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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1997 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
________________________ to _______________________
Commission file number 333-38875
MGC COMMUNICATIONS, INC.
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(Exact name of registrant as specified in its charter)
NEVADA 88-0360042
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3301 N. Buffalo Drive, Las Vegas, NV 89129
(Address of principal executive offices) (Zip Code)
(702) 310-1000
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Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
None None
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Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes____ No X
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As of March 20, 1998, the aggregate market value of voting stock held
by non-affiliates of the Registrant, based on the sale price of preferred stock
in January 1998, was approximately $32,000,000. As of March 20, 1998, the
Registrant had 15,309,400 shares of Common Stock outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X ]
Exhibit Index is located on page 57 .
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THE COMPANY
The Company is a rapidly growing integrated communications services
provider offering switched local and long distance voice and data services. The
Company targets small business and residential users, the largest segment of the
national communications market, based on access lines in service. The Company
began operations in December 1996 in Las Vegas, Nevada as a switched local
exchange service provider, and has subsequently expanded service to selected
suburban areas of Los Angeles, California and Atlanta, Georgia. As of February
28, 1998, the Company had 22,724 end user access lines sold, of which 18,345
lines were in service. MGC plans to enter seven new markets by the end of 1998
in California, Illinois and Florida and expects to be collocated in over 200
central offices of five incumbent local exchange carriers by that date. This
expansion will allow MGC to access over 11 million customer lines.
MGC's network strategy consists of purchasing and deploying switching
equipment, collocating interconnection equipment in ILECs' COs and leasing fiber
optic transmission capacity from ILECs and other providers of telecommunications
transport services. The Company believes its switch based network architecture
represents a demand-driven approach requiring less capital deployment than
required for the buildout of a fiber optic infrastructure. Further, upon
receiving state certification as a competitive local exchange carrier in a
particular market, the Company can begin to offer services in that market in as
little as six months. Management believes the Company's network architecture and
equipment installation plan will enable it to (i) rapidly penetrate and expand
its addressable market, (ii) achieve cost effective network operations and
economies of scale in sales and marketing, (iii) secure a physical presence for
collocation in ILEC central offices before space becomes more difficult to
obtain and (iv) maximize economic returns when compared to total service resale
and other network construction alternatives.
The Company's network platform can also be used to support high speed data
services. During 1998, the Company plans to introduce a portfolio of high speed
data services for remote LAN and Internet access utilizing new digital
subscriber line modems. The Company has recently deployed an ATM backbone
connecting its service territories and has installed Nortel's Internet Thruway
hardware product which eliminates the need for an Internet service provider to
install traditional terminating modem hardware. Moreover, because of the
transport capabilities of the Company's ATM backbone, an ISP who purchases the
Company's ITW hardware product will also be able to offer its services in remote
cities where the Company is located without the traditional upfront investment
in modem hardware in each remote location.
The Company believes that superior customer service is critical to
capturing and retaining customers within its markets. The Company continually
enhances its service approach, which utilizes a highly trained team of customer
sales and service representatives to coordinate customer installation, billing
and service. Because a comprehensive and robust operations support system is a
critical component of MGC's service goal, the Company has installed a fully
automated and proprietary operations support and management information system
which it believes will provide significant competitive advantage. The Company's
operations support system is designed to provide integrated functionality for
all aspects of its business, including order provisioning, monitoring, customer
care, billing and collection, general ledger, payroll, fixed asset management,
purchasing and personnel management.
BUSINESS STRATEGY
MGC's objective is to become the primary provider of telecommunications
services to its existing and target customers. Key elements of the Company's
strategy include:
Target Small Business and Residential Users. The Company believes the
small business and residential customer base is the largest segment of the
telecommunications market in the United States, based on access lines in
service. The Company is targeting suburban areas of Tier I Markets because these
areas have concentrated numbers of small businesses (3-50 lines), ISPs, pay
phone operators, multiple dwelling unit customers and single family residences.
The Company believes its only significant switch-based competition for these
customers in these markets is the ILEC.
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Implement Rapid Service Rollout. The Company's strategy is to address the
greatest percentage of its target market as quickly as possible. To accomplish
this, the Company has accelerated its ILEC CO collocation program and is rapidly
deploying its combined local and long distance switches, unbundled transport and
local loops and data services infrastructure in each of its markets.
Deploy a Capital Efficient Network. MGC is one of the first ICPs to
utilize a network strategy of purchasing and deploying switches, collocating in
the COs of the ILEC and leasing the necessary transport. The Company employs
three basic types of transport: (i) unbundled loops which connect a customer to
the Company's collocated facilities in an ILEC CO, (ii) local transport which
connects the Company's collocation equipment to its switching centers that house
its Nortel DMS 500 circuit-based local and long distance switches and data
switching equipment, and (iii) long distance transport from its switching
centers which connects its customers' long distance calls to national and
international destinations. Management believes this network strategy provides
for a demand-driven capital deployment plan that will provide an attractive
return on invested capital. Recently, the Company implemented packetized voice
over a dedicated leased ATM backbone as an alternative long distance network
transport solution.
Control Customer Elements of the Networks. The Company obtains control of
its customers through the acquisition of local loop connections. Upon leasing a
line from the ILEC, the Company effectively places the customer on its network.
This connection serves as the platform for delivering the Company's current and
future communication services to the customer. Any changes to the customer's
service profile, including service enhancements, are under the direct control of
the Company, with the exception of repairs which are infrequent and may require
the participation of the ILEC's network maintenance staff.
Ensure Timely and Accurate Provisioning Process. The Company believes one
of the keys to its success is managing the provisioning process so that new
customers are transferred from the ILEC's network to the Company's network
correctly and in a timely fashion. The Company has committed significant time
and resources to devising more efficient provisioning processes in each of its
markets. It closely monitors ILEC installation performance to assure
provisioning is in accordance with the standards set forth in the Company's
interconnection agreement with the ILEC. The Company is also working with ILECs
to create an interface whereby orders are provisioned electronically, which
should further improve provisioning performance.
Focus on Targeted Sales and Marketing Effort. The Company's sales programs
include direct sales to business customers, vendor and affinity programs, direct
mail, telemarketing and targeted advertising, particularly for residential
customers. The Company has both local and national sales personnel for business
customers and has centralized its sales order personnel for residential
customers. The Company's national sales group concentrates on large basic
telephone service users such as multi-tenant buildings, pay phone operators,
ISPs and wholesale customers. The local sales group solicits business customers
and coordinates activities with equipment vendors and affinity groups.
Provide Superior Customer Service. The Company utilizes a centralized team
of highly trained customer sales and service representatives to coordinate
initial residential inquiries and orders, as well as post-installation, billing
and customer care related issues for all customers. The CSRs are able to
leverage the Company's proprietary management information system to gain
immediate access to the Company's customer data, enabling quick and effective
responses to customer requests and needs at any time. Furthermore, this system
permits the Company to present its customers with one fully integrated monthly
billing statement for all basic communication services. By having a centralized
call service center operated on a 24 hour per day, seven day a week basis in Las
Vegas, the Company is better able to control quality of service, personnel and
related training than if call centers were maintained in each market.
Leverage Sophisticated Management Information System. A comprehensive
operations support system is a critical component to managing the Company's
business as well as offering superior customer service. The
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Company has installed a fully automated, proprietary management information
system designed to provide comprehensive, integrated features addressing all
aspects of its business, including customer care, billing and collections,
general ledger, payroll, fixed asset management, purchasing and personnel. The
Company believes this system is adaptable to changing circumstances and multiple
ILEC interfaces, and is scaleable to support the Company's operations throughout
its expected growth.
Capitalize on Management Expertise. The Company has recruited a team of
experienced business executives with entrepreneurial backgrounds. Maurice J.
Gallagher, Jr., Chairman, has been a founder of a number of start-up businesses,
including ValuJet and BankServ. Nield J. Montgomery, CEO and President, has over
35 years of telephone experience, most recently with ICG Communication, Inc.
Other executives have held senior management positions at major
telecommunications companies, including, among others, Sprint, Centel, NYNEX,
Contel, GTE and MCI.
Introduce Data Services. The Company plans to introduce a new class of
data products, specifically high speed Internet access, remote LAN access, DSL
technologies and voice products using data protocols to deliver voice traffic
over data networks. The Company believes the introduction of these services will
provide a distinct advantage in the marketing and sale of bundled packages of
local, long distance and data. These services are expected to provide value
added product offerings to the Company's customers. In addition, the proposed
data-based voice product should constitute a competitive service offering to
customers seeking a lower cost alternative to voice services currently provided
over traditional circuit switched networks. The Company believes these new
service offerings, when implemented, should increase its penetration of the
traditional voice services market and provide improved returns on the Company's
invested capital.
PRODUCTS AND SERVICES
The Company focuses primarily on offering basic telephone services,
including switched local dialtone and enhanced calling features such as voice
mail, call waiting and call forwarding ("basic telephone services"). These
services are required by virtually all users of telecommunications. The Company
also offers long distance services to its local exchange customers in each of
its markets in operation and has recently begun offering data services. The
Company's specific product offerings include:
Business Lines
- Single line business (with optional feature packages), Centrex service,
access trunks and customer owned coin operated telephone lines
("COCOTs").
Residential Lines
- Single and second lines (including multiple dwelling unit lines) and
basic telephone service with optional feature packages.
Long Distance Services
- Outbound 1+.
- Inbound 800/888 and calling cards (to be introduced during the first
half of 1998).
Data Services
- NorTel's Internet Thruway product (ISP ports).
- Remote LAN and Internet Access utilizing DSL Modems (to be introduced
during 1998).
The Company has contracted for the use of IXC Communications Inc.'s
fiberoptic network on a resale basis to provide long distance services. The
Company offers everyday prices to its customers at $.10 per minute or less for
continental United States direct dial long distance calls and more attractive
rates for customers with greater volumes. Moreover, the Company is able to bill
domestic calls in six second increments. To obtain the Company's long distance
rates, customers have to purchase the Company's switched local service. The
Company believes it can offer competitive long distance rates because calls
originating through the Company's switches eliminate a portion of the switched
access charges. The Company believes its low cost long distance will generate
business from all of the Company's customer segments.
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The Company has made arrangements with each ILEC and other carriers in its
markets for the provision of interim number portability, operator and directory
services, 911 services and Yellow Page and White Page listings. Interim number
portability is available for a nominal fee to customers that desire to retain
existing telephone numbers by means of remote call forwarding. Operator services
are offered through a major long distance carrier or ILEC. Emergency 911
services are provisioned through links to the ILEC switch which, in turn, is
connected to a 911 service bureau. The Company's proprietary management
information system updates customer addresses and immediately supplies them to
the appropriate emergency authorities. In addition, the Company's
interconnection agreement with the ILEC in each of its markets contains a
provision requiring the ILEC to list each of the Company's business customers in
the Yellow Pages.
MARKETS
A key component of the Company's strategy is to concentrate on early market
entry into suburban areas of Tier I Markets. These suburban areas typically
contain large populations of residential and small business, including COCOT and
ISP, prospects. In addition to its currently operational markets of Las Vegas
and selected suburban areas of Atlanta and Los Angeles, during fiscal 1998, the
Company plans to enter seven additional markets in the states of California,
Florida and Illinois and expects to enter up to an additional nine markets in
1999. These markets were chosen in part because of their pro-competitive
regulatory environments.
SALES AND MARKETING
The Company concentrates its sales and marketing efforts on users of basic
telephone services. The specific customer groups the Company targets are:
- Small business customers that typically have between three and 50 lines.
- Single family residential users.
- Customer owned coin operated telephone providers (COCOTs).
- Multi-dwelling unit owners and managers (MDUs).
- Internet Service Providers (ISPs).
The Company's highly focused marketing efforts seek to generate
well-managed, profitable growth through increased market share with minimal
customer churn. The Company's sales programs include direct sales efforts,
vendor and affinity programs, direct mail, telemarketing and targeted
advertising.
As of February 28, 1998, the Company employed twelve local sales personnel
and seven national sales personnel. Within each local market, the Company
expects to employ five sales personnel and two sales assistants. The national
sales force is responsible for identifying and soliciting prospective small
business, multi-dwelling unit owners and managers, COCOT and ISP customers. The
local sales personnel solicit business customers and coordinate activities with
equipment vendors and affinity groups.
To complement its local and national sales representatives, the Company
intends to use established telephone equipment vendors as agents to sell the
Company's local and long distance services in conjunction with equipment sales
to potential business customers. In Las Vegas, for instance, the Company is
currently selling local service through equipment vendors to whom it pays a
commission for each sale.
Affinity programs in which the Company and the selected organizations will
jointly promote the Company's services will be used to pursue members of
organizations such as schools, religious organizations, charities and local
chambers of commerce. The organizations will receive a royalty for each member
who purchases the Company's services.
Prior to service initiation and during the early stages of each market's
operation, the Company seeks to begin promoting its name and establishing
awareness of its presence through focused public relations activities. To date,
the Company's inauguration of service in each of its existing markets has
generated meaningful publicity in both the print and broadcast media.
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Due to the fact the Company initiates service in each market in a limited
area, advertising activities employ geographically specific media during the
early phase of operation in each market. As a result, the Company uses targeted
media such as Cable TV, zoned editions of neighborhood/business press and radio
(on a limited basis) as each new market opens. Direct mail and telemarketing are
employed to augment the Company's broadcast and print efforts. As a given market
reaches a critical mass of collocation expansion (expected to be within 9 to 12
months after initiation of service), the Company will employ more broad-based
general market media in order to achieve greater cost efficiencies in its
message delivery. These media options include the expanded use of radio and
utilization of broadcast TV and full-run print publications. Initially, the
advertising messages are created to establish name awareness and credibility for
the Company in each new market. After the initiation of service, the messages
are crafted to specifically promote the Company's service offerings.
Additionally, the Company works closely with a national directory clearinghouse
to insure timely and accurate placement of its directory advertising information
in each market.
The Company also seeks wholesale customers (i.e., IXCs) who desire to
resell the Company's local service product offerings. The Company is selling
this product through its national sales force and has extended these efforts
into each of its operational markets.
Customer Owned Coin Operated Telephone Providers. The Company has been
successful in targeting the COCOT segment in its markets because (i) the Company
offers such customers lower rates compared with the ILEC in each market, and
(ii) the Company provides its COCOT customers a sophisticated management report
that enables them to accurately bill IXCs for dial-around compensation. The
Company believes that in its markets it is the only ICP or CLEC offering such
management reports. MGC currently has contracts with several COCOT operators in
Las Vegas and selected suburban areas of Atlanta and Los Angeles.
Multi-Dwelling Unit Owners and Managers. The Company also targets
apartments and multi-dwelling units by offering owners and managers a turn-key
telephone product for its occupants. To initiate such service at an apartment
complex, the Company will initially utilize the ILEC's unbundled loop from each
apartment to the Company's collocated equipment in the ILEC central office. Once
installed, the service will remain active for future tenants. Under the
Company's multi-dwelling unit program, the tenant does not have to arrange for
the service independently, pay deposits (which can be managed through the
deposit process for the apartment) or wait for installation. Additionally,
installation charges may be reduced from traditional amounts charged to
individual customers. After the Company and the apartment complex complete the
initial installation, the apartment owner/manager will be able to offer new
tenants telephone service the day the lease is signed. A call from the apartment
manager or the tenant will provide the necessary customer information to begin
service. Larger complexes (100 or more lines) will allow the Company to
economically install hardware at the apartment site and lease T1 spans to
transport the traffic directly to its switch, bypassing the ILEC's loops.
Internet Service Providers. The Company believes that ISPs provide a
significant opportunity for incremental line growth. In conjunction with the
introduction of the Company's ATM backbone, Nortel's Internet Thruway product
was introduced to MGC's ISP customers in February 1998. By replacing the need
for data modems, the Internet Thruway eliminates the need for ISPs to purchase
large amounts of capital equipment to expand their business. The product is sold
on a "per port" basis to the ISP and the technology available with the Internet
Thruway allows an ISP to operate in any of MGC's markets without requiring a
physical presence in such market. Further, the Company has deployed the
capability to shift ISP traffic off its voice network at the point of origin. As
a result, the Company optimizes the voice ports of its DMS-500 switches while
providing ISP customers with a high quality data connection. Additionally, the
Company gains access by contract to the ISP's Internet customer base allowing it
to market local and long distance service to that customer base.
NETWORK
Network Architecture. MGC has chosen to build an exclusively switch-based
network and to lease transport and local loops on an incremental basis, as
demand dictates, from ILECs, CAP/CLECs and other
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ICPs. As a result, the Company is not and will not be burdened by the operating
and financing expenses associated with owning a fiber optic transport network.
By using the ILEC's or other telecommunications services provider's fiber
network interconnecting central offices and loops through collocation, the
Company seeks to reach a broad market of customers for a fraction of the cost of
a constructed fiber network.
The Company believes the traditional copper loop connection from the ILEC
central office to the end user (the "last mile") is receiving considerable
attention from service providers looking for more economic solutions. Beyond the
traditional copper based T-1 span and the more recent direct fiber connections,
wireless radio, including 38GHz, 28GHz and 2.4GHz, is becoming practical and,
often, less costly. The Company believes "last mile" solutions, including an
array of new technologies (such as DSL) with significant bandwidth improvement,
are on the horizon. The Company's network architecture anticipates this
evolution and avoids capital investment that may become obsolete.
The Company believes it will be able to lease the necessary transport at
reasonable prices in all its planned markets. Prior to the passage of the Act in
February 1996, ILEC's fiber transport was subject to tariffs and usually priced
substantially higher than a competing CAP/CLEC's. With the passage of the Act,
ILECs were required to lease their network elements at cost based prices. MGC
seeks to find two or three competing transport suppliers in each of its markets
with competitive prices.
Las Vegas Network. MGC's Las Vegas network demonstrates its network
strategy. In 1996, the Company installed a Nortel DMS 500 digital switch with
approximately 7,000 lines of capacity and connections (via leased transport from
Sprint, the ILEC) to nine of the 19 Sprint COs in Las Vegas at an equipment cost
of approximately $3.3 million. Such investment gave MGC access to an addressable
market of approximately 450,000 lines. This project was completed in seven
months and the switch became operational in December 1996. In response to its
initial success in provisioning access lines, the Company expanded its capacity.
By the end of December 1997, the Company had spent an additional $4.4 million to
increase network capacity to approximately 20,000 lines and connected an
additional seven COs (for a total of 16 of the 19 COs in the Las Vegas
metropolitan area). The 1997 expansion increased the Company's addressable
market to approximately 90% of Las Vegas' 800,000 lines.
In Las Vegas, the Company has signed an interconnection agreement with
Sprint with a term of two years (expiring in November 1998). MGC utilizes
Sprint, NextLink Communications and American Communications Services for
transport. The Company seeks to select the transport provider that can best
interconnect the Company's customer locations through redundant network at the
lowest possible price.
Atlanta Network. MGC's Atlanta network initiated service in December 1997
with a DMS 500 switch in the Company's leased premise and collocation equipment
in three BellSouth Telecommunications Inc. ("BellSouth") COs with approximately
6,000 lines of capacity and access to 213,000 lines. By year end 1998, the
Company intends to be collocated in 27 COs with access to 1,525,000 lines and
have 32,000 lines of capacity in the Atlanta market.
In Atlanta, the Company has negotiated what it believes to be favorable
transport pricing with BellSouth and will continue to seek alternative transport
providers for greater cost efficiencies. The Company has signed an
interconnection agreement with BellSouth for the Atlanta market with a term of
two years (expiring in April 1999).
Los Angeles Network. In Los Angeles, the Company initiated service with a
DMS 500 switch installed in a Company owned building and collocation equipment
in six GTE COs. Service in this market commenced in December 1997, with
approximately 8,000 lines of capacity and access to 255,000 lines. By year end
1998, MGC plans to be collocated in 28 COs with access to 1,236,000 lines and
have 28,900 lines of capacity.
The Company utilizes both GTE and GST (a CAP transport provider) for
transport in Los Angeles and has signed an interconnection agreement with GTE
for the State of California with a term of three years (expiring in January
2000).
Switch Hardware. The Company's switching platform is the Nortel DMS 500.
MGC has executed a contract with Nortel providing for the purchase of 20 DMS 500
switches by the end of 1999 (three of which
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have already been delivered). The contract specifies industry standard
warranties. The DMS 500 system offers a flexible and cost effective means of
establishing a single point of presence in, and the ability to provide revenue
generating services to, both the local and long distance services markets. The
DMS 500 combines the DMS 100 local switch functionality with long distance toll
and tandem switching capability.
The Company's early-to-market strategy requires an accelerated switch
deployment schedule. Reducing the customization of the building to house the
switch is one method. With this in mind, the Company is purchasing prefabricated
buildings for use in its Chicago and Ft. Lauderdale markets built to
specifications which allow the actual switch installation to occur in a minimal
timeframe. This approach evolved from the Company's early efforts to design a
"switch in a box." Utilizing raw land and a prefabricated building approach
allows the switch to be installed at Nortel's factory in a series of
self-contained units, with all the necessary environmental, fire and other
elements pre-installed. By using this approach or other modifications to
traditional installation, the Company believes it can move quickly to open new
markets and be operational in as short as four months from the date of site
selection. The Company may employ more than one switch in a particular market.
Interconnection Agreements. The Company has interconnection agreements
with Sprint for operation in Las Vegas, BellSouth in Georgia, GTE in California,
Pacific Bell ("PacBell") in California and Ameritech Corp. ("Ameritech") in
Illinois. The Company expects to expand its agreement with Sprint to cover its
operations in Chicago. The Company believes it has secured favorable agreements
which will allow it to operate profitably in these jurisdictions, but there can
be no assurance to that effect. The Company has authority to operate as a CLEC
in Illinois, Georgia, Nevada, California, Florida and Massachusetts. The Company
will apply for additional CLEC authority in additional states as necessary.
OPERATIONS
Customer Service. The Company strives to provide customer service superior
to the ILEC in each of its markets. This includes:
- Personnel. CSRs and sales personnel who are well trained and attentive
to customers' needs. CSRs are available 24 hours a day, seven days a week,
365 days a year.
- Phones. Prioritizing the response to customer phone calls such that
calls are answered and responded to with minimal (if any) wait time.
- Coordination. Coordinating service installation with both the customer
and the ILEC, if involved.
- Customer Information. Keeping the customer informed if there is an
installation or repair problem and dedicating the necessary resources to
resolve the problem as soon as possible.
- Billing. Providing the customer a timely bill which is comprehensive,
accurate and simple to read and understand.
Centralization. The Company has a centralized customer service center,
including a centralized call center in Las Vegas, which operates 24 hours a day,
seven days per week. Centralization allows the Company to control personnel and
their training to a greater degree than with call centers in each city and
thereby provides consistent, high quality customer service with lower overhead
costs.
Automation. The Company believes automation of internal processes
contributes greatly to the overall success of a service provider and billing is
a critical element of any telephone company's operation. The Company's
management information system has been designed to allow a CSR to quickly take
all the necessary information from a customer in a logical, conversational
manner, establish the appropriate billing and credit information and
electronically process the order with the ILEC for the local loop provisioning.
The system creates the correct emergency 911 address update for new customers
and supplies the information to the appropriate emergency authorities.
Concurrently, the system will establish the related cost elements with the order
to track the expense of the facility leased from the ILEC.
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Thereafter, the system will track the progress of the order based on
electronic or facsimile updates from the ILEC. The installation desk will follow
the customer's order, ensuring the installation date is met. Additionally, CSRs
will be able to handle all other customer service inquiries, including billing
questions and repair calls. All this information is available in the integrated
system available to the CSR.
In addition, the Company's proprietary management information system has
been designed to track and bill all forms of local service, including line and
feature charges and long distance charges. Additionally, the billing system can
provide sophisticated solutions for business bills. Companies desiring a single
bill for many locations, summary bills only without detail or any other
combination can be accommodated. Lastly, the Company expects to be able to
deliver billing information in a number of media besides paper including
electronic files, Internet inquiry or on-line inquiry.
LOW COST FOCUS
To offer service to its targeted segments of the market and insure long
term profitability, the Company has created a low cost structure and focus. The
key components of this strategy are:
Low Cost Network Architecture. MGC has chosen to build an exclusively
switch-based network and to lease the necessary transport and local loops on an
incremental basis, as demand dictates, from ILECs, CAP/CLECs and other ICPs. As
a result, the Company will not be burdened by the carrying cost of a constructed
transport network. This approach allows the Company to precisely target its
capital expenditures to the specifics of each market and developing conditions.
Standardized Switch/Installation. The Company plans to use only Nortel
switches, all configured in the same manner for ease of installation into the
Company's prefabricated buildings (or existing building structures, as the case
may be). The Company believes this approach will reduce the time to install its
switches.
Basic Product. The Company offers basic voice and data services. This
simplified approach allows the Company to standardize training, order processing
and interfaces with the different ILECs. The Company does not expect to offer a
broad array of complex communications packages.
Automation. An important component in producing a low cost environment is
automation of the processes involved. The Company has installed a proprietary
management information system designed to be a comprehensive, integrated system
that addresses all aspects of its business, including customer care and billing,
general ledger, payroll, fixed asset management, purchasing and personnel. This
system is scaleable and has been designed to support the Company's operation as
it grows.
Credit Policy. To minimize its bad debt exposure, the Company has
implemented a policy generally requiring new customers to meet minimum credit
standards or make deposits for specified services and estimated usage prior to
the initiation of services. The Company's current credit and deposit policies
are in line with and in some instances more conservative than competing ILECs in
its markets. Additional personnel have been dedicated to collections and credit
monitoring to lower the Company's credit exposure.
Efficient Customer Service. The Company has a centralized customer service
center, including a call center located in Las Vegas, which operates 24 hours
per day, seven days per week. The centralized calling center handles all
inquiries and orders for new service. This centralization allows the Company to
control personnel and their training to a greater degree than with call centers
in each city.
Voice Over Data. The Company has deployed and is using its ATM data
network to interconnect all its territories. While using this network for data,
the Company is also making internal voice calls through this network. The
packetized voice transmission has been of good quality and the Company plans to
begin transporting interstate long distance calls via this network. The Company
currently expects the transport cost per minute for these calls to be less than
one cent.
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COMPETITION
The Company believes the only significant switch-based competitor for its
targeted markets (small businesses and residential users in suburban areas of
large metropolitan markets) is the ILEC. However, the CAP/CLECs and other
communications suppliers in each of the metropolitan areas in which the Company
will be present could also elect to compete for the Company's targeted market.
General competition in each of the service categories provided by the
Company is discussed below.
Local Services. In each of its geographic markets, the Company faces
significant competition for the local services it offers from RBOCs and other
ILECs, which currently dominate their local telecommunications markets. These
companies all have long-standing relationships with their customers and have
financial, personnel and technical resources substantially greater than those of
MGC.
