**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

| **(Mark One)** |
|----------------|
| **ý**     |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the Quarterly Period Ended March 31, 2003** |
|           |   |   |
|           |   | **or** |
|           |   |   |
| **o**          |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the transition period                                 to                              ** |
|           |   |   |
|           |   | **Commission file number 0-20763** |

 

| **McLEODUSA  INCORPORATED**                            |
|--------------------------------------------------------|
| (Exact name of registrant as specified in its charter) |

 

| **Delaware**                                                                       |   | **42-1407240**                    |
|------------------------------------------------------------------------------------|--------|-----------------------------------|
| (State of Incorporation)                                                           |   | (IRS Employer Identification No.) |
|                                                                               |   |                              |
| **McLeodUSA Technology Park  6400 C Street SW  P.O. Box 3177  Cedar Rapids, Iowa** |   | **52406-3177**                    |
| (Address of principal executive office)                                            |   | (Zip Code)                        |
|                                                                               |
| **319-364-0000**                                                                   |
| (Registrant’s telephone number,  including area code)                         |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90days.            Yes   ý  Noo

 

Indicate by check markwhether the registrant is an accelerated filed (as defined in Rule 12b-2 of theExchange Act). Yes o No ý

 

Indicate by check mark whether the registrant has filed all documentsand reports required to be filed by Section 12, 13 or 15(d) of the SecuritiesExchange Act of 1934 subsequent to the distribution of securities under a planconfirmed by a court.  Yes  ý         No o

 

The number of sharesoutstanding of each class of the issuer’s common stock as of May 1, 2003:

| Common Stock Class  A:  ($0.01 par value) |   | 162,368,920  shares |
|------------------------------------------------|--------|---------------------|
| Common Stock Class  B:  ($0.01 par value) |   | 78,203,135  shares  |
| Common Stock Class  C:  ($0.01 par value) |   | 35,546,879  shares  |

 

 

----

 

**McLEODUSA INCORPORATED ANDSUBSIDIARIES**

**INDEX**

 
| **PART I.  Financial  Information** |
|------------------------------------------|
|                                     |
| Item 1.                                  | Condensed Consolidated  Financial Statements: |
|                                     |   |
|                                     |   | Condensed  Consolidated Balance Sheets, March 31, 2003 (unaudited) and December 31, 2002 |
|                                     |   |   |
|                                     | Unaudited  Condensed Consolidated Statements of Operations and Comprehensive Loss |
|                                     |   |
|                                     |   | Reorganized McLeodUSA – for the three months  ended March 31, 2003 |
|                                     |   |   |
|                                     |   | Predecessor McLeodUSA – for the three months  ended March 31, 2002 |
|                                     |   |   |
|                                     | Unaudited  Condensed Consolidated Statements of Cash Flows |
|                                     |   |
|                                     |   | Reorganized McLeodUSA – for the three months  ended March 31, 2003 |
|                                     |   |   |
|                                     |   | Predecessor McLeodUSA – for the three months ended  March 31, 2002 |
|                                     |   |   |
|                                     | Notes to the Condensed Consolidated Financial  Statements |
|                                     |   |
| Item  2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                     |   |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk |
|                                     |   |
| Item 4.                                  | Controls and Procedures |
|                                     |
| **PART II.  Other Information**     |
|                                     |
| Item  1.                                 | Legal  Proceedings |
|                                     |   |
| Item 6.                                  | Exhibits and  Reports on Form 8-K |
|                                     |   |
| Signatures                               |
|                                     |
| Certifications                           |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

**McLEODUSA INCORPORATED ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In millions, except share data)**

** **
|                                                                                                                                                                                                         |   | **March 31,  2003** |    | **December  31,  2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|------------|
|                                                                                                                                                                                                         |   | **(unaudited)**     |    |                    |       |
| **ASSETS**                                                                                                                                                                                                   |   |                |    |                    | ** ** |
| Current  assets                                                                                                                                                                                              |   |                |    |                    |       |
| Cash  and cash equivalents                                                                                                                                                                                   |   | $                   | 115.5   |                    | $          | 170.6 |   |
| Trade receivables, net                                                                                                                                                                                       |   | 92.1                |    | 93.1                    |       |
| Prepaid expenses and other                                                                                                                                                                                   |   | 26.3                |    | 26.2                    |       |
| Assets held for sale                                                                                                                                                                                         |   | 10.8                |    | 11.1                    |       |
| Total current assets                                                                                                                                                                                         |   | 244.7               |    | 301.0                   |       |
| Property  and equipment                                                                                                                                                                                      |   |                |    |                    |       |
| Land and buildings                                                                                                                                                                                           |   | 73.6                |    | 72.9                    |       |
| Communications networks                                                                                                                                                                                      |   | 852.1               |    | 816.0                   |       |
| Furniture, fixtures and equipment                                                                                                                                                                            |   | 185.0               |    | 181.3                   |       |
| Networks in progress                                                                                                                                                                                         |   | 276.0               |    | 303.5                   |       |
|                                                                                                                                                                                                         |   | 1,386.7             |    | 1,373.7                 |       |
| Less accumulated depreciation                                                                                                                                                                                |   | 235.1               |    | 170.6                   |       |
|                                                                                                                                                                                                         |   | 1,151.6             |    | 1,203.1                 |       |
| Intangibles and other assets                                                                                                                                                                                 |   |                |    |                    |       |
| Goodwill, net                                                                                                                                                                                                |   | 237.8               |    | 237.8                   |       |
| Other intangibles, net                                                                                                                                                                                       |   | 226.3               |    | 234.5                   |       |
| Other                                                                                                                                                                                                        |   | 22.7                |    | 23.9                    |       |
|                                                                                                                                                                                                         |   | 486.8               |    | 496.2                   |       |
| **TOTAL ASSETS**                                                                                                                                                                                             |   | $                   | 1,883.1 |                    | $          | 2,000.3 |   |
|                                                                                                                                                                                                         |   |                |    |                    |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                               |   |                |    |                    |       |
| Current  liabilities                                                                                                                                                                                         |   |                |    |                    |       |
| Current  maturities of long-term debt                                                                                                                                                                        |   | $                   | 19.9    |                    | $          | 15.0 |   |
| Accounts payable                                                                                                                                                                                             |   | 68.4                |    | 71.1                    |       |
| Accrued payroll and payroll related expenses                                                                                                                                                                 |   | 20.7                |    | 23.6                    |       |
| Other accrued liabilities                                                                                                                                                                                    |   | 131.6               |    | 152.8                   |       |
| Deferred revenue, current portion                                                                                                                                                                            |   | 9.8                 |    | 9.8                     |       |
| Liabilities related to discontinued operations                                                                                                                                                               |   | 1.0                 |    | 6.3                     |       |
| Total current liabilities                                                                                                                                                                                    |   | 251.4               |    | 278.6                   |       |
| Long-term debt, less current maturities                                                                                                                                                                      |   | 698.6               |    | 704.9                   |       |
| Deferred revenue, less current portion                                                                                                                                                                       |   | 12.9                |    | 13.5                    |       |
| Other long-term liabilities                                                                                                                                                                                  |   | 55.8                |    | 54.9                    |       |
|                                                                                                                                                                                                         |   | 1,018.7             |    | 1,051.9                 |       |
| Redeemable  convertible preferred stock                                                                                                                                                                      |   |                |    |                    |       |
| McLeodUSA  Preferred Series A, redeemable, convertible, $0.01 par value; 10,000,000  authorized and issued; 9,999,800 and 9,999,900 outstanding at March  31, 2003 and December 31, 2002,  respectively |   | 173.9               |    | 172.6                   |       |
| Stockholders’  equity                                                                                                                                                                                   |   |                |    |                    |       |
| McLeodUSA Common, Class A $0.01 par value;  1,886,249,986 authorized, 162,500,978 and 162,500,481 issued and outstanding  at March 31, 2003 and December 31, 2002, respectively                              |   | 1.6                 |    | 1.6                     |       |
| McLeodUSA  Common, Class B $0.01 par value; 78,203,135 authorized, issued and  outstanding at March 31, 2003 and December 31, 2002                                                                           |   | 0.8                 |    | 0.8                     |       |
| McLeodUSA  Common, Class C $0.01 par value; 35,546,879 authorized, issued and  outstanding at March 31, 2003 and December 31, 2002                                                                           |   | 0.3                 |    | 0.3                     |       |
| McLeodUSA  Preferred Series B, $0.01 par value; 10 authorized, issued and outstanding at  March 31, 2003 and December 31, 2002                                                                               |   | —              |    | —                  |       |
| McLeodUSA  Warrants                                                                                                                                                                                          |   | 22.6                |    | 22.6                    |       |
| Additional  paid-in capital                                                                                                                                                                                  |   | 950.6               |    | 951.9                   |       |
| Accumulated  deficit                                                                                                                                                                                         |   | (285.4              | )       | (201.4                  | )          |
|                                                                                                                                                                                                         |   | 690.5               |    | 775.8                   |       |
| **TOTAL LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                         |   | $                   | 1,883.1 |                    | $          | 2,000.3 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

3

----

 

**McLEODUSA INCORPORATED ANDSUBSIDIARIES**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**AND COMPREHENSIVE LOSS**

