1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
( x ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1996
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
MCLEOD, INC.
(Exact name of registrant as specified in its charter)
Delaware 58-421407240
(State of Incorporation) (IRS Employer Identification No.)
221 Third Avenue S.E.,
Suite 500, Cedar Rapids Iowa 52401
(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 No X
--- ---
The number of shares outstanding of each class of the issuer's common
stock as of August 7, 1996:
Common Stock Class A: ($.01 par value)...............30,753,784 shares
Common Stock Class B: ($.01 par value)...............15,625,929 shares
2
INDEX
PART I. Financial Information Page
- -----------------------------------
Item 1. Financial Statements............................................................ 2
Consolidated Balance Sheets, June 30, 1996 (unaudited)
and December 31, 1995 .......................................................... 2
Unaudited Consolidated Statements of Operations for the
three and six months ended June 30, 1996 and 1995.............................. 3
Unaudited Consolidated Statements of Cash Flows for the
six months ended June 30, 1996 and 1995......................................... 4
Notes to Consolidated Financial Statements (unaudited)......................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ................................. 7
PART II - Other Information
- --------------------------------
Item 1. Legal Proceedings............................................................... 16
Item 4. Submission of Matters to a Vote of Security-Holders ............................ 17
Item 6. Exhibits and Reports on Form 8-K ............................................... 18
Signatures ................................................................................... 19
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MCLEOD, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1996 1995 *
-------------- ---------------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $232,019,068 ------
Trade receivables, less allowance for doubtful accounts and
discounts 1995 $219,000; 1996 $280,000 12,975,005 6,689,069
Inventory (Note 2) 3,075,351 2,638,829
Prepaid expenses and other 1,458,181 295,689
-------------- ---------------
TOTAL CURRENT ASSETS 249,527,605 9,623,587
-------------- ---------------
Property and Equipment
Land 309,539 310,917
Telecommunication networks 14,870,155 7,696,101
Equipment 10,538,142 6,100,470
Networks in progress 12,841,810 3,115,361
-------------- ---------------
38,559,646 17,222,849
Less accumulated depreciation 3,337,089 2,144,615
-------------- ---------------
35,222,557 15,078,234
-------------- ---------------
Intangible and Other Assets
Deferred line installation costs, less accumulated amortization
1995 $518,000; 1996 $737,000 1,705,252 1,424,685
Goodwill, less accumulated amortization 1995 $117,000; 1996 $205,000 2,436,333 2,525,091
Other 407,746 334,855
-------------- ---------------
4,549,331 4,284,631
-------------- ---------------
$289,299,493 $28,986,452
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $14,848,252 $5,832,543
Checks issued not yet presented for payment ------ 918,932
Accrued payroll and payroll related expenses 2,503,400 1,954,621
Other accrued liabilities 1,653,497 874,916
Deferred revenue, current portion 602,664 134,325
-------------- ---------------
TOTAL CURRENT LIABILITIES 19,607,813 9,715,337
-------------- ---------------
Long-Term Debt (Note 4) ------ 3,600,000
-------------- ---------------
Deferred Revenue, less current portion 3,762,281 713,173
-------------- ---------------
Commitments
Stockholders' Equity
Capital stock:
Preferred, Class A, $5.50 par value; authorized 1,150,000 shares; none
issued ------ ------
Preferred, $.01 par value; authorized 2,000,000 shares; none issued; terms
determined upon issuance ------ ------
Common, Class A, $.01 par value; authorized 75,000,000 shares; issued
1995 16,387,081 shares; 1996 30,210,519 302,105 163,871
Common, Class B, convertible, $.01 par value; authorized 22,000,000 shares;
issued 1995 and 1996 15,625,929 shares 156,259 156,259
Additional paid-in capital 299,833,502 40,117,164
Accumulated deficit (34,362,467) (25,479,352)
-------------- ---------------
265,929,399 14,957,942
-------------- ---------------
$289,299,493 $28,986,452
============== ===============
* Condensed from audited financial statements
See Notes to Consolidated Financial Statements
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MCLEOD, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -----------------------------
1996 1995 1996 1995
--------------- ------------ ------------- --------------
Telecommunications revenue $13,918,304 $6,657,421 $26,405,823 $11,418,728
--------------- ------------ ------------- --------------
Operating expenses:
Cost of service 9,474,008 4,361,335 18,723,990 7,628,002
Selling, general and administrative 7,631,403 4,310,719 13,976,310 8,289,459
Depreciation and amortization 1,604,235 445,585 2,572,849 763,238
--------------- ------------ ------------- --------------
TOTAL OPERATING EXPENSES 18,709,646 9,117,639 35,273,149 16,680,699
--------------- ------------ ------------- --------------
OPERATING LOSS (4,791,342) (2,460,218) (8,867,326) (5,261,971)
Financial income (expense):
Interest income 503,842 27,459 504,891 27,510
Interest (expense) (255,309) (332,378) (520,679) (487,396)
--------------- ------------ ------------- --------------
LOSS BEFORE INCOME TAXES (4,542,810) (2,765,137) (8,883,115) (5,721,857)
Income Taxes ------- ------- ------- -------
--------------- ------------ ------------- --------------
NET LOSS ($4,542,810) ($2,765,137) ($8,883,115) ($5,721,857)
=============== ============ ============= ==============
Loss per common and common
equivalent share ($0.11) ($0.07) ($0.23) ($0.15)
=============== ============ ============= ==============
Weighted average common and
common equivalent shares
outstanding 39,968,386 37,055,053 38,511,720 37,054,553
=============== ============ ============= ==============
See Notes to Consolidated Financial Statements
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MCLEOD, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1996 JUNE 30, 1995
------------------ ------------------
Cash Flows from Operating Activities
Net loss ($8,883,115) ($5,721,857)
Adjustments to reconcile net loss to net cash ( used in)
operating activities:
Depreciation 1,197,499 560,187
Amortization 1,716,515 460,051
Changes in assets and liabilities, net of effects of
purchase of MWR Telecom Inc.
