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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2001
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period ______________ to ________________
Commission file number 0-20763
McLEODUSA INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 42-1407240
(State of Incorporation) (IRS Employer Identification No.)
McLeodUSA Technology Park
6400 C Street SW
P.O. Box 3177
Cedar Rapids, Iowa 52406-3177
(Address of principal executive office) (Zip Code)
319-364-0000
(Registrant's telephone number,
including area code)
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
The number of shares outstanding of each class of the issuer's common stock
as of May 9, 2001:
Common Stock Class A: ($.01 par value)................... 613,292,978 shares
Common Stock Class B: ($.01 par value)................... None
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INDEX
Page
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PART I. Financial Information
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Item 1. Financial Statements.................................................................... 3
Consolidated Balance Sheets, March 31, 2001 (unaudited) and December 31, 2000........... 3
Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss)
for the three months ended March 31, 2001 and 2000.................................... 4
Unaudited Consolidated Statements of Cash Flows for the three months ended
March 31, 2001 and 2000............................................................... 5
Notes to Consolidated Financial Statements (unaudited).................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations... 10
PART II. Other Information
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Item 6. Exhibits and Reports on Form 8-K....................................................... 16
Signatures....................................................................................... 17
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
McLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except shares)
March 31, December 31,
2001 2000
----------------- ----------------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents.............................................................. $ 226.4 $ 15.7
Investment in available-for-sale securities............................................ 97.4 64.7
Trade receivables, net................................................................. 377.5 354.0
Inventory.............................................................................. 33.9 25.1
Deferred expenses...................................................................... 48.8 48.3
Prepaid expenses and other............................................................. 63.5 55.0
--------- ---------
TOTAL CURRENT ASSETS.................................................................. 847.5 562.8
--------- ---------
Property and Equipment
Land and building...................................................................... 114.4 118.4
Communications networks................................................................ 1,575.3 1,411.4
Furniture, fixtures and equipment...................................................... 496.1 428.6
Networks in progress................................................................... 1,427.3 1,492.6
Building in progress................................................................... 6.3 5.1
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3,619.4 3,456.1
Less accumulated depreciation.......................................................... 465.1 437.0
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3,154.3 3,019.1
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Investments, Intangible and Other Assets
Other investments...................................................................... 30.5 29.2
Goodwill, net.......................................................................... 3,214.2 3,226.2
Other intangibles, net................................................................. 412.6 391.0
Other.................................................................................. 159.3 137.3
--------- ---------
3,816.6 3,783.7
--------- ---------
$ 7,818.4 $ 7,365.6
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt................................................... $ 27.2 $ 27.3
Accounts payable....................................................................... 226.1 275.9
Accrued payroll and payroll related expenses........................................... 41.5 43.0
Other accrued liabilities.............................................................. 305.9 393.8
Deferred revenue, current portion...................................................... 54.8 52.6
Customer deposits...................................................................... 42.8 53.8
--------- ---------
TOTAL CURRENT LIABILITIES............................................................. 698.3 846.4
Long-term Debt, less current maturities................................................. 3,498.3 2,732.2
Deferred revenue, less current portion.................................................. 20.5 12.1
Other long-term liabilities............................................................. 18.3 18.8
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4,235.4 3,609.5
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Redeemable convertible preferred stock
Preferred, Series B, redeemable, convertible, $.01 par value, authorized, issued and
outstanding 2001 275,000 shares; 2000 275,000 shares.................................. 687.5 687.5
Preferred, Series C, redeemable, convertible, $.01 par value, authorized, issued and
outstanding 2001 125,000 shares; 2000 125,000 shares.................................. 312.5 312.5
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1,000.0 1,000.0
--------- ---------
Stockholders' Equity
Capital Stock:
Preferred, Series A, $.01 par value: authorized, issued and outstanding 2001
1,149,398 shares; 2000 1,149,400 shares............................................. --- ---
Common, Class A, $.01 par value; authorized 2,000,000,000 shares;
issued and outstanding 2001 611,986,851 shares; 2000 606,596,945
shares............................................................................... 6.1 6.1
Common, Class B, convertible, $.01 par value; authorized 22,000,000
shares; issued and outstanding 2001 and 2000 none.................................... --- ---
Additional paid-in capital............................................................. 3,776.9 3,749.7
Accumulated deficit.................................................................... (1,213.8) (1,027.1)
Accumulated other comprehensive income................................................. 13.8 27.4
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2,583.0 2,756.1
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$ 7,818.4 $ 7,365.6
========= =========
The accompanying notes are an integral part of these
consolidated financial statements
3
McLEODUSA INCORPORATED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In millions, except per share data)
Three Months Ended
March 31,
--------------------
2001 2000
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Revenues:
Communications services................................................................... $ 335.5 $197.3
Directory................................................................................. 71.8 64.8
