<PAGE>
________________________________________________________________________________
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 September 30, 1998
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 October 30, 1998:
Common Stock Class A: ($.01 par value)........... 63,265,321 shares
Common Stock Class B: ($.01 par value)........... None
________________________________________________________________________________
<PAGE>
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
- ------ ---------------------
Item 1. Financial Statements......................................................................... 3
Consolidated Balance Sheets, September 30, 1998 (unaudited) and December 31, 1997............ 3
Unaudited Consolidated Statements of Operations and Comprehensive Income
for the three and nine months ended September 30, 1998 and 1997........................... 4
Unaudited Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1997............................................................... 5
Notes to Consolidated Financial Statements (unaudited)....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 13
PART II. OTHER INFORMATION
- ------- -----------------
Item 1. Legal Proceedings............................................................................ 22
Item 2. Changes in Securities and Use of Proceeds.................................................... 23
Item 6. Exhibits and Reports on Form 8-K............................................................. 24
Signatures............................................................................................. 25
</TABLE>
2
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MCLEODUSA INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.............................................................. $ 230,991 $ 331,941
Investment in available-for-sale securities............................................ 171,391 34,696
Trade receivables, net................................................................. 119,851 108,472
Inventory.............................................................................. 4,923 3,992
Deferred expenses...................................................................... 27,627 27,641
Prepaid expenses and other............................................................. 16,001 11,044
---------- ----------
TOTAL CURRENT ASSETS.................................................................. 570,784 517,786
---------- ----------
Property and Equipment
Land and building...................................................................... 60,129 35,420
Telecommunications networks............................................................ 258,979 198,046
Furniture, fixtures and equipment...................................................... 123,354 70,579
Networks in progress................................................................... 172,013 81,432
Building in progress................................................................... 3,553 10,002
---------- ----------
618,028 395,479
Less accumulated depreciation.......................................................... 58,711 21,675
---------- ----------
559,317 373,804
---------- ----------
Investments, Intangible and Other Assets
Other investments...................................................................... 34,812 30,189
Goodwill, net.......................................................................... 287,580 273,442
Other intangibles, net................................................................. 111,391 97,935
Other.................................................................................. 57,680 52,496
---------- ----------
491,463 454,062
---------- ----------
$1,621,564 $1,345,652
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt................................................... $ 7,470 $ 6,004
Contracts and notes payable............................................................ 12,463 6,556
Accounts payable....................................................................... 58,723 45,354
Accrued payroll and payroll related expenses........................................... 18,466 21,454
Other accrued liabilities.............................................................. 38,670 36,793
Deferred revenue, current portion...................................................... 10,141 10,381
Customer deposits...................................................................... 15,585 12,710
---------- ----------
TOTAL CURRENT LIABILITIES............................................................. 161,518 139,252
---------- ----------
Long-term Debt, less current maturities................................................. 939,102 613,384
---------- ----------
Deferred Revenue, less current portion.................................................. 16,101 12,664
---------- ----------
Other long-term liabilities............................................................. 21,098 20,973
---------- ----------
Stockholders' Equity
Capital Stock:
Common, Class A, $.01 par value; authorized 250,000,000 shares;
issued and outstanding 1998 63,135,843 shares; 1997 61,799,412
shares............................................................................... 631 618
Common, Class B, convertible, $.01 par value; authorized 22,000,000
shares; issued and outstanding 1998 and 1997 none.................................... --- ---
Additional paid-in capital............................................................. 707,022 688,964
Accumulated deficit.................................................................... (220,835) (127,735)
Accumulated other comprehensive income................................................. (3,073) (2,468)
---------- ----------
483,745 559,379
---------- ----------
$1,621,564 $1,345,652
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
McLEODUSA INCORPORATED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1998 1997 1998 1997
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications:
Local and long distance........................................ $ 68,835 $ 26,783 $194,151 $ 60,182
Local exchange services........................................ 16,791 --- 49,344 ---
Private line and data.......................................... 11,158 2,848 31,127 7,517
Network maintenance and equipment.............................. 8,964 6,396 24,049 11,815
Other telecommunications....................................... 7,099 --- 20,875 ---
-------- -------- -------- --------
Total telecommunications revenue.............................. 112,847 36,027 319,546 79,514
Directory....................................................... 30,613 11,073 104,091 45,560
Telemarketing................................................... 5,156 2,225 15,005 6,521
-------- -------- -------- --------
TOTAL REVENUES................................................. 148,616 49,325 438,642 131,595
Operating expenses:
Cost of service................................................. 81,082 30,987 239,195 77,745
Selling, general and administrative............................. 63,830 31,975 189,579 86,363
Depreciation and amortization................................... 23,186 6,355 63,663 15,708
Other........................................................... 1,775 82 5,575 2,689
-------- -------- -------- --------
TOTAL OPERATING EXPENSES....................................... 169,873 69,399 498,012 182,505
-------- -------- -------- --------
OPERATING LOSS................................................. (21,257) (20,074) (59,370) (50,910)
Nonoperating income (expense):
Interest income................................................. 6,640 7,618 19,074 18,070
Interest (expense).............................................. (19,429) (11,270) (54,593) (20,756)
Other income.................................................... 1,004 21 1,789 40
-------- -------- -------- --------
TOTAL NONOPERATING INCOME (EXPENSE)............................ (11,785) (3,631) (33,730) (2,646)
-------- -------- -------- --------
LOSS BEFORE INCOME TAXES....................................... (33,042) (23,705) (93,100) (53,556)
Income Taxes..................................................... --- --- --- ---
-------- -------- -------- --------
NET LOSS....................................................... $(33,042) $(23,705) $(93,100) $(53,556)
======== ======== ======== ========
Loss Per Common Share............................................ $(0.52) $(0.45) $(1.49) $(1.02)
======== ======== ======== ========
Weighted Average Common Shares Outstanding....................... 62,955 53,335 62,620 52,752
======== ======== ======== ========
Other comprehensive income (loss), net of tax:
Unrealized gains on securities:
Unrealized holding gains (losses) arising during the
period........................................................ (866) --- 1,405 ---
Less: reclassification adjustment for gains included in
net income.................................................... (1,041) --- (2,010) ---
-------- -------- -------- --------
TOTAL OTHER COMPREHENSIVE INCOME (LOSS)........................ (1,907) --- (605) ---
-------- -------- -------- --------
COMPREHENSIVE LOSS............................................. $(34,949) $(23,705) $(93,705) $(53,556)
======== ======== ======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
4
<PAGE>
MCLEODUSA INCORPORATED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss............................................................................... $ (93,100) $ (53,556)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation.......................................................................... 38,107 8,290
Amortization.......................................................................... 25,556 7,418
Accretion of interest on senior discount notes........................................ 25,982 18,343
Changes in assets and liabilities, net of effects of acquisitions:
(Increase) in trade receivables....................................................... (10,088) (13,510)
(Increase) in inventory............................................................... (341) (320)
(Increase) Decrease in deferred expenses.............................................. 14 (1,544)
(Increase) in deferred line installation costs........................................ (9,033) (6,731)
Increase in accounts payable and accrued expenses..................................... 10,698 19,077
Increase in deferred revenue.......................................................... 3,046 6,661
Increase in customer deposits......................................................... 2,873 2,616
Other, net............................................................................ (4,662) (3,260)
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES................................................ (10,948) (16,516)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment.................................................... (204,727) (104,138)
Available-for-sale securities:
Purchases............................................................................. (516,294) (107,126)
Sales................................................................................. 246,053 88,177
Maturities............................................................................ 132,941 86,497
Acquisitions........................................................................... (27,602) (180,373)
Payments on PCS licenses............................................................... --- (28,007)
Other.................................................................................. (3,614) (892)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (373,243) (245,862)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on contracts and notes payable................................................ (3,091) (5,455)
Net proceeds from long-term debt....................................................... 291,680 508,038
Payments on long-term debt............................................................. (7,824) (1,221)
Net proceeds from issuance of common stock............................................. 2,476 610
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES............................................ 283,241 501,972
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................. (100,950) 239,594
CASH AND CASH EQUIVALENTS:
Beginning.............................................................................. 331,941 96,480
--------- ---------
Ending................................................................................. $ 230,991 $ 336,074
========= =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
5
<PAGE>
McLEODUSA INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of and for the Three and Nine Months Ended
September 30, 1998 and 1997 is Unaudited)
NOTE 1: BASIS OF PRESENTATION
Interim Financial Information (unaudited): The financial statements and
notes related thereto as of September 30, 1998, and for the three and nine month
periods ended September 30, 1998 and 1997, are unaudited, but in the opinion of
management include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the Company's 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 have been condensed or omitted pursuant to
instructions, rules and regulations prescribed by the Securities and Exchange
Commission ("SEC"). Although the Company believes that the disclosures provided
are adequate to make the information presented not misleading, it recommends
that these consolidated condensed financial statements be read in conjunction
with the audited consolidated financial statements and the footnotes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997, filed with the SEC on March 9, 1998.