**(In millions, except per share data)**

 
|                                                                                                                              |   | **Reorganiz****ed****McLeodUSA**        |   | **Predecess****or****McLeodUSA**        |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                                              |   | **Three  months ended  March 31, 2003** |   | **Three  months ended  March 31, 2002** |   |
| Revenues                                                                                                                          |   | $                                       | 225.9  |                                    | $      | 264.1 |   |
|                                                                                                                              |   |                                    |   |                                    |   |
| Operating expenses:                                                                                                               |   |                                    |   |                                    |   |
| Cost of service (exclusive of depreciation shown  separately below)                                                               |   | 137.4                                   |   | 179.1                                   |   |
| Selling, general and administrative                                                                                               |   | 81.7                                    |   | 91.4                                    |   |
| Depreciation and amortization                                                                                                     |   | 82.2                                    |   | 108.9                                   |   |
| Reorganization charges, net                                                                                                       |   | —                                  |   | 57.2                                    |   |
| **Total operating expenses**                                                                                                      |   | 301.3                                   |   | 436.6                                   |   |
| **Operating loss**                                                                                                                |   | (75.4                                   | )      | (172.5                                  | )      |
|                                                                                                                              |   |                                    |   |                                    |   |
| Nonoperating expense:                                                                                                             |   |                                    |   |                                    |   |
| Interest expense, net of amounts capitalized  (contractual interest was $80.5 million for the three months ended March 31,  2002) |   | (8.7                                    | )      | (31.4                                   | )      |
| Other income                                                                                                                      |   | —                                  |   | 3.0                                     |   |
| **Total nonoperating expense**                                                                                                    |   | (8.7                                    | )      | (28.4                                   | )      |
| **Loss from continuing operations**                                                                                               |   | (84.1                                   | )      | (200.9                                  | )      |
| Discontinued operations:                                                                                                          |   |                                    |   |                                    |   |
| Income from discontinued operations                                                                                               |   | —                                  |   | 14.5                                    |   |
| **Net loss**                                                                                                                      |   | (84.1                                   | )      | (186.4                                  | )      |
| Preferred stock dividend (contractual dividends were  $8.0 million for the three months ended March 31, 2002)                     |   | (1.2                                    | )      | (4.8                                    | )      |
| **Net loss applicable to common shares**                                                                                          |   | (85.3                                   | )      | (191.2                                  | )      |
|                                                                                                                              |   |                                    |   |                                    |   |
| Basic and diluted loss per common share:                                                                                          |   |                                    |   |                                    |   |
| Loss from continuing operations                                                                                                   |   | $                                       | (0.31  | )                                       | $      | (0.33 | ) |
| Discontinued operations                                                                                                           |   | —                                  |   | 0.02                                    |   |
| Loss per common share                                                                                                             |   | $                                       | (0.31  | )                                       | $      | (0.31 | ) |
| Weighted average common shares outstanding                                                                                        |   | 276.3                                   |   | 627.7                                   |   |
|                                                                                                                              |   |                                    |   |                                    |   |
| Other comprehensive income, net of tax:                                                                                           |   |                                    |   |                                    |   |
| Unrealized holding losses arising during the period                                                                               |   | $                                       | — |                                    | $      | (2.1 | ) |
| Less:   reclassification adjustment for gains included in net income                                                         |   | —                                  |   | 3.2                                     |   |
| **Total other comprehensive income**                                                                                              |   | —                                  |   | 1.1                                     |   |
| **Comprehensive loss**                                                                                                            |   | $                                       | (84.1  | )                                       | $      | (185.3 | ) |

 

The accompanyingnotes are an integral part of these condensed consolidated financial statements

 

4

----

 

**McLEODUSA INCORPORATED ANDSUBSIDIARIES**

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In millions)**

 
|                                                                         |   | **Reorganized****McLeodUSA**            |       | **Predecessor****McLeodUSA**            |       |
|------------------------------------------------------------------------------|--------|-----------------------------------------|------------|-----------------------------------------|------------|
|                                                                         |   | **Three  months ended  March 31, 2003** |       | **Three  months ended  March 31, 2002** | ** ** |
|                                                                         |   |                                    | ** ** |                                    | ** ** |
| **Cash Flows from Operating Activities**                                     |   |                                    |       |                                    |       |
| Net loss from continuing operations                                          |   | $                                       | (84.1      | )                                       | $          | (200.9 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities: |   |                                    |       |                                    |       |
| Depreciation                                                                 |   | 65.9                                    |       | 93.6                                    |       |
| Amortization                                                                 |   | 16.3                                    |       | 15.3                                    |       |
| Accretion of interest                                                        |   | —                                  |       | 4.1                                     |       |
| Gain on sale of assets                                                       |   | (0.2                                    | )          | (3.6                                    | )          |
| Non cash reorganization items                                                |   | —                                  |       | 53.3                                    |       |
| Changes in assets and liabilities, net of  dispositions:                     |   |                                    |       |                                    |       |
| Trade receivables                                                            |   | 1.0                                     |       | 6.4                                     |       |
| Inventory                                                                    |   | —                                  |       | (6.1                                    | )          |
| Prepaid expenses and other                                                   |   | 2.9                                     |       | 3.6                                     |       |
| Accounts payable and accrued expenses                                        |   | (31.2                                   | )          | (42.5                                   | )          |
| Deferred revenue                                                             |   | (0.6                                    | )          | 1.5                                     |       |
| **Net cash used in operating activities**                                    |   | (30.0                                   | )          | (75.3                                   | )          |
|                                                                         |   |                                    |       |                                    |       |
| **Cash Flows from Investing Activities**                                     |   |                                    |       |                                    |       |
| Purchases of property and equipment                                          |   | (13.8                                   | )          | (31.9                                   | )          |
| Other assets                                                                 |   | (10.4                                   | )          | (14.1                                   | )          |
| Sale of available for sale securities                                        |   | —                                  |       | 2.0                                     |       |
| Proceeds from the sale of assets                                             |   | 0.2                                     |       | 17.8                                    |       |
| Proceeds from the sale of businesses                                         |   | —                                  |       | 58.7                                    |       |
| **Net cash (used in) provided by investing activities**                      |   | (24.0                                   | )          | 32.5                                    |       |
|                                                                         |   |                                    |       |                                    |       |
| **Cash Flows from Financing Activities**                                     |   |                                    |       |                                    |       |
| Payments on long-term debt                                                   |   | (1.1                                    | )          | (3.9                                    | )          |
| **Net cash used in financing activities**                                    |   | (1.1                                    | )          | (3.9                                    | )          |
|                                                                         |   |                                    |       |                                    |       |
| **Net decrease in cash and cash equivalents from continuing  operations**    |   | (55.1                                   | )          | (46.7                                   | )          |
|                                                                         |   |                                    |       |                                    |       |
| **Net cash provided by discontinued operations**                             |   | —                                  |       | 21.7                                    |       |
|                                                                         |   |                                    |       |                                    |       |
| **Cash and cash equivalents**                                                |   |                                    |       |                                    |       |
| Beginning                                                                    |   | 170.6                                   |       | 137.1                                   |       |
| Ending                                                                       |   | $                                       | 115.5      |                                    | $          | 112.1 |   |
|                                                                         |   |                                    |       |                                    |       |
| **Supplemental Disclosure of Cash Flow Information:**                        |   |                                    |       |                                    |       |
| Cash payments for interest                                                   |   | $                                       | 10.6       |                                    | $          | 15.0 |   |
|                                                                         |   |                                    |       |                                    |       |
| **Supplemental Schedule of Noncash Investing and Financing  Activities**     |   |                                    |       |                                    |       |
| Preferred stock dividends                                                    |   | $                                       | 1.2        |                                    | $          | 4.8 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

5

----

 

**McLEODUSA INCORPORATED AND SUBSIDIARIES**

**NOTES****TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Information as of and for the three months ended March 31,2003 and 2002 is unaudited)**

 

**Note 1:  Basis of Presentation**

 

McLeodUSA Incorporated (“McLeodUSA”), a Delaware corporation, throughits subsidiaries, provides integrated communications services, including localservices, primarily in 25 Midwest, Southwest, Northwest and Rocky Mountainstates.  McLeodUSA’s business is highlycompetitive and is subject to various federal, state and local regulations.

 

On January 31, 2002, McLeodUSA Incorporated, the parent company, fileda voluntary petition for relief under Chapter 11 of the United StatesBankruptcy Code in the United States Bankruptcy Court for the District ofDelaware (the “Bankruptcy Court”).  OnApril 16, 2002, McLeodUSA Incorporated emerged from the Bankruptcy Courtproceedings pursuant to the terms of its amended plan of reorganization (the“Plan”).  The Plan was filed with theBankruptcy Court on February 28, 2002 and was confirmed on April 5, 2002.

 

During the period from January 31, 2002 to March 31, 2002, McLeodUSAoperated as a debtor-in-possession.  The unaudited condensed consolidated financial statements during the periodfrom January 31, 2002 to March 31, 2002, have been prepared in accordance withthe provisions of Statement of Position 90-7, *Financial Reporting by Entities inReorganization Under the Bankruptcy Code* (“SOP 90-7”).  McLeodUSAadopted the provisions SOP 90-7 upon commencement of the Bankruptcy Courtproceedings. The unaudited condensed consolidated statement of operations forthe period January 1, 2002 to March 31, 2002 separately discloses expensesrelated to the Chapter 11 proceedings as reorganization charges. Interestexpense on all of the outstanding senior notes and the preferred stockdividends on the Series A Preferred Stock ceased to accrue after filing byMcLeodUSA on January 31, 2002. Interest and dividends ceased by operation oflaw.  See Note 3 for further discussionof the emergence from bankruptcy.

 

Upon emergence from bankruptcy, McLeodUSA implemented fresh-startreporting under the provisions of SOP 90-7. Under SOP 90-7, the reorganization fair value of McLeodUSA was allocatedto its assets and liabilities, its accumulated deficit was eliminated, and itsnew equity was issued according to the Plan as if it were a new reportingentity.  As a result of thereorganization occurring as of April 16, 2002, the financial statements havebeen separately presented under the label “Predecessor McLeodUSA” for the threemonths ended March 31, 2002 and “Reorganized McLeodUSA” for the three monthsended March 31, 2003.

