<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1997
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 No X
------ ------
The number of shares outstanding of the issuer's common stock, as of November
13, 1997:
Common stock ($.001 par value) . . . . 14,666,000 shares
================================================================================
<PAGE> 2
MGC COMMUNICATIONS, INC.
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
<S> <C> <C>
Item 1. Financial Statements
Statements of Operations - Three months ended
September 30, 1997 and 1996 (Unaudited);
Nine months ended September 30, 1997 and 1996
(Unaudited) 3
Balance Sheets - September 30, 1997 (Unaudited)
and December 31,1996 4
Statements of Stockholders' Equity for the nine
months ended September 30, 1997 (Unaudited) and for
the year ended December 31, 1996. 5
Statements of Cash Flows - Nine months ended
September 30, 1997 and 1996 (Unaudited) 6
Condensed Notes to Unaudited Interim
Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II - OTHER INFORMATION
Item 2. Changes in Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
MGC COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except for per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Telecommunications services:
Operating revenues $ 1,060 $ -- $ 1,924 $ --
Cost of operating revenues
(excluding depreciation shown below) 1,152 42 2,512 44
-------- -------- -------- --------
Gross loss (92) (42) (588) (44)
-------- -------- -------- --------
Operating expenses:
Selling, general and administrative 1,801 284 3,954 359
Depreciation and amortization 402 -- 818 --
-------- -------- -------- --------
2,203 284 4,772 359
-------- -------- -------- --------
Loss from operations (2,295) (326) (5,360) (403)
Other income (expense):
Interest income 67 28 338 31
Interest expense (115) -- (117) --
-------- -------- -------- --------
Net loss $ (2,343) $ (298) $ (5,139) $ (372)
======== ======== ======== ========
Net loss per share of common stock $ (.17) $ (.25) $ (0.37) $ (.40)
======== ======== ======== ========
Weighted average shares outstanding 14,147 1,200 13,917 936
======== ======== ======== ========
</TABLE>
See accompanying condensed notes to unaudited interim financial statements.
3
<PAGE> 4
MGC COMMUNICATIONS, INC.
BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- -----------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 95,390 $ 7,897
Restricted investments 18,235 --
Amounts receivable for shares issued 400 1,153
Accounts receivable:
Trade, less allowance for doubtful accounts of
$137 (unaudited) at September 30, 1997 744 1
Other 394 9
--------- ---------
Total accounts receivable 1,138 10
Prepaid expenses 66 23
--------- ---------
Total current assets 115,229 9,083
Property and equipment, net 18,339 3,250
Restricted investments 38,532 --
Deferred financing costs 5,870 --
Other assets 56 6
--------- ---------
Total assets $ 178,026 $ 12,339
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 390 $ --
Accounts payable:
Trade 923 76
Property and equipment 5,251 1,372
Accrued expenses 455 99
--------- ---------
Total current liabilities 7,019 1,547
Senior Secured Notes, net of unamortized discount of $4,026 155,974 --
Other long-term debt 225 --
--------- ---------
Total liabilities 163,218 1,547
Commitments and contingencies -- --
Stockholders' equity
Common stock, $.001 par value, 100,000,000 shares
authorized; shares issued and outstanding
14,666,000 at September 30, 1997
(unaudited), and 11,960,000 at December 31, 1996 15 12
Additional paid-in capital 22,111 12,271
Accumulated deficit (6,630) (1,491)
--------- ---------
15,496 10,792
Notes receivable from stockholders for issuance of
common stock (688) --
--------- ---------
Total stockholders' equity 14,808 10,792
--------- ---------
Total liabilities and stockholders' equity $ 178,026 $ 12,339
========= =========
</TABLE>
See accompanying condensed notes to unaudited interim financial statements.
4
<PAGE> 5
MGC COMMUNICATIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Notes
receivable
Price Common Stock Additional from stockholders Total
per ------------------- paid-in Accumulated for issuance of Stockholders'
share Shares Amount capital deficit common stock Equity
-------- ------------------- -------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 $ 0.0025 400,000 $-- $ 1 $ -- $ -- $ 1
Issuance of common stock for
services contributed by
stockholder $ 0.0025 800,000 1 1 -- -- 2
Issuance of common stock for
cash $ 0.50 6,160,000 6 3,074 -- -- 3,080
Issuance of common stock for
cash $ 2.00 4,600,000 5 9,195 -- -- 9,200
Net loss -- -- -- (1,491) -- (1,491)
----------------- ---------------------------------------------------------
Balance at December 31, 1996 11,960,000 12 12,271 (1,491) -- 10,792
Issuance of common stock for
cash (unaudited) $ 2.00 2,431,000 3 4,859 -- -- 4,862
Issuance of common stock for
notes receivable (unaudited) $ 2.50 275,000 -- 688 -- (688) --
Proceeds from Senior Secured
Notes and Warrants offering
allocated to warrants, net
of expenses of $141 (unaudited) -- -- 3,884 -- -- 3,884
Warrants issued as
consideration in Senior
Secured Notes and Warrants
offering (unaudited) -- -- 409 -- -- 409
Net loss (unaudited) -- -- -- (5,139) -- (5,139)
----------------- ---------------------------------------------------------
Balance at September 30, 1997 (unaudited) 14,666,000 $15 $22,111 $(6,630) $(688) $14,808
================= =========================================================
</TABLE>
See accompanying condensed notes to unaudited interim financial statements.
