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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(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, 1998
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 75-2644120
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
1122 CAPITAL OF TEXAS HIGHWAY SOUTH, AUSTIN, TEXAS 78746-6426
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (512) 328-1112
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
COMMON STOCK, PAR VALUE $.01 PER SHARE
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 19, 1999, based on the closing price
of the Common Stock on the NASDAQ National Market on such date, was
$1,711,187,165.
The number of shares of Common Stock, $.01 par value, outstanding (the only
class of common stock of the Company outstanding) was 36,602,934 on March 19,
1999.
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, 1998, 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, 1998
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 4
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......................................... 31
Item 6. Selected Financial Data..................................... 32
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 32
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 43
Item 8. Financial Statements and Supplementary Data................. 43
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 43
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 44
Item 11. Executive Compensation...................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
Item 13. Certain Relationships and Related Transactions.............. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 44
Signatures............................................................ 50
Glossary.............................................................. 51
Financial Statements.................................................. F-1
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FORWARD-LOOKING STATEMENTS
We have included "forward-looking statements" throughout this document.
These statements describe our attempt to predict future events. We use the words
"believe," "anticipate," "expect," and similar expressions to identify
forward-looking statements. You should be aware that these forward-looking
statements are subject to a number of risks, assumptions, and uncertainties,
such as:
- Risks associated with our capital requirements and existing debt,
including the need to obtain additional capital to refinance indebtedness
and provide working capital for operations;
- Risks associated with increasing competition in the telecommunications
industry, including industry over-capacity and declining prices;
- Risks associated with our ability to successfully integrate our recent
acquisitions;
- Changes in laws and regulations that govern the telecommunications
industry;
- Risks related to continuing our network expansion without delays
including the need to obtain permits and rights-of-way;
- Risks associated with our ability to continue our strategy of growth
through acquisitions; and
- Risks related to our ability to prepare our information technology
systems for Year 2000.
This list is only an example of some of the risks that may affect our
forward-looking statements. If any of these risks or uncertainties materialize
(or if they fail to materialize), or if the underlying assumptions are
incorrect, then our results may differ materially from those we have projected
in the forward-looking statements. We have no obligation to revise these
statements to reflect future events or circumstances.
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ITEM 1. BUSINESS
OVERVIEW
We are a leading provider of data and voice telecommunications transmission
services. We own and operate an advanced coast-to-coast digital communications
network that includes 9,300 fiber route miles of fiber optic transmission
facilities. Substantial additions to our network are under construction, and we
project our network to include approximately 16,400 fiber route miles by the end
of 1999. Our facilities also include 9 long distance switches and 26 ATM-Frame
Relay switches, which we are using to capitalize on the growing demand for
Internet and electronic data transfer services. Through a combination of our
facilities and the facilities of other carriers, we originate and terminate long
distance traffic in all 50 U.S. states, and terminate long distance traffic in
over 200 foreign countries. Revenue has grown rapidly, from $154.7 million in
1995 to $668.6 million in 1998.
Our customers include AT&T, MCIWorldCom, Sprint, PSINet, Inc., Cable &
Wireless, Excel Communications, Inc., Qwest, Frontier and over 500 other long
distance companies, wireless companies, cable television providers, Internet
Service Providers ("ISPs") and government agencies. We also have over 113,000
retail customers, most of which are small and medium size businesses.
We have three principal segments of business. First, we lease dedicated
circuits, or private lines, to other companies for the transmission of voice and
data. Second, we provide long distance switched services by transmitting long
distance traffic through our switches. Finally, we are an Internet services and
backbone provider that also provides ATM-Frame Relay-based switched data
services.
Private Line. Our private line customers include ISPs, long distance
carriers and cable television companies. Our customers may transmit voice, data,
or Internet traffic over our network. Our pricing for private line sales
contracts varies with both the amount of capacity, or bandwidth, and the length
of the leased circuit. We provide capacity in varying increments, including the
ability to provision circuits with multiple OC-192 capacity. Private line sales
contracts are typically either service agreements that provide for recurring
monthly payments or indefeasible right to use ("IRU") agreements, in which a
large payment is received by us at the beginning of the service term. Generally,
month-to-month service contracts contain substantial "take or pay" commitments
that require the customer to make the payment regardless of whether full
capacity was utilized. We provide private line circuit contracts to over 275
customers, including AT&T, MCIWorldCom, Sprint, PSINet, Level 3 Communications,
Cable & Wireless, Qwest Communications, and Frontier.
Long Distance Switched. Our long distance switched services are processed
through digital switches and carried over our network or over other long
distance circuits and transmission facilities that we lease. We sell these
services on a per-call basis, charging by minutes of use, with payment due
monthly after services are rendered. Our focus in this business is end users,
however, we also service long distance resellers (both switchless resellers and
switched resellers that lack switches in geographic regions). The end users, our
retail customer base, consist primarily of small and medium size businesses. We
are expanding our sales to retail customers through internal growth after the
acquisition of Telecom One in 1997, Eclipse Telecommunications, Inc. (formerly
named Network Long Distance, Inc.) in 1998, and the planned acquisition of
Coastal Telecom Limited Company in 1999. Additionally, we formed a joint venture
with Unidial Communications to sell communications services using our network
through a full-time, national direct sales force. We may continue acquiring
additional resellers that provide significant network or product synergies. We
sell long distance switched services to over 113,000 end users and over 245 long
distance resellers.
Data/Internet Services. Our network includes 26 ATM-Frame Relay switches
and was built with SONET technology and broadband capabilities. It supports
advanced, capacity-intensive products that use comparatively large amounts of
bandwidth, such as ATM-Frame Relay, multimedia, and Internet-related
applications. We market a full line of data/Internet products and services. We
market these products and services to ISP's, resellers, CLECs and end users.
Included in our suite of products are back office support functions including
branded order entry and provisioning. To simplify Internet connectivity for
customers requiring dedicated services, we include a comprehensive line of
customer-premise equipment in our offerings.
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In order to accelerate our ability to provide these offerings to our customers,
we acquired four companies in the Internet technology business, as follows:
- We acquired Network Evolutions, Inc. ("NEI"), a company that provides
data consulting services and network design solutions. Beginning in 1999
NEI will also become a Cisco Systems, Inc. certified training center;
- We acquired The Data Place, Inc. ("Data Place"), which supplies companies
with complete network systems integration solutions. This acquisition
gave us additional expertise in the systems integrator channel for
selling broadband services.
- We acquired ntr.net Corporation ("NTR"), an ISP located in Louisville,
Kentucky. NTR offers custom back office support to wholesale customers as
well as multiple Internet dial-up services. Through this subsidiary, we
offer a fully operational back office solution, including private label
capability for supporting wholesale accounts. This affords us a wholesale
dedicated and dial-up product for both our wholesale and retail customer
bases.
- We acquired the assets of SMARTNAP, a subsidiary of SMART Technologies in
Austin, Texas. SMARTNAP is an ISP that provides aggregated Internet
access, collocation of Web servers and routers and end-site Internet
managed connectivity. These operations gave us an immediate entry into
Web hosting and dedicated Internet connectivity markets.
In addition to these acquisitions, we consummated an agreement with PSINet,
Inc. in which we provided PSINet an IRU in 10,000 miles of OC-48 capacity on our
network in exchange for 10.2 million shares of PSINet's common stock. We also
acquired 34% of Applied Theory Communications, Inc. This investment gave us
access to critical Internet expertise. Applied Theory services the New York
state research and education community.
In December 1998, we activated the first coast-to-coast next generation
Internet Protocol OC-48 backbone network to carry both commercial and research
community traffic. Named Gemini2000, this network carries traffic at speeds of
2.5 gigabits per second. Gemini2000 will offer a full range of voice, data,
Internet and integrated communications services to our customers.
Fiber Sales. We have sold IRUs in excess fiber to various other
communications companies including MCIWorldCom, LCI International Management
Services, Inc. (now a subsidiary of Qwest), and The Williams Companies. We
received cash proceeds of approximately $128.5 million in cash and $105.2
million in notes receivable from these sales in 1998. Revenue from these
transactions amounted to only $8.9 million in 1998 because we recognize revenue
from sales of fiber over the term of these agreements, which range from 10 to 25
years. In addition to fiber sales, we have swapped excess fiber with other
carriers. In 1997, we acquired rights to fiber in routes to be constructed from
Los Angeles to San Francisco, Las Vegas to Portland, Washington, D.C. to
Houston, and New York City to Washington, D.C. in such exchanges.
International Joint Ventures. We formed Storm Communications, Ltd., a joint
venture with Telenor AS, the Norwegian national telephone company, to provide
telecommunication services to carriers and resellers in Europe. We also
indirectly hold a minority interest in Grupo Marca-Tel S.A. de C.V. ("Marca-
Tel"), a Mexican telecommunications provider.
Our principal executive offices are located at 1122 Capital of Texas
Highway South, Austin, Texas, 78746. Our telephone number is (512) 328-1112.
INDUSTRY
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
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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, MCIWorldcom and Sprint for
long distance services.
The Telecommunications Act of 1996 ("Telecom Act"), among other things,
allows the RBOCs and others such as electric utilities and cable television
companies to enter the long distance business. The Telecom Act will
substantially alter the way in which the telecommunications industry is
regulated. Such changes are, however, difficult to predict accurately, because
FCC proceedings and appellate review of the numerous administrative regulations
adopted to implement the Telecom Act, including universal service and access
charge reform, are still ongoing. 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 us and other long distance
providers. See "-- Risk Factors -- Competition," "-- Risk Factors -- Recent
Legislation and Regulatory Uncertainty" and "-- Regulation."
Market and Competition
General. The telecommunications market is highly competitive. Competition
for both resellers and end-user customers is based upon pricing, advertising,
customer service, network quality and value-added services. Industry observers
estimate that over 600 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 (those who own transmission facilities) and
non-facilities-based carriers (those who do not own transmission facilities).