(Increase) in trade receivables (6,285,935) (906,170)
(Increase) in inventory (436,522) (92,023)
(Increase) in deferred line installation costs (500,009) (445,875)
Increase in accounts payable and accrued
expenses 7,003,339 1,343,620
Increase (decrease) in deferred revenue 3,517,448 (14,263)
Other, net (1,167,521) (194,917)
---------------- ----------------
NET CASH (USED IN) OPERATING ACTIVITIES (3,838,301) (5,011,247)
---------------- ----------------
Cash Flows from Investing Activities
Purchase of property and equipment (17,997,066) (564,069)
Other (258,038) (267,749)
---------------- ----------------
NET CASH (USED IN) INVESTING ACTIVITIES (18,255,104) (831,818)
---------------- ----------------
Cash Flows from Financing Activities
Decrease in checks issued not yet presented for
payment (918,932) (34,115)
Proceeds from line of credit agreement 34,400,000 33,400,000
Payments on line of credit agreement (38,000,000) (35,100,000)
Net proceeds from issuance of common stock 258,631,405 14,000,000
Reissuance of treasury stock -- 39,000
---------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 254,112,473 12,304,885
---------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 232,019,068 6,461,820
Cash and cash equivalents:
Beginning -- --
---------------- ----------------
Ending $232,019,068 $6,461,820
================ ================
Supplemental Disclosure of Cash Flow Information
Cash payment for interest, net of interest
capitalized 1995 $5,889; 1996 $204,056 $408,291 $227,782
================ ================
Supplemental Schedule of Noncash Investing and
Financing Activities
Accounts payable incurred for property and equipment $4,573,509 $66,548
================ =================
Acquisition of MWR Telecom Inc.:
Working capital acquired, net $392,508
Fair value of other assets acquired, principally fiber optic
telecommunication networks 5,298,082
Goodwill 2,641,807
----------------
Stock issued $8,332,397
================
See Notes to Consolidated Financial Statements
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MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1995 AND
1996 IS UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
Interim Financial Information (unaudited): The financial statements
and notes related thereto as of June 30, 1996, and for the three and six month
periods ended June 30, 1995 and 1996, are unaudited, but in the opinion of
management include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the 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. Not all disclosures required by generally accepted accounting
principles necessary for a complete presentation have been included. It is
recommended that these consolidated condensed financial statements be read in
conjunction with the Registration Statement on Form S-1 and all related
amendments and exhibits (including all financial statements and notes therein),
filed by the Company with the Securities and Exchange Commission in connection
with its IPO (as defined in Note 3, below), and declared effective on June 10,
1996.
NOTE 2: INVENTORIES
Inventory is carried principally at the lower of average cost or
market and consists primarily of new and reusable parts to maintain and build
fiber optic networks. Inventories of approximately $1.6 million used to
support a maintenance agreement are amortized on a straight-line basis over the
10-year life of the agreement.
NOTE 3: OFFERING
On June 14, 1996, the Company completed an initial public offering of
its Class A Common Stock (the "IPO"). The Company issued 13,800,000 shares at
an initial public offering price of $20.00 per share. The total proceeds from
the IPO, net of underwriting discounts and expenses, were approximately $259
million.
NOTE 4: DEBT
Immediately following completion of the IPO, the Company paid off all
existing indebtedness on its credit facility with the First National Bank of
Chicago (the "Credit Facility") with proceeds from the IPO. The Credit
Facility was subsequently canceled.
