-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N1xBSdpi2JXxNOqIR6t5dXe/sX20eicjBMOWhCKv08tgdT0G9p8lNbxHG/N2Glpz rXmv1Iihu8e0W6yI+AofzQ== 0001005477-01-502009.txt : 20020410 0001005477-01-502009.hdr.sgml : 20020410 ACCESSION NUMBER: 0001005477-01-502009 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WORLDCOM INC/GA// CENTRAL INDEX KEY: 0000723527 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 581521612 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10415 FILM NUMBER: 1790951 BUSINESS ADDRESS: STREET 1: 500 CLINTON CENTER DRIVE CITY: CLINTON STATE: MS ZIP: 39056 BUSINESS PHONE: 6014605600 FORMER COMPANY: FORMER CONFORMED NAME: LDDS COMMUNICATIONS INC /GA/ DATE OF NAME CHANGE: 19930916 FORMER COMPANY: FORMER CONFORMED NAME: MCI WORLDCOM INC DATE OF NAME CHANGE: 19980914 FORMER COMPANY: FORMER CONFORMED NAME: WORLDCOM INC /GA/ DATE OF NAME CHANGE: 19970127 10-Q 1 d01-35105.txt FORM 10-Q - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2001 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: 0-11258 ---------- WORLDCOM, INC. (Exact name of registrant as specified in its charter) ---------- Georgia 58-1521612 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 500 Clinton Center Drive, Clinton, Mississippi 39056 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (601) 460-5600 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 |_| Common shares outstanding, net of treasury shares, at October 31, 2001: WorldCom group common stock 2,959,402,201 MCI group common stock 118,323,949
- -------------------------------------------------------------------------------- QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of December 31, 2000 and September 30, 2001 .................. 3 Consolidated Statements of Operations for the three and nine months ended September 30, 2000 and September 30, 2001 .................................... 4 Consolidated Statements of Cash Flows for the nine months ended September 30, 2000 and September 30, 2001 .................................... 5 Notes to Consolidated Financial Statements ................... 6 Combined Financial Statements of WorldCom group (an integrated business of WorldCom, Inc.) ................ 26 Combined Financial Statements of MCI group (an integrated business of WorldCom, Inc.) ................ 36 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............. 42 Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 62 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................ 63 Item 2. Changes in Securities and Use of Proceeds .................... 63 Item 3. Defaults Upon Senior Securities .............................. 63 Item 4. Submission of Matters to a Vote of Securities Holders ........ 63 Item 5. Other Information ............................................ 63 Item 6. Exhibits and Reports on Form 8-K ............................. 63 Signature .............................................................. 64 Exhibit Index .............................................................. 65 2 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited. In Millions, Except Share Data)
December 31, September 30, 2000 2001 ------------ ------------- ASSETS Current assets: Cash and cash equivalents $ 761 $ 2,581 Accounts receivable, net of allowance for bad debts of $1,532 in 2000 and $1,412 in 2001 6,815 5,648 Deferred tax asset 172 249 Other current assets 2,007 2,050 --------- --------- Total current assets 9,755 10,528 --------- --------- Property and equipment: Transmission equipment 20,288 22,053 Communications equipment 8,100 7,313 Furniture, fixtures and other 9,342 11,007 Construction in progress 6,897 6,839 --------- --------- 44,627 47,212 Accumulated depreciation (7,204) (9,061) --------- --------- 37,423 38,151 --------- --------- Goodwill and other intangible assets 46,594 50,820 Other assets 5,131 5,403 --------- --------- $ 98,903 $ 104,902 ========= ========= LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 7,200 $ 1,109 Accounts payable and accrued line costs 6,022 4,770 Other current liabilities 4,451 4,928 --------- --------- Total current liabilities 17,673 10,807 --------- --------- Long-term liabilities, less current portion: Long-term debt 17,696 30,161 Deferred tax liability 3,611 3,310 Other liabilities 1,124 632 --------- --------- Total long-term liabilities 22,431 34,103 --------- --------- Commitments and contingencies Minority interests 2,592 110 Company obligated mandatorily redeemable and other preferred securities 798 1,975 Shareholders' investment: Series B preferred stock, par value $.01 per share; authorized, issued and outstanding: 10,693,437 shares in 2000 and 621,670 shares in 2001 (liquidation preference of $1.00 per share plus unpaid dividends) -- -- Preferred stock, par value $.01 per share; authorized: 31,155,008 shares in 2000 and 2001; none issued -- -- Common stock: WorldCom, Inc. common stock, par value $.01 per share; authorized: 5,000,000,000 shares in 2000 and none in 2001; issued and outstanding: 2,887,960,378 shares in 2000 and none in 2001 29 -- WorldCom group common stock, par value $.01 per share; authorized: none in 2000 and 4,850,000,000 shares in 2001; issued and outstanding : none in 2000 and 2,965,789,112 shares in 2001 -- 30 MCI group common stock, par value $.01 per share; authorized: none in 2000 and 150,000,000 shares in 2001; issued and outstanding: none in 2000 and 118,591,409 in 2001 -- 1 Additional paid-in capital 52,877 54,271 Retained earnings 3,160 4,257 Unrealized holding gain on marketable equity securities 345 10 Cumulative foreign currency translation adjustment (817) (477) Treasury stock, at cost, 6,765,316 shares of WorldCom, Inc. in 2000, 6,765,316 shares of WorldCom group stock and 270,613 shares of MCI group stock in 2001 (185) (185) --------- --------- Total shareholders' investment 55,409 57,907 --------- --------- $ 98,903 $ 104,902 ========= =========
The accompanying notes are an integral part of these statements. 3 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited. In Millions, Except Per Share Data)
For the Three Months Ended For the Nine Months Ended September 30, September 30, -------------------------- ------------------------- 2000 2001 2000 2001 -------- ------- -------- -------- Revenues $ 10,037 $ 8,966 $ 29,456 $ 26,701 -------- ------- -------- -------- Operating expenses: Line costs 3,867 3,745 11,376 11,171 Selling, general and administrative 3,081 2,517 7,847 8,503 Depreciation and amortization 1,237 1,524 3,570 4,266 -------- ------- -------- -------- Total 8,185 7,786 22,793 23,940 -------- ------- -------- -------- Operating income 1,852 1,180 6,663 2,761 Other income (expense): Interest expense (245) (442) (699) (1,095) Miscellaneous 107 107 327 330 -------- ------- -------- -------- Income before income taxes, minority interests and cumulative effect of accounting change 1,714 845 6,291 1,996 Provision for income taxes 688 329 2,554 773 -------- ------- -------- -------- Income before minority interests and cumulative effect of accounting change 1,026 516 3,737 1,223 Minority interests (75) 20 (225) 20 -------- ------- -------- -------- Income before cumulative effect of accounting change 951 536 3,512 1,243 Cumulative effect of accounting change (net of income tax of $50 in 2000) -- -- (85) -- -------- ------- -------- -------- Net income 951 536 3,427 1,243 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 43 49 75 -------- ------- -------- -------- Net income applicable to common shareholders $ 935 $ 493 $ 3,378 $ 1,168 ======== ======= ======== ======== Net income attributed to WorldCom group before cumulative effect of accounting change $ 583 $ 460 $ 2,023 $ 1,102 ======== ======= ======== ======== Cumulative effect of accounting change $ -- $ -- $ (75) $ -- ======== ======= ======== ======== Net income attributed to WorldCom group $ 583 $ 460 $ 1,948 $ 1,102 ======== ======= ======== ======== Net income attributed to MCI group before cumulative effect of accounting change $ 352 $ 33 $ 1,440 $ 66 ======== ======= ======== ======== Cumulative effect of accounting change $ -- $ -- $ (10) $ -- ======== ======= ======== ======== Net income attributed to MCI group $ 352 $ 33 $ 1,430 $ 66 ======== ======= ======== ======== Earnings per common share: PRO FORMA WorldCom group: ------------------------------------------------- Net income attributed to WorldCom group before cumulative effect of accounting change: Basic $ 0.20 $ 0.16 $ 0.71 $ 0.38 ======== ======= ======== ======== Diluted $ 0.20 $ 0.16 $ 0.69 $ 0.38 ======== ======= ======== ======== Cumulative effect of accounting change $ -- $ -- $ (0.03) $ -- ======== ======= ======== ======== Net income attributed to WorldCom group: Basic $ 0.20 $ 0.16 $ 0.68 $ 0.38 ======== ======= ======== ======== Diluted $ 0.20 $ 0.16 $ 0.67 $ 0.38 ======== ======= ======== ======== MCI group: Net income attributed to MCI group before cumulative effect of accounting change: Basic $ 3.06 $ 0.28 $ 12.52 $ 0.56 ======== ======= ======== ======== Diluted $ 3.06 $ 0.28 $ 12.52 $ 0.56 ======== ======= ======== ======== Cumulative effect of accounting change $ -- $ -- $ (0.09) $ -- ======== ======= ======== ======== Net income attributed to MCI group: Basic $ 3.06 $ 0.28 $ 12.43 $ 0.56 ======== ======= ======== ======== Diluted $ 3.06 $ 0.28 $ 12.43 $ 0.56 ======== ======= ======== ========
The accompanying notes are an integral part of these statements. 4 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited. In Millions)
For the Nine Months Ended September 30, ------------------------- 2000 2001 ---------- --------- Cash flows from operating activities: Net income $ 3,427 $ 1,243 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change 85 -- Minority interests 225 (20) Depreciation and amortization 3,570 4,266 Provision for deferred income taxes 850 477 Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net (890) (25) Other current assets (627) 56 Accounts payable and other current liabilities (361) (604) All other operating activities (372) 379 -------- ------- Net cash provided by operating activities 5,907 5,772 -------- ------- Cash flows from investing activities: Capital expenditures (8,777) (6,086) Acquisitions and related costs (14) (167) Increase in intangible assets (725) (544) Decrease in other liabilities (659) (425) All other investing activities (400) (215) -------- ------- Net cash used in investing activities (10,575) (7,437) -------- ------- Cash flows from financing activities: Principal borrowings on debt, net 4,467 4,062 Common stock issuance 551 112 Distributions on mandatorily redeemable and other preferred securities and dividends paid on preferred stock (49) (58) Redemptions of preferred stock (190) (200) All other financing activities (75) (272) -------- ------- Net cash provided by financing activities 4,704 3,644 Effect of exchange rate changes on cash 4 57 -------- ------- Net increase in cash and cash equivalents 40 2,036 Cash and cash equivalents at beginning of period 876 761 Deconsolidation of Embratel -- (216) -------- ------- Cash and cash equivalents at end of period $ 916 $ 2,581 ======== =======
The accompanying notes are an integral part of these statements. 5 WORLDCOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) GENERAL The financial statements included herein, are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and SEC regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2000. The results for the three- and nine-month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. (B) RECAPITALIZATION On June 7, 2001, our shareholders approved a recapitalization involving the creation of two separately traded tracking stocks: o WorldCom group stock, which is intended to reflect the performance of our data, Internet, international and commercial voice businesses and is quoted on The Nasdaq National Market under the trading symbol "WCOM", and o MCI group stock, which is intended to reflect the performance of our consumer, small business, wholesale long distance voice and data, wireless messaging and dial-up Internet access businesses and is quoted on The Nasdaq National Market under the trading symbol "MCIT". In connection with the recapitalization, we amended our articles of incorporation to replace our existing common stock with two new series of common stock that are intended to reflect, or track, the performance of the businesses attributed to the WorldCom group and the MCI group. Effective with the recapitalization on June 7, 2001, each share of our existing common stock was changed into one share of WorldCom group stock and 1/25 of a share of MCI group stock. A tracking stock is a separate class of a company's common stock intended to provide a return to investors based upon the financial performance of a distinct business unit of the company, sometimes referred to as the targeted business. These targeted businesses are collections of businesses that we have grouped together in order for us to issue WorldCom group stock and MCI group stock. The ownership of the targeted business does not change, and while each of the classes of stock trade separately, all shareholders are common shareholders of a single company, WorldCom, and are subject to all risks of an investment in WorldCom as a whole. During the second quarter of 2001, we declared the first quarterly dividend for the MCI group common stock. A cash dividend of $0.60 per share of MCI group common stock, or approximately $70 million in the aggregate, was paid on October 15, 2001 to shareholders of record as of the close of business on September 28, 2001. During the third quarter of 2001, we declared the fourth quarter dividend of $0.60 per share of MCI group common stock to be paid on January 15, 2002 to shareholders of record as of the close of business on December 31, 2001. The MCI group was initially allocated notional debt of $6 billion and our remaining debt was allocated on a notional basis to the WorldCom group. We intend, for so long as the WorldCom group stock and the MCI group stock remains outstanding, to include in filings by WorldCom under the Securities Exchange Act of 1934, as amended, the combined financial statements of each of the WorldCom group and the MCI group. These combined financial statements will be prepared in accordance with accounting principles generally accepted in the United States, and in the case of annual financial statements, will be audited. These combined financial statements are not legally required under current law or SEC regulations. 6 Voting rights of the holders of the WorldCom group stock and the MCI group stock are prorated based on the relative market values of WorldCom group stock and MCI group stock. We will conduct shareholder meetings that encompass all holders of voting stock. The WorldCom group and the MCI group shareholders will vote together as a single class on all matters brought to a vote of shareholders, including the election of our directors. Our board of directors may at any time convert each outstanding share of MCI group stock into shares of WorldCom group stock at 110% of the relative trading value of MCI group stock for the 20 days prior to the announcement of the conversion. No premium will be paid on a conversion that occurs three years after the issuance of MCI group stock. If all or substantially all of the WorldCom group or MCI group assets are sold, either: (i) the relevant shareholders will receive a distribution equal to the fair value of the net proceeds of the sale, either by special dividend or by redemption of shares; or (ii) each outstanding share of MCI group stock will be converted into shares of WorldCom group stock at 110% or 100% of the relative trading value of MCI group stock for a 10 trading day period following the sale. (C) EMBRATEL DECONSOLIDATION During the second quarter of 2001, we reached a long-term strategic decision to restructure our investment in Embratel Participacoes S.A., or Embratel. The restructuring included the resignation of certain Embratel Board of Directors seats, the irrevocable obligation to vote a portion of our common shares in a specified manner and the transfer of certain economic rights associated with such shares to an unrelated third party. Based on these actions, the accounting principles generally accepted in the United States prohibit the continued consolidation of Embratel's results. Accordingly, we have deconsolidated Embratel's results effective January 1, 2001. (D) BUSINESS COMBINATIONS On July 1, 2001, we acquired Intermedia Communications Inc. for approximately $5.8 billion, including assumed long-term debt, pursuant to the merger of a wholly owned subsidiary with and into Intermedia, with Intermedia continuing as the surviving corporation and as a subsidiary of WorldCom. As a result of the Intermedia merger, we acquired a controlling interest in Digex, Incorporated, or Digex, a provider of managed Web and application hosting services for some of the world's fastest growing companies. In connection with the Intermedia merger, stockholders of Intermedia received one share of WorldCom group common stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a share of MCI group common stock (or 2.3 million MCI group shares in the aggregate) for each share of Intermedia common stock they owned. Holders of Intermedia preferred stock, other than Intermedia's 13.5% Series B Redeemable Exchangeable Preferred Stock due 2009, or Intermedia Series B Preferred Stock, received one share of a class or series of our preferred stock, with substantially identical terms, which were established upon consummation of the Intermedia merger. As a result of the merger with Intermedia, we own approximately 90% of the voting securities of Intermedia. Upon effectiveness of the merger with Intermedia, the then outstanding and unexercised options for shares of Intermedia common stock were converted into options exercisable for an aggregate of approximately 10 million shares of WorldCom group common stock having the same terms and conditions as the Intermedia options, except that the exercise price and the number of shares issuable upon exercise were divided and multiplied, respectively, by 1.0319. The merger with Intermedia was accounted for as a purchase and was allocated to the WorldCom group. The purchase price in the Intermedia merger was allocated based on appraised fair values at the date of acquisition. This resulted in an excess purchase price over net assets acquired of $5.1 billion of which $67 million was allocated to customer lists, which will be amortized over approximately four years on a straight line basis. The remaining excess of $5.0 billion has been allocated to goodwill and tradename which are not subject to amortization and the goodwill is not expected to be deductible for tax purposes. In connection with the Intermedia merger, the Antitrust Division of the Department of Justice is requiring us to dispose of Intermedia's Internet service provider business, which provides integrated Internet connectivity solutions. In addition to this required divestiture, we have also committed to a plan to sell Intermedia's Advanced Building Network business, which provides centralized telecommunications services in multi-tenant commercial office buildings, and the systems integration business through which Intermedia sells, installs, operates and maintains business telephony customer premise equipment for its customers. We included the appraised fair values of these 7 assets to be disposed of in our initial allocation of the Intermedia purchase price and also included accrued anticipated losses expected to be incurred through disposal date. Any difference between the actual results of operations and the amounts accrued will result in an adjustment of goodwill unless there is a difference resulting from a post-merger event. For the three months ended September 30, 2001, operating losses for these assets to be disposed of were approximately $25 million, before corporate allocations. We anticipate that we will complete these planned disposals within the next twelve months. Since the Intermedia merger, WorldCom initiated plans to improve cash flow and operating results by reorganizing and restructuring Intermedia's operations. These plans include workforce reductions and other administrative cost savings, the discontinuance of all product lines with unacceptable or negative margins and the ultimate disposal of all assets associated with such product lines or businesses. (E) EARNINGS PER SHARE Our consolidated financial statements present basic and diluted earnings per share for WorldCom group stock and MCI group stock using the two-class method. The two-class method is an earnings formula that determines the attributed earnings per share for WorldCom group stock and MCI group stock according to participation rights in undistributed earnings. The combined financial statements of the WorldCom group and the MCI group do not separately present earnings per share because WorldCom group stock and MCI group stock are series of our common stock, and the WorldCom group and the MCI group are not legal entities with a capital structure. For purposes of our consolidated financial statements, basic earnings per share attributed to WorldCom group stock and MCI group stock is computed by dividing the respective attributed net income for the period by the respective number of weighted-average shares of WorldCom group stock and MCI group stock then outstanding. Diluted earnings per share attributed to WorldCom group stock and MCI group stock is computed by dividing the respective attributed net income for the period by the respective weighted-average number of shares of WorldCom group stock and MCI group stock outstanding, including the respective dilutive effect of WorldCom group stock and MCI group stock equivalents. The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations for the WorldCom group and the MCI group for the three and nine months ended September 30, 2000 and 2001 (in millions, except share and per share data):
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------- ----------------- 2000 2001 2000 2001 ------ ------ ------ ------ PRO FORMA --------------------------------------- WORLDCOM GROUP STOCK BASIC Income attributed to WorldCom group before cumulative effect of accounting change $ 599 $ 503 $2,072 $1,177 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 43 49 75 ------ ------ ------ ------ Net income attributed to WorldCom group before cumulative effect of accounting change $ 583 $ 460 $2,023 $1,102 ====== ====== ====== ====== Weighted-average shares of WorldCom group stock outstanding 2,874 2,957 2,864 2,910 ====== ====== ====== ====== Basic earnings per share attributed to WorldCom group stock before cumulative effect of accounting change $ 0.20 $ 0.16 $ 0.71 $ 0.38 ====== ====== ====== ====== DILUTED Net income attributed to WorldCom group before cumulative effect of accounting change $ 583 $ 460 $2,023 $1,102 ====== ====== ====== ====== Weighted-average shares of WorldCom group stock outstanding 2,874 2,957 2,864 2,910 WorldCom group stock equivalents 38 5 53 10 WorldCom group stock issuable upon conversion of preferred stock 2 1 2 2 ------ ------ ------ ------ Diluted shares of WorldCom group stock outstanding 2,914 2,963 2,919 2,922 ====== ====== ====== ====== Diluted earnings per share attributed to WorldCom group stock before cumulative effect of accounting change $ 0.20 $ 0.16 $ 0.69 $ 0.38 ====== ====== ====== ======
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FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------- ----------------- 2000 2001 2000 2001 ------ ------ ------ ------ PRO FORMA --------------------------------------- MCI GROUP STOCK BASIC Net income attributed to MCI group before cumulative effect of accounting change $ 352 $ 33 $1,440 $ 66 ====== ====== ====== ====== Basic weighted-average MCI group shares outstanding 115 118 115 116 ====== ====== ====== ====== Basic earnings per share attributed to MCI group stock before cumulative effect of accounting change $ 3.06 $ 0.28 $12.52 $ 0.56 ====== ====== ====== ====== DILUTED Net income attributed to MCI group before cumulative effect of accounting change $ 352 $ 33 $1,440 $ 66 ====== ====== ====== ====== Weighted-average shares of MCI group stock outstanding 115 118 115 116 MCI group stock issuable upon conversion of WorldCom preferred stock -- 1 -- 1 ------ ------ ------ ------ Diluted shares of MCI group stock outstanding 115 119 115 117 ====== ====== ====== ====== Diluted earnings per share attributed to MCI group stock before cumulative effect of accounting change $ 3.06 $ 0.28 $12.52 $ 0.56 ====== ====== ====== ======
As discussed in Note B, the recapitalization of WorldCom was effective June 7, 2001, and each share of WorldCom stock was changed into one share of WorldCom group stock and 1/25 of a share of MCI group stock. The weighted- average shares outstanding and attributed earnings per share information including periods prior to June 7, 2001 above is pro forma and assumes the recapitalization occurred at the beginning of 2000 and the WorldCom group stock and MCI group stock existed for all periods presented. (F) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid during the nine months ended September 30, 2000 and 2001, amounted to $793 million and $774 million, respectively. Income taxes paid during the nine months ended September 30, 2000 and 2001, totaled $183 million and $130 million, respectively. In conjunction with business combinations during the nine months ended September 30, 2000 and 2001, assets acquired and liabilities assumed were as follows (in millions):
2000 2001 ---- ------- Fair value of assets acquired $ -- $ 2,063 Excess of cost over net tangible assets acquired 43 5,194 Liabilities assumed (29) (5,824) Common stock issued -- (1,266) ---- ------- Net cash paid $ 14 $ 167 ==== =======
(G) COMPREHENSIVE INCOME The following table reflects the calculation of our comprehensive income for the three and nine months ended September 30, 2000 and 2001 (in millions):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 2000 2001 2000 2001 ----- ----- ------- ------- Net income applicable to common shareholders $ 935 $ 493 $ 3,378 $ 1,168 ----- ----- ------- ------- Other comprehensive income (loss): Foreign currency translation gains (losses) (156) 53 (358) 5 Derivative financial instruments: Cumulative effect of adoption of SFAS 133 as of January 1, 2001 -- -- -- 28 Reclassification of derivative financial instruments to current earnings -- (23) -- (88) Change in fair value of derivative financial instruments -- 59 -- 106 Unrealized holding gains (losses):
