McLeodUSA reports large loss

Lower EBITDA, a sequential revenue decline, lower gross margins, and a one-time charge of nearly $3 billion did not make for a happy third quarter for McLeodUSA--and things may not improve any time soon.

Although the company has refocused its sales strategy, launched cost-cutting measures, and is migrating 1,000 customers per day from resale lines to its own network, McLeodUSA apparently will face a cash crunch if it can’t generate the $400 million to $450 million it expects from proposed asset sales. At least one analyst believes the projection is optimistic.

“Given the long list of telco assets on the auction block, the low prices they are fetching, and uncertainty about timing and the full list of assets under consideration for disposal, we are excluding the asset sales from [McLeodUSA’s] funding assumptions until more details are available,” said Frank Governali, analyst at Goldman Sachs.

Governali said McLeodUSA has enough liquidity to last until the fourth quarter of 2002 and estimates the company’s funding gap at $864 million. The company exited the quarter with $609 million of cash and available credit, but has already drawn down $200 million of a $542 million facility in this quarter.

According to Governali, cash interest expense on McLeodUSA’s $3.7 billion in debt will hamper the company’s financial flexibility and competitiveness. Under the existing capital structure, EBITDA will not cover interest expense prior to 2004, he said. For example, McLeodUSA faces about $400 million in interest expenses in 2002.

McLeodUSA’s liquidity issue was not addressed on its earnings call, but a company statement said it is discussing “long-term capital alternatives” with its banks. Without new terms, the carrier is in danger of violating lender covenants regarding interest-expense ratios and number of access lines, said Daniel Zito, analyst at Lehman Brothers.

McLeodUSA is making progress in its effort to refocus on retail customers in its 25-state footprint and de-emphasizing wholesale services, out-of-region long distance, and international long distance, according to CEO Steve Gray. The company is also aggressively cutting costs--closing facilities, cutting jobs, and resizing its capital expenditures. The facility closings and job cuts are expected to save $105 million annually.

For the third quarter, McLeodUSA reported revenues of $450.5 million--a 5% sequential drop--and EBITDA of $26 million, down from $34.2 million in the second quarter. The quarter’s net loss reached $2.3 billion, or a loss of $3.62 per share, compared with a loss of $165.8 million, or 24¢ per share, in the year-earlier quarter.

The quarter’s one-time non-cash charge of $2.9 billion consisted of write-downs of goodwill and other assets, inventory associated with discontinued operations, and restructuring costs. McLeodUSA also took a $35 million charge to operating income, $21 million of which was for bad-debt reserves.

McLeodUSA is projecting revenue of $1.8 billion for 2002, essentially flat with year-end estimates for 2001.