<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 September 30, 1998
Commission file number 0-24059
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 November 13, 1998:
Common stock ($.001 par value) .... 17,154,319 shares outstanding
<PAGE> 2
MGC COMMUNICATIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -- Three months ended
September 30, 1998 and 1997 (Unaudited); Nine months ended
September 30, 1998 and 1997 (Unaudited) 3
Consolidated Balance Sheets -- September 30, 1998 (Unaudited)
and December 31, 1997 4
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Equity for the period from January 1, 1997
to September 30, 1998 5
Consolidated Statements of Cash Flows -- Nine months ended
September 30, 1998 and 1997 (Unaudited) 6
Condensed Notes to Unaudited Interim Consolidated
Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Telecommunications services:
Operating revenues $ 4,908 $ 1,060 $ 11,772 $ 1,924
Operating expenses:
Cost of operating revenues 4,789 1,152 10,575 2,512
Selling, general and administrative 5,364 1,799 11,250 3,954
Depreciation and amortization 1,158 402 3,149 818
------------ ----------- ------------ -----------
11,311 3,353 24,974 7,284
------------ ----------- ------------ -----------
Loss from operations (6,403) (2,293) (13,202) (5,360)
Other income (expense):
Interest income 2,524 67 6,989 338
Interest expense(net of amounts capitalized) (5,213) (116) (16,080) (117)
------------ ----------- ------------ -----------
Net loss (9,092) (2,342) (22,293) (5,139)
============ =========== ============ ===========
Basic and diluted loss per share of
common stock $ (.53) $ (.28) $ (1.69) $ (.62)
============ =========== ============ ===========
Basic and diluted weighted average
shares outstanding 17,154,034 8,488,024 13,171,681 8,350,322
============ =========== ============ ===========
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 4
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 11,420 $ 45,054
Investments held to maturity ............................... 25,958 7,797
Restricted investments ..................................... 29,602 18,482
Amounts receivable for shares issued ....................... 110 --
Trade accounts receivable, less allowance for doubtful
accounts of $268 and $216 ............................... 3,621 1,200
Prepaid expenses ........................................... 230 277
--------- ---------
Total current assets ............................... 70,941 72,810
Property and equipment, net .................................. 88,604 24,617
Investments held to maturity ................................. 74,374 49,913
Restricted investments ....................................... 19,617 39,092
Deferred financing costs, net of amortization of $856 and
$198 ....................................................... 4,923 5,448
Other assets ................................................. 137 97
--------- ---------
Total assets ....................................... $ 258,596 $ 191,977
========= =========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt ....................... $ 234 $ 381
Accounts payable:
Trade ................................................... 3,324 462
Property and equipment .................................. 11,578 3,123
Accrued interest ........................................... 10,400 5,328
Accrued other expenses ..................................... 4,222 786
--------- ---------
Total current liabilities .......................... 29,758 10,080
Senior Secured Notes, net of unamortized discount of $3,451
and $3,882 ................................................. 156,549 156,118
Other long-term debt ......................................... 75 138
--------- ---------
Total liabilities .................................. 186,382 166,336
--------- ---------
Commitments and contingencies
Redeemable preferred stock:
8% Series A convertible preferred stock, 6,571,450 shares
authorized, 0 and 5,148,570 issued and outstanding ...... -- 16,665
Stockholders' equity:
Preferred stock, 50,000,000 shares authorized and
50,000,000 and 43,428,550 unissued ...................... -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 17,154,319 and 8,799,600 shares issued and
outstanding ............................................. 17 9
Additional paid-in capital ................................. 108,990 22,118
Accumulated deficit ........................................ (34,620) (12,463)
--------- ---------
74,387 9,664
Notes receivable from stockholders for issuance of common
stock ................................................... (2,173) (688)
--------- ---------
Total stockholders' equity ......................... 72,214 8,976
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' equity ............................. $ 258,596 $ 191,977
========= =========
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 5
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
REDEEMABLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
----------------------- ---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
---------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 ..... -- $ -- 7,176,000 $ 7 $ 12,276 $ (1,491)
Common stock issued for cash ..... -- -- 1,458,600 2 4,860 --
Common stock issued for notes
receivable ..................... -- -- 165,000 -- 688 --
Proceeds from offering allocated
to warrants .................... -- -- -- -- 3,885 --
Warrants issued for common stock
commitment ..................... -- -- -- -- 409 --