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THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 2000 2001 2000 2001 ----- ----- ------- ------- Unrealized holding gains (losses) during the period 424 (105) 805 (492) Reclassification adjustment for investment writeoffs included in net income -- -- -- 181 Reclassification adjustment for gains included in net income (167) (94) (382) (300) ----- ----- ------- ------- Other comprehensive income (loss) before tax 101 (110) 65 (560) Income tax benefit (expense) (96) 74 (159) 230 ----- ----- ------- ------- Other comprehensive income (loss) 5 (36) (94) (330) ----- ----- ------- ------- Comprehensive income applicable to common shareholders $ 940 $ 457 $ 3,284 $ 838 ===== ===== ======= =======
(H) SEGMENT INFORMATION Based on our organizational structure, we operate in six reportable segments: Commercial voice, data and Internet; International operations; Consumer; Wholesale; Alternative channels and small business; and Dial-up Internet. Our reportable segments represent business units that primarily offer similar products and services; however, the business units are managed separately due to the type and class of customer as well as the geographic dispersion of their operations. The Commercial voice, data and Internet segment includes voice, data and other types of domestic communications services for commercial customers, and Internet services including dedicated access and web and application hosting services. International operations provide voice, data, Internet and other similar types of communications services to customers primarily in Europe and the Asia Pacific region. Consumer includes domestic voice communications services for consumer customers. Wholesale includes long distance voice and data domestic communications services for wholesale customers. Alternative channels and small business includes domestic long distance voice and data, agents, prepaid calling cards and paging services provided to alternative wholesale and small business customers. Dial-up Internet includes dial-up Internet access services. Our chief operating decision-maker utilizes revenue information in assessing performance and making overall operating decisions and resource allocations. Communications services are generally provided utilizing our fiber optic networks, which do not make a distinction between the types of services provided. Profit and loss information for WorldCom, the WorldCom group and the MCI group is reported only on a consolidated basis to the chief operating decision-maker and our board of directors. The accounting policies of the segments are the same policies as those used by us in preparing our consolidated financial statements. Information about our segments for the three and nine months ended September 30, 2000 and 2001, is as follows (in millions):
REVENUES FROM EXTERNAL CUSTOMERS ------------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ---------------------- 2000 2001 2000 2001 -------- ------- -------- -------- Voice, data and Internet $ 4,275 $ 4,721 $ 12,557 $ 13,838 International operations 637 761 1,742 2,209 Consumer 1,989 1,873 5,890 5,516 Wholesale 847 657 2,655 2,050 Alternative channels and small business 954 591 2,792 1,896 Dial-up Internet 403 363 1,225 1,192 -------- ------- -------- -------- Total before Embratel 9,105 8,966 26,861 26,701 Embratel 970 -- 2,707 -- Elimination of intersegment revenues (38) -- (112) -- -------- ------- -------- -------- Total $ 10,037 $ 8,966 $ 29,456 $ 26,701 ======== ======= ======== ========
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ------------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ---------------------- 2000 2001 2000 2001 -------- ------- -------- -------- Voice, data and Internet $ 787 $ 967 $ 2,320 $ 2,927 International operations 301 344 830 1,030 Consumer 651 752 2,050 2,245 Wholesale 122 151 385 467 Alternative channels and small business 249 263 742 820 Dial-up Internet 105 126 304 394 Corporate - other charges 685 -- 778 888 Elimination of intergroup expenses (55) (86) (185) (268) -------- ------- -------- -------- Total before Embratel 2,845 2,517 7,224 8,503 Embratel 245 -- 650 -- Elimination of intersegment expenses (9) -- (27) -- -------- ------- -------- -------- Total $ 3,081 $ 2,517 $ 7,847 $ 8,503 ======== ======= ======== ========
As discussed in Note C, we deconsolidated our investment in Embratel as of January 1, 2001. Embratel, which provides communications services in Brazil, was designated as a separate reportable segment for periods prior to January 1, 2001. Accordingly, we have included Embratel in our segment information presented for 2000. See Note N for a reconciliation of the WorldCom group's and the MCI group's operating results to our consolidated results of operations. (I) CONTINGENCIES We are involved in legal and regulatory proceedings that are incidental or otherwise related to our business and have included loss contingencies in other current liabilities and other liabilities for these matters. In some instances, rulings by federal and state regulatory authorities may result in increased operating costs to us. The outcomes and ramifications of these various legal and regulatory matters are uncertain and could have a material adverse effect on our consolidated results of operations or financial position. WorldCom is subject to varying degrees of federal, state, local and international regulation. In the United States, our subsidiaries are most heavily regulated by the states, especially for the provision of local exchange services. We must be certified separately in each state to offer local exchange and intrastate long distance services. No state, however, subjects us to price cap or rate of return regulation, nor are we currently required to obtain FCC authorization for installation or operation of our network facilities used for domestic services, other than licenses for specific multichannel multipoint distribution services, wireless communications service and terrestrial microwave and satellite earth station facilities that utilize radio frequency spectrum. FCC approval is required for the installation and operation of our international facilities and services. We are subject to varying degrees of regulation in the foreign jurisdictions in which we conduct business, and those regulations cover, among other things, authorization for the installation and operation of network facilities. No assurance can be given that changes in current or future regulations adopted by the FCC, state or foreign regulators or legislative initiatives in the United States or abroad would not have a material adverse effect on us. In August 1996, the FCC established nationwide rules pursuant to the Telecom Act designed to encourage new entrants to compete in local service markets through interconnection with the incumbent local telephone companies, resale of incumbent local telephone companies' retail services, and use of individual and combinations of unbundled network elements, owned by the incumbent local telephone companies. Unbundled network elements are defined in the Telecom Act as any "facility or equipment used in the provision of a telecommunication service," as well as "features, function, and capabilities that are provided by means of such facility or equipment." In January 1999, the Supreme Court of the United States confirmed the FCC's authority to issue nationwide local competition rules, including a pricing methodology for unbundled network elements. On remand, the FCC clarified the requirement that incumbent local telephone companies make specific unbundled network elements available to new entrants. The incumbent local telephone companies have sought reconsideration of the FCC's order and have petitioned for review of the order in the United States Court of Appeals for the D.C. Circuit. That case is pending. 11 In its January 1999 decision, the Supreme Court remanded to the United States Court of Appeals for the Eighth Circuit various substantive questions concerning the FCC's rules for pricing unbundled network elements. In July 2000, the Eighth Circuit upheld the use of a forward-looking methodology but struck down the portion of the rule that calculates costs based on efficient technology and design choices. At the request of various parties, including WorldCom, the Supreme Court is reviewing the Eighth Circuit's decision. The Supreme Court heard oral argument in October 2001, and a ruling is expected in the first half of 2002. The Telecom Act requires Bell Operating Companies to petition the FCC for permission to offer long distance services for each state within their region. Section 271 of the Telecom Act provides that for these applications to be granted, the FCC must find, among other things, that the Bell Operating Companies have demonstrated that they have satisfied a 14-point competitive checklist to open their local network to competition and that granting the petition is in the public interest. To date, the FCC has rejected five traditional phone company applications and it has granted seven: Verizon's for New York, Massachusetts, Connecticut, and Pennsylvania and SBC's for Texas, Kansas and Oklahoma. WorldCom, and other new entrants to the local market, have appealed to the D.C. Circuit the approvals for Kansas, Oklahoma and Massachusetts alleging that the FCC erred in concluding that the incumbent local telephone companies had satisfied the section 271 checklist prior to granting the application. Briefing of the Kansas and Oklahoma case concluded in July 2001 and argument was held in September 2001; a briefing schedule has not been established for the Massachusetts appeal. BellSouth has filed another application for Georgia. SBC has also filed a petition for Missouri and Arkansas. Other applications may be challenged at any time. WorldCom has challenged, and will continue to challenge, any application that does not satisfy the requirements of section 271 or the FCC's local competition rules. To date, these challenges have focused on the pricing of unbundled network elements and on the adequacy of the Bell Operating Companies' operations support systems. In addition, legislation has been introduced in Congress that would have the effect of allowing Bell Operating Companies to offer in-region long distance data services without satisfying section 271 of the Telecom Act and/or of making it more difficult for competitors to resell incumbent local telephone company high-speed Internet access services or to lease the unbundled network elements used to provide these services. To date, WorldCom and others have successfully opposed these legislative initiatives. In December 1999, the FCC concluded that in providing high speed digital subscriber line services, the incumbent local telephone companies should be required to share primary telephone lines with competitive local exchange carriers, and the FCC identified the high frequency portion of the loop as a network element. In February 2000, Qwest and the United States Telephone Association petitioned for review of the order in the United States Court of Appeals for the D.C. Circuit; the Court held the case in abeyance pending reconsideration at the FCC. On January 19, 2001, the FCC issued its order on reconsideration which again is favorable to WorldCom and other firms seeking to gain access to the high bandwidth portion of the local loop. More specifically, the FCC clarified that the requirement to share lines applies to the entire loop, even where the traditional phone company has deployed fiber in the loop. Under the order, the incumbent local telephone companies must permit competing carriers to self-provision or partner with a data carrier in order to furnish voice and data service on the same line. The incumbent local telephone companies have appealed this ruling and we have intervened in support of the FCC's order. In February 1999, the FCC issued a Declaratory Ruling and Notice of Proposed Rulemaking regarding the regulatory treatment of calls to Internet service providers. Prior to the FCC's order, over thirty state public utility commissions issued orders finding that carriers, including WorldCom, are entitled to collect reciprocal compensation for completing calls to Internet service providers under the terms of their interconnection agreements with incumbent local telephone companies. Many of these public utility commission decisions were appealed by the incumbent local telephone companies and, since the FCC's order, many incumbent local telephone companies have filed new cases at the public utility commissions or in court. WorldCom petitioned for review of the FCC's order in the United States Court of Appeals for the D.C. Circuit, which vacated the order and remanded the case to the FCC for further proceedings. In April 2001, the FCC issued an Order on Remand and Report and Order asserting jurisdiction over calls to Internet service providers and establishing a three-year transitional scheme of decreasing reciprocal compensation rates. WorldCom has filed a petition for review of the FCC's order with the D.C. Circuit, and the Court will hear oral arguments in February 2002. It is possible that rights held by WorldCom to multi-channel multipoint distribution service and/or instructional television fixed service spectrum may be disrupted by FCC decisions to re-allocate some or all of that spectrum to 12 other services. If this re-allocation were to occur, we cannot predict whether current deployment plans for our multi-channel multipoint distribution service services will be sustainable. In November 2000, class action complaints were filed in the United States District Courts for the Southern District of Mississippi, the Southern District of New York, and the District of Columbia against WorldCom and some of its executive officers. All of these actions were consolidated in the Southern District of Mississippi on March 27, 2001, along with another purported class action lawsuit filed on behalf of individuals who purchased stock in Intermedia Communications Inc. between September 5 and November 1, 2000, which action asserts substantially similar claims and alleges that after the announcement of the WorldCom-Intermedia merger, the price of Intermedia stock was tied to the price of WorldCom stock. On June 1, 2001, the plaintiffs filed a consolidated amended complaint. Among other things, the consolidated amended complaint alleged that statements regarding WorldCom's revenues, the integration of MCI, the success of UUNET, and the expansion of WorldCom's network were false; WorldCom's financial disclosures were false; and WorldCom's announcement of its "generation d" initiative was misleading. Based on these allegations, the consolidated amended complaint asserts claims for violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and Section 20(a) of the Securities Exchange Act of 1934. The consolidated amended complaint seeks to certify a class of persons who purchased WorldCom shares between February 10, 2000 and November 1, 2000, inclusive; it does not assert separate claims on behalf of purchasers of Intermedia shares. On August 7, 2001, WorldCom and the individual defendants filed a motion to dismiss the consolidated amended complaint in its entirety. We believe that the factual allegations and legal claims asserted in the consolidated amended complaint are without merit and intend to defend them vigorously. In August 1997, three complaints were filed in the United States District Court for the District of Columbia, as class actions on behalf of purchasers of MCI shares. The three cases were consolidated on April 1, 1998. On or about May 8, 1998, the plaintiffs in all three cases filed a consolidated amended complaint alleging, on behalf of purchasers of MCI's shares between July 11, 1997 and August 21, 1997, inclusive, that MCI and some of its officers and directors failed to disclose material information about MCI, including that MCI was renegotiating the terms of the MCI BT merger agreement. The consolidated amended complaint seeks damages and other relief. WorldCom and the other defendants have moved to dismiss the consolidated amended complaint. (J) LONG-TERM DEBT On June 8, 2001, we replaced our existing $7 billion 364-Day Revolving Credit and Term Loan Agreement with two new credit facilities consisting of a $2.65 billion 364-Day Revolving Credit Agreement (the "364-Day Facility") and a $1.6 billion Revolving Credit Agreement (the "Multi-Year Facility"). The 364-Day Facility and the Multi-Year Facility, together with our existing $3.75 billion Amended and Restated Facility A Revolving Credit Agreement (the "Existing Facility"), provide us with aggregate credit facilities of $8 billion. These credit facilities provide liquidity support for our commercial paper program and for other general corporate purposes. The Existing Facility and the Multi-Year Facility mature on June 30, 2002 and June 8, 2006, respectively. The 364-Day Facility has a 364-day term, which may be extended for successive 364-day terms to the extent of the committed amounts from those lenders consenting thereto, with a requirement that lenders holding 51% of the committed amounts consent and so long as the final maturity date does not extend beyond June 8, 2006. Additionally, we may elect to convert the principal debt outstanding under the 364-Day Facility to a term loan maturing no later than one year after the conversion date, so long as the final maturity date does not extend beyond June 8, 2006. The Existing Facility is subject to annual commitment fees not to exceed 0.25% of any unborrowed portion of the facilities. The 364-Day Facility and the Multi-Year Facility are subject to annual facility fees not to exceed 0.20% or 0.25%, respectively, of the average daily commitment under each such facility (whether used or unused). The credit facilities bear interest payable in varying periods, depending on the interest period, not to exceed six months, or with respect to any Eurodollar Rate borrowing, 12 months if available to all lenders, at rates selected by us under the terms of the credit facilities, including a Base Rate or Eurodollar Rate, plus the applicable margin. The applicable margin for the Eurodollar Rate borrowing generally varies from 0.35% to 0.75% as to loans under the Existing Facility, from 0.29% to 0.80% as to loans under the 364-Day Facility and 0.27% to 0.75% as to loans under the Multi-Year Facility, in each case based upon our then current debt ratings. 13 The credit facilities are unsecured but include a negative pledge of our assets and, subject to exceptions, the covered subsidiaries. The credit facilities require compliance with a financial covenant based on the ratio of total debt to total capitalization, calculated on a consolidated basis. The credit facilities require compliance with operating covenants which limit, among other things, the incurrence of additional indebtedness by us and the covered subsidiaries and sales of assets and mergers and dissolutions. The credit facilities do not restrict distributions to shareholders, provided we are not in default under the credit facilities. As of the date of this filing, we were in compliance with these covenants. On May 9, 2001, we completed the pricing of a public debt offering of approximately $11.9 billion principal amount of debt securities, based on currency exchange rates on May 8, 2001. The net proceeds of $11.7 billion have been or will be used for general corporate purposes, including to repay commercial paper, and repayment of $1.5 billion of our 6.125% notes due August 15, 2001 and $1.5 billion of our floating rate notes due November 26, 2001. The public debt offering consisted of the following series of notes:
Principal Interest First Amount Maturity Payable Interest Date - --------------------------------------------------------------------------------------------------------------------- 6.50% Notes due 2004 $1.5 billion May 15, 2004 Semiannually on May 15 and November 15 November 15, 2001 7.50% Notes due 2011 $4.0 billion May 15, 2011 Semiannually on May 15 and November 15 November 15, 2001 8.25% Notes due 2031 $4.6 billion May 15, 2031 Semiannually on May 15 and November 15 November 15, 2001 6.75% Notes due 2008 (euro)1.25 billion May 15, 2008 Annually on May 15 May 15, 2002 7.25% Notes due 2008 (pound)500 million May 15, 2008 Annually on May 15 May 15, 2002
All of the notes, except for the 6.50% Notes due 2004 are redeemable, as a whole or in part, at our option, at any time or from time to time, at respective redemption prices equal to: In the case of the U.S. dollar notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the sum of the present values of the Remaining Scheduled Payments, as defined therein, discounted, on a semiannual basis, assuming a 360-day year consisting of twelve 30-day months, at the Treasury Rate, as defined therein, plus: o 30 basis points for the Notes due 2011, and o 35 basis points for the Notes due 2031; In the case of the euro notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the sum of the present values of the Remaining Scheduled Payments, as defined therein, discounted, on an annual basis (based on the actual number of days elapsed divided by 365 or 366, as the case may be), at the Reference Euro Dealer Rate, as defined therein, plus 25 basis points; and In the case of the sterling notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the price expressed as a percentage (rounded to three decimal places, with .0005 being rounded up) at which the Gross Redemption Yield, as defined therein, on the outstanding principal amount of the notes on the Reference Date, as defined therein, is equal to the Gross Redemption Yield (determined by reference to the middle-market price) at 3:00 p.m. (London time) on that date on the Benchmark Gilt, as defined therein, plus 25 basis points; plus, in the case of the U.S. dollar notes, the euro notes and the sterling notes, accrued interest to the date of redemption which has not been paid. In connection with the Intermedia merger, we assumed Intermedia's outstanding debt including $1.2 billion of senior discount notes with interest rates ranging from 11.25% to 12.5%, $0.9 billion of senior notes with interest rates ranging from 8.5% to 9.5%, credit facility borrowings of $258 million and other long-term debt including capital 14 leases of $0.6 billion. We repaid the Intermedia credit facility borrowings of $258 million and subsequently terminated Intermedia's credit facility during the third quarter of 2001. Additionally, on September 28, 2001, we redeemed all of Intermedia's 12.5% senior discount notes for $337 million. Cash balances were used to pay all amounts under the Intermedia credit facility and Intermedia 12.5% senior discount notes. During the third quarter of 2001, $1.5 billion of 6.125% senior notes matured, we redeemed all of our outstanding 8.875% senior notes due 2006 for $694 million, and we retired $1.1 billion of our outstanding debt through open market debt repurchases (including $481 million of outstanding debt assumed in the Intermedia merger). Cash balances were used to repay these amounts. The following table sets forth our outstanding debt as of September 30, 2001 (in millions): Commercial paper and credit facilities $ 11 Floating rate notes due 2001 through 2002 977 7.88% - 8.25% Notes Due 2003 - 2010 3,500 7.38% Notes Due 2006 - 2011 2,000 6.25% - 6.95% Notes Due 2003 - 2028 4,600 7.13% - 7.75% Notes Due 2004 - 2027 2,000 7.13% - 8.25% Senior Debentures Due 2023 - 2027 1,435 6.13% - 7.50% Senior Notes Due 2004 - 2012 1,927 6.50% - 8.25% Notes Due 2004 - 2031 11,976 Intermedia 11.25% - 12.25% Senior Discount Notes Due 2007 - 2009 665 Intermedia 8.5% - 9.5% Senior Notes Due 2007 - 2009 614 Capital lease obligations (maturing through 2017) 987 Other debt (maturing through 2008) 578 -------- 31,270 Short-term debt and current maturities of long-term debt (1,109) -------- $ 30,161 ========
(K) PREFERRED STOCK In connection with the Intermedia merger, we issued the following series of preferred stock:
NUMBER OF AGGREGATE # OF SHARES CONVERTIBLE PREFERRED ANNUAL AT THE OPTION OF HOLDER SHARES LIQUIDATION DIVIDEND --------------------------------- AUTHORIZED, PREFERENCE PER ASSOCIATED ISSUED AND PER PREFERRED PREFERRED DEPOSITORY WORLDCOM MCI GROUP OUTSTANDING SHARE SHARE SHARES GROUP SHARES SHARES ----------------------------------------------------------------------------------- Series D Junior Convertible preferred stock, par value $0.01 per share 53,724 $2,500 $175 5,372,410 6,905,398 276,215 Series E Junior Convertible preferred stock, par value $0.01 per share 64,047 $2,500 $175 6,404,690 5,295,766 211,830 Series F Junior Convertible preferred stock, par value $0.01 per share 79,600 $2,500 $175 7,960,000 4,729,649 189,185 Series G Junior Convertible Participating preferred stock, par value $0.01 per share 200,000 $1,000 $ 70 n/a 5,555,555 222,222