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MCLEOD, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1995 AND
1996 IS UNAUDITED)
NOTE 5: SUBSEQUENT EVENTS
On July 15, 1996, the Company acquired Ruffalo, Cody & Associates,
Inc., an Iowa corporation ("Ruffalo, Cody"), for a total purchase price of up
to approximately $4.9 million in cash, 474,807 shares of Class A Common Stock
issuable in exchange for Ruffalo, Cody common stock and 158,009 shares of Class
A Common Stock issuable upon the exercise of options to purchase 158,009 shares
of Class A Common Stock, which options were granted in exchange for
cancellation of certain Ruffalo, Cody stock options (the "Substitute Options").
On July 15, 1996, the Company paid Ruffalo, Cody and its shareholders an
aggregate of approximately $4.8 million in cash, 361,420 shares of Class A
Common Stock, and Substitute Options to purchase 158,009 shares of Class A
Common Stock. An additional $50,782 in cash and 113,387 shares of Class A
Common Stock were placed into escrow by the Company, and will be delivered to
the shareholders of Ruffalo, Cody over a period of 18 months, contingent upon
the fulfillment of certain conditions relating to Ruffalo, Cody's ongoing
revenues. The Company will record the Ruffalo, Cody acquisition as a purchase
for accounting purposes.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company is a provider of integrated local and long distance
telecommunications services to small and medium-sized businesses primarily in
Iowa and Illinois. The Company derives its telecommunications revenue from (i)
the sale of "bundled" local and long distance telecommunications services to
end users, (ii) telecommunications network maintenance services and (iii)
competitive access services, including special access and private line
services. The Company offers "one-stop" integrated telecommunications services
tailored to the customer's individual needs. This approach simplifies the
customer's telecommunications procurement and management tasks and provides for
customized services, such as "least-cost" long distance pricing and enhanced
calling features, to customers who might otherwise be unable to secure such
services directly on a cost-effective basis. The Company also operates a
competitive access provider that offers a variety of special access and private
line services to 74 large businesses, institutional customers and
interexchange carriers. In addition, the Company provides network maintenance
services for the State of Iowa's fiber optic network. As of June 30, 1996, the
Company served over 10,550 customers in 54 cities and towns.
The Company was formed on June 6, 1991 as McLeod Telecommunications,
Inc. It began operations in November of 1992, providing fiber optic
maintenance services for the Iowa Communications Network. On August 1, 1993,
the Company was reincorporated in the State of Delaware. McLeod
Telemanagement, Inc. ("McLeod Telemanagement") received regulatory approvals
in Iowa and Illinois to offer local and long distance services in December 1993
and began providing such services in January 1994. In April 1995, the Company
acquired all of the outstanding stock of MWR Telecom Inc. ("MWR"), a
competitive access provider in Des Moines, Iowa.
The Company is organized as a holding company and operates through
four wholly owned subsidiaries: (i) McLeod Telemanagement, which is the
Company's retail marketing and sales entity, providing "telemanagement"
services for small and medium-sized business customers and residential
customers; (ii) MWR, which provides competitive access services to
interexchange carriers and other high-volume users of telecommunications
services, primarily in Des Moines, Iowa; (iii) McLeod Network Services, Inc.,
which is engaged in network construction; and (iv) McLeod Telecommunications,
Inc., which is engaged in the Company's network maintenance activities.
The Company currently derives its telecommunications revenue from (i)
the sale of local and long distance telecommunications services to end users,
(ii) telecommunications network maintenance services and (iii) special access
and private line services. The table set forth below summarizes the Company's
percentage of revenues from these sources:
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Six Months
Ended
June 30,
------------
1995 1996
---- -----
Local and long distance telecommunications
services . . . . . . . . . . . . . . . . . . . . 76% 68%
Telecommunications network maintenance
services . . . . . . . . . . . . . . . . . . . . 20% 11%
Special access and private line services . . . . 4% 21%
-- ---
100% 100%
----- -----
The Company began offering "bundled" local and long distance services
to business customers in January 1994. At the end of 1995, the Company began
marketing and providing long distance services to residential customers. The
Company currently plans to continue its efforts to market and provide local and
long distance telecommunications services to business customers and plans to
accelerate its efforts to market such services to residential users by employing
additional telemarketing sales personnel. The Company believes its efforts to
market its residential telecommunications services offering, known as Primeline
(TM), will be enhanced by its July 1996 acquisition of Ruffalo, Cody &
Associates ("Ruffalo, Cody"), a firm with expertise in telemarketing sales of
telecommunications services. Because its revenue from network maintenance is
derived almost exclusively from the Iowa Communications Network Maintenance
Contract and such revenue is expected to increase more slowly than the Company's
other types of revenue, the Company expects that revenue derived from network
maintenance services will continue to constitute a decreasing percentage of the
Company's revenue in the future. The percentage increase in revenue from
special access and private line services for the six months ended June 30, 1996
was primarily due to the revenue from a one-time construction and sale of a
fiber optic network. Excluding the revenue from this project, the percentage of
total revenues from the three sources would have been 76%, 12% and 12%,
respectively.