Net loss ......................... -- -- -- -- -- (10,836)
8% Series A Convertible Preferred
Stock issued for cash .......... 5,148,570 16,665 -- -- -- --
Accrued preferred stock
dividend ....................... -- -- -- -- -- (136)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1997 ..... 5,148,570 16,665 8,799,600 9 22,118 (12,463)
Common stock issued for cash ..... -- -- 100,680 -- 774 --
Common stock issued for notes
receivable ..................... -- -- 189,000 -- 1,485 --
Warrants and options exercised
for common stock ............... -- -- 97,200 -- 13 --
8% Series A Convertible Preferred
Stock issued for cash .......... 1,422,857 4,980 -- -- -- --
Accrued preferred stock dividend . -- -- -- -- -- (654)
Common stock issued for cash (IPO) -- -- 4,025,000 4 62,959 --
Conversion of preferred stock to
common stock .................. (6,571,427) (21,645) 3,942,839 4 21,641 790
Net loss ......................... -- -- -- -- -- (22,293)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT SEPTEMBER 30, 1998
(UNAUDITED) ...................... -- $ -- 17,154,319 $ 17 $ 108,990 $ (34,620)
========== ========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
NOTES
RECEIVABLE FROM
STOCKHOLDERS FOR TOTAL
ISSUANCE OF STOCKHOLDERS'
COMMON STOCK EQUITY
------------ -------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1996 ..... $ -- $ 10,792
Common stock issued for cash ..... -- 4,862
Common stock issued for notes
receivable ..................... (688) --
Proceeds from offering allocated
to warrants .................... -- 3,885
Warrants issued for common stock
commitment ..................... -- 409
Net loss ......................... -- (10,836)
8% Series A Convertible Preferred
Stock issued for cash .......... -- --
Accrued preferred stock
dividend ....................... -- (136)
---------- ----------
BALANCE AT DECEMBER 31, 1997 ..... (688) 8,976
Common stock issued for cash ..... -- 774
Common stock issued for notes
receivable ..................... (1,485) --
Warrants and options exercised
for common stock ............... -- 13
8% Series A Convertible Preferred
Stock issued for cash .......... -- --
Accrued preferred stock dividend . -- (654)
Common stock issued for cash (IPO) -- 62,963
Conversion of preferred stock to
common stock .................. -- 22,435
Net loss ......................... -- (22,293)
---------- ----------
BALANCE AT SEPTEMBER 30, 1998
(UNAUDITED) ...................... $ (2,173) $ 72,214
========== ==========
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 6
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $ (22,293) $ (5,139)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ................................... 3,149 818
Amortization of debt discount ................................... 431 --
Amortization of deferred debt financing costs ................... 658 --
Changes in assets and liabilities:
Increase in accounts receivable, net ......................... (2,531) (1,128)
Decrease/(Increase) in prepaid expenses ...................... 47 (43)
Increase in other assets ..................................... (40) (50)
Increase in accounts payable -- trade ........................ 2,862 847
Increase in accrued expenses ................................. 8,644 356
--------- ---------
Net cash used in operating activities ...................... (9,073) (4,339)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables ........................................................ (58,681) (11,413)
Purchase of investments held to maturity .......................... (42,622) --
Sale/(Purchase) of restricted investments ......................... 8,355 (56,767)
--------- ---------
Net cash used in investing activities ...................... (92,948) (68,180)
--------- ---------
Cash flows from financing activities:
Proceeds from the issuance of Senior Secured Notes
and warrants .................................................... -- 160,000
Costs associated with issuance of Senior Secured
Notes and warrants .............................................. (133) (5,603)
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs .......................... 4,980 --
Payments on other long term debt .................................. (210) --
Proceeds from issuance of common stock ............................ 787 5,615
Proceeds from issuance of common stock (IPO) ...................... 62,963 --
--------- ---------
Net cash provided by financing activities .................. 68,387 160,012
--------- ---------
Net (decrease)/increase in cash ............................ (33,634) 87,493
Cash and cash equivalents at beginning of period .................... 45,054 7,897
--------- ---------
Cash and cash equivalents at the end of period ...................... $ 11,420 $ 95,390
========= =========
Supplemental schedule of non-cash investing and financing activities:
Increase in property and equipment purchases included in
accounts/notes payable -- property and equipment ................ $ 8,455 $ 4,494
========= =========
Stock issued for notes receivable ................................. $ 1,485 $ 688
========= =========
Warrants issued as consideration in debt and warrant
offering capitalized as deferred financing costs ................ $ -- $ 409
========= =========
Other disclosures:
Cash paid for interest net of amounts capitalized ................. $ 11,008 $ --
========= =========
</TABLE>
See accompanying condensed notes to unaudited
interim consolidated financial statements.