On August 20, 2001, the holder of our Series G preferred stock exercised its right to require us to redeem all of the outstanding Series G preferred stock at par plus accrued dividends, or approximately $200 million in the aggregate. The Series D, E and F preferred stock is currently redeemable in whole or in part, at our option for cash plus accrued and unpaid dividends at rates ranging from 103% down to 100% beginning 2004 and thereafter for the Series D and E preferred stock and from 104% down to 100% beginning 2005 and thereafter for the Series F preferred stock. 15 Dividends on the Series D, E and F preferred stock are payable in cash or shares of our common stock, at our election on each July 15, October 15, January 15 and April 15. We paid the initial dividend on July 15, 2001 in cash and we expect to continue to pay cash dividends on our Series D, E and F preferred stock. The Series D, E and F preferred shareholders are generally entitled to vote on the basis of 0.10 of a vote per share of Series D, E or F preferred stock on all matters. In October 2001, we exercised our option to redeem all of our outstanding Series B Preferred Stock. Prior to the redemption date, substantially all of the holders of our Series B Preferred Stock elected to convert the preferred stock into 0.1460868 shares of WorldCom group stock and 0.005843472 shares of MCI group stock for each share of Series B Preferred Stock held. (L) REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES At the time of the Intermedia merger, Intermedia had outstanding Intermedia Series B Preferred Stock, and Digex had outstanding Series A Convertible Preferred Stock, or Digex Series A Preferred Stock. As of September 30, 2001, there were 549,896 shares of Intermedia Series B Preferred Stock outstanding. Dividends on the Intermedia Series B Preferred Stock accumulate at a rate of 13.5% of the aggregate liquidation preference thereof and are payable quarterly, in arrears. Dividends are payable in cash or, at Intermedia's option, by the issuance of additional shares of Intermedia Series B Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends. Historically, Intermedia has paid the Intermedia Series B Preferred Stock dividend by the issuance of additional shares of Intermedia Series B Preferred Stock. The Intermedia Series B Preferred Stock is subject to mandatory redemption at its liquidation preference of $1,000 per share, plus accumulated and unpaid dividends on March 31, 2009. The Intermedia Series B Preferred Stock will be redeemable at the option of Intermedia at any time after March 31, 2002 at rates commencing with 106.75%, declining to 100% on March 31, 2007. Intermedia Series B Preferred Stock is generally entitled to one-tenth of one vote per share on all matters voting together with the common stock of Intermedia as a single class. The Digex Series A Preferred Stock has an aggregate liquidation preference of $100 million, and is convertible into approximately 1,462,000 shares of Class A Common Stock of Digex. The Digex Series A Preferred Stock does not pay dividends and there are no voting rights. (M) DERIVATIVE FINANCIAL INSTRUMENTS Effective January 1, 2001, we adopted the Financial Accounting Standards Board's, or FASB's, Statement of Financial Accounting Standard, or SFAS, No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. This statement establishes accounting and reporting standards requiring that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at fair value. As of January 1, 2001, our exposure to derivative financial instruments primarily consisted of option collar transactions designated as cash flow hedges of anticipated sales of an equity investment, which we maintain to minimize the impact of adverse changes in the market price of the related equity investment, and various equity warrants. The initial adoption of SFAS No. 133 provided a net transition gain from our designated cash flow hedges resulting in an increase in other comprehensive income of approximately $28 million. We recorded no net impact from adoption of SFAS No. 133 related to the various equity warrants. During the nine months ended September 30, 2001, shares of the hedged equity investment were sold and we reclassified respective hedging gains of $88 million from accumulated comprehensive income to miscellaneous income. As of September 30, 2001, we estimate during the next twelve months we will reclassify from accumulated comprehensive income into earnings approximately $46 million relating to our derivative financial instruments as the underlying hedged equity investment is sold. The actual amounts that will be reclassified to earnings over the next twelve months will vary from this amount as a result of changes in market conditions. No amounts were reclassified to earnings resulting from any ineffective portion of the designated derivative hedges or from the discontinuance of designation of any cash flow hedges. 16 (N) CONSOLIDATING INFORMATION Below is the consolidating financial information of the WorldCom group and the MCI group. The financial information reflects the businesses attributed to the WorldCom group and the MCI group including the allocation of revenues and expenses between the WorldCom group and the MCI group in accordance with our allocation policies. The attribution of the assets, liabilities, equity, revenues and expenses for each group, as reflected in our interim consolidated financial statements, which are consolidated in accordance with accounting principles generally accepted in the United States, is primarily based on specific identification of the businesses included in each group. Where specific identification was impractical, other methods and criteria were used that our management believes are equitable and provide a reasonable estimate of the assets, liabilities, equity, revenues and expenses attributable to each group. Our shared corporate services and related balance sheet amounts (such as executive management, human resources, legal, regulatory, accounting, tax, treasury, strategic planning and information systems support) have been attributed to the WorldCom group or the MCI group based upon identification of such services specifically benefiting each group. Where determinations based on specific usage alone are impractical, other methods and criteria were used that our management believes are equitable and provide a reasonable estimate of the cost attributable to each group. Our management believes that the allocation methods developed will be comparable to the expected future allocation methods. Our board of directors or any special committee appointed by the board of directors may, without shareholder approval, change the polices set forth in our tracking stock policy statement, including any resolution implementing the provisions of our tracking stock policy statement. Our board of directors or any special committee appointed by the board of directors also may, without shareholder approval, adopt additional policies or make exceptions with respect to the application of the policies described in our tracking stock policy statement in connection with particular facts and circumstances, all as our board of directors or any special committee appointed by the board of directors may determine to be in our best interests as a whole. Any such change, adoption or exception will be final, binding and conclusive unless otherwise determined by our board of directors or any special committee appointed by the board of directors. 17 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING BALANCE SHEET (UNAUDITED. IN MILLIONS)
AT DECEMBER 31, 2000 ---------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM -------- ------- ------------ -------- Current assets $ 8,092 $ 2,312 $ (649) $ 9,755 Property and equipment, net 35,177 2,246 -- 37,423 Goodwill and other intangibles 36,685 9,909 -- 46,594 Other assets 5,939 168 (976) 5,131 ------- ------- ------- ------- Total assets $85,893 $14,635 $(1,625) $98,903 ======= ======= ======= ======= Current liabilities $14,213 $ 4,109 $ (649) $17,673 Long-term debt 11,696 6,000 -- 17,696 Noncurrent liabilities 3,648 2,063 (976) 4,735 Minority interests 2,592 -- -- 2,592 Company obligated mandatorily redeemable preferred securities 798 -- -- 798 Shareholders' investment 52,946 2,463 -- 55,409 ------- ------- ------- ------- Total liabilities and shareholders' investment $85,893 $14,635 $(1,625) $98,903 ======= ======= ======= =======
18 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF INCOME (UNAUDITED. IN MILLIONS)
THREE MONTHS ENDED SEPTEMBER 30, 2000 ----------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM -------- ------- ------------ -------- Revenues $ 5,844 $ 4,193 $ -- $ 10,037 ------- ------- ------- -------- Operating expenses: Line costs: Attributed costs 2,184 1,683 -- 3,867 Intergroup allocated expenses 23 94 (117) -- Selling, general and administrative: Attributed costs 924 673 1,484 3,081 Shared corporate services 740 744 (1,484) -- Other intergroup allocated expenses -- 55 (55) -- Depreciation and amortization: Attributed costs 983 254 -- 1,237 Intergroup allocated expenses (149) (23) 172 -- ------- ------- ------- -------- Total 4,705 3,480 -- 8,185 ------- ------- ------- -------- Operating income 1,139 713 -- 1,852 Interest expense (118) (127) -- (245) Miscellaneous income 107 -- -- 107 ------- ------- ------- -------- Income before income taxes and minority interests 1,128 586 -- 1,714 Provision for income taxes 454 234 -- 688 ------- ------- ------- -------- Income before minority interests 674 352 -- 1,026 Minority interests (75) -- -- (75) ------- ------- ------- -------- Net income before distributions on mandatorily redeemable preferred securities 599 352 -- 951 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 -- -- 16 ------- ------- ------- -------- Net income $ 583 $ 352 $ -- $ 935 ======= ======= ======= ========
19 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF INCOME (UNAUDITED. IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, 2000 ------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM -------- -------- ------------ -------- Revenues $ 16,894 $ 12,562 $ -- $ 29,456 -------- -------- ------- -------- Operating expenses: Line costs: Attributed costs 6,343 5,033 -- 11,376 Intergroup allocated expenses 64 279 (343) -- Selling, general and administrative: Attributed costs 2,538 2,129 3,180 7,847 Shared corporate services 1,668 1,512 (3,180) -- Other intergroup allocated expenses -- 185 (185) -- Depreciation and amortization: Attributed costs 2,852 718 -- 3,570 Intergroup allocated expenses (464) (64) 528 -- -------- -------- ------- -------- Total 13,001 9,792 -- 22,793 -------- -------- ------- -------- Operating income 3,893 2,770 -- 6,663 Interest expense (318) (381) -- (699) Miscellaneous income 327 -- -- 327 -------- -------- ------- -------- Income before income taxes, minority interests and cumulative effect of accounting change 3,902 2,389 -- 6,291 Provision for income taxes 1,605 949 -- 2,554 -------- -------- ------- -------- Income before minority interests and cumulative effect of accounting change 2,297 1,440 -- 3,737 Minority interests (225) -- -- (225) -------- -------- ------- -------- Income before cumulative effect of accounting change 2,072 1,440 -- 3,512 Cumulative effect of accounting change (75) (10) -- (85) -------- -------- ------- -------- Net income before distributions on mandatorily redeemable preferred securities 1,997 1,430 -- 3,427 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 49 -- -- 49 -------- -------- ------- -------- Net income $ 1,948 $ 1,430 $ -- $ 3,378 ======== ======== ======= ========
20 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED. IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, 2000 -------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM -------- ----- ------------ -------- Cash flows from operating activities: Net income $ 1,997 $ 1,430 $ -- $ 3,427 Adjustments to reconcile net income to net cash provided by operating activities: 2,332 148 -- 2,480 -------- ------- ---- -------- Net cash provided by operating activities 4,329 1,578 -- 5,907 -------- ------- ---- -------- Cash flows from investing activities: Capital expenditures (8,407) (370) -- (8,777) Acquisitions and related costs (14) -- -- (14) All other investing activities, net (1,584) (200) -- (1,784) -------- ------- ---- -------- Net cash used in investing activities (10,005) (570) -- (10,575) -------- ------- ---- -------- Cash flows from financing activities: Principal borrowings on debt, net 4,467 -- -- 4,467 Attributed stock activity of WorldCom, Inc. 551 -- -- 551 Intergroup advances, net 1,002 (1,002) -- -- All other financing activities, net (314) -- -- (314) -------- ------- ---- -------- Net cash provided by (used in) financing activities 5,706 (1,002) -- 4,704 Effect of exchange rates changes on cash 4 -- -- 4 -------- ------- ---- -------- Net increase in cash and cash equivalents 34 6 -- 40 Cash and cash equivalents beginning of period 806 70 -- 876 -------- ------- ---- -------- Cash and cash equivalents end of period $ 840 $ 76 $ -- $ 916 ======== ======= ==== ========
21 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING BALANCE SHEET (UNAUDITED. IN MILLIONS)
AT SEPTEMBER 30, 2001 ---------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM -------- ----- ------------ -------- Current assets $ 9,384 $ 2,015 $ (871) $ 10,528 Property and equipment, net 36,090 2,061 -- 38,151 Goodwill and other intangibles 41,018 9,802 -- 50,820 Other assets 6,144 235 (976) 5,403 ------- ------- ------- -------- Total assets $92,636 $14,113 $(1,847) $104,902 ======= ======= ======= ======== Current liabilities $ 7,538 $ 4,140 $ (871) $ 10,807 Long-term debt 24,568 5,593 -- 30,161 Noncurrent liabilities 3,121 1,907 (976) 4,052 Company obligated mandatorily redeemable and other preferred securities 1,975 -- -- 1,975 Shareholders' investment 55,434 2,473 -- 57,907 ------- ------- ------- -------- Total liabilities and shareholders' investment $92,636 $14,113 $(1,847) $104,902 ======= ======= ======= ========
22 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF INCOME (UNAUDITED. IN MILLIONS)
THREE MONTHS ENDED SEPTEMBER 30, 2001 --------------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM --------- --------- ------------ --------- Revenues $ 5,482 $ 3,484 $ -- $ 8,966 --------- --------- --------- --------- Operating expenses: Line costs: Attributed costs 2,059 1,686 -- 3,745 Intergroup allocated expenses 26 89 (115) -- Selling, general and administrative: Attributed costs 833 779 905 2,517 Shared corporate services 478 427 (905) -- Other intergroup allocated expenses -- 86 (86) -- Depreciation and amortization: Attributed costs 1,262 262 -- 1,524 Intergroup allocated expenses (175) (26) 201 -- --------- --------- --------- --------- Total 4,483 3,303 -- 7,786 --------- --------- --------- --------- Operating income 999 181 -- 1,180 Interest expense (316) (126) -- (442) Miscellaneous income 107 -- -- 107 --------- --------- --------- --------- Income before income taxes and minority interests 790 55 -- 845 Provision for income taxes 307 22 -- 329 --------- --------- --------- --------- Income before minority interests 483 33 -- 516 Minority interests 20 -- -- 20 --------- --------- --------- --------- Net income before distributions on mandatorily redeemable and other preferred securities 503 33 -- 536 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 43 -- -- 43 --------- --------- --------- --------- Net income $ 460 $ 33 $ -- $ 493 ========= ========= ========= =========
23 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF INCOME (UNAUDITED. IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, 2001 --------------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM --------- --------- ------------ --------- Revenues $ 16,047 $ 10,654 $ -- $ 26,701 --------- --------- --------- --------- Operating expenses: Line costs: Attributed costs 6,036 5,135 -- 11,171 Intergroup allocated expenses 75 273 (348) -- Selling, general and administrative: Attributed costs 3,195 2,657 2,651 8,503 Shared corporate services 1,516 1,135 (2,651) -- Other intergroup allocated expenses -- 268 (268) -- Depreciation and amortization: Attributed costs 3,491 775 -- 4,266 Intergroup allocated expenses (541) (75) 616 -- --------- --------- --------- --------- Total 13,772 10,168 -- 23,940 --------- --------- --------- --------- Operating income 2,275 486 -- 2,761 Interest expense (717) (378) -- (1,095) Miscellaneous income 330 -- -- 330 --------- --------- --------- --------- Income before income taxes and minority interests 1,888 108 -- 1,996 Provision for income taxes 731 42 -- 773 --------- --------- --------- --------- Income before minority interests 1,157 66 -- 1,223 Minority interests 20 -- -- 20 --------- --------- --------- --------- Net income before distributions on mandatorily redeemable and other preferred securities 1,177 66 -- 1,243 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 75 -- -- 75 --------- --------- --------- --------- Net income $ 1,102 $ 66 $ -- $ 1,168 ========= ========= ========= =========
24 (N) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED. IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, 2001 -------------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM --------- -------- ------------ ---------- Cash flows from operating activities: Net income $ 1,177 $ 66 $ -- $ 1,243 Adjustments to reconcile net income to net cash provided by operating activities: 3,534 995 -- 4,529 --------- -------- --------- ---------- Net cash provided by operating activities 4,711 1,061 -- 5,772 --------- -------- --------- ---------- Cash flows from investing activities: Capital expenditures (5,898) (188) -- (6,086) Acquisitions and related costs (167) -- -- (167) All other investing activities, net (673) (511) -- (1,184) --------- -------- --------- ---------- Net cash used in investing activities (6,738) (699) -- (7,437) --------- -------- --------- ---------- Cash flows from financing activities: Principal borrowings (repayments) on debt, net 4,470 (408) -- 4,062 Attributed stock activity of WorldCom, Inc. 112 -- -- 112 Intergroup advances, net (15) 15 -- -- All other financing activities, net (530) -- -- (530) --------- -------- --------- ---------- Net cash provided by (used in) financing activities 4,037 (393) -- 3,644 Effect of exchange rates changes on cash 57 -- -- 57 --------- -------- --------- ---------- Net increase (decrease) in cash and cash equivalents 2,067 (31) -- 2,036 Cash and cash equivalents beginning of period 720 41 -- 761 Deconsolidation of Embratel (216) -- (216) --------- -------- --------- ---------- Cash and cash equivalents end of period $ 2,571 $ 10 $ -- $ 2,581 ========= ======== ========= ==========
25 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED BALANCE SHEETS (Unaudited. In Millions)
December 31, September 30, 2000 2001 ------------ ------------- ASSETS Current assets: Cash and cash equivalents $ 720 $ 2,571 Accounts receivable, net of allowance for bad debts of $1,018 in 2000 and $969 in 2001 4,980 4,011 Deferred tax asset 131 243 Other current assets 1,612 1,688 Receivable from MCI group, net 649 871 -------- -------- Total current assets 8,092 9,384 -------- -------- Property and equipment: Transmission equipment 19,883 21,663 Communications equipment 5,873 4,873 Furniture, fixtures and other 8,666 10,318 Construction in progress 6,727 6,712 -------- -------- 41,149 43,566 Accumulated depreciation (5,972) (7,476) -------- -------- 35,177 36,090 -------- -------- Goodwill and other intangible assets 36,685 41,018 Long-term receivable from MCI group, net 976 976 Other assets 4,963 5,168 -------- -------- $ 85,893 $ 92,636 ======== ======== LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 7,200 $ 1,109 Accounts payable and accrued line costs 3,584 2,662 Other current liabilities 3,429 3,767 -------- -------- Total current liabilities 14,213 7,538 -------- -------- Long-term liabilities, less current portion: Long-term debt 11,696 24,568 Deferred tax liability 2,683 2,445 Other liabilities 965 566 -------- -------- Total long-term liabilities 15,344 27,579 -------- -------- Commitments and contingencies Minority interests 2,592 110 Company obligated mandatorily redeemable and other preferred securities 798 1,975 Allocated net worth 52,946 55,434 -------- -------- $ 85,893 $ 92,636 ======== ========
The accompanying notes are an integral part of these statements. 26 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF OPERATIONS (Unaudited. In Millions)
For the Three Months Ended For the Nine Months Ended September 30, September 30, -------------------------- ------------------------- 2000 2001 2000 2001 ------- ------- -------- -------- Revenues $ 5,844 $ 5,482 $ 16,894 $ 16,047 ------- ------- -------- -------- Operating expenses: Line costs 2,207 2,085 6,407 6,111 Selling, general and administrative 1,664 1,311 4,206 4,711 Depreciation and amortization 834 1,087 2,388 2,950 ------- ------- -------- -------- Total 4,705 4,483 13,001 13,772 ------- ------- -------- -------- Operating income 1,139 999 3,893 2,275 Other income (expense): Interest expense (118) (316) (318) (717) Miscellaneous 107 107 327 330 ------- ------- -------- -------- Income before income taxes, minority interests and cumulative effect of accounting change 1,128 790 3,902 1,888 Provision for income taxes 454 307 1,605 731 ------- ------- -------- -------- Income before minority interests and cumulative effect of accounting change 674 483 2,297 1,157 Minority interests (75) 20 (225) 20 ------- ------- -------- -------- Income before cumulative effect of accounting change 599 503 2,072 1,177 Cumulative effect of accounting change (net of income tax of $43 in 2000) -- -- (75) -- ------- ------- -------- -------- Net income before distributions on mandatorily redeemable preferred securities 599 503 1,997 1,177 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 43 49 75 ------- ------- -------- -------- Net income $ 583 $ 460 $ 1,948 $ 1,102 ======= ======= ======== ========
The accompanying notes are an integral part of these statements. 27 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF CASH FLOWS (Unaudited. In Millions)
For the Nine Months Ended September 30, ------------------------- 2000 2001 -------- ------- Cash flows from operating activities: Net income before distributions on mandatorily redeemable preferred securities $ 1,997 $ 1,177 Adjustments to reconcile net income before distributions on mandatorily redeemable preferred securities to net cash provided by operating activities: Cumulative effect of accounting change 75 -- Minority interests 225 (20) Depreciation and amortization 2,388 2,950 Provision for deferred income taxes 693 505 Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net (856) (140) Receivable from MCI group, net (480) (222) Other current assets (416) 23 Accounts payable and other current liabilities 1,075 199 All other operating activities (372) 239 -------- ------- Net cash provided by operating activities 4,329 4,711 -------- ------- Cash flows from investing activities: Capital expenditures (8,407) (5,898) Acquisitions and related costs (14) (167) Increase in intangible assets (643) (270) Decrease in other liabilities (602) (332) All other investing activities (339) (71) -------- ------- Net cash used in investing activities (10,005) (6,738) -------- ------- Cash flows from financing activities: Principal borrowings on debt, net 4,467 4,470 Attributed stock activity of WorldCom, Inc. 551 112 Distributions on mandatorily redeemable and other preferred securities (49) (58) Redemptions of preferred stock (190) (200) Advances (to) from MCI group, net 1,002 (15) All other financing activities (75) (272) -------- ------- Net cash provided by financing activities 5,706 4,037 Effect of exchange rate changes on cash 4 57 -------- ------- Net increase in cash and cash equivalents 34 2,067 Cash and cash equivalents at beginning of period 806 720 Deconsolidation of Embratel -- (216) -------- ------- Cash and cash equivalents at end of period $ 840 $ 2,571 ======== =======
The accompanying notes are an integral part of these statements. 28 WORLDCOM GROUP (AN INTEGRATED BUSINESS OF WORLDCOM, INC.) NOTES TO COMBINED FINANCIAL STATEMENTS (A) GENERAL The combined financial statements included herein for the WorldCom group (an integrated business of WorldCom, Inc.), are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and SEC regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the combined financial statements of the WorldCom group reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2000. The results for the three- and nine-month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. (B) RECAPITALIZATION On June 7, 2001, our shareholders approved a recapitalization involving the creation of two separately traded tracking stocks: o WorldCom group stock, which is intended to reflect the performance of our data, Internet, international and commercial voice businesses and is quoted on The Nasdaq National Market under the trading symbol "WCOM", and o MCI group stock, which is intended to reflect the performance of our consumer, small business, wholesale long distance voice and data, wireless messaging and dial-up Internet access businesses and is quoted on The Nasdaq National Market under the trading symbol "MCIT". In connection with the recapitalization, we amended our articles of incorporation to replace our existing common stock with two new series of common stock that are intended to reflect, or track, the performance of the businesses attributed to the WorldCom group and the MCI group. Effective with the recapitalization on June 7, 2001, each share of our existing common stock was changed into one share of WorldCom group stock and 1/25 of a share of MCI group stock. A tracking stock is a separate class of a company's common stock intended to provide a return to investors based upon the financial performance of a distinct business unit of the company, sometimes referred to as the targeted business. These targeted businesses are collections of businesses that we have grouped together in order for us to issue WorldCom group stock and MCI group stock. The ownership of the targeted business does not change, and while each of the classes of stock trade separately, all shareholders are common shareholders of a single company, WorldCom, and are subject to all risks of an investment in WorldCom as a whole. During the second quarter of 2001, we declared the first quarterly dividend for the MCI group common stock. A cash dividend of $0.60 per share of MCI group common stock, or approximately $70 million in the aggregate, was paid on October 15, 2001 to shareholders of record as of the close of business on September 28, 2001. During the third quarter of 2001, we declared the fourth quarter dividend of $0.60 per share of MCI group common stock to be paid on January 15, 2002 to shareholders of record as of the close of business on December 31, 2001. The MCI group was initially allocated notional debt of $6 billion and our remaining debt was allocated on a notional basis to the WorldCom group. We intend, for so long as the WorldCom group stock and the MCI group stock remains outstanding, to include in filings by WorldCom under the Securities Exchange Act of 1934, as amended, the combined financial statements of each of the WorldCom group and the MCI group. These combined financial statements will be prepared in accordance with accounting principles generally accepted in the United States, and in the case of annual financial statements, will be audited. These combined financial statements are not legally required under current law or SEC regulations. 