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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended June 30, 2002
Commission file number 33339884-01
Mpower Holding Corporation
(Exact name of registrant as specified in its charter)
Delaware 52-2232143
(State of incorporation) (I.R.S. Employer Identification No.)
175 Sully's Trail, Suite 300
Pittsford, NY 14534
(Address of principal executive offices)
(585) 218-6550
(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 [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the court.
YES [x] NO [ ]
The number of shares outstanding of the issuer's common stock,
as of August 9, 2002:
Common stock (par value $0.001 per share) .... 65,000,000 shares outstanding
MPOWER HOLDING CORPORATION
INDEX
Page No.
--------
PART I- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - June 30, 2002 and December 31, 2001................................ 3
Consolidated Statements of Operations - Three and Six months ended June 30, 2002
and 2001......................................................................................... 4
Consolidated Statements of Redeemable Preferred Stock and Stockholders' Deficit for
the period from December 31, 2000 to June 30, 2002............................................... 5
Consolidated Statements of Cash Flows - Six months ended June 30, 2002
and 2001......................................................................................... 6
Condensed Notes to Unaudited Interim Consolidated Financial Statements........................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................... 37
PART II- OTHER INFORMATION
Item 1. Legal Proceedings................................................................................ 38
Item 2. Changes in Securities and Use of Proceeds........................................................ 38
Item 5. Other Information................................................................................ 39
Item 6. Exhibits and Reports on Form 8-K................................................................. 39
SIGNATURES ................................................................................................. 41
2
PART I - FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
MPOWER HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
June 30, December 31,
2002 2001
---- ----
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 28,228 $ 9,136
Investments available-for-sale ............................................. 63,223 161,144
Restricted investments ..................................................... 11,074 12,640
Accounts receivable, less allowance for doubtful accounts of $4,917 and
$4,330 at June 30, 2002 and December 31, 2001, respectively.............. 24,055 24,825
Prepaid expenses and other current assets................................... 7,703 5,587
--------------- ----------------
Total current assets ................................................. 134,283 213,332
Property and equipment, net ................................................... 346,820 385,872
Deferred financing costs, net of accumulated amortization of $2,682 and
$2,095 at June 30, 2002 and December 31, 2001, respectively................. 7,812 8,400
Other assets .................................................................. 9,744 6,043
--------------- ----------------
Total assets ............................................................ $ 498,659 $ 613,647
=============== ================
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and capital lease obligations ......... $ 4,918 $ 7,729
Accounts payable:
Trade ................................................................... 19,703 24,336
Property and equipment .................................................. 591 4,493
Accrued interest ........................................................... 1,508 14,023
Accrued sales tax payable .................................................. 6,280 7,077
Accrued network optimization costs ......................................... 2,511 13,593
Accrued other expenses ..................................................... 17,064 24,087
--------------- ----------------
Total current liabilities not subject to compromise...................... 52,575 95,338
Current liabilities subject to compromise .................................. 440,341 --
--------------- ----------------
Total current liabilities................................................ 492,916 95,338
Senior Notes, net of unamortized discount of $416 and $10,686 at June 30, 2002
and December 31, 2001, respectively......................................... 50,529 420,803
Other long-term debt and capital lease obligations............................. 11 2,154
--------------- ----------------
Total liabilities .................................................... 543,456 518,295
--------------- ----------------
Commitments and contingencies
Redeemable preferred stock:
10% Series C convertible preferred stock, 1,250,000 shares authorized,
issued and outstanding at June 30, 2002 and December 31, 2001,
respectively ............................................................ 47,763 46,610
7.25% Series D convertible preferred stock, 2,963,388 shares and 3,013,388
shares authorized, issued and outstanding at June 30, 2002 and December
31, 2001, respectively .................................................. 156,616 156,220
Stockholders' deficit :
Preferred stock, 45,686,612 and 45,636,612 shares authorized but unissued
at June 30, 2002 and December 31, 2001, respectively..................... -- --
Series E preferred stock, 100,000 shares authorized but unissued............ -- --
Common stock, $0.001 par value, 300,000,000 shares authorized, 59,465,233
and 59,488,843 shares issued and outstanding at June 30, 2002 and
December 31, 2001, respectively ......................................... 59 59
Additional paid-in capital .................................................... 711,275 712,334
Accumulated deficit ........................................................... (962,257) (826,615)
Less: treasury stock, 13,710 shares, at cost .................................. (76) (76)
Notes receivable from stockholders for issuance of common stock ............... (538) (973)
Accumulated other comprehensive income ........................................ 2,361 7,793
--------------- ----------------
Total stockholders' deficit ......................................... (249,176) (107,478)
--------------- ----------------
Total liabilities, redeemable preferred stock and stockholders'
deficit ........................................................... $ 498,659 $ 613,647
=============== ================
See accompanying condensed notes to unaudited interim
consolidated financial statements.
3
MPOWER HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Operating revenues:
Telecommunication services................... $ 56,907 $ 49,225 $ 109,728 $ 95,431
Operating expenses:
Cost of operating revenues
(excluding depreciation)........... 36,802 42,191 76,377 82,763
Selling, general and administrative.......... 41,361 50,982 83,491 103,354
Reorganization expenses...................... 20,702 -- 20,702 --
Stock-based compensation expense............. 141 933 342 1,867
Network optimization cost.................... -- 209,083 19,000 233,083
Depreciation and amortization................ 17,858 22,476 35,306 44,045
--------------- --------------- -------------- ---------------
116,864 325,665 235,218 465,112
--------------- --------------- -------------- ---------------
Loss from operations...................... (59,957) (276,440) (125,490) (369,681)
Other income (expense):
Gain on sale of assets, net.................. 187 1,002 4,420 2,775
Interest income.............................. 1,163 5,645 2,934 13,372
Interest expense, net of amount capitalized
(contractual interest was $14,594 and
$28,789 for the three and six months ended
June 30, 2002, respectively)................. (3,311) (14,893) (17,506) (29,659)
--------------- --------------- -------------- ---------------
Net loss before extraordinary item........ (61,918) (284,686) (135,642) (383,193)
Extraordinary item:
Gain on early retirement of debt............. -- 32,322 -- 32,322
--------------- --------------- -------------- ---------------
Net loss ................................. (61,918) (252,364) (135,642) (350,871)
Accrued preferred stock dividend (contractual
dividend was $3,829 and $7,463 for the
three and six months ended June 30, 2002,
respectively)............................. (340) (4,696) (3,974) (14,419)
--------------- --------------- -------------- ---------------
Net loss applicable to common stockholders...... $ (62,258) $ (257,060) $ (139,616) $ (365,290)
============== ============== ============= ==============
Basic and diluted loss per share of common
stock ....................................... $ (1.05) $ (4.32) $ (2.35) $ (6.17)
============== ============== ============= ==============
Gain per share applicable to extraordinary
item ....................................... $ -- $ 0.54 $ -- $ 0.55
============== ============== ============= ==============
Basic and diluted weighted average
shares outstanding........................... 59,464,973 59,436,179 59,459,413 59,206,906
============== ============== ============= ==============
See accompanying condensed notes to unaudited interim
consolidated financial statements.
4
MPOWER HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
Redeemable
Preferred Stock Common Stock Additional
Comprehensive --------------- ------------ Paid-In
Loss Shares Amount Shares Amount Capital
---- ------ ------ ------ ------ -------
Balance at December 31, 2000 5,390,000 $ 244,886 56,875,870 $ 57 $ 672,031
Unrealized loss on investments
available-for-sale............... $ (1,231) -- -- -- -- --
Warrants and options exercised for
common stock..................... -- -- -- 211,072 -- 72
Cancellation of stockholder's note
for common stock................. -- -- -- (225,000) -- (4,904)
Stock-based compensation............ -- -- -- -- -- 3,081
Accrued preferred stock dividend.... -- -- 15,157 -- -- (15,157)
Preferred dividends paid in common
stock ........................... -- -- (2,995) 427,070 -- 2,995
7.25% Series D convertible preferred
stock converted to common stock .... -- (1,126,612) (54,218) 2,199,831 2 54,216
Net loss............................ (467,740) -- -- -- -- --
------------- ------------ ---------- ------------ ------- ----------
Comprehensive Loss.................. $ (468,971)
============
Balance at December 31, 2001........ 4,263,388 202,830 59,488,843 59 712,334
Unrealized loss on investments
available-for-sale............... $ (5,432) -- -- -- -- --
Cancellation of stockholders' notes
for common stock................. -- -- -- (81,000) -- (435)
Principal stockholder's short swing
profit........................... -- -- -- -- -- 583
Stock-based compensation............ -- -- -- -- -- 342
Accrued preferred stock dividend.... -- -- 3,974 -- -- (3,974)
7.25% Series D convertible preferred
stock converted to common stock . -- (50,000) (2,425) 57,390 -- 2,425
Net loss............................ (135,642) -- -- -- -- --
------------- ------------ ---------- ------------ ------- ----------
Comprehensive Loss.................. $ (141,074)
============
Balance at June 30, 2002............ 4,213,388 $ 204,379 59,465,233 $ 59 $ 711,275
=========== ========= =========== ====== =========
Notes Accumulated
Receivable from Other
Treasury Stock Stockholders for Comprehensive Total
Accumulated -------------- Issuance of Income Stockholders'
Deficit Shares Amount Common Stock (Loss) (Deficit)
------- ------ ------ ------------ ------ ------------
Balance at December 31, 2000 $(358,875) 13,710 $ (76) $ (5,294) $ 9,024 $ 316,867
Unrealized loss on investments
available-for-sale............... -- -- -- -- (1,231) (1,231)
Warrants and options exercised for
common stock..................... -- -- -- -- -- 72
Cancellation of stockholder's note
for common stock................ -- -- -- 4,321 -- (583)
Stock-based compensation............ -- -- -- -- -- 3,081
Accrued preferred stock dividend.... -- -- -- -- -- (15,157)
Preferred dividends paid in common
stock ........................... -- -- -- -- -- 2,995
7.25% Series D convertible preferred
stock converted to common stock . -- -- -- -- -- 54,218
Net loss............................ (467,740) -- -- -- -- (467,740)
---------- ------- ------- --------- ---------- ----------
Comprehensive Loss..................
Balance at December 31, 2001........ (826,615) 13,710 (76) (973) 7,793 (107,478)
Unrealized loss on investments
available-for-sale............... -- -- -- -- (5,432) (5,432)
Cancellation of stockholders' notes
for common stock................. -- -- -- 435 -- --
Principal stockholder's short swing
profit........................... -- -- -- -- -- 583
Stock-based compensation............ -- -- -- -- -- 342
Accrued preferred stock dividend.... -- -- -- -- -- (3,974)
7.25% Series D convertible preferred
stock converted to common stock . -- -- -- -- -- 2,425
Net loss............................ (135,642) -- -- -- -- (135,642)
---------- ------- ------- --------- ---------- ----------
Comprehensive Loss..................
Balance at June 30, 2002............ $(962,257) 13,710 $ (76) $ (538) $ 2,361 $(249,176)
========= ====== ====== ======== ========= =========
See accompanying condensed notes to unaudited interim
consolidated financial statements.
5
MPOWER HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
June 30,
--------
2002 2001
---- ----
Cash flows from operating activities:
Net loss.................................................................... $ (135,642) $ (350,871)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................ 35,306 44,045
Gain on early retirement of debt ......................................... -- (32,322)
Network optimization cost ................................................ 19,000 233,083
Gain on sale of assets, net .............................................. (4,420) (2,857)
Bad debt expense.......................................................... 4,736 4,041
Amortization of debt discount ............................................ 703 776
Amortization of deferred debt financing costs ............................ 588 685
Stock-based compensation expense.......................................... 342 1,867
Changes in assets and liabilities:
(Increase) decrease in accounts receivable............................ (2,472) 7,072
Increase in prepaid expenses and other current assets................. (2,116) (2,341)
(Increase) decrease in other assets .................................. (4,524) 525
Increase (decrease) in accounts payable - trade ...................... 18,432 (11,751)
Decrease in sales tax payable ........................................ (797) (213)
Decrease in accrued network optimization costs ....................... (3,559) (10,566)
Increase (decrease) in accrued interest and other expenses ........... 9,711 (1,534)
------------- -------------
Net cash used in operating activities .............................. (64,712) (120,361)
-------------- -------------
Cash flows from investing activities:
Purchase of property and equipment, net of payables......................... (9,635) (62,471)
Proceeds from sale of customer base ........................................ -- 1,601
Sale of investments available-for-sale, net ................................ 95,022 222,538
Sale of restricted investments, net......................................... 1,566 --
-------------- --------------
Net cash provided by investing activities .......................... 86,953 161,668
-------------- --------------
Cash flows from financing activities:
Proceeds from principal stockholder's short swing profit ................... 583 --
Repurchase of Senior Notes.................................................. -- (14,134)
Proceeds from issuance of common stock...................................... -- 75
Payments on other long-term debt and capital lease obligations.............. (3,732) (3,781)
--------------- ---------------
Net cash used in financing activities .............................. (3,149) (17,840)
--------------- ---------------
Net increase in cash ............................................... 19,092 23,467
Cash and cash equivalents at beginning of period ............................... 9,136 10,437
-------------- --------------
Cash and cash equivalents at the end of period.................................. $ 28,228 $ 33,904
============= =============
Supplemental schedule of non-cash investing and financing activities:
Preferred stock converted to common stock................................... $ 2,425 $ 54,170
============= =============
Preferred dividends paid in common stock.................................... $ -- $ 2,995
============= =============
Preferred stock dividends accrued .......................................... $ 3,974 $ 7,795
============= =============
Other disclosures:
Cash paid for interest, net of amounts capitalized ......................... $ 2,114 $ 28,863
============= =============
See accompanying condensed notes to unaudited interim
consolidated financial statements.