<PAGE> 7
MGC COMMUNICATIONS, INC.
Condensed Notes to Unaudited Interim Consolidated Financial Statements
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
MGC Communications, Inc. (the "Company"), a Nevada corporation, include the
accounts of the Company and its wholly-owned subsidiary, MGC Lease Corporation.
All significant inter-company balances and transactions have been eliminated.
These consolidated financial statements 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>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
Building and property ................ $ 661 $ 278
Switching equipment .................. 32,657 21,621
Leasehold improvements ............... 716 956
Computer hardware and software ....... 1,835 1,404
Office equipment and vehicles ........ 536 300
-------- --------
36,405 24,559
Less accumulated depreciation and
amortization ....................... (4,466) (1,317)
-------- --------
31,939 23,242
Switching equipment under construction 56,665 1,375
-------- --------
Net property and equipment . $ 88,604 $ 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>
<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 "Note 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 as of December 31, 1997 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 Note 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 Note 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
anti-dilution 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 4, the Company completed the preferred stock
offering for $3.50 per share. Accordingly, the warrants issued in connection
with the Note Offering were increased from 774,200 to 862,923 shares and have
been reflected in the accompanying financial statements as of December 31, 1997.
Expenses allocated to the warrants in connection with the Note Offering were
$141,000. The warrants expire on October 1, 2004.
In conjunction with the Note 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 Note 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:
<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 Note 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 shares of preferred stock, $.001 par value per share.
In January 1998, the Company filed a registration statement offering to
exchange the Notes 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.
(4) 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 for a specified period and agreed to
finance the purchase price of the shares purchased 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 1998, the Company issued 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 1998, the Company approved agreements with 11 key members of
management to purchase a total of 255,000 shares of common stock. The purchase
price of these shares ranged from $5.83 to
<PAGE> 10
$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.
During the three months ended June 30, 1998, the Company sold 4,025,000
shares of common stock at $17.00 per share pursuant to the registration
statement filed on Form S-1, which was declared effective by the Securities and
Exchange Commission on May 11, 1998. In connection with the initial public
offering of the Company's common stock, the Company effected a six for ten
reverse stock split, which has been reflected in the accompanying financial
statements. In addition to the reverse stock split, the Company's 6,571,427
outstanding shares of Preferred Stock (as defined below) were converted to
3,942,839 shares of the Company's common stock upon the completion of the
initial public offering. The conversion of the Preferred Stock has been
reflected in the accompanying financial statements.
On July 30, 1998, the Company filed a registration statement on Form S-8 to
register 2,392,740 shares of the Company's common stock under the MGC
Communications, Inc. Stock Option Plan.
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.
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.
Each share of Preferred Stock was automatically converted into common stock
on a six for ten basis upon the consummation of the Company's IPO. In accordance
with the terms of the Preferred Stock, the accrued dividends were reversed at
the time of conversion.
(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.
<PAGE> 11
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 and other telecommunications
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 that 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 a material adverse effect on the Company's financial position,
results of operations, or liquidity.
<PAGE> 12
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 the
incumbent local exchange carrier's (ILEC) central offices 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, Atlanta and in selected suburban areas of Southern California.
The Company's 1997 revenues were primarily generated from local phone
service, switched access billings and non-recurring charges, principally
installation charges. In 1998 long distance services also contributed to the
Company's revenue base.
The Company's principal operating expenses consist of cost of operating
revenues, selling, general and administrative costs and depreciation and
amortization expense. Cost of operating revenues consists primarily of access
charges, line installation expenses, transport expenses, compensation expenses
of technical personnel, long distance expenses and central office facility
rentals. Selling, general and administrative expenses consist primarily of
compensation expenses, advertising, provision for bad debts, professional fees
and facility rentals. Depreciation and amortization expense includes
depreciation on switching and collocation equipment as well as general property
and equipment.