Local exchange services................................................................... 21.4 21.6
Other................................................................................. 4.4 4.6
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TOTAL REVENUE............................................................................ 433.1 288.3
Operating expenses:
Cost of service........................................................................... 246.1 148.1
Selling, general and administrative....................................................... 164.6 122.2
Depreciation and amortization............................................................. 142.0 60.6
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TOTAL OPERATING EXPENSES................................................................. 552.7 330.9
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OPERATING LOSS........................................................................... (119.6) (42.6)
Nonoperating income (expense):
Interest income........................................................................... 6.7 15.3
Interest expense.......................................................................... (56.7) (31.0)
Other income (expense).................................................................... (3.6) (.2)
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TOTAL NONOPERATING INCOME (EXPENSE)...................................................... (53.6) (15.9)
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NET LOSS................................................................................. $(173.2) $(58.5)
Preferred stock dividend................................................................... (13.6) (13.6)
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NET LOSS APPLICABLE TO COMMON SHARES..................................................... $(186.8) $(72.1)
======= ======
Loss per common share...................................................................... $ (0.31) $(0.15)
======= ======
Basic and diluted weighted average common shares outstanding............................... 610.4 479.2
======= ======
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) arising during the ........
period.................................................................................. (13.4) 20.0
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Comprehensive LOSS....................................................................... $(200.2) $(52.1)
======= ======
The accompanying notes are an integral part of these
consolidated financial statements
4
McLEODUSA INCORPORATED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Three Months Ended
March 31,
------------------------------
2001 2000
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Cash Flows from Operating Activities
Net loss............................................................................... $(173.2) $ (58.5)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation.......................................................................... 76.3 35.1
Amortization.......................................................................... 65.7 25.5
Accretion of interest on senior discount notes........................................ 11.7 10.1
Changes in assets and liabilities, net of effects of acquisitions:
Increase in trade receivables.................................................... (32.7) (35.6)
Increase in inventory............................................................ (8.8) (2.4)
(Increase) Decrease in deferred expenses.......................................... (0.5) 2.2
(Increase) Decrease in prepaid expenses and other................................. (8.5) 31.0
Increase in other assets......................................................... (17.5) (9.0)
Decrease in accounts payable and accrued expenses................................ (151.1) (31.2)
Increase in deferred revenue..................................................... 10.5 14.3
(Decrease) Increase in customer deposits.......................................... (11.0) 1.9
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NET CASH USED IN OPERATING ACTIVITIES........................................... (239.1) (16.6)
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Cash Flows from Investing Activities
Purchases of property and equipment.................................................... (229.6) (239.4)
Available-for-sale securities:
Purchases............................................................................. (69.7) (280.6)
Sales................................................................................. 25.0 ---
Maturities............................................................................ --- 759.4
Business Acquisitions.................................................................. (21.8) (10.9)
Other.................................................................................. 0.2 (2.5)
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NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (295.9) 226.0
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Cash Flows from Financing Activities
Net proceeds from long-term debt....................................................... 734.3 ----
Payments on long-term debt............................................................. (1.2) (8.4)
Payments of preferred stock dividends.................................................. (8.7) (8.7)
Proceeds from issuance of common stock................................................. 21.3 17.6
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NET CASH PROVIDED BY FINANCING ACTIVITIES...................................... 745.7 0.5
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS...................................... 210.7 209.9
Cash and cash equivalents:
Beginning.............................................................................. 15.7 326.9
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Ending................................................................................. $ 226.4 $ 536.8
======= =======
Supplemental Disclosure of Cash Flow Information:
Cash payment for interest.............................................................. $68.8 $43.9
======= =======
Supplemental Schedule of Noncash Investing and Financing Activities
Capital leases incurred for the acquisition of property and equipment.................. $ 9.3 $ 5.2
======= =======
The accompanying notes are an integral part of these consolidated financial
statements
5
McLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of and for the Three Months Ended
March 31, 2001 and 2000 is Unaudited)
Note 1: Basis of Presentation
Interim Financial Information (unaudited): The financial statements and related
notes as of March 31, 2001, and for the three month periods ended March 31, 2001
and 2000, are unaudited, but in the opinion of management include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of our financial position and results of operations. The
operating results for the interim periods are not indicative of the operating
results to be expected for a full year or for other interim periods. Certain
information and footnote disclosure normally included in financial statements
prepared in accordance with generally accepted accounting principles in the
United States have been condensed or omitted pursuant to instructions, rules and
regulations prescribed by the Securities and Exchange Commission ("SEC").