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 services nationwide.
Facilities-based 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: (1) facilities-based carriers that require long distance
transmission capacity where they have geographic gaps in their facilities, need
additional capacity or require geographically diverse routing; (2)
non-facilities-based carriers requiring long distance transmission capacity to
carry their customers' long distance traffic, and (3) ISP companies who desire
capacity to provide a more robust Internet atmosphere for their customers. Our
competitors in the private line business include AT&T, MCIWorldCom, Sprint,
Qwest, Frontier, Williams, Level 3, and certain regional carriers. Important
competitive factors in the private line business are quality, reliability,
price, customer service, network location and availability. See "-- Private Line
Services."
Long Distance Switched Services. Long distance companies may be
characterized as switched or switchless carriers. A switch is a device that
opens and closes circuits or selects the paths or circuits to transmit
information. Switching interconnects circuits to form a transmission path
between users. Sellers of long distance switched services are generally switched
carriers that own one or more switches that direct telecommunications traffic.
Facilities-based carriers are generally switched carriers. Our customers for
wholesale switched services include both switched and switchless resellers. Our
retail customers are generally small to medium size businesses seeking
inexpensive, reliable long distance voice and data transmission capability.
Competitors in the long distance switched services business include AT&T,
MCIWorldCom, Sprint, Qwest, Frontier, as switched carriers. Important
competitive factors in the long distance switched services business are price,
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 our
network to complete calls with a minimum of network-caused busy signals, scope
of services offered, reliability and transmission quality.
Data/Internet Services. This business consists of assisting customers in
using the Internet for internal purposes and for advertising and selling their
products over the Internet. Also known as "e-commerce", the
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sale of products and services over the Internet is growing rapidly. The ability
of businesses to participate in e-commerce depends upon the technological
expertise available to the businesses, either internally or from others. As
e-commerce is a recent phenomenon, few small or medium size businesses have
sufficient internal technological resources. As a result, these companies look
to consultants for Internet, networking and web-hosting assistance. Service
providers in the industry range from small consulting firms to large
telecommunications industry leaders such as MCIWorldCom. We provide service to
resellers in the wholesale market and to end users in the retail market.
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 Telecom Act, state proceedings may in certain instances determine LEC
access charge rates. Further, ongoing access charge proceedings at the federal
level may affect the access charges long distance carriers pay to LECs. It is
uncertain at this time what effect such proceedings may have on such rates.
Network Transmission Medium
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 data and voice 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 eight or more OC-192s. 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 is used in the expansion of our network, 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 2 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
electro-physical 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 weaken 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.
BUSINESS STRATEGY
Our objective is to become the preferred provider of integrated
network-based information delivery solutions, utilizing our high-capacity,
state-of-the-art nation-wide fiber network. To that end, we plan to:
- focus on high value integrated data and voice services to end users;
- expand our network by constructing, swapping and building new fiber
routes and reduce operating costs by replacing capacity currently leased
from other carriers with our own network capacity;
- integrate our Internet-related services, our voice services, and our
private line services to accommodate complete business solutions;
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- pursue additional revenue opportunities in our private line business by
leveraging our network's capacity and focusing on large capacity
requirements of customers;
- capitalize on the rapid growth in demand for data transmission services,
by aggressively marketing data services;
- expand retail channel revenue through Telecom One, Eclipse, and Coastal,
and by making selective acquisitions of other strategically positioned
resellers; and
- utilize international alliances to obtain additional international
traffic on our network and provide global connectivity to our customers.
In order to implement this strategy we intend to pursue the following:
Expand the Data and Internet Business. The SONET technology and broadband
capabilities in our network provide a platform to support advanced,
capacity-intensive products such as ATM-Frame Relay, multimedia, and
Internet-related applications. We have equipped our network with 26 data
switches and other equipment that has allowed us to be in the ATM-Frame Relay
transmission business. In 1998, we acquired four Internet-related businesses to
improve our offerings in this area. We acquired NEI, which provides Internet
consulting; Data Place, which supplies businesses with complete network systems
integration solutions; NTR, which supplies back office support to wholesale
customers and Internet dial-up services to end users; and the assets of
SMARTNAP, which provides aggregated Internet access, collocation of Web servers
and routers, and end-site managed connectivity.
Increase Private Line Revenue. We will continue to sell high capacity (e.g.
OC-3, OC-12, OC-48, OC-192) long- term private line agreements. These
transactions will consist of both IRU capacity agreements and monthly leases of
capacity. We expect our current success of supporting major ISP's will expand in
the future as e-commerce increases.
We designed our network to traverse routes geographically diverse from
those of other facilities-based carriers. In recent years, companies such as
AT&T, MCIWorldCom and Sprint have used our network's routes to help protect
their networks in case of a service outage. Such companies prefer routes
separated geographically from their own networks to increase the possibility
that the alternative route will be functional in case of a natural disaster. We
believe our network expansion greatly increases the attractiveness of our
network as an alternative routing backup to the major carriers.
Improve the Long Distance Switched Services Business. We have established
ourself as an alternative provider of long distance switched services with
nationwide origination and domestic and international termination capability. We
plan to expand the focus of our retail products and services, including services
designed to enhance our customers' ability to pursue business and manage their
business over the Internet. We plan to market these integrated data and voice
services to the end users through our retail marketing organization, which
currently consists of Eclipse, Telecom One, and will also include Coastal if and
when the purchase of that company is completed. We have approximately 113,500
retail long distance customers.
Reduce Operating Costs. As we expand our network, capacity leased from
other carriers may be transferred to our network. Revenue growth may result in
increased future off-net usage if revenue opportunities include geographic areas
that our network currently does not reach or if capacity on our network is
unavailable.
Enter Into Cost-Saving Arrangements. We have built excess fiber in our
network that can leased or sold to other carriers or exchanged for fibers or
capacity on other carriers' networks. We will seek to obtain the right to
install our fibers in new routes being constructed by other carriers along our
planned network expansion routes in exchange for sharing network construction
costs, allowing the other carrier to use excess fiber along certain of our
existing routes, or allowing the other carrier to add its fiber to existing
certain segments of our network. We have already completed several fiber
exchanges with other carriers that have reduced the per-route-mile cost of
construction.
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THE NETWORK
Facilities
Our network includes approximately 9,300 fiber route miles. Our owned
facilities are supplemented with approximately 283,000 DS-3-equivalent miles of
capacity obtained from other carriers. Of such capacity, we lease over 244,000
DS-3 miles. Approximately 39,000 DS-3 miles of such capacity has been obtained
through long-term capacity-exchange agreements with other companies. These
exchange agreements are possible because of the placement of our network in
locations where other facilities-based carriers require additional capacity and
the comparatively large expense to other carriers of constructing new fiber
optic facilities. Such exchange agreements increase the scope of our network
through the addition of the exchanged capacity and reduce our cash expenditures
for off-net facilities.
Our network includes nine digital long distance voice/data switches in
major cities. Each of the switches is directly connected over on-net or off-net
private line circuits to: (1) at least two other switching centers; (2) certain
of our hubs (central locations where telecommunications traffic is collected for
transport and distribution); and (3) certain switching centers or central
switching facilities of LECs (central offices). 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 use common channel
signaling (SS7), which reduces connect time delays. The network also includes 26
ATM-Frame Relay data switches located in major cities. Our switched operations
are supplemented by agreements with MCIWorldCom. Under these agreements
MCIWorldCom supplies switched capacity on a per-minute basis, automatically
handling calls routed through LEC central offices not connected to our hubs or
switches and handling calls which exceed the capacity of our switched network.
The capacity of our switches may be expanded with processor upgrades, and
additional memory and ports.
Our fiber optic routes are constructed with fiber capable of supporting
bi-directional SONET rings for enhanced network reliability. As each new route
is completed and placed into service, it is equipped with at least one OC-192 in
order to provide initial transmission capacity. We also equip certain of our
routes with additional OC-48/OC-192 capacity in order to meet customer demand.
Network Reliability
Our network offers a reliable means of transmitting large volumes of voice
and data signals. Monitoring is conducted from the national operations center in
Austin on a 24-hour, seven-day per week basis. This system alerts technicians to
situations that could affect customer transmission and generally allows us to
take remedial actions before customer service is affected. In addition, at
December 31, 1998, approximately 157 operations personnel were employed along
our network to perform preventative maintenance as well as repair functions on
our private line network. Operations personnel conduct annual system performance
testing and make periodic unannounced visits to terminal sites to evaluate
technician performance. At December 31, 1998, a staff of 31 technicians was
employed to provide maintenance and other technical support services for
switched long distance services.
Network Expansion
The expansion of our network delivers the following significant strategic
and financial benefits:
- substantial savings by moving traffic onto our network that is currently
carried on circuits that are leased from other carriers;
- high-capacity new routes and substantially increased capacity on certain
existing routes, allowing increased revenue by leasing additional
circuits to customers, including high-capacity circuits such as OC-3s,
OC-12s and OC-48s;
- lower underlying transmission and network operating costs;
- addition of sufficient capacity to support increasing demand from
Internet and ATM-Frame Relay; and
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- reduced capital costs through sales and exchanges of excess fiber which
is included in our network expansion specifically for that purpose;
We are adding thousands of additional fiber route miles to increase the
geographic scope and capacity of our network. Our network connects our switches
with high-capacity private line circuits, utilizing advanced fiber optic
technology capable of efficiently transmitting capacity-intensive services, such
as Internet, Intranet, multimedia applications, and ATM-Frame Relay. The routes
of our network expansion have generally been geographically diverse from the
existing fiber networks of AT&T, MCIWorldCom and Sprint.