As the Company expands into new markets, both cost of operating revenues
and selling, general and administrative costs are expected to increase as many
of the fixed costs of providing service in new markets are incurred before
significant revenue can be generated from those markets. In addition,
significant levels of marketing activity are anticipated in new markets in order
for the Company to build its initial base of customers.
The development and expansion of the Company's business will require
significant capital expenditures primarily consisting 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
switching facilities. As part of its initial network strategy, the Company has
decided to purchase switches in each of its target markets. The Company
believes this strategy, while initially increasing its level of capital
expenditures and operating losses, will enhance its long-term financial
performance.
The Company has experienced operating losses and generated negative EBITDA
since inception and expects to continue to generate negative EBITDA through the
next year 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
Quarterly Comparison - September 30, 1998 vs. June 30, 1998
Total operating revenues increased to $4.9 million for the quarter ended
September 30, 1998 as compared to $4.0 million for the quarter ended June 30,
1998. The 23% increase is a result of the increase in the number of lines in
service during the third quarter and increased long distance service revenue.
The Company had 36,357 lines in service at the end of the third quarter as
compared to 26,677 lines in service at the end of the second quarter, a 36%
increase.
Cost of operating revenues for the quarter ended September 30, 1998 was
$4.8 million as compared to $3.4 million for the quarter ended June 30, 1998.
The 41% increase is due to the increased number of lines in service during the
third quarter and installation and operational expenses associated with the
expansion of the Company's network.
For the quarter ended September 30, 1998, selling, general and
administrative expenses totaled $5.4 million, a 64% increase over the $3.3
million for the quarter ended June 30, 1998. The increase is a result of
increased costs attributable to the
<PAGE> 13
marketing of the Company's services, delivery of customer service and to support
the Company's continued network expansion.
For the quarter ended September 30, 1998 depreciation and amortization was
$1.2 million as compared to $1.1 million for the quarter ended June 30, 1998.
This increase is a result of placing additional assets in service during the
third quarter 1998 in accordance with the planned build-out of the Company's
network.
Interest expense for the quarter ended September 30, 1998 totaled $5.2
million as compared to $5.4 million for the quarter ended June 30, 1998.
Interest expense is primarily attributable to the Senior Secured Notes issued by
the Company in September 1997.
Interest income was $2.5 million during the quarter ended September 30,
1998 compared to $2.3 million for the quarter ended June 30, 1998. The income is
attributable to earnings on investments made with the proceeds from the issuance
of Senior Secured Notes in September 1997 and with the proceeds from the sale of
the Company's common and Preferred Stock.
The Company incurred net losses of $9.1 million and $6.9 million during the
third quarter 1998 and the second quarter 1998, respectively.
Quarterly Comparison -- September 30, 1998 vs. September 30, 1997
Total operating revenues for the quarter ended September 30, 1998 were $4.9
million as compared to $1.1 million for the quarter ended September 30, 1997.
The increase is a result of the addition of two markets to the Company's
operating territory, an increase in the number of lines in service and the
introduction of long distance service in early 1998. The Company conducted
business in Las Vegas, Atlanta and selected suburban areas of Southern
California during the third quarter 1998 as compared to Las Vegas only during
third quarter 1997. The Company had 36,357 lines in service at the end of third
quarter 1998 as compared to 12,710 lines in service at the end of the third
quarter 1997.
Cost of operating revenues for the quarter ended September 30, 1998 was
$4.8 million as compared to $1.2 million for the quarter ended September 30,
1997. The increase is due to the increased number of lines in service during the
third quarter 1998, network expenses associated with long distance service, and
installation and operation expenses associated with the expansion of the
Company's network.
For the quarter ended September 30, 1998, selling, general and
administrative expenses totaled $5.4 million as compared to $1.8 million for the
quarter ended September 30, 1997. The increase in expenses resulted from
increased costs attributable to the marketing of the Company's services,
delivery of customer service and to support the Company's continued network
expansion.
For the quarter ended September 30, 1998, depreciation and amortization was
$1.2 million as compared to $0.4 million for the quarter ended September 30,
1997. This increase is a result of placing additional assets in service during
the period in accordance with the Company's planned build-out of its network.