Reclassifications: Certain items in the December 31, 1997 balance sheet
and the unaudited statement of operations for the three and nine month periods
ended September 30, 1997 have been reclassified to be consistent with the
presentation in the September 30, 1998 unaudited financial statements.
NOTE 2: SUPPLEMENTAL ASSET DATA
Cash and cash equivalents: For purposes of reporting cash flows, the
Company considers all highly liquid debt instruments purchased with a maturity
of three months or less and all certificates of deposit, regardless of maturity,
to be cash equivalents.
Trade Receivables: The composition of trade receivables, net is as
follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(In thousands)
<S> <C> <C>
Trade Receivables:
Billed...................................................... $ 95,112 $ 86,309
Unbilled.................................................... 37,354 34,114
-------- --------
132,766 120,423
Allowance for doubtful accounts and discounts................ (12,915) (11,951)
-------- --------
$119,851 $108,472
======== ========
</TABLE>
Inventory: Inventory is carried principally at the lower of average cost or
market and consists primarily of new and reusable parts required to maintain
fiber optic networks and parts and equipment used in the maintenance and
installation of telephone systems.
Goodwill: Goodwill resulting from the Company's acquisitions is being
amortized over a range of 15 to 30 years using the straight-line method and is
periodically reviewed for impairment based upon an assessment of future
operations to ensure that it is appropriately valued. Accumulated amortization
on goodwill totaled $13,855,000 and $5,834,000, at September 30, 1998 and
December 31, 1997, respectively.
Other intangibles: Other intangibles consist of customer lists and
noncompete agreements related to the Company's acquisitions, deferred line
installation costs incurred in the establishment of local access lines for
customers and franchise rights to provide cable services to customers in three
Illinois counties and in a Michigan city. The customer lists and noncompete
agreements are being amortized using the straight-line method over periods
ranging from 3 to 15 years. The deferred line installation costs are being
amortized using the straight-line method over 36 to 60 months, which
approximates the average
6
<PAGE>
lives of residential and business customer contracts. The franchise rights are
being amortized using the straight-line method over periods ranging from 10 to
15 years. Accumulated amortization on the other intangibles totaled $21,589,000
and $9,158,000 at September 30, 1998 and December 31, 1997, respectively.
NOTE 3: LONG-TERM DEBT
On March 16, 1998, the Company completed a private offering of its 8 3/8%
Senior Notes due March 15, 2008 (the "March 1998 Privately Placed Senior
Notes"), for which the Company received net proceeds of approximately $291.9
million. The Company filed a registration statement with the SEC for the
registration of $300 million principal amount of 8 3/8% Senior Notes due March
15, 2008 (the "March Exchange Notes," together with the March 1998 Privately
Placed Senior Notes, the "March 1998 Senior Notes") to be offered in exchange
for the March 1998 Privately Placed Senior Notes (the "March Exchange Offer").
The registration statement was declared effective by the SEC on May 15, 1998 and
the March Exchange Offer was commenced. The March Exchange Offer expired on
June 25, 1998, at which time all of the March 1998 Privately Placed Senior Notes
were exchanged for the March Exchange Notes. The form and terms of the March
Exchange Notes are identical in all material respects to the form and terms of
the March 1998 Privately Placed Senior Notes except that (i) the March Exchange
Notes have been registered under the Securities Act of 1933 (the "Securities
Act") and (ii) holders of the March Exchange Notes are not entitled to certain
rights under a registration agreement relating to the March 1998 Privately
Placed Senior Notes. Interest on the March 1998 Senior Notes will be payable in
cash semi-annually in arrears on March 15 and September 15 of each year at a
rate of 8 3/8% per annum, commencing September 15, 1998. The March 1998 Senior
Notes rank pari passu in right of payment with all existing and future senior
unsecured indebtedness of the Company and rank senior in right of payment to all
existing and future subordinated indebtedness of the Company. As of September
30, 1998, the Company had no outstanding subordinated indebtedness and had
$577.7 million outstanding indebtedness that would rank pari passu with the
March 1998 Senior Notes. The March 1998 Senior Notes will mature on March 15,
2008. The March 1998 Senior Notes will be redeemable at the option of the
Company, in whole or in part, at any time on or after March 15, 2003 at 104.188%
of their principal amount at maturity, plus accrued and unpaid interest,
declining to 100.000% of their principal amount at maturity, plus accrued and
unpaid interest, on or after March 15, 2006. In the event of certain equity
investments in the Company by certain strategic investors on or before March 15,
2001, the Company may, at its option, use all or a portion of the net proceeds
from such sale to redeem up to 33 1/3% of the originally issued principal amount
of the March 1998 Senior Notes at a redemption price equal to 108.375% of the
principal amount of the March 1998 Senior Notes plus accrued and unpaid interest
thereon, if any, to the redemption date, provided that at least 66 2/3% of the
originally issued principal amount of the March 1998 Senior Notes would remain
outstanding immediately after giving effect to such redemption. In addition, in
the event of a Change of Control (as defined in the indenture dated as of March
16, 1998 between the Company and the United States Trust Company of New York as
trustee, governing the March 1998 Senior Notes (the "March 1998 Senior Note
Indenture")) of the Company, each holder of March 1998 Senior Notes shall have
the right to require the Company to repurchase all or any part of such holder's
March 1998 Senior Notes at a purchase price equal to 101% of the principal
amount of the March 1998 Senior Notes tendered by such holder plus accrued and
unpaid interest, if any, to any Change of Control Payment Date (as defined in
the March 1998 Senior Note Indenture).
The March 1998 Senior Note Indenture imposes operating and financial
restrictions on the Company and its subsidiaries. These restrictions affect,
and in certain cases significantly limit or prohibit, among other things, the
ability of the Company and its subsidiaries to incur additional indebtedness,
pay dividends or make distributions in respect of the Company's or such
subsidiaries' 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. There can be no assurance that such
covenants will not adversely affect the Company's ability to finance its future
operations or capital needs or to engage in other business activities that may
be in the interest of the Company.
7
<PAGE>
NOTE 4: SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
1998 1997
---------------- ---------------
<S> <C> <C>
(In Thousands)
(Unaudited)
Supplemental Disclosure of Cash Flow Information
Cash payment for interest, net of interest capitalized 1998 $6,529,000;
1997 $2,855,000....................................................................... $29,545 $ ---
======= ===============
Supplemental Schedule of Noncash Investing and Financing Activities
Release of 56,177 shares of Class A Common Stock from escrow to certain
of the shareholders of Ruffalo, Cody & Associates, Inc. ("Ruffalo Cody")
as additional consideration for the Company's acquisition of Ruffalo,
Cody in July 1996..................................................................... $1,347
===============
Capital leases incurred for the acquisition of property and equipment.................. $ 5,914 $2,988
======= ===============
Acquisition of F.D.S.D. Rapid City, Inc. directory:
Cash purchase price................................................................... $ 2,226
=======
Other intangibles..................................................................... $ 2,226
=======
Acquisition of Bi-Rite Directories, Inc. directory:
Cash purchase price................................................................... $ 3,500
Long-term debt........................................................................ 190
-------
$ 3,690
=======
Other intangibles..................................................................... $ 3,690
=======
Acquisition of Smart Pages, Inc. and Yellow Pages Publishers, Inc. directory:
Cash purchase price................................................................... $ 628
Contract payable...................................................................... 628
-------
$ 1,256
=======
Other intangibles..................................................................... $ 1,256
=======
Acquisition of NewCom Technologies, Inc. and NewCom OSP Services, Inc.:
Cash purchase price................................................................... $ 1,019
Stock issued.......................................................................... 3,217
-------
$ 4,236
=======
Working capital acquired, net......................................................... $ 341
Fair value of other assets acquired, primarily property and equipment................. 906
Goodwill.............................................................................. 3,864
Long-term debt assumed................................................................ (875)
-------
$ 4,236
=======
Acquisition of certain assets of Communications Cable-Laying Company, Inc.:
Acquisition costs..................................................................... $ 78
Stock issued.......................................................................... 5,965
-------
$ 6,043
=======
Working capital acquired, net......................................................... (475)
Fair value of other assets acquired, primarily property and equipment................. 954
Goodwill.............................................................................. 5,715
Other intangibles..................................................................... 1,341
Long-term debt assumed................................................................ (1,492)
-------
$ 6,043
=======
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
1998 1997
--------------- ----------------
<S> <C> <C>
(In Thousands)
(Unaudited)
Acquisition of ADCO Publishing Co., Inc. directory:
Contract payable...................................................................... $ 8,300
Long-term debt........................................................................ 625
-------
$ 8,925
=======
Other intangibles..................................................................... $ 8,925
=======
Acquisition of QST Communications, Inc.:
Cash acquisition costs................................................................ $ 151
Cash purchase price................................................................... 20,000
-------
$20,150
=======
Working capital acquired, net......................................................... $ 114
Fair value of other assets acquired, primarily property and equipment................. 11,119
Goodwill.............................................................................. 8,918
-------
$20,151
=======
Acquisition of Digital Communications of Iowa, Inc.:
Cash acquisition costs................................................................ $ 29