Construction. Our network expansion is planned to cover, to the greatest
extent practicable, routes where one or more of the following factors are
present: (1) customer demand indicates a need for high-capacity fiber network on
the route; (2) the route is attractive as a complement to the routes of other
carriers, allowing the lease of capacity on the route to other carriers to
exchange a portion of capacity on the route for capacity in routes from other
carriers; or (3) the capacity will replace capacity currently leased from other
carriers.
Cost. The principal components of network expansion cost include: (1) fiber
optic cable in conduit; (2) engineering and construction labor; (3) optronic and
electronic equipment and (4) rights-of-way. The rights-of-way are 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 we have not yet
obtained all the necessary rights-of-way along the planned routes, it is
anticipated that the rights-of-way will be available.
Through cost-saving arrangements, our network cost has been reduced. The
cost-saving arrangements include: (1) leasing or selling excess fiber to other
carriers; (2) exchanging excess fiber for fibers or capacity on other carriers'
networks; or (3) installing our fibers in new routes being constructed by other
carriers along our proposed network expansion route in exchange for (a) sharing
network construction costs; (b) allowing other carriers to use excess fiber
along certain of our network routes; or (c) allowing other carriers to add their
fiber to certain segments of our network. See "Risk Factors -- Negative Cash
Flow and Capital Requirements." We have experience with these arrangements with
several major carriers, including MCIWorldCom, Sprint, Cable & Wireless, Qwest,
GST and the Williams Company.
PRIVATE LINE SERVICES
Overview
Approximately 33.7% of total revenue in 1998, approximately 31.0% of total
revenue in 1997, and 35.4% of total revenue in 1996 were generated by the
private line business. We currently have over 275 active private line customers.
Strategy
We seek to expand our private line business through meeting these
objectives:
- expand our network to provide additional capacity on existing routes and
new high-capacity routes with access to major population centers
(including routes that may be attractive to other major carriers as
backup routes);
- provide high-quality, reliable private line services on a fixed-cost
basis at rates generally below those currently offered by competitors;
and
- use the expanded network as a platform to support increased private line
circuit demand from Internet, ATM-Frame Relay, multimedia, and other
capacity-intensive applications.
We have reduced expenses in the private line business related to
transmission expense as traffic from circuits leased from other carriers moved
onto our network.
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Customers and Marketing
We have over 275 active private line customers, including AT&T,
MCIWorldCom, Frontier, Sprint, PSINet, Cable & Wireless, Qwest and Level 3
Communications. We have historically enjoyed a high customer retention rate in
the private line business.
Private line circuit capacity is generally marketed to: (1) ISP's to
support their Internet business; (2) 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 (3) non-facilities-based carriers requiring private line capacity to carry
their customers' long distance traffic. Most of our direct sales efforts are
focused on providing customer support services to existing customers and on
adding new customers. A single sales force sells both private line and wholesale
long distance services. That sales force consists of 43 account managers based
at our 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 1998 MCIWorldCom accounted for approximately 19.4% of our private
line revenue. See "-- Risk Factors -- Reliance on Major Customers."
Prices and Contracts
Private line sales contracts are typically either service agreements that
provide for recurring monthly payments or IRU agreements in which a large
payment is received by us at the beginning of the service term.
The first type of sales contract is the monthly service agreement. These
agreements generally provide for either a lease with original terms of 1 to 5
years and for monthly payment in advance on a fixed-rate basis, calculated
according to the capacity and length of the circuit. Generally, month-to-month
service agreements 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 canceled by the customer. However, the agreements
generally provide that the customer may terminate service without penalty "for
cause" in the event of substantial and prolonged outages arising from causes
within our control, and for 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 giving us notice. However,
termination for convenience generally requires either full payment of all
charges through the end of the initial lease term or payment of substantial
termination fees intended to allow the recovery of certain costs and, in some
cases, lost profits. Damages attributable to a customer's termination of the
agreement are generally reduced by an offset for any income earned from
re-leasing the terminated capacity during the remaining portion of the lease
term.
The second type of sales contract is the IRU agreement. IRU agreements
generally give the customer the right to use a specified level of capacity for a
fixed period. The terms of IRU agreements range from 10 to 20 years and are
typically longer than the terms of monthly service agreements. IRU agreements
are typically paid for by the customer at the time the contract is signed.
Competition
Our competitors in this business include AT&T, which is the largest
supplier of long distance voice and data transmission services in the United
States, MCIWorldCom, Sprint, Qwest, and the Williams Company. Certain of these
competitors have substantially greater financial resources than we have and some
have a more extensive transmission network than our network. Because of the
Telecom Act and agreement with the World Trade Organization ("WTO"), countries
are required to open world telecommunications markets to competition. This
became effective on February 5, 1998, and so United States carriers could now
face competition from foreign carriers. In the future, we will face competition
from the RBOCs, GTE Corporation and others such as electric utilities and cable
television companies. See "-- Risk Factors -- Competition."
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LONG DISTANCE SWITCHED SERVICES
Overview
Long distance switched services are telecommunications services processed
through digital switches and carried over long-haul circuits and other
transmission facilities we own or lease. We sell long distance switched services
on both a wholesale and a retail basis charging by minutes-of-use per call, with
payment due monthly after services are rendered. In 1998, sales of long distance
switched services accounted for approximately 62.0% of total revenue.
Strategy
We seek to increase margins from long distance switched services business
through meeting these objectives:
- increase retail penetration in small and medium size businesses through
our rapidly expanding retail sales force;
- offer higher-value integrated packages of dedicated circuit, Internet and
long distance services to end users;
- offer pricing which is generally lower than that charged by AT&T and
competitive with that of other long distance service providers
We seek to increase the profitability of the long distance switched
services business by offering higher value packages of services, decreasing our
average cost per minutes-of-use through efficiencies achieved with higher
volumes and through reducing network costs through our network expansion. See
"-- Business Strategy."
Customers and Marketing
We intend to focus on selling retail long distance services directly to
small and medium size businesses, targeting those businesses that use $1,000 or
more per month of such services. At December 1998, 305 sales executives were
responsible for selling retail long distance services. The wholesale business
sales efforts have been focused on large reseller customers with monthly volumes
of at least $1.0 million.
Excel. Excel has been our largest long distance switched services customer.
In 1998 Excel accounted for 18.2% of total switched long distance revenue. Going
forward, this will change as our contract with them has been amended to include
both private line and long distance switched service business. We expect Excel
to use more of our private line services and reduce its use of our long distance
switched services.
Customer Contracts. Our 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 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 with customers for long distance
switched services generally provide for payment in arrears based on
minutes-of-use. The agreements generally also provide that wholesale customers
may terminate the affected service without penalty in the event of substantial
and prolonged outages arising from causes within our 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 use at least a minimum dollar amount (measured by dollars or
minutes-of-use) of long distance switched services per month for the term of the
agreement.
Customer Care. We believe that customer support is an important factor in
attracting and retaining both wholesale and retail customers for our long
distance switched services. Customer service for long distance switched services
includes processing new accounts, responding to inquiries and disputes relating
to billing, credit adjustments and cancellations and conducting technical repair
and other support services. We manage customer care for wholesale customers
using IXC Online, which is our proprietary customer service software
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that is designed to allow customers to: (1) place orders for switched services;
(2) arrange with the appropriate LEC to register the carrier as the designated
long distance carrier for its new end users; and (3) download current call
detail records for its end users for billing purposes.
Decreased Costs through Increased Volumes or Greater Efficiency
Large minutes-of-use volumes should enable us to spread fixed network costs
over more minutes-of-use and to more efficiently configure our network, thereby
reducing the average cost per minutes-of-use. We seek to efficiently configure
the circuits available so that calls are completed on a cost-effective basis.
Periodically, calling patterns are analyzed 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
transmission circuitry in an area may be upgraded from DS-1 to DS-3. A similar
analysis will be made when deciding whether to install a new switch in a region.
We are continuing to develop procedures to better analyze expected traffic
patterns in order to enhance network efficiency and identify customers
generating an unprofitable mix of traffic.
Services
We market a variety of wholesale and retail switched long distance
services, including 1-800, credit card, operator services, directory assistance,
international service and the following:
1 Plus Switched Service. Provides direct-dial service over our network.
1 Plus Dedicated Service. Provides direct-dial service over our network for
end users that have arranged to connect to our 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 service for business over our network
that allows calls to be made for specific location at no charge to the calling
party. Use of the "800" or "888" service code denotes calls that are to be
billed to the receiving party.
800/888 Dedicated Service. Provides 800/888 service over our network for
end users that have arranged to connect to our 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 using a switch in
one area with termination services in other areas.
Direct Access Line Service. Provides customers with direct access to long
distance lines, bypassing the LEC lines.
Acquisitions and Investments
The acquisitions of Telecom One in July 1997 and Eclipse in June 1998 were
made to enhance our retail sales growth, using shares of our common stock as
consideration. We obtained 4.25 million shares of DCI Telecommunications, Inc.
in November 1998, in consideration for a note from one of our customers which
was also a vendor of DCI and other consideration. DCI is an international
provider of telephone services, including long distance, prepaid telephone cards
and Internet services. DCI has an option to repurchase all 4.25 million shares
of its common stock from us through April 1, 1999, at a price of approximately
$18 million. In the event the option is not exercised there will be an
adjustment to the number of shares we own on June 1, 1999, if the 15-day volume
weighted average price of the DCI shares is outside the range of $4.20 to $5.88.
After this adjustment, if any, we will own common stock of DCI with a minimum
value of approximately $18 million and a maximum value of $22 million. We
account for this investment using the cost method.
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In January 1999, we entered into an agreement (subject to certain
regulatory requirements and other conditions) to acquire Coastal in exchange for
shares of our common stock, warrants to purchase common stock, a note and cash.
