<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 June 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 August 14, 1998:
Common stock ($.001 par value) .... 17,154,319 shares outstanding
<PAGE> 2
MGC COMMUNICATIONS, INC.
INDEX
Page No.
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -- Three months ended
June 30, 1998 and 1997 (Unaudited); Six months ended
June 30, 1998 and 1997 (Unaudited) 3
Consolidated Balance Sheets -- June 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 June 30, 1998 5
Consolidated Statements of Cash Flows -- Six months ended
June 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 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
<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 Six Months Ended
June 30, June 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Telecommunications services:
Operating revenues $ 4,018 $ 652 $ 6,864 $ 864
Operating expenses:
Cost of operating revenues 3,415 821 5,786 1,360
Selling, general and administrative 3,325 1,271 5,887 2,154
Depreciation and amortization 1,123 257 1,990 417
------------ ------------ ------------ ------------
7,863 989 13,663 2,571
------------ ------------ ------------ ------------
Loss from operations (3,845) (1,697) (6,799) (3,067)
Other income (expense):
Interest income 2,296 143 4,465 271
Interest expense(net of amounts capitalized) (5,363) -- (10,868) --
------------ ------------ ------------ ------------
Net loss (6,912) (1,554) (13,202) (2,796)
============ ============ ============ ============
Basic and diluted loss per share of
common stock $ (.52) $ (.18) $ (1.18) $ (.34)
============ ============ ============ ============
Basic and diluted weighted average
shares outstanding 13,377,938 8,479,630 11,147,502 8,280,330
============ ============ ============ ============
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 4
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
--------- ---------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................... $ 42,273 $ 45,054
Investments held to maturity ............................ 23,384 7,797
Restricted investments .................................. 19,121 18,482
Amounts receivable for shares issued .................... 66 --
Trade accounts receivable, less allowance for doubtful
accounts of $327 and $216 ............................ 4,407 1,200
Prepaid expenses ........................................ 404 277
--------- ---------
Total current assets ............................ 89,655 72,810
Property and equipment, net ............................... 58,443 24,617
Investments held to maturity .............................. 75,935 49,913
Restricted investments .................................... 29,410 39,092
Deferred financing costs, net of amortization of $644 and
$198 .................................................... 5,135 5,448
Other assets .............................................. 105 97
--------- ---------
Total assets .................................... $ 258,683 $ 191,977
========= =========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt .................... $ 321 $ 381
Accounts payable:
Trade ................................................ 2,442 462
Property and equipment ............................... 10,340 3,123
Accrued interest ........................................ 5,200 5,328
Accrued other expenses .................................. 2,525 786
--------- ---------
Total current liabilities ....................... 20,828 10,080
Senior Secured Notes, net of unamortized discount of $3,594
and $3,882 .............................................. 156,406 156,118
Other long-term debt ...................................... 88 138
--------- ---------
Total liabilities ............................... 177,322 166,336
--------- ---------
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, 43,428,550 shares authorized but
unissued ............................................. -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 17,153,479 and 8,799,600 shares issued and
outstanding .......................................... 17 9
Additional paid-in capital .............................. 109,047 22,118
Accumulated deficit ..................................... (25,530) (12,463)
--------- ---------
83,534 9,664
Notes receivable from stockholders for issuance of common
stock ................................................ (2,173) (688)
--------- ---------
Total stockholders' equity ...................... 81,361 8,976
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' equity .......................... $ 258,683 $ 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>
NOTES
RECEIVABLE
FROM
REDEEMABLE STOCKHOLDERS
PREFERRED STOCK COMMON STOCK ADDITIONAL FOR TOTAL
--------------------- ----------------- PAID-IN ACCUMULATED ISSUANCE OF STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT COMMON STOCK EQUITY
---------- -------- ---------- --- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 ..... -- $ -- 7,176,000 $ 7 $ 12,276 $ (1,491) $ -- $ 10,792
Common stock issued for cash ..... -- -- 1,458,600 2 4,860 -- -- 4,862
Common stock issued for notes
receivable ..................... -- -- 165,000 -- 688 -- (688) --