 

For the three months ended March 31, 2002 and 2003, the operatingresults of businesses held for sale have been reported as discontinuedoperations in the McLeodUSA Unaudited Condensed Consolidated Statements ofOperations in accordance with Statement of Financial Accounting Standards(“SFAS”) No. 144 *Accounting for the Impairment or Disposal of Long-Lived Assets*(“SFAS 144”).  Assets held for sale andliabilities related to discontinued operations have been presented separatelyin the asset and liabilities sections of the condensed consolidated balancesheets.  See Note 2 for further discussionof discontinued operations.

 

Certainitems in the 2002 consolidated financial statements have been reclassified tobe consistent with the presentation in the 2003 consolidated financialstatements.

** **

**Interim Financial Information (unaudited)**

In the opinion of management, the accompanying unaudited condensedconsolidated financial statements include all adjustments, consisting of normalrecurring adjustments, necessary for a fair presentation of the financialposition and results of operations of McLeodUSA.  The operating results for the interim periods are not necessarilyindicative of the operating results to be expected for a full year or for otherinterim periods.  Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) have been condensed or omitted pursuant to instructions,rules and regulations prescribed by the Securities and Exchange Commission(“SEC”).  Although management believesthat the disclosures provided are adequate to make the information presentednot misleading, management recommends that you read these unaudited condensedconsolidated financial statements in conjunction with the audited consolidatedfinancial statements and the related footnotes included in the McLeodUSA AnnualReport on Form 10-K/A for the fiscal year ended December 31, 2002, filedwith the SEC on April 10, 2003.

 

**Accounting forStock-based Compensation**

Aspermitted by SFAS No. 123, *Accounting for Stock-Based Compensation*(‘‘SFAS123’’), McLeodUSA measures compensation using the intrinsic value based methodas prescribed by Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*but is required to make proformadisclosures in the footnotes to the financial statements as if the measurementprovisions of SFAS 123 and SFAS No. 148 *Accounting for Stock-Based Compensation-Transitionand Disclosure — an Amendment of SFAS 123*had been adopted. Underthe intrinsic value method, compensation is measured as the difference betweenthe market value of the stock on the grant date, less the amount

 

6

----

 

requiredto be paid for the stock. The difference, if any, is charged to expense overthe vesting period of the options. No stock-based employee compensation cost isreflected in net loss, as all options granted under the plan had an exerciseprice greater than or equal to the market value of the underlying common stock onthe date of grant. The following table illustrates the effect on net loss andnet loss per share for the quarter ended March 31, 2003 as if McLeodUSA hadapplied the fair value recognition provisions of SFAS 123 to stock-basedemployee compensation.  During the firstquarter of 2002, there were options outstanding under Predecessor McLeodUSAoption plans.  No pro forma informationhas been presented below for 2002 because the option plans were terminated uponthe confirmation of the Plan on April 5, 2002.

 
|                                                                                                 |   | **Reorganized  McLeodUSAThree months  ended  March 31, 2003** |   |
|------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|
| Net  loss applicable to common shares, as reported                                                   |   | $                                                             | (85.3  | ) |
| Less:  total stock-based employee compensation expense determinedunder fair value based methods |   | (2.3                                                          | )      |
| Pro forma net loss applicable  to common shares                                                      |   | $                                                             | (87.6  | ) |
|                                                                                                 |   |                                                          |   |
| **Loss per share:**                                                                                  |   |                                                          |   |
| Basic and diluted, as reported                                                                       |   | $                                                             | (0.31  | ) |
| Basic and diluted, pro forma                                                                         |   | $                                                             | (0.32  | ) |

 

**Basic and diluted loss per common share**

Lossper common share has been computed using the weighted average number of sharesof common stock outstanding.  All stockoptions granted, and the convertible preferred stock and warrants outstandingare anti-dilutive, and are therefore excluded from the computation of earningsper share. In the future, the stock options, convertible preferred stock andwarrants may become dilutive.  Assumingexercise or conversion of stock options and convertible securities, dilutedshares would have been approximately 416 million at March 31, 2003.

 

**Guarantees**

In November 2002, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*.  This interpretation clarifies disclosures that are required to bemade by a guarantor in its interim and annual financial statements aboutobligations under certain of its issued guarantees. In addition, theinterpretation clarifies that a guarantor is required to recognize, at theinception of certain types of guarantees, a liability for the fair value of theobligation undertaken in issuing these guarantees. The recognition andmeasurement provisions of this interpretation are applicable to guaranteesissued or modified after December 31, 2002, and the disclosure requirementsbecame effective as of December 31, 2002. At March 31, 2003, McLeodUSA, theparent company, has various guarantees related to subsidiary commitments underoperating leases. The guarantees total $39.8 million and expire over variousperiods through September 2016, corresponding with the termination of the leaseagreements.

 

**Note 2:  Assets Held For Sale**

 

In August 2001, McLeodUSAinitiated a broad strategic and operational restructuring to re-focus itsbusiness on its core areas of expertise within its 25-state footprint, improvebusiness discipline and processes and reduce its cost structure, all with thegoal of eventually developing positive cash flow from operations.  A key element of this operationalrestructuring included selling certain non-core assets, including McLeodUSATelecom Development, Inc. and McLeodUSA Community Telephone, Inc. (collectively“DTG”), Greene County Partners, Inc., Caprock Services Corp., and McLeodUSAIntegrated Business Systems, Inc. (“IBS”).

 

Also in 2001, McLeodUSAinitiated a financial restructuring to substantially reduce its outstandingdebt.  As part of the financialrestructuring, McLeodUSA and its senior secured lenders agreed to amendMcLeodUSA’s Credit Agreement to permit the financial restructuring.  The key elements of the financialrestructuring included, among other things (1) the sale

 

7

----

 

of McLeodUSA Media GroupInc. and its subsidiaries (“Pubco”) and the use of the proceeds therefrom tomake a payment to holders of all of itsoutstanding notes (including its 10 1/ 2 % Senior Discount Notes, 9 1/ 4 %Senior Notes, 8 3/ 8 % Senior Notes, 9 1/ 2 % Senior Notes, 8 1/ 8% SeniorNotes, 12% Senior Notes, 11 1 / 2 % Senior Notes and 11 3 / 8 % Senior Notes (collectively,the “Notes”)), and (2) the sale of McLeodUSA’s Illinois independentlocal exchange carrier (“ICTC”) upon completion of the restructuring and use ofthe first $225 million of net proceeds to prepay the term loans under theCredit Agreement.

 

For the three monthsended March 31, 2002, the operating results of the businesses listed below havebeen reported as discontinued operations in the McLeodUSA Unaudited CondensedConsolidated Financial Statements in accordance with SFAS 144.  At December 31, 2002, all of the businesseshave been sold.  The remaining assetsheld for sale totaling $10.8 million are comprised of real estate and an equityinterest in a partnership.  Theliabilities related to discontinued operations represent unpaid selling costs.

 

For the three monthsended March 31, 2002, the amount of revenue and net income (including gains orlosses on the sales) attributable to discontinued operations and the assetsheld for sale were as follows (in millions):

 
|             |   | **Predecessor McLeodUSA****Three months ended  March 31, 2002** |   |
|------------------|--------|-----------------------------------------------------------------|--------|
|             |   | **Revenues**                                                    |   | **Net income  (loss)** |   |
| IBS              |   | $                                                               | 1.2    |   | $ | (0.1 | ) |
| CapRock Services |   | 8.2                                                             |   | 0.7 |   |
| Pubco            |   | 76.3                                                            |   | 6.6 |   |
| DTG              |   | 10.4                                                            |   | — |   |
| Greene County    |   | 2.0                                                             |   | 0.2 |   |
| ICTC             |   | 26.8                                                            |   | 7.1 |   |
|             |   | $                                                               | 124.9  |   | $ | 14.5 |   |

 

**Note 3:   Emergence from Chapter 11 Proceedings**

 

*Confirmationof the Plan: *On April5, 2002, the Bankruptcy Court confirmed the Plan.  The general unsecured creditors of McLeodUSA, except for theholders of the Notes, were unaffected by the Chapter 11 proceedings and thePlan.  The Plan became effective onApril 16, 2002 and resulted in the following:

 

•                                          Theelimination of approximately $3 billion of indebtedness, including accruedinterest, represented by the Notes;

 

**•**                                          Inexchange for the cancellation of the Notes and the unpaid interest thereon, thebondholders received their pro rata share of (1) $670 million in cash, (2)10,000,000 shares of Series A Preferred Stock, which is convertible into 15% ofClass A Common Stock on a fully diluted basis as of the Effective Date of thePlan after giving effect to the Plan and conversion of the Class B Common Stockand Class C Common Stock (but prior to the exercise of the warrants) and (3)5-year warrants to purchase 22,159,091 shares of Reorganized McLeodUSA Class ACommon Stock for $30 million;

 

•                                          Thesale of Pubco to Yell Group Ltd. for $600 million;

 

•                                          Theinvestment by two funds affiliated with Forstmann Little & Co. of $175million in exchange for (1) 74,027,764 shares of Reorganized McLeodUSA Class ACommon Stock, (2) 5-year warrants to purchase 22,159,091 shares of ReorganizedMcLeodUSA Class A Common Stock for $30 million and (3) 10 shares of ReorganizedMcLeodUSA Series B Preferred Stock;

 

•                                          Theconversion of Predecessor McLeodUSA Series D Preferred Stock and PredecessorMcLeodUSA Series E Preferred Stock, held by Forstmann Little & Co., into78,203,135 shares of Reorganized McLeodUSA Class B Common Stock and 35,546,879shares of Reorganized McLeodUSA Class C Common Stock, respectively; and

 

8

----

 

•                                          Theconversion of the Predecessor McLeodUSA Series A Preferred Stock into33,696,559 shares of Reorganized McLeodUSA Class A Common Stock.