29 Voting rights of the holders of the WorldCom group stock and the MCI group stock are prorated based on the relative market values of WorldCom group stock and MCI group stock. We will conduct shareholder meetings that encompass all holders of voting stock. The WorldCom group and the MCI group shareholders will vote together as a single class on all matters brought to a vote of shareholders, including the election of our directors. Our board of directors may at any time convert each outstanding share of MCI group stock into shares of WorldCom group stock at 110% of the relative trading value of MCI group stock for the 20 days prior to the announcement of the conversion. No premium will be paid on a conversion that occurs three years after the issuance of MCI group stock. If all or substantially all of the WorldCom group or MCI group assets are sold, either: (i) the relevant shareholders will receive a distribution equal to the fair value of the net proceeds of the sale, either by special dividend or by redemption of shares; or (ii) each outstanding share of MCI group stock will be converted into shares of WorldCom group stock at 110% or 100% of the relative trading value of MCI group stock for a 10 trading day period following the sale. (C) EMBRATEL DECONSOLIDATION During the second quarter of 2001, we reached a long-term strategic decision to restructure our investment in Embratel. The restructuring included the resignation of certain Embratel Board of Directors seats, the irrevocable obligation to vote a portion of our common shares in a specified manner and the transfer of certain economic rights associated with such shares to an unrelated third party. Based on these actions, the accounting principles generally accepted in the United States prohibit the continued consolidation of Embratel's results. Accordingly, we have deconsolidated Embratel's results effective January 1, 2001. (D) BUSINESS COMBINATIONS On July 1, 2001, we acquired Intermedia Communications Inc. for approximately $5.8 billion, including long-term debt, pursuant to the merger of a wholly owned subsidiary with and into Intermedia, with Intermedia continuing as the surviving corporation and as a subsidiary of WorldCom. As a result of the Intermedia merger, we acquired a controlling interest in Digex, Incorporated, or Digex, a provider of managed Web and application hosting services for some of the world's fastest growing companies. In connection with the Intermedia merger, stockholders of Intermedia received one share of WorldCom group common stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a share of MCI group common stock (or 2.3 million MCI group shares in the aggregate) for each share of Intermedia common stock they owned. Holders of Intermedia preferred stock, other than Intermedia's 13.5% Series B Redeemable Exchangeable Preferred Stock due 2009, or Intermedia Series B Preferred Stock, received one share of a class or series of our preferred stock, with substantially identical terms, which were established upon consummation of the Intermedia merger. As a result of the merger with Intermedia, we own approximately 90% of the voting securities of Intermedia. Upon effectiveness of the merger with Intermedia, the then outstanding and unexercised options for shares of Intermedia common stock were converted into options exercisable for an aggregate of approximately 10 million shares of WorldCom group common stock having the same terms and conditions as the Intermedia options, except that the exercise price and the number of shares issuable upon exercise were divided and multiplied, respectively, by 1.0319. The merger with Intermedia was accounted for as a purchase and was allocated to the WorldCom group. The purchase price in the Intermedia merger was allocated based on appraised fair values at the date of acquisition. This resulted in an excess purchase price over net assets acquired of $5.1 billion of which $67 million was allocated to customer lists, which will be amortized over approximately four years on a straight line basis. The remaining excess of $5.0 billion has been allocated to goodwill and tradename which are not subject to amortization, and the goodwill is not expected to be deductible for tax purposes. In connection with the Intermedia merger, the Antitrust Division of the Department of Justice is requiring us to dispose of Intermedia's Internet service provider business, which provides integrated Internet connectivity solutions. In addition to this required divestiture, we have also committed to a plan to sell Intermedia's Advanced Building Network business, which provides centralized telecommunications services in multi-tenant commercial office buildings, and the systems integration business through which Intermedia sells, installs, operates and maintains business telephony customer premise equipment for its customers. We included the appraised fair values of these 30 assets to be disposed of in our initial allocation of the Intermedia purchase price and also included accrued anticipated losses expected to be incurred through disposal date. Any difference between the actual results of operations and the amounts accrued will result in an adjustment of goodwill unless there is a difference resulting from a post-merger event. For the three months ended September 30, 2001, operating losses, exclusive of associated depreciation and amortization for these assets to be disposed of were approximately $25 million, before corporate allocations. We anticipate that we will complete these planned disposals within the next twelve months. Since the Intermedia merger, WorldCom initiated plans to improve cash flow and operating results by reorganizing and restructuring Intermedia's operations. These plans include workforce reductions and other administrative cost savings, the discontinuance of all product lines with unacceptable or negative margins and the ultimate disposal of all assets associated with such product lines or businesses. (E) EARNINGS PER SHARE Our consolidated financial statements present basic and diluted earnings per share for WorldCom group stock and MCI group stock using the two-class method. The two-class method is an earnings formula that determines the attributed earnings per share for WorldCom group stock and MCI group stock according to participation rights in undistributed earnings. The combined financial statements of the WorldCom group do not present earnings per share because WorldCom group stock is a series of our common stock, and the WorldCom group is not a legal entity with a capital structure. For purposes of our consolidated financial statements, basic earnings per share attributed to WorldCom group stock is computed by dividing attributed net income for the period by the number of weighted-average shares of WorldCom group stock then outstanding. Diluted earnings per share attributed to WorldCom group stock is computed by dividing attributed net income for the period by the weighted-average number of shares of WorldCom group stock outstanding, including the dilutive effect of WorldCom group stock equivalents. (F) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid by the WorldCom group during the nine months ended September 30, 2000 and 2001, amounted to $366 million and $407 million, respectively. Income taxes paid by the WorldCom group during the nine months ended September 30, 2000 and 2001 totaled $135 million and $129 million, respectively. In conjunction with business combinations attributed to the WorldCom group during the nine months ended September 30, 2000 and 2001, assets acquired and liabilities assumed were as follows (in millions):
2000 2001 ---- ---- Fair value of assets acquired $ -- $ 2,063 Excess of cost over net tangible assets acquired 43 5,194 Liabilities assumed (29) (5,824) Common stock issued -- (1,266) --------- ------- Net cash paid $ 14 $ 167 ========= =======
(G) COMPREHENSIVE INCOME The following table reflects the calculation of comprehensive income attributed to the WorldCom group for the three and nine months ended September 30, 2000 and 2001 (in millions):
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- --------------------- 2000 2001 2000 2001 ----- ----- ------- ------- Net income $ 583 $ 460 $ 1,948 $ 1,102 ----- ----- ------- ------- Other comprehensive income (loss): Foreign currency translation gains (losses) (156) 53 (358) 5 Derivative financial instruments: Cumulative effect of adoption of SFAS 133 as of January 1, 2001 -- -- -- 28 Reclassification of derivative financial instruments to current earnings -- (23) -- (88) Change in fair value of derivative financial instruments -- 59 -- 106 Unrealized holding gains (losses): Unrealized holding gains (losses) during the period 424 (105) 805 (492) Reclassification adjustment for investment writeoffs included in net income -- -- -- 181 Reclassification adjustment for gains included in net income (167) (94) (382) (300) ----- ----- ------- -------
31
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- --------------------- 2000 2001 2000 2001 ----- ----- ------- ------- Other comprehensive income (loss) before tax 101 (110) 65 (560) Income tax benefit (expense) (96) 74 (159) 230 ----- ----- ------- ------- Other comprehensive income (loss) 5 (36) (94) (330) ----- ----- ------- ------- Comprehensive income $ 588 $ 424 $ 1,854 $ 772 ===== ===== ======= =======
(H) SEGMENT INFORMATION Based on its organizational structure, the WorldCom group operates in two reportable segments: Commercial voice, data and Internet, and International operations. The WorldCom group's reportable segments represent business units that primarily offer similar products and services; however, the business units are managed separately due to the type and class of customer as well as the geographic dispersion of their operations. The Commercial voice, data and Internet segment includes voice, data and other types of domestic communications services for commercial customers, and Internet services including dedicated access and web and application hosting services. International operations provide voice, data, Internet and other similar types of communications services to customers primarily in Europe and the Asia Pacific region. Our chief operating decision-maker utilizes revenue information in assessing performance and making overall operating decisions and resource allocations. Communications services are generally provided utilizing our fiber optic networks, which do not make a distinction between the types of services provided. Profit and loss information is reported only on a combined basis to our chief operating decision-maker and our board of directors. The accounting policies of the segments are the same policies as those used by the WorldCom group in preparing its combined financial statements. Information about the WorldCom group's segments for the three and nine months ended September 30, 2000 and 2001, is as follows (in millions):
REVENUES FROM EXTERNAL CUSTOMERS ---------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- --------------------- 2000 2001 2000 2001 ------- ------ -------- ------- Voice, data and Internet $ 4,275 $4,721 $ 12,557 $13,838 International operations 637 761 1,742 2,209 ------- ------ -------- ------- Total before Embratel 4,912 5,482 14,299 16,047 Embratel 970 -- 2,707 -- Elimination of intersegment revenues (38) -- (112) -- ------- ------ -------- ------- Total $ 5,844 $5,482 $ 16,894 $16,047 ======= ====== ======== =======
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2000 2001 2000 2001 ------- ------ ------- ------ Voice, data and Internet $ 787 $ 967 $ 2,320 $2,927 International operations 301 344 830 1,030 Corporate - other charges 340 -- 433 754 ------- ------ ------- ------ Total before Embratel 1,428 1,311 3,583 4,711 Embratel 245 -- 650 -- Elimination of intersegment expenses (9) -- (27) -- ------- ------ ------- ------ Total $ 1,664 $1,311 $ 4,206 $4,711 ======= ====== ======= ======
As discussed in Note C, we deconsolidated our investment in Embratel as of January 1, 2001. Embratel, which provides communications services in Brazil, was designated as a separate reportable segment of the WorldCom group for periods prior to January 1, 2001. Accordingly, we have included Embratel in our WorldCom group segment information presented for 2000. 32 The following is a reconciliation of the segment information to income before income taxes, minority interests and cumulative effect of accounting change for the three and nine months ended September 30, 2000 and 2001 (in millions):
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- -------------------- 2000 2001 2000 2001 ------ ------ ------- ------- Revenues $5,844 $5,482 $16,894 $16,047 Operating expenses 4,705 4,483 13,001 13,772 ------ ------ ------- ------- Operating income 1,139 999 3,893 2,275 Other income (expense): Interest expense (118) (316) (318) (717) Miscellaneous 107 107 327 330 ------ ------ ------- ------- Income before income taxes, minority interests and cumulative effect of accounting change $1,128 $ 790 $ 3,902 $ 1,888 ====== ====== ======= =======
(I) LONG-TERM DEBT As of January 1, 2000, $6.0 billion of our outstanding debt was notionally allocated to the MCI group and the remaining outstanding debt was notionally allocated to the WorldCom group. Our debt was allocated between the WorldCom group and the MCI group based upon a number of factors including estimated future cash flows and the ability to pay debt service and dividends of each of the groups. In addition, we considered certain measures of creditworthiness, such as coverage ratios and various tests of liquidity, in the allocation process. Our management believes that the initial allocation is equitable and supportable by both the WorldCom group and the MCI group. Each group's debt will increase or decrease by the amount of any net cash generated by, or required to fund, the group's operating activities, investing activities, share repurchases and other financing activities. Interest expense on borrowings incurred by us and allocated to the WorldCom group reflects the difference between our actual interest expense and the interest expense allocated to the MCI group. The MCI group was allocated interest based on our weighted-average interest rate, excluding capitalized interest, of our debt plus 1 1/4 percent. See Note J to our interim consolidated financial statements for information pertaining to our outstanding long-term debt. (J) PREFERRED STOCK In connection with the Intermedia merger, we issued the following series of preferred stock:
NUMBER OF AGGREGATE # OF SHARES CONVERTIBLE PREFERRED ANNUAL AT THE OPTION OF HOLDER SHARES LIQUIDATION DIVIDEND --------------------------------- AUTHORIZED, PREFERENCE PER ASSOCIATED ISSUED AND PER PREFERRED PREFERRED DEPOSITORY WORLDCOM MCI GROUP OUTSTANDING SHARE SHARE SHARES GROUP SHARES SHARES ----------- ------------- --------- ---------- ------------------ ---------- Series D Junior Convertible preferred stock, par value $0.01 per share 53,724 $2,500 $175 5,372,410 6,905,398 276,215 Series E Junior Convertible preferred stock, par value $0.01 per share 64,047 $2,500 $175 6,404,690 5,295,766 211,830 Series F Junior Convertible preferred stock, par value $0.01 per share 79,600 $2,500 $175 7,960,000 4,729,649 189,185 Series G Junior Convertible Participating preferred stock, par value $0.01 per share 200,000 $1,000 $ 70 n/a 5,555,555 222,222
On August 20, 2001, the holder of our Series G preferred stock exercised its right to require us to redeem all of the outstanding Series G preferred stock at par plus accrued dividends, or approximately $200 million in the aggregate. 33 The Series D, E and F preferred stock is currently redeemable in whole or in part, at our option for cash plus accrued and unpaid dividends at rates ranging from 103% down to 100% beginning 2004 and thereafter for the Series D and E preferred stock and from 104% down to 100% beginning 2005 and thereafter for the Series F preferred stock. Dividends on the Series D, E and F preferred stock are payable in cash or shares of our common stock, at our election on each July 15, October 15, January 15 and April 15. We paid the initial dividend on July 15, 2001 in cash and we expect to continue to pay cash dividends on our Series D, E and F preferred stock. The Series D, E and F preferred shareholders are generally entitled to vote on the basis of 0.10 of a vote per share of Series D, E or F preferred stock on all matters. In October 2001, we exercised our option to redeem all of our outstanding Series B Preferred Stock. Prior to the redemption date, substantially all of the holders of our Series B Preferred Stock elected to convert the preferred stock into 0.1460868 shares of WorldCom group stock and 0.005843472 shares of MCI group stock for each share of Series B Preferred Stock held. (K) REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES At the time of the Intermedia merger, Intermedia had outstanding Intermedia Series B Preferred Stock, and Digex had outstanding Series A Convertible Preferred Stock, or Digex Series A Preferred Stock. As of September 30, 2001, there were 549,896 shares of Intermedia Series B Preferred Stock outstanding. Dividends on the Intermedia Series B Preferred Stock accumulate at a rate of 13.5% of the aggregate liquidation preference thereof and are payable quarterly, in arrears. Dividends are payable in cash or, at Intermedia's option, by the issuance of additional shares of Intermedia Series B Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends. Historically, Intermedia has paid the Intermedia Series B Preferred Stock dividend by the issuance of additional shares of Intermedia Series B Preferred Stock. The Intermedia Series B Preferred Stock is subject to mandatory redemption at its liquidation preference of $1,000 per share, plus accumulated and unpaid dividends on March 31, 2009. The Intermedia Series B Preferred Stock will be redeemable at the option of Intermedia at any time after March 31, 2002 at rates commencing with 106.75%, declining to 100% on March 31, 2007. Intermedia Series B Preferred Stock is generally entitled to one-tenth of one vote per share on all matters voting together with the common stock of Intermedia as a single class. The Digex Series A Preferred Stock has an aggregate liquidation preference of $100 million, and is convertible into approximately 1,462,000 shares of Class A Common Stock of Digex. The Digex Series A Preferred Stock does not pay dividends and there are no voting rights. (L) CONTINGENCIES The WorldCom group's shareholders are subject to all of the risks related to an investment in WorldCom and the WorldCom group, including the effects of any legal proceedings and claims against the MCI group. See Note I to our interim consolidated financial statements for information related to our contingencies. (M) DERIVATIVE FINANCIAL INSTRUMENTS Effective January 1, 2001, we adopted the Financial Accounting Standards Board's, or FASB's, Statement of Financial Accounting Standard, or SFAS, No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. This statement establishes accounting and reporting standards requiring that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at fair value. As of January 1, 2001, our exposure to derivative financial instruments primarily consisted of option collar transactions designated as cash flow hedges of anticipated sales of an equity investment, which we maintain to minimize the impact of adverse changes in the market price of the related equity investment, and various equity warrants. The initial adoption of SFAS No. 133 provided a net transition gain from our designated cash flow hedges resulting in an increase in other comprehensive income of approximately $28 million. We recorded no net impact from adoption of SFAS No. 133 related to the various equity warrants. During the nine months ended September 30, 2001, shares of the hedged equity investment were sold and we reclassified 34 respective hedging gains of $88 million from accumulated comprehensive income to miscellaneous income. As of September 30, 2001, we estimate during the next twelve months we will reclassify from accumulated comprehensive income into earnings approximately $46 million relating to our derivative financial instruments as the underlying hedged equity investment is sold. The actual amounts that will be reclassified to earnings over the next twelve months will vary from this amount as a result of changes in market conditions. No amounts were reclassified to earnings resulting from any ineffective portion of the designated derivative hedges or from the discontinuance of designation of any cash flow hedges. All of our derivative instruments are attributed to the WorldCom group. 35 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED BALANCE SHEETS (Unaudited. In Millions)
December 31, September 30, 2000 2001 ------------ ------------- ASSETS Current assets: Cash and cash equivalents $ 41 $ 10 Accounts receivable, net of allowance for bad debts of $514 in 2000 and $443 in 2001 1,835 1,637 Deferred tax asset 41 6 Other current assets 395 362 ---------- ---------- Total current assets 2,312 2,015 ---------- ---------- Property and equipment: Transmission equipment 405 390 Communications equipment 2,227 2,440 Furniture, fixtures and other 676 689 Construction in progress 170 127 ---------- ---------- 3,478 3,646 Accumulated depreciation (1,232) (1,585) ---------- ---------- 2,246 2,061 ---------- ---------- Goodwill and other intangible assets 9,909 9,802 Other assets 168 235 ---------- ---------- $ 14,635 $ 14,113 ========== ========== LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Payable to WorldCom group, net $ 649 $ 871 Accounts payable and accrued line costs 2,438 2,108 Other current liabilities 1,022 1,161 ---------- ---------- Total current liabilities 4,109 4,140 ---------- ---------- Long-term liabilities, less current portion: Long-term debt 6,000 5,593 Long-term payable to WorldCom group, net 976 976 Deferred tax liability 928 865 Other liabilities 159 66 ---------- ---------- Total long-term liabilities 8,063 7,500 ---------- ---------- Allocated net worth 2,463 2,473 ---------- ---------- $ 14,635 $ 14,113 ========== ==========
The accompanying notes are an integral part of these statements. 36 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF OPERATIONS (Unaudited. In Millions)
For the Three Months Ended For the Nine Months Ended September 30, September 30, --------------------------- ------------------------- 2000 2001 2000 2001 --------- ---------- ---------- --------- Revenues $ 4,193 $ 3,484 $ 12,562 $ 10,654 --------- ---------- ---------- --------- Operating expenses: Line costs 1,777 1,775 5,312 5,408 Selling, general and administrative 1,472 1,292 3,826 4,060 Depreciation and amortization 231 236 654 700 --------- ---------- ---------- --------- Total 3,480 3,303 9,792 10,168 --------- ---------- ---------- --------- Operating income 713 181 2,770 486 Other income (expense): Interest expense (127) (126) (381) (378) --------- ---------- ---------- --------- Income before income taxes and cumulative effect of accounting change 586 55 2,389 108 Provision for income taxes 234 22 949 42 --------- ---------- ---------- --------- Income before cumulative effect of accounting change 352 33 1,440 66 Cumulative effect of accounting change (net of income tax of $7 in 2000) -- -- (10) -- --------- ---------- ---------- --------- Net income $ 352 $ 33 $ 1,430 $ 66 ========= ========== ========== =========
The accompanying notes are an integral part of these statements. 37 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF CASH FLOWS (Unaudited. In Millions)
For the Nine Months Ended September 30, -------------------------- 2000 2001 ---------- ---------- Cash flows from operating activities: Net income $ 1,430 $ 66 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change 10 -- Depreciation and amortization 654 700 Provision for deferred income taxes 157 (28) Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net (34) 115 Other current assets (211) 33 Accounts payable and other current liabilities (908) (187) Payable to WorldCom group, net 480 222 All other operating activities -- 140 ---------- ---------- Net cash provided by operating activities 1,578 1,061 ---------- ---------- Cash flows from investing activities: Capital expenditures (370) (188) Increase in intangible assets (82) (274) Decrease in other liabilities (57) (93) All other investing activities (61) (144) ---------- ---------- Net cash used in investing activities (570) (699) ---------- ---------- Cash flows from financing activities: Principal repayments on debt, net -- (408) Advances (to) from WorldCom group, net (1,002) 15 ---------- ---------- Net cash used in financing activities (1,002) (393) ---------- ---------- Net increase (decrease) in cash and cash equivalents 6 (31) Cash and cash equivalents at beginning of period 70 41 ---------- ---------- Cash and cash equivalents at end of period $ 76 $ 10 ========== ==========
