-----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, IB9gsDLl8wjQ+lSknowa2h6n6OyxwP5nANYgD0UNc4azhrA41MoaZxyeiZUvP/+B X3Y9b1Of72JeM2fBUJsbEA== 0000912057-02-020812.txt : 20020515 0000912057-02-020812.hdr.sgml : 20020515 20020515163724 ACCESSION NUMBER: 0000912057-02-020812 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 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: 02653060 BUSINESS ADDRESS: STREET 1: 500 CLINTON CENTER DRIVE CITY: CLINTON STATE: MS ZIP: 39056 BUSINESS PHONE: 6014605600 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 FORMER COMPANY: FORMER CONFORMED NAME: LDDS COMMUNICATIONS INC /GA/ DATE OF NAME CHANGE: 19930916 10-Q 1 a2079976z10-q.txt 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 March 31, 2002 -------------- 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 incorporation or organization) Identification No.) 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 April 30, 2002: WorldCom group stock 2,962,836,179 MCI group stock 118,325,109 - -------------------------------------------------------------------------------- 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, 2001 and March 31, 2002.............................. 3 Consolidated Statements of Operations for the three months ended March 31, 2001 and March 31, 2002.............. 4 Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and March 31, 2002.............. 5 Notes to Consolidated Financial Statements........................... 6 Combined Financial Statements of WorldCom group (an integrated business of WorldCom, Inc.)........................ 19 Combined Financial Statements of MCI group (an integrated business of WorldCom, Inc.)........................ 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 30 Item 3. Quantitative and Qualitative Disclosures about Market Risk........... 47 PART II. OTHER INFORMATION Item 1. Legal Proceedings.................................................... 47 Item 2. Changes in Securities and Use of Proceeds............................ 47 Item 3. Defaults Upon Senior Securities...................................... 47 Item 4. Submission of Matters to a Vote of Securities Holders................ 47 Item 5. Other Information.................................................... 47 Item 6. Exhibits and Reports on Form 8-K..................................... 49 Signature ..................................................................... 50 Exhibit Index ..................................................................... 51
2 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Millions, Except Share Data)
December 31, March 31, 2001 2002 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 1,416 $ 2,267 Accounts receivable, net of allowance for bad debts of $1,086 in 2001 and $1,215 in 2002 5,308 5,005 Deferred tax asset 251 222 Other current assets 2,230 2,202 --------- --------- Total current assets 9,205 9,696 --------- --------- Property and equipment: Transmission equipment 23,814 25,219 Communications equipment 7,878 7,595 Furniture, fixtures and other 11,263 12,171 Construction in progress 5,706 4,977 --------- --------- 48,661 49,962 Accumulated depreciation (9,852) (10,807) --------- --------- 38,809 39,155 --------- --------- Goodwill and other intangible assets 50,537 50,607 Other assets 5,363 4,345 --------- --------- $ 103,914 $ 103,803 ========= ========= LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 172 $ 858 Accrued interest 618 853 Accounts payable and accrued line costs 4,844 4,612 Other current liabilities 3,576 3,641 --------- --------- Total current liabilities 9,210 9,964 --------- --------- Long-term liabilities, less current portion: Long-term debt 30,038 29,300 Deferred tax liability 4,066 4,034 Other liabilities 576 536 --------- --------- Total long-term liabilities 34,680 33,870 --------- --------- Commitments and contingencies Minority interests 101 52 Company obligated mandatorily redeemable and other preferred securities 1,993 2,011 Shareholders' investment: Preferred stock, par value $.01 per share; authorized: 30,967,637 shares in 2001 and 30,967,639 shares in 2002; none issued -- -- Common stock: WorldCom group stock, par value $.01 per share; authorized: 4,850,000,000 shares in 2001 and 2002; issued and outstanding: 2,967,436,680 shares in 2001 and 2,969,549,369 in 2002 30 30 MCI group stock, par value $.01 per share; authorized: 150,000,000 shares in 2001 and 2002; issued and outstanding: 118,595,711 in 2001 and 118,595,720 in 2002 1 1 Additional paid-in capital 54,297 54,314 Retained earnings 4,400 4,388 Unrealized holding gain (loss) on marketable equity securities (51) 4 Cumulative foreign currency translation adjustment (562) (646) Treasury stock, at cost, 6,765,316 shares of WorldCom group stock and 270,611 shares of MCI group stock in 2001 and 2002 (185) (185) --------- --------- Total shareholders' investment 57,930 57,906 --------- --------- $ 103,914 $ 103,803 ========= =========
The accompanying notes are an integral part of these statements. 3 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Millions, Except Per Share Data)
For the Three Months Ended March 31, -------------------- 2001 2002 ------- ------- Revenues $ 8,825 $ 8,120 ------- ------- Operating expenses: Line costs 3,696 3,479 Selling, general and administrative 2,597 2,476 Depreciation and amortization 1,335 1,322 ------- ------- Total 7,628 7,277 ------- ------- Operating income 1,197 843 Other income (expense): Interest expense (305) (447) Miscellaneous 100 (156) ------- ------- Income before income taxes and minority interests 992 240 Provision for income taxes 382 86 ------- ------- Income before minority interests 610 154 Minority interests -- 18 ------- ------- Net income 610 172 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 42 ------- ------- Net income applicable to common shareholders $ 594 $ 130 ======= ======= Net income attributed to WorldCom group $ 532 $ 184 ======= ======= Net income (loss) attributed to MCI group $ 62 $ (54) ======= ======= Earnings (loss) per common share: Net income attributed to WorldCom group: Basic $ 0.18 $ 0.06 ======= ======= Diluted $ 0.18 $ 0.06 ======= ======= Net income (loss) attributed to MCI group: Basic $ 0.54 $ (0.46) ======= ======= Diluted $ 0.54 $ (0.46) ======= =======
The accompanying notes are an integral part of these statements. 4 WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Millions)
For the Three Months Ended March 31, -------------------- 2001 2002 ------- ------- Cash flows from operating activities: Net income $ 610 $ 172 Adjustments to reconcile net income to net cash provided by operating activities: Minority interests -- (18) Depreciation and amortization 1,335 1,322 Deferred income taxes 213 (34) Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net (19) 317 Other current assets (11) (4) Accrued interest 45 235 Accounts payable and other current liabilities (483) (151) All other operating activities (115) (38) ------- ------- Net cash provided by operating activities 1,575 1,801 ------- ------- Cash flows from investing activities: Capital expenditures (2,235) (1,280) Acquisitions and related costs (142) (2) Increase in intangible assets (224) (176) Decrease in other liabilities (209) (134) All other investing activities (144) 743 ------- ------- Net cash used in investing activities (2,954) (849) ------- ------- Cash flows from financing activities: Principal borrowings (repayments) on debt, net 1,271 (22) Common stock issuance 71 14 Distributions on mandatorily redeemable and other preferred securities and dividends paid on other equity securities (16) (24) Dividends paid on MCI group stock -- (71) ------- ------- Net cash provided by (used in) financing activities 1,326 (103) Effect of exchange rate changes on cash (4) 2 ------- ------- Net increase (decrease) in cash and cash equivalents (57) 851 Cash and cash equivalents at beginning of period 545 1,416 ------- ------- Cash and cash equivalents at end of period $ 488 $ 2,267 ======= =======
The accompanying notes are an integral part of these statements. 5 WORLDCOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) GENERAL The consolidated 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 for the year ended December 31, 2001. The results for the three-month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. (B) 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. 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 months ended March 31, 2001 and 2002 (in millions, except per share data):
2001(1) 2002 ------- ------- WORLDCOM GROUP STOCK -------------------- BASIC - ----- Income attributed to WorldCom group ...................................... $ 548 $ 226 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements ............................. 16 42 ------- ------- Net income attributed to WorldCom group .................................. $ 532 $ 184 ======= ======= Weighted-average shares of WorldCom group stock outstanding .............. 2,885 2,962 ======= ======= Basic earnings per share attributed to WorldCom group stock .............. $ 0.18 $ 0.06 ======= ======= DILUTED - ------- Net income attributed to WorldCom group .................................. $ 532 $ 184 ======= ======= Weighted-average shares of WorldCom group stock outstanding .............. 2,885 2,962 WorldCom group stock equivalents ......................................... 12 1 WorldCom group stock issuable upon conversion of preferred stock ......... 2 -- ------- ------- Diluted shares of WorldCom group stock outstanding ....................... 2,899 2,963 ======= ======= Diluted earnings per share attributed to WorldCom group stock ............ $ 0.18 $ 0.06 ======= ======= MCI GROUP STOCK --------------- BASIC AND DILUTED - ----------------- Net income (loss) attributed to MCI group ................................ $ 62 $ (54) ======= ======= Basic and diluted MCI group shares outstanding ........................... 115 118 ======= ======= Basic and diluted earnings (loss) per share attributed to MCI group stock $ 0.54 $ (0.46) ======= =======
(1) In June 2001, we completed a recapitalization whereby 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 for periods prior to June 7, 2001 above is pro 6 forma and assumes the recapitalization occurred at the beginning of 2001 and the WorldCom group stock and MCI group stock existed for all periods presented. (C) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid during the three months ended March 31, 2001 and 2002, amounted to $262 million and $220 million, respectively. We made income tax payments totaling $13 million and received a net refund of previously paid income taxes totaling $214 million during the three months ended March 31, 2001 and 2002, respectively. In conjunction with business combinations during the three months ended March 31, 2001 and 2002, assets acquired and liabilities assumed were as follows (in millions):
2001 2002 ----- ----- Fair value of assets acquired .................. $ 13 $ 21 Excess of cost over net tangible assets acquired 142 12 Liabilities assumed ............................ (13) (31) ----- ----- Net cash paid .................................. $ 142 $ 2 ===== =====
(D) COMPREHENSIVE INCOME The following table reflects the calculation of our comprehensive income for the three months ended March 31, 2001 and 2002 (in millions):
2001 2002 ----- ----- Net income applicable to common shareholders .......................... $ 594 $ 130 ----- ----- Other comprehensive income (loss): Foreign currency translation losses .............................. (172) (84) Derivative financial instruments: Cumulative effect of adoption of SFAS 133 as of January 1, 2001 ...................................................... 28 -- Reclassification of derivative financial instruments to current earnings .......................................... (39) -- Change in fair value of derivative financial instruments .... 32 -- Unrealized holding gains (losses): Unrealized holding gains (losses) during the period ......... (409) 6 Reclassification adjustment for investment writeoffs included in net income .......................................... -- 81 Reclassification adjustment for gains included in net income ............................................. (141) -- ----- ----- Other comprehensive income (loss) before tax .......................... (701) 3 Income tax benefit (expense) .......................................... 207 (32) ----- ----- Other comprehensive loss .............................................. (494) (29) ----- ----- Comprehensive income applicable to common shareholders ................ $ 100 $ 101 ===== =====
(E) 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 7 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 set forth in our Annual Report on Form 10-K for the year ended December 31, 2001. Information about our segments for the three months ended March 31, 2001 and 2002, is as follows (in millions):
REVENUES FROM SELLING, GENERAL AND EXTERNAL CUSTOMERS ADMINISTRATIVE EXPENSES ------------------- ----------------------- 2001 2002 2001 2002 ------- ------- ------- ------- Voice, data and Internet .............. $ 4,493 $ 4,267 $ 999 $ 899 International operations .............. 710 811 350 395 Consumer .............................. 1,807 1,595 748 678 Wholesale ............................. 695 584 159 168 Alternative channels and small business 695 525 293 276 Dial-up Internet ...................... 425 338 138 145 Elimination of intergroup expenses .... -- -- (90) (85) ------- ------- ------- ------- Total ............................ $ 8,825 $ 8,120 $ 2,597 $ 2,476 ======= ======= ======= =======
See Note H for a reconciliation of the WorldCom group's and the MCI group's operating results to our consolidated results of operations. (F) CONTINGENCIES We are involved in legal and regulatory proceedings that are incidental to our business and have included loss contingencies in other current liabilities and other liabilities for these matters in our financial statements. In some instances, rulings by federal, state and international regulatory authorities may result in increased operating costs to us. The results 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. REGULATION. We are 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. Our subsidiaries must be certified separately in each state to offer local exchange and intrastate long distance services. No state, however, subjects us to 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, however, 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, including authorization for the installation and operation of network facilities. Although the trend in federal, state and international regulation appears to favor increased competition, 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 Telecommunications Act of 1996, or the Telecom Act, designed to encourage new entrants to compete in local service markets through interconnection with the traditional local phone companies, resale of traditional local phone companies' retail services, and use of individual and combinations of unbundled network elements, provided by the traditional local phone 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 the rules, including a pricing methodology for unbundled network elements. On remand, the FCC clarified the requirement that traditional local phone companies make specific unbundled network elements available to new entrants. The traditional local phone companies appealed the decision to the United States Court of Appeals for the D.C. Circuit. Oral argument was held March 7, 2002. 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 8 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 us, the Supreme Court reviewed the Eighth Circuit's decision. On May 13, 2002, the Supreme Court upheld the FCC's pricing rules in their entirety, including the portion that calculates costs. Numerous other issues related to the list of available unbundled network elements are under active consideration at the FCC or in the courts. In December 2001, the FCC began an examination of whether certain high capacity and broadband services offered by traditional phone companies were subject to sufficient competition such that they no longer needed to be regulated as "dominant". In February 2002, the FCC initiated a proceeding seeking to streamline and simplify the unbundled network element requirements imposed on traditional local phone companies in its "Triennial Review" of its local competition rules. In a separate proceeding, the FCC is examining whether broadband Internet access, or "DSL service" provided by traditional telephone companies should be treated as an information service and not subject to common carrier unbundling requirements. On March 7, 2002, the D.C. Circuit heard oral argument in a case that will determine whether traditional phone companies must unbundle the voice portion of a DSL connection. The FCC may begin to resolve these proceedings in the fourth quarter of 2002. If regulations are streamlined or removed, there are elements and combinations of elements upon which WorldCom relies to provide local services, broadband and advanced services that might no longer be required as a matter of federal regulation. Substantial reduction in unbundling requirements for traditional phone companies would also foreclose WorldCom's future range of options in provisioning local service to customers. The Telecom Act requires traditional local phone companies to petition the FCC for permission to offer long distance services for each state within their region. Under section 271 of the Telecom Act, for these applications to be granted, the FCC must find, among other things, that the traditional phone company has demonstrated that it has satisfied a 14-point competitive checklist to open its local network to competition and that granting the petition is in the public interest. To date, the FCC has rejected five traditional local phone company applications and it has granted eleven: Verizon's for New York, Massachusetts, Connecticut, Pennsylvania, Rhode Island, and Vermont and SBC's for Texas, Kansas, Oklahoma, Missouri and Arkansas. WorldCom and other competitive carriers appealed to the D.C. Circuit the approvals for Kansas, Oklahoma and Massachusetts. On December 28, 2001, the D.C. Circuit decided that the FCC had not adequately addressed whether the prices charged for leasing network elements by SBC in Kansas and Oklahoma create a price squeeze which violated the standards for SBC to gain long distance approval. Without vacating the approval, the D.C. Circuit remanded the case to the FCC for it to address the price squeeze issue. In the Massachusetts appeal, oral argument is scheduled for September 9, 2002. BellSouth has filed applications to offer long distance service for Georgia and Louisiana, and Verizon has filed applications for New Jersey and Maine. Other applications may be filed at any time. We have challenged, and will continue to challenge, any application that we believe 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 traditional local phone companies' operations support systems. In addition, legislation has been introduced in Congress that would have the effect of allowing traditional local phone 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 phone company high-speed Internet access services or to lease the unbundled network elements used to provide these services. This legislation passed the House of Representatives on February 27, 2002 and has been referred to the Senate Commerce Committee. 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 us, are entitled to collect reciprocal compensation for completing calls to Internet service providers under the terms of their interconnection agreements with traditional local phone companies. Many of these public utility commission decisions were appealed by the traditional local phone companies and, since the FCC's order, many traditional local phone companies have filed new cases at the public utility commissions or in court. We petitioned for review of the FCC's order in 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. We filed a petition for review of the FCC's order with the D.C. Circuit, and on May 3, 2002, the D.C. Circuit upheld our challenge and remanded the case to the FCC, ruling that the FCC's legal analysis was based on a flawed reading of the Telecom Act. The Court expressly declined to decide any of the remaining challenges 9 to the transitional scheme, opting to wait until the FCC provided a sufficient legal basis in support of the conclusions it had reached in the Order. In the interim, however, because the Court apparently believed that there may be other legal basis for adopting the rules chosen here, it decided not to vacate the Order and instead left the FCC transitional scheme in place. It is possible that spectrum rights held may be disrupted by FCC decisions to re-allocate some or all of that spectrum to other services. If this re-allocation were to occur, we cannot predict whether current deployment plans for our multi-channel multipoint distribution services will be sustainable. LITIGATION. 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 our 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 between September 5 and November 1, 2000, which action asserted 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 Technologies, 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 March 29, 2002, the district court granted the motion to dismiss the consolidated amended complaint filed by WorldCom and the individual defendants, and it entered final judgment dismissing the complaint with prejudice. On April 4, 2002, plaintiffs filed a notice of appeal to the U.S. Court of Appeals for the Fifth Circuit. We believe that the consolidated amended complaint and the notice of appeal are without merit and will continue to defend them vigorously. Complaints dated April 30, 2002 and May 3, 2002, purportedly made on behalf of a class of WorldCom shareholders, were filed in the United States District Court for the Southern District of New York. The complaints, which name as defendants WorldCom, various officers and directors, and our auditors, allege that the defendants failed to properly account for goodwill and other intangible assets in connection with numerous acquisitions. One of the actions also alleges pendent state law claims. We believe the factual allegations and legal claims asserted in these complaints are without merit and will defend them vigorously. On March 18, 2002, a current and a former employee filed suit in the United States District Court for the Northern District of California against WorldCom and certain of its executive officers claiming that they breached their fiduciary duty under the Employee Retirement Income Security Act with respect to the administration of the WorldCom 401(k) Plan. Among other things, they allege that the defendants misrepresented and/or concealed WorldCom's revenue, cashflow, earnings and the reason(s) for its change in financial performance. They further allege that the defendants knowingly participated in and/or concealed these alleged acts or omissions while continuing to direct the purchase and retention of WorldCom stock by the WorldCom 401(k) Plan. The complaint seeks to certify a class of persons who participated in the WorldCom 401(k) Plan for the period of February 8, 2000 to November 1, 2000, and requests damages and other relief. We believe the factual allegations and legal claims asserted in the complaint are without merit and will 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. 10 (G) GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, we adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets", or SFAS No. 142, which establishes accounting and reporting standards for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. The statement also includes provisions for the identification of reporting units for purposes of assessing potential future impairments of goodwill. Upon adoption, we stopped amortizing intangible assets with indefinite useful lives, including goodwill and tradenames. Additionally, we made no revisions to the assigned useful lives of intangible assets that continue to be amortized. We are conducting impairment reviews of all intangible 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. Based on our preliminary analyses, we estimate that as a result of the adoption of SFAS No. 142, we will reduce goodwill by $15 to $20 billion. Our earnings and earnings per share information for the three months ended March 31, 2001, adjusted to exclude the after-tax effect of amortization of intangible assets with indefinite useful lives, is as follows (in millions, except per share amounts):