6
MPOWER HOLDING CORPORATION
CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Mpower
Holding Corporation, (the "Company"), a Delaware corporation, include the
accounts of the Company and its wholly owned subsidiary, Mpower Communications
Corp. ("Communications") and other subsidiaries of Communications. All
significant inter-company balances and transactions have been eliminated.
These consolidated financial statements reflect all normal recurring
adjustments, which management believes are necessary to present fairly the
financial position, results of operations, and cash flows for the Company for
the respective periods presented. Certain information and footnote disclosures
normally included in the annual consolidated financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission for Form 10-Q. These unaudited interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's annual report on Form
10-K filed with the Securities and Exchange Commission.
On April 8, 2002, the Company, Communications and Mpower Lease Corporation,
a wholly-owned subsidiary of Communications (collectively, the "Debtors"),
each filed a voluntary petition for relief under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the District
of Delaware. See Note 6 for a description of these proceedings and the effect
of the Company's Reorganization Plan.
The Debtors adopted the provisions of Statement of Position 90-7 ("SOP
90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code," upon commencement of the Bankruptcy Proceedings. In accordance with SOP
90-7, liabilities subject to compromise under the Chapter 11 proceedings have
been segregated on the consolidated balance sheet. Liabilities subject to
compromise are recorded for the amounts the Company expects to be allowed on
known claims rather than estimates of the amounts for which those claims may be
settled as a result of the Bankruptcy Court approved plan of reorganization. The
consolidated statement of operations for the six months ended June 30, 2002,
separately discloses expenses related to the Chapter 11 proceedings as
reorganization expense. Interest expense on the Company's 13% Senior Notes due
2010 (the "2010 Notes") and the preferred stock dividends on the 10% Series C
Convertible Redeemable Preferred Stock (the "Series C Preferred Stock") and
7.25% Series D Convertible Redeemable Preferred Stock (the "Series D Preferred
Stock") ceased to accrue after filing by the Debtors on April 8, 2002. Interest
and dividends ceased by operation of law.
As of July 30, 2002, the Company and its subsidiaries will implement Fresh
Start Accounting under the provisions of SOP 90-7. Under SOP 90-7, the
reorganization fair value of the Company will be allocated to its assets and
liabilities, its accumulated deficit will be eliminated, and its new equity will
be issued according to the Plan. The Company is still evaluating the impact but
anticipates that the adoption of SOP 90-7 and Fresh Start Accounting will have a
material effect on its financial statements. As a result, the financial
statements published for periods following the effectiveness of the Plan will
not be comparable to those published before the effectiveness of the Plan.
The consolidated balance sheet at December 31, 2001 was derived from the
audited consolidated financial statements of the Company, but does not include
all disclosures required under generally accepted accounting principles.
Preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Certain reclassifications have been made in the prior period financial
statements to conform to the current presentation.
7
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
June 30, December 31,
2002 2001
---- ----
Buildings and property ........................................................ $ 5,737 $ 5,715
Telecommunication and switching equipment ..................................... 339,594 335,475
Leasehold improvements ........................................................ 45,572 41,213
Computer hardware and software ................................................ 32,902 28,436
Office equipment and other .................................................... 26,736 26,494
--------------- ----------------
450,541 437,333
Less accumulated depreciation and amortization................................. (157,872) (123,687)
--------------- ----------------
292,669 313,646
Assets held for future use .................................................... 48,265 42,134
Construction in progress....................................................... 5,886 30,092
--------------- ----------------
Net property and equipment..................................................... $ 346,820 $ 385,872
=============== ================
As further discussed in Note 5 "Network Optimization Cost", the assets held
for future use are primarily related to the recovery of switch and collocation
equipment from markets cancelled or exited during 2001 and 2002 which will be
redeployed in future periods throughout the Company's remaining operating
markets.
(3) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
In January 2002, holders of the Series D Preferred Stock converted 50,000
preferred shares into 57,390 shares of the Company's common stock.
In January 2002, the Company entered into certain agreements with former
employees, whereby in consideration for the payment of $0.1 million and return
of 81,000 shares of the Company's common stock, the former employees were
released from $0.4 million of obligations related to the notes receivable from
stockholders for issuance of common stock.
In January 2002, the Company announced a deferral of the quarterly dividend
on the Company's Series D Preferred Stock. As discussed in Note 1, dividends on
the Series C Preferred Stock and the Series D Preferred Stock ceased to accrue
after filing by the Debtors on April 8, 2002.
A principal stockholder purchased and sold shares of the Company's common
stock, resulting in a short-swing profit under Section 16(b) of the Securities
Exchange Act of 1934. The settlement agreement between the Company and the
principal stockholder required that the Company be reimbursed for the
short-swing profit in the amount of $0.6 million. In March 2002 the Company
received $0.1 million of the settlement, and received the remaining $0.5 million
in April 2002.
(4) COMMITMENTS AND CONTINGENT LIABILITIES
In the ordinary course of business, the Company enters into purchase
agreements with its equipment vendors and collocation site providers. As of June
30, 2002, the Company had total unfulfilled commitments with equipment vendors
and collocation site providers for the augmentation of collocation sites of $2.5
million. The Company also has various agreements with certain carriers for
transport, long distance and other network services. At June 30, 2002, the
Company's commitment under these agreements is $26.9 million, which expire
through July 2005.
8
The Company is party to various legal proceedings, most of which relate to
routine matters incidental to its business. However, on September 20, 2000, a
class action lawsuit was commenced against the Company and its chief executive
officer (the "CEO"), in federal court for the Western District of New York. On
March 6, 2001, an amended consolidated class action complaint was served in that
action, seeking to recover damages for alleged violations by the Company of the
Securities Exchange Act of 1934 and rule 10(b)-5 thereunder (the "Exchange Act")
and section 11 of the Securities Act of 1933. The amended consolidated complaint
also seeks to recover damages against several of the Company's officers and
former members of its board of directors in addition to the CEO. The amended
consolidated complaint also named various underwriters as defendants in the
action. However, by agreement of the parties and order of the court, the action
against the Underwriters has been discontinued, subject to the plaintiff's
right to rename the underwriters as defendants prior to completion of
discovery. On February 11, 2002, the Court issued its Decision and Order
dismissing the class action lawsuit. The decision of the Court has been
appealed to the Court of Appeals in the Second Circuit. The final outcome of
this lawsuit is uncertain.
The Company and the individual defendant officers and former board members
have denied any wrongdoing and will vigorously contest the class action lawsuit.
Any judgment that is significantly greater than the Company's available
insurance coverage could have a material adverse effect on the Company's results
of operations and/or financial condition.
Except as set forth above and except for the Chapter 11 reorganization
proceedings discussed in Note 6, management does not believe that the outcome of
any legal proceedings will have a material adverse effect on the Company's
financial position or results of operations.
(5) NETWORK OPTIMIZATION COST
The Company has recognized several charges related to the cancellation of
certain markets.
In September 2000, the Company recognized a $12.0 million network
optimization charge associated with commitments made for collocation sites. As
of June 30, 2002, the Company had incurred $9.1 million of these charges and had
$2.9 million of remaining reserves.
In February 2001, the Company recognized a network optimization charge of
$24.0 million associated with the commitments made for switch sites and
collocations. During the fourth quarter of 2001, as a result of unfavorable
lease negotiations, the Company revised its original estimate and recorded an
additional network optimization charge of $2.1 million to cover lease
commitments through July 2002. As of June 30, 2002, the Company had incurred
$26.1 million of these charges and does not anticipate any additional charges
associated with this network optimization.
In May 2001, the Company recognized a network optimization charge of $209.1
million. Included in the charge was $126.8 million for the goodwill and customer
base associated with the Primary Network business, $65.1 million for property
and equipment including collocations and switch sites and $17.2 million for
other costs associated with exiting these markets. During the fourth quarter of
2001, as a result of favorable negotiations with various carriers, the Company
reduced its original network optimization charge by $2.1 million. As of June 30,
2002, the Company had incurred $65.1 million and $7.5 million of charges related
to property and equipment and other costs, respectively, and had $7.6 million of
remaining reserves.
In February 2002, the Company closed down operations in Charlotte, North
Carolina and eliminated certain other non-performing sales offices. The Company
also cancelled the implementation of a new billing system in February 2002. The
Company recognized a network optimization charge of $19.0 million in the first
quarter of 2002. Included in the charge was $12.5 million for the write down of
its investment in software and assets for a new billing system, $3.7 million for
property and equipment including collocations and switch sites and $2.8 million
for other costs associated with exiting these markets. As of June 30, 2002, the
Company had incurred $12.5 million, $3.7 million and $1.4 million of charges
related to the billing system, property and equipment and other costs,
respectively, and had $1.4 million of remaining reserves.
The remaining $11.9 million of Accrued Network Optimization costs as of June
30, 2002 represent amounts estimated to be paid, $9.4 million of which has been
classified as current liabilities subject to compromise in the Consolidated
Balance Sheet. Actual
9
payments will be based on ultimate settlements with various carriers and
vendors, net of any costs that may be recoverable through sales of the related
assets, and the Company's ability to enter into sublease or termination
agreements for its switch site and sales office leases.
(6) CHAPTER 11 PROCEEDINGS
On February 25, 2002, the Company announced that it had reached an agreement
with an informal committee representing approximately 66% of the outstanding
principal amount of its 2010 Notes on a comprehensive recapitalization plan
that would eliminate a significant portion of the Company's long-term debt and
all of its preferred stock. Under the proposed recapitalization plan, the
Company would use $19.0 million of cash on hand and issue common stock to
eliminate $583.4 million in debt and preferred stock, as well as the associated
$49.5 million of annual interest expense related to the Company's 2010 Notes
and $15.8 million of annual dividend payments on its preferred stock.
On March 22, 2002, the Company announced that it had successfully completed
its bondholder solicitation which resulted in more than 99% of the holders of
the Company's 2010 Notes entering into voting agreements with the Company in
support of the proposed recapitalization plan announced on February 25, 2002. On
March 27, 2002, each bondholder who participated in the solicitation received a
consent fee equal to their pro-rata share of the $19.0 million.
In addition, more than two-thirds of the holders of the Company's issued and
outstanding shares of preferred stock entered into voting agreements with the
Company in support of the proposed recapitalization plan.
On April 8, 2002, the Company, Communications and Mpower Lease Corporation
("Mpower LeaseCorp"), a wholly-owned subsidiary of Communications, each filed a
voluntary petition for relief (collectively, the "Chapter 11 Cases") under
Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy
Court for the District of Delaware (the "Bankruptcy Court"). None of the
Company's other direct or indirect subsidiaries were parties to the Chapter 11
Cases or any related bankruptcy, reorganization or liquidation proceedings. The
Chapter 11 Cases were jointly administered (Case No. 02-11046 (PJW)). During the
course of the Chapter 11 Cases, the Debtors managed their properties and
operated their businesses as "debtors-in-possession" under the jurisdiction of
the Bankruptcy Court and in accordance with the applicable provisions of the
Bankruptcy Code.
On April 8, 2002, the Debtors jointly filed a pre-negotiated plan of
reorganization and a disclosure statement with respect to the joint plan of
reorganization with the Bankruptcy Court. On May 20, 2002, the Debtors filed the
Debtors' First Amended Joint Plan of Reorganization (the "Plan") and a related
Debtors' First Amended Disclosure Statement (the "Disclosure Statement") with
the Bankruptcy Court. Mpower Leasecorp is not a party to the Plan.