5
<PAGE> 6
MGC COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine months ended
September 30,
1997 1996
--------- ---------
(Unaudited) (Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (5,139) $ (372)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 818 --
Changes in assets and liabilities:
Increase in accounts receivable, net (1,128) (2,391)
Increase in prepaid expenses (43) (17)
Increase in other assets (50) (11)
Increase in accounts payable - trade 847 --
Increase in accrued expenses 356 19
--------- ---------
Net cash used in operating activities (4,339) (2,772)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net of payables (11,413) (308)
Purchase of restricted investments (56,767) -
--------- ---------
Net cash used in investing activities (68,180) (308)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of Senior Secured Notes and warrants, 160,000 --
Costs associated with issuance of Senior Secured Notes and
warrants of $5,462 and $141, respectively (5,603)
Proceeds from issuance of common stock 5,615 3,080
--------- ---------
Net cash provided by financing activities 160,012 3,080
--------- ---------
Net increase in cash 87,493 --
Cash and cash equivalents at beginning of period 7,897 --
--------- ---------
Cash and cash equivalents at end of period $ 95,390 $ --
========= =========
Non-cash transactions:
Stock issued for services rendered $ -- $ 2
========= =========
Increase in property and equipment purchases included in
accounts payable - property and equipment $ 3,879 $ --
========= =========
Notes payable issued for property and equipment $ 615 $ --
========= =========
Stock issued for notes receivable $ 688 --
========= =========
Warrants issued as consideration with
debt and warrant offering capitalized as deferred financing
costs $ 409 $ --
========= =========
</TABLE>
See accompanying condensed notes to unaudited interim financial statements.
6
<PAGE> 7
MGC COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Nine months ended September 30, 1997 and 1996
1. BASIS OF PRESENTATION
The accompanying unaudited interim financial statements reflect all adjustments,
consisting of normal recurring accruals, which management believes are necessary
to present fairly the financial position, results of operations, and cash flows
for MGC Communications, Inc. (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 the notes thereto included in the Registration
Statement No. 333-38875 and amendments thereto on Form S-4 initially filed by
the Company with the Securities and Exchange Commission on October 28, 1997.
The condensed balance sheet and stockholders' equity at December 31, 1996 were
derived from audited financial statements, but does not include all disclosures
required under generally accepted accounting principles.
As of December 31, 1996, the Company was a development stage company wherein the
Company's activities consisted primarily of raising capital, acquiring
telecommunications equipment, designing and developing the Company's networks,
negotiating agreements with incumbent local exchange carriers for the
utilization of their transport network architecture. The Company began its
operations in December 1996 by operating its first telephone switch in Las
Vegas, Nevada. During the nine months ended September 30, 1997, the Company's
planned principal activities commenced. Therefore, the Company has emerged from
its development stage and the inception to date disclosures have been excluded
from the accompanying financial statements.
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1997 DECEMBER 31,
(unaudited) 1996
-------------- -------------
(in thousands)
<S> <C> <C>
Building and property $ 257 $ --
Switching equipment 11,526 2,813
Leasehold improvements 445 429
Computer hardware and software 593 51
Office equipment 74 --
------------ -------------
12,895 3,293
Less accumulated depreciation (861) (43)
------------ -------------
12,034 3,250
Switching equipment under construction 6,305 --
------------ -------------
Net property and equipment $ 18,339 $ 3,250
============ =============
</TABLE>
3. DEBT
The Company had no long-term borrowings as of December 31, 1996. Long-term
borrowings at September 30, 1997 (unaudited) consist of the following:
<TABLE>
<CAPTION>
(in
thousands)
<S> <C>
13% Senior Secured Notes, due October 1, 2004, net of
unamortized discount of $4,026 $155,974
10% note payable in monthly installments through February 1999 597
Other 18
--------
156,589
Less current portion (390)
--------
$156,199
========
</TABLE>
Maturities of long-term debt for each of the next five years consist of the
following:
<TABLE>
<CAPTION>
Year ending September 30; (in
thousands)
<S> <C>
1998 $ 390
1999 225
2000 --
2001 --
2002 --
2003 and thereafter 155,974
--------
$156,589
========
</TABLE>
In September 1997, the Company completed an offering for 160,000 units
consisting of $160 million of 13% Senior Secured Notes ("Notes") due in 2004 and
warrants to purchase 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 Agreement dated September 29, 1997, the Company is required to place
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 $56.8 million as restricted investments being held 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 September 30, 1997,
the Notes were secured by a security interest in telecommunications equipment
with a net book value of $7.1 million and restricted investments of
approximately $56.8 million (at cost).