WORLDCOM, WORLDCOM MCI INC. GROUP GROUP ----------- ---------- -------- Net income - as reported ................ $594 $532 $ 62 Add back the after-tax effect of: Goodwill amortization .............. 294 227 67 Tradename amortization ............. 4 4 -- Other amortization ................. 4 3 1 ---- ---- ------- Net income - adjusted ................... $896 $766 $ 130 ==== ==== ======= Earnings per common share: Basic and diluted income - as reported $0.18 $ 0.54 Goodwill amortization ................ 0.08 0.58 Tradename amortization ............... -- -- Other amortization ................... -- 0.01 ----- ------- Basic and diluted income - adjusted ..... $0.26 $ 1.13 ===== =======
The components of our intangible assets are as follows (in millions):
DECEMBER 31, MARCH 31, 2001 2002 -------- -------- Amortized intangible assets: Developed technology ...... $ 1,700 $ 1,700 Other intangibles ......... 4,298 4,557 -------- -------- 5,998 6,257 Accumulated amortization ..... (1,874) (2,085) -------- -------- $ 4,124 $ 4,172 ======== ======== Unamortized intangible assets: Goodwill .................. $ 44,973 $ 44,995 Tradenames ................ 1,023 1,023 Other ..................... 417 417 -------- -------- $ 46,413 $ 46,435 ======== ========
Depreciation and amortization expense for the net carrying amount of intangible assets, primarily software development, as of March 31, 2002 is estimated to be $856 million in 2002, $911 million in 2003, $860 million in 2004, $752 million in 2005 and $419 million in 2006. 11 (H) 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 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. 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. 12 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING BALANCE SHEET (IN MILLIONS)
AT DECEMBER 31, 2001 ------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS(1) WORLDCOM -------- -------- --------------- -------- Current assets $ 8,179 $ 1,926 $ (900) $ 9,205 Property and equipment, net 36,792 2,017 -- 38,809 Goodwill and other intangibles 40,818 9,719 -- 50,537 Other assets 6,112 227 (976) 5,363 -------- -------- -------- -------- Total assets $ 91,901 $ 13,889 $ (1,876) $103,914 ======== ======== ======== ======== Current liabilities $ 5,915 $ 4,195 $ (900) $ 9,210 Long-term debt 24,533 5,505 -- 30,038 Noncurrent liabilities 3,742 1,876 (976) 4,642 Minority interests 101 -- -- 101 Company obligated mandatorily redeemable and other preferred securities 1,993 -- -- 1,993 Shareholders' investment 55,617 2,313 -- 57,930 -------- -------- -------- -------- Total liabilities and shareholders' investment $ 91,901 $ 13,889 $ (1,876) $103,914 ======== ======== ======== ========
(1) Represents the elimination of intergroup receivables and payables associated with other intergroup allocations between the WorldCom group and the MCI group. The WorldCom group had a net receivable from the MCI group (and the MCI group had a corresponding net payable to the WorldCom group) of $1.9 billion, of which $900 million was classified as current with the remainder classified as long-term. 13 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING BALANCE SHEET (IN MILLIONS)
AT MARCH 31, 2002 ------------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS(1) WORLDCOM -------- -------- --------------- -------- Current assets $ 8,782 $ 1,835 $ (921) $ 9,696 Property and equipment, net 37,222 1,933 -- 39,155 Goodwill and other intangibles 40,805 9,802 -- 50,607 Other assets 5,154 167 (976) 4,345 -------- -------- -------- -------- Total assets $ 91,963 $ 13,737 $ (1,897) $103,803 ======== ======== ======== ======== Current liabilities $ 6,594 $ 4,291 $ (921) $ 9,964 Long-term debt 23,804 5,496 -- 29,300 Noncurrent liabilities 3,713 1,833 (976) 4,570 Minority interests 52 -- -- 52 Company obligated mandatorily redeemable preferred securities 2,011 -- -- 2,011 Shareholders' investment 55,789 2,117 -- 57,906 -------- -------- -------- -------- Total liabilities and shareholders' investment $ 91,963 $ 13,737 $ (1,897) $103,803 ======== ======== ======== ========
(1) Represents the elimination of intergroup receivables and payables associated with other intergroup allocations between the WorldCom group and the MCI group. The WorldCom group had a net receivable from the MCI group (and the MCI group had a corresponding net payable to the WorldCom group) of $1.9 billion, of which $921 million was classified as current with the remainder classified as long-term. 14 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS (IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2001 ---------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM ------- ------- ------------ -------- Revenues $ 5,203 $ 3,622 $ -- $ 8,825 ------- ------- ------- ------- Operating expenses: Line costs: Attributed costs (1) 1,963 1,733 -- 3,696 Intergroup allocated expenses (2) 24 93 (117) -- Selling, general and administrative: Attributed costs (1) 774 935 888 2,597 Shared corporate services (3) 575 313 (888) -- Other intergroup allocated expenses (4) -- 90 (90) -- Depreciation and amortization: Attributed costs (1) 1,084 251 -- 1,335 Intergroup allocated expenses (5) (183) (24) 207 -- ------- ------- ------- ------- Total 4,237 3,391 -- 7,628 ------- ------- ------- ------- Operating income 966 231 -- 1,197 Interest expense (179) (126) -- (305) Miscellaneous income 100 -- -- 100 ------- ------- ------- ------- Income before income taxes and minority interests 887 105 -- 992 Provision for income taxes 339 43 -- 382 ------- ------- ------- ------- Income before minority interests 548 62 -- 610 Minority interests -- -- -- -- ------- ------- ------- ------- Net income before distributions on mandatorily redeemable preferred securities 548 62 -- 610 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 -- -- 16 ------- ------- ------- ------- Net income $ 532 $ 62 $ -- $ 594 ======= ======= ======= =======
(1) Attributed costs represent costs directly incurred by or attributed to the WorldCom group and the MCI group and do not include any intergroup allocations. (2) The WorldCom group was allocated $24 million for its usage of our business voice switches, which have been attributed to the MCI group, and the MCI group was allocated $93 million for its usage of our fiber optic systems, which have been attributed to the WorldCom group. (3) Our shared corporate services (such as executive management, human resources, legal, regulatory, accounting and tax, treasury, strategic planning and information systems support) have been allocated to the WorldCom group and the MCI group in the amounts of $575 million and $313 million, respectively. (4) The MCI group was allocated $83 million of costs related to its use of buildings, furniture and fixtures and $7 million for use of the MCI tradenames, which assets have been attributed to the WorldCom group. (5) A credit of $176 million and $24 million to depreciation expense has been recorded by the WorldCom group and the MCI group, respectively, to reflect the allocation of a portion of the applicable costs for the use by the WorldCom group of the business voice switches attributed to the MCI group, and the proportionate use by the MCI group of the fiber optic systems and buildings, furniture and fixtures attributed to the WorldCom group. Additionally, a credit of $7 million to amortization expense has been recorded by the WorldCom group to reflect the charge to the MCI group for use of the MCI tradenames. 15 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS (IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2002 ---------------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM ------- ------- ------------ -------- Revenues $ 5,078 $ 3,042 $ -- $ 8,120 ------- ------- ------- ------- Operating expenses: Line costs: Attributed costs (1) 1,999 1,480 -- 3,479 Intergroup allocated expenses (2) 21 91 (112) -- Selling, general and administrative: Attributed costs (1) 829 787 860 2,476 Shared corporate services (3) 465 395 (860) -- Other intergroup allocated expenses (4) -- 85 (85) -- Depreciation and amortization: Attributed costs (1) 1,132 190 -- 1,322 Intergroup allocated expenses (5) (176) (21) 197 -- ------- ------- ------- ------- Total 4,270 3,007 -- 7,277 ------- ------- ------- ------- Operating income 808 35 -- 843 Interest expense (327) (120) -- (447) Miscellaneous expense (156) -- -- (156) ------- ------- ------- ------- Income (loss) before income taxes and minority interests 325 (85) -- 240 Provision for income taxes 117 (31) -- 86 ------- ------- ------- ------- Income (loss) before minority interests 208 (54) -- 154 Minority interests 18 -- -- 18 ------- ------- ------- ------- Net (loss) income before distributions on mandatorily redeemable preferred securities 226 (54) -- 172 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 42 -- -- 42 ------- ------- ------- ------- Net income (loss) $ 184 $ (54) $ -- $ 130 ======= ======= ======= =======
(1) Attributed costs represent costs directly incurred by or attributed to the WorldCom group and the MCI group and do not include any intergroup allocations. (2) The WorldCom group was allocated $21 million for its usage of our business voice switches, which have been attributed to the MCI group, and the MCI group was allocated $91 million for its usage of our fiber optic systems, which have been attributed to the WorldCom group. (3) Our shared corporate services (such as executive management, human resources, legal, regulatory, accounting and tax, treasury, strategic planning and information systems support) have been allocated to the WorldCom group and the MCI group in the amounts of $465 million and $395 million, respectively. (4) The MCI group was allocated $85 million of costs related to its use of buildings, furniture and fixtures which assets have been attributed to the WorldCom group. (5) A credit of $176 million and $21 million to depreciation expense has been recorded by the WorldCom group and the MCI group, respectively, to reflect the allocation of a portion of the applicable costs for the use by the WorldCom group of the business voice switches attributed to the MCI group, and the proportionate use by the MCI group of the fiber optic systems and buildings, furniture and fixtures attributed to the WorldCom group. 16 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS (IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2001 ----------------------------------------- WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM ------- ------- ------------ -------- Cash flows from operating activities: Net income $ 548 $ 62 $-- $ 610 Adjustments to reconcile net income to net cash provided by operating activities 667 298 -- 965 ------- ------- --- ------- Net cash provided by operating activities 1,215 360 -- 1,575 ------- ------- --- ------- Cash flows from investing activities: Capital expenditures (2,140) (95) -- (2,235) Acquisitions and related costs (142) -- -- (142) All other investing activities, net (276) (301) -- (577) ------- ------- --- ------- Net cash used in investing activities (2,558) (396) -- (2,954) ------- ------- --- ------- Cash flows from financing activities: Principal borrowings on debt, net 1,271 -- -- 1,271 Attributed stock activity of WorldCom, Inc. 71 -- -- 71 All other financing activities, net (31) 15 -- (16) ------- ------- --- ------- Net cash provided by financing activities 1,311 15 -- 1,326 Effect of exchange rate changes on cash (4) -- -- (4) ------- ------- --- ------- Net decrease in cash and cash equivalents (36) (21) -- (57) Cash and cash equivalents beginning of period 504 41 -- 545 ------- ------- --- ------- Cash and cash equivalents end of period $ 468 $ 20 $-- $ 488 ======= ======= === =======
17 (H) CONSOLIDATING INFORMATION - (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS (IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2002 ------------------------------------------ WORLDCOM MCI GROUP GROUP ELIMINATIONS WORLDCOM ------- ------- ------------ -------- Cash flows from operating activities: Net income (loss) $ 226 $ (54) $-- $ 172 Adjustments to reconcile net income (loss) to net cash provided by operating activities 1,366 263 -- 1,629 ------- ------- --- ------- Net cash provided by operating activities 1,592 209 -- 1,801 ------- ------- --- ------- Cash flows from investing activities: Capital expenditures (1,250) (30) -- (1,280) Acquisitions and related costs (2) -- -- (2) All other investing activities, net 536 (103) -- 433 ------- ------- --- ------- Net cash used in investing activities (716) (133) -- (849) ------- ------- --- ------- Cash flows from financing activities: Principal repayments on debt, net (13) (9) -- (22) Attributed stock activity of WorldCom, Inc. 14 -- -- 14 All other financing activities, net (24) (71) -- (95) ------- ------- --- ------- Net cash used in financing activities (23) (80) -- (103) Effect of exchange rate changes on cash 2 -- -- 2 ------- ------- --- ------- Net increase (decrease) in cash and cash equivalents 855 (4) -- 851 Cash and cash equivalents beginning of period 1,409 7 -- 1,416 ------- ------- --- ------- Cash and cash equivalents end of period $ 2,264 $ 3 $-- $ 2,267 ======= ======= === =======
18 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED BALANCE SHEETS (In Millions)
December 31, March 31, 2001 2002 -------- -------- ASSETS Current assets: Cash and cash equivalents $ 1,409 $ 2,264 Accounts receivable, net of allowance for bad debts of $693 in 2001 and $775 in 2002 3,734 3,521 Deferred tax asset 241 222 Other current assets 1,895 1,854 Receivable from MCI group, net 900 921 -------- -------- Total current assets 8,179 8,782 -------- -------- Property and equipment: Transmission equipment 23,369 24,765 Communications equipment 5,434 5,082 Furniture, fixtures and other 10,583 11,489 Construction in progress 5,576 4,897 -------- -------- 44,962 46,233 Accumulated depreciation (8,170) (9,011) -------- -------- 36,792 37,222 -------- -------- Goodwill and other intangible assets 40,818 40,805 Long-term receivable from MCI group, net 976 976 Other assets 5,136 4,178 -------- -------- $ 91,901 $ 91,963 ======== ======== LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Short-term debt and current maturities of long-term debt $ 172 $ 858 Accrued interest 507 733 Accounts payable and accrued line costs 2,751 2,557 Other current liabilities 2,485 2,446 -------- -------- Total current liabilities 5,915 6,594 -------- -------- Long-term liabilities, less current portion: Long-term debt 24,533 23,804 Deferred tax liability 3,196 3,204 Other liabilities 546 509 -------- -------- Total long-term liabilities 28,275 27,517 -------- -------- Commitments and contingencies Minority interests 101 52 Company obligated mandatorily redeemable and other preferred securities 1,993 2,011 Allocated net worth 55,617 55,789 -------- -------- $ 91,901 $ 91,963 ======== ========
The accompanying notes are an integral part of these combined statements. 19 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF OPERATIONS (In Millions)
For the Three Months Ended March 31, --------------------- 2001 2002 ------- ------- Revenues $ 5,203 $ 5,078 ------- ------- Operating expenses: Line costs 1,987 2,020 Selling, general and administrative 1,349 1,294 Depreciation and amortization 901 956 ------- ------- Total 4,237 4,270 ------- ------- Operating income 966 808 Other income (expense): Interest expense (179) (327) Miscellaneous 100 (156) ------- ------- Income before income taxes and minority interests 887 325 Provision for income taxes 339 117 ------- ------- Income before minority interests 548 208 Minority interests -- 18 ------- ------- Net income before distributions on mandatorily redeemable preferred securities 548 226 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 42 ------- ------- Net income $ 532 $ 184 ======= =======
The accompanying notes are an integral part of these combined statements. 20 WORLDCOM GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF CASH FLOWS (In Millions)
For the Three Months Ended March 31, -------------------- 2001 2002 ------- ------- Cash flows from operating activities: Net income before distributions on mandatorily redeemable preferred securities $ 548 $ 226 Adjustments to reconcile net income before distributions on mandatorily redeemable preferred securities to net cash provided by operating activities: Minority interests -- (18) Depreciation and amortization 901 956 Deferred income taxes 207 (4) Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net (81) 227 Receivable from MCI group, net (187) (21) Accrued interest 41 226 Accounts payable and other current liabilities (16) 30 Other current assets (83) 8 All other operating activities (115) (38) ------- ------- Net cash provided by operating activities 1,215 1,592 ------- ------- Cash flows from investing activities: Capital expenditures (2,140) (1,250) Acquisitions and related costs (142) (2) Increase in intangible assets (106) (116) Decrease in other liabilities (121) (131) All other investing activities (49) 783 ------- ------- Net cash used in investing activities (2,558) (716) ------- ------- Cash flows from financing activities: Principal borrowings (repayments) on debt, net 1,271 (13) Attributed stock activity of WorldCom, Inc. 71 14 Distributions on mandatorily redeemable and other preferred securities and dividends paid on other equity securities (16) (24) Advances to MCI group, net (15) -- ------- ------- Net cash provided by (used in) financing activities 1,311 (23) Effect of exchange rate changes on cash (4) 2 ------- ------- Net increase (decrease) in cash and cash equivalents (36) 855 Cash and cash equivalents at beginning of period 504 1,409 ------- ------- Cash and cash equivalents at end of period $ 468 $ 2,264 ======= =======
The accompanying notes are an integral part of these combined statements. 21 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 for the year ended December 31, 2001. The results for the three-month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. (B) 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. (C) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid by the WorldCom group during the three months ended March 31, 2001 and 2002, amounted to $140 million and $109 million, respectively. The WorldCom group made income tax payments totaling $7 million and received a net refund of previously paid income taxes totaling $214 million during the three months ended March 31, 2001 and 2002, respectively. In conjunction with business combinations attributed to the WorldCom group during the three months ended March 31, 2001 and 2002, assets acquired and liabilities assumed were as follows (in millions):
2001 2002 ----- ----- Fair value of assets acquired .................. $ 13 $ 21 Excess of cost over net tangible assets acquired 142 12 Liabilities assumed ............................ (13) (31) ----- ----- Net cash paid .................................. $ 142 $ 2 ===== =====
(D) COMPREHENSIVE INCOME The following table reflects the calculation of comprehensive income attributed to the WorldCom group for the three months ended March 31, 2001 and 2002 (in millions):
2001 2002 ----- ----- Net income .............................................................. $ 532 $ 184 ----- ----- Other comprehensive income (loss): Foreign currency translation losses ................................ (172) (84) Derivative financial instruments: Cumulative effect of adoption of SFAS 133 as of January 1, 2001 28 -- Reclassification of derivative financial instruments to current earnings ................................................... (39) -- Change in fair value of derivative financial instruments ...... 32 -- Unrealized holding gains (losses): Unrealized holding gains (losses) during the period ........... (409) 6 Reclassification adjustment for investment writeoffs included in net income .................................... -- 81
22
2001 2002 ----- ----- Reclassification adjustment for gains included in net income .. (141) -- ----- ----- Other comprehensive income (loss) before tax ............................ (701) 3 Income tax benefit (expense) ............................................ 207 (32) ----- ----- Other comprehensive loss ................................................ (494) (29) ----- ----- Comprehensive income .................................................... $ 38 $ 155 ===== =====
(E) 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 set forth in our Annual Report on Form 10-K for the year ended December 31, 2001. Information about the WorldCom group's segments for the three months ended March 31, 2001 and 2002, is as follows (in millions):
REVENUES FROM SELLING, GENERAL AND EXTERNAL CUSTOMERS ADMINISTRATIVE EXPENSES ------------------ ----------------------- 2001 2002 2001 2002 ------ ------ ------ ------ Voice, data and Internet .. $4,493 $4,267 $ 999 $ 899 International operations .. 710 811 350 395 ------ ------ ------ ------ Total ................ $5,203 $5,078 $1,349 $1,294 ====== ====== ====== ======
The following is a reconciliation of the segment information to income before income taxes and minority interests for the three months ended March 31, 2001 and 2002 (in millions):
2001 2002 ------- ------- Revenues ........................................ $ 5,203 $ 5,078 Operating expenses .............................. 4,237 4,270 ------- ------- Operating income ................................ 966 808 Other income (expense): Interest expense ........................... (179) (327) Miscellaneous .............................. 100 (156) ------- ------- Income before income taxes and minority interests $ 887 $ 325 ======= =======
(F) 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 F to our interim consolidated financial statements for information related to our contingencies. 23 (G) GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, we adopted SFAS No. 142, which establishes accounting and reporting standards for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. The statement also includes provisions for the identification of reporting units for purposes of assessing potential future impairments of goodwill. Upon adoption, we stopped amortizing intangible assets with indefinite useful lives, including goodwill and tradenames. Additionally, we made no revisions to the assigned useful lives of intangible assets that continue to be amortized. We are conducting impairment reviews of all intangible 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. Based on our preliminary analyses, we estimate that as a result of the adoption of SFAS No. 142 we will reduce goodwill by $15 to $20 billion. Our earnings attributed to the WorldCom group for the three months ended March 31, 2001, adjusted to exclude the after-tax effect of amortization of intangible assets with indefinite useful lives, is as follows (in millions):
WORLDCOM GROUP -------- Net income - as reported ........ $532 Add back the after-tax effect of: Goodwill amortization ........ 227 Tradename amortization ....... 4 Other amortization ........... 3 ---- Net income - adjusted ........... $766 ====
The components of intangible assets attributed to the WorldCom group are as follows (in millions):
DECEMBER 31, MARCH 31, 2001 2002 -------- -------- Amortized intangible assets: Developed technology ...... $ 1,190 $ 1,190 Other intangibles ......... 3,014 3,125 -------- -------- 4,204 4,315 Accumulated amortization ..... (1,324) (1,470) -------- -------- $ 2,880 $ 2,845 ======== ======== Unamortized intangible assets: Goodwill .................. $ 36,632 $ 36,654 Tradenames ................ 1,023 1,023 Other ..................... 283 283 -------- -------- $ 37,938 $ 37,960 ======== ========
