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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 0-20803
IXC COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2644120
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5000 PLAZA ON THE LAKE, SUITE 200, AUSTIN, TEXAS 78746
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (512) 328-1112
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
NAME OF EACH EXCHANGE ON WHICH REGISTERED: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR
VALUE $.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No _
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock of the Registrant held by
non-affiliates of the Registrant on March 21, 1997, based on the closing price
of the Common Stock on the Nasdaq National Market on such date, was
$280,181,250.
The number of shares of the Registrant's Common Stock outstanding as of
March 21, 1997 was 30,799,560 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission within 120 days of December 31, 1996 in
connection with the Annual Meeting of Stockholders are incorporated by reference
into Part III hereof.
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IXC COMMUNICATIONS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
INDEX
PAGE
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PART I
Item 1. Business..................................................................... 1
Item 2. Properties................................................................... 29
Item 3. Legal Proceedings............................................................ 30
Item 4. Submission of Matters to a Vote of Security Holders.......................... 30
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 30
Item 6. Selected Financial Data...................................................... 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................... 32
Item 8. Financial Statements and Supplementary Data.................................. 41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................... 41
PART III
Item 10. Directors and Executive Officers of the Registrant........................... 41
Item 11. Executive Compensation....................................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management............... 41
Item 13. Certain Relationships and Related Transactions............................... 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports and Form 8-K............ 42
Glossary................................................................................ A-1
Financial Statements.................................................................... F-1
Signatures.............................................................................. I-1
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PART I
Certain of the information contained in the Registrant's Form 10-K (the
"Form 10-K"), including information regarding its network expansion and switched
long distance services and related strategy and financing, are forward-looking
statements which involve risks and uncertainties. The Registrant's actual
results may differ significantly from the results discussed in the
forward-looking statements. For a discussion of important factors that could
cause actual results to differ materially from the matters described in the
forward-looking statements, see "Business -- Risk Factors." Certain terms used
herein are defined in the Glossary at page A-1.
As used herein, unless the context otherwise requires, the term "Company"
refers to IXC Communications, Inc. ("IXC Communications") and its subsidiaries,
including predecessor corporations. Industry data was obtained from a report
issued in March 1996 from the FCC and from reports dated April 1995 and January
1996 from International Data Corporation (an industry research organization),
which the Company has not independently verified.
ITEM 1. BUSINESS.
INDUSTRY OVERVIEW
DEVELOPMENT AND REGULATION
The development of the long distance telecommunications industry was
strongly influenced by a 1982 court decree requiring the divestiture by AT&T of
its seven RBOCs and dividing the country into approximately 200 LATAs. The seven
RBOCs were allowed to provide local telephone service, local access service to
long distance carriers and intra-LATA long distance service (service within a
LATA), but were prohibited from providing inter-LATA service (service between
LATAs). The right to provide inter-LATA service was given to AT&T and the other
interexchange carriers, including the LECs that are not RBOCs. The FCC requires
all interexchange carriers to allow the resale of their inter-LATA services to
long distance carriers, and the 1982 court decree substantially eliminated
different access arrangements as distinguishing features among long distance
carriers. These and other legislative and judicial factors have helped smaller
long distance carriers emerge as alternatives to AT&T, MCI and Sprint for long
distance services.
In 1996, the federal government enacted the Telecommunications Act of 1996
(the "Telecommunications Act"), which, among other things, allows the RBOCs and
others such as electric utilities and cable television companies to enter the
long distance business. The Company expects that the Telecommunications Act will
substantially alter the way in which the telecommunications industry is
regulated. Such changes are, however, difficult to predict accurately, because
the FCC has not yet enacted all of the numerous regulations necessary to
implement the Telecommunications Act. Entry of the RBOCs or other entities such
as electric utilities, cable television companies or foreign companies into the
long distance business may result in reduced market shares for existing long
distance companies and additional pricing pressure on long distance providers
such as the Company. See "-- Risk Factors -- Competition," "-- Risk
Factors -- Recent Legislation and Regulatory Uncertainty" and "-- Regulation."
MARKET AND COMPETITION
General. Companies in the domestic long distance market had estimated
revenues of $75.9 billion in 1995. AT&T is the largest long distance carrier,
with an estimated 56.5% of total market revenues in 1995, while MCI and Sprint
had an estimated 19.7% and 9.4%, respectively, of total market revenues in that
year. These three carriers constitute what generally is referred to as the
"first tier" in the long distance market. Medium-sized long distance companies,
some with national capabilities, such as WorldCom, Frontier, Cable & Wireless
and LCI, constitute the "second tier" of the industry and, cumulatively, are
believed to have accounted for approximately 8.4% of total market revenues in
1995. The remainder of the market share is held by smaller companies, which are
known as "third-tier" carriers. The Company provides private line services to
companies in all three tiers and switched long distance services to companies in
the second and third tiers.
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According to data included in Long Distance Market Shares, Fourth Quarter
1995, an FCC report issued in March 1996, while long distance revenues grew at a
compound annual rate of over 8% during the period from 1989 through 1995, the
revenues of all carriers other than the first tier grew in the aggregate at a
compound annual rate of over 22% during the same period. The report also stated
that the smaller second-tier and third-tier carriers increased their market
share sixfold over a ten-year period, increasing from less than 3% in 1984 to
more than 17% in 1994. In addition, industry sources estimate that combined
revenues of second-tier and third-tier carriers grew by 17.9% in 1995.
Competition among the Company's customers and other retail long distance
providers for end-user customers is based upon advertising, pricing, customer
service, network quality and value-added services. The Company believes that
AT&T, MCI and Sprint engage in only limited direct sales to small and
medium-sized commercial users, generally focusing on residential and large
commercial accounts, thus creating opportunities for smaller long distance
providers. Industry observers estimate that over 400 smaller companies have
emerged to compete in the long distance business. See "-- Risk
Factors -- Competition."
Private Line Services. Long distance companies may be categorized as
facilities-based carriers and nonfacilities-based carriers. Sellers of private
line services are generally facilities-based carriers that own long distance
transmission facilities, such as fiber optic cable or digital microwave
equipment. The first-tier and some second-tier long distance companies are
facilities-based carriers offering private line service nationwide.
Facilitiesbased carriers in the third tier of the market generally offer private
line services only in a limited geographic area. Customers using private line
services include: (i) facilities-based carriers that require long distance
transmission capacity where they have geographic gaps in their facilities, need
additional capacity or require geographically different alternative routing; and
(ii) non-facilities-based carriers requiring long distance transmission capacity
to carry their customers' long distance traffic. The Company's competitors in
the private line business include AT&T, MCI, Sprint and WorldCom and certain
regional carriers. Qwest has announced its intention to construct a
coast-to-coast fiber optic network and Frontier has announced that it will pay
$500.0 million for fibers in Qwest's network. As such network is completed,
Qwest will become a competitor of the Company, and Frontier may also become a
competitor of the Company, in the private line business. Important competitive
factors in the private line business are price, customer service, network
location and quality, reliability and availability. See "-- Private Line
Services."
Switched Long Distance Services. Long distance companies may be
characterized as switched or switchless carriers. Sellers of switched long
distance services are generally switched carriers, such as the Company, that own
one or more switches that direct telecommunications traffic. Facilities-based
carriers are generally switched carriers. However, many non-facilities based
carriers (i.e., many long distance resellers) have switches. The Company's
customers are switchless carriers that depend on switched carriers to provide
switched long distance services to their end users. The Company's competitors in
the switched long distance business include AT&T, MCI, Sprint, WorldCom and
Frontier and many non-facilities-based switched carriers. Important competitive
factors in the switched long distance business are customer service
(particularly with respect to speed in delivery of computer billing records and
set-up of new end users with the LECs), ability of the network to complete calls
with a minimum of network-caused busy signals, scope of services offered, price,
reliability and transmission quality.
CALL ROUTING
An inter-LATA long distance telephone call begins with the caller's LEC
transmitting the call by means of its local switched network to a point of
connection with an interexchange carrier. The interexchange carrier, through its
switches and long distance transmission network, transmits the call to the
called party's LEC, which then completes the call over its local facilities. For
each long distance call, the originating LEC charges an access fee. The
interexchange carrier also charges a fee for its transmission of the call, a
portion of which consists of a fee charged by the LEC used to deliver the call.
Under the Telecommunications Act, state proceedings may in certain instances
determine LEC access charge rates. It is uncertain at this time what effect such
proceedings may have on such rates.
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TECHNOLOGY
Long distance voice traffic generally is transmitted through digital
microwave or fiber optic systems. Long distance data traffic is generally
transmitted through fiber optic systems or satellites.
Fiber Optic Systems. Fiber optic systems use laser-generated light to
transmit voice and data in digital format through fine strands of glass. Fiber
optic systems are characterized by large circuit capacity, good sound quality,
resistance to external signal interference and direct interface with digital
switching equipment. A pair of modern fiber optic strands, using current
technology, is capable of carrying 192 DS-3s, or over 129,000 simultaneous
telephone calls. Because fiber optic signals disperse over distance, they must
be regenerated at sites located along the fiber optic cable (on older fiber
optic systems the interval is 20 to 25 miles; on newer systems that utilize
modern fiber optic cable and splicing methods, such as will be used in the
network expansion, it is approximately 50 to 75 miles).
Microwave Systems. Although limited in capacity in comparison with fiber
optic systems (generally, no more than 28 DS-3s can be transmitted by microwave
between two antennae), digital microwave systems offer an effective and reliable
means of transmitting voice and data signals over intermediate and longer
distances. Microwaves are very high frequency radio waves that can be reflected,
focused and beamed in a line-of-sight transmission path. Because of their
electrophysical properties, microwaves can be used to transmit signals through
the air, with relatively little power. To create a communications circuit,
microwave signals are transmitted through a focusing antenna, received by an
antenna at the next station in the network, then amplified and retransmitted.
Because microwaves attenuate as they travel through the air, this transmission
process must be repeated at repeater stations, which consist of radio equipment,
antennae and back-up power sources, located on average every 25 miles along the
transmission network. As of December 31, 1996, the remaining net depreciated
book value of the Company's microwave equipment was less than 3% of total
assets.
Satellites. An alternative method of transmitting telecommunications
traffic is through satellite transmission. Satellite transmission is superior to
fiber optic transmission for distribution communications, for example, video
broadcasting. Although satellite transmission is not preferred to fiber optic
transmission for voice traffic in most parts of the United States because it
exhibits a slight (approximately one-quarter-second) time delay, such delay is
not important for many data-oriented uses. In the event the market for data
transmission grows, the Company will compete with satellite carriers in such
market.
COMPANY OVERVIEW
The Company provides two principal services to long distance companies: (i)
transmission of voice and data over dedicated circuits ("private lines"); and
(ii) switched long distance services. The Company is one of only five carriers
that currently own a digital telecommunications network extending from
coast-to-coast (the other carriers are AT&T, MCI, Sprint and WorldCom). As of
February 28, 1997, the Company's network included approximately 10,000 digital
route miles, containing over 96,000 fiber miles (excluding fibers as to which
the Company has sold or exchanged long-term rights to use). Its facilities
include five long distance switches located in Los Angeles, Dallas, Chicago,
Philadelphia and Atlanta and ten Frame Relay-ATM switches located in major
cities.