The Company also faces competition in most markets in which it will operate
from one or more CAP/CLECs or ICP operating fiber optic networks. Other local
service providers have operations or are initiating operations within one or
more of the Company's service areas. MGC expects AT&T (through its pending
acquisition of Teleport Communications Group, Inc.), WorldCom (through its
pending acquisition of MCI), Sprint and certain cable television providers, all
of which are substantially larger and have substantially greater financial
resources than the Company, to enter some or all of the markets the Company
serves. MGC also understands other entities have indicated their desire to enter
the local exchange services market within specific metropolitan areas served or
targeted by MGC.
In addition, a continuing trend toward consolidation and strategic
alliances within the communications industry could result in significant new
competition for the Company. AT&T and MCI have begun to enter the local services
market through acquisitions and internal growth. Other potential competitors of
the Company include utility companies, other long distance carriers and wireless
telephone systems. The Company cannot predict the number of competitors that
will emerge as a result of existing or new federal and state regulatory or
legislative actions.
Competition in all of the Company's market areas is based on quality,
reliability, customer service and responsiveness, service features and price.
The Company intends to keep its prices at levels below those of the ILECs while
providing, in the opinion of the Company, a higher level of service and
responsiveness to its customers. Innovative packaging and pricing of basic
telephone services is expected to provide competitive differentiation for the
Company in each of its markets.
Although the ILECs are generally subject to greater pricing and regulatory
constraints than other local network service providers, ILECs are achieving
increasing pricing flexibility for their local services as a result of recent
legislative and regulatory developments. The ILECs have continued to lower
rates, resulting in downward pressure on prices for certain services.
Long Distance Services. The Company competes with AT&T, MCI, Sprint and a
host of other second and third tier providers in the long distance services
market. Many of the Company's competitors have long-standing relationships with
their customers and have financial, personnel and technical resources
substantially greater than those of MGC. In providing these services, the
Company will focus on quality service and low cost to distinguish itself in a
very competitive marketplace. In addition, the Company may face additional
competitive challenges if the price of long distance minutes falls as a result
of decreased access charges. The Company believes the introduction of its ATM
backbone and Internet Thruway products will enable it to compete for ISP traffic
on the basis of the quality and low cost of its services; however, the market
for such ISP traffic is extremely competitive.
GOVERNMENT REGULATIONS
Overview. The Company's services are subject to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications common carriers such
as the Company, to the extent those facilities are used to provide, originate or
terminate interstate or international communications. The state regulatory
commissions retain jurisdiction over most of
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the same facilities and services to the extent they are used to originate or
terminate intrastate communications. In addition, many of the regulations issued
by these regulatory bodies may be subject to judicial review, the result of
which the Company is unable to predict.
Federal Regulation. The Company must comply with the requirements of
common carriage under the Communications Act of 1934 (the "Communications Act"),
as amended. Comprehensive amendments to the Communications Act were made by the
Act, which was signed into law on February 8, 1996. The Act effected plenary
changes in regulation at both the federal and state levels that affect virtually
every segment of the telecommunications industry. The stated purpose of the Act
is to promote competition in all areas of telecommunications and to reduce
unnecessary regulation to the greatest extent possible. While it will take years
for the industry to feel the full impact of the Act, it is already clear the
legislation provides the Company with both opportunities and challenges.
The Act gives the FCC the authority to forebear from regulating companies
if it finds such regulation does not serve the public interest, and directs the
FCC to review its regulations for continued relevance on a regular basis. As a
result of this directive, a number of the regulations that historically applied
to IXCs have been and may continue to be eliminated in the future. While it is
therefore expected that a number of regulations that were developed prior to the
Act will be eliminated in time, those which apply to the Company at present are
discussed below.
Pursuant to the Communications Act, the Company is subject to the general
requirement that its charges and regulations for communications services must be
"just and reasonable" and that it may not make any "unjust or unreasonable
discrimination" in its charges or regulations.
The FCC has established different levels of regulation for dominant and
non-dominant carriers. Of domestic common carrier service providers, only GTE,
the RBOCs and other ILECs are classified as dominant carriers, and all other
providers of domestic common carrier services, including the Company, are
classified as non-dominant carriers. The Act provides the FCC with the authority
to forebear from imposing any regulations it deems unnecessary, including
requiring non-dominant carriers to file tariffs. On November 1, 1996, in its
first major exercise of regulatory forbearance authority granted by the Act, the
FCC issued an order detariffing domestic interexchange services. The order
required mandatory detariffing and gave carriers such as the Company nine months
to withdraw federal tariffs and move to contractual relationships with its
customers. This order subsequently was stayed by a federal appeals court. Until
further action is taken by the FCC or the courts, the Company will continue to
maintain tariffs for these services.
Although the FCC does not directly regulate local exchange service, which
is within the jurisdiction of state regulatory authorities, its actions may
impact directly on such service. The Act greatly expands the FCC's
interconnection requirements on the ILECs. The Act requires the ILECs to: (i)
provide physical collocation, which allows companies such as MGC and other
interconnectors to install and maintain their own network termination equipment
in ILEC central offices, and virtual collocation only if requested or if
physical collocation is demonstrated to be technically unfeasible, (ii) unbundle
components of their local service networks so other providers of local service
can compete for a wider range of local services customers, (iii) establish
"wholesale" rates for their services to promote resale by CLECs and other
competitors, (iv) establish number portability, which will allow a customer to
retain its existing phone number if it switches from the ILEC to a competitive
local service provider, (v) establish dialing parity, which ensures customers
will not detect a quality difference in dialing telephone numbers or accessing
operators or emergency services, and (vi) provide nondiscriminatory access to
telephone poles, ducts, conduits and rights-of-way. In addition, the Act
requires ILECs to compensate competitive carriers for traffic originated by the
ILECs and terminated on the competitive carrier's networks. The FCC is charged
with establishing national guidelines to implement the Act. The FCC issued its
Interconnection Order on August 8, 1996, which established detailed rules
regarding rates, terms and conditions for interconnection between CLECs and
ILECs. The Interconnection Order was appealed to the U.S. Court of Appeals for
the Eighth Circuit. On July 18, 1997, the Court issued a final decision vacating
the interconnection pricing rules and "most favored nation" rules as well as
certain other interconnection rules. The FCC's and other parties' petitions to
the Supreme Court requesting review of these decisions have been granted. Even
though the Eighth Circuit's decision currently restricts the role of the
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<PAGE> 12
FCC with respect to pricing and other issues (pending review by the Supreme
Court), these issues currently remain subject to scrutiny and oversight by state
regulatory commissions which may exercise their discretion to adopt policies
similar to or different from those proposed by the FCC. Although it is not
possible at this time to determine how the Supreme Court will respond to these
appeals, MGC does not believe the Eighth Circuit decision will have any
significant impact on its operation. On October 14, 1997, the U.S. Court of
Appeals for the Eighth Circuit, in response to motions regarding its earlier
decision, ruled that ILECs are under no obligation to provide CLECs with a
rebundled package of individual network elements. The Company believes that the
impact of this ruling is neutral to the Company in light of the Company's switch
and collocation based network strategy employing unbundled network elements and
may be beneficial in the short-term by delaying entrance into the local service
market by IXCs such as AT&T.
As a result of provisions of the Act, the Company has taken the steps
necessary to be a provider of local exchange services. As of February 28, 1998,
MGC had obtained CLEC certification in six states. In addition, the Company has
successfully negotiated interconnection agreements with five ILECs and is in
negotiation for interconnection agreements with four additional ILECs. At the
same time, the Act also makes competitive entry more attractive to RBOCs, other
ILECs and interexchange carriers and other companies, and likely will increase
the level of competition the Company faces.
The Act's interconnection requirements also apply to interexchange carriers
and all other providers of telecommunications services, although the terms and
conditions for interconnection provided by these carriers are not regulated as
strictly as interconnection provided by the ILECs. This may provide the Company
with the ability to reduce its own access costs by interconnecting directly with
non-ILECs, but may also cause the Company to incur additional administrative and
regulatory expenses in replying to interconnection requests from other carriers.
On May 16, 1997, the FCC released an order that fundamentally restructured
the "access charges" ILECs charge to interexchange carriers and end user
customers. The Company's analysis of the FCC's order leads it to believe the
FCC's new access charge rules do not adversely affect the Company's business
plan, and they do in fact present significant opportunities for new entrants,
including the Company. Aspects of the order may be changed and to the extent
access charges may be reduced in the future, competitors will have an increased
ability to offer low cost long distance services. At least ten parties have
filed appeals with federal courts, and numerous parties have asked the FCC to
reconsider portions of its new rules.
As part of its pro-competitive policies, the Act may free the RBOCs from
the judicial order that prohibited their provision of interLATA services.
Specifically, the Act permits RBOCs to provide long distance services outside
their local service regions immediately, and will permit them to provide
in-region interLATA service upon demonstrating to the FCC and state regulatory
agencies they have adhered to the FCC's interconnection regulations. As of
December 31, 1997, ILECs in four states have filed applications for in-region
long distance authority with the FCC, all of which have been denied by the FCC.
At least two of these decisions have been appealed. Additional applications are
being filed and will be considered by the FCC. On December 31, 1997, a federal
District Court in Texas ruled key sections of the Act unconstitutional on the
grounds that RBOCs were unfairly denied access to the in-region long distance
segment of the industry. This decision was immediately appealed by numerous IXCs
and the District Court has stayed its decision pending appeal.
While the Act reduces regulation to which non-dominant local exchange
carriers are subject, it also reduces the level of regulation that applies to
the ILECs and increases their ability to respond quickly to competition from the
Company and others. For example, in accordance with the Act, the FCC has applied
"streamlined" tariff regulation to the ILECs which greatly accelerates the time
required for changes to tariffed service rates to take effect and eliminates the
requirement that ILECs obtain FCC authorization before constructing new domestic
facilities. These actions will allow ILECs to change service rates more quickly
in response to competition. Similarly, the FCC is considering proposals that may
provide significant new pricing flexibility to ILECs. To the extent such
increased pricing flexibility is provided, the Company's ability to compete with
ILECs for certain service may be adversely affected.
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On May 8, 1997, in compliance with the requirements of the Act, the FCC
released an order establishing a new Universal Service support fund, which
provides subsidies to carriers that provide service to under-served individuals
and customers in high cost areas, and to companies that provide
telecommunications services and wiring for schools and libraries. The Company is
required to contribute into the Universal Service support fund, but may also be
eligible to obtain subsidies for services it provides. The new Universal Service
rules will be administered jointly by the FCC and state regulatory authorities,
many of which are still in the process of establishing their administrative
rules. The net financial effect of these regulations on the Company cannot be
determined at this time.
State Regulation. The Company has satisfied state requirements to provide
CLEC and intrastate long distance service in Nevada, Georgia, Illinois,
California, Florida and Massachusetts. State authorizations vary in their
regulatory intensity. State laws and regulations that prohibit, or have the
effect of prohibiting, local and intrastate long distance telecommunications
competition have been preempted under the Act. Although the Act's prohibition of
state barriers to competitive entry took effect on February 8, 1996, various
legal and policy matters must be resolved before the Act's policies are fully
implemented. The Company continues to support efforts at the state government
level to encourage competition in its markets under the federal law and to
permit CLECs to operate on the same basis and with the same rights as the ILECs.
In most states, the Company is required to file tariffs setting forth the
terms, conditions, and prices for services which are classified as intrastate.
In some states, the Company's tariff can list a range of prices for particular
services and in others such prices can be set on an individual customer basis.
The Company is not at this time subject to price cap or to rate of return
regulation in any of its current or planned expansion markets.
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<PAGE> 14
Since early 1997, several CAP/CLECs have entered into co-carrier agreements
with ILECs which address CLEC/ILEC interconnection issues such as reciprocal
compensation and number portability. While the Act mandates the implementation
of interconnection arrangements, there can be no assurance the Company will be
able to secure its desired co-carrier arrangements in a timely fashion or upon
reasonable rates and terms. State regulators retain primary authority in setting
rates for these interconnection agreements, and for enforcing the implementation
of such agreements once they are signed. All of the states in which the Company
operates or currently plans to operate have established rates and terms
governing interconnection agreements. While additional hearings are pending in
all of these states that may further impact the Company's interconnection
agreements, the Company does not expect that any such proceeding will have an
adverse impact on the Company.
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<PAGE> 15
PERSONNEL
As of February 28, 1998, there were 160 employees of the Company, the
majority of whom were located in Las Vegas. The Company expects to substantially
increase its employee count as its business expands into new markets.
MGC has non-disclosure and non-compete agreements with all of its executive
employees. None of MGC's employees is represented by a collective bargaining
agreement.
RISK FACTORS
Any investment in the securities of the Company involves a high degree of
risk. Prospective investors should consider carefully the following factors
together with the other information contained in this Report.
Limited Operations; Net Losses
The Company began providing local exchange services in Las Vegas in
December 1996 and, to date, substantially all of the Company's revenues have
been derived from such services. The Company is expecting to significantly
increase the size of its operations in 1998 and beyond. Prospective investors,
therefore, have limited historical financial information about the Company upon
which to base an evaluation of the Company's performance. Although many of the
Company's managerial and supervisory personnel have had substantial
communications industry experience, the Company has a very limited operating
history. Accordingly, there is no firm basis, other than management's judgment,
on which to estimate the number of customers or the amount of revenues the
Company's planned operations will generate. Given the Company's limited
operating history, there is no assurance that it will be able to compete
successfully in the communications business.
The development and expansion of the Company's business will require
significant capital, operational and administrative expenditures, a substantial
portion of which are incurred before the realization of revenues. These capital
expenditures will result in negative cash flow until an adequate customer base
is established. Although its revenues have increased since its inception, the
Company has incurred significant increases in expenses associated with the
installation of switches and the expansion of its services and customer base.
The Company recorded a net loss of $10.8 million in 1997 and anticipates
recording significant net losses through 1999. There can be no assurance the
Company will achieve or sustain profitability or positive EBITDA in the future.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this Report.
Risks Associated with Implementation of Growth Strategy
The expansion and development of MGC's operations will depend on, among
other things, the Company's ability to (i) purchase, install and operate
switches and obtain required interconnection agreements, (ii) identify, hire and
retain qualified personnel, and (iii) provision local loops and lease access to
suitable transport networks, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions. In addition, MGC has experienced rapid growth
since its inception, and management believes that sustained growth will place a
strain on operational, human and financial resources. The Company's ability to
manage its expansion effectively will also depend on the continued development
of plans, systems and controls for its operational, financial and management
needs. Given the Company's limited operating history, there can be no assurance
that the Company will be able to satisfy these requirements or otherwise manage
its growth effectively. The failure of MGC to satisfy these requirements could
have a material adverse effect on the Company's financial condition and its
ability to fully implement its expansion plans.
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The Company's growth strategy also involves the following risks:
Implementation, Equipment and Suitable Interconnection and Collocation
Arrangements. An essential element of the Company's current strategy is the
provisioning of switched local service. In implementing its strategy, the
Company may utilize new technologies or may utilize existing technologies in new
applications. There can be no assurance that installation of the switches and
associated electronics necessary to implement the Company's business plan will
continue to be completed on a timely basis or that, during the testing of this
equipment, the Company will not experience technological problems that cannot be
resolved. In addition, the development and expansion of the Company's business
and its entry into new markets will be dependent on, among other things, its
ability to lease or purchase suitable sites, obtain equipment on a timely basis,
obtain sufficient blocks of telephone numbers, negotiate suitable
interconnection and collocation arrangements with ILECs on satisfactory terms
and conditions and finance such expansion. Collocation space is obtained from
the ILECs on a first come/first served basis. As a result, there can be no
assurance that the Company will be able to obtain collocation sites in the
markets it desires. These factors and others could adversely affect the
expansion of the Company's customer base and commencement of operations in new
markets. If the Company is not able to expand its customer base or enter new
markets in accordance with its plans, the growth of its business would be
materially adversely affected.
Expansion Risk; Qualified Personnel. The Company expects to expand rapidly.
This growth will increase the operating complexity of the Company as well as the
level of responsibility for both existing and new management personnel. In
addition, the Company's business is managed by a small number of key management
and operating personnel, the loss of certain of whom could have a material
adverse impact on the Company's business. None of the Company's key executives
is a party to a long-term employment agreement with the Company and the Company
does not maintain key man insurance on its officers. The Company's ability to
manage its expansion effectively will require it to continue to implement and
improve its operational and financial systems and to expand, train and manage
its employee base. If the Company is unable to effectively manage its expansion
or attract and retain highly skilled and qualified personnel, the Company's
business could be materially adversely affected.
Reliance on Third Parties and Availability of UNEs. Because a key element
of its business and growth strategy is to lease transport capacity, the Company
is dependent upon the cooperation of ILECs and/or CAP/CLECs whose fiber optic
networks and local loops are being leased by the Company. The risks inherent in
this approach include, but are not limited to, negotiating and renewing
favorable interconnection and collocation agreements, timeliness of the ILECs or
CAP/CLECs in processing the Company's orders for customers who seek to utilize
the Company's service; and maintenance of the unbundled network elements
("UNEs"). The ILECs have had little experience in providing UNEs and there can
be no assurance the ILECs will provide and maintain the UNEs in a prompt and
efficient manner. The Company's interconnection agreements currently provide for
the Company's connection and maintenance orders to receive attention at parity
with those of the ILEC's or other CAP/CLEC's customers and for the ILEC to
provide adequate trunking capacity to keep blockage within industry standards.
Accordingly, the Company and its customers are dependent on the ILEC and/or
CAP/CLEC to assure uninterrupted service. In Las Vegas, the Company has, from
time to time, experienced blockage, in the delivery of calls from the ILEC to
the Company's switches due to inadequate trunk provisioning by the ILEC. Blocked
calls result in customer dissatisfaction which may result in the loss of
business. There can be no assurance that ILECs will comply with their network
provisioning requirements. Furthermore, there can be no assurance the rates to
be charged to the Company under the interconnection agreements will allow the
Company to offer low enough usage rates to attract a sufficient number of
customers and to operate the business on a profitable basis.
Automation and Information Systems. The Company employs a proprietary
management information system which is expected to be an important factor in its
success. If the management information system fails or is unable to perform as
expected, it would have a substantial adverse effect on the Company.
Furthermore, problems may be encountered with higher processing volumes or with
additional automation features, in which case, the Company might experience
system breakdowns, delays and additional, unbudgeted expense to remedy the
defect or to replace the defective system with an alternative system.
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Lack of New Service Acceptance by Customers. While CLECs targeting business
customers have had some success inducing customers to utilize an alternative
local exchange provider, the Company believes it is currently the only ICP
targeting residential customers in its markets. The success of the Company will
be dependent upon, among other things, the willingness of such customers to
accept the Company as an alternative provider of local, long distance and data
service. No assurance can be given that such acceptance will occur and the lack
of such acceptance could have a material adverse effect on the Company.
Untested Collection Procedures. The Company has in the past experienced an
unacceptable level of uncollectible accounts and resulting bad debt expense. To
minimize its bad debt exposure, the Company has recently implemented a policy
generally requiring new customers to meet minimum credit standards or make
deposits. While the Company believes its current credit and deposit policies are
in line with industry standards, there can be no assurance that such policies
will be effective in achieving the desired reduction in uncollectible accounts.
Products and Services. The Company currently focuses its efforts on
providing local and long distance telecommunications services. In order to
address the needs of its target customers, the Company will be required to
emphasize and develop additional products and services, such as high speed data
services. No assurance can be given that the Company will be able to provide the
range of communication services that its target customers need or desire.
Acquisitions. The Company may acquire other businesses as a means of
expanding into new markets or developing new services. The Company is unable to
predict whether or when any prospective acquisitions will occur or the
likelihood of a material transaction being completed on favorable terms and
conditions. Such transactions involve certain risks including, but not limited
to: (i) difficulties assimilating acquired operations and personnel, (ii)
potential disruptions of the Company's ongoing business, (iii) the diversion of
resources and management time, (iv) the possibility that uniform standards,
controls, procedures and policies may not be maintained, (v) risks associated
with entering new markets in which the Company has little or no experience, and
(vi) the potential impairment of relationships with employees or customers as a
result of changes in management. If an acquisition were to be made, there can be
no assurance that the acquired business would perform as expected.
Substantial Leverage: Insufficiency of Earnings to Cover Fixed Charges
The Company is highly leveraged. At December 31, 1997, the Company had
approximately $156.6 million in aggregate principal amount of indebtedness
outstanding. The degree to which the Company is leveraged could have important
consequences to stockholders of the Company, including the following: (i) a
substantial portion of the Company's cash flow from operations will be dedicated
to payment of the principal of and interest on its indebtedness, thereby
reducing funds available for other purposes; (ii) the Company's significant
degree of leverage could increase its vulnerability to changes in general
economic conditions or increases in prevailing interest rates; (iii) the
Company's ability to obtain additional financing for working capital, capital
expenditures, acquisitions, general corporate purposes or other purposes could
be impaired; and (iv) the Company may be more leveraged than certain of its
competitors, which may be a competitive disadvantage.
For the year ended December 31, 1997, the Company had net losses of $10.8
million and incurred fixed charges of $5.7 million. The Company anticipates
earnings will be insufficient to cover fixed charges through 1999. In order for
the Company to meet its debt service obligations, the Company will need to
substantially improve its operating results. There can be no assurance the
Company's operating results will be of sufficient magnitude to enable the
Company to meet its debt service obligations. In the absence of such operating
results, the Company could face substantial liquidity problems and might be
required to seek additional financing through the issuance of debt or equity
securities; however, there can be no assurance the Company would be successful
in raising such financing, or the terms or timing thereof. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" in Item 7 of this Report.
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Significant Capital Requirements and Need for Additional Financing
Expansion and development of the Company's business and services and the
development of new markets require significant capital expenditures. The Company
expects to fund its capital requirements through existing resources, debt or
equity financing and internally generated funds. The Company expects that to
continue to expand its business may require raising substantial additional
equity and/or debt capital. There can be no assurance, however, the Company will
be successful in raising sufficient debt or equity capital on terms it will
consider acceptable. In addition, the Company's future capital requirements will
depend upon a number of factors, including marketing expenses, staffing levels
and customer growth, as well as other factors that are not within the Company's
control, such as competitive conditions, government regulation and capital
costs. Failure to generate sufficient funds may require the Company to delay or
abandon some of its future expansion or expenditures, which would have a
material adverse effect on its growth and its ability to compete in the
communications industry.
Control of the Company
As of March 20, 1998, Maurice J. Gallagher, Jr., Nield J. Montgomery,
Timothy P. Flynn and Robert L. and Carol A. Priddy owned, directly or
indirectly, in the aggregate, approximately 44.2% of the outstanding Common
Stock and voting power of the Company (assuming the conversion of the
outstanding Series A Convertible Preferred Stock into Common Stock).
Accordingly, such stockholders collectively will likely be able to control the
management policy of the Company, decide all fundamental corporate actions,
including mergers, substantial acquisitions and dispositions and elect the Board
of Directors of the Company.
Nortel Contract
The Company is obligated to purchase 20 Nortel DMS 500 switches (three of
which have already been delivered) by the end of 1999. There can be no assurance
the Company will be able to utilize all of those switches in its business.
Dependence upon Network Infrastructure; Risk of System Failure; Security Risks
The Company's success in marketing its services to business and residential
users requires the Company to provide reliable service. The Company's networks
are subject to physical damage, power loss, capacity limitations, software
defects, breaches of security (by computer virus, break-ins or otherwise) and
other factors which may cause interruptions in service or reduced capacity for
the Company's customers. Interruptions in service, capacity limitations or
security breaches could have a material adverse effect on customer acceptance
and, therefore, on the Company's business, financial condition and results of
operations.
Rapid Technological Changes
The communications industry is subject to rapid and significant changes in
technology. While the Company believes that for the foreseeable future these
changes will not materially affect or hinder the Company's ability to acquire
necessary technologies, the effect of technological changes on the business of
the Company cannot be predicted. Thus, there can be no assurance technological
developments will not have a material adverse effect on the Company.
Competition
In its existing markets and the markets into which it intends to expand,
the Company faces significant competition for its local telephone services,
including local exchange services, from ILECs, which currently dominate their
local telecommunications markets, and others. ILECs have long-standing
relationships with their customers which relationships may create competitive
barriers. Although CLECs as a whole tripled their customer lines in service in
1997 to 1.5 million lines, CLECs currently account for only 2.6% of all local
telephone revenues, according to FCC statistics. Furthermore, ILECs may have the
potential to subsidize competitive service from monopoly service revenues. In
addition, a continuing trend toward business combinations and alliances in the
telecommunications
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<PAGE> 19
industry may create significant new competitors to the Company. The Company also
faces and will face competition in the markets in which it operates and in
markets into which it intends to expand from one or more CAP/CLECs and ICPs
operating fiber optic networks and, possibly, from local cable systems which may
offer communication services. Many of the Company's existing and potential
competitors have financial, personnel and other resources significantly greater
than those of the Company.
The Company believes various legislative initiatives, including the
Telecommunications Act of 1996 (the "Act"), have removed most of the remaining
legislative barriers to local exchange competition. Nevertheless, in light of
the passage of the Act, regulators are also likely to provide ILECs with
increased pricing flexibility as competition increases. If ILECs are permitted
to lower their rates substantially or engage in excessive volume or term
discount pricing practices, the net income or cash flow of the Company could be
materially adversely affected.
The Company competes with AT&T, MCI, Sprint and others in the long distance
services market. Additionally, recent federal legislation permits the Regional
Bell Operating Companies ("RBOCs") to provide in-region long distance services
once certain criteria are met. Once the RBOCs begin to provide such services,
they will be in a position to offer single source service similar to the service
the Company offers. In addition, AT&T, MCI and Sprint have entered, and other
interexchange carriers have announced their intention to enter, the local
exchange services market, which is facilitated by the Act's resale and unbundled
network element provisions. AT&T recently has announced its intention to acquire
a leading CLEC, Teleport Communications Group, Inc., and MCI has agreed to be
acquired by WorldCom, which also has very substantial CLEC operations. The
Company cannot predict the number of competitors that will emerge as a result of
existing or new federal and state regulatory or legislative actions. Competition
from the RBOCs with respect to in-region long distance services or from AT&T,
MCI, Sprint or others with respect to local exchange services could have a
material adverse effect on the Company's business.
Competitive Reaction
Although the Company plans to offer rates for its services which are below
those currently charged by ILECs, ILECs or new competitors with greater capital
and resources than the Company may meet or undercut the Company's price
structure and prevent the Company from attaining the share of the local
communications market necessary to achieve profitable operations. The Company's
ability to meet price competition may depend on its ability to operate at costs
equal to or lower than its competitors or potential competitors. There is a risk
that competitors, perceiving the Company to lack capital resources, may undercut
the Company's rates or increase their services in an effort to force the Company
out of business. Competitors may also attempt to place their existing customer
base under long-term contractual agreements which may inhibit the Company's
ability to convert these users to its services. In addition, the success of the
Company will ultimately depend on management's ability to react expeditiously
and effectively to exigencies that have not been taken into account in the
Company's business plan.