Coastal is a retail long distance service provider with over 100,000 small
business customers. We may, from time to time, acquire other businesses, assets
or securities of companies that we believe provide a strategic fit with our
business and network. We continue to review potential acquisition candidates and
have held discussions with several of these candidates. We may use our common
stock as consideration for other acquisitions. See "-- Risk Factors -- Growth
Through Acquisitions; Integration of Acquired Businesses."
Competition
We compete with numerous facilities-based interexchange carriers, some of
which are substantially larger, have substantially greater financial, technical
and marketing resources and use larger transmission systems. AT&T is the largest
supplier of long distance switched services in the United States inter-LATA
market. Other competitors in selling long distance switched services include (1)
facilities-based carriers such as MCIWorldCom, Sprint, Frontier, and Qwest and
certain regional carriers, and (2) non-facilities-based carriers. Because of the
Telecom Act and the recent WTO Agreement, we will also face competition from the
RBOCs, GTE and others such as electric utilities, cable television companies and
foreign companies. We believe that the principal competitive factors affecting
us are price, 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 our network to complete calls with a minimum of network-caused busy signals,
scope of services offered, reliability and transmission quality. The ability to
compete effectively will depend upon our ability to maintain high-quality
services at prices generally equal to or below those charged by our competitors.
In the United States, price competition in the long distance business has been
intensive over the last 5 years. The combination of MCI and Worldcom in 1998 and
the 1995 classification by the FCC of AT&T as a "non-dominant" carrier, freeing
it from price regulation, have resulted in decreasing long distance service
prices. We believe that to compete with these large competitors, we need to
price our services below theirs. See "-- Risk Factors -- Competition."
DATA/INTERNET SERVICES
Overview
Data/Internet services generated $9.0 million of revenue in 1998,
representing approximately 1% of our 1998 revenue. Prior to 1998, we had less
than $1.0 million of revenue in this segment.
Strategy
We plan on expanding our data/Internet business through meeting these
objectives:
- expand our network's ability to carry digital traffic by using our 26
ATM-Frame Relay switches and using SONET technology that supports
capacity-intensive products;
- increase the products available by having our 1998 Internet acquisitions
act as product houses to quickly bring to market new Internet-related
products;
- sell the products developed by this product group as both stand-alone
products and as integrated products with our private line and long
distance products;
- use our wholesale and retail sales forces to sell products developed by
our data/Internet group; and
- implement a billing system that will invoice customers for data/Internet,
private line and long distance services on one bill;
In February 1999, we announced an alliance with Cisco Systems, Inc. to
deploy emerging packet-based technologies utilizing Cisco's internetworking
solutions over our network. This alliance is working on areas of emerging
Internet protocol internetworking such as packet over SONET product and service
definition. As
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part of this relationship, we will be deploying Cisco 12000-gigabit switch
routers throughout an OC-48 advanced Internet backbone network called
Gemini2000. Using this configuration, we will be positioned to offer end-to-end
Internet Protocol based solutions at the customer premises.
Customers and Marketing
We had over 36,000 data/Internet customers at year-end 1998. These
customers are generally small and mid-size businesses which use our services to
enhance internal communications and communications and commerce with their
customers. In 1998 we had no materially significant customers in this segment of
our business.
Our wholesale and retail sales forces provide the direct sales efforts for
these services. These sales forces have sales offices in major cities throughout
the United States. Our wholesale and retail customer service departments provide
customer care for these customers. Technological issues are handled by our
employees in the product development area.
Prices and Contracts
The data/Internet segment includes a variety of services; therefore, we do
not have a standard agreement. Agreements for non-usage based services are
generally 12 month agreements which may be terminated by either side with 30
days notice. These agreements may contain a minimum take or pay period. These
services are generally billed to the customer in advance of the service being
provided. Usage based services are typically also 12 month agreements with 30
day termination available. The customer is generally billed after the services
are provided. Agreements for one-time services, such as consulting work, are for
specific work performed and are billed to the customer based either upon project
completion criteria or upon when the services have been completed.
Acquisitions and Investments
From March through June 1998, we acquired four companies to expand our
data/Internet product offerings, as follows:
- We acquired NEI, a company that provides data consulting services and
network design solutions. Beginning in 1999 NEI will also become a Cisco
Systems, Inc. certified training center;
- We acquired Data Place, which supplies companies with complete network
systems integration solutions. This acquisition gave us additional
expertise in the systems integrator channel for selling broadband
services.
- We acquired NTR, an ISP located in Louisville, Kentucky. NTR offers
custom back office support to wholesale customers as well as multiple
Internet dial-up services. Through this subsidiary, we offer a fully
operational back office solution, including a private label capability
for supporting wholesale accounts. This affords us wholesale dedicated
and dial-up products for both our wholesale and retail customer bases.
- We acquired the assets of SMARTNAP, a subsidiary of SMART Technologies in
Austin, Texas. SMARTNAP is an ISP that provides aggregated Internet
access, collocation of Web servers and routers and end-site Internet
managed connectivity. These operations gave us an immediate entry into
Web hosting and dedicated Internet connectivity markets.
In February 1998 we consummated agreements with PSINet in which we provided
PSINet an IRU in 10,000 miles of OC-48 capacity on our network over a 20-year
period in exchange for 10.2 million shares of PSINet's common stock. The 10.2
million shares of PSINet stock was valued at $211.6 million at December 31,
1998. We also acquired 34% of Applied Theory, which gave us access to critical
Internet expertise. Applied Theory services the New York state research and
education community.
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Competition
There are many competitors in the data/Internet field. Competition for
consultative type services range from individuals to large consulting firms such
as Andersen Consulting. Competition for providing Internet service comes from
ISPs of all sizes including MCIWorldCom, which acquired UUNet, and PSINet.
Some of our competitors have substantially greater financial, technical and
marketing resources. They also have more experience in delivering
Internet-related products and therefore, have greater market share and
brand-name recognition. In addition, traditional telecommunications carriers,
such as AT&T, Cable & Wireless and Sprint compete with us in offering Internet
access services. These carriers have greater network coverage and large existing
customer bases as well as greater financial and technical resources. Internet-
related businesses compete based on price, customer service, and quality of
service delivery. The level of competition we expect to experience in the
business is affected by consolidations and mergers of existing Internet service
and backbone providers and the entry into the Internet service market of
traditional telephone service providers including CLECs and other interexchange
carriers.
REGULATION
Certain of our subsidiaries 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 Telecom Act and regulations already promulgated and
currently being developed thereunder. See "-- Risk Factors -- Recent
Legislation and Regulatory Uncertainty." In addition, those subsidiaries that
operate our 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 right to operate
a microwave radio station for the term of the license. Currently, we hold
licenses to operate the microwave sites in the 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. We expect that
the FCC will renew these 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. We are 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 Telecom 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 Telecom Act gives the FCC authority to forbear from applying
certain provisions of the Communications Act, including the requirement that
carriers file tariffs. In 1997, the FCC issued an order implementing a mandatory
detariffing policy that eliminates the tariff requirements for non-dominant
interstate, interexchange carriers. An appeal of the FCC's order resulted in the
order being stayed. The appeal is being held in abeyance, pending the FCC's
action on motions for reconsideration. In this proceeding, on March 18, 1999,
the FCC adopted rules requiring long distance carriers to disclose their rates
on the Internet, once interstate long distance services have been detariffed.
The FCC's public disclosure rules will not go into effect until the appellate
court has ruled on the merits of the stayed appeal. Regardless of the outcome of
the detariffing proceeding, 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.
The FCC regulates many of the rates, charges and services provided by the
LECs. Such regulation can also affect the costs of our business and for our
customers and competitors, because carriers 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. Pursuant to the Telecom Act, the FCC
issued two orders regarding access charge reform and transport rate structure
and pricing. The FCC's access charge reform order was recently affirmed by the
U.S. Court of Appeals for the Eighth Circuit. LEC tariffs implementing the
requirements of the FCC orders have gone into effect. The FCC recently sought
additional comments on access charge reform, and the outcomes of any subsequent
FCC rulemaking proceedings are impossible to predict. Future changes with
respect to access charges may occur.
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Further, on July 18, 1997, in Iowa Utilities Board v. FCC, the United
States Court of Appeals for the Eighth Circuit invalidated key portions of the
FCC's August 29, 1996 interconnection order, which the FCC had adopted to
facilitate the emergence of local exchange competition. The Eighth Circuit's
order was appealed to the United States Supreme Court, and on January 25, 1999,
the Supreme Court overturned the Eighth Circuit's ruling. The Supreme Court
reinstated most aspects of the FCC's interconnection rules. However, the Supreme
Court remanded to the FCC the issue of which specific local exchange network
elements must be made available to competitors of local exchange carriers. The
further emergence and development of local exchange competition may likely be
delayed because of appeals of other aspects of the interconnection order and the
FCC's decision on the remand issue. Consequently, long distance companies such
as us may not benefit as quickly from the lower access costs that might
otherwise have resulted had competition in the provision of local access
services not been delayed.
The Telecom Act directed the FCC to establish a system for compensating
payphone service providers ("PSPs") on a per-call basis for calls made from
payphones, including coinless calls, such as calling card, collect, and "800"
calls. On October 9, 1997, the FCC released an order that set a $0.284 per-call
"default" rate that long distance carriers are required to pay to PSPs for
certain coinless calls. The FCC's order went into effect, but was appealed, and
the order was subsequently remanded to the FCC. The FCC recently issued an order
setting a default rate of $0.24 per call. However, the new order has not yet
gone into effect. Further, the new order is likely to be appealed. Accordingly,
the amount of compensation long distance carriers will ultimately be required to
pay to PSPs is currently uncertain.
In addition, the Telecom Act 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 IXC or our customers. The Telecom Act also establishes
criteria for RBOC re-entry into in-region long distance markets, and RBOCs are
required to obtain FCC approval before they can begin providing such services.
