<PAGE> 1
==============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 1998
Commission file number 333-38875
MGC Communications, Inc.
(Exact name of registrant as specified in its charter)
Nevada 88-0360042
(State of incorporation) (IRS Employer Identification Number)
3301 North Buffalo Drive
Las Vegas, Nevada 89129
(Address of principal executive offices)
(702) 310-1000
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
YES X NO
----- -----
The number of shares outstanding of the issuer's common stock,
as of May 11, 1998:
Common stock ($.001 par value) .... 9,185,640
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<PAGE> 2
MGC COMMUNICATIONS, INC.
INDEX
==============================================================================
Page No.
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Operations -- Three months ended
March 31, 1998 and 1997 (Unaudited) 3
Balance Sheets -- March 31, 1998 (Unaudited) and
December 31, 1997 4
Statements of Redeemable Preferred Stock and
Stockholders' Equity for the period from January 1, 1997
to March 31, 1998 5
Statements of Cash Flows -- Three months ended
March 31, 1998 and 1997 (Unaudited) 6
Condensed Notes to Unaudited Interim Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
PART II -- OTHER INFORMATION
Item 2. Changes in Securities 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
-2-
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
MGC COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
------------ ------------
(UNAUDITED)
<S> <C> <C>
Telecommunication services:
Operating revenues..................... $ 2,846 $ 212
Operating expenses:
Cost of operating revenues (excluding
depreciation)....................... 2,371 539
Selling, general and administrative.... 2,562 883
Depreciation and amortization.......... 867 160
----------- -----------
5,800 1,582
----------- -----------
Loss from operations................ (2,954) (1,370)
Other income (expense):
Interest income........................ 2,169 128
Interest expense (net of amount
capitalized)........................ (5,505) --
----------- -----------
Net loss............................ (6,290) (1,242)
Accrued preferred stock dividend......... (444) --
----------- -----------
Net loss applicable to common
stockholders........................... $ (6,734) $ (1,242)
=========== ===========
Basic and diluted loss per share of
common stock........................... $ (.76) $ (.15)
=========== ===========
Basic and diluted weighted average shares
outstanding............................ 8,892,282 8,078,306
=========== ===========
</TABLE>
See accompanying condensed notes to unaudited interim
financial statements.
3
<PAGE> 4
MGC COMMUNICATIONS, INC.
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- --------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 39,411 $ 45,054
Investments held to maturity.............................. 8,619 7,797
Restricted investments.................................... 28,449 18,482
Amounts receivable for shares issued...................... 163 --
Trade accounts receivable, less allowance for doubtful
accounts of $239 and $216.............................. 2,617 1,200
Prepaid expenses.......................................... 323 277
-------- --------
Total current assets.............................. 79,582 72,810
Property and equipment, net................................. 34,421 24,617
Investments held to maturity................................ 49,367 49,913
Restricted investments...................................... 29,917 39,092
Deferred financing costs, net of amortization of $408 and
$198...................................................... 5,371 5,448
Other assets................................................ 149 97
-------- --------
Total assets...................................... $198,807 $191,977
======== ========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt...................... $ 387 $ 381
Accounts payable:
Trade.................................................. 1,908 462
Property and equipment................................. 3,999 3,123
Accrued interest.......................................... 10,528 5,328
Accrued other expenses.................................... 1,011 786
-------- --------
Total current liabilities......................... 17,833 10,080
Senior Secured Notes, net of unamortized discount of $3,738
and $3,882................................................ 156,262 156,118
Other long-term debt........................................ 40 138
-------- --------
Total liabilities................................. 174,135 166,336
-------- --------
Commitments and contingencies
Redeemable preferred stock:
8% Series A convertible preferred stock, 6,571,450 shares
authorized, 6,571,427 and 5,148,570 issued and
outstanding............................................ 21,645 16,665
Stockholders' equity:
Preferred stock, 43,428,550 shares authorized but
unissued............................................... -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 9,185,640 and 8,799,600 shares issued and
outstanding............................................ 9 9
Additional paid-in capital................................ 24,388 22,118
Accumulated deficit....................................... (19,197) (12,463)
-------- --------
5,200 9,664
Notes receivable from stockholders for issuance of common
stock.................................................. (2,173) (688)
-------- --------
Total stockholders' equity........................ 3,027 8,976
-------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity............................ $198,807 $191,977
======== ========
</TABLE>
See accompanying condensed notes to unaudited interim
financial statements.