The Company's principal operating expenses consist of cost of service;
selling, general and administrative expenses ("SG&A"); and depreciation and
amortization. Cost of service includes local services purchased from two
Regional Bell Operating Companies, costs to terminate the long distance calls
of the Company's customers through an interexchange carrier, costs associated
with maintaining the Iowa Communications Network and costs associated with
operating the Company's network. SG&A consists of selling and marketing,
customer service and corporate administrative expenses. Depreciation and
amortization include depreciation of the Company's telecommunications network
and equipment; amortization of goodwill related to the Company's acquisition of
MWR; amortization expense related to the excess of estimated fair market value
in aggregate of certain options over the aggregate exercise price of such
options granted to certain officers, other employees, and directors; and
amortization of one-time installation costs associated with transferring
customers' local line service from the Regional Bell Operating Companies to the
Company's telemanagement service.
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As the Company expands into new markets, both cost of service and SG&A
will increase. The Company expects to incur SG&A expenses prior to achieving
significant revenues in new markets. Significant levels of marketing activity
may be necessary in new markets in order for the Company to build a customer
base large enough to generate sufficient revenue to offset such marketing
expenses. In addition, SG&A may increase as a percentage of revenue in the
short term after the Company enters a new market, because many of the fixed
costs of providing service in new markets are incurred before significant
revenue can be expected from those markets.
The Company has experienced operating losses since its inception as a
result of efforts to build its customer base, develop and construct its network
infrastructure, build its internal staffing, develop its systems and expand
into new markets. The Company expects to continue to focus on increasing its
customer base and geographic coverage. Expansion of the Company's operations
and facilities, network and services will require significant capital
expenditures. Accordingly, the Company expects that its cost of service, SG&A
and capital expenditures will continue to increase significantly, all of which
may have a negative impact on operating results. The Company expects to incur
significant operating losses and to generate negative cash flows from operating
and construction activities during the next several years while it develops
its business and installs and expands its fiber optic network.
The Company has generated net operating losses since its inception
and, accordingly, has incurred no income tax expense. The Company has 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 carryforwards. The Company 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 JUNE 30, 1996 COMPARED WITH
THREE MONTHS ENDED JUNE 30, 1995
Telecommunications revenue increased from $6.7 million for the three
months ended June 30, 1995 to $13.9 million for the three months ended June 30,
1996, representing an increase of $7.2 million or 109%. Revenue from the sale
of local and long distance telecommunications services accounted for $4.6
million of this increase. There also was an increase of $2.4 million related to
special access and private line services, of which $1.1 million was a one-time
construction and sale of a fiber optic network.
Revenue from telecommunications network maintenance services for the three
months ended June 30, 1996 was $1.5 million, compared to $1.2 million for the
second quarter of 1995. This increase was primarily attributable to additional
services provided to the State of Iowa. The Company acquired MWR, a
competitive access provider that offers special access and private line
services, in April 1995 in an acquisition accounted for as a purchase. MWR
represented $393,000 and $862,000 of the Company's revenue, respectively, for
the three months ended June 30, 1995 and 1996.
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Cost of service increased from $4.4 million for the three months ended
June 30, 1995, to $9.5 million for the three months ended June 30, 1996,
representing an increase of $5.1 million or 117%. This increase in cost of
service resulted primarily from costs for providing local and long distance
services and costs of $884,000 related to the one-time construction and
sale of a fiber optic network discussed above. Cost of service as a
percentage of telecommunication revenue increased from 66% for the three months
ended June 30, 1995 to 68% for the three months ended June 30, 1996. While the
cost of providing local and long-distance services remained the same as a
percentage of the local and long-distance telecommunications revenue, the
overall 2% increase was principally due to the low margin realized on the
one-time construction and sale of a fiber optic network.
SG&A increased from $4.3 million for the three months ended June 30,
1995 to $7.6 million for the three months ended June 30, 1996, an increase of
$3.3 million or 77%. This increase was due to increased compensation resulting
from selling and customer support activities of $1.3 million, additional
administrative personnel expenses of $788,000 and associated costs of $1.2
million required to handle the growth experienced primarily in local and long
distance services.
Depreciation and amortization expenses increased from $446,000 for the
three months ended June 30, 1995 to $1.6 million for the three months ended
June 30, 1996, representing an increase of $1.2 million or 260%. The increase
consisted of $567,000 of amortization expense related to the excess of
estimated fair market value in aggregate of certain options over the aggregate
exercise price of such options granted to certain officers, other employees and
directors; depreciation of $184,000 related to the additional fiber optic
network purchased and built during 1995 and the first six months of 1996;
$87,000 resulting from the amortization of one-time installation costs
primarily associated with transferring customers' local line service from the
Regional Bell Operating Companies to the Company's telemanagement service;
$310,000 of depreciation related to capital costs associated with the growth of
the Company; and amortization of goodwill of $11,000 related to the Company's
acquisition of MWR in April 1995.