Regulation
The Company is subject to varying degrees of federal, state and local
regulation. The Company is not currently subject to price cap or rate of return
regulation, nor is it currently required to obtain FCC authorization for the
installation, acquisition or operation of its network facilities. The Company is
or will be generally subject to certification and tariff or price list filing
requirements for intrastate services by state regulators. Although passage of
the Act should result in increased opportunities for companies competing with
the ILECs, no assurance can be given that changes in current or future
regulations adopted by the FCC or state regulators or other legislative or
judicial initiatives relating to the telecommunications industry would not have
a material adverse effect on the Company. Furthermore, while the Act reduces
regulations to which non-dominant local exchange carriers are subject, it also
reduces the level of regulation that applies to the ILECs and increases their
ability to respond quickly to competition from the Company and others. In
addition, although the Act provides incentives to ILECs to negotiate
interconnection agreements with local competitors, there can be no assurance
the ILECs will negotiate quickly with competitors such as the Company for the
required interconnection of the competitor's networks with those of the ILECs.
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<PAGE> 20
On December 31, 1997, a federal District Court in Texas ruled key sections
of the Act unconstitutional on the grounds that RBOCs were unfairly restricted
by the Act from providing interLATA service in the regions where they also
operate as ILECs until they could show that there was local exchange service
competition in those areas. This decision was immediately appealed by numerous
interexchange carriers ("IXCs") and has been stayed pending appeal. There can be
no assurance that these provisions of the Act, which are favorable to the
Company, will ultimately be determined to be constitutional.
It is anticipated the FCC may issue an order in 1998 permitting significant
new pricing flexibility to ILECs. To the extent such increased pricing
flexibility is afforded to the ILECs, the ability of the Company to compete with
ILECs for certain services may be adversely affected. On May 8, 1997, the FCC
issued an order establishing a new Universal Service support fund. The new
Universal Service support fund rules will be administered jointly by the FCC and
state regulatory authorities, many of which rules are still in the process of
being formulated. The net revenue effect on the Company of these rules is
incalculable at this time.
In some of the areas where the Company provides facilities based services,
the Company may be required to pay license or franchise fees based on a
percentage of gross revenues. There is no assurance that certain local
governmental authorities will not seek to impose such fees in the future.
Lack of Dividend Risk
The Company has never declared or paid any cash dividends on its Common
Stock and does not currently expect to declare any such dividends. Payment of
any future dividends will depend upon the earnings and capital requirements of
the Company, the Company's debt facilities and other factors the Board of
Directors considers appropriate. The Company intends to retain its earnings, if
any, to finance the development and expansion of its business. The Company's
ability to declare and pay dividends on its Common Stock is restricted by
certain covenants in the Indenture governing the Company's 13% Senior Secured
Notes due 2004 (the "Senior Secured Notes").
Year 2000 Risk
The Company has implemented a Year 2000 program to ensure that the
Company's computer systems and applications will function properly beyond 1999.
The Company does not expect to incur significant expenditures to address this
issue. The ability of third parties with whom the Company transacts business to
adequately address their Year 2000 issues is outside of the Company's control.
There can be no assurance that the failure of the Company or such third parties
to adequately address their respective Year 2000 issues will not have a material
adverse effect on the Company's business, financial condition, cash flows and
results of operations.
Forward Looking Statements
The statements contained in this Report that are not historical facts are
"forward-looking statements" which can be identified by the use of
forward-looking terminology such as "estimates," "projects," "anticipates,"
"expects," "intends," "believes" or the negative thereof or other variations
thereon or comparable terminology, or by discussions of strategy that involve
risks and uncertainties. Management wishes to caution the reader of the
forward-looking statements (cautionary statements), such as the Company's plans
to expand to its existing network or to commence service in new areas, the
market opportunity presented by the Company's target markets, the Company's
anticipation of installation of switches or the provision of local exchange and
long distance services, and statements regarding the development of the
Company's business, that the estimate of market sizes and addressable markets
for the Company's
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<PAGE> 21
services and products, the Company's anticipated capital expenditures, the
effect of regulatory reform and other statements contained in this Report
regarding matters that are not historical facts, are only estimates or
predictions. No assurance can be given future results will be achieved; actual
events or results may differ materially as a result of risks facing the Company
or actual events differing from the assumptions underlying such statements. Such
risks and assumptions include, but are not limited to, the Company's ability to
successfully market its services to current and new customers, generate customer
demand for its services in the particular markets where it plans to market
services, access markets, obtain suitable locations for its switches, install
switches, negotiate suitable interconnect agreements with the ILECs and secure
adequate collocation in the COs of the ILECs in its targeted markets, all in a
timely manner, at reasonable costs and on satisfactory terms and conditions, as
well as regulatory, legislative and judicial developments that could cause
actual results to vary materially from the future results indicated, expressed
or implied in such forward-looking statements. All written and oral
forward-looking statements made in connection with this Report which are
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by these cautionary statements.
ITEM 2. PROPERTY
In Las Vegas, the Company has a five year lease (expiring in 2001) with a
five year option for the 8,000 square feet housing its switch site. In addition,
the Company leases 24,125 square feet of additional space to house the Company's
corporate headquarters, national customer service operations, national sales
personnel, Las Vegas sales personnel and general administration. This lease
expires in 2003. This building is owned by a limited liability company which is
principally owned by two of the Company's principal stockholders and Directors,
Maurice J. Gallagher, Jr. and Timothy P. Flynn. See "Certain Relationships and
Related Transactions" in Item 13 of this Report. Management believes the terms
and conditions of this transaction are equal to or better than market rates.
Additionally, Messrs. Gallagher and Flynn have agreed to work with the Company
to construct additional facilities when needed.
The Company leases or owns premises sufficient to house its switch
facilities and its local sales staff and administrative support in its existing
markets and has contracted to acquire properties in Ft. Lauderdale, suburban
Chicago and Long Beach and San Diego, California.
The Company places great importance on each switch facility and seeks to
insure maximum security and environmental control. MGC believes this can be
achieved through standalone structures. This approach minimizes the risk of fire
or other hazards from adjacent tenants or properties.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending legal proceedings of a material
nature.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
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<PAGE> 22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market Information
The Company's Common Stock, $.001 par value, is privately held and there is
no public trading market for the Company's Common Stock. As of March 20, 1998,
there were approximately 100 holders of record of the Company's Common Stock.
Dividends
No cash dividends have ever been declared by the Company on its Common
Stock. The Company intends to retain earnings to finance the development and
growth of its business. Accordingly, the Company does not anticipate that any
dividends will be declared on its Common Stock for the foreseeable future.
Future payments of cash dividends, if any, will depend on the Company's
financial condition, results of operations, business conditions, capital
requirements, restrictions contained in agreements, future prospects and other
factors deemed relevant by the Company's Board of Directors. The Company's
ability to declare and pay dividends on its Common Stock is restricted by
certain covenants in the Indenture governing the Senior Secured Notes.
Unregistered sales of stock
During the period from December 1996, through May 1997, a group of
initial investors in the Company (approximately 80 persons) purchased 14,141,000
shares of Common Stock in the Company for cash in the aggregate amount of
$16,645,275. All such issuances of securities were made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act of
1933 as transactions by an issuer not involving a public offering. All of the
securities were acquired by the recipients thereof for investment and with no
view toward the sale or redistribution thereof. In each instance, the purchaser
was either a founder of the Company, other Company insider as a result of his
relationship with the Company or otherwise had a pre-existing relationship with
the Company or its founders; the offers and sales were made without any public
solicitation; the stock certificates bear restrictive legends; and appropriate
stop transfer instructions have been or will be given to the transfer agent. No
underwriter was involved in the transactions and no commissions were paid.
During September 1997, the Company issued $160,000,000 of its 13% Senior
Secured Notes due 2004 and warrants to purchase 1,291,200 shares of Common Stock
at $.01 per share to qualified institutional investors who purchased the
securities in a private offering under Rule 144A and to persons who purchased
the securities pursuant to offers and sales outside the United States in
accordance with Regulation S. The gross proceeds of this private offering were
$160,000,000, of which $159,300,000 was paid by qualified institutional buyers
under Rule 144A and $700,000 was paid by investors under Regulation S. In each
instance, the offers and sales were made without any public solicitation, the
notes and warrant certificates bear restrictive legends and appropriate stop
transfer instructions will be given to the transfer agent. In connection with
such offering, Bear, Stearns & Co. Inc. and Furman Selz LLC received customary
commissions. All issuances of securities under this private offering were made
in reliance on the exemptions from registration provided by Rule 144A and
Regulation S as transactions by an issuer not involving a public offering.
On September 30, 1997, two officers of the Company purchased 250,000 shares
of Common Stock from the Company for $500,000 in cash and also purchased an
additional 275,000 shares of Common Stock for promissory notes for $687,500. The
Common Stock was purchased pursuant to rights granted to the officers by letter
agreements signed in May 1997 and June 1997. The promissory notes are payable on
or before September 30, 2000, provide for annual interest payments based on an
interest rate of 7.5% per annum and are secured by a pledge of the shares of
Common Stock purchased with such promissory notes. These issuances of securities
were made in reliance on the exemption from registration provided by Section
4(2) of the Securities Act of 1933 as transactions by an issuer
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<PAGE> 23
not involving a public offering; the sales were made without any public
solicitation; the stock certificates bear restrictive legends; and appropriate
stop transfer instructions have been or will be given to the transfer agent. No
underwriter was involved in these transactions and no commissions were paid.
During November 1997 and January 1998, the Company issued 6,571,427 shares
of its Series A Preferred Stock to 50 investors who purchased the securities in
a private placement. The gross proceeds of this private placement were
$23,000,000. All of the securities were acquired by the recipients thereof for
investment and with no view toward the sale or redistribution thereof. In each
instance, the offers and sales were made without any public solicitation, the
stock certificates bear restrictive legends and appropriate stop transfer
instructions will be given to the transfer agent. In connection with such
private placement, Bear, Stearns & Co. Inc. and Furman Selz LLC received
customary commissions with respect to the sale of $18,020,000 of such securities
and no commissions were paid with respect to the sale of $4,980,000 of such
securities. All issuances of securities under this private placement were made
in reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933 as transactions by an issuer not involving a public
offering and Rule 506 under Regulation D promulgated under the Securities Act of
1933.
In January and February 1998, the Company issued 150,000 shares of Common
Stock to four persons (two of whom are Directors of the Company and the other
two of whom are significant stockholders in the Company) who exercised warrants
at $.01 per share for a total consideration of $1,500. These warrants were
issued in September 1997 to these persons in consideration for their providing a
commitment to purchase Common Stock of the Company in the event the Company
failed to sell at least $15,000,000 of its Preferred Stock within a certain
period of time. All of the securities were acquired by the recipients thereof
for investment and with no view toward the sale or redistribution thereof. In
January 1998, a former officer exercised options to purchase 12,000 shares of
Common Stock for a total purchase price of $12,000. These issuances of
securities were made in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933 as transactions by an issuer not
involving a public offering; the sales were made without any public
solicitation; the stock certificates bear restrictive legends; and appropriate
stop transfer instructions have been or will be given to the transfer agent. No
underwriter was involved in these transactions and no commissions were paid.
In March 1998, the Company issued 425,000 shares of Common Stock to 11
Executive Officers of the Company for a total consideration of $2,012,500,
consisting of $562,500 in cash and $1,450,000 in three-year promissory notes.
All of the securities were acquired by the recipients thereof for investment and
with no view toward the sale or redistribution thereof. These issuances of
securities were made in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933 as transactions by an issuer not
involving a public offering; the sales were made without any public
solicitation; the stock certificates bear restrictive legends; and appropriate
stop transfer instructions have been or will be given to the transfer agent. No
underwriter was involved in these transactions and no commissions were paid.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is as follows:
<TABLE>
<CAPTION>
(in thousands except per share data)
1997 1996 1995
------------------------------------------------
<S> <C> <C> <C>
Operating revenues $3,791 $ 1 $ --
Net loss (10,836) ( 1,491) --
Basic and diluted loss per (.78) (1.27) --
share of common stock*
Total assets 191,977 12,339 1
Long-term debt including
current maturities 156,637 -- --
Redeemable Series A
Convertible Preferred Stock 16,665 -- --
</TABLE>
* See Note 1 of Notes to Financial Statements
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<PAGE> 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
MGC began providing competitive local exchange services to small businesses
and residential users in December 1996, and in February 1998, began offering
long distance services in its existing markets. MGC's network strategy consists
of purchasing and deploying switching equipment, collocating equipment in ILECs'
COs and leasing fiber optic transmission capacity from ILECs and other providers
of telecommunications transport services. Currently, the Company has switches
fully operational in Las Vegas and in selected suburban areas in Atlanta and Los
Angeles.
The Company's 1997 revenues were primarily generated from non-recurring
(principally installation charges) and recurring local phone service and
switched access billings. As a result of the introduction of long distance and
data services in late 1997, the Company expects that a meaningful portion of its
revenues will be generated from such services beginning in 1998.
The Company's principal operating expenses consist of: direct costs,
operating costs and depreciation. Direct costs consist of access charges, line
installation expenses, transport expenses, engineering costs and long distance
expenses. Operating costs are comprised of sales and marketing, customer service
and general and administrative expenses. As the Company expands into new
markets, both direct costs and selling, general and administrative costs
increase prior to achieving significant revenue. Significant levels of marketing
activity may be necessary in new markets in order for the Company to build a
customer base large enough to generate sufficient revenue to offset such
marketing expenses. In addition, selling, general and administrative costs may
increase in the short term after the Company enters a new market because many of
the fixed costs of providing service in new markets are incurred before
significant revenue can be expected from those markets.
The development and expansion of the Company's business will require
significant expenditures. The Company's capital expenditures primarily consist
of the purchase of telecommunications switching and associated equipment, the
purchase of land for host switching sites and the construction of buildings or
leasehold improvements to house host switches. As part of its network strategy,
the Company has made the strategic decision to purchase and install Nortel DMS
500 switches in each of its target markets. This strategy initially increases
its level of capital expenditures and operating losses. However, over the long
term, the Company believes this will enhance the Company's financial
performance.
The Company has experienced operating losses and generated negative
operating cash flow since inception and expects to continue to generate negative
operating cash flow through 2000 and to incur significant operating losses
during the next several years while it installs and expands its networks and
develops its business. There can be no assurance the Company's revenue or
customer base will grow or that the Company will be able to achieve or sustain
positive cash flow.
RESULTS OF OPERATIONS
The Company's operations prior to December 1996 were limited to start-up
activities and, as a result, the Company's revenues prior to December 1996
(limited to interest earned on cash deposits) and expenditures for such period
are not indicative of anticipated revenues which may be attained or expenditures
which may be incurred by the Company in future periods. The Company did not
begin revenue generating operations until December 1996. As a result, any
comparison of the three months or year ended December 31, 1997 with the three
months or year ended December 31, 1996 would not be meaningful. Consequently,
the following is a comparison of the fourth quarter 1997 with the third quarter
1997.
Quarter over Quarter Comparison -- December 31, 1997 vs. September 30, 1997
Total operating revenues for the quarter ended December 31, 1997 were $1.9
million as compared to $1.1 million for the quarter ended September 30, 1997.
The increase from the third quarter 1997 to the fourth quarter 1997 is a
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<PAGE> 25
result of the increase in the number of lines placed in service during the
fourth quarter. The Company had 15,590 lines in service at the end of the fourth
quarter as compared to 12,710 lines in service at the end of the third quarter.
Cost of operating revenues for the quarter ended December 31, 1997 was $1.4
million as compared to $1.2 million for the quarter ended September 30, 1997.
The increase from quarter to quarter is due to the increased number of lines
placed in service during the fourth quarter 1997.
For the quarter ended December 31, 1997, selling, general and
administrative expenses totaled $2.5 million as compared to $1.8 million for the
quarter ended September 30, 1997. These expenses were incurred in connection
with the initial marketing of the Company's services and the continued buildout
of the Company's network. These expenses consisted primarily of payroll
expenses, provision for bad debts, professional fees and rents.
Depreciation and amortization expense includes depreciation on switching
equipment as well as general property and equipment. For the quarter ended
December 31, 1997 depreciation and amortization was $0.5 million as compared to
$0.4 million for the quarter ended September 30, 1997. This increase is a result
of the Company's placing additional assets in service during the fourth quarter
in accordance with the planned buildout of its network.
Interest expense for fourth quarter 1997 totaled $5.4 million as compared
to$0.1 million for third quarter 1997. This amount is attributable to interest
incurred on the Senior Secured Notes issued by the Company in late September
1997.
Interest income for the quarter ended December 31, 1997 was $2.2 million as
compared to $0.1 million for the quarter ended September 30, 1997. The increase
is attributable to earnings on investments made in late September 1997 with the
proceeds from the issuance of Senior Secured Notes.
The Company incurred net losses of $5.7 million and $2.3 million during
fourth quarter 1997 and third quarter 1997, respectively.
Year ended December 31, 1997
During the year ended December 31, 1997, the Company generated $3.8 million
in operating revenues, had cost of operating revenues of $3.9 million and
incurred selling, general and administrative expenses of $6.4 million in
connection with the initial marketing of its services and the continued buildout
of its network. These expenses consisted primarily of payroll expenses,
provision for bad debts, professional fees and rents.
During the year ended December 31, 1997, the Company recorded bad debt
expense of approximately $0.7 million primarily because its credit procedures
for residential customers were not sufficiently stringent. To begin remedying
the situation, a cash prepayment policy for prospective customers was introduced
in October 1997 and approximately 3,900 lines were disconnected for non-payment.
Effective January 1, 1998, the Company enhanced its credit procedures by
introducing credit scoring via a nationally recognized credit verification
service and, where appropriate, by requiring deposits prior to initiating
service. Additional personnel have been dedicated to collections and credit
monitoring to seek to improve the quality of the Company's accounts receivable.
Depreciation and amortization expense for the year was $1.3 million as a
result of the Company's assets placed in service in accordance with the planned
buildout of its network.
Interest expense for the year ended December 31, 1997 totaled $5.5 million.
This amount is attributable to interest incurred on the Senior Secured Notes
issued by the Company in late September 1997.
The Company had interest income of $2.5 million for the year ended December
31, 1997, as a result of earnings on investments made with the proceeds of its
private placements.
As a result, the Company incurred a net loss for the year of $10.8 million.
The loss is primarily attributable to the expenses incurred during the period in
connection with the continued development of the Company's business.
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<PAGE> 26
Year ended December 31, 1996
During the year ended December 31, 1996, the Company generated $1,000 in
operating revenues as a result of commencing service during the month of
December. The Company had cost of operating revenues of $0.3 million which
represents primarily fixed costs. In addition, the Company incurred other
operating expenses, including depreciation and amortization, of $1.3 million in
connection with the commencement of operations and the buildout of its network.
These expenses consisted primarily of payroll expenses, professional fees,
expenses related to the introduction of initial service and a one-time write-off
of purchased software.
The Company earned interest income in the period of $0.1 million.
As a result, the Company incurred a net loss in the period of $1.5 million.
This loss is primarily attributable to the expenses incurred in connection with
the initial development of the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have required substantial capital investment for
the purchase of communications equipment and the design and development of the
Company's networks. Capital expenditures for the Company were $3.7 million and
$22.6 million in 1996 and 1997, respectively. The Company expects it will
continue to have substantial capital requirements in connection with the (i)
purchase of switches necessary for expansion of local exchange services and
provisioning of long distance services, and (ii) development of new markets.
Management expects capital expenditures of $84.6 million for 1998.
The Company has funded a substantial portion of these expenditures through
the private sales of debt and equity securities. From its inception through
December 31, 1997, the Company raised approximately $17.1 million from private
sales of Common Stock.
In September 1997, the Company completed an offering of units consisting of
$160 million of Senior Secured Notes and warrants to purchase 1,438,205 shares
of Common Stock (after giving effect to certain anti-dilution adjustments). At
the closing of the sale of the Senior Secured Notes, the Company used
approximately $56.8 million of the net proceeds of the sale of the Senior
Secured Notes to purchase a portfolio of securities that has been pledged as
security to cover the first six interest payments on the Senior Secured Notes
and the Company used approximately $3.1 million of the net proceeds to pay
accounts payable incurred in connection with the acquisition of equipment. In
addition, the Company has granted the holders of the Senior Secured Notes a
security interest in certain of the Company's communications equipment.
In November 1997 and January 1998, the Company issued an aggregate of
6,571,427 shares of Series A Convertible Preferred Stock at $3.50 per share for
net proceeds of $21.7 million.
The substantial capital investment required to initiate the Company's
services and the funding of the Company's initial operations has resulted in
negative cash flow since the Company's inception. This negative cash flow is a
result of the need to establish the Company's switching network in anticipation
of connecting revenue generating customers. The Company expects to continue to
produce negative cash flow through 2000 due to expansion activities associated
with the development of the Company's markets. There can be no assurance the
Company will attain break-even cash flow in subsequent periods. Until sufficient
cash flow is generated, the Company will be required to utilize its current and
future capital resources to meet its cash flow requirements and may be required
to issue additional debt and/or equity securities. There can be no assurance the
Company will not require additional financing or as to the availability or the
terms upon which such financing might be available. Moreover, the indenture
governing the Senior Secured Notes imposes certain restrictions upon the
Company's ability to incur additional indebtedness or issue preferred stock.
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<PAGE> 27
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer-controlled systems using two
digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
The Company believes its internal software and hardware systems will
function properly with respect to dates in the year 2000 and thereafter. The
Company is in the process of contacting all of its significant suppliers to
determine the extent to which the Company's interface systems are vulnerable to
those third parties' failure to remediate their own Year 2000 issues.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity sections of a statement of
financial position, and is effective for financial statements issued for fiscal
years beginning after December 15, 1997. The Company is currently assessing the
impact on the financial statements for the year ended December 31, 1997 and for
the year ended December 31, 1996 and believes that SFAS No. 130 will not result
in comprehensive income different from net income as reported in the
accompanying financial statements.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information. SFAS No. 131 establishes additional
standards for segment reporting in financial statements and is effective for
fiscal years beginning after December 15, 1997. The Company currently operates
as one segment.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required to be included.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this Item is submitted as a separate section of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company did not re-elect KPMG Peat Marwick LLP ("KPMG") as its
independent accountant on February 6, 1998. KPMG's report on the Company's
financial statements for the years ended December 31, 1996 and 1995, did not
contain an adverse opinion or a disclaimer of opinion and was not qualified or
modified as to uncertainty, audit scope or accounting principles. The decision
to change accountants was approved by the Company's Board of Directors. During
KPMG's engagement with the Company, there have been no disagreements with KPMG
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure which were
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<PAGE> 28
not resolved to KPMG's satisfaction. During KPMG's engagement with the Company,
there have been no reportable events (as defined in Item 304(a)(1)(v) of
Regulation S-K issued under the Securities Act of 1933, as amended).
As of February 6, 1998, Arthur Andersen LLP has been engaged by the Company
as its principal accountants to audit the Company's financial statements
beginning with the financial statements for the year ended December 31, 1997.
The Company did not consult Arthur Andersen LLP prior to its engagement
regarding the application of accounting principles to a specified transaction,
either completed or proposed, the type of audit opinion that might be rendered
on the Company's financial statements or any matter that was either the subject
of a disagreement with KPMG or a reportable event.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth, as of February 28, 1998, the name, age and
position within the Company of each Executive Officer and Director of the
Company. Their respective backgrounds are described following the table.
<TABLE>
<CAPTION>
Name Age Position
- ------------------------------- --- -----------------------------
<S> <C> <C>
Maurice J. Gallagher, Jr....... 48 Chairman of the Board of Directors
Nield J. Montgomery............ 53 Chief Executive Officer, President, Director
Timothy P. Flynn............... 47 Director
Jack Hancock................... 67 Director
David Kronfeld................. 50 Director
Thomas Neustaetter............. 46 Director
Mitchell Allee................. 46 Vice President--Information Technology, Chief Information Officer
John Boersma................... 37 Vice President--Operations
Michael E. Burke............... 53 Vice President--Network Operations
David S. Clark................. 37 Vice President--Marketing
Kent F. Heyman................. 42 Vice President and General Counsel
James J. Hurley, III........... 49 President--Midwest Region
Thomas G. Keough............... 53 Vice President--Sales
James Mitchell................. 37 President--Eastern Region
Carol A. Mittwede.............. 42 Vice President--Human Resources
Mark W. Peterson............... 43 President--Western Region
David A. Rahm.................. 43 Vice President--Network Development
Walter J. Rusak................ 49 Vice President--Engineering
Linda M. Sunbury............... 36 Vice President--Chief Financial Officer
</TABLE>
MAURICE J. GALLAGHER, JR. has served as the Chairman of the Board of
Directors since the Company's founding. Mr. Gallagher was instrumental in
organizing the Company with Mr. Montgomery. Mr. Gallagher was a founder of
ValuJet in 1993 and served as a Director of ValuJet from 1993 until November
1997. Mr. Gallagher also held prior positions (President and Chief Financial
Officer) with ValuJet from 1993 to 1994 and served as Vice Chairman from 1994 to
1997. Prior to that, Mr. Gallagher was a founder and President of WestAir
Holding, Inc. ("WestAir"), a commuter airline headquartered in Fresno,
California. WestAir was sold to Mesa Airlines ("Mesa") in June 1992. Mr.
Gallagher was a member of the Mesa Board of Directors from June 1992 through
March 1993 and served as a Director of Submicron Systems, Inc. from April 1997
until November 1997.
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<PAGE> 29
NIELD J. MONTGOMERY has been the Chief Executive Officer and President and
a member of the Board of Directors of the Company since he participated in its
founding. Mr. Montgomery has over 35 years of telephone experience, most
recently serving as a general manager for ICG from April 1994 to June 1995. In
that capacity, he was responsible for developing strategy and deploying
telephone switches nationally to position IGC to enter the local phone service
business. Prior to that, Mr. Montgomery served as General Marketing and Sales
Manager for Sprint/Centel (successor to Centel Nevada) ("Centel"). During his 13
year Centel career from 1989 to 1993, he served in senior executive positions
directing engineering, operations, business office, sales, and marketing
functions. Before joining Centel, Mr. Montgomery held a variety of management
positions with NYNEX from 1969 to 1980.
TIMOTHY P. FLYNN has served as Member of the Board of Directors of the
Company since 1996. Mr. Flynn served as a member of the Board of Directors of
ValuJet since he participated in its founding in 1993 until November 1997. Prior
to that, Mr. Flynn was Chairman of the Board and CEO of WestAir Holding, Inc. He
and Mr. Gallagher founded WestAir in 1983 and operated it through June 1992 when
it was sold to Mesa. Mr. Flynn was a member of the Board of Directors of Mesa
from June 1992 through March 1993. Mr. Flynn and Mr. Gallagher are affiliated in
a number of other transactions.