4
<PAGE> 5
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 DECEMBER
31, 1996........... -- $ -- 7,176,000 $ 7 $12,276 $ (1,491) $ -- $ 10,792
Common stock issued
for cash........... -- -- 1,458,600 2 4,860 -- -- 4,862
Common stock issued
for notes
receivable......... -- -- 165,000 -- 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 8,799,600 9 22,118 (12,463) (688) 8,976
Common stock issued
for cash........... -- -- 99,840 -- 772 -- -- 772
Common stock issued
for notes
receivable......... -- -- 189,000 -- 1,485 -- (1,485) --
Warrants and options
exercised for
Common Stock....... -- -- 97,200 -- 13 -- -- 13
Net loss............. -- -- -- -- -- (6,290) -- (6,290)
8% Series A
Convertible
Preferred Stock
issued for cash.... 1,422,857 4,980 -- -- -- -- -- --
Accrued preferred
stock dividend..... -- -- -- -- -- (444) -- (444)
---------- ------- ---------- --- ------- -------- ------- --------
BALANCE AT MARCH 31,
1998 (UNAUDITED)... 6,571,427 $21,645 9,185,640 $ 9 $24,388 $(19,197) $(2,173) $ 3,027
========== ======= ========== === ======= ======== ======= ========
</TABLE>
See accompanying condensed notes to unaudited
interim financial statements.
5
<PAGE> 6
MGC COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
-------- -------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................... $ (6,290) $(1,242)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization.................... 867 160
Amortization of debt discount.................... 144 --
Amortization of deferred debt financing costs.... 210 --
Changes in assets and liabilities:
Increase in accounts receivable, net.......... (1,442) (89)
(Increase) decrease in prepaid expenses....... (46) 10
Increase in other assets...................... (52) (5)
Increase in accounts payable -- trade......... 1,446 235
Increase in accrued expenses.................. 4,981 25
-------- -------
Net cash used in operating activities....... (182) (906)
-------- -------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables......................................... (9,795) (847)
Purchase of investments held to maturity........... (276) --
Purchase of restricted investments................. (792) --
-------- -------
Net cash used in investing activities....... (10,863) (847)
-------- -------
Cash flows from financing activities:
Costs associated with issuance of Senior Secured
Notes and warrants............................... (133) --
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs........... 4,980 --
Payments on other long term debt................... (92) --
Proceeds from issuance of common stock during
1996............................................. -- 1,153
Proceeds from issuance of common stock during
1997............................................. -- 4,331
Proceeds from issuance of common stock during
1998............................................. 647 --
-------- -------
Net cash provided by financing activities... 5,402 5,484
-------- -------
Net (decrease) increase in cash............. (5,643) 3,731
Cash and cash equivalents at beginning of period..... 45,054 7,897
-------- -------
Cash and cash equivalents at the end of period....... $ 39,411 $11,628
======== =======
Supplemental schedule of non-cash investing and
financing activities:
Increase in property and equipment purchases
included in accounts payable -- property and
equipment........................................ $ 876 $ --
======== =======
Stock issued for notes receivable.................. $ 1,485 $ --
======== =======
Other disclosures:
Cash paid for interest net of amounts
capitalized...................................... $ 305 $ --
======== =======
</TABLE>
See accompanying condensed notes to unaudited
interim financial statements.
6
<PAGE> 7
MGC COMMUNICATIONS, INC.
Condensed Notes to Unaudited Interim Financial Statements
(1) BASIS OF PRESENTATION
The accompanying unaudited interim financial statements of MGC
Communications, Inc., a Nevada corporation (the "Company") reflect all normal
recurring adjustments, which management believes are necessary to present fairly
the financial position, results of operations, and cash flows for the Company
for the respective periods presented. Certain information and footnote
disclosures normally included in the annual financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission for Form 10-Q. These unaudited interim financial statements should be
read in conjunction with the audited financial statements and notes thereto
included in the Registration Statement on Form S-1 filed by the Company with the
Securities and Exchange Commission.
The balance sheet at December 31, 1997 was derived from the audited
financial statements, but does not include all disclosures required under
generally accepted accounting principles.
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Building and property........................... $ 258 $ 278
Switching equipment............................. 23,326 21,621
Leasehold improvements.......................... 990 956
Computer hardware and software.................. 1,485 1,404
Office equipment and vehicles................... 348 300
------- -------
26,407 24,559
Less accumulated depreciation and
amortization.................................. (2,184) (1,317)
------- -------
24,223 23,242
Switching equipment under construction.......... 10,198 1,375
------- -------
Net property and equipment............ $34,421 $24,617
======= =======
</TABLE>
(3) DEBT
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>
7
<PAGE> 8
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 774,720 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 $4.68 per share of common
stock less the exercise price of $.02 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 for stock issued through December 31, 1997 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 774,200 to 862,923 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
90,000 shares of Common Stock at $.02 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 $4.68 per
share less the exercise price of $.02 per share for the warrant. All such
warrants were exercised in January and February 1998.
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:
8
<PAGE> 9
<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 60,000,000 shares of common stock, $.001 par value per
share, and 50,000,000 share of preferred stock, $.001 par value per share.