Depreciation and amortization expense for the net carrying amount of intangible assets attributed to the WorldCom group, primarily software development, as of March 31, 2002 is estimated to be $600 million in 2002, $637 million in 2003, $602 million in 2004, $529 million in 2005 and $305 million in 2006. 24 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED BALANCE SHEETS (In Millions)
December 31, March 31, 2001 2002 -------- -------- ASSETS Current assets: Cash and cash equivalents $ 7 $ 3 Accounts receivable, net of allowance for bad debts of $393 in 2001 and $440 in 2002 1,574 1,484 Deferred tax asset 10 -- Other current assets 335 348 -------- -------- Total current assets 1,926 1,835 -------- -------- Property and equipment: Transmission equipment 445 454 Communications equipment 2,444 2,513 Furniture, fixtures and other 680 682 Construction in progress 130 80 -------- -------- 3,699 3,729 Accumulated depreciation (1,682) (1,796) -------- -------- 2,017 1,933 -------- -------- Goodwill and other intangible assets 9,719 9,802 Other assets 227 167 -------- -------- $ 13,889 $ 13,737 ======== ======== LIABILITIES AND SHAREHOLDERS' INVESTMENT Current liabilities: Payable to WorldCom group, net $ 900 $ 921 Accrued interest 111 120 Accounts payable and accrued line costs 2,093 2,055 Other current liabilities 1,091 1,195 -------- -------- Total current liabilities 4,195 4,291 -------- -------- Long-term liabilities, less current portion: Long-term debt 5,505 5,496 Long-term payable to WorldCom group, net 976 976 Deferred tax liability 870 830 Other liabilities 30 27 -------- -------- Total long-term liabilities 7,381 7,329 -------- -------- Commitments and contingencies Allocated net worth 2,313 2,117 -------- -------- $ 13,889 $ 13,737 ======== ========
The accompanying notes are an integral part of these combined statements. 25 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF OPERATIONS (In Millions)
For the Three Months Ended March 31, -------------------- 2001 2002 ------- ------- Revenues $ 3,622 $ 3,042 ------- ------- Operating expenses: Line costs 1,826 1,571 Selling, general and administrative 1,338 1,267 Depreciation and amortization 227 169 ------- ------- Total 3,391 3,007 ------- ------- Operating income 231 35 Other expense: Interest expense (126) (120) ------- ------- Income (loss) before income taxes 105 (85) Income tax expense (benefit) 43 (31) ------- ------- Net income (loss) $ 62 $ (54) ======= =======
The accompanying notes are an integral part of these combined statements. 26 MCI GROUP (an integrated business of WorldCom, Inc.) COMBINED STATEMENTS OF CASH FLOWS (In Millions)
For the Three Months Ended March 31, ---------------- 2001 2002 ----- ----- Cash flows from operating activities: Net income (loss) $ 62 $ (54) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 227 169 Deferred income taxes 6 (30) Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net 62 90 Other current assets 72 (12) Accrued interest 4 9 Accounts payable and other current liabilities (260) 16 Payable to WorldCom group, net 187 21 ----- ----- Net cash provided by operating activities 360 209 ----- ----- Cash flows from investing activities: Capital expenditures (95) (30) Increase in intangible assets (118) (60) Decrease in other liabilities (88) (3) All other investing activities (95) (40) ----- ----- Net cash used in investing activities (396) (133) ----- ----- Cash flows from financing activities: Principal repayments on debt, net -- (9) Dividends paid on MCI group common stock -- (71) Advances from WorldCom group, net 15 -- ----- ----- Net cash provided by (used in) financing activities 15 (80) ----- ----- Net decrease in cash and cash equivalents (21) (4) Cash and cash equivalents at beginning of period 41 7 ----- ----- Cash and cash equivalents at end of period $ 20 $ 3 ===== =====
The accompanying notes are an integral part of these combined statements. 27 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 for the year ended December 31, 2001. The results for the three-month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. (B) 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 (loss) 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. (C) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid by the MCI group during the three months ended March 31, 2001 and 2002, amounted to $122 million and $111 million, respectively. Income taxes paid, net of refunds received, during the three months ended March 31, 2001 totaled $6 million. No income taxes were paid during the three months ended March 31, 2002. (D) 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 set forth in our Annual Report on Form 10-K for the year ended December 31, 2001. Information about the MCI group's segments for the three months ended March 31, 2001 and 2002, is as follows (in millions): 28
REVENUES FROM SELLING, GENERAL AND EXTERNAL CUSTOMERS ADMINISTRATIVE EXPENSES ------------------ ----------------------- 2001 2002 2001 2002 ------ ------ ------ ------ Consumer .............................. $1,807 $1,595 $ 748 $ 678 Wholesale ............................. 695 584 159 168 Alternative channels and small business 695 525 293 276 Dial-up Internet ...................... 425 338 138 145 ------ ------ ------ ------ Total ............................ $3,622 $3,042 $1,338 $1,267 ====== ====== ====== ======
The following is a reconciliation of the segment information to income (loss) before income taxes for the three months ended March 31, 2001 and 2002 (in millions):
2001 2002 ------- ------- Revenues ........................ $ 3,622 $ 3,042 Operating expenses .............. 3,391 3,007 ------- ------- Operating income ................ 231 35 Other income (expense): Interest expense ........... (126) (120) ------- ------- Income (loss) before income taxes $ 105 $ (85) ======= =======
(E) 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 F to our interim consolidated financial statements for information related to our contingencies. (F) GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, we adopted SFAS No. 142, which establishes accounting and reporting standards for goodwill and other intangible assets. Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. The statement also includes provisions for the identification of reporting units for purposes of assessing potential future impairments of goodwill. Upon adoption, we stopped amortizing intangible assets with indefinite useful lives, including goodwill and tradenames. Additionally, we made no revisions to the assigned useful lives of intangible assets that continue to be amortized. We are conducting impairment reviews of all intangible 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. Based on our preliminary analyses, we estimate that as a result of the adoption of SFAS No. 142 we will reduce goodwill by $15 to $20 billion. Our earnings attributed to the MCI group for the three months ended March 31, 2001, adjusted to exclude the after-tax effect of amortization of intangible assets with indefinite useful lives, is as follows (in millions):
MCI GROUP --------- Net income - as reported ........ $ 62 Add back the after-tax effect of: Goodwill amortization ........ 67 Other amortization ........... 1 ---- Net income - adjusted ........... $130 ====
29 The components of intangible assets attributed to the MCI group are as follows (in millions):
DECEMBER 31, MARCH 31, 2001 2002 ------- ------- Amortized intangible assets: Developed technology ...... $ 510 $ 510 Other intangibles ......... 1,284 1,432 ------- ------- 1,794 1,942 Accumulated amortization ..... (550) (615) ------- ------- $ 1,244 $ 1,327 ======= ======= Unamortized intangible assets: Goodwill .................. $ 8,341 $ 8,341 Other ..................... 134 134 ------- ------- $ 8,475 $ 8,475 ======= =======
Depreciation and amortization expense for the net carrying amount of intangible assets attributed to the MCI group, primarily software development, as of March 31, 2002 is estimated to be $256 million in 2002, $274 million in 2003, $258 million in 2004, $223 million in 2005 and $114 million in 2006. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Our common stock consists of two separately traded tracking stocks: WorldCom group stock, which is intended to reflect the 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 aligned 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 communications services. Through the businesses that we have aligned 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. Our services include: 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. 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. 30 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 or any special committee appointed by our board of directors may, without shareholder approval, change the policies set forth in our tracking stock policy statement. Our board of directors or any special committee appointed by our 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 policy statement in connection with particular facts and circumstances, all as they may determine to be in the best interests of WorldCom. 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, pricing trends, anticipated benefits from The Neighborhood, our credit facilities or receivables purchase program, the sufficiency of our liquidity and cash flow, the markets for WorldCom's services and products, anticipated capital expenditures, 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, including price compression; o risks associated with debt service requirements and our financial leverage; o the impact of technological change on our business, alternative technologies, and dependence on availability of transmission facilities; o risks of international business; o regulatory risks in the United States and internationally; o contingent liabilities; o uncertainties regarding the collectibility of receivables; o uncertainties associated with the success of acquisitions; 31 o the ongoing war on terrorism; and o other risks referenced from time to time in WorldCom's filings with the SEC. 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. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. The following discussion and analysis relates to our financial condition and results of operations for the three months ended March 31, 2001 and 2002. 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 revenues:
FOR THE THREE MONTHS ENDED MARCH 31, ---------------- 2001 2002 ------ ------ Revenues ................................................... 100.0% 200.0% Line costs ................................................. 41.9 42.8 Selling, general and administrative ........................ 29.4 30.5 Depreciation and amortization .............................. 15.1 16.3 ------ ------ Operating income ........................................... 13.6 10.4 Other income (expense): Interest expense ...................................... (3.5) (5.5) Miscellaneous ......................................... 1.1 (1.9) ------ ------ Income before income taxes and minority interests .......... 11.2 3.0 Provision for income taxes ................................. 4.3 1.1 ------ ------ Income before minority interests ........................... 6.9 1.9 Minority interests ......................................... -- 0.2 ------ ------ Net income ................................................. 6.9 2.1 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements ............. 0.2 0.5 ------ ------ Net income applicable to common shareholders ............... 6.7% 1.6% ====== ======
THREE MONTHS ENDED MARCH 31, 2001 VS. THREE MONTHS ENDED MARCH 31, 2002 For the three months ended March 31, 2001 and 2002, our revenues were as follows (dollars in millions):
2001 2002 ------------------- ------------------- PERCENT PERCENT $ OF TOTAL $ OF TOTAL ------ ------- ------ ------- WorldCom group $5,203 59.0% $5,078 62.5% MCI group .... 3,622 41.0 3,042 37.5 ------ ------- ------ ------- $8,825 100.0% $8,120 100.0% ====== ======= ====== =======
Actual reported revenues by category for the three months ended March 31, 2001 and 2002 reflect the following changes by category (dollars in millions): 32
PERCENT 2001 2002 CHANGE ------ ------ --------- COMMERCIAL SERVICES REVENUES Voice ................................... $1,726 $1,518 (12.1) Data .................................... 2,045 1,963 (4.0) International ........................... 710 811 14.2 Internet ................................ 722 786 8.9 ------ ------ TOTAL COMMERCIAL SERVICES REVENUES ........ 5,203 5,078 (2.4) Consumer ................................ 1,807 1,595 (11.7) Wholesale ............................... 695 584 (16.0) Alternative channels and small business . 695 525 (24.5) Dial-up Internet ........................ 425 338 (20.5) ------ ------ TOTAL ..................................... $8,825 $8,120 (8.0) ====== ======
Commercial services revenues, which include the revenues generated from commercial voice, data, international and Internet services, for the first quarter of 2002 were $5.1 billion versus $5.2 billion for the first quarter of 2001. The decrease reflects the current economic conditions as well as continued overall price compression in the marketplace. Voice revenues for the first quarter of 2002 decreased 12.1% over the prior year period and traffic decreased 2.5%. Price compression for long distance business voice services drove this decline while wireless and local voice services reflected a modest increase of 4.0% to $482 million. Price compression on voice revenues is expected to continue for the near term, which will negatively affect revenue growth in this area. Data revenues for the first quarter of 2002 decreased 4.0% over the prior year period. The decrease was driven by customer data network reductions resulting from economic restraints which caused many companies to not only reduce their capital spending but to also reduce their network requirements or groom their network into more cost effective alternatives. While we continue to add new sales to our customer base, the customer downsizing noted above outpaced new sales in the first quarter of 2002. Data includes both commercial long distance and local dedicated bandwidth sales. International revenues for the first quarter of 2002 increased 14.2% to $811 million versus $710 million, for the first quarter of 2001. Geographically, Europe grew 18.3% and Asia Pacific and other areas grew 6.6% for the first quarter of 2002. These increases were partially offset by foreign currency fluctuations that had the effect of reducing revenues by approximately $22 million in the first quarter of 2002. Our international business continues to experience significant price pressure on its products as we continue to penetrate the retail markets and wholesale continues to represent a large portion of international revenues. Internet revenues for the first quarter of 2002 increased 8.9% over the prior year period. The increase included $34 million of Digex revenues, after intercompany eliminations, as a result of our merger with Intermedia in July 2001. While less of an impact than data, customer network grooming on Internet networks partially offset new customer growth in the first quarter of 2002. Our Internet protocol virtual private network product, or IP-VPN, continued to show improvement during the first quarter of 2002. This new product has grown to approximately $120 million in annualized revenue. We have recently signed several large customer contracts for IP-VPN services and these customers, combined with overall market acceptance of this product, should continue to drive growth in this product. Despite this, IP-VPNs have not yet achieved a size or scale to overcome the attrition on our remote access product. Our legacy x.25 remote access product is supported by more mature technologies and our customers are migrating their services to more cost effective alternatives, such as IP-VPN. Excluding the revenues from the legacy x.25 product, Internet revenues grew 25%. 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 first quarter of 2002 decreased 11.7% 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' continued substitution of wire line services with wireless and e-mail. Our consumer local initiatives continue to perform well as consumer local revenues increased over 108% for the first quarter of 2002. In an effort to align our product offerings with consumer needs and increase our marketshare, we launched The Neighborhood built by MCIsm in the second quarter of 2002. The Neighborhood is a new nationwide telecommunications business which unifies local and long 33 distance services. The Neighborhood is currently available in 32 states and is expected to eventually reach more than 50 million households. The brand's flagship offering, Neighborhood Complete, provides unlimited calling within the U.S., whether across the street or across the country. It also provides a complete suite of calling and messaging features from one company, on one bill for one fixed monthly price. We believe that The Neighborhood will attract incremental revenue from existing customers as well as new revenues from new customers. While this product is in its early marketing stages, we believe we will begin to see the benefits from The Neighborhood as early as the second half of 2002. Wholesale revenues for the first quarter of 2002 decreased 16.0% over the prior year period. The wholesale market continues to be extremely price competitive, although the average rate per minute has been relatively stable since the second quarter of 2001. Alternative channels and small business revenues for the three months ended March 31, 2002 decreased 24.5% over the prior year period. Alternative channels and small business includes sales agents and affiliates, wholesale alternative channels, small business, prepaid calling card and wireless messaging revenues. The decrease is attributed to pricing pressures in the wholesale alternative channels and small business markets which negatively affected revenue growth and gross margins in this area. Dial-up Internet revenues for the three months ended March 31, 2002 decreased 20.5% over the prior year amount. Our dial access network has grown 7.5% to approximately 3.2 million modems as of March 31, 2002, compared with the prior year period. However, Internet connect hours decreased 7.2% to 1.8 billion hours for the first quarter of 2002 versus the prior year period. The decrease in dial-up Internet revenues is attributed to pricing pressure resulting from the impact of volume discounts and off-net traffic, which lowered average revenue per hour by approximately 14% for the first quarter of 2002 versus the prior year period. LINE COSTS. For the three months ended March 31, 2001 and 2002, our line costs were as follows (dollars in millions):
2001 2002 -------------------- ---------------------- PERCENT PERCENT $ OF TOTAL $ OF TOTAL ------- ------- ------- -------- WorldCom group ........ $ 1,987 53.8% $ 2,020 58.1% MCI group ............. 1,826 49.4 1,571 45.1 Intergroup eliminations (117) (3.2) (112) (3.2) ------- ------- ------- ------- $ 3,696 100.0% $ 3,479 100.0% ======= ======= ======= =======
Line costs as a percentage of revenues for the first quarter of 2002 increased to 42.8% as compared to 41.9% for the first quarter of 2001. The increase as a percentage of revenues is a direct result of the pricing pressure in most of our business segments without adequate volume offsets. 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. 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 utilization of our networks, favorable contracts with carriers and network efficiencies. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three months ended March 31, 2001 and 2002, our selling, general and administrative expenses were as follows (dollars in millions): 34
2001 2002 ----------------------- ---------------------- PERCENT PERCENT $ OF TOTAL $ OF TOTAL ------- -------- ------- -------- WorldCom group ........ $ 1,349 51.9% $ 1,294 52.3% MCI group ............. 1,338 51.5 1,267 51.2 Intergroup eliminations (90) (3.4) (85) (3.5) ------- ------- ------- ------- $ 2,597 100.0% $ 2,476 100.0% ======= ======= ======= =======
Selling, general and administrative expenses for the first quarter of 2002 were $2.5 billion or 30.5% of revenues as compared to $2.6 billion or 29.4% of revenues for the prior year period. Selling, general and administrative expenses for the three months ended March 31, 2001 include pre-tax costs of $125 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions ($77 million allocated to the WorldCom group and $48 million allocated to the MCI group). Excluding these charges in 2001, selling, general and administrative expenses as a percentage of revenues would have been 28.0% for the first quarter of 2001. The increase in selling, general and administrative expenses as a percentage of revenues for the three months ended March 31, 2002 is primarily the result of increased selling, general and administrative expenses associated with our wireless resale unit. At the end of the first quarter of 2002 we initiated actions to reduce costs in reaction to the decline in revenues we experienced in the first quarter of 2002. These actions include our recently announced workforce reductions. We plan to continue to take steps to reduce our selling, general and administrative expenses in response to the pricing pressure on our products, which we believe should help to stabilize selling, general and administrative expense as a percentage of revenues during the second half of 2002. DEPRECIATION AND AMORTIZATION. For the three months ended March 31, 2001 and 2002, our depreciation and amortization expense was as follows (dollars in millions):
2001 2002 ----------------- ----------------- PERCENT PERCENT $ OF TOTAL $ OF TOTAL ------ ------ ------ ------ WorldCom group ........ $ 901 67.5 % $ 956 72.3 % MCI group ............. 227 17.0 169 12.8 Intergroup eliminations 207 15.5 197 14.9 ------ ------ ------ ------ $1,335 100.0% $1,322 100.0% ====== ====== ====== ======
Depreciation and amortization expense for the first quarter of 2002 decreased to $1.32 billion or 16.3% of revenues from $1.34 billion or 15.1% of revenues for the first quarter of 2001. Depreciation and amortization for the first quarter of 2002 reflects our discontinued amortization of intangible assets with indefinite useful lives, in accordance with SFAS No. 142. For the first quarter of 2001, depreciation and amortization expense was $1.01 billion excluding the amortization of indefinite-lived intangibles no longer amortized under SFAS No. 142. On a comparable basis, depreciation and amortization expense increased as a result of increased depreciation associated with 2000 and 2001 capital expenditures as well as increased depreciation associated with the assets acquired in our merger with Intermedia. INTEREST EXPENSE. Interest expense for the first quarter of 2002 was $447 million or 5.5% of revenues as compared to $305 million or 3.5% of revenues for the first quarter of 2001. For the three months ended March 31, 2001 and 2002, weighted-average annual interest rates on our long-term debt were 7.13% and 7.44%, respectively, while weighted-average levels of borrowings were $24.9 billion and $30.2 billion, respectively. Interest expense for the three months ended March 31, 2002 increased as a result of higher debt levels and $3.0 billion of debt obligations acquired in the Intermedia merger. Capitalized interest for the first quarter of 2002 was $102 million, versus $128 million in the prior year period. The decrease is a result of lower capital and construction expenditures. For 2002, we expect capitalized interest to continue to decline $10-$15 million each quarter. 35 MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous expense for the first quarter of 2002 was $156 million or 1.9% of revenues compared to miscellaneous income of $100 million or 1.1% of revenues for the first quarter of 2001. 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. Miscellaneous expense for the first quarter of 2002 includes pre-tax charges of $141 million associated with the disposition of investments, including the News Corporation sale. PROVISION FOR INCOME TAXES. The effective income tax rate of 35.8% of income before taxes for the first quarter of 2002 is less than the 38.5% effective income tax rate in the first quarter of 2001 primarily due to our discontinued amortization of goodwill in 2002. NET INCOME APPLICABLE TO COMMON SHAREHOLDERS. For the three months ended March 31, 2002, we reported net income applicable to common shareholders of $130 million as compared to $594 million for the three months ended March 31, 2001. ATTRIBUTION AND ALLOCATION OF ASSETS, LIABILITIES, REVENUES AND EXPENSES BETWEEN THE WORLDCOM GROUP AND THE MCI GROUP 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. These methods have been consistently applied for all periods presented. Additionally, our management believes that the cost allocations outlined below are equitable and provide a reasonable estimate of the costs attributable to each 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 March 31, 2002 are as follows:
WORLDCOM MCI GROUP GROUP WORLDCOM -------- -------- -------- (IN MILLIONS) Transmission equipment ...... $ 24,765 $ 454 $ 25,219 Communications equipment .... 5,082 2,513 7,595 Furniture, fixtures and other 11,489 682 12,171 Construction in progress .... 4,897 80 4,977 -------- -------- -------- 46,233 3,729 49,962 Accumulated depreciation .... (9,011) (1,796) (10,807) -------- -------- -------- $ 37,222 $ 1,933 $ 39,155 ======== ======== ========
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 line costs and related liabilities 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 have been attributed to the WorldCom group and the MCI group predominantly based on specific identification of network usage by that group. Where determinations based on specific usage alone were impractical, we used other allocation methods, including methods based on 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, we used other allocation methods that we believe are fair, including methods based on such factors as the number of employees and total line costs or revenues generated by each group. 36 ALLOCATION OF INTANGIBLE ASSETS. Intangible assets include 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. Prior to 2002, the MCI group was allocated an expense of $27.5 million per annum, and the WorldCom group was allocated a corresponding decrease in depreciation and amortization expense, for the use of the MCI tradenames. Beginning January 1, 2002, we stopped amortizing intangible assets with indefinite useful lives, including goodwill and tradenames, in accordance with SFAS No. 142. We therefore discontinued the allocation of this expense to the MCI group. Goodwill and other intangibles assigned or allocated to the WorldCom group and the MCI group as of March 31, 2002 are as follows:
WORLDCOM MCI GROUP GROUP WORLDCOM -------- -------- -------- Amortized intangible assets: Developed technology ...... $ 1,190 $ 510 $ 1,700 Other intangibles ......... 3,125 1,432 4,557 -------- -------- -------- 4,315 1,942 6,257 Accumulated amortization ..... (1,470) (615) (2,085) -------- -------- -------- $ 2,845 $ 1,327 $ 4,172 ======== ======== ======== Unamortized intangible assets: Goodwill .................. $ 36,654 $ 8,341 $ 44,995 Tradenames ................ 1,023 -- 1,023 Other ..................... 283 134 417 -------- -------- -------- $ 37,960 $ 8,475 $ 46,435 ======== ======== ========
FINANCING ARRANGEMENTS. As of January 1, 2001, $6.0 billion of our outstanding debt was notionally allocated to the MCI group and the remainder 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 was 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 are calculated on a quarterly basis. Debt allocated to the MCI group bears 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. Each group's allocated debt increases or decreases by the amount of any net cash generated by, or required to fund, the group's operating activities, investing activities, dividend payments, share repurchases and other financing activities. As of March 31, 2002, our receivables purchase program consisted of a $4.0 billion pool of receivables in which the purchaser had an undivided interest including $2.0 billion sold. The WorldCom group was allocated $2.7 billion of the pool and $1.7 billion of the sold receivables. The MCI group was allocated the balance. The receivables sold were assigned based on specific identification where practical, 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. 37 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:
2001 2002 -------------------- -------------------- Revenues ................................................ $ 5,203 100.0% $ 5,078 100.0% Line costs .............................................. 1,987 38.2 2,020 39.8 Selling, general and administrative ..................... 1,349 25.9 1,294 25.5 Depreciation and amortization ........................... 901 17.3 956 18.8 ------- ------- ------- ------- Operating income ........................................ 966 18.6 808 15.9 Other income (expense): Interest expense ................................... (179) (3.4) (327) (6.4) Miscellaneous ...................................... 100 1.9 (156) (3.1) ------- ------- ------- ------- Income before income taxes and minority interests ....... 887 17.0 325 6.4 Provision for income taxes .............................. 339 6.5 117 2.3 ------- ------- ------- ------- Income before minority interests ........................ 548 10.5 208 4.1 Minority interests ...................................... -- -- 18 0.4 Distributions on mandatorily redeemable preferred securities and other preferred dividend requirements 16 0.3 42 0.8 ------- ------- ------- ------- Net income .............................................. $ 532 10.2% $ 184 3.6% ======= ======= ======= =======
THREE MONTHS ENDED MARCH 31, 2001 VS. THREE MONTHS ENDED MARCH 31, 2002 REVENUES. Actual reported revenues by category for the three months ended March 31, 2001 and 2002 reflect the following changes by category (dollars in millions):
PERCENT 2001 2002 CHANGE --------- ---------- -------- COMMERCIAL SERVICES REVENUES Voice............................... $ 1,726 $ 1,518 (12.1) Data................................ 2,045 1,963 (4.0) International....................... 710 811 14.2 Internet............................ 722 786 8.9 -------- -------- $ 5,203 $ 5,078 (2.4) ======== ========
WorldCom group revenues for the first quarter of 2002 were $5.1 billion versus $5.2 billion for the first quarter of 2001. The decrease reflects the current economic conditions as well as continued overall price compression in the marketplace. Voice revenues for the first quarter of 2002 decreased 12.1% over the prior year period and traffic decreased 2.5%. Price compression for long distance business voice services drove this decline while wireless and local voice services reflected a modest increase of 4.0% to $482 million. Price compression on voice revenues is expected to continue for the near term, which will negatively affect revenue growth in this area. Data revenues for the first quarter of 2002 decreased 4.0% over the prior year period. The decrease was driven by customer data network reductions resulting from economic restraints which caused many companies to not only reduce their capital spending but to also reduce their network requirements or groom their network into more cost effective alternatives. While we continue to add new sales to our customer base, the customer downsizing noted above outpaced new sales in the first quarter of 2002. Data includes both commercial long distance and local dedicated bandwidth sales. International revenues for the first quarter of 2002 increased 14.2% to $811 million versus $710 million, for the first quarter of 2001. Geographically, Europe grew 18.3% and Asia Pacific and other areas grew 6.6% for the first quarter of 2002. These increases were partially offset by foreign currency fluctuations that had the effect of reducing revenues by approximately $22 million in the first quarter of 2002. Our international business continues to experience significant price pressure on its products as we continue to penetrate the retail markets and wholesale continues to represent a large portion of international revenues. 38 Internet revenues for the first quarter of 2002 increased 8.9% over the prior year period. The increase included $34 million of Digex revenues, after intercompany eliminations, as a result of our merger with Intermedia in July 2001. While less of an impact than data, customer network grooming on Internet networks partially offset new customer growth in the first quarter of 2002. Our Internet protocol virtual private network product, or IP-VPN, continued to show improvement during the first quarter of 2002. This new product has grown to approximately $120 million in annualized revenues. We have recently signed several large customer contracts for IP-VPN services and these customers, combined with overall market acceptance of this product, should continue to drive growth in this product. Despite this, IP-VPNs have not yet achieved a size or scale to overcome the attrition on our remote access product. Our legacy x.25 remote access product is supported by more mature technologies and our customers are migrating their services to more cost effective alternatives, such as IP-VPN. Excluding the revenues from the legacy x.25 product, Internet revenues grew 25%. 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 first quarter of 2002 increased to 39.8% as compared to 38.2% reported for the first quarter of 2001. The increase as a percentage of revenues is a direct result of the pricing pressure in the data, international and Internet markets without adequate volume offsets. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses for the first quarter of 2002 were $1.3 billion or 25.5% of revenues as compared to $1.3 billion or 25.9% of revenues for the prior year period. Selling, general and administrative expenses for the first quarter of 2001 include pre-tax costs of $77 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions. Excluding these charges in 2001, selling, general and administrative expenses as a percentage of revenues would have been 24.4% for the first quarter of 2001. The increase in selling, general and administrative expenses is primarily the result of increased selling, general and administrative expenses associated with our wireless resale unit. At the end of the first quarter of 2002 we initiated actions to reduce costs in reaction to the decline in revenues we experienced in the first quarter of 2002. These actions include our recently announced workforce reductions. We plan to continue to take steps to reduce our selling, general and administrative expenses in response to the pricing pressure on our products, which we believe should help to stabilize selling, general and administrative expense as a percentage of revenues during the second half of 2002. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the first quarter of 2002 increased to $956 million or 18.8% of revenues from $901 million or 17.3% of revenues for the prior year period. Depreciation and amortization for the first quarter of 2002 reflects the WorldCom group's discontinued amortization of intangible assets with indefinite useful lives, in accordance with SFAS No. 142. For the first quarter of 2001, depreciation and amortization expense was $650 million excluding the amortization of indefinite-lived intangibles no longer amortized under SFAS No. 142. On a comparable basis, depreciation and amortization expense increased as a result of additional depreciation associated with 2000 and 2001 capital expenditures and increased depreciation associated with the assets acquired in our merger with Intermedia. INTEREST EXPENSE. Interest expense for the first quarter of 2002 was $327 million or 6.4% of revenues as compared to $179 million or 3.4% of revenues for the first quarter of 2001. 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 is allocated interest based on the weighted-average interest rate, excluding capitalized interest, of WorldCom debt plus 1 1/4 percent. Capitalized interest for the first quarter of 2002 was $102 million, versus $128 million in the prior year period. The decrease is a result of lower capital and construction expenditures. For 2002, we expect capitalized interest to continue to decline $10-$15 million each quarter. MISCELLANEOUS INCOME AND EXPENSE. Miscellaneous expense for the first quarter of 2002 was $156 million, or 3.1% of revenues as compared to miscellaneous income of $100 million, or 1.9% of revenues for the first quarter of 2001. 39 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. Miscellaneous expense for the first quarter of 2002 includes pre-tax charges of $141 million associated with the disposition of investments, including the News Corporation sale. PROVISION FOR INCOME TAXES. The effective income tax rate of 36.0% of income before taxes for the first quarter of 2002 is less than the 38.2% effective income tax rate in the first quarter of 2001 primarily due to our discontinued amortization of goodwill in 2002. NET INCOME. For the three months ended March 31, 2002, the WorldCom group reported net income of $184 million as compared to $532 million for the three months ended March 31, 2001. Diluted income per WorldCom group share for the first quarter of 2002 was $0.06 compared to income per WorldCom group share of $0.18 for the first quarter of 2001. Diluted income per share for the 2001 period assumes the recapitalization occurred at the beginning of 2001 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:
THREE MONTHS ENDED MARCH 31, ------------------------------------------- 2001 2002 ------------------- ------------------- Revenues .......................... $ 3,622 100.0 % $ 3,042 100.0 % Line costs ........................ 1,826 50.4 1,571 51.6 Selling, general and administrative 1,338 36.9 1,267 41.7 Depreciation and amortization ..... 227 6.3 169 5.6 ------- ------ ------- ------ Operating income .................. 231 6.4 35 1.1 Other income (expense): Interest expense ............. (126) (3.5) (120) (3.9) ------- ------ ------- ------ Income (loss) before income taxes . 105 2.9 (85) (2.8) Income tax expense (benefit) ...... 43 1.2 (31) (1.0) ------- ------ ------- ------ Net income (loss) ................. $ 62 1.7% $ (54) (1.8)% ======= ====== ======= ======
THREE MONTHS ENDED MARCH 31, 2001 VS. THREE MONTHS ENDED MARCH 31, 2002 REVENUES. Revenues for the three months ended March 31, 2002 decreased 16.0% to $3.0 billion versus $3.6 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. Actual reported revenues by category for the three months ended March 31, 2001 and 2002 reflect the following changes by category (dollars in millions):
PERCENT 2001 2002 CHANGE ------ ------ ------- Consumer .............................. $1,807 $1,595 (11.7) Wholesale ............................. 695 584 (16.0) Alternative channels and small business 695 525 (24.5) Dial-up Internet ...................... 425 338 (20.5) ------ ------ TOTAL ................................. $3,622 $3,042 (16.0) ====== ======
Consumer revenues for the first quarter of 2002 decreased 11.7% 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' continued substitution of wire line services with wireless and e-mail. Our consumer local initiatives continue to perform well as consumer local revenues increased over 108% for the first quarter of 2002. In an effort to align our product offerings with consumer needs and increase our market share, we launched The Neighborhood built by MCIsm in the second quarter of 2002. The Neighborhood is a new nationwide telecommunications business which unifies local and long distance services. The Neighborhood is currently available in 32 states and is expected to eventually reach more than 50 40 million households. The brand's flagship offering, Neighborhood Complete, provides unlimited calling within the U.S., whether across the street or across the country. It also provides a complete suite of calling and messaging features from one company, on one bill for one fixed monthly price. We believe that The Neighborhood will attract incremental revenue from existing customers as well as new revenues from new customers. While this product is in its early marketing stages, we believe we will begin to see the benefits from The Neighborhood as early as the second half of 2002. Wholesale revenues for the first quarter of 2002 decreased 16.0% over the prior year period. The wholesale market continues to be extremely price competitive, although the average rate per minute has been relatively stable since the second quarter of 2001. Alternative channels and small business revenues for the three months ended March 31, 2002 decreased 24.5% over the prior year period. Alternative channels and small business includes sales agents and affiliates, wholesale alternative channels, small business, prepaid calling card and wireless messaging revenues. The decrease is attributed to pricing pressures in the wholesale alternative channels and small business markets which negatively affected revenue growth and gross margins in this area. Dial-up Internet revenues for the three months ended March 31, 2002 decreased 20.5% over the prior year amount. Our dial access network has grown 7.5% to approximately 3.2 million modems as of March 31, 2002, compared with the prior year period. However, Internet connect hours decreased 7.2% to 1.8 billion hours for the first quarter of 2002 versus the prior year period. The decrease in dial-up Internet revenues is attributed to pricing pressure resulting from the impact of volume discounts and off-net traffic, which lowered average revenue per hour by approximately 14% for the first quarter of 2002 versus the prior year period. LINE COSTS. Line costs as a percentage of revenues for the first quarter of 2002 increased to 51.6% as compared to 50.4% reported for the prior year period. This increase resulted from the continued competitive pricing on the dial-up Internet business and 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 first quarter of 2002 were $1.27 billion or 41.7% of revenues as compared to $1.34 billion or 36.9% of revenues for the prior year period. Selling, general and administrative expenses for the first quarter of 2001 include $48 million associated with domestic severance packages and other costs related to our February 2001 workforce reductions. Excluding this, selling, general and administrative expenses as a percentage of revenues were 35.6% for the first quarter of 2001. The increase in selling, general and administrative expenses as a percentage of revenues can be attributed to the pricing pressure on our products as noted above. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for the first quarter of 2002 decreased to $169 million or 5.6% of revenues from $227 million or 6.3% of revenues for the same period in the prior year. Depreciation and amortization for the first quarter of 2002 reflects the MCI group's discontinued amortization of intangible assets with indefinite useful lives, in accordance with SFAS No. 142. For the first quarter of 2001, depreciation and amortization expense was $154 million excluding the amortization of indefinite-lived intangibles no longer amortized under SFAS No. 142. On a comparable basis, depreciation and amortization expense increased as a result of additional depreciation associated with 2000 and 2001 capital expenditures. INTEREST EXPENSE. Interest expense for the first quarter of 2002 was $120 million or 3.9% of revenues as compared to $126 million or 3.5% of revenues for the same period in 2001. Interest expense on borrowings incurred by WorldCom and allocated to the MCI group is based on the weighted-average interest rate, excluding capitalized interest, of WorldCom debt plus 1 1/4 percent. As of January 1, 2001, $6.0 billion of WorldCom's outstanding debt was notionally allocated to the MCI group. INCOME TAX EXPENSE (BENEFIT). The effective income tax rate of 36.5% of loss before taxes for the first quarter of 2002 is less than the 41.0% effective income tax rate in the first quarter of 2001 primarily due to our discontinued amortization of goodwill in 2002. 41 NET INCOME. For the three months ended March 31, 2002, the MCI group reported net loss of $54 million as compared to net income of $62 million for the three months ended March 31, 2001. Diluted loss per MCI group share for the first quarter of 2002 was $0.46 compared to diluted income per MCI group share of $0.54 for the first quarter of 2001. Diluted income per share assumes the recapitalization occurred at the beginning of 2001 and that the WorldCom group stock and MCI group stock existed for all periods presented. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2002, our total debt was $30.2 billion and we had available liquidity of $10.2 billion under our credit facilities, which are described in our Annual Report on Form 10-K for the year ended December 31, 2001, and from available cash. As of January 1, 2001, 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 first quarter of 2002, the MCI group generated sufficient cash to pay $71 million for dividends on MCI group stock and to repay $9 million of its allocated notional debt. As of March 31, 2002, we had no amounts drawn against our credit facilities which include the following: o $1.6 billion revolving credit facility that expires June 8, 2006; o $2.65 billion 364-day revolving credit facility that expires June 7, 2002 with a one-year conversion feature; and o $3.75 billion revolving credit facility that expires June 30, 2002. We intend to replace our $2.65 billion 364-day revolving credit facility and we do not intend to renew the $3.75 billion revolving credit facility. Additionally, we are working with our banking group to increase the size of our facilities in exchange for security. These negotiations, if successfully completed, will result in $5.0 billion or more of availability under credit facilities which would mature between 2005 - 2006. We remain on schedule in these negotiations and expect to complete the process over the next few weeks. It is anticipated that in the interim, we will draw against the $2.65 billion revolving credit facility in order to preserve the one-year conversion feature on the facility. However, it is intended that the amounts drawn under the $2.65 billion revolving credit facility will be repaid upon completion of the new credit facility agreements. Our senior debt is currently rated as follows:
Rating Agency Rating Outlook ------------------------------------------------------------------- Moody's Investors Service Ba2 negative Standard & Poor's BB negative Fitch Ratings BB negative
These ratings, or any further downgrade in rating, have not and will not trigger any defauls on our outstanding bond debt or our undrawn credit facilities, although our interest rates and our annual commitment fee under our credit facilities are sensitive to ratings adjustments. On May 9, 2002, we obtained a waiver on our existing $2.0 billion receivables purchase program, which eliminates any concerns regarding the effect of credit ratings on this program during the period covered by the waiver. Additionally, we are in the process of negotiating the replacement of our current receivables purchase program with a new $1.5 billion facility that does not contain any ratings triggers. We expect the new program will be in place by May 23, 2002, when the current waiver expires on our existing $2.0 billion receivables purchase program. We expect the funds used to reduce the receivables purchase program down to a $1.5 billion facility will be obtained from a combination of cash and availability under our credit facilities. 42 In February 2002, we liquidated our remaining investment in News Corporation and received cash proceeds of $870 million, net of $60 million for sales discounts and banking fees. Additionally, on April 15, 2002, we elected to redeem our $700 million 6.125% senior notes due 2012. Cash balances were used to repay this obligation. OPERATING ACTIVITIES For the three months ended March 31, 2001 and 2002, our cash flows from operations were as follows (dollars in millions):