Net interest expense decreased from $332,000 for the second quarter of
1995 to $255,000 for the second quarter of 1996. The net decrease is primarily
a result of increased amortization expense related to the excess of estimated
fair market value in aggregate of certain options over the aggregate exercise
price of such options granted to non-employees relative to a credit facility
entered into in 1995; offset by lower interest expense on reduced borrowings as
a result of the Company's payment of all amounts outstanding under its lines of
credit with the First National Bank of Chicago (the "Credit Facility") in June
1996 with a portion of the proceeds from the Company's initial public offering
("IPO"); and the capitalization of interest costs in the amounts of $6,000 and
$143,000 for the three-month periods ended June 30, 1995 and 1996 respectively.
Interest income increased from $27,000 for the three-month period
ended June 30, 1995, to $504,000 for the same period in 1996. This increase
resulted from additional
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highly liquid interest-bearing investments made in June 1996 with a portion of
the proceeds from the IPO.
Net loss increased from $2.8 million for the three months ended June
30, 1995 to $4.5 million for the three months ended June 30, 1996, an increase
of $1.7 million. This increase resulted primarily from the expansion of the
local and long distance businesses and amortization expense related to stock
options granted to certain officers, other employees and directors. The
development of the Company's business and the construction and expansion of its
network require significant expenditures, a substantial portion of which is
incurred before the realization of revenues.
SIX MONTHS ENDED JUNE 30, 1996, COMPARED WITH
SIX MONTHS ENDED JUNE 30, 1995
Telecommunications revenue increased from $11.4 million for the
six-month period ended June 30, 1995, to $26.4 million for the same period in
1996, representing an increase of $15.0 million or 131%. Revenue from the
sale of local and long distance telecommunications services accounted for $9.3
million of this increase. There also was an increase of $5.0 million related to
special access and private line services, of which $2.8 million was a one-time
construction and sale of a fiber-optic network.
Revenue from telecommunications network maintenance services was $3.0
million for the six-month period ended June 30, 1996, and $2.3 million for the
corresponding period in 1995. This increase was primarily attributable to
increased revenues from the Company's Iowa Communications Network Maintenance
Contract. The Company acquired MWR, a competitive access provider that offers
most of the Company's special access and private line services, in April 1995
in an acquisition accounted for as a purchase. MWR represented $393,000 and
$1.7 million, respectively, of the Company's revenue for the six-month periods
ending June 30, 1995 and 1996.
Cost of service increased from $7.6 million for the six-month period
ended June 30, 1995, to $18.7 million for the six-month period ended June 30,
1996, an increase of $11.1 million or 145%. This increase in cost of service
resulted primarily from costs for providing local and long distance services.
Cost of service as a percentage of telecommunications revenue increased from
67% for the six-month period ended June 30, 1995 to 71% for the six-month
period ended June 30, 1996. While the cost of providing local and long-distance
services decreased as a percentage of the local and long-distance
telecommunications revenue by less than 1%, the overall 4% increase was
principally due to the low margin realized on the one-time construction and
sale of a fiber optic network.
SG&A increased from $8.3 million for the six-month period ended June
30, 1995 to $14.0 million for the six-month period ended June 30, 1996, an
increase of $5.7 million or 69%. This increase was due to increased
compensation resulting from selling and customer support activities of $2.4
million, additional administrative personnel expenses of $1.2 million and
associated costs of $2.1 million required to handle the growth experienced
primarily in local and long distance revenues.
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Depreciation and amortization expenses increased from $763,000 for the
six-month period ended June 30, 1995 to $2.6 million for the six-month period
ended June 30, 1996, an increase of $1.8 million or 237%. This increase
consisted of $882,000 of amortization expense related to the excess of
estimated fair market value in aggregate of certain options over the aggregate
exercise price of such options granted to certain officers, other employees,
and directors; depreciation of $359,000 related to the additional fiber optic
network purchased and built during 1995 and the first six months of 1996;
$367,000 of depreciation related to capital costs associated with the growth of
the Company; $145,000 resulting from the amortization of one-time installation
costs primarily associated with transferring customers' local line service from
the Regional Bell Operating Companies to the Company's telemanagement service;
and amortization of goodwill of $56,000 related to the Company's acquisition of
MWR in April 1995.
Net interest expense increased from $487,000 for the first half of 1995
to $521,000 for the first half of 1996. The net increase is primarily a result
of increased amortization expense related to the excess of estimated fair
market value in aggregate of certain options over the aggregate exercise price
of such options granted to non-employees relative to a credit facility entered
into in 1995; offset by lower interest expense on reduced borrowings as a
result of the Company's payment of all amounts outstanding under its Credit
Facility in June 1996 with a portion of the proceeds from the IPO; and the
capitalization of interest costs in the amounts of $6,000 and $204,000 for the
six-month periods ended June 30, 1995 and 1996, respectively.