Although management believes that the disclosures provided are adequate to make
the information presented not misleading, management recommends that you read
these consolidated condensed financial statements in conjunction with the
audited consolidated financial statements and the related footnotes included in
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2000, filed with the SEC on March 30, 2001.
Reclassifications: Networks in progress at December 31, 2000 reflects a $429.8
million reclassification for CapRock Communications Corp. assets previously
recorded as Communications networks. Certain items in the unaudited statement
of operations for the three month period ended March 31, 2000 have been
reclassified to be consistent with the presentation in the March 31, 2001
unaudited financial statements.
In the McLeodUSA Incorporated Report on Form 10-K, the Company misreported the
conversion ratio on the Series B Preferred Shares. The Series B Preferred
Shares are convertible into shares of the Company's Class A common stock at a
rate of (a) the liquidation preference divided by (b) approximately $12.16667.
Note 2: Supplemental Asset Data
Trade Receivables: The composition of trade receivables, net is as follows:
March 31, December 31,
2001 2000
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(In millions)
Trade Receivables:
Billed.................................................. $368.4 $323.4
Unbilled................................................ 104.6 120.4
------ ------
473.0 443.8
Allowance for doubtful accounts and discounts............ (95.5) (89.8)
------ ------
$377.5 $354.0
====== ======
Note 3: Acquisitions
Splitrock Services, Inc. (Splitrock): On March 30, 2000, the Company acquired
Splitrock pursuant to the Amended Plan of Merger dated February 11, 2000, in
exchange for approximately 93.2 million shares of Class A common stock. The
total purchase price was approximately $2.3 billion based on the average closing
price of the Company's Class A common stock five days before and after January
6, 2000, the initial date of the Merger Agreement. Approximately $261 million
in Splitrock debt remained outstanding after the closing. This debt has been
retired.
6
The following table summarizes the purchase price allocations for business
acquisitions in the three months ended March 31, 2001 and 2000 (in millions):
Transaction Year: 2001 2000
----------------- -------- --------
Cash purchase price $ 21.8 $ 10.8
Acquisition costs -- 41.7
Promissory notes 4.8 38.4
Stock issued -- 1,832.4
Option agreements -- 103.3
-------- --------
$ 26.6 $2,026.6
======== ========
Working capital acquired, net $ -- $ 15.8
Fair value of other assets acquired -- 184.1
Intangibles 26.6 2,117.4
Liabilities assumed -- (290.7)
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$ 26.6 $2,026.6
======== ========
These acquisitions have been accounted for as purchases and the results of
operations are included in the consolidated financial statements since the dates
of acquisition.
Note 4: Information by Business Segment
The Company operates predominantly in two reportable operating segments: (1)
providing communications and related services, such as local and long distance
service, providing end-to-end data communications, telecommunications network
sales and expanding fiber optic network (communications services); and (2)
selling advertising space in telephone directories, and publishing and
distributing directories to local area subscribers (directory). These business
segments have separate management teams and infrastructures that offer different
products and services.
The Company previously reported under three operating segments after the
acquisition of Splitrock on March 30, 2000. The former Splitrock entity
operations were reported under the Data segment. Due to changes in the
Company's structure and the way it evaluates performance the Data segment,
representing the former Splitrock entity, has been merged into the
Communications Services segment. The period ended March 31, 2000 has been
restated for this change.
The Company evaluates the performance of its operating segments based on
earnings before interest, taxes, depreciation and amortization, excluding
general corporate expenses ("EBITDA"). The accounting policies of the
reportable segments are the same as those described in Note 1 of Notes to
Consolidated Financial Statements in the Company's Annual Report on 10-K.
Intersegment transfers are accounted for on an arm's length pricing basis.
Identifiable assets (excluding intersegment receivables) are the Company's
assets that are identified in each business segment. Other primarily includes
cash and cash equivalents, investments in available-for-sale securities,
administrative headquarters and goodwill recorded as a result of acquisitions.
In 2001 and 2000, no single customer or group under common control represented
10% or more of the Company's sales.