2001 2002 ------ ------ WorldCom group ............................... $1,215 $1,592 MCI group .................................... 360 209 ------ ------ Net cash provided by operating activities $1,575 $1,801 ====== ======
The increase for the three months ended March 31, 2002 versus the prior year amount reflects an improved working capital position, which was partially offset by lower operating results in both the WorldCom group and the MCI group. INVESTING ACTIVITIES For the three months ended March 31, 2001 and 2002, our net cash used in investing activities was as follows (dollars in millions):
2001 2002 ------- ------- WorldCom group ........................... $(2,558) $ (716) MCI group ................................ (396) (133) ------- ------- Net cash used in investing activities $(2,954) $ (849) ======= =======
The WorldCom group's capital expenditures totaled $2.1 billion in the first three months of 2001 and $1.3 billion in the first three months of 2002. Primary capital expenditures include purchases of transmission, communications and other equipment. The MCI group's capital expenditures totaled $95 million in the first three months of 2001 and $30 million in the first three months of 2002. The MCI group's capital expenditures include purchases of switching equipment, dial modems and messaging and other equipment. Investing activities include intangible asset increases at the WorldCom group of $106 million for the first quarter of 2001 and $116 million for the first quarter of 2002, and at the MCI group of $118 million for the first quarter of 2001 and $60 million for the first quarter of 2002. Intangible asset additions primarily represent costs incurred to develop software for internal use. Investing activities include acquisitions and related costs at the WorldCom group of $142 million and $2 million in the first three months of 2001 and 2002, respectively. FINANCING ACTIVITIES For the three months ended March 31, 2001 and 2002, cash provided by (used in) financing activities was as follows (dollars in millions):
2001 2002 ------ ------ WorldCom group ......................................... $1,311 $ (23) MCI group .............................................. 15 (80) ------ ------ Net cash provided by (used in) financing activities $1,326 $ (103) ====== ======
Financing activities include net repayments on debt of $22 million for the first three months of 2002 and net proceeds from borrowings on debt of $1.3 billion for the first three months of 2001. Financing activities for the MCI group reflect the payment of dividends to MCI group shareholders and repayment of notionally allocated debt from WorldCom. 43 Also included in financing activities are proceeds from WorldCom's common stock issuances of $71 million and $14 million in the first three months of 2001 and 2002, respectively, as a result of WorldCom common stock option and warrant exercises. Distributions on mandatorily redeemable preferred securities and dividends paid on preferred stock in the first three months of 2001 and 2002 were $16 million and $24 million, respectively. The increase represents dividends associated with our Series D, E and F preferred stock which was issued in connection with the Intermedia merger. Dividends on the Series D, E and F preferred stock are payable in cash or shares of our common stock, at our election. To date, we have paid these dividends in cash, however, we expect that future dividends on the Series D, E and F preferred stock will be paid in shares of our common stock. During the first quarter of 2002, we paid a cash dividend of $0.60 per share of MCI group common stock, or $71 million in the aggregate. Additionally, the dividends payable during the second and third quarters of 2002 have already been declared and/or paid. We anticipate that 2002 capital expenditures for the WorldCom group will be up to $4.5 billion and will be approximately $400 million (including software development) at the MCI group. Additionally, we believe that free cash flow (cash flow from operations less cash flow used in investing activities) will approximate $1.0 billion in 2002 and will increase each subsequent year by more than $250 million through at least 2004. Currently, scheduled debt maturities are $60 million for the remainder of 2002, after our redemption of $700 million of remarketable notes on April 15, 2002, $1.6 billion in 2003, $2.5 billion in 2004 and $2.3 billion in 2005. Additionally, we have $1.0 billion in dealer remarketable securities which are subject to mandatory tender in January 2003, and we have $500 million of bonds with a stated 2027 maturity which have a put feature for June 2003. We believe that the free cash flow noted above in addition to available cash and availability under our credit facilities will be more than sufficient to meet our debt and capital requirements beyond the next twelve months. CRITICAL ACCOUNTING POLICIES Our significant accounting policies are described in Note 1 to the consolidated and combined financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2001. We believe some of our most critical accounting policies include: o estimating valuation allowances and accrued liabilities associated with revenue reserves and provisions for uncollectible accounts and pending litigation and regulatory matters; o accounting for income taxes; o goodwill and intangibles; o valuation of long-lived and intangible assets, and goodwill; o estimating depreciation and amortization associated with long-lived assets; and o allocation policies between the WorldCom group and the MCI group. ESTIMATING VALUATION ALLOWANCES AND ACCRUED LIABILITIES. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities as well as the reported amounts of revenues and expenses for the periods presented. Specifically, our management must make estimates of future customer credits through the analysis of historical trends and known events. Significant management judgments and estimates must be made and used in connection with establishing the revenue reserves associated with discounts earned on special customer agreements, billing reserves for pricing changes and customer disputes. Material differences may result in the amount and timing of our revenue adjustments if management projections differ from actual results. Similarly, our management must make estimates regarding the collectibility of our accounts receivable. Management specifically analyzes accounts receivable including historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of 44 the allowance for doubtful accounts. As of March 31, 2002, our accounts receivable balance was $5.0 billion, net of allowance for doubtful accounts of $1.2 billion. We have recorded accruals for loss contingencies in our consolidated financial statements associated with legal and regulatory proceedings that are incidental to our business. Such accruals are based on our management's estimate of the projected liability and range of loss in accordance with applicable accounting guidance. Because of the uncertainties related to both the amount and range of loss on the remaining pending matters, management is unable to make a reasonable estimate of the ultimate liability related to an unfavorable outcome. As additional information becomes available, we will assess the potential liability related to our pending matters and revise our estimates. The results of these various legal and regulatory matters are uncertain and could have a material adverse affect on our consolidated results of operations or financial position. ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves our estimating actual current tax exposure for WorldCom together with assessing temporary differences resulting from differing treatment of items, such as property, plant and equipment depreciation, for tax and accounting purposes. Actual income taxes could vary from these estimates due to future changes in income tax law or results from final tax exam reviews. GOODWILL AND INTANGIBLES. Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market value of the assets and liabilities purchased. In our recording of acquisitions, we allocate the purchase price among certain identifiable intangible assets and goodwill based on third party appraisals. VALUATION OF LONG-LIVED ASSETS, GOODWILL AND INTANGIBLES. We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following: o significant underperformance relative to expected historical or projected future operating results; o significant changes in the use of our assets or the strategy for our overall business; o significant negative industry or economic trends; o significant decline in our stock price for a sustained period; and o our market capitalization relative to net book value. We determine any impairment by comparing the undiscounted future cash flows estimated to be generated by those assets to their respective carrying amounts. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset or group of assets. If quoted market prices for an asset are not available, fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on property and equipment to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose. As discussed below, SFAS No. 142, became effective on January 1, 2002 and as a result, we stopped amortizing approximately $45.0 billion of net goodwill and $1.0 billion of net tradenames. Based on our current levels of such assets, this will reduce amortization by approximately $1.3 billion annually. In lieu of amortization, we are required to perform an initial impairment review of our goodwill and tradenames in 2002 and an annual impairment review thereafter. We expect to complete our initial impairment review in the second quarter of 2002. We currently estimate that we will record an impairment charge upon completion of the initial impairment review of approximately $15 to $20 billion. 45 DEPRECIATION AND AMORTIZATION OF LONG-LIVED ASSETS. We assign useful lives for long-lived assets based on periodic studies of actual asset lives and our intended use for those assets. Any change in these asset lives would be reported in our statement of operations as soon as any change in estimate is determined. There have been no material changes in asset lives during the periods presented. ALLOCATION POLICIES BETWEEN THE WORLDCOM GROUP AND THE MCI GROUP. The financial information for the WorldCom group and the MCI group reflect the performance of the businesses attributed to each group and includes the attribution and allocation of our assets, liabilities, revenues and expenses between the WorldCom group and the MCI group in accordance with our tracking stock policy. Our management believes that the attribution and allocation methods used are equitable and provide a reasonable estimate of the costs attributable to each group. However, it is not practical to determine whether the allocated amounts represent amounts that would have been incurred on a stand-alone basis. Our board of directors or any special committee appointed by our board of directors may, without shareholder approval, change the policies set forth in our tracking stock policy statement and may adopt additional policies or make exceptions with respect to the application of the policies described in our policy statement in connection with particular facts and circumstances, all as they may determine to be in the best interests of WorldCom. 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. These policies are discussed in this management's discussion and analysis of financial condition and results of operations. RELATED PARTY TRANSACTIONS The information regarding related party transactions is included in Part II, Item 5, below, which is hereby incorporated by reference herein. 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 are 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 are no longer amortized but are subject to annual impairment tests. The statement includes provisions for the identification of reporting units for purposes of assessing potential future impairments of goodwill. Upon adoption, we stopped amortizing intangible assets with indefinite useful lives, including goodwill and tradenames. Based on current levels of such assets, this will 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 intangible 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. Based on our preliminary analyses, we estimate that as a result of the adoption of SFAS No. 142 we will reduce goodwill by $15 to $20 billion. 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 supersedes both SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and 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. 46 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to the impact of foreign currency fluctuations and changes in market values of our investments. We 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 our international operation's holding of approximately $512 million in U.S. dollar denominated debt, and our holding of approximately $1.8 billion of indebtedness indexed in other foreign currencies including the Euro and Sterling Pound as of March 31, 2002. Our potential immediate loss that would result from a hypothetical 10% change in foreign currency exchange rates based on this position would be approximately $205 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. 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 March 31, 2002, 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 for the year ended December 31, 2001, except as reflected in the discussion under Note F 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 We have entered into certain loan and guaranty arrangements involving Bernard J. Ebbers, principally relating to certain obligations to financial institutions secured by Mr. Ebbers' stock in WorldCom. We initially established these arrangements in 2000, and have agreed to a series of modifications since January 1, 2001. On April 29, 2002, in connection with Mr. Ebbers' resignation as President, Chief Executive Officer and Director of WorldCom, we consolidated these various loan and guaranty arrangements into a single promissory note in the principal amount of approximately $408.2 million, repayable with accrued interest over five years. This principal amount includes approximately $198.7 million that we have paid to Bank of America, N.A., or Bank of America, as repayment of outstanding indebtedness of Mr. Ebbers or certain companies controlled by him which we had guaranteed, approximately $36.5 million that we have deposited to collateralize a letter of credit used to support financing to an unrelated third party, 47 approximately $165 million that we have loaned to Mr. Ebbers and all interest accrued on the foregoing amounts to April 29, 2002. These transactions are further described below. Since establishing these arrangements, we agreed to guarantee $150 million principal amount of indebtedness owed by Mr. Ebbers to Bank of America, as well as certain additional payments and related costs. The additional payments included, among other things, amounts payable to Bank of America by Mr. Ebbers or certain companies controlled by him relating to an approximately $45.6 million letter of credit secured by a portion of Mr. Ebbers' stock and used to support financing to an unrelated third party; specified amounts, including margin debt, that became payable following stock price declines; and amounts subject to a margin call with respect to certain margin debt. The scheduled maturity of the Bank of America margin debt was extended in January 2002 for a period of up to two years. However, following declines in the closing price of the WorldCom group stock through early February 2002, we made aggregate payments of approximately $198.7 million to repay all of the outstanding debt covered by our guaranty and deposited with Bank of America approximately $36.5 million to collateralize the letter of credit, which is scheduled to expire on February 15, 2003, subject to renewal, extension or substitution. Our payments, together with any amounts paid or costs incurred by us in connection with the letter of credit, plus accrued interest at a floating rate equal to that under one of our credit facilities, were payable by Mr. Ebbers to us, as modified in early April 2002, within 90 days after demand, or within 180 days after demand if subsequent to his death or incapacity. In addition to the guaranty arrangements, during 2000 we loaned $100 million to Mr. Ebbers. Since January 1, 2001, we have loaned him approximately an additional $65 million, for a total maximum principal amount of approximately $165 million. These loans bore interest at floating rates equal to that under certain of our credit facilities and, as modified in early April 2002, were payable within 90 days after demand, or within 180 days after demand if subsequent to Mr. Ebbers' death or incapacity. As noted above, on April 29, 2002, Mr. Ebbers' obligations to WorldCom under these loans and guaranty arrangements were consolidated into a single promissory note, which replaced the former notes. As of May 14, 2002, the aggregate principal amount of indebtedness owed by Mr. Ebbers to us under this note was approximately $408.2 million, which constitutes the largest aggregate amount of indebtedness outstanding since January 1, 2001. The principal amount is subject to payment over five years on the following schedule: $25 million on April 29, 2003, $25 million on April 29, 2004, $75 million on April 29, 2005, $100 million on April 29, 2006, and all remaining principal on April 29, 2007. Mr. Ebbers is also obligated to pay interest on the outstanding balance, compounded monthly, on each repayment date at a fluctuating interest rate equal to that under one of our credit facilities, which was 2.32% per annum as of April 29, 2002. All principal and accrued interest under this note are immediately due and payable (1) upon the death of Mr. Ebbers, or (2) upon demand in the case of certain events of default, or (3) automatically without notice in the case of certain events of bankruptcy by or against Mr. Ebbers. We have been advised that Mr. Ebbers has used the proceeds of the loans from us principally to repay certain indebtedness under loans secured by shares of our stock owned by him and that the proceeds of such secured loans were used for private business purposes. The loans and guaranty arrangements by us were made following a determination that they were in the best interests of WorldCom and our shareholders in order to avoid additional forced sales of Mr. Ebbers' stock in WorldCom. The determination was made by our compensation and stock option committee as a result of the pressure on our stock price, margin calls faced by Mr. Ebbers and other considerations. Such actions by our compensation and stock option committee were ratified and approved by our board of directors. In connection with the transactions described above and, as to a portion of the shares, subject to certain limitations and effective upon termination of restrictions under existing lending agreements, Mr. Ebbers pledged to us the shares of our stock currently owned by him or later acquired upon option exercise with respect to his obligations under the loans and guaranty arrangements from us. This pledge has been perfected as to 9,287,277 shares of WorldCom group stock and 575,149 shares of MCI group stock. The pledge of the remaining shares of WorldCom and MCI group stock owned by Mr. Ebbers will 48 take effect as and to the extent the limitations and restrictions under existing lending arrangements terminate. Following recent margin sales in respect of his shares, Mr. Ebbers' remaining holdings consist of an additional 5,091,483 shares of WorldCom group stock and no shares of MCI group stock. In addition, Mr. Ebbers has pledged to us security interests in certain equity interests in privately held businesses owned by him. Mr. Ebbers also agreed to indemnify us for any amounts expended or losses, damages, costs, claims or expenses incurred under the guaranty arrangements or the loans from us. Mr. Ebbers has also entered into a separation agreement with us as of April 29, 2002, which provides that he resigned from all directorships, offices and positions with us, and that he would be appointed to serve our board of directors as non-executive CHAIRMAN EMERITUS at the pleasure of the board. The agreement further provides that Mr. Ebbers will remain available for a period of five years to provide consulting services to us from time to time. The agreement also provides that we will pay an annual pension of $1.5 million to Mr. Ebbers for the remainder of his life, and an annual pension benefit of $750,000 to his current spouse for the remainder of her life, should she survive him, as well as continued medical and life insurance benefits for Mr. Ebbers' lifetime at our expense, limited use of our aircraft and the right to lease office space from us. The agreement further provides that all of Mr. Ebbers' outstanding options to purchase WorldCom group stock or MCI group stock became fully vested and exercisable as of April 29, 2002, and will generally remain exercisable for a period of five years following that date (or, if earlier, the expiration of the original term). As of that date, Mr. Ebbers held unvested options to acquire 1,788,627 shares of WorldCom group stock at a weighted-average exercise price of $30.90 per share and vested options to acquire 9,510,678 shares of WorldCom group stock at a weighted- average exercise price of $21.25 per share. Mr. Ebbers does not hold any outstanding options to acquire MCI group stock. Under the agreement, Mr. Ebbers also is subject to a number of restrictive covenants, including a five-year non-competition covenant in favor of us and our affiliates. Mr. Ebbers and we also agreed to a mutual release of actual or potential claims, subject to certain exceptions. Finally, in the event of any breach of the agreement or default by Mr. Ebbers in any of his obligations under the promissory note and related arrangements or the filing of bankruptcy by him, the payment of pension benefits described above will be permanently discontinued and all outstanding amounts due to us by him will be accelerated as provided in the promissory note. Effective with Mr. Ebbers' resignation, John W. Sidgmore, previously Vice Chairman of WorldCom, was appointed President and CEO of WorldCom and Bert C. Roberts has remained Chairman of our board of directors. Additionally, Scott D. Sullivan has been made Executive Vice President and Chief Financial Officer, and Ronald R. Beaumont has been made Chief Operating Officer of WorldCom, overseeing operations for both the WorldCom group and the MCI group. Item 6. Exhibits and Reports on Form 8-K A. Exhibits See Exhibit Index. B. Reports on Form 8-K Pursuant to Item 5, "Other Events," we filed two Current Reports on Form 8-K dated February 7, 2002 (filed February 7, 2002) and one Current Report on Form 8-K dated March 7, 2002 (filed March 13, 2002). 