 

The Plan also provided for the distribution of a portion of ReorganizedMcLeodUSA common stock to holders of Predecessor McLeodUSA common stock.  These holders were entitled to share,together with holders of certain securities claims, in the distribution of54,775,663 shares of Reorganized McLeodUSA Class A Common Stock.  On May 2, 2002, the Bankruptcy Court enteredan order establishing a disputed claims reserve at 18,000,000 shares ofReorganized McLeodUSA Class A Common Stock pending resolution of the securitiesclaims against McLeodUSA associated with the putative securities class actionlawsuits.  McLeodUSA then commenced thedistribution of 36,775,663 shares of Reorganized McLeodUSA Class A Common Stockto record holders of Predecessor McLeodUSA common stock as of April 5, 2002,the distribution record date under the Plan. Upon the final determination of the amount, if any, of allowedsecurities claims under the Plan, such holders of Predecessor McLeodUSA commonstock may be entitled to additional distributions of Reorganized McLeodUSAClass A Common Stock from the 18,000,000 shares held in the disputed claimsreserve.

 

The condensed financial information for the predecessor parent company,McLeodUSA Incorporated, for the quarter ended March 31, 2002 is as follows (inmillions):

 

**CondensedStatement of OperationsThree months ended March 31, 2002(Unaudited)**

 
| Operating expenses:                                                                    |   |   |   |
|----------------------------------------------------------------------------------------|--------|--------|--------|
| Selling, general and administrative                                                    |   | $      | 5.8    |   |
| Depreciation and amortization                                                          |   | 4.6    |   |
| Reorganization charges, net                                                            |   | 57.2   |   |
| Total operating expenses                                                               |   | 67.6   |   |
|                                                                                   |   |   |   |
| Other operating expense:                                                               |   |   |   |
| Interest expense, net of amounts capitalized  (contractual interest was $80.5 million) |   | (31.3  | )      |
| Equity in net losses of subsidiaries                                                   |   | (102.0 | )      |
| Total other operating loss                                                             |   | (133.3 | )      |
| Loss from continuing operations                                                        |   | (200.9 | )      |
| Income from discontinued operations                                                    |   | 14.5   |   |
| Net loss                                                                               |   | (186.4 | )      |
| Preferred stock dividend (contractual dividends were  $8.0 million)                    |   | (4.8   | )      |
| Net loss applicable to common shares                                                   |   | $      | (191.2 | ) |

 

9

----

 

 

**Condensed Statement of Cash FlowsThree months ended March 31, 2002(Unaudited)**

 
| *Cash Flows from Operating Activities*                                     |   |   |   |
|----------------------------------------------------------------------------|--------|--------|--------|
| Net loss from continuing operations                                        |   | $      | (200.9 | ) |
| Adjustments to reconcile net income to cash used in  operating activities: |   |   |   |
| Depreciation and amortization                                              |   | 4.7    |   |
| Accretion of interest on senior discount notes                             |   | 4.1    |   |
| Noncash reorganization items                                               |   | 53.3   |   |
| Equity in net losses of subsidiaries                                       |   | 102.0  |   |
| Changes in assets and liabilities, net of  dispositions:                   |   |   |   |
| Prepaid and other assets                                                   |   | 5.8    |   |
| Accounts payable and accrued expenses                                      |   | 8.7    |   |
| Intercompany receivables                                                   |   | (96.9  | )      |
| **Net cash used in operating activities**                                  |   | (119.2 | )      |
|                                                                       |   |   |   |
| *Cash flows from Investing Activities*                                     |   |   |   |
| Proceeds from the sale of businesses and assets                            |   | 58.8   |   |
| **Net cash provided by investing activities**                              |   | 58.8   |   |
|                                                                       |   |   |   |
| **Net decrease in cash and cash equivalents from continuing  operations**  |   | (60.4  | )      |
| **Net cash provided by discontinued operations**                           |   | 37.7   |   |
| **Cash and cash equivalents:**                                             |   |   |   |
| Beginning                                                                  |   | 120.2  |   |
| Ending                                                                     |   | $      | 97.5   |   |

 

*Reorganizationcharges, net:* Reorganization charges, net, are comprised of items incurred byMcLeodUSA as a result of reorganization under Chapter 11 of the BankruptcyCode.  Charges for the quarter endedMarch 31, 2002 consisted of the following (in millions):

 
| Write-off of deferred financing fees and discounts |   | $   | 53.3   |   |
|----------------------------------------------------|--------|-----|--------|--------|
| Professional fees and related expenses             |   | 3.9 |   |
|                                               |   | $   | 57.2   |   |

 

**Note 4:  TradeReceivables**

 

The composition of tradereceivables, net, is as follows (in millions):

 

|                                          |   | **March 31,  2003** |   | **December  31,  2002** |   |
|-----------------------------------------------|--------|---------------------|--------|-------------------------|--------|
| Trade  Receivables:                           |   |                |   |                    |   |
| Billed                                        |   | $                   | 141.0  |                    | $      | 137.6 |   |
| Unbilled                                      |   | 6.1                 |   | 11.2                    |   |
|                                          |   | 147.1               |   | 148.8                   |   |
| Allowance for doubtful accounts and discounts |   | (55.0               | )      | (55.7                   | )      |
|                                          |   | $                   | 92.1   |                    | $      | 93.1 |   |

 

10

----

 

**Note 5:  Other Accrued Liabilities**

 

Other accrued liabilities consisted of the following (in millions):

 

|                            |   | **March 31,  2003** |   | **December  31,  2002** |   |
|---------------------------------|--------|---------------------|--------|-------------------------|--------|
| Restructuring                   |   | $                   | 50.3   |                    | $      | 61.2 |   |
| Accrued  Sales/Use/Excise Taxes |   | 16.8                |   | 18.3                    |   |
| Accrued  Property Taxes         |   | 13.6                |   | 15.8                    |   |
| Other                           |   | 50.9                |   | 57.5                    |   |
|                            |   | $                   | 131.6  |                    | $      | 152.8 |   |

 

**Note 6:  Restructuring Charges**

 

Changes in the carryingamount of the restructuring liability for the three months ended March 31, 2003is summarized as follows (in millions):

|                          |   | **Liability at  December 31,  2002** |   | **Cash Payments  Through  March 31,  2003** |   | **Remaining  Liability  March 31,  2003** |   |
|-------------------------------|--------|--------------------------------------|--------|---------------------------------------------|--------|-------------------------------------------|--------|
| Employee separations          |   | $                                    | 0.6    |                                        | $      | 0.4                                       |   | $ | 0.2 |   |
| Facility closure costs        |   | 58.8                                 |   | 10.2                                        |   | 48.6                                      |   |
| Other contractual commitments |   | 1.8                                  |   | 0.3                                         |   | 1.5                                       |   |
|                          |   | $                                    | 61.2   |                                        | $      | 10.9                                      |   | $ | 50.3 |   |

 

**Note 7:  Goodwill andOther Intangible Assets**

 

On January 1, 2002, McLeodUSA adopted SFAS 142, *Accounting for Goodwill and OtherIntangible Assets* (“SFAS 142”). SFAS 142 requires the use of a non-amortization approach to account forpurchased goodwill and for separately recognized (non-goodwill) intangibleassets that have an indefinite useful life.  Under this approach, goodwill and intangibles with indefinitelives are not amortized but are reviewed at least annually for impairment.  Intangible assets that do have finite liveswill continue to be amortized over their estimated useful lives.  As permitted by SFAS 142, McLeodUSAperformed the transitional impairment tests on goodwill by comparing the fairvalues of its reportable units containing goodwill balances to their carryingvalues in the second quarter of 2002.

 

Intangible assets withfinite lives at March 31, 2003 are summarized as follows (in millions):

 

|                             |   | **Gross** |   | **Accumulated  Amortization** |   | **Net** |   |
|----------------------------------|--------|-----------|--------|-------------------------------|--------|---------|--------|
|                             |   |      |   |                          |   |    |   |
| Deferred line installation costs |   | $         | 170.9  |                          | $      | 51.6    |   | $ | 119.3 |   |
| Customer base                    |   | 29.8      |   | 6.6                           |   | 23.2    |   |
|                             |   | $         | 200.7  |                          | $      | 58.2    |   | $ | 142.5 |   |

 

In connection with ouradoption of fresh-start reporting, independent appraisers valued the intangibleassets.  McLeodUSA’s customer base wasvalued at $24.0 million with a remaining life of five years.  Also included in the customer base is acustomer contract, valued at $5.8 million, and assigned a remaining life of 33months.  The trademarks McLeodUSA andPrimeLine were assigned a value collectively of $83.8 million.  The trademarks were determined to haveindefinite lives and are not being amortized.

 

11

----

 

**Note 8:  Accountingfor Asset Retirement Obligations**

 

In July 2001, the FASBissued SFAS 143, *Accounting for Asset Retirement Obligations* (“SFAS143”).  SFAS 143 requires entities torecord the fair value of a liability for an asset retirement obligation in theperiod in which the legal or contractual removal obligation is incurred.  McLeodUSA’s asset retirement obligationsrelate to three categories of assets; fiber, central office colocationequipment and technical sites.