The Company had revenues of $203.8 million for 1996, with approximately
$99.8 million generated by its private line business and approximately $104.0
million generated by its switched services business. The Company has private
line circuit contracts with over 200 long distance carriers, including AT&T,
MCI, Sprint, WorldCom, Cable & Wireless, Frontier and LCI. The Company also
provides private line transmission service to customers after contract
expiration on a monthto-month basis. Pursuant to the Company's private line
contracts, customers are required to make fixed monthly payments, generally in
advance. Many of such contracts contain substantial "take or pay" commitments.
The Company has historically enjoyed a high customer retention rate in its
private line business.
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The Company expanded into the business of selling switched long distance
services to long distance resellers in order to complement its private line
business and to capitalize on its ability to provide switched services over its
own network. Switched long distance services are telecommunications services
that are processed through the Company's digital switches and carried over long
distance circuits and other transmission facilities owned or leased by the
Company. The Company sells switched long distance services on a per-call basis,
charging by minutes of use ("MOUs"), with payment due monthly after services are
rendered. The Company's switched network became fully operational in February
1996.
The Company has switched long distance services contracts with over 70 long
distance resellers. Excel, the Company's largest customer of switched long
distance services, is contractually obligated to continue to utilize a minimum
of 70 million minutes of traffic per month until reaching total usage of 4.2
billion minutes (subject to Excel's right to reduce or terminate its commitment
under certain circumstances), of which approximately 3.3 billion minutes
remained as of February 28, 1997. The Company's switched long distance business
has grown rapidly, with Excel accounting for most of the growth. The Company's
switched long distance revenues amounted to approximately $104.0 million for
1996, with $3.6 million in the first quarter, $19.0 million in the second
quarter, $35.3 million in the third quarter and $46.1 million in the fourth
quarter. The Company plans to continue to expand the capabilities of the
switched network in 1997 to meet customer demand by adding additional equipment,
including at least three long distance switches anticipated to be located in
Fresno, California, Joplin, Missouri and New York, New York. See "-- Switched
Long Distance Services." The Company believes that it is well-positioned to
continue to attract long distance resellers as customers for its switched long
distance services because: (i) it is not currently a significant competitor for
sales to end users; and (ii) it provides more focused service to its reseller
customers, since servicing such customers is its primary business, unlike its
major competitors whose main business is selling retail long distance service to
end users in competition with their reseller customers.
The Company's primary business objectives over the near term are: (i) to
continue to increase revenue from its switched long distance services business;
(ii) to complete a substantial portion of the network expansion in 1997; and
(iii) to utilize its expanded network to increase its revenues and
profitability.
Because of geographic limitations and capacity constraints, the Company
currently supplements its own facilities with a significant amount of fiber
capacity obtained from other carriers. The Company is currently engaged in a
major expansion of its network, to increase the Company's geographic scope and
network capacity. Prior to beginning construction of the network expansion in
late 1995, the Company owned a coast-to-coast network containing over 1,700
route miles of fiber optic cable and over 5,000 route miles of digital
microwave. The network expansion includes routes planned: (i) from New York to
Los Angeles via Cleveland, Chicago, St. Louis, Dallas and Phoenix; (ii) from Los
Angeles to San Francisco; (iii) from New York to Houston via Atlanta; and (iv)
from Houston to Dallas. These routes would add approximately 7,000 route miles
to the Company's network. As of February 28, 1997, over 3,100 route miles of the
network expansion were complete.
The network expansion is expected to deliver significant strategic and
financial benefits to the Company through:
(i) producing substantial savings by allowing the Company to move a portion
of its excess private line traffic from leased circuits on the networks of other
carriers to its own expanded network;
(ii) providing high-capacity new routes and substantially increasing the
capacity of certain existing routes, allowing the Company to increase revenues
by leasing additional circuits to its customers, including high-capacity
circuits such as OC-48's, OC-12's and OC-3's;
(iii) allowing the Company to improve profitability in its switched long
distance services business by reducing its underlying transmission costs; and
(iv) creating sufficient capacity to support increased demand which may
result from Internet and multimedia applications, Frame Relay and ATM.
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The Company plans to meet the costs of the routes from New York to Los
Angeles via St. Louis and from New York to Houston via Atlanta with cash on
hand, the proceeds of a proposed offering of Junior Convertible Preferred Stock
Due 2007 (the "Convertible Preferred Stock") of IXC Communications which is
expected to close at the end of March 1997 or the beginning of April 1997 (the
"Convertible Stock Sale"), the proceeds in connection with a contract with LCI
pursuant to which LCI will purchase an indefeasible right to use fibers from
Chicago to Los Angeles for approximately $97.9 million (the "LCI Fiber Sale")
and a contract with MCI pursuant to which MCI will purchase an indefeasible
right to use fibers from Los Angeles to New York for approximately $121.0
million (the "MCI Fiber Sale"), additional cost-saving arrangements, cash flow
from its operations and vendor financing it may seek. The Company is reducing
the per-route-mile cost of these routes through fiber sales to LCI and MCI,
fiber exchange arrangements with WorldCom and Vyvx and joint construction
arrangements with other carriers.
In 1996 the Company began equipping its network with the data switches and
other equipment necessary to enter into the Frame Relay and ATM transmission
business. This equipment, in connection with the network expansion and
additional equipment and software to be installed in 1997, should allow the
Company to enter into the business of Frame Relay and ATM transmission for
Internet and Intranet providers and other large users of data capacity. The
Company began beta-testing such facilities in late 1996 and will begin such
services in the first half of 1997. Although such services will not be a
significant source of revenues in 1997, the Company expects that the market for
such high-capacity data uses will grow substantially in the future along with
the expected growth of Internet and Intranet use. To position itself to benefit
from such growth, the Company seeks to establish itself as a high quality
provider of choice of these services.
During the last six months, the Company continued to sign contracts with
new and existing customers for switched long distance services and private line
services. During this period, Excel's usage of the Company's network increased
substantially above its 70 million minute per month minimum. In addition, the
Company entered into a significant agreement with a major long distance carrier
that will obtain private line services from the Company. Under this contract the
Company will supply DS-3 circuits for aggregate revenues of over $24.0 million
during 1997-1998. The Company also entered into an interconnection agreement
with Bell Atlantic that will facilitate its entry into the data communications
business.
Over 3,100 route miles of the network expansion had been completed through
February 28, 1997. The Company has entered into several agreements with other
carriers that will result in reductions or offsets to its per-route-mile cost of
construction, including:
(i) a contract with LCI pursuant to which LCI will purchase an indefeasible
right to use fibers from Chicago to Los Angeles for approximately $97.9 million;
(ii) a contract with MCI pursuant to which MCI will purchase an
indefeasible right to use fibers from Los Angeles to New York for approximately
$121.0 million. This contract replaces a $20.0 million lease contract with MCI
for OC-48 capacity announced in January 1997;
(iii) a contract with Vyvx to exchange the use of certain fibers on the
Company's New York to Los Angeles route for the use of fibers on a 1,600-mile
route Vyvx is constructing from Washington, D.C. to Houston;
(iv) joint construction contracts with other carriers: LCI (Youngstown,
Ohio -- Toledo), DTI (Anderson, Missouri -- Kansas City), and CCTS (Riverdale,
Illinois -- Chicago). These arrangements allow the Company and the other
carriers to share the costs of construction of these routes;
(v) a contract with MFS, a recently acquired subsidiary of WorldCom,
pursuant to which MFS will include fibers for the Company in a route MFS is
constructing from Cleveland through upstate New York to New York City. This
route, which replaces a previously planned Company route from Cleveland to
Philadelphia, will substantially increase the scope of the Company's network by
including cities in upstate New York, bring the network to Albany (which may
facilitate a future extension to Boston), and provide many additional fibers
into New York City; and
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(vi) other contracts providing for the Company to sell another carrier the
use of fibers in routes the Company is constructing: GST (Phoenix to the
Arizona-New Mexico border) and WorldCom (Phoenix -- Las Vegas).
In January 1997, the Company entered into agreements to purchase two long
distance companies, LDS, a switchless reseller with 1996 revenues of
approximately $30.0 million, and Telecom One, a switchless reseller with 1996
revenues of approximately $8.0 million. The consideration for these acquisitions
will be the Company's common stock (the "Common Stock"). The Company expects to
complete these acquisitions in 1997 upon the satisfaction of certain conditions,
including receipt of regulatory approvals. For a description of how many shares
of the Common Stock will be issued pursuant to these acquisitions, see
"-- Acquisitions."
BUSINESS STRATEGY
The Company's primary business objectives over the near term are: (i) to
continue to increase revenue from its switched long distance services business;
(ii) to complete the route from New York to Los Angeles via St. Louis and a
substantial portion of the route from New York to Houston via Atlanta in 1997;
and (iii) to utilize its expanded network to increase its revenues and
profitability.
The key elements of the Company's strategy to achieve these objectives are:
Reducing Costs. The Company seeks to achieve substantial cost savings
through the network expansion by reducing the amount of capacity it would
otherwise obtain from other carriers. The Company incurred costs (including
through noncash capacity exchanges) of $60.1 million for off-net fiber optic
capacity from other carriers for 1996. In the event the Company achieves revenue
growth in the private line business or the switched long distance business, its
usage of long distance transmission capacity (including capacity leased from
other carriers) will increase. The Company believes the network expansion will
enable it to reduce expenditures for capacity now leased off-net (and to reduce
the additional expenses for leasing capacity that would otherwise be required to
support revenue growth) and thereby increase its operating cash flow, because
the new fiber routes: (i) should carry much of the traffic that would otherwise
be transmitted over off-net circuits and (ii) may enable the Company to enter
into additional exchanges of fiber capacity with other carriers. See "-- The
Company's Network" and "-- Risk Factors -- Risks Relating to Completion of the
Network Expansion."
Increasing Private Line Revenues. The Company's ability to expand its
private line business has previously been limited because the existing network
owned by the Company is geographically limited and because the digital microwave
portion of its network has been utilized at or near its maximum practical
capacity. The Company seeks through the network expansion to install
high-capacity new routes and substantially increase the capacity of certain
existing routes, allowing the Company to lease additional circuits to its
customers, including high-capacity circuits such as OC-48's, OC-12's and OC-3's.
The network expansion has already enabled the Company to obtain significant
orders for capacity on the new routes. The Company entered into a contract in
September 1996 with a major long distance carrier for the Company to provide
DS-3 circuits, each with a one-year term, principally along the route from New
York to Los Angeles via St. Louis. The carrier has ordered circuits under the
contract for aggregate revenue in excess of $24.0 million during 1997-1998. The
Company continues to seek significant new orders over the network expansion
routes and believes that it is well positioned to obtain such orders.