The accompanying notes are an integral part of these statements. 38 MCI GROUP (AN INTEGRATED BUSINESS OF WORLDCOM, INC.) NOTES TO COMBINED FINANCIAL STATEMENTS (A) GENERAL The combined financial statements included herein for the MCI group (an integrated business of WorldCom, Inc.), are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and SEC regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the combined financial statements of the MCI group reflect all adjustments (of a normal and recurring nature) which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2000. The results for the three- and nine-month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. (B) RECAPITALIZATION On June 7, 2001, our shareholders approved a recapitalization involving the creation of two separately traded tracking stocks: o WorldCom group stock, which is intended to reflect the performance of our data, Internet, international and commercial voice businesses and is quoted on The Nasdaq National Market under the trading symbol "WCOM", and o MCI group stock, which is intended to reflect the performance of our consumer, small business, wholesale long distance voice and data, wireless messaging and dial-up Internet access businesses and is quoted on The Nasdaq National Market under the trading symbol "MCIT". In connection with the recapitalization, we amended our articles of incorporation to replace our existing common stock with two new series of common stock that are intended to reflect, or track, the performance of the businesses attributed to the WorldCom group and the MCI group. Effective with the recapitalization on June 7, 2001, each share of our existing common stock was changed into one share of WorldCom group stock and 1/25 of a share of MCI group stock. A tracking stock is a separate class of a company's common stock intended to provide a return to investors based upon the financial performance of a distinct business unit of the company, sometimes referred to as the targeted business. These targeted businesses are collections of businesses that we have grouped together in order for us to issue WorldCom group stock and MCI group stock. The ownership of the targeted business does not change, and while each of the classes of stock trade separately, all shareholders are common shareholders of a single company, WorldCom, and are subject to all risks of an investment in WorldCom as a whole. During the second quarter of 2001, we declared the first quarterly dividend for the MCI group common stock. A cash dividend of $0.60 per share of MCI group common stock, or approximately $70 million in the aggregate, was paid on October 15, 2001 to shareholders of record as of the close of business on September 28, 2001. During the third quarter of 2001, we declared the fourth quarter dividend of $0.60 per share of MCI group common stock to be paid on January 15, 2002 to shareholders of record as of the close of business on December 31, 2001. The MCI group was initially allocated notional debt of $6 billion and our remaining debt was allocated on a notional basis to the WorldCom group. We intend, for so long as the WorldCom group stock and the MCI group stock remains outstanding, to include in filings by WorldCom under the Securities Exchange Act of 1934, as amended, the combined financial statements of each of the WorldCom group and the MCI group. These combined financial statements will be prepared in accordance with accounting principles generally accepted in the United States, and in the case of annual financial statements, will be audited. These combined financial statements are not legally required under current law or SEC regulations. 39 Voting rights of the holders of the WorldCom group and the MCI group stock are prorated based on the relative market values of WorldCom group stock and MCI group stock. We will conduct shareholder meetings that encompass all holders of voting stock. The WorldCom group and the MCI group shareholders will vote together as a single class on all matters brought to a vote of shareholders, including the election of our directors. Our board of directors may at any time convert each outstanding share of MCI group stock into shares of WorldCom group stock at 110% of the relative trading value of MCI group stock for the 20 days prior to the announcement of the conversion. No premium will be paid on a conversion that occurs three years after the issuance of MCI group stock. If all or substantially all of the WorldCom group or MCI group assets are sold, either: (i) the relevant shareholders will receive a distribution equal to the fair value of the net proceeds of the sale, either by special dividend or by redemption of shares; or (ii) each outstanding share of MCI group stock will be converted into shares of WorldCom group stock at 110% or 100% of the relative trading value of MCI group stock for a 10 trading day period following the sale. (C) EARNINGS PER SHARE Our consolidated financial statements present basic and diluted earnings per share for WorldCom group stock and MCI group stock using the two-class method. The two-class method is an earnings formula that determines the attributed earnings per share for WorldCom group stock and MCI group stock according to participation rights in undistributed earnings. The combined financial statements of the MCI group do not present earnings per share because MCI group stock is a series of our common stock, and the MCI group is not a legal entity with a capital structure. For purposes of our consolidated financial statements, basic earnings per share attributed to MCI group stock is computed by dividing attributed net income for the period by the number of weighted-average shares of MCI group stock then outstanding. Diluted earnings per share attributed to MCI group stock is computed by dividing attributed net income for the period by the weighted-average number of shares of MCI group stock outstanding, including the dilutive effect of MCI group stock equivalents. (D) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid by the MCI group during the nine months ended September 30, 2000 and 2001, amounted to $427 million and $367 million, respectively. Income taxes paid, net of refunds received, during the nine months ended September 30, 2000 and 2001, totaled $48 million and $1 million, respectively. (E) SEGMENT INFORMATION Based on its organizational structure, the MCI group operates in four reportable segments: Consumer; Wholesale; Alternative channels and small business; and Dial-up Internet. The MCI group's reportable segments represent business units that primarily offer similar products and services; however, the business units are managed separately due to the type and class of customer as well as the geographic dispersion of their operations. Consumer includes domestic voice communications services for consumer customers. Wholesale includes domestic long distance voice and data communications services for wholesale customers. Alternative channels and small business includes domestic long distance voice and data, agents, prepaid calling cards and paging services provided to alternative wholesale and small business customers. Dial-up Internet includes dial-up Internet access services. Our chief operating decision-maker utilizes revenue information in assessing performance and making overall operating decisions and resource allocations. Communications services are generally provided utilizing our network facilities, which do not make a distinction between the types of services provided. Profit and loss information is reported only on a combined basis to our chief operating decision-maker and our board of directors. The accounting policies of the segments are the same policies as those used by the MCI group in preparing its combined financial statements. Information about the MCI group's segments for the three and nine months ended September 30, 2000 and 2001, is as follows (in millions): 40
REVENUES FROM EXTERNAL CUSTOMERS ------------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ----------------------- 2000 2001 2000 2001 -------- -------- --------- --------- Consumer $ 1,989 $ 1,873 $ 5,890 $ 5,516 Wholesale 847 657 2,655 2,050 Alternative channels and small business 954 591 2,792 1,896 Dial-up Internet 403 363 1,225 1,192 -------- -------- --------- --------- Total $ 4,193 $ 3,484 $ 12,562 $ 10,654 ======== ======== ========= ========= SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ------------------------------------------------- FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ----------------------- 2000 2001 2000 2001 -------- -------- --------- --------- Consumer $ 651 $ 752 $ 2,050 $ 2,245 Wholesale 122 151 385 467 Alternative channels and small business 249 263 742 820 Dial-up Internet 105 126 304 394 Corporate - other charges 345 -- 345 134 -------- -------- --------- --------- Total $ 1,472 $ 1,292 $ 3,826 $ 4,060 ======== ======== ========= =========
The following is a reconciliation of the segment information to income before income taxes and cumulative effect of accounting change for the three and nine months ended September 30, 2000 and 2001 (in millions):
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ----------------------- ------------------------- 2000 2001 2000 2001 --------- --------- ---------- ---------- Revenues $ 4,193 $ 3,484 $ 12,562 $ 10,654 Operating expenses 3,480 3,303 9,792 10,168 --------- --------- ---------- ---------- Operating income 713 181 2,770 486 Other income (expense): Interest expense (127) (126) (381) (378) --------- --------- ---------- ---------- Income before income taxes and cumulative effect of accounting change $ 586 $ 55 $ 2,389 $ 108 ========= ========= ========== ==========
(F) LONG-TERM DEBT As of January 1, 2000, $6.0 billion of our outstanding debt was notionally allocated to the MCI group and the remaining outstanding debt was notionally allocated to the WorldCom group. Our debt was allocated between the WorldCom group and the MCI group based upon a number of factors including estimated future cash flows and the ability to pay debt service and dividends of each of the groups. In addition, we considered certain measures of creditworthiness, such as coverage ratios and various tests of liquidity, in the allocation process. Our management believes that the initial allocation is equitable and supportable by both the WorldCom group and the MCI group. Each group's debt will increase or decrease by the amount of any net cash generated by, or required to fund, the group's operating activities, investing activities, share repurchases and other financing activities. During 2001, the MCI group repaid $408 million of the notionally allocated debt and as of September 30, 2001, the MCI group's long-term debt balance was $5.6 billion. Interest expense on borrowings incurred by us and allocated to the WorldCom group reflects the difference between our actual interest expense and the interest expense allocated to the MCI group. The MCI group was allocated interest based on our weighted-average interest rate, excluding capitalized interest, of our debt plus 1 1/4 percent. See Note J to our interim consolidated financial statements for information pertaining to our outstanding long-term debt. 41 CONTINGENCIES The MCI group's shareholders are subject to all of the risks related to an investment in WorldCom and the MCI group, including the effects of any legal proceedings and claims against the WorldCom group. See Note I to our interim consolidated financial statements for information related to our contingencies. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW On June 7, 2001, our shareholders approved a recapitalization involving the creation of two separately traded tracking stocks: WorldCom group stock, which is intended to track the separate performance of our data, Internet, international and commercial voice businesses; and MCI group stock, which is intended to reflect the performance of our consumer, small business, wholesale long distance voice and data, wireless messaging and dial-up Internet access businesses. Through the businesses that we have realigned as the WorldCom group, which have an extensive, advanced facilities-based global communications network, we provide a broad range of integrated communications and managed network services to both U.S. and non-U.S. based corporations. Offerings include data services such as frame relay, asynchronous transfer mode and Internet protocol networks; Internet related services, including dedicated access, virtual private networks, digital subscriber lines, web centers encompassing application and server hosting and managed data services; commercial voice services; and international services. Through the businesses that we have realigned as the MCI group, we provide a broad range of retail and wholesale communications services, including long distance voice and data communications, consumer local voice communications, wireless messaging, private line services and dial-up Internet access services. Our retail services are provided to consumers and small businesses in the United States. We are the second largest carrier of long distance telecommunications services in the United States. We provide a wide range of long distance telecommunications services, including: basic long distance telephone service, dial around, collect calling, operator assistance and calling card services (including prepaid calling cards) and toll free or 800 services. We offer these services individually and in combinations. Through combined offerings, we provide customers with benefits such as single billing, unified services for multi-location companies and customized calling plans. Our wholesale businesses include wholesale voice and data services provided to carrier customers and other resellers and dial-up Internet access services. On July 1, 2001, we acquired Intermedia Communications Inc. for approximately $5.8 billion, including assumed long-term debt, pursuant to the merger of a wholly owned subsidiary with and into Intermedia, with Intermedia continuing as the surviving corporation and as a subsidiary of WorldCom. As a result of the Intermedia merger, we acquired a controlling interest in Digex, Incorporated, or Digex, a provider of managed Web and application hosting services for some of the world's fastest growing companies. In connection with the Intermedia merger, stockholders of Intermedia received one share of WorldCom group common stock (or 57.1 million WorldCom group shares in the aggregate) and 1/25th of a share of MCI group common stock (or 2.3 million MCI group shares in the aggregate) for each share of Intermedia common stock they owned. Holders of Intermedia preferred stock, other than Intermedia Series B Preferred Stock, received one share of a class or series of our preferred stock, with substantially identical terms, which were established upon consummation of the Intermedia merger. As a result of the merger with Intermedia, we own approximately 90% of the voting securities of Intermedia. Upon effectiveness of the merger with Intermedia, the then outstanding and unexercised options for shares of Intermedia common stock were converted into options exercisable for an aggregate of approximately 10 million shares of WorldCom group common stock having the same terms and conditions as the Intermedia options, except that the exercise price and the number of shares issuable upon exercise were divided and multiplied, respectively, by 1.0319. The merger with Intermedia was accounted for as a purchase and was allocated to the WorldCom group. Since the Intermedia merger, WorldCom initiated plans to improve cash flow and operating results by reorganizing and restructuring Intermedia's operations. These plans include workforce reductions and other administrative cost savings, the discontinuance of all product lines with unacceptable or negative margins and the ultimate disposal of all assets associated with such product lines or businesses. During the second quarter of 2001, we reached a long-term strategic decision to restructure our investment in Embratel. The restructuring included the resignation of certain Embratel Board of Directors seats, the irrevocable obligation to vote a portion of our common shares in a specified manner and the transfer of certain economic rights associated with such shares to an unrelated third party. Based on these actions, the accounting principles generally accepted in the United States prohibit the continued consolidation of Embratel's results. Accordingly, we have 42 deconsolidated Embratel's results effective January 1, 2001. ADDITIONAL DISCUSSION RELATED TO THE WORLDCOM GROUP AND THE MCI GROUP FINANCIAL STATEMENTS Each of the WorldCom group and the MCI group includes the results of operations shown in the combined statements of operations and the attributed assets and liabilities shown in the combined balance sheets of the relevant group. If we acquire interests in other businesses, we intend to attribute those assets and any related liabilities to our WorldCom group or our MCI group in accordance with our tracking stock policy statement. All net income and cash flows generated by the assets will be attributed to the group to which the assets were attributed and all net proceeds from any disposition of these assets will also be attributed to that group. Although we sometimes refer to such assets and liabilities as those of the WorldCom group or the MCI group, neither of the groups is a separate legal entity. Rather, all of the assets of a group are owned by WorldCom and holders of the WorldCom group stock or the MCI group stock are shareholders of WorldCom and subject to all of the risks of an investment in WorldCom and all of its businesses, assets and liabilities. We intend, for so long as the WorldCom group stock and the MCI group stock remains outstanding, to include in filings by WorldCom under the Securities Exchange Act of 1934, as amended, the combined financial statements of each of the WorldCom group and the MCI group. These combined financial statements will be prepared in accordance with accounting principles generally accepted in the United States, and in the case of annual financial statements, will be audited. These combined financial statements are not legally required under current law or SEC regulations. Our board of directors may at any time modify, make exceptions to, or abandon any of the policies set forth in our tracking stock policy statement with respect to the allocation of corporate opportunities, financing arrangements, assets, liabilities, debt, interest and other matters, or may adopt additional policies, in each case without shareholder approval. Our board is subject to fiduciary duties to all of WorldCom's shareholders as one group, not to the holders of any series of stock separately. Any changes or exceptions will be made after a determination by our board of what is in the best interests of WorldCom as a whole, which may be detrimental to the interests of the holders of one series of stock. The ability to make these changes may make it difficult to address the future of a group based on the group's past performance. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS The following statements are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995: (i) any statements contained or incorporated herein regarding possible or assumed future results of operations of WorldCom's business, anticipated cost savings or other synergies, the markets for WorldCom's services and products, anticipated capital expenditures, the outcome of euro conversion efforts, regulatory developments or competition; (ii) any statements preceded by, followed by or that include the words "intends," "estimates," "believes," "expects," "anticipates," "should," "could," or similar expressions; and (iii) other statements contained or incorporated by reference herein regarding matters that are not historical facts. Because such statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements; factors that could cause actual results to differ materially include, but are not limited to: o economic uncertainty; o the effects of vigorous competition; o the impact of technological change on our business, new entrants and alternative technologies, and dependence on availability of transmission facilities; o uncertainties associated with the success of acquisitions; 43 o risks of international business; o regulatory risks in the United States and internationally; o contingent liabilities; o risks associated with euro conversion efforts; o uncertainties regarding the collectibility of receivables; o risks associated with debt service requirements and interest rate fluctuations; o our financial leverage; and o the other risks referenced from time to time in WorldCom's filings with the SEC, including the risk factors described in our Form S-4, as amended (Registration No. 333-52920). Potential purchasers of WorldCom capital stock are cautioned not to place undue reliance on such statements, which speak only as of the date thereof. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by WorldCom or persons acting on its behalf. The following discussion and analysis relates to our financial condition and results of operations for the three and nine months ended September 30, 2000 and 2001. This information should be read in conjunction with the consolidated financial statements and notes thereto contained herein, and the combined financial statements and notes thereto of each of the WorldCom group and the MCI group contained herein. RESULTS OF OPERATIONS The following table sets forth for the periods indicated our statements of operations as a percentage of its revenues for the periods indicated:
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- --------------------- 2000 2001 2000 2001 ------ ------ ------ ------ Revenues ............................................................... 100.0% 100.0% 100.0% 100.0% Line costs ............................................................. 38.5 41.8 38.6 41.8 Selling, general and administrative .................................... 30.7 28.1 26.6 31.8 Depreciation and amortization .......................................... 12.3 17.0 12.1 16.0 ------ ------ ------ ------ Operating income ....................................................... 18.5 13.2 22.6 10.3 Other income (expense): Interest expense ...................................................... (2.4) (4.9) (2.4) (4.1) Miscellaneous ......................................................... 1.1 1.2 1.1 1.2 ------ ------ ------ ------ Income before income taxes, minority interests and cumulative effect of accounting change ........................................... 17.1 9.4 21.4 7.5 Provision for income taxes ............................................. 6.9 3.7 8.7 2.9 ------ ------ ------ ------ Income before minority interests and cumulative effect of accounting change ..................................................... 10.2 5.8 12.7 4.6 Minority interests ..................................................... (0.7) 0.2 (0.8) 0.1 Cumulative effect of accounting change ................................. -- -- (0.3) -- ------ ------ ------ ------ Net income ............................................................. 9.5 6.0 11.6 4.7 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements ............................. 0.2 0.5 0.2 0.3 ------ ------ ------ ------ Net income applicable to common shareholders ........................... 9.3% 5.5% 11.5% 4.4% ====== ====== ====== ======
44 THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 VS. THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 For the three and nine months ended September 30, 2000 and 2001, our revenues were as follows (dollars in millions):
FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, -------------------------------------------- ------------------------------------------- 2000 2001 2000 2001 --------------------- ------------------- -------------------- -------------------- PERCENT PERCENT PERCENT PERCENT $ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL ------- -------- ------ -------- ------- -------- ------- -------- WorldCom group .............. $ 5,844 58.2% $5,482 61.1% $16,894 57.4% $16,047 60.1% MCI group ................... 4,193 41.8 3,484 38.9 12,562 42.6 10,654 39.9 ------- ----- ------ ----- ------- ----- ------- ----- $10,037 100.0% $8,966 100.0% $29,456 100.0% $26,701 100.0% ======= ===== ====== ===== ======= ===== ======= =====
Actual reported revenues by category for the three and nine months ended September 30, 2000 and 2001 reflect the following changes by category (dollars in millions):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------------- ----------------------------------- PERCENT PERCENT 2000 2001 CHANGE 2000 2001 CHANGE ------- ------ ------- ------- ------- ------- COMMERCIAL SERVICES REVENUES Voice ....................................... $ 1,731 $1,629 (5.9) $ 5,328 $ 5,021 (5.8) Data ........................................ 1,909 2,257 18.2 5,462 6,481 18.7 International ............................... 637 761 19.5 1,742 2,209 26.8 Embratel, net ............................... 932 -- n/a 2,595 -- n/a Internet .................................... 635 835 31.5 1,767 2,336 32.2 ------- ------ ------- ------- TOTAL COMMERCIAL SERVICES REVENUES ............ 5,844 5,482 (6.2) 16,894 16,047 (5.0) Consumer .................................... 1,989 1,873 (5.8) 5,890 5,516 (6.3) Wholesale ................................... 847 657 (22.4) 2,655 2,050 (22.8) Alternative channels and small business ..... 954 591 (38.1) 2,792 1,896 (32.1) Dial-up Internet ............................ 403 363 (9.9) 1,225 1,192 (2.7) ------- ------ ------- ------- TOTAL ......................................... $10,037 $8,966 (10.7) $29,456 $26,701 (9.4) ======= ====== ======= =======
Commercial services revenues, which include the revenues generated from commercial voice, data, international and Internet services, for the third quarter of 2001 were $5.5 billion versus $5.8 billion for the third quarter of 2000. For the nine months ended September 30, 2001, commercial services revenues were $16.0 billion versus $16.9 billion for the prior year period. As indicated above, during the second quarter of 2001, we took steps to restructure our investment in Embratel which resulted in the deconsolidation of Embratel effective January 1, 2001. Excluding Embratel from the 2000 periods, commercial services revenues for the three and nine months ended September 30, 2001 increased 11.6% and 12.2%, respectively, versus the prior year periods. Voice revenues for the third quarter of 2001 decreased 5.9% over the prior year period on traffic growth of 2.2%. For the nine months ended September 30, 2001, voice revenues decreased 5.8% on traffic growth of 4.3%. The revenue decreases were partially offset by wireless voice revenue increases of 19.1% for the third quarter of 2001 and 47.9% for the first nine months of 2001. Data revenues for the third quarter of 2001 increased 18.2% over the prior year period. For the nine months ended September 30, 2001, data revenues increased 18.7% over the prior year period. Data includes both commercial long distance and local dedicated bandwidth sales. As of September 30, 2001, approximately 32% of data revenues were derived from frame relay and asynchronous transfer mode services, where we experienced strong demand for capacity increases across the product set as businesses moved more of their mission-critical applications to their own networks during the period. Additionally, we continue to experience strong price pressure for data services in our emerging markets due to competition and the general decline in economic condition of our customers, which we expect to continue in the foreseeable future. 45 International revenues for the third quarter 2001 increased 19.5% to $761 million versus $637 million, excluding Embratel, for the third quarter of 2000. For the nine months ended September 30, 2001, international revenues increased 26.8% to $2.2 billion versus $1.7 billion, excluding Embratel, for the prior year period. Geographically, Europe grew 15.9% and Asia Pacific and other areas grew 27.4% for the third quarter of 2001. For the first nine months of 2001, Europe grew 16.3% and Asia Pacific and other areas grew 54.0%. These increases were partially offset by foreign currency fluctuations that had the effect of reducing revenues by approximately $50 million in the third quarter of 2001 and approximately $140 million for the first nine months of 2001. Although our retail mix is improving towards a more profitable blend of data versus voice, and retail versus wholesale, our international business continues to experience significant price pressure on its products. Internet revenues for the third quarter of 2001 increased 31.5% over the prior year period. For the first nine months of 2001, Internet revenues increased 32.2% over the prior year period. Growth was driven by demand for dedicated circuits as business customers continue to migrate their data networks and applications to Internet-based technologies requiring greater amounts of bandwidth. Additionally, Internet revenues growth for the third quarter of 2001 included $29 million of Digex revenues, after intercompany eliminations, as a result of the Intermedia merger. During 2001, we began to introduce our new managed hosting products and virtual private networks on public and shared environments. These products, which are in the initial phases of their life cycle, should gradually contribute to our revenue growth over the next several quarters. Internet revenues include dedicated Internet access, managed networking services and applications (such as virtual private networks), web hosting and electronic commerce and transaction services (such as web centers and credit card transaction processing). Consumer revenues for the third quarter of 2001 decreased 5.8% over the prior year period. For the first nine months of 2001, consumer revenues decreased 6.3% over the prior year period. The majority of this decrease is attributed to decreases in calling card, dial around and dial-1 revenues as a result of consumers' substitution of wire line services with wireless and e-mail. Our consumer local initiatives continue to perform well as consumer local revenues increased over 200% for the third quarter of 2001 and over 175% for the first nine months of 2001 versus the prior year period. Wholesale revenues for the third quarter of 2001 decreased 22.4% over the prior year period. For the first nine months of 2001, wholesale revenues decreased 22.8%. The wholesale market continues to be extremely price competitive, although rate per minute began to stabilize in the second quarter of 2001. Wholesale revenues during the past year were also impacted by proactive revenue initiatives, which were made to improve the quality of the wholesale revenue stream as we shift the MCI group's focus from revenue growth to cash generation. Alternative channels and small business revenues for the three and nine months ended September 30, 2001 decreased 38.1% and 32.1%, respectively, over the prior year periods. Alternative channels and small business includes sales agents and affiliates, wholesale alternative channels, small business, prepaid calling card and wireless messaging revenues. These decreases are attributed to pricing pressures in the wholesale and small business markets which negatively affected revenue growth and gross margins in this area, and proactive initiatives to de-emphasize services with unacceptable gross margins as we shift the MCI group's focus from revenue growth to cash generation. Dial-up Internet revenues for the three and nine months ended September 30, 2001 decreased 9.9% and 2.7%, respectively, over the prior year amounts. Our dial access network has grown 28% to approximately 3.2 million modems as of September 30, 2001, compared with the prior year period. Additionally, Internet connect hours increased 13.6% to 5.4 billion hours for the first nine months of 2001 versus the prior year. These network usage increases were more than offset by pricing pressure resulting from the impact of volume discounts and off-net traffic, which lowered average revenue per hour by approximately 16% for the third quarter of 2001 and 18% for the first nine months of 2001 versus the prior year periods. LINE COSTS. For the three and nine months ended September 30, 2000 and 2001, our line costs were as follows (dollars in millions): 46
FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, -------------------------------------------------- ------------------------------------------------- 2000 2001 2000 2001 --------------------- ---------------------- ---------------------- -------------------- PERCENT PERCENT PERCENT PERCENT $ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL -------- -------- -------- -------- -------- -------- -------- -------- WorldCom group .......... $ 2,207 57.1% $ 2,085 55.7% $ 6,407 56.3% $ 6,111 54.7% MCI group ............... 1,777 45.9 1,775 47.4 5,312 46.7 5,408 48.4 Intergroup eliminations . (117) (3.0) (115) (3.1) (343) (3.0) (348) (3.1) -------- -------- -------- -------- -------- -------- -------- -------- $ 3,867 100.0% $ 3,745 100.0% $ 11,376 100.0% $ 11,171 100.0% ======== ======== ======== ======== ======== ======== ======== ========
Line costs as a percentage of revenues for the third quarter of 2001 increased to 41.8% as compared to 38.5% for the third quarter of 2000. On a year-to-date basis, line costs as a percentage of revenues increased to 41.8% as compared to 38.6% reported for the same period of the prior year. Excluding Embratel for the 2000 periods, line costs for the third quarter of 2000 were $3.4 billion, or 37.7% of revenues, and line costs for the nine months ended September 30, 2000 were $10.2 billion, or 37.8% of revenues. The increases as a percentage of revenues reflect the pricing pressure in the commercial data, Internet and international markets as well as the continued competitive pricing and off-net traffic in the dial-up Internet business which resulted in a modest increase in average cost per hour while average dial-up revenues per hour decreased 16% for the third quarter of 2001 and 18% for the first nine months of 2001. Additionally, line costs as a percentage of revenues have increased as a result of the decrease in higher margin calling card and dial around revenues due to wireless substitution as noted above. Line costs were partially offset by foreign currency exchange fluctuations, which had the effect of reducing line costs as a percentage of revenues by almost one-half of a percentage point for both the three- and nine-month periods ended September 30, 2001, as compared to the prior year periods, and by increased data and dedicated Internet traffic over our own facilities, which positively affected line costs as a percentage of revenues by almost one percentage point for both the three- and nine-month periods ended September 30, 2001. The principal components of line costs are access charges and transport charges. Regulators have historically permitted access charges to be set at levels that are well above traditional phone companies' costs. As a result, access charges have been a source of universal service subsidies that enable local exchange rates to be set at levels that are affordable. We have actively participated in a variety of state and federal regulatory proceedings with the goal of bringing access charges to cost-based levels and to fund universal service using explicit subsidies funded in a competitively neutral manner. We cannot predict the outcome of these proceedings or whether or not the results will have a material adverse impact on our consolidated financial position or results of operations. However, our goal is to manage transport costs through effective utilization of our networks, favorable contracts with carriers and network efficiencies made possible as a result of expansion of our customer base. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three and nine months ended September 30, 2000 and 2001, our selling, general and administrative expenses were as follows (dollars in millions):
FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------------------- ---------------------------------------------- 2000 2001 2000 2001 ---------------------- --------------------- --------------------- --------------------- PERCENT PERCENT PERCENT PERCENT $ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL ------- -------- ------- -------- ------- -------- ------- -------- WorldCom group ........... $ 1,664 54.0% $ 1,311 52.1% $ 4,206 53.6% $ 4,711 55.4% MCI group ................ 1,472 47.8 1,292 51.3 3,826 48.8 4,060 47.7 Intergroup eliminations .. (55) (1.8) (86) (3.4) (185) (2.4) (268) (3.1) ------- ------- ------- ------- ------- ------- ------- ------- $ 3,081 100.0% $ 2,517 100.0% $ 7,847 100.0% $ 8,503 100.0% ======= ======= ======= ======= ======= ======= ======= =======
Selling, general and administrative expenses for the third quarter of 2001 were $2.5 billion or 28.1% of revenues as compared to $3.1 billion or 30.7% of revenues for the quarter ended September 30, 2000. Selling, general and administrative expenses for the third quarter of 2000 includes a $685 million pre-tax charge ($340 million from WorldCom group and $345 million from MCI group) associated with specific domestic and international wholesale accounts that were deemed uncollectible due to bankruptcies, litigation and settlements of contractual disputes that occurred in the third quarter of 2000. We maintain general uncollectible reserves based on historical experience, and 47 specific reserves for items such as bankruptcies, litigation and contractual settlements that are established in the period in which the settlement is both estimable and probable. During the third quarter of 2000, an unprecedented number of our wholesale customers either filed for bankruptcy or changed their status in bankruptcy from reorganization to liquidation. This, combined with the third quarter 2000 declines in stock prices for many companies in the telecommunications industry and the overall tightening of the capital markets, which limited the access of many telecommunications providers to the necessary capital to continue operations, led to our specific write-off of such accounts. Prior to the third quarter 2000 events, the general uncollectible reserves were, in our view, adequate. Additionally, under contractual arrangements with traditional phone companies and other competitive local exchange carriers, we billed the traditional phone companies and competitive local exchange carriers for traffic originating on the traditional phone company's or competitive local exchange carrier's networks and terminating on our network. The traditional phone companies and competitive local exchange carriers have historically disputed these billings, although the collectibility of these billings had continued to be affirmed by public service commission and FCC rulings and by the full payment from a traditional phone company of the largest past due amount. However, during the third quarter of 2000, court rulings and congressional discussions led to our negotiation and settlement with certain traditional phone companies and competitive local exchange carriers for these outstanding receivables. Based on the outcome of these negotiations, we recorded a specific provision for the associated uncollectible amounts. Excluding these charges and Embratel in 2000, selling, general and administrative expenses for the third quarter of 2000 would have been $2.2 billion or 23.7% of revenues. On a year-to-date basis, selling, general and administrative expenses as a percentage of revenues increased to $8.5 billion, or 31.8% of revenues as compared to 26.6% for the same period of the prior year. Selling, general and administrative expenses for the nine months ended September 30, 2001 also includes pre-tax costs of $865 million ($742 million from WorldCom group and $123 million from MCI group) related to the write-off of investments in certain publicly traded and privately held companies, $23 million ($12 million from WorldCom group and $11 million from MCI group) as a result of the costs associated with the tracking stock capitalization and $125 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions. Additionally, selling, general and administrative expenses for the nine months ended September 30, 2000 includes a $93 million pre-tax one-time charge associated with the termination of the Sprint Corporation merger agreement in addition to the charge for uncollectible accounts discussed above. Excluding these charges and Embratel in 2000, selling, general and administrative expenses as a percentage of revenues would have been 28.1% for the first nine months of 2001 versus 24.0% for the first nine months of 2000. The increase in selling, general and administrative expenses for the three and nine months ended September 30, 2001, includes increased costs associated with "generation d" initiatives, which are designed to position us as a leading supplier of e-business solutions, that include product marketing, customer care, information systems and product development, employee retention costs, and costs associated with multichannel multipoint distribution service product development. Additionally, the increase in selling, general and administrative expenses can be attributed to non-core wholesale initiatives which began in the fourth quarter of 2000 as discussed above, which had no immediate effect on selling, general and administrative expenses for both the wholesale and alternative channels and small business channels and increases during 2000 to our consumer workforce to support retail activities. Workforce reductions in February 2001 have helped to stabilize selling, general and administrative expenses since the second quarter of 2001. Selling, general and administrative expenses were offset in part by foreign currency exchange fluctuations which had the effect of reducing selling, general and administrative expenses as a percentage of revenues by approximately one-quarter of a percentage point for both the three- and nine-month periods ended September 30, 2001. DEPRECIATION AND AMORTIZATION. For the three and nine months ended September 30, 2000 and 2001, our depreciation and amortization expense was as follows (dollars in millions):
FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------- ------------------------------------------------- 2000 2001 2000 2001 ---------------------- ---------------------- ---------------------- ---------------------- PERCENT PERCENT PERCENT PERCENT $ OF TOTAL $ OF TOTAL $ OF TOTAL $ OF TOTAL ------ -------- ------ -------- ------ -------- ------ -------- WorldCom group .......... $ 834 67.4% $1,087 71.3% $2,388 66.9% $2,950 69.2% MCI group ............... 231 18.7 236 15.5 654 18.3 700 16.4 Intergroup eliminations . 172 13.9 201 13.2 528 14.8 616 14.4 ------ ------ ------ ------ ------ ------ ------ ------ $1,237 100.0% $1,524 100.0% $3,570 100.0% $4,266 100.0% ====== ====== ====== ====== ====== ====== ====== ======
48 Depreciation and amortization expense for the third quarter of 2001 increased to $1.5 billion or 17.0% of revenues from $1.2 billion or 12.3% of revenues for the third quarter of 2000. On a year-to-date basis, this expense increased to $4.3 billion or 16.0% of revenues versus $3.6 billion or 12.1% of revenues for the first nine months of 2000. Excluding Embratel in 2000, depreciation and amortization would have been $1.1 billion or 12.2% of revenues for the third quarter of 2000 and $3.2 billion or 11.9% of revenues for the first nine months of 2000. These increases reflect additional depreciation associated with 2000 and 2001 capital expenditures as well as increased depreciation associated with the assets acquired in the Intermedia merger. INTEREST EXPENSE. Interest expense for the third quarter of 2001 was $442 million or 4.9% of revenues as compared to $245 million or 2.4% of revenues for the third quarter of 2000. For the nine months ended September 30, 2001, interest expense was $1.1 billion, or 4.1% of revenues compared to $699 million, or 2.4% of revenues for the first nine months of 2000. Excluding Embratel in 2000, interest expense would have been $262 million or 2.9% of revenues for the third quarter of 2000 and $731 million, or 2.7% of revenues for the first nine months of 2000. For the three months ended September 30, 2000 and 2001, weighted-average annual interest rates on our long-term debt, excluding Embratel in all periods, were 7.34% and 7.43% respectively, while weighted-average levels of borrowings were $21.2 billion and $33.0 billion, respectively. For the nine months ended September 30, 2000 and 2001, weighted-average annual interest rates on our long-term debt, excluding Embratel in all periods, were 7.21% and 7.27% respectively, while weighted-average levels of borrowings were $19.8 billion and $29.1 billion, respectively. Interest expense for the three and nine months ended September 30, 2001 increased as a result of higher debt levels from the May 2001 bond offering and debt acquired in the Intermedia merger. MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous income for the third quarter of 2001 was $107 million or 1.2% of revenues compared to $107 million or 1.1% of revenues for the third quarter of 2000. For the nine months ended September 30, 2001, miscellaneous income was $330 million or 1.2% of revenues compared to $327 million or 1.1% of revenues for the first nine months of 2000. Miscellaneous income includes investment income, equity in income and losses of affiliated companies, the effects of fluctuations in exchange rates for transactions denominated in foreign currencies, gains and losses on the sale of assets and other non-operating items. PROVISION FOR INCOME TAXES. The effective income tax rate was 38.9% of income before taxes for the third quarter of 2001 and 38.7% of income before taxes for the first nine months of 2001. The 2001 rates are greater than the expected federal statutory rate of 35% primarily due to the amortization of non-deductible goodwill. CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which requires certain activation and installation fee revenues to be amortized over the average life of the related service rather than be recognized immediately. Costs directly related to these revenues may also be deferred and amortized over the customer contract life. This adoption resulted in a one-time expense of $85 million, net of income tax benefit of $50 million in the first quarter of 2000. NET INCOME APPLICABLE TO COMMON SHAREHOLDERS. For the three months ended September 30, 2001, we reported net income applicable to common shareholders of $493 million as compared to $935 million for the three months ended September 30, 2000. For the nine months ended September 30, 2001, we reported net income applicable to common shareholders of $1.2 billion as compared to $3.4 billion for the nine months ended September 30, 2000. ADDITIONAL DISCUSSION RELATED TO THE WORLDCOM GROUP AND THE MCI GROUP FINANCIAL STATEMENTS Each of the WorldCom group and the MCI group includes the results of operations shown in the combined statements of operations and the attributed assets and liabilities shown in the combined balance sheets of the relevant group. If we acquire interests in other businesses, we intend to attribute those assets and any related liabilities to our WorldCom group or our MCI group in accordance with our tracking stock policy statement. All net income and cash flows generated by the assets will be attributed to the group to which the assets were attributed and all net proceeds from any disposition of these assets will also be attributed to that group. Although we sometimes refer to such assets and liabilities as those of the WorldCom group or the MCI group, neither of the groups is a separate legal entity. Rather, all of the assets of a group are owned by WorldCom and holders of the 49 WorldCom group stock or the MCI group stock are shareholders of WorldCom and subject to all of the risks of an investment in WorldCom and all of its businesses, assets and liabilities. We intend, for so long as the WorldCom group stock and the MCI group stock remains outstanding, to include in filings by WorldCom under the Securities Exchange Act of 1934, as amended, the combined financial statements of each of the WorldCom group and the MCI group. These combined financial statements will be prepared in accordance with accounting principles generally accepted in the United States, and in the case of annual financial statements, will be audited. These combined financial statements are not legally required under current law or SEC regulations. Our board of directors may at any time modify, make exceptions to, or abandon any of the policies set forth in our tracking stock policy statement with respect to the allocation of corporate opportunities, financing arrangements, assets, liabilities, debt, interest and other matters, or may adopt additional policies, in each case without shareholder approval. Our board is subject to fiduciary duties to all of WorldCom's shareholders as one group, not to the holders of any series of stock separately. Any changes or exceptions will be made after a determination by our board of what is in the best interests of WorldCom as a whole, which may be detrimental to the interests of the holders of one series of stock. The ability to make these changes may make it difficult to address the future of a group based on the group's past performance. ATTRIBUTION AND ALLOCATION OF ASSETS, LIABILITIES, REVENUES AND EXPENSES The following is a discussion of the methods used to attribute and allocate property and equipment, revenues, line costs, shared corporate services, intangible assets and financing arrangements to the WorldCom group and the MCI group. PROPERTY AND EQUIPMENT. Property and equipment was attributed to the WorldCom group and the MCI group based on specific identification consistent with the assets necessary to support the continuing operations of the businesses attributed to the respective groups. The balances of property and equipment attributed to each of the groups as of September 30, 2001 are as follows:
WORLDCOM MCI GROUP GROUP WORLDCOM ----- ----- -------- (IN MILLIONS) Transmission equipment ...... $ 21,663 $ 390 $ 22,053 Communications equipment .... 4,873 2,440 7,313 Furniture, fixtures and other 10,318 689 11,007 Construction in progress .... 6,712 127 6,839 -------- -------- -------- 43,566 3,646 47,212 Accumulated depreciation .... (7,476) (1,585) (9,061) -------- -------- -------- $ 36,090 $ 2,061 $ 38,151 ======== ======== ========
Under our tracking policy statement, our board of directors may reallocate assets to the other group for fair value at any time without shareholder approval. REVENUES. Revenues have been attributed to the WorldCom group and the MCI group based on specific identification of the lines of business that are attributed to the two groups. LINE COSTS. Allocated costs and related liabilities within this caption include the costs of the fiber optic systems attributed to the WorldCom group and the costs of the business voice switched services attributed to the MCI group. Line costs which are specifically identifiable to a particular group based on usage of the network are allocated to that group; any remaining line costs that cannot be specifically identified are allocated between the groups using methodologies that our management believes are reasonable, such as the total revenues generated by each group. SHARED CORPORATE SERVICES. A portion of our shared corporate services and related balance sheet amounts (such as executive management, human resources, legal, regulatory, accounting, tax, treasury, strategic planning and information systems support) has been attributed to the WorldCom group or the MCI group based upon identification of such services specifically benefiting such group. Where determinations based on specific usage alone have been impractical, other allocation methods were used, including methods based on number of employees and the total revenues generated 50 by each group. Our management believes these allocation methods are equitable and provide a reasonable estimate of the costs attributable to each group. ALLOCATION OF INTANGIBLE ASSETS. Intangible assets consist of the excess consideration paid over the fair value of net tangible assets acquired by us in business combinations accounted for under the purchase method and include goodwill, channel rights, developed technology and tradenames. These assets have been attributed to the respective groups based on specific identification and where acquired companies have been divided between the WorldCom group and the MCI group, the intangible assets have been allocated based on the respective fair values at the date of purchase of the related operations attributed to each group. Our management believes that this method of allocation is equitable and provides a reasonable estimate of the intangible assets attributable to the WorldCom group and the MCI group. All tradenames, including the MCI tradename and the other related MCI tradenames, have been attributed to the WorldCom group. The MCI group will be allocated an expense, and the WorldCom group will be allocated a corresponding decrease in costs, for the use of the MCI tradenames. For purposes of preparing the historical financial statements for the groups, an expense of $27.5 million per annum was allocated to the MCI group, and a corresponding decrease in costs was allocated to the WorldCom group, in each case since the date of acquisition of MCI, for use by the MCI group of the MCI tradenames. The charge for the next five years will be based on the following schedule: 2001: $27.5 million 2002: $30.0 million 2003: $35.0 million 2004: $40.0 million 2005: $45.0 million
Any renewal or termination of use of the MCI tradename by the MCI group will be subject to the general policy that our board of directors will act in the best interests of WorldCom. Goodwill and other intangibles assigned or allocated to the WorldCom group and the MCI group as of September 30, 2001 are as follows:
WORLDCOM MCI GROUP GROUP WORLDCOM ----- ----- -------- (IN MILLIONS) Goodwill ............... $ 40,644 $ 9,269 $ 49,913 Tradenames ............. 1,112 -- 1,112 Developed technology ... 1,590 510 2,100 Other intangibles ...... 2,975 1,386 4,361 -------- -------- -------- 46,321 11,165 57,486 Accumulated depreciation (5,303) (1,363) (6,666) -------- -------- -------- $ 41,018 $ 9,802 $ 50,820 ======== ======== ========
FINANCING ARRANGEMENTS. As of January 1, 2000, $6.0 billion of our outstanding debt was notionally allocated to the MCI group and $18.9 billion of our debt was notionally allocated to the WorldCom group. Our debt was allocated between the WorldCom group and the MCI group based upon a number of factors including estimated future cash flows and the ability to pay debt service and dividends of each of the groups. In addition, we considered certain measures of creditworthiness, such as coverage ratios and various tests of liquidity, in the allocation process. Our management believes that the initial allocation is equitable and supportable by both the WorldCom group and the MCI group. The debt allocated to the MCI group bears interest at a rate indicative of the rate at which the MCI group would borrow from third parties if it was a wholly owned subsidiary of WorldCom but did not have the benefit of any guarantee by WorldCom. Interest rates will be calculated on a quarterly basis. For purposes of the combined historical financial statements of each of the groups, debt allocated to the MCI group was determined to bear an interest rate equal to the weighted-average interest rate, excluding capitalized interest, of WorldCom debt plus 1 1/4 percent. Interest allocated to the WorldCom group reflects the difference between our actual interest expense and the interest expense charged to the MCI group. 51 Each group's debt will increase or decrease by the amount of any net cash generated by, or required to fund, the group's operating activities, investing activities, share repurchases and other financing activities. As of September 30, 2001, our receivables purchase program consisted of a $3.6 billion pool of receivables in which the purchaser had an undivided interest in $2.0 billion of those receivables. The WorldCom group was allocated $2.9 billion of the pool and $1.7 billion of the sold receivables. The MCI group was allocated the balance. The receivables sold were attributed principally based on specific identification, or allocated based on total revenues. Our management believes that this method of allocation is equitable and provides a reasonable estimate of the receivables attributable to the groups. WORLDCOM GROUP RESULTS OF OPERATIONS The following table sets forth for the periods indicated the WorldCom group's statements of operations in millions of dollars and as a percentage of its revenues:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, --------------------------------------- --------------------------------------- 2000 2001 2000 2001 ----------------- ------------------ ------------------ ----------------- Revenues ...................................... $ 5,844 100.0% $ 5,482 100.0% $ 16,894 100.0% $ 16,047 100.0% Line costs .................................... 2,207 37.8 2,085 38.0 6,407 37.9 6,111 38.1 Selling, general and administrative ........... 1,664 28.5 1,311 23.9 4,206 24.9 4,711 29.4 Depreciation and amortization ................. 834 14.3 1,087 19.8 2,388 14.1 2,950 18.4 -------- ------- -------- -------- -------- -------- -------- ------- Operating income .............................. 1,139 19.5 999 18.2 3,893 23.0 2,275 14.2 Other income (expense): Interest expense ......................... (118) (2.0) (316) (5.8) (318) (1.9) (717) (4.5) Miscellaneous ............................ 107 1.8 107 2.0 327 1.9 330 2.1 -------- ------- -------- -------- -------- -------- -------- ------- Income before income taxes, minority interests and cumulative effect of accounting change 1,128 19.3 790 14.4 3,902 23.1 1,888 11.8 Provision for income taxes .................... 454 7.8 307 5.6 1,605 9.5 731 4.6 -------- ------- -------- -------- -------- -------- -------- ------- Income before minority interests and cumulative effect of accounting change .............. 674 11.5 483 8.8 2,297 13.6 1,157 7.2 Minority interests ............................ (75) (1.3) 20 0.4 (225) (1.3) 20 0.1 Cumulative effect of accounting change ........ -- -- -- -- (75) (0.4) -- -- Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements .................... 16 0.3 43 0.8 49 0.3 75 0.5 -------- ------- -------- -------- -------- -------- -------- ------- Net income .................................... $ 583 10.0% $ 460 8.4% $ 1,948 11.5% $ 1,102 6.9% ======== ======= ======== ======== ======== ======== ======== =======