 

•                                          Fiber:McLeodUSA utilizes nearly 18,000 route miles of fiber throughout its network,over 80% of which is buried in the ground. The remaining balance of fiber is located on poles.  In most cases, McLeodUSA may be obligated toremove its fiber if either the underlying right-of-way is terminated orMcLeodUSA chooses to decommission those assets.

 

•                                          CentralOffice Colocation Equipment:  McLeodUSAutilizes space within regional bell operating companies’ (“RBOCs”) centraloffices in which it has deployed a substantial number of assets.  Termination of business in those marketswould require removal of the equipment and restoration of the central office toits original state.

 

•                                          TechnicalSites:  McLeodUSA leases space innumerous technical sites throughout its market area in which it deployssignificant assets. Termination of the lease or business in those markets wouldrequire the removal of those assets and restoration of the leased space to itsoriginal state.

 

The present value of theasset retirement obligation was calculated using a discount rate of 6.1% over aperiod of 15 years, which is representative of the estimated life ofMcLeodUSA’s telecommunications network.

 

Changes in the carryingamount of the asset retirement obligation for the three months ended March 31,2003 is summarized as follows (in millions):

 

 
| Balance, December 31, 2002 |   | $   | 54.9   |   |
|----------------------------|--------|-----|--------|--------|
| Interest accretion         |   | 0.9 |   |
| Balance, March 31, 2003    |   | $   | 55.8   |   |

 

**Note 9:  Litigation**

 

OnDecember 7, 2000, McLeodUSA acquired CapRock Communications Corp. (‘‘CapRock’’)pursuant to an Agreement and Plan of Merger, dated October 2, 2000, in exchangefor approximately 15.0 million shares of Class A Common Stock.  Several class action complaints have beenfiled in the United States District Court for the Northern District of Texas onbehalf of all purchasers of CapRock common stock during the period April 28,2000 through July 6, 2000.  The lawsuitsprincipally allege that, prior to its merger with McLeodUSA, CapRock madematerial misstatements or omissions of fact in violation of Section 10(b) ofthe Securities Exchange Act. Consolidated with these claims are allegations that CapRock’s June 2000registration statement for a public offering of common stock containedmaterially false and misleading statements and omitted certain materialinformation about CapRock in violation of Section 11 of the SecuritiesAct.  The named defendants in theselawsuits include CapRock and certain of its officers and directors.  The plaintiffs in the lawsuits seek monetarydamages and other relief. On September 25, 2002, the Court denied Defendants’motion to dismiss.  While discovery hasbeen limited and a final evaluation cannot be made at this point, McLeodUSAbelieves these lawsuits are without merit and is vigorously defending againstthem.

 

FormerChairman Clark E. McLeod, President Stephen C. Gray (then also Chief ExecutiveOfficer), Chairman and Chief Executive Officer Chris A. Davis (then ChiefOperating and Financial Officer) and former Chief Financial and AccountingOfficer J. Lyle Patrick (the ‘‘Individual Defendants’’) are defendants in anumber of putative class action complaints that have been consolidated into asingle complaint entitled In Re McLeodUSA Incorporated Securities Litigation,Civil Action No. C02-0001 (E.D. Iowa) (the ‘‘Iowa Class Action’’).  The Individual Defendants have filed amotion to dismiss the amended consolidated complaint in the Iowa ClassAction.  McLeodUSA has indemnificationobligations running to the Individual Defendants.  One of the putative class plaintiffs, New Millenium Growth FundLLC, also filed proofs of claim against McLeodUSA in McLeodUSA’s Chapter 11Case for at least $104,650 on its own behalf and for no less than approximately$300 million (plus interest, costs and attorney’s fees as allowed) on behalf ofall class claimants in the Iowa Class Action (the ‘‘Bankruptcy Claims’’ and,together with the Iowa Class Action, the ‘‘Securities Claims’’).  As the Securities Claims are in earlystages, it is impossible to evaluate the likelihood of unfavorable outcomes or,with respect to

 

12

----

 

theIowa Class Action, to estimate the amount or range of potential loss, if any,to McLeodUSA. With respect to the Bankruptcy Claims, on May 2, 2002 theBankruptcy Court issued an order establishing a disputed claims reserve of18,000,000 shares of Reorganized McLeodUSA Class A Common Stock.  Any recovery from the Bankruptcy Claimswould be limited to those shares of stock. McLeodUSA believes that theSecurities Claims are without merit and intends to defend them vigorously.

 

OnJanuary 31, 2002, McLeodUSA Incorporated filed a voluntary petition in theUnited States Bankruptcy Court for the District of Delaware for relief underChapter 11 of the United States Bankruptcy Code, Case No. 02-10288 (DelawareBankruptcy). The Plan was confirmed by the Bankruptcy Court on April 5, 2002and became effective on April 16, 2002. Information relating to the bankruptcyproceedings was previously reported by McLeodUSA on its Current Report on Form8-K filed on February 14, 2002 and on its Current Report on Form 8-K filed onApril 22, 2002.

 

McLeodUSAis also involved in numerous regulatory proceedings before various publicutility commissions and the FCC, particularly in connection with actions by theRBOCs.  McLeodUSA anticipates the RBOCswill continue to pursue litigation, regulations and legislation in stateswithin McLeodUSA’s 25-state footprint and before the FCC to reduce regulatoryoversight and regulation over their rates and operations.  The RBOCs are also actively pursuing majorchanges in the Telecommunications Act of 1996, by regulatory litigation andlegislation, which McLeodUSA believes would adversely affect competitivetelecommunications service providers including McLeodUSA.  If adopted, these initiatives could make itmore difficult for McLeodUSA to challenge the RBOCs’ actions, or to competewith the RBOCs, in the future.  Thereare no assurances that McLeodUSA will prevail in its disputes with theRBOCs.  On May 9, 2003, legislation wasenacted in Illinois that changes the methodology to be applied by the IllinoisCommerce Commission in setting rates to be charged by incumbent local exchangecarriers for unbundled local loops. While challenges to this legislation are anticipated, McLeodUSA can makeno assurances as to the final outcome of this legislation.

 

McLeodUSAis not aware of any other material litigation against it.  McLeodUSA does, however, have various otherlegal proceedings pending against it or its subsidiaries or on its behalf orthat of its subsidiaries.

 

 

13

----

 

**Item 2.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

The following discussionand analysis provides information concerning the results of operations and ourfinancial condition and should be read in conjunction with the accompanyingunaudited condensed consolidated financial statements and notes thereto.  Additionally, the following discussion andanalysis should be read in conjunction with our audited consolidated financialstatements included in our Annual Report on Form 10-K/A for the year endedDecember 31, 2002.

 

Some of the statements inthis discussion include statements about our future expectations.  Statements that are not historical facts are“forward-looking statements” for the purpose of the safe harbor provided bySection 21E of the Exchange Act and Section 27A of the Securities Act.  Such statements include projections of financialand operational results and goals, revenue, profitability, savings andcash.  These forward-looking statementsare subject to known as well as unknown risks and uncertainties that may causeactual results to differ materially from our expectations.  Our expectations are based on variousfactors and assumptions and reflect only our predictions.  Factors that could cause actual results todiffer materially from the forward-looking statements include technological,regulatory, public policy or other developments in our industry, availabilityand adequacy of capital resources, current and future economic conditions, theexistence of strategic alliances, our ability to generate cash, our ability toimplement process and network improvements, our ability to attract and retaincustomers, our ability to migrate traffic to appropriate platforms, and changesin the competitive climate in which we operate.  These and other risks are described in more detail in our mostrecent Annual Report on Form 10-K and Form 10-K/A both filed with the SEC.  We undertake no obligation to updatepublicly any forward-looking statements, whether as a result of future events,new information or otherwise.

 

**Overview**

 

We provide integratedtelecommunication services, including local services, in 25 Midwest, Southwest,Northwest and Rocky Mountain states.  Weare a facilities-based telecommunications provider with, as of March 31, 2003,38 ATM switches, 46 voice switches, 567 collocations, 433 DSLAMS and 3,720employees.

 

Wederive our revenue from our core competitive telecommunications and relatedcommunications services.  These servicesinclude local and long-distance services; dial-up Internet access services;high-speed/broadband Internet access services such as services using DSL, cablemodems and dedicated T1 access; bandwidth and network facilities leasing, salesand services, including access services; facilities and services dedicated fora particular customer’s use; advanced communication services for largerbusinesses such as frame relay, private line, and ISDN; and value-addedservices such as virtual private networks and web hosting.

 

Our principal operatingexpenses consist of cost of service; selling, general and administrativeexpenses (“SG&A”); and depreciation and amortization.  Cost of service primarily includes local andlong distance services purchased from certain Regional Bell Operating Companies(“RBOCs”) and interexchange carriers and the cost of fiber related to sales andleases of network facilities.  SG&Aexpenses consist of sales and marketing, customer service and administrativeexpenses, including the costs associated with operating our communicationsnetwork.  Depreciation and amortizationincludes depreciation of our communications network and equipment; amortizationof other intangibles determined to have finite lives; and amortization over thelife of the customer contract of one-time direct installation costs associatedwith transferring customers’ local line service from the RBOCs to our localtelecommunications service.

 

Thecommunications services industry is highly competitive. Our local exchangebusiness competes with incumbent local telephone companies which currentlydominate their respective local telecommunications markets. Our largest localservice competitors, the RBOCs, have gained approval to offer long distanceservices in a majority of the states in our 25-state footprint and we expectthat eventually they will no longer be prohibited from providing long distanceservices in any state. Our long-distance services also compete with theservices of hundreds of other companies in the long-distance marketplace inmost states.  AT&T, WorldCom(including its MCI group) and Sprint currently dominate the long-distancemarket. The RBOCs have become important long-distance competitors in manystates and we expect them to become major competitors in each state as theygain approval to enter the long-distance markets in remaining states in whichthey presently lack such authority. Our local and long-distance services alsocompete with the services of other competitive local telephone companies inmany markets.