Stock issued.......................................................................... 2,250
-------
$ 2,279
=======
Working capital acquired, net......................................................... $ 543
Fair value of other assets acquired, principally furniture, fixtures and
equipment............................................................................ 658
Goodwill.............................................................................. 1,118
Long-term debt assumed................................................................ (40)
-------
$ 2,279
=======
Acquisition of Fronteer Financial Holdings, Ltd. directories:
Cash purchase price................................................................... $ 1,500
Contract payable...................................................................... 1,867
Option agreement...................................................................... 500
-------
$ 3,867
=======
Other intangibles..................................................................... $ 3,867
=======
Acquisition of Indiana Directories, Inc. directories:
Cash purchase price................................................................... $ 6,000
Contract payable...................................................................... 4,031
-------
$10,031
=======
Furniture, fixtures and equipment..................................................... $ 150
Other intangibles..................................................................... 9,881
-------
$10,031
=======
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
1998 1997
--------------- ----------------
<S> <C> v<C>
(In Thousands)
(Unaudited)
Acquisition of assets of ESI Communications, Inc.:
Cash purchase price................................................................... $ 15,228
========
Working capital acquired, net......................................................... $ 2,170
Fair value of other assets acquired................................................... 493
Goodwill.............................................................................. 12,960
Other intangibles..................................................................... 376
Long-term debt assumed................................................................ (771)
--------
Other intangibles..................................................................... $ 15,228
========
Acquisition of Smart Pages, Inc and Yellow Pages Publishers, Inc. directories (Note 5):
Cash purchase price................................................................... $ 749
Contract payable...................................................................... 1,124
Promissory note....................................................................... 100
--------
$ 1,973
========
Customer list......................................................................... $ 967
Noncompete agreement.................................................................. 1,006
--------
$ 1,973
========
Acquisition of Consolidated Communications, Inc. (Note 5)
Cash purchase price................................................................... $155,000
Acquisition costs..................................................................... 3,207
Stock issued.......................................................................... 223,675
--------
$381,822
========
Working capital acquired, net......................................................... $ 40,999
Fair value of other assets acquired................................................... 182,799
Goodwill.............................................................................. 203,480
Customer list......................................................................... 35,434
Noncompete agreement.................................................................. 713
Long-term debt and other liabilities assumed.......................................... (81,543)
--------
$381,822
========
</TABLE>
Note 5: Acquisitions
Digital Communications of Iowa, Inc. ("Digital Communications"): On January
30, 1997, the Company issued 84,430 shares of the Company's Class A common
stock, par value $.01 per share (the "Class A Common Stock"), in exchange for
all the outstanding shares of Digital Communications, in a transaction accounted
for using the purchase method of accounting. The total purchase price was
approximately $2.3 million based on the average closing market price of the
Class A Common Stock at the time of the acquisition.
ESI Communications, Inc. ("ESI"): On June 10, 1997, the Company acquired
substantially all of the assets of ESI and related entities at a cash purchase
price of approximately $15.2 million.
Consolidated Communications Inc. ("CCI"): On September 24, 1997, pursuant
to the terms and conditions of an Agreement and Plan of Reorganization dated
June 14, 1997 (the "Merger Agreement"), the Company issued 8,488,586 shares of
Class A Common Stock and paid approximately $155 million in cash to the
shareholders of CCI in exchange for all of the outstanding shares of CCI in a
transaction accounted for using the purchase method of accounting. The total
purchase price was approximately $382.1 million based on the average closing
price of the Company's Class A Common Stock five days before and after the date
of the Merger Agreement. The purchase price includes approximately $3.4 million
of direct acquisition costs.
10
<PAGE>
Directories: On February 25, 1997, McLeodUSA Publishing (as defined herein)
acquired six directories from Fronteer Financial Holdings, Ltd., ("Fronteer")
for a cash purchase price of approximately $3.9 million.
On March 31, 1997, McLeodUSA Publishing acquired 26 telephone directories
published by Indiana Directories, Inc. ("Indiana Directories") at a cash
purchase price of approximately $10 million.
On March 17, 1998, McLeodUSA Publishing acquired a telephone directory
published by F.D.S.D. Rapid City Directories, Inc. at a cash purchase price of
approximately $2.2 million.
On March 20, 1998, McLeodUSA Publishing acquired a telephone directory
published by Bi-Rite Directories, Inc. for a cash purchase price of
approximately $3.7 million.
On April 8, 1998, McLeodUSA Publishing acquired a telephone directory
published by Smart Pages, Inc. and Yellow Pages Publishers, Inc. for a cash
purchase price of approximately $1.3 million.
On September 15, 1998, McLeodUSA Publishing acquired 2 telephone
directories published by ADCO Publishing Co., Inc for a cash purchase price of
approximately $8.9 million.
NewCom Technologies, Inc. and NewCom OSP Services, Inc. ("NewCom"): On
April 24, 1998, the Company issued 70,508 shares of Class A common stock and
paid approximately $1 million cash for all of the outstanding shares of NewCom,
in a transaction accounted for using the purchase method of accounting. The
total purchase price was approximately $4.2 million based on the average closing
market price of the Class A Common Stock at the time of the acquisition.
Communications Cable-Laying Company, Inc. ("CCC"): On June 29, 1998, the
Company issued 151,019 shares of Class A common stock to acquire certain of the
assets of CCC. The total purchase price was approximately $6 million based on
the average closing market price of the Class A Common Stock at the time of the
acquisition and including $78,000 of cash acquisition costs.
QST Communications, Inc ("QST"): On August 21, 1998, the Company acquired
all the outstanding shares of QST for approximately $20 million cash and options
to acquire 245,536 shares of the Company's Class A common stock at an exercise
price of the lower of $40.00 or the closing price of the Class A common stock on
the day prior to the closing date of the acquisition ($37.25). This transaction
is accounted for using the purchase method of accounting. The purchase price
includes approximately $151,000 of cash acquisition costs.
The acquisitions of Digital Communications, CCI, NewCom and QST have been
accounted for as purchases and the results of operations are included in the
consolidated financial statements since the dates of acquisition.
The unaudited consolidated results of operations for the nine months ended
September 30, 1997 on a pro forma basis as though CCI had been acquired as of
the beginning of the period is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1997
--------
<S> <C>
Revenue........................................................ $325,900
Net loss....................................................... (60,686)
Loss per common share.......................................... (0.99)
</TABLE>
The pro forma financial information is presented for informational purposes
only and is not necessarily indicative of the operating results that would have
occurred had the acquisitions been consummated as of the above dates, nor are
such operating results necessarily indicative of future operating results.
NOTE 6: SUBSEQUENT EVENTS
On October 27, 1998, the Company entered into an Agreement and Plan of
Reorganization with Dakota Telecommunications Group, Inc. (DTG) pursuant to
which the Company agreed, subject to certain conditions, to acquire DTG for an
aggregate of 1,295,000 shares of Class A Common Stock and the assumption of
$30.9 million in debt.
11
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On October 30, 1998, the Company completed a private offering of its 9 1/2%
Senior Notes due November 1, 2008, for which the Company received net proceeds
of approximately $291.9 million. The Company intends to file a registration
statement with the SEC for the registration of the $300 million principal amount
of the 9 1/2% Senior Notes due November 1, 2008.
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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, technological
changes and development of a PCS system, 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 the Company's business, the ability of the
Company, its major vendors, other material service providers or customers to
make their computer software Year 2000 compliant by the projected deadlines and
on budgeted costs, changes in the competitive climate in which the Company
operates and the emergence of future opportunities and other factors more fully
described under the caption "Business--Risk Factors" in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997, filed with the
Commission on March 9, 1998 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
The Company derives its revenue from (i) the sale of local, long distance
and related telecommunications services to end users, typically in a "bundled"
package, (ii) telecommunications network maintenance services and telephone
equipment sales, service and installation, (iii) special access, private line
and data services, (iv) the sale of advertising space in telephone directories,
(v) local exchange services through the operation of an independent local
exchange company, Illinois Consolidated Telephone Company ("ICTC"), acquired as
part of the acquisition of Consolidated Communications Inc. ("CCI") in September
1997 (the "CCI Acquisition"), (vi) telemarketing services and (vii) other
telecommunications services, including cellular, operator, payphone and paging
services. The Company began providing local exchange services and other
telecommunications services as a result of the CCI Acquisition in September
1997, telephone directory advertising as a result of its acquisition of Telecom
USA Publishing Group, Inc., now known as McLeodUSA Media Group, Inc. ("McLeodUSA
Publishing") in September 1996, and telemarketing services as a result of its
acquisition of Ruffalo, Cody & Associates, Inc. ("Ruffalo Cody") in July 1996.