JACK L. HANCOCK has served as a Member of the Board of Directors of the
Company since 1996. Mr. Hancock was Vice President of Systems Technology and
Executive Vice President, Product and Technology for PacBell (from 1988 to
1993). Prior to joining PacBell, Mr. Hancock was Executive Vice President for
Information Systems, Strategic Planning, and Human Resources at Wells Fargo Bank
(from 1982 to 1987). Before that, he was Senior Vice President for Management
Information Systems at Chemical Bank (from 1978 to 1981). He is a member of the
Boards of Directors of several public and private companies, including Union
Bank of California (from 1994 to present) and Wittaker Corporation (from 1994 to
present).
DAVID KRONFELD was elected to serve as a Director of the Company in
February 1998. Mr. Kronfeld is the founder of JK&B Management Co., L.L.C., a
venture capital firm, and has managed its affairs since 1995. Since 1989, Mr.
Kronfeld has also been a partner at Boston Capital Ventures, a venture capital
firm where he specialized in the telecommunications and software industries.
From 1984 to 1989, Mr. Kronfeld was Vice President of Acquisitions and Venture
Investments at Ameritech. Mr. Kronfeld was a Senior Manager at Booz, Allen &
Hamilton, an international management consulting firm, from 1977 to 1982 and a
systems analyst at Electronic Data Systems from 1973 to 1975.
THOMAS NEUSTAETTER was elected to service as a Director in February 1998.
Since January 1996, Mr. Neustaetter has been a principal in The Chatterjee Group
("TCG"), an investment firm. Prior to TCG, he was managing director and founder
of Bancroft Capital (financial advisory services) from January 1996 to December
1996 and was a managing director at Chemical Bank from 1990 to 1995.
MITCHELL ALLEE has served as Vice President -- Information Technology and
Chief Information Officer of the Company since July 1997. Although Mr. Allee is
expected to devote the majority of his time to the Company, pursuant to an
independent contractor agreement, he will continue to direct CMS Solutions
("CMS"), a company which he owns and serves as president. Since its founding in
1985, CMS has been a software development company specializing in high volume
financial transaction software. CMS clients have ranged from the smallest public
utility district in California to Unocal Corporation where CMS developed a
nationwide chemical distribution and accounting system. CMS also developed a
ticketless reservation system for ValuJet.
JOHN BOERSMA has served as Vice President -- Operations of the Company
since May 1997. He served as Vice President of Carrier Relations for ICG Telecom
Group, Inc. ("ICG Telecom") from 1996 to 1997. He was responsible for ICG
Telecom's relationship with local exchange carriers and implementation, purchase
agreements and service quality and served as Vice President, Northern California
Operations from April 1994 to September 1996. He joined Bay Area Teleport, now a
part of ICG Telecom, in 1986 and held various positions having responsibility
for overall financial and operational performance, marketing management, new
business development, regulatory affairs, and information systems development.
He served on the Association for Local Telecommunications Services (ALTS) Board
of Directors and served as the chairman of the association's Tariff Committee
from 1991 until 1993.
MICHAEL E. BURKE has served as Vice President -- Network Operations of the
Company since December 1996. Mr. Burke has over 27 years of engineering and
engineering project management experience in the telecommunications industry,
and served from 1990 to 1995 as a member of the Board of Directors and as Vice
President -- Network Design for Contel of California. Mr.
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<PAGE> 30
Burke also served in various engineering management roles with Continental
Telephone Company (from 1971 to 1995), California Pacific Utilities (from 1970
to 1971), and General Telephone Company of California (from 1963 to 1970).
DAVID S. CLARK has served as Vice President - Marketing of the Company
since May 1997. Mr. Clark has been in the telecommunications industry for nine
years, with responsibilities including engineering, purchasing, product
development, client acquisition and maintenance, marketing and advertising. From
1989 to 1997, Mr. Clark was employed by North American InTeleCom, his last
position being Vice President of Communications Services. Prior to that, Mr.
Clark held various management positions with national advertising agencies.
KENT F. HEYMAN has served as Vice President and General Counsel of the
Company since June 1996. Mr. Heyman has 17 years of legal experience, most
recently as chairman of the litigation department and Senior Trial Counsel of
the Dowling, Magarian, Aaron & Heyman Law Firm. Mr. Heyman has served as a
California Superior Court Judge pro tempore presiding over trial, settlement
conference and other proceedings from 1990 to 1996.
JAMES J. HURLEY, III has served as President -- Midwest Region of the
Company since March 1998. He previously served as Chief Operating Officer of
Wireless Works, Inc. in Chicago, Illinois from 1996 to 1998. From 1992 to 1996,
Mr. Hurley was President and Chief Executive Officer of Inn Room Systems, Inc.
(a manufacturer of on-line room refreshment centers). From 1976 to 1992, he
held various finance, administration and operations management positions with
Centel Corporation. Mr. Hurley began his career with Arthur Andersen and
Company from 1970 to 1976.
THOMAS G. KEOUGH has served as Vice President -- Sales of the Company since
December 1996 and is responsible for all sales of the Company. He has over 20
years experience as a marketing and sales executive, serving most recently as
Executive Vice President and Director of Sales for Jetstream Aircraft, a
subsidiary of British Aerospace from 1992 to 1996. Mr. Keough also served in
senior marketing and sales management roles with Beech Aircraft (from 1989 to
1992), Bombardier (from 1988 to 1989), Saab Aircraft of America (from 1983 to
1988), and DeHavilland (from 1976 to 1983).
JAMES MITCHELL has served as President - Eastern Region of the Company
since February 1998. Mr. Mitchell has over eight years of telephone industry
experience, serving from 1990 to 1998 in various sales and marketing management
roles with MCI, his last position being Regional Sales and Marketing Manager for
the Southeast Region. Prior to joining MCI, Mr. Mitchell served as General
Partner and Chief Financial Officer of Oak Value Partners, (a private money
management firm) from 1987 to 1990. Mr. Mitchell began his career as an auditing
associate with Price Waterhouse in Philadelphia.
CAROL MITTWEDE has served as Vice President - Human Resources since January
1998. Her responsibilities include all aspects of human resource management for
MGC. Ms. Mittwede has spent the past 18 years working in the casino industry in
both human resources and operations. She was Vice President of Human Resources
for the 2,000 room Flamingo Hilton in Laughlin, Nevada from 1989 to 1994. From
1994 to 1997, she served as the Vice President and General Manager of the Las
Vegas Hilton.
MARK W. PETERSON has served as President -- Western Region of the Company
since March 1997. He previously served as head of corporate affairs for both
WestAir Holding, Inc. operating as United Express in Fresno, California from
1988 to 1992 and for AirCal Airlines in Newport Beach, California from 1978 to
1982. He also served as a marketing communications manager with Bank of America
in San Francisco, worked as marketing consultant in Northern California from
1985 to 1986, and was an instructor in business communications at California
State University, Chico.
DAVID A. RAHM has served as Vice President -- Network Development of the
Company since May 1996. Mr. Rahm served as general counsel of Chadmoore Wireless
Group, Inc. from 1995 to 1996. Prior to that, Mr. Rahm served as Director of
Administration, Acting Director of Production and General Counsel of Sigma Game,
Inc. from 1993 to 1994. Mr. Rahm also served as Assistant Vice President,
Manager of Marketing, Credit, Leasing and Administration for Lodgistix, Inc.
from 1980 to 1990.
WALTER J. RUSAK has served as Vice President -- Engineering of the Company
since March 1998. Mr. Rusak served as Chief Technical Officer of United Digital
Network, Inc. from 1996 to 1998. Previously, Mr. Rusak was Senior Vice President
and General Manager of California for ICG from 1995 to 1996. From 1991 to 1995,
he was Vice
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<PAGE> 31
President of Operations for U.S. Long Distance, Inc. Mr. Rusak was Director of
Domestic Network Engineering for MCI from 1989 to 1991. From 1970 to 1989, Mr.
Rusak held various engineering management positions with RBOCs and IXCs.
LINDA M. SUNBURY has served as Vice President of the Company since June
1996 and Chief Financial Officer of the Company since February 1998. Ms. Sunbury
has over 12 years accounting and administrative experience, having held similar
positions in the airline industry. Most recently, Ms. Sunbury was Vice President
of Administration for Business Express, Inc. ("Business Express") dba the Delta
Connection from 1994 to 1996. While Ms. Sunbury was at Business Express,
creditors of Business Express filed an involuntary petition for bankruptcy in
January 1996. Business Express subsequently reorganized and emerged from
bankruptcy in April 1997. Prior to that, Ms. Sunbury served as Controller for
WestAir Holding Inc. operating as United Express from 1988 to 1994. Ms. Sunbury
began her career with the accounting firm of KPMG Peat Marwick LLP where she was
employed from 1983 to 1988.
Messrs. Kronfeld and Neustaetter have been selected to serve on the Board
of Directors by holders of the Company's Series A Convertible Preferred Stock in
accordance with the terms of such Series A Convertible Preferred Stock.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table shows, for the fiscal year ended December 31, 1997, the
cash compensation paid by the Company, as well as certain other compensation
paid or accrued for such year, for the Company's Chief Executive Officer and the
four highest paid other Executive Officers. No compensation was paid to any
Executive Officers of the Company prior to April 1, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
Awards All other
Name and Principal Position Year Salary Bonus Options Compensation
- ------------------------------------------ ---- ----------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Nield J. Montgomery 1997 $139,424 $20,000 --- ---
President and Chief Executive Officer 1996 45,077 (1) --- 600,000 ---
Thomas G. Keough 1997 $105,769 $10,000 --- $21,713 (2)
Vice President -- Sales 1996 --- --- 80,000 ---
Michael E. Burke 1997 $100,000 $10,000 --- $2,876 (2)
Vice President -- Network Operations 1996 3,846 --- 60,000 250 (2)
Michael D. English(3) 1997 $100,000 --- --- ---
Vice President -- Eastern Region 1996 11,923 --- 60,000 ---
Kent F. Heyman 1997 $90,000 $10,000 --- ---
Vice President and General Counsel 1996 48,462 --- 80,000 ---
</TABLE>
(1) $2,000 of such compensation was paid in April 1996, prior to the
commencement of the Company's operations, in the form of 800,000 shares of
Common Stock in the Company.
(2) The amounts indicated were paid for reimbursement of moving and related
expenses.
(3) Mr. English's employment with the Company terminated in January 1998.
EMPLOYMENT AND STOCK PURCHASE/REPURCHASE AGREEMENTS
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<PAGE> 32
Nield J. Montgomery. The Company's employment agreement with Mr. Montgomery
provides for a base salary of $150,000 per year, effective September 1, 1997,
and discretionary bonuses. Prior to the commencement of revenue producing
operations in December 1996, Mr. Montgomery's base salary was $5,000 per month.
Mr. Montgomery is required to devote his full time and efforts to the business
of the Company during the term of his employment agreement which expires in
September 2000. Mr. Montgomery's employment may be terminated by either the
Company or Mr. Montgomery at any time. Mr. Montgomery has agreed not to
participate in a business offering local, long distance and related telephone
services during the term of his employment and for a period of 18 months
following termination. If Mr. Montgomery's employment is terminated by the
Company without cause, he will be entitled to severance pay of $150,000 payable
over a period of 12 months. Under the terms of Mr. Montgomery's employment
agreement, the other stockholders have certain rights to repurchase a portion of
Mr. Montgomery's stock in the Company if his employment is terminated on or
before April 1, 2001.
Mitchell Allee. Mitchell Allee has exercised certain rights to acquire
200,000 shares of Common Stock at $2.00 per share and an additional 175,000
shares of Common Stock at $2.50 per share. The Company has agreed to finance
over a period of three years the purchase price of the shares purchased at $2.50
per share. A prorated portion of such shares is subject to repurchase at their
cost if Mr. Allee's engagement with the Company is terminated (other than as a
result of his death or disability) prior to June 2000.
Other Executive Officers. The Company has entered into Employment/Stock
Repurchase Agreements with several of its Executive Officers (John Boersma,
Michael E. Burke, David S. Clark, Kent F. Heyman, James J. Hurley III, Thomas G.
Keough, James Mitchell, Carol A. Mittwede, Mark W. Peterson, David A. Rahm,
Walter J. Rusak and Linda M. Sunbury). These agreements establish base salaries
and provide that each employee may earn a bonus of up to 50% of his or her base
salary based on the employee's and the Company's performance. Each employee's
employment may be terminated at any time by either the Company or the employee.
Each of these Executive Officers has agreed not to participate in a business
offering local, long distance and related telephone services in the area of his
or her employment during the term of employment and for a period of six months
following termination. Each of these Executive Officers has exercised rights to
acquire Common Stock at $3.50 to $5.00 per share. All or a portion of such
shares are subject to repurchase at their cost if the Executive Officer's
employment with the Company is terminated within a three year period. The
Company has financed the purchase price of certain of these shares over a period
of three years. See "Certain Relationships and Related Transactions" in Item 13
of this Report.
STOCK OPTION PLAN
The Company has adopted the NevTEL, Inc. Stock Option Plan (the "Plan"). A
total of 4,400,000 shares of Common Stock are reserved for issuance under the
Plan. As of March 20, 1998, options to purchase 2,136,200 shares have been
granted under the Plan. As of March 20, 1998, 12,000 options issued under the
Plan have been exercised and options to purchase 127,000 shares have lapsed. At
such date, options to purchase 1,997,200 shares were outstanding under the Plan
at an average exercise price of $1.90 per share. Options for up to 2,402,800
additional shares may be granted under the Plan.
Options granted under the Plan may be either incentive stock options or
nonqualified options.
The Plan contemplates that options may be granted to directors, employees
and consultants of the Company. The exercise price of the options granted under
the Plan will be determined by the Company's Board of Directors or by the
Compensation Committee of the Board of Directors. The terms of the options and
the dates after which they become exercisable are established by the
Compensation Committee or the Board of Directors, subject to the terms of the
Plan. Options granted under the Plan generally vest over a five year period.
The Company has from time to time granted stock options under the Plan in
order to provide certain officers, directors, employees and consultants with a
competitive total compensation package and to reward them for their contribution
to the Company's performance. These grants of stock options are designed to
align the individual's interest with that of the Stockholders of the Company.
BONUS PLAN
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<PAGE> 33
The Company's Bonus Plan is predicated on established EBITDA targets and
individual goals and achievements of key corporate personnel.
OPTION GRANTS IN LAST FISCAL YEAR
During the 1997 fiscal year there were no options granted to any of the
Executive Officers of the Company named in the Compensation Table above.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES
The following table shows aggregate exercises of options during 1997 and
the values of options held by the Company's Executive Officers named in the
Compensation Table above as of December 31, 1997.
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
DECEMBER 31, 1997 (#) DECEMBER 31, 1997 (1)
Valued EXERCISABLE (E)/ EXERCISABLE (E)/
Name on Exercise Realized UNEXERCISABLE (U) UNEXERCISABLE (U)
- --------------------- ----------- -------- --------------------- ---------------------
<S> <C> <C> <C> <C>
Nield J. Montgomery - - 120,000 E $ 277,200 E
- - 480,000 U $1,108,800 U
Thomas G. Keough - - 16,000 E $ 12,960 E
- - 64,000 U $ 51,840 U
Michael E. Burke - - 12,000 E $ 21,720 E
- - 48,000 U $ 86,880 U
Michael D. English - - 12,000 E $ 21,720 E
- - 48,000 U $ 86,880 U
Kent F. Heyman - - 16,000 E $ 28,960 E
- - 64,000 U $ 115,840 U
</TABLE>
(1) Amounts shown are based upon the estimated fair market value for the
Company's Common Stock on December 31, 1997, which was $2.81 per share.
DIRECTOR COMPENSATION
The Company's outside Directors receive meeting fees of $500 per meeting of the
Board of Directors or committees of the Board of Directors attended in person in
addition to reimbursement of their expenses in attending meetings of the Board
of Directors.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 20, 1998, certain
information with respect to the Company's Common Stock owned beneficially by
each director, by all Executive Officers and Directors as a group and by each
person known by the Company to be a beneficial owner of more than 5% of the
outstanding Common Stock of the Company. Except as noted in the footnotes, each
of the persons listed has sole investment and voting power with respect to the
shares of Common Stock included in the table.
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<PAGE> 34
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OWNERSHIP (1)
- ----------------------------- ------------------ ------------------
<S> <C> <C>
Maurice J. Gallagher, Jr. (2).......................................... 5,311,500 24.3%
David Kronfeld (3)..................................................... 1,714,286 7.8%
Timothy P. Flynn (4)................................................... 1,491,500 6.8%
Robert L. and Carol A. Priddy (5)...................................... 1,482,500 6.8%
Nield J. Montgomery (6)................................................ 1,380,000 6.3%
Circle F Ventures, LLC (7)............................................. 1,250,000 5.7%
Thomas Neustaetter (8)................................................. 1,142,857 5.2%
Wind Point Partners III, L.P. (9)...................................... 1,142,857 5.2%
Jack L. Hancock (10)................................................... 54,000 *
All Executive Officers and Directors as a Group
(19 persons) (2)(3)(4)(6)(8)(10)(11).............................. 12,946,372 58.6%
</TABLE>
- -------------------
* Less than 1% of total.
(1) The percent of outstanding Common Stock owned is determined by assuming the
conversion of all outstanding Series A Convertible Preferred Stock and by
assuming that in each case the person only, or group only, exercised his or
its rights to purchase all shares of Common Stock underlying presently
exercisable stock options.
(2) Includes options to purchase 20,000 shares of Common Stock which are
presently exercisable, 5,212,500 shares of Common Stock owned by the
various partnerships, trusts or corporations with respect to which Mr.
Gallagher is a general partner, beneficiary and/or controlling stockholder,
and 41,500 shares of Series A Convertible Preferred Stock. Mr. Gallagher's
address is 3301 N. Buffalo Drive, Las Vegas, Nevada 89129.
(3) Includes 957,143 shares of Series A Convertible Preferred Stock owned by
JK&B Capital, L.P. ("JK&B"), 471,429 shares of Series A Convertible
Preferred Stock owned by JK&B Capital II, L.P. ("JK&BII") and 285,714
shares of Series A Convertible Preferred Stock owned by Boston Capital
Ventures III, L.P. ("BCV"). JK&B Management Co., L.L.C. ("JK&BM") is the
general partner of JK&B and JK&B II. David Kronfeld is the manager of
JK&BM. The address of these beneficial owners is c/o JK&B Capital
Management, L.L.C., 205 North Michigan, Suite 808, Chicago, Illinois 60601.
Mr. Kronfeld is a general partner of BCV.
(4) Includes options to purchase 4,000 shares which are presently exercisable.
Includes 170,000 shares of Common Stock owned by various partnerships or
corporations with respect to which Mr. Flynn is a general partner and/or
controlling stockholder and 45,000 shares of Series A Convertible Preferred
Stock. Mr. Flynn's address is 6900 Westcliff Drive, Suite 505, Las Vegas,
Nevada 89128.
(5) Includes 45,000 shares of Series A Convertible Preferred Stock. The
Priddys' address is 9410 Laguna Niguel Drive, Las Vegas, Nevada 89134.
(6) Includes options to purchase 120,000 shares which are presently
exercisable. Mr. Montgomery's address is 3301 N. Buffalo Drive, Las Vegas,
Nevada 89129.
(7) Includes 250,000 shares owned by Hayden R. Fleming, the managing member of
Circle F Ventures, LLC. Mr. Fleming has voting and dispositive power over
the shares of Common Stock owned by Circle F Ventures, LLC. The address of
Hayden R. Fleming and Circle F Ventures, LLC is 14988 N. 78th Way,
Scottsdale, Arizona 85260.
(8) Includes 571,429 shares of Series A Convertible Preferred Stock owned by
Strategic Investment Partners Limited ("SIP"), 357,142 shares of Series A
Convertible Preferred Stock owned by S-C Phoenix Holdings, L.L.C. ("SC"),
142,857 shares of Series A Convertible Preferred Stock owned by Winston
Partners II LDC ("Winston LDC") and 71,429 shares of Series A Convertible
Preferred Stock owned by Winston Partners II LLC ("Winston LLC"), entities
associated with Chatterjee
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<PAGE> 35
Management Company. Mr. Neustaetter is an officer of Chatterjee Management
Company. Mr. Neustaetter disclaims beneficial ownership of these shares
over which he does not exercise investment or voting power. Purnendu
Chatterjee may be deemed to be the person ultimately in control of
Chatterjee Management Company and may be deemed to have ownership of the
shares set forth above. Mr. Neustaetter's and Dr. Chatterjee's address is
c/o Chatterjee Management Company, 888 Seventh Avenue, New York, New York
10106.
(9) Includes 1,142,857 shares of Series A Convertible Preferred Stock. Wind
Point Partners III, L.P. ("WPIII") is a private equity investment limited
partnership, for which Wind Point Investors, L.L.C. ("WPI") is the general
partner. Decisions with respect to investment and voting of shares by WPI
are made by a committee of managing directors. WPI expressly disclaims
beneficial ownership of shares owned by WPIII. The address of this
beneficial owner is 676 N. Michigan Avenue, Suite 3300, Chicago, Illinois
60611.
(10) Includes options to purchase 4,000 shares which are presently exercisable.
(11) Includes options to purchase 127,000 shares owned by Executive Officers not
named above which are presently exercisable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has entered into an agreement to lease 24,125 square feet of
office space from a limited liability company which is principally owned by two
of the Company's Directors and principal stockholders, Maurice J. Gallagher, Jr.
and Timothy P. Flynn. The rental rate is $1.65 per square foot per month which
includes common area maintenance charges of $.20 per square foot per month.
Management believes that the terms and conditions of this lease arrangement are
at least as favorable to the Company as those which the Company could have
received from an unaffiliated third party.
During 1997, the Company paid $68,000 to a corporation principally owned
by Messrs. Gallagher and Flynn for charter services in connection with the
issuance of the Senior Secured Notes.
The Company has entered into an agreement with Palms Centre Drive, Inc.
("PCDI"), a company owned and operated by Mitchell Allee, an officer and
stockholder of the Company, to provide, support and maintain the Company's
proprietary management information computer system. Management believes that the
terms of the agreement with PCDI are at competitive prices and terms. During
1997, the Company paid $640,000 to PCDI for these services, including $600,000
for the design and installation of the Company's system.
Certain persons deposited an aggregate of $15.0 million in escrow (the
"Common Stock Commitment"), which funds were to have been applied to the
purchase of shares of Common Stock in the event the Company failed to sell at
least $15.0 million of preferred stock within a certain period of time. Since
sufficient preferred stock was issued within the time provided, the investors
received a return of their funds contributed in escrow. As a commitment fee for
the Common Stock Commitment, the Company issued to all such persons contributing
to the escrow fund warrants to purchase an aggregate of 150,000 shares of Common
Stock at $.01 per share. Such warrants were exercised by all such investors in
January and February 1998.
A significant portion of the Common Stock Commitment was provided by the
following Directors and more than 5% stockholders of the Company: Maurice J.
Gallagher, Jr. -- $3.75 million, Timothy P. Flynn -- $3.75 million and Robert L.
Priddy -- $3.75 million. As a commitment fee for their Common Stock Commitment,
such persons received warrants to purchase shares of Common Stock at $.01 per
share as follows: Gallagher -- 37,500 shares, Flynn -- 37,500 shares and Priddy
- -- 37,500 shares.
In September 1997, Mitchell Allee purchased 200,000 shares of Common Stock
from the Company for cash in the amount of $400,000 and an additional 175,000
shares for a promissory note in the amount of $437,500. The promissory note is
payable on or before September 30, 2000, bears interest at the rate of 7.5% per
annum and is secured by a pledge of the shares of Common Stock purchased with
such promissory note. As of December 31, 1997, the promissory note had an
outstanding balance of $445,703 (principal plus accrued interest).
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<PAGE> 36
In September 1997, John Boersma purchased 50,000 shares of Common Stock
from the Company for cash in the amount of $100,000 and an additional 100,000
shares for a promissory note in the amount of $250,000. The promissory note is
payable on or before September 30, 2000, bears interest at the rate of 7.5% per
annum and is secured by the pledge of the shares of Common Stock purchased with
such promissory note. As of December 31, 1997, the promissory note had an
outstanding balance of $254,688 (principal plus accrued interest).
In the first five months of 1997, the following persons purchased shares
of Common Stock in the Company: certain partnerships and trusts affiliated with
Maurice J. Gallagher, Jr. - 92,500 shares at a purchase price of $185,000;
Michael Burke - 50,000 shares at a purchase price of $100,000; Thomas Keough -
100,000 shares at a purchase price of $200,000; and Kent Heyman - 25,000 shares
at a purchase price of $50,000.
The following persons or entities purchased Series A Convertible Preferred
Stock in the Company for cash in a private placement of securities of the
Company in January 1998: (i) a corporation owned by Timothy P. Flynn - 45,000
shares for $157,500, (ii) a corporation owned by Maurice J. Gallagher, Jr.
41,500 shares for $145,250 (iii) Thomas Keough - 21,429 shares for $75,000, and
(iv) Robert L. Priddy - 45,000 shares for $157,500.
During March 1998, the following Executive Officers purchased shares of
Common Stock from the Company for cash and a promissory note as follows:
<TABLE>
<CAPTION>
AMOUNT PAID
--------------------------
SHARES BY PROMISSORY
EXECUTIVE OFFICER PURCHASED IN CASH NOTE
- ----------------------------------- --------- ------- -------------
<S> <C> <C> <C>
Mitchell E. Burke................................ 20,000 --- $100,000
David S. Clark................................... 22,000 $10,000 $100,000
Kent F. Heyman................................... 30,000 $50,000 $100,000
James J. Hurley, III............................. 30,000 $50,000 $100,000
Thomas G. Keough................................. 31,000 $55,000 $100,000
James Mitchell................................... 75,000 $87,500 $175,000
Carol A. Mittwede................................ 30,000 $50,000 $100,000
Mark W. Peterson................................. 20,000 --- $100,000
David A. Rahm.................................... 20,000 --- $100,000
Walter J. Rusak.................................. 125,000 $250,000 $375,000
Linda M. Sunbury................................. 22,000 $10,000 $100,000
</TABLE>
The purchase price for all purchases was $5.00 per share except that James
Mitchell's shares were purchased at $3.50 per share. In each case, the
promissory note is payable within three years, bears interest at 7.5% per annum
and is secured by the pledge of the shares of Common Stock purchased with such
promissory note. In each case, all or a portion of such shares are subject to
repurchase at their cost if the officer's employment with the Company is
terminated within three years.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)
l. The response to this portion of Item 14 is submitted as a
separate section of this report.
2. The response to this portion of Item 14 is submitted as a
separate section of this report.
3. Filing of Exhibits:
-36-
<PAGE> 37
Exhibit 27 - Financial Data Schedule
(b) The Registrant did not file any current report on Form 8-K for the
fourth quarter 1997.
(c) The following exhibits are filed herewith or incorporated by reference
as indicated. Exhibit numbers refer to Item 60l of Regulation S-K.
Exhibit No. and Description
3.1 Articles of Incorporation and Amendments. (1)
3.2 By-laws.(1)
3.3 Stockholders Agreement dated as of November 26, 1997, among the
Company, Maurice J. Gallagher, Jr., Nield J. Montgomery and certain
investors identified therein. (1)
4.1 See the Articles of Incorporation and amendments filed as Exhibit 3.1,
the By-laws filed as Exhibit 3.2 and the Stockholders Agreement filed
as Exhibit 3.3.
