10-Q 1 y48485e10-q.txt MPOWER COMMUNICATIONS CORP. 1 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 MARCH 31, 2001 COMMISSION FILE NUMBER 0-24059 MPOWER COMMUNICATIONS CORP. (Exact name of registrant as specified in its charter) NEVADA 88-0360042 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 175 SULLY'S TRAIL, SUITE 300 PITTSFORD, NY 14534 (Address of principal executive offices) (716) 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 [ ] The number of shares outstanding of the issuer's common stock, as of May 3, 2001: Common stock (par value $0.001 per share) .... 59,507,724 shares outstanding 1 2 MPOWER COMMUNICATIONS CORP. INDEX

2 3 PART I - FINANCIAL INFORMATION ITEM 1. Consolidated Financial Statements MPOWER COMMUNICATIONS CORP. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

See accompanying condensed notes to unaudited interim consolidated financial statements. 3 4 MPOWER COMMUNICATIONS CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)

See accompanying condensed notes to unaudited interim consolidated financial statements. 4 5 MPOWER COMMUNICATIONS CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

See accompanying condensed notes to unaudited interim consolidated financial statements. 5 6 MPOWER COMMUNICATIONS CORP. CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

See accompanying condensed notes to unaudited interim consolidated financial statements. 6 7 MPOWER COMMUNICATIONS CORP. CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION The accompanying unaudited interim consolidated financial statements of Mpower Communications Corp. (the "Company"), a Nevada corporation, include the accounts of the Company and its wholly-owned subsidiaries, including Mpower Holding Corp., MGC Lease Corporation, Primary Network Holdings, Inc. ("Primary Network"), Mpower Communications of New York, Mpower Communications of Virginia, and Mpower Management Corp., formerly MGCi Corp. 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. The consolidated balance sheet at December 31, 2000 was derived from the audited consolidated financial statements, 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, which have no effect on net income, have been made in the prior period financial statements to conform to the current presentation. (2) PROPERTY AND EQUIPMENT Property and equipment consist of the following (in thousands):

7 8 (3) ACQUISITION AND DIVESTITURE ACQUISITION The Company acquired 100% of the common stock of Primary Network on June 23, 2000. The acquisition was accounted for using the purchase method of accounting and the results of operations of Primary Network have been included in the Company's operations since July 1, 2000. The following table sets forth the unaudited pro forma results of operations of the Company for the three months ended March 31, 2001 and 2000, which gives effect to the acquisition of Primary Network as if it occurred on January 1, 2000. The unaudited pro forma results of operations are based on currently available information and on certain assumptions that the Company believes are reasonable under the circumstances. The unaudited pro forma results do not purport to present what the Company's results of operations would actually have been if the aforementioned transaction had in fact occurred at the beginning of the period indicated, nor do they project the Company's results of operations at any future date or for any future period.