To date, the FCC has rejected 5 such RBOC applications, at least one of which
was appealed. In that proceeding, the FCC's order denying the application was
recently upheld by the appellate court. On December 31, 1997, the U.S. District
Court for the Northern District of Texas ruled that the provisions of the
Telecom Act that apply specifically to RBOCs are unconstitutional. On February
11, 1998, the District Court stayed its order, and the order was appealed. On
September 4, 1998, the U.S. Court of Appeals for the Fifth Circuit overturned
the district court's December 31, 1998 Order. The U.S. Court of Appeals for the
D.C. Circuit has also rejected arguments that the Telecom Act's restrictions on
RBOC reentry are constitutional. Further, the FCC has been working with the
RBOC, using a "collaborative process," to facilitate the review and ultimately
the approval of such applications.
The Telecom Act also provides that state proceedings may in certain
instances determine access charge long distance providers 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 our customers and us. See
"-- Risk Factors -- Recent Legislation and Regulatory Uncertainty" and "Industry
Overview."
Our ability to provide long distance services within any state is generally
subject to regulation by a regulatory board in that state. As of December 31,
1998, we are operating and have obtained the requisite licenses and approvals in
the 48 contiguous continental United States.
MARCA-TEL
At December 31, 1998, we owned 50% of Progress International, LLC, which
owned 49% of Marca-Tel. This resulted in our indirect ownership in Marca-Tel of
24.5%. The remaining 51% of Marca-Tel was owned by a Mexican individual and a
subsidiary of Fomento Radio Beep, S.A. de C.V. The other 50% of Progress was
owned by Westel International, Inc. Marca-Tel is developing a telecommunications
network in Mexico.
Through December 31, 1998, we had invested $44.8 million in Progress,
including $14.9 million made on behalf of Westel. In 1998 Westel agreed to give
us a note for $14.9 million to repay us for certain contributions previously
made to Progress on Westel's behalf. The balance of the note receivable from
Westel at December 31, 1998, was $9.4 million. The final note payment was due in
May 1999 and was secured by a
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portion of Westel's ownership in Progress. In March 1999 Westel agreed to
transfer certain of its share interest collateral to us as repayment of Westel's
note payable to us. We gave Westel the right to repurchase such share interests
no later than May 31, 1999.
We account for Progress and Marca-Tel using the equity method of
accounting. Through the third quarter of 1998, we recognized our share of losses
from Progress and Marca-Tel based on the relative amount of funds we contributed
to Progress compared to Westel. Beginning with the fourth quarter of 1998, the
sum of our remaining investment in Marca-Tel and the promissory note from Westel
was below zero due to the amount of losses we previously recorded; therefore, we
suspended recognition of losses from Marca-Tel. We will continue to suspend
recognition of losses until Marca-Tel begins reporting net income and all
suspended losses have been recovered.
In September 1995 Marca-Tel entered into an agreement with a vendor to
construct a portion of Marca-Tel's telecommunications network in Mexico and to
provide significant financing for construction and related equipment and fiber
purchases. The vendor has been granted security interests in all of Marca-Tel's
assets, including the telecommunications network, and the owners of Marca-Tel,
including Progress, have pledged their interests in Marca-Tel to collateralize
payment to the vendor. As of December 31, 1998, Marca-Tel owed approximately
$77.1 million to the vendor. In February 1999, Marca-Tel amended its credit
agreement with the vendor. Marca-Tel restructured its financing and deferred
certain payments until June of 1999. In exchange, Marca-Tel granted the vendor
the right to acquire up to ten percent of Marca-Tel's non-voting common shares.
As of March 1, 1999, the vendor owned 7% of the common equity of Marca-Tel. This
has diluted our ownership interest. Progress' overall ownership in Marca-Tel is
now 48%, and our indirect interest is now 24%. If Marca-Tel does not pay the
vendor, it will be in default under its amended credit agreement.
Marca-Tel has put further investment in new fiber routes on hold and
reduced its scope of operations, awaiting more suitable regulatory and market
conditions. We do not anticipate providing significant additional funding to
Progress for investment in Marca-Tel until the regulatory and market conditions
in Mexico improve. We are not obligated to continue to fund Progress or
Marca-Tel. Our existing indentures and our $600 million credit facility contain
significant limitations on the amount we may invest in Marca-Tel and other
non-majority owned entities. However, failure to provide further significant
funding to Progress may prevent Marca-Tel from meeting its financial obligations
and may result in the foreclosure of the vendor's security interest. Our
interest in Progress, and thus our indirect interest in Marca-Tel, could be lost
entirely.
EMPLOYEES
At December 31, 1998, we employed 1,567 people, of whom 568 provided
operational and technical services, 62 provided engineering services and the
balance were engaged in administration and marketing. Our employees are not
represented by any labor union. We consider our employee relations to be good
and have not experienced any work stoppages.
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RISK FACTORS
NEGATIVE CASH FLOW AND CAPITAL REQUIREMENTS
Significant Amount of Capital Expenditures Required in our Business
Our capital expenditures were $476.4 million and our interest cost
including capitalized interest was $47.9 million in 1998. Our earnings before
interest, taxes, depreciation and amortization, or EBITDA, were $90.7 million in
1998. Our cash flow from operating activities was $202.3 million and our net
loss was $162.5 million in 1998. We expect to make capital expenditures of over
$600 million during 1999 and substantial amounts thereafter. We expect to meet
the cash requirements of our capital expenditures from:
- cash on hand;
- cash flow from fiber sales and operations; and
- borrowings under our $600 million credit facility;
- additional equity and/or debt financings; and
- vendor financing, if available;
We expect to incur significant additional debt to fund our capital
expenditures and expand our business. Among other factors, cost-saving
arrangements, increases or decreases in traffic on our network, and unexpected
costs, delays or advances in the timing of capital expenditures may cause
capital expenditures to vary materially.
Our ability to make capital expenditures depends in part on:
- completing our network expansion as scheduled;
- satisfying our fiber sale obligations;
- entering into cost-saving arrangements with carriers or other large users
of fiber capacity;
- meeting financial covenants to allow borrowing under our bank credit
line;
- otherwise raising significant capital; and/or
- increasing cash flow.
Our failure to accomplish any of these may significantly delay or prevent
capital expenditures. If we are unable to make our capital expenditures as
planned, our business may grow slower than expected. This would have a material
adverse effect on our business, financial condition and results of operations
and the value of our securities.
Insufficient Cash Flow from Operations
We need cash to meet the operating expenses of our long distance switched
services and data/Internet businesses. These services are processed through
digital switches and delivered over long-haul circuits and other transmission
facilities. To offer long distance switched services, we installed switches and
connected them to our network and to the local exchange carriers or LECs, who
provide local telephone services. We acquired new software and hired personnel
to establish a national switched network. Our long distance switched services
business did not generate sufficient gross margins to cover the operating
expenses required to support this business. Our goals for continued gross margin
improvement include:
- obtaining traffic that meets our profitability requirements and aligns
with our current and planned network;
- identifying new high-value products and customers with large capacity
requirements;
- identifying Internet, intranet and data traffic opportunities; and
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- identifying joint venture and acquisition candidates to increase the flow
and mix of traffic on our network and increase our global reach.
We cannot guarantee that we will be able to generate sufficient gross
margins in the long distance switched services business in the future. For a
discussion of important factors that could cause the failure of our long
distance switched services business to generate sufficient gross margin, see
"-- Development Risks and Dependence on Long Distance Switched Services
Business."
Significant Amount of Interest and Dividend Payments
We currently make interest payments on our 9% Senior Subordinated Notes of
which there is $450 million in principal outstanding. We also make interest and
principal payments under a $28 million secured equipment financing facility with
NTFC Capital Corporation and Export Development Corporation of which $23.8
million was outstanding at December 31, 1998. In addition, we also make interest
payments on a $600 million credit agreement with institutional lenders of which
$200 million was borrowed at December 31, 1998. We will also have payments due
for other debts we may incur. Dividends on our 7 1/4% Convertible Preferred
Stock are payable quarterly in cash, except that such dividends may be paid in
additional shares of 7 1/4% Convertible Preferred Stock on or before March 31,
1999. Dividends on our 12 1/2% Exchangeable Preferred Stock are payable in cash
except that such dividends may be paid in shares of the same stock on or before
February 15, 2001. Dividends on our 6 3/4% Convertible Preferred Stock are
payable quarterly in cash, except that we may pay dividends using shares of
common stock if we are prohibited from paying dividends in cash under the terms
of our debt agreements. Our ability to meet our debt and dividend obligations
and to obtain additional funding could be impaired by the following factors:
- delays in our network expansion;
- larger than anticipated capital expenditures for our network; and
- continued negative cash flow from the long distance switched services
business.
Any of these factors would have a material adverse effect on our business,
financial condition and results of operations since we might not have sufficient
cash to make these payments when required. See "-- Risks Relating to the Network
Expansion and acquiring Rights-of-Way and Permits," and "-- Development Risks
and Dependence on Long Distance Switched Services Business."
We may have to curtail or delay our planned network expansion if we are
unable to obtain financing on acceptable terms, complete our existing fiber
sales, or sell additional equity and/or debt securities. Furthermore, we may be
required to obtain the consent of, or repay, our debtholders before acquiring
additional debt. Our failure to obtain additional financing or the decision to
cut back or delay our network expansion could have a material adverse effect on
our business, financial condition and results of operations and the value of our
securities.
The cash requirements described above do not include any cash that may be
required for acquisitions we may make. We have entered into an agreement to
acquire Coastal. We will be required to pay $62.5 million in cash and we have an
option to pay an additional $25 million in cash instead of using our common
stock to complete the acquisition. See "-- Growth Through Acquisitions;
Integration of Acquired Businesses."