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. As set
forth in the Warrant Agreement, if the preferred stock offering or the common
stock commitment is consummated at a price less than $5.00 per share, the number
of warrants issued will be adjusted to represent 6.4% of the outstanding common
stock on a fully diluted basis. As further discussed in Note 6, 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
September 30, 1997. Expenses allocated to the warrants in connection with the
Offering were approximately $140,896. The warrants expire on October 1, 2004.
In conjunction with the Offering, the Company received binding commitments
from certain investors to purchase common stock for $15 million if a preferred
stock offering had not been consummated within a specified period of time.
Certain investors deposited an aggregate of $15.0 million in escrow, which was
to have been applied to the purchase of common stock in the event the preferred
stock offering was not closed within a specified period of time. As a
commitment fee for the common stock commitment, the Company issued to all such
investors warrants to purchase an aggregate of 150,000 shares of common stock
at $.01 per share. Such warrants will be exercisable at any time prior to
October 1, 2004. 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.
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>
October 1, 2001 106.50%
October 1, 2002 103.25%
October 1, 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.
The Indenture Agreement contains certain covenants that among other things,
limits 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.
4. STOCKHOLDERS' EQUITY
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 stockholders 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
stockholder 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 for the fair value of services rendered by a stockholder totaling $2,000
resulting in an issuance price of $.0025 per share.
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 agreement called
for LLC to advance funds for operational 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
operational 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 (unaudited) shares and 4,600,000 shares
of $.001 par value common stock and received proceeds of $4,362,000 (unaudited)
and $9,200,000 during the nine months ended September 30, 1997 and the year
ended December 31, 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
within a certain period of time 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 $100,000 and
$400,000 in September 1997 and October 1997, respectively, for the 250,000
shares issued at $2.00 per share. The Company has classified in the
accompanying balance sheet as amounts receivable for shares issued $400,000,
which proceeds were received in October 1997 for 200,000 shares. 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 stockholders' equity as notes
receivable from stockholders for issuance of common stock.
In August 1997, 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
shares of preferred stock, $.001 par value per share. As of September 30, 1997,
no shares of preferred stock have been issued.
5. COMMITMENTS AND CONTINGENCIES
Lease Obligations
During the year ended December 31, 1996, the Company entered into a lease
agreement for its offices and switching facility in Las Vegas. During the nine
months ended September 30, 1997, the Company entered into lease agreements for
additional offices in Las Vegas and its offices and switching facility in
Atlanta.
The facility which houses the Company's headquarters in Las Vegas is owned by
two of the Company's principal stockholders and directors. Future minimum lease
obligations in effect as of September 30, 1997 and December 31, 1996 are as
follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Payments during the year ending December 31:
1997 (payments through December 31, 1997)............... $ 79 $ 67
1998.................................................... 166 69
1999.................................................... 152 71
2000.................................................... 156 74
2001.................................................... 123 37
2002.................................................... 88 --
Thereafter.............................................. 429 --
------ -----
$1,193 $ 318
====== =====
</TABLE>
Rent expense was approximately $134,000 and $33,000 for the nine months ended
September 30, 1997 and the year ended December 31, 1996, respectively.
Purchase Commitments
In May 1997, the Company signed an agreement to purchase 20 Northern Telecom
DMS-500 switches and related AccessNodes. As of September 30, 1997, the Company
had approximately $40,542,000 of remaining purchase commitments for
the purchase of switching equipment.
In May 1997, the Company entered into an agreement with Palm Centre Drive, Inc.,
the owner of which is a stockholder of the Company, for the purchase of certain
computer software pursuant to which the Company is required to pay the contract
price of $600,000 in six equal monthly installments beginning July 1, 1997. At
September 30, 1997, $43,750 is included in accounts payable for property and
equipment related to this agreement. Subsequent to entering into the agreement,
the stockholder became an officer of the Company.
