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Covad's annual report outlines huge losses

The company finally releases its financial results for the fourth quarter and fiscal year, posting a startling loss of $1.44 billion for the year.

Covad Communications finally released its financial results for the fourth quarter and fiscal year Thursday, posting a startling loss of $1.44 billion for the year and warning that unless it gets additional funding it will likely go the way of other bankrupt DSL providers.

In the fourth quarter, it lost $259.7 million, or $1.55 a share, on sales of $55.2 million. For the fiscal year, it dropped $1.44 billion on sales of $158.7 million.

First Call consensus pegged the Santa Clara, Calif., company for a loss of $1.62 a share in the quarter.

Covad shares closed up 22 cents to $1.26 ahead of the earnings report and belated filing of its annual report, before falling to $1.11 a share in after-hours trading.

Covad burned through more than $200 million in cash, down from $350 million last quarter, leaving it with only $869 million in cash and short-term investments at year's end.

Auditors who helped prepare the financial results and annual report now rate Covad a "going concern," accounting parlance that essentially means the company does not have enough cash to sustain operations for the next year.

"Despite all the problems in this industry, Covad is still the largest independent DSL provider," said Don Sinsabaugh, an analyst at Punk, Ziegel & Co. "There's a market there. I also expect they'll be able to find some investors in the near future."

Covad is at least making an impact on the market, if not on its balance sheet. According to Amy Harris, an analyst at IDC, Covad had 319,000 lines installed at the end of this year's first quarter, beating out Baby Bells Qwest (306,000) and BellSouth (303,000), but lagging behind SBC Communications (954,000) and Verizon (720,000).

In its annual report, originally due March 31 according to Securities and Exchange Commission regulations, Covad executives detailed the restatement of sales and earnings for the first three quarters of the fiscal year--one of many issues the company blamed for the delayed report.

The company now says it posted a net loss of $535.6 million, or $3.51 a share, on sales of $128.3 million in the first three quarters of 2000, down from its original report of a loss of $433.5 million, or $2.84 a share, on sales of $156.3 million.

These restated figures were a result of a new accounting standard that effects how companies recognize nonrecurring revenue from the installation of equipment.

Covad executives originally told shareholders its review could reduce 2000 revenue by about $52 million and increase losses before interest, depreciation, taxes and amortization (EBIDTA) by about $17 million.

"We simply had to take the time to review all the items that impacted our business last year," Chief Executive Chuck McMinn said in a statement. "The root cause of our delay in filing our Form 10-K was that certain internal controls were unable to fully support this unexpected combination of events."

The delayed filing prompted the Nasdaq Stock Market to initiate delisting proceedings and add an "E" to Covad's ticker symbol--Wall Street's equivalent of the scarlet letter, warning investors that the company has not complied with SEC filing requirements.

For Covad critics, the annual report's list of risks that could affect its future performance provided plenty of ammunition to justify Wall Street's disinterest in the stock:

• It will continue to post losses and negative cash flow at least into fiscal 2003, adding to its current debt of roughly $1.7 billion.

• In the third and fourth quarters, Covad was unable to collect $21.8 million and $18.2 million, respectively, in sales from delinquent customers.

• In some cases, it will continue to provide services to these past-due accounts but expects about 50 percent of these lines will be disconnected in the next couple quarters.

•  Its viability is also contingent on "our ability to manage our relations with our bondholders" as well as the effects of securities and regulatory litigation and other pending shareholder lawsuits.

Convertible bondholders told Covad in an April 30 letter that it's responsible for managing assets to increase their value to creditors, adding that the money-losing company has $1.3 billion in debt rated below investment grade. Some of Covad's convertible bonds were valued at just 10 cents on the dollar in late April.

• Last but not least, its ability to raise additional capital.

"In this very difficult environment, it will take an act of God to keep these guys in business," said Doug Shapiro, an analyst at Banc of America Securities. "Frankly, I'm not paying that much attention to this story anymore because there's no interest in it from an institutional standpoint."

Sinsabaugh, the lone analyst to maintain a "buy-aggressive" recommendation on the stock, said Covad could receive additional funding from a combination of lending institutions and corporate partners.

"Sony wants turn their PlayStation 2 into a broadband product where people will be able to play against each other through the Internet," he said. "That requires a high-speed connection. I could see Sony putting some money into Covad for that project."

For now, analysts expect Covad to post a loss of $4.91 a share in fiscal 2001 and $3.60 a share in fiscal 2002.

"We believe they have enough cash to survive for another six months," Sinsabaugh said. "That's not a lot of time but I think the spigot will be much wider in three months than it is now. If they don't get the cash, they won't survive."

News.com's Sam Ames contributed to this report.

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