49 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: May 15, 2002 50 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 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 (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 Rights Agreement between WorldCom and The Bank of New York, as Rights Agent, dated as of March 7, 2002 (incorporated herein by reference to Exhibit 1 to WorldCom's Form 8-A dated March 13, 2002 (File No. 0-11258)) 10.1 Letter Agreement made as of April 2, 2002, between Bernard J. Ebbers ("Borrower") and WorldCom, amending, restating and confirming the understandings contained in the Letter Agreement dated November 1, 2000 10.2 Pledge and Security Agreement dated April 18, 2002 by Borrower in favor of WorldCom 10.3 Promissory note dated April 29, 2002 payable by Borrower to WorldCom 10.4 Letter Agreement made as of April 29, 2002 between Borrower and WorldCom 10.5 Separation Agreement between WorldCom and Borrower, dated April 29, 2002 10.6 Mutual Release by and between Borrower and WorldCom dated as of April 29, 2002 51 EX-10.1 3 a2079976zex-10_1.txt EXHIBIT 10.1 Exhibit 10.1 [WORLDCOM LOGO] April 2, 2002 Bernard J. Ebbers 500 Clinton Center Drive Clinton, MS 39056 Dear Bernie: This letter (the "Agreement") shall serve to amend, restate and confirm the understandings contained in our November 1, 2000 letter agreement. WorldCom, Inc. (the "Company") and you have entered into various contractual arrangements respecting certain of your obligations that are, or have been, secured by shares of the Company, to wit: (i) Limited Guaranty dated as of November 14, 2000 executed by the Company for the benefit of Bank of America, N.A. (the "Prior Guaranty"); (ii) Limited Guaranty dated as of February 12, 2001 executed by the Company for the benefit of Bank of America, N.A., as modified by that certain First Modification and Reaffirmation of Limited Guaranty, dated as of January 25, 2002, replacing the Prior Guaranty (items (i) and (ii), together with any amendments, modifications, supplements or replacements thereof, are sometimes collectively referred to herein as the "Guaranty"); (iii) Promissory Note dated as of September 8, 2000 in the maximum principal amount of $25 million made by you payable to the order of the Company; (iv) Promissory Note dated as of November 1, 2000 in the maximum principal amount of $25 million made by you payable to the order of the Company; (v) Promissory Note dated as of December 29, 2000 in the maximum principal amount of $50 million made by you payable to the order of the Company; (vi) Promissory Note dated as of September 10, 2001 made by you payable to the order of the Company relating to the Guaranty; and (vii) Promissory Note dated as of January 30, 2002 in the maximum principal amount of $65 million made by you payable to the order of the Company (items (iii) through (vii), together with any amendments, modifications, supplements, or replacements thereof, are sometimes hereinafter collectively referred to as the "Promissory Notes"). 1. INDEMNITY. You shall indemnify, reimburse and hold harmless the Company for any amounts expended, losses, damages, costs, claims or expenses (including, but not limited to, court costs and attorneys' fees) under or arising out of the Guaranty, this Agreement or the Promissory Notes. 2. PLEDGE. (a) To secure the prompt payment and full performance of all obligations owing by you to the Company (the "Liabilities"), whether direct, contingent, fixed or otherwise, now or from time to time hereafter arising, with respect to this Agreement, the Promissory Notes and the Bernard J. Ebbers April 2, 2002 Page 2 Guaranty, you have granted and/or hereby grant to the Company a security interest in and to, and pledge and assign to the Company, under Articles 8 and 9 of the Uniform Commercial Code as currently effective in the State of Mississippi, all of your right, title, share and interest in the shares of stock of the Company now owned by you (except for the stock of the Company currently the subject of pledges for the benefit of Citibank, N.A. and Bank of America, N.A., respectively, pursuant to agreements in effect on November 1, 2000, or any renewals, replacements, amendments, modifications, or extensions thereof, hereinafter, the "Existing Pledges"), or hereafter acquired by you pursuant to the exercise of stock options, together with all proceeds thereof and amounts or other securities or property derived therefrom, and, upon the release of the Existing Pledges, you shall be deemed to have granted to the Company a security interest under Articles 8 and 9 of the Uniform Commercial Code as currently effective in the State of Mississippi in such additional shares of stock in the Company as were the subject of the Existing Pledges (all of the shares referenced above are sometimes hereinafter collectively referred to as the "Collateral"). You agree to keep the Collateral free from any lien, security interest or encumbrance other than those in favor of the Company, or arising out of the Existing Pledges, or as to which the Company consents in writing. (b) Upon demand by the Company pursuant to any one or more of the Promissory Notes (which shall be subject to a majority vote of the Board of Directors of the Company) or upon the breach by you of any of the terms of this Agreement or any of the Promissory Notes, the Company may exercise the rights and pursue the remedies provided under Article 9 of the Uniform Commercial Code as currently effective in, or as hereafter amended by, the State of Mississippi, including but not limited to exercising all voting rights with respect to the Collateral, collecting all dividends and other distributions with respect to the Collateral, and selling the Collateral at any public or private sale, at the Company's option, without advertisement; provided, however, that upon any such demand, you shall have 90 days from the date thereof to make payment; provided, further, that if such demand is made subsequent to your death or incapacity, your estate shall have 180 days from the date thereof to make payment; in either such case, interest shall continue to accrue at the "Normal Rate" as provided in the Promissory Notes until such payment is due and, until such payment is due, the Company shall refrain from exercising the aforementioned rights and remedies. The Company may bid and become a purchaser at any such sale, and upon any such sale the Company shall collect, receive, and hold and apply the proceeds as provided herein. If notice of intended disposition is required by law, such notice, if mailed, shall be deemed reasonably and properly given if mailed to your address appearing on the records of the Company at least five days before the time of such disposition. The proceeds from any such sale or action shall be applied first to the payment of all legal and other costs and expenses incurred in connection with the sale or action and next to the payment of the Liabilities, as determined by the Company. The balance, if any, of such proceeds remaining after such application shall be paid to you. If the proceeds of any such sale or action are insufficient to pay in full the amounts specified above, you shall remain liable for such deficiency. 3. PERFECTION. To perfect the Company's security interest in the Collateral, (a) you hereby irrevocably authorize the Company at any time and from time to time to file in any appropriate jurisdiction any UCC financing statements or amendments thereto, and (b) you are delivering to the Company certain of the Collateral, together with irrevocable stock powers endorsed in blank. You, from time to time hereafter, shall deliver to the Company any additional Collateral that comes within your possession or control, together with irrevocable stock powers endorsed in blank. 4. ADDITIONAL SECURITY. You represent and warrant to the Company that your personal financial statement dated December 31, 2001 (the "Statement") provided to the Company is complete and Bernard J. Ebbers April 2, 2002 Page 3 accurate in all material respects and, except as noted on the Statement, all of the assets listed thereon are owned by you individually, free and clear of any liens, security interests or other encumbrances, except for statutory liens securing immaterial amounts arising in the ordinary course of business. On or within 10 days of the date hereof, you agree to provide such information with respect to your interests in Joshua Holdings LLC, BC Yacht Sales Inc., Savannah Yacht & Ship LLC, BCT Real Estate LLC, Douglas Lake Land & Timber Company LLP and Douglas Lake Properties, Inc., together with any related or subsidiary entities (the "Additional Assets"), and as the Company reasonably may request from time to time, including without limitation: (i) Outstanding debt and liability information with respect to each Additional Asset; (ii) Existing appraisal information, evaluations and title reports with respect to each Additional Asset; and (iii) Historical operating statements for each Additional Asset. Except for liens in existence as of the date hereof, until the Liabilities have been paid in full, you will not sell, assign, transfer, pledge or encumber in any other matter any of the Additional Assets without the prior written consent of the Company. On or within 10 days of the date hereof, you shall pledge to the Company (and shall cause the pledge by related minority investors) of a security or mortgage interest in each of the Additional Assets. In the event that the value of the Collateral or the Additional Assets should materially increase in the aggregate during the term of this Agreement, the Company will take reasonable steps to release that portion of the Collateral and/or Additional Assets that is no longer necessary to sufficiently collateralize the Liabilities. 5. FURTHER ASSURANCES. You agree to perform all acts and do all things which the Company may request, now or hereafter, in order to evidence, preserve or protect its rights and the creation, attachment or perfection of the security interests granted or to be granted hereunder including, without limitation, execution and delivery of one or more promissory notes evidencing your obligations arising out of any advance under the Guaranty and delivery of stock certificate(s) with appropriate stock powers in order to perfect the Company's security interest in the Collateral or the Additional Assets. 6. MISCELLANEOUS. This Agreement 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 you hereby consent to the jurisdiction of the courts of or in the State of Mississippi in connection with any dispute, controversy, action or other matter relating to or arising out of this Agreement. Whenever possible each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement 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 Agreement. This Agreement shall be binding upon you and your heirs and legal representatives and shall inure to the benefit of the Company and its successors and assigns. The powers, rights, and remedies of the Company under this Agreement are cumulative and are not exclusive of any other power, right or remedy that the Company otherwise may have. Any single or partial exercise or pursuit of any power, right or remedy under this Agreement by the Company shall not preclude other or further exercise or pursuit thereof or the exercise or pursuit of any other power, right or remedy. The Company's rights and remedies under this Agreement shall be unaffected by any change in the provisions of Bernard J. Ebbers April 2, 2002 Page 4 any agreement, instrument, or document evidencing or affecting any of the Liabilities, by any extension of time for payment or performance of any of the Liabilities or by any partial or full release of any security for payment or performance of any of the Liabilities. No delay by the Company in exercising or pursuing any power, right or remedy under this Agreement shall operate as a waiver thereof, and no failure by the Company to exercise or pursue any power, right or remedy shall prevent the Company from exercising the same in the future. WorldCom, Inc. By: WorldCom, Inc. Compensation and Stock Option Committee By: /s/ Stiles A. Kellett, Jr. ------------------------------------ Stiles A. Kellett, Jr., Chairman Acknowledged and agreed as of the date first above written. /s/ Bernard J. Ebbers --------------------------------------- Bernard J. Ebbers EX-10.2 4 a2079976zex-10_2.txt EXHIBIT 10.2 Exhibit 10.2 PLEDGE AND SECURITY AGREEMENT THIS PLEDGE AND SECURITY AGREEMENT (this "Agreement"), is executed and delivered as of the 18th day of April, 2002, by Bernard J. Ebbers ("Debtor"), in favor of WorldCom, Inc. ("Lender"). RECITALS A. Debtor is the owner of the issued and outstanding shares of common stock or membership interests of those companies (collectively, the "Additional Assets") described as issuers on SCHEDULE A attached hereto and incorporated herein by this reference; and B. Debtor has agreed to execute and deliver this Agreement pursuant to the letter agreement dated April 2, 2002 between Debtor and Lender (the "Letter Agreement"), and Lender has agreed to extend credit to and make certain financial accommodations on behalf of Debtor in reliance on this Agreement. NOW, THEREFORE, in consideration of the foregoing, Debtor agrees with Lender as follows: 1. GRANT OF SECURITY. To secure the prompt payment and full and faithful performance of the Liabilities, whether direct, contingent, fixed or otherwise, now or from time to time arising, with respect to the Guaranty, the Promissory Notes or the Letter Agreement (each as may be amended, modified, supplemented, or replaced, the "Loan Agreements"), Debtor grants to Lender a security interest in and to, and pledges and assigns to Lender, under Articles 8 and 9 of the Uniform Commercial Code (as defined in Section 14 of this Agreement, the "UCC"), all of Debtor's now owned and hereafter acquired right, title, share and interest in, to and under: (a) the issued and outstanding shares of common stock or membership interests of the Additional Assets (other than Joshua Holdings LLC ("Holdings")); (b) until the restrictions set forth in Section 4.42 of the Amended and Restated Loan Agreement dated as of February 15, 2000 (the "Travelers Loan Agreement") between Joshua Timberlands LLC ("Timberlands") and The Travelers Insurance Company ("Travelers") shall have been terminated, amended or waived to eliminate the restrictions on Debtor's transfer of his membership interests in Holdings, all of Debtor's membership interests in Holdings, which constitute 86.25% of the total outstanding membership interests of Holdings, except for 65% of the total outstanding membership interests of Holdings; (c) effective upon the termination, amendment or waiver of the restrictions set forth in Section 4.42 of the Travelers Loan Agreement, Debtor's remaining 65% of the total outstanding membership interests of Holdings, without any action required on the part of Debtor or Lender (the common stock and membership interests described in the foregoing paragraphs (a) and (b) and this paragraph (c) are collectively referred to herein as the "Pledged Interests"); (d) together with any and all distributions, whether in cash or in kind, upon or in connection with the Pledged Interests, whether such distributions or payments are dividends, are in partial or complete liquidation, or are the result of reclassification, readjustment or other changes in the capital structure of the entity issuing the same, or otherwise, and any and all subscriptions, warrants, options and other rights issued upon and/or in connection therewith; (e) any and all substitutions, renewals, improvements and replacements of the Pledged Interests and additions thereto; (f) all Promissory Notes, Instruments, Chattel Paper, General Intangibles (including Payment Intangibles), contract rights, and all other forms of obligations respecting the rights of Debtor to the payment of money from any of the Additional Assets ("collectively, the Company Obligations"); and (g) all Proceeds arising from any of the foregoing. All of the foregoing items are referred to herein individually and/or collectively as the "Collateral". Capitalized terms not otherwise defined herein or in the Letter Agreement shall have the meaning given them in the UCC. 2. PERFECTION. To perfect the Lender's security interest in the Collateral: (a) Debtor hereby irrevocably authorizes the Lender at any time and from time to time to file in any appropriate jurisdiction any UCC financing statements or amendments thereto. (b) Debtor is delivering to the Lender the Pledged Interests evidenced by certificated securities, if any, together with irrevocable stock powers endorsed in blank. (c) Debtor, Lender and each issuer of the Pledged Interests which are not evidenced by certificated securities are executing and delivering control agreements (collectively, the "Control Agreements"). If at any time any after the date hereof any of the Pledged Interests which are not evidenced by certificated securities shall be evidenced or represented by certificates, Debtor shall promptly deliver any such certificates to Lender, together with irrevocable stock powers endorsed in blank. (d) Solely with respect to the Company Obligations, Debtor is delivering and pledging to the Lender all Instruments (including Promissory Notes) duly endorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance satisfactory to Lender. (e) Debtor from time to time hereafter shall deliver to the Lender any additional Collateral that comes within the possession or control of the Debtor and, if necessary, irrevocable stock powers endorsed in blank, Control Agreements, and/or duly executed instruments of transfer or assignment as requested by Lender. 2 3. VOTING AND TRADING RIGHTS. If no Event of Default (as hereinafter defined) has occurred and is continuing, Debtor may exercise any voting rights that Debtor may have as to any of the Collateral. If an Event of Default has occurred and is continuing, Lender may exercise, subject to Section 7 of this Agreement, all voting rights as to any of the Collateral and Debtor shall deliver to Lender all notices, proxy statements, proxies and other information relating to the exercise of such rights received by Debtor promptly upon receipt and, at the request of Lender, shall execute and deliver to Lender any proxies or other instruments which are, in the judgment of Lender, necessary for Lender to exercise such voting rights. 4. DUTY OF LENDER. Debtor shall have all risk of loss with respect to the Collateral. Lender shall have no liability or duty, either before or after the occurrence of an Event of Default, on account of loss of or damage to, or to collect or enforce any of its rights against, the Collateral, to collect any income accruing on the Collateral, or to preserve or maintain the Collateral or rights against other parties. If Lender actually receives any notices requiring action with respect to Collateral in Lender's possession, Lender shall take reasonable steps to forward such notices to Debtor. Except as provided in Section 3, Debtor is responsible for responding to notices concerning the Collateral, voting the Collateral, and exercising rights and options, calls and conversions of the Collateral. While Lender is not required to take certain actions, if action is needed, in Lender's sole discretion, to preserve and maintain the Collateral, Debtor hereby authorizes Lender to take such actions, but Lender is not obligated to do so. 5. REPRESENTATIONS AND WARRANTIES. Debtor represents and warrants to Lender that: a. SCHEDULE A is a complete and accurate statement of the ownership interests in the Additional Assets owned by the Debtor as of the date thereof. b. This Agreement and the Control Agreements have been duly executed and delivered by Debtor, constitute Debtor's valid and legally binding obligations and are enforceable in accordance with their respective terms against Debtor. c. The execution, delivery and performance of this Agreement, the grant of the security interest in the Collateral and the consummation of the transactions contemplated hereunder will not, with or without the giving of notice or the lapse of time, (i) violate any law applicable to Debtor, (ii) violate any judgment, writ, injunction or order of any court or governmental body or officer applicable to Debtor, (iii) violate or result in the breach of any agreement to which Debtor is a party or by which any of Debtor's properties, including the Collateral, is bound, or (iv) violate any restriction on the transfer of any of the Collateral. d. No consent, approval or authorization of any third party (other than with respect to any of the Additional Assets party to any of the Control Agreements) or any governmental body or officer is required for the valid and lawful execution and delivery of this Agreement and the Control Agreements, the creation and perfection of Lender's security interest in the Collateral or the valid and lawful exercise by Lender of remedies available to it under this Agreement, the Control Agreements or applicable law or of the voting and other rights granted to it in this Agreement or the Control Agreements, except as may be required for the offer or sale of securities under applicable securities laws. 3 e. The address of Debtor's principal residence is set forth in Section 12 of this Agreement. f. Debtor is the sole owner of the Collateral, has the right to grant the security interest provided for herein to Lender and has granted to Lender a valid and perfected first priority security interest in the Collateral free of all liens, encumbrances, transfer restrictions and adverse claims. 6. COVENANTS. Debtor covenants and agrees that so long as this Agreement shall be in effect: a. DEFENSE OF TITLE. Debtor shall defend Debtor's title to the Collateral and the security interest of Lender against the claims of any person claiming rights in the Collateral. b. SALE OF COLLATERAL. Without the prior written consent of the Lender, (i) Debtor shall not sell, gift, pledge, exchange or otherwise transfer any of the Collateral; and (ii) Debtor shall cause each of the Additional Assets to not sell, exchange or otherwise transfer any of its material assets other than (a) the sale of inventory in the ordinary course of business or the sale of obsolete or unused assets; or (b) the sale of one or both of the BC Yachts (as hereinafter defined) in accordance with Section 6(n) hereof. In the event of any such sale, exchange or transfer consented to by Lender, Debtor shall cause such Additional Asset to dividend or distribute upon receipt the proceeds of such sale, exchange or transfer to its shareholders or members, and, contemporaneously therewith, Debtor shall pay, or cause such Additional Asset to pay, any such distribution with respect to the Pledged Interests to the Lender for application to the Liabilities. c. NO MODIFICATIONS OR TERMINATIONS. Debtor shall not modify or terminate the terms of any Control Agreement with any of the Additional Assets and shall not file any amendments, correction statements or termination statements to financing statements concerning the Collateral without the prior written consent of Lender. d. PAYMENT OF OBLIGATIONS. The Debtor will, and will cause each of the Additional Assets to, pay and discharge when due all of his or its material obligations and liabilities (including, without limitation, tax liabilities which if unpaid when due might by law give rise to a lien on any asset of the Debtor or such Additional Asset), except where the same may be contested in good faith by appropriate proceedings. e. INSURANCE. The Debtor will cause each of the Additional Assets to maintain with financially sound and responsible insurance companies: (i) casualty insurance on all tangible personal property of the Additional Assets, in each case naming the Lender as an insured and (ii) liability insurance on behalf of the Additional Assets, in each case naming the Lender as an insured and in each case in at least such amounts and against at least such risks (and with such risk retention) as are usually insured against in the same general area by persons of established repute of comparable financial standing; and will furnish to the Lender, upon request from the Lender, information presented in reasonable detail as to the insurance so carried. 