Interest income increased from $27,000 for the six-month period ended
June 30, 1995 to $505,000 for the same period in 1996. This increase resulted
from additional highly liquid interest-bearing investments made in June 1996
with a portion of the proceeds of the IPO.
Net loss increased from $5.7 million for the six-month period ended
June 30, 1995 to $8.9 million for the six-month period ended June 30, 1996, an
increase of $3.2 million. This increase resulted primarily from the expansion
of the local and long distance businesses and amortization expense related to
stock options granted to certain officers, other employees, and directors. The
development of the Company's business and the construction and expansion of its
network require significant expenditures, a substantial portion of which is
incurred before the realization of revenues.
LIQUIDITY AND CAPITAL RESOURCES
Since the inception of the Company in June 1991, the Company's total
assets have grown to $289.3 million at June 30, 1996. At June 30, 1996, $35.2
million of the total assets consisted of property and equipment, net of
depreciation. The growth of the Company has been funded through private sales
of equity securities yielding proceeds of $41.0 million, drawings under the
Credit Facility, and net proceeds of $258.6 million from the IPO. At June 30,
1996,
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the Company's current assets of $249.5 million exceeded its current liabilities
of $19.6 million, providing working capital of $229.9 million, which
represents an improvement of $230.0 million compared to December 31, 1995 as a
result of the Company's successful completion of the IPO. At December 31,
1995, the Company's current liabilities of $9.7 million exceeded current
assets of $9.6 million, resulting in a working capital deficit of $92,000.
This working capital deficit resulted from the growth experienced by the
Company, the increase in working capital components and the substantial
investment in property and equipment.
The net cash used in operating activities totaled $3.8 million for the
six months ended June 30, 1996 and $9.5 million for the year ended December
31, 1995. During the six months ended June 30, 1996, cash for operating
activities was used primarily to fund the Company's net loss of $8.9 million
for such period. The Company also required cash to fund the growth in trade
receivables of $6.3 million and other assets of $937,000 as a result of the
growth in local and long distance telecommunications services and special
access and private line services. These uses of cash were partially offset by
an increase in accounts payable and accrued expenses of $7.0 million due to the
costs associated with the increase in telecommunications revenue, an increase
in deferred revenue of $3.5 million resulting primarily from amounts received
in advance from completed segments under long-term leases of fiber optic
telecommunication networks and an increase in depreciation and amortization
expense. During the year ended December 31, 1995, cash for operating activities
was used primarily to fund the Company's net loss of $11.3 million for such
period. The Company also required cash to fund the growth in trade receivables
of $3.6 million and deferred line installation costs of $800,000 as a result of
the growth in local and long distance telecommunications services and entry
into special access and private line services. The use of cash during the year
ended December 31, 1995 was partially offset by an increase in accounts payable
and accrued expenses of $4.1 million due to the costs associated with the
increase in telecommunications revenue and an increase in depreciation and
amortization expense.
The Company's investing activities used cash of $18.3 million during
the six months ended June 30, 1996 and $5.5 million during the year ended
December 31, 1995 primarily as a result of its continued development and
expansion of its fiber optic telecommunications network. During 1994, the
Company started building its tele management business by offering local and
long distance services to business customers through the purchase of Centrex
services from two Regional Bell Operating Companies and interexchange carrier
services for termination of long distance calls. The equipment required for the
growth of the telemanagement business and the Company's development and
construction of its fiber optic telecommunications network resulted in
purchases of equipment and fiber optic cable totaling $18.0 million
and $5.3 million during the six months ended June 30, 1996 and the year ended
December 31, 1995, respectively.
Cash received from net financing activities was $254.1 million during
the six months ended June 30, 1996, primarily as a result of the IPO. The
Company paid off and canceled the Credit Facility with a portion of the IPO
proceeds during the same period. Cash received from financing activities
during 1995 was $15.0 million and was primarily obtained
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through the issuance of Common Stock for an aggregate purchase price of $14.0
million in a private placement transaction. In addition, in April 1995 the
Company issued Class B Common Stock valued at $8.3 million to acquire MWR.
On July 15, 1996, the Company acquired Ruffalo, Cody, which will
continue to provide affinity telemarketing services as a wholly owned
subsidiary of the Company. The total purchase price for the acquisition
consisted of up to $4.9 million in cash, 474,807 shares of Class A Common Stock
issuable in exchange for Ruffalo, Cody common stock and 158,009 shares of Class
A Common Stock issuable upon the exercise of options to purchase 158,009 shares
of Class A Common Stock, which options were granted in exchange for
cancellation of certain Ruffalo, Cody stock options (the "Substitute Options").