 

We have experiencedoperating losses since our inception as a result of efforts to build ourcustomer base, develop and construct our communications network infrastructure,develop our systems and expand into new markets.  We will continue to focus on increasing our customer base andmigrating our customer base onto our network, along with improving our

 

14

----

 

operating margins bygrooming our network to deliver service in the most effective and efficientmanner, as well as scaling back certain general and administrativefunctions.  We believe these actionswill better leverage our existing assets to produce more profitablerevenues.  While we have undertakencertain strategic initiatives to improve our business that are designed toresult in eventually generating positive cash flow, we may continue to generatenegative cash from operations as a result of capital expenditures and projectedinterest on our remaining outstanding debt. We may be forced to change our strategy to respond to a changingcompetitive regulatory environment and we cannot assure you that we will beable to maintain our operating margin.  Wecannot assure you that through our revised strategy we will be able to achieveor sustain profitability or positive cash flows.

 

As of April 17, 2002, weimplemented fresh-start reporting under the provisions of SOP 90-7.  Under SOP 90-7, the reorganization equityvalue of McLeodUSA was allocated to our assets and liabilities, our accumulateddeficit was eliminated, and our new equity was issued according to the Plan asif we were a new reporting entity.  As aconsequence of the reorganization occurring as of April 16, 2002, the financialresults for the three months ended March 31, 2002 have been separatelypresented under the label “Predecessor McLeodUSA” and “Reorganized McLeodUSA”for the three months ended March 31, 2003.

 

**SFAS 144 Re-Audit Requirement**

 

Inconnection with our reorganization, McLeodUSA completed the sale of certainbusinesses, including Pubco and ICTC. In our most recent Annual Report on Form10-K/A, based on the requirements of SFAS 144, McLeodUSA reflected thesebusinesses and other businesses that were sold as discontinued operations forthe periods January 1, 2002 to April 16, 2002 and April 17, 2002 to December31, 2002.  In accordance with accountingprinciples generally accepted in the United States of America (“GAAP”),McLeodUSA is required to present its financial statements for the years endedDecember 31, 2000 and 2001, reflecting these businesses as discontinuedoperations.  McLeodUSA’s formerauditors, Arthur Andersen LLP (“Arthur Andersen”), audited McLeodUSA’sfinancial statements and issued an audit opinion for the years ended December31, 2000 and 2001.  On April 24, 2002,McLeodUSA engaged Deloitte & Touche LLP (“Deloitte & Touche”) to serveas its independent accountants for fiscal year 2002.  In order for McLeodUSA to comply with GAAP requirements relatedto the financial presentation for discontinued operations in accordance withRegulation S-X, McLeodUSA would be required to obtain a new audit opinion withrespect to the years ending December 31, 2000 and 2001.  Since Arthur Andersen is no longer able toperform audits of publicly traded companies, Deloitte & Touche has informedMcLeodUSA, consistent with *Interpretations of SAS No. 58 (AU Section 508),*thatthey would be required to re-audit McLeodUSA’s financial statements for theyears ending December 31, 2000 and 2001 to provide McLeodUSA with an auditopinion on such financial statements.

 

Inlight of McLeodUSA’s reorganization, sale of businesses, and implementation offresh-start accounting on April 16,

2002,McLeodUSA has determined that the expense and effort associated with a re-auditis not in the best interest of

McLeodUSAor its stockholders.  As an alternativeto a re-audit McLeodUSA included in its most recent Annual Report on Form10-K/A unaudited consolidated financial statements, prepared in accordance withGAAP, reflecting the impact of the discontinued operations for the years endedDecember 31, 2001 and December 31, 2000.

 

Inorder for McLeodUSA to sell securities with a registration statement declaredeffective by the SEC, such registration

statementmust contain three years of audited financials.  Should McLeodUSA elect to conduct a re-audit of 2001, or 2000

and2001, in order to utilize such effective registration statements, McLeodUSAdoes not know if Deloitte & Touche would

haveany differences in opinion with the prior audit(s) conducted by ArthurAndersen.  At this time McLeodUSA isaware of no material differences of opinion.

 

**Critical Accounting Policies andEstimates**

 

Preparation of thefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses.Management believes the most complex and sensitive judgments, because of theirsignificance to the consolidated financial statements, result primarily fromthe need to make estimates about the effects of matters that are inherentlyuncertain. Management’s Discussion and Analysis and Note 1 to the ConsolidatedFinancial Statements in the McLeodUSA Annual Report on Form 10-K/A for the yearended December 31, 2002, describe the significant accounting estimates andpolicies used in preparation of the Condensed Consolidated FinancialStatements. Actual results in these areas could differ from management’sestimates. There have been no significant changes in our critical accountingestimates during the first quarter of 2003.

 

15

----

 

**Three Months Ended March 31, 2003 Compared with Three MonthsEnded March 31, 2002**

 

Revenue was $225.9million for the quarter ended March 31, 2003, a decrease of $38.2 million or15% from the quarter ended March 31, 2002. The decrease in revenue was primarily due to a reduction in customers,including our efforts to eliminate non-profitable customers, as well as loweraverage long distance revenue per customer. Long distance volume was down approximately 20% compared to the sameperiod last year reflecting the general economic slowdown.  In addition, we sold the assets of SplitrockServices, Inc. in 2002, which generated approximately $4.7 million of revenueduring the first quarter of 2002.  Ourcustomer churn rate has improved to 2.4% in the first quarter of 2003 comparedto 2.7% in the first quarter of 2002 as we continue to focus on improving thecustomer experience and strengthening customer loyalty.

 

Cost of service was$137.4 million for the quarter ended March 31, 2003, a decrease of $41.7million or 23% from the quarter ended March 31, 2002.  Approximately $26 million of this decrease is attributable to thereduction in revenues.  The balance ofthe decrease reflects the margin improvement initiatives that we began in 2002,including network cost reductions, migration of customers to the McLeodUSA networkand the elimination of non-profitable customers.  As a result of these cost savings initiatives, gross margin as apercent of revenue improved to 39% for the first quarter of 2003 from 32% forthe same period a year ago.  As of March31, 2003, 56% of our customer lines were serviced over our own network comparedto 39% as of March 31, 2002. Utilization of our own network infrastructure allows us to better manage our customer base and provides for improvedprofitability.

 

SG&A expenses were$81.7 million for the quarter ended March 31, 2003, a decrease of $9.7 millionor 11% from the quarter ended March 31, 2002. The decline in SG&A expensesis primarily attributable to a reduction in headcount resulting from ourconsolidation of facilities from eleven at September 30, 2001 to three by June30, 2002.  The cost savings experiencedas a result of the reduced workforce and improved business processes waspartially offset by increased spending on selling and marketing to support ourstrategic goal to grow the business and gain profitable market share.  In thefirst quarter of 2003, we launched a marketing campaign for our new PreferredAdvantageSM product offerings which we introduced in the fourthquarter of 2002.

 

Depreciation andamortization expenses were $82.2 million for the quarter ended March 31, 2003,a decrease of $26.7 million from the quarter ended March 31, 2002.  This decrease was primarily due to areduction in our depreciable asset base as a result of fresh-start fair marketvalue adjustments of approximately $1.2 billion upon our emergence frombankruptcy in April 2002.

 

Inaccordance with SOP 90-7, expenses resulting from the reorganization of thebusiness in a bankruptcy proceeding are reported separately as reorganizationcharges. Reorganization charges, net of $57.2 million during the three monthsended March 31, 2002, were comprised of professional fees of $3.9 million andthe write-off of deferred financing fees and discounts on the Notes of $53.3million.

 

Gross interest expensewas $11.8 million for the quarter ended March 31, 2003, a decrease of $26.8million from the quarter ended March 31, 2002. The significant reduction was principally caused by the cancellation ofour Notes on the effective date of our Plan of Reorganization.  The remaining decrease is due to a reductionin the amounts outstanding under the Credit Agreement.  Interest expense of approximately $3.1million and $7.2 million was capitalized as part of our construction of ourfiber optic network during the first quarter of 2003 and 2002, respectively.

 

In accordance with SFAS144, the operating results of businesses held for sale, and the gain or lossresulting from the sale thereof, have been reported as discontinued operationsin the unaudited condensed consolidated statements of operations of McLeodUSA.  All businesses held for sale were soldduring 2002, and, as such, there is no income or loss from discontinuedoperations included in the 2003 results.

 

**Liquidity and Capital Resources**

 

We had $115.5 million of cash and cash equivalents at March 31,2003.  During the first quarter of 2003cash used in operating activities was $30.0 million and was primarily relatedto decreases in current liability accounts, as a result of payments for payrollrelated expenses, restructuring liabilities and selling costs associated withdiscontinued operations.

 

Our capital expenditureswere $13.8 million during the quarter ended March 31, 2003, a decrease of $18.1million from the same period in 2002. Within our core footprint, our network infrastructure is largely in placeand our capital expenditures

 

16

----

 

are mainly focused onmigrations of customers from resale platforms onto our own network, augments toexisting facilities, and improvements to business systems and processes.  Based upon our business plan, capitalrequirements and growth projections, we expect to spend up to $350 million incapital expenditures over the next two years. Our first quarter 2003 capital expenditures were consistent with thetiming of the sales growth ramp that we are currently experiencing.  We intend to continue to manage our capitalexpenditures consistent with business conditions to support our on-switch,facilities-based strategy and augment for profitable revenue growth asnecessary.