Establishing a Platform for Capacity-Intensive Data Applications. The
Company is using advanced fiber optic technology in the network expansion. The
expanded network will have SONET technology and the broadband capabilities to
provide a platform to support advanced, capacity-intensive products such as
Frame Relay, ATM, multimedia and Internet related applications. In 1996 the
Company began equipping its network with the data switches and other equipment
necessary to enter into the Frame Relay and ATM transmission business. This
equipment, in connection with the network expansion and additional equipment and
software to be installed in 1997, should allow the Company to enter into the
business of Frame Relay and ATM transmission for Internet and Intranet providers
and other large users of data capacity. The Company began beta-testing with such
facilities in late 1996 and will begin offering such services in the first half
of 1997.
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Although such services will not be a significant source of revenues in 1997, the
Company expects that the market for such high-capacity data uses will grow
substantially in the future along with the expected growth of Internet and
Intranet use. To position itself to benefit from such growth, the Company seeks
to establish itself as a high quality provider of choice of these services. The
Company entered into an interconnection agreement with Bell Atlantic in late
1996 that will facilitate its entry into the data services business. See "-- The
Company's Network" and "-- Risk Factors -- Development Risks of the Frame Relay
and ATM Transmission Business."
Providing Backup Routing for Major Carriers. An area of growth in certain
markets for the Company in recent years has been the provision of circuits to
facilities-based carriers such as AT&T, MCI, Sprint and WorldCom (the other four
companies that currently own coast-to-coast digital networks), to be used as
alternative routes by such carriers in the event of a service outage. Such
companies prefer alternative routes separated geographically from their routes
to increase the possibility that the alternative route will be functional in the
event of a natural disaster. The Company has planned the network expansion to be
separated geographically as far as practicable from the existing fiber routes of
such carriers. The Company believes that the network expansion, with the
resulting significant increase in fiber optic geographic coverage and capacity,
will greatly increase the attractiveness of the Company's network as alternative
routing to certain major carriers as a backup to their own networks.
Capitalizing on Excel Relationship. The Company views Excel as the "anchor
tenant" of its switched network, providing the Company with significant traffic
volumes on which to base its entry into the switched long distance services
business. The Company seeks to maintain and increase its level of traffic from
Excel, which currently obtains the bulk of the switched long distance services
it requires from other carriers, through customer service, network quality and
geographic availability. See "-- Switched Long Distance Services -- Customers
and Marketing." Excel entered into a four-year, $900.0 million contract to
purchase switched long distance services from WorldCom and a two-year, $120.0
million contract to purchase switched long distance services from MCI. Although
the Company believes that Excel's commitments to WorldCom, MCI and its other
suppliers will not impair Excel's relationship with the Company, WorldCom and
MCI will be significant competitors for Excel's business. See "-- Risk
Factors -- Reliance on Major Customers."
Establishing Other Long-Term Relationships. The Company seeks to establish
a dependable revenue stream through long-term relationships with its customers.
The Company has private line contracts (generally on a long-term basis) with
over 200 long distance carriers, including AT&T, MCI, Sprint, WorldCom, Cable &
Wireless, Frontier and LCI. The Company has historically enjoyed a high customer
retention rate in its private line business. Although the Company's switches
first became fully operational in the first quarter of 1996, the Company has
already entered into contracts with over 70 long distance resellers.
Providing an Automated Software Interface. The Company seeks to increase
its attractiveness to existing and potential customers of switched long distance
services by providing a sophisticated automated interface to the Company's
computer system through its proprietary IXC Online software. Utilizing IXC
Online, customers are able to access up-to-date information regarding their
end-user customers and the calls made by such end-users. IXC Online is designed
to allow each of the Company's carrier customers to: (i) download call detail
records for its end-users for billing purposes; (ii) arrange with the
appropriate LEC to register the carrier as the designated long distance carrier
for its new end-users; and (iii) file trouble reports for resolution.
Acting as an Alternative Switched Long Distance Services Provider. The
Company believes that it is well positioned to attract long distance resellers
as customers for its switched long distance services because: (i) it is not
currently a significant competitor for sales to end users; and (ii) it provides
more focused service to its reseller customers, since servicing such customers
is its primary business, unlike its major competitors (AT&T, MCI, Sprint,
WorldCom and Frontier) whose main business is selling retail long distance
service to end-users in competition with their reseller customers. See
"-- Switched Long Distance Services" and "-- Risk Factors -- Development Risks
and Dependence on Switched Long Distance Business."
Acquisitions. As part of its growth strategy, the Company has agreed to
acquire LDS and Telecom One and may, from time to time, acquire businesses,
assets or securities of companies which it believes provide a
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strategic fit with its business and network. Although the Company currently has
no commitments or agreements with respect to any possible acquisitions other
than with LDS and Telecom One, it has reviewed potential acquisition candidates
and has held preliminary discussions with a number of these candidates. The
Company will use shares of its Common Stock as consideration for the LDS and
Telecom One acquisitions and may use Common Stock as consideration for other
acquisitions. See "-- Acquisitions" and "-- Risk Factors -- Acquisition Risks."
THE COMPANY'S NETWORK
Services
The Company provides two basic services: (i) private line services; and
(ii) switched long distance services. In addition, the Company is entering into
the business of providing data services.
Private Line Services. A private line is an unswitched telecommunications
transmission circuit used by customers, such as non-facilities-based carriers
that have switches but do not own transmission facilities, to transport their
traffic between LATAs. Calls being transmitted over a private line circuit for a
carrier customer are generally routed by the customer through a switch to a
receiving terminal in the Company's network. The Company transmits the signals
over a private line to the terminal where the signals exit the Company's
network. The signals are generally then routed by the carrier customer through
another switch and to the call recipient through a LEC. The Company typically
bills carrier customers a fixed monthly rate depending on the capacity and
length of the circuit, regardless of the amount the circuit is actually used.
See "-- Private Line Services."
Switched Long Distance Services. Switched long distance services are
telecommunications services such as residential and commercial long distance
service that involve processing calls through the switches of a carrier. Among
the Company's switched long distance services product offerings are two basic
services: (i) call origination and termination services and (ii) call
termination services. For non-facilities-based carriers such as switchless
carriers, the Company provides call origination and termination. This generally
includes: (i) arranging with the caller's LEC to connect the call to the
Company's switching center (this is referred to as "origination") and (ii)
transmitting the call to another Company switching center or a hub connecting
the call to the recipient's LEC and arranging with the LEC to connect the call
to the recipient (this is referred to as "termination"). Other customers (for
example, non-facilities based carriers with regional switches in certain areas
but not in others) require termination but not origination services. In this
case, the customer delivers a call to the Company's switching center and the
Company transmits the call to the recipient's LEC, which then terminates the
call. The Company typically bills the customer at a variable rate depending on
the duration, day and time of day of the call and whether the call is
intrastate, interstate or international. See "-- Switched Long Distance
Services."
Data Services. Data services are telecommunications services such as ATM
and Frame Relay that provide highspeed transmission of data. The Company will
offer these services to carriers for resale to end users. Although the Company
is still beta-testing its data services facilities, when these facilities are in
commercial use the Company intends to bill customers for data services generally
at a variable rate depending on usage.
Facilities
The Company is one of only five carriers that currently owns a
coast-to-coast digital network. As of February 28, 1997, the Company's network
included approximately 10,000 route miles (containing over 96,000 fiber miles).
Prior to beginning construction of the network expansion in late 1995, the
Company owned a coast-to-coast network containing over 1,700 route miles of
fiber optic cable and over 5,000 route miles of digital microwave. As of
February 28, 1997, the Company and its partners in cost-saving arrangements had
substantially completed over 3,100 fiber route miles of the network expansion.
The Company's own facilities are supplemented with over 200,000 DS-3 miles
of fiber capacity obtained from other carriers. Of such capacity, over 161,000
DS-3 miles are leased by the Company. Approximately
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39,000 DS-3 miles of such capacity are obtained by the Company through long-term
capacity-exchange agreements with MCI and WorldCom whereby the Company trades
capacity or fibers on its fiber network for capacity on the other carriers'
networks. In addition, the Company has recently entered into agreements with
CCTS and LCI to exchange OC-48 capacity on certain routes. The Company has been
able to negotiate these significant exchange agreements because of the placement
of the Company's existing networks in locations where other facilities-based
carriers require additional capacity and the comparatively large expense to such
other carriers of constructing new fiber optic facilities. Such exchange
agreements increase the scope of the Company's network through the addition of
the exchanged capacity while reducing the Company's cash expenditures for
off-net facilities.
The Company's network includes five digital switches located in Los
Angeles, Dallas, Chicago, Philadelphia and Atlanta, each directly connected over
either on-net or off-net private line circuits: (i) to at least two other
switching centers; (ii) to certain of the Company's over 50 Hubs (local
connection points); and (iii) to certain LEC Central Office switches. The
Company plans to install additional switches in 1997 in Fresno, California,
Joplin, Missouri and New York, New York. The Hubs are connected (generally by
off-net circuits) to LEC Central Office switches, which in turn are connected to
end-user telephone lines. The switches utilize common channel signaling (SS7),
which reduces connect time delays and directs calls using least-cost routing.
The Company's network also includes ten Frame Relay-ATM data switches located in
major cities. The Company's switched operations are supplemented by agreements
with Allnet and WorldCom. Under such agreements, Allnet and WorldCom supply
switched capacity to the Company on a per-minute basis, automatically handling
calls routed through LEC Central Offices not connected to the Company's Hubs or
switches and calls which exceed the capacity of the Company's switched network.
The capacity of the Company's switches may be expanded with processor
upgrades, additional memory and ports. The Company plans to add more ports and
other equipment for its existing switches and to add additional switches as
required to accommodate customer demand. While the Company cannot yet ascertain
the capital cost of such ports, additional equipment and switches, the Company
anticipates that it will be able, subject to certain restrictions under the
indenture (the "Indenture") for the Company's outstanding $285.0 million
principal amount of 12 1/2% Senior Notes due 2005 (the "Senior Notes"), to
obtain such equipment under capital leases.
Network Reliability
The Company's network offers a reliable means of transmitting large volumes
of voice and data signals. To assist in providing reliable and high-quality
transmission service, all important functions of the network are monitored
during regular business hours from regional operations centers in Columbus,
Kansas City, Fort Worth and Tucson. Thereafter, monitoring is conducted from the
Company's national operations center in its Austin headquarters. The national
center also provides overall system monitoring on a 24-hour basis. This system
alerts the Company to situations which could affect customer transmission and
generally allows the Company to take remedial actions before customer service is
affected. In addition, at December 31, 1996, the Company employed approximately
34 operations personnel who are based along the network to perform preventative
maintenance as well as repair functions on its private line network. Company
operations personnel conduct annual system performance testing and make periodic
unannounced visits to terminal sites to evaluate technician performance. At
December 31, 1996, the Company maintained a staff of 21 technicians to provide
maintenance and other technical support services for switched long distance
services.