Proceeds from offering allocated
to warrants .................... -- -- -- -- 3,885 -- -- 3,885
Warrants issued for common stock
commitment ..................... -- -- -- -- 409 -- -- 409
Net loss ......................... -- -- -- -- -- (10,836) -- (10,836)
8% Series A Convertible Preferred
Stock issued for cash .......... 5,148,570 16,665 -- -- -- -- -- --
Accrued preferred stock
dividend ....................... -- -- -- -- -- (136) -- (136)
---------- -------- ---------- --- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1997 ..... 5,148,570 16,665 8,799,600 9 22,118 (12,463) (688) 8,976
Common stock issued for cash ..... -- -- 99,840 -- 772 -- -- 772
Common stock issued for notes
receivable ..................... -- -- 189,000 -- 1,485 -- (1,485) --
Warrants and options exercised
for common stock ............... -- -- 97,200 -- 13 -- -- 13
8% Series A Convertible Preferred
Stock issued for cash .......... 1,422,857 4,980 -- -- -- -- -- --
Accrued preferred stock dividend . -- -- -- -- -- (654) -- (654)
Common stock issued for cash (IPO) -- -- 4,025,000 4 63,017 -- -- 63,021
Conversion of preferred stock to
common stock .................. (6,571,427) (21,645) 3,942,839 4 21,642 789 -- 22,435
Net loss ......................... -- -- -- -- -- (13,202) -- (13,202)
---------- -------- ---------- --- -------- -------- ------- --------
BALANCE AT JUNE 30, 1998
(UNAUDITED) ...................... -- $ -- 17,153,479 $17 $109,047 $(25,530) $(2,173) $ 81,361
========== ======== ========== === ======== ======== ======= ========
</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>
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss ............................................ $(13,202) $(2,796)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ..................... 1,990 417
Amortization of debt discount ..................... 288 --
Amortization of deferred debt financing costs ..... 446 --
Changes in assets and liabilities:
Increase in accounts receivable, net ........... (3,273) (423)
Increase in prepaid expenses ................... (127) (16)
Increase in other assets ....................... (8) (26)
Increase in accounts payable -- trade .......... 1,980 712
Increase in accrued expenses ................... 1,747 196
-------- -------
Net cash used in operating activities ........ (10,159) (1,936)
-------- -------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables .......................................... (28,599) (3,597)
Purchase of investments held to maturity ............ (41,609) --
Sale of restricted investments ...................... 9,043 --
-------- -------
Net cash used in investing activities ........ (61,165) (3,597)
-------- -------
Cash flows from financing activities:
Costs associated with issuance of Senior Secured
Notes and warrants ................................ (133) --
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs ............ 4,980 --
Payments on other long term debt .................... (110) --
Proceeds from issuance of common stock during
1996 .............................................. -- 1,153
Proceeds from issuance of common stock during
1997 .............................................. -- 4,343
Proceeds from issuance of common stock during
1998 .............................................. 785 --
Proceeds from issuance of common stock (IPO) ........ 63,021 --
-------- -------
Net cash provided by financing activities .... 68,543 5,496
-------- -------
Net decrease in cash ......................... (2,781) (37)
Cash and cash equivalents at beginning of period ...... 45,054 7,897
-------- -------
Cash and cash equivalents at the end of period ........ $ 42,273 $ 7,860
======== =======
Supplemental schedule of non-cash investing and
financing activities:
Increase in property and equipment purchases
included in accounts payable -- property and
equipment ......................................... $ 7,217 $ 372
======== =======
Stock issued for notes receivable ................... $ 1,485 $ --
======== =======
Other disclosures:
Cash paid for interest net of amounts
capitalized ....................................... $ 10,996 $ --
======== =======
</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>
JUNE 30, DECEMBER 31,
1998 1997
-------- --------
(UNAUDITED)
<S> <C> <C>
Building and property .......................... $ 258 $ 278
Switching equipment ............................ 25,830 21,621
Leasehold improvements ......................... 1,025 956
Computer hardware and software ................. 1,598 1,404
Office equipment and vehicles .................. 516 300
-------- --------
29,227 24,559
Less accumulated depreciation and
amortization ................................. (3,308) (1,317)
-------- --------
25,919 23,242
Switching equipment under construction ......... 32,524 1,375
-------- --------
Net property and equipment ........... $ 58,443 $ 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 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 the three months ended March 31, 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 the three months ended March 31, 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.