 

In2001, we began to explore restructuring our capital structure.  Any restructuring involving a payment toholders of our Notes, other than regularly scheduled payments of principal andinterest required a majority consent under McLeodUSA’s Credit Agreement datedMay 31, 2000 (the “Credit Agreement”). In order to effect such a restructuring, we entered into the ThirdAmendment to the Credit Agreement dated November 29, 2001 (the “ThirdAmendment”).  The Third Amendmentcontained certain modifications that became effective upon the consummation ofour amended plan of reorganization, including, among other things, themodification of various financial covenants and the addition of a capitalexpenditure limitation, a 1% increase in the applicable rates of interest onthe borrowings under the Credit Agreement and the establishment of certainprepayment premiums applicable to the Credit Agreement term loan repaymentsmade in the first three years following the restructuring.

 

Inaccordance with the Plan, the holders of our Notes received their pro ratashare of (1) $670 million in cash, (2) 10,000,000 shares of Series A PreferredStock and (3) 5-year warrants to purchase 22,159,091 shares of our Class ACommon Stock for $30 million.  Also uponthe effective date of the Plan, approximately $3.0 billion of debt and relatedaccrued interest were cancelled.  Thecancellation of the Notes substantially de-leveraged our balance sheet andeliminated quarterly interest expense of approximately $74 million.  The Third Amendment required payments on ourTranche A and Tranche B term loans (the ‘‘Term Loans’’) of $60 million uponconsummation of the Plan, and $225 million from the proceeds from the sale ofICTC completed on December 31, 2002.  Asof March 31, 2003, there remained $715 million outstanding under the CreditAgreement with principal repayments of $16.6 million due within the next twelvemonths.

 

Asprovided for in the Third Amendment to the Credit Agreement, we entered into anExit Financing Facility with a consortium of banks upon consummation of thePlan on April 16, 2002 (the “Exit Facility”). The Exit Facility consistsinitially of a revolving credit facility of $110 million. In addition, we havethe right to obtain additional commitments to increase the size of the ExitFacility up to $160 million. The Exit Facility matures on May 31, 2007, withany outstanding amounts due on that date; no principal payments are due untilthis maturity date. The Exit Facility is secured by first priority liens on theassets of McLeodUSA and its domestic subsidiaries and ranks superior to theCredit Agreement.  As of March 31, 2003no amounts had been drawn on the Exit Facility. However, we have standbyletters of credit outstanding of $7.5 million that reduce our borrowingavailability under the Exit Facility.

 

Weare required to pay a commitment fee on the average daily unused balance of theExit Facility at a rate ranging from 1 /2 % to 1%. Funds borrowed under theExit Facility bear interest at a rate per annum equal to either (a) the greaterof (1) the prime rate and (2) the federal funds effective rate plus 1 /2 %, ineach case plus a margin ranging from 1.00% to 2.50%; or (b) LIBOR plus a marginranging from 2.00% to 3.50%.

 

TheExit Facility and the Credit Agreement include restrictions as to, among otherthings, additional indebtedness, liens, sale and lease-back transactions,investments, asset sales, certain payments by restricted subsidiaries, anddesignation of unrestricted subsidiaries. Both restrict our ability to make capital expenditures in excess of $300million annually in each of the years ending 2003 through 2005 and $350 millionannually in each of the years 2006 and 2007. The Exit Facility and the Credit Agreement also limit our leverage ratioand require minimum levels of access lines in service, interest coverage andconsolidated revenue.  Our ability toborrow under the Exit Facility is subject to compliance with all of thecovenants contained in the agreement. As of March 31, 2003, we were in compliance with all financial andoperating covenants under the Exit Facility and Credit Agreement.  On March 14, 2003, we obtained a waiver froma majority of the participants in the Credit Agreement and Exit Facility of theprovisions in the Credit Agreement and Exit Facility that required McLeodUSA tosubmit audited comparative financial statements as of and for the year endedDecember 31, 2002.

 

We expect to have fundsavailable to meet our operating and capital requirements from various sources,including existing cash balances, the Exit Facility, and cash flow from futureoperations.  We may meet any additionalfinancial needs by borrowing funds under the Exit Facility or by issuingadditional debt or equity securities. We cannot assure you that additional financing will be available oravailable on terms that are acceptable to us. Our ability to issue debt securities, borrow funds from additionallenders and participate in vendor financing programs is restricted by the termsof the Third Amendment and Exit Facility.

 

17

----

 

Failure to generate orraise sufficient funds may require us to delay or abandon some of our plans orexpenditures, which could have a material adverse effect on our business,results of operations or financial condition. Our estimate of future capitalrequirements is a forward-looking statement within the meaning of the safeharbor provisions of the Private Securities Litigation Reform Act of 1995.  The actual amount and timing of our futurecapital requirements may differ substantially from our estimate due to factorssuch as:

 

•                  changesin demand for our services;

•                  regulatory,technological or competitive developments;

•                  generaleconomic conditions;

•                  networkdevelopment and maintenance schedules and the associated costs;

•                  achange in our plans or projections; and

•                  newopportunities.

 

We also requiresubstantial funds for general corporate and other expenses and may requireadditional funds for working capital fluctuations.

 

**Inflation**

 

We do not believe thatinflation has had a significant impact on our consolidated operations.

 

**Item 3.  Quantitative and Qualitative Disclosures About Market Risk**

 

Upon the consummation ofour restructuring on April 16, 2002, substantially all of our fixed rate debtwas eliminated. We have variable rate debt of $715 million under the CreditAgreement outstanding at March 31, 2003. If market interest rates average 1% more in subsequent quarters than therates during the quarter ended March 31, 2003, quarterly interest expense wouldincrease by $1.8 million.  This amountwas determined by calculating the effect of the hypothetical interest rateincrease on our variable rate debt for the quarter and does not assume changesin our financial structure.

 

**Item 4.    Controls and Procedures**

 

(a) *Evaluation of Disclosure Controls and Procedures*.  The Company’s Chief Executive Officer andChief Financial Officer have evaluated the effectiveness of the Company’sdisclosure controls and procedures (as such term is defined in Rules 13a-14(c)and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of theEvaluation Date, the Company’s disclosure controls and procedures are effectivein alerting them on a timely basis to material information relating to theCompany (including its consolidated subsidiaries) required to be included inthe Company’s periodic filings under the Exchange Act.

 

(b)  *Changes in Internal Controls*.  Since the Evaluation Date, there have notbeen any significant changes in the Company’s internal controls or in otherfactors that could significantly affect such controls.

 

18

----

 

**PARTII**

**OTHER INFORMATION**

**Item1. Legal Proceedings**

 

OnDecember 7, 2000, McLeodUSA acquired CapRock Communications Corp. (‘‘CapRock’’)pursuant to an Agreement and Plan of Merger, dated October 2, 2000, in exchangefor approximately 15.0 million shares of Class A Common Stock.  Several class action complaints have beenfiled in the United States District Court for the Northern District of Texas onbehalf of all purchasers of CapRock common stock during the period April 28,2000 through July 6, 2000.  The lawsuitsprincipally allege that, prior to its merger with McLeodUSA, CapRock madematerial misstatements or omissions of fact in violation of Section 10(b) ofthe Securities Exchange Act. Consolidated with these claims are allegations that CapRock’s June 2000registration statement for a public offering of common stock containedmaterially false and misleading statements and omitted certain materialinformation about CapRock in violation of Section 11 of the SecuritiesAct.  The named defendants in theselawsuits include CapRock and certain of its officers and directors.  The plaintiffs in the lawsuits seek monetarydamages and other relief. On September 25, 2002, the Court denied Defendants’motion to dismiss.  While discovery hasbeen limited and a final evaluation cannot be made at this point, McLeodUSAbelieves these lawsuits are without merit and is vigorously defending againstthem.

 

FormerChairman Clark E. McLeod, President Stephen C. Gray (then also Chief ExecutiveOfficer), Chairman and Chief Executive Officer Chris A. Davis (then ChiefOperating and Financial Officer) and former Chief Financial and AccountingOfficer J. Lyle Patrick (the ‘‘Individual Defendants’’) are defendants in anumber of putative class action complaints that have been consolidated into asingle complaint entitled In Re McLeodUSA Incorporated Securities Litigation,Civil Action No. C02-0001 (E.D. Iowa) (the ‘‘Iowa Class Action’’).  The Individual Defendants have filed amotion to dismiss the amended consolidated complaint in the Iowa ClassAction.  McLeodUSA has indemnificationobligations running to the Individual Defendants.  One of the putative class plaintiffs, New Millenium Growth FundLLC, also filed proofs of claim against McLeodUSA in McLeodUSA’s Chapter 11Case for at least $104,650 on its own behalf and for no less than approximately$300 million (plus interest, costs and attorney’s fees as allowed) on behalf ofall class claimants in the Iowa Class Action (the ‘‘Bankruptcy Claims’’ and,together with the Iowa Class Action, the ‘‘Securities Claims’’).  As the Securities Claims are in earlystages, it is impossible to evaluate the likelihood of unfavorable outcomes or,with respect to the Iowa Class Action, to estimate the amount or range ofpotential loss, if any, to McLeodUSA. With respect to the Bankruptcy Claims, onMay 2, 2002 the Bankruptcy Court issued an order establishing a disputed claimsreserve of 18,000,000 shares of Reorganized McLeodUSA Class A Common Stock.  Any recovery from the Bankruptcy Claims wouldbe limited to those shares of stock. McLeodUSA believes that the SecuritiesClaims are without merit and intends to defend them vigorously.