SUBSTANTIAL INDEBTEDNESS AND ABILITY TO SERVICE DEBT
We have a substantial amount of debt. As of December 31, 1998, we had
approximately $679.0 million of long-term debt and capital lease obligations
principally consisting of the 9% Senior Subordinated Notes and the $200 million
credit agreement.
Under our credit facility with several institutional lenders, we may, if
certain conditions are met, borrow up to $600 million of which $200 million has
been borrowed as of December 31, 1998. We are in discussions with various
investment bankers, vendors and lending institutions regarding additional debt
financing transactions. If we complete additional debt financing transactions,
or if we exchange our 12 1/2% Exchangeable
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Preferred Stock for 12 1/2% Subordinated Exchange Debentures, as allowed under
our charter documents, our level of debt will increase even further.
Our large amount of indebtedness could significantly impact the holders of
our common stock and our other securities, due to the following:
- All or most of our cash flow from operations could be needed to meet our
debt obligations and would not be available for use in our business.
- We could be more vulnerable if there is a downturn in our business or in
general economic conditions or if interest rates increase.
- Our ability to obtain additional financing for working capital, capital
expenditures or other reasons may be limited.
- We may be at a competitive disadvantage with our competitors who are not
as highly leveraged.
Our ability to satisfy our debt obligations depends on our future operating
performance and our ability to obtain additional debt or equity financing.
Economic conditions and financial, business and other factors, many of which are
beyond our control, will affect our ability to make these payments. If we are
unable to generate sufficient cash from operations to make the scheduled
payments on our 9% Senior Subordinated Notes or meet our other obligations, we
will need to refinance or obtain additional financing. We cannot assure you that
our cash flow from operations will be sufficient to meet our debt obligations as
they become due or that we will be able to satisfy the dividend and redemption
requirements of our preferred stock for the next several years. If we do not
substantially improve our operating results, we could face significant liquidity
problems which would require us to raise additional capital by issuing debt or
equity securities. We cannot assure you that we will be successful in obtaining
such financing.
RECENT AND EXPECTED LOSSES
We reported a net loss of $162.5 million for the year ended December 31,
1998 and a net loss of $99.2 million for the year ended December 31, 1997. These
net losses may continue. During the remainder of 1999 and thereafter, our
ability to generate operating income, EBITDA and net income will depend largely
on demand for the private line circuits constructed in our network expansion and
the success of our long distance switched services and data services. We cannot
assure you that we will be profitable in the future. Failure to accomplish these
goals will impair our ability to:
- meet our obligations under the 9% Senior Subordinated Notes, our $600
million credit facility, or other indebtedness;
- pay dividends on our preferred stock; or
- raise additional equity or debt financing needed to expand our network or
for other reasons.
These events could have a material adverse effect on our business,
financial condition and results of operations and the value of our securities.
RISKS RELATING TO THE NETWORK EXPANSION AND ACQUIRING RIGHTS-OF-WAY AND PERMITS
Our continuing network expansion is an essential element of our future
success. In the past, we have experienced delays in constructing our network and
may experience similar delays in the future. These delays have prevented us from
transferring long distance traffic from leased facilities to our facilities. We
have substantial existing commitments to purchase materials and labor for
expanding our network. In addition, we will need to obtain additional materials
and labor that may cost more than anticipated. Some sections of our network are
constructed by other carriers or their contractors pursuant to cost-saving
arrangements. One type of cost-saving arrangement is where another carrier
constructs a route and includes additional fibers for our use. We cannot
guarantee that these third parties will complete their work according to
schedule. If any delays prevent or slow down our network expansion our financial
results and the value of our securities would be materially and adversely
effected.
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The expansion of our network depends, among other things, on acquiring
rights-of-way and required permits from railroads, utilities and governmental
authorities on satisfactory terms and conditions and on financing such
expansion, acquisition and construction. In addition, after our network is
completed and required rights and permits are obtained, we cannot guarantee that
we will be able to maintain all of the existing rights and permits. If we fail
to obtain rights and permits or we lose a substantial number of rights and
permits our financial results would suffer which could have a material adverse
effect on our business, financial condition and results of operation and the
value of our securities.
RISK OF NETWORK FAILURE
To successfully market our services to business and government users, our
network must have sufficient capacity and be reliable and secure. Our network
and other companies' networks that we use can sometimes experience physical
damage, power loss, capacity limitations, software defects, breaches of security
(by computer virus, break-ins or otherwise) and other disruptions. All of these
hazards may cause interruptions in service or reduced capacity for customers.
Poor service due to interruptions or reduced capacity could negatively impact
our business, financial condition and results of operations and the value of our
securities.
PRICING PRESSURES DUE TO INDUSTRY OVER-CAPACITY
The long distance transmission industry has generally been characterized by
over-capacity and declining prices since shortly after the AT&T break-up in
1984. We believe that in the last several years, increased demand has somewhat
reduced the excess capacity and as a result, reduced competition in pricing.
However, we anticipate that our prices will continue to decline over the next
several years because of new competition. Other long distance carriers (new and
existing) are expanding their capacity and may construct new fiber optic and
other long distance transmission networks. As a result of the recent mergers,
companies such as MCIWorldCom, Inc. and Qwest have become stronger competitors
with larger networks and greater capacity. In addition, the Williams Companies,
Inc. has also announced that it is accelerating the expansion of its national
fiber optic network with a $2.7 billion investment to create a 32,000 mile
system by the end of 2000. There can be significant barriers to building a fiber
optic network for companies entering the long distance business, including
substantial construction costs, the difficulty and expense of securing
rights-of-way, establishing and maintaining a sufficient customer base,
recruiting and retaining personnel and maintaining a reliable network. We
believe that although some new entrants face these barriers, others (such as
Qwest, utility companies or railroads which already have significant
rights-of-way) may not experience some or any of these difficulties. For
example, Level 3 Communications, Inc. has announced it is constructing a 15,000
mile fiber optic communications network using Internet technology, with
completion expected in the first quarter of 2001.
Not only are our competitors expanding existing networks and building new
networks, these networks will have greater capacity. Because the cost of fiber
is a relatively small portion of the cost of building new transmission lines,
companies building such lines are likely to install fiber that provides far 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 us to increase our network's capacity, an
increase in our competitors' capacity could adversely affect our business. If
overall capacity in the industry exceeds demand in general or along any of our
routes, severe additional pricing pressure could develop. 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 much more
expensive than local calls. In addition, several companies (including AT&T and
ICG Communications, Inc.) have announced plans to offer long distance voice
telephony over the Internet at substantially reduced prices. Price reductions
could have a negative and material impact on our business and the value of our
securities.
DEVELOPMENT RISKS AND DEPENDENCE ON LONG DISTANCE SWITCHED SERVICES BUSINESS
Our success in the long distance switched services business depends on
generating significant customer traffic, managing an efficient switched long
distance network, providing reliable customer service and
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completing our network expansion on schedule. We have only been managing a
switched long distance network since 1996 and we cannot assure you that this
segment of our business can generate significant gross profits. Our failure to
accomplish any of our objectives would have a material adverse effect on our
results of operations. Our long distance switched services business requires
cash to meet its operating expenses and has generated low gross margins since
1998 due to access costs and uneven traffic patterns creating high network
overflow costs. These gross margins are too low to fund the operating costs
supporting the switched services business.
Access charges are the fees paid by long distance carriers to LECs for
originating and terminating long distance calls on their local networks. In
1998, the FCC mandated a new rate structure for access charges in which a fixed
charge was instituted for connections to the LECs' serving wire centers (direct
trunk transport charge). This charge was in addition to the existing unitary
charge assessed on a minutes of use basis. Large carriers who connect directly
to the LECs' local end office facilities are able to avoid a large portion of
the direct trunk transport charge, and therefore, benefit from the new access
structure. Connection to local end office facilities is economically justifiable
only where there are large minute of use volumes. Because our volumes do not
justify as many direct local office connections as do the volumes of larger
carriers, we may be at a cost disadvantage, versus our larger competitors.
We seek to improve the gross margins generated by our long distance
switched services business by expanding our network, by increasing the number of
our end-user customers who are medium size businesses, and by increasing our
suite of higher-value services. Important factors, some of which are beyond our
control, which could cause the failure of our long distance switched services
business to generate higher gross margin include:
- changes in reseller customers' businesses;
- an inability to attract new customers or problems with transferring them
to our network;
- loss of existing customers;
- problems operating the switched network;
- customer billing issues;
- credit and collection issues;
- delays in expanding our network; and
- increased expenses related to access charges and network overflow.
Our long distance switched services business credit risk is substantially
greater than that for our private line business. This is because long distance
switched services customers are billed at the end of the month on the basis of
minutes of use and because many long distance switched services customers are
not as well capitalized as most of our private line customers.
RISKS INHERENT IN RAPID GROWTH
Part of our business strategy is to grow quickly by expanding our long
distance switched services and data/Internet businesses through selective
acquisitions and expanding our network. In addition, we may grow by acquiring
resellers of long distance services, such as Coastal, Eclipse and Telecom One,
which we believe provide a strategic fit with our business and network. See
"-- Growth Through Acquisitions; Integration of Acquired Businesses." Rapid
growth has placed, and will continue to place, a significant and increasing
strain on our financial, management, technical, information and accounting
resources. See "-- Dependence on Billing, Customer Services and Information
Systems." Our continued rapid growth requires:
- hiring and training new personnel;
- satisfactory performance by our customer interface and billing systems;
- developing and introducing new products; and
- controlling our expenses.
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If we fail to satisfy these requirements, or otherwise manage our growth
effectively, our business and the value of our securities would be materially
and adversely effected.