Interest expense for third quarter 1998 totaled $5.2 million as compared to
$0.1 million during third quarter 1997. The increase is primarily attributable
to interest incurred on the Senior Secured Notes issued by the Company in
September 1997.
Interest income for the quarter ended September 30, 1998 was $2.5 million
as compared to $0.1 million for the quarter ended September 30, 1997. The
increase is attributable to earnings on investments made in September 1997 with
the proceeds from the issuance of Senior Secured Notes as well as proceeds
received from the sale of the Company's common and Preferred Stock.
The Company incurred net losses of $9.1 million and $1.9 million during the
third quarter 1998 and 1997, respectively.
Nine Month Comparison - September 30, 1998 vs. September 30, 1997
Total operating revenues for the nine months ended September 30, 1998 were
$11.8 million as compared to $1.9 million for the nine months ended September
30, 1997. The increase is a result of the addition of two markets to the
Company's operating territory,
<PAGE> 14
an increase in the number of lines in service and the introduction of long
distance service in February 1998. The Company conducted business in Las Vegas,
Atlanta and selected suburban areas of Southern California during the first nine
months of 1998 as compared to Las Vegas only during the first nine months of
1997. The Company had 36,357 lines in service as of September 30, 1998 as
compared to 12,710 lines in service as of September 30, 1997.
Cost of operating revenues for the nine months ended September 30, 1998 was
$10.6 million as compared to $2.5 million for the nine months ended September
30, 1997. The increase is due to the increased number of lines in service during
the period, network expenses associated with the addition of long distance
service, and installation and operational expenses associated with the expansion
of the Company's network.
For the nine months ended September 30, 1998, selling, general and
administrative expenses totaled $11.3 million as compared to $4.0 million for
the nine months ended September 30, 1997. The increase in expenses resulted from
increased costs attributable to the marketing of the Company's services,
delivery of customer service and to support the Company's continued network
expansion.
For the nine months ended September 30, 1998, depreciation and amortization
was $3.1 million as compared to $0.8 million for the nine months ended September
30, 1997. This increase is a result of placing additional assets in service
during the period in accordance with the Company's planned build-out of its
network.
Interest expense for the nine months ended September 30, 1998 totaled $16.1
million as compared $0.1 million incurred for the nine months ended September
30, 1997. The increase is primarily attributable to interest incurred on the
Senior Secured Notes issued by the Company in September 1997.
Interest income for the nine months ended September 30, 1998 was $7.0
million as compared to $0.3 million for the nine months ended September 30,
1997. The increase is attributable to earnings on investments made with the
proceeds from the issuance of Senior Secured Notes in September 1997 as well as
proceeds from the sale of the Company's common and Preferred Stock.
The Company incurred net losses of $22.3 million and $5.1 million during
the nine months ended September 30, 1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require substantial capital investment for the
purchase of telecommunications equipment and the development and installation of
the Company's network. Capital expenditures for the quarter and nine month
period ended September 30, 1998 were $31.3 million and $58.7 million,
respectively. The Company expects it will continue to have substantial capital
requirements in connection with the purchase of equipment necessary for
expansion of local exchange services, the provisioning of long distance
services, and the development of new markets. Management expects capital
expenditures of $85 million for fiscal year 1998, which will be fully funded by
cash on hand generated through the private sales of debt and equity securities
as well as through its initial public offering of common stock.
From its inception through its initial public offering (IPO), 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. In May 1998, the shares of Series A Convertible
Preferred Stock were
<PAGE> 15
converted into 3,942,856 shares of common stock simultaneously with the
Company's initial public offering which is discussed below.
The Company's Registration Statement on Form S-1 relating to the sale of
common stock was declared effective by the Securities and Exchange Commission on
May 11, 1998. A total of 4,025,000 shares were sold resulting in net proceeds to
the Company of $63.0 million. In connection with the initial public offering of
the Company's common stock, the Company effected a six for ten reverse stock
split. In addition to the stock split, the Company's outstanding shares of
Preferred Stock were converted into common stock.
The substantial capital investment required to initiate the Company's
services and the funding of the Company's initial operations has resulted in
negative investing and operating cash flow since the Company's inception. This
negative cash flow from operations is a result of the need to establish the
Company's network in anticipation of connecting revenue-generating customers.