The Company began offering "bundled" local and long distance services to
business customers in January 1994. At the end of 1995, the Company began
offering, on a test basis, long distance services to residential customers. In
June 1996, the Company began marketing and providing to residential customers in
Cedar Rapids, Iowa and Iowa City, Iowa an integrated package of
telecommunications services, marketed under the name PrimeLine(R), that includes
local and long distance service, voice mail, Internet access and travel card
services. Since June 1996, the Company has expanded the states in which it
offers service to business customers to include Iowa, Illinois, Indiana,
Minnesota, Wisconsin, North Dakota, South Dakota, Colorado, Missouri and
Wyoming. The Company has also expanded its PrimeLine(R) service to certain
additional cities in Iowa and Illinois and begun offering the service to
customers in North Dakota, South Dakota, Wisconsin, Wyoming and Colorado. The
Company plans to continue its efforts to market and provide local, long distance
and other telecommunications services to business customers and market its
PrimeLine(R) service to residential customers. The Company believes its efforts
to market its integrated telecommunications services have been enhanced by its
July 1996 acquisition of Ruffalo Cody, which specializes in direct marketing and
telemarketing services, including telecommunications sales, its September 1996
acquisition of McLeodUSA Publishing, which publishes and distributes proprietary
"white page" and "yellow page" telephone directories in twenty states in the
Midwestern and Rocky Mountain regions of the United States, including most of
the Company's target markets, and its September 1997 acquisition of CCI,
including its subsidiary Consolidated Communications Directories Inc. ("CCD"),
which publishes and distributes "white page" and "yellow page" telephone
directories for third parties in 38 states and the United States Virgin Islands.
In September 1997, the Company completed the CCI Acquisition. For the
period beginning January 1, 1997 through September 24, 1997, CCI had revenues of
$194.3 million and net income of $5.6 million. As a result of the CCI
Acquisition, the Company now owns all of the former CCI subsidiaries,
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<PAGE>
including ICTC, an independent local exchange carrier serving east central
Illinois; Consolidated Communications Telecom Services Inc. ("CCTS"), a
competitive local exchange carrier which offers integrated local, long distance
and other telecommunications services in central and southern Illinois and in
Indiana; CCD, a telephone directory publishing company; an operator service
company; an inmate pay-phone company; a full service telemarketing agency; a
majority interest in a cable television company serving customers in Greene,
Sangamon and Menard counties in Illinois and Benton Harbor, Michigan; and a
minority interest in a cellular telephone partnership serving parts of east
central Illinois. The Company believes the CCI Acquisition has enhanced its
efforts to offer its telecommunications services in adjoining target markets
including its expansion into Indiana and Missouri, states where CCI provided
telecommunications services.
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 primarily includes local services purchased from
Regional Bell Operating Companies, costs to terminate the long distance calls of
the Company's customers through interexchange carriers, costs of printing and
distributing the telephone directories published by McLeodUSA Publishing and
CCD, costs associated with maintaining the Iowa Communications Network and costs
associated with operating the Company's network. The Iowa Communications
Network is a fiber optic network that links certain of the State of Iowa's
schools, libraries and other public buildings. SG&A consists of sales and
marketing, customer service and administrative expenses. Depreciation and
amortization include depreciation of the Company's telecommunications network
and equipment; amortization of goodwill and other intangibles related to the
Company's acquisitions; 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 local telecommunications service.
As the Company expands into new markets, both cost of service and SG&A will
increase. The Company expects to incur cost of service and SG&A expenses prior
to achieving significant revenues in new markets. Fixed costs related to
leasing of central office facilities needed to provide telephone services must
be incurred prior to generating revenue in new markets, while significant levels
of marketing activity may be necessary in the new markets in order for the
Company to build a customer base large enough to generate sufficient revenue to
offset such fixed costs and marketing expenses.
In January and February 1996, the Company granted options to purchase an
aggregate of 965,166 and 688,502 shares of its Class A Common Stock,
respectively, at an exercise price of $2.67 per share, to certain directors,
officers and other employees. The estimated fair market value of these options,
in the aggregate, at the date of grant was later determined to exceed the
aggregate exercise price by approximately $9.2 million. Additionally, in
September 1997, the Company granted options to purchase an aggregate of
1,468,945 shares of its Class A Common Stock at an exercise price of $24.50 to
certain employees of CCI. The fair market value of these options, in the
aggregate, at the date of grant exceeded the aggregate exercise price by
approximately $15.8 million. These amounts are being amortized on a monthly
basis over the four-year vesting period of the options.
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. 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. As
a result of the CCI Acquisition, the Company anticipates a reduction in
operating losses and the generation of positive cash flows from operations in
the future. The anticipated financial benefits from CCI Acquisition are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The financial benefits the Company will actually
derive from the CCI Acquisition may differ materially as a result of a variety
of factors, including technological, regulatory or other developments in the
Company's business, the difficulty of assimilating CCI's operations and
personnel, the possible inability of management to maximize the financial and
strategic position of the Company through successful incorporation of CCI into
the Company's operations, and the risks of entering markets in which the Company
has little or no direct prior experience. In addition, the projected increases
in capital expenditures will continue to generate negative cash flows from
construction activities during the next several years while the Company installs
and expands its fiber optic network and develops and constructs its proposed PCS
system. The Company may also be forced to change its pricing policies to
respond to a changing competitive environment, and there can be no assurance
that the company will
14
<PAGE>
be able to maintain its operating margin. There can be no assurance that growth
in the Company's revenue or customer base will continue or that the Company will
be able to achieve or sustain profitability or positive cash flows.
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 SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 1997
Total revenue increased from $49.3 million for the three months ended
September 30, 1997 to $148.6 million for the three months ended September 30,
1998, representing an increase of $99.3 million or 201%. Revenue from the sale
of local and long distance telecommunications services accounted for $42.1
million of the increase, including $16.4 million contributed by CCI, which was
acquired on September 24, 1997. Local exchange services generated by ICTC
represented $16.8 million for the period, for which there were no corresponding
1997 revenues. Private line and data revenues accounted for $8.3 million of
increased revenues over 1997, which was primarily attributable to the CCI
Acquisition. Network maintenance and equipment revenue increased $2.6 million
over 1997 due primarily to the acquisitions of Digital Communications of Iowa,
Inc. ("Digital Communications"), ESI Communications, Inc. ("ESI
Communications"), CCI and NewCom Technologies, Inc. and NewCom OSP Services,
Inc. (collectively, "NewCom"). Other telecommunications revenue, which was due
almost entirely to the CCI Acquisition, represented $7.1 million of the third
quarter 1998 revenues with no corresponding 1997 amount. Directory revenues
increased $19.5 million from the third quarter of 1997 to the third quarter of
1998 due to revenues from new directories acquired in 1998 and the acquisition
of CCD on September 24, 1997. The $2.9 million increase in telemarketing
revenues from the third quarter of 1997 to the third quarter of 1998 was due
almost entirely to the CCI Acquisition.
Cost of service increased from $31.0 million for the three months ended
September 30, 1997, to $81.1 million for the three months ended September 30,
1998, representing an increase of $50.1 million or 162%. This increase in cost
of service was due primarily to the growth in the Company's local and long
distance telecommunications services and to the acquisitions of Digital
Communications, ESI Communications, CCI and NewCom, which contributed an
aggregate of $35.1 million to the increase. Cost of service as a percentage of
revenue decreased from 63% for the three months ended September 30, 1997 to 55%
for the three months ended September 30, 1998, as a result of the effect of
these acquisitions and as a result of reductions in the cost of providing
competitive local and long distance services as a percentage of competitive
local and long distance telecommunications revenue, which decreased from 75% to
71% during those same periods. This decrease was primarily due to the
realization of benefits associated with new wholesale line cost rate agreements
with the Regional Bell Operating Companies and reduced long distance costs
resulting from migration of over 60% of customer long distance traffic to the
Company's fiber optic network.
SG&A increased from $31.9 million for the three months ended September 30,
1997 to $63.8 million for the three months ended September 30, 1998, an increase
of $31.9 million or 100%. The acquisitions of Digital Communications, ESI
Communications, CCI and NewCom contributed an aggregate of $20.3 million to the
increase. Also contributing to this increase were increased costs of $11.6
million related primarily to expansion of selling, customer support and
administration activities to support the Company's growth.
Depreciation and amortization expenses increased from $6.4 million for the
three months ended September 30, 1997 to $23.2 million for the three months
ended September 30, 1998, representing an increase of $16.8 million or 265%.
This increase consisted of $11.3 million related to the acquisitions of Digital
Communications, ESI Communications, CCI and NewCom, and $5.5 million due
primarily to the growth of the Company's network.
Other operating expenses represented the amortization of capitalized costs
associated with CCD directories in progress at the time the Company acquired
CCI.