7
Segment information for the three months ended March 31, 2001 and 2000 was as
follows (in millions):
Communications Services Directory Other Total
---------------------------------------------------------------------
Three months ended
March 31, 2001
Revenues $ 361.3 $ 71.8 $ -- $ 433.1
=====================================================================
EBITDA $ 16.7 $ 11.7 $ (6.0) $ 22.4
Depreciation and amortization (83.2) (9.0) (49.8) (142.0)
Interest Revenue 0.1 -- 6.6 6.7
Interest Expense (1.1) -- (55.6) (56.7)
Taxes and Other (2.7) (0.3) (0.6) (3.6)
---------------------------------------------------------------------
Net Income (Loss) $ (70.2) $ 2.4 $ (105.4) $ (173.2)
=====================================================================
Total assets $3,552.8 $518.9 $3,746.7 $7,818.4
Capital expenditures $ 217.5 $ 29.7 $ 4.2 $ 251.4
Communications Services Directory Other Total
---------------------------------------------------------------------
Three months ended
March 31, 2000
Revenues $ 222.8 $ 65.5 $ -- $ 288.3
=====================================================================
EBITDA $ 10.3 $ 13.0 $ (5.3) $ 18.0
Depreciation and amortization (37.0) (7.4) (16.2) (60.6)
Interest Revenue 0.4 0.1 14.8 15.3
Interest Expense (1.0) -- (30.0) (31.0)
Taxes and Other (2.3) -- 2.1 (0.2)
---------------------------------------------------------------------
Net Income (Loss) $ (29.6) $ 5.7 $ (34.6) $ (58.5)
=====================================================================
Total assets $2,330.1 $469.9 $3,730.1 $6,530.1
Capital expenditures $ 243.0 $ 1.0 $ 266.1 $ 510.1
Note 5: Long-term debt
On January 16, 2001, the Company completed a public offering of $750 million
aggregate principal amount of its 11 3/8% Senior Notes due January 1, 2009 (the
"January Senior Notes"), yielding net proceeds of approximately $734.3 million.
Interest on the January Senior Notes will be payable in cash semi-annually in
arrears on January 1 and July 1 of each year, commencing July 1, 2001.
Note 6: Effects of New Accounting Standards
Accounting for Derivative Instruments and Hedging
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, is effective for
fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and hedging activities by
requiring that entities recognize all derivatives as either assets or
liabilities at fair market value on the balance sheet. The Company does not
currently hold any derivative instruments or engage in hedging activities. As
such, the adoption of SFAS 133 as of January 1, 2001 had no effect on the
Company's operations.
8
Business Combinations and Intangible Assets--Accounting for Goodwill
On February 14, 2001, the FASB issued an Exposure Draft "Business Combinations
and Intangible Assets - Accounting for Goodwill." The Exposure Draft requires
the use of a non-amortization approach to account for purchased goodwill and for
separately recognized (non-goodwill) intangible assets that have an indefinite
useful economic life. Under this approach, goodwill and intangibles would not
be amortized, but would be written down and expensed against earnings only in
periods in which the recorded value exceeds the fair value. The Company has not
yet quantified the impacts of adopting the new Exposure Draft, but it could
result in significant changes to amortization expense and the classification and
recording of intangibles currently on the books, as well as any future
acquisitions.
Note 7: Subsequent events
Sale of PCS licenses
In May 2001, the Company announced the sale of two of its PCS licenses and
entered into agreements to sell the remainder of its PCS licenses to four buyers
for a combined total exceeding $100 million, subject to regulatory approval.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Statements included in this discussion relating, but not limited, to future
revenues, operating expenses, capital requirements, growth rates, cash flows,
operational performance, sources and uses of funds, acquisitions, and
technological changes and developments, are forward-looking statements that
involve certain risks and uncertainties. Factors that may cause the actual
results, performance, achievements or investments expressed or implied by such
forward-looking statements to differ materially from any future results,
performance, achievements or investments expressed or implied by such forward-
looking statements include, among other things, the availability of financing
and regulatory approvals, the number of potential customers in a target market,
the existence of strategic alliances and relationships, technological,
regulatory or other developments in our business, changes in the competitive
climate in which the we operate and the emergence of future opportunities and
other factors more fully described under the caption "Business--Risk Factors" in
the our Annual Report on Form 10-K for the fiscal year ended December 31, 2000,
filed with the Securities and Exchange Commission on March 30, 2001 and which
section is incorporated herein by reference.
Unless otherwise indicated, all dollar amounts in the following Management's
Discussion and Analysis of Financial Condition and Results of Operations that
exceed $1 million have been rounded to one decimal place and all dollar amounts
less than $1 million have been rounded to the nearest thousand.