In June 1997, in connection with the switching facility in Atlanta, the Company
entered into an agreement for leasehold improvements of approximately $298,000.
In July 1997, in connection with the switching facility in Pomona, the Company
entered into an agreement for building improvements of approximately $309,000.
Interconnection Agreements
In September 1996, March 1997 and May 1997, the Company signed interconnection
agreements with Sprint for operations in Nevada, Bell South for operations in
Georgia and GTE for operations in California, respectively. These agreements
expire from November 1998 to March 2000.
Certain rates per the Sprint interconnection agreement have been established at
the Federal Communications Commission (FCC) proxy rates and are subject to
adjustment upon final negotiations. The Company has recorded costs of sales
related to this agreement in amounts which are management's best estimates of
the probable outcome of the final negotiated rates, which are less than the FCC
proxy rates. The difference, which totals approximately $307,000 at September
30, 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.
(6) SUBSEQUENT EVENT
CONVERTIBLE PREFERRED STOCK
In November 1997, the Company completed a private placement offering in which
5,148,570 shares of 8% Series A Convertible Preferred Stock ("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 the
closing of a qualified firm-commitment underwritten public 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 shares of Preferred Stock are
entitled to vote together with the holders of 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 the price equal to the greater of (i)
$3.50, plus an amount equal to any unpaid dividends thereon, or (ii) the market
value of the Preferred Stock, on an as converted basis, determined by an
independent appraiser.
The $15 million deposited in escrow with respect to the Common Stock commitment
was released after consummation of the Preferred Stock offering. As set forth
in the Warrant Agreement, if the Preferred Stock offering or the Common Stock
commitment is consummated at a price less than $5.00 per share, the number of
warrants issued was to have been adjusted to represent 6.4% of the outstanding
Common Stock on a fully diluted basis. 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 September
30, 1997.
9
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company began providing competitive local exchange services to small
businesses and residential users in December 1996. In the fourth quarter of
1997, the Company expects to begin offering long distance services. The Company
has adopted a strategy of providing services through the leasing of unbundled
network elements of the incumbent local exchange carrier and dedicated transport
to the Company's switches. The Company has one switch fully operational in Las
Vegas, completed installation of its second switch in Atlanta in September 1997,
and anticipates having its third switch operational in the Inland Empire region
of California by the end of 1997.
The development and expansion of the Company's business will require significant
expenditures. The Company has made the strategic decision to install
Company-owned switches with broad market coverage, which initially increases its
level of capital expenditures and operating losses. The Company believes this
approach will enhance the Company's financial performance over the long term
through control of customer accounts.
The Company's principal operating expenses consist of: direct costs, operating
costs and depreciation. Direct costs consist of access fees, 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 will 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 Company has experienced operating losses and generated negative operating
cash flow since inception and expects to continue to generate negative operating
cash flow through 1999, 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 operations until December 1996. As a result, any comparison of the
three or nine months ended September 30, 1997 with the three or nine months
ended September 30, 1996 would not be meaningful. Consequently, the following is
a comparison of the second quarter 1997 with the third quarter 1997.
10
<PAGE> 9
Quarter over Quarter Comparison - September 30, 1997 vs. June 30, 1997
Total operating revenues for the quarter ended September 30, 1997 were $1.1
million as compared to $.7 million for the quarter ended June 30, 1997. The
increase from the second quarter 1997 to the third quarter 1997 is a result of
the increase in the number of lines in service during the third quarter. The
Company had 12,482 lines in service at the end of the third quarter as compared
to 9,002 lines in service at the end of the second quarter.
Cost of operating revenues for the quarter ended September 30, 1997 was $1.2
million as compared to $.8 million for the quarter ended June 30, 1997. The
increase from quarter to quarter is due to the increased number of lines in
service during the third quarter 1997.
For the quarter ended September 30, 1997, selling, general and administrative
expenses totaled $1.8 million as compared to $1.3 million for the quarter ended
June 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 expense includes depreciation on switching equipment as well as
general property and equipment. For the quarter ended September 30, 1997
depreciation was $.4 million as compared to $.3 million for the quarter ended
June 30, 1997. This increase is a result of the Company's placing additional
assets in service during the third quarter in accordance with the planned
buildout of its network.
Interest expense for third quarter 1997 totaled $.1 million. This amount is
attributable to interest incurred on the Senior Secured Notes issued by the
Company in late September 1997. No interest expense was incurred by the
Company in the second quarter of 1997.