On July 15, 1996, the Company paid Ruffalo, Cody and its shareholders an
aggregate of $4.8 million in cash, 361,420 shares of Class A Common Stock, and
Substitute Options to purchase 158,009 shares of Class A Common Stock. An
additional $50,782 in cash and 113,387 shares of Class A Common Stock were
placed into escrow by the Company, and will be delivered to the shareholders of
Ruffalo, Cody over a period of 18 months, contingent upon the fulfillment of
certain conditions relating to Ruffalo, Cody's ongoing revenues. The Company
will record the Ruffalo, Cody acquisition as a purchase for accounting purposes.
The Company's cash management practices result in a short-term float
position at the end of most months, which is reflected on the Company's balance
sheet as checks issued not yet presented for payment. This position is due
primarily to the timing of payments on telecommunications line capacity
purchased from U S WEST Communications, Inc. ("U S West") and Ameritech
Corporation ("Ameritech"). The Company generally writes checks
every Friday for outstanding bills due within the next seven days. The Company
releases the checks on the appropriate due dates.
At December 31, 1995, the Company had actual remaining contractual
capital commitments of $8.7 million for costs associated with the construction
of fiber optic networks. The Company estimates its capital requirements for
1996, 1997 and 1998 will be, in the aggregate, approximately $157.0 million.
These capital commitments and requirements are expected to be funded, in large
part, by the net proceeds of the IPO and by lease payments to the Company for
portions of the Company's network.
The Company expects that it will require additional capital in the
future for funding operating losses and working capital as well as continuing
expansion into new markets and further network development and construction. In
addition, the Company expects to explore alternatives to permit it to provide
PCS and other wireless services and may decide to pursue the acquisition of PCS
licenses or other strategic acquisitions, which could require substantial
additional capital. The Company expects to meet its additional capital needs
with the proceeds from credit facilities and other borrowings to be negotiated
in the future, public and private debt and equity financings, and possible
joint ventures. There can be no assurance that the Company will be successful
in producing sufficient cash flows or raising sufficient debt or equity capital
to enable it to meet its strategic objectives or that such funds, if available
at all, will be available on a timely basis or on terms that are acceptable to
the Company.
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INFLATION
The Company does not believe that inflation has had a significant
impact on the Company's consolidated operations.
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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company is dependent on the Regional Bell Operating
Companies for provision of its local and certain of its long distance
services. U S WEST and Ameritech are currently the Company's sole
suppliers of access to local central office switches. The Company uses
such access to partition the local switch and provide local service to
its customers.
The Company purchases access in the form of a product
generally known as "Centrex." Without such access, the Company could
not currently provide bundled local and long distance services,
although it could provide stand-alone long distance service. Since the
Company believes its ability to offer bundled local and long distance
services is critical to its current sales efforts, any successful
effort by U S WEST or Ameritech to deny or substantially limit the
Company's access to partitioned switches would have a material adverse
effect on the Company.
On February 5, 1996, U S WEST filed tariffs and other notices
announcing its intention to limit future Centrex access to its
switches by Centrex customers (including the Company) throughout U S
WEST's fourteen-state service region, effective February 5, 1996.
Although U S WEST stated that it would "grandfather" existing Centrex
agreements with the Company and permit the Company to continue to use
U S WEST's central office switches through April 29, 2005, it also
indicated that it would not permit the Company to expand to new cities
and would severely limit the number of new lines it would permit the
Company to partition onto U S WEST's portion of the switches in cities
currently served by the Company. Because of U S WEST's commitment to
"grandfather" service to the Company, the Company does not believe its
current customers are at risk that service will be interrupted. The
Company has challenged, or is challenging, the U S WEST Centrex Action
before the public utilities commissions in each of the states served
by U S WEST where the Company is doing business or currently plans to
do business. The Company based such challenges on various state and
federal laws, regulations and regulatory policies, including Sections
251(b)(1) and 251(c)(4)(B) of the Telecommunications Act, which the
Company believes impose upon the Regional Bell Operating Companies the
duty not to prohibit, and not to impose unreasonable or discriminatory
conditions or limitations on, the resale of their telecommunications
services, and Section 251(c)(4)(A) of the Telecommunications Act,
which the Company believes obligates the Regional Bell Operating
Companies to offer for resale at wholesale rates any telephone
communications services that are provided at retail to subscribers who
are not telecommunications carriers. Additional statutes cited in the
Company's challenges include provisions of the laws of Iowa, Minnesota
and Colorado, which the Company believes prohibit restrictions on the
resale of local exchange services, functions or capabilities; prohibit
local exchange carriers from refusing access by other carriers to
essential facilities on the same terms and conditions as the local
exchange carrier provides to itself; and prohibit the provision of
carrier services pursuant to rates, terms and conditions that are
unreasonably discriminatory.