4.2 Certificate of MGC Communications, Inc. of the Rights, Preferences,
Privileges and Restrictions of Series A Preferred Stock. (1)
4.3 Indenture dated as of September 29, 1997, between the Company and
Marine Midland Bank, as Trustee. (1)
4.4 Registration Rights Agreement dated as of September 29, 1997, among the
Company, Bear, Stearns & Co. Inc. and Furman Selz LLC. (1)
4.5 Security Agreement dated as of September 29, 1997, between the Company
and Marine Midland Bank. (1)
4.6 Collateral Pledge and Security Agreement dated as of September 29,
1997, between the Company and Marine Midland Bank. (1)
10.1 Network Products Purchase Agreement dated May 21, 1997, between the
Company and Northern Telecom, Inc. (1) The Commission has granted
confidential treatment with respect to certain portions of this
Agreement.
10.2 Employment/Stock Repurchase Agreement dated as of June 1996 between the
Company and Nield J. Montgomery, as amended as of September 1, 1997.
(1)
10.3 Employment and Stock Repurchase Agreement dated May 28, 1997, between
the Company and John Boersma. (1)
10.4 Stock Purchase Agreement dated August 29, 1997, between the Company and
Mitchell Allee. (1)
10.5 Stock Option Plan. (1)
10.6 Purchase Agreement dated September 24, 1997, among the Company, Bear,
Stearns & Co. Inc. and Furman Selz LLC. (1)
10.7 Warrant Agreement dated September 29, 1997, between the Company and
Marine Midland Bank. (1)
10.8 Warrant Registration Rights Agreement dated as of September 29, 1997,
among the Company, Bear, Stearns & Co. Inc. and Furman Selz LLC. (1)
10.9 Private Placement Bank Escrow Agreement dated September 1997 among the
Company, Bear, Stearns & Co. Inc. and certain investors identified
therein. (1)
10.10 Standard Office Lease Agreement dated July 1, 1997, between the Company
and Cheyenne Investments L.L.C. (1)
10.11 Securities Purchase Agreement dated as of November 26, 1997, among
the Company and the investors identified therein. (1)
10.12 Securities Purchase Agreement dated as of January 8, 1998, among the
Company and the investors identified therein.
16 Letter re: change in certifying accountant. (2)
27 Financial Data Schedule
- -------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (File No. 333-38875) previously filed with the Commission.
(2) Incorporated by reference to the Registrant's Current Report on Form
8-K dated February 6, 1998, previously filed with the Commission.
-37-
<PAGE> 38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MGC COMMUNICATIONS, INC.
By: /s/ Nield J. Montgomery
----------------------------------
Nield J. Montgomery, President and
Chief Executive Officer
Date: March 27, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
/s/ Nield J. Montgomery March 27, 1998
- ---------------------------------------
Nield J. Montgomery, President (Chief
Executive Officer) and Director
/s/ Linda M. Sunbury March 27, 1998
- ---------------------------------------
Linda M. Sunbury, Vice President (Chief
Financial Officer and Principal
Accounting Officer)
/s/ Maurice J. Gallagher, Jr. March 27, 1998
- ---------------------------------------
Maurice J. Gallagher, Jr. Director
(Chairman of the Board)
/s/ Timothy P. Flynn March 27, 1998
- ---------------------------------------
Timothy P. Flynn, Director
/s/ Jack L. Hancock March 27, 1998
- ---------------------------------------
Jack L. Hancock, Director
March , 1998
- ---------------------------------------
David Kronfeld, Director
March , 1998
- ---------------------------------------
Thomas Neustaetter, Director
-38-
<PAGE> 39
INDEX TO FINANCIAL STATEMENTS
MGC COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Independent Auditors' Report................................ F-3
Balance Sheets as of December 31, 1997 and 1996............. F-4
Statements of Operations for the years ended December 31,
1997 and 1996............................................. F-5
Statements of Redeemable Preferred Stock and Stockholders'
Equity for the years ended December 31, 1997 and 1996..... F-6
Statements of Cash Flows for the years ended December 31,
1997 and 1996............................................. F-7
Notes to Financial Statements............................... F-8
</TABLE>
F-1
<PAGE> 40
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of
MGC Communications, Inc.:
We have audited the accompanying balance sheet of MGC Communications, Inc. (the
"Company") as of December 31, 1997, and the related statements of operations,
redeemable preferred stock and stockholders' equity and cash flows for the year
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of MGC Communications, Inc. as of
December 31, 1997, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
March 4, 1998
F-2
<PAGE> 41
INDEPENDENT AUDITORS' REPORT
The Board of Directors
MGC Communications, Inc.
We have audited the accompanying balance sheet of MGC Communications, Inc. as of
December 31, 1996, and the related statements of operations, stockholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of MGC Communications, Inc. as of
December 31, 1996, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Las Vegas, Nevada
August 18, 1997
F-3
<PAGE> 42
MGC COMMUNICATIONS, INC.
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 45,054 $ 7,897
Investments held to maturity.............................. 7,797 --
Restricted investments.................................... 18,482 --
Amounts receivable for shares issued...................... -- 1,153
Trade accounts receivable, less allowance for doubtful
accounts of $216 and $0 at December 31, 1997 and 1996,
respectively........................................... 1,200 10
Prepaid expenses.......................................... 277 23
-------- -------
Total current assets.............................. 72,810 9,083
Property and equipment, net................................. 24,617 3,250
Investments held to maturity................................ 49,913 --
Restricted investments...................................... 39,092 --
Deferred financing costs, net of amortization of $198....... 5,448 --
Other assets................................................ 97 6
-------- -------
Total assets...................................... $191,977 $12,339
======== =======
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt...................... $ 381 $ --
Accounts payable:
Trade.................................................. 462 76
Property and equipment................................. 3,123 1,372
Accrued interest.......................................... 5,328 --
Accrued other expenses.................................... 786 99
-------- -------
Total current liabilities......................... 10,080 1,547
Senior Secured Notes, net of unamortized discount of
$3,882.................................................... 156,118 --
Other long-term debt........................................ 138 --
-------- -------
Total liabilities................................. 166,336 1,547
-------- -------
Commitments and contingencies
Redeemable preferred stock:
8% Series A convertible preferred stock, 6,571,450 shares
authorized, 5,148,570 issued and outstanding........... 16,665 --
Stockholders' equity:
Preferred stock, 43,428,550 shares authorized but
unissued............................................... -- --
Common stock, $0.001 par value, 100,000,000 shares
authorized, 14,666,000 and 11,960,000 shares issued and
outstanding............................................ 15 12
Additional paid-in capital................................ 22,112 12,271
Accumulated deficit....................................... (12,463) (1,491)
-------- -------
9,664 10,792
Notes receivable from stockholders for issuance of common
stock.................................................. (688) --
-------- -------
Total stockholders' equity........................ 8,976 10,792
-------- -------
Total liabilities, redeemable preferred stock and
stockholders' equity............................. $191,977 $12,339
======== =======
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 43
MGC COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------------
1997 1996
---------- ---------
<S> <C> <C>
Telecommunication services:
Operating revenues........................................ $ 3,791 $ 1
---------- ---------
Operating expenses:
Cost of operating revenues (excluding depreciation)....... 3,928 305
Selling, general and administrative....................... 6,440 841
Depreciation and amortization............................. 1,274 54
Write-off of purchased software........................... -- 355
---------- ---------
11,642 1,555
---------- ---------
Loss from operations................................... (7,851) (1,554)
Other income (expense):
Interest income........................................... 2,507 63
Interest expense (net of amount capitalized).............. (5,492) --
---------- ---------
Net loss............................................... (10,836) (1,491)
Accrued preferred stock dividend............................ (136) --
---------- ---------
Net loss applicable to common stockholders.................. $ (10,972) $ (1,491)
========== =========
Basic and diluted loss per share of common stock............ $ (.78) $ (1.27)
========== =========
Basic and diluted weighted average shares outstanding....... 14,098,318 1,178,932
========== =========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 44
MGC COMMUNICATIONS, INC.
STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
NOTES
REDEEMABLE RECEIVABLE FROM
PREFERRED COMMON STOCK ADDITIONAL STOCKHOLDERS FOR TOTAL
-------------------- ------------------- PAID-IN ACCUMULATED ISSUANCE OF STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT COMMON STOCK EQUITY
---------- ------- ---------- ------ ---------- ----------- ---------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1,
1996............... -- $ -- 400,000 $-- $ 1 $ -- $ -- $ 1
Common stock issued
for services
contributed by
stockholder........ -- -- 800,000 1 1 -- -- 2
Common stock issued
for cash........... -- -- 10,760,000 11 12,269 -- -- 12,280
Net loss............. -- -- -- -- -- (1,491) -- (1,491)
---------- ------- ---------- --- ------- -------- ----- --------
BALANCE AT DECEMBER
31, 1996........... -- -- 11,960,000 12 12,271 (1,491) -- 10,792
Common stock issued
for cash........... -- -- 2,431,000 3 4,859 -- -- 4,862
Common stock issued
for notes
receivable......... -- -- 275,000 -- 688 -- (688) --
Proceeds from
offering allocated
to warrants........ -- -- -- -- 3,885 -- -- 3,885
Warrants issued for
common stock
commitment......... -- -- -- -- 409 -- -- 409
Net loss............. -- -- -- -- -- (10,836) -- (10,836)
8% Series A
Convertible
Preferred Stock
issued for cash.... 5,148,570 16,665 -- -- -- -- -- --
Accrued preferred
stock dividend..... -- -- -- -- -- (136) -- (136)
---------- ------- ---------- --- ------- -------- ----- --------
BALANCE AT DECEMBER
31, 1997........... 5,148,570 $16,665 14,666,000 $15 $22,112 $(12,463) $(688) $ 8,976
========== ======= ========== === ======= ======== ===== ========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 45
MGC COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (10,836) $(1,491)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 1,274 54
Write-off of purchased software........................ -- 355
Amortization of debt discount.......................... 144 --
Amortization of deferred debt financing costs.......... 198 --
Stock issued for services rendered..................... -- 2
Changes in assets and liabilities:
Increase in accounts receivable, net................. (1,190) (9)
Increase in prepaid expenses......................... (254) (23)
Increase in other assets............................. (91) (5)
Increase in accounts payable -- trade................ 386 76
Increase in accrued expenses......................... 5,879 99
--------- -------
Net cash used in operating activities............. (4,490) (942)
--------- -------
Cash flows from investing activities:
Purchase of property and equipment, net of payables....... (20,207) (2,287)
Purchase of investments held to maturity.................. (57,710) --
Purchase of restricted investments........................ (57,574) --
--------- -------
Net cash used in investing activities............. (135,491) (2,287)
--------- -------
Cash flows from financing activities:
Proceeds from issuance of Senior Secured Notes
net of discount of $4,026.............................. 155,974 --
Costs associated with issuance of Senior Secured Notes and
warrants............................................... (5,237) --
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs................. 16,665 --
Proceeds from issuance of warrants........................ 3,885 --
Payments on other long term debt.......................... (164) --
Proceeds from issuance of common stock during 1996........ 1,153 11,126
Proceeds from issuance of common stock during 1997........ 4,862 --
--------- -------
Net cash provided by financing activities......... 177,138 11,126
--------- -------
Net increase in cash.............................. 37,157 7,897
Cash and cash equivalents at beginning of period............ 7,897 --
--------- -------
Cash and cash equivalents at the end of period.............. $ 45,054 $ 7,897
========= =======
Supplemental schedule of non-cash investing
and financing activities:
Stock issued for services rendered........................ $ -- $ 2
========= =======
Increase in property and equipment purchases included in
accounts payable -- property and equipment............. $ 1,751 $ 1,372
========= =======
Notes payable issued for property and equipment........... $ 683 $ --
========= =======
Stock issued for notes receivable......................... $ 688 $ --
========= =======
Warrants issued as consideration in debt offering
capitalized as deferred financing costs................ $ 409 $ --
========= =======
Other disclosures:
Cash paid for interest net of amounts capitalized $ 164 $ --
========= =======
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE> 46
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
DESCRIPTION OF BUSINESS
MGC Communications, Inc. (the Company), a Nevada Corporation, was organized
on October 16, 1995 as a competitive local exchange carrier to provide low cost
alternative communication services to residential and small business users
through the utilization of Company owned switches and network architecture
leased from incumbent local exchange carriers. The Company's revenue generating
operations commenced in December 1996. During the year ended December 31, 1997,
the Company operated in Las Vegas, Nevada and in selected suburban areas of
Atlanta, Georgia; and Los Angeles, California with substantially all of its
operating revenues being derived from the Las Vegas operations.
PERIOD FROM OCTOBER 16, 1995 (INCEPTION) TO DECEMBER 31, 1995
Statements of operations and cash flows for the period from October 16,
1995 (inception) to December 31, 1995 have been omitted as no revenues or
expenses were recognized and no cash transactions occurred during the period.
One non-cash transaction occurred during the period ended December 31, 1995 in
which the Company issued 400,000 shares of $.001 par value common stock valued
at $.0025 per share to the founding shareholder as reimbursement for
incorporation costs.
As of December 31, 1996, the Company was a development stage company
wherein the Company's activities consisted primarily of acquiring communications
equipment, designing and developing the Company's networks, negotiating
agreements with incumbent local exchange carriers for the utilization of their
transport network architecture and raising capital. The Company began its
operations in December 1996 by operating its first telephone switch in Las
Vegas, Nevada. During the year ended December 31, 1997, the Company's planned
principal activities commenced. The Company emerged from the development stage
in September 1997 and the inception to date figures have been excluded from the
accompanying financial statements.
REVENUE RECOGNITION
The Company recognizes operating revenues from communication services in
the period the related services are provided.
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with a remaining maturity of
three months or less at the date of purchase to be cash equivalents.
RESTRICTED INVESTMENTS
Restricted investments consist of U.S. Treasury Notes which are restricted
in that they must be used for the repayment of interest on certain debt and are
stated at amortized cost plus accrued interest. Management designated these
investments as held-to-maturity securities in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The fair value of the
restricted investments approximates the carrying value.
ADVERTISING COSTS
The Company expenses advertising costs in the period incurred. As of
December 31, 1997 and 1996, the Company had expensed advertising costs of
$125,000 and $0, respectively.
F-8
<PAGE> 47
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INVESTMENTS HELD-TO-MATURITY
Investments held-to-maturity represent a contractual arrangement between
the Company and an investment banking firm whereby Company funds are invested in
various U.S. Government securities and Federal Agency securities for a
guaranteed return on investment. At December 31, 1997, the guaranteed minimum
return on the investment portfolio was 5.35% for the two year investment period
ending November 1999.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation.
Direct costs of construction are capitalized, and include $188,000 of interest
costs related to construction during 1997. There were no interest costs
capitalized prior to September 1997. Depreciation is computed using the
straight-line method over estimated useful lives beginning in the month an asset
is put into service.
Estimated useful lives of property and equipment are as follows:
<TABLE>
<S> <C>
Buildings........................................ 40 years
Telecommunications and other switching
equipment...................................... 5-10 years
Computer hardware and software................... 3-5 years
Office furniture & equipment..................... 3-5 years
Leasehold improvements........................... the lesser of the estimated
useful lives or term of lease
</TABLE>
DEFERRED FINANCING COSTS
Deferred financing costs are amortized to interest expense over the life of
the related financing using the effective interest method.
INCOME TAXES
The Company has applied the provisions of SFAS No. 109, "Accounting for
Income Taxes," which requires the recognition of deferred tax assets and
liabilities for the consequences of temporary differences between amounts
reported for financial reporting and income tax purposes. SFAS No. 109 requires
recognition of a future tax benefit of net operating loss carryforwards and
certain other temporary differences to the extent that realization of such
benefit is more likely than not; otherwise, a valuation allowance is applied.
LOSS PER SHARE
Basic and diluted loss per share were computed in accordance with SFAS No.
128, "Earnings Per Share."
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires all entities to disclose the fair value of financial instruments, both
assets and liabilities recognized and not recognized on the balance sheet, for
which it is practicable to estimate fair value. SFAS No. 107 defines fair value
of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. At December 31, 1997
and 1996, the carrying value of all financial instruments (accounts receivable,
accounts payable and long-term debt) approximates fair value due to the short
term nature of the instruments or interest rates, which are comparable with
current rates.
F-9
<PAGE> 48
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
LONG-LIVED ASSETS
Management periodically evaluates the carrying value of its long-lived
assets, including property, equipment and intangible assets, whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. To the extent the estimated future cash inflows attributable to the
asset, less estimated future cash outflows, is less than the carrying amount, an
impairment loss is recognized. Management believes no material impairment in the
value of long-lived assets exists at December 31, 1997 or 1996.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity sections of a statement of
financial position, and is effective for financial statements issued for fiscal
years beginning after December 15, 1997. The Company is currently assessing the
impact on the financial statements for the years ended December 31, 1997 and
1996, and believes that SFAS No. 130 will not result in comprehensive income
different from net income as reported in the accompanying financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information." SFAS No. 131 establishes additional
standards for segment reporting in financial statements and is effective for
fiscal years beginning after December 15, 1997. The Company currently operates
as one segment.
CONCENTRATION OF SUPPLIERS
The Company currently leases its transport capacity from a limited number
of suppliers and is dependent upon the availability of collocation space and
fiber optic transmission facilities owned by the suppliers. The Company is
currently vulnerable to the risk of renewing favorable supplier contracts,
timeliness of the supplier in processing the Company's orders for customers and
is at risk to regulatory agreements that govern the rates to be charged to the
Company.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
RECLASSIFICATION
Certain reclassifications, which have no effect on net income, have been
made in the 1996 financial statements to conform to the current presentation.
(2) PLAN OF OPERATIONS
During September 1997, the Company completed an offering of 160,000 units
consisting of $160 million of 13% Senior Secured Notes due in 2004 (the "Notes")
and warrants to purchase shares of common stock, as discussed in Note 4. The
Company expects to continue expansion and development of services and entering
into new markets. This expansion includes plans to be operational in an
additional fourteen suburban
F-10
<PAGE> 49
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
metropolitan areas by the end of 1999. The Company expects to fund its capital
requirements through existing resources, debt or equity financing and internally
generated funds.
Management recognizes that the Company must generate additional resources
or consider modifications to its expansion plans. To the extent the Company is
unable to achieve its funding plan, management has contingency plans which
include curtailing capital expenditure activities, reducing infrastructure costs
associated with expansion and development plans and achieving profitable
operations as soon as practicable. However, no assurance can be given that the
Company will be successful in raising additional capital, achieving profitable
results, or entering into new markets.
Management also recognizes that certain risks are inherent to the industry.
Such risks and assumptions include, but are not limited to, the Company's
ability to successfully offer its services to current and new customers,
generate customer demand for its services in the particular markets where it
plans to offer services, access markets, install switches and obtain suitable
locations for its switches and negotiate suitable interconnect agreements with
the incumbent local exchange carriers (ILECs), all in a timely manner, at
reasonable cost, and on satisfactory terms and conditions, as well as
regulatory, legislative and judicial developments that could cause actual
results to vary materially from any future results implied in these financial
statements.
(3) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Building and property...................................... $ 278 $ --
Switching equipment........................................ 21,621 2,813
Leasehold improvements..................................... 956 429
Computer hardware and software............................. 1,404 51
Office equipment and vehicles.............................. 300 --
------- ------
24,559 3,293
Less accumulated depreciation.............................. (1,317) (43)
------- ------
23,242 3,250
Switching equipment under construction..................... 1,375 --
------- ------
Net property and equipment....................... $24,617 $3,250
======= ======
</TABLE>
(4) DEBT
The Company had no long-term borrowings as of December 31, 1996. Long-term
borrowings at December 31, 1997 consist of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
13% Senior Secured Notes, due October 1, 2004, net of
unamortized discount of $3,882............................ $156,118
10% note payable in monthly installments through February
1999...................................................... 441
Other....................................................... 78
--------
156,637
Less current portion........................................ (381)
--------
$156,256
========
</TABLE>
F-11
<PAGE> 50
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Maturities of long-term debt for each of the next five years ending
December 31, consist of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
1998........................................................ $ 381
1999........................................................ 117
2000........................................................ 21
2001........................................................ --
2002 and thereafter......................................... 156,118
--------
$156,637
========
</TABLE>
In September 1997, the Company completed an offering for 160,000 units
consisting of $160 million of 13% Senior Secured Notes due in 2004 and warrants
to purchase 1,291,200 shares of common stock (collectively the "Offering").
The Notes bear interest at the rate of 13% per annum, payable semi-annually
in arrears on April 1 and October 1, commencing April 1, 1998. As set forth in
the Indenture pursuant to which the Notes were issued the Company is required to
hold in a trust account sufficient funds to provide for payment in full of
interest on the Notes through October 1, 2000. The accompanying financial
statements reflect approximately $57.6 million as restricted investments as
security for the interest payments on the Notes. In addition, the Notes are
secured by a security interest in certain telecommunications equipment owned by
the Company or which may be acquired in the future. As of December 31, 1997, the
Notes were secured by a security interest in telecommunications equipment with a
net book value of $11.1 million and restricted investments of $57.6 million (at
fair market value).
In conjunction with the Offering, the Company engaged an investment banking
firm which determined a value for each warrant and share of common stock.
Consistent with this determination, the Company has allocated a portion of the
Offering proceeds to the warrants based on a value of $2.81 per share of common
stock less the exercise price of $.01 per share for the warrant.
The warrants are exercisable at any time on or after the earlier to occur
of (i) October 1, 1998, or (ii) the date on which a change in control occurs.
The agreement pursuant to which the warrants were issued required an
antidilution adjustment if the preferred stock offering was consummated at a
price less than $5.00 per share. As further discussed in Note 5, the Company
completed the preferred stock offering for $3.50 per share. Accordingly, the
warrants issued in connection with the Offering were increased from 1,291,200 to
1,438,205 and have been reflected in the accompanying financial statements as of
December 31, 1997. Expenses allocated to the warrants in connection with the
Offering were $141,000. The warrants expire on October 1, 2004.
In conjunction with the Offering, certain persons deposited an aggregate of
$15.0 million in escrow (the Common Stock Commitment), which funds were to
have been applied to the purchase of shares of Common Stock in the event the
Company failed to sell at least $15.0 million of preferred stock within a
certain period of time. Since sufficient preferred stock was issued within the
time period, the investors received a return of their funds contributed to
escrow. As a commitment fee for the Common Stock Commitment, the Company issued
to all such persons contributing to the escrow funds warrants to purchase an
aggregate of 150,000 shares of Common Stock at $.01 per share.
The Company has recorded the commitment fee as non-cash consideration in
connection with the Offering. The value of the warrants issued as a commitment
fee was determined based on a value of the Company's common stock at $2.81 per
share less the exercise price of $.01 per share for the warrant. All such
warrants were exercised in January and February 1998.
F-12
<PAGE> 51
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Notes may be redeemed at the option of the Company, in whole or in
part, on or after October 1, 2001, at a premium declining to par in 2003, plus
accrued and unpaid interest and liquidated damages, if any, through the
redemption date as follows:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2001..................... 106.50
2002..................... 103.25
2003 and thereafter...... 100.00
</TABLE>
In the event of a sale by the Company prior to October 1, 2000 of its
capital stock in one or more equity offerings, up to a maximum of 35% of the
aggregate principal amount of the Notes originally issued will, at the option of
the Company, be redeemed from the net cash proceeds at a redemption price equal
to 113% of the principal amount, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, provided at least 65% of the aggregate
principal amount of Notes originally issued remain outstanding immediately after
the occurrence of such redemption. As of the date of these financial statements,
management has no intention of redeeming the Notes prior to their stated
redemption date.
The Indenture contains certain covenants that among other things, limit the
ability of the Company and its restricted subsidiaries to incur additional
indebtedness and issue preferred stock, pay dividends or make other
distributions, repurchase equity interests or subordinated indebtedness, acquire
an aggregate of more than 20 Switches until consolidated earnings before
interest, taxes, depreciation and amortization (EBITDA) is positive for two
consecutive quarters (with certain exceptions), engage in sale and lease back
transactions, create certain liens, enter into certain transactions with
affiliates, sell assets of the Company or its restricted subsidiaries, conduct
certain lines of business, issue or sell equity interests of the Company's
restricted subsidiaries or enter into certain mergers and consolidations. As of
December 31, 1997, management believes it is in compliance with all debt
covenants.
In conjunction with the Offering, the authorized capital stock of the
Company was increased to 100,000,000 shares of common stock, $.001 par value per
share, and 50,000,000 share of preferred stock, $.001 par value per share.
Associated with the issuance of the Notes, expenses of $68,000 were paid to
a related party for charter services.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
COMMON STOCK
On December 6, 1996, the Board of Directors approved a four-hundred-for-one
stock split, effected in the form of a stock dividend distributed on December
31, 1996 to shareholders of record as of June 8, 1996. All share and per share
data presented in the financial statements and notes thereto have been
retroactively restated to give effect to this stock split.
During 1995, in exchange for expending cash to incorporate the Company, a
shareholder received 400,000 shares of $.001 par value common stock valued at
$.0025 per share. The Company capitalized the value of the issued shares as
organization costs included in other assets in the accompanying financial
statements, which costs are being amortized over 60 months using the
straight-line method.
In April 1996, the Company issued 800,000 shares of $.001 par value common
stock valued at $.0025 per share in exchange for services rendered by a
stockholder.
During 1996, NevTEL LLC (the "LLC") was formed for the purpose of funding
the development stage of MGC Communications, Inc. In June 1996, the Company and
LLC entered into an agreement whereby LLC would acquire 6,160,000 shares of
$.001 par value common stock of the Company for $.50 per share. The
F-13
<PAGE> 52
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
agreement called for LLC to advance funds for operating expenses incurred by
the Company (to be applied against the purchase price of the stock) until the
Company produced operating revenues, at which time the remaining purchase price
would be remitted to the Company, the Company's common stock would be issued to
LLC owners and LLC would terminate. The agreement stipulated that the funds
advanced for operating expenses were to be paid back to LLC if the Company did
not generate operating revenue by December 31, 1996. The Company began revenue
generating activities in December 1996. The shares were issued to LLC owners on
December 31, 1996, at which time LLC terminated and the remaining purchase price
was owed to the Company. Such amount was transferred to the Company in February
1997 and is classified as amounts receivable for shares issued at December 31,
1996.
In December 1996, the Company offered 6,781,000 shares of $.001 par value
common stock at $2.00 per share through a private placement. In connection with
this offering, the Company issued 2,181,000 shares and 4,600,000 shares of $.001
par value common stock and received proceeds of $4,362,000 and $9,200,000 during
the years ended December 31, 1997 and 1996, respectively.
In June 1997, the Company approved agreements with two key members of
management granting them rights to purchase a total of 250,000 shares at $2.00
per share and 275,000 shares at $2.50 per share. In both cases, the Company
retains the right to repurchase these shares at their cost in the event of
termination of employment for any reason and has agreed to finance the purchase
price of the shares purchasable at $2.50 per share over a period of three years.