4 f. COMPLIANCE WITH LAWS. The Debtor will comply, and will cause each of the Additional Assets to comply, in all material respects with all laws, ordinances, rules, regulations, and requirements of any Federal, state, local or foreign court, agency, authority, instrumentality or regulatory body applicable to it, except where the necessity of compliance therewith is contested in good faith by appropriate proceedings. g. NOTICE OF CERTAIN EVENTS AND CONDITIONS. The Debtor will give prompt written notice to the Lender, and will cause each of the Additional Assets to give prompt written notice to the Lender, of any event of default or any event which with notice or lapse of time or both would constitute an event of default under any evidence or evidences of Indebtedness aggregating in excess of $100,000, or under any indenture, mortgage or other agreement or instrument relating to any such evidence of such Indebtedness or under any other agreement or instrument relating to preferred stock (or comparable equity interests) of the Debtor and each of the Additional Assets, respectively, or under any material lease for or in respect of which the Debtor or any of the Additional Assets, respectively, may be liable. For purposes of this Agreement, "Indebtedness" shall mean (i) all obligations for borrowed money, (ii) all obligations evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations to pay the deferred purchase price of property or services, except trade accounts payable in the ordinary course of business, (iv) all obligations of a lessee which are capitalized in accordance with generally accepted accounting principles, (v) all non-contingent obligations to reimburse any bank or other person or business in respect of amounts paid under a letter of credit or similar instrument, (vi) all Indebtedness secured by a mortgage, lien pledge, charge, security interest or encumbrance of any kind on any asset of the Debtor or the Additional Assets, and (vii) a guaranty of any Indebtedness of any other person, including without limitation, a "take or pay" agreement or similar obligation. h. EXISTENCE. The Debtor will cause each of the Additional Assets to, at all times preserve and maintain its existence as a corporation or limited liability company, as the case may be, and all rights, permits, licenses, approvals, privileges and franchises material to its business. i. FUNDAMENTAL CHANGES. Without the prior written consent of the Lender, the Debtor shall not permit any of the Additional Assets to merge or consolidate with or into any person or liquidate, wind-up or dissolve itself, or permit or suffer any liquidation or dissolution or sell all or substantially all of its assets. j. CHANGE OF RESIDENCE. Debtor shall notify Lender at least thirty (30) days before Debtor changes his principal residence. k. CASH RECEIPTS. In the event any cash is payable or distributable to Debtor as a result of Debtor's ownership of the Collateral ("Cash Receipts"), whether such payments or distributions are dividends or distributions from, are in partial or complete liquidation of, or are the result of any redemption or other change in the capital structure of any of the Additional Assets, Debtor will remit the Cash Receipts or cause the Cash Receipts to be remitted to Lender within two (2) business days following receipt thereof, and, at all times prior to such remittance, Debtor will hold or, if applicable, will cause such Cash Receipts to be held in trust for the exclusive benefit of 5 the Lender; provided that Debtor shall be permitted to retain any Cash Receipts from regularly scheduled dividends or distributions from Joshua Holdings LLC until payment under the Promissory Notes (as defined in the Letter Agreement) is due pursuant to the terms of the Letter Agreement. l. INFORMATION. Debtor will deliver to Lender and cause each of the Additional Assets to deliver to Lender additional information regarding the business, property, condition (financial or otherwise), or prospects of Debtor and each of the Additional Assets as the Lender may reasonably request from time to time. m. PROHIBITED LOANS. Without the prior written consent of Lender, Debtor shall not, and shall cause each of the Additional Assets to not, at any time, create, incur, assume or suffer to exist any Indebtedness, except (i) Indebtedness of Debtor under the Loan Agreements, (ii) Indebtedness in existence on the date hereof as previously disclosed in writing to Lender, (iii) any loan or advance made after the date hereof to any of the Additional Assets by Debtor which is evidenced by an Instrument (including a Promissory Note) that is delivered and pledged to the Lender in accordance with Section 2(d) of this Agreement, or (iv) any Indebtedness incurred after the date hereof which, individually or in the aggregate with any other Indebtedness incurred after the date hereof, is less than $100,000, or (v) Indebtedness permitted under Section 6.n. of this Agreement. n. BC YACHT. BC Yacht Sales, Inc. ("BCSI") shall be permitted to borrow up to $10.0 million in principal amount from a financial institution on terms satisfactory to Lender (the "Yacht Loan") and to execute a first preferred ship mortgage to secure such loan with respect to the following yachts now owned by BCSI: (i) 118 foot Intermarine Raised Pilothouse Motor Yacht, identification hull number 116-2; and (ii) 145 foot Intermarine Tri-Level Motor Yacht Yacht, identification hull number 142-1 (collectively, the "BC Yachts"). Contemporaneous with any sale of either of the BC Yachts, the Debtor will cause BCSI to use the proceeds of such sale to repay the Yacht Loan. In the event the proceeds of any such sale exceed the outstanding principal balance of the Yacht Loan, Debtor shall cause BCSI to dividend or distribute such excess upon receipt to its shareholders, and, contemporaneously therewith, Debtor shall pay, or cause BCSI to pay, any such dividend or distribution with respect to the Pledged Interests to the Lender for application to the Liabilities. Without the prior written consent of Lender, Debtor shall not permit BCSI to create, incur, assume or suffer to exist any Indebtedness (other than as permitted in Section 6.m.) or to create, assume, or suffer to exist any lien, mortgage, security interest, or encumbrance of any kind on any yacht (other than the BC Yachts) or other asset of BCSI now owned or hereafter acquired. Notwithstanding anything to the contrary set forth in this Agreement, Debtor shall be permitted to provide a personal guaranty with respect to the Yacht Loan. o. CAPITAL STRUCTURE. Without the prior written consent of Lender, Debtor shall not permit any of the Additional Assets to make any change in its capital structure or issue or create any stock, membership interest, or other equity interest (or any non-equity interest that is convertible into any stock, membership interest, or other equity interest in any of the Additional Assets). p. NOTICE OF TRANSACTIONS. Debtor shall give written notice to the Lender, and will cause each of the Additional Assets to give written notice to the Lender, at least ten (10) days prior 6 to (i) any sale, transfer, exchange, lease or other disposal of any of the assets of the Additional Assets, except the sale of inventory in the ordinary course of business or the sale of obsolete or unused assets, or (ii) the payment of any dividends or distributions to Debtor by any Additional Asset. q. ADDITIONAL REQUESTS. At Debtor's expense, do such further acts and execute and deliver such additional conveyances, certificates, instruments, legal opinions and other assurances as Lender may at any time request or require to protect, assure or enforce its interests, rights and remedies under this Agreement. 7. EVENT OF DEFAULT; REMEDIES. Upon (a) demand by the Lender pursuant to any one or more of the Promissory Notes or (b) upon the breach by Debtor of any of the terms of the Letter Agreement, this Agreement, any of the Promissory Notes or any of the Control Agreements (each, an "Event of Default"), the Lender may exercise the rights and pursue the remedies provided under Article 9 of the UCC, as currently effective in or as hereafter amended, including but not limited to exercising all voting rights with respect to the Collateral, collecting all dividends and other distributions with respect to the Collateral, selling the Collateral at any public or private sale, at the Lender's option, without advertisement, and delivering a notice of exclusive control under any of the Control Agreements to the respective issuer named therein; provided, however, that upon any such demand, you shall have 90 days from the date thereof to make payment; provided, further, that if such demand is made subsequent to your death or incapacity, your estate shall have 180 days from the date thereof to make payment; in either such case, and, until such payment is due, the Lender shall refrain from exercising the aforementioned rights and remedies. The Lender may bid and become a purchaser at any such sale, and upon any such sale the Lender shall collect, receive, and hold and apply the proceeds as provided herein. If notice of intended disposition is required by law, such notice, if mailed, shall be deemed reasonably and properly given if mailed to the address of Debtor appearing on the records of the Lender at least five days before the time of such disposition. The proceeds from any such sale or action shall be applied first to the payment of all legal and other costs and expenses incurred in connection with the sale or action and next to the payment of the Liabilities, as determined by the Lender. The balance, if any, of such proceeds remaining after such application shall be paid to Debtor. If the proceeds of any such sale or action are insufficient to pay in full the amounts specified above, Debtor shall remain liable for such deficiency. 8. APPOINTMENT OF LENDER AS AGENT. Debtor appoints Lender, its successors and assigns, as Debtor's agent and attorney-in-fact to carry out this Agreement and take any action or execute any instrument or assignment that Lender considers necessary or convenient for such purpose, including the power to endorse and deliver checks, notes and other instruments for the payment of money in the name of and on behalf of Debtor, to endorse and deliver in the name of and on behalf of Debtor securities certificates and such forms, schedules and other documents as are necessary or desirable in Lender's sole judgment to deliver to the United States Securities and Exchange Commission. This appointment is coupled with an interest and is irrevocable and will not be affected by the death, incapacity or bankruptcy of Debtor nor by the lapse of time. If Debtor fails to perform any act required by this Agreement, Lender may perform such act in the name of Debtor and at Debtor's expense. 7 9. SECURITIES LAWS. Debtor acknowledges that compliance with the Securities Act of 1933 and the rules and regulations thereunder, state securities laws and other laws may impose limitations on the right of Lender to dispose of the Collateral. Debtor authorizes Lender to sell the Collateral in such manner and to such persons as, in the judgment of Lender, would help to ensure that the sale will be given prompt approval by regulatory authorities and will not require the Collateral to be registered or qualified under any applicable laws and agrees that such a sale is commercially reasonable. Such a sale may yield a substantially lower price than if the Collateral were registered and sold in the open market. If Lender sells the Collateral at such sale, Lender shall have the right to rely upon the advice and opinion of a qualified appraiser or investment banker as to the commercially reasonable price obtainable on the sale, but Lender is not obligated to obtain or follow such advice or opinion. 10. EXPENSES. Debtor agrees that Debtor will pay to Lender upon demand the amount of any out-of-pocket expenses, including the fees and disbursements of counsel, that Lender incurs in connection with the enforcement of this Agreement, including expenses incurred to preserve the value of the Collateral and Lender's security interest, the collection, sale or other disposition of any of the Collateral, the exercise by Lender of any of its rights, or any action to enforce its rights under this Agreement. 11. RELEASE OF COLLATERAL. Except as provided in Section 4 of the Letter Agreement, the security interest granted to Lender shall not terminate and Lender shall not be required to return the Collateral to Debtor or to terminate its security interest unless and until (a) the Liabilities have been fully paid and performed, and (b) Debtor has reimbursed Lender for any expenses of returning the Collateral and filing any termination statements and other instruments as are required to be filed in public offices under applicable laws. After termination of this security interest, within 30 days after Debtor's request, Lender shall release control of any security interest in the Collateral perfected by control and, in Lender's sole discretion, shall terminate or send Debtor appropriate documentation to terminate any financing statements filed by Lender with respect to the Collateral. 12. NOTICES. Any notices, communications and waivers under this Agreement or the Control Agreements shall be in writing and shall be (i) delivered in person, (ii) mailed, postage prepaid, either by registered or certified mail, return receipt requested, or (iii) by overnight express carrier, addressed in each case as follows: 8 To Lender: WorldCom, Inc. 500 Clinton Center Drive Clinton, Mississippi 39056 Attn: Chief Financial Officer To Debtor: Bernard J. Ebbers 2116 Hwy 84 East Oak Hill Farm Brookhaven, Mississippi 39601 13. MISCELLANEOUS. This Agreement 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 Debtor hereby consents to the jurisdiction of the courts of or in the State of Mississippi in connection with any dispute, controversy, action or other matter relating to or arising out of this Agreement. Whenever possible each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement 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 Agreement. This Agreement shall be binding upon Debtor and the heirs and legal representatives of Debtor and shall inure to the benefit of the Lender and its successors and assigns. The powers, rights, and remedies of the Lender under this Agreement are cumulative and are not exclusive of any other power, right or remedy that the Lender otherwise may have. Any single or partial exercise or pursuit of any power, right or remedy under this Agreement by the Lender shall not preclude other or further exercise or pursuit thereof or the exercise or pursuit of any other power, right or remedy. The Lender's rights and remedies under this Agreement shall be unaffected by any change in the provisions of any agreement, instrument, or document evidencing or affecting any of the Liabilities, by any extension of time for payment or performance of any of the Liabilities or by any partial or full release of any security for payment or performance of any of the Liabilities. No delay by the Lender in exercising or pursuing any power, right or remedy under this Agreement shall operate as a waiver thereof, and no failure by the Lender to exercise or pursue any power, right or remedy shall prevent the Lender from exercising the same in the future. 14. UNIFORM COMMERCIAL CODE. For purposes of this Agreement, "UCC" means the Uniform Commercial Code as the same may, from time to time, be in effect in the State of Mississippi; provided, however, in the event that, by reason of mandatory provisions of law, any or all of the attachment, perfection or priority of Lender's security interest in any Collateral is governed by the Uniform Commercial Code as in effect in a jurisdiction other than the State of Mississippi, the term "UCC" shall mean the Uniform Commercial Code as in effect in such other jurisdiction for purposes of the provisions hereof relating to such attachment, perfection or priority and for purposes of definitions related to such provisions. 9 IN WITNESS WHEREOF, the parties have executed this Pledge and Security Agreement as of the date first written above. /s/ Bernard J. Ebbers ----------------------------------------- Bernard J. Ebbers WORLDCOM, INC. By: WorldCom, Inc. Compensation and Stock Option Committee By: /s/ Stiles A. Kellett, Jr. ------------------------------------- Stiles A. Kellett, Jr., Chairman SCHEDULE A ---------- PLEDGED SHARES OR INTERESTS
DATE NUMBER OF PERCENTAGE OF ISSUER OF ISSUE CERTIFICATE NO. SHARES/UNITS OWNERSHIP Joshua Holdings LLC 12-22-99 N/A N/A 86.25% BC Yacht Sales, Inc. 12-31-01 3 100 100.00% Douglas Lake Land & 07-10-98 N/A N/A 99.0% Timber Company, LLP Douglas Lake Properties, 07-15-98 No. 1 1,000 100.0% Inc. BCT Holdings, LLC 03-26-99 N/A N/A 99.80%
EX-10.3 5 a2079976zex-10_3.txt EXHIBIT 10.3 Exhibit 10.3 PROMISSORY NOTE Clinton, Mississippi April 29, 2002 This Note amends, restates and replaces (i) the Promissory Note dated September 8, 2000 in the maximum principal amount of $50 million made by the Borrower (as defined below) payable to the order of the Lender (as defined below), (ii) the Promissory Note dated November 1, 2000 in the maximum principal amount of $25 million made by the Borrower payable to the order of the Lender, (iii) the Promissory Note dated December 29, 2000 in the maximum principal amount of $25 million made by the Borrower payable to the order of the Lender, (iv) the Promissory Note dated September 10, 2001 made by the Borrower payable to the order of the Lender relating to the Guaranty (as defined below) and (v) the Promissory Note dated January 30, 2002 in the maximum principal amount of $65 million made by the Borrower payable to the order of the Lender. The principal amount of this Note includes all accrued and unpaid interest on the foregoing promissory notes through April 29, 2002. 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, the principal sum of (a) FOUR HUNDRED EIGHT MILLION TWO HUNDRED FOURTEEN THOUSAND NINE HUNDRED THIRTY DOLLARS ($408,214,930) PLUS (b) the amount of any payments made after the date hereof by the Lender under the Guaranty. The principal amount hereunder shall be paid in the amounts and on the dates set forth below: Date Amount ---- ------ April 29, 2003 $25,000,000 April 29, 2004 $25,000,000 April 29, 2005 $75,000,000 April 29, 2006 $100,000,000 April 29, 2007 All remaining principal The Borrower further promises to pay interest on the outstanding balance under this Note, compounded monthly, from the date hereof until payment in full of this Note, payable on each date of repayment of principal set forth above, 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 hereof plus the Applicable Margin during the corresponding period applicable to Eurodollar Rate Borrowings by the Lender pursuant to that certain Revolving Credit Agreement among the Lender, Bank of America, N.A. and JPMorgan Chase 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; provided, however, that following any demand for payment, the Borrower promises to pay interest on the unpaid balance hereunder, compounded monthly, at the Default Rate, as defined herein, payable from time to time upon demand. 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. The Borrower may at his option, at any time, prepay this Note, in whole or in part, without premium or penalty. Any such optional prepayment shall be applied to reduce the then remaining installments of principal in the direct order of maturity; provided that any return of all or any portion of the Lender's approximately $36.5 million deposit (the "Deposit") supporting the B of A (as defined below) letter of credit shall be applied to the final principal payment and not to any earlier payment. For the avoidance of doubt, any payment or deposit by the Lender simultaneous with or after the date of such return relating to the B of A letter of credit, any alternative or replacement letter of credit or similar arrangement shall be added to the principal amount of this Note when paid or advanced; provided that such alternative or replacement letter of credit or similar arrangement is reasonably acceptable to the Borrower. The Borrower hereby agrees not to borrow after the date hereof any amount from Bank of America, N.A. ("B of A") that would be covered by (i) the Limited Guaranty, dated as of November 14, 2000 (as amended, supplemented or otherwise modified from time to time, the "Prior Guaranty"), executed by the Lender for the benefit of B of A or (ii) the Limited Guaranty, dated as of February 12, 2001, as modified by that certain First Modification and Reaffirmation of Limited Guaranty, dated as of January 25, 2002 (and as further amended, supplemented or otherwise modified from time to time, the "New Guaranty" and, together with the Prior Guaranty, the "Guaranty"), executed by the Lender for the benefit of B of A. All principal and accrued interest under this Note shall become immediately due and payable upon the death of the Borrower or upon demand by the Lender (or, in the case of an event specified in clause (iv) below, automatically without notice) if any one of the following events shall occur and be continuing (each, an "Event of Default"): (i) the Borrower shall fail to pay any principal or interest under this Note when due, (ii) the Borrower shall default in the observance or performance of any agreement contained herein, (iii) the Borrower shall default in the observance or performance of any agreement contained in the Separation Agreement, dated as of April 29, 2002, or (iv) the Borrower shall become, or there shall be commenced against the Borrower a case to declare him, bankrupt. If any amount of this Note is not paid when due, 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. This Note shall constitute a Promissory Note within the meaning and subject to the provisions of that certain letter agreement dated April 2, 2002, as the same may be amended or otherwise modified, between the Borrower and the Lender. 