On July 12, 2002, the Debtors filed an affidavit certifying the ballots
accepting or rejecting the Plan that indicated that, in accordance with the
Bankruptcy Code, the Plan was accepted by all classes entitled to vote on the
Plan.
On July 17, 2002, the Bankruptcy Court confirmed the Plan, as modified by
the Findings of Fact, Conclusions of Law, and Order Under Section 1129 of the
Bankruptcy Code and Rule 3020 of the Bankruptcy Rules Confirming Debtors' First
Amended Joint Plan of Reorganization entered by the Bankruptcy Court on the same
date (the "Confirmation Order," the Plan as modified by the Confirmation Order
is referred to herein as the "Final Plan"). Also, on July 17, 2002, the
Bankruptcy Court dismissed the Chapter 11 Case of Mpower LeaseCorp, effective as
of July 30, 2002.
On July 30, 2002 (the "Effective Date"), the Final Plan became effective,
and the Debtors emerged from Chapter 11 protection and are now operating their
businesses and properties as reorganized entities pursuant to the terms of the
Final Plan.
The following is a summary of the material features of the Final Plan.
Unless otherwise indicated, each of the actions described below occurred on the
Effective Date. References to the "Reorganized Company" below refer to the
Company after it has emerged from bankruptcy.
10
- - The 2010 Notes were canceled and the indenture governing the 2010 Notes
(the "2010 Note Indenture") was terminated. Pursuant to the Final Plan,
holders of the 2010 Notes prior to the emergence (the "2010 Noteholders")
received their pro rata share of 55,250,000 shares of the Reorganized
Company's common stock (the "New Common Stock") representing 85% of the
issued and outstanding common stock of the Reorganized Company, which
included 150,000 shares of New Common Stock withheld by the Trustee under
the 2010 Note Indenture to satisfy certain fees owed to the Trustee.
- - The authorized, issued and outstanding Series C Preferred Stock and Series
D Preferred Stock were canceled. Pursuant to the Final Plan, holders of
the Series C Preferred Stock and Series D Preferred Stock prior to the
emergence (collectively, the "Preferred Stockholders") received, on a pro
rata basis, 1,862,214 and 6,912,786 shares of New Common Stock,
respectively, which represent a total of 13.5% of the issued and
outstanding common stock of the Reorganized Company.
- - The authorized, issued and outstanding common stock, par value of $0.001
per share, (the "Old Common Stock") was canceled. Pursuant to the Final
Plan, holders of the Old Common Stock prior to the emergence (the "Old
Common Stockholders") received their pro rata share of 975,000 shares of
New Common Stock representing 1.5% of the issued and outstanding common
stock of the Reorganized Company.
- - Pursuant to the Final Plan, the Rights Agreement, dated as of June 28, 2001
between the Company and Continental Stock Transfer & Trust Company, as
rights agent, was canceled, along with all rights granted to holders of the
Old Common Stock thereunder. In addition, the authorized Series E Preferred
Stock was also canceled.
- - Pursuant to the Final Plan, no fractional shares of New Common Stock will
be issued. All distributions of New Common Stock pursuant to the Final Plan
will reflect rounding, to avoid the issuance of fractional shares. As a
result, the actual shares of New Common Stock issued to holders of each
class of the old securities may differ from the share numbers specifically
enumerated in the preceding paragraphs.
- - The Reorganized Company has entered into a new stock option plan for
certain selected key employees (the "New Key Employee Option Plan") that is
substantially identical to the existing Amended and Restated Mpower Holding
Corporation Stock Option Plan (the "Old Option Plan"). Under the New Key
Employee Option Plan, a total of 7,222,222 shares of New Common Stock have
been reserved for issuance to employees of the Reorganized Company.
- - The Reorganized Company shall enter into a registration rights agreement
with holders of the New Common Stock who individually recieved in excess
of ten percent (10%) of the New Common Stock under the Final Plan.
- - The board of directors of the Reorganized Company (the "Board of
Directors") will initially consist of six members. Among them, Rolla P.
Huff is the Chief Executive Officer of the Reorganized Company; Joseph M.
Wetzel is the President and Chief Operating Officer and is the designee of
the Company; Robert M. Pomeroy, Michael E. Cahr, Richard L. Shorten, Jr.
and Michael M. Earley are the designees of the 2010 Noteholders (the "2010
Noteholder Designees"). The Final Plan further provides that the 2010
Noteholder Designees will serve for a term of two years during which they
cannot be removed without cause. Thereafter, the Board of Directors will be
elected in accordance with the Reorganized Company's certificate of
incorporation and by-laws, as amended and restated, and applicable law.
- - As of the Effective Date, the Reorganized Company's certificate of
incorporation, as amended and restated pursuant to the Final Plan,
authorized 1,000,000,000 shares of common stock, $0.001 par value and
50,000,000 shares of preferred stock, $0.001 par value. Pursuant to the
terms of the Final Plan, on the Effective Date, the Reorganized Company
issued 65,000,000 shares of the New Common Stock (subject to rounding
adjustments made to avoid the issuance of fractional shares described
above), which constitutes 100% of the issued and outstanding common stock
of the Reorganized Company as of the Effective Date.
- - The New Common Stock began trading on July 31, 2002 on the NASD
Over-the-Counter Bulletin Board under the symbol MPOW.
11
- - As of the Effective Date, 1,000 shares of Mpower Communications' common
stock remain issued and outstanding, and are held by the Reorganized
Company.
- - The series of transactions included in the Chapter 11 filing and
reorganization plan will reduce federal income tax attributes by the amount
of any debt forgiveness income. The federal and state net operating loss
("NOL") carryforwards will be reduced and any remaining NOL carryforward
amount will be subject to limitations under Section 382 of the Internal
Revenue Code.
The condensed financial information for the Company and Communications (the
"Reorganized Companies"), as of and for the six months ended June 30, 2002
is as follows (in thousands except per share data):
CONDENSED BALANCE SHEET
AS OF JUNE 30, 2002
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 28,011
Investments available-for-sale 63,209
Restricted investments 11,074
Other current assets 31,395
Intercompany receivable 441,795
---------------
Total current assets 575,484
Property and equipment, net 163,187
Other long-term assets 17,556
Investments in subsidiaries (273,961)
---------------
$ 482,266
===============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Current liabilities not subject to compromise $ 36,193
Current liabilities subject to compromise 440,341
---------------
Total current liabilities 476,534
Long-term debt 50,529
10% Series C convertible preferred stock 47,763
7.25% series D convertible preferred stock 156,616
Stockholders' deficit (249,176)
---------------
$ 482,266
===============
12
CONDENSED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(IN THOUSANDS)
Operating revenues $ 109,728
Cost of operating revenues 76,404
Selling, general and
administrative 97,825
Reorganization expense 20,702
Network optimization cost 7,788
Depreciation and amortization 20,417
----------
Loss from operations (113,408)
Gain on sale of assets, net 1
Interest income 29,838
Interest expense, net (contractual interest was
$12,368 for the six months ended
June 30, 2002) (17,119)
Equity earnings in subsidiary (34,954)
----------
Net Loss $ (135,642)
==========
13
CONDENSED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(IN THOUSANDS)
Net cash used in operating
activities $ (64,225)
Cash flows from investing activities:
Purchases of property and
equipment, net (1,445)
Transfer of investments
available for sale 85,124
Sale of restricted
investments 1,566
-----------
Net cash provided by investing
activities 85,245
-----------
Cash flows from financing activities:
Payments on other long-term
debt and capital lease
obligations, net (584)
Proceeds from short swing
profit 583
-----------
Net cash used in financing
activities (1)
-----------
Net increase in cash and cash
equivalents 21,019
Cash and cash equivalents, beginning
of year 6,992
-----------
Cash and cash equivalents, end
of year $ 28,011
-----------
14
Liabilities for which payment was subject to the Chapter 11 proceedings have
been classified as liabilities subject to compromise in the consolidated
balance sheet. As of June 30, 2002, liabilities of the Company subject to
compromise consisted of the following (in thousands):
2010 Notes $ 370,977
Accrued interest- 2010 Notes 25,820
Other liabilities 43,544
------------
$ 440,341
============
Reorganization items: Reorganization items are comprised of items of expense
that were realized or incurred by the Company as a result of reorganization
under Chapter 11 of the Bankruptcy Code. Items for the six months ended June
30, 2002 consisted of the following (in thousands):
Consent fee $ 19,025
Professional fees 1,677
-----------
$ 20,702
===========
Loss per common share: Loss per common share has been computed using the
weighted average number of shares of common stock outstanding. As discussed
above, on the Effective Date, the outstanding common stock and preferred stock
were cancelled and the Reorganized Company distributed 65,000,000 new shares of
common stock under the Final Plan. The increase in the number of shares
outstanding will have a significant impact on the loss per share calculation.
(7) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS No. 142). The Company adopted the provisions of this standard on January
1, 2002. SFAS No. 142 provides that goodwill and other acquired intangible
assets with indefinite lives will no longer be amortized, but will be subject to
at least an annual assessment for impairment through the application of a
fair-value-based test. The adoption of SFAS No. 142 has not had a material
effect on the financial results of the Company as the Company eliminated its
goodwill and other intangible assets in May 2001 (Refer to Note 5). Had the
Company adopted the provisions of SFAS No. 142 for all periods presented the
effect would have been as follows:
- -------------------------------------------------------------------- --------------------------
Three Months Ended June 30, Six Months Ended June 30,
- -------------------------------------------------------------------- --------------------------
2002 2001 2002 2001
- -------------------------------------------------------------------- --------------------------
Net loss applicable to common
stockholders, as reported $ (62,258) $ (257,060) $ (139,616) $ (365,290)
- -------------------------------------------------------------------- ---------------------------
Goodwill amortization -- 3,220 -- 6,440
- -------------------------------------------------------------------- ---------------------------
Adjusted net loss applicable to
common stockholders $ (62,258) $ (253,840) $ (139,616) $ (358,850)
- -------------------------------------------------------------------- ---------------------------
Basic and diluted loss per share,
as reported $ (1.05) $ (4.32) $ (2.35) $ (6.17)
- -------------------------------------------------------------------- ---------------------------
Goodwill amortization per share -- 0.05 -- 0.11
- -------------------------------------------------------------------- ---------------------------
Adjusted basic and diluted loss
per share $ (1.05) $ (4.27) $ (2.35) $ (6.06)
- -------------------------------------------------------------------- ---------------------------
15
In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" (SFAS No. 143). The Company will adopt this standard on July 30,
2002, in connection with the implementation of Fresh Start Accounting. Upon
adoption of SFAS No. 143, the fair value of a liability for an asset retirement
obligation will be recognized in the period in which it is incurred. The
associated retirement costs will be capitalized as part of the carrying amount
of the long-lived asset and subsequently allocated to expense over the asset's
useful life. Management is still assessing the impact that SFAS No. 143 will
have on the financial results of the Company.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144). The Company adopted the
provisions of this standard on January 1, 2002. This standard addresses
financial accounting and reporting for the impairment and disposal of long-lived
assets. The adoption of SFAS No. 144 has not had a material effect on the
financial results of the Company.
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13, and Technical Corrections" (SFAS No.
145). This standard rescinds FASB No. 4 and an amendment to that Statement, FASB
No. 64, which relates to extinguishment of debt. It rescinds FASB No. 44 which
relates to certain sale-leaseback transactions. The Company will adopt this
standard on July 30, 2002 in connection with its implementation of Fresh Start
Accounting. Management is still assessing the impact that the adoption of SFAS
No. 145 will have on the Company's financial results.
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (SFAS No. 146). This standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". This Statement requires recognition of a
liability for a cost associated with an exit or disposal activity when the
liability is incurred, as opposed to when the entity commits to an exit plan
under EITF No. 94-3. The provisions of this Statement are effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. Management is still assessing the impact that SFAS No.
146 will have on the Company's financial results.
(8) GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business.
The Company incurred losses applicable to common stockholders of $139.6
million during the first six months of 2002 and $365.3 million during the first
six months of 2001. The Company continues to incur negative cash flows from
operating activities and estimates that it has the resources to fund the
Company's current operations through the first quarter of 2003, but that
additional resources may be required thereafter. These factors, among others,
indicate that the Company could be unable to continue as a going concern.
The Company's operations require substantial capital investment for the
purchase of equipment and the development and maintenance of its network.
Management expects to continue to require substantial amounts of capital to
acquire customers, fund operating losses, augment the network in existing
markets and develop new products and services.