DIVESTITURE In February 2001, the Company entered into an agreement with Earthlink, Inc., an Internet service provider, to sell a portion of its residential dial-up ISP customer base. The Company acquired this customer base through its acquisition of Primary Network in June of 2000. The Company received initial proceeds from the sale of approximately $1.3 million during the first quarter of 2001, with the potential to receive additional contingent payments. The Company does not expect to recognize any material gain or loss on this transaction. (4) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Beginning in January 2001, the Company entered into privately negotiated conversions of its 7.25% Series D Convertible Redeemable Preferred Stock ("Series D Preferred Stock") into shares of the Company's common stock. As of March 31, 2001, the Company had converted 985,047 preferred shares into 1,917,554 common shares, primarily resulting from these agreements. The Company recognized an additional $6.4 million associated with the inducement feature included in the conversion of preferred shares into common stock, calculated as the excess of the fair value of the common stock issued in the exchange over the fair value of the common stock issuable under the current conversion terms for the Series D Preferred Stock. This amount has been recognized in the Consolidated Balance Sheet as an increase in additional paid- in capital, with an offsetting decrease in additional paid-in capital, and has been included as a part of preferred stock dividends within the Consolidated Statement of Operations. On January 24, 2001, the Company's Board of Directors declared a quarterly dividend of $0.91 per share on the Company's Series D Preferred Stock payable in shares of the Company's common stock on February 15, 2001 to Series D Preferred stockholders of record on January 31, 2001. The number of shares of common stock issued on February 15, 2001 was 427,070. (5) 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 March 31, 2001 and December 31, 2000, the Company had total commitments with equipment vendors of approximately $16.0 million and $23.1 million, respectively, and with collocation site providers of approximately $3.5 million and $12.4 million, respectively, of remaining commitments for the build-out of collocation sites. 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, 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 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 members of its board of directors in addition to Mr. Huff. The amended consolidated complaint also names various underwriters as defendants in the action. 8 9 The Company and the individual defendant officers and board members have denied any wrongdoing and will vigorously contest the class action suit. 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, 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. (6) NON-RECURRING ITEMS During February 2001, the Company announced the cancellation of its plans to enter 12 markets in the Northeast and Northwest, representing more than 350 collocations. The Company recognized a charge of $24.0 million in the first quarter of 2001 associated with the commitments made for switch sites and collocations for these markets. The charge represents estimated amounts paid or estimated to be paid. Actual payments will be based on ultimate settlements with the incumbent local exchange carriers, net of any costs that may be recoverable through sales of the related assets, and the Company's ability to enter into sublease agreements for its switch site leases. Equipment will be redeployed for growth in the Company's existing network. At March 31, 2001, the Company has switch site lease commitments related to these markets, expiring from 2005 through 2010. In connection with these switch site leases, the charge in the first quarter of 2001 reflects only the first year's lease payment commitments as the Company estimates that it will be successful in entering into sublease agreements or terminating the remaining lease commitments within one year. (7) SUBSEQUENT EVENTS During April 2001, the Company announced a deferral of a quarterly dividend on the Company's Series D Preferred Stock. Dividends will continue to accrue on the liquidation amount of $50.00 per share at the rate of 7.25% per year and will be payable, at the option of the Company, in cash or in shares of the Company's common stock. 9 10 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW Mpower Communications Corp. is a growing communications company offering local dialtone, long distance, Internet access via dial-up or dedicated Symmetrical Digital Subscriber Line ("SDSL") technology, voice over SDSL ("VoSDSL") and other voice and data services primarily to small and medium size business customers. We have launched bundled voice and high-speed data services using SDSL technology in all of our current markets. We currently have 784 incumbent carrier central office collocation sites, over 760 of which are SDSL capable. We currently deliver our services in 40 metropolitan areas in 15 states. As of March 31, 2001, we had 358,824 customer lines sold, of which 324,487 lines were in service. Our revenues are generated from sales of communications services consisting primarily of local phone 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 local, long distance and data services. As a result, the portion of our revenues attributable to each kind of service is not identifiable and, therefore, we do not record or report these amounts separately. Our principal operating expenses consist of cost of operating revenues, selling expenses, 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. Selling expenses consist primarily of salaries and related personnel costs and facilities costs. General and administrative expenses consist primarily of salaries and related personnel costs, provision for bad debts, professional fees and facilities expenses. Depreciation and amortization expense includes depreciation of switching and collocation equipment as well as general property and equipment and the amortization of goodwill and other intangibles. Building and expanding our network and business in our existing markets has required and will continue to require us to incur significant capital expenditures. As part of our network growth strategy, we purchased and installed host switches in each of our markets while leasing the means of transporting voice and data traffic from these switches to our customers' telephones or other equipment. We believe this strategy, referred to as a "smart build" strategy, while initially increasing our level of capital expenditures and operating losses, will enhance our long-term financial performance in comparison to a resale strategy. 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 expand 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 a market are incurred before significant revenues can be generated from that market. In addition, we expect to incur significant selling costs to build our initial base of customers in our recently developed 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. RESULTS OF OPERATIONS Quarterly Comparison - March 31, 2001 vs. March 31, 2000 Total operating revenues increased to $46.6 million for the quarter ended March 31, 2001 as compared to $25.5 million for the quarter ended March 31, 2000. The 83% increase was primarily the result of the increase in the number of lines in service. Total lines in service increased 92% from 168,786 at March 31, 2000 to 324,487 at March 31, 2001. Our switched access revenues increased $3.4 million or 35% from the quarter ended March 30, 2000, but decreased as a percentage of our total operating revenues from 38% to 28% over the same period. On April 27, 2001, the Federal Communications Commission ("FCC") issued a ruling that will impact switched access rates. We are in the process of evaluating how the ruling will impact our revenues in the future. 