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In Iowa, the Company filed a complaint with the Iowa Utilities
Board against U S WEST's actions and was granted interim relief on an
ex parte basis that allowed the Company to continue to expand to new
cities and expand the number of new lines partitioned onto U S WEST's
switches. Subsequent to the grant of interim relief, the Company on
March 18, 1996 agreed to a settlement agreement with U S WEST that
permits the Company to continue to expand, without restrictions, the
number of new lines it serves in Iowa through March 18, 2001. In
addition, the settlement agreement provides that the Company may
expand to seven new markets (central offices) in Iowa per year through
March 18, 2001. As a result of the settlement agreement, the Company
has withdrawn its complaint before the Iowa Utilities Board.
In Iowa, the Utilities Board did not seek to review the
settlement between US WEST and McLeod of the complaint filed by McLeod
on this issue. Complaints filed by other parties with respect to US
WEST's attempt to withdraw Centrex Plus service in Iowa proceeded to
hearing before the Utilities Board, and resulted in a decision adverse
to US WEST. US WEST has appealed this decision to Polk County, Iowa,
District Court.
Litigation continues in all states where McLeod has challenged
US WEST's action. In Nebraska, the matter is awaiting decision by the
Nebraska Public Service Commission. In South Dakota, the Public
Utilities Commission has rendered an oral decision rejecting US WEST's
attempt to limit Centrex access, but no written order has yet been
issued. McLeod expects US WEST to appeal a written order of the
South Dakota Commission rejecting US WEST's action in that state. In
Colorado, North Dakota, and Minnesota, proceedings before the
respective regulatory agencies are still underway to consider
US WEST's action.
ITEM 4. Submission of Matters to a Vote of Security-Holders
The following matters were submitted to a vote of security
holders at the 1996 Annual Meeting of Stockholders held on April 30,
1996.
1. Proposed amendment and restatement of the Certificate of
Incorporation of the Company. There were 6,042,897 votes cast
for approval of the amendment and restatement of the
Certificate of Incorporation, no votes cast against approval
of the amendment and restatement of the Certificate of
Incorporation, no votes withheld and no abstentions. There
were no broker non-votes recorded.
2. Proposed amendment and restatement of the Amended Bylaws of
the Company. There were 6,042,897 votes cast for approval of
the amendment and restatement of the Amended Bylaws, no votes
cast against approval of the amendment and restatement of the
Amended Bylaws, no votes withheld and no abstentions. There
were no broker non-votes recorded.
3. Proposed Employee Stock Option Plan. There were 6,042,897
votes cast for approval of the Employee Stock Option Plan, no
votes cast against approval of the Employee Stock Option
Plan, no votes withheld and no abstentions. There were no
broker non-votes recorded.
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4. Proposed Employee Stock Purchase Plan. There were 6,042,897
votes cast for approval of the Employee Stock Purchase Plan,
no votes cast against approval of the Employee Stock Purchase
Plan, no votes withheld and no abstentions. There were no
broker non-votes recorded.
5. Proposed Director Stock Purchase Plan. There were 6,042,897
votes cast for approval of the Director Stock Purchase Plan,
no votes cast against approval of the Director Stock Purchase
Plan, no votes withheld and no abstentions. There were no
broker non-votes recorded.
6. Proposed amendment and restatement of the Company's
1992 Incentive Stock Option Plan, 1993 Incentive Stock Option
Plan and 1995 Incentive Stock Option Plan (collectively, the
"Incentive Stock Option Plans"). There were 6,042,897 votes
cast for approval of the amendment and restatement of the
Incentive Stock Option Plans, no votes cast against approval
of the amendment and restatement of the Incentive Stock Option
Plans, no votes withheld and no abstentions. There were no
broker non-votes recorded.
7. Election of two Directors to the Board of Directors of the
Company. The following votes were cast in the election of
directors:
WITHHOLD
FOR AUTHORITY
---------------------- ---------
Stephen C. Gray 6,042,897 0
Paul D. Rhines 6,042,897 0
8. Proposed ratification of the appointment by the Board of
Directors of the firm of McGladrey & Pullen, LLP as
independent public accountants of the Company for the year
ending December 31, 1996. There were 6,042,897 votes cast for
ratification, no votes cast against ratification, no votes
withheld and no abstentions. There were no broker non-votes
recorded.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11. Statement Re: Computation of loss per common share
27. Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed with the Securities
and Exchange Commission during the quarter ended June 30,
1996.
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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.
MCLEOD, INC.
(registrant)
Date: August 14, 1996 /s/ STEPHEN C. GRAY
--- ------------------------------------------
Stephen C. Gray
President & Chief Operating Officer
Date: August 14, 1996 /s/ BLAKE O. FISHER, JR.
--- -----------------------------------------
Blake O. Fisher, Jr.
Chief Financial Officer & Treasurer
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INDEX TO EXHIBITS
Sequentially
Exhibit Numbered
Number Exhibit Description Page
------- ------------------- ------------
11 Statement Regarding Computation
of Per Share Earnings
27 Financial Data Schedule