes and plan to
implement the contingency plans being put in place by industry organizations. 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.
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 is effective for
fiscal years beginning after June 15, 1999, 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.
14
<PAGE> 15
PART II
OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company's $50.0 million senior secured revolving credit facility,
which it obtained in April 1999, contains quarterly financial performance
covenants regarding minimum revenues and maximum EBITDA losses, which the
Company did not satisfy for the quarter ended June 30, 1999. General Electric
Capital Corporation, as Administrative Agent and lender under this facility, has
agreed to waive the Company's non-compliance with these covenants for the
quarter ended June 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)
27.1 Financial Data Schedule for Three Months Ended June 30, 1999
27.2 Financial Data Schedule for Three Months Ended June 30, 1998
27.3 Financial Data Schedule for Six Months Ended June 30, 1999
27.4 Financial Data Schedule for Six Months Ended June 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 no reports on Form 8-K during the quarter ended
June 30, 1999.
15
<PAGE> 16
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.
August 16, 1999 By: /s/ Richard Postma
---------------------------------------------------
Richard Postma, Co-Chairman and Chief Executive
Officer
August 16, 1999 By: /s/ Joseph Miglore
---------------------------------------------------
Joseph Miglore, Executive Vice President and
Chief Financial Officer (Principal Financial Officer
and Principal Accounting Officer)
16
<PAGE> 17
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)
27.1 Financial Data Schedule for Three Months Ended June 30, 1999
27.2 Financial Data Schedule for Three Months Ended June 30, 1998
27.3 Financial Data Schedule for Six Months Ended June 30, 1999
27.4 Financial Data Schedule for Six Months Ended June 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
17
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