The Company has completed, and is pursuing, several initiatives intended to
increase liquidity and better position the Company to compete under current
conditions and anticipated changes in the telecommunications sector. These
include:
- Implementation of the recapitalization of its balance sheet as
described in Note 6
- Aggressively seeking additional equity or debt financing
- Discussions with companies who may be interested in acquiring the
Company or its assets, in whole or in part, and discussions with
companies who may be interested in selling their assets or business,
in whole or in part.
16
- Continuing to update its prospective business plans and forecasts to
assist in monitoring current and future liquidity
- Closing unprofitable or underperforming markets
- Reducing general and administrative expenses through various cost
cutting measures
- Introducing new products and services with greater profit margins
- Analyzing the pricing of its current products and services to ensure
they are competitive and meet Company objectives
- Redeploying assets held for future use to reduce the requirement for
capital expenditures
The Company's continuation as a going concern is dependent on its ability to
meet the above initiatives, among others. However, there can be no assurance
that the Company will be successful in obtaining additional debt or equity
financing, or in obtaining a bank facility on terms acceptable to the Company,
or at all, or that management's estimate of additional funds required is
accurate. The financial statements do not include any adjustments relating to
the recoverability and classification of assets and the satisfaction and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
(9) CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The following information sets forth the condensed consolidating balance
sheets of the Company as of June 30, 2002 and December 31, 2001 and the
condensed consolidating statements of operations and cash flows for the six
months ended June 30, 2002 and 2001, for the Company (the "Parent Company"),
the subsidiary of the Company , Communications, which guarantees the 2004 Notes
("Subsidiary Guarantor") and the combined subsidiaries of the Company which are
not Subsidiary Guarantors ("Subsidiary Nonguarantors.") The Subsidiary
Guarantor is wholly owned and the guarantee is the full, unconditional, joint
and several obligation of the Subsidiary Guarantor. The accounting policies of
the subsidiaries are the same as those of the Company which are described in
Note 1 of the Company's annual report on Form 10-K filed with the Securities
and Exchange Commission. There are no restrictions on the ability of the
Subsidiary Guarantor to transfer funds to the Company in the form of cash
dividends, loans or advances.
17
CONDENSED CONSOLIDATING BALANCE SHEET
AT JUNE 30, 2002
(IN THOUSANDS)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
------------- ------------- ------------- -------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 100 $ 27,911 $ 217 $ -- $ 28,228
Investments available-for-sale -- 63,209 14 -- 63,223
Restricted investments -- 11,074 -- -- 11,074
Accounts receivable, net -- 23,955 100 -- 24,055
Prepaid expenses and other current assets -- 7,440 263 -- 7,703
Intercompany receivable (payable) (47,998) 489,793 (441,795) -- --
------------ ------------ ------------ ------------ ------------
Total current assets (47,898) 623,382 (441,201) -- 134,283
Property and equipment, net -- 163,187 183,633 -- 346,820
Investments in subsidiaries 391,808 (273,961) -- (117,847) --
Other assets 7,281 10,275 -- -- 17,556
------------ ------------ ------------ ------------ ------------
Total assets $ 351,191 $ 522,883 $ (257,568) $ (117,847) $ 498,659
=========== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS'(DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term debt and
capital lease obligations $ -- $ -- $ 4,918 $ -- $ 4,918
Accounts payable 3 22,200 (1,909) -- 20,294
Accrued interest -- 1,508 -- -- 1,508
Other liabilities 1,008 11,474 13,373 -- 25,855
------------ ------------ ------------ ------------ ------------
Total current liabilities not
subject to compromise 1,011 35,182 16,382 -- 52,575
Current liabilities subject to compromise 396,800 43,541 -- -- 440,341
------------ ------------ ------------ ------------ ------------
Total current liabilities 397,811 78,723 16,382 -- 492,916
Senior notes, net -- 50,529 -- -- 50,529
Other long-term debt and capital lease
obligations -- -- 11 -- 11
------------ ------------ ------------ ------------ ------------
Total liabilities 397,811 129,252 16,393 -- 543,456
Commitments and contingencies
10% Series C convertible preferred stock 47,763 -- -- -- 47,763
7.25% Series D convertible preferred stock 156,616 -- -- -- 156,616
Stockholders' (deficit) equity:
Common stock 59 -- -- -- 59
Additional paid-in capital 711,275 1,289,085 75,697 (1,364,782) 711,275
Accumulated deficit (962,257) (897,277) (349,658) 1,246,935 (962,257)
Treasury stock and other (76) 1,823 -- -- 1,747
------------ ------------ ------------ ------------ ------------
Total stockholders' (deficit)
equity (250,999) 393,631 (273,961) (117,847) (249,176)
------------ ------------ ------------ ------------ ------------
Total liabilities, redeemable preferred stock
and stockholders' (deficit) equity $ 351,191 $ 522,883 $ (257,568) $ (117,847) $ 498,659
=========== =========== =========== =========== ===========
18
CONDENSED CONSOLIDATING BALANCE SHEET
AT DECEMBER 31, 2001
(IN THOUSANDS)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
---------- ---------- -------------- ------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 100 $ 6,892 $ 2,144 $ -- $ 9,136
Investments available-for-sale -- 10,671 150,473 -- 161,144
Restricted investments -- 12,050 590 -- 12,640
Accounts receivable, net -- 24,001 824 -- 24,825
Prepaid expenses and other current assets -- 5,315 272 -- 5,587
Intercompany receivable (payable) (24,839) 588,507 (563,668) -- --
----------- ----------- ----------- ----------- -----------
Total current assets (24,739) 647,436 (409,365) -- 213,332
Property and equipment, net -- 182,419 203,453 -- 385,872
Investments in subsidiaries 488,258 (239,148) -- (249,110) --
Goodwill and other intangibles, net -- -- -- -- --
Other assets 7,746 6,697 -- -- 14,443
----------- ----------- ----------- ----------- -----------
Total assets $ 471,265 $ 597,404 $ (205,912) $ (249,110) $ 613,647
=========== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term debt and
capital lease obligations $ -- $ 697 $ 7,032 $ -- $ 7,729
Accounts payable -- 28,877 (48) -- 28,829
Accrued interest 12,367 1,656 -- -- 14,023
Other liabilities -- 27,200 17,557 -- 44,757
----------- ----------- ----------- ----------- -----------
Total current liabilities 12,367 58,430 24,541 -- 95,338
Senior notes, net 370,366 50,437 -- -- 420,803
Other long-term debt and capital lease
obligations -- 811 1,343 -- 2,154
----------- ----------- ----------- ----------- -----------
Total liabilities 382,733 109,678 25,884 -- 518,295
Commitments and contingencies
10% Series C convertible preferred stock 46,610 -- -- -- 46,610
7.25% Series D convertible preferred stock 156,220 -- -- -- 156,220
Stockholders' (deficit) equity:
Common stock 59 -- -- -- 59
Additional paid-in capital 712,334 1,289,012 75,556 (1,364,568) 712,334
Accumulated (deficit) (826,615) (800,754) (314,704) 1,115,458 (826,615)
Treasury stock and other (76) (532) 7,352 -- 6,744
----------- ----------- ----------- ----------- -----------
Total stockholders' (deficit) equity (114,298) 487,726 (231,796) (249,110) (107,478)
----------- ----------- ----------- ----------- -----------
Total liabilities, redeemable preferred stock
and stockholders' (deficit) equity $ 471,265 $ 597,404 $ (205,912) $ (249,110) $ 613,647
=========== =========== =========== =========== ===========
19
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(IN THOUSANDS)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
----------- ------------ --------------- -------------- --------------
Operating revenues $ -- $ 109,728 $ 22,817 $ (22,817) $ 109,728
Cost of operating revenues -- 76,404 (27) -- 76,377
Selling, general and administrative 1,324 96,501 8,483 (22,817) 83,491
Reorganization expenses 20,702 -- -- -- 20,702
Stock-based compensation
expense -- -- 342 -- 342
Network optimization cost -- 7,788 11,212 -- 19,000
Depreciation and amortization -- 20,417 14,889 -- 35,306
--------- --------- --------- --------- ---------
Loss from operations (22,026) (91,382) (12,082) -- (125,490)
Gain on sale of assets, net -- 1 4,419 -- 4,420
Interest income -- 32,404 1,760 (31,230) 2,934
Interest expense, net 17,093 2,592 29,051 (31,230) 17,506
Loss on investments in subsidiary (96,523) (34,954) -- 131,477 --
--------- --------- --------- --------- ---------
Net Loss $(135,642) $ (96,523) $ (34,954) $ 131,477 $(135,642)
========= ========= ========= ========= =========
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(IN THOUSANDS)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
----------- ------------ --------------- -------------- --------------
Operating revenues $ -- $ 86,172 $ 34,548 $ (25,289) $ 95,431
Cost of operating revenues -- 71,242 11,521 -- 82,763
Selling, general and
administrative -- 110,730 17,913 (25,289) 103,354
Stock-based compensation
expense -- 1,867 -- -- 1,867
Network optimization cost -- 50,090 182,993 -- 233,083
Depreciation and amortization -- 17,460 26,585 -- 44,045
--------- --------- --------- --------- ---------
Loss from operations -- (165,217) (204,464) -- (369,681)
Gain on sale of assets, net -- 1,512 1,263 -- 2,775
Interest income -- 44,547 10,780 (41,955) 13,372
Interest expense, net -- 28,695 42,919 (41,955) 29,659
Loss on investments in subsidiary (350,871) (235,340) -- 586,211 --
--------- --------- --------- --------- ---------
Net Loss before extraordinary item (350,871) (383,193) (235,340) 586,211 (383,193)
Gain on early retirement of debt -- 32,322 -- -- 32,322
--------- --------- --------- --------- ---------
Net Loss $(350,871) $(350,871) $(235,340) $ 586,211 $(350,871)
========= ========= ========= ========= =========
20
Condensed Consolidating Statement of Cash Flows
for the Six Months Ended June 30, 2002
(in thousands)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
----------- ------------ --------------- -------------- --------------
Net cash used in
operating activities $ -- $(64,225) $ (487) $ -- $(64,712)
Cash flows from investing activities:
Purchases of property and
equipment, net -- (1,445) (8,190) -- (9,635)
Transfers of investments
available for sale -- 85,124 (85,124) -- --
Sale of investments
available for sale, net -- -- 95,022 -- 95,022
Sale of restricted
investments -- 1,566 -- -- 1,566
-------- -------- -------- -------- --------
Net cash provided by
investing activities -- 85,245 1,708 -- 86,953
-------- -------- -------- -------- --------
Cash flows from financing activities:
Payments on other long-term
debt and capital lease
obligations, net -- (584) (3,148) -- (3,732)
Proceeds from short swing
profit -- 583 -- -- 583
-------- -------- -------- -------- --------
Net cash used in financing
activities -- (1) (3,148) -- (3,149)
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents -- 21,019 (1,927) -- 19,092
Cash and cash equivalents, beginning
of year 100 6,892 2,144 -- 9,136
-------- -------- -------- -------- --------
Cash and cash equivalents, end of year $ 100 $ 27,911 $ 217 $ -- $ 28,228
======== ======== ======== ======== ========
21
Condensed Consolidating Statement of Cash Flows
for the Six Months Ended June 30, 2001
(in thousands)
Parent Subsidiary Subsidiary
Company Guarantor Nonguarantors Eliminations Consolidated
------- --------- ------------- ------------ ------------
Net cash (used in) provided by
operating activities $ 100 $(105,909) $ (14,552) $ -- $(120,361)
Cash flows from investing activities:
Purchases of property and
equipment, net -- (46,853) (15,618) -- (62,471)
Sale of investments
available for sale, net -- 182,273 40,265 -- 222,538
Proceeds from sale of customer base 1,601 1,601
--------- --------- --------- ----------- ---------
Net cash provided by investing
activities -- 135,420 26,248 -- 161,668
--------- --------- --------- ----------- ---------
Cash flows from financing activities:
Payments on other long-term
debt and capital lease
obligations, net -- (247) (3,534) -- (3,781)
Repurchase of senior notes -- (14,134) -- -- (14,134)
Proceeds from issuance of
common stock -- 75 -- -- 75
--------- --------- --------- ----------- ---------
Net cash used in by financing
activities -- (14,306) (3,534) -- (17,840)
--------- --------- --------- ----------- ---------
Net increase in cash and cash
equivalents 100 15,205 8,162 -- 23,467
Cash and cash equivalents, beginning
of year -- 4,359 6,078 -- 10,437
--------- --------- --------- ----------- ---------
Cash and cash equivalents, end of year $ 100 $ 19,564 $ 14,240 $ -- $ 33,904
========= ========= ========= =========== =========
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT EVENTS
We announced on July 30, 2002, that Mpower Holding Corporation and our
subsidiary Mpower Communications Corp., formally emerged from Chapter 11
effective that day as our recapitalization plan became effective.