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 VS. THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 REVENUES. Actual reported revenues by category for the three and nine months ended September 30, 2000 and 2001 reflect the following changes by category (dollars in millions):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------- ------------------------------------- PERCENT PERCENT 2000 2001 CHANGE 2000 2001 CHANGE ------- ------- ------- ------- ------- ------- COMMERCIAL SERVICES REVENUES Voice .............................. $ 1,731 $ 1,629 (5.9) $ 5,328 $ 5,021 (5.8) Data ............................... 1,909 2,257 18.2 5,462 6,481 18.7 International ...................... 637 761 19.5 1,742 2,209 26.8 Embratel, net ...................... 932 -- n/a 2,595 -- n/a Internet ........................... 635 835 31.5 1,767 2,336 32.2 ------- ------- ------- ------- TOTAL COMMERCIAL SERVICES REVENUES .... $ 5,844 $ 5,482 (6.2) $16,894 $16,047 (5.0) ======= ======= ======= =======
WorldCom group revenues for the third quarter of 2001 were $5.5 billion versus $5.8 billion for the prior year period. For the nine months ended September 30, 2001, WorldCom group revenues were $16.0 billion versus $16.9 billion for the prior year period. As previously indicated, during the second quarter of 2001, we took steps to restructure our investment in Embratel which resulted in the deconsolidation of Embratel effective January 1, 2001. Excluding 52 Embratel from the 2000 periods, WorldCom group revenues for the three and nine months ended September 30, 2001 increased 11.6% and 12.2%, respectively, versus the prior year periods. Voice revenues for the third quarter of 2001 decreased 5.9% over the prior year period on traffic growth of 2.2%. For the nine months ended September 30, 2001, voice revenues decreased 5.8% on traffic growth of 4.3%. The revenue decreases were partially offset by wireless voice revenue increases of 19.1% for the third quarter of 2001 and 47.9% for the first nine months of 2001, as customers purchased "all-distance" voice services from us. Voice revenues include both domestic commercial long distance and local switched revenues. Data revenues for the third quarter of 2001 increased 18.2% over the prior year period. For the nine months ended September 30, 2001, data revenues increased 18.7% over the prior year period. Data includes both commercial long distance and local dedicated bandwidth sales. As of September 30, 2001, approximately 32% of data revenues were derived from frame relay and asynchronous transfer mode services, where we experienced strong demand for capacity increases across the product set as businesses moved more of their mission-critical applications to their own networks during the period. Additionally, we continue to experience strong price pressure for data services in our emerging markets due to competition and the general decline in economic condition of our customers, which we expect to continue in the foreseeable future. International revenues for the third quarter 2001 increased 19.5% to $761 million versus $637 million, excluding Embratel, for the third quarter of 2000. For the nine months ended September 30, 2001, international revenues increased 26.8% to $2.2 billion versus $1.7 billion, excluding Embratel, for the prior year period. Geographically, Europe grew 15.9% and Asia Pacific and other areas grew 27.4% for the third quarter of 2001. For the first nine months of 2001, Europe grew 16.3% and Asia Pacific and other areas grew 54.0%. These increases were partially offset by foreign currency fluctuations that had the effect of reducing revenues by approximately $50 million in the third quarter of 2001 and approximately $140 million for the first nine months of 2001. Although our retail mix is improving towards a more profitable blend of data versus voice, and retail versus wholesale, our international business continues to experience significant price pressure on its products. Internet revenues for the third quarter of 2001 increased 31.5% over the prior year period. For the first nine months of 2001, Internet revenues increased 32.2% over the prior year period. Growth was driven by demand for dedicated circuits as business customers continue to migrate their data networks and applications to Internet-based technologies requiring greater amounts of bandwidth. Additionally, Internet revenues growth for the third quarter of 2001 included $29 million of Digex revenues, net of intercompany eliminations, as a result of the Intermedia merger. During 2001, we began to introduce our new managed hosting products and virtual private networks on public and shared environments. These products, which are in the initial phases of their life cycle, should gradually contribute to our revenue growth over the next several quarters. Internet revenues include dedicated Internet access, managed networking services and applications (such as virtual private networks), web hosting and electronic commerce and transaction services (such as web centers and credit card transaction processing). LINE COSTS. Line costs as a percentage of revenues for the third quarter of 2001 increased to 38.0% as compared to 37.8% reported for the third quarter of 2000. On a year-to-date basis, line costs as a percentage of revenues was 38.1% as compared to 37.9% for the nine months ended September 30, 2000. Excluding Embratel in 2000, line costs would have been $1.8 billion, or 36.1% of revenues for the third quarter of 2000 and $5.2 billion, or 36.3% of revenues for the first nine months of 2000. The increases as a percentage of revenues reflect the pricing pressure in the data, international and Internet markets. Beginning in the fourth quarter of 2000, pricing pressure began to stabilize as a result of our actions to improve gross margins. Line costs were partially offset by foreign currency exchange fluctuations which had the effect of reducing line costs as a percentage of revenues by less than one percentage point for both the three- and nine-month periods ended September 30, 2001, and by increased data and dedicated Internet traffic over our own facilities, which positively affected line costs as a percentage of revenues by less than one percentage point for both the three- and nine-month periods ended September 30, 2001. 53 SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses for the third quarter of 2001 were $1.3 billion or 23.9% of revenues as compared to $1.7 billion or 28.5% of revenues for the prior year period. Selling, general and administrative expenses for the third quarter of 2000 includes a $340 million pre-tax charge associated with specific domestic and international wholesale accounts that were deemed uncollectible due to bankruptcies, litigation and settlements of contractual disputes that occurred in the third quarter of 2000. Excluding these charges and Embratel in 2000, selling, general and administrative expenses for the third quarter of 2000 would have been 22.1% of revenues. On a year-to-date basis, selling, general and administrative expenses were $4.7 billion or 29.4% of revenues as compared to $4.2 billion or 24.9% of revenues for the first nine months of 2000. Selling, general and administrative expenses for the first nine months of 2001 includes pre-tax costs of $742 million related to the write-off of investments in certain publicly traded and privately held companies, $12 million as a result of the costs associated with the tracking stock capitalization and $77 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions. Selling, general and administrative expenses for the nine months ended September 30, 2000 also includes a $93 million pre-tax one-time charge associated with the termination of the Sprint Corporation merger agreement in addition to the charge for uncollectible accounts discussed above. Excluding these charges and Embratel in 2000, selling, general and administrative expenses as a percentage of revenues would have been 24.2% for the first nine months of 2001 versus 22.0% for the first nine months of 2000. Selling, general and administrative expenses for the three and nine months ended September 30, 2001, include increased costs associated with "generation d" initiatives that include product marketing, customer care, information system and product development, employee retention costs, and costs associated with multichannel multipoint distribution service product development. Selling, general and administrative expenses were offset in part by foreign currency exchange fluctuations which had the effect of reducing selling, general and administrative expenses as a percentage of revenues by less than one-half of a percentage point for both the three- and nine-month periods ended September 30, 2001. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the third quarter of 2001 increased to $1.1 billion or 19.8% of revenues from $834 million or 14.3% of revenues for the prior year period. On a year-to-date basis, depreciation increased to $3.0 billion, or 18.4% of revenues as compared to $2.4 billion, or 14.1% of revenues for the first nine months of 2000. Excluding Embratel in 2000, depreciation and amortization would have been $710 million or 14.5% of revenues for the third quarter of 2000 and $2.0 billion or 14.2% of revenues for the first nine months of 2000. These increases reflect increased depreciation associated with 2000 and 2001 capital expenditures as well as increased depreciation associated with the assets acquired in the Intermedia merger. INTEREST EXPENSE. Interest expense for the third quarter of 2001 was $316 million or 5.8% of revenues as compared to $118 million or 2.0% of revenues for the third quarter of 2000. On a year-to-date basis, interest expense was $717 million, or 4.5% of revenues as compared to $318 million, or 1.9% of revenues for the first nine months of 2000. Excluding Embratel in 2000, interest expense would have been $135 million, or 2.7% of revenues for the third quarter of 2000 and $350 million, or 2.4% of revenues for the first nine months of 2000. Interest expense on borrowings incurred by WorldCom and allocated to the WorldCom group reflects the difference between WorldCom's actual interest expense and the interest expense allocated to the MCI group. The MCI group was allocated interest based on the weighted-average interest rate, excluding capitalized interest, of WorldCom debt plus 1 1/4 percent. MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous income for the third quarter of 2001 was $107 million, or 2.0% of revenues as compared to $107 million, or 1.8% of revenues for the third quarter of 2000. On a year-to-date basis, miscellaneous income was $330 million, or 2.1% of revenues as compared to $327 million, or 1.9% of revenues for the first nine months of 2000. Miscellaneous income includes investment income, equity in income and losses of affiliated companies, the effects of fluctuations in exchange rates for transactions denominated in foreign currencies, gains and losses on the sale of assets and other non-operating items. 54 PROVISION FOR INCOME TAXES. The effective income tax rate was 38.9% of income before taxes for the third quarter of 2001 and 38.7% of income before taxes for the first nine months of 2001. The 2001 rates are greater than the expected federal statutory rate of 35% primarily due to the amortization of non-deductible goodwill. CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which requires certain activation and installation fee revenues to be amortized over the average life of the related service rather than be recognized immediately. Costs directly related to these revenues may also be deferred and amortized over the customer contract life. This adoption resulted in a one-time expense of $75 million, net of income tax benefit of $43 million, for the WorldCom group in the first quarter of 2000. NET INCOME. For the three months ended September 30, 2001, the WorldCom group reported net income of $460 million as compared to $583 million for the three months ended September 30, 2000. Pro forma diluted income per common share for the third quarter of 2001 was $0.16 compared to income per common share of $0.20 for the third quarter of 2000. On a year-to-date basis, pro forma diluted income per common share was $0.38 as compared to $0.67 for the first nine months of 2000. Pro forma diluted income per share assumes the recapitalization occurred at the beginning of 2000 and that the WorldCom group stock and MCI group stock existed for all periods presented. MCI GROUP RESULTS OF OPERATIONS The following table sets forth for the periods indicated the MCI group's statements of operations in millions of dollars and as a percentage of its revenues for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------- --------------------------------------- 2000 2001 2000 2001 ------------------- ------------------- ------------------ ----------------- Revenues .................................... $ 4,193 100.0% $ 3,484 100.0% $ 12,562 100.0% $ 10,654 100.0% Line costs .................................. 1,777 42.4 1,775 50.9 5,312 42.3 5,408 50.8 Selling, general and administrative ......... 1,472 35.1 1,292 37.1 3,826 30.5 4,060 38.1 Depreciation and amortization ............... 231 5.5 236 6.8 654 5.2 700 6.6 -------- -------- -------- -------- -------- -------- -------- ------- Operating income ............................ 713 17.0 181 5.2 2,770 22.1 486 4.6 Other income (expense): Interest expense ....................... (127) (3.0) (126) (3.6) (381) (3.0) (378) (3.5) -------- -------- -------- -------- -------- -------- -------- ------- Income before income taxes and cumulative effect of accounting change ............ 586 14.0 55 1.6 2,389 19.0 108 1.0 Provision for income taxes .................. 234 5.6 22 0.6 949 7.6 42 0.4 -------- -------- -------- -------- -------- -------- -------- ------- Income before cumulative effect of accounting change ................................. 352 8.4 33 0.9 1,440 11.5 66 0.6 Cumulative effect of accounting change ...... -- -- -- -- (10) (0.1) -- -- -------- -------- -------- -------- -------- -------- -------- ------- Net income .................................. $ 352 8.4% $ 33 0.9% $ 1,430 11.4% $ 66 0.6% ======== ======== ======== ======== ======== ======== ======== =======
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 VS. THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 REVENUES. Revenues for the three months ended September 30, 2001 decreased 16.9% to $3.5 billion versus $4.2 billion for the prior year period. The decrease in total revenues is primarily attributable to consumers' substitution of wire line services with wireless and e-mail, and proactive revenue initiatives resulting in services being de-emphasized as we shift the MCI group's focus from revenue growth to cash generation. Actual reported revenues by category for the three and nine months ended September 30, 2000 and 2001 reflect the following changes by category (dollars in millions):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------- ------------------------------------- PERCENT PERCENT 2000 2001 CHANGE 2000 2001 CHANGE ------- ------- ------- ------- ------- ------- Consumer .............................. $ 1,989 $ 1,873 (5.8) $ 5,890 $ 5,516 (6.3) Wholesale ............................. 847 657 (22.4) 2,655 2,050 (22.8) Alternative channels and small business 954 591 (38.1) 2,792 1,896 (32.1) Dial-up Internet ...................... 403 363 (9.9) 1,225 1,192 (2.7) ------- ------- ------- ------- TOTAL ................................. $ 4,193 $ 3,484 (16.9) $12,562 $10,654 (15.2) ======= ======= ======= =======
55 Consumer revenues for the third quarter of 2001 decreased 5.8% over the prior year period. For the first nine months of 2001, consumer revenues decreased 6.3% over the prior year period. The majority of this decrease is attributed to decreases in calling card, dial around and dial-1 revenues as a result of consumers' substitution of wire line services with wireless and e-mail. Our consumer local initiatives continue to perform well as consumer local revenues increased over 200% for the third quarter of 2001 and over 175% for the first nine months of 2001 versus the prior year period. Wholesale revenues for the third quarter of 2001 decreased 22.4% over the prior year period. For the first nine months of 2001, wholesale revenues decreased 22.8%. The wholesale market continues to be extremely price competitive, although rate per minute began to stabilize in the second quarter of 2001. Wholesale revenues during the past year were also impacted by proactive revenue initiatives, which were made to improve the quality of the wholesale revenue stream as we shift the MCI group's focus from revenue growth to cash generation. Alternative channels and small business revenues for the three and nine months ended September 30, 2001 decreased 38.1% and 32.1%, respectively, over the prior year periods. Alternative channels and small business includes sales agents and affiliates, wholesale alternative channels, small business, prepaid calling card and wireless messaging revenues. These decreases are attributed to pricing pressures in the wholesale and small business markets which negatively affected revenue growth and gross margins in this area, and proactive initiatives to de-emphasize services with unacceptable gross margins as we shift the MCI group's focus from revenue growth to cash generation. Dial-up Internet revenues for the three and nine months ended September 30, 2001 decreased 9.9% and 2.7%, respectively, over the prior year amounts. Our dial access network has grown 28% to approximately 3.2 million modems as of September 30, 2001, compared with the prior year period. Additionally, Internet connect hours increased 13.6% to 5.4 billion hours for the first nine months of 2001 versus the prior year. These network usage increases were more than offset by pricing pressure resulting from the impact of volume discounts and off-net traffic, which lowered average revenue per hour by approximately 16% for the third quarter of 2001 and 18% for the first nine months of 2001 versus the prior year periods. LINE COSTS. Line costs as a percentage of revenues for the third quarter of 2001 increased to 50.9% as compared to 42.4% reported for the prior year period. On a year-to-date basis, line costs as a percentage of revenues increased to 50.8% of revenues as compared to 42.3% for the first nine months of 2000. These increases were primarily the result of continued competitive pricing on the dial-up Internet business as noted above, which resulted in a modest increase in average cost per hour while average dial-up Internet revenues per hour decreased by 16% for the third quarter of 2001 and 18% for the first nine months of 2001. Additionally, line costs as a percentage of revenues increased as a result of the decrease in higher margin calling card and dial around revenues due to wireless substitution as noted above. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses for the third quarter of 2001 were $1.3 billion or 37.1% of revenues as compared to $1.5 billion or 35.1% of revenues for the prior year period. Selling, general and administrative expenses for the third quarter of 2000 includes a $345 million pre-tax charge associated with specific wholesale accounts that were deemed uncollectible due to bankruptcies, litigation and settlements of contractual disputes that occurred in the third quarter of 2000. Excluding these charges, selling, general and administrative expenses for the third quarter of 2000 would have been 26.9%. On a year-to-date basis, selling, general and administrative expenses were $4.1 billion, or 38.1% of revenues as compared to $3.8 billion or 30.5% of revenues for the first nine months of 2000. Selling, general and administrative expenses for the nine months ended September 30, 2001 includes pre-tax costs of $123 million related to the write-off of investments in certain publicly traded and privately held companies, $11 million as a result of the costs associated with the tracking stock capitalization and $48 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions. Excluding these costs, selling, general and administrative expenses as a percentage of revenues were 36.4% for the first nine months of 2001 versus 27.7% for the prior year period, after excluding the charge for uncollectible accounts discussed above. 56 The increase in selling, general and administrative expenses can be attributed to non-core wholesale initiatives which began in the fourth quarter of 2000 as discussed above, which had no immediate effect on selling, general and administrative expenses for both the wholesale and alternative channels and small business channels and increases during 2000 to our consumer workforce to support retail activities. Workforce reductions in February 2001 have helped to stabilize selling, general and administrative expenses since the second quarter of 2001. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the third quarter of 2001 increased to $236 million or 6.8% of revenues from $231 million or 5.5% of revenues for the same period in the prior year. On a year-to-date basis, depreciation increased to $700 million, or 6.6% of revenues as compared to $654 million, or 5.2% of revenues for the first nine months of 2000. These increases primarily reflect additional depreciation associated with 2000 and 2001 capital expenditures. INTEREST EXPENSE. Interest expense for the third quarter of 2001 was $126 million or 3.6% of revenues as compared to $127 million or 3.0% of revenues for the same period in 2000. On a year-to-date basis, interest expense was $378 million, or 3.5% of revenues as compared to $381 million, or 3.0% of revenues for the first nine months of 2000. Interest expense on borrowings incurred by WorldCom and allocated to the MCI group was based on the weighted-average interest rate, excluding capitalized interest, of WorldCom debt plus 11/4 percent. As of January 1, 2000, $6.0 billion of WorldCom's outstanding debt was notionally allocated to the MCI group. During 2001, the MCI group repaid $408 million of the notionally allocated debt and as of September 30, 2001 the MCI group's long-term debt balance was $5.6 billion. PROVISION FOR INCOME TAXES. The effective income tax rate was 40% of income before taxes for the third quarter of 2001 and 38.9% of income before taxes for the first nine months of 2001. The 2001 rates are greater than the expected federal statutory rate of 35% primarily due to the amortization of non-deductible goodwill. CUMULATIVE EFFECT OF ACCOUNTING CHANGE. During 2000, we adopted SAB 101, which requires certain activation and installation fee revenues to be amortized over the average life of the related service rather than be recognized immediately. Costs directly related to these revenues may also be deferred and amortized over the customer contract life. This adoption resulted in a one-time expense of $10 million, net of income tax benefit of $7 million for the MCI group in the first quarter of 2000. NET INCOME. For the three months ended September 30, 2001, the MCI group reported net income of $33 million as compared to net income of $352 million for the three months ended September 30, 2000. Pro forma diluted income per common share for the third quarter of 2001 was $0.28 compared to income per common share of $3.06 for the third quarter of 2000. On a year-to-date basis, pro forma diluted income per common share was $0.56 as compared to $12.43 for the first nine months of 2000. Pro forma diluted income per share assumes the recapitalization occurred at the beginning of 2000 and that the WorldCom group stock and MCI group stock existed for all periods presented. 57 LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2001, our total debt, net of cash and cash equivalents, was $28.7 billion. Additionally, at September 30, 2001, we had available liquidity of $10.5 billion under our credit facilities and commercial paper program and cash on hand. As of January 1, 2000, the MCI group was notionally allocated $6.0 billion of WorldCom's debt and the remaining outstanding debt was notionally allocated to the WorldCom group. WorldCom management has a wide degree of discretion over the cash management policies of both the WorldCom group and the MCI group. Cash generated by either group can be transferred to the other group without prior approval of WorldCom's shareholders. Due to the discretion possessed by management over the cash management policies of both groups, including the timing and decision of whether to finance capital expenditures, it may be difficult to assess each group's liquidity and capital resource needs, and, in turn, the future prospects of each group based on past performance. For the nine months ended September 30, 2001, the MCI group generated sufficient cash to repay $408 million of its allocated notional debt. On June 8, 2001, we replaced our existing $7 billion 364-Day Revolving Credit and Term Loan Agreement with two new credit facilities consisting of a $2.65 billion 364-Day Facility, and a $1.6 billion Multi-Year Facility. The 364-Day Facility and the Multi-Year Facility, together with our $3.75 billion Existing Facility, provide us with aggregate credit facilities of $8 billion. These credit facilities provide liquidity support for our commercial paper program and for other general corporate purposes. The Existing Facility and the Multi-Year Facility mature on June 30, 2002 and June 8, 2006, respectively. The 364-Day Facility has a 364-day term, which may be extended for successive 364-day terms to the extent of the committed amounts from those lenders consenting thereto, with a requirement that lenders holding 51% of the committed amounts consent and so long as the final maturity date does not extend beyond June 8, 2006. Additionally, we may elect to convert the principal debt outstanding under the 364-Day Facility to a term loan maturing no later than one year after the conversion date, so long as the final maturity date does not extend beyond June 8, 2006. The Existing Facility is subject to annual commitment fees not to exceed 0.25% of any unborrowed portion of the facilities. The 364-Day Facility and the Multi-Year Facility are subject to annual facility fees not to exceed 0.20% or 0.25%, respectively, of the average daily commitment under each such facility (whether used or unused). The credit facilities bear interest payable in varying periods, depending on the interest period, not to exceed six months, or with respect to any Eurodollar Rate borrowing, 12 months if available to all lenders, at rates selected by us under the terms of the credit facilities, including a Base Rate or Eurodollar Rate, plus the applicable margin. The applicable margin for the Eurodollar Rate borrowing generally varies from 0.35% to 0.75% as to loans under the Existing Facility, from 0.29% to 0.80% as to loans under the 364-Day Facility and 0.27% to 0.75% as to loans under the Multi-Year Facility, in each case based upon our then current debt ratings. The credit facilities are unsecured but include a negative pledge of our assets and, subject to exceptions, the covered subsidiaries. The credit facilities require compliance with a financial covenant based on the ratio of total debt to total capitalization, calculated on a consolidated basis. The credit facilities require compliance with operating covenants which limit, among other things, the incurrence of additional indebtedness by us and the covered subsidiaries and sales of assets and mergers and dissolutions. The credit facilities do not restrict distributions to shareholders, provided we are not in default under the credit facilities. As of the date of this filing, we were in compliance with these covenants. On May 9, 2001, we completed the pricing of a public debt offering of approximately $11.9 billion principal amount of debt securities, based on currency exchange rates on May 8, 2001. The net proceeds of $11.7 billion have been or will be used for general corporate purposes, including to repay commercial paper, and repayment of $1.5 billion of our 6.125% notes due August 15, 2001 and $1.5 billion of our floating rate notes due November 26, 2001. The public debt offering consisted of the following series of notes: 58