In January 1998, the Company filed a registration statement offering to
exchange the Notes (discussed in Note 3) 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.
Associated with the issuance of the Notes, expenses of $68,000 were paid to
a related party for charter services.
9
<PAGE> 10
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
COMMON STOCK
In June 1997, the Company approved agreements with two key members of
management granting them rights to purchase a total of 150,000 shares at $3.33
per share and 165,000 shares at $4.17 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 $4.17 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 150,000 shares issued at $3.33 per share. The $688,000 owed to the Company
for the 165,000 shares issued at $4.17 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.
During the three months ended March 31, 1998, the Company offered 99,840
shares of $.001 par value Common Stock at prices ranging from $5.83 to $8.33 per
share, for total proceeds to the Company of $772,000.
During the three months ended March 31, 1998, the Company approved
agreements with 12 key members of management to purchase a total of 189,000
shares of Common Stock. The purchase price of these shares ranged from $5.83 to
$8.33 per share. The $1,485,000 owed to the Company is 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.
In January 1998, the Company completed an additional 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.
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.
10
<PAGE> 11
(5) 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.
Future minimum lease obligations in effect as of December 31, 1997 are as
follows (in thousands):
<TABLE>
<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 for the year ended December 31, 1997.
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.
(6) 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
<PAGE> 12
(7) SUBSEQUENT EVENT
The Company's registration statement on Form S-1/A relating to the sale of
3,500,000 shares of common stock at $17.00 per share, was declared effective by
the Securities and Exchange Commission on May 11, 1998. The Company granted the
underwriters a 30-day option to purchase up to 525,000 additional shares of
common stock. The offering is expected to close on May 15, 1998. In conjunction
with the initial public offering of the Company's common stock, the Company
effected a six for ten reverse stock split (the "reverse stock split"), which
has been reflected in the accompanying financial statements. The Company intends
to pay cash for the repurchase of any fractional shares created by the reverse
stock split. In addition to the reverse stock split, the Company's 6,571,427
outstanding shares of Preferred Stock are to convert to 3,942,856 shares of
common stock upon consummation of a qualified firm-commitment underwritten
public offering, as defined. The conversion of the Preferred Stock has not been
reflected in the accompanying financial statements.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MGC began providing competitive local exchange services to small business
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 communications transport services. Currently, the Company has switches fully
operational in Las Vegas and in selected suburban areas of Atlanta and Los
Angeles.
The Company's 1997 revenues were primarily generated from local phone
service, switched access billings and non-recurring charges (principally
installation charges). 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 revenues 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 communications switching and associated equipment, the
purchase of land for switching sites and the construction of buildings or
leasehold improvements to house 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 its financial performance.
The Company has experienced operating losses and generated negative EBITDA
since inception and expects to continue to generate negative EBITDA through the
year 1999 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 EBITDA.
RESULTS OF OPERATIONS
The following is a comparison of the first quarter 1998 with the fourth
quarter 1997 and first quarter 1997.
Quarter over Quarter Comparison -- March 31, 1998 vs. December 31, 1997
Total operating revenues for the quarter ended March 31, 1998 were $2.8
million as compared to $1.9 million for the quarter ended December 31, 1997. The
increase from the fourth quarter 1997 to the first quarter 1998 is a result of
the increase in the number of lines placed in service during the first quarter
1998, the introduction of long distance service which commenced in February
13
<PAGE> 14
1998 and the first full quarter of operations for the Atlanta and Los Angeles
markets. The Company had 20,924 lines in service at the end of the first
quarter 1998 as compared to 15,590 lines in service at the end of the fourth
quarter 1997.
Cost of operating revenues for the quarter ended March 31, 1998 was $2.4
million as compared to $1.4 million for the quarter ended December 31, 1997. The
increase from quarter to quarter is due to the increased number of lines placed
in service during the first quarter 1998 and the incurrence of network expenses
associated with the Company's long distance product.
For the quarter ended March 31, 1998, selling, general and administrative
expenses totaled $2.6 million as compared to $2.5 million for the quarter ended
December 31, 1997. These expenses were incurred in connection with the 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 March
31, 1998 depreciation and amortization was $0.9 million as compared to $0.5
million for the quarter ended December 31, 1997. This increase is a result of
the Company's placing additional assets in service during the first quarter 1998
in accordance with the planned buildout of its network.
Interest expense for the first quarter 1998 totaled $5.5 million as
compared to $5.4 million for the fourth quarter 1997. This amount is
attributable to interest incurred on the Senior Secured Notes issued by the
Company in late September 1997.
Interest income was $2.2 million in both the fourth quarter 1997 and the
first quarter 1998. The interest income 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 $6.3 million and $5.7 million during the
first quarter 1998 and the fourth quarter 1997, respectively.