The following background summarizes the events leading to the
recapitalization and material features of the plan. We announced on February 25,
2002 that we had reached agreement with an informal committee representing
approximately 66% of the outstanding principal amount of our 13% Senior Notes
due 2010 (the "2010 Notes") on a comprehensive recapitalization plan that
eliminated a significant portion of our long-term debt and all of our preferred
stock. Under the recapitalization plan, we paid $19.0 million of cash on hand
and issued common stock to eliminate $583.4 million in debt and preferred
stock, as well as $49.5 million of annual interest expense related to our 2010
Notes and $15.8 million of annual dividend payments on our preferred stock.
On March 22, 2002, we announced that we successfully completed our
bondholder solicitation which resulted in more than 99% of the holders of our
2010 Notes entering into voting agreements in support of the proposed
recapitalization plan announced on February 25, 2002. On March 27, 2002, each
bondholder who participated in the solicitation received a consent fee equal to
their pro-rata share of the $19.0 million. In addition, more than two-thirds of
the holders of our issued and outstanding shares of preferred stock entered
into voting agreements with us in support of the proposed recapitalization
plan.
On April 8, 2002, we filed a voluntary, pre-negotiated reorganization plan
for us along with our subsidiaries, Mpower Communications Corp.
("Communications") and Mpower Lease Corporation, a wholly owned subsidiary of
Communications, (collectively, "the Debtors"), under Chapter 11 of the Federal
bankruptcy code in the U.S. Bankruptcy Court for the District of Delaware. None
of our other direct or indirect subsidiaries were parties to the Chapter 11
Cases or any related bankruptcy, reorganization or liquidation proceedings. The
Chapter 11 Cases were jointly administered (Case No 02-11046 (PJW)). We
operated as a debtor in posession from April 8, 2002 until our emergence from
bankruptcy on July 30, 2002.
On April 8, 2002, we filed a pre-negotiated plan of reorganization and a
disclosure statement with respect to the joint plan of reorganization with the
Bankruptcy Court. On May 20, 2002, we filed the Debtors' First Amended Joint
Plan of Reorganization and a related Debtors' First Amended Disclosure Statement
with the Bankruptcy Court. Mpower Leasecorp was not a party to the Joint Plan.
On July 12, 2002, we filed an affidavit certifying the ballots accepting or
rejecting the Joint Plan that indicated that, in accordance with the Bankruptcy
Code, the Plan was accepted by all classes entitled to vote on the Joint Plan.
On July 17, 2002, the Bankruptcy Court confirmed the pre-negotiated Plan,
as modified by the Findings of Fact, Conclusions of Law, and Order Under
Section 1129 of the Bankruptcy Code and Rule 3020 of the Bankruptcy Rules
Confirming Debtors' First Amended Joint Plan of Reorganization entered by the
Bankruptcy Court on the same date (the Plan as modified by the Confirmation
Order is referred to as the "Final Plan"). Also, on July 30, 2002, the
Bankruptcy Court dismissed the Chapter 11 Case of Mpower Leasecorp.
On July 30, 2002, the Final Plan became effective (the "Effective Date"),
and we and Mpower Communications emerged from Chapter 11 protection and we are
now operating our businesses and properties as reorganized entities pursuant to
the terms of the Final Plan.
See Note 6 in the Condensed Notes to unaudited Interim Consolidated
Financial Statements for a Summary of the material features of the Final Plan.
23
ADOPTION OF FRESH START ACCOUNTING
As of July 30, 2002, we will implement Fresh Start Accounting under the
provisions of SOP 90-7. Under SOP 90-7, our reorganization fair value will be
allocated to our assets and liabilities, our accumulated deficit will be
eliminated, and our new equity will be issued according to the Final Plan. We
are still evaluating the impact but anticipate that the adoption of SOP 90-7 and
Fresh Start Accounting will have a material effect on its financial statements.
AS A RESULT, THE FINANCIAL STATEMENTS PUBLISHED FOR PERIODS FOLLOWING THE
EFFECTIVENESS OF THE PLAN WILL NOT BE COMPARABLE TO THOSE PUBLISHED BEFORE THE
EFFECTIVENESS OF THE PLAN.
An estimate of the effect of Fresh Start Accounting as of June 30, 2002
follows (in thousands). The amounts are based on preliminary valuation
information and, as such, the final reorganization fair value that will be
allocated to our assets and liabilities as of June 30, 2002 will be different
from the amounts below.
MPOWER HOLDING CORPORATION PRO FORMA RESTRUCTURING
June 30, 2002
Unaudited
($ in thousands)
------------------------------------------------------------------------------------------
Fresh Start
Debt Accounting Projected
Assets Pre-Confirmation Restructuring Adjustments Post-Confirmation
---------------- -------------- ------------ -------------------
Current assets $ 134,283 $ -- $ -- $ 134,283
Long-term assets 364,376 (7,281)(2) (257,960)(1) 99,135
--------- --------- --------- ---------
Total Assets $ 498,659 $ (7,281) $(257,960) $ 233,418
========= ========= ========= =========
Liabilities
Current liabilities $ 492,916 $(396,797)(3) $ -- $ 96,119
Long-term liabilities 50,540 -- -- 50,540
--------- --------- --------- ---------
Total Liabilities 543,456 (396,797) -- 146,659
Stockholders' equity (including
Redeemable Convertible Preferred
Stock) (44,797) 389,516(4) (257,960) 86,759(5)
--------- --------- --------- ---------
Total Liabilities and Equity $ 498,659 $ (7,281) $(257,960) $ 233,418
========= ========= ========= =========
(1) Anticipated Fair Value of Gross Property and Equipment at original cost,
adjusted for reorganization value less the amounts allocated to identified
assets, net of certain intangibles.
(2) Elimination of deferred financing costs and its associated accumulated
amortization in connection with restructuring of notes.
(3) Elimination of notes and related accrued interest expense and unamortized
discount related to restructuring of notes.
(4) Conversion of preferred stock to common equity per restructuring agreement.
(5) Includes a net equity balance equal to the reorganization equity value of
$87.3 million per "Fresh Start" accounting guidelines.
- --------------------------------------------------------------------------------
THE BUSINESS
We operate through our wholly owned subsidiary, Mpower Communications Corp.
("MCC"), which offers voice and high-speed data services using both SDSL and T1
technology in all of our markets. As of June 30, 2002, we provided services in
27 metropolitan areas in 8 states. Our network consists of 578 incumbent carrier
central office collocation sites providing us access to more than 11 million
addressable business lines. All of our 578 central office collocation sites are
SDSL capable and 374 are T1 capable. We have established working relationships
with the following incumbent local exchange carriers (ILEC's) BellSouth,
Verizon, and
24
Southwestern Bell Corporation (including its operating subsidiaries PacBell and
Ameritech, collectively referred to as "SBC"). We have over 415,000 lines in
service.
We were one of the first competitive communications carriers to implement a
facilities-based network strategy. As a result, we own the network equipment
that controls how voice and data transmissions originate and terminate, which we
refer to as switches, and lease the telephone lines over which the voice and
data traffic are transmitted, which we refer to as transport.
We install our network equipment at the site of the incumbent carrier from
whom we rent standard telephone lines. These sites are referred to as
collocation sites within the telecommunications industry. As we have already
invested and built our network, we believe our strategy allows us to serve a
broad geographic area at a comparatively low cost while maintaining control of
the access to our customers.
Our business is to deliver packaged voice and broadband data solutions to
small and mid-sized businesses. Specifically, our business plan is based on
serving the small and medium enterprise customers that find business value in
high-speed broadband Internet access integrated with local dial-tone service. We
have more than 86,000 business customers, providing them broadband Internet via
SDSL and T1, integrated services over VoDSL, T1 and local voice telephone
service.
In the fourth quarter of 2001, we began to upgrade our network with T1
technology to increase our revenue potential, gross margin and addressable
customer base. By leveraging our existing equipment, interconnection agreements
with incumbent carriers and network capabilities, we are able to offer fully
integrated and channelized voice and data products over a T1 connection,
overcoming the DSL loop length limitations. This platform utilizes central
office equipment provisioned with T1 line cards that leverage low-cost T1
unbundled network elements leased from incumbent carriers. Our collocation DSL
equipment then aggregates Internet traffic to the central office Internet
gateway. This delivery mechanism provides guaranteed bandwidth and a data
service that is positioned to be a superior offering when compared to the
incumbent carriers' DSL service offering.
By using a T1 service delivery platform, we expect to increase the amount of
revenue per customer. In order to serve the largest portion of our target
audience, our combined voice and data network allows us to deliver services in
several combinations over the most favorable technology: basic phone service on
the traditional phone network, SDSL service, integrated T1 voice and data
service, or data-only T1 connectivity.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to revenue
recognition, allowance for doubtful accounts, network optimization accruals and
disputes with carriers. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of
our consolidated financial statements.
Revenue Recognition: Revenue from monthly recurring charges, enhanced
features and usage is recognized in the period in which service is provided.
Deferred revenue represents advance billings for services not yet provided. Such
revenue is deferred and recognized in the period in which service is provided.
We recognize revenue from switched access in the period in which service is
provided and based on management's best estimate of its collectibility.
Approximately 78% of the switched access minutes carried on our network in the
quarter ended June 30, 2002 were from our largest carriers with who we have
existing contracts governing the amount of our switched access charges. The
remaining 22% of the switched access traffic comes from carriers who have been
slow to pay or have had some dispute of
25
our billings. If the amount we collect in the future for these other carriers
varies significantly from our estimates, our revenue may be negatively affected.
These certain judgments in measuring revenue may affect our results. Revenue
results may be difficult to predict, and any shortfall in revenue or delay in
recognizing revenue could cause our operating results to vary significantly and
could result in future operating losses.
Allowance For Doubtful Accounts: We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
pay for our services. In order to estimate the appropriate level of this
allowance, we analyze historical bad debts, current economic trends and changes
in our customer payment patterns. If the financial condition of our customers
were to deteriorate and impact their ability to make payments, additional
allowances may be required. Several of the carriers that terminate or originate
traffic for our customers are currenly in Chapter 11 proceedings. The largest of
these vendors include Global Crossing and Worldcom. In establishing the
allowance for doubtful accounts we have taken into consideration the aggregate
risk of our receivables. If actual results differ from our estimates we may
need to adjust our reserves in the future.
Network Optimization Accruals: In establishing the accrual for the network
optimization costs, we made certain assumptions related to the wind down and
closure of certain markets and related future severance costs and other exit
costs. While we feel the assumptions were appropriate, there can be no assurance
that actual costs will not differ from estimates used to establish the
restructuring accrual. If actual results differ significantly from the
estimates, we may need to adjust our restructuring accrual in the future.
Disputes With Carriers: Various long distance carriers and incumbent
carriers lease loop, transport and network facilities to us. The pricing of such
facilities are governed by either a tariff or an interconnection agreement.
These carriers bill us for our use of such facilities. From time to time, the
carriers present inaccurate bills to us, which we dispute. As a result of such
billing inaccuracies, we record an estimate of our liability based on our
measurement of services received. As of June 30, 2002 we had $6.9 million of
disputes with carriers. We have reserved $4.2 million against those disputed
balances. Based on the nature and history of disputes with the carriers, we
believe this amount to be adequate. Any significant victories or losses when
these disputes are resolved may require us to adjust our reserves in the future.
RESULTS OF OPERATIONS
Our revenues are generated from sales of communications services consisting
primarily of local phone services, data services, long-distance services,
switched access billings and non-recurring charges, principally installation
charges. Local, long distance and data services are generally provided and
billed as a bundled offering under which customers pay a fixed amount for a
package of combined services. As a result, the portion of our revenues
attributable to each service is not identifiable and, therefore, we do not
record or report these amounts separately.
We took measures during the second quarter of 2002 which we believe will
further improve the quality of new revenue added, including more stringent
credit checks, minimum customer line thresholds, term contracts, and higher
prices in many markets. In spite of our expectation of positive results we
cannot assure the investor that our revenues will continue to grow as a result
of the softness in the economy, the difficulties in the competitive telecom
sector and our own Chapter 11 restructuring process.
The growth in revenue during the remainder of 2002 will primarily be
dependent on our ability to continue to add new customers in a competitive
market, manage our churn (defined as the percentage of installed lines that
disconnect service each month), and sell additional services to our existing
customers.