Network Expansion
In 1995 the Company undertook a significant increase in its network. The
Company believes the network expansion will improve its profitability and cash
flow by improving its cost of communications services as it moves traffic onto
facilities it owns and increasing its revenues by allowing the lease of
substantial additional private line capacity. The network expansion is planned
to add thousands of additional fiber route miles to increase the geographic
scope and capacity of the Company's previously existing network. It will connect
the Company's switches with high-capacity private line circuits, utilizing
advanced fiber optic technology capable of efficiently transmitting
capacity-intensive services, such as Internet, Intranet and multimedia
applications,
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Frame Relay and ATM. The routes of the network expansion are planned to be
generally geographically diverse from the existing fiber networks of AT&T, MCI,
Sprint and WorldCom.
In 1996 the Company began equipping its network with the data switches and
other equipment necessary to enter into the Frame Relay and ATM transmission
business. This equipment, in connection with the network expansion and
additional equipment and software being installed in 1997, should allow the
Company to enter into the business of Frame Relay and ATM transmission for
Internet and Intranet providers and other large users of data capacity. The
Company began beta-testing such facilities in late 1996 and will begin offering
such services in the first half of 1997. Although such services will not be a
significant source of revenues in 1997, the Company expects that the market for
such high-capacity data uses will grow substantially in the future along with
the expected growth of Internet and Intranet use. To position itself to benefit
from such growth, the Company seeks to establish itself as a high quality
provider of choice of these services.
The Company estimates that the network expansion will produce additional
cost savings by supporting growth in its private line and switched long distance
businesses which would otherwise require significant off-net capacity usage. The
network expansion will enable the Company to avoid increased expenditures for
leasing off-net capacity because the new fiber routes: (i) should carry much of
the traffic that would otherwise be transmitted over off-net circuits and (ii)
may enable the Company to enter into additional exchanges of fiber capacity with
other carriers. In this way, the Company seeks to improve cash flow through
increasing revenues and improving certain costs. The network expansion has
already enabled the Company to obtain significant orders for capacity on the new
routes. The Company entered into a contract in September 1996 with a major long
distance carrier for the Company to provide DS-3 circuits, each with a one-year
term, principally along the new route from New York to Los Angeles via St.
Louis. The Company will supply circuits under the contract for aggregate
revenues in excess of $24.0 million during 1997-1998. The Company continues to
seek significant new orders over the network expansion routes and believes that
it is well positioned to obtain such orders.
Construction. The Company has planned the network expansion to cover, to
the greatest extent practicable, routes where one or more of the following
factors are present: (i) customer demand indicates a need for high-capacity
fiber network on the route; (ii) the route is attractive as a complement to the
routes of other carriers, which may enable the Company to lease its new capacity
on the route to other carriers or exchange a portion of its new capacity on the
route for capacity from other carriers; or (iii) the capacity will replace
capacity leased by the Company from other carriers. At the time of the initial
public offering of the Company's Common Stock (the "IPO") in July 1996, the
Company had planned to construct the network expansion in two phases: Phase I
from Philadelphia through Chicago, Dallas and Phoenix to Los Angeles and Phase
II from New York to Houston along with additional spurs to the Phase I route.
The Company's plans for the network expansion routes and the scheduled
completion of such routes have changed because the Company has been successful
in selling capacity on certain uncompleted routes and in entering advantageous
cost-saving arrangements and because of certain delays in constructing portions
of the planned routes. The most significant route changes made include (i)
acceleration of the Joplin, Missouri to Kansas City route originally planned for
Phase II because significant new capacity on the route has been ordered by the
Company's customers; (ii) replacement of the AkronPittsburgh-Philadelphia route
with a Cleveland-upstate New York-New York City route because of a cost-saving
arrangement with MFS through which MFS will include fibers for the Company in
the route which MFS is constructing for its own use, and (iii) acceleration of
the Washington, D.C. to Houston route originally planned for Phase II because,
pursuant to the cost-saving arrangement entered into with Vyvx, Vyvx will
construct such route (at no cash cost to the Company other than the costs of
electronics to equip the route) for the Company in exchange for fibers elsewhere
on the Company's network.
Although such changes in the planned routes make exact comparisons
impossible, the Company believes that the network expansion is progressing well,
without significant delays or cost overruns. The Cleveland to Phoenix portion of
the route from New York to Los Angeles via St. Louis is now complete. In
addition, to meet customer demand, the Company has augmented that route to
include: (i) a Kansas City to Joplin, Missouri route and other routes not
originally planned for Phase I; and (ii) substantially more electronics than
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originally planned. The New York to Cleveland portion of the network expansion
is scheduled for completion in the fourth quarter of 1997. The Phoenix to Los
Angeles portion of the network expansion is also scheduled for completion in
1997.
The Company presently plans to complete the network expansion along the
following routes (the routes and expected delivery dates are subject to change):
(i) One route will consist of a fiber optic route to supplement the
Company's existing New York-Los Angeles route, which consists primarily of
digital microwave facilities which are now used to capacity. This coast-to-coast
route is to extend from New York to Los Angeles over new fiber optic cable
through upstate New York, Cleveland, Chicago, St. Louis, Dallas and Phoenix.
This route, much of which is already complete, is scheduled for completion in
1997.
(ii) An additional route is now under construction from New York via
Washington, D.C. and Atlanta to Houston. The Washington-Houston portion of the
route will be constructed by Vyvx and is scheduled for completion by the end of
1997. The portion of the route from New York to Washington, D.C. is also
scheduled to be completed by the end of 1997.
(iii) Routes are also planned for later construction from Los Angeles to
San Francisco, from Houston to Dallas, from Toledo to Detroit, and from South
Bend to Chicago.
Additional routes will be added to the network expansion as opportunities
for advantageous cost sharing or exchange arrangements arise or as customer
demand requires.
The Company plans generally to light initially only four of the new fibers
in the route from New York to Los Angeles via St. Louis and the route from New
York to Houston via Atlanta (which will add an aggregate of approximately
350,000 DS-3 miles to the Company's network). Certain of the remaining fibers
will be reserved and used as a platform to support emerging capacity-intensive
data and multimedia applications. The Company intends to light additional fibers
as needed in the future and may use the other additional fibers for sale or
exchange arrangements. See "-- Business Strategy" and "-- Risk Factors -- Risks
Relating to the Network Expansion."
A portion of the network expansion is being constructed in connection with
an agreement entered into with WorldCom (the "WorldCom Fiber Build Agreement").
Pursuant to this agreement, each company is constructing a fiber route
approximately 1,100 miles long and placing fibers for both companies in the
route. WorldCom's route extends from Akron through Indianapolis to a suburb of
St. Louis, with a spur from Indianapolis to a suburb of Chicago. The Company's
route extends from Dallas to Phoenix. Each party will maintain the fiber in its
route at no cost to the other party. This arrangement will result in substantial
savings for the Company as compared to constructing both routes by itself.
In December 1996, the Company entered into an agreement with Vyvx whereby
the Company will provide Vyvx with the use of fibers from Los Angeles to New
York in exchange for the use of fibers from Houston to Washington, D.C. The
parties are required to complete their routes by December 31, 1997, with
penalties taking effect in July 1998 if one party, but not the other, has failed
to complete its route. Although the Company anticipates that it will complete
its route in time to avoid any penalty, there can be no assurance in this
regard. Such penalties increase from $400,000 per month commencing July 1998 to
$800,000 per month commencing October 1998.
The Company has entered into several additional agreements with others that
will result in reductions to its per-route-mile cost of construction, including:
(i) the LCI Fiber Sale pursuant to which LCI will purchase an indefeasible
right to use fibers from Chicago to Los Angeles for approximately $97.9 million;
(ii) the MCI Fiber Sale pursuant to which MCI will purchase an indefeasible
right to use fibers from Los Angeles to New York for approximately $121.0
million. This contract replaces a $20.0 million lease contract with MCI for
OC-48 capacity announced in January 1997;
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(iii) a contract with Vyvx to exchange the use of certain fibers on the
Company's New York to Los Angeles route for the use of fibers on a 1,600-mile
route to be constructed by Vyvx from Washington, D.C. to Houston;
(iv) joint construction contracts with other carriers: LCI (Youngstown,
Ohio -- Toledo), DTI (Anderson, Missouri -- Kansas City), and CCTS (Riverdale,
Illinois -- Chicago). These arrangements allow the Company and the other
carriers to share the costs of construction of these routes;
(v) a contract with MFS, a recently acquired subsidiary of WorldCom,
pursuant to which MFS will include fibers for the Company in a route MFS is
constructing from Cleveland through upstate New York to New York City. This
route, which replaces a previously planned Company route from Cleveland to
Philadelphia, will substantially increase the scope of the Company's network by
including cities in upstate New York, bring the network to Albany (which may
facilitate a future extension to Boston), and provide many additional fibers
into New York City; and
(vi) other contracts providing for the Company to sell another carrier the
use of fibers in routes the Company is constructing: GST (Phoenix to the
Arizona-New Mexico border) and WorldCom (Phoenix -- Las Vegas).
Cost. The principal components of the cost of the network expansion will
include: (i) fiber optic cable; (ii) engineering and construction; (iii)
electronics; and (iv) rights-of-way. The rights-of-way will be provided pursuant
to long-term leases or other arrangements (some of which may provide for
substantial continuing payments) entered into with railroads, highway
commissions, pipeline owners, utilities or others. Although the Company has not
yet obtained all the necessary rights-of-way along the planned routes, the
Company anticipates that the rights-of-way will be available.
Through the WorldCom Fiber Build Agreement, the Vyvx fiber exchange and the
other cost-saving arrangements described above, the Company has reduced its
expected cost of the network expansion. The Company seeks to enter into
additional cost-saving arrangements such as: (i) including additional fibers in
the network expansion for lease or sale to other carriers; (ii) exchanging
excess fibers or capacity on the Company's expanded network for excess fibers or
capacity on other carriers' networks; and (iii) obtaining the right to install
Company-owned fibers in new fiber optic routes being constructed by other
carriers along the proposed network expansion routes in exchange for the Company
(a) sharing construction costs with the other carrier, (b) allowing the other
carrier to use excess Company fiber elsewhere in the Company's network, or (c)
allowing the other carrier to add its own fibers to segments of the network
expansion. The Company has had experience with arrangements of this type with
several major carriers, including MCI, Sprint, Cable & Wireless, WorldCom and
LCI.
The Company anticipates that the routes from New York to Los Angeles via
St. Louis and from New York to Houston via Atlanta will cost approximately
$310.0 million (taking into account the effect of cost-saving arrangements it
has already entered into). After deducting the net proceeds of the LCI Fiber
Sale and the MCI Fiber Sale, the net cost of these routes will be less than
$120.0 million or approximately $19,000 per route mile. The Company will seek to
meet the remaining costs of the 1997 and 1998 network expansion through: (i)
cash on hand; (ii) the proceeds of the Convertible Stock Sale; (iii) the
proceeds of the LCI Fiber Sale, the MCI Fiber sale or other fiber sales; (iv)
additional costsaving arrangements; (v) cash flow from its existing operations;
(vi) increased cash flow resulting from reduced off-net capacity costs as
segments of the network expansion are completed; (vii) if the Company is able to
successfully develop the switched-products business, increased cash flow from
the switched-products business; and (viii) vendor financing the Company may
seek. In the event no other cost-saving arrangements are entered into, and the
sources of cash referred to above are not available as soon as desired, the
Company anticipates that, to complete the network expansion, it will be
necessary either: (i) to meet the remaining costs through a combination of debt
or equity funding (subject to the restrictions set forth in the Indenture); or
(ii) to slow or delay the construction until sufficient funds are available.