During September 1997, the members of management exercised their rights and the
respective aforementioned shares were issued. The Company received $500,000 for
the 250,000 shares issued at $2.00 per share. The $688,000 owed to the Company
for the 275,000 shares issued at $2.50 per share has been classified in the
accompanying statements of redeemable preferred stock and stockholders' equity
as notes receivable from stockholders for issuance of common stock.
REDEEMABLE PREFERRED STOCK
The Company has authorized the issuance of up to 50,000,000 shares of
preferred stock. In November 1997, the Company designated 6,571,450 shares as 8%
Series A Convertible Preferred Stock (the "Preferred Stock").
In November 1997, the Company completed a private placement offering in
which 5,148,570 shares of the Preferred Stock were issued at $3.50 per share,
for total proceeds to the Company of approximately $16.7 million, net of
expenses. Each share of Preferred Stock is convertible into shares of Common
Stock at any time at the option of the holder. In addition, each share of
Preferred Stock is automatically converted into Common Stock at its then
applicable conversion rate in the event of a qualified firm-commitment
underwritten public offering, as defined.
Dividends on the Preferred Stock accumulate whether or not the Company has
earnings or profits, whether or not there are funds legally available for the
payment of such dividends and whether or not dividends are declared. Except as
may otherwise be required by law, holders of Preferred Stock are entitled to
vote together with the holders of the Common Stock and not as a separate class
and are entitled to elect two members of the Company's Board of Directors.
Commencing at any time on or after October 2, 2004, at the option and
written election of the holders of a majority of the outstanding shares of the
Preferred Stock, the Company shall, subject to applicable law, redeem all of the
outstanding shares of Preferred Stock at a price equal to the greater of (1)
$3.50, plus an amount equal to any unpaid dividends thereon, or (2) the market
value of the Preferred Stock, on an as converted basis, determined by an
independent appraiser.
(6) STOCK OPTION PLAN
In June 1996, the Company adopted a stock option plan which allows the
Board of Directors to grant incentives to employees in the form of incentive
stock options and non-qualified stock options. As of
F-14
<PAGE> 53
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1997 and 1996, the Company has reserved 2,400,000 shares of common
stock to be issued under the plan.
Under the plan, substantially all options have been granted to employees at
a price exceeding the then-current market price, as estimated by management, and
vest primarily over a 5-year period. All options expire within ten years of the
date of grant.
Stock option transactions during 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- --------
<S> <C> <C>
Outstanding at December 31, 1995............................ -- --
Granted..................................................... 1,353,100 $0.81
Canceled.................................................... (50,000) $1.00
---------
Outstanding at December 31, 1996............................ 1,303,100 $0.81
Granted..................................................... 457,600 $3.47
Canceled.................................................... (5,500) $3.05
---------
Outstanding at December 31, 1997............................ 1,755,200 $1.50
=========
Exercisable at December 31, 1996............................ 19,600 $2.00
=========
Exercisable at December 31, 1997............................ 276,200 $1.05
=========
</TABLE>
The weighted average fair value of each of the options issued during the
years ended December 31, 1997 and 1996, substantially all of which have been
granted at a price exceeding the then current market price as estimated by
management, was estimated to be $2.42 and $.55, respectively, using an option
pricing model with the following assumptions: dividend yield of 0%; expected
option life of 6.5 years; and risk free interest rate at December 31, 1997 and
1996 of 5.74% and 6.12%, respectively.
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OUT- AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF STANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICE 1997 LIFE PRICE 1997 PRICE
-------- ------------ ----------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.50 700,000 8.25 years $0.50 140,000 $0.50
$1.00 510,000 8.59 years $1.00 100,600 $1.00
$2.00 99,600 8.92 years $2.00 35,600 $2.00
$3.50 431,100 9.52 years $3.50 -- $3.50
$3.75 14,500 10.00 years $3.75 -- $3.75
--------- -------
$0.50 to
$3.75 1,755,200 8.71 years $1.49 276,200 $ .88
========= =======
</TABLE>
The Company applied Accounting Principles Board (APB) Opinion No. 25 in
accounting for its plan. No compensation expense was recognized for the years
ended December 31, 1997 and 1996. Had the Company determined compensation cost
based on the minimum value method under SFAS No. 123, the Company's net loss
for the years ended December 31, 1997 and 1996 would have increased by
approximately $7,000 and $10,000, respectively, which would have had no effect
on the basic and diluted loss per share of common stock as stated in the
accompanying statements of operations.
(7) LOSS PER SHARE
SFAS No. 128, "Earnings Per Share," requires the Company to calculate its
earnings per share based on basic and diluted earnings per share, as defined.
Basic and diluted loss per share for the years ended
F-15
<PAGE> 54
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1997 and 1996 were computed by dividing net loss applicable to
common stockholders by the weighted average number of shares of common stock.
The Company's warrants, preferred stock and stock options granted and
issued during 1997 and 1996, and outstanding as of December 31, 1997 and 1996,
are antidilutive and have been excluded from the diluted loss per share
calculation for the years ended December 31, 1997 and 1996. Had the Company
shown the effects of dilution, the warrants, preferred stock and options would
have added an additional 2.7 million and 0.8 million shares to the weighted
average shares outstanding for the years ended December 31, 1997 and 1996,
respectively.
(8) INCOME TAXES
The net deferred tax asset as of December 31, 1997 and 1996 is as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -----
<S> <C> <C>
Deferred Tax Asset
Net operating loss carry-forward...................... $ 4,529 $ 276
Start-up expenditures................................. 220 276
Other................................................. 141 5
------- -----
4,890 557
Less: valuation allowance............................. (4,309) (522)
------- -----
Net deferred tax asset................................ 581 35
------- -----
Deferred Tax Liability
Excess of tax depreciation over book.................. 481 32
Other................................................. 100 3
------- -----
Net deferred tax liability............................ 581 35
------- -----
Net..................................................... $ -- $ --
======= =====
</TABLE>
SFAS No. 109 requires recognition of the future tax benefit of these assets
to the extent realization of such benefits is more likely than not; otherwise, a
valuation allowance is applied. At December 31, 1997 and 1996, the Company
determined that $4,309,000 and $522,000, respectively, of tax benefits did not
meet the realization criteria because of the Company's historical operating
results. Accordingly, a valuation allowance was applied to reserve against the
applicable deferred tax asset.
At December 31, 1997 and 1996, the Company had net operating loss
carry-forwards available for income tax purposes of approximately $12,940,000
and $788,000, respectively, which expire principally from 2011 to 2012.
(9) COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
The Company has entered into various leasing agreements for its switching
facilities and offices. The facility which houses the Company's headquarters in
Las Vegas is owned by two of the Company's principal stockholders and directors.
Management believes the terms and conditions of this agreement are equal to or
better than the terms which would be available from an unaffiliated lessor.
F-16
<PAGE> 55
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease obligations in effect as of December 31, 1997 are as
follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Payments during the year ending December 31:
1998........................................................ $ 679
1999........................................................ 643
2000........................................................ 660
2001........................................................ 633
2002........................................................ 617
Thereafter.................................................. 478
------
$3,710
======
</TABLE>
Rent expense was $207,000 and $33,000 for the years ended December 31, 1997
and 1996, respectively.
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment. In May 1997, the
Company signed an agreement to purchase 20 Northern Telecom DMS-500 switches and
related Access Nodes from its primary vendor. As of December 31, 1997, the
Company had a total for all vendors of approximately $37.4 million of remaining
purchase commitments for purchases of switching equipment.
INTERCONNECTION AGREEMENTS
The Company has interconnection agreements with five incumbent local
exchange carriers. These agreements expire on various dates through July 2000.
The Company is dependent on the cooperation of the incumbent local exchange
carriers to provide access service for the origination and termination of its
local and long distance traffic. Historically, these access charges can make up
a significant percentage of the overall cost of providing these services. To the
extent the access services of the local exchange carriers are used, the Company
and its customers are subject to the quality of service, equipment failures and
service interruptions of the local exchange carriers.
(10) RISKS AND UNCERTAINTIES
Certain rates in the interconnection agreements have been established by
the Federal Communications Commission (FCC) and are subject to adjustment upon
final negotiations. The Company has recorded costs of sales related to the
Sprint (Nevada) interconnection agreement at amounts which are management's best
estimates of the probable outcome of the final negotiated rates, which are less
than the FCC established rates. The difference, which totals approximately $1.1
million at December 31, 1997, has not been recorded in the accompanying
financial statements. Management believes that the resolution of this matter
will not have an adverse effect on the Company's financial position, results of
operations, or liquidity.
(11) RELATED PARTY TRANSACTION
In May 1997, the Company entered into an agreement with a company, the
owner of which is an officer and stockholder of the Company, for the purchase of
certain computer software pursuant to which the Company paid the contract price
of $600,000 in six equal monthly installments beginning July 1, 1997. In
addition, the Company has paid $40,000 under such agreement to support and
maintain the Company's proprietary management information computer system.
Management believes the terms and conditions of this agreement are equal to or
better than the terms which would be available from an unaffiliated party.
F-17
<PAGE> 56
MGC COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(12) SUBSEQUENT EVENTS
In January 1998, the Company completed a private placement offering in
which 1,422,857 shares of Preferred Stock were issued at $3.50 per share, for
total proceeds to the Company of approximately $5.0 million, net of expenses.
The terms of the offering were substantially identical to those of the previous
preferred stock offering.
In January 1998, the Company filed a registration statement offering to
exchange the Notes (discussed in Note 4) for 13% Series B Senior Secured Notes
Due 2004 under the Securities Act of 1933, as amended. Terms of the 13% Series B
Senior Secured Notes due 2004 are substantially the same as the Notes. The
exchange was consummated in March 1998.
F-18
<PAGE> 57
EXHIBIT INDEX
-------------
Exhibit No. Description
3.1 Articles of Incorporation and Amendments. (1)
3.2 By-laws. (1)
3.3 Stockholders Agreement dated as of November 26, 1997, among the
Company, Maurice J. Gallagher, Jr., Nield J. Montgomery and certain
investors identified therein. (1)
4.1 See the Articles of Incorporation and amendments filed as Exhibit 3.1,
the By-laws filed as Exhibit 3.2 and the Stockholders Agreement filed
as Exhibit 3.3.
4.2 Certificate of MGC Communications, Inc. of the Rights, Preferences,
Privileges and Restrictions of Series A Preferred Stock. (1)
4.3 Indenture dated as of September 29, 1997, between the Company and
Marine Midland Bank, as Trustee. (1)
4.4 Registration Rights Agreement dated as of September 29, 1997, among the
Company, Bear, Stearns & Co. Inc. and Furman Selz LLC. (1)
4.5 Security Agreement dated as of September 29, 1997, between the Company
and Marine Midland Bank. (1)
4.6 Collateral Pledge and Security Agreement dated as of September 29,
1997, between the Company and Marine Midland Bank. (1)
10.1 Network Products Purchase Agreement dated May 21, 1997, between the
Company and Northern Telecom, Inc. (1) The Commission has granted
confidential treatment with respect to certain portions of this
Agreement.
10.2 Employment/Stock Repurchase Agreement dated as of June 1996 between the
Company and Nield J. Montgomery, as amended as of September 1, 1997.
(1)
10.3 Employment and Stock Repurchase Agreement dated May 28, 1997, between
the Company and John Boersma. (1)
10.4 Stock Purchase Agreement dated August 29, 1997, between the Company and
Mitchell Allee. (1)
10.5 Stock Option Plan. (1)
10.6 Purchase Agreement dated September 24, 1997, among the Company, Bear,
Stearns & Co. Inc. and Furman Selz LLC. (1)
10.7 Warrant Agreement dated September 29, 1997, between the Company and
Marine Midland Bank. (1)
10.8 Warrant Registration Rights Agreement dated as of September 29, 1997,
among the Company, Bear, Stearns & Co. Inc. and Furman Selz LLC. (1)
10.9 Private Placement Bank Escrow Agreement dated September 1997 among the
Company, Bear, Stearns & Co. Inc. and certain investors identified
therein. (1)
10.10 Standard Office Lease Agreement dated July 1, 1997, between the Company
and Cheyenne Investments L.L.C. (1)
10.11 Securities Purchase Agreement dated as of November 26, 1997, among the
Company and the investors identified therein. (1)
10.12 Securities Purchase Agreement dated as of January 8, 1998, among the
Company and the investors identified therein.
16 Letter re: change in certifying accountant. (2)
27 Financial Data Schedule
- -------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (File No. 333-38875) previously filed with the Commission.
(2) Incorporated by reference to the Registrant's Current Report on Form
8-K dated February 6, 1998, previously filed with the Commission.
<PAGE> 1
Exhibit 10.12
SECURITIES PURCHASE AGREEMENT
AMONG
MGC COMMUNICATIONS, INC.
AND
THE PURCHASERS LISTED ON
SCHEDULE I HERETO
Dated as of January 8, 1998
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
1. Sale and Purchase of Shares...................................................................1
1.1 Sale and Purchase of Shares.........................................................1
2. Purchase Price................................................................................1
2.1 Amount of Purchase Price............................................................1
2.2 Payment of the Purchase Price.......................................................1
3. Closing; Termination of Agreement.............................................................1
3.1 Closing Date........................................................................1
4. Representations and Warranties of the Company.................................................1
4.1 Organization and Good Standing......................................................2
4.2 Authorization of Agreement; Enforceability..........................................2
4.3 Subsidiaries........................................................................2
4.4 Consents of Third Parties...........................................................2
4.5 Authorization of Preferred Shares and Reserved Shares...............................3
4.6 Financial Statements................................................................3
4.7 No Undisclosed Liabilities..........................................................3
4.8 Absence of Certain Developments.....................................................3
4.9 Taxes...............................................................................5
4.10 Real Property......................................................................6
4.11 Tangible Personal Property.........................................................6
4.12 Intangible Property................................................................7
4.13 Material Contracts.................................................................9
4.14 Employee Benefits..................................................................9
4.15 Employees..........................................................................11
4.16 Litigation.........................................................................11
4.17 Compliance with Laws; Permits......................................................11
4.18 Environmental Matters..............................................................11
4.19 Investment Company Act.............................................................12
4.20 Transactions with Affiliates.......................................................12
4.21 Disclosure; Survival...............................................................12
4.22 Financial Advisors.................................................................13
4.23 Insurance..........................................................................13
4.24 Dissolution of Previous Entities...................................................13
4.26 Improper Actions...................................................................13
5. Representations and Warranties of the Purchasers..............................................13
5.1 Organization and Good Standing......................................................13
5.2 Authorization of Agreement..........................................................14
5.3 Purchaser Representation............................................................14
5.4 Investment Intention................................................................14
5.5 Financial Advisors..................................................................14
5.6 Reliance............................................................................14
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C> <C>
6. Further Agreements of the Parties.............................................................14
6.1 Covenants...........................................................................14
6.2 Use of Proceeds.....................................................................14
6.3 Access to Information...............................................................15
6.4 Confidentiality.....................................................................15
6.5 Other Actions.......................................................................15
6.6 Indemnity...........................................................................15
6.7 U.S. Real Property Holding Corporation..............................................16
6.8 Financial Statements, Reports, Etc. ................................................16
7. Documents to be Delivered at the Closing......................................................17
7.1 Documents to be Delivered by the Company............................................17
7.2 Delivery of Purchase Price..........................................................17
8. Miscellaneous.................................................................................18
8.1 Certain Definitions.................................................................18
8.2 Tax Treatment of Preferred Stock....................................................21
8.3 Expenses............................................................................21
8.4 Specific Performance................................................................21
8.5 Further Assurances..................................................................22
8.6 Submission to Jurisdiction; Consent to Service of Process...........................22
8.7 Entire Agreement; Amendments and Waivers............................................22
8.8 Governing Law.......................................................................22
8.9 Table of Contents; Headings; Interpretive Matters...................................22
8.10 Notices............................................................................22
8.11 Severability.......................................................................23
8.12 Binding Effect; Assignment.........................................................23
8.13 Counterparts.......................................................................24
</TABLE>
ii
<PAGE> 4
SECURITIES PURCHASE AGREEMENT
SECURITIES PURCHASE AGREEMENT, dated as of January 8, 1998
(this "Agreement"), among MGC Communications, Inc., a Nevada corporation (the
"Company"), and the Purchasers listed on Schedule I (the "Purchasers").
W I T N E S S E T H :
WHEREAS, the Company desires to issue to each Purchaser, and
each Purchaser desires to purchase from the Company, the Shares (as such term is
defined below) in such amounts as set forth next to such Purchaser on Schedule
1, and
WHEREAS, certain terms used in this Agreement are defined in
Section 8.1 hereof,
NOW, THEREFORE, in consideration of the promises and mutual
covenants and agreements hereinafter contained, the parties hereto hereby agree
as follows:
1. SALE AND PURCHASE OF SHARES.
1.1 Sale and Purchase of Shares. Subject to the terms and
conditions of this Agreement, on the Closing Date (as defined in Section 3.1
hereof) the Company shall sell, assign, transfer, convey and deliver to each
Purchaser, and each Purchaser shall purchase from the Company the number of
shares of Series A Convertible Preferred Stock, par value $.001 per share (the
"Series A Preferred Stock") listed next to such Purchaser on Schedule I (the
"Shares"), for the Purchase Price (as defined in Section 2.1 below) and upon the
terms and conditions hereinafter set forth.
2. PURCHASE PRICE.
2.1 Amount of Purchase Price. The purchase price for the
Shares shall be as indicated on Schedule I (the "Purchase Price"). The Purchase
Price shall be payable as provided in Section 2.2 hereof
2.2 Payment of the Purchase Price.. At the Closing, the
Purchasers shall pay the Purchase Price by wire transfer of clearinghouse funds
or by such other method as may be reasonably acceptable to the Company and the
Purchasers to such account of the Company as shall have been designated in
advance to the Purchasers by the Company.
3. CLOSING; TERMINATION OF AGREEMENT.
3.1 Closing Date. The closing of the sale and purchase of the
Shares provided for in Section 1.1 (the "Closing") shall take place at 9:00 a.m.
at the offices of Ellis, Funk, Goldberg, Labovitz & Dokson, P.C. in Atlanta,
Georgia (or at such other place as the parties hereto may mutually agree) on the
date hereof, or on such other date as the parties hereto may mutually agree. The
date on which the Closing is held is referred to in this Agreement as the
"Closing Date." At the Closing, the parties shall execute and deliver the
documents referred to in Section 7 hereof.
4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company
represents and warrants to each Purchaser that:
1
<PAGE> 5
4.1 Organization and Good Standing. (a) The Company is duly
organized, validly existing and in good standing under the laws of the State of
Nevada and has full corporate power and authority to own, lease and operate its
properties and assets and to carry on its business as now conducted and as it is
proposed to be conducted. The Company is duly qualified or authorized to do
business as a foreign corporation and is in good standing under the laws of each
jurisdiction in which the conduct of its business or the ownership of its
properties or assets requires such qualification or authorization, except for
those jurisdictions where the failure to be so qualified would not, individually
or in the aggregate, have or result in a material adverse effect on the
business, properties, results of operations, prospects or conditions (financial
or otherwise) of the Company.
(b) The authorized capital stock of the Company is as set
forth on Schedule 4.1 (b). Except as disclosed on Schedule 4.1 (b), there is no
existing option, warrant, call, right, commitment or other agreement of any
character to which the Company is a party requiring, and there are no securities
of the Company outstanding which upon conversion or exchange would require, the
issuance, sale or transfer of any additional shares of capital stock or other
equity securities of the Company or other securities convertible into,
exchangeable for or evidencing the right to subscribe for or purchase shares of
capital stock or other equity securities of the Company. Except as disclosed on
Schedule 4. l(b), the Company is not a party to, nor aware of, any voting trust
or other voting agreement with respect to any of the securities the Company or
to any agreement relating to the issuance, sale, redemption, transfer or other
disposition of the capital stock of the Company.
4.2 Authorization of Agreement; Enforceability. The Company
has all requisite corporate power and authority to execute and deliver this
Agreement and each other agreement, document, instrument or certificate
contemplated by this Agreement or to be executed by the Company in connection
with the consummation of the transactions contemplated by this Agreement (the
"Transaction Documents"), and to perform fully its obligations hereunder and
thereunder. The execution, delivery and performance by the Company of this
Agreement and the Transaction Documents have been duly authorized by all
necessary corporate action on the part of the Company and its shareholders. This
Agreement and each of the Transaction Documents have been duly and validly
executed and delivered by the Company and (assuming the due authorization,
execution and delivery thereof by each Purchaser) this Agreement and each of the
Transaction Documents constitutes the legal, valid and binding obligations of
the Company, enforceable against the Company in accordance with their respective
terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium
and similar laws affecting creditors' rights and remedies generally and subject,
as to enforceability, to general principles of equity (regardless of whether
enforcement is sought in a proceeding at law or in equity).
4.3 Subsidiaries. The Company has no Subsidiaries.
4.4 Consents of Third Parties. None of the execution and
delivery by the Company of this Agreement and the Transaction Documents, the
consummation of the transactions contemplated hereby or thereby, or compliance
by the Company with any of the provisions hereof or thereof will (a) conflict
with, or result in the breach of, any provision of the articles of incorporation
or by-laws of the Company; (b) conflict with, violate, result in the breach or
termination of, or constitute a default or give rise to any right of termination
or acceleration or right to increase the obligations or otherwise modify the
terms thereof under any Contract, Permit or Order to which the Company is a
party or by which the Company or any of its properties or assets is bound; (c)
constitute a violation of any Law applicable to the Company, or (d) result in
the creation of any Lien upon the properties or assets of the Company, other
than, in the case of clauses
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(b), (c) and (d), any such conflict, violation, breach, termination,
acceleration or other event which, individually or in the aggregate, could not
reasonably be expected to cause a Material Adverse Change. Other than those
which have been obtained or made, no consent, waiver, approval, Order, Permit or
authorization of, or declaration or filing with, or notification to, any Person
or Governmental Body is required on the part of the Company in connection with
the execution and delivery of this Agreement or the Transaction Documents, or
the compliance by the Company with any of the provisions hereof or thereof
4.5 Authorization of Preferred Shares. The issuance, sale, and
delivery of the Shares have been duly authorized by all requisite action of the
Company, and, when issued, sold, and delivered in accordance with this
Agreement, the Shares, and the Common Stock delivered upon conversion of the
Shares will be validly issued and outstanding, fully paid, and nonassessable,
with no personal liability attaching to the ownership thereof, and, except as
may be set forth in the Stockholders Agreement, not subject to preemptive or any
other similar rights of the shareholders of the Company or others.
4.6 Financial Statements. The Company has provided prior to
the Closing Date (a) copies of the unaudited consolidated balance sheets of the
Company as of September 30, 1997 and the related unaudited consolidated
statements of income and cash flows for the quarter then ended (the "Unaudited
Financial Statements") and (b) the audited consolidated balance sheets of the
Company as of December 31, 1996 and the related consolidated statements of
income and cash flows for such year ended (such statements, including the
related notes and schedules thereto, and the Unaudited Financial Statements, are
referred to herein as the "Financial Statements"). Each of the Financial
Statements was prepared in good faith by the Company, is complete and correct in
all material respects, has been prepared in accordance with GAAP and in
conformity with the practices consistently applied by the Company and presents
fairly the consolidated financial position, results of operations and cash flows
of the Company as of the dates and for the periods indicated, except, with
respect to the Unaudited Financial Statements, for the absence of footnotes and
year end adjustments.
4.7 No Undisclosed Liabilities. Except as set forth on
Schedule 4.7, the Company has no liabilities (whether accrued, absolute,
contingent or otherwise, and whether due or to become due or asserted or
unasserted), except (a) obligations under Contracts described in Schedule 4.13
or under Contracts that are not required to be disclosed thereon as a result of
dollar thresholds therein; (b) liabilities provided for in the Unaudited
Financial Statements; (c) liabilities (other than accounts payable) incurred
since the Unaudited Financial Statements, in the ordinary course of business,
the sum of which is, in the aggregate, no greater than $500,000; and (d)
accounts payable in excess of those shown on the Unaudited Financial Statements,
incurred in the ordinary course of business, the sum of which is, in the
aggregate, not greater than $500,000. Unless specifically disclosed as a breach
on Schedule 4.7, disclosure of a Contract on Schedule 4.13 shall not be
indicative of a breach of any provision of such Contract.
4.8 Absence of Certain Developments.
(a) Except as set forth in Schedule 4.8(a) the general nature
of the business of the Company (the "Business") is described in the Offering
Memorandum with respect to the Company's issuance of $160,000,000 of 13% Senior
Secured Notes due 2004 (and related warrants) dated September 24, 1997 (to the
extent not superseded by the Prospectus contained in the Registration Statement
on Form S-4 filed with the Securities and Exchange Commission on October 28,
1997 (the "Registration Statement")) and the Registration Statement
(collectively, the "Offering Memorandum"), which previously has been delivered
to the Purchasers.
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(b) Except as set forth in Schedule 4.8(b) and since the date
of the Unaudited Financial Statements:
(i) there has not been any Material Adverse Change nor
has any event occurred which could reasonably be expected to result in any
Material Adverse Change; or
(ii) there has not been any damage, destruction or loss,
whether or not covered by insurance, with respect to the property and assets of
the Company having a replacement cost of more than $100,000 for any single loss
or $500,000 for all such losses;
(iii) there has not been any declaration, setting a record
date, setting aside or authorizing the payment of, any dividend or other
distribution in respect of any shares of capital stock of the Company or any
repurchase, redemption or other acquisition by the Company, of any of the
outstanding shares of capital stock or other securities of, or other ownership
interest in, the Company;
(iv) except for grants of 78,600 shares under the
Company's stock option plan, there has not been any transfer, issue, sale or
other disposition by the Company of any shares of capital stock or other
securities of the Company or any grant of options, warrants, calls or other
rights to purchase or otherwise acquire shares of such capital stock or such
other securities;
(v) except with respect to the hiring of new Employees
in the ordinary course of business whose annual compensation in the aggregate is
not greater than $500,000 (exclusive of benefits), the Company has not awarded
or paid any bonuses to Employees of the Company nor has the Company entered into
any employment, deferred compensation, severance or similar agreements (nor
amended any such agreement) or agreed to increase the compensation payable or to
become payable by it to any of the Company's directors, officers, Employees,
agents or Representatives or agreed to increase the coverage or benefits
available under any severance pay, termination pay, vacation pay, company
awards, salary continuation for disability, sick leave, deferred compensation,
bonus or other incentive compensation, insurance, pension or other employee
benefit plan, payment or arrangement made to, for or with such directors,
officers, Employees, agents or Representatives, other than in the ordinary
course of business consistent with past practice which increases in the
aggregate do not exceed $100,000 in annual cost to the Company, and other than
as may have been required by law or insurers;
(vi) the Company has not made any loans, advances or
capital contributions to, or investments in, any Person or paid any fees or
expenses to any Affiliate of the Company, other than for reimbursement of
expenses in the ordinary course of business consistent with past practices;
(vii) except for Liens with respect to the Senior Notes,
the Company has not mortgaged, pledged or subjected to any Lien any of its
assets, or acquired any assets or sold, assigned, transferred, conveyed, leased
or otherwise disposed of any assets, except for assets acquired or sold,
assigned, transferred, conveyed, leased or otherwise disposed of in the ordinary
course of business consistent with past practice;
(viii) the Company has not discharged or satisfied any
Lien, or paid any obligation or liability (fixed or contingent), except in the
ordinary course of business consistent with past practice and which, in the
aggregate, would not be material to the Company;
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(ix) the Company has not canceled or compromised any
debt or claim or amended, canceled, terminated, relinquished, waived or released
any Contract or right except in the ordinary course of business consistent with
past practice and which, in the aggregate, would not be material to the Company;
(x) the Company has not transferred or granted any
rights under any contracts, leases, licenses, agreements or Intangible Property
(as defined in Section 4.12 hereof) used by the Company in its business which
reasonably could be expected to result in a Material Adverse Change; and
(xi) the Company has not made any binding commitment to
make any capital expenditures or capital additions or betterments in excess of
$500,000 in the aggregate.