26
Our revenues consist of:
- the monthly recurring charge for basic local voice and data services;
- usage-based charges for local and toll calls in certain markets;
- charges for services such as call waiting and call forwarding;
- certain non-recurring charges, such as set-up charges for additional lines
for existing customers; and
- interconnection revenues from switched access charges to long distance
carriers.
Our switched access revenues historically have been subject to uncertainties
such as various federal and state regulations and disputes with our long
distance carriers. As of June 30, 2002, we have agreements with those carriers
that provide over 78% of our switched access traffic. In addition, the Federal
Communications Commission (the "FCC") in April 2001 adopted new rules that
limit the rates we can charge carriers for use of our facilities. Under these
rules, which took effect on June 20, 2001, competitive carriers are required to
reduce their tariffed interstate access charges to agreed upon contractual
rates or rates no higher than 2.5 cents per minute. After one year, the rate
ceiling will be reduced to 1.8 cents and after two years to 1.2 cents per
minute. After three years, all competitive carriers will be required to charge
rates no higher than the incumbent telephone company. As a result of our
agreements and the reductions in rates dictated by the FCC, we anticipate a
continued decrease of switched access revenues as a percent of total revenue.
Switched access revenue as a percent of total revenue was 19% for the second
quarter of 2002 and 31% in the second quarter of 2001.
Our principal operating expenses consist of cost of operating revenues,
selling, general and administrative expenses, and depreciation and amortization
expense. Cost of operating revenues consists primarily of access charges, line
installation expenses, transport expenses, long distance expenses and lease
expenses for our switch sites and our collocation sites. While we cannot be
certain that we will be successful controlling cost and achieving operating
efficiencies in our network, we expect these costs to remain flat or slightly
decrease as a percentage of total revenue during the remainder of 2002.
Selling, general and administrative expenses consist primarily of salaries,
commissions and related personnel costs, marketing costs, the cost of
maintaining the hardware in our network and back office systems, provision for
bad debts, professional fees and facilities expenses.
Reorganization expenses consist of legal, audit and financial advisor fees,
as well as the $19.0 million consent fee payment made to holders of our 2010
Senior Notes. We estimate that we will incur fees and expenses in connection
with the restructuring that will be approximately $29.6 million, consisting of:
- - $19.0 million of consent fee payments;
- - $10.0 million of legal and financial advisors fees;
- - $0.6 million of other fees and expenses; and
During the quarter ending June 30, 2002, we incurred $20.7 million of those
fees and expenses.
We will also record the write-off of $16.8 million of deferred debt issuance
costs and unamortized debt discount as a reorganization expense. This will be a
non-cash transaction.
Depreciation and amortization expense includes depreciation of switching and
collocation equipment, business application software as well as general property
and equipment and the amortization of leasehold improvements, goodwill and other
intangible assets. Upon the implementation of Fresh Start Accounting,
depreciation and amortization expense will be significantly reduced in the
future periods.
27
Gross interest expense is primarily attributable to the 13% Senior Notes due
2010 we issued in March 2000 and the 13% Senior Notes due 2004 issued in
September 1997. Interest was paid on our 13% Senior Notes due 2004 in April
2002. The interest payable on the 13% Senior Notes due 2010 was accrued through
April 8, 2002 but not paid as agreed upon by the holders of the notes in
connection with the consent solicitation and reorganization plan. With Fresh
Start Accounting, interest expense will be significantly reduced in future
periods.
Interest income results from the investment of cash and cash equivalents,
United States Treasury and other federal agency securities.
We have experienced operating losses and generated negative cash flow from
operations since inception and expect to continue to generate negative cash flow
from operations for the foreseeable future while we continue to grow our
existing network and develop our product offerings and customer base. During
this period, we expect to incur significant operating losses as many of the
fixed costs of providing service in newer markets are incurred before
significant revenue can be generated from those markets. In addition, we expect
to incur significant costs to build our base of customers in our newer markets.
We cannot assure investors that our revenue or customer base will grow or that
we will be able to achieve or sustain positive cash flow from operations.
Quarterly Comparison - June 30, 2002 vs. June 30, 2001
Total operating revenues increased to $56.9 million for the quarter ended
June 30, 2002 as compared to $49.2 million for the quarter ended June 30, 2001.
The 16% increase in revenue was primarily the result of the putting more
customers on our network and increasing the lines in service as well as price
increases we implemented in several of our markets in the second quarter of
2002. Total lines in service increased 24% from 337,420 at June 30, 2001 to
416,857 at June 30, 2002. Our switched access revenues decreased $4.6 million or
30% from the quarter ended June 30, 2001 and decreased as a percentage of our
revenues to 19%. This decrease in switched access revenues was primarily a
result of the reduction in rates we negotiated with our major carriers and FCC
mandated rate rules. We expect switched access revenue to continue to decline as
a percentage of total revenue.
Cost of operating revenues for the quarter ended June 30, 2002 was $36.8
million as compared to $42.2 million for the quarter ended June 30, 2001. The
13% decrease is primarily due to the closure of non-performing markets during
2001 and efforts to improve the costs effectiveness of our network, offset
slightly by increased costs attributable to an increase in the number of lines
in service.
For the quarter ended June 30, 2002, selling, general and administrative
expenses totaled $41.4 million, a 19% decrease from the $51.0 million for the
quarter ended June 30, 2001. The decrease is primarily a result of the closure
of non-performing markets in 2001, management initiatives that resulted in a
decrease in administrative personnel, facilities expenses and reduction in
occupancy costs relating to the closure of non-performing markets and management
initiatives to reduce customer acquisition costs.
For the quarter ended June 30, 2002, we recorded $0.1 million in stock-based
compensation compared to $0.9 million recorded for the quarter ended June 30,
2001. This expense relates to in-the-money stock options granted
in 1999, 2000, and 2001. The reduction in expense from the quarter ending June
30, 2001 was primarily the result of the rescinded stock agreement with Mr.
Huff, our Chief Executive Officer. Due to the September 2000 and September 2001
re-pricings of stock options, we are now subject to variable plan accounting.
We have not recognized compensation expense for the options re-priced in
September 2000 and 2001 as the market price of the common stock at June 30,
2002 was below the exercise prices. However, we are unable to predict the
expense that may be recognized in future periods as this amount is subject to
fluctuations in the market price of our stock.
As filed in our Final Plan with the Bankruptcy Court, 7,222,222 shares of
New Common Stock have been reserved for issuance pursuant to the terms of a new
stock option plan (the "New Key Employee Option Plan") adopted by us
28
for the benefit of certain selected key employees that will be substantially
identical to the Amended and Restated Mpower Holding Corporation Stock Option
Plan (the "Old Option Plan") canceled as of the Effective Date. The adoption of
the Stock Option Plan may have an effect on future compensation expense.
In accordance with Statement of Position ("SOP") 90-7, expenses resulting
from the reorganization of the business in a bankruptcy proceeding are to be
reported separately as reorganization items. Reorganization items of $20.7
million were recognized during the second quarter 2002. The expenses consisted
primarily of the $19.0 million consent fee payment to our bondholders and $1.7
million of legal and financial advisor fees.
In May 2001, we announced plans to close down operations in twelve of our
markets, representing more than 180 collocations. We exited most of these
markets in the third quarter ending September 30, 2001 and recognized a network
optimization charge of $209.1 million in the second quarter of 2001. Included in
the charge was $126.8 million for the goodwill and customer base associated with
the Primary Network business, which was eliminated as a result of the market
closings, $65.1 million for property including collocations and switch sites,
and $17.2 million for other costs associated with exiting these markets. With
respect to the network optimization charges, the total actual charges will be
based on ultimate settlements with the incumbent local exchange carriers,
recovery of costs from any subsequent subleases, our ability to sell or
re-deploy network equipment for growth in our existing network and other
factors.
For the quarter ended June 30, 2002, depreciation and amortization was $17.9
million as compared to $22.5 million for the quarter ended June 30, 2001. This
decrease is primarily the result of the retirement of assets in closed markets
and write-off of goodwill and other intangible assets prior to May 2001, which
more than offset depreciation from assets placed in service since June 30 2001.
Interest income was $1.2 million for the quarter ended June 30, 2002
compared to $5.6 million for the quarter ended June 30, 2001. The decrease is a
result of decreases in cash and investments during 2001 and 2002. Cash and
investments have been used to purchase capital equipment, pay interest on our
senior secured notes and fund operating losses.
Gross interest expense for the quarter ended June 30, 2002 totaled $3.7
million compared to $16.8 million for the quarter ended June 30, 2001. As
required by SOP 90-7, interest expense ceased on our 2010 Notes upon filing our
petition for relief under Chapter 11 of the Bankruptcy Code on April 8, 2002.
Contractual interest was $14.6 million for the quarter ending June 30, 2002.
The decrease in interest expense is primarily due to the cessation of interest
accruals due to the reorganization. Interest capitalized for the quarter ended
June 30, 2002 decreased to $0.4 million as compared to $1.9 million for the
quarter ended June 30, 2001. The decrease in interest capitalized is due to the
decrease in switching equipment under construction as our network expansion has
slowed.
We incurred net losses of $61.9 million and $252.4 million for the quarters
ended June 30, 2002 and 2001, respectively.
For the quarter ended June 30, 2002 and 2001, we accrued preferred stock
dividends of $.3 million and $4.7 million, respectively, payable to holders of
our Series D convertible preferred stock. As required by SOP 90-7, accrual of
preferred stock dividends ceased upon filing of our petition for relief under
Chapter 11 of the Bankruptcy Code on April 8, 2002. Contractual dividends were
$3.8 million for the quarter ending June 30, 2002. For the quarter ended June
30, 2001, we also recognized $6.4 million associated with the inducement feature
included in our conversion of preferred shares into common stock.
Six Month Period Ended - June 30, 2002 vs. June 30, 2001
29
Total operating revenues increased to $109.7 million for the six months
ended June 30, 2002 as compared to $95.4 million for the six months ended June
30, 2001. This 15% increase was primarily the result of putting more customers
on our network and increase in the number of lines in service.
Cost of operating revenues for the six months ended June 30, 2002 was $76.4
million as compared to $82.8 million for the six months ended June 30, 2001. The
8% decrease is due to market reductions and cost saving initiatives, offset by
increases in cost attributable to the increased number of lines in service.
For the six months ended June 30, 2002, selling, general and administrative
expenses totaled $83.5 million, a 19% decrease from the $103.4 million for the
comparable 2001 period. The decrease is primarily a result of the closure of
non-performing markets in 2001, management initiatives that resulted in a
decrease in administrative personnel, facilities expenses and reduction in
occupancy costs relating to the closure of non-performing markets and management
initiatives to reduce customer acquisition costs.
For the six months ended June 30, 2002 we recorded $0.3 million in
stock-based compensation compared to $1.9 million for the comparable 2001
period. This expense relates to in-the-money stock options granted in 1999,
2000, and 2001. The reduction in expense from the six months ending June 30,
2001 was primarily the result of the rescinded stock agreement with Mr. Huff,
our Chief Executive Officer. Due to the September 2000 and September 2001
re-pricings of stock options, we are now subject to variable plan accounting. We
have not recognized compensation expense for the options re-priced in September
2000 and 2001 as the market price of the common stock at June 30, 2002 was below
the exercise prices. However, we are unable to predict the expense that may be
recognized in future periods as this amount is subject to fluctuations in the
market price of our stock.
In May 2001, we announced plans to close down operations in twelve of our
recently opened markets, representing more than 180 collocations. We exited most
of these markets in the third quarter ending September 30, 2001 and recognized a
network optimization charge of $209.1 million in the second quarter of 2001.
Included in the charge was $126.8 million for the goodwill and customer base
associated with the Primary Network business, which was eliminated as a result
of the market closings, $65.1 million for property including collocations and
switch sites, and $17.2 million for other costs associated with exiting these
markets. The total actual charges incurred will be based on ultimate settlements
with various carriers, recovery of costs from any subsequent subleases, our
ability to sell or redeploy network equipment for growth in our existing network
and other factors.
For the six months ended June 30, 2002, depreciation and amortization was
$35.3 million as compared to $44.0 million for the six months ended June 30,
2001. This 20% decrease is primarily the result of the retirement of assets in
closed markets and write-off of goodwill and other intangible assets prior to
May 2001, which more than offset depreciation from assets placed in service
since June 30 2001.
Interest income was $2.9 million during the six months ended June 30, 2002
compared to $13.4 million for the six months ended June 30, 2001. The decrease
is a result of decreases in cash and investments during 2001 and 2002. Cash and
investments have been used to purchase capital equipment, pay interest on the
senior secured notes and fund operating losses.