There can be no assurance that sufficient cash will in fact be available from
the sources listed above. See "-- The Company's Network," "-- Business
Strategy," "-- Risk Factors -- Risks Relating to the Network Expansion" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
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Construction Management. The Company's management and staff have
substantial experience in the construction of long-haul telecommunications
systems. The Company's existing nationwide digital network including 3,100 miles
of fiber optic cable completed as part of the network expansion and its 346-mile
Texas fiber network constructed in 1993, were engineered and constructed by the
Company. The completed segments of the network expansion and Texas fiber network
incorporated modern fiber optic cable and SONET optronics. In addition, the
Company successfully closed contracts on its Texas fiber network with AT&T, MCI
and Sprint after such companies carefully reviewed the Company's engineering and
operations capabilities. The Company believes that its experienced engineering
and operations management and staff have the requisite skills and experience to
successfully complete the network expansion.
PRIVATE LINE SERVICES
Overview
Substantially all of the Company's 1995 revenues, approximately 49% of its
revenues in 1996 and approximately 37% of its revenues in the fourth quarter of
1996 were generated by its private line business. The Company has private line
circuit contracts with over 200 long distance carriers.
Strategy
The Company is seeking to increase revenues in its private line business
through meeting these primary objectives: (i) expanding its network to provide
additional capacity on its existing routes and high-capacity new routes to
provide access to major population centers (including routes which may be
attractive to major carriers as backup routes); (ii) providing high-quality,
reliable private line services on a fixed-cost basis at rates generally below
those currently offered by AT&T and competitive with those offered by other
carriers; and (iii) using the expanded network as a platform to support
increased private line circuit demand which may result in the future from Frame
Relay, ATM, multimedia, Internet and other capacity-intensive applications.
The Company is seeking to decrease expenses in its private line business
through the network expansion, which the Company anticipates will allow it to
move traffic from circuits leased from other carriers to its own network.
Customers and Marketing
The Company has private line contracts with over 200 long distance
carriers, including AT&T, MCI, Sprint, WorldCom, Cable & Wireless, Frontier and
LCI. The Company also provides private line transmission to customers after
contract expiration on a month-to-month basis. The Company's private line
contracts provide for fixed monthly payments, generally in advance. Many of such
contracts contain substantial "take or pay" commitments. The Company has
historically enjoyed a high customer retention rate in its private line
business.
The Company markets its private line circuit capacity generally to: (i)
facilities-based carriers that require private line capacity where they have
geographic gaps in their facilities, need additional capacity or require
geographically different, alternative routing; and (ii) non-facilities-based
carriers requiring private line capacity to carry their customers' long distance
traffic. The Company focuses most of its direct sales efforts on providing
customer support services to existing customers and on adding new customers. The
Company's long-haul circuit sales force at December 31, 1996 consisted of ten
account managers based at the Company's headquarters in Austin and at direct
sales offices in or near Washington, D.C., New Haven, San Francisco, Kansas
City, Chicago, St. Louis, Houston and Sunrise Beach, Missouri.
During 1994, 1995 and 1996, WorldCom and Frontier, the Company's two
largest private line customers, accounted for 25% and 23%, 20% and 21%, and 8%
and 10% respectively, of the Company's revenues. During 1996, the Company leased
transmission capacity to 252 customers. The ten largest private line customers
during that year accounted for approximately 36% of revenues. See "-- Risk
Factors -- Reliance on Major Customers."
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Prices and Contracts
The Company's strategy is to offer prices generally lower than those of
AT&T and competitive with the prices of other carriers, to permit the Company's
customers, through a stable, long-term fixed pricing structure, to maintain
control over transmission costs. The Company's private line transmission
agreements with its customers generally provide for original terms of one to
three years and for monthly payment in advance on a fixed-rate basis, calculated
according to the capacity and length of the circuit. Many of such contracts
contain substantial "take or pay" commitments. Furthermore, circuit orders under
private line agreements are generally for a term of one year or more and may not
be cancelled by the customer. However, the agreements generally provide that the
customer may terminate the affected service without penalty "for cause" in the
event of substantial and prolonged outages arising from causes within the
Company's control, and for certain other defined causes. Generally, the lease
agreements further provide that the customer may terminate the agreement "for
convenience" at its discretion at any time upon notice to the Company. However,
termination for convenience generally requires either full payment of all
charges through the end of the lease term or the payment of substantial
termination fees intended to allow the Company to recover certain costs and, in
some cases, lost profits. Damages attributable to a customer's termination of
the agreement are generally reduced, however, by an offset for any income the
Company earns from re-leasing the terminated capacity during the remaining
portion of the lease term.
Competition
In providing private line capacity, the Company competes with AT&T, which
is the largest supplier of long distance voice and data transmission services in
the United States, MCI, WorldCom and Sprint, all of which have substantially
greater financial resources than the Company and a far more extensive
transmission network than the Company's network. As a result of the
Telecommunications Act and recent WTO Agreement (as defined below), the Company
and its customers will also face competition from the RBOCs, GTE and others such
as electric utilities, cable television companies and foreign companies. Qwest
has announced its intention to construct a coast-to-coast fiber optic network
and Frontier has announced that it will pay $500 million for fibers in Qwest's
network. As such network is completed, Qwest will become a competitor of the
Company and Frontier may also become a competitor of the Company in the
long-haul business. Important competitive factors in the long-haul business are
price, customer service, network location and quality, reliability and
availability. See "-- Private Line Services." The Company also competes on a
regional basis with major regional carriers. Important competitive factors in
the long-haul business are price, customer service, network location and
quality, reliability and availability. See "-- Risk Factors -- Competition."
SWITCHED LONG DISTANCE SERVICES
Overview
In late 1995, the Company expanded into the business of selling switched
long distance services to long distance resellers in order to complement its
private line business and to capitalize on its ability to provide switched
services over its own network. Switched long distance services are
telecommunications services that are processed through the Company's digital
switches and carried over long-haul circuits and other transmission facilities
owned or leased by the Company. During 1995, the Company set up the
infrastructure for its switched long distance business by installing its
switches, connecting them to its network and to the LECs, acquiring software,
hiring personnel and entering into contracts with customers. The Company's
switched network became fully operational in February 1996. The Company sells
switched long distance services on a per-call basis, charging by MOUs with
payment due monthly after services are rendered. The Company believes that it is
well-positioned to attract long distance resellers as customers for its switched
long distance services because: (i) it is not currently a significant competitor
for sales to end users; and (ii) it provides more focused service to its
reseller customers, since servicing such customers is its primary business,
unlike its major competitors whose main business is selling retail long distance
service to end users.
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Strategy
The Company seeks to rapidly increase revenues from its switched long
distance business through: (i) long-term arrangements with significant customers
and customers the Company considers likely to grow quickly; (ii) providing a
sophisticated automated software interface with its customers; (iii) offering
pricing which is generally lower than that charged by AT&T and competitive with
that of other long distance service providers; and (iv) acquisitions. The
Company seeks to increase the profitability of its switched long distance
services business by decreasing its average cost per MOU through efficiencies
achieved with higher volumes and through reducing network costs through the
network expansion. See "-- Business Strategy."
Customers and Marketing
The Company focuses its sales efforts on directly contacting large reseller
customers with monthly volumes of at least $1 million and smaller, growing
resellers with volumes between $50,000 and $250,000 per month that the Company
expects to be reasonably likely to grow to the $1 million per month level. The
Company's switched-products sales force at December 31, 1996 included 29 sales
executives based at the Company's headquarters in Austin and at direct sales
offices in Atlanta, Dallas, Denver and Los Angeles. Although sales of switched
long distance services to end-user customers do not currently account for a
significant portion of the Company's switched long distance business, LDS and
Telecom One, companies which the Company expects to acquire, do sell directly to
end users. In addition, the Company may, from time to time, consider acquiring
other long distance resellers or end-user customer bases. Notwithstanding such
potential acquisitions, however, the Company does not expect to change its
strategic focus from its reseller customers. Instead, the Company intends to
operate any such acquired companies separately from its reseller business so as
to ensure its continued focus on reseller customers.
Excel. Excel, the Company's largest customer of switched long distance
services, is contractually obligated to utilize at least 70 million minutes of
traffic per month. Excel's commitment continues through the earlier of the date
on which Excel has routed 4.2 billion minutes over the Company's network or June
30, 2001. As of February 28, 1997, approximately 3.3 billion minutes of the
commitment remained. The minimum commitment is subject to reduction or
termination: (i) if Excel installs its own switches and invites the Company to
bid along with other carriers (to win such bids, the Company would have to be
the lowest bidder) to provide Excel with the long-haul circuits utilized by such
switches (even if this did occur, Excel would still have to meet the minimum
commitment of 70 million minutes per month until June 30, 1998); or (ii) for
breach of contract by the Company or for other reasons which the Company
believes should be under its control. Although Excel's minimum commitment is 70
million minutes per month, its usage increased substantially above the minimum
commitment by December 1996. The Company is Excel's main or sole supplier of 1
Plus Switched Service in over 50 LATAs. The Company believes that Excel will
utilize the Company's 1 Plus Switched Service for most or all of Excel's growth
in such LATAs.
Customer Contracts. The Company's rates for switched long distance
services generally vary with the duration of the call, the day and the time of
day the call was made and whether the traffic is intrastate, interstate or
international. The rates charged are not affected by which facilities are
selected by the Company's switching centers for transmission of the call or by
the distance of the call. Different rates are applied to combined origination
and termination services than are applied to termination services. The
agreements between the Company and its customers for switched long distance
services generally provide for payment in arrears based on MOUs. The agreements
generally also provide that the customer may terminate the affected service
without penalty in the event of substantial and prolonged outages arising from
causes within the Company's control, and for certain other defined causes.
Generally, the agreements provide that the customer, in order to avoid being
obligated to pay higher rates (or, in some cases, penalties), must utilize at
least a minimum dollar amount (measured by dollars or MOUs) of switched long
distance services per month for the term of the agreement.
Customer Care. The Company believes that customer support is an important
factor in attracting and retaining customers for its switched long distance
services. Customer service for switched long distance services includes
processing new accounts, responding to inquiries and disputes relating to
billing, credit
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adjustments and cancellations and conducting technical repair and other support
services. IXC Online is designed to allow each of the Company's carrier
customers to: (i) download current call detail records for its end-users for
billing purposes; (ii) arrange with the appropriate LEC to register the carrier
as the designated long distance carrier for its new end users; and (iii) file
trouble reports for resolution. The Company employed approximately 45 people in
its switched long distance services customer service group as of December 31,
1996. See "-- Risk Factors -- Development Risks and Dependence on Switched Long
Distance Business."