PRINCIPAL INTEREST FIRST AMOUNT MATURITY PAYABLE INTEREST DATE --------------------------------------------------------------------------------------------------- 6.50% Notes due 2004 $1.5 billion May 15, 2004 Semiannually on May 15 and November 15 November 15, 2001 7.50% Notes due 2011 $4.0 billion May 15, 2011 Semiannually on May 15 and November 15 November 15, 2001 8.25% Notes due 2031 $4.6 billion May 15, 2031 Semiannually on May 15 and November 15 November 15, 2001 6.75% Notes due 2008 (euro)1.25 billion May 15, 2008 Annually on May 15 May 15, 2002 7.25% Notes due 2008 (pound)500 million May 15, 2008 Annually on May 15 May 15, 2002
All of the notes, except for the 6.50% Notes due 2004 are redeemable, as a whole or in part, at our option, at any time or from time to time, at respective redemption prices equal to: In the case of the U.S. dollar notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the sum of the present values of the Remaining Scheduled Payments, as defined therein, discounted, on a semiannual basis, assuming a 360-day year consisting of twelve 30-day months, at the Treasury Rate, as defined therein, plus: o 30 basis points for the Notes due 2011, and o 35 basis points for the Notes due 2031; In the case of the euro notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the sum of the present values of the Remaining Scheduled Payments, as defined therein, discounted, on an annual basis (based on the actual number of days elapsed divided by 365 or 366, as the case may be), at the Reference Euro Dealer Rate, as defined therein, plus 25 basis points; and In the case of the sterling notes, the greater of: o 100% of the principal amount of the notes to be redeemed and o the price expressed as a percentage (rounded to three decimal places, with .0005 being rounded up) at which the Gross Redemption Yield, as defined therein, on the outstanding principal amount of the notes on the Reference Date, as defined therein, is equal to the Gross Redemption Yield (determined by reference to the middle-market price) at 3:00 p.m. (London time) on that date on the Benchmark Gilt, as defined therein, plus 25 basis points; plus, in the case of the U.S. dollar notes, the euro notes and the sterling notes, accrued interest to the date of redemption which has not been paid. In connection with the Intermedia merger, we assumed Intermedia's outstanding debt including $1.2 billion of senior discount notes with interest rates ranging from 11.25% to 12.5%, $0.9 billion of senior notes with interest rates ranging from 8.5% to 9.5%, credit facility borrowings of $258 million and other long-term debt including capital leases of $0.6 billion. We repaid the Intermedia credit facility borrowings of $258 million and subsequently terminated Intermedia's credit facility during the third quarter of 2001. Additionally, on September 28, 2001, we redeemed all of Intermedia's 12.5% senior discount notes for $337 million. Cash balances were used to pay all amounts under the Intermedia credit facility and Intermedia 12.5% senior discount notes. 59 During the third quarter of 2001, $1.5 billion of 6.125% senior notes matured, we redeemed all of our outstanding 8.875% senior notes due 2006 for $694 million, we retired $1.1 billion of our outstanding debt through open market debt repurchases (including $481 million of outstanding debt assumed in the Intermedia merger) and we redeemed all of our outstanding Series G preferred stock at par for $200 million. Cash balances were used to repay these amounts. OPERATING ACTIVITIES For the nine months ended September 30, 2000 and 2001, our cash flows from operations were as follows (dollars in millions):
2000 2001 ------ ------ WorldCom group ............................... $4,329 $4,711 MCI group .................................... 1,578 1,061 ------ ------ Net cash provided by operating activities $5,907 $5,772 ====== ======
The decrease for the nine months ended September 30, 2001 versus the prior year amount reflects increases in working capital requirements combined with lower operating results in both the WorldCom group and the MCI group. INVESTING ACTIVITIES For the nine months ended September 30, 2000 and 2001, our net cash used in investing activities was as follows (dollars in millions):
2000 2001 -------- ------- WorldCom group ........................... $(10,005) $(6,738) MCI group ................................ (570) (699) -------- ------- Net cash used in investing activities $(10,575) $(7,437) ======== =======
The WorldCom group's primary capital expenditures totaled $8.4 billion in the first nine months of 2000 and $5.9 billion in the first nine months of 2001. Primary capital expenditures include purchases of transmission, communications and other equipment. The MCI group's capital expenditures totaled $370 million in the first nine months of 2000 and $188 million in the first nine months of 2001. The MCI group's capital expenditures include purchases of switching equipment, dial modems and messaging and other equipment. Investing activities include acquisitions and related costs at the WorldCom group of $14 million and $167 million in the first nine months of 2000 and 2001, respectively. FINANCING ACTIVITIES For the nine months ended September 30, 2000 and 2001, cash provided by financing activities was as follows (dollars in millions):
2000 2001 ------- ------- WorldCom group ............................... $ 5,706 $ 4,037 MCI group .................................... (1,002) (393) ------- ------- Net cash provided by financing activities $ 4,704 $ 3,644 ======= =======
Financing activities include net proceeds from borrowings on debt of $4.5 billion and $4.1 billion for the first nine months of 2000 and 2001, respectively. Financing activities for the MCI group reflect the repayments of intergroup advances and repayment of notionally allocated debt from WorldCom. 60 Also included in financing activities are proceeds from WorldCom's common stock issuances of $551 million and $112 million in the first nine months of 2000 and 2001, respectively, as a result of WorldCom common stock option and warrant exercises. Dividends paid in the first nine months of 2000 and 2001 were $49 million and $58 million, respectively. The increase represents dividends associated with our Series D, E, F and G preferred stock which was issued in connection with the Intermedia merger. On August 20, 2001 the holder of our Series G preferred stock exercised its right to require us to redeem all of the outstanding Series G preferred stock at par for $200 million. Additionally, in January 2000, we redeemed all of our outstanding Series C preferred stock for $190 million. In October 2001, we exercised our option to redeem all of our outstanding Series B Preferred Stock. Prior to the redemption date, substantially all of the holders of our Series B Preferred Stock elected to convert the preferred stock into 0.1460868 shares of WorldCom group stock and 0.005843472 shares of MCI group stock for each share of Series B Preferred Stock held. During the second quarter of 2001, we declared the first quarterly dividend for the MCI group common stock. A cash dividend of $0.60 per share of MCI group common stock, or approximately $70 million in the aggregate, was paid on October 15, 2001 to shareholders of record as of the close of business on September 28, 2001. During the third quarter of 2001, we declared the fourth quarter dividend of $0.60 per share of MCI group common stock to be paid on January 15, 2002 to shareholders of record as of the close of business on December 31, 2001. We believe that we will generate sufficient cash flow to service our debt and capital requirements; however, economic downturns and other adverse developments, including factors beyond our control, could impair our ability to service our indebtedness. In addition, the cash flow required to service our debt may reduce our ability to fund internal growth, additional acquisitions and capital improvements. We believe that the Intermedia merger should support our web hosting expansion by providing a comprehensive portfolio of hosting products and services for mid-sized and large businesses. This will allow us to accelerate our ability to provide managed web and application hosting services by 12 to 18 months. Additionally, we expect that Digex will continue to build its operations and its plan to expand its customer base, causing it to continue to incur operating losses for the foreseeable future, which could adversely affect our results of operations. The development of our businesses and the installation and expansion of our domestic and international networks will continue to require significant capital expenditures. We anticipate that such capital expenditures will be approximately $7.5 billion to $8.0 billion in 2001 for the WorldCom group, and approximately $500 million for the MCI group. For 2002, we anticipate capital expenditures to be $5.5 billion for the WorldCom group and $500 million for MCI group. Absent significant capital requirements for acquisitions, we believe that cash flow from operations and available liquidity, including our credit facilities and commercial paper program and available cash will be sufficient to meet our capital needs for the next twelve months. RECENTLY ISSUED ACCOUNTING STANDARDS In June 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets." SFAS No. 141 requires business combinations initiated after June 30, 2001, which includes the Intermedia merger, to be accounted for using the purchase method of accounting and broadens the criteria for recording intangible assets separate from goodwill. Recorded goodwill and intangibles will be evaluated against this new criteria and may result in certain intangibles being subsumed into goodwill, or alternatively, amounts initially recorded as goodwill may be separately identified and recognized apart from goodwill. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. The statement includes provisions for the identification of reporting units for purposes of assessing potential future impairments of goodwill. Goodwill and other intangibles, acquired prior to July 1, 2001, will continue to be amortized 61 until the adoption of the statement on January 1, 2002. Upon adoption, we will stop amortizing intangible assets with indefinite useful lives, including goodwill and tradenames. Based on current levels of such assets, this would reduce amortization expense by approximately $1.3 billion annually ($1.0 billion at WorldCom group and $0.3 billion at MCI group). Additionally, we are conducting impairment reviews of all intangibles assets with indefinite useful lives and we expect to complete this assessment no later than the second quarter of 2002, in accordance with the provisions of SFAS No. 142. In June 2001, the FASB issued SFAS No. 143 "Asset Retirement Obligations," which establishes new accounting and reporting standards for legal obligations associated with retiring assets. The fair value of a liability for an asset retirement obligation must be recorded in the period in which it is incurred, with the cost capitalized as part of the related long-lived assets and depreciated over the asset's useful life. Changes in the liability resulting from the passage of time will be recognized as operating expenses. SFAS No. 143 must be adopted by 2003. We have not yet quantified the impact of adopting SFAS No. 143 on our consolidated results of operations or financial position. In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long Lived Assets," which supercedes both SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions for the disposal of a segment of a business contained in APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations. The provisions of SFAS No. 144 are effective beginning in 2002 and are not expected to have a material impact on our consolidated results of operations or financial position. EURO CONVERSION On January 1, 1999, 11 out of the 15 member countries of the European Union established the euro, a new common currency for member countries, and fixed conversion rates between their existing currencies and the euro. The transition period for the introduction of the euro is between January 1, 1999 to December 31, 2001. We are establishing plans to address the many issues involved with the introduction of the euro, including the conversion of information technology systems, recalculating currency risk, recalibrating derivatives and other financial instruments, assessing strategies concerning continuity of contracts, and refining the processes for preparing taxation and accounting records. At this time, we have not yet determined the cost related to addressing this issue. We believe that our business will potentially be affected by the impact of increased price transparency, however, we expect to be able to maintain our margins across our international operations as a result of any pricing changes that we decide to make purely as a result of the euro transition. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to the impact of interest rate changes, foreign currency fluctuations and changes in market values of our investments. Our policy is to manage interest rates through the use of a combination of fixed and variable rate debt. We typically do not use derivative financial instruments to manage our interest rate risk. We have minimal cash flow exposure due to general interest rate changes for our fixed rate, long-term debt obligations. We do not believe a hypothetical 10% adverse rate change in our variable rate debt obligations would be material to our results of operations. We are exposed to foreign exchange rate risk primarily due to other international operation's holding of approximately $509 million in U.S. dollar denominated debt, and our holding of approximately $1.9 billion of indebtedness indexed in other foreign currencies including the Euro and Sterling Pound as of September 30, 2001. Our potential immediate loss that would result from a hypothetical 10% change in foreign currency exchange rates based on this position would be approximately $212 million. In addition, if that change were to be sustained, our cost of financing would increase in proportion to the change. We are also subject to risk from changes in foreign exchange rates for our international operations which use a foreign currency as their functional currency and are translated into U.S. dollars. 62 We believe our market risk exposure with regard to our marketable equity securities is limited to changes in quoted market prices for the securities. Based upon the composition of our marketable equity securities at September 30, 2001, we do not believe a hypothetical 10% adverse change in quoted market prices would be material to our results of operations or financial position. PART II. OTHER INFORMATION Item 1. Legal Proceedings There have been no material changes in the legal proceedings reported in our Annual Report on Form 10-K/A for the year ended December 31, 2000, except as reflected in the discussion under Note I of the Notes to Consolidated Financial Statements in Part I, Item 1, above, which is hereby incorporated by reference herein. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults upon Senior Securities None. Item 4. Submission of Matters to a Vote of Securities Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K A. Exhibits See Exhibit Index. B. Reports on Form 8-K Pursuant to Item 9, "Regulation FD Disclosure", we filed a Current Report on Form 8-K dated August 29, 2001 (filed August 29, 2001). Additionally, pursuant to Item 5, "Other Events," we filed a Current Report on Form 8-K dated September 20, 2001 (filed September 21, 2001). 63 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q to be signed on its behalf by Scott D. Sullivan, thereunto duly authorized to sign on behalf of the registrant and as the principal financial officer thereof. WORLDCOM, INC. By: /s/ Scott D. Sullivan ------------------------- Scott D. Sullivan Chief Financial Officer Dated: November 14, 2001. 64 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 2.1 Agreement and Plan of Merger between WorldCom, Wildcat Acquisition Corp. and Intermedia Communications Inc. dated as amended May 14, 2001 (filed as Annex A to WorldCom's Registration Statement on Form S-4, Registration No. 333-60482 and incorporated herein by reference)* 4.1 Articles of Amendment to the Second Amended and Restated Articles of Incorporation of WorldCom (amending former Article Seven by inserting Articles Seven D, E, F, and G) (incorporated herein by reference to Exhibit 3.1 to WorldCom's registration statement on Form S-8 dated August 22, 2001 (Registration No. 333-68204)) 4.2 Articles of Amendment to the Second Amended and Restated Articles of Incorporation of WorldCom (amending former Article Four by deleting the text thereof and substituting new Article Four) (incorporated herein by reference to Exhibit 3.2 to WorldCom's registration statement on Form S-8 dated August 22, 2001 (Registration No. 333-68204)) 4.3 Articles of Amendment to the Second Amended and Restated Articles of Incorporation of WorldCom (amending former Article Eleven by deleting the text thereof and substituting new Article Eleven) (incorporated herein by reference to Exhibit 3.3 to WorldCom's registration statement on Form S-8 dated August 22, 2001 (Registration No. 333-68204)) 4.4 Second Amended and Restated Articles of Incorporation of WorldCom (including preferred stock designations), as amended as of May 1, 2000 (incorporated herein by reference to Exhibit 3.4 to WorldCom's registration statement on Form S-8 dated August 22, 2001 (Registration No. 333-68204)) 4.5 Restated ByLaws of WorldCom, Inc. (incorporated by reference to Exhibit 3.5 to WorldCom's registration statement on Form S-8 dated August 22, 2001 (Registration No. 333-68204)) 4.6 Restated Rights Agreement dated as of June 7, 2001, between WorldCom and The Bank of New York, which includes the form of Certificate of Designations, setting forth the terms of the Series 4 Junior Participating Preferred Stock, par value $.01 per share, and the Series 5 Junior Participating Preferred Stock, par value $.01 per share, as Exhibit A, and the form of Rights Certificates as Exhibits B and C (incorporated by reference to Exhibit 4.4 to WorldCom's Current Report on Form 8-K dated June 7, 2001 (filed June 7, 2001) (File No. 0-11258)) 10.1 Promissory note dated September 10, 2001 payable by Bernard J. Ebbers (the "Borrower") to the order of WorldCom 99.1 Description of WorldCom, Inc.-WorldCom group common stock and WorldCom, Inc.-MCI group common stock excerpted from WorldCom's Registration Statement on Form S-4, as amended (No. 333-52920) * The registrant hereby agrees to furnish supplementally a copy of any omitted schedules to this Agreement to the SEC upon request. 65 EX-10.1 3 ex10-1.txt PROMISSORY NOTE EXHIBIT 10.1 PROMISSORY NOTE Clinton, Mississippi September 10, 2001 FOR VALUE RECEIVED, the undersigned (the "Borrower") hereby unconditionally promises to pay to the order of WorldCom, Inc., a Georgia corporation (the "Lender"), in lawful money of the United States of America and in immediately available funds, any and all amounts properly reflected on the records of the Lender as having been paid by the Lender under that certain Limited Guaranty in favor of Bank of America, N.A. (the "Bank") dated as of February 12, 2001, or any predecessor or successor guaranty, as the same may be modified, amended or supplemented (the "Guaranty"), whether such payment occurred before, on or after the date hereof and whether made directly to the Bank, through the Borrower or otherwise. The Borrower further promises to pay interest on the outstanding balance under this Note, compounded monthly, until payment in full of this Note, at a fluctuating rate of interest (the "Normal Rate") equal to the Eurodollar Rate applicable to each one-month Interest Period commencing on the date of the first payment by the Lender under the Guaranty reflected on the records of the Lender plus the Applicable Margin during the corresponding period applicable to Eurodollar Rate Borrowings by the Lender pursuant to (i) that certain Amended and Restated 364-Day Revolving Credit and Term Loan Agreement among the Lender, the Bank, as Administrative Agent, and the other Lenders identified therein dated as of August 5, 1999, as amended (the "Original Credit Agreement") which terminated on June 8, 2001, for periods or portion of a period prior to June 8, 2001, and (ii) that certain Revolving Credit Agreement among the Lender, the Bank and The Chase Manhattan Bank, as Co-Administrative Agents, and the other Lenders identified therein dated as of June 8, 2001, as the same may be amended or replaced (the "New Credit Agreement"), for periods or portion of a period beginning on or after June 8, 2001; provided, however, that following demand for payment, the Borrower promises to pay interest on the unpaid balance hereunder, compounded monthly, at the Default Rate, as defined herein. The "Default Rate" shall be a fluctuating rate of interest equal to the sum of the otherwise applicable Normal Rate plus three percent (3%) per annum. Upon each change in the applicable Normal Rate, the Default Rate shall simultaneously change to correspond with such change in the Normal Rate. Interest shall be computed on the basis of a 360-day year consisting of twelve 30-day months. From and after June 8, 2001, a reference to the New Credit Agreement shall be substituted for references to the Original Credit Agreement in each of the three Promissory Notes by the Borrower payable to the order of the Lender dated September 8, 2000, November 1, 2000 and December 29, 2000. The principal and accrued interest under this Note are payable on demand. If this Note is not paid upon demand, the Borrower hereby promises to pay all costs of collection, including but not limited to the fees and expenses of an attorney and court costs, in addition to the full amount due hereon. Interest shall be due and payable under this Note at the Normal Rate or the Default Rate, as provided herein, after as well as before demand, default and judgment, notwithstanding any applicable statutory judgment rate of interest. If any interest payment or other charge or fee payable hereunder exceeds the maximum amount then permitted by applicable law, then the Borrower shall pay the maximum amount then permitted by applicable law. The Borrower hereby waives presentment, protest and notice of demand, presentment, protest and nonpayment. This Note shall be interpreted and the rights and liabilities of the parties hereto shall be determined in accordance with the internal laws (as opposed to the conflicts of law provisions) and decisions of the State of Mississippi and the Borrower hereby consents to the jurisdiction of the courts of or in the State of Mississippi in connection with any dispute, controversy, collection action or other matter relating to or arising out of this Note. Whenever possible each provision of this Note shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Note shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Note. Whenever in this Note reference is made to the Borrower or the Lender, such reference shall be deemed to include, in the case of the Borrower, a reference to his heirs and legal representatives and, in the case of the Lender, its successors and assigns. The provisions of this Note shall be binding upon and shall inure to the benefit of such heirs, legal representatives, successors and assigns. /s/ Bernard J. Ebbers --------------------------- Bernard J. Ebbers - 2 - -----END PRIVACY-ENHANCED MESSAGE-----