10 11 Cost of operating revenues for the quarter ended March 31, 2001 was $40.6 million as compared to $18.9 million for the quarter ended March 31, 2000. The 115% increase is due to the increased number of lines in service and installation and operational expenses associated with the expansion of our network. For the quarter ended March 31, 2001, selling expenses totaled $15.9 million, a 108% increase over the $7.6 million for the quarter ended March 31, 2000. The increase is primarily a result of increased costs attributable to our expanded geographic footprint and increased sales force and related sales support personnel. For the quarter ended March 31, 2001, general and administrative expenses totaled $36.9 million, an 86% increase over the $19.8 million for the quarter ended March 31, 2000. The increase is primarily a result of costs attributable to administrative personnel and facilities expenses necessary to support our expanded network. For the quarter ended March 31, 2001 we recorded $0.9 million in stock-based compensation compared to $1.6 million for the quarter ended March 31, 2000. This expense relates to in-the-money stock options granted in 1999 and 2000. Due to the September 2000 repricing of stock options, we are now subject to variable plan accounting. The variable plan accounting did not increase the amount of stock-based compensation recognized in the quarter ended March 31, 2001, due to the closng price of our stock at March 31, 2001. However, we are unable to predict the expense which may be recognized in future periods as this amount is subject to fluctuations of the market price of our stock. During February 2001, we announced the cancellation of our plans to enter 12 Northeast and Northwest markets and the related elimination of more than 350 collocations. We recognized a $24.0 million network optimization charge for the quarter ended March 31, 2001 associated with the commitments we made for switch sites and collocations in 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 redeploy network equipment for growth in our existing network and other factors. For the quarter ended March 31, 2001, depreciation and amortization was $21.6 million as compared to $6.8 million for the quarter ended March 31, 2000. This 219% increase is a result of placing additional assets in service in accordance with the planned build-out of our network. Gross interest expense for the quarter ended March 31, 2001 totaled $16.8 million compared to $5.9 million for the quarter ended March 31, 2000. Interest capitalized for the quarter ended March 31, 2001 increased to $2.0 million as compared to $0.9 million for the quarter ended March 31, 2000. This increase is due to the increase in switching and facilities under construction. 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 we issued in September 1997. Interest income was $7.7 million during the quarter ended March 31, 2001 compared to $8.9 million for the quarter ended March 31, 2000. The 13% decrease results from the usage of cash and investments during 2000 and 2001 to make capital expenditures, pay interest on the senior notes and fund operating losses. For the three months ended March 31, 2001 and 2000, we incurred a net loss of $98.5 million and $25.3 million, respectively. For the quarter ended March 31, 2001, we accrued dividends of $3.3 million payable to holders of our convertible preferred stock. We recognized an additional $6.4 million associated with the inducement feature included in our conversion of preferred shares into common stock, calculated as the excess of the fair value of the common stock issued in the exchange over the fair value of the common stock issuable under the current conversion terms for the Series D Preferred Stock. Effective June 30, 2000, we acquired Primary Network, a provider of data-centric communications services to business and residential customers in the Midwest. From July 1, 2000, the results of Primary's operations are included in our consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES Our operations require substantial capital investment for the purchase of communications equipment and the development and installation of our network. Capital expenditures were $17.1 million for the quarter ended March 31, 2001. We expect we will continue to require substantial amounts of capital to fund our operating losses, the continued augmentation of our network in our existing markets and the development of new products and services. 11 12 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 our network in anticipation of connecting revenue-generating customers. We expect to continue recording negative cash flow from operations for a period of time. We cannot assure you we will attain break-even cash flow from operations in subsequent periods. We expect that our available cash will be adequate to fund our operating losses and planned capital expenditures, as currently projected, into late 2002. Management intends to explore a number of alternatives to improve our funding position, including one or a combination of the following: bank financing, vendor financing, private equity investments and additional cost management initiatives including further reduction of new markets. However, 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. In addition, the indenture governing our 13% Senior Notes due 2010 and the terms of our preferred stock impose restrictions upon our ability to incur additional debt or issue preferred stock. We continually evaluate our capital expenditure plan in light of developments in the telecommunications industry and market acceptance of our service offerings. As a result of this evaluation, we may decide to add new markets and accelerate or expand our capital expenditure plan depending on conditions in the capital markets and other factors in the future. We might also expand our markets or customer base through acquisitions. To fund an accelerated or expanded capital expenditure plan or acquisitions, we would likely issue additional debt or equity securities. We cannot assure investors we would be successful in raising additional capital on terms acceptable to us or at all. Beginning in January 2001, we entered into privately negotiated conversions of our Series D Preferred Stock into shares of our common stock. As of March 31, 2001, we had converted 985,047 Series D preferred shares into 1,917,554 common shares, primarily resulting from these agreements. 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 and/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, projections of future sales, market acceptance of our product offerings, our ability to secure adequate financing or equity capital to fund our operations and network expansion, our ability to maintain a high level of customer service, the performance of our network and equipment, the cooperation of incumbent local exchange carriers in provisioning lines and interconnecting our equipment, regulatory rulings and processes, changes in technology, price competition and other market conditions. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk All of our long-term debt bears 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. A hypothetical 1% decrease in interest rates would increase the fair value of our long-term debt by $6.2 million. 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: 12 13 - the cost and provisioning of those network elements we lease; - the establishment of customer care and provisioning; - the allocation of subsidies; and - collocation costs and procedures. 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. In July 2000, we filed a complaint in U.S. District Court District of Nevada, to enjoin Sprint Corporation from anti-competitive conduct in the Las Vegas market. In August 2000, we filed a complaint against BellSouth Telecommunications, Inc. to enjoin BellSouth from anti-competitive conduct in the Southern Florida area. The final outcome of these disputes is uncertain. 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 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 plaintiff's right to rename the underwriters as defendants prior to the completion of discovery. We and the individual defendant officers and 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. 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 During first quarter 2001, we issued 1,917,554 shares of common stock in exchange for 985,047 shares of our Series D Preferred Stock primarily from privately negotiated transactions. We did not receive any proceeds from the issuance. No underwriter was involved in these transactions and no commissions were paid with 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)(9) of the Securities Act of 1933. 13 14 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed as part of this report. The exhibit numbers refer to Item 601 of Regulation S-K