Overview
We derive most of our revenue from our core business of providing communications
services, including:
. local and long distance services
. dial and dedicated Internet access
. higher bandwidth Internet access services, such as digital subscriber
line (DSL) and cable modem
. value-added services such as virtual private networks and web hosting
. bandwidth leasing and colocation services
. facilities and services dedicated for a particular customer's use
. telephone and computer sales, leasing, networking, service and
installation
. other communications services, including video, cellular, operator,
payphone,
mobile radio and paging services
We also derive revenue from the following services related to our core business:
. sale of advertising in print and electronic telephone directories
. traditional local telephone company services in east central Illinois
and southeast South Dakota
. telemarketing services
The table set forth below summarizes our percentage of revenues from these
sources:
Quarter Ended March 31,
-------------------------
2001 2000
---- ----
Communications services........................... 77% 68%
Directory services................................ 17 22
Local exchange services........................... 5 8
Other............................................. 1 2
---- ----
100% 100%
==== ====
10
We provide integrated communications services, including local services, in 25
Midwest, Southwest, Northwest and Rocky Mountain states. We also provide long
distance and advanced data services in all 50 states. We are a facilities-based
telecommunications provider with, as of March 31, 2001, 396 ATM switches, 50
voice switches, nearly 30,000 route miles of fiber optic network and
approximately 11,300 employees. Our fiber optic network is capable of
transmitting integrated next-generation data, Internet, video and voice
services, reaching 800 cities and approximately 90% of the U.S. population. In
the next 12 months, we plan to distribute 34 million telephone directories in 26
states, serving a population of 56 million. McLeodUSA is a Nasdaq-100 company
traded under the symbol "MCLD".
Our principal operating expenses consist of cost of service; selling, general
and administrative expenses ("SG&A"); and depreciation and amortization. Cost
of service primarily includes local and long distance services purchased from
certain MegaBells and interexchange carriers, the cost of providing local
exchange services in the independent local exchange service areas, and the cost
of printing and distributing telephone directories. SG&A consists of sales and
marketing, customer service and administrative expenses, including the costs
associated with operating our communications network. Depreciation and
amortization include depreciation of our communications network and equipment;
amortization of goodwill and other intangibles related to our acquisitions;
amortization expense related to the excess of estimated fair market value in
aggregate of options over the aggregate exercise price of such options granted
to some of our officers, other employees and directors; and amortization of one-
time direct installation costs associated with transferring customers' local
line service from the MegaBells to our local telecommunications service over the
life of the customer contract.
As we expand into new markets, both cost of service and SG&A will increase. We
expect to incur cost of service and SG&A expenses before achieving significant
revenues in new markets. Fixed costs related to leasing of central office
facilities needed to provide telephone services must be incurred in most markets
prior to generating revenue in new markets, while significant levels of
marketing activity may be necessary in the new markets in order for us to build
a customer base large enough to generate sufficient revenue to offset such fixed
costs and marketing expenses.
We have experienced operating losses since our inception as a result of efforts
to build our customer base, develop and construct our communications network
infrastructure, build our internal staffing, develop our systems and expand into
new markets. We expect to continue to focus on increasing our customer base and
geographic coverage and bringing our customer base onto our communications
network. Accordingly, we expect that our cost of service, SG&A and capital
expenditures will continue to increase significantly, all of which may have a
negative impact on operating results.
In addition, our projected additional capital expenditures will continue to
generate negative cash flows from construction activities during the next
several years while we install and expand our fiber optic communications
network. We may also be forced to change our pricing policies to respond to a
changing competitive environment, and we cannot assure you that we will be able
to maintain our operating margin. We cannot assure you that growth in our
revenue or customer base will continue or that we will be able to achieve or
sustain profitability or positive cash flows.
We have generated net operating losses since our inception and, accordingly,
have incurred no income tax expense. We have reduced the net deferred tax
assets generated by these losses by a valuation allowance which offsets the net
deferred tax asset due to the uncertainty of realizing the benefit of the tax
loss carry forwards. We will reduce the valuation allowance when, based on the
weight of available evidence, it is more likely than not that some portion or
all of the deferred tax assets will be realized.
Three Months Ended March 31, 2001 Compared with Three Months Ended
March 31, 2000
Total revenue increased from $288.3 million for the three months ended March 31,
2000 to $433.1 million for the three months ended March 31, 2001, representing
an increase of $144.8 million or 50%. Revenue from the sale of communications
services accounted for $138.2 million of this increase. The acquisition of
Splitrock and CapRock completed on March 30, 2000 and December 7, 2000,
respectively, accounted for $76.6 million of the increase in communication
services. The remaining increase in communication services revenue was driven
by the growth of our competitive customer base excluding additional customers
from acquisitions, to 314,700 customers, a 41% increase over March 31, 2000.