Gross interest expense for the six months ended June 30, 2002 totaled $18.7
million compared to $33.6 million for the six months ended June 30, 2001.
Interest capitalized for the six months ended June 30, 2002 decreased to $1.2
million as compared to $3.9 million for the six months ended June 30, 2001. As
required by SOP 90-7, interest expense ceased on our 2010 Notes upon filing our
petition for relief under Chapter 11 of the Bankruptcy Code on April 8, 2002.
Contractual interest on our 2010 Notes was $28.8 million for the six months
ended June 30, 2002. The decrease in interest expense is primarily due to the
cessation of interest accruals due to the reorganization. The decrease in
interest capitalized is due to the decrease in switching equipment under
construction as our network expansion has slowed.
30
During the six months ended June 30, 2001, we recognized an extraordinary
gain on the early retirement of debt of $32.3 million. For the six months ended
June 30, 2002 and 2001, we incurred net losses after extraordinary items of
$135.6 million and $350.9 million, respectively.
For the six months ended June 30, 2002, we accrued dividends of $4.0
million, payable to holders of our convertible preferred stock, compared to
$14.4 million for the six months ended June 30, 2001. As required by SOP 90-7,
accrual of preferred stock dividends ceased upon filing of our petition for
relief under Chapter 11 of the Bankruptcy Code on April 8, 2002. Contractual
dividends were $7.5 million for the six months ended June 30, 2002. For the six
months ended June 30, 2001, we also recognized $6.4 million associated with the
inducement feature included in our conversion of preferred shares into common
stock.
LIQUIDITY AND CAPITAL RESOURCES
We continue to incur negative cash flows from operating activities and
estimate that we have the resources to fund our current operations through the
first quarter of 2003, but we will likely require additional debt or equity
financing thereafter. These factors, among others, may indicate that we may be
unable to continue as a going concern.
We expect to continue to require substantial amounts of capital to acquire
customers, fund operating losses, augment and maintain the network in existing
markets and develop new products and services.
We have completed, and are pursuing, several initiatives intended to
increase liquidity and better position ourselves to compete under current
conditions and anticipated changes in the telecommunications sector. These
include:
- Complete the implementation of the recapitalization of our balance sheet
as described in Note 6 of the Condensed Notes to the Unaudited Interim
Consolidated Financial Statements
- Aggressively seeking additional equity or debt financing
- Discussions with companies who may be interested in acquiring our assets
or business in whole or in part, and discussions with companies who may be
interested in selling their assets or business, in whole or in part
- Continuing to update our prospective business plans and forecasts to
assist in monitoring current and future liquidity
- Closing unprofitable or under-performing markets
- Reducing general and administrative expenses through various cost cutting
measures
- Introducing new products and services with greater profit margins
- Analyzing the pricing of our current products and services to ensure they
are competitive and meet our objectives
- Re-deploying our assets held for future use to reduce the requirement for
capital expenditures
Our continuation as a going concern is dependent on our ability to meet the
above initiatives, among others. However, there can be no assurance that we will
be successful in obtaining additional debt or equity financing, or in obtaining
a bank facility on terms acceptable to us, or at all, or that management's
estimate of additional funds required is accurate.
31
As of June 30, 2002, we had $91.5 million in unrestricted cash and cash
equivalents and investments available for sale and this will be our near-term
source of liquidity. As a result of our Chapter 11 filing, we had certain
pre-petition and post-petition liabilities of approximately $17.0 million that
had not been paid as of June 30, 2002. Had we paid these liabilities in the
second quarter of 2002 our associated ending cash balance would have been
lower. We have been generating from revenues only a portion of the cash
necessary to fund our operations. We have incurred a loss in each year since
inception, and we expect to incur substantial losses for the near future.
We emerged from our Chapter 11 proceeding effective July 30, 2002 and our
liquidity position has improved substantially as we have eliminated $583.4
million of debt and preferred stock and $65.3 million of related annual interest
and preferred dividend payments. We cannot assure investors that we will be able
to successfully find adequate funding to operate until we are cash flow
positive. Without additional capital, we may have to make further changes to our
current business plan. We cannot assure investors that we will be successful in
obtaining additional debt or equity financing or in obtaining a bank facility on
terms acceptable to us, or at all, or that our estimate of additional funds
required is accurate.
Developing and maintaining our network and business has required and will
continue to require us to incur capital expenditures primarily consisting of the
costs of purchasing switching and associated equipment. Cash outlays for capital
expenditures were $9.6 million through the second quarter of 2002. We expect we
will continue to require substantial amounts of capital to acquire customers,
fund our operating losses, augment our network in our existing markets and
develop new products and services.
Our capital expenditures for the remainder of 2002 will focus on the
augmentation of our network to add new products and customers and to improving
the cost efficiency of our network, as we have completed the footprint build-out
of our network in the markets in which we operate. To conserve cash we have also
decided to delay any further upgrade and augmentation of our operational support
systems. Once we have attracted new capital into the business, we will revisit
this decision. We will continue to rely on our existing operational support
systems in the interim. We cannot assure investors that these systems will be
adequate to support the continued scaling of our business.
The substantial capital investment required to initiate services and fund
our operations has exceeded our operating cash flow. This negative cash flow
from operations results from the need to establish and maintain our network and
sales and support functions in anticipation of connecting revenue-generating
customers. We expect to continue recording negative cash flow from operations
until we generate adequate revenue to cover the fixed cost of the network. We
cannot assure you we will attain break-even cash flow from operations in
subsequent periods, nor that we have the funding to scale the business to
operating cash flow positive.
We continually evaluate our capital requirements plan in light of
developments in the telecommunications industry and market acceptance of our
service offerings. The actual amount and timing of future capital requirements
may differ materially from our estimates as a result of, among other things:
- our ability to obtain any necessary financing
- the cost of the development and support of our networks in each of our
markets
- the extent of price and service competition for telecommunication services
in our markets
- the demand for our services
32
- regulatory and technological developments
- our ability to develop, acquire and integrate necessary operating support
systems
- our ability to re-deploy assets held for future use
As such, actual costs and revenues may vary from expected amounts, possibly
to a material degree, and such variations are likely to affect our future
capital requirements.
CASH FLOW DISCUSSION
In summary our cash flows were:
Six Months Ending
June 30, 2002
-------------
(in thousands)
Net Cash Used in Operating Activities ............... $ (64,712)
Net Cash Provided by Investing Activities............ $ 86,953
Net Cash Used in Financing Activities $ (3,149)
This summary of cash flows includes cash and cash equivalents and it does
not include investments available for sale.
Cash, Cash Equivalents And Investments Available For Sale: We invest excess
cash predominantly in debt instruments that are highly liquid, of high-quality
investment grade, and predominantly have maturities of less than two years with
the intent to make such funds readily available for operating purposes. At June
30, 2002, cash, cash equivalents and investments available-for-sale were $91.5
million. Restricted cash amounted to $11.1 million as of June 30, 2002. The
restricted cash balance as of June 30, 2002 primarily represents a commitment we
made in September 2001, to pay up to $4.5 million during the period through
December 31, 2002 for employee retention and incentive compensation bonuses,
subject to the terms of the agreements. In addition, we committed to pay up to
$7.5 million in severance payments to certain employees in the event they are
terminated involuntarily, without cause or voluntarily, with good cause. In
November 2001, we established a trust, which was funded at a level sufficient to
cover the maximum commitment for retention, incentive compensation and severance
payments. For the six months ended June 30, 2002 we paid out $2.9 million
relating to these commitments.
Operating Activities: We used $64.7 million in cash for operations for the
six months ended June 30, 2002. The use of cash in 2002 was primarily the result
of operating expenses, incurred in the on-going operation of our business,
offset by cash revenues.
Investing Activities: For the six months ended June 30, 2002, we were p
rovided with $87.0 million in cash from investing activities. The cash provided
in 2002 primarily represents sale of investments available-for-sale to fund our
operating losses and capital requirements.
33
Financing Activities: For the six months ended June 30, 2002, we used $3.1
million of cash for financing activities. The cash used in 2002 represents
primarily payments on capital lease obligations.
EFFECTS OF NEW ACCOUNTING STANDARDS
Accounting for Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS No. 142). We adopted the provisions of this standard on January 1, 2002.
SFAS No. 142, provides that goodwill and other acquired intangible assets with
indefinite lives will no longer be amortized, but will be subject to at least an
annual assessment for impairment through the application of a fair-value-based
test. The adoption of SFAS No. 142 has not had a material effect on our
financial results as we eliminated our goodwill and other intangible assets in
May 2001
Accounting for Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" (SFAS No. 143). We will adopt this standard on July 30, 2002 in
connection with our implementation of Fresh Start reporting. Upon adoption of
SFAS No. 143, the fair value of a liability for an asset retirement obligation
will be recognized in the period in which it is incurred. The associated
retirement costs will be capitalized as part of the carrying amount of the
long-lived asset and subsequently allocated to expense over the asset's useful
life. We are still assessing the impact SFAS No. 143 will have on the financial
results of the Company.
Accounting for the Impairment or Disposal of Long-Lived Assets
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144). We adopted the provisions of this
standard on January 1, 2002. This standard addresses financial accounting and
reporting for the impairment and disposal of long-lived assets. The adoption of
SFAS No. 144 has not had a material effect on our financial results.
Recission of FASB Statements Nos. 4, 44, and 64, an amendment of FASB
Statement No. 13, and Technical Corrections
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13, and Technical Corrections" (SFAS No.
145). This standard rescinds FASB No. 4 and an amendment to that Statement, FASB
No. 64 which relates to extinguishment of debt. It rescinds FASB No. 44 which
relates to certain sale-leaseback transactions. We will adopt SFAS No. 145
effective on July 30, 2002 in connection with our implementation of Fresh Start
reporting. We are still assessing the impact SFAS No. 145 will have on the
financial results of the Company.
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (SFAS No. 146). This standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EIFT) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. We are
still assessing the impact SFAS No. 146 will have on the financial results of
the Company.
TRENDS/UNCERTAINTIES THAT MAY AFFECT THE BUSINESS
34
The sector in which our business operates has had many changes over the past
two years. As a result of the downturn of the economy and the dramatic shrinking
of the technology sector, many of our competitors have discontinued doing
business or have restructured in order to be able to continue to operate. As a
result of the downturn, competitive carriers may face over-capacity, large
amounts of debt and uncertain economic and regulatory conditions.
In spite of trends resulting from the further deterioration in the overall
U.S. economy and continuing weakness in the telecom market, there exists
continued growing demand for competitive telecommunications services as well as
high-speed data services. We hope that with the reduction in the number of
competitors our position in the marketplace will improve.
We scaled back the markets we serve from early to mid 2001, to focus our
resources on the markets we expect to be the most profitable. Most recently, on
February 25, 2002, we announced we were ceasing operations in Charlotte, North
Carolina, where we were serving approximately 500 customers. We do not currently
have any plans to close any additional markets, and no assurance can be given
that future operating results will improve after these closings, or that these
closings will not negatively affect our operations. Further, there can be no
assurance that additional market closings will not be required in the future.
Various long distance carriers and incumbent carriers lease loop, transport
and network facilities to us. The pricing of such facilities are governed by
either a tariff or an interconnection agreement. These carriers bill us for our
use of such facilities. From time to time, the carriers present bills to us,
which we believe to be inaccurate and which we dispute. As a result of such
billing inaccuracies, we record an estimate of our liability based on our
measurement of services received. We cannot assure you that our estimates will
be upheld as any disputes are resolved.
From time to time, we have had preliminary discussions with companies who
may be interested in acquiring our assets or business, in whole or in part. We
intend to consider any desirable acquisition proposals that may be made in the
future. However, we cannot assure investors that we will agree, or that we will
not agree, to be acquired by another company.
Several key legal, regulatory and economic factors may affect our business
over the next 12-15 months. On December 12, 2001, the FCC initiated a review of
the current regulatory requirements for incumbent carriers' broadband
telecommunications services. Incumbent carriers are generally treated as
dominant carriers, and hence are subject to certain regulatory requirements,
such as tariff filings and pricing requirements. In this proceeding, the FCC
seeks to determine what regulatory safeguards and carrier obligations, if any,
should apply when a carrier that is dominant in the provision of traditional
local exchange and exchange access services provides broadband service. A
decision by the FCC to exempt the incumbent carriers' broadband services from
traditional regulation could have a significant adverse competitive impact. We
cannot reasonably predict the ultimate outcome of this proceeding.
In several orders adopted in recent years, the FCC has made major changes in
the structure of the access charges incumbent carriers impose for the use of
their facilities to originate or complete interstate and international calls.