 

OnJanuary 31, 2002, McLeodUSA Incorporated filed a voluntary petition in theUnited States Bankruptcy Court for the District of Delaware for relief underChapter 11 of the United States Bankruptcy Code, Case No. 02-10288 (DelawareBankruptcy). The Plan was confirmed by the Bankruptcy Court on April 5, 2002and became effective on April 16, 2002. Information relating to the bankruptcyproceedings was previously reported by McLeodUSA on its Current Report on Form8-K filed on February 14, 2002 and on its Current Report on Form 8-K filed onApril 22, 2002.

 

McLeodUSAis also involved in numerous regulatory proceedings before various publicutility commissions and the FCC, particularly in connection with actions by theRBOCs.  McLeodUSA anticipates the RBOCswill continue to pursue litigation, regulations and legislation in stateswithin McLeodUSA’s 25-state footprint and before the FCC to reduce regulatoryoversight and regulation over their rates and operations.  The RBOCs are also actively pursuing majorchanges in the Telecommunications Act of 1996, by regulatory litigation andlegislation, which McLeodUSA believes would adversely affect competitivetelecommunications service providers including McLeodUSA.  If adopted, these initiatives could make itmore difficult for McLeodUSA to challenge the RBOCs’ actions, or to compete withthe RBOCs, in the future.  There are noassurances that McLeodUSA will prevail in its disputes with the RBOCs.  On May 9, 2003, legislation was enacted inIllinois that changes the methodology to be applied by the Illinois CommerceCommission in setting rates to be charged by incumbent local exchange carriersfor unbundled local loops.  Whilechallenges to this legislation are anticipated, McLeodUSA can make noassurances as to the final outcome of this legislation.

 

McLeodUSAis not aware of any other material litigation against it.  McLeodUSA does, however, have various otherlegal proceedings pending against it or its subsidiaries or on its behalf orthat of its subsidiaries.

 

 

19

----

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)           Exhibits

 
| **Exhibit  Number** |   | **Exhibit  Description**                                                                                                         |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                             |
| 99.1                |   | Certification of CEO  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 99.2                |   | Certification of CFO  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

(b)           Reports on Form 8-K

 

OnJanuary 8, 2003, we filed a Current Report on Form 8-K announcing thecompletion of the sale of Illinois Consolidated Telephone Company and certainrelated telecommunications businesses to Consolidated Communications, Inc., asubsidiary of Consolidated Communications Holdings, Inc. (f/k/a HomebaseAcquisition Corp.).

 

20

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                     | **McLEODUSA INCORPORATED** |
|--------------------------|----------------------------|
|                     | (registrant)               |
|                     |                       |
|                     |                       |   |
| Date:  May 15, 2003 | By:                        | /s/ Chris A.  Davis |   |
|                     |                       | Chris A. Davis |   |
|                     |                       | *Chairman and Chief Executive  Officer* |   |
|                     |                       |   |
|                     |                       |   |
| Date:  May 15, 2003 | By:                        | /s/ G. Kenneth  Burckhardt |   |
|                     |                       | G. Kenneth  Burckhardt |   |
|                     |                       | *Chief Financial Officer* |   |

 

21

----

 

**Certifications**

 

I, Chris A. Davis,certify that:

 

1.   Ihave reviewed this quarterly report on Form 10-Q of McLeodUSA Incorporated;

 

2.   Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.   Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.   Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.   Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.   Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

7.   The certifications set forth herein are beingmade within the context of, and subject to, the facts and circumstances setforth below in this item 7.

 

In connection with its reorganization, McLeodUSAcompleted the sale of certain businesses, including Pubco and ICTC.  In the most recent McLeodUSA Annual Reporton Form 10-K/A, based on the requirements of SFAS 144, McLeodUSA reflectedthese businesses and other businesses that were sold as discontinued operationsfor the periods January 1, 2002 to April 16, 2002 and April 17, 2002 toDecember 31, 2002.  In accordance withaccounting principles generally accepted in the United States of America(“GAAP”), McLeodUSA is required to present its financial statements for theyears ended December 31, 2000 and 2001, reflecting these businesses asdiscontinued operations.  McLeodUSA’sformer auditors, Arthur Andersen LLP (“Arthur Andersen”), audited McLeodUSA’sfinancial statements and issued an audit opinion for the years ended December31, 2000 and 2001.  On April 24, 2002,McLeodUSA engaged Deloitte & Touche LLP (“Deloitte & Touche”) to serveas its independent accountants for fiscal year 2002.  In order for McLeodUSA to comply with GAAP requirements relatedto the financial presentation for discontinued operations in accordance withRegulation S-X, McLeodUSA would be required to obtain a new audit opinion withrespect to the years ending December 31, 2000 and 2001.  Since Arthur Andersen is no longer able toperform audits of publicly traded companies, Deloitte & Touche has

 

22

----

 

informedMcLeodUSA, consistent with Interpretations of SAS No. 58 (AU Section 508), thatDeloitte & Touche would be required to re-audit McLeodUSA’s financialstatements for the years ending December 31, 2000 and 2001 to provide McLeodUSAwith an audit opinion on such financial statements.

 

In light of McLeodUSA’s reorganization, sale ofbusinesses, and implementation of fresh-start accounting on April 16, 2002,McLeodUSA has determined that the expense and effort associated with a re-auditis not in the best interest of McLeodUSA or its stockholders.  As an alternative to a re-audit McLeodUSAincluded in its most recent Annual Report on Form 10-K/A, unauditedconsolidated financial statements, prepared in accordance with GAAP, reflectingthe impact of the discontinued operations for the years ended December 31, 2001and December 31, 2000.

 

In order for the Company to sell securities with aregistration statement declared effective by the SEC, such registrationstatement must contain three years of audited financials.  Should the Company elect to conduct are-audit of 2001, or 2000 and 2001, in order to utilize such effectiveregistration statements, the Company does not know if Deloitte & Touchewould have any differences in opinion with the prior audit(s) conducted byArthur Andersen.  At this time theCompany is aware of no material differences of opinion.

 

 
|   | Date:  May  15, 2003               |   | /s/ Chris A.  Davis |   |
|--------|-----------------------------------------|--------|---------------------|--------|
|   | Chris A. Davis                          |   |
|   | *Chairman and Chief Executive  Officer* |   |
|   |                                    |
|        |                                         |        |                     |        |  |  |

 

23

----

 

I, G. Kenneth Burckhardt,certify that:

 

1.   Ihave reviewed this quarterly report on Form 10-Q of McLeodUSA Incorporated;

 

2.   Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.   Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.   Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.   Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.   Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

7.   The certifications set forth herein are being made within the context of,and subject to, the facts and circumstances set forth below in this item 7.

 

In connection with its reorganization, McLeodUSAcompleted the sale of certain businesses, including Pubco and ICTC.  In the most recent McLeodUSA Annual Reporton Form 10-K/A, based on the requirements of SFAS 144, McLeodUSA reflected thesebusinesses and other businesses that were sold as discontinued operations forthe periods January 1, 2002 to April 16, 2002 and April 17, 2002 to December31, 2002.  In accordance with accountingprinciples generally accepted in the United States of America (“GAAP”),McLeodUSA is required to present its financial statements for the years endedDecember 31, 2000 and 2001, reflecting these businesses as discontinuedoperations.  McLeodUSA’s formerauditors, Arthur Andersen LLP (“Arthur Andersen”), audited McLeodUSA’sfinancial statements and issued an audit opinion for the years ended December31, 2000 and 2001.  On April 24, 2002,McLeodUSA engaged Deloitte & Touche LLP (“Deloitte & Touche”) to serveas its independent accountants for fiscal year 2002.  In order for McLeodUSA to comply with GAAP requirements relatedto the financial presentation for discontinued operations in accordance withRegulation S-X, McLeodUSA would be required to obtain a new audit opinion withrespect to the years ending December 31, 2000 and 2001.  Since Arthur Andersen is no longer able toperform audits of publicly traded companies, Deloitte & Touche has informedMcLeodUSA, consistent with Interpretations of SAS No. 58 (AU Section 508), thatDeloitte & Touche

 

24

----

 

wouldbe required to re-audit McLeodUSA’s financial statements for the years endingDecember 31, 2000 and 2001 to provide McLeodUSA with an audit opinion on suchfinancial statements.

 

In light of McLeodUSA’s reorganization, sale ofbusinesses, and implementation of fresh-start accounting on April 16, 2002,McLeodUSA has determined that the expense and effort associated with a re-auditis not in the best interest of McLeodUSA or its stockholders.  As an alternative to a re-audit McLeodUSAincluded in its most recent Annual Report on Form 10-K/A, unauditedconsolidated financial statements, prepared in accordance with GAAP, reflectingthe impact of the discontinued operations for the years ended December 31, 2001and December 31, 2000.

 

In order for the Company to sell securities with aregistration statement declared effective by the SEC, such registrationstatement must contain three years of audited financials.  Should the Company elect to conduct are-audit of 2001, or 2000 and 2001, in order to utilize such effectiveregistration statements, the Company does not know if Deloitte & Touchewould have any differences in opinion with the prior audit(s) conducted byArthur Andersen.  At this time theCompany is aware of no material differences of opinion.

 

 
|   | Date:  May  15, 2003 |   | /s/ G. Kenneth  Burckhardt |   |
|--------|---------------------------|--------|----------------------------|--------|
|   | G. Kenneth  Burckhardt    |   |
|   | *Chief Financial Officer* |   |
|   |                      |

 

25

----

 

**INDEX TO EXHIBITS**

 
| **Exhibit  Number** |   | **Exhibit  Description**                                                                                                         |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                             |
| 99.1                |   | Certification of CEO  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 99.2                |   | Certification of CFO  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

26

----