Directory revenues increased by $7.0 million or 11% to $71.8 million in 2001
primarily due to acquisitions in 2000.
11
Cost of service increased from $148.1 million for the three months ended March
31, 2000, to $246.1 million for the three months ended March 31, 2001,
representing an increase of $98.0 million or 66%. Cost of service primarily
includes local and long distance services purchased from certain MegaBells and
interexchange carriers, the cost of providing local exchange services in the
independent local exchange service areas, and the cost of printing and
distributing telephone directories. For the quarter ended March 31, 2001 the
inclusion of Splitrock and CapRock contributed $59.7 million to the increase.
Excluding Splitrock and CapRock, margins have remained relatively consistent.
SG&A increased from $122.2 million for the three months ended March 31, 2000 to
$164.6 million for the three months ended March 31, 2001, an increase of $42.4
million or 35%. The acquisition of Splitrock and CapRock accounted for
approximately $12.4 million of the increase. SG&A as a percentage of revenues
dropped from 42% for the period ending March 31, 2000 to 38% in 2001. This
decrease in SG&A as a percentage of revenues primarily resulted from the cost
savings achieved in combining the general and administrative functions of the
acquired companies with our own offset by increased sales and marketing and
customer support expenses incurred to support our internal growth and the
acquisitions. Our full-time equivalent employee base excluding Splitrock and
CapRock increased 19% from approximately 8,800 at March 31, 2000 to 10,500 at
March 31, 2001.
Depreciation and amortization expenses increased from $60.6 million for the
three months ended March 31, 2000 to $142.0 million for the three months ended
March 31, 2001, representing an increase of $81.4 million or 134%. Depreciation
and amortization related to the Splitrock and CapRock acquisitions contributed
approximately $45 million in the first quarter 2001. The remaining increase is
attributed to a higher asset base as a result of continued infrastructure
investment and increased assets placed in service. Capital expenditures totaled
$1,229.6 versus $734.5 for the twelve months ended March 31, 2001 and March 31,
2000, respectively.
Interest income decreased from $15.3 million for the three month period ended
March 31, 2000, to $6.7 million for the same period in 2001 as a result of a
lower average investment balance during the first quarter 2001.
Gross interest expense increased from $41.2 million for the first quarter of
2000 to $87.8 million for the first quarter of 2001. This increase was
primarily a result of interest on our Credit Facilities of $15.7 million,
interest on our 12% senior notes, 11 1/2% senior notes, and 11 3/8% senior
notes totaling $28.3 million and the increase in accretion of interest on our 10
1/2% senior discount notes of $1.6 million. Interest expense of approximately
$31.1 and $10.2 million was capitalized as part of our construction of fiber
optic network during the first quarter of 2001 and 2000, respectively.
Net loss applicable to common shares increased from $72.1 million for the three
months ended March 31, 2000 to $186.8 million for the three months ended March
31, 2001, an increase of $114.7 million. This increase resulted primarily from
the following four factors: (1) the expansion of our local and long distance
services, which requires significant expenditures, a substantial portion of
which is incurred before the realization of revenues; (2) the increased
depreciation expense related to the construction and expansion of our
communications networks and amortization of intangibles related to acquisitions;
(3) net interest expense on indebtedness to fund market expansion, network
development and acquisitions; and (4) dividends on preferred stock issued.
Liquidity and Capital Resources
Our total assets increased from $7.4 billion at December 31, 2000 to $7.8
billion at March 31, 2001. The increase is primarily due the proceeds from the
issuance of our $750 million senior notes offset by our net loss and payments of
current liabilities. At March 31, 2001, our current assets of $847.5 million
exceeded our current liabilities of $698.3 million, providing working capital of
$149.2 million, which represents an increase in working capital of $432.8
million compared to December 31, 2000. At December 31, 2000, our current
liabilities of $846.4 million exceeded current assets of $562.8 million,
creating a working capital deficit of $283.6 million.
The net cash used in operating activities totaled $239.1 million for the three
months ended March 31, 2001 and $16.6 million for the three months ended March
31, 2000. During the three months ended March 31, 2001, cash used in operating
activities was used primarily to fund our net loss of $186.8 million for such
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period, excluding the noncash impact of depreciation and amortization, to fund
the increase in our trade receivables, and to pay CapRock liabilities for
capital equipment assumed in the acquisition.
During the first quarter of 2001, we used $295.9 million in our investing
activities primarily to fund the expansion of our fiber optic network and the
acquisition of a directory company.