4.9 Taxes.
(a) The amount, if any, shown on the Unaudited Financial
Statements, as provision for Taxes is sufficient for payment of all accrued and
unpaid federal, state, county, local and foreign Taxes for the period then ended
and all prior periods.
(b) The Company has filed all Tax Returns (federal, state,
county, local and foreign) required to be filed by it and all such returns are
true and correct in all material respects. All Taxes shown to be due and payable
on such returns, any assessments imposed, and to the Company's knowledge all
other Taxes due and payable by the Company on or before the Closing have been
paid or will be paid prior to the time they become delinquent, other than those
being contested in good faith and listed on Schedule 4.9(b).
(c) Federal Income Tax Returns of the Company have not been
audited by the Internal Revenue Service, and no controversy with respect to
Taxes of any type is pending or, to the best of the Company's knowledge,
threatened.
(d) Neither the Company nor any of its stockholders has ever
filed (i) an election pursuant to Section of the Code that the Company be taxed
as an S Corporation or (ii) consent pursuant to Section 341 (f) of the Code
relating to collapsible corporations.
(e) Except as set forth on Schedule 4.9(e) , the Company's net
operating losses, if any, for federal income tax purposes, as set forth in the
Financial Statements, are not subject to any limitations imposed by Section 382
of the Code, and consummation of the transactions contemplated by this Agreement
or by any other agreement, understanding or commitment, contingent or otherwise,
to which the Company is a party or by which it is otherwise bound will not have
the effect of limiting the Company's ability to use such net operating losses in
full to offset such taxable income.
(f) The Company has not waived any statute of limitation in
respect of Taxes or agreed to any extension of time with respect to a Tax
assessment or deficiency.
(g) The Company is not a party to any Income Tax allocation or
sharing agreement.
(h) The Company is not and has never been a member of an
Affiliated Group filing a consolidated Federal Income Tax Return (other than a
group the common parent of which was the Company).
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(i) The Company is not a "United States real property holding
corporation" within the meaning of Section 847(c)(2) of the Internal Revenue
Code of 1986, as amended.
4.10 Real Property.
(a) The Company does not own any real property other than as set
forth on Schedule 4. 10(a).
(b) Except as set forth on Schedule 4. 1 0(b), the Company has good,
legal, and marketable title to all of its assets, including all properties and
assets free and clear of all Liens, except those assets disposed of since the
date of the Unaudited Financial Statement in the ordinary course of business and
except for Liens incurred with respect to the Senior Notes and Liens incurred in
the ordinary course of business which would not impair the Company's use of such
property in any material way.
(c) Schedule 4.10(c) sets forth a complete list of all real property
and interests in real property leased by the Company (each a "Real Property
Lease", and collectively, the Real Property Leases) as lessee or lessor. The
Company has good and marketable title to the leasehold estates in all Real
Property Leases in each case free and clear of all Liens, except for Liens
incurred with respect to the Senior Notes and Liens incurred in the ordinary
course of business which would not impair the Company's use of such property in
any material way. The Company has no reason to believe that such title would not
be insurable subject to customary exceptions.
(d) Each of the Real Property Leases is valid and enforceable in
accordance with its terms, subject to applicable bankruptcy, insolvency,
reorganization, moratorium and similar laws affecting creditors' rights and
remedies generally and subject, as to enforceability, to general principles of
equity (regardless of whether enforcement is sought in a proceeding at law or in
equity), and there is no material default under any Real Property Lease by the
Company or, to the best knowledge of the Company, by any other party thereto,
and no event has occurred that with the lapse of time or the giving of notice or
both would constitute a material default thereunder. The Company has made
available to each Purchaser true, correct and complete copies of the Real
Property Leases, together with all amendments, modifications, supplements or
side letters affecting the obligations of any party thereunder.
(e) No previous or current party to any Real Property Lease has given
notice of or made a claim with respect to any breach or default thereunder. With
respect to those Real Property Leases that were assigned or subleased to the
Company by a third party, all necessary consents to such assignments or
subleases have been obtained.
4.11 Tangible Personal Property.
(a) Schedule 4.11(a) sets forth all leases of personal property
("Personal Property Leases") involving annual payments in excess of $50,000
relating to personal property used in the business of the Company or to which
the Company is a party or by which the Company or any of its respective
properties or assets is bound. The Company has made available to each Purchaser
true, correct and complete copies of the Personal Property Leases, together with
all amendments, modifications, supplements or side letters affecting the
obligations of any party thereunder.
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(b) (i) Each of the Personal Property Leases is in full force and
effect and is valid, binding and enforceable in accordance with its terms,
subject to applicable bankruptcy, insolvency, reorganization, moratorium and
similar laws affecting creditors' rights and remedies generally and subject, as
to enforceability, to general principles of equity (regardless of whether
enforcement is sought in a proceeding at law or in equity), and there is no
material default under any Personal Property Lease by the Company or, to the
best knowledge of the Company, by any other party thereto, and no event has
occurred that with the lapse of time or the giving of notice or both would
constitute a material default thereunder; and
(ii) No previous or current party to any such Personal Property
Lease has given notice of or made a claim with respect to any breach or default
thereunder.
(c) With respect to those Personal Property Leases that were assigned
or subleased to the Company by a third party, all necessary consents to such
assignments or subleases have been obtained.
(d) The Company has good, legal and marketable title to all of the
material items of tangible personal property used by it (except as sold or
disposed of subsequent to the date hereof in the ordinary course of business
consistent with past practice), free and clear of any and all Liens, except for
Liens incurred with respect to the Senior Notes and Liens incurred in the
ordinary course of business which would not impair the Company's use of such
property in any material way. All such items of tangible personal property
which, individually or in the aggregate, are material to the operation of the
business of the Company are suitable for the purposes used for the operation of
the business of the Company.
4.12 Intangible Property.
(a) "Proprietary Rights" shall mean any and all of the following
which have been or are used and/or owned by, and/or issued or licensed to the
Company, along with all income, royalties, damages and payments due or payable
at the Closing or thereafter, including, without limitation, damages and
payments for past, present or future infringements or misappropriations thereof,
the right to sue and recover for past infringements or misappropriations thereof
and any and all corresponding rights that, now or hereafter, may be secured
throughout the world: patents, patent applications, patent disclosures and
inventions (whether or not patentable and whether or not reduced to practice)
and any reissue, continuation, continuation-in-part, division, revision,
extension or reexamination thereof, utility model registrations and
applications; design registrations and applications; trademarks, service marks,
trade dress, logos, trade names and corporate names together with all goodwill
associated therewith, copyrights registered or unregistered and copyrightable
works; mask works; and all registrations, applications, and renewals for any of
the foregoing; trade secrets and confidential information (including without
limitation, ideas, formulae, compositions, know-how, manufacturing and
production processes and techniques, research and developmental information,
drawings, specifications, designs, plans, proposals, technical data, financial,
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business and marketing plans, and customer and supplier lists and related
information); computer software and software systems (including, without
limitation, data, databases, object code, source code, macrocyte and firmware
and related documentation); other proprietary and intellectual property rights;
licenses or other agreements including but not limited to those assigning,
waiving or relating to rights of publicity, moral rights or neighboring rights
to or from third parties; and all copies and tangible embodiments of the
foregoing (in whatever form or medium), in each case including, without
limitation, the items set forth on the Schedule 4.12(b) attached hereto.
(b) Schedule 4.12(b) sets forth a complete and correct list of (i)
all patents, trademark and serviceman registrations, copyright registrations and
other registered Proprietary Rights as well as all pending applications
therefor; (ii) all corporate names, trade names and unregistered trademarks used
by the Company (to the extent not reflected on other schedules attached hereto)
as their own marks; (iii) all material unregistered copyrightable works
authorized by the Company, mask works, and material computer software owned or
licensed by the Company (other than commercial software products generally
available to consumers); and (iv) all material licenses or similar agreements to
which the Company is or just prior to closing was a party either as licensee or
licensor for the Proprietary Rights, in each case identifying the subject
Proprietary Rights.
(c) Except as set forth on Schedule 4.12(c), (i) the Company owns and
possess all right, title and interest, free and clear of all Liens, in and to,
and to the best knowledge of the Company has a valid and enforceable right to,
each of the Proprietary Rights as described on Schedule 4.12(b), and no claim by
any third party contesting the validity, enforceability, use or ownership of any
of the Proprietary Rights has been made, is currently outstanding or, to the
best knowledge of the Company, is threatened, except for those which could not
reasonably be expected, individually or in the aggregate, to cause a Material
Adverse Change; (ii) the Proprietary Rights comprise all material intellectual
property rights which are currently being used by the Company or which are
necessary for the operation business as currently conducted by the Company, and
as currently proposed to be conducted; (iii) no loss or expiration of any
Proprietary Right or related group of Proprietary Rights is, to the Company's
knowledge, threatened, or is pending or reasonably foreseeable, except for those
which could not reasonably be expected, individually or in the aggregate, to
cause a Material Adverse Change; (iv) the Company has not received any notices
of, nor is the Company aware of any facts which indicate a likelihood of any
infringement or misappropriation by, or conflict with, any third party with
respect to any of the Proprietary Rights including, without limitation, any
demand or request by the Company that such third party license any of the
Proprietary Rights from the Company or to the Company; (v) to the best of the
Company's knowledge, the Company has not infringed, misappropriated or otherwise
conflicted with any rights, including intellectual property rights, of any third
parties, and the Company is not aware of any infringement, misappropriation or
conflict by the Company of any third-party patent, trademark, copyright or other
intellectual property right, or of any such infringement, misappropriation or
conflict which shall occur as a result of the continued operation of the
business by the Company, as currently conducted or as currently proposed to be
conducted, and there is no demand or request from a third party that the Company
take a license under any intellectual property right; and (vi) none of the
Proprietary Rights owned by or licensed to the Company are, to the best
knowledge of the Company, being infringed, misappropriated or conflicted by any
third party.
(d) All of the Proprietary Rights are owned by, or properly assigned
or licensed to, the Company or use thereof is otherwise authorized, except to
the extent that the failure to be so owned,
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assigned, licensed or otherwise authorized could not reasonably be expected to,
individually or in the aggregate, cause a Material Adverse Change. The Company
has not disclosed, or is aware of any disclosure by any other Person of any of
its trade secrets or confidential information to any third party other than
pursuant to a written confidentiality agreement or disclosure to the Company's
shareholders.
4.13 Material Contracts.
(a) Except as set forth on Schedule 4.13(a), neither the Company nor
any of its respective properties or assets is a party to or bound by any (i)
Contract not made in the ordinary course of business, or involving a commitment
or payment in excess of $500,000 or otherwise material to the business of the
Company; (ii) employment, consulting, noncompetition, severance, "golden
parachute" or indemnification Contract involving, individually or in the
aggregate, annual payments of more than $250,000 (including, without limitation,
in each case any Contract to which the Company is a party involving Employees of
the Company); (iii) Contract among shareholders or granting a right of first
refusal or for a partnership or a joint venture or for the acquisition, sale or
lease of any assets (except in the ordinary course of business) or capital stock
of the Company or any other Person or involving a sharing of profits; (iv)
mortgage, pledge, conditional sales contract, security agreement, factoring
agreement or other similar Contract with respect to any real or tangible
personal property of the Company; (v) loan agreement, credit agreement,
promissory note, guarantee, subordination agreement, letter of credit or any
other similar type of Contract; (vi) Contract with any Governmental Body; (vii)
Contract with respect to the discharge, storage or removal of Hazardous
Materials; or (viii) binding commitment or agreement to enter into any of the
foregoing. The Company has delivered or otherwise made available to each
Purchaser true, correct and complete copies of the Contracts listed on Schedule
4.13(a) (except as noted thereon), together with all amendments, modifications,
supplements or side letters affecting the obligations of any party thereunder.
(b) (i) Each of the Contracts listed on Schedule 4.13(a) is valid
and enforceable in accordance with its terms, subject to applicable bankruptcy,
insolvency, reorganization, moratorium and similar laws affecting creditors'
rights and remedies generally and subject, as to enforceability, to general
principles of equity (regardless of whether enforcement is sought in a
proceeding at law or in equity), and there is no material default under any
Contract listed on Schedule 4.13(a) by the Company or, to the best knowledge of
the Company, by any other party thereto, and no event has occurred that with the
lapse of time or the giving of notice or both would constitute a material
default thereunder.
(ii) No previous or current party to any Contract has given
notice to the Company of or made a claim with respect to any breach or default
thereunder and the Company is not aware of any notice of or claim to any such
breach or default.
(c) With respect to the Contracts listed on Schedule 4.13(a) that
were assigned to the Company by a third party, all necessary consents to such
assignment have been obtained.
4.14 Employee Benefits.
(a) The Company has not made contributions to any pension, defined
benefit, or defined contribution plans for its Employees which are subject to
ERISA.
(b) Set forth on Schedule 4.14(b) is a true and complete list of
each Company
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Benefit Plan and each Employee Agreement providing for annual compensation in
excess of $100,000. Except as set forth on Schedule 4.14(b), the Company does
not have any plan or commitment, whether legally binding or not, to establish
any new Company Benefit Plan, to enter into any Employee Agreement or to modify
or to terminate any Company Benefit Plan or Employee Agreement (except to the
extent required by law or to conform any such Company Benefit Plan or Employee
Agreement to the requirements of any applicable law, in each case as previously
disclosed to the Purchasers, or as required by this Agreement), nor has any
intention to do any of the foregoing been communicated to Employees.
(c) Except as set forth on Schedule 4.14(c), (i) the Company does not
maintain or contribute to any Company Benefit Plan which provides, or has any
liability to provide, life insurance, medical, severance or other employee
welfare benefits to any Employee upon his retirement or termination of
employment, except as may be required by Section 4980B of the code; and (ii) the
Company has never represented, promised or contracted (whether in oral or
written form) to any Employee (either individually or to Employees as a group)
that such Employee(s) would be provided with life insurance, medical, severance
or other employee welfare benefits upon their retirement or termination of
employment, except to the extent required by Section 4980B of the Code.
(d) The Company (i) is in compliance with all applicable federal,
state and local laws, rules and regulations (domestic and foreign) respecting
employment, employment practices, labor, terms and conditions of employment and
wages and hours, in each case, with respect to Employees, except where the
failure to be in such compliance could not reasonably be expected, individually
or in the aggregate, to cause a Material Adverse Change; (ii) has withheld all
amounts required by law or by agreement to be withheld from the wages, salaries
and other payments to Employees; (iii) is not liable for any arrears of wages or
any taxes or any penalty for failure to comply with any of the foregoing; and
(iv) is not liable for any payment to any trust or other fund or to any
governmental or administrative authority, with respect to unemployment
compensation benefits, social security or other benefits for Employees.
(e) No work stoppage or labor strike against the Company by Employees
is pending or, to the best knowledge of the Company, threatened. The Company (i)
is not involved in or, to the best knowledge of the Company, threatened with any
significant labor dispute, grievance, or litigation relating to labor matters
involving any Employees, including, without limitation, violation of any
federal, state or local labor, safety or employment laws (domestic of foreign),
charges of significant unfair labor practices or discrimination complaints; (ii)
has not engaged in any unfair labor practices within the meaning of the National
Labor Relations Act or the Railway Labor Act which would cause a Material
Adverse Change ; or (iii) is not presently, nor has been in the past a party to,
or bound by, any collective bargaining agreement or union contract with respect
to Employees and no such agreement or contract is currently being, negotiated by
the Company or any of its affiliates. No Employees are currently represented by
any labor union for purposes of collective bargaining and, to the best knowledge
of the Company, no activities the purpose of which is to achieve such
representation of all or some of such Employees are ongoing or threatened.
(f) Except as set forth on Schedule 4.14(f), no benefits shall
accrue, become payable vest or accelerate as a result of the Transaction under
any Company Benefit Plan or Employee Agreement, including, but not limited to,
the vesting of benefits under any "employee benefit plan" within the meaning of
Section 3(3) of ERISA, the acceleration of stock or stock related awards, or the
payment of any amount under any Employee Agreement or Company Benefit Plan.
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4.15 Employees.
Except as set forth on Schedule 4.15, to the best knowledge of the
Company, no key executive Employee and no group of Employees or independent
contractors of the Company has any plans to terminate his, her or its employment
or relationship as an Employee or independent contractor with the Company.
4.16 Litigation.
There are no Legal Proceedings pending or, to the best knowledge of
the Company, threatened that question the validity of this Agreement or the
Transaction Documents or any action taken or to be taken by the Company in
connection with the consummation of the transactions contemplated hereby or
thereby. Schedule 4.16 sets forth a true, correct and complete list of all Legal
Proceedings pending or, to the best knowledge of the Company, threatened against
or affecting the Company or any of its properties or assets (including Company
Benefit Plans) of the Company, at law or in equity, and, to the best knowledge
of the Company, there is no reasonable basis for any other such Legal
Proceeding. There is no outstanding or, to the best knowledge of the Company,
threatened Order of any Governmental Body against, affecting or naming the
Company or affecting any of its properties or assets.
4.17 Compliance with Laws; Permits.
(a) The Company is and at all times has been in compliance with all
Laws and Orders promulgated by any Governmental Body applicable to the Company
or to the conduct of the business or operations of the Company or the use of its
properties (including any leased properties) and assets, except where the
failure to be in such compliance could not reasonably be expected, individually
or in the aggregate, to cause a Material Adverse Change. The Company has not
received or knows of the issuance of, any notices of violation or alleged
violation of any such Law or Order by any Governmental Body.
(b) The Company has or is in the process of obtaining all Permits
necessary for the conduct of its business as currently conducted, except where
the failure to obtain a Permit could not reasonably be expected, individually or
in the aggregate, to cause a Material Adverse Change. Schedule 4.17(b) lists all
material Permits of the Company obtained (or for which applications have been
made for) from all Governmental Bodies, indicating, in each case, the expiration
date thereof, which are required by the nature of the operations of the Company
to permit the operation thereof in the manner in which they are currently
conducted. Such Permits have been issued pursuant to valid applications by the
Company to the appropriate Governmental Bodies made in compliance with all
applicable Laws, and the Company has substantially complied with all conditions
of such Permits applicable to it. No material default or violation, or event
that with the lapse of time or giving of notice or both would become a material
default or violation, has occurred in the due observance of any such Permit. All
such Permits are in full force and effect without further consent or approval of
any Person. The Company has not received any notice from any source to the
effect that there is lacking any such Permit required in connection with the
current operations of the Company. The Company has made all required filings
with Governmental Bodies, except where the failure to make such filings could
not reasonably be expected, individually or in the aggregate, to cause a
Material Adverse Change.
4.18 Environmental Matters. (a) Except as set forth on Schedule 4.18,
the operations
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of the Company have been and, as of the Closing Date, will be in compliance with
all Environmental Laws, except where the failure to be in such compliance could
not reasonably be expected, individually or in the aggregate, to cause a
Material Adverse Change; (b) the Company has obtained, currently maintains and,
as of the Closing Date, will have all Environmental Permits necessary for its
operations, other than such Environmental Permits the lack of which could not
reasonably be expected, individually or in the aggregate, to cause a Material
Adverse Change; all such Environmental Permits are and, as of the Closing Date,
will be, in good standing; there are no Legal Proceedings pending or, to the
best knowledge of the Company, threatened to revoke any such Environmental
Permit; the Company is, and as of the Closing Date will be, in compliance with
such Environmental Pen-nits; and the Company has not received any notice from
any source, or has otherwise obtained knowledge, to the effect that there is
lacking any Environmental Permit required in connection with the current use or
operation of any Real Property Lease; (c) the Company and all of its past and
current Facilities and operations are not subject to any outstanding written
Order or Contract, including Environmental Liens, with any Governmental Body or
Person, or to the best knowledge of the Company subject to any federal, state,
local or foreign investigation respecting (1) Environmental Laws, (2) any
Remedial Action or (3) any Environmental Claim arising from the Release or
threatened Release of a Hazardous Material; (d) the Company is not subject to
any Legal Proceeding alleging the violation of any Environmental Law or
Environmental Permit; (e) the Company has not received (nor, to the best
knowledge of the Company, has there been issued) any written communication,
whether from a Governmental Body, citizens' group, Employee or any other Person,
that alleges that the Company is not in compliance with any Environmental Law or
Environmental Permit; (f) the Company has not caused or permitted any Hazardous
Materials to remain or be disposed of, either on or under real property legally
or beneficially owned or operated by the Company or on any real property not
permitted to accept, store or dispose of such Hazardous Materials; (g) the
Company does not have any liabilities with respect to Hazardous Materials, and
no facts or circumstances exist which, in the aggregate, could give rise to
liabilities with respect to Hazardous Materials; (h) none of the operations of
the Company involves the generation, transportation, treatment, storage or
disposal of hazardous waste or subject waste, as defined under 40 C.F.R. Parts
260-270 (in effect as of the date of this Agreement); and (i) there is not now
on or in any property of the Company (1) any underground storage tanks or
surface tanks, dikes or impoundments; (2) any asbestos-containing materials or
(3) any polychlorinated biphenyls, that, in any such case described in this
clause (i), could reasonably be expected, individually or in the aggregate, to
cause a Material Adverse Change.
4.19 Investment Company Act. The Company is not, nor is it directly
or indirectly controlled by or acting on behalf of any Person that is, an
investment company within the meaning of the Investment Company Act of 1940, as
amended.
4.20 Transactions with Affiliates. Except as set forth on Schedule
4.20, the Company has not made any payment to, or received any payment from, or
made or received any investment in, or entered into any transaction with, any
Affiliate, including without limitation, the purchase, sale or exchange of
property or the rendering of any service, where the amounts involved is material
to the business of the Company.
4.21 Disclosure; Survival. This Agreement, the Financial Statements,
schedules provided in connection with this Agreement and the Offering
Memorandum, taken as a whole, do not contain any untrue statement of material
fact, fairly represent the business, properties, assets, and condition,
financial or otherwise, of the Company in all material respects, and do not fail
to state a material fact necessary in order to make the statements contained
therein and herein, when taken as a whole, not misleading. There is no fact
which has not been disclosed to the Purchasers of which the
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Company is aware and which materially adversely affects or could reasonably be
anticipated to materially adversely effect the business, financial condition,
operating results, earnings, assets, customary, supplier, Employee or sales
representative relations or business prospects of the Company. All
representations, warranties, covenants and agreements set forth in this
Agreement or in any writing or certificate delivered in connection with this
Agreement shall survive the execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby and shall not be affected
by any examination made for or on behalf of any Purchaser, the knowledge of any
Purchaser, or the acceptance by any Purchaser of any certificate or opinion.
4.22 Financial Advisors. Except as disclosed on Schedule 4.22, no
agent, broker, investment banker, finder, financial advisor or other person
acting on behalf of the Company or under its authority is or will be entitled to
any broker's or finder's fee or any other commission or similar fee, directly or
indirectly, in connection with the transactions contemplated by this Agreement
or any Transaction Document and no Person is entitled to any fee or commission
or like payment in respect thereof based in any way on agreements, arrangements
or understandings made by or on behalf of the Company.
4.23 Insurance. Schedule 4.23 lists all insurance policies carried by
the Company covering its properties and business. Such insurance insures against
such losses and risks as are adequate in accordance with customary industry
practice to protect the Company and its business. The Company is not in material
default with respect to its obligations under any insurance policy maintained by
it.
4.24 Dissolution of Previous Entities. The dissolution of MGC
Communications, LLC, a Georgia limited liability company, formerly known as
NevTEL, LLC (the "LLC"), and the distribution of the shares of Common Stock of
the Company held by the LLC (the "Reorganization") was consummated in compliance
with all applicable Laws. No person was or is entitled to receive any shares of
capital stock or other consideration which have been distributed as a result of
the Reorganization.
4.25 Improper Actions. The Company, or to the best knowledge of the
Company, any of its officers, directors, partners, employees, agents or
affiliates or any other person acting on behalf of the Company has not, directly
or indirectly, given or agreed to give any money, gift or similar benefit (other
than legal price concessions to customers in the ordinary course of business) to
any customer, supplier, employee or agent of a customer or supplier, official or
employee of any Governmental Body), Governmental Body or any political party or
candidate for office (domestic or foreign) or other person who was, is or may be
in a position to help or hinder the business of the Company (or assist the
Company in connection with any actual or proposed transaction) which (i) might
subject the Company, or any other individual or entity to any damage or penalty
in any Legal Proceeding, (ii) if not given in the past, might have caused a
Material Adverse Change or (iii) if not continued in the future, might cause a
Material Adverse Change.
5. REPRESENTATIONS AND WARRANTIES OF THE PURCHASERS. Each Purchaser
hereby represents and warrants to the Company, severally, for itself only, that:
5.1 Organization and Good Standing. Each Purchaser which is an entity
is duly organized, validly existing and in good standing under the laws of the
jurisdiction of its formation or incorporation, as applicable.
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5.2 Authorization of Agreement. (a) Each Purchaser which is an entity
has full corporate or partnership power and authority to execute and deliver
this Agreement and each other agreement, document, instrument or certificate
contemplated by this Agreement or to be executed by each such Purchaser in
connection with the consummation of the transactions contemplated hereby and
thereby (the "Purchaser Documents"), and to perform fully its obligations
hereunder and thereunder. The execution, delivery and performance by such
Purchaser of this Agreement and each Purchaser Document has been duly authorized
by all necessary corporate or partnership action on behalf of such Purchaser.
(b) This Agreement and each Purchaser Document has been duly executed
and delivered by each Purchaser and (assuming the due authorization, execution
and delivery by the other parties hereto and thereto) this Agreement and each
Purchaser Document constitute the legal, valid and binding obligations of each
Purchaser, enforceable against such Purchaser in accordance with their
respective terms.