DEPENDENCE ON BILLING, CUSTOMER SERVICES AND INFORMATION SYSTEMS
Sophisticated information and processing systems are vital to our growth
and our ability to monitor costs, bill customers, fill customer orders and
efficiently operate our business. In the past, we have produced billing and
information systems in-house with partial reliance on third-party vendors. These
systems have generally met our needs due in part to the low volume of customer
billing. As our long distance operation grows, the need for sophisticated
billing and information systems will significantly increase. As we integrated
Eclipse's operations, some billing system issues arose which increased our
customer turnover. These issues are being addressed and corrected. No assurance
can be given that these difficulties will be solved quickly or completely.
The development and implementation of our future billing systems relies,
for the most part, on third party vendors delivering products and services. The
following could have a material adverse effect on our business, financial
condition and results of operations:
- vendors failing to deliver proposed products and services in a timely and
effective manner and at acceptable costs;
- our failure to adequately identify all of our information and processing
needs;
- the failure of our related processing or information systems, including a
failure to solve current difficulties; or
- our failure to upgrade systems as necessary.
YEAR 2000 RISKS
Some of our older computer programs identify years with two digits instead
of four. It is possible that some of our programs may recognize the Year 2000 as
the year 1900. These Year 2000 problems could result in a system failure or
miscalculations that disrupt operations, including a temporary inability to
process transactions, send invoices or engage in similar normal business
activities. We have identified the programs that will have to be modified or
replaced in order to function properly in the Year 2000 and thereafter. We
believe that the cost of modifying those systems that were not already scheduled
for replacement for business reasons before 2000 is immaterial. Updating the
current software to be Year 2000-compliant is scheduled to be completed by
mid-1999, before any anticipated impact on operating systems. We do not expect
Year 2000 problems to have a material adverse effect on our internal operations,
but it is possible that they could have a material adverse effect on our
customers, suppliers and other business partners and their ability to provide
service or accurate invoices for services and to accurately process payments. It
is also possible that Year 2000 problems could have a material adverse effect on
our customers and their ability to continue using our services, to collect from
their customers and to pay us for services. The cumulative effect of such
problems, if they occur, could negatively impact our business, financial
condition and results of operations and the value of our securities.
GROWTH THROUGH ACQUISITIONS; INTEGRATION OF ACQUIRED BUSINESSES
Part of our growth strategy includes the possible acquisition of
businesses, assets or securities of companies that we believe provide a
strategic fit with our business and our network. The success of our strategy is
dependent on our ability to identify suitable acquisition candidates, acquire
such companies on suitable terms and integrate their operations with our
operations. We may be unable to acquire other companies on suitable terms or
otherwise successfully expand our business and product offerings through
acquisitions. Moreover, other telecommunications companies are actively
competing for acquisition candi-
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dates, which may result in an increase in the price of acquisition candidates.
Risks commonly associated with acquisitions include:
- potential exposure to unknown liabilities of acquired companies;
- difficulty and expense of integrating the operations, personnel, and
billing systems of the companies;
- potential disruption to our business;
- potential diversion of management time and attention;
- strained relationships with, and the possible loss of, key employees and
customers of the acquired business;
- increased amortization expense if an acquisition is accounted for as a
purchase; and
- dilution to our stockholders if the acquisition is made for stock.
We continually review and evaluate acquisition candidates to complement and
expand our business, and are at various stages of evaluation and discussion with
a number of such candidates. We have not entered into a definitive purchase or
acquisition agreement for any acquisition candidate other than Coastal and there
is no assurance that we will complete a transaction with any of the candidates
with whom we are currently in negotiations. In addition, it is possible that a
substantial number of shares of our common stock or a significant amount of cash
could be used for one or more acquisitions. We intend, when possible, to use our
common stock to pay for all or a portion of the purchase price for future
acquisitions. Our ability to use our common stock could be adversely affected if
our common stock does not maintain sufficient value, potential acquisition
candidates are unwilling to accept our common stock as consideration for the
sale of their businesses, or we do not have a sufficient number of authorized
shares of common stock to effect such acquisition.
Any acquired businesses will need to be integrated with our existing
operations. This will entail, among other things, integration of switching,
transmission, technical, sales, marketing, billing, accounting, quality control,
management, personnel, payroll, regulatory compliance and other systems and
operating hardware and software, some or all of which may be incompatible with
our existing systems. We have limited expertise dealing with these problems. We
cannot assure you that services, technologies or businesses of acquired
companies will be effectively assimilated into our business or product offerings
or that they will contribute materially to our revenues or earnings. In
particular, transferring substantial amounts of additional traffic to our
network can cause service interruptions and integration problems. The risks
associated with acquisitions could have a material adverse effect on our
business, financial condition and results of operations and the value of our
securities.
RELIANCE ON MAJOR CUSTOMERS
A relatively small number of customers account for a significant amount of
our total revenues. Our 10 largest customers in 1998 accounted for approximately
46.7% of our revenues. Our 10 largest customers in 1997 accounted for
approximately 49.2% of our revenues.
Most of our arrangements with large customers do not provide any guarantees
that they will continue using our services at current levels. In addition, if
our customers build their own facilities, our competitors build additional
facilities or there are further consolidations in the telecommunications
industry involving our customers, then our customers could reduce or stop their
use of our services which could have a material adverse effect on our business,
financial condition and results of operations.
DEPENDENCE UPON SOLE AND LIMITED SOURCES OF SUPPLY
We rely on other companies to supply key components of our network
infrastructure, including telecommunications services, network capacity and
switching and networking equipment. These components are available only from
sole or limited sources in the quantity and quality that we demand. We also
depend on LECs to provide telecommunications services and facilities. In the
past, we have experienced delays in receiving telecommunications services and
facilities, and we cannot be certain that we will be able to obtain
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such services or facilities at an affordable cost, or at all in the future. If
we can not obtain such services or additional capacity on a timely basis or at
an affordable cost, our business, financial condition and results of operations
would be materially and adversely effected. We also depend on our suppliers for
products that comply with various Internet and telecommunications standards,
work with products from other vendors and correctly function in our network. If
our suppliers failed to provide such products, our business, financial condition
and results of operations would be materially and adversely affected.
COMPETITION
The telecommunications industry is highly competitive. Many of our
competitors and potential competitors have far greater financial, personnel,
technical, marketing and other resources than we do. Many also have a more
extensive transmission network. These competitors may build additional fiber
capacity in the geographic areas that our network serves or in which we plan to
expand. Qwest, for example, is building a new nationwide long distance fiber
optic network and Frontier Corporation has agreed to pay $500 million to obtain
fibers in Qwest's network. In addition, MCIWorldCom and Qwest have each become
larger competitors of ours in connection with recent mergers. Furthermore,
Williams' announced network expansion and Level 3's proposed new network will
provide additional competition. Many telecommunications companies are acquiring
switches and our reseller customers will have more alternatives for meeting
their switched long distance services needs. We compete primarily on the basis
of pricing, availability, transmission quality, customer service (including the
capability of making rapid additions to add end users and access to end-user
traffic records) and variety of services. Our ability to compete effectively
depends on our ability to maintain high-quality services at prices generally
equal to or lower than those of our competitors.
An alternative method of transmitting telecommunications traffic is through
satellite transmission. Satellite transmission is superior to fiber optic
transmission for distribution communications, like 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 an approximately
one-quarter-second delay, this slight time delay is unimportant for many
data-oriented uses. If the market for data transmission grows, we will compete
with satellite carriers in that market. Also, at least one satellite company has
announced its intention to provide Internet access services to businesses
through satellite technology.
We compete with large and small facilities-based interexchange carriers as
well as with other coast-to-coast and regional fiber optic network providers. We
also sell long distance switched services to both facilities-based carriers and
non-facilities-based carriers (switchless resellers), competing with
facilities-based carriers such as AT&T, MCIWorldCom and Sprint, and certain
regional carriers. Our competition is based on such factors as price,
transmission quality, network reliability and customer service and support. Our
ability to compete effectively in our markets depends upon our ability to
maintain high quality services at prices equal to or less than those of our
competitors, many of whom have extensive experience in the long distance market.
In addition, the federal government enacted the Telecom Act, which allows the
RBOCs and others to enter the long distance market. When RBOCs enter the long
distance market, they may acquire, or take substantial business from, our
customers or us. We cannot assure you that we will be able to compete
successfully with existing competitors or new entrants in our markets. Our
failure to do so would have a material adverse effect on our business, financial
condition and results of operations and the value of our securities. See
"-- Risks Related to Technological Change" and "Business -- Regulation."
On February 15, 1997, the United States Trade Representative designate
announced that an agreement had been reached with World Trade Organization
countries to open world telecommunications markets to competition. The
agreement, known as the WTO Basic Telecommunications Services Agreement or the
WTO Agreement, became effective on February 5, 1998. The WTO Agreement provides
U.S. companies with foreign market access for local, long distance, and
international services, either on a facilities basis or through resale of
existing network capacity. The WTO Agreement also provides that U.S. companies
can acquire, establish or hold a significant stake in telecommunications
companies around the world. Conversely, foreign companies will be permitted to
enter domestic U.S. telecommunications markets and acquire ownership interest in
U.S. companies. On June 4, 1997, the Federal Communications Commission or the
FCC initiated a rulemaking proceeding to bring FCC policies and procedures into
conformance with the WTO Agreement. On
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November 26, 1997, the FCC released an order on foreign entry, although a
petition for reconsideration of the order is pending. While the outcome of the
petition for reconsideration cannot be predicted, foreign telecommunications
companies could also be significant new competitors to our customers or us. See
"Business -- Industry Overview," "Business -- Private Line Services" and
"Business -- Long Distance Switched Services."