Our financing activities provided net cash of $745.7 million. On January 16,
2001, we completed an offering of $750.0 million aggregate principal amount of
our 11 3/8% senior notes due January 1, 2009, yielding net proceeds of
approximately $734.3 million. Interest on the notes is payable in cash semi-
annually in arrears on January 1 and July 1 of each year, commencing July 1,
2001. We also received proceeds of $21.3 million from the issuance of common
stock, partially offset by payments on long-term debt and preferred stock
dividends totaling $9.9 million.
In May 2001, we announced the sale of two of our PCS licenses and entered into
agreements to sell the remainder of our PCS licenses to four buyers for a
combined total exceeding $100 million, subject to regulatory approval.
On May 31, 2000, we entered into $1.3 billion of Senior Secured Credit
Facilities (together the "Credit Facilities") with a syndicate of financial
institutions. The credit facilities consist of (1) a seven year Senior Secured
Revolving Facility with an aggregate principal amount of $450 million (the
"Revolving Credit Facility"), (2) a seven year Senior Secured Multi-Draw Term
Loan Facility with an aggregate principal amount of $275 million ("Tranche A
Term Facility"), and (3) an eight year single draw Senior Secured Term Loan with
an aggregate principal amount of $575 million ("Tranche B Term Facility"). The
Tranche A Term Facility provides for multiple ($50 million minimum) draws for
the first 24 months of the agreement at which time any undrawn commitments
expire. At March 31, 2001, the Tranche B Term Facility was drawn in full and
the Tranche A Term Facility and Revolving Credit Facility remained undrawn.
Interest on the Credit Facilities is payable quarterly at LIBOR plus 1% to LIBOR
plus 3.25% based on the Company's debt rating. A commitment fee of 0.5% to 1.0%
per annum is charged on the undrawn portion of the commitment relating to the
Revolving Facility and the Tranche A Term Facility.
The Credit Facilities are secured by (1) a first priority pledge of all the
capital stock owned by us and by each subsidiary, and (2) a perfected first
priority security interest in substantially all our tangible and intangible
assets and, to the extent of $100 million, by the assets of each subsidiary. In
addition, telecommunications assets acquired with proceeds or refinanced from
the Credit Facilities serve as collateral.
The Credit Facilities impose operating and financial restrictions on us and our
subsidiaries. These restrictions affect, and in certain cases significantly
limit or prohibit, among other things, our ability and the ability of our
subsidiaries to incur additional indebtedness, pay dividends or make
distributions in respect of capital stock, make other restricted payments, enter
into sale and leaseback transactions, create liens upon assets, enter into
transactions with affiliates or related persons, sell assets, or consolidate,
merge or sell all or substantially all of their assets. These covenants also
require the maintenance of certain financial covenants and minimum access
service lines. We cannot assure you that such covenants will not adversely
affect our ability to finance our future operations or capital needs or to
engage in other business activities that may be in our interests.
Our 12% senior notes, 11 1/2% senior notes, 11 3/8% senior notes, 10 1/2%
senior discount notes, 9 1/2% senior notes, 9 1/4% senior notes, 8 3/8% senior
notes, and 8 1/8% senior notes (collectively the "Senior Notes") are senior
unsecured obligations of McLeodUSA, ranking pari passu in right of payment with
all other existing and future senior unsecured obligations of McLeodUSA and
senior to all existing and future subordinated debt of McLeodUSA. The Senior
Notes are effectively subordinated to all existing and future secured
indebtedness of McLeodUSA and our subsidiaries to the extent of the value of the
assets securing such indebtedness. The Senior Notes also are effectively
subordinated to all existing and future third-party indebtedness and other
liabilities of our subsidiaries.
13
The indentures governing our Senior Notes impose operating and financial
restrictions on our subsidiaries and us. These restrictions affect, and in many
cases significantly limit or prohibit, among other things, our subsidiaries'
ability to:
. incur additional indebtedness
. pay dividends or make distributions in respect of our or our
subsidiaries' capital stock
. redeem capital stock
. make other restricted payments
. enter into sale and leaseback transactions
. create liens upon assets
. enter into transactions with affiliates or related persons
. sell assets
. consolidate, merge or sell all or substantially all of our assets
We cannot assure you that such covenants in our various indentures will not
adversely affect our ability to finance our future operations or capital needs
or to engage in other business activities that may be in our interests.
As of May 3, 2001 based on our business plan, capital requirements and growth
projections as of that date, we estimate that we will require approximately $900
million from April 1, 2001 through 2002 to fund our planned capital
expenditures. Our estimated aggregate capital requirements include the
projected costs of:
. expanding our fiber optic communications network, including national
and intra-city fiber optic networks
. adding voice and data switches
. constructing, acquiring, developing or improving telecommunications
assets in existing and new markets
We expect to meet these funding needs through various sources, including
existing cash balances, the existing McLeodUSA lines of credit, prospective
sales of selected assets, exercises by employees of outstanding stock options
and cash flow from future operations.