Interest income decreased from $7.6 million for the three-month period
ended September 30, 1997, to $6.6 million for the same period in 1998.
15
<PAGE>
Gross interest expense increased from $12.7 million for the third quarter
of 1997 to $22.5 million for the third quarter of 1998. This increase was
primarily a result of an increase in the accretion of interest on the Company's
10 1/2% Senior Discount Notes due March 15, 2007 (the "1997 Senior Discount
Notes") of $860,000 and an increase of interest of $7.2 million as the result of
the issuance of the Company's 9 1/4% Senior Notes due July 15, 2007 (the "1997
Senior Notes") and the 8 3/8% Senior Notes due March 15, 2008 (the "March 1998
Senior Notes"). Interest expense of approximately $2.2 million and $1.4 million
was capitalized as part of the Company's construction of fiber optic network
during the third quarter of 1998 and 1997, respectively. In addition, interest
expense of approximately $899,000 was capitalized as part of the Company's
operating facilities building construction and the Company's software
development in 1998 with no corresponding amount in 1997.
Net loss increased from $23.7 million for the three months ended September
30, 1997 to $33.0 million for the three months ended September 30, 1998, an
increase of $9.3 million. This increase resulted primarily from the following
three factors: the expansion of the Company's local and long distance services,
which requires significant expenditures, a substantial portion of which is
incurred before the realization of revenues; the increased depreciation expense
related to the construction and expansion of the Company's networks and
amortization of intangibles related to acquisitions; and net interest expense on
indebtedness to fund market expansion, network development and acquisitions.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1997
Total revenue increased from $131.6 million for the nine months ended
September 30, 1997 to $438.6 million for the nine months ended September 30,
1998, representing an increase of $307 million or 233%. Revenue from the sale
of local and long distance telecommunications services accounted for $134
million of this increase, including $52.2 million contributed by CCI. Local
exchange services generated by ICTC represented $49.3 million for the period,
for which there were no corresponding 1997 revenues. Private line and data
revenues accounted for $23.6 million of increased revenues over 1997, which was
primarily attributable to the CCI Acquisition. Network maintenance and
equipment revenue increased $12.2 million over 1997 due primarily to the
acquisitions of Digital Communications, ESI Communications, CCI and NewCom.
Other telecommunications revenue, which was due almost entirely to the CCI
Acquisition, represented $20.9 million of the revenues for the first nine months
of 1998 with no corresponding 1997 amount. Directory revenues increased $58.5
million from the first nine months of 1997 to the first nine months of 1998 due
to revenues from new directories acquired in 1998 and the acquisition of CCD.
The $8.5 million increase in telemarketing revenues from the first nine months
of 1997 to the first nine months of 1998 was due almost entirely to the CCI
Acquisition.
Cost of service increased from $77.7 million for the nine months ended
September 30, 1997, to $239.2 million for the nine months ended September 30,
1998, representing an increase of $161.5 million or 208%. This increase in cost
of service was due primarily to the growth in the Company's local and long
distance telecommunications services and to the acquisitions of Digital
Communications, ESI Communications, CCI and NewCom, which contributed an
aggregate of $106.7 million to the increase. Cost of service as a percentage of
revenue decreased from 59% for the nine months ended September 30, 1997 to 55%
for the nine months ended September 30, 1998, as a result of these acquisitions
and as a result of reductions in the cost of providing local and long distance
services as a percentage of local and long distance telecommunications revenue,
which decreased from 77% to 71% for those same periods. This decrease was
primarily due to the realization of benefits associated with new wholesale line
cost rate agreements with the Regional Bell Operating Companies and reduced long
distance costs resulting from migration of over 60% of customer long distance
traffic to the Company's fiber optic network.
SG&A increased from $86.4 million for the nine months ended September 30,
1997 to $189.6 million for the nine months ended September 30, 1998, an increase
of $103.2 million or 120%. The acquisitions of Digital Communications, ESI
Communications, CCI and NewCom contributed an aggregate of $66.8 million to the
increase. Also contributing to this increase were increased costs of $36.4
million primarily related to expansion of selling, customer support and
administration activities to support the Company's growth.
Depreciation and amortization expenses increased from $15.7 million for the
nine months ended September 30, 1997 to $63.7 million for the nine months ended
September 30, 1998, representing an increase of $48.0 million or 305%. This
increase consisted of $32.8 million related to the acquisitions of Digital
Communications, ESI Communications, CCI and NewCom, and $15.2 million due
primarily to the growth of the Company's network.
16
<PAGE>
Other operating expenses represented the amortization of capitalized costs
associated with CCD directories in progress at the time the Company acquired
CCI.
Interest income increased from $18.1 million for the nine-month period
ended September 30, 1997, to $19.1 million for the same period in 1998. This
increase resulted from increased earnings on investments made with the remaining
proceeds from the Company's debt offerings in March and July 1997 and the
proceeds from the Company's offering of the 1998 Senior Notes in March 1998.
Gross interest expense increased from $23.6 million for the first nine
months of 1997 to $61.1 million for the first nine months of 1998. This
increase was primarily a result of an increase in the accretion of interest on
the 1997 Senior Discount Notes of $7.5 million and an increase of interest of
$24.9 million as the result of the issuance of the 1997 Senior Notes and the
March 1998 Senior Notes. Interest expense of approximately $5.6 million and
$2.9 million was capitalized as part of the Company's construction of fiber
optic network during the nine months of 1998 and the first nine months of 1997,
respectively. In addition, interest expense of approximately $899,000 was
capitalized as part of the Company's operating facilities building construction
and the Company's software development in 1998 with no corresponding amount in
1997.
Net loss increased from $53.6 million for the nine months ended September
30, 1997 to $93.1 million for the nine months ended September 30, 1998, an
increase of $39.5 million. This increase resulted primarily from the following
three factors: the expansion of the Company's local and long distance services,
which requires significant expenditures, a substantial portion of which is
incurred before the realization of revenues; the increased depreciation expense
related to the construction and expansion of the Company's networks and
amortization of intangibles related to acquisitions; and net interest expense on
indebtedness to fund market expansion, network development and acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets increased from $1.3 billion at December 31, 1997
to $1.6 billion at September 30, 1998, primarily due to the net proceeds of
approximately $291.9 million from the Company's March 1998 offering of the March
1998 Senior Notes. At September 30, 1998, the Company's current assets of
$570.9 million exceeded its current liabilities of $161.5 million, providing
working capital of $409.4 million, which represents an increase of $30.9 million
compared to December 31, 1997 primarily attributable to the net proceeds from
the March 1998 Senior Notes. At December 31, 1997, the Company's current assets
of $517.8 million exceeded current liabilities of $139.3 million, providing
working capital of $378.5 million.
The net cash used in operating activities totaled $10.9 million for the
nine months ended September 30, 1998 compared to net cash used in operating
activities of $16.5 million for the nine months ended September 30, 1997.
During the nine months ended September 30, 1998, cash for operating activities
was used primarily to fund the Company's net loss of $93.1 million for such
period. The Company also required cash to fund the growth in trade receivables
and deferred line installation costs of $10.1 million and $9.0 million,
respectively, primarily as a result of the expansion of the Company's local and
long distance telecommunications services. These uses of cash for operating
activities during the nine months ended September 30, 1998, were offset by an
increase in accounts payable and accrued expenses of $10.7 million and
cumulative non-cash expenses of $89.6 million. During the nine months ended
September 30, 1997, cash for operating activities was used primarily to fund the
Company's net loss of $53.6 million for such period. The Company also required
cash to fund the growth in trade receivables and deferred line installation
costs of $13.5 million and $6.7 million, respectively.
The Company's investing activities used cash of $373.2 million during the
nine months ended September 30, 1998 and $245.9 million during the nine months
ended September 30, 1997. The equipment required for the expansion of the
Company's local and long distance telecommunications services, the Company's
development and construction of its fiber optic telecommunications network and
other capital expenditures resulted in purchases of equipment and fiber optic
cable and other property and equipment totaling $204.7 million and $104.1
million during the nine months ended September 30, 1998 and 1997, respectively.
The Company also used cash of $516.3 million and $107.1 million to acquire
available-for-sale securities during the first nine months of 1998 and 1997,
respectively, offset by proceeds from sales and maturities of available-for-sale
securities of $246.1 million and $88.2 million, respectively, during those
periods.
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<PAGE>
The Company used an aggregate of $27.6 million cash during the nine months
ended September 30, 1998 to acquire directories from F.D.S.D. Rapid City
Directories, Inc., Bi-Rite Directories, Inc., Smart Pages, Inc. and Yellow Pages
Publishers, Inc., and ADCO Publishing Co., Inc. on March 17, 1998, March 20,
1998, April 8, 1998, and September 15, 1998 respectively, and in its
acquisitions of NewCom capital stock, Communications Cable-Laying Company, Inc.
assets, and QST Communications capital stock in April, June and August 1998,
respectively.