DEVELOPMENT RISKS OF THE ATM-FRAME RELAY TRANSMISSION BUSINESS
We began offering ATM-Frame Relay and other data transmission services
during the first quarter of 1997. Although we have not yet generated significant
revenues from this business, we believe that Internet related services and data
transmission services present a promising opportunity for us. To succeed in
providing these services, we must compete with AT&T, Sprint, MCIWorldCom and
other large competitors. In addition, we expect that we will need to continue to
upgrade our network (in advance of related revenues) to be competitive.
Providing Internet and data transmission services involves technical issues with
which we have limited experience. In addition, providing these services must be
successfully integrated with our existing businesses. Unless we are able to
successfully compete in providing these services, we will not realize a return
on our investment in data switches and other equipment and we will not benefit
from the growth, if any, in demand for these services. A failure to successfully
compete in Internet related services and data transmission services could have a
material adverse effect on our business, financial condition and results of
operations and the value of our securities.
RECENT LEGISLATION AND REGULATORY UNCERTAINTY
Some of our operations are regulated by the FCC under the Communications
Act of 1934. In addition, some of our businesses are regulated by state public
utility or public service commissions. Regulatory or interpretive changes in
existing legislation or new legislation that affects our operations could have a
material adverse effect on our business, financial condition and results of
operations. In 1996 the federal government enacted the 1996 Telecom Act, which,
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 our customers or us. We anticipate that some entrants will be strong
competitors because, among other reasons, they may:
- be well capitalized;
- already have substantial end-user customer bases; and/or
- enjoy cost advantages relating to local loops and access charges.
The addition of strong competitors into the switched long distance business
could have a material adverse effect on our business, financial condition and
results of operations.
In July 1997, the United States Court of Appeals for the Eighth Circuit
invalidated key portions of the FCC's interconnection order, which the FCC
adopted to facilitate local exchange competition. On January 25, 1999, the
Supreme Court overturned the Eighth Circuit's ruling and reinstated most aspects
of the FCC's interconnection rules. The Supreme Court remanded to the FCC one
issue relating to interconnection, which will likely delay the further emergence
and development of local exchange competition. Consequently, neither our
customers nor we may benefit as quickly from the lower access costs that might
have resulted if competition in providing local access services was not delayed.
Further, the FCC issued orders relating to universal service funding by
interstate telecommunications carriers, and to the access charges we and our
customers are required to pay to LECs. The FCC's access charge reform order was
recently affirmed after a lengthy appeal. The FCC has since sought additional
comments on access charge reform, but the outcome of this and any future FCC
proceedings are impossible to predict. In addition, the Telecom Act provides
that state proceedings may, in certain instances, determine access charges that
our customers and we are required to pay to the LECs. These proceedings could
result in rate increases that could have a material adverse effect on our
customers and us. See "Business -- Industry Overview;" and
"Business -- Regulation."
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Some members of Congress are dissatisfied with the Telecom Act, and in
particular with the development of local exchange competition, RBOC re-entry
into in-region long distance markets and universal service funding. It is
possible that additional legislation will also be introduced to further amend
the Telecom Act. However, it is impossible to predict the scope or likelihood of
success of any possible further legislation, or the potential impact of any
possible further legislation.
RISKS RELATING TO MARCA-TEL
Marca-Tel has put further investment in new fiber routes on hold and
reduced its scope of operations, awaiting more suitable regulatory and market
conditions. At the present time, we do not anticipate significant additional
funding to Progress for investment in Marca-Tel until the regulatory and market
conditions in Mexico improve. We are not obligated to continue to fund Progress
or Marca-Tel. Our existing indentures and our $600 million credit facility
contain significant limitations on the amount we may invest in Marca-Tel and
other non-majority owned entities. Although Marca-Tel amended its credit
agreement in February 1999 allowing it to defer certain payments until June
1999, we cannot assure you that Marca-Tel will be able to make payments at that
time or at any time in the future. A default such as this could result in the
foreclosure of the creditor's security interest in all of Marca-Tel's assets. If
that occurs, our investment in Marca-Tel could be further diluted or entirely
lost.
POTENTIAL LIABILITY OF INTERNET ACCESS PROVIDERS
We provide services to on-line service providers and Internet access
providers. We also own approximately 10.2 million shares of common stock of
PSINet, an Internet access provider. The law governing the liability of on-line
services providers and Internet access providers for information carried on or
disseminated through their networks is unsettled. Under the 1996 Telecom Act,
both civil and criminal penalties can be imposed for the use of interactive
computer services for the transmission of certain indecent or obscene
communications. However, some of these provisions were recently held
unconstitutional by the Supreme Court. Other provisions of the Communications
Decency Act have been challenged in court proceedings which are ongoing. In
addition, Congress recently passed the Child Online Protection Act, which
currently is subject to a temporary injunction. Nonetheless, many states have
adopted or are considering adopting similar requirements, and the
constitutionality of these state requirements remains unsettled. In addition,
several private lawsuits have been filed seeking to hold Internet access
providers accountable for information which they transmit. In one case, the
court ruled that an Internet access provider is not directly liable for copies
that are made and stored on its computer but may be held liable as a
contributing infringer where, with knowledge of the infringing activity, the
Internet access provider induces, causes or materially contributes to another
person's infringing conduct. As the law in this area develops, potential
imposition of liability on Internet access providers for information carried on
or disseminated through their networks could materially change the way they
conduct business. To avoid undue exposure to liability, Internet access
providers could be compelled to engage in burdensome investigation of subscriber
materials or even discontinue offering the service altogether.
RISKS RELATING TO SWITCHED SERVICES
Switched services resellers account for a substantial portion of our long
distance switched services revenue. A substantial portion of revenue is derived
from a limited number of switched services resellers. Sales to switched services
resellers generate low margins for us. In addition, these customers frequently
choose to move their business to other carriers based solely on small price
changes and generally are perceived to have a high risk of payment delinquency
or non-payments. Our service credits and bad debt in the past have been as
follows:
SERVICE CREDIT AND PERCENT OF
PERIOD BAD DEBT (IN MILLIONS) TOTAL REVENUE
------ ---------------------- -------------
Year Ended
1996......... $ 6.3 2.2%
Year Ended
1997......... $20.8 4.0%
Year Ended
1998......... $55.1 8.2%
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We seek to control service credits and bad debts by implementing procedures
to improve our billing accuracy and control our credit exposure. Any significant
increase in service credit and bad debt expense as a percentage of revenues
could have a material adverse effect on our business, financial condition and
results of operations.
RISKS RELATED TO TECHNOLOGICAL CHANGE
The market for our telecommunications services is characterized by rapidly
changing technology, evolving industry standards, emerging competition and
frequent new product and service introductions. We cannot guarantee that we will
successfully identify new service opportunities and develop and bring new
services to market. There is also a risk that fundamental changes in the way
telecommunications services are marketed and delivered will occur. We assume
that technology such as ATM-Frame Relay protocols and using fiber optic or
copper-based telecommunications infrastructures will continue to be the primary
protocols and transport infrastructure for data communications services. Future
technological changes, including changes related to the emerging wireline and
wireless transmission and switching technologies, could have a material adverse
effect on our business, results of operations, and financial condition. Our
pursuit of necessary technological advances may require substantial time and
expense. We cannot be certain that we will succeed in adapting our
telecommunications services business to alternate access devices, conduits and
protocols.
In addition, recent technological advances with the potential to greatly
expand the capacity of existing and new fiber optic cable, which could greatly
increase supply, could have a material adverse effect on our business, financial
condition, and results of operations and the value of our securities.
STOCKHOLDER RIGHTS PLAN AND OTHER CHANGE IN CONTROL IMPEDIMENTS
In September 1998, we adopted a stockholder rights agreement that permits
owners of our common stock to purchase shares of common stock at one-half of its
fair market value in limited instances. Each share of common stock is entitled
to one right. These rights are exercisable if a person or group acquires 20% or
more of our common stock or announces a tender offer for 20% or more of our
common stock. The rights are also exercisable if a stockholder currently holding
more than 20% of our outstanding stock acquires any additional shares of our
common stock. Our stockholder rights agreement may prevent or deter acquisitions
of more than 20% of our common stock and ultimately an acquisition of IXC. In
addition, certain covenants in our debt and preferred securities may require us
to offer to repurchase or adjust the conversion price of such securities in the
event of a change in control of IXC. These covenants may prevent, deter or
adversely affect the value of our common stock in connection with an acquisition
of IXC involving a change in control.
CONCENTRATED OWNERSHIP OF CONTROL GROUP
At December 31, 1998, Trustees of General Electric Pension Trust
beneficially owned approximately 26.5% of our outstanding common stock, Grumman
Hill Investments, L.P., Richard D. Irwin and their affiliates together
beneficially owned approximately 9% of our outstanding common stock, and one
director, one executive officer and their affiliates beneficially owned
approximately 10.8% of our outstanding common stock. As a result, certain of
these stockholders, if they act with others so as to constitute a majority,
generally would be able to elect a majority of directors elected by the holders
of our common stock and exercise control over our business, policies and
affairs, and would have the power to approve or disapprove most actions
requiring stockholder approval without the approval of minority stockholders.
ITEM 2. PROPERTIES
The principal properties we own consist of: (i) certain portions of our
network completed or under construction; and (ii) the coast-to-coast microwave
system, consisting of microwave transmitters, receivers, towers and antennae,
auxiliary power equipment, transportation equipment, equipment shelters and
miscellaneous components. Generally, fiber optic system and microwave relay
system components are standard commercial products available from a number of
suppliers. The use of all these assets are shared by all of our segments of
business.
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Our principal offices are located in Austin, Texas, comprising two separate
office leases. In 1999, we added a third office space in Austin. We lease these
three offices pursuant to the terms of the respective leases which expire at
different times varying from January 2002 to December 2004. In addition, we
sublease former office space in two other locations in Austin. The sublease
payments satisfy our monthly rental oblig