Our estimate of future capital requirements is a forward-looking statement
within the meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The actual amount and timing of our future
capital requirements may differ substantially from our estimate due to factors
such as:
. strategic acquisition costs and effects of acquisitions on our
business plan, capital requirements and growth projections
. unforeseen delays
. cost overruns
. engineering design changes
. changes in demand for our services
. regulatory, technological or competitive developments
. new opportunities
We also expect to evaluate potential acquisitions, joint ventures and strategic
alliances on an ongoing basis. We may require additional financing if we pursue
any of these opportunities. We also require substantial funds for general
corporate and other expenses and may require additional funds for working
capital fluctuations.
14
We may meet any additional capital needs by issuing additional debt or equity
securities or borrowing funds from one or more lenders. In addition, in the
event vendor financing arrangements are available on terms that allow rates of
return comparable to current capital projects and are otherwise favorable to us,
we may use such financing to accelerate or increment the development of our
network. We cannot assure you that we will have timely access to additional
financing sources on acceptable terms.
Failure to generate or raise sufficient funds may require us to delay or abandon
some of our expansion plans or expenditures, which could have a material adverse
effect on our business, results of operations or financial condition. See
"Business--Risk Factors--Failure to Raise Necessary Capital Could Restrict Our
Ability to Develop Our Network and Services and Engage in Strategic
Acquisitions" in our Annual Report on Form 10-K.
Market Risk
At March 31, 2001, we recorded the marketable equity securities that we hold at
a fair value of $30.8 million. These securities have exposure to price risk. A
hypothetical ten percent adverse change in quoted market prices would amount to
a decrease in the recorded value of investments of approximately $3.1 million.
We believe our exposure to market price fluctuations on all other investments is
nominal due to the short-term nature of our investment portfolio.
Substantially all of our long-term debt obligations are fixed rate obligations
which do not expose us to material future earnings or cash flow exposure from
changes in interest rates. We have $575 million of variable rate debt
outstanding at March 31, 2001 under the Tranche B Term Facility. If market
interest rates average 1% more in subsequent quarters than the rates during the
quarter ended March 31, 2001, quarterly interest expense would increase by $1.4
million. This amount was determined by calculating the effect of the
hypothetical interest rate increase on our variable rate debt for the quarter
and does not assume changes in our financial structure.
Effects of New Accounting Standards
Accounting for Derivative Instruments and Hedging Activities
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended, is effective for
fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and hedging activities by
requiring that entities recognize all derivatives as either assets or
liabilities at fair market value on the balance sheet. The Company does not
currently hold any derivative instruments or engage in hedging activities. As
such, the adoption of SFAS 133 as of January 1, 2001, had no effect on the
Company's operations.
Business Combinations and Intangible Assets--Accounting for Goodwill
On February 14, 2001, the FASB issued an Exposure Draft "Business Combinations
and Intangible Assets - Accounting for Goodwill." The Exposure Draft requires
the use of a non-amortization approach to account for purchased goodwill and for
separately recognized (non-goodwill) intangible assets that have an indefinite
economic useful life. Under this approach, goodwill and intangibles would not
be amortized, but would be written down and expensed against earnings only in
periods in which the recorded value exceeds the fair value. We have not yet
quantified the impacts of adopting the new Exposure Draft, but it could result
in significant changes to amortization expense and the classification and
recording of intangibles currently on the books, as well as any future
acquisitions.
Inflation
We do not believe that inflation has had a significant impact on our
consolidated operations.
15
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
-------
Number Exhibit Description
------ -------------------
11.1 Statement regarding computation of loss per common share.
(b) Reports on Form 8-K
On May 7, 2001, we filed a Current Report on Form 8-K (1) to report our
financial and operating results for the first quarter 2001 and (2) to report our
sale of PCS licenses.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
McLEODUSA INCORPORATED
(registrant)
Date: May 15, 2001 By: /s/ Stephen C. Gray
-------------------------------------
Stephen C. Gray
President and Co-Chief
Executive Officer
Date: May 15, 2001 By: /s/ J. Lyle Patrick
-------------------------------------
J. Lyle Patrick
Chief Financial Officer
17
INDEX TO EXHIBITS
Sequentially
Exhibit Numbered
Number Exhibit Description Page
--------- ------------------- ------------
11.1 Statement regarding computation of loss per common share.