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 EX-10.4 6 a2079976zex-10_4.txt EXHIBIT 10.4 Exhibit 10.4 April 29, 2002 Bernard J. Ebbers 500 Clinton Center Drive Clinton, MS 39056 Dear Bernie: Reference is made to our letter agreement dated April 2, 2002 (the "Letter Agreement"). Unless otherwise defined, terms defined in the Letter Agreement and used herein shall have the meanings given to them therein. The Company and you (the "Parties") agree that the promissory note dated April 29, 2002 made by you and payable to the order of the Company (the "New Promissory Note") hereby replaces each of the Promissory Notes referred to in the Letter Agreement. The New Promissory Note is hereby deemed to be the Promissory Note referred to in the Letter Agreement. The Parties further agree that an event of default under the New Promissory Note constitutes a breach of the Promissory Note for purposes of the Letter Agreement. This letter agreement 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 you hereby consent to the jurisdiction of the courts of or in the State of Mississippi in connection with any dispute, controversy, action or other matter relating to or arising out of this letter agreement. The provisions of the second, third, fourth, fifth, sixth and seventh sentences of Section 6 of the Letter Agreement shall apply to this letter agreement as though it were the "Agreement" as referenced therein. WorldCom, Inc. By: /s/ John W. Sidgmore ------------------------------------- John W. Sidgmore President and Chief Executive Officer Acknowledged and agreed as of the date first above written. /s/ Bernard J. Ebbers ----------------------------------------- Bernard J. Ebbers EX-10.5 7 a2079976zex-10_5.txt EXHIBIT 10.5 Exhibit 10.5 SEPARATION AGREEMENT (BERNARD J. EBBERS) SEPARATION AGREEMENT, dated as of April 29, 2002, between WORLDCOM, INC., a Georgia corporation (the "Company"), and BERNARD J. EBBERS (the "Executive"). SECTION 1. RESIGNATION. The Executive hereby resigns from all directorships, offices and positions with the Company and its subsidiaries, affiliates and employee benefit plans and trusts, effective April 29, 2002 (the "Termination Date"). The Executive will be appointed to serve the Company's board of directors as non-executive CHAIRMAN EMERITUS at the pleasure of the board, and also will serve as a consultant as described in Section 9. SECTION 2. PENSION BENEFITS. Commencing as soon as practicable following May 1, 2002, and on each May 1 thereafter that occurs during the Executive's lifetime, the Company shall pay the Executive $1,500,000, in cash. Should the Executive be survived by the individual who is the Executive's spouse on the Termination Date, the Company shall pay such spouse $750,000 in cash on each May 1 after the Executive's death that occurs during such spouse's lifetime. These pension benefits are subject to complete discontinuance pursuant to Section 14. SECTION 3. OTHER BENEFITS. (a) The Company shall provide the Executive, at its expense (and subject to offset for Medicare coverage), with continued medical and life insurance benefits for the remainder of his lifetime at the level applicable generally to senior executives of the Company. The Executive also shall receive (without duplication) such amounts, if any, to which the Executive may be entitled as of the Termination Date pursuant to the terms of the employee benefit programs and compensation programs of the Company (other than severance programs). (b) The Executive will have use of the Company aircraft for a maximum of 30 hours per calendar year, subject to reimbursement of the Company by the Executive on the same basis as is currently in effect with the Company for personal usage, in order to avoid imputed income. (c) Subject to Section 6(b), the Executive may retain, at no additional cost to him, his current Company-issued desktop computer. (d) The Executive may lease office space from the Company at its 515 Amite Street location on terms and conditions mutually agreeable to the parties. SECTION 4. STOCK OPTIONS. Each outstanding option granted to the Executive to purchase WorldCom group common stock or MCI group common stock (collectively, "Company Stock") shall become fully vested and exercisable on the Termination Date, and each such option shall 2 remain exercisable until the fifth anniversary of the Termination Date (or, if earlier, the expiration of such option's original term), except to the extent the applicable option agreement cannot be amended to permit such extension of the option's exercise period. SECTION 5. LOANS. Simultaneously herewith, the Executive shall execute the letter agreement dated of even date herewith between the Executive and the Company (the "Letter Agreement") and the related promissory note (the "Promissory Note"). The Executive further acknowledges and agrees that his obligations under the letter agreement dated April 2, 2002 (the "April 2 Letter Agreement"), as modified by the Letter Agreement, shall continue to apply in full force and effect. The payments due from the Executive under the Promissory Note are subject to acceleration as described in Section 14. SECTION 6. RESTRICTIVE COVENANTS. (a) NON-COMPETITION. Executive acknowledges and recognizes the highly competitive nature of the businesses of the Company and its affiliates and accordingly agrees as follows: (i) For a period of five years following the Termination Date (the "Restricted Period"), the Executive will not, whether on the Executive's own behalf or on behalf of or in conjunction with any person, firm, partnership, joint venture, association, corporation or other business organization, entity or enterprise whatsoever ("Person"), directly or indirectly: (A) engage in any business which is in competition with the business of the Company or an affiliate, which shall include any business which is principally involved in the purchase, sale or other dealing in any property or the rendering of any service purchased, sold, dealt in or rendered by the Company or an affiliate as a material part of the business of the Company or an affiliate within the same geographic area in which the Company or an affiliate makes such purchases, sales or dealings or renders such services (a "Competitive Business"); (B) enter the employ of, or render any services to, any Person (or any division or controlled or controlling affiliate of any Person) in respect of any Competitive Business; (C) acquire a financial interest in, or otherwise become actively involved with, any Competitive Business, directly or indirectly, as an individual, partner, shareholder, officer, director, principal, agent, trustee or consultant; or (D) interfere with, or attempt to interfere with, business relationships (whether formed before, on or after the Termination Date) between the Company or any of its affiliates and customers, clients, suppliers or investors of the Company or its affiliates. (ii) Notwithstanding anything to the contrary in this Agreement, Executive may directly or indirectly own, solely as an investment, securities of any Person which are publicly traded on a national or regional stock exchange or on the over-the-counter market if Executive (A) is not a controlling person of, or a member of a group which controls, such person and (B) does not, directly or indirectly, own 5% or more of any class of securities of such Person. 3 (iii) During the Restricted Period, Executive will not, whether on Executive's own behalf or on behalf of or in conjunction with any Person, directly or indirectly: (A) solicit or encourage any employee of the Company or its affiliates to leave the employment of the Company or its affiliates; or (B) hire any such employee who was employed by the Company or its affiliates as of the Termination Date, or, if later, within the six-month period prior to such date of hire; provided however, notwithstanding any other provision hereof, Executive may hire his current secretary, Debra Blackwell. (iv) During the Restricted Period, Executive will not, directly or indirectly, solicit or encourage to cease to work with the Company or its affiliates any consultant then under contract with the Company or its affiliates. (v) It is expressly understood and agreed that although the Executive and the Company consider the restrictions contained in this Section 6 to be reasonable, if a final determination is made by a court of competent jurisdiction or an arbitrator that the time or territory or any other restriction contained in this Agreement is an unenforceable restriction against the Executive, the provisions of this Agreement shall not be rendered void but shall be deemed amended to apply as to such maximum time and territory and to such maximum extent as such court or arbitrator may determine or indicate to be enforceable. Alternatively, if any such court of competent jurisdiction or arbitrator finds that any restriction contained in this Agreement is unenforceable, and such restriction cannot be amended so as to make it enforceable, such finding shall not affect the enforceability of any of the other restrictions contained herein. (b) CONFIDENTIALITY. (i) The Executive will not at any time use, divulge or convey any secret or confidential information, knowledge, or data of the Company or its affiliates, including information, knowledge or data of third parties as to which the Company or its affiliates is under an obligation of confidentiality (as, for example, information supplied to allow the Company to evaluate a potential acquisition), obtained by the Executive in the course of the Executive's activities as a director, officer or employee of the Company except where required to do so by a court of law, by a governmental agency having supervisory authority over the business of the Company or by any administrative or legislative body with apparent jurisdiction over the Executive to order the Executive to divulge, disclose or make accessible such information. Such information, knowledge or data includes, but is not limited to, secret or confidential matters (A) of a technical nature such as, but not limited to, methods, know-how, formulae, compositions, process, discoveries, machines, inventions, computer programs and similar items or research projects, (B) of a business nature such as, but not limited to, information about cost, purchasing, profits, market, sales or lists of customers, and (C) pertaining to future developments such as, but not limited to, research and development of future marketing or merchandising ("Confidential Information"). Such Confidential Information does not include information, knowledge or data that becomes publicly known other than through a breach of this Agreement by the Executive. (ii) On and after the Termination Date the Executive shall (A) not use of any 4 Confidential Information or intellectual property owned or used by the Company, its subsidiaries or affiliates, (B) immediately destroy, delete, or return to the Company, at the Company's option, all originals and copies in any form or medium in the Executive's possession or control (including any of the foregoing stored or located in the Executive's office, home, laptop or other computer, whether or not Company property) to the extent that they contain Confidential Information. (c) NON-DISPARAGEMENT. The Company and its affiliates shall refrain from making any statements or comments of a defamatory or disparaging nature to any third party regarding the Executive, and the Executive shall refrain from making any statements or comments of a defamatory or disparaging nature to any third party regarding the Company, any of its affiliates, or any of their directors, officers, personnel, policies or product; provided, however, that it shall not be a violation of this Section 6(c) for either party to make truthful statements when required to do so by a court of law, by any governmental agency having supervisory authority over the party, or by any administrative or legislative body with apparent jurisdiction to order the party to divulge, disclose or make accessible such information. SECTION 7. SPECIFIC PERFORMANCE. The Executive acknowledges and agrees that the Company's remedies at law for a breach or threatened breach of any of the provisions of Section 6 would be inadequate and the Company would suffer irreparable damages as a result of such breach or threatened breach. In recognition of this fact, the Executive agrees that, in the event of such a breach or threatened breach, in addition to any remedies at law, the Company, without posting any bond, shall be entitled to cease making any payments or providing any entitlement or benefit otherwise required by this Agreement (including without limitation the payments, entitlements and benefits otherwise provided pursuant to Sections 2, 3, 4 and 5), and, notwithstanding Section 22, shall be entitled to bring an action in any court of competent jurisdiction for the purpose of obtaining equitable relief in the form of specific performance, temporary restraining order, temporary or permanent injunction or any other equitable remedy which may then be available. SECTION 8. COOPERATION. The Executive shall provide reasonable cooperation in connection with any action or proceeding which relates to the Company or any of its affiliates, including without limitation in connection with any litigation and disputes arising out of actions or inactions of the Company or any affiliate of which the Executive has knowledge or information. The Executive further agrees to cooperate with the Company in supplying data, information, and expertise within the Executive's special knowledge or competence and otherwise assist the Company in the protection of the interests of the Company and its affiliates. The Company shall reimburse the Executive for reasonable out-of-pocket expenses (such as hotel and travel expenses) incurred by the Executive in connection with such cooperation following its receipt of the Executive's appropriately itemized request. SECTION 9. CONSULTATION. For a period of five years following the Termination Date, the Executive shall remain available to provide consulting services to the Company and its affiliates, in particular the Chief Executive Officer of the Company, on business matters from time to time at the Company's reasonable request. The Executive acknowledges that all such consulting services will be performed by the Executive as an independent contractor, and not as an employee, and that the Executive will not be eligible or entitled to participate, as a result of the performance of such consulting services, in any Company benefit or incentive program. SECTION 10. INDEMNITY. The existing rights of the Executive and obligations of the Company 5 with regard to indemnification of the Executive that are not dependent upon Executive's continued employment or holding an office or directorship with the Company or an affiliate, and the indemnification rights under the Company's current by-laws, shall continue. SECTION 11. RELEASE. The Executive acknowledges that certain payments provided for hereunder are in excess of the amounts that the Executive would otherwise be entitled to receive and that the Company had no obligation to enter into this Agreement. In consideration of the Company assuming these additional obligations and entering into this Agreement, and as a material inducement to the Executive to enter into this Agreement, the parties agree to execute (and not revoke) a release ("Release") substantially in the form attached hereto as EXHIBIT A. This Agreement is subject in all respects to Executive's execution (and non-revocation) of the Release. SECTION 12. SEVERABILITY. In the event that any one or more of the provisions of this Agreement shall be or become invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions of this Agreement shall not be affected thereby. SECTION 13. ASSIGNMENT. This Agreement, and all of Executive's rights and duties hereunder, shall not be assignable or delegable by Executive. Any purported assignment or delegation by Executive in violation of the foregoing shall be null and void AB INITIO and of no force and effect. This Agreement may be assigned by the Company to a person or entity which is a successor in interest to substantially all of the business operations of the Company. Upon such assignment, the rights and obligations of the Company hereunder shall become the rights and obligations of such successor person or entity. SECTION 14. SET-OFF; BREACH. In the event of any breach of this Agreement by the Executive, the Company's obligation to pay any amounts to the Executive, whether under this Agreement or otherwise, and the Company's obligation to make the arrangements provided under this Agreement, net of any withholding obligations, shall be subject to set-off by or against, counterclaim or recoupment of, amounts owed by the Executive to the Company or its affiliates. Without limiting the generality of the foregoing, in the event of any breach of this Agreement by the Executive, any default by the Executive on any of the obligations contained in the Letter Agreement, the Promissory Note or the April 2 Letter Agreement, or the filing of voluntary or involuntary bankruptcy by the Executive, payment of the pension benefits described in Section 2 will be permanently discontinued and all outstanding amounts due to the Company by the Executive will be accelerated as provided in the Promissory Note. SECTION 15. NO MITIGATION. Executive shall not be required to mitigate the amount of any payment provided for pursuant to this Agreement by seeking other employment, and the Executive shall not be required to pay the Company any amounts the Executive may receive from such alternative employment. SECTION 16. SUCCESSORS; BINDING AGREEMENT. This Agreement shall inure to the benefit of and be binding upon personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. SECTION 17. NOTICE. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered by hand or overnight courier or three days after it has been mailed by United 6 States registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below in this Agreement, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. Notice to the Company shall be addressed to: WorldCom, Inc. 500 Clinton Center Drive Clinton, MS 39056 Attn: General Counsel With a copy to: Kenneth C. Edgar, Jr., Esq. Simpson Thacher & Bartlett 425 Lexington Avenue New York, NY 10017 Notice to the Executive shall be addressed to: Mr. Bernard J. Ebbers 2116 Highway 84 East Oakhill Farm Brookhaven, MS 39601 With a copy to: Charles P. Adams, Jr., Esq. Adams and Reese, LLP P.O. Box 24297 Jackson, MS 39225-4297 SECTION 18. WITHHOLDING TAXES. The Company may withhold from any amounts payable under this Agreement such Federal, state and local taxes as may be required to be withheld pursuant to any applicable law or regulation. SECTION 19. ENTIRE AGREEMENT/AMENDMENTS. This Agreement, the Release, the Letter Agreement and the Promissory Note contain the entire understanding of the parties with respect to the subject matter hereof; except that the obligations described in the April 2 Letter Agreement, as modified by the Letter Agreement, shall continue to apply in all respects. There are no restrictions, agreements, promises, warranties, covenants or undertakings between the parties with respect to the subject matter herein other than those expressly set forth herein and therein. This Agreement may not be amended except by written instrument signed by the parties hereto. SECTION 20. NO WAIVER. The failure of a party to insist upon strict adherence to any term of this Agreement on any occasion shall not be considered a waiver of such party's rights or deprive such party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. 7 SECTION 21. ARBITRATION. Except as set forth in Section 7, any dispute, controversy or claim arising out of or relating to this Agreement shall be settled exclusively by binding arbitration by a single arbitrator, conducted in the State of Mississippi in accordance with the rules of the American Arbitration Association then in effect. If the Executive and the Company are unable to mutually agree on the arbitrator, the arbitrator shall be chosen in accordance with the rules of the American Arbitration Association. Judgment may be entered on the arbitrator's award in any court in the State of Mississippi having jurisdiction. SECTION 22. GOVERNING LAW; VENUE. This Agreement shall be governed by and construed in accordance with the laws of the State of Mississippi, without regard to conflicts of laws principles thereof. The Executive irrevocably submits to the non-exclusive jurisdiction of the courts of the State of Mississippi and the courts of the United States located in the State of Mississippi for the purpose of any action or proceeding arising out of or relating to this Agreement, and acknowledges that the designated FORA have a reasonable relation to this Agreement and the parties' relationship to one another. SECTION 23. COUNTERPARTS. This Agreement may be signed in counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. WORLDCOM, INC. /s/ John W. Sidgmore -------------------------------------- By: John W. Sidgmore President and Chief Executive Officer /s/ Bernard J. Ebbers -------------------------------------- Bernard J. Ebbers EX-10.6 8 a2079976zex-10_6.txt EXHIBIT 10.6 Exhibit 10.6 EXHIBIT A MUTUAL RELEASE THIS RELEASE ("Release") is made by and between Bernard J. Ebbers ("you") and WorldCom, Inc. (the "Company") as of the date set forth below in connection with the parties' execution of the Separation Agreement dated April 29, 2002 (the "Separation Agreement"). 1. EXECUTIVE RELEASE. In consideration of the payments and benefits provided for under the Separation Agreement, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, you hereby agree as follows: a. You hereby agree on behalf of yourself, your agents, assignees, attorneys, successors, assigns, heirs and executors, to, and you do hereby, forever release the Company and its affiliates, predecessors and successors and all of their respective past and/or present officers, directors, partners, members, managing members, employees, agents, representatives, administrators, attorneys, insurers and fiduciaries in their individual and/or representative capacities (hereinafter collectively referred to as the "Company Releasees"), from any and all causes of action, agreements, damages, judgments, claims, debts, covenants, executions and demands of any kind whatsoever, which you or your heirs, executors, administrators, successors and assigns ever had, now have or may have against the Company Releasees or any of them, in law or equity, whether known or unknown to you, for, upon, or by reason of, any matter whatsoever occurring up to the date this Release is signed by you, including without limitation in connection with or in relation to your employment relationship with the Company or its affiliates or the termination of such relationship; PROVIDED that such released claims shall not include any claims to enforce your rights under, or with respect to, the Separation Agreement (such released claims are collectively referred to herein as the "Released Claims"). b. Notwithstanding the generality of clause (a) above, the Released Claims include, without limitation, (i) any and all claims under Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act of 1967, the Civil Rights Act of 1971, the Civil Rights Act of 1991, the Fair Labor Standards Act, the Employee Retirement Income Security Act of 1974, the Americans with Disabilities Act, the Family and Medical Leave Act of 1993, and any and all other federal, state or local laws, statutes, rules and regulations pertaining to employment or otherwise, and (ii) any claims for wrongful discharge, breach of contract, fraud, misrepresentation or any claims relating to compensation, benefits or equity, or any other claims under any statute, rule or regulation or under the common law, including compensatory damages, punitive damages, attorney's fees, costs, expenses and all claims for any other type of damage or relief. To ensure that the foregoing release is fully enforceable in accordance with its terms, you agree to waive any protection that may exist under any statute and under any principle of common law of the United States or any and all States. 2 c. You expressly understand and agree that the obligations of the Company as set forth in the Separation Agreement are in lieu of any and all other amounts which you might be, are now, or may become entitled to receive from the Company or any affiliate upon any claim released herein and, without limiting the generality of the foregoing, you expressly waive any right or claim that you may have or assert with respect to any agreement or arrangement relating to employment, compensation, benefits or equity with the Company or its affiliates, and any damages and/or attorney's fees and costs. d. You represent that you have read carefully and fully understand the terms of this Release, and that you have been advised to consult with an attorney and have had the opportunity to consult with an attorney prior to signing this Release. You acknowledge that you are executing this Release voluntarily and knowingly and that you have not relied on any representations, promises or agreements of any kind made to you in connection with your decision to accept the terms of this Release, other than those set forth in this Release. 2. COMPANY RELEASE. As a material inducement for you to enter the Separation Agreement, the Company does hereby agree to forever release you, your heirs, successors and assigns (hereinafter collectively referred to as the "Executive Releasees"), from any and all causes of action, agreements, damages, judgments, claims, debts, covenants, executions and demands of any kind whatsoever, which the Company ever had, now has or may have against the Executive Releasees or any of them, in law or equity, whether known or unknown, for, upon, or by reason of, any matter whatsoever occurring up to the date this Release is signed by the Company, including without limitation in connection with or in relationship to your employment relationship with the Company or its affiliates or the termination of such relationship; PROVIDED that such released claims shall not include any claims (i) to enforce the Company's rights under, or with respect to, the Separation Agreement, or the Letter Agreement, Promissory Note or April 2 Letter Agreement referenced in Section 5 of the Separation Agreement, or (ii) in connection with any fraud, willful misconduct, gross negligence or criminal act on your part. BERNARD J. EBBERS /s/ Bernard J. Ebbers ----------------------------------------- Date: April 29, 2002 WORLDCOM, INC. By: /s/ John W. Sidgmore ----------------------------------------- Name: John W. Sidgmore Title: President and Chief Executive Officer Date: April 29, 2002 -----END PRIVACY-ENHANCED MESSAGE-----