Quarter over Quarter Comparison -- March 31, 1998 vs. March 31, 1997
Total operating revenues for the quarter ended March 31, 1998 were $2.8
million as compared to $0.2 million for the quarter ended March 31, 1997. The
increase from the first quarter 1997 to the first quarter 1998 is a result of
the addition of two markets to the Company's operating territory, increases in
the number of lines placed in service and the introduction of long distance
service during February 1998. The Company conducted business in Las Vegas and
selected suburban areas of Atlanta and Los Angeles during the first quarter 1998
as compared to Las Vegas only during first quarter 1997. The Company had 20,924
lines in service at the end of first quarter 1998 as compared to 3,801 lines in
service at the end of the first quarter 1997.
Cost of operating revenues for the quarter ended March 31, 1998 was $2.4
million as compared to $0.5 million for the quarter ended March 31, 1997. The
increase from quarter to quarter is due to the increased number of lines placed
in service, opening the Atlanta and Los Angeles markets and introducing the
Company's long distance product. The Company began incurring network expenses
associated with its long distance product during the first quarter 1998.
For the quarter ended March 31, 1998, selling, general and administrative
expenses totaled $2.6 million as compared to $0.9 million for the quarter ended
March 31, 1997. These expenses were incurred in connection with the 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 March
31, 1998, depreciation and amortization was $0.9 million as compared to $0.2
million for the quarter ended March 31, 1997. This increase is a result of the
Company placing additional assets in service during the twelve month period in
accordance with the planned buildout of its network.
14
<PAGE> 15
Interest expense for first quarter 1998 totaled $5.5 million as compared to
no interest expense being incurred during first 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 March 31, 1998 was $2.2 million as
compared to $0.1 million for the quarter ended March 31, 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 $6.3 million and $1.2 million during the
first quarter 1998 and the first quarter 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have required substantial capital investment for
the purchase of telecommunications equipment and the design and development of
the Company's networks. Capital expenditures for the quarter ended March 31,
1998 were $10.7 million. 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 fiscal year 1998.
The Company has funded a substantial portion of these expenditures through
the private sales of debt and equity securities. From its inception through
March 31, 1998, the Company raised approximately $17.9 million from private
sales of Common Stock.
In September 1997, the Company completed a $160.0 million offering of
Senior Secured Notes and warrants to purchase 862,923 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 from 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 telecommunications 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 $21.6 million. The shares of Series A Convertible Preferred
Stock will be converted into 3,942,856 shares of Common Stock upon consummation
of a qualified firm-commitment underwritten public offering.
The Company's Registration Statement on Form S-1/A relating to the sale of
3,500,000 shares of common stock at $17.00 per share was declared effective by
the Securities and Exchange Commission on May 11, 1998, and public trading of
the Company's common stock commenced on May 12, 1998. This offering is expected
to close on May 15, 1998.
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 switch-based network in
anticipation of connecting revenue generating customers. The Company expects to
continue to produce negative cash flow through the year 1999 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. Based upon its current business plan, the Company does not expect to
require additional financing; however, 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.
15
<PAGE> 16
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 has adopted SFAS No. 130
during the three month period ended March 31, 1998 and has determined that such
adoption 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.
The American Institute of Certified Public Accountants recently issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 requires start-up costs, as defined, to be expensed as
incurred and is effective for financial statements for fiscal years beginning
after December 15, 1998. The Company intends to adopt SOP 98-5, as required,
and expense any previously capitalized start-up costs at that time. Management
believes application of SOP 98-5 will not have a material impact on the
Company's financial statements.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
During January 1998, the Company issued 1,422,857 shares of its Series A
Convertible Preferred Stock to 35 investors who purchased the securities in a
private placement. The gross proceeds of this private placement were $4,980,000.
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 have been or will be given to the transfer agent. No underwriter
was involved in this transaction and no commissions were paid with respect to
the sale 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 90,000 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 approximately $.02 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 raise at least $15.0 million through the sale 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 7,200 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 255,000 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 acquires 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.
The above numbers of shares of Common Stock and per share price therefor
reflect a six for ten reverse split implemented by the Company on May 8, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
There are no exhibits being filed with this Quarterly Report on Form 10-Q.
(b) Reports on Form 8-K
A Form 8-K dated as of February 6, 1998, was filed with the Commission to
report that the Company did not renew the engagement of KPMG Peat Marwick LLP as
its independent auditors and that Arthur Andersen LLP has been retained as the
Company's independent auditors.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
MGC COMMUNICATIONS
Date: May 12, 1998 /s/ Maurice J. Gallagher, Jr.
-----------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: May 12, 1998 /s/ Linda M. Sunbury
-----------------------------
Linda M. Sunbury
Vice President-Administration
Chief Financial Officer
18
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