---------- (1) 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. 14 15 (2) Incorporated by reference to the Company's Registration Statement on Form S-4 (file No. 333-39884) filed with the Commission on June 22, 2000, and amendments thereto. (3) Incorporated by reference to the Company's quarterly report on Form 10-Q (Commission File No. 0-24059) for the quarter ended June 30, 2000. (4) Incorporated by reference to the Company's Registration Statement on Form S-3, registration statement number 333-79863, filed with the Commission on June 3, 1999, and amendments thereto. (5) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 333-49085) filed with the Commission on April 1, 1998, and amendments thereto. (6) Incorporated by reference to the Company's Registration Statement on Form S-3 (File No. 333-91353) filed with the Commission on November 19, 1999, and amendments thereto. (7) Incorporated by reference to the Company's annual report on Form 10-K (Commission File No. 0-24059) for the year ended December 31, 1999. (8) Incorporated by reference to the Company's Registration Statement on Form S-4 (File No. 333-36672) filed with the Commission on May 10, 2000, and amendments thereto. (9) Incorporated by reference to the Company's Report on Form 8-K (File No. 0-24059) filed with the Commission on June 2, 2000. (10) Incorporated by reference to the Company's annual report on Form 10-K (Commission File No. 0-24059) for the year ended December 31, 2000. 15 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MPOWER COMMUNICATIONS CORP. Date: May 7, 2001 /s/ ROLLA P. HUFF ---------------------------------------------------- Rolla P. Huff President, Chief Executive Officer Date: May 7, 2001 /s/ MICHAEL R. DALEY ---------------------------------------------------- Michael R. Daley Executive Vice President, Chief Financial Officer 16

MPOWER COMMUNICATIONS CORP 10-Q