Decreased Costs through Increased Volumes
Large MOU volumes should enable the Company to spread its fixed costs over
more MOUs and to more efficiently configure its network, reducing the cost per
MOU. The Company seeks to efficiently configure the circuits available so that
calls are completed on a cost-effective basis. The Company periodically analyzes
calling patterns using mathematical formulas to determine the circuit capacity
required to cost-effectively service the expected call volume. For example, if
there is sufficient calling traffic available, the Company may upgrade
transmission circuitry in an area from DS-1 to DS3. A similar analysis will be
made when deciding whether to install a new switch in a region.
Services
The Company markets a variety of switched long distance services, including
operator services, directory assistance, international service and the
following:
1 Plus Switched Service. Provides direct-dial service over the Company's
digital network.
1 Plus Dedicated Service. Provides direct-dial service over the Company's
digital network for end users that have arranged to connect to the Company's
nearest hub through a local loop. This service is less expensive than 1 Plus
Switched Service because the access charges of the end-user's LEC are reduced.
800/888 Switched Service. Provides 800/888 service over the Company's
digital network.
800/888 Dedicated Service. Provides 800/888 service over the Company's
digital network for end users that have arranged to connect to the Company's
nearest hub through a local loop. This service is less expensive than 800/888
Switched Service because the access charges of the end-user's LEC are reduced.
Calling Card Service. Provides telephone card service.
Debit Card Service. Provides prepaid telephone card service.
Switched Termination Service. Provides carrier customers having use of a
switch in one area with termination services in other areas.
Acquisitions
As part of its growth strategy, the Company has agreed to acquire LDS and
Telecom One and may, from time to time, acquire businesses, assets or securities
of companies which it believes provide a strategic fit with its business and
network. Although the Company currently has no commitments or agreements with
respect to any possible acquisitions other than with LDS and Telecom One, it has
reviewed potential acquisition candidates and has held preliminary discussions
with a number of these candidates. The Company will use shares of its Common
Stock as payment for the LDS and Telecom One acquisitions and may use Common
Stock as consideration for other acquisitions.
In January 1997, the Company agreed to purchase all the stock of LDS, a
switchless reseller, for a purchase price payable in the Company's Common Stock.
LDS is based in Los Angeles and markets to niche ethnic markets (for example,
immigrants from Mexico, India and Asia). The acquisition by the Company of LDS
is contingent on the satisfaction of a number of conditions, including receipt
of certain regulatory approvals from federal and state agencies. There can be no
assurance that such regulatory approvals will be obtained or that the other
conditions will be satisfied. The exact number of shares to be paid to the LDS
shareholders will not be determined until the closing date. The purchase price
has two components:
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(i) 1,015,385 shares of Common Stock (calculated to be worth $29.7 million based
on a per share price of $29.25, the 20-day average closing price of the Common
Stock when the agreement was reached), the number of shares will be adjusted
depending on the LDS balance sheet at the closing date; and (ii) in the event
the five-day average closing price of the Common Stock prior to the closing has
increased above $29.25 per share, a number of shares of Common Stock having a
market value on the closing date equal to 150,000 multiplied by the amount of
the increase. In addition, the Company has agreed to grant certain registration
rights to the LDS shareholders upon the closing of the acquisition of LDS. The
Company anticipates that this acquisition will be completed in mid-1997.
In January 1997, the Company agreed to purchase all the stock of Telecom
One, a switchless reseller with an agent program, for a purchase price payable
in the Company's Common Stock. Telecom One's agent program is an arrangement in
which Telecom One pays commissions to agents who sell Telecom One's services to
end users. The acquisition by the Company of Telecom One is contingent on the
satisfaction of a number of conditions, including the receipt of certain
regulatory approvals from federal and state agencies. There can be no assurance
that such regulatory approvals will be obtained or that the other conditions
will be satisfied. The shareholders of Telecom One will be paid Common Stock in
two installments: at the closing date and at the end of 1999. The value of the
Common Stock to be issued to the shareholders of Telecom One on the closing date
will be equal to 50% of the estimated value of Telecom One, calculated based on
revenues. The value of the Common Stock to be issued at the end of 1999 will be
equal to 50% of the estimated value of Telecom One, calculated based on its then
current revenues and EBITDA. The amount of these payments will be adjusted
depending on the Telecom One balance sheet at the payment dates. The Company
estimates that the initial payment will be approximately 106,000 shares of
Common Stock (or approximately $3.0 million based on a per-share price of
$28.14, the average closing price of the Common Stock during the 20-day period
prior to the date of the acquisition agreement). In addition, the Company has
agreed to grant certain registration rights to the Telecom One shareholders. The
Company anticipates that this acquisition will be completed in mid-1997.
The Company estimates that the aggregate number of shares of Common Stock
to be issued to the shareholders of LDS at the closing of the LDS acquisition
and in the initial installment of the Telecom One acquisition will be between
1.1 million and 1.3 million. In addition, at the end of 1999, the Company will
be required to pay the Telecom One shareholders additional shares of Common
Stock, depending upon the future revenues of Telecom One and the balance sheet
of Telecom One at the end of 1999, which the Company estimates is unlikely to
exceed 200,000 shares.
The Company expects that the acquisitions of LDS and Telecom One will
result in increased revenues to the Company. In addition, the Company believes
it can improve the profitability of the acquired companies because it can lower
their costs of call transmission. These acquisitions are a part of a Company
strategy to expand by acquiring select resellers on advantageous terms as
opportunities arise. The Company believes that LDS's niche marketing business
and that Telecom One's agent program present solid opportunities for continued
growth. The Company does not expect these acquisitions to change its strategic
focus of providing services to its reseller customers. Instead, the Company
intends to operate the acquired companies under their own names and separately
from its reseller business so as to ensure the Company's continued focus on
reseller customers. Accordingly, the Company does not believe these acquisitions
will adversely affect the Company's relationship with its existing reseller
customers although there can be no assurance in this regard. See "-- Risk
Factors -- Acquisition Risks."
Competition
The Company competes with numerous facilities-based interexchange carriers,
some of which are substantially larger, have substantially greater financial,
technical and marketing resources and utilize larger transmission systems than
the Company. AT&T is the largest supplier of switched long distance services in
the United States inter-LATA market. The Company also competes in selling
switched long distance services with: (i) other facilities-based carriers, such
as MCI, Sprint, WorldCom and certain regional carriers, and (ii) certain
nonfacilities-based carriers. Qwest has announced its intention to construct a
coast-to-coast fiber optic network and Frontier has announced that it will pay
$500 million for fibers in Qwest's network. Upon
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completion of segments of such network, Qwest and Frontier may also become
competitors of the Company. As a result of the Telecommunications Act and recent
WTO Agreement, the Company will also now face competition from the RBOCs, GTE
and others such as electric utilities, cable television companies and foreign
companies. The Company believes that the principal competitive factors affecting
it are customer service (particularly with respect to speed in delivery of
computer billing records and set-up of new end users with the LECS), ability of
the network to complete calls with a minimum of network-caused busy signals,
scope of services offered, price, reliability and transmission quality. The
Company seeks to compete effectively with other interexchange carriers and
resellers on the basis of these factors. The ability of the Company to compete
effectively will depend upon its ability to maintain high-quality services at
prices generally equal to or below those charged by its competitors. In the
United States, price competition in the long distance business has been
intensive over the last five years. The FCC has, on several occasions since
1984, approved or required price decreases by AT&T through the imposition of
"price cap" regulations. However, the FCC recently classified AT&T as a
"non-dominant interexchange carrier," with the effect that AT&T is no longer
subject to price regulation of its long distance services. Since the Company
believes that its customers generally price their service offerings at or below
the prices charged by AT&T for its telecommunications services, reductions by
AT&T in its rates may necessitate similar price decreases by the Company. See
"-- Risk Factors -- Competition."
An alternative method of transmitting telecommunications traffic is through
satellite transmission. Satellite transmission is superior to fiber optic
transmission for distribution communications, for example, video broadcasting.
Although satellite transmission is not preferred to fiber optic transmission for
voice traffic in most parts of the United States because it exhibits a slight
(approximately one-quarter-second) time delay, such delay is not important for
many data-oriented uses. In the event the market for data transmission grows,
the Company will compete with satellite carriers in such market. Also, at least
one satellite company, Orion Network Systems, Inc., has announced its intent to
provide internet access services to businesses through satellite technology.
REGULATION
Certain subsidiaries of the Company operate as communications common
carriers. These subsidiaries are subject to applicable FCC regulations under the
Communications Act of 1934, as amended (the "Communications Act"), some of which
may be affected by the Telecommunications Act and regulations being promulgated
thereunder. See "-- Risk Factors -- Recent Legislation and Regulatory
Uncertainty." In addition, those subsidiaries which operate the Company's
microwave network are subject to applicable FCC regulations for use of the radio
frequencies. The FCC issues licenses to use certain radio frequency spectrum at
transmitter site locations. Each license gives the Company the right to operate
the microwave radio station for the term of the license. Currently, the Company
holds licenses to operate the microwave sites in the Company's network. The
licenses all expire in 2001. These licenses are renewable upon application
containing a statement that they are used in compliance with the applicable FCC
rules. The Company expects that the FCC will renew its licenses in due course.
The Communications Act currently limits ownership of an entity holding such
licenses by non-U.S. citizens, foreign corporations and foreign governments. The
Company is subject to regulation by the Federal Aviation Administration with
respect to the construction of transmission towers and to certain local zoning
regulation affecting construction of towers and other facilities.
Recent court decisions (which were issued before the Telecommunications
Act) require the FCC to require carriers to file tariffs. However, the FCC
currently does not actively exercise its authority to regulate such carriers'
rates and services. Moreover, the Telecommunications Act gives the FCC authority
to forbear from applying provisions of the Communications Act, including the
requirement that carriers file tariffs. The FCC has recently issued an order
implementing a mandatory detariffing policy that eliminates the tariff
requirements for non-dominant interstate, interexchange carriers. A court
challenge of the FCC's order resulted in the order being stayed. (Oral argument
is scheduled for September 1997.) The FCC will retain jurisdiction to act upon
complaints against any common carrier for failure to comply with its statutory
obligations as a common carrier.
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In addition, the FCC recently freed AT&T from price cap regulation. This
FCC action may affect the Company, because it competes with AT&T. The FCC's
current and future actions could result in decreases in the rates charged to
end-user customers by AT&T and other competitors for their services. Thus, one
effect of the FCC's action may be to further intensify price competition among
long distance companies.