Under the FCC's plan, per-minute access charges have been significantly reduced,
and replaced in part with higher monthly fees to end-users and in part with a
new interstate universal service support system. Under this plan, the largest
incumbent carriers are required to reduce their average access charge to $.0055
per minute over a period of time, and some of these carriers have already
reduced their access charges to the target level.
In August 1999, the FCC adopted an order providing additional pricing
flexibility to incumbent carriers subject to price cap regulation in their
provision of interstate access services, particularly special access and
dedicated transport. The FCC eliminated rate scrutiny for "new services" and
permitted incumbent carriers to establish additional geographic zones within a
market that would have separate rates. Additional and more substantial pricing
flexibility will be given to incumbent carriers as specified levels of
competition in a market are reached through the collocation of competitive
carriers and their use of competitive transport. This flexibility includes,
among other items, customer specific pricing, volume and term discounts for some
services and streamlined tariffing. As part of the same August 1999 order, the
FCC initiated another
35
proceeding to consider additional pricing flexibility proposals for incumbent
carriers. We cannot predict the outcome of this proceeding, which may have an
unfavorable effect on our business.
Under the Telecommunications Act, competitive local exchange carriers are
entitled to receive reciprocal compensation from other telephone companies for
delivering traffic to their customers. A dispute has existed for several years
on whether this compensation applies to calls bound for Internet service
provider clients of the competitive local exchange carriers. Most states have
required telephone companies to pay this compensation to competitive local
exchange carriers. In April 2001, however, the FCC adopted new rules limiting
the right of competitive local exchange carriers to collect compensation on
calls that terminate to Internet service providers, and preempting inconsistent
state rules. Under the new rules, which took effect on June 14, 2001, the amount
of compensation payable on calls to Internet service providers was limited to
$.0015 per minute for the first six months after the rules took effect, $.0010
per minute for the next eighteen months, and $.0007 per minute thereafter. In
addition, the overall amount of compensation payable in each state is limited
based upon the number of minutes of Internet traffic terminated in the first
quarter of 2001. The FCC rules permit carriers to continue collecting the
existing higher rates on calls that terminate to customers who are not Internet
service providers. Any traffic exchanged between carriers that exceeds a three
to one ratio of terminating to originating minutes is presumed to be Internet
calls, although either carrier may attempt to rebut this presumption and claim a
different level of Internet traffic.
Internet service providers may be among our potential customers and these
new reciprocal compensation rules could limit our ability to service this group
of customers profitably. While some competitive carriers target Internet service
providers in order to generate additional revenues from reciprocal compensation
charges, at the present time we do not focus our marketing efforts on Internet
service providers. Therefore, we expect that these rules will have a minimal
impact on us.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy program. This order established new
subsidies for telecommunications and information services provided to qualifying
schools, libraries and rural health providers. The FCC also expanded federal
subsidies for local dial-tone services provided to low-income consumers.
Providers of interstate telecommunications service, including us, must
contribute to these subsidies. In later years, the FCC created additional
subsidies that primarily benefit incumbent telephone companies. On a quarterly
basis, the FCC announces the contribution factor proposed for the next quarter.
For the second quarter of the year 2002, the contribution factor is 0.068086 of
a provider's interstate and international revenue for the third quarter of 2001.
We intend to recover our share of these costs through charges assessed directly
to our customers and participation in federally subsidized programs. The FCC is
considering proposals to change the way contributions are assessed, but we
cannot predict when or whether the FCC will act on these proposals.
In 1994, Congress passed the Communications Assistance for Law Enforcement
Act ("CALEA") to ensure that law enforcement agencies would be able to conduct
properly authorized electronic surveillance of digital and wireless
telecommunications services CALEA requires telecommunications carriers to modify
their equipment, facilities and services to ensure that they are able to comply
with authorized electronic surveillance requests. For circuit-switched
facilities, carriers such as us were required to comply with CALEA by November
19, 2001. As a result of litigation, the FCC extended the deadline for carriers
to implement the Department of Justice / Federal Bureau of Investigation "punch
list" capabilities until June 30, 2002. We have now complied with the CALEA
requirements.
FORWARD LOOKING STATEMENTS
Under the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995, we caution investors that certain statements contained in this
Report regarding our or management's intentions, hopes, beliefs, expectations or
predictions of the future are forward-looking statements. We wish to caution the
reader these forward-looking statements are not historical facts and are only
estimates or predictions. Actual results may differ materially from those
projected as a result of risks and uncertainties including, but not limited to,
market makers' independent decisions to create a market in the common stock of
our recapitalized company, future sales growth, market acceptance of our
product offerings, our ability to secure adequate financing or equity capital
to fund our operations, network expansion and proposed recapitalization plan,
our ability to manage rapid growth and maintain a high level of customer
service, the performance of our network and equipment, our ability to enter into
strategic alliances, the cooperation of incumbent local exchange carriers in
provisioning lines and interconnecting our equipment, regulatory approval
processes, changes in technology, price competition and other market
conditions and risks detailed from time to time in our Securities and Exchange
Commission Filings.
36
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Upon the consummation of our restructuring on July 30, 2002 a substantial
amount of our fixed rate debt was eliminated. Prior to the consummation of our
restructuring, our 13% Senior Notes due 2010 (the "2010 Notes) traded at a
significant discount to its face amount due in part to our plan of
reorganization. Because of the significant discounting of our 2010 Notes, for
reasons unrelated to interest rates, we do not believe that a hypothetical
change of one percentage point in average interest rates would have a material
effect on the fair value of our 2010 Notes. Our 13% Senior Notes due 2004 (the
"2004 Notes") bear fixed interest rates. However, the fair market value of this
debt is sensitive to changes in prevailing interest rates. We run the risk that
market rates will decline and the required payments will exceed those based on
the current market rate. We do not use interest rate derivative instruments to
manage our exposure to interest rate changes. Based upon quoted market prices,
the fair value of our 2004 Notes outstanding is approximately $20.4 million at
June 30, 2002 as compared to a carrying value of $50.9 million. A hypothetical
1% decrease in interest rates would increase the fair value of our long-term
debt by $0.6 million.
The remainder of our long-term debt consists primarily of variable rate debt
with carrying amounts that approximate their fair values.
37
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
We are party to numerous state and federal administrative proceedings. In
these proceedings, we are seeking to define and/or enforce incumbent carrier
performance requirements related to:
- the nature and availability of network elements;
- the cost and provisioning of those network elements we lease;
- the terms of interconnection agreements;
- the establishment of customer care and provisioning; and
- collocation costs and procedures.
- winback programs based on discriminatory marketing and predatory
pricing.
The outcome of these proceedings will establish the rates and procedures by
which we obtain and provide leased network elements and could have a material
effect on our operating costs.
On September 20, 2000, a class action lawsuit was commenced against us and
our chief executive officer, Rolla P. Huff, in federal court for the Western
District of New York. On March 6, 2001, an amended consolidated class action
complaint was served in that action, seeking to recover damages for alleged
violations by us of the Securities Exchange Act of 1934 and rule 10(b)-5
thereunder (the "Exchange Act") and section 11 of the Securities Act of 1933.
The amended consolidated complaint also seeks to recover damages against several
of our officers and former members of our board of directors in addition to Mr.
Huff. The amended consolidated complaint also named various underwriters as
defendants in the action. However, by agreement of the parties and order of the
court, the action against the underwriters has been discontinued, subject to
the plaintiffs' right to rename the underwriters as defendants prior to the
completion of discovery. On February 11, 2002, the Court issued its Decision
and Order dismissing the class action lawsuit. The decision of the Court has
been appealed to the Court of Appeals for the Second Circuit and the final
outcome of this lawsuit is uncertain.
We and the individual defendant officers and former board members have
denied any wrongdoing and will vigorously contest the class action suit. Any
judgment that is significantly greater than our available insurance coverage
could have a material adverse effect on our results of operations and/or
financial condition.
In addition, on April 8, 2002, we commenced a voluntary, pre-negotiated
proceeding under Chapter 11 of the Federal Bankruptcy Code in the U.S.
Bankruptcy Court for the District of Delaware. On July 17, 2002, our Final Plan
was approved and as of July 30, 2002, the Final Plan became effective and we
have emerged from our reorganization in bankruptcy. Please refer to Management's
Discussion and Analysis for a more complete discussion of the bankruptcy
proceedings.
From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of our business. We do not believe any other
pending litigation or governmental proceeding will have a material adverse
effect on our results of operations or financial condition.
ITEM 2. Changes in Securities and Use of Proceeds
As of July 30, 2002, all of our outstanding 2010 Notes, Series C Preferred
Stock, Series D Preferred Stock and Old Common Stock were cancelled and
approximately 65,000,000 shares of our New Common Stock were issued in exchange
therefor. See Note 6 to the Consolidated Financial Statements for a more
complete description of the exchange. We did not receive any proceeds from the
issuance. No underwriter was involved in these transactions and no commissions
were paid with
38
respect to the issuance of such securities. These issuances of securities
were made in reliance on the exemption from registration provided by Section
3(a) (7) of the Securities Act of 1933.
ITEM 5. Other Information
Changes in Board of Directors
Effective as of July 30, 2002, our board of directors consists of six
members. Among them, Rolla P. Huff is our Chief Executive Officer; Joseph M.
Wetzel is our President and Chief Operating Officer and has been designated by
us to serve on our board of directors; and Robert M. Pomeroy, Michael E. Cahr,
Richard L. Shorten, Jr. and Michael M. Earley are the designees of the 2010
Noteholders (the "2010 Noteholder Designees"). The Final Plan provides that the
2010 Noteholder Designees will serve for a term of two years during which they
cannot be removed without cause. Thereafter, our board of directors will be
elected in accordance with our certificate of incorporation and by-laws, as
amended and restated, and applicable law.
ITEM 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed herewith or incorporated by reference
as indicated. Exhibit numbers refer to Item 60l of Regulation S-K.
2.1 Findings of Fact, Conclusions of Law, and Order
Under Section 1129 of the Bankruptcy Code and
Rule 3020 of the Bankruptcy Rules Confirming
Debtors' First Amended Joint Plan of
Reorganization, dated July 17, 2002. (1)
2.2 Debtors' First Amended Joint Plan of
Reorganization dated May 20, 2002. (1)
2.3 Debtors' First Amended Disclosure Statement
dated May 20, 2002. (1)
3.1 Second Amended and Restated Certificate of
Incorporation filed with the Secretary of
State of the State of Delaware on July 30,
2002. (2)
3.2 Amended and Restated Articles of Incorporation
of Mpower Communications Corp. filed with the
Secretary of State of the State of Nevada on
July 30, 2002. (1)
3.3 Amended and Restated By-laws. (2)
4.1 See the Second Amended and Restated Certificate
of Incorporation filed as Exhibit 3.1 and the
Amended and Restated By-laws filed as Exhibit
3.3.
4.2 Indenture dated as of September 29, 1997,
between the Company and Marine Midland Bank,
as Trustee. (3)
4.3 Form of Note for the Company's registered 13%
Senior Secured Notes due 2004. (3)
4.4 Form of New Key Employee Option Plan to be
adopted by Mpower Holding Corporation. (2)
4.5 Form of Registration Rights Agreement, to be
entered into by Mpower Holding Corporation
pursuant to the Final Plan. (2)
99.1 Certification of Principal Executive Officer
pursuant to 18 U.S.C. Section 1350
99.2 Certification of Principal Financial Officer
pursuant to 18 U.S.C. Section 1350
(1) Incorporated by reference to the Company's Current Report on Form 8-K
S-4 (file No. 33339884-01) filed with the Commission on July 30, 2002.
(2) Incorporated by reference to the Company's Registration Statement on Form
8-A filed with the Commission on July 30, 2002.
(3) Incorporated by reference to the Company's Registration Statement on Form
S-4 (File No. 333-38875) filed with the Commission on October 28, 1997, and
amendments thereto.
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(b) The registrant filed the following reports on Form 8-K during the
quarter ended June 30, 2002:
(1) On April 15, 2002, the Company filed a Form 8-K to report that the Company
and its operating subsidiary had filed a pre-negotiated plan of reorganization
under the bankruptcy laws.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MPOWER HOLDING CORPORATION
Date: August 14, 2002 /s/ ROLLA P. HUFF
-----------------------------------------
Rolla P. Huff
Chief Executive Officer and
Chairman of the Board
Date: August 14, 2002 /s/ S. GREGORY CLEVENGER
-----------------------------------------
S. Gregory Clevenger
Executive Vice President, Chief
Financial Officer
41