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.
<PAGE> 11
Future minimum lease obligations in effect as of December 31, 1997 are
as follows (in thousands):
<TABLE>
<CAPTION>
Payments during the year ending December 31:
<S> <C>
1998 ........................................................... $ 679
1999 ........................................................... 643
2000 ........................................................... 660
2001 ........................................................... 633
2002 ........................................................... 617
Thereafter ..................................................... 478
------
$3,710
======
</TABLE>
Rent expense was $207,000 for the year ended December 31, 1997.
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment. In May 1997, the
Company signed an agreement to purchase 20 Northern Telecom DMS-500 switches and
related Access Nodes from its primary vendor. As of December 31, 1997, the
Company had a total for all vendors of approximately $37.4 million of remaining
purchase commitments for purchases of switching 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.
(7) SUBSEQUENT EVENT
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.
<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 ILECs' 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 and in selected suburban
areas of Atlanta and Los Angeles.
The Company's 1997 revenues were primarily generated from local phone
service, switched access billings and non-recurring charges, principally
installation charges. 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. 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 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 expected 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 network strategy, the Company has decided
to purchase and install Nortel DMS 500 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 - JUNE 30, 1998 VS. MARCH 31, 1998
Total operating revenues increased to $4.0 million for the quarter
ended June 30, 1998 as compared to $2.8 million for the quarter ended March
31,1998. The 41% increase is a result of the increase in the number of lines in
service during the second quarter and the Company's first full quarter of long
distance service revenue. The Company had 26,677 lines in service at the end of
the second quarter as compared to 20,924 lines in service at the end of the
first quarter.
Cost of operating revenues for the quarter ended June 30, 1998 was $3.4
million as compared to $2.4 million for the quarter ended March 31, 1998. The
quarterly increase is due to the increased number of lines in service during the
second quarter, network expenses associated with the first full quarter of long
distance service, and installation and operational expenses associated with the
expansion of the Company's network.
For the quarter ended June 30, 1998, selling, general and
administrative expenses totaled $3.3 million, a 30% increase over the $2.6
million for the quarter ended March 31, 1998. These expenses were incurred in
connection with the marketing of the Company's
<PAGE> 13
services, delivery of customer service and to support the Company's continued
network expansion.
For the quarter ended June 30, 1998, depreciation and amortization was
$1.1 million as compared to $0.9 million for the quarter ended March 31, 1998.
This increase is a result of placing additional assets in service during the
second quarter 1998 in accordance with the planned build-out of the Company's
network.
Interest expense for the second quarter 1998 totaled $5.4 million as
compared to $5.5 million for the first quarter 1998. Interest expense is
primarily attributable to the Senior Secured Notes issued by the Company in
September 1997.
Interest income was $2.3 million in the second quarter 1998 and $2.2
million in the first quarter 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 $6.9 million and $6.3 million during
the second quarter 1998 and the first quarter 1998, respectively.
QUARTERLY COMPARISON -- JUNE 30, 1998 VS. JUNE 30, 1997
Total operating revenues for the quarter ended June 30, 1998 were $4.0
million as compared to $0.7 million for the quarter ended June 30, 1997. The
increase from the second quarter 1997 to the second quarter 1998 is a result of
the addition of two markets to the Company's operating territory, an increased
number of lines in service and the introduction of long distance service in
early 1998. The Company conducted business in Las Vegas and selected suburban
areas of Atlanta and Los Angeles during the second quarter 1998 as compared to
Las Vegas only during second quarter 1997. The Company had 26,677 lines in
service at the end of second quarter 1998 as compared to 9,002 lines in service
at the end of the second quarter 1997.