The FCC regulates many of the rates, charges and services provided by the
local exchange carriers. Such regulation can also affect the costs of business
for the Company, its customers and its competitors, because carriers such as the
Company must purchase local access services from LECs to originate and terminate
calls. The FCC's current price cap regulation of the RBOCs and other LECs
provides them with considerable flexibility in pricing their services. The
pricing of transport services is under an interim rate structure which is a
transitional step toward pro-competitive, cost-based transport rates. The FCC
has commenced a proceeding to reform access charges and transport rate structure
and pricing. As part of access charge reform, the FCC is considering whether to
use: (i) a market-based approach, which would ultimately deregulate LEC
interstate access services when such services are subject to substantial
competition; or (ii) a prescriptive approach, under which the FCC would adopt
rules to drive access rates to economically efficient levels. The outcome of the
FCC proceeding is impossible to predict, but future changes with respect to
access charges are likely.
The Telecommunications Act, among other things, allows the RBOCs and others
to enter the long distance business. Entry of the RBOCs or other entities such
as electric utilities and cable television companies into the long distance
business may have a negative impact on the Company or its customers. In
addition, the Telecommunications Act provides that State proceedings may in
certain instances determine access charge rates the Company and its customers
are required to pay to the LECs. It is uncertain at this time what effect such
proceedings may have on such rates. There can be no assurance that such rates
will not be increased. Such increases could have a material adverse effect on
the Company and its customers. See "-- Risk Factors -- Recent Legislation and
Regulatory Uncertainty" and "-- Industry Overview."
The ability of the Company to provide long distance services within any
State is generally subject to regulation by a regulatory board in that State. As
of December 31, 1996, the Company is operating in the 48 contiguous continental
United States. The Company has obtained the requisite licenses and approvals in
46 of those States, and is being permitted to operate in the two remaining
States while its applications are pending. The Company expects to obtain all
such licenses and approvals by the end of 1997.
MEXICAN JOINT VENTURE
The Company is indirectly participating in the development of a long
distance network to engage in the telecommunications business in Mexico by
Marca-Tel. The Company indirectly owns 24.5% of Marca-Tel through its ownership
of 50% of Progress International which owns 49% of Marca-Tel. The remaining 51%
of Marca-Tel is owned by a Mexican individual and Fomento Radio Beep, S.A. de
C.V. The other 50% of Progress International is owned by Westel.
Progress International, which is seeking FCC authority to operate in the
United States as an international resale carrier, is responsible for providing
all the capital that may be required from Marca-Tel's stockholders in order to
finance Marca-Tel. The Company and Westel jointly have contributed funds to
Progress International (approximately $7.3 million by the Company as of December
31, 1996), substantially all of which has been used to fund Marca-Tel. Although
the Company cannot accurately predict the capital that will be required from
Progress International to implement the MarcaTel business plan, it estimates
that an additional $45.0 million (and possibly significantly more) will be
required by Marca-Tel from the stockholders of Progress International during
1997-1998. Progress International is considering selling equity interests in
Progress International to one or more third parties who could assist Progress
International with the funding of Marca-Tel. However, Progress International has
not had any material discussions in this regard and there can be no assurance
that any such funding will be available on satisfactory terms or at all. The
Company is currently, and may remain, the primary source of funds available to
Progress International for investment in Marca-Tel. Since the ownership
interests of the Company and Westel in Progress International are to be
proportional to their respective capital contributions, the Company's percentage
ownership of Progress International, and therefore its indirect ownership
interest in Marca-Tel, could increase if it makes additional
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capital contributions. The Indenture contains significant limitations on the
Company's ability to invest in Progress International or Marca-Tel.
Marca-Tel is deploying three switching centers and a fiber optic route
linking Mexico's three major cities (Mexico City, Monterrey and Guadalajara),
with interconnection to the Company's U.S. network at its border crossing at
Reynosa/McAllen. Marca-Tel has entered into a turnkey contract with a major
international supplier of telecommunications equipment for a portion of this
build that provides for interim vendor financing for the equipment and fiber
purchases as well as a portion of the construction work. The Company anticipates
that Marca-Tel may be able to obtain additional funding through some combination
of the following: (i) offerings of debt or equity securities; (ii) other
incurrences of debt; (iii) joint venture arrangements with third parties; and
(iv) additional vendor financing of equipment purchases. Initially, such sources
of capital likely will not be adequate to meet the needs of Marca-Tel, and the
Company anticipates that, until such sources are adequate to enable Marca-Tel to
continue to pursue its business plan, it will be necessary for Progress
International to fund the shortfall. The Company is not obligated to continue to
fund Progress International; however, if Progress International does not fund
Marca-Tel's needs, the Company's interest in Progress International, and thus
its indirect interest in Marca-Tel, may be diluted or lost entirely. Although
the Indenture generally restricts the amount of funding the Company can provide
Progress International, the Indenture does allow the Company to use the $12.5
million proceeds from the sale of 840,053 shares of Common Stock to GEPT in a
private placement which occurred simultaneously with the closing of the IPO (the
"GEPT Private Placement") for Progress International (as of February 28, 1997
approximately $1.1 million of such proceeds remained available for this
purpose). The Indenture also allows the Company to fund Progress International
with the proceeds of certain equity offerings or, under certain circumstances,
with funds raised through debt incurrence or, provided that the Company meets
certain financial ratios, from working capital. No assurance can be given that
adequate funding sources will be available from Progress International or from
third parties to implement Marca-Tel's business plan or, if implemented, that
such business plan will be successful.
HISTORY
IXC Communications, a holding company formed in July 1992, acquired a
one-half interest in Electra Communications Corporation ("Electra"), the owner
of a fiber optic network in Texas, for $9.0 million. IXC Communications became
the sole owner of Electra in 1993 when stock held by the other stockholder was
redeemed for $13.7 million. IXC Communications acquired I-Link, Inc., the owner
of another fiber optic network in Texas, in 1994 in a stock-for-stock merger. At
the same time, it also acquired IXC Carrier, Inc. in a stock-for-stock merger.
IXC Carrier has certain subsidiaries that have been active in the communications
business for over 25 years, initially serving as analog microwave carriers for
television signals for cable operators in Ohio and Texas. Commencing in 1979,
IXC Carrier, then a subsidiary of The Times Mirror Company ("Times Mirror"),
entered into long-term circuit lease agreements with various carriers such as
MCI in Texas and Sprint in the Ohio Valley and began the development of a
coast-to-coast network through the acquisition, construction and leasing of
microwave and fiber optic facilities.
EMPLOYEES
As of December 31, 1996, the Company employed 520 people, of whom 242
provided operational and technical services, 58 provided engineering services
and the balance were engaged in administration and marketing. The Company's
employees are not represented by any labor union. The Company considers its
employee relations to be good and has not experienced any work stoppages.
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RISK FACTORS
Statements contained in this Annual Report on Form 10-K regarding the
Company's expectations with respect to its network expansion, related financings
and fiber sale and cost-saving agreements, future operations and other
information, which can be identified by the use of forward-looking terminology,
such as "may," "will," "expect," "anticipate," "estimate," "seek" or "continue"
or the negative thereof or other variations thereon or comparable terminology,
are forward-looking statements. The discussions set forth below constitute
cautionary statements identifying important factors with respect to such
forward-looking statements, including risks and uncertainties, that could cause
actual results to differ materially from results referred to in the
forward-looking statements. There can be no assurance that the Company's
expectations regarding any of these matters will be fulfilled.
RELIANCE ON CONVERTIBLE STOCK SALE
Although the Company is seeking to realize approximately $96.5 million in
proceeds, after applicable discounts and commissions, from the Convertible Stock
Sale, there can be no assurance that the Company will be successful in
completing the Convertible Stock Sale, or, if completed, in a sufficient amount
so as to realize net proceeds in such amount. The ability of the Company to
complete the Convertible Stock Sale is dependent on many factors, including the
future prospects of the Company and its industry in general, sales, earnings and
other financial and operating results of the Company in recent periods and
market conditions. An inability to complete the Convertible Stock Sale would
prevent or significantly delay the completion of the network expansion and would
have a material adverse effect on the Company.
NEGATIVE CASH FLOW AND CAPITAL REQUIREMENTS
The Company's total capital expenditures were $136.4 million for 1996 and
the Company's EBITDA minus interest expense and capital expenditures (adjusted
for the change in working capital) was negative $130.2 million. The Company
estimates that the total capital expenditures for 1997 will be $340.0 million
(of which $49.7 million were made in the first two months of 1997) and the
Company expects to continue to make substantial capital expenditures thereafter.
The Company anticipates meeting the cash requirements relating to such capital
expenditures from cash on hand, the proceeds of the Convertible Stock Sale, the
proceeds of the LCI Fiber Sale and the MCI Fiber Sale, additional cost-saving
arrangements, cash flow from its operations and vendor financing it may seek.
The amount of actual capital expenditures may vary materially as a result of
cost-saving arrangements, increases or decreases in the amount of traffic on the
Company's network, unexpected costs, delays or advances in the timing of certain
capital expenditures and other factors. See "-- Acquisitions." The Company's
ability to meet the cash costs of such capital expenditures is dependent upon
the Company's ability to complete the construction of the network expansion in a
timely manner and otherwise perform its obligations so that it can complete the
LCI Fiber Sale and the MCI Fiber Sale, to enter into cost- saving arrangements
with carriers or other large users of fiber capacity, to otherwise raise
significant capital and/or to significantly increase its cash flow. The failure
of the Company to accomplish any of the foregoing may significantly delay or
prevent such capital expenditures, which would have a material adverse effect on
the Company and the value of the Convertible Preferred Stock and the Common
Stock.
The Company's switched long distance business will require cash to meet
operating expenses. In order to offer switched long distance services, the
Company installed switches, connected them to its network and to the LECs,
acquired software and hired the personnel needed to establish a national
switched network. Taken on a stand-alone basis, the switched long distance
business generated negative gross margins over the first two quarters of 1996
and began to generate slightly positive gross margins during the third and
fourth quarters of 1996 as the Company began to carry more switched long
distance traffic. After allocating selling, general and administrative expense
to the switched long distance business, however, it would have generated
negative EBITDA for each of the four quarters of 1996. The Company expects that
the network expansion will result in an improvement in the gross margins and
EBITDA generated by its switched long distance business. For a discussion of
important factors that could cause the Company's switched long distance business
to fail to generate positive EBITDA, see "-- Risk Factors -- Development Risks
and Dependence on Switched Long Distance Business."
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The forward-looking statements set forth above with respect to the
estimated cash requirements relating to capital expenditures, the Company's
ability to meet such cash requirements, and the Company's ability to improve its
gross margins and EBITDA in its switched long distance business are based on
certain assumptions, including that: (i) there will be no significant delays or
cost overruns with respect to the network expansion; (ii) the Company's
contractors and partners in cost-saving arrangements will perform their
obligations; (iii) rights-of-way can be obtained on a timely, cost-effective
basis; (iv) the routes of the network expansion scheduled for completion in 1997
are substantially completed on schedule; (v) the Company will continue to
increase traffic on its switched network; (vi) the Company can successfully
commence service for new switched long distance customers and successfully
provide switched long distance services on a cost effective basis (including the
provision of billing information in an accurate and timely manner) for volumes
that it has not previously handled; (vii) the Company can successfully complete
the LCI Fiber Sale and the MCI Fiber Sale; and (viii) the Company can obtain
vendor financing. See "-- Risk Factors -- Risks Relating to the Network
Expansion," "-- Risk Factors -- Development Risks and Dependence on Switched
Long Distance Business," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "-- The Company's Network."