The Company expects to continue to record negative cash flow from operations
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 from operations in subsequent periods. Until
sufficient cash flow from operations 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 of
any such financing. Moreover, the indenture governing the Senior Secured Notes
imposes certain restrictions upon the Company's ability to incur additional
indebtedness or issue preferred stock.
IMPACT OF YEAR 2000
The Company's internal computer software and computerized operating systems
were installed in 1997 and were designed to take into consideration the Year
2000 issue. Additionally, the Company has implemented a Year 2000 compliance
program to ensure that the Company's computer systems and applications will
perform properly beyond 1999. In addition to the internal review, the Company
has received assurance from its significant vendors that their applications are
Year 2000 compliant. Maintenance or modification costs associated with making
changes, if needed, will be expensed as incurred.
The Company's business relies in part on third parties. The ability of
third parties upon whom the Company relies to adequately address their Year 2000
issue is outside the Company's control. However, the Company is coordinating
efforts with these parties to minimize the extent to which its business will be
vulnerable to their failure to remediate their own Year 2000 issues. The Company
is evaluating the need for a contingency plan in the event any third parties
cannot demonstrate to the Company, on a timely basis, their Year 2000
compliance. There can be no assurance that the systems of the third parties will
be modified on a timely basis. The Company's business, financial condition and
results of operations could be materially adversely affected by the failure of
those systems and applications, licensed to or operated for third parties, or
operated by other parties to properly operate on dates beyond 1999.
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
for 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
<PAGE> 16
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.
Forward Looking Statements
The statements that are 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
ability to fund its business plan and to achieve positive cash flow from
operations in the future, statements regarding the development of the Company's
business, 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 that 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 interconnection agreements with the ILECs in its
targeted markets, obtain an acceptable level of cooperation from the ILECs, all
in a timely manner, at reasonable costs and on satisfactory terms and
conditions, as well as regulatory, legislative and judicial developments that
could materially affect the Company's future results. Additional information
concerning factors that could cause actual results to vary materially from the
future results indicated, expressed or implied in such forward looking
statements is contained in the Company's Form 10-K for the year ended December
31, 1997. All forward-looking statements made in connection with this report are
expressly qualified in their entirety by these cautionary statements.
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has filed various complaints against ILECs in order to seek to
enforce their compliance with regulations requiring their cooperation with the
provision of service by the Company. These complaints have been filed against
Sprint Corporation in February and June 1998 before the Nevada Public Utilities
Commission, Ameritech in March 1998 before the Illinois Commerce Commission, and
BellSouth Telecommunications Inc. in June 1998 before the Georgia Public Service
Commission.
The Company is also currently participating in costing dockets before the
Nevada Public Utilities Commission and California Public Utilities Commission
under which there will be established the amount payable by the Company for its
unbundled network elements ("UNEs"). Although rates for UNEs are subject to
change from time to time, the establishment of rates by the respective public
utilities commissions could have a material effect on the Company's cost of
revenues.
From time to time, the Company is engaged in other litigation and
governmental proceedings in the ordinary course of its business. The Company
does not believe that any such pending litigation or governmental proceedings
will have a material adverse effect on its results of operation or financial
condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company's Registration Statement No. 333-49085 was declared effective
on May 11, 1998, which was the offering date of Common Stock thereunder. During
the period from May 11, 1998 until September 30, 1998, the Company paid
$4,790,000 in underwriting discounts and commissions and other offering expenses
of $672,000 for total offering expenses of $5,462,000, resulting in net offering
proceeds to the Company of $62,963,000. Of such amounts, expenses of $16,000
were paid for charter services to a related party of which two current board
members are major shareholders. No other amounts were paid for offering expenses
directly or indirectly to officers, Directors, 10% or greater stockholders or
other affiliates of the Company.
During the period from May 11, 1998 until September 30, 1998, the net
offering proceeds were invested in government securities and money market funds.
None of such amounts were paid directly or indirectly to officers, Directors,
10% or greater stockholders or other affiliates of the Company.
<PAGE> 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report. The exhibit
numbers refer to Item 601 of Regulation S-K.
27-Financial Data Schedule
(b) No reports on Form 8-K were filed during the third quarter 1998.
<PAGE> 19
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: November 13, 1998 /s/ Maurice J. Gallagher, Jr.
-----------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: November 13, 1998 /s/ Linda M. Sunbury
-----------------------------
Linda M. Sunbury
Vice President
Chief Financial Officer
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