Nine Months Ended September 30, 1997
During the nine months ended September 30, 1997, the Company generated $1.9
million in operating revenues, had cost of operating revenues of $2.5 million,
and incurred selling, general and administrative expenses of $4.0 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.
Depreciation expense for the nine months ended September 30, 1997 was $ .8
million as a result of the Company's assets being placed in service in
accordance with the planned network buildout.
Interest expense for nine months ended September 1997 totaled $.1 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 for the nine month period of $.3 million as a
result of earnings on investments made with the proceeds of its prior private
placements.
As a result, the Company incurred a net loss in the nine month period of $5.1
million. The loss is primarily attributable to the expenses incurred during the
period in connection with continued development of the Company's business.
11
<PAGE> 10
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 Company were $15.9 million for
the first nine months of 1997. The Company expects it will continue to have
substantial capital requirements in connection with the purchase of switches
necessary for expansion of local exchange services and provision of long
distance services and development of new markets.
The substantial capital investment required to initiate the Company's services
and the funding of the Company's initial operations have resulted in negative
cash flow since the Company's inception. This negative cash flow is a result of
the requirement 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 1999 due to expansion activities associated
with the development of the Company's markets. However, 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.
The Company has funded a substantial portion of these expenditures through the
private sales of equity securities and the issuance of debt. From its inception
through September 30, 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 13% Senior Secured Notes (the
"Notes") and warrants to purchase shares of Common Stock.
At the closing of the sale of Notes, the Company used approximately $56.8
million of the net proceeds of the sale of the Notes to purchase a portfolio of
Government Securities that has been pledged as security to cover the first six
interest payments on the 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. The remainder of the proceeds from the sale of the
Notes is expected to be used to fund the cost of acquiring and installing
telecommunications equipment and for general working capital purposes. In
addition, the Company has granted the holders of the Notes a security interest
in certain of the Company's telecommunications equipment.
In November 1997, the Company completed a private placement offering in which
5,148,570 shares of 8% Series A Convertible Preferred Stock were issued at
$3.50 per share, for total proceeds to the Company of approximately $16.7
million, net of expenses.
The Company expects its available cash, including the proceeds from the sale of
the Notes and the preferred stock offering will be sufficient to fund its
capital plan and operations through 1999. If the Company's expansion occurs more
rapidly than currently anticipated or if the Company's available cash resources
are not sufficient to fund all the Company's operating expenses and capital
expenditures, the Company will require additional capital before that time. In
addition, depending on market conditions, the Company may determine to raise
additional capital before such time. There can be no assurance as to the
availability or the terms upon which such financing might be available.
Moreover, the indenture governing the Notes imposes certain restrictions upon
the Company's ability to incur additional indebtedness or issue preferred stock.
The information in this 10-Q contains forward-looking statements that involve
risks and uncertainties, including, but not limited to, the Company's ability to
successfully market its services and generate demand for its services, obtain
suitable locations for and installation of switches, negotiate suitable
interconnection agreements with the incumbent local exchange carriers, address
potential regulatory reform and other risks detailed from time to time in the
Company's filings with the Securities and Exchange Commission. The Company
does not intend to update or correct any of its forward-looking statements.
12
<PAGE> 11
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
During third quarter 1997, the Company issued 525,000 shares of its Common Stock
to two officers of the Company at an average price of $2.26 per share for a
total sales price of $1,187,500. Of such amount, $100,000 was paid in cash to
the Company in September 1997 and $400,000 was paid in October 1997. The
remaining $687,500 is payable pursuant to promissory notes. The promissory notes
bear interest at 7.75% per annum, are due in the year 2000 and are secured by
the pledge of the shares of Common Stock purchased upon the execution of such
promissory notes.
Such issuances of securities described above 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. In each
instance, the purchaser was an officer of the Company, the offer 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.
See Item 4 below with respect to changes in authorized shares of Common and
Preferred Stock.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In August 1997, the stockholders of the Company approved an amendment to the
Company's Articles of Incorporation to increase the number of shares of Common
Stock to 100,000,000 and to authorize the issuance of up to 50,000,000 shares of
Preferred Stock with rights, privileges and restrictions approved by the Board
of Directors of the Company. Such action was approved by the written consent of
stockholders owning 7,995,000 shares of the 14,141,000 shares outstanding on the
date of the action.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 Financial Data Schedule (for SEC use only)
13
<PAGE> 12
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, INC.
Date: January 16, 1998 /s/ Maurice J. Gallagher, Jr.
------------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: January 16, 1998 /s/ Linda M. Sunbury
---------------------
Linda M. Sunbury
Vice President - Administration
(Principal Accounting Officer)
14
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