The cash requirements described above do not include any cash which may be
required for acquisitions the Company may make. See "-- Risk
Factors -- Acquisition Risks" and "-- Acquisitions."
RISKS RELATING TO THE NETWORK EXPANSION
The continuing network expansion is an essential element of the Company's
future success. Although the Company has made significant progress, right-of-way
acquisition for, and construction of, the New York to Los Angeles via St. Louis
route are not yet complete. The Company has, from time to time, experienced
delays with respect to the construction of certain portions of the network
expansion and may experience similar delays in the future. These delays have not
had a material effect on the Company to date but have delayed the receipt of
certain revenues from its private line business and have affected operating
results, including EBITDA, by delaying the Company's ability to carry long
distance traffic over its owned facilities instead of facilities it leases from
other carriers. The Company has substantial existing commitments to purchase
materials and labor for construction of the network expansion, and will need to
obtain additional materials and labor which may cost more than anticipated. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources." Substantial segments of the
route from New York to Los Angeles via St. Louis and all the route from
Washington to Houston via Atlanta are being constructed by contractors or,
pursuant to cost-saving arrangements, by third parties such as right-of-way
providers or carriers that will include the Company's fiber in routes such
carriers are constructing for their own use. See "-- The Company's Network" for
a description of such cost-saving arrangements. The successful completion of
these routes is dependent, among other things, on the performance of such
contractors, right-of-way providers and carriers and on the Company's ability:
(i) to obtain rights-of-way; (ii) to manage effectively the construction of the
new fiber routes; and (iii) to enter into additional cost-saving arrangements,
obtain additional financing and/or significantly increase its cash flow.
Difficulties or delays with respect to any of the foregoing may significantly
delay or prevent the completion of the network expansion, which would have a
material adverse effect on the Company, its financial results and the value of
the Common Stock.
The Company has entered into an agreement with WorldCom, relating to the
construction by each party of a fiber route approximately 1,100 miles long and
the placing of fiber for the use of both parties in such route. WorldCom's route
extends from Akron through Indianapolis to the Missouri-Oklahoma border, with a
spur from Indianapolis to a suburb of Chicago. The Company's route extends from
Dallas to Phoenix with a spur to Ft. Worth.
In December 1996, the Company entered into an agreement with Vyvx whereby
the Company will provide Vyvx with the right to use fibers from Los Angeles to
New York in exchange for the right to use fibers from Houston to Washington,
D.C. The parties are required to complete their routes by December 31, 1997,
with penalties taking effect in July 1998 if one party, but not the other, has
failed to complete its route. Although the Company anticipates that it will
complete its route in time to avoid any penalty, there can be no
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assurance in this regard. Such penalties increase from $400,000 per month
commencing in July 1998 to $800,000 per month commencing in October 1998.
The Company entered into a significant agreement with a major long distance
carrier that will obtain private line services from the Company utilizing routes
included in the network expansion, including routes under construction. Under
this contract, the Company will supply DS-3 circuits for aggregate revenues of
over $24.0 million during 1997-1998. Delays in completion of such routes could
result in cancellation of orders under such contract.
In February 1997, the Company agreed to make the LCI Fiber Sale. The
agreement provides for (i) the Company to issue credits to LCI in the amount of
$3.00 per route mile per day on uncompleted sections if the route is not
completed by September 1, 1997 and (ii) the Company to provide OC-48 capacity to
LCI along uncompleted sections (which capacity may have to be obtained by the
Company from other carriers), if the route is not completed by December 1, 1997.
In March 1997, the Company agreed to make the MCI Fiber Sale. The agreement
provides for the Company to issue a credit to MCI of $100 per route mile per
month along any incomplete route segment, commencing January 1, 1998.
Although the Company does not anticipate undue difficulty in obtaining
performance by its contractors or by its partners in cost-sharing arrangements
or in acquiring the necessary rights-of-way or in managing the construction of
the network expansion, there can be no assurance that such third parties
(including WorldCom and Vyvx) will perform or that such rights will be acquired
or that the network expansion routes (including the routes from New York to Los
Angeles via St. Louis and from New York to Houston via Atlanta) will be
completed without significant delays or penalties, within its budget or at all.
Increased costs or significant delays in the completion of these routes,
including the portion to be constructed by WorldCom or Vyvx, could have a
material adverse effect on the Company and the value of the Common Stock. See
"-- The Company's Network."
PRICING PRESSURES AND RISKS OF INDUSTRY OVER-CAPACITY
The long distance transmission industry has generally been characterized by
over-capacity and declining prices since shortly after the AT&T divestiture in
1984. The Company believes that, in the last several years, increasing demand
has ameliorated the over-capacity and that pricing pressure has been reduced.
However, the Company anticipates that prices for its services will continue to
decline over the next several years. The Company is aware that certain long
distance carriers (WorldCom, MCI, LCI and others) are expanding their capacity
and believes that other long distance carriers, as well as potential new
entrants to the industry, are considering the construction of new fiber optic
and other long distance transmission networks. In particular, Qwest has
announced its intention to construct a coast-to-coast fiber optic network and
Frontier has announced it will purchase fibers for $500 million in Qwest's
network. Although the Company believes that there are significant barriers to
entry for some new entrants that may consider building a new fiber optic
network, such as substantial construction costs, and the difficulty and expense
of securing appropriate rights-of-way, establishing and maintaining a sufficient
customer base, recruiting and retaining appropriate personnel and maintaining a
reliable network, certain of these barriers may not apply to some new entrants
(such as Qwest, utility companies or railroads which already have significant
rights-of-way). Since the cost of the actual fiber is a relatively small portion
of building new transmission lines, companies building such lines are likely to
install fiber that provides substantially more transmission capacity than will
be needed over the short or medium term. Further, recent technological advances
have shown the potential to greatly expand the capacity of existing and new
fiber optic cable. Although such technological advances may enable the Company
to increase its capacity, an increase in the capacity of the Company's
competitors could adversely affect the Company's business. In addition, the LCI
Fiber Sale, the MCI Fiber Sale and the Company's cost-saving arrangements with
other carriers, which involve the sale or lease of capacity or fibers on the
network expansion, will result in competitors having capacity on the Company's
routes, which may in turn result in pricing pressures with respect to traffic
carried along these routes. If industry capacity expansion results in capacity
that exceeds overall demand in general or along any of the Company's routes,
severe additional
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pricing pressure could develop. In addition, strategic alliances or similar
transactions, such as the long distance capacity purchasing alliance among
certain RBOCs announced in the spring of 1996, could result in additional
pricing pressure on long distance carriers. Furthermore, the marginal cost of
carrying additional calls over existing fiber optic cable is extremely low. As a
result, certain industry observers have predicted that, within a few years,
there may be dramatic and substantial price reductions and that long distance
calls will not be materially more expensive than local calls. Price reductions
could have a material adverse effect on the Company and the value of the Common
Stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview."
DEVELOPMENT RISKS AND DEPENDENCE ON SWITCHED LONG DISTANCE BUSINESS
The success of the Company in the switched long distance business is
dependent on the Company's ability to generate significant customer traffic, to
manage an efficient switched long distance network and related customer service
and the timely completion of the network expansion, especially the route from
New York to Los Angeles via St. Louis. Prior to 1996 the Company had not
previously managed a switched long distance network and there can be no
assurance that its switched long distance services can generate positive EBITDA
or net income. The failure of the Company to generate increased customer
traffic, to complete these routes in a timely manner, or to effectively manage
the switched network and related customer service or to generate positive EBITDA
or net income from the switched long distance business would have a material
adverse effect on the Company and the value of the Common Stock. The Company's
switched long distance business will require cash to meet its operating
expenses. In order to offer switched long distance services, the Company
installed switches, connected them to its network and to the LECs, acquired
software and hired the personnel needed to establish a national switched
network. Taken on a stand-alone basis, the switched long distance business
generated negative gross margins over the first two quarters of 1996 and began
to generate slightly positive gross margins during the third and fourth quarters
of 1996 as the Company began to carry more switched long distance traffic. After
allocating selling, general and administrative expense to the switched long
distance business, however, it would have generated negative EBITDA for each of
the four quarters of 1996. The Company expects that the network expansion will
result in an improvement in the gross margins and EBITDA generated by its
switched long distance business. The Company has experienced and expects to
continue to experience difficulties in commencing services for end users of
carrier customers. In late 1996, Excel experienced service interruptions and
other difficulties in connection with transferring its end users to the networks
of MCI, WorldCom and the Company. The Company has encountered similar
difficulties in transferring end user customers of other carriers to its
network. These difficulties have, on occasion, led to billing disputes and
requests by carrier customers that the Company provide refunds or credits.
Although the Company believes that its performance with respect to these matters
has met or exceeded industry norms, such difficulties may adversely affect the
Company's relationships with its customers.
Important factors that could cause the Company's switched long distance
business to fail to generate positive EBITDA include changes in the businesses
of the Company's reseller customers, an inability to attract new customers, or
to quickly transfer new customers to its network without problems, the loss of
existing customers, problems in the operation of the switched network, the
Company's lack of experience with switched long distance services, increases in
operating expenses or other factors affecting the Company's revenue or expenses,
including delays in the construction of the network expansion. If such traffic
does not increase, there can be no assurance that the switched long distance
business will ever generate positive EBITDA. In addition, to the extent that
LECs grant volume discounts with respect to local access charges, the Company
may have a cost disadvantage versus the larger carriers. Furthermore, the credit
risk for the Company's switched long distance business is substantially greater
than the credit risk for the Company's long-haul business, because switched long
distance customers will be charged in arrears on the basis of MOUs (which are
frequently subject to dispute), and because many switched long distance
customers (in particular, resellers of debit card services) are not as well
capitalized as most of the Company's private line customers. See "-- Switched
Long Distance Services."
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RISKS INHERENT IN RAPID GROWTH
Part of the Company's strategy is to achieve rapid growth through expanding
its switched long distance business and through completing the network
expansion. In addition, the Company may from time to time make acquisitions of
resellers which it believes provide a strategic fit with its business and
network. See "-- Acquisition Risks." The Company's rapid growth has placed, and
its planned future growth will continue to place, a significant and increasing
strain on the Company's financial, management, technical, information and
accounting resources. Continued rapid growth would require: (i) the retention
and training of new personnel; (ii) the satisfactory performance by the
Company's customer interface and billing systems; (iii) the development and
introduction of new products; and (iv) the control of the Company's expenses
related to the expansion into the switched long distance business and the
network expansion. The failure by the Company to satisfy these requirements, or
otherwise to manage its growth effectively, would have a material adverse effect
on the Company and the value of the Common Stock. See "-- Private Line Services"
and "-- Switched Long Distance Services." An area of recent and anticipated
growth for the Company has been in selling private lines to Internet service
providers. Be