The Company used cash of $180.4 million during the nine months ended
September 30, 1997 to acquire Digital Communications, Fronteer, the Indiana
Directories, ESI and CCI in January 1997, February 1997, March 1997, June 1997
and September 1997, respectively.
On October 27, 1998, the Company entered into an Agreement and Plan of
Reorganization with Dakota Telecommunications Group, Inc. ("DTG") pursuant to
which the Company agreed, subject to certain conditions, to acquire DTG for an
aggregate of 1,295,000 shares of Class A Common Stock and the assumption of
$30.9 million in debt (the "DTG Transaction").
Consummation of the DTG Transaction is subject to the satisfaction or
waiver of certain conditions, including receipt of required regulatory approvals
and other customary conditions, and the completion of the Company's due
diligence investigation and review of DTG and its subsidiaries. There can be no
assurance that the DTG Transaction will be consummated.
Cash received from net financing activities was $283.2 million during the
nine months ended September 30, 1998, primarily as a result of the Company's
offering of the March 1998 Senior Notes in March 1998. Cash received from
financing activities during the nine months ended September 30, 1997 was $502.0
million and was primarily obtained from the Company's offering of the 1997
Senior Discount Notes in March 1997 and the 1997 Senior Notes in July 1997.
On October 30, 1998, the Company completed a private offering of its 9 1/2%
Senior Notes due November 1, 2008 (the "October 1998 Privately Placed Senior
Notes"), for which the Company received net proceeds of approximately $291.9
million. The Company intends to file a registration statement with the SEC for
the registration of $300 million principal amount of 9 1/2% Senior Notes due
November 1, 2008 (the "October 1998 Exchange Notes," together with the October
1998 Privately Placed Senior Notes, the "October 1998 Senior Notes") to be
offered in exchange for the October 1998 Privately Placed Senior Notes (the
"October 1998 Exchange Offer"). The form and terms of the October 1998 Exchange
Notes are identical in all material respects to the form and terms of the
October 1998 Privately Placed Senior Notes except that (i) the October 1998
Exchange Notes have been registered under the Securities Act of 1933 (the
''Securities Act'') and (ii) holders of the October 1998 Exchange Notes are not
entitled to certain rights under a registration agreement relating to the
October 1998 Privately Placed Senior Notes. Interest on the October 1998 Senior
Notes will be payable in cash semi-annually in arrears on May 1 and November 1
each year at a rate of 9 1/2% per annum, commencing May 1, 1999. The October
1998 Senior Notes rank pari passu in right of payment with all existing and
future senior unsecured indebtedness of the Company and rank senior in right of
payment to all existing and future subordinated indebtedness of the Company. As
of September 30, 1998, the Company had no outstanding subordinated indebtedness
and had $877.7 million outstanding indebtedness that would rank pari passu with
the October 1998 Senior Notes. The October 1998 Senior Notes will mature on
November 1, 2008. The October 1998 Senior Notes will be redeemable at the option
of the Company, in whole or in part, at any time on or after November 1, 2003 at
106.75% of their principal amount at maturity, plus accrued and unpaid interest,
declining to 100% of their principal amount at maturity, plus accrued and unpaid
interest, on November 1, 2008. In the event of certain equity investments in the
Company by certain strategic investors on or before November 1, 2001, the
Company may, at its option, use all or a portion of the net proceeds from such
sale to redeem up to 33 1/3% of the originally issued principal amount of the
October 1998 Senior Notes at a redemption price equal to 111.5% of the principal
amount of the October 1998 Senior Notes plus accrued and unpaid interest
thereon, if any, to the redemption date, provided that at least 66 2/3% of the
originally issued principal amount of the October 1998 Senior Notes would remain
outstanding immediately after giving effect to such redemption. In addition, in
the event of a Change of Control (as defined in the indenture dated as of
October 30, 1998 between the Company and the United States Trust Company of New
York as trustee, governing the October 1998 Senior Notes (the "October 1998
Senior Note Indenture")) of the Company, each holder of October 1998 Senior
Notes shall have the right to require the Company to repurchase all or any part
of such holder's October 1998 Senior Notes at a purchase price equal to 101% of
the principal amount of the October 1998 Senior Notes tendered by such holder
plus accrued and unpaid interest, if any, to any Change of Control Payment Date
(as defined in the October 1998 Senior Note Indenture).
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The October 1998 Senior Note Indenture imposes operating and financial
restrictions on the Company and its subsidiaries. These restrictions affect,
and in certain cases significantly limit or prohibit, among other things, the
ability of the Company and its subsidiaries to incur additional indebtedness,
pay dividends or make distributions in respect of the Company's or such
subsidiaries' 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. There can be no assurance that such
covenants will not adversely affect the Company's ability to finance its future
operations or capital needs or to engage in other business activities that may
be in the interest of the Company.
Continued expansion of the Company's operations, facilities, network and
services will require significant capital expenditures. As of September 30,
1998, the Company estimates, based on its current business plan and projections,
that its aggregate capital requirements for the remainder of 1998, 1999, 2000
and 2001 will be approximately $1.1 billion. The Company's estimated capital
requirements include the projected costs of (i) developing and constructing its
fiber optic network, including intra-city fiber optics networks, (ii) market
expansion activities, (iii) developing, constructing and operating a PCS system,
and (iv) working capital and general corporate purposes. The Company expects to
fund these capital requirements with (i) approximately $291.9 million in net
proceeds from the offering of the October 1998 Senior Notes, (ii) approximately
$402.4 million of cash on hand and short-term investments at September 30, 1998,
(iii) a proposed $100.0 million revolving credit facility, and (iv) projected
operating cash flows of the Company.
The actual amount and timing of the Company's future capital requirements
may differ materially from the Company's estimates, and additional financing may
be required in the event of changes in or expansion of the Company's business
plan and projections, including those that may be caused by unforeseen delays,
cost overruns, engineering design changes, demand for the Company's services
that varies from that expected by the Company, and regulatory, technological, or
competitive developments. The Company may also require additional capital, or
require financing sooner that anticipated, if it changes the schedule or scope
of its business plan in response to such developments or otherwise. The Company
expects to evaluate potential acquisitions, joint ventures and strategic
alliances on an ongoing basis, and may require additional financing if it elects
to pursue any such opportunities. There can be no assurance that the Company
will be able to fund its planned network deployment and operations or achieve
operating profitability with its anticipated capital resources. Furthermore,
there can be no assurance that any additional financing will be available on
terms acceptable to the Company or at all.
The Company's estimate of its future capital requirements contained in this
report is a "forward looking statement" within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The
Company's actual capital requirements may differ materially as a result of
regulatory, technological and competitive developments (including new
opportunities) in the Company's industry.
The Company expects to meet its additional capital needs as they arise with
the proceeds from credit facilities and other borrowings, and additional debt
and equity issuances. The Company has received a non-binding commitment from
The Chase Manhattan Bank to lead a syndication to provide a senior secured
revolving credit facility. There can be no assurance, however, that the Company
will be successful in completing such credit facility on terms acceptable to the
Company or at all, or that the Company will otherwise be successful in producing
sufficient cash flows. Failure to generate or raise sufficient funds may
require the Company to delay or abandon some of its expansion plans or
expenditures, which could have a material adverse effect on the Company.
MARKET RISK
At September 30, 1998, marketable equity securities of the Company are
recorded at fair value of $28.2 million. The marketable equity securities held
by the Company 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 million. The Company believes its exposure
to market rate fluctuations on all other investments is nominal due to the
short-term nature of its investment portfolio.
The Company has no material future earnings or cash flow exposures from
changes in interest rates on its long-term debt obligations, as substantially
all of the Company's long-term debt obligations are fixed rate obligations.
19
<PAGE>
Year 2000 Date Conversion
The Company is currently verifying system readiness for the processing of
date-sensitive information by the Company's computer systems. The Year 2000
problem impacts computer programs and hardware timers using two digits (rather
than four) to define the applicable year. Any of the Company's programs that
have time-sensitive functions may recognize a date using "00" as the year 1900
rather than 2000, which could result in miscalculations or system failures.
The Company is reviewing its information technology ("IT") and non-IT
computer systems and programs to determine which are not capable of recognizing
the Year 2000 and to verify system readiness for the millennium date. The
review includes consideration of:
(1) awareness and communication,
(2) inventory of systems hardware, software and data interfaces and
confirmation with key vendors of Year 2000 readiness,
(3) identification of mission-critical components for both internal
systems and vendor and third-party relations,
(4) estimated costs for remediation,
(5) estimated dates of compliance,
(6) correction/remediation,
(7) replacement activities,
(8) testing and verification,
(9) implementation,
(10) development of contingency plans and
(11) training for contingency plans.