5.3 Purchaser Representation. Each Purchaser has such knowledge and
experience in financial and business matters that it is capable of evaluating
the merits and risks of an investment in the Shares. Each Purchaser has been
given the opportunity to examine all documents provided by, conduct due
diligence and ask questions of, and to receive answer from, the Company and
their respective representatives concerning the terms and conditions of an
investment in the Shares.
5.4 Investment Intention. Each Purchaser is acquiring the Shares for
its own account, for investment purposes only and not with a view to the
distribution (as such term is used in Section 2(11) of the Securities Act)
thereof in violation of the Securities Act, and that it is an "accredited
investor" within the meaning of Rule 501 of Regulation D of the Securities and
Exchange Commission. Each Purchaser understands that the Shares have not been
registered under the Securities Act and cannot be sold unless subsequently
registered under the Securities Act or an exemption from such registration is
available. The principal place of business or domicile of each Purchaser is
located in the jurisdiction where notices are to be sent to such Purchaser as
set forth on Schedule 1.
5.5 Financial Advisors. No agent, broker, investment banker, finder,
financial advisor or other person acting on behalf of each Purchaser or under
its authority is or will be entitled to any broker's or finder's fee or any
other commission or similar fee, directly or indirectly, in connection with the
transactions contemplated by this Agreement or any Transaction Document and no
Person is entitled to any fee or commission or like payment in respect thereof
based in any way on agreements, arrangements or understandings made by or on
behalf of each Purchaser.
5.6 Reliance. In making its decision to acquire the Shares, no
Purchaser has relied on any information provided by the Company or its
representatives other than the Offering Memorandum and the representations and
warranties contained herein and in the other documents executed in connection
herewith.
6. FURTHER AGREEMENTS OF THE PARTIES.
6.1 Covenants. For so long as the Shares are convertible, the Company
shall reserve that number of shares of Common Stock issuable upon conversion of
the Shares, which shares shall not be subject to any preemptive or other similar
rights (collectively, the "Reserved Shares").
6.2 Use of Proceeds. The Company shall use all of the proceeds from
the sale of the
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<PAGE> 18
Shares under this Agreement in accordance with the "Use of Proceeds" section of
the Offering Memorandum.
6.3 Access to Information. Until the consummation of a Public
Offering, the Purchasers shall be entitled, at their expense, upon reasonable
notice, to make such reasonable investigation of the properties, businesses and
operations of the Company and such examination of the books, records and
financial condition of the Company as they reasonably request and to make
extracts and copies of such books and records. Any such investigation and
examination shall be conducted during regular business hours and under
reasonable circumstances without material interference with the Company's normal
business operations, and the Company and its respective employees shall
cooperate fully therein. No investigation by the Purchasers prior to or after
the date of this Agreement shall diminish or obviate any of the representations,
warranties, covenants or agreements of the Company contained in this Agreement
or the Transaction Documents. In order that the Purchasers may have full
opportunity to make such physical, business, accounting and legal review,
examination of the affairs of the Company investigation as may be reasonably
requested, the Company shall cause its Representative to cooperate fully with
the Representatives of the Purchaser in connection with such review and
examination; provided that the Company shall not incur any material expense
related thereto. Each Purchaser shall use its reasonable best efforts to
maintain the confidentiality of information obtained as a result of the exercise
of its rights granted under this Section 6.3.
6.4 Confidentiality. Except as may be required by applicable law,
neither the Company nor the Purchasers or any of their respective Affiliates
shall at any time divulge, disclose, disseminate, announce or release any
information to any person concerning this Agreement, the Transaction Documents
or the transactions contemplated hereby or thereby without first obtaining the
prior written consent of the other party hereto; provided, however, each
Purchaser shall be entitled to disclose information with respect to its
investment in the Company on any reports such Purchaser furnishes to its
investors or as otherwise required by Law and the Company may disclose the terms
of this Agreement in connection with an issuance of debt or equity securities.
6.5 Other Actions. The Company and the Purchasers agree to execute
and deliver such other documents and take such other actions, as the other party
may reasonably request for the purpose of carrying out the intent of this
Agreement and the Transaction Documents.
6.6 Indemnity (a) The Company agrees to indemnify, defend and hold
harmless each Purchaser (and its partners (and each officer and director
thereof), directors, officers, members, shareholders, Employees, affiliates,
agents and permitted assigns) from and against any and all losses, liabilities,
damages, deficiencies, costs or expenses (including interest, penalties, and
reasonable attorneys' fees, disbursements and related charges) (collectively,
"Losses") based upon, arising out of or otherwise in respect of any inaccuracy
in or breach of any representations, warranties, covenants or agreements of the
Company contained in this Agreement or the Transaction Documents.
(b) Each Purchaser agrees, severally, for itself only, to indemnify,
defend and hold harmless the Company (and its partners (and each officer and
director thereof), directors, officers, members, shareholders, Employees,
affiliates, agents and permitted assigns) from and against any and all Losses
based upon, arising out of or otherwise in respect of any inaccuracy in or
breach of any representations, warranties, covenants or agreements of each
Purchaser contained in this Agreement or the Transaction Documents.
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6.7 U.S. Real Property Holding Corporation. The Company covenants
that it will operate in a manner such that it will not become a "United States
real property holding corporation" as such term is defined in Section 897(c)(2)
of the Internal Revenue Code of 1986, as amended ("USRPHC"), and the regulations
thereunder. The Company agrees to make determinations as to its status as a
USRPHC, and will file statements concerning those determinations with the
Internal Revenue Service, in the manner and at the times required under Reg.
1.897-2(h), or any supplementary or successor provision thereto. Within 30 days
of a request from a Purchaser, the Company will inform the requesting party, in
the manner set forth in Reg. 1.897-2(h) or any supplementary or successor
provision thereto, whether that party's interest in the Company constitutes a
United States real property interest (within the meaning of Internal Revenue
Code Section 897(c)(1) and the regulations thereunder) and whether the Company
has provided to the Internal Revenue Service all required notices as to its
USRPHC status.
6.8 Financial Statements, Reports, Etc. The Company shall furnish to
each Purchaser which, together with its Affiliates, purchases and continues to
own at least 285,714 Shares:
(a) as soon as available, and in any event within 90 days after the
end of each fiscal year of the Company, (i) a consolidated audited financial
statement of the Company as of the end of such fiscal year; (ii) the related
consolidated statements of income, stockholders' equity and cash flows for the
fiscal year then ended, prepared in accordance with GAAP and certified by a firm
of independent public accountants of recognized national standing selected by
the board of directors of the Company and acceptable to a majority of the
Purchasers (the "Annual Financial Statement"); and (iii) any related management
letters from such accounting firm. The Audited Financial statements shall be
accompanied by a management report describing the state of the Company's
business at year end.
(b) as soon as available, and in any event within 30 days after the
end of each month in each fiscal year a consolidated balance sheet of the
Company, and the related consolidated statement of income (with statements of
stockholders' equity and cash flows to be provided quarterly), unaudited but
prepared in accordance with GAAP (except that such unaudited financial statement
do not contain all of the required footnotes and are subject to normal,
recurring non-material year-end adjustments) and certified by the chief
financial officer of the Company (the "Monthly Balance Sheet"). The Monthly
Balance Sheet should be prepared as of the end of such month with consolidated
statements of income, stockholders' equity and cash flows for such month and for
the period from the beginning of the fiscal year to the end of such month, in
each case with comparative statements for the prior fiscal year and the most
recent 12-month budget delivered by the Company pursuant to Section 6.8(c)
hereof;
(c) as soon as available and in any event no later than 30 days prior
to the start of each fiscal year an annual business plan and consolidated
capital and operating expense budget, cash flow projections and income and loss
projections for the Company, in respect of such fiscal year, as approved by the
board of directors of the Company and all itemized in reasonable detail and
prepare on a quarterly basis, and, promptly after preparation, any revisions to
any of the foregoing;
(d) any document relating to the affairs of the Company delivered to
the shareholders of the Company; or
(e) prompt notice, and in any event within five days after notice has
been received by the Company, of any material litigation or an adverse claims,
dispute or any other developments which could reasonably be expected to be
material to operations, assets, or properties of the Company
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provided, however, that the rights provided in this Section 6.8 to a Purchaser
shall terminate with respect to such Purchaser (a) upon the earlier of a Public
Offering or (b) when such Purchaser (or its Affiliates) owns less than fifty
percent of the Shares, (including the Common Stock issuable thereto) purchased
by such Purchaser at the Closing; and provided further that the rights provided
in this Section 6.8 shall only be transferable to a transferee that acquires and
continues to own at least 50% of the Shares acquired by the Purchaser hereunder.
7. DOCUMENTS TO BE DELIVERED AT THE CLOSING.
7.1 Documents to be Delivered by the Company. At the Closing, the
Company shall deliver, or cause to be delivered, to each Purchaser the
following:
(a) Certificates representing the Shares issued hereunder;
(b) an opinion of Ellis Funk, Goldberg, Labovitz & Dokson, P.C. in
form and substance satisfactory to the Purchasers;
(c) a supplement to the Stockholders Agreement under which the
Purchasers will become parties thereto;
(d) (i) certificate of good standing with respect to the Company
issued by the secretary of state of Nevada; (ii) copy, certified by the
secretary or assistant secretary of the Company, as being a true and complete
copy as of the Closing Date, of the by-laws of the Company; and (iii) copy,
certified by the Secretary of State of Nevada, of the certificate of
incorporation of the Company;
(e) (i) copy of resolutions of the board of directors of the Company,
authorizing the execution, delivery and performance of this Agreement and the
Transaction Documents, the issuance of the Series A Preferred Stock and the
reservation of the Reserved Shares; (ii) and a certificate of the secretary or
assistant secretary of the Company, dated the Closing Date certifying that such
resolutions were duly adopted and are in full force and effect and attesting to
the true signatures and to the incumbency of the officers of the Company,
executing this Agreement and the Transaction Documents; and
(f) a certificate, certified by the President or any Vice-President
of the Company, stating that the respective representations and warranties of
the Company contained in this Agreement are true and correct in all material
respects on and as of the Closing Date.
(g) such other documents as the Purchasers shall reasonably request.
7.2 Delivery of Purchase Price. At the Closing, each Purchaser shall
deliver its Purchase Price by wire transfer to an account of which the Company
shall notify the Purchasers prior to the Closing Date.
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8. MISCELLANEOUS.
8.1 Certain Definitions
"Affiliate" of any Person means any Person that directly or
indirectly controls, or is under common control with, or is controlled by, such
Person. As used in this definition, "control" (including with its correlative
meanings, "controlled by" and "under common control with") shall mean the
possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of a Person (whether through ownership
of securities or partnership or other ownership interests, by contract or
otherwise).
"Benefit Plan " means each plan, program, policy, payroll practice,
contract, agreement or other arrangement providing for compensation, severance,
termination pay, performance awards, stock or stock related awards, fringe
benefits or other employee benefits of any kind, whether formal or informal,
funded or unfunded, written or oral and whether or not legally binding,
including, without limitation, each "Employee benefit plan," within the meaning
of Section 3(3) of ERISA and each "multi-employer plan" within the meaning of
Section 3(37) or 4001(a)(3) of ERISA.
"Code " means the Internal Revenue Code of 1986, as amended, and the
rules and regulations promulgated thereunder.
"Common Stock" means the Company's common stock, par value $.001 per
share.
"Communications Act" means the Communications Act of 1934, as
amended, and the rules and regulations and practices of the FCC.
"Company Benefit Plan " means each Benefit Plan (other than an
Employee Agreement) which is now or previously has been sponsored, maintained,
contributed to, or required to be contributed to, or with respect to which any
withdrawal liability (within the meaning of Section 4201 of ERISA) has been
incurred, by the Company for the benefit of any Employee, and pursuant to which
the Company has or may have any liability, contingent or otherwise.
"Contract " means any contract, agreement, indenture, note, bond,
loan, instrument, lease, conditional sale contract, mortgage, license,
franchise, insurance policy, commitment or other arrangement or agreement,
whether written or oral.
"Employee" means each current, former, or retired employee, office
consultant, independent contractor, agent or director of the Company.
"Employee Agreement" means each management, employment, severance,
consulting, non-compete, confidentiality, or similar agreement or contract
between the Company, and any Employee pursuant to which the Company has or may
have any liability contingent or otherwise.
"Environmental Claim " means any accusation, allegation, notice of
violation, action, claim, Lien, demand, abatement or other Order or direction
(conditional or otherwise) by any Governmental Body or any Person for personal
injury (including sickness, disease or death), tangible or intangible property
damage, damage to the environment, nuisance, pollution, contamination or other
adverse effects on the environment, or for fines, penalties or restrictions
resulting from or based upon (i)
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the existence, or the continuation of the existence, of a Release (including,
without limitation, sudden or non-sudden accidental or non-accidental Releases)
of, or exposure to, any Hazardous Material or other substance, chemical,
material, pollutant, contaminant, odor, audible noise, or other Release in, into
or onto the environment (including, without limitation, the air, soil, surface
water or groundwater) at, in, by, from or related to the Facilities or any
activities conducted thereon; (ii) the environmental aspects of the
transportation, storage, treatment or disposal of Hazardous Materials in
connection with the operation of the Facilities; or (iii) the violation, or
alleged violation, of any Environmental Laws, Orders or Permits of or from any
Governmental Body relating to environmental matters connected with the
Facilities.
"Environmental Law" means any Law concerning Releases into any part
of the natural environment, or activities that might result in damage to the
natural environment, or any Law that is concerned in whole or in part with the
natural environment and with protecting or improving the quality of the natural
environment and protecting public and Employee health and safety and includes,
but is not limited to, the Comprehensive Environmental Response, Compensation,
and Liability Act ("CERCLA") (42 U.S.C. ss. 9601 et seq.), the Hazardous
Materials Transportation Act (49 U.S.C. ss. 1801 et seq.), the Resource
Conservation and Recovery Act (42 U.S.C. ss. 6901 et seq.), the Clean Water Act
(33 U.S.C. ss. 1251 et seq.), the Clean Air Act (33 U.S.C. ss. 7401 et seq.),
the Toxic Substances Control Act (15 U.S.C. ss. 2601 et seq.), the Federal
Insecticide, Fungicide, and Rodenticide Act (7 U.S.C. ss. 136 et seq.) and the
Occupational Safety and Health Act (29 U.S.C. ss. 651 et seq.) ("OSHA"), as such
laws have been amended or supplemented, and the regulations promulgated pursuant
thereto, and any and all analogous state or local statutes, and the regulations
promulgated pursuant thereto, and any and all treaties, conventions and
environmental public and employee health and safety statutes and regulations or
analogous requirements of non-United States jurisdictions in which the Company
conducts any business.
"Environmental Matters" means any matter arising out of or relating
to the production, storage, transportation, disposal or Release of any Hazardous
Material or otherwise arising out of or relating to safety, health or the
environment which could give rise to liability or require the expenditure of
money to address, and shall include, without limitation, the costs of
investigating and remedying any of the foregoing matters, any fines and
penalties arising in connection therewith, and any claim in respect thereof for
damages or injunctive relief for alleged personal injury, property damage or
damage to natural resources under common law or other Environmental Law.
"Environmental Permit" means any Permit, variance, registration, or
permission required under any applicable Environmental Laws.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended and any regulations promulgated or proposed thereunder.
"Facility" means real property owned, leased or operated by the
Company.
"FCC" means the Federal Communication Commission and any successor
thereto.
"GAAP" means generally accepted accounting principles, as in effect
in the United States.
"Governmental Body" means any government or governmental or
regulatory body thereof, or political subdivision thereof, whether federal,
state, local or foreign, or any agency, instrumentality or authority thereof, or
any court or arbitrator (public or private).
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"Hazardous Materials " means any substance, material or waste which
is regulated by any local, state or federal Governmental Body in the
jurisdiction in which the Company conducts business, or the United States,
including, without limitation, any material or substance which is defined as a
"hazardous waste," "hazardous material," "hazardous substance," "extremely
hazardous waste" or "restricted hazardous waste," "subject waste,"
"contaminant," "toxic waste" or "toxic substance" under any provision of
Environmental Law, including but not limited to, petroleum products, asbestos,
radon and polychlorinated biphenyls.
"Law" means any federal, state, local or foreign law (including
common law), statute, code, ordinance, rule, regulation or other requirement or
guideline (including, without limitation, the Communications Act and the rules
and regulations of the FCC.
"Legal Proceeding" means any judicial, administrative or arbitral
actions, suits, proceedings (public or private), claims or governmental
proceedings.
"Lien" means any lien, pledge, hypothecation, levy, mortgage, deed of
trust, security interest, claim, lease, charge, option, right of first refusal,
easement, or other real estate declaration, covenant, condition, restriction or
servitude, transfer restriction under any shareholder or similar agreement,
encumbrance or any other restriction or limitation whatsoever.
"Material Adverse Change" means any material adverse change in the
business, properties, results of operations, prospects or condition (financial
or otherwise) of the Company.
"material default" me ans a default which could reasonably be
expected to result in a Material Adverse Change.
"Order" means any order, injunction, judgment, decree, ruling, writ,
assessment or arbitration award.
"Permits" means any approvals, authorizations, consents, licenses,
permits or certificates by any Governmental Body (including, with respect to the
FCC).
"Person" means any individual, corporation, partnership, firm, joint
venture, association, joint-stock company, trust, unincorporated organization,
Governmental Body or other entity.
"Public Offering" means a firm commitment underwritten public
offering of shares of Common Stock pursuant to an effective registration
statement under the Securities Act of 1933, as then in effect or any comparable
statement under any similar federal statute then in force or effect.
"Release " means any release, spill, effluent, emission, leaking,
pumping, injection, deposit, disposal, discharge, dispersal, leaching, or
migration into the indoor or outdoor environment, or into or out of any property
owned, operated or leased by the Company, including the movement of any
Hazardous Material or other substance through or in the air, soil, surface
water, groundwater, or property.
"Remedial Action" means all actions, including, without limitation,
any capital expenditures, required or voluntarily undertaken to (i) clean up,
remove, treat, or in any other way
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address any Hazardous Material or other substance in the indoor or outdoor
environment; (ii) prevent the Release or threat of Release, or minimize the
further Release of any Hazardous Material or other substance so it does not
migrate or endanger or threaten to endanger public health or welfare of the
indoor or outdoor environment; iii) perform pre-remedial studies and
investigations or post-remedial monitoring and care; or (iv) bring any Facility
into compliance with all Environmental Laws and Environmental Permits.
"Representatives " of a Person means its officers, Employees, agents,
legal advisors and accountants.
"Senior Notes" means the Company's 13% Senior Secured Notes due 2004.
"Stockholders Agreement" means the Stockholders' Agreement dated as
of the date hereof, by and among the Company and the shareholders listed on the
signature pages thereto.
"Taxes" means any federal, state, local or foreign income, gross
receipts, license, payroll, employment, excise, severance, stamp, occupation,
premium, windfall profits, environmental (including taxes under Section 59A of
the Internal Revenue Code of 1986, as amended (the "Code")), customs duties,
capital stock, franchise, profits, withholding, social security (or similar),
unemployment, disability, real property, personal property, sales, use,
transfer, registration, value added, alternative or add-on minimum, estimated,
or other tax of any kind whatsoever, including any interest, penalty, or
addition thereto, whether disputed or not.
"Tax Return " means any return declaration, report, claim for refund,
or information return or statement relating to Taxes, including any schedule or
attachment thereto, and including any amendment thereof.
8.2 Tax Treatment of Preferred Stock. The Company agrees that the
Series A Preferred Stock is stock which participates in corporate growth to a
significant extent within the meaning of Treasury Regulation ss.1.305-5(a), and
hence will not be treated as preferred stock for purposes of Internal Revenue
Code ss.305 and the regulations thereunder. Accordingly, the Company has
determined that there will not be constructive distributions under Treasury
Regulation ss.1.305-5(b) with respect to the Series A Preferred Stock.
8.3 Expenses. Each Purchaser shall pay its own fees and expenses
associated with this transaction, including legal expenses and out-of pocket
expenses. The Company shall pay all stamp and other taxes which may be payable
in respect of the execution and delivery of this Agreement, the Transaction
Documents, or the issuance, delivery or acquisition of the Shares and all blue
sky expenses.
8.4 Specific Performance. The Company acknowledges and agrees that
the breach of this Agreement would cause irreparable damage to the Purchasers
and that the Purchasers will not have an adequate remedy at law. Therefore, the
obligations of the Company under this Agreement, including, without limitation,
the Company's obligation to sell the Shares to the Purchasers, shall be
enforceable by a decree of specific performance issued by any court of competent
jurisdiction, and appropriate injunctive relief may be applied for and granted
in connection therewith. Such remedies shall, however, be cumulative and not
exclusive and shall be in addition to any other remedies which any party may
have under this Agreement or otherwise.
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<PAGE> 25
8.5 Further Assurances. The Company and the Purchasers each
agree to execute and deliver such other documents or agreements as may be
necessary or desirable for the implementation of this Agreement and the
consummation of the transactions contemplated hereby.
8.6 Submission to Jurisdiction; Consent to Service of Process.
(a) The parties hereto hereby irrevocably submit to the non-exclusive
jurisdiction of any federal or state court located within the County of Cook,
State of Illinois over any dispute arising out of or relating to this Agreement
or any of the transactions contemplated hereby and each party hereby irrevocably
agrees that all claims in respect of such dispute or any suit, action or
proceeding related thereto may be heard and determined in such courts. The
parties hereby irrevocably waive, to the fullest extent permitted by applicable
law, any objection which they may now or hereafter have to the laying of venue
of any such dispute brought in such court or any defense of inconvenient forum
for the maintenance of such dispute. Each of the parties hereto agrees that a
judgment in any such dispute may be enforced in other jurisdictions by suit on
the judgment or in any other manner provided by law.
(b) Each of the parties hereto hereby consents to process being
served by any party to this Agreement in any suit, action or proceeding by the
mailing of a copy thereof in accordance with the provisions of Section 8.9.
8.7 Entire Agreement; Amendments and Waivers. This Agreement
(including the schedules and exhibits hereto) represents the entire
understanding and agreement between the parties hereto with respect to the
subject matter hereof and can be amended, supplemented or changed, and any
provision hereof can be waived, only by written instrument making specific
reference to this Agreement signed by the parties hereto. No action taken
pursuant to this Agreement, including without limitation, any investigation by
or on behalf of any party, shall be deemed to constitute a waiver by the party
taking such action of compliance with any representation, warranty, covenant or
agreement contained herein. The waiver by any party hereto of a breach of any
provision of this Agreement shall not operate or be construed as a further or
continuing waiver of such breach or as a waiver of any other or subsequent
breach. No failure on the part of any party to exercise, and no delay in
exercising, any right, power or remedy hereunder shall operate as a waiver
thereof, nor shall any single or partial exercise of such right, power or remedy
by such party preclude any other or further exercise thereof or the exercise of
any other right, power or remedy. All remedies hereunder are cumulative and are
not exclusive of any other remedies provided by law.
8.8 Governing Law. This Agreement shall be governed by and construed
in accordance with the laws of the State of New York without giving effect to
the principles of conflict of laws thereunder which would specify the
application of the law of another jurisdiction.
8.9 Table of Contents; Headings; Interpretive Matters. The table of
contents and section headings of this Agreement are for reference purposes only
and are to be given no effect in the construction or interpretation of this
Agreement. No provision of this Agreement will be interpreted in favor of, or
against, any of the parties hereto by reason of the extent to which any such
party or its counsel participated in the drafting thereof or by reason of the
extent to which any such provision is inconsistent with any prior draft hereof
or thereof.
8.10 Notices. All notices and other communications under this
Agreement shall be in writing and shall be deemed given when delivered
personally, telecopied or mailed by certified mail,
22
<PAGE> 26
return receipt requested, to the parties at the following addresses (or to such
other address as a party may have specified by notice given to the other party
pursuant to this provision):
If to the Company, to:
MGC Communications, Inc.
3301 North Buffalo Drive
Las Vegas, Nevada 89129
Attn:
Fax: (702)310-1111
With a copy (which shall by itself not constitute notice) to:
Ellis, Funk, Goldberg, Labovitz & Dokson, P.C.
3490 Piedmont Road
Suite 400
Atlanta, Georgia 30305
Attn: Robert B. Goldberg
Fax: (404) 233-2188
If to the Purchasers, to the address listed in Schedule 1.
All notices are effective upon receipt or upon refusal if properly
delivered.
8.11 Severability. If any provision of this Agreement is invalid or
unenforceable, the balance of this Agreement shall remain in effect.
8.12 Binding Effect; Assignment. This Agreement shall be binding upon
and inure to the benefit of the parties and their respective successors and
permitted assigns (as permitted in accordance with the terms of this Agreement).
Nothing in this Agreement shall create or be deemed to create any third-party
beneficiary rights in any person or entity not a party to this Agreement except
as provided below. No assignment of this Agreement or of any rights or
obligations hereunder may be made by the Company or the Purchaser (by operation
of law or otherwise) without the prior written consent of the other parties
hereto and any attempted assignment without the required consents shall be void;
provided, however, that the Purchasers may assign this Agreement and any or all
rights and obligations hereunder, in whole or in part, to any Affiliate of the
Purchasers, but any such assignment shall not relieve the Purchasers of their
respective obligations hereunder. In addition, and whether or not any express
assignment has been made, the provisions of this Agreement which are for the
benefit of any
23
<PAGE> 27
Purchaser as a purchaser or holder of Shares (or any securities pursuant to
which such Shares may be converted or exercised into) are also for the benefit
of and enforceable by, any subsequent holder of such securities. Upon any
permitted assignment, the references in this Agreement to the Purchasers shall
also apply to any such assignee unless the context otherwise requires.
8.13 Counterparts. This Agreement may be executed simultaneously in
two or more counterparts, each of which shall be deemed an original but all of
which together shall constitute one and the same instrument.
SECURITIES PURCHASE AGREEMENT SIGNATURE PAGES
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by their respective officers thereunto duly authorized, as of the date
first written above.
MGC COMMUNICATIONS, INC.
By:
---------------------------------
Name:
Title:
PURCHASERS:
---------------------------------
---------------------------------
---------------------------------
---------------------------------
---------------------------------
---------------------------------
---------------------------------
24
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
MGC Lease Corporation, a Nevada corporation
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 45,054
<SECURITIES> 115,284
<RECEIVABLES> 1,416
<ALLOWANCES> (216)
<INVENTORY> 0
<CURRENT-ASSETS> 72,810
<PP&E> 25,934
<DEPRECIATION> (1,317)
<TOTAL-ASSETS> 191,977
<CURRENT-LIABILITIES> 10,080
<BONDS> 156,118
16,665
0
<COMMON> 15
<OTHER-SE> 8,961
<TOTAL-LIABILITY-AND-EQUITY> 191,977
<SALES> 3,791
<TOTAL-REVENUES> 3,791
<CGS> 3,928
<TOTAL-COSTS> 11,642
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,492
<INCOME-PRETAX> (10,836)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,386)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,836)
<EPS-PRIMARY> .78
<EPS-DILUTED> .78
</TABLE>