Cost of operating revenues for the quarter ended June 30, 1998 was $3.4
million as compared to $0.8 million for the quarter ended June 30, 1997. The
increase is due to the increased number of lines in service during the second
quarter 1998, network expenses associated with the first full quarter of long
distance service, and installation and operational expenses associated with the
expansion of the Company's network.
For the quarter ended June 30, 1998, selling, general and
administrative expenses totaled $3.3 million as compared to $1.3 million for the
quarter ended June 30, 1997. These expenses were incurred in connection with the
marketing of the Company's services, delivery of customer service and to support
the Company's continued network expansion.
For the quarter ended June 30, 1998, depreciation and amortization was
$1.1 million as compared to $0.3 million for the quarter ended June 30, 1997.
This increase is a result of placing additional assets in service during the
twelve-month period in accordance with the Company's planned build-out of its
network.
Interest expense for second quarter 1998 totaled $5.4 million as
compared to no interest expense incurred during second quarter 1997. This
amount is primarily attributable to interest incurred on the Senior Secured
Notes issued by the Company in September 1997.
Interest income for the quarter ended June 30, 1998 was $2.3 million as
compared to $0.1 million for the quarter ended June 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 received from the
sale of the Company's common and Preferred Stock.
The Company incurred net losses of $6.9 million and $1.6 million during
the second quarter 1998 and 1997, respectively.
SIX MONTH COMPARISON - JUNE 30, 1998 VS. JUNE 30, 1997
Total operating revenues for the six months ended June 30, 1998 were
$6.9 million as compared to $0.9 million for the six months ended June 30, 1997.
The increase from the first six months of 1997 to the first six months of 1998
is a result of the addition of two markets to the Company's operating territory,
an increased number of lines in service
<PAGE> 14
and the introduction of long distance service in February 1998. The Company
conducted business in Las Vegas and selected suburban areas of Atlanta and Los
Angeles during the first six months of 1998 as compared to Las Vegas only during
the first six months of 1997. The Company had 26,677 lines in service as of June
30, 1998 as compared to 9,002 lines in service as of June 30, 1997.
Cost of operating revenues for the six months ended June 30, 1998 was
$5.8 million as compared to $1.4 million for the six months ended June 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 six months ended June 30, 1998, selling, general and
administrative expenses totaled $5.9 million as compared to $2.2 million for the
six months ended June 30, 1997. These expenses were incurred in connection with
the marketing of the Company's services, delivery of customer service and to
support the Company's continued network expansion.
For the six months ended June 30, 1998, depreciation and amortization
was $2.0 million as compared to $0.4 million for the six months ended June 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 six months ended June 30, 1998 totaled $10.9
million as compared to no interest expense incurred for the six months ended
June 30, 1997. This amount is primarily attributable to interest incurred on the
Senior Secured Notes issued by the Company in September 1997.
Interest income for the six months ended June 30, 1998 was $4.5 million
as compared to $0.3 million for the six months ended June 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 $13.2 million and $2.8 million
during the six months ended June 30, 1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have required substantial capital investment
for the purchase of telecommunications equipment and the development and
installation of the Company's network. Capital expenditures for the quarter
ended June 30, 1998 were $25.1 million. 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, the provisioning of
long distance services, and the development of new markets. Management expects
capital expenditures of $85 million for fiscal year 1998.
The Company has funded a substantial portion of these expenditures
through the private sales of debt and equity securities as well as through its
initial public offering of common stock.
From its inception through June 30, 1998, the Company raised
approximately $17.9 million from private sales of Common Stock.
In September 1997, the Company completed a $160.0 million offering of
Senior Secured Notes and warrants to purchase 862,923 shares of common stock
(after giving effect to certain anti-dilution adjustments). At the closing of
the sale of the Senior Secured Notes, the Company used approximately $56.8
million of the net proceeds from the sale of the Senior Secured Notes to
purchase a portfolio of securities that has been pledged as security to cover
the first six interest payments on the Senior Secured Notes and the Company used
approximately $3.1 million of the net proceeds to pay accounts payable incurred
in connection with the acquisition of equipment. In addition, the Company has
granted the holders of the Senior Secured Notes a security interest in certain
of the Company's telecommunications equipment.