The Company is considering these areas for each of its major operating
business units. As of October 22, 1998, the Company has completed more than 85%
of the activities required to conclude the first three areas and more than 55%
of the activities required to conclude the fourth and fifth areas. The Company
is in the initial stages of activities required for review of the remaining
areas.
The Company currently estimates its Year 2000 readiness costs will not
exceed $11.5 million. These costs generally are expensed as incurred. These
costs are not expected to have a material adverse effect on the Company's
financial position, results of operations or cash flows.
Many statements contained in this description of the Company's Year 2000
activities are forward-looking statements that involve risks and uncertainties.
Actual results, performance and effects of Year 2000 activities described in
such forward-looking statements may differ materially from actual results,
performance and effects in the future due to the interrelationship and
interdependence of computer systems of the Company, its vendors and other third-
parties.
The Company has not yet fully identified its most reasonably likely worst
case Year 2000 scenarios. The Company continues to contact its vendors,
suppliers and third parties with which it has a material relationships,
regarding the state of readiness. Until the Company has received and analyzed
substantial responses from those entities, it will have difficulty determining
its worst case scenarios.
The Company has begun to develop contingency plans to handle worst case
scenarios, to the extent they can be identified fully. The Company intends to
complete its contingency planning after determination of worst case scenarios is
complete. Completion of these activities depends upon responses to
substantially all of the inquiries it has made of its major vendors, material
service providers and third parties with which it has a material relationship.
The Company has also begun work on contingency plans for certain systems
identified as critical to operations.
While the Company's efforts are designed to be successful, because of
the complexity of the Year 2000 issues and the interdependence of organizations
using computer systems, there can be no assurance that the Company's efforts or
those of a third party with which the Company interacts will be satisfactorily
completed in a timely fashion. If the Company, its major vendors, other material
service providers or customers, fail to address the Year 2000 issues in a timely
manner, such failure could have a material adverse effect on the Company's
business, results of operations and financial condition. The Company is
dependent on Regional Bell Operating Companies to provide most of its local
and some of its long distance services. To the extent Ameritech Corporation, SBC
or U S WEST fail to address Year 2000 issues which might interfere with the
ability of those companies to fulfill their obligations to the Company, such
interference could have a material adverse effect on the Company's future
operations.
20
<PAGE>
EFFECTS OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information," ("SFAS 131"). This pronouncement is
effective for calendar year 1998 financial statements and requires reporting
segment information consistent with the way executive management of an entity
disaggregates its operations internally to assess performance and make decisions
regarding resource allocations. Among information to be disclosed, SFAS 131
requires an entity to report a measure of segment profit or loss, certain
specific revenue and expense items and segment assets. SFAS 131 also requires
reconciliations of total segment revenues, total segment profit or loss and
total segment assets to the corresponding amounts shown in the entity's
consolidated financial statements. The Company is in the process of identifying
reportable segments and has not yet determined the effect of implementing SFAS
131.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. This statement provides guidance on
accounting for the costs of computer software developed or obtained for internal
use and is required to be adopted no later than the Company's 1999 fiscal year.
The Company plans to modify its method of capitalization of such costs by
adopting this statement prospectively on January 1, 1999. The Company is
currently evaluating this statement but does not expect to have a material
impact on its financial condition or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," ("SFAS 133") SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
133 requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting.
SFAS 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement SFAS 133 as of the beginning of any fiscal quarter
after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). SFAS 133 cannot be applied retroactively. SFAS 133 must be
applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998).
The Company does not expect the impact of the adoption of SFAS 133 to be
material on the Company's results of operations as the Company does not
currently hold any derivative instruments or engage in hedging activities.
INFLATION
The Company does not believe that inflation has had a significant impact on
the Company's consolidated operations.
21
<PAGE>
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is not aware of any material litigation against the Company.
The Company is involved in numerous regulatory proceedings before various state
public utilities commissions, as well as before the Federal Communications
Commission ("FCC").
The Company is dependent on the Regional Bell Operating Companies for
provision of its local and certain of its long distance services. As of the
date hereof, U S WEST, Southwestern Bell Telephone Company (SBC) and Ameritech
are the Company's sole suppliers of access to incumbent local central office
switches or, in the case of customers served in central Illinois, to local
lines. The Company uses such access to partition the local switch or transmit
traffic over unbundled local line segments (loops) and thereby provide local
service to its customers.
The Company typically purchases access to local switches in the form of a
product generally known as "Centrex." Without such access, the Company could
not, as of the date hereof, provide bundled local and long distance services to
most of its customers, 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, Ameritech or SBT 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 (the "U S WEST Centrex Action"). 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 served by the Company.
The Company has challenged, or is challenging, the U S WEST Centrex Action
before the public utilities commissions in certain of the states served by U S
WEST where the Company is doing business or plans to do business. The Company's
challenges to the U S WEST Centrex Action have as of the date hereof been
successful in Iowa, Minnesota, South Dakota, North Dakota and Colorado. In
Wyoming, state regulators rejected U S WEST's action, but the matter remains
pending on appeal. The Company has, however, been unsuccessful in its
challenges to the U S WEST Centrex Action in Nebraska and Idaho. In Utah, the
Company has requested that the Utah Public Utilities Commission reconsider its
order imposing temporary restrictions on Centrex resale. As of the date hereof,
the Company's request remains pending before the Utah Public Utilities
Commission.
In addition to the U S WEST Centrex Action, U S WEST has taken other
measures that may impede the Company's ability to use Centrex service to provide
its competitive local exchange services. For example, in January 1997, U S WEST
proposed to implement certain interconnection surcharges in several of the
states in its service region. On February 20, 1997, the Company and several
other parties filed a petition with the Federal Communication commission (FCC)
objecting to U S WEST's proposal. The petition was based on Section 252(d) of
the Telecommunications Act, which governs the pricing of interconnection and
network elements. The Company believes that U S WEST's proposal is an unlawful
attempt to recover costs associated with the upgrading of U S WEST's network, in
violation of Section 252 of the Telecommunications Act. U S WEST filed an
opposition to the Company's petition with the FCC on March 3, 1997. The matter
remains pending before the FCC and various state public utilities commissions.
There can be no assurance that the Company will ultimately succeed in its
remaining legal challenges to the U S WEST Centrex Action or other actions by U
S WEST that have the effect of preventing or deterring the Company from using
Centrex service, or that these actions by U S WEST, or similar actions by other
Regional Bell Operating Companies, will not have a material adverse effect on
the Company. In any jurisdiction where U S WEST prevails, the Company's ability
to offer integrated telecommunications services would be impaired, which could
have a material adverse effect on the Company.
22
<PAGE>
The Company also anticipates that U S WEST will continue to pursue various
legislative initiatives in states within the Company's target market area in an
effort to reduce state regulatory oversight over its rates and operations.
There can be no assurance that U S WEST will not succeed in such efforts or that
any such state legislative initiatives, if adopted, will not have a material
adverse effect on the Company.
LEGAL CHALLENGES TO THE INTERCONNECTION DECISION. The Company's plans to
provide local switched services are dependent upon obtaining favorable
interconnection agreements with local exchange carriers. In August 1996, the
FCC released the Interconnection Decision implementing the interconnection
portions of the Telecommunications Act. Certain provisions of the
Interconnection Decision were appealed to the U.S. Eighth Circuit Court of
Appeals. In July and October 1997, the U.S. Eighth Circuit Court of Appeals
vacated portions of the Interconnection Decision, including provisions
establishing a pricing methodology and a procedure permitting new entrants to
"pick and choose" among various provisions of existing interconnection
agreements. Although the decisions vacating the Interconnection Decision do not
prevent the Company from negotiating interconnection agreements with local
exchange carriers, they do create uncertainty about the rules governing pricing,
terms and conditions of interconnection agreements, and could make negotiating
such agreements more difficult and protracted. The U.S. Supreme Court has
granted certiorari in this matter and is scheduled to review the decisions of
the U.S. Eighth Circuit Court of Appeals during the 1998 term. There can be no
assurance that the Company will be able to obtain interconnection agreements on
terms acceptable to the Company, or that the pending Supreme Court appeal will
be resolved on terms that promote local exchange competition as originally
contemplated by the FCC.
WIRELINE COMPETITION. In May 1998, each of U S WEST and Ameritech
announced that it had entered into a marketing arrangement with Qwest
Communications International Inc. ("Qwest"). The FCC has ruled that each of
these arrangements constitutes the provision of long distance services by U S
West or Ameritech, respectively, in contravention of the Telecommunications Act.
The FCC's decision has been appealed by U S West, Ameritech and Qwest. The
ability of U S West, Ameritech or other competitors of the Company to enter into
and operate such arrangements could put the Company at a significant
disadvantage.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 21, 1998, the Company acquired all the outstanding shares of QST
Communications, Inc. ("QST") for approximately $20 million cash and options to
acquire 245, 536 shares of the Company's Class A common stock at an exercise
price of the lower of $40.00 or the closing price of the Class A common stock on
the day prior to the closing date of the acquisition ($37.25). The purchase
price includes approximately $151,000 of cash acquisition costs.
This issuance of securities was made in reliance on the exemptions from
registration provided by Section 4(2) and/or Regulation D of the Securities Act
as a transaction by an issuer not involving any public offering. The recipient
of securities in this transaction represented its intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the option
agreement, and will be affixed to any share certificates recieved upon the
exercise of such stock option.
23
<PAGE>
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.
27.1 Financial Data Schedule.
99.1 Press Release dated July 27, 1998.
99.2 Press Release dated September 2, 1998 (Filed as exhibit 99.4
to the Current Report on Form 8-K, File No. 0-20763, filed
with the Commission on October 29, 1998).
99.3 Press Release dated October 22, 1998 (Filed as exhibit 99.1
to the Current Report on Form 8-K, File No. 0-20763, filed
with the Commission on October 29, 1998).
99.4 Press Release dated October 22, 1998 (Filed as exhibit 99.2
to the Current Report on Form 8-K, File No. 0-20763, filed
with the Commission on October 29, 1998).
99.5 Press Release dated October 27, 1998 (Filed as exhibit 99.3
to the Current Report on Form 8-K, File No. 0-20763, filed
with the Commission on October 29, 1998).
99.6 Press Release dated October 28, 1998 (Filed as exhibit 99.1
to the Current Report on Form 8-K, File No. 0-20763, filed
with the Commission on October 29, 1998).
(b) Reports on Form 8-K
On October 29, 1998, the Company filed a Current Report on Form 8-K which
reported that the Company proposed to make a private offering of October 1998
Senior Notes, announced a definitive agreement to acquire Dakota
Telecommunications Group, Inc and announced the Company's executive realignment.
The Company also filed on October 29, 1998 a second Current Report on Form 8-K
which announced the Company's third quarter results for 1998.
24
<PAGE>
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: November 13, 1998 By: /s/ Stephen C. Gray
-----------------------------------
Stephen C. Gray
President and Chief Operating Officer
Date: November 13, 1998 By: /s/ J. Lyle Patrick
-----------------------------------
J. Lyle Patrick
Chief Financial Officer
25
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
Number EXHIBIT DESCRIPTION Page
------- ------------------- ------------
<S> <C>
11.1 Statement regarding computation of loss per common share.
27.1 Financial Data Schedule.
99.1 Press Release dated July 27, 1998
99.2 Press Release dated September 2, 1998 (Filed as exhibit 99.4 to the
Current Report on Form 8-K, File No. 0-20763, filed with the Commission
on October 29, 1998).
99.3 Press Release dated October 22, 1998 (Filed as exhibit 99.1 to the
Current Report on Form 8-K, File No. 0-20763, filed with the Commission
on October 29, 1998).
99.4 Press Release dated October 22, 1998 (Filed as exhibit 99.2 to the
Current Report on Form 8-K, File No. 0-20763, filed with the Commission
on October 29, 1998).
99.5 Press Release dated October 27, 1998 (Filed as exhibit 99.3 to the
Current Report on Form 8-K, File No. 0-20763, filed with the Commission
on October 29, 1998).
99.6 Press Release dated October 28, 1998 (Filed as exhibit 99.1 to the
Current Report on Form 8-K, File No. 0-20763, filed with the Commission
on October 29, 1998).
</TABLE>
<PAGE>
EXHIBIT 11.1
McLEODUSA INCORPORATED
COMPUTATION OF LOSS PER COMMON SHARE
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Computation of weighted average number of
common shares outstanding:
Common shares, Class A, outstanding at the
beginning of the period......................................... 62,879 52,628 61,799 36,173
Common shares, Class B, outstanding at the
beginning of the period (A)..................................... --- --- --- 15,626
Weighted average number of shares issued
during the period............................................... 76 707 821 953
-------- -------- -------- --------
Weighted average number of common shares......................... 62,955 53,335 62,620 52,752
======== ======== ======== ========
Net loss......................................................... $(33,042) $(23,705) $(93,100) $(53,556)
======== ======== ======== ========
Loss per common share............................................ $ (0.52) $ (0.45) $ (1.49) $(1.02)
======== ======== ======== ========
</TABLE>
(A) The Class B common stock, $.01 par value per share is convertible on a one-
for-one basis at any time at the option of the holder into Class A common
stock. As of September 30, 1998, all shares of Class B common stock had
been converted into shares of Class A common stock.
<PAGE>
EXHIBIT 99.1
McLeodUSA Logo
MCLEODUSA ACQUIRES QST COMMUNICATIONS OF PEORIA, IL
CEDAR RAPIDS, IA, JULY 27, 1998 - McLeodUSA Telecommunications Services, Inc., a
wholly-owned subsidiary of McLeodUSA Incorporated (Nasdaq/NMS:MCLD) announced
today that it has signed a definitive agreement to purchase QST Communications
Inc. of Peoria, Illinois. The cash and stock transaction requires regulatory
approval before closing.
QST Communications is a subsidiary of QST Enterprises Inc., which is a first-
tier subsidiary of CILCORP Inc. (NYSE: CER), an energy industry holding company
headquartered in Peoria. QST Communications provides high bandwidth fiber optic-
based communication services to business customers in the Peoria area. QST
Communications began constructing an intra-city fiber optic network in Peoria in
the spring of 1996 and now has approximately 112 route miles in the Peoria area
and will continue development on a 65 route mile extension connecting Peoria to
Springfield.
Steve Gray, President and Chief Operating Officer of McLeodUSA, stated, "This is
a strategic acquisition for us, adding route miles of advanced fiber optic
network in and between two key Illinois cities where we have market share and
had planned to build network soon."
The long-standing McLeodUSA three-part strategy includes building customer
share, constructing network, and migrating customers onto that network as a true
facilities-based provider. Gray: "The addition of more than 175 route miles, and
the opportunity to serve QST Communications' existing customers using our own
facilities, accelerates all three elements of our strategy. In addition, this
agreement is an extension of the McLeodUSA emphasis on creating strategic
alliances with energy/utility companies."
QST Enterprises President Mark Elliott stated, "By delivering exceptional
customer service and reliability to key customers through our SONET network, QST
Communications has been very successful in becoming a premier communications
provider in central Illinois. This agreement between QST and McLeodUSA will
result in central Illinois businesses having a wide array of telecommunications
services available through McLeodUSA, while still maintaining the level of
customer support and reliability consumers have come to expect from QST."
Gray added, "McLeodUSA has had a local presence in central Illinois for many
years, and we are committed to increasing our presence in the region. Peoria is
one of the thirty Midwestern cities identified in our October 1997 agreement
with AT&T to provide dedicated access service. And, Peoria is also one of our
initial 50 "MainStreet" cities targeted for network construction along the
business corridors of the City. This acquisition speeds our ability to
accomplish something we had already planned to do, and will allow us to begin
selling dial tone in Peoria soon after receiving regulatory clearance and
closing this deal."
McLeodUSA is a provider of integrated telecommunications services to businesses
and residential customers. The Company's telecommunications customers are
located in ten Midwestern and Rocky Mountain States. The combined firm is a 14-
state facilities-oriented telecommunications provider with 7 switches, and
nearly 314,000 local lines, 4,700 employees, and 5,100 route miles of fiber
optics network. In the next 12 months, the Company's publishing subsidiaries
will distribute nearly 15 million copies of competitive directories in 21
states, reaching a population of nearly 27 million.
# # #
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial infomation extracted from the
unaudited consolidated financial statements of McLeodUSA Incorporated and
subsidiaries for the three and nine months ended September 30, 1998 and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-1-1998 JAN-1-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 230,991 230,991
<SECURITIES> 171,391 171,391
<RECEIVABLES> 132,766 132,766
<ALLOWANCES> 12,915 12,115
<INVENTORY> 4,923 4,923
<CURRENT-ASSETS> 570,784 570,784
<PP&E> 618,028 618,028
<DEPRECIATION> 58,711 58,711
<TOTAL-ASSETS> 1,621,564 1,621,564
<CURRENT-LIABILITIES> 161,518 161,518
<BONDS> 939,102 939,102
0 0
0 0
<COMMON> 631 631
<OTHER-SE> 483,114 483,114
<TOTAL-LIABILITY-AND-EQUITY> 1,621,564 1,621,564
<SALES> 148,616 438,642
<TOTAL-REVENUES> 148,616 438,642
<CGS> 81,082 239,195
<TOTAL-COSTS> 81,082 239,195
<OTHER-EXPENSES> 84,230 245,628
<LOSS-PROVISION> 4,561 13,189
<INTEREST-EXPENSE> 19,429 54,593
<INCOME-PRETAX> (33,042) (93,100)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (33,042) (93,100)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (33,042) (93,100)
<EPS-PRIMARY> (0.52) (1.49)
<EPS-DILUTED> (0.52) (1.49)
</TABLE>