In November 1997 and January 1998, the Company issued an aggregate of
6,571,427 shares of Series A Convertible Preferred Stock at $3.50 per share for
net proceeds of $21.6 million. 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 cash flow from operations since the Company's inception. This negative
cash flow from operations is a result of the need to establish the Company's
switch-based network in anticipation of connecting revenue-generating customers.
The Company expects to continue to produce negative cash flow 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
upon which such financing might be available. Moreover, the indenture governing
the Senior Secured Notes imposes certain restrictions upon the Company's ability
to incur additional indebtedness or issue Preferred Stock.
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer-controlled systems using
two digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
The Company believes its internal software and hardware systems will
function properly with respect to dates in the year 2000 and thereafter. The
Company is in the process of contacting all of its significant suppliers to
determine the extent to which the Company's interface systems are vulnerable to
those third parties' failure to remediate their own Year 2000 issues.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity sections of a statement of
financial position and is effective for financial statements issued for fiscal
years beginning after December 15, 1997. The Company has adopted SFAS No. 130
during the three month period ended March 31, 1998 and has determined that such
adoption will not result in comprehensive income different from net income as
reported in the accompanying financial statements.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments
of an Enterprise and Related Information. SFAS No. 131 establishes additional
standards for segment reporting in financial statements and is effective for
fiscal years beginning after December 15, 1997. The Company currently operates
as one segment.
The American Institute of Certified Public Accountants recently issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 requires start-up costs, as defined, to be expensed as
incurred and is effective for financial statements for fiscal years beginning
after December 15, 1998. The Company intends to adopt SOP 98-5, as required,
<PAGE> 16
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 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 December 31, 1997. All forward-looking
statements made in connection with this report which are attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by these cautionary statements.
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has filed various complaints against incumbent local
exchange carriers (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, BellSouth Telecommunications Inc.
in June 1998 before the Georgia Public Service Commission and GTE Corporation in
July 1998 before the California Public Utilities 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. The offering of Common Stock thereunder has been completed. The
managing underwriters of the offering were Bear, Stearns & Co. Inc. and Furman
Selz. In the offering, 4,025,000 shares of the Company's Common Stock, $.001 par
value per share, were registered and sold on behalf of the Company at $17.00 per
share. The aggregate amount of Common Stock registered and sold was $68,425,000.
No shares were registered on behalf of any selling stockholder. During the
period from May 11, 1998 until June 30, 1998, the Company paid $4,789,750 in
underwriting discounts and commissions and other offering expenses of $600,000
(estimated) for total offering expenses of $5,389,750 (estimated), resulting
in net offering proceeds to the Company of $63,035,250 (estimated). None of the
amounts paid for offering expenses were paid directly or indirectly to officers,
Directors, 10% or greater stockholders or other affiliates of the Company.
During the period from May 11, 1998 until June 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on Friday,
April 3, 1998. At the meeting, Timothy P. Flynn, Maurice J. Gallagher, Jr., Jack
Hancock, David Kronfeld, Nield J. Montgomery and Thomas Neustaetter were elected
to serve as the Company's Board of Directors for the ensuing year. Each director
received the vote of all 16,344,798 shares of stock represented at the meeting.
At the meeting, the Stockholders also approved an amendment of the Company's
Stock Option Plan to increase the number of shares issuable under such Plan from
1,440,000 to 2,640,000 shares (which numbers reflect the six for ten reverse
split effected in May 1998) by the vote of 16,344,798 shares for, with no shares
voting against or abstaining. The vote totals reported above do not reflect the
six for ten reverse stock split subsequently effected in May 1998.
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 second 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: August 14, 1998 /s/ Maurice J. Gallagher, Jr.
-----------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: August 14, 1998 /s/ Linda M. Sunbury
-----------------------------
Linda M. Sunbury